Caution: Home Office Deduction
- Published: 11/05/2012
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If you are the sole owner of an unincorporated business and have not elected to be treated as a corporation for tax purposes, you are considered a “sole proprietor” for tax purposes. Sole proprietors report their business income and expenses on Schedule C, Profit or Loss from Business. Schedule C then becomes part of the owner’s individual tax return, Form 1040. Sole Proprietorships are the most common form of business in the United States, making Schedule C the most common business form filed with the IRS.
Top IRS Target: Unfortunately, the IRS attributes much of the United States’ “Tax Gap” - the difference between taxes that should be paid and tax actually reported – to errors sole proprietors make on their Schedule Cs. The frequency of errors made on Schedule C has made them among the most targeted for IRS “review.”
In an earlier column, I discussed three of the red flags most often waved at the IRS by sole proprietors: 1) Using the incorrect business classification code, 2) Errors made in reporting their business auto use, and 3) Claiming losses year after year. If you missed this article it is available at the Journal-news.net or in the articles section of hbsbusiness.com. Today, I will revisit our “red-flag” discussion by reviewing the 4th major Schedule C red flag: the home office deduction.
Benefits and Requirements: Business owners who do not have separate places of business often have no choice but to perform business activities from their home. Those who have a home area that is used regularly and exclusively for business may be entitled to take the Home Office Deduction. Claiming the Home Office Deduction allows the business owner to deduct a portion of many household expenses such as mortgage interest, property taxes, and utilities from business income. Those who start their day working in the home office may also be entitled to start counting business mileage from the home instead of from their first business appointment.
Unfortunately, many who claim the Home Office Deduction do so in error. The frequency with which this deduction is erroneously claimed makes it one of the first deductions the IRS questions. This article will help owners ensure their home office passes muster if and when it is questioned.
There are two tests a workspace must pass to be considered a home office for tax purposes:
- The workspace must be used exclusively for business, and
- The workspace must be used regularly as your principal place of business, for storing supplies/ inventory, and/or for meeting clients in the normal course of business.
Exclusive Use Test: To qualify as exclusive use, the workspace must only be used for conducting business. The area does not have to be an entire room. Part of a room - a desk, chair and filing cabinet, for example, that is used strictly and only for business will qualify. Caution: The dinner table or a desk shared with children to do their homework does not pass the exclusive use test. Please note that different rules apply to space used to store supplies or inventory as well as areas used for daycare.
Regular Use Test: In addition to being used exclusively for business, the workspace must also be used on a consistent basis, not incidentally or occasionally as the owner’s principal place of business. This rule becomes complicated when the business has more than one business location. Under these circumstances, the home workspace must be of “significantly greater” importance in providing the product or service than any other location.
If, however, a business has no other business location, the office will qualify as the principal place of business when: 1) It is used regularly and exclusively for management and administrative activities (such as invoicing and preparing estimates) and, 2) The owner has no other location from which to conduct these activities.
This article has discussed the basic requirements one must meet to claim the Home Office Deduction. There remain, however, many rules, limits and requirements not included in this article. Please remember: this or any article does not constitute or replace the advice of a qualified professional. If you have any questions regarding your taxes or would like assistance in preparing your tax returns, please feel free to call our office at (304) 267-2594.