According to data compiled in tax year 2009, more than 4 million Americans claimed the home-office deduction on their tax returns. That’s about 3 percent of the total 140 million returns filed in 2010. The number is likely to increase this year, with business startup rates having increased substantially in 2011.
Kathy Pickering, executive director of the Tax Institute, research and analysis division of tax-services provider H&R Block (HRB), says the average home-office deduction is valued at more than $2,600. Yet many taxpayers are unclear about how to claim the deduction, or they worry that if they do, they’ll face an IRS audit. Pickering says that although the home-office deduction is scrutinized closely, it should be used by those who are eligible. She spoke recently about home-office deductions and other overlooked tax opportunities with me; edited excerpts of our conversation follow.
What advice do you give individuals running home-based businesses when it comes to accounting for their expenses—particularly home-office expenses?
We try to remind them of the things that are important. For instance, you have to be very precise that a hobby is not your business. A home office needs to be just that—an office. It can’t double as a kids’ playroom or a video game room where you happen to do your crafts.
Now, there’s an exception if you’re a licensed day-care operator and you have the children using the living room and the playroom. In that case, you can deduct all that space as part of operating your business.
According to the IRS, the home office has to be not only exclusively used for business but it also has to be your principal place of business. What does that mean in practical terms?
The office has to be where you conduct most of your business and it has to be in your house—or garage or guest house on your property. It can’t be at somebody else’s place. And if you primarily work in an office building but you check your e-mail at night in a room in your home, that doesn’t work. In that case, your home is not your principal place of business.
If you call on clients or conduct meetings off-site, but you administer the business from your home office and you have no other place to do that administrative work, you can take the home-office deduction. Just be aware that eligibility rules are very strict and we absolutely recommend that people err on the side of being conservative about taking this deduction.
How does it actually work?
It allows you to deduct a percentage of your home expenses, based on the square footage of the office as compared to the size of the entire home. So you can deduct a portion of your home’s expenses, including depreciation, rent, insurance, utilities, maintenance, and general repairs, based on the business use of that part of your home.
What caveats do you give clients on this topic?
First, the deduction for the home office cannot exceed the net annual income from the business. And second, it’s important to document. If you’re legitimately entitled to take the home office deduction, keep records that show how you use your home office and take pictures of your work space and keep them with your tax records.
What credits and tax deductions do you find are frequently overlooked by small business owners and the self-employed?
A: The small business health-care tax credit is in effect and if you’ve got 25 or fewer employees and you’re paying 50 percent of their insurance premiums, you’re eligible to take it. We have a calculator where you can go plug in your numbers and see whether it will work for you.
Unfortunately, probably a lot of small employers are not eligible for the credit the way it’s written now, because either they’re not providing insurance or they’re not paying enough of the premium.
Are there other benefits that taxpayers routinely miss out on?
We pulled in a bunch of individuals as part of a marketing campaign and looked over their previous years’ tax returns. One that we caught a lot of people missing, whether they were self-employed or not, was the American opportunity tax credit. This is the best and most generous credit for people paying higher-education costs.
You can get a credit of up to $2,500 per student for the first four years of college costs, including tuition, fees, and course materials. This can mean saving $10,000 per student and you can claim it for multiple students at the same time if you’re a parent paying for your children’s college educations.