I am continually approached by people intrigued with the fact that my family has operated six different businesses out of our home, or who want advice about starting a business of their own. When it comes to having a home business, the most common questions I’m asked are “How did you start?” and “What is it like having a business in your home?” and “What do I need to do to start my own business?”
I will try to cover the answers to these questions in blog posts, along with some pros and cons of operating a business out of your home. But here I want to address the major benefits of having a home business, no matter how small.
- I wanted to earn extra income at home.
- I wanted my children to learn entrepreneurial skills.
- I wanted my children to have meaningful labor.
- I wanted to do something that would help other people.
- I wanted to do something I had a passion for and get paid for it.
I started the Elijah Company on my kitchen table, never dreaming that it would eventually grow into an international business that not only supported our whole family, but provided the livelihood for up to five other families as well as summer employment for several single men and women. It also touched the lives of hundreds of thousands of home schooling families. So that was an added benefit to the business.
Not all of the businesses I have started have been as successful financially, but they have been successful in many other ways.
The benefits to my children were enormous. They grew up helping in family businesses and having meaningful labor, and they learned to think like entrepreneurs (which statistics show that children who grow up in family businesses tend to become entrepreneurs themselves). Although they complained a lot about the work when they were kids, now that they are all young adults, they thank me for not only the experience they had in business growing up, but also for their entrepreneurial mindset. And now they each have businesses of their own.
Another perk to having my own businesses was that I was able to make a living doing things I loved: reading books, writing, hanging around horses, and helping others.
But the main reason I tell everyone who has even the slightest spark of entreneurial interest to start their own business is because of the enormous tax benefits available to home-based businesses.
These tax benefits are the “hidden” ways having a home business earns you income.
Hidden ways having a home business “earns” you income
Yes, there are the sad statistics that 9 out of 10 small businesses fail within the first five years, but that really shouldn’t be a deterrent to you starting your own business if you are careful not to invest more than you are willing to lose. After all, even having a home business for five years can create enormous benefits to you and your family, not just in the area of entrepreneurial education, but also in the financial arena.
One of the major benefits is in the tax advantages to having a home business.
If you have a home-based business of any kind, including consulting, sales, free-lance writing, art or crafts, babysitting, dog-walking, selling on E-Bay, or even Network Marketing, you actually have many tax benefits built right into your financial picture that will save you a lot of money!
And did you know…you do not even have to make a profit to qualify for these benefits? You must simply operate with the intention of making a profit. Some of the businesses I started flopped, but not really, because the tax benefits of having them were worth the costs of operating them, even though they showed losses on paper.
In fact, one of the keys to being successful at business is to stop thinking in terms of “making a profit” and start thinking in terms of deducting everything you can possibly deduct so at income tax time, there’s a minimal amount of profit to tax. (But that doesn’t mean you didn’t make quite a bit of money and a good living with your business. You just found ways to create legitimate deductions that minimized the amount of profit the IRS could tax.)
The key: You must actively work your business with the intention of making a profit. And the IRS gives you five years to show a profit.
Think about it. What I’m saying will eventually make sense to you.
So, what are the tax advantages to having my own business?
When thinking about money and the tax advantages to having a home business, it is helpful to think in terms of “before tax dollars” and “after tax dollars.” Most of us pay all of our expenses with “after tax dollars.” This means we are living on the money that is left over after the government takes out its share.
But what if you could take a huge chunk of the money you earn, even at a job, and legally pay certain expenses with it before it was taxed? Then there would be less taxable income, and therefore your taxes would be lower. So having a home business allows you tax deductions that mean you can keep more of what you earn.
To make this a little easier to understand, let’s imagine you are in a 25% tax bracket. That means that 25 cents out of every dollar you earn goes to paying taxes. But what if you could still earn that dollar, but only be taxed on 50 cents of it? That would mean that for every dollar you earned, you deduct 50 cents of it and you are only taxed on 50 cents. So your tax is now 12 and a half cents instead of 25 cents of every dollar.
The best advantages of owning a home-based business are you can turn many of your ordinary, ongoing expenses into tax deductions.I’m talking about ordinary, ongoing expenses like your mortgage, your utilities, your car, your healthcare, and more. These deductions not only reduce federal income tax, they also reduce self-employment tax, Medicare tax, and state and local taxes.
But, before I go into some of the tax deductions, let me assure you that I am neither an accountant nor a tax expert, so anything you do needs to be checked out thoroughly with a tax specialist. And it’s not as easy as you might think to find an accountant who is savvy about tax deductions for home businesses. Take your time and ask around, because most accountants only handle 1040’s.
Some favorite tax deductions for home-based businesses
Household expenses. A traditional business writes off costs like gas, electric, water, and sewer. With the correct formula in hand, you can do the same, and deduct a portion of your home’s basic utilities.
How about rent and mortgage? Yes, just like a traditional business, you may do the same. If you are a renter, this may be a huge relief!
Your car can be worth HUGE tax deductions if you use the “IRS Two Business Location Rule” to connect your small or home-based business with your “day job”. This rule actually turns non-deductible commuting miles into fully deductible business miles. Wow! If you’re not taking advantage of that, it’s like throwing a $10 bill out the window every time you drive 30 miles!
For most taxpayers, vehicle mileage deduction alone is worth some $3,000-5,000 in new tax deductions.
Meals and Entertainment can be 50% deductible when you are with prospective or existing clients, vendors, etc. If you are in a service business or sell products, almost every person is a potential client. It is important to follow the simple documentation guidelines issued by the IRS and to understand there are limitations. An example of a deduction you cannot take is dining out with your spouse. Even if you are business partners, the IRS says no to this. If together, you take a potential client to lunch, then the meeting expense is deductible.
