Tax Tips for Professionals & Small Business Owners

OVERVIEW:

Home Office Deduction

Tax Incentives

Red Flags

The Home Office Deduction

The home office deduction allows you to deduct the business portion of the following expenses of your home:• utilities• home insurance premiums• repairs• the lower of the cost of your home or its market value

(through depreciation over 39 years)• property taxes• mortgage interest

Requirements of the Home Office Deduction   Your home must be used REGULARLY and EXCLUSIVELY as:• your principal place of business• a place where you meet with customers or clients• connected with your business if your home office is in a

separate structure (such as a detached garage or barn)

REGULARLY requires that business use is not occasional-such as a dentist using a home office only for occasional emergencies.

Requirements of the Home Office Deduction  EXCLUSIVELY means that if there is ANY personal use of the home office, the home office deduction will not be allowed.

There are two exceptions to the EXCLUSIVELY requirement:• you are running a daycare out of your home • the home is being used to store inventory and there is no

other fixed location where you are storing inventory

Home Office Deduction-Principal Place of BusinessTwo ways to meet the Principal Place of Business test:• The facts and circumstances test, which is based on

o the nature of the work you perform at each locationo the amount of time you spend at each location

• You perform managerial or administrative work out of your home office, and you do not perform substantial administrative or managerial work at another fixed location

Home Office Deduction-Principal Place of Business (Example)Doc is a cardiologist who has a home office where he:• does billing work• reads medical journals• schedules appointments• does bookkeeping work for his practice

Under the facts and circumstances test, the IRS looks to Doc's business and the nature of the work he performs at each location.  Doc is a cardiologist and performs surgeries and consultations at hospitals.  Since the work of a cardiologist is primarily surgical and consultative, Doc cannot take a home office deduction (under the facts and circumstances test) because his primary work is done at hospitals.

Home Office Deduction-Principal Place of Business (Example cont'd)However, Doc can take a home office deduction because he performs managerial and administrative work out of his home office (and doesn't do such work at another fixed location).

This fact scenario is based on the Solimon v. Commissioner case.  In this Supreme Court case, the Court agreed with the IRS and disallowed the home office deduction under the facts & circumstances test.  In response, Congress changed the law by expanding the definition of principal place of business to include the place where managerial and administrative tasks are performed.

Home Office Deduction-Bonus

A very important advantage of having your home as your principal place of business is that commuting expenses become deductible.  Normally, your commute to your first business stop (and from your last business stop to your home) are not deductible.  When your home is your principal place of business, commuting expenses from your home office to your first business stop (and from your last business stop to your home office) become deductible.

Home Office Deduction

If you can't meet the principal place of business requirement, there are two other ways to qualify for the home office deduction:• you meet with customers or clients in your home office

o you must actually meet with customers/clients at your home (i.e., teleconferencing or videoconferencing does not count)

• your home office is "connected with" your business if the home office is in a separate structureo the "connected with" requirement is a less stringent

requirement that the principal place of business test.  The reason for this less stringent standard is because a separate structure is less likely to be used for personal reasons.

Home Office Deduction-Caveats

• The home office deduction is limited to the income from the business (or job) for which you are using the home office

• home office deductions for employees and owners of corporations are only allowed if the employee's home office is used for the convenience of the employero If your employer provides you with an office at work, but

you choose to work at home, you can't take a home office deduction because you are working at home for you own convenience

o If your employer does not provide you with an office at work (or the availability of the work office is too restricted), your home office is more likely to be for the convenience of your employer and be deductible.

Incentives

Tax changes in 2010 created tax incentives for investing in physical capital:• 100% bonus depreciation between September 9, 2010 and

December 31, 2011• 50% bonus depreciation for all of 2012• Increased Section 179 deduction for 2011• New Section 179 deduction for real estate for 2010 and

2011

Incentives-Bonus Depreciation

Bonus depreciation allows you to deduct the purchase price of certain assets much faster than if you had to follow the normal depreciation schedules.  Under bonus depreciation, you can immediately deduct either 100% (Sep 9, 2010 to Dec 31, 2011) or 50% (January 1, 2010 through September 8, 2010 and all of 2012) of the cost of eligible property.  The remaining purchase price is depreciated over the asset's useful life.

