Previous research published by the Office of Advocacy documented a disproportionate impact of federal regulations on small business. The forthcoming report continues this inquiry by investigating the impact of regulations (federal, state, and local) on home-based business as compared to other small businesses.

The objectives of this report include: 1) to develop a complete profile of regulatory burdens that may be born by home-based businesses; 2) determine which types of regulatory burdens are either disproportionately large or disproportionately small for home-based businesses; 3) to determine which regulatory burdens specifically make it difficult to start home-based businesses, drive them underground, or prevent their growth; and 4) to provide an empirical basis for policy development.

Since consistent data on home based business is virtually unavailable, the study was qualitative rather than quantitative. Information was gathered through literature reviews, use of previous studies, interviews, review of statutes and regulations, review of forms and publications, and case studies. Case studies were the means through which information was obtained on state and local governments. Five states were selected for the study: California, District of Columbia, Illinois, Maryland, and Vermont.

Regulations with disproportionate burdens on home-based businesses are concentrated in two areas: 1) Federal Internal Revenue Service regulations; and 2) local zoning regulations. State regulations are not a major source of regulatory burdens on home-based businesses.

Federal Internal Revenue Service

This agency appears to have the most burdensome regulations of any federal agency for home-based businesses. Burdens arise both from the complexity of the tax code and from specific provisions. Examples cited included (but were not limited to):

• The tax code treats home offices as a piece of commercial real estate and the owner as a commercial real estate investor. The office must be depreciated over an unrealistically long time (39 years) and there are tax consequences if the home is sold. Most small businesses by contrast, can pay and deduct rent.
  
  
• Tax codes require that, in order to be deducted at all, a home office must be used exclusively for business. This requirement is more stringent than any tax code provision that applies to other businesses. Under this standard, regular commercial office space should not be deductible if staff brings their children to work.
  
  
• The tax code allows deductions for equipment only to the extent that it is used in the business, regardless of the necessity to the business. This requirement penalizes home-based businesses for their small scale, creates record keeping burdens, and is inconsistent with exclusive business use of an office.

Local Zoning Regulations

Over the last decade, zoning codes in many jurisdictions have been substantially revised. Some zoning codes take into consideration factors such as the character of the neighborhood or the impact of the business on the neighborhood. However, many codes still contain stringent restrictions.

• Many codes prohibit or impose limits on various aspects of home-based businesses, including restrictions on employees, visitors, parking, exterior changes, or specific businesses.
  
  
• Zoning regulations on home-based businesses seem to be designed for the most vulnerable residential neighborhoods and then applied on a jurisdiction-wide basis. Very few local jurisdictions utilize different residential zoning categories (pertaining to density and type) as a means of providing more flexibility in home-based business regulation.

While the authority to enact zoning codes is delegated to local governments, the study found that some states are enacting home occupation legislation that is supportive of home-based businesses. For example, Maryland has statutes that include a definition of "no-impact" home occupations, and thus has taken a large step toward tipping the scales favorably for home-based businesses. Vermont statutes forcefully state the right of a person to operate a business in his home. California statutes require all local jurisdictions to allow day care homes.

Implications for Business Development

The perceived reputation of the IRS creates a fear factor among home-based business owners that is intensified by the complexity of the tax code. This tends to make the very small business owner hesitant to take deductions to which they are entitled, adding to the burdens they already face. The burdens often compel businesses to go underground which serves neither IRS interests nor business growth.

Local restrictions are especially restrictive for growing home-based businesses that need to take on employees. This clearly limits the ability of the business to grow. The rationale for prohibiting certain activities in some residential areas is clear. However, jurisdiction-wide prohibition may be too strong. In areas where certain types of businesses are treated in different ways in different jurisdictions, the community values seem possibly to be in force.

The full Home-Based Business and Government Regulations report provides valuable information and insight for anyone working with home-based businesses. Early chapters outline the importance and economic impact of home-based businesses as well as characteristics such as Industry Distribution of Home Based Businesses; Distribution of Home Based Businesses by Sector; Distribution of Home Based Businesses by Type of Business Organization, and Distribution of Home Based Businesses by Employees. The remaining chapters study the regulatory burdens on home-based businesses at the local, state, and federal levels and provide examples of state rules that reduce burdens as well as recommendations.

Link to full study