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The rules and regulations that home business owners must adhere to are more daunting than ever. Particularly challenging are the tax regulations, according to Home-Based Business and Government Regulations, a report compiled for the Small Business Administration by Henry B.R. Beale of Microeconomic Applications Inc. At the federal level, IRS regulations penalize home-based businesses when it comes to deductions, while at the local level, zoning laws and other stipulations present significant barriers to entry. Having to comply with certain building, fire, and health codes can also burden home-based businesses.
Beale’s report supports previous research published by the Office of Advocacy, which showed that federal regulations were more of a problem for the smallest businesses — those with fewer than 20 employees. Roughly 53% of all small businesses are based in the home. More than two-thirds of all small businesses are either sole proprietorships, partnerships, or S corporations. Ninety percent of home-based businesses have no employees and 77% have gross receipts under $25,000. Moreover, 52% of home businesses provide services; 16% are in construction; 14% are in retail trade; and the remainder are in areas such as finance and real estate, manufacturing, and wholesale trade.
State tax codes are often clearer than federal ones. State taxes don’t apply to most home-based businesses and, when they do, they’re fairly simple. However, home business owners spend about an hour a week on activities such as record keeping, just for the purpose of filing federal tax forms. Not only are the rules often hard to understand but some of the tax laws themselves are confusing. For instance, the IRS requires that a home-based business file income taxes, employee taxes and expenses, and depreciation. And there are three separate criteria for three different kinds of employee: corporate officers, common law employees, and statutory employees. There are at least 28 tax forms that a home business owner may have to file. It takes a proprietor about 123 hours and nine minutes to fill them out properly. Though publications to help home business owners are provided by the IRS, they can be difficult to sort through and contain numerous cross-references.
Your best bet is to work with an accountant, even if you are a sole proprietor. “You need to be clear about what you can and can’t write off,” says Lisa Price, president of Carol’s Daughter Inc., a multimillion-dollar bath and fragrance retail business, which she started in her Brooklyn, New York, home. “The IRS is very particular about things like — you can’t have a room you use for business that might be used for something else,” she explains. “I separated my living space from my workspace. We lived on one floor and the other was for the business. It was a good thing for growing the business because you have more control over your expenses and there’s not much overhead.”
But that advantage was also Price’s biggest difficulty. “I had employees and customers in the place where I lived and I had two small children (a 19-month-old and a newborn),”