Working from home instead of an office has become a popular option in the 1990s, but establishing a home office means you’ll have to make decisions about the scope of your business and the ramifications those could have on your financial situation.
“Start with a plan that relates to the type of business you’re going to run,” says Judy Clemens, a manager for Nykiel-Carlin & Co. Ltd, an accounting firm in Schaumburg. “Your plan must include answering questions about cash projection, the costs of startup, what will be your source of income, plus financing.
Clemens adds that the scope of your business determines the way you’ll file your taxes each year.
“You need to know what type of entity you’ll be–whether you’re the sole proprietor who will file a Schedule C on your tax return and is not incorporated or what’s called a C corporation or S corporation (that are designated) for small businesses.”
Clemens says the difference with C and S corporations is that the former pays taxes through the corporation itself, while the S corporation funnels profits through the individual’s tax return.
“You usually need a tax accountant and an attorney to set these up,” adds Ron Cooper, marketing director for Nykiel-Carlin. “You have to decide if your business is local or international, multistate or not. And find out about (other) businesses like yours and something about their structure. We have people who started a business in their garage with no employees and have grown to a $90 million enterprise. When they started out, they did not incorporate.”
Larry Mraz, an attorney for Bryan Mraz & Associates in Roselle, says corporations are often formed for liability protection in addition to tax purposes.
“The issue, often, is liability, which limits your risk,” Mraz said. “If someone sues you, the liability is limited to the assets of the corporation. The corporation is a way of providing protection.”
Mraz said both C and S corporations involve filing essentially the same articles of incorporation. Costs include a $100 incorporation fee that’s filed with the State of Illinois and attorney fees that Mraz says could average $500 to $1,000, depending on the size and scope of the corporation.
“There’s also LLC, or limited liability corporations, which would probably cost $1,000 to $1,500 to draw up, but they’re much more complicated and the average person with a home office doesn’t need them,” Mraz said, adding that any attorney fees should cover drafting articles, establishing bylaws and preparing minutes for the corporation, in addition to filling out and filing the papers.
Clemens says the best way to finance a business is to talk to banks that specialize in helping small businesses with startup costs.
“We’ve created `Express Loans’ just for this purpose–to give small businesses money without a lot of the paperwork,” says Tom Kelly, vice president of media relations for First National Bank of Chicago. “These loans have a quick turnaround time in terms of processing. No one wants to write out their whole biography applying for a loan, and nobody at the bank wants to read it. We’d have to charge a lot more interest to process all that.”
Kelly adds that another option is “a home equity loan or line of credit, where the loan gives you a set amount you pay back like a mortgage, and the line allows you a certain amount of money like a credit card, except the interest on both is deductible.”
There are also microloan funds available from groups such as Accion in Chicago that administer small loans with a minimum as low as $500. “Money from a variety of banks is pooled and made available through these microloan groups,” Kelly said. Call the government offices in your area or the economic development department in your village to find out if any microloan program exists.
Experts say it’s vital to establish a financial identity separate from your personal accounts.
“Never mix your own money with that from the corporation or business,” Clemens says. “Try to keep all the company assets, including cars, in the company name. When it comes time for taxes, the IRS wants to see good records.”
“Never pay for anything you buy for the office in cash if you can help it,” advises Richard Czerniawski, who owns an accounting and tax preparation firm in Hoffman Estates. “Keep invoices for everything you buy, since by law the IRS can dispute canceled checks. Sometimes people will buy something at a garage sale for their home office and they’ll have no record.”
The home-office deduction allowed on income taxes may be another reason to establish a workplace where you live, but there are a number of guidelines to follow. First of all, your home office must be your principal place of business and must be used exclusively for business and used on a regular basis.
“The law today allows for a pro-rated share of the real estate and property taxes, interest on the mortgage, utilities, home insurance and indirect expenses like security alarms to be deducted from your taxable income, based on the percentage of space the office occupies in your home,” Czerniawski said. “All direct expenses like painting your office, cabinets, furniture and equipment used to run your business are fully deductible.”
The threat of a tax audit has steered many away from claiming a home-office deduction. Experts admit the deduction is a “red flag” on a return but suggest these guidelines if you plan to take one:
– Keep detailed records of all taxes, utility bills and expense receipts.
– Expenses of less than $75 can be claimed without furnishing receipts as proof. Keep track of them in a journal or log book.
– Take a picture of your office that clearly shows the work space you use. Czerniawski says to remember that if you’re audited, you’ll be visiting the IRS and not the other way around.
“Having a picture of your office to bring with you can resolve a lot of questions,” he says. “And remember that less than 1 percent of all returns are audited anyway.”
– For returns in general, Clemens says deductions for meals and entertainment can be questioned if extensive, and adds they’re deductible only up to 50 percent.
“Expenses in general that are way out of line relative to the work you do will likely be questioned,” she adds. “People who are the sole proprietor that file Schedule C’s might be questioned for telephone expenses, for instance, that seem extensive.”
“The biggest problem isn’t how much furniture, or computer equipment, or anything like that,” Cooper says. “It’s that there’s no paper trail, a lack of sophisticated tracking on the financial side. A $59 piece of software, used properly, can keep a balance sheet and produce an income statement perfectly.”
