Another tax season has come and gone, but this one marks the end of a particularly significant source of headaches for a growing population of taxpayers – the home business person. Beginning with this 2013 tax year, the IRS will provide new, simpler options for calculating home office tax deductions for those that work from home. The change is projected to collectively save these taxpayers more than 1.6 million hours a year in tax preparation time. For a certain portion of those that work from home, this new policy will be a huge relief and will hopefully generate interest in small business.
While the number of people who work from home full-time has been growing, the number of people who take advantage of the tax breaks it offers has not. Between 2005 and 2010 there was an increase in home workers from about 4.8 to 5.8 million people – roughly 20%. However, during this time, deductions increased by less than 7% - from about 3.2 to 3.4 million. Why are there so many not taking advantage of the deductions available to them? Some just aren’t eligible, but it is believed that, of the ones that are, many are passing on the opportunity due to complex and confusing rules and regulations and the fear of getting in trouble with the IRS. It may be for this reason that the IRS has changed the process for computing the business use of your home and made it more appealing. While the new simplified option does not change the criteria for who may claim a home office deduction, it does remove some of the complexity involved with the calculating and recordkeeping required. What this means is it will now be easier for those who work from home to deduct “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”
Before you can even consider a home business tax deduction, you must first qualify. The IRS is very clear about what constitutes a home office. For one thing, you must regularly and exclusively use part of your home for conducting business. That’s not to say you must exclusively work from home, but that the area of your home you work from is used exclusively for business. This area can be an entire room used as an office or even just a corner of a room – any space specifically set aside for work. Another thing is, while you do not have to work exclusively from your home, it does have to be your principal place of business. You may work elsewhere allowing your home is where you primarily operate.
It is widely believed that taking advantage of the home business tax break sends a red flag to the IRS and can likely result in an audit. Don’t let that discourage you. As long as you follow the rules, you can avoid trouble. Be sure your work area contains only work related materials. For instance, if you’re a music teacher and your child’s crib is in your office, you’re likely to get penalized. Take photos of your office space and keep them with your tax records. And if your “office” is just an area of a particular room rather than its own designated room, be sure you mark it clearly. Use what you can to create a distinct workspace so it is unmistakable to an auditor. Also, the deduction for your business cannot exceed the net annual income for your business. In other words, you will have had to earn more than what you try to claim. An even simpler way to say this is “don’t try to pass off a hobby as work.” If you’ve made a few bucks knitting scarves for your friends, that isn’t a business. If you plan on taking a deduction on your taxes you need to take it seriously because, rest assured, an auditor will.
Consult your accountant if a home office deduction is something you feel you qualify for. Even though the language and process has been simplified, it can still be confusing and intimidating. A tax professional will be able to break down the requirements and maybe even point out other deductions you qualify for.
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