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Business Management

Expensing the Home-based Business

Deductible and non-deductible costs

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My father, who was always self-employed, didn’t keep business records. Because he had no idea what his expenses were, he often didn’t charge enough for his work. He innocently violated zoning laws and omitted proper paperwork more than once.

Home-based businesses often share the same fate, because their owners don’t realize they face business expenses. Whether you operate your business in another city or work at home, running a business still incurs costs.

Hopefully, within the next two years, we’ll move our shop for the first time in more than 25 years. We believe the benefits of living and working on one property outweigh the moving expenses. But, when I asked how other, home-based signshops track home-office expenses, too many told me they have no expenses because they work from their home.

They overlooked a few things. Home-based businesses incur not only materials and supplies expenses, but also innumerable business expenses that appear hidden.

Professional services

Each governmental entity has its own set of business laws. Any business, regardless of location, must know zoning regulations and obtain the required work licenses. Local zoning laws may require a home-business license or limit customer traffic, which would increase outside sales calls and vehicle expenses. In Greeley, CO, any violation of the zoning laws can result in a $1,000 fine, plus a cease-and-desist order.

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Our new location, an innovative, mixed-use, residential-commercial zone, will allow customers to visit. Because we perform installation work, we must maintain contractor licenses in the communities we serve. We also have a sales-tax license, because we provide "items of a material nature," not merely services. This license, which costs $8 a year, "allows" us to charge sales tax and remit it to the state and city.

Our county no longer requires an annual material-and-supply inventory, but we pay property tax, not only on real estate, but also on equipment and furniture "used to produce income." Both the IRS and many states have enacted specific laws applying to artists. These may, in some cases, apply to signshops.

Any public business needs appropriate insurance. Liability coverage, a necessity, is often required for licensing. Property insurance (for home, vehicles and equipment) is discretionary, but not automatic. Many personal insurance policies (for house, health and vehicle) require a rider to cover business activity. We learned, the hard way, about the advantages of disability insurance if you’re not covered by workers’ compensation.

Some insurance companies provide separate computer coverage. Non-owned vehicles may require separate coverage. A good, independent insurance agent can help determine your most advisable coverage.

A standalone operation greatly simplifies bookkeeping and tax reporting, but a home business raises many questions. A good accountant can resolve complex situations ? nothing’s more complex than mixing house and shop.

Vehicle expenses

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As business expenses, vehicles entail more than gas money. Signshop owners may simply drive a separate vehicle for business, but, if this is impractical, the IRS allows two ways to deduct shared-vehicle costs. However, the same method must be used for the vehicle’s life. Thus, you must decide this when you purchase a new vehicle or begin costing expenses.

For the more popular Plan A, you must track all vehicle expenses and mileage. Add up costs for gasoline/oil, other supplies, repairs and service, and take a percentage. For example, if you drove the car 700 miles for business and 300 miles for personal use, 70% of the expenses would be deductible. You then apply the same percentage to the insurance and depreciation. For more expensive vehicle costs, this method probably allows more deductions.

Plan B is based on mileage. The 2006 mileage rate is 44.5 cents per mile (it peaked at 48.5 cents in 2005’s fourth quarter). Consequently, our example allows a $311.50 deduction for 700 business miles. Also, Plan B entails far less recordkeeping, although you must still record all business miles driven in the personal car, plus location and purpose.

Communication expenses

Any more, business success requires more than just a phone and a street address. We currently have three business-phone lines, with one strictly for faxes. Additionally, we have e-mail, two websites, a post-office box, our home phone, cable for both locations and our cell phones. Also, we regularly receive and send UPS and FedEx shipments.

For tax purposes, we maintain separate phone lines. Under today’s IRS rules, you can’t deduct the first, home-phone line, but business-related long-distance calls may be deducted. Even non-deductible expenses should be considered, and only your accountant can decipher what’s best for you.

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Occupancy expenses

The office and design room of our new property, which we’ll own, will be inside the house. The shop, in a separate building, 10 ft. from the house, will also hold our personal cars.

During the 1980s, business owners frequently kept a secondary home office, often purely for tax purposes. By beginning and ending the day at home, business owners deducted not only the office costs, but also commuting expenses.

Because of this legal, if not moral, abuse, the IRS red-flags home-office deductions. Qualifying home-office deductions still exist, but this loophole has virtually disappeared.

The IRS often audits home-office expenses, and each business owner must decide whether to take the deductions. Your income must sufficiently warrant them. If your home is the primary business location, or where most administrative activity occurs, the deduction should be easily justified. If the space isn’t shared with personal activities, then you can deduct it. However, you must keep accurate and meticulous records. Ask yourself: "Can I withstand an audit?"

In our case, the 55 3 40-ft. (2,200-sq.-ft.) shop interior will also house a 400-sq.-ft. garage, leaving 1,800 sq. ft. of shop space. A 10 x 10-ft. extension (without the high ceiling), or an external building, will store signs to be installed (if zoning laws allow it). Exclusive business use will occupy only 1,519 sq. ft. of the total 5,202 sq. ft. My kitchen (not included) will serve as an employee break room and also for family meals and activities. Our total business allotment is 3,419 sq. ft. (1,800 + 1,519 + 100) of 7,502 sq. ft. (2,200 + 5,202 + 100), or 46% of the total space.

Square-foot calculation is easy. Deciding applicable occupancy expenses is hard. Property tax, mortgage interest, depreciation, building insurance, utilities (gas, electric, water and trash) and the security system will be calculated. Depending on my accountant’s advice, I’ll include housecleaning supplies. Whether or not you apply the deduction, these expenses exist. Based upon the previous square-foot ratio, 46% of this is a deductible.

Miscellaneous expenses

Here’s the most difficult category to establish and justify. In the shop, we currently supply paper plates and cups, plastic silverware, beverages and snack items for our employees. Toilet paper, paper towels, tissues and first-aid supplies also qualify. To simplify a possible audit, I’ll continue to follow common daycare rules and separate these supplies from household goods.

I haven’t supplied a complete list of home-based expenses, but I’ve detailed some that are most often overlooked. Active businesses can accrue substantial expenses, but, although they’re considerably smaller, sideline or hobby businesses should still account for their business costs. Smart entrepreneurs know their expenses, and set prices and budgets accordingly, which helps determine project profitability.

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