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Tuesday, 8 September 2009

The Perils of Running a Business From Home

By Matthew Bandyk

While vacancies in commercial properties have soared in the last two years, millions of business owners who work from home have avoided the burdens of renting or buying office space. Telecommunications technology has made running a business out of your home easier than ever. Recent numbers are murky, but official statistics suggest that a substantial number of businesses in the United States are home-based. The Census Bureau's most recent Survey of Business Owners--in 2002--found that 22 percent of employer firms (firms that hire workers) were home-based, out of 5.6 million businesses. For one-person businesses, the percentage is even higher: 58 percent of 17.6 million nonemployer firms worked from homes.

For many people, never having to deal with commutes or cubicles sounds great. But home-based businesses face some unique challenges. Jessica Satterfield of Aubrey, Texas, launched her public relations company out of her home two years ago. Having worked for large companies in the past, she was surprised by the amount of resources she previously could take for granted. "Any sort of computer problem you have to figure out on your own instead of having the IT person come to your desk and figure it out for you," she says.

Other burdens for home-based entrepreneurs are more subtle. They include complicated legal topics that few people think about before they go into entrepreneurship. Here are a few:

Zoning. The very act of launching a home business could be illegal. Almost every local government has zoning ordinances that limit how much business activity can go on in a residential area. "One of the real concerns is that you might bring in 'unpleasant elements' or excessive foot traffic," says Nina Kaufman, a lawyer and small-business adviser with the Legal Edge. Many home-based businesses need only an Internet connection and a phone line to operate and therefore wouldn't garner much attention in a residential neighborhood. But other types of businesses could draw the authorities. For example, a home-based repair shop could upset the neighbors if too many visitors start showing up. "They don't want you to turn your backyard into a parking lot," says Kaufman. She recommends that anyone starting a business of this nature read their local zoning ordinances or talk to a local attorney who is knowledgeable about the issues. "You have the very great potential for a lawsuit, fines, or penalties," Kaufman says. What if your city won't let you start a home-based business? You may have to apply for a variance, in which the municipality makes an exception to the zoning rules. But most local governments don't like to make exceptions. "Getting a variance is not an inexpensive process," says Kaufman.

Home-office deduction. Taxes are one area where home-based business owners can run into special problems. That's because they may have a hard time getting the same tax benefits enjoyed by traditional businesses. Perhaps the best example is the home-office deduction. A business owner who owns or rents office space gets to deduct those expenses from his or her taxes. If your office is in your home, you have to determine how much of your home is taken up by your office. You can deduct a portion of rent, mortgage interest, and other housing expenses from your taxes--but only the exact percentage that corresponds to the size of your office. For example, with a 1,000-square-foot home, if your office space is 200 square feet, you can deduct 20 percent of your housing expenses from your taxes.

But it's not as easy as simple math. Filling out the form to apply for a home-office deduction can get complicated. "You almost have to be a CPA to figure out that form. The phrase 'see instructions' appears 14 times on a one-page form," says Keith Hall, tax adviser for the National Association of the Self-Employed. Hall estimates that roughly one-third of all businesses that are eligible for the deduction do not claim it. Satterfield found the help necessary to get money back for her office, which takes up 11 percent of her home. "If I didn't have the accountant, there's no way," she says. But even with the help of an accountant, there's still a lot to do. Satterfield uses a spreadsheet to keep track of any costs that can count toward deductions, such as electricity bills, water bills, and pest control. Despite the extra work, she says it's worth it to get the tax deduction.

Previously, getting the home-office deduction was an even more burdensome process. Because home offices used to be rare, declaring one was a sure way to raise a red flag with IRS, says Kaufman. But in recent decades, with more people running businesses from their homes, the IRS has audited requests for home-office deductions less frequently. That doesn't mean a home entrepreneur doesn't need to be careful. To avoid IRS problems if there is an audit, Kaufman says to make sure any recreational and nonbusiness items are removed from your home office. To avoid an audit in the first place, don't fudge the numbers about the size of your office. "If your whole house is 1,000 square feet, and you try to take a deduction on 900 square feet, it's going to raise suspicion," she says.

Other tax deductions. For traditional businesses, expenses are pretty obvious. "If you're a printer with a big printing press," says Hall, you know the purchase of that equipment is a business expense you can deduct from your taxes. But what if a home-based entrepreneur buys a printer for his or her business use? It's not so easy to claim the deduction when the IRS gets suspicious that the equipment in question is for personal use. "Your car, your computer--these things lend themselves to personal use," says Hall. So if you want to deduct gas mileage or Internet service as a business cost, you need to show that at least 50 percent of those items are for business use only. Hall suggests keeping a log of mileage or of how often you use your computer. But it's up to each entrepreneur to decide whether or not the time and effort involved in keeping those logs is worthwhile.

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