If you’ve ever wondered about the incentives to starting a home-based business this short article is for you. We’ll go over the tax advantages and how you could potentially cut your tax bill. We’ll also briefly go over the non-tax benefits of a home-based business.
How Starting a Home-Based Business Could Save You in Taxes
The key to understanding how a home-based business could cut your tax bill is to consider this. When you regularly spend money as an employee, much of what you’re spending on will count as non-deductible. Even if you were to itemize your deductions in your personal tax return (which yields less tax in select few cases), you just aren’t getting deductions from what you spend.
Now let’s say that you start your home-based business. At that point some of the expenses that used to be non-deductible in your daily life can become deductible. You just have to know how to tweak things in order to make it perfectly allowable.
As an example, a lot of the restaurant meals you were having during your lunch breaks could count as deductible as long as you’re having a business purpose related to them. Check out this article were we go over the rules on the deductibility of meals.
Certain Non-Deductible Items Will become Deductible When "Doing it Right"
How about your car expenses? If you’re having at least a percentage of your car usage for business, and you keep track of your miles and/or expenses, it may become deductible. There’s also the potential of having your home-office as a write-off.
Let’s say that in order to qualify for a job, you had to invest in your education from a non-accredited, independent source. This would not be deductible as an employee. Now let’s say that you invest in a similar course to start your business. That would become deductible as part of your initial expenses.
Example of Take-Home Income As Employee Vs. Home-Based Business
Let’s take the example of Lisa. That’s what we call my Chinese mother-in-law. We don’t really know her real name! My wife learned a lot of Chinese dishes from her. Love Chinese people, love Chinese culture too. I learned to read kanji (hanzi) studying Japanese. Got up to reading Murakami Haruki in Japanese but have lost most of it by now
Her husband works but hopes to supplement their income with her work activities. Let’s take two scenarios where they’re married filing jointly. We’re assuming her husband’s income is already taking the standard deduction.
Option one, she gets a job grossing $50K at a tax rate, federal & state combined, of 15%. Option two, she starts a home-based business, also grossing $50K top line.
Here’s a chart and how they fare:
How they Compare
With the same kind of expenses to compare, we can see that with a home-based business we’re having a tax savings of $3,255. That’s pretty good.
But be aware that tax savings should not be the focus or primary reason of going into business. There are many benefits beside taxes to set up even a part-time home business (or any business for that matter).
With the first option, the only way to break through the income level is to get a raise or promotion. With a business, you can increase revenue by more sales, new lines of products and services, or reducing costs. You can also work to scale your business and take your income to a whole different level. That kind of jump in income would be really difficult to do as an employee.
Make sure to check out this video recapping the two scenarios:
Reaping Even More Benefits From Your Home-Based Business
There are even more potential advantages when you start your home-based business. Once you get to a certain level of income – typically from $40K and up (that would apply for Lisa) – you can start reaping the benefits of using another strategy.
By using an S Corporation, Lisa could pay herself a salary and save on self-employment taxes. Remember the 7.25% in Social Security she pays as an employee? She has to pay even more than that (the employer side) as self-employed. By taking only part of her net profits as a salary, while the other part she can take as a distribution, she can drastically reduce the SE taxes she pays.
Check out this video to better understand how this strategy works. Consider if it could potentially apply to you!