If you own a home business, odds are you're a sole proprietor and claim your business income and expenses on your personal tax return. Even though your business didn't make a profit, the Internal Revenue Service still requires you to report all your business activity on your tax return. Claiming a loss from your business can help reduce your overall taxable income.

Do You Need to Report Your Income?

The only time the IRS doesn’t require you to report your home business on your taxes is when your business has no activity for the year. If you did earn income or invest in your business, you must report the activity on Schedule C. In the "Income" section you subtract your returns, allowances and cost of goods sold from your gross receipts to determine your gross income. Because the income you earned from your business isn't necessarily money that went straight into your pocket, the IRS doesn't tax your gross income. The IRS taxes your business income after deducting your business expenses.

Report Your Expenses

According to the IRS, a business expense must be necessary and ordinary for your business to be tax-deductible. The expense doesn't have to be crucial, but it does have to be common for the type of business you operate. For example, you can't claim the cost of a new truck for an accounting business because you perform the work inside your home; however, you can claim the expense for a landscaping business because your business requires you to travel for work.

Business Use of Your Home

When you use a portion of your home to work, you can deduct a part of your home's bills as a business expense. To qualify, you must use the area exclusively for business. For example, if you're an editor and you transform a spare bedroom into an office, you can write off that portion of your home's expenses as long as you only use the office for business. The amount of expenses the IRS allows you to write off is equal to the portion of your home you use for business. For example, if your home is 2,000 square feet and your office area is 200 square feet, you can write off 10 percent of your home's expenses as a business expense. Expenses that qualify include your mortgage interest, real estate taxes, rent, utilities, depreciation, insurance, repairs, maintenance and casualty losses.

Losses That Offset Other Income

The IRS understands that starting a business can be costly and that some businesses take a few years to earn a profit. When your business doesn't earn a profit, the amount of your loss offsets your other income. For example, if your wife earned $50,000 and you lost $20,000 starting up your business, your taxable income for the year is only $30,000. The IRS typically allows you to claim a loss for three out of five tax years before investigating the business activities. If your business doesn't earn a profit after the third year, the IRS might consider the business a hobby. The expenses you incur for a hobby are not deductible on your taxes.