The Home Office Deduction
The tax break has been expanded, but make sure you know the rules.
The Taxpayer Relief Act of 1997 included a modification of the IRS’s definition of “principal place of business” that will permit a larger number of taxpayers to qualify for the home-office deduction. For tax years beginning after 1998, the deduction will be available for home offices that are used for administrative or management activities related to the taxpayer’s business (for example, billing, maintaining records, ordering supplies, scheduling appointments, creating reports).
Business/Personal Boundaries Home-based businesses, by their very nature, often have less structure. While many consider this to be an advantage, working at home can be a double-edged sword. The lack of structure tends to result in home-based workers putting in more hours than when they did not work at home. Having set office hours and “closing up” at the end of the day will help you balance business and personal matters.
Under the amended rules, a taxpayer is allowed to deduct expenses of a home office that is used for business purposes only if the space is used “exclusively” on a “regular basis” as:
The principal place of business carried on by the taxpayer,
- A place for meeting with clients or customers in the ordinary course of business, or
- A place for the taxpayer to perform administrative or management activities associated with the business, provided there is no other fixed location from which the taxpayer conducts a substantial amount of such administrative or management activities.
The Taxpayer Relief Act of 1997 added this third provision to the definition of principal place of business.
The exclusive-use test will be satisfied if a specific portion of the taxpayer’s home is used solely for business purposes or inventory storage. The regular-basis test is satisfied if the space is used on a continuing basis for business purposes (that is, incidental business use will not qualify.)
In determining the principal place of business (first provision under the definition of principal place of business, above), the IRS considers two factors: Does the taxpayer spend more business-related time in the home office than anywhere else? Are the most significant revenue-generating activities performed in the home office? Both of these factors must be considered when determining the principal place of business.
Employees
To qualify for the home-office deduction, an employee must satisfy two additional criteria. First, the use of the home office must be for the convenience of the employer (for example, the employer does not provide a space for the employee to do his/her job). Second, the taxpayer does not rent all or part of the home to the employer. Employees who telecommute may be able to satisfy the requirements for the home-office deduction.
Expenses
Home office expenses are classified into three categories:
Direct Business Expenses relate only to the taxpayer’s business activity (for example, supplies, salaries). Expenditures for additional phone lines, long-distance calls, and optional phone services for the business may be deductible as direct business expenses. However, basic local telephone service charges (that is, monthly access charges) for the first phone line in the residence generally do not qualify for the deduction.
Permissible Expenses are expenditures that could be included as itemized deductions in the individual’s tax return (for example, mortgage interest, real estate taxes, and casualty losses).
Previously Non-deductible Expenses would not be deductible if not for the home office deduction (for example, insurance, utilities, and depreciation).
Limitation
Home office deductions are limited to the gross income from the business activity. Previously non-deductible expenses cannot create or increase a net loss from a business activity. However, a carryover to future years is available for unused, allowable home-office expenses.
Sale of Residence
Tax rules generally permit a $500,000 (married filing jointly) or $250,000 (single or married filing separately) exclusion on the gain from the sale of a primary residence. If part of the home is used for business purposes, the gain is divided into two parts — personal-use portion (the exclusion applies) and business-use portion (exclusion does not apply). For example, a taxpayer who qualifies for the exclusion, but has used 25 percent of the home for business purposes during the during past five years, will only be able to apply the exclusion against 75 percent of any gain recognized on the sale of the home.
As with many tax laws there are exceptions to this rule. If you’d like a clearer picture of the size of the exclusion you qualify for, please call us.
Taxes
The “office-in-home” tax deduction is valuable because it converts a portion of otherwise nondeductible expenses (for example, utilities and homeowners insurance) into a deduction. The treatment of home offices for income tax purposes is one of the more controversial provisions in the tax law.
An individual is not entitled to deduct any expenses of using his/her home for business purposes unless the space is used exclusively on a regular basis as the “principal place of business.” The IRS applies a 2-part test to determine if the home office is the principal place of business.
Do you spend more business-related time in your home office than anywhere else?
Are the most significant revenue-generating activities performed in your home office?
If the answer to either of these questions is no, the home office will not be considered the principal place of business, and the deduction will not be available.
Business use of the home by an employee must also be for the convenience of the employer. These rules make it very difficult for an employee to qualify for the deduction.
If these three tests are met, the deduction is limited to the gross income from the business activity. Furthermore, a deduction for home-office expenses cannot create or increase a net loss from the business. Any disallowed deduction may be carried over to future years.
