TAXES AND ACCOUNTING

The New and Improved Home Office Deduction!!

If you're self-employed and work out of your home at least part of the time, you may be eligible for additional deductions this year related to using your residence in your business activities. To deduct home office expenses, the space must be used exclusively and regularly

Of these three tests, the principal place of business test is the one most taxpayers try to meet. A 1993 Supreme Court case identified two primary factors for determining whether a home office qualifies as the taxpayer's principal place of business: (1) the relative importance of the activities performed at each business location and (2) the time spent at each place. The "relative importance" test is analyzed first, and if no definitive answer is reached, the "time" test is considered. In analyzing the relative importance of the activities performed at each location, the place where clients are met or goods and services are delivered is the most important.

Example: Larry is a self-employed plumber who spends 40 hours per week at customer locations and 10 hours per week in his home office doing paperwork. In addition, a full-time unrelated employee works at Larry's home office performing administrative tasks such as scheduling and keeping the books.

Under the pre-1999 rules, Larry's home does not qualify as his principal place of business. Although the tasks performed in the home office are essential to the business, the work performed at the customer locations is more important.

Fortunately, Congress finally decided a couple of years ago that it was unfair for taxpayers in Larry's position to be denied a home office deduction. As a result, effective this year, it broadened the definition of "principal place of business" to include a place used regularly and exclusively to conduct administrative or management activities for a business if no other fixed location is available for these activities.

According to a recent IRS publication on the subject, administrative or managerial activities include:

The same publication also notes that the following activities will not disqualify your home office from being a principal place of business based on the administrative or management activities performed there.

Example: Paul is a self-employed anesthesiologist. He spends the majority of his time administering anesthesia and postoperative care in three local hospitals. One of the hospitals provides him with a small shared office where he could conduct administrative or management activities. However, he instead chooses to use a room in his home that he has converted to an office. The room is used regularly and exclusively to contact patients, surgeons, and hospitals regarding scheduling and to prepare for treatments;, to prepare and maintain billing records and patient logs; and to read medical journals and books.

Prior to 1999, Paul was not entitled to a deduction for his home office expenses because the activities performed there were less important than the services he performed at the hospitals. However, beginning this year, his home office qualifies as a principal place of business because of the administrative and management activities he conducts there. His choice to use his home office rather than the one provided by one of the hospitals doesn't disqualify his deduction.

Conclusion: Qualifying for the home office deduction can open the door to significant tax savings. However, in a few instances, it's a deduction you'll want to avoid. Call us if you'd like to discuss whether the deduction is available.
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