The IRS Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ) Publication 334 is a mandatory desktop, laptop, and bedside reading. Onerous as that sounds, this is the definitive tax reporting source for your home office and business operations. Even if you have another job and run a little operation on weekends, you can deduct a host of expenses against any income you earn. Here’s the IRS Rule of Thumb:
A business expense must be both ordinary and necessary to be deductible. An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate for your company. An expense does not have to be indispensable to be considered necessary.
The key is to do your homework and keep good records. Use a separate bank account (those fees are deductible, if your bank charges). At least a particular credit card for your business versus your personal use. The statement makes it easier to remember and record the costs of doing business. Publication 334 and several do-it-yourself tax software programs offer guidance on home-based and self-employment business expenses.
Record keeping is especially important for vehicle deductions. This is tedious but manageable and worth the time if it will save you a dime in taxes. Working as a consultant, I use my car for both business (deductible expense) and personal use (non-deductible). I use my cell phone calendar to track my activities. It helps me with billing clients (after all, that is why we are in business, right?) and to track related expenses like meals, supplies purchased for work, etc. Some people are diligent odometer recorders and gas trackers - kudos to you. The rest of us rely on Google Maps or Mapquest for mileage calculations. I add the mileage to my calendar as part of the appointment, along with other expenses. At tax time, I tally up those miles and take the standard deduction allowed for business miles driven. Allow me to stress that proper recording requires little more than simple notebook, pencil, and your attention. High-tech solutions are handy but not essential. Refer to IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses to better understand the rules on car expenses and more.
For my business, I converted a spare bedroom into my home office. Not much to it: a working space with file cabinets and mountains of paper which I vow to tame this year with a scanner. The IRS is very specific on this matter, made clear to me decades ago when my dad was audited and received a home visit from a friendly agent - that turned out fine. According to Chapter 8, “Business Use of Your Home” in Pub 334,
The business part of your home must be one of the following: (a.) Your principal place of business, (b.) A place where you meet or deal with patients, clients, or customers in the ordinary course of your company, or (c.) A separate structure (not attached to your home) you use in connection with your business.
Exclusive use. To qualify under the exclusive use test, you must use a particular area of your home only for your trade or business. The area used for business can be a room or other separately identifiable space. The area does not need to be marked off by a permanent partition. You do not meet the requirements of the exclusive use test if you use the area in question both for business and for personal purposes.
The detailed list of accepted business expenses and non-deductibles n IRS Publication 535 is aptly named “Business Expenses”. I suggest you add this to your tax library as well. You’ll find it among my mountains of paper, along with a pledge to hire an accountant next year!