Trips must be mostly business-related to be deductible. If a small element of fun is involved, you will most likely still have a completely deductible trip. The deductions will not apply to a spouse who tags along, unless it is also a working trip for the spouse. Compliance with IRS regulations can be tricky, so it is best to check with your tax advisor before assuming your trip to Hawaii will be deductible. (However, I’ve been able to deduct a Carribbean cruise because I attended an Internet Marketing Conference onboard. I deducted the entire cost of the cruise even though the conference sessions only lasted a few hours each day.) For years, our family criss-crossed the country going to Home School bookfairs with our business. We almost always drove, camping out and taking the scenic or historical route to wherever we were going so our children not only had a lot of family time, but they got to visit almost every state in the union.
Conferences are also deductible as continuing education expenses. This means you could attend the conferences we recommend and deduct all the costs associated with attending.
Utilities and other expenses for the portion of your home or apartment you use exclusively for business are powerful deductions. Without a home-based business, the most one can deduct is interest and property taxes (on Schedule A). In relation to a home-based business, a portion of utilities, maintenance, cleaning, lawn service, pest control, etc. can be deducted on a Schedule C.
Deduct the kids’ salaries
Income Shifting is another way to create tax deductions. You may already be familiar with the concept of income shifting by putting property or stocks in your children’s names. But did you know that if you own your own business, you can employ your children (over eight years old) and pay them to work in your business and their salary is tax deductible?
Depending on the age of the child, each child can earn close to $5,000 (check the current amount, because it changes every few years) without paying income tax. You also have the advantage of not paying Social Security or Medicare taxes on your dependent children who work in your business. For example, if you employ three of your children and pay them each $5,000 a year, you have shifted nearly $15,000 tax-free dollars to your kids. This is clearly better than giving them an allowance. There are rules, however. The kids have to actually work and be paid fair (not excessive) wages for their services.
We used this strategy with our three boys and from the time they were each eight years old paid them minimum wage salaries for doing odd jobs for the business. They used their salaries to pay for things we would have normally paid for, like their clothing, piano and dance lessons, and even a portion of our mortgage.
What is the power of this? Here’s an example. If you have an income of $50,000 per year, have three children, and are married and file jointly, you get a $3,800 deduction for you, your spouse, and each of your three children which brings your taxable income to $31,000. If you have no other deductions, your taxes will be roughly $3,780.
But, what happens if you employ your children in your home business and pay each a salary of $5,000 a year? (The minimum wage in most states is $7.25 an hour. $5,000 a year at $7.25 an hour is 689 hours a year, which amounts to roughly 13 hours a week of work or roughly 2 hours a day. It’s easy to find at least 14 hours of work for your business, even for an 8 year old. This work can be cleaning, emptying trash cans, doing lawn care around your “office,” helping with mailings, filing, posting sales on E-Bay, etc. But if you have teenagers, you can safely pay them $12 to $15 an hour which means they have to work less hours per week for the same $5,000 a year.)
The children’s salaries are deducted from your taxable income, which means your income has dropped to $$16,000. Now you are in a lower tax bracket and only owe $1,600 in taxes, which is a tax savings of $2,180.
But wait, you say! I spent $15,000 in salaries to save $2,180 in taxes. How is that smart? I’ll tell you how that’s smart. You’re not just giving your children that money. Out of the $5,000 salary you’ve paid each child, you are going to have them pay for things you would have paid for anyway. They can pay for their piano lessons, their clothing, their schoolbooks, etc.—even a portion of the groceries, utilities and the rent or mortgage on your house.
If you treat this as a teaching opportunity and show your children how to create a budget, manage their money, and pay for their own expenses, they will be way ahead of the game when they are out on their own. Plus, you will have paid for a lot of the family’s living expenses with “before tax dollars” instead of “after tax dollars” and will have saved quite a bit in taxes.
Educational Expenses are also deductible. Did you also know that an employee can receive $5250 a year from a corporation for educational expenses and that amount is not considered income to them. You can spend $5250 on educational expenses for each child who is an employee of your business and it becomes a tax deduction for you and tax-free income to them.
Other ways of creating tax deductions with your children is to use their photos in ads and pay them royalties. Put the royalty money in their education or retirement accounts.
More tax deduction ideas
There are even more tax deductions available that we haven’t experimented with. For example, did you know that your business can have a “cafeteria plan” where it provides meals for all employees? For a large family, this could mean a huge savings if even some of your meals were deductible.
Do you lose thousands of dollars in medical deductions each year because you fail to meet the minimum percentage required to claim the expenses? There is a way you can claim every single dollar that anyone in your family spends on medical out-of-pocket costs, deductibles, co-pays, plus many non-covered health-related expenses such as eyeglasses, dental exams, chiropractic services, holistic healing and sometimes even cosmetic surgery.
How does this work? Your small or home-based business gives “Employee Benefit” reimbursement for these categories.
Do you have a dog that barks when someone approaches your home? You may have a tax-deductible “guard dog”, allowing you to deduct your dog’s vet bills, license fees, even dog food.
And this is just the tip of the iceberg!
There are dozens of other deductions, too. The rule of thumb is, if a traditional business can deduct it, your home-based business probably can, too. With all the advantages available to households with a home-based business, the average savings in tax relief can be between $4,000-$14,000 a year!
These are just a few of the many tax advantages available to owners of home-based businesses. However, before implementing them, I strongly recommend you enlist a qualified tax advisor to help you learn how to document your expenses and how to legally take every deduction to which you are entitled.