Right now, I’m sitting in my comfy chair in the corner by the window of my home office and drinking a freshly brewed cup of coffee from my favorite mug. The dog has done her security patrol of the perimeter, deemed me to be safe from the local deer and bunny rabbits, and has settled in for her morning nap. I’m having one of those, “This is why I’m doing this,” kind of moments and it’s nice.
As a tax person who specializes in small businesses, I get asked a lot of questions about different business practices–Should I set up an LLC? I always answer, “That depends.” Should I lease a car or buy it? That depends. Should I set up as a sub-chapter S corporation? That depends. You get the picture. But when people ask me about a home office I always say, “Yes! Every small business owner who files a schedule C should have a home office.” My answer has nothing to do with the comfy chair and coffee either. As usual with me–it’s all about the money.
A home office is good for your tax return. First, you get to use a portion of your living expenses (that you would already be paying anyway) to offset your self employment income. Remember–your self employment income is taxed at 13.2% more than your regular income tax so even something like your mortgage interest-which is already deductible, is a better deduction when it goes against your self employment income. Kaching!
a home office is foThe other reason you want r your mileage. Yes, you read that right–you want the home office deduction to claim mileage. Here’s the deal–let’s say you’re a contractor, you drive to jobs all over town. You probably put close to 20,000 miles on your truck a year for business. You claim that on your tax return and get audited. (Side note: claiming exactly 20,000 business miles on your tax return will get you audited it’s a red flag.) Anyway, you go through the audit process and the IRS disallows all 20,000 miles because you’re commuting to those job sites from your home and commuting miles are not tax deductible. That’s over $3800 worth of tax money that you just lost right there. Add the fines and penalties and you’re well over 5 grand in tax debt.
But if you had a home office–all of that mileage becomes deductible because ou’re traveling from your office to a job site.
But what if I don’t really have a home office? Seriously, you need to set something up. It doesn’t have to be a whole room–it can be a corner of a room (like my comfy chair spot although most people have a desk or table.) You can’t just say you have a home office on your tax return and not really have one. (You’ve heard of fraud, right?) Be be realistic. If you have a small business–you’ve got something–files, or a computer, or make up, or something–and it needs to be put someplace. You need a spot to make phone calls from, pay the business bills, do your adminsitrative work–that’s your home office.
Aren’t I more likely to get audited if I claim a home office? To be honest, I keep hearing that, but my experience says no. The only time I’ve seen home office expenses audited was when they really were wrong and it was part of a broader audit. (Oh yeah, and when I redid those numbers correctly the taxpayer got a bigger home office deduction.) Be honest about it and you’ve got nothing to worry about.
But what if I have a real office in a business building that I go to every day? Can I still have a home office? Yes you can. You make your home office your administrative office. Like I said, pay bills, balance the business check book. I never meet clients in my home office, they always come to my “business office” location. My business office doesn’t prevent me from having an “administrative” office at home.
If you’d like more information about claiming a home office, try this link: http://robergtaxsolutions.com/2010/09/can-you-claim-a-home-office-deduction/ It has more information about the rules and what the IRS is looking for. But seriously, if you’re a sole proprietor, you need a home office.
If you’ve claimed a home office deduction on your tax return, you’re familiar with the form—they ask you for the square footage of your home office and then they ask for the square footage of your home. Let’s say that your home is 2,000 square feet and your home office is 100 square feet, then your home office percentage is 5%. If your home operating expenses were $10,000 then you’d get to claim $500 for your home office deduction before claiming depreciation (because $500 is 5% of$10,000).
But did you know that if the rooms in your home are roughly the same size that you can figure the percentage based upon the number of rooms in your house? Say you had 8 rooms in your house, a kitchen, living room, dining room, family room, three bedrooms and your office. That would change your percentage to 12.5%, and now your deduction would be $1250—that’s more than double the difference.
Now if your home is like mine, your rooms aren’t all the same size and you can’t use the ‘number of rooms’ formula. But—the ‘number of rooms’ formula does help those of us who must use the regular square footage formula. You see, when you use the ‘number of rooms’ formula, you’re leaving out things like hallways, staircases, and bathrooms. When you’re determining the square footage for your whole home, you are allowed to deduct the following items from your total square footage:
o Space occupied by heating and air conditioning units, and water heaters
o Outside walls
By reducing your overall square footage, you increase the percentage that you can use for your home office expense. Using the office mentioned above, let’s say the taxpayer measures out his stairs, foyer, hallways, etc. and finds that it reduces his overall square footage by 500 feet. Now his percentage would be 6.67% raising his deduction to by $167 to $667.