Example:  You buy $100,000 of eligible property (defined below).  The annual depreciation under regular depreciation and bonus depreciation (assuming it’s 5 year property) is shown in the following table:

Incentives-Bonus Depreciation

Year Regular Depreciation

50% BonusDepreciation

100% BonusDepreciation

1 20,000 60,000 100,000

2 32,000 16,000

3 19,200 9,600

4 14,400 7,200

5 14,400 7,200

Total 100,000 100,000 100,000

Incentives-Bonus DepreciationBonus Depreciation is available only for assets that fall into 

one of the following categories:• property with a recovery period of 20 years or less• ITS ORIGINAL USE BEGINS WITH THE TAXPAYER

(I.E., IT IS PURCHASED NEW)• computer software (generally off-the-shelf software)• qualified leasehold improvement property

o made pursuant to leaseo occupied by lesseeo placed in service more than 3 years after date building

was placed in service

Incentives-Increased Section 179Under Section 179, a taxpayer can elect to deduct as an expense in the year of purchase up to a specified amount of the tangible personal property.  The remainder of the purchase cost is depreciated over the asset's useful life.  For tax years beginning in 2010 and 2011, the dollar limitation on the expense deduction is $500,000.  The amount was $250,000 for 2010 before the law change.  The Section 179 expense  allowance is reduced dollar for dollar when the cost of property placed in service for the year exceeds $2 million.

Example:  ABC Corp buys machinery and equipment for $2.1million.  Since the property placed in service exceeds the limitby $100,000, the allowable Section 179 expense is reduced by $100,000 to $400,000. 

Incentives-Increased Section 179The Section 179 expense is limited to taxable income from anyof the taxpayer's trades or businesses.  If the taxpayer operatesunder an S corporation or LLC, Section 179 is also subject tothe taxable income of the S corporation or LLC.  However, when determining the taxable income of an S corporation or LLC, shareholder wages (for an S corporation) or guaranteedpayments (for an LLC) are added back to the business' taxableincome.  Section 179 disallowed because of the taxable income limitation can be carried forward indefinitely.  

Incentives-Increased Section 179Example:  S Corp has $100,000 of taxable income before Section 179 expense.  If S Corp buys $150,000 of equipment, its Section 179 expense is limited to its taxable income of $100,000.

Example 2:  Same as above example except that the $100,000 taxable income is after a $60,000 deduction for shareholder wages.  Since shareholder wages are added back to taxable income for Section 179 purposes, the adjusted taxable income is $160,000 and the S corp can claim the full $150,000 Section 179 deduction.

Example 3:  NEW SET OF FACTS:  Joan operates as a proprietorship and files a Schedule C (Profit or Loss from Business).  She has $2,000 of taxable income from the business and bought $5,000 of equipment. Her husband has wages of $50,000.  Even though her proprietorship only has $2,000 of taxable income, she can claim the full $5,000 Section 179 expense because her husband's $50,000 wages count as taxable income from a trade or business for Section 179 purposes.  

Incentives-Section 179 on Real PropertyFor any tax year beginning in 2010 or 2011, a taxpayer canimmediately expense up to $250,000 of qualified real property. The qualified real property must be used in the active conduct of a trade or business, and can’t be certain ineligible property (e.g.used for lodging, used outside the U.S., used by governmental units, foreign persons or entities, and certain tax exempt organizations).

There are three types of qualifying real property:• Qualified leasehold improvement property• Qualified restaurant property• Qualified retail improvement property

Red Flags    

• Home Office Deductiono IRS is looking at "exclusively" requirement & personal

expenses being deducted through home office• Compensation for S corporation officers• Form 1099 compliance• Foreign bank account reporting• Hobby losses• Shareholder basis