Home Office Measurement Methods

In today's economy and with today's technology it is becoming more common that people work as independent contractors, statutory employees or simply have side jobs in the evening that provide extra income. For each of these scenarios, a person might use part of their home as their place of business.

One of the first things you'll have to do when meeting the requirements for and intending to take a home office deduction on your tax return, is to estimate the amount of space in your home you're using for business. There are two ways you can do this:

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Safe Harbor Home Office Deduction

A taxpayer (either a business owner or an employee) may elect a simplified method to compute the home office deduction for tax years beginning on or after January 1, 2013 without having to substantiate, calculate, and allocate deductible home office expenses. This is referred to as a safe harbor method of taking the home office deduction.

Under the safe harbor, the deduction is equal to $5.00 times the number of square feet of the home office. It is limited to a maximum of 300 square feet. So even if your home office is 500 square feet, the maximum deduction you can take is $1,500. Additionally, the deduction cannot exceed the taxpayer's gross income from the business (and this has to be calculated as a percentage if you are conducting your business elsewhere for parts of the day, week or year).

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Are Traveling Expenses Tax Deductible?

In general, a taxpayer may deduct ordinary and necessary traveling expenses incurred while away from home in the conduct of a trade or business. Internal Revenue Code Section 162(a)(2) and Treasury Regulation Section 1.162-2 allow for a deduction when individuals are away from home if it is reasonable for them to need to sleep or rest while their duties require them to be away from the general area of their tax home for a period substantially longer than an ordinary workday.

It doesn't always have to be that you are away for more than 24 hours. In some cases, travel expenses may be deductible even though you are away for part of the day. So, for example, a pilot that flies a charter trip and needs to rest because of duty time limits.

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Tax Deductible Car Expenses

Did you know that expenses for fuel, oil, tires, repairs, insurance, depreciation, parking fees and tolls, licenses, and even garage rent incurred for cars used in a trade or business are deductible? They are, but only to the extent the expenses are attributable to business use.

Keep in mind that these expenses must be substantiated with an exact record of the amount paid for fuel, insurance, etc. You also have to keep a mileage log of where you went, number of miles driven, and the business purpose for the trip. In lieu of calculating the operating and fixed costs for business purposes, taxpayers may use the standard mileage rate method as a simplified way to compute deductions for car expenses. So instead of adding up all the actual expenses, you simply take the total business mileage for the year and multiply it by a standard rate. For 2016 the standard mileage rate is 54 cents per mile. Even if you use the standard mileage rate method for calculating your deduction, you still have to keep a mileage log. It is the first thing an auditor will ask for when he or she sees a car expenses deduction. If you don't have one, you'll likely lose the deduction altogether and consequently have to pay tax on the added income.

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Startup Business Deductions

If you are starting a business, be careful that you do not spend too much before you technically "start" the business. Of course, you have to do some spending, but you are limited to $5,000 in business startup costs on your first year's tax return. Any overage is amortized over 180 months (yes, that's 15 years!).

What is the startup phase? That depends on a number of factors and it can differ for each individual business, since each one is unique. However, generally, you are in the startup phase during development and planning of the business. Once you become operational - generally when you are available for hire (and not necessarily that anyone has yet hired you) - then your expenses are considered those of a business in operation (and no longer "starting up").

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Home Office Deduction by Employees

Let's say you're an employee of a business and you use your home office exclusively for business work that you do at home. Can you take a home office deduction? The answer is yes, but to qualify, you must not only meet the exclusive use requirement but your