This might not seem like a huge savings, and certainly it will vary depending upon the size of your home and your expenses. The important thing here is that its extra tax savings to you without spending any additional cash. You’ve done nothing extra except re-measure your house.
Let’s add depreciation into the mix. Let’s say, for this same house, the owner’s purchased it for $250,000. $50,000 of that was attributed to the cost of the land so we’re depreciating $200,000. If 5% of the home were depreciated, the deduction would be $256 (200,000 x 5% x 2.54% depreciation rate). By increasing the percentage used to 6.67%, then the depreciation would be $342, an increase of $86.
So now, by doing nothing more than re-measuring your house, you’ve increased your home office deduction by $253 and, if you’re self employed and in the 25% tax bracket, you’ve just saved yourself $101 in taxes.
This is one of those cases where everyone’s results will be different, but the example that I used was pretty conservative. It’s highly likely that you can save even more than this example does, especially if your expenses are higher or your home office is larger to begin with.
You always want to take advantage of any tax issue that puts money in your pocket without you putting money out. Re-measuring your home for the home office deduction is like a little gift from the IRS to help you save money on your taxes.
Filed under: Self Employed, Tax Deductions, Uncategorized
For many people who own their own business, claiming a home office is a great tax deduction. Some people who work for employers can also claim a home office, but they must also meet the requirement that it’s for the benefit of the employer. What about you? Should a home office deduction be on your tax return this year?
The first criteria for a home office is “regular and exclusive”. This basically means that you have a defined space that is only used for business. It doesn’t mean you have to have four walls, your defined space can be a section of another room. For example, let’s say you have a desk in your bedroom that you do your office work out of. You make your business calls there, the computer is there, it’s your business headquarters. Your bedroom can’t be your home office, but that corner of your bedroom certainly is. Many people think that since they don’t have a dedicated room to call an office that the home office deduction isn’t available to them. That’s not true. Let’s say that this guy’s bedroom is 12×14 feet. His office space is basically his desk, his chair and a file cabinet that takes up about 5×8 feet. His home office space is 40 square feet. Granted, that’s not much of an office, but it’s still going to help reduce his taxes and that’s the whole point isn’t it?.
Let’s go back to the “exclusive” use idea again. Let’s say you’re using your kitchen table for you office. (To be honest, it’s my favorite place to work.) The problem is, because its the kitchen table, it doesn’t qualify as exclusive use. Come five o’clock (at least at my house) I clean the table off and get ready for dinner. I actually have another spot in the house that I do claim as my home office, and I really do work up there. It doesn’t mean I never work at the kitchen table, it just means that I don’t claim the kitchen as my home office.
The concept of office space as a function of business is changing. How many people do you know would say their office is at Starbucks? The cab of their truck? Wherever their Blackberry is? (The IRS doesn’t yet allow Starbucks receipts to be claimed as office rent expense, but I wish they did.) For many people, these places really are their offices, but they still need a place where they can regularly store paperwork and/or product and receive mail. Starbucks may seam like your main office, but I would argue that you could also claim a home office deduction if you made space for it.
Now if you actually meet clients in your home, the home office deduction is almost a gimme. Also, if your home has a separate structure where you do business, that’s pretty much guaranteed. Qualified daycare providers have special rules for claiming the home office deduction, but they definitely are able to claim a portion of the home expenses against their business income.
So what home office claims are going to get denied? Well, one example that didn’t work was a woman who had a party plan business. Every week she was hosting parties in her home for 10-20 couples selling her product. She had claimed her whole house as a home office business deduction because the guests had full run of her house during the weekly parties. Right about now you may be wondering, “what the heck was she selling anyway?” Pretty mundane stuff actually. If you’re selling a home party product like Avon, or Pampered Chef, you can claim a home office deduction for the storage of your product. You can also claim office space for your administrative duties. I would even go so far as to say you could claim an area of your home if you used it exclusively for your home parties on a regular basis like this woman did. But, claiming your whole house (including your kid’s bedrooms, your bedroom, your kitchen, your personal bathroom) …that’s not going to fly.
Many people are afraid that a home office deduction guarantees an audit. That’s not the case. But, there are trip points that will make the IRS look closer at your return like claiming the whole house in the example above. Be sure to have a professional prepare, or at least review, your return when you claim a home office. The money you spend up front will be well worth it in the time and taxes saved.