As a tax professional, you are well aware that every one of your business clients has two main goals at tax time:
- Calculate as many deductions as possible
- Avoid an IRS audit
They’re counting on you for help. Most of them are unable to do this on their own, so your guidance is priceless.
This is especially true for small businesses—and most vulnerable to RED FLAGS are home-based businesses. Knowing how to advise your clients about what to deduct when filing taxes is essential.
The most important advice you can give your clients is to avoid comingling funds by keeping business and personal expenditures separate. The best way to do that is to have separate accounts—and the sooner the better. As soon as your clients start talking about starting a business, be sure they know that separate accounts from the start will reduce complication at tax time.
One of the most common misconceptions of home-based business owners is that they are allowed to deduct their personal household expenses as business expenses.
Business owners must be made aware of IRS guidelines if they plan to use their homes to conduct business. For example, if they use a spare room as an office or workroom, they may take a home office deduction for that extra room.
In order to earn that deduction, business owners must be able to show that they use their homes as their principle place of business. In some cases, if they conduct business at a location other than their homes, but use their home space for that purpose regularly, they may qualify for a home office deduction.
Here are a couple examples:
Joe The Insurance Guy
Joe lives 30 miles from his insurance brokerage in Los Angeles. The commute takes about three and a half hours out of his day, so he works from home whenever possible. On those days, he works from his first floor den, which he converted into an office to meet with clients and do paperwork.
Even though his business is at another location, Joe can deduct his expenses for this part of his home because he uses it exclusively for business on a regular basis.
Linda The Hairstylist
Linda decided to move her cosmetology business home when her husband retired. They wanted to spend more time together so she cut down on the number of hours she worked and invested in a freestanding studio behind their house.
She uses the structure exclusively for business so she can deduct expenses. If she wanted to rent a chair by the hour in a salon, she could do that without any penalty.
For the most part, deductions for home offices are based on the percentage of your clients’ homes devoted to business usage. Be sure they know that whether they use a whole room or part of a room for business, they need to calculate the percentage of their home devoted to business activities.
If your client is employed by a company he/she does not own, and using a home office, he/she might be allowed to claim deductions if certain criteria are met.
Sarah The Travel Agent
Sarah works for a popular cruise vacation company. She works from home, signing onto her computer every day at 9 and signing off at 5. Because she uses the spare room in her home exclusively as an office, and she meets the following criteria, she is allowed deductions:
- Her business use is for the employer’s convenience.
- She does not rent any part of her home to her employer and use that space to perform services as an employee for that employer.
Providing your clients with the information they need to file taxes on their home-based businesses will save both of you a lot of headache. Most importantly, you’ll help them avoid being red flagged by the IRS.
For a full explanation of tax deductions for home-based businesses, look at Publication 587, Business Use of Your Home.