Home-based businesses are an area in which even well-intentioned taxpayers can easily run afoul of the IRS.
Common misconceptions among small business owners include, “It’s not my real job – I’m a nurse! I only make and sell the bird houses on the side!” or “But I’m not making enough money to report it on my taxes!” Every home-based business, no matter how small, must file a tax return. Even if you are not dependent on your home-based business to make ends meet, see it as a sideline, a part-time job or a hobby, IRS considers you self-employed and expects you to file a return that reflects that status.
“Sole proprietors file their usual Form 1040 to report their W-2s, interest, capital gains, etc.,” explained Sherrill Trovato, EA, USTCP, an enrolled agent in Fountain Valley CA. “They report their business income on Schedule C and will calculate any self-employment tax on Schedule SE. If they deduct expenses for an office in their home, they will also file Form 8829 to report the business percentage of their property taxes, mortgage interest, utilities and insurance, among other items.”
If you use a portion of your home for business, consider whether or not you qualify for the home office deduction. The general rule is that to take the home office deduction you must regularly and exclusively use part of your home either as your principal place of business, or to meet with customers, patients or clients there. The amount you can deduct depends on the percentage of your home used for business.
Hobby income can be tricky. IRS considers income from your hobby to be other taxable income, unless it has consistently been profitable over the past few years. After three years in the black, IRS says it’s a business and you must report it as self-employment income. Hobby losses can be claimed as a deduction up to the amount you are claiming as taxable income.
Make sure to deduct all the costs of running your business – those are legitimate deductions that you don’t want to miss! Form 4562 is used by small business owners to claim deductions for depreciation and amortization. And importantly, if you are making a profit, don’t forget you owe quarterly payments to cover your income, Social Security and self-employment taxes. Many taxpayers with home businesses on the side are used to having their taxes withheld by an employer and are unaware that failing to pay quarterly taxes on profits can cost them more in late filing penalties.
Good record keeping is essential for small business owners, so throughout the year be sure to save receipts you may need to substantiate information on your tax return. And because owning a home-based business adds a new level of complexity to filing your taxes, you may want to consider consulting a licensed tax preparer, such as an enrolled agent. A tax expert can strategize with you each year and help you minimize your tax burden by taking advantages of all the tax options available to home-based businesses.
About Enrolled Agents
Enrolled agents (EAs) are America’s tax experts. They are the only federally-licensed tax practitioners who specialize in taxation and also have unlimited rights to represent taxpayers before the IRS. While attorneys and certified public accountants are also licensed, only enrolled agents specialize exclusively in taxes. Enrolled agents are required to complete many hours of continuing education each year to ensure they are up-to-date on the constantly changing tax code and must abide by a code of ethics. To locate an enrolled agent in your area, go to the “Find an EA near you” directory at www.CSEA.org or call (800) 777-2732 for additional information.
CSEA is a nonprofit 501(c)(6) organization with more than 4,200 active Members. It is a professional association dedicated to serving EAs in California and abroad, enabling them to grow, prosper, and lead as The Tax Professionals while serving taxpayers in a dynamic, rapidly changing environment with integrity and trust.