US Tax Rules For A Sideline Business

Posted: 13 Feb 2008 | Categories: Taxes

I would like to focus in this article on sideline businesses and the implications they have on your tax situation. More and more people are operating business from their home and claiming the home office deduction, according to the IRS.

Those with the entrepreneurial spirit are selling on eBay and other online venues. Taxpayers are doing this with low start up costs. Sideline businessmen and businesswomen will find that tax rules apply to their business just as it does to full time businesses. This means that you will need to maintain an accurate accounting of income and expenses. You certainly is to your benefit to understand how the tax rules apply so that you can develop a strategy that will minimize the tax on your profits.

Main businesses and sideline businesses for the most part follow the same tax rules, but there are some special points that deserve close attention. First I want to touch on the home office deduction.

The cost of operating an office from home is a business tax deduction if the office is the principal place of business for you It doesn’t need to be the principal place of business for your main business, or employment. You may still qualify for a deduction as long as your home office is the principal place of business for your sideline business. Using a home office for managerial activities or administrative duties such as keeping records, scheduling appointments and preparing proposals, allows it to be treated as a principal place of business, even if the revenue is generated at another location.

You should know that a sideline business might not always be treated as a business. If you hold real estate investments or buy and sell securities, then you may not be considered a sideline business. In the case of real estate investments, holding even one property may amount to a business, depending on the level of the taxpayer’s activities. The Tax Court has held that a taxpayer’s activities constituted a business where he sought new tenants, cleaned and prepared the six units he owned, and provided furnishings for them In the case of securities, deductibility depends on whether the taxpayer is considered to be an investor or a trader. Occasional trades and long-term positions indicate investor status for which a home office deduction would not be allowed.

However, if you spend substantial amount of time managing a sizable portfolio and seeking short-term profits, you usually would be considered a trader for whom a home office deduction would be allowed.

The home office must be used regularly and exclusively for the business; personal use of the space when it is not being used for business disallows the deduction. The space need not be a whole room or even physically partitioned from the rest of the home, however its business function must be respected.

This home office deduction could be quite important because it is a way to convert nondeductible personal expenses into deductible business expenses. The deduction is composed of both direct and indirect expenses attributable to business use of space within the home. Direct expenses are those items attributable to the home office, such as painting the space. Indirect expenses are those items that relate to the entire home, such as painting the exterior of the home. The portion of indirect expenses related to the home office is part of the home office deduction. The allocation generally is made on a percentage of square footage basis.

The allocation of indirect expenses can be made on a per-room basis if the rooms are approximately the same size. In the case of depreciation for those who own their home, the deduction is figured on the home office space. The basis for depreciation is cost or fair market value, whichever is lower. Since most homes appreciate, the home’s cost typically determines basis. The recovery period would be 39 years and the percentage used would depend on the month which the space was first used for business.

The home office deduction cannot exceed the gross income of the business.. Gross income in this case means net profit as reported on Schedule C if the taxpayer is a sole proprietor, reduced by the allocable portion of mortgage interest, real estate taxes and casualty losses, if any.

Deductions for these items are used to offset gross income first. If there is any excess gross income, then it is offset by homeowner’s insurance premiums, repairs and maintenance, utilities, and rent. Finally, if there is still excess gross income, it can be offset by depreciation. The good thing is if expenses are disallowed because of the gross income limitation, they can be carried forward and treated as part of home office expenses in the following year. There is no limit to the carry forward period. These expenses are reported on form 8829.

This article is not to be used as the entire representation of tax law as it relates to sideline businesses. In other articles I will explain the hobby loss rules; discuss retirement plan options for your sideline businesses and I will explain Social Security and Medicare taxes on sideline business earnings.

I am a twenty year professional in the income tax preparation business in the US. Over the twenty years I have helped thousands of clients understand US tax law as it relates to their individual returns. I am writing articles on subjects that I find most taxpayers don’t fully understand. I hope this information is useful to you.. Visit me at http://www.jjackson328.com

Article Author :Steven_B_Jackson