Ask a Tax Expert: How Can I Qualify for the Home Office Deduction?
Q: We’ve already been using our house as an office but I’m not quite sure if it’s official. What do we need to qualify for the home office deduction?
-Scott in Tempe, Arizona
Stephen Fishman: You have to jump through several hoops to qualify for the home office deduction, but it can be worth it. It can be an extremely valuable deduction, particularly if you’re renter and pay a lot of rent.
Rent for the place where you live is ordinarily not deductible, but part of it can be if you have a home office. In one recent case, for example, a PR professional who had a home office in her Manhattan studio apartment qualified for an annual home office deduction of $9,293.
To qualify to take the home office deduction you must pass these tests:
(1) Exclusive Use Test: You must use a portion of your home exclusively for your business. If you use part of your home—such as a room or studio—as your business office, but you also use that space for personal purposes, you won’t qualify for the home office deduction. You can use an entire room or rooms for your office, or just part of a room.
(2) Regular Use Test: You must also use your home office regularly for your business. The IRS doesn’t say exactly how much this is, but you should use your home office at least a few hours every week.
(3) Business Importance Test: Finally, your home office has to serve an important function in your business. There are several ways to pass this test—for example:
- your home office is your principal place of business—for example, you work only in your home office or you perform your most important business activities there
- you do administrative or management work at your home office, such as billing or scheduling, and there is no other place where you regularly perform these activities
- you regularly meet clients or customers in your home office, or
- you store inventory or product samples at home.
If you pass all tests, you next need to determine what percentage of your home you use for business. Divide the square footage of your home office by the total square footage of your home.
For example, if your home is 1,600 square feet and you use 400 square feet for your home office, 25% of the total area is used for business. You can deduct your home office percentage of your rent, mortgage and property taxes, depreciation, utilities, home maintenance, insurance, and other home expenses.
However, you cannot deduct more than the annual net profit you earn from your business. If your deductions exceed your profits, you can deduct the excess in the following year and in each succeeding year until you deduct the entire amount.
Another important aspect of the home office deduction is that it enables you to take a mileage deduction when driving from your home to a place of work. Normally, this would be considered commuting and it wouldn’t be deductible. But with a qualifying home office, you can write off any business drives from your home.
You claim the deduction on your tax return by filing IRS Form 8829, Expenses for Business Use of Your Home.
Q: I have a small business that I’ve been running on my own that’s suddenly taken off. We’re planning to have my husband quit his accounting position and come to work full time for the business. However, all of our insurance is through his job. We’re considering continuing it under COBRA. Can we deduct our COBRA payments as a business expense?
-Nancy in Des Moines, IA
Stephen Fishman: If you hire your husband to work as an employee in your business, you can provide him with health insurance and deduct the cost as a business expense. In fact, such insurance can cover your whole family, not just your husband, and the whole cost is deductible.
Health insurance is a tax free employee fringe benefit, so your husband need not include the value of the insurance in his taxable income. You must treat your husband as a bona fide employee. This means you must pay him reasonable compensation, pay and withhold income taxes and Social Security and Medicare taxes, and file employment tax returns with the IRS. A payroll tax service can help with these details. You may also have to pay for unemployment insurance and workers’ compensation insurance coverage.
By the way, you before deciding to pay for COBRA coverage, you should check out the Obamacare health insurance exchange in your state. The coverage you can obtain through your state exchange could be cheaper than COBRA coverage. You can find a link to your state exchange at www.healthcare.gov
Each week, our resident small business tax expert, Stephen Fishman, answers your small business tax questions. Have a tax question for Stephen? Submit it here.
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