| Introduction | | | | of the taxpayer's home is otherwise not deductible. |
| The IRS provides numerous examples on a variety of | | | | This expense is taken on the taxpayer's Schedule C |
| topics, usually focused on what the taxpayer cannot | | | | and results in a reduction of the 15.3% SE tax. Even if |
| do. This article covers some of the planning | | | | the taxpayer later sells the house and has to |
| opportunities, focusing on what you can do to | | | | recapture the depreciation, the SE tax savings are |
| legitimately deduct your home office expenses and to | | | | permanent. |
| maximize your home office expense deductions. The | | | | The business use portion of otherwise |
| home office deduction is one of the least understood | | | | deductible real estate taxes and home mortgage |
| deductions. Many taxpayers avoid the deduction, | | | | interest are shifted from the taxpayer's Schedule A |
| frequently on the advice of their tax accountant or | | | | (itemized personal deductions) to the Schedule C |
| attorney, for fear of an IRS audit. This is nonsense! | | | | (deductible business expenses). The legitimate shifting |
| The IRS provides detailed instructions on Business Use | | | | of the business use percentage of the taxpayer's |
| of Your Home in its Publication 587. This publication is | | | | home from Schedule A (reducing FIT and SIT) to |
| updated every year and is provided to the public, for | | | | Schedule C (reducing FIT, SIT, and SE tax) results in |
| free, by calling the IRS tax forms 1-800 telephone | | | | the additional reduction of the 15.3% SE tax. Again, the |
| number or by downloading the publication from the | | | | SE tax savings are permanent. |
| Internet at . Home office deductions are reported on | | | | For taxpayers otherwise unable to itemize, |
| Form 8829, Expenses for Business Use of Your | | | | the business use portion of otherwise deductible real |
| Home. | | | | estate taxes and home mortgage interested are |
| Folklore - The "red flag" to the IRS | | | | added to the taxpayer's Schedule C. In this case, the |
| Folklore suggests that use of the home office | | | | taxpayer benefits from combined FIT, SIT, and SE tax |
| deduction will send up a "red flag" and result in an IRS | | | | savings. |
| audit. However, it does not make sense to fail to take | | | | The business use portion of otherwise |
| a deduction that you are legitimately entitled to! | | | | non-deductible expenses such as: utilities, repairs, |
| Consider the following: | | | | homeowner's association dues, basic cable, etc., are |
| For the 1997 tax year fewer than 1.5% of all | | | | legitimately converted to deductible business expenses. |
| individual income tax returns included claims for the | | | | Not only are the related SE tax savings permanent, |
| home-office deduction. | | | | but FIT and SIT reductions are also achieved and are |
| In recent years, about 15% to 16% of all tax | | | | permanent. |
| returns have included self-employment income/losses | | | | How to qualify for the home office deduction |
| and a Schedule C or F. | | | | To qualify for the home office deduction, you must use |
| Therefore, if the IRS devoted 100 percent of | | | | the business portion of your home... |
| its audit resources to the tax returns for self-employed | | | | Exclusively (except for inventory storage or |
| taxpayers, they would only be able to audit 1/10th of | | | | day-care facilities) |
| the individual federal income tax returns with | | | | AND |
| self-employment income or losses. | | | | Regularly for your trade or business |
| Of course, the IRS does not audit the tax returns for | | | | AND |
| all self-employed taxpayers. Self-employed taxpayers | | | | The business use percentage must be: |
| establish a home office for several reasons. First, they | | | | (1) Your principal place of business |
| already own or rent a home, so operating out of their | | | | OR |
| personal residence reduces the duplication of | | | | (2) A place where you meet or deal with patients, |
| overhead and/or the maintenance of a separate | | | | clients, or customers in the normal course of your |
| office or place of business. The reduction of overhead, | | | | trade or business |
| and related monthly cash outlays for the additional | | | | OR |
| expense associated with rent, utilities, etc., reduces | | | | (3) A separate structure (detached from your home) |
