Home Business Requirements

The idea of running a business from home has always had a certain appeal--albeit one that can be easily undercut when you actually wade through the complex rules surrounding taxes, insurance and other details.

Getting started isn't as simple as plugging in a computer and getting down to business. If you've set up shop at home or you're thinking about doing so, it's now more important than ever to understand what's involved and how to use current home-work rules to your advantage.

Where the tax picture is brighter. Deductions are the name of the game here, and the big question is: Do you qualify to write off home-office-related expenses? To get the "yes" answer you want, the IRS generally requires that you use your home office "exclusively" and "regularly" for business--meaning you can't transform your office into a family room after business hours. Moreover, the home office still has to meet one of three criteria. You're fine if the structure that's used for your business isn't attached to your residence, if you use the office to meet with clients or if the office is your "principal place of business."

So what can you deduct? In general, you can write off a portion of expenses that pertain to your whole residence, such as repairs, mortgage interest or rent, property taxes, insurance and utilities. You can figure the deductible percentage of these expenses one of two ways: Divide the number of rooms in your office by the number of rooms in the house (if they are roughly the same size), or calculate the square footage of your home office and divide by the square footage of the entire home.

Remember, though, that home-related deductible expenses can't exceed the income generated by the business. Expenses that pertain only to the home office--business owners insurance or office supplies, say--are 100% deductible and not subject to that limitation.

Zoning matters. This may not be the first thing you think of, but local zoning laws can affect your home office. In some cities, you need a business license and will have to pay a fee every year. Other cities restrict the right of property owners to build separate structures. Zoning laws can limit the number of employees or clients in your home office at the same time (or even forbid you from having them). There may also be restrictions on how much of your home can be used exclusively for business.

Insurance. What if an employee or a client gets hurt in your office? Don't count on homeowners insurance to cover you. A standard homeowners insurance policy provides no business liability coverage and very limited property coverage for business equipment. And if you operate a business without your insurer's knowledge, things can get murky. For example, if you are baking cookies to sell and there's a fire as a result, you may not be covered. The reason is that the business operation, not normal household activity, was responsible for the damage.

One solution may be to add an endorsement to your homeowners policy to cover your office property and equipment, and general liability. This could run from $50 to $500 a year, depending on the nature of your business.

With some enterprises, you may need a separate business owners policy, which offers more comprehensive coverage, including business auto insurance, workers' compensation and different types of liability coverage. Landscapers or others who generate income off-site aren't even eligible for an endorsement. Also, if lots of clients visit or you have more than $5,000 in equipment, consider a separate policy.

Because of the recent explosion of the home-office market, some insurers have developed specialized policies, which cost between $250 and $1,000 a year for property, on- and off-premises liability and loss of business data or income. Your best bet is to ask the agent who wrote your homeowners policy to write your home-office policy. That way you can be sure to avoid coverage gaps or overlaps.