The current economic climate has kept me very busy helping people who have an IRS tax debt. This is due in large part to the high unemployment, which caused many Americans to attempt freelance work. The self-employed are among the top ten people I talk to about tax problems. It's no wonder, IRS tax law is exceedingly complicated for people trying to make it out there on their own.
A common misconception I hear from people working at home is that all of their house expenses now count as deductible business expenses. Another mistaken belief is that figuring out the appropriate home office deduction is both too difficult and too much of an audit risk. While you don't want to go around itemizing everything from your electricity bill to your new jacuzzi tub as a deduction, you also don't want to miss out on any deductions that are due to you. A little research paired with a conservative approach, can help you claim deductions without the risk of an unfavorable audit.
Is This Even a Home Office?
The first thing you need to do is figure out just whether or not the IRS even thinks you have a legitimate home office. Follow the flowchart below. It will help you figure that part out.
The only question that may be confusing is if the part of your home you are claiming is an office is regular AND exclusive. Let me clear that up now.
Do you need to work from that space? Do you need to meet your clients there? Then, it passes the regular test. Or, is it just a more comfortable alternative to your office that you occasionally use when you just don't feel like commuting? Then, it is not regularly used for business purposes.
Is the area you are claiming as a home office strictly a "business only" area of your house? Then, it passes the exclusive test. Or, do you do non-business related activities in that area? For instance, do you write out your personal bills at that office desk or play video games on that computer? Then, this space isn't exclusively used for business.
How Much Can You Claim?
Get out your tape measure. Go to the area that you regularly and exclusively use for business, and measure it. This could be the measurements of the desk you use for business in the corner of the master bedroom, the sewing table you use to make the aprons you sell, or the shelving unit you store your supplies. In order to keep this simpler, we're going to use a 12x12 foot room used as a home office. This would mean that 144 square feet of your house is used regularly and exclusively for your business. Let's say the total area of your house is 1,440 square feet. If you divide 1,440 by 144, you would find that your home office takes up 10% of your house. So, 10% of your house expenses can be used for your home office deduction.
The following is a picture of what deduction you could take for a year's worth of expenses might look like:
$800 per month Mortgage x 12 months= $9,600
$100 per month Utilities x 12 months= $1,200
$150 per month House Insurance x 12 months= $1,800
Property Taxes= $1750
Air Conditioner Repair= $600
Security System Installation= $1,400
$50 per month Security System Fees x 12 months= $600
TOTAL= $16,950 10% of Total Expenses= $1,695
So, $1,695 could easily be used as part of your home office deduction. Also, anything that is an expense regularly and exclusively for your business, is fully deductible. Did you buy a cell phone strictly for business purposes? Did you buy a new computer or software to be used specifically for work? Did you put up walls and a door to create a room that you could use as a home office? Any of that can go toward your home office deduction.
When is the Home Office Deduction is a Risk?
For anyone who is self-employed, they have to prove to the IRS that they are running a business and not just a hobby. If you don't turn a profit for more than a year or two, the IRS will consider your business a hobby making that home office deduction could easily be dismissed by the IRS. If your business hasn't made any money in a year or so, it may not be worth the risk to claim the home office deduction.
Even if you are running what the IRS would consider a legitimate business, you need to make sure that you keep up with all of your IRS filings and payments. Not doing this could wave a giant red flag in front of the IRS, and you could very well get audited. And, believe me, they will go over the specifics of any home office deductions you have taken. Even if you are an exemplary taxpayer and everything is on time, you may be randomly selected to be audited. It is incredibly rare, but it happens. So, be prepared. Keep every receipt, contract, and record on file for at least seven years.
Some helpful links to help you stay on top of your IRS filing:
What if You Already Messed Up?
So, you may have already erroneously jotted down the home office deduction on your Schedule C. If it has been less than 3 years since you filed the original return or 2 years since you paid the tax due on it, you can fill out a corrected 1040X and mail it in to the IRS (it has to be a paper return). However, if it was a while back and you're already in deep debt to the IRS, you may need help. In that case, call me at 1-888-415-1337
or fill out the submission form
for a free, no-obligation consultation with the best in the industry.