| business risk and business failure rates. Establishment | | | | used in connection with the trade or business. |
| of the home office as the principal place of the | | | | FIGURE 1: Non-itemizers |
| self-employed taxpayer's trade or business also | | | | FIGURE 2: Itemizers |
| minimizes non-deductible commuting expenses and | | | | The above sections and flowcharts illustrate the tax |
| increases the business use percentage of the | | | | savings, associated with the home office deduction, |
| business use automobile and, of course, reducing fuel | | | | available to both non-itemizer and itemizer taxpayers. |
| consumption. In summary, one could legitimately argue | | | | The home office deduction for the non-itemizer |
| that the home office is good for the U.S. economy! | | | | The non-itemizer taxpayer does not file a Schedule A |
| IRS Audit Statistics | | | | with the federal income tax return. This taxpayer uses |
| The IRS publishes audit statistics. For the 1996 tax | | | | the standard deduction, because it is larger than the |
| year, 1,519,243 individual federal income tax returns | | | | itemized deductions available. This does not, however, |
| were audited (1.28%), down from 1.67% of the returns | | | | prevent the non-itemizer from deducting the business |
| filed for the 1995 tax year. The "no change" rate | | | | use portion of their home office expenses on their |
| averaged 14% for office audits, 10% for field audits | | | | Schedule C. |
| and 13% for correspondence audits. Additional | | | | As FIGURE 11-1 illustrates, the otherwise non-deductible |
| percentage audited measures for 1996 individual | | | | business use portion of utilities, insurance, depreciation, |
| federal income tax returns follows: | | | | repairs, real estate taxes and home mortgage interest |
| TABLE 1 | | | | results in FIT, SIT, and SE tax savings. Establishment of |
| Individuals - Non-business and based on Total Positive | | | | the legitimately deductible home office may also result |
| Income (TPI) | | | | in a reduction of otherwise non-deductible commuting |
| $100,000 2.27% | | | | and increased deductible business use mileage, which |
| Individuals - Schedule C with Gross Receipts as | | | | also results in increase FIT, SIT, and SE tax savings. |
| indicated | | | | The home office deduction for the itemizer |
| $100,000 4.13% | | | | The itemizer taxpayer files a Schedule A with the |
| Generally, the percentage of returns examined will | | | | federal income tax return. This taxpayer is able to |
| depend on IRS staffing available for a particular | | | | legitimately shift the otherwise deductible business use |
| geographical region. The returns least likely to be | | | | portion of real estate taxes and home mortgage |
| selected for audit are those on which the majority of | | | | interest from the Schedule A to the Schedule C. The |
| the income was subject to withholding (e.g., salaries | | | | business use portion of otherwise deductible, personal |
| and wages) and where the taxpayer does not itemize | | | | expenses, are reclassified as deductible business |
| deductions on their Schedule A. | | | | expenses, resulting in additional and permanent 15.3% |
| The IRS selects returns for examination based on | | | | SE tax savings. |
| discrepancies identified against informational returns | | | | As FIGURE 11-3 illustrates, the otherwise non-deductible |
| (e.g., W-3 and 1098 transmittals), history of deficiencies, | | | | business use portion of utilities, insurance, depreciation, |
| statistically selected random sampling from an updated | | | | and repairs results in FIT, SIT, and SE tax savings. As |
| variation of the Taxpayer Compliance Measurement | | | | was the case for the non-itemizer, establishment of |
| Program (TCMP), questionable refunds and their | | | | the legitimately deductible home office may also result |
| computerized discriminant income function (i.e., DIF | | | | in a reduction of otherwise non-deductible commuting |
| scores). | | | | and increased deductible business use mileage, which |
| Why pursue the home office deduction? | | | | also results in increased FIT, SIT, and SE tax savings. |
| There are several reasons why the taxpayer should | | | | Feel free to publish or reproduce anywhere, as long as |
| deduct a home office: | | | | you provide a copy to and/or notify the author . |
| The depreciation of the business use portion | | | | |