Business Activity in the Home
The boundary separating the owner of a business and the business per se is often indistinct. One is an extension of the other. Nowhere is that clearer than in the amount of business activity occurring in the home, activity typically outside the commercial and industrial territory that constitutes the traditional business districts of the country. This activity falls into two classes: actual business operations located principally in the home or an associated structure and home offices where small employers can continue to work after they leave the firm’s primary site. Because it contributes relatively little to GDP, business activity generated from the home is frequently overlooked. Still, it provides a low overhead and an efficient means of operation for many, including those transitioning from paid employment to business ownership, as well as the social advantages of keeping the family in greater proximity. Thus this issue of the National Small Business Poll is devoted to Business Activity in the Home.
About one in four (22%) employing businesses operates primarily out of the home, including associated structures such as a garage or a barn (Q#1). Three of four of them (77%) function from the residence itself while 16 percent do from a free-standing structure outside (Q#1a). The overwhelming majority of these are among the smallest of small businesses, with 27 percent of employing firms with fewer than 10 people operating out of the home compared to 6 percent of those employing 10 – 19 people and 4 percent employing 20 people or more.
Most of these businesses are also physically small, occupying modest square footage and rooms. The median space occupied by the business is about 250 square feet, the size of a large bedroom in a middle class home (Q#1b). At the extremes, 17 percent have less than 100 square feet while another 8 percent have 2,500 square feet or more.
Almost half (48%) consist of a single room (Q#1c). Eighty (80) percent use just one or two. Nine percent have four or more rooms in their home-based business. These more spacious businesses constitute about 2 percent of the small employer population.
A popular impression is that businesses often begin in the home as a means to cut costs and transition from a job to the business. That clearly does occur, but many home-based businesses are of long standing. For example, 15 percent of all employing home-based businesses have used their residence as their primary business location for more than 30 years (Q#8). Still, there is no difference in age of businesses located primarily in the home and those that are not; both are average about 17 years.
The two groups do tend to operate in different industries, however. Home-based businesses are substantially more likely to operate on a proportional basis in the agricultural services, construction, transportation, professional services and administrative services industries. On an absolute basis, they appear more numerous in the agricultural services and on a par in construction and administrative services. Home-based, employing businesses are less common in retail, hospitality, and personal services.
a. In the Neighborhood
Traffic to and from these businesses appears light. Their employees typically work off-site and comparatively few have customers and/ or vendors as routine visitors. Fifty-two (52) percent have no one other than members of the household routinely spending a majority of their time at the business and another 30 percent have only one (Q#6a). Just 5 percent have four or more. One in four (25%) have customers and or vendors routinely visit them, an example being a solo dentist working out of the home with patients coming and going.
Because of their location, typically in residential neighborhoods, business signage is not encouraged. Just 18 percent have a sign or other identifying business markings on the entryway to or on the business premises (Q#7).
Businesses located in the home try to keep a low profile if for no other reason than keeping the neighbors happy. They seem to be successful, at least as it affects neighbor response. Ninety-six (96) percent have not had a single complaint in the last three years from the neighbors about any problem the neighbors think the business causes (Q#5). One percent field complaints frequently. This assessment is, of course, from the business perspective and may not capture silent neighbors’ irritations, but the relationship between business and neighborhood typically appears satisfactory.
b. Governmental Concerns
Zoning is often considered an impediment to establishing a business in the home, but that is not the experience of those now operating one. Fifteen (15) percent did have to obtain special zoning or land use permission to operate their business on the premises, but 83 percent did not (Q#3). Similarly, 96 percent encounter no legal or regulatory problems operating their business from the home (Q#4). These data only include small employers who successfully started, not those who may have been discouraged or terminated because of them. Still, it appears that local authorities are often reasonable about impeding businesses that start and operate from the home.
Federal tax law allows business owners to deduct business expenses. The costs of a business location, such as rent or a mortgage, heating, lighting, maintenance, are items that can be deducted. But the deduction becomes more complicated when the business is located in the home because while the share of expenses attributable to the business can be deducted, the share of expenses attributable to the residence cannot. This separation creates issues of definition, allocation, and time. It further creates an accounting recapture problem if the home is sold.
