Home Offices: What the Taxman Says

There are tax advantages to working at home, just avoid the temptation to claim more and greater deductions than the IRS is prepared to swallow

By Karen E. Klein

Q: I am a medical transcriptionist and have worked from home for 18 years. I was recently told that if I were to incorporate I could deduct the entire cost of my mortgage as my "corporate headquarters" and also deduct 100% of such expenses as a company car, educational costs and child care because they could be listed as "employee" benefits, with me being the employee. Is this true? -- B.S., Levittown, Pa.


There are a number of benefits to being incorporated, but you need to be earning significant dollars to justify the expense of setting up and maintaining the corporation, which requires annual fees and paperwork. Generally, you can deduct mortgage-interest expense and, if it is a rental property or used in a trade or business, you can depreciate the building (not land) cost, says Barbara Rosenbaum, a CPA with Gumbiner, Savett, Finkel, Fingleson & Rose in Santa Monica, Calif.


  "Deducing the entire cost of a mortgage is not an option, whether you are incorporated or not," Rosenbaum says. "You are entitled to a business deduction for the business use of an auto, but from experience, I can tell you that if you use only one car -- whether you own it individually or in your 100%-owned corporation -- the tax authorities will have a hard time accepting 100% business use of that auto."

You are entitled to a business deduction for educational expenses related to training in your field of current work, she says. But if you were to go to, say, law school, that would be considered a change in occupation, so the related educational expenses would not qualify as a business deduction.

There are many employee benefits available to self-employed taxpayers, as well as to incorporated businesses. A corporation may be able to provide a medical reimbursement plan, cafeteria plan, or retirement plan that you cannot provide for yourself as a self-employed entity. But again, the expense and time involved in incorporating typically is not justified for a sole proprietor with no employees.


  Since you have worked from home for many years, you should be familiar with the home office and business-use-of-an-auto deductions available to self-employed taxpayers. Make sure you are taking full advantage by talking to your accountant and checking out the Internal Revenue Service's guidelines on home-office deductions in Publication 587, Business Use of Your Home 2003. Make special note of the strict rules that govern home-office deductions.

If you maintain your office at home, you may be entitled to a special tax break on your commuting costs. For most people, the cost of daily travel between home and a regular work location is a nondeductible expense. However, taxpayers who have an office at home can deduct the daily costs of travel between home and another work location in the same business, regardless of distance and regardless of whether the other location is regular or temporary. "Note that you get this break only if your home is your principal place of business," Rosenbaum cautions. You must be able to substantiate the auto expenses that you claim through adequate records, such as a log or diary. You can either use the standard mileage rate or deduct your actual expenses.

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Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.