Many people took the opportunity to start their own small businesses in 2020 and 2021. During the heart of the pandemic, a record 4.4 million new businesses were created. Up significantly from an annual average that has rested around 600,000 per year for the past quarter century. Nearly 32 million small businesses currently operate in the United States. If you were one of those new business owners or sole proprietors in the past few years, or you are looking to start a new business in 2022, the idea of working from a home-based office is an attractive one.
Many new business owners start out by working from home and the great news is that many home office supplies can be deductions for your small business. But what is and is not eligible to be written off on your taxes? As a home-based business owner, do you know what you are allowed to expense? Do you know what counts as an office expense deduction? Let’s review some broad categories for home office expenses and break down what is allowed and what to avoid when filing home office deductions for your small business.
Home Office Deduction
The home office tax deduction applies if you use a specific portion of your house regularly and exclusively for your business. This is mainly based on the honor system, but here are a few examples that you can think about when deciding how the home office tax deduction applies to your unique business set-up.
If you have a room that is used solely for your home office, such as a second bedroom that is not used for anything other than your small business activity, then that would qualify for your home office deduction because it is a dedicated space for your business. However, if you have that spare room set up as an office but occasionally work from your dining room table, you could not also include the square footage of your dining room to increase the deduction for your home office expenses. The dining room is obviously used for activities outside of business purposes.
Another example would be independent contractors who are able to do all their business from their laptops and choose to work from their kitchen table. In that case, it is going to be impossible to quantify the use of the whole kitchen as an acceptable home office deduction. A kitchen will never be seen as a principal workplace or dedicated space for business because it is impossible to prove that it is used exclusively for your business. So not only do you need to prove that the space is used to run your small business on a regular basis, you also need to prove that the space is not used for any other purposes.
There are also two different ways to go about quantifying the home office deduction and calculating the office expenses for use of the space; the regular option and the simplified option. With the simplified version, rather than deducting expenses you’ll calculate the square footage of your space and multiply it by the rate of $5 per square foot up to 300 square feet of space. This means that, at a maximum, you would get a $1500 deduction for your home office.
With the regular option, you’ll value your home office tracking the actual expenditures of the space against your total home expenses. To do this, you’ll have to add up allowable deductions including mortgage interest, taxes, maintenance, repairs, utilities bills, insurance, and other related expenses. Then you’ll calculate the percentage of those expenses for the size of your home office.
The simplified method is obviously easiest, but you should consider going with the standard method if your home office space is significantly larger than 300 square feet or if you feel that your home expenses and utility bills would put the deduction value of your home office above $1500. Your tax preparer can help you understand which of these methods will be best to track the legitimate deduction for your small business.
There are also a few exceptions that relate to specific types of business owners, one example being if you provide day care services or run a daycare facility from your home. Another example is that you use part of your home for the storage of inventory. If you have a significant amount of inventory and product samples in storage in your home, you can potentially use this exception. Check with your tax preparer prior to tax season to see if there are any exceptions that could apply to your home office space.
Internet and Phone Deductions
If you work out of a home office, some of the most common types of expenses you could deduct are your internet services, telephone service, and fax bills. For a home-based business, those are easy to quantify as a tax-deductible expense. However, you can only count an office expense deduction that is directly related to your business. This means you can’t expense the entire cost of your home phone and internet bills simply because you work from home; to be a legitimate business deduction it has to be related to the running of your business.
It can be tricky to figure out what was purchased for personal purposes and what are deductible home office expenses for business-related activity. The easiest way to manage this is to either add a second phone line to your home, or get a cell phone to use exclusively for your business. Otherwise it will be very difficult to determine what calls were made for personal use vs. what calls related to your home-based business.
Similarly, it can be challenging to know how to deduct a portion of your internet expenses. What you can consider is the cost to build, maintain, and manage your business website. Those are reasonable expenses to deduct if you use a website to manage your current business.
Office Supply Deductions
To be able to deduct office supplies you have to prove that they are ordinary and necessary business expenses, and not materials for personal use. So a printer that is stored in your home office space and not used by anyone else is an acceptable expense, whereas a printer that is used by all members of your family (for example, your kids use it for homework) is not going to be approved as a home office deduction.
Likewise, if you do a school supply run for your kids at Target and decide to grab some office supplies for yourself at the same time, it is going to be a challenge to itemize what you purchased for household use and what you purchased for yourself in order to submit an itemized deduction of office supplies.
An easy way to get around this is to use your business bank account for appropriate office supply expenses. That way your receipts and bank records will already be separated from family expenses and household budgeting and you will have an easier time identifying your business purchases. If you are trying to estimate your business taxes, it is much easier to identify appropriate business tax deductions if you are only looking at your company’s bank account. Maintaining accurate records and separating your personal expenses from your business expenses is always recommended, especially for home-based business owners.
The best way to keep track of all potential tax deductions is to have an excellent bookkeeping system in place to keep detailed records of all your business transactions. Sound Accounts provides bookkeeping, payroll, and licensing services. Whether you have a small business or sole proprietorship, and whatever stage your small business is at, we can work with you to provide accurate accounting and payroll support. Contact us to learn more about how we can serve you!
For answers to some standard tax deduction questions, check out our frequently asked questions below:
FAQ’s
What is a home office deduction?
According to the IRS, a home office deduction allows qualifying taxpayers to deduct certain home expenses on their tax return if they run a small business or do work for their small business from home.
What qualifies for a home office deduction?
There are many home office deductions that you may qualify for. The biggest one is usually deducting a specific amount for the physical space that you use in your home for small business operations. There are both simple and standard options for calculating the amount of deduction for your home office space.
Are there limits to what I can expense or deduct for my home office?
Yes, there are some strict stipulations for what you can expense. To get the deduction for the use of a physical space in your home, it has to be a space that is used exclusively for your small business. For office supplies, again they must be used exclusively by you for the management of your small business. There are a few highly-specific exceptions to these limits, so check with your tax preparer to ensure that you are getting all the deductions that your small business may qualify for in 2021.