Taxpayers taking a deduction for business use of their home must complete Form 8829. Some tax experts believe that taking a deduction for home-office expenses, whether clearly allowable or not, increases the likelihood of an IRS audit.
These are some thoughts to consider.
If you have a home office or are considering one, please contact me. This is a specialty of mine.
Home-Office Deductions
More than one million new businesses are started each year. There are more than 27.2 million small, non-farm businesses in America. Of that Include 52 percent home-based businesses and two percent franchises. Of that, 52 percent are home-based businesses. 44 percent survive at least four years, and 31 percent survive at least seven years. Twenty-four percent of all new businesses begin with no outside financing.
What this is all pointing to (in my opinion) is there are a lot of Home based businesses out there, meaning there ought to be a lot of you with a home office for that business. Good news, the expense you have there are indeed deductions. But use caution.
The IRS has a lot of material out there for you to gather information on what’s what. After and or during your reading of all this material I would suggest you find a qualified tax professional to get a more in-depth look at your particular situation.
Note:
Depending on the size and nature of your business you may also need the year-round services and guidance of a public accountant, or perhaps just an experienced bookkeeper. Obviously there is a big difference in the costs involved with a public accountant vs that of a bookkeeper or bookkeeping service. Many tax professionals offer year-round bookkeeping, accounting and payroll services for their small business clients, while others do not. You should look for a tax professional, and/or an accountant or bookkeeper, with experience in your specific type of business.
If you feel you need an accountant be aware that you do not “need” to use a “CPA”, although there are many qualified public accountants specializing in small business that happen to be “certified”, and there may be situations where a bank or creditor may require financial statements prepared by a CPA (in which case you can hire one for the specific “engagement”).
A qualified and experienced “non-certified” public accountant may be better depending on your individual situation and needs. Many states require the licensing of “non-certified” public accountants. (As a general rule, CPA firms tend to charge a higher fee than a “non-CPA” firm, sometimes substantial, and a small “non-certified” firm may provide more personalized or individualized service.)
You should make your decision on which firm or individual to use based on your specific needs and the specific training and experience of the firm or individual, and not make any false assumptions based on initials or lack thereof.
This note appreciatively provided by
tax professional, colleague, and friend,
Robert Flach The Wondering Tax Pro.
Record keeping or bookkeeping is vital. Most (especially when starting out) will forgo the paper work side of things and concentrate 100% on carrying out their business and worry about the accounting of it all later.
One of the most important things you can do for your business is keep a calendar. In the calendar write down what you did, whom you met with, where you went, how many miles you went and what you spent. Keeping accurate records will save you money with your tax professional as you have all the numbers gathered already, thus reducing their time on your bookkeeping, reducing their bill.
Okay, so what some valid home office business deduction? A valid business deduction is generally an expense that specifically relates to the production of income, or anything that is “ordinary and necessary” to maintain your business. Of course there are exceptions. For more you can take a read through the IRS Publication 587, Business Use of Your Home and the instructions for Form 8829, Expenses for Business Use of Your Home (Instructions). Below are some examples of possible home office deductions.
- Telephone
- Computers/software
- Office furniture
- General office expenses
You’ll also be able to write off some of your regular household expenses as business deductions. To be a valid deduction there are several stipulations that must be met. The business portion of your home must be used exclusively and on a regular basis
- Your principal place of business
- A place of business used to meet with clients or customers
The deductions will be based on a percentage of business space to regular living space of your home.
Example:
Your home has 2,548 total square feet of space. 253 square feet is the total amount of space you are using as your office. This will give you a deduction of about 10.13% of certain expenses.
“There are actually several way to calculate the percentage and you’ll want to consult your tax pro on what is most advantageous for you.”
Some examples of home office expenses
- Real estate taxes
- Mortgage interest
- Utilities
- Home insurance
- Snow removal
- Exterminators
- Plumbers
- Casualty losses
- Home repairs and maintenance
- Security system
- Depreciation
Also, keep track of those things that are a direct expense. Meaning if you have a repair in the home office itself that expense is direct and generally is 100% deductable.
Note:
There is no requirement that the business portion of a room be physically separated from the rest of the room by a wall, partition or other demarcation.
Please read IRS Publication 587, Exclusive Use
For other great information, please visit
The U.S. Small Business Administration site.
Other helpful post from TWTP
THREE CHEERS FOR THE HOME OFFICE DEDUCTION! – January 8, 2008
HOME OFFICE EXPENSES OF A ONE-MAN CORPORATION – December 4, 2006
Are Credit Card Statements Sufficient Documentation for the IRS?