Though the business deduction for space used in the business is perfectly legitimate, only 46 percent take the deduction; 51 percent do not (Q#2). The obvious followup question is why, why should nearly half eligible to take a deduction fail to do so. Though the number of cases is small (N=50), two responses appear more frequently than do others. Twenty four (24) percent did not take the deduction because it was too complicated to make it worthwhile (Q#2a). Another 23 percent did not take it because their tax advisor cautioned against it. The reasons their tax advisors cautioned them are unknown, but complexity compared to the benefit and the potential of triggering an audit are two. The complexity rationale makes sense. If one assumes 250 square feet, the median of a home-based business, and an average home of 2,500 square feet, pro-rated business expenses are only 10 percent of the cost of a mortgage payment, heating, lighting and maintenance. That may be more trouble than it is worth.
Thirty-three (33) percent of small business owners whose businesses are not based in the home have a home office (Q#9). That constitutes about one-quarter of the small employer population. A non-mutually exclusive 3 percent have a home office in a secondary residence (Q#9a).
Home offices are somewhat smaller than home-based businesses, many of the latter consisting of a single room. Half (50%) of home offices are between 100 and 250 square feet and another 26 percent are less than 100 square feet (Q#13). The typical size of a home office therefore resembles that of a bedroom in a middle class home, not a very big bedroom at that. Just 4 percent have a home office that is larger than 500 square feet. These offices are almost always a single room. Ninety-two (92) percent of home offices consist of a single room (Q#13a). Home office suites, defined as three rooms or more, are occupied by just 3 percent of this group or 2 percent of the population.
Most home offices are used considerably. Fifty-four (54) percent of small employers use their home office every day while another 36 percent use it a few times a week (Q#10). Just 9 percent use it only a few times a month.
Home offices of small business owners appear to be used for business purposes. For example, 91 percent of home offices contain business equipment, such as a land line telephone, a desktop computer, fax or copy machine (Q#14). Moreover, in 71 percent of cases these home offices are exclusively home offices (Q#12). In 28 percent of cases, home offices occasionally double up as an extra bedroom, playroom, hobby room or personal activity rooms. These offices are typically off-limits to business partners. Only 4 percent with a home office indicate that customers, employees, and/or vendors enter it routinely (Q#11). The bulk of interaction with these three groups occurs elsewhere, presumably at the business itself.
Home offices can be deducted as a business expense from federal (and state income taxes where they exist) as a business expense. Every jurisdiction has its own rules including the federal requirement that the home office must be used exclusively for business purposes. Twenty-six (26) percent of those with a home office or 8 percent of the small employer population take the home office deduction; 69 percent do not (Q#15). The most frequently cited reason (28%) that they do not is that the deduction is too complicated to make it worthwhile, the same rationale most frequently used by those not taking a deduction of their home-based business (Q#15a). However, the second most frequently cited rationale for not taking the deduction is that they were unaware of it (21%) followed by tax advisor cautioned against it (17%) and the home office does not legally qualify for the deduction (15%).
It is important to remember that the data and discussion presented above apply only to businesses employing people other than their owners. They do not consider individuals who work full-time for themselves or who own and manage part-time operations. Including these two groups is likely to change the overall profile developed above, as combined they constitute a different population that in numerical terms swamps the population of employing business examined.
Home-based business arrangements whether in terms of primary location or home offices appear to work well. They leverage resources for those affected, allowing their owners to minimize costs which would otherwise eat into profit. They permit small business owners to remain engaged even when not on their firm’s principal physical premises, a form of telecommuting extensively employed long before the term became popular. And, the downside appears minimal. Virtually all owners think conflicts rarely arise due to business activity in homes, though neighbors and regulators may be less positive. However, the common sense informal rule governing most homebased activity, that is, ‘if it does not bother the neighbors, it’s probably just fine,’ seems largely followed.
One policy issue emerges – the complexity of the home business or office tax deduction prevents business owners from writing off legitimate business expenses. Telling is the large percentage who fail to take the deduction because their tax advisors caution them against it. That is an indictment of the applicable tax provisions and their implementation.