Even before COVID-19 took over the country (and the world), working entirely from home was becoming more fashionable by the minute. This has highlighted the utility of the home office write-off, which is available to employees by the state of California. However, this blog will focus on using the federal home office deduction for business owners, as well as reducing your audit risk when using the deduction.
What Qualifies as a Home Office?
To preface the requirements, you do not have to own the property you are working in to take advantage of the home office deduction. There are also no restrictions on the type of dwelling you are using.
Beyond that, there are relatively strict conditions you have to meet in order to use the deduction. There are two main requirements that need to be met: the regular and exclusive use and principal place of business requirements. To satisfy the first test, you must use your home office more often than not and ONLY for conducting business. You cannot count your living room or screened-in porch for your home office deduction.
To be the principal place of business, you must do the majority of administrative or management tasks for your company in your home office. The IRS recognizes that for many small business owners, essential tasks must be performed outside the home office. However, as long as the operation is run, for lack of a better term, out of your home office, you may use the deduction.
Simplified vs. Actual Expense Method
Partly in response to the proliferation of home offices, the IRS instituted a simplified process for using the home office deduction in 2013. With this simplified method, you can multiply $5 for every square footage of your home office with a limit of $1,500 (300 square feet).
For home offices larger than 300 square feet, you must generally calculate your home office deduction using the actual expense method. This involves calculating your annual expenses for your home—like utilities, maintenance, property taxes, insurance premiums, mortgage interest, and rent—and figuring out the percentage of each expense applies to your home office. You use IRS Form 8829 to figure out your actual expense deduction. However, you can set up an Accountable Plan to run your home office reimbursements through as indicated below.
For instance, let’s say the expenses previously mentioned totaled $5,000 for your tax year. Your home office takes up 275 square feet of your 2,000-square-foot house. Because your home office takes up 13.75 percent of your home, you may deduct 13.75 percent of $5,000 for your home office deduction, which comes out to $687.50. However, if you were to use the simplified method ($5 multiplied by 275), your deduction would be significantly higher at $1,375.
Accountable Plan and the Home Office Write-Off
Conversely, setting up an Accountable Plan can make using the home office deduction easier and better for your company’s bottom line. If your business reimburses an employee (including you as the business owner) for personal costs incurred during the course of employment (such as keeping up a home office), that will be considered taxable income unless it is reimbursed in accordance with an Accountable Plan. Simply having your home office write-off on your Accountable Plan as a line item is more cost-efficient. It also greatly reduces your audit risk, as you are not required to file IRS Form 8829 to claim your home office deduction.
Attorney Tyler Q. Dahl’s passion is finding creative ways for entrepreneurs and Californians to save money through precise and smart tax planning. On top of handling all legal matters for your business, Dahl is one of fewer than 100 attorneys nationwide who is also a Certified Tax Coach. Please get in touch with our firm today to discuss your options.
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