Written By: Steve Sildon
For those running small or home-based businesses, you may have gotten in the habit of using a credit card to charge items for your business. The nice thing about using a credit card, especially a small business credit card, is that card issuers typically provide year-end expense statements that itemize and categorize expenses, nicely and neatly. Especially at tax time, this is a nice feature for a credit card to have.
There is some confusion, however, for some small business owners about what constitutes legitimate documentation for tax purposes on their business expense deductions. Simply put, is your credit card statement good enough to document your business expenses for the IRS? If you’ve been convinced that using your credit card statements as proof enough for your business tax deductions, depending on who you ask, you just might be in for a rude awakening at tax time-even if you e-file.
Regarding business expenses, some tax preparers implore their clients to always save hard copies of their receipts, no matter what, of all their “ordinary and necessary” business expenses as proof of these expense deductions. Other tax preparers indicate that merely keeping your credit card statements, in most cases, should be satisfactory enough.
In fact, both may be right. To be safe, keeping hard copies of the actual receipts (preferably with notes about the specific purchase on the back of the receipt) is the safest and most defensible approach that you can take. Using just your credit card statements for documentation is generally not a good idea for a few reasons, but having them is certainly far better than having no documentation at all. In fact, in certain circumstances, credit card statements might just be enough proof. The IRS has warned tax professionals and businesses alike, however, that, at the very least, you’ll also have to have additional supporting documentation on top of the card statement itself to prove your tax deduction.
In some cases, your credit card statement might simply be the only documentation that you have, specifically for merchants and vendors ordered from online or by telephone where written order confirmations were not provided. In that case, you should keep your own notes and records about those purchases in your files, including the dates, the credit card used for the transaction, the items purchased, and the vendor used.
The IRS requires that any legitimate expense qualifying as deductible for your business must be “both ordinary and necessary.” An ordinary expense is one that is “common and accepted” in your specific trade or business type and a necessary expense is one that is also “helpful and appropriate” for your trade or business. Having an expense item on a card statement for purchases made at Staples, Office Depot or any local office supply store doesn’t automatically qualify the purchase as a legitimate business expense. That’s simply not proof enough. As far as the IRS is concerned, you could have easily just loaded up on iPod accessories, stereo equipment or video games (all of which are sold at Staples, Office Depot). The IRS suggests that business owners keep all the original store receipts that itemize the details of the items purchased. Ideally, the receipts should also have notes on the receipt indicating the business purpose for the items as well.
Scanning the receipts and storing them on a computer is another method that the IRS says is OK, but IRS knows about and fully understands the ease with which these digital files can be manipulated. If you are audited by the IRS and you show up with scanned images of your receipts, they will assuredly test their authenticity by cross-checking some of the scanned receipts with the original copies of the same receipts.
Another legitimate concern of business owners is fading that occurs on the original receipt paper, a fairly common occurrence. In addition to scanning the receipts, you can also make copies and file them alongside (or stapled to) the original receipts for your records as added insurance for record-keeping purposes.
While saving credit card receipts is preferred and certainly the most defensible method, there are instances, however, when a credit card statement will suffice. For example, many small business owners who take out their customers for coffee, meals or other entertainment purposes might not have all of their actual receipts because of disorganization or simply because they might have misplaced or even lost some of these receipts. Just because you’ve lost receipts does not mean that you cannot legitimately deduct them as business expenses. If you have a car expense or vehicle mileage log that tracks your mileage and vehicle expense items or an entertainment expense item log, you can use those as supporting documentation for the items in question on your credit card statement. To be legitimate and verifiable, however, business owners will need to verify who, what, why, where and how the items in question were purchased. What was the specific item? Where was it purchased? With whom and for what purpose were the items purchased? If you can provide answers to those questions and support it with documentation, you can legitimately expense the items.
The bottom line is that, as a business owner, you should make it a general practice to save all of your credit card receipts, no matter what. There’s no doubt that the physical receipt is the most ideal and simply the best evidence that you can provide for legitimizing any expense. In some instances, however, you just might not have a hard copy of the actual receipt. You can legitimately deduct these items in question, but if, and only if, you can provide sufficient supporting documentation in lieu of an actual receipt for items that you purchased.
Steve Sildon is a Senior Contributing Editor for Credit Card Assist. Steve writes about a wide variety of personal finance and credit-related topics, including credit cards, debt consolidation and credit repair.
Be sure to check out the Carnival of Pecuniary Delights No. 1: The Madoline Hatter Pecuniary Art Edition. it is a must read for us all.
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