- NOTE: The simplified election starts with tax year 2013. We cannot use this election when preparing your 2012 individual tax return, unfortunately.
Wednesday, January 16, 2013
Change in Office-In-Home Rules (Starting Next Year)
The IRS surprised me yesterday.
Do you ever work from home? Let me phrase it differently: do you have an office-in-home, as the IRS defines the term?
I have an office at home and I work from home occasionally (I try to keep my workload at the office). I do not however have an office-in-home for tax purposes. Why? My office would have to meet one of three criteria to rise to a tax deduction:
(1) My office–in-home is the principal place of my trade or business
· I will not meet this test as I have an office in Cincinnati.
(2) A place where I meet with clients, patients or customers in the normal course of my business
· Granted, I do a lot of my work on a computer or over a cell phone, but I primarily meet with clients at my office in Cincinnati.
(3) I work from home for the convenience of my employer
· The IRS has interpreted this test to mean that the employer does not provide the employee with an office, so the employee – needing a place to work – has one in his/her home. If the employer does provide an office, one will have an almost insurmountable challenge in meeting this test. There may be some latitude in a hoteling situation, but you get the idea. I will likely fail this test.
Let’s say that you meet one of the three tests. Perhaps you freelance as a second job. That freelancing may qualify you for the office-in-home deduction. We meet for preparation of your taxes. We discuss expenses related to your office-in-home: the interest, taxes, utilities, insurance, security and etc. We calculate the depreciation. We then have to prorate between the personal use of your home and the business use. All the while, I am remembering that just putting this deduction on your return increases your odds of audit selection.
So the IRS came out yesterday and provided a simplified rule for an office-in-home. They will spot you $5 per square foot – up to 300 square feet - for your office. No depreciation. No proration of expenses. There is a downside: you will not be able to carryover excess office-in-home deductions under this method. There is an upside: you can elect annually which method you want to use. Obviously if you have more than 300 square feet, or your expenses run more than $5 per square foot, you will probably elect to use actual expenses.
By the way, let me clarify what the IRS means by office-in-home. Any direct expenses you have – say a camera or film for a photographer or payroll for an employee – are not considered office-in-home expenses. An alternate phrasing is that these expenses would be avoidable if you did not engage in the business activity. The office-in-home expenses are indirect and unavoidable. That is, you would still have the mortgage, taxes, and insurance whether you freelanced or not.