BY MELINDA BUCKNAM, CPA
Afraid of an automatic audit from the tax man
this year? Want to write-off that home office but
you’ve heard it’s a red flag? Not necessarily the
case.
Articles sometimes claim that having a home
office increases your chances of being audited.
While this may be statistically true, the IRS still
audits less than 1 percent of returns annually. For
folks making more than $200k, the audit rate is just
about 3 percent and for income over $1 million,
it jumps to almost 10 percent. I’m guessing most
people that make over $1 million a year don’t have
a home office anyway. But if you legitimately qualify
for a home office, you should take it.
The home office deduction has gone through
many changes over the years. It went from an easy
write-off, to stringent rules that made it almost
impossible, to court cases that made it easier again,
and with the latest twist, the new simplified option.
Introduced by the IRS in 2013, we’ve found our
clients like this new method much better.
Some people think that the write-off for a home
office isn’t worth the trouble. This would generally
be true if it were not for the ability to include as
a deduction commuting back and forth from your
home office to any business meeting or event,
which the IRS calls “commuting mileage.” Adding
this can make the auto write-off quite large, and
having a home office is the pathway to get there.
While the auto portion may be easy, the traditional
way (prior to the 2013 change) of calculating
the home office deduction can be a bit of a nightmare.
It involves figuring out the square footage of
the entire home and dividing the home office area
into that, to get to a percentage use, which is then
multiplied by qualifying home expenses.
After this, you need to calculate depreciation for
the home (the nightmarish part), which involves
digging up original closing documents and capital
improvements over the years, then doing a number of complex calculations regarding land and being
exposed to depreciation recapture if the house is
sold for a gain later. If you moved during the tax
year–let’s not even go there. Bottom line, this
is a lot of information to gather and can be overwhelming
the first year the home office expense
deduction is taken, especially if it’s the first year
you are in business. Putting together income and
expenses can be perplexing enough for some new
business owners.
Alternatively, by using the new IRS simplified
method, the only thing needed is the square footage
of the actual office. Just multiply that by the
IRS-determined rate of $5 to arrive at the write-off
for the year. This is absolutely perfect for people
with incomplete records, who didn’t keep their
receipts, or who just want to make tax time easier.
Plus, the full amount of mortgage interest and
property taxes paid can be taken as an itemized
deduction, instead of deducting out the part taken
on the home office form. An added benefit: no
depreciation recapture upon later sale of the home.
One method may be better than the other from
year to year, and the IRS allows switching back
and forth. The traditional way may still be worth
it for businesses that have a home office space and
storage greater than 300 square feet, the limit for
the simplified method. For offices under 300 square
feet, the traditional approach may still make sense
if you have significant home expenses, provided
you have the records necessary to do it this way.
Let’s not forget, that the rules for qualifying for
the home office still apply. The office must be used
exclusively and regularly for the business. It can be
part of a room, not necessarily a separate room, so
long as it meets this exclusive and regular use test.
When figuring out the square footage of your office,
space used to store supplies, inventory, tools, and
samples can be used.
S corporation owners with home offices are subject
to itemize deduction limitations that usually
make it almost impossible to deduct home offices.
But recently the IRS has allowed this deduction via
an employee reimbursement expense check since
owners of S corps are also employees. The company
must set up an accountable plan by preparing a
written agreement and follow some guidelines,
but once it’s set up, it’s quite easy. This is a great
tax-free way to get money out of the business, while
the company gets the deduction.
Rather than spending valuable time gathering
up all of the receipts and information to use the traditional
way of deducting a home office, consider
spending that time on growing your business. The
new simplified option is a quick and easy way to
still get a decent deduction.
Bucknam is a partner in Bucknam, Rodecker
CPAs, Wilton.
Photo Courtesy Bucknam, Rodecker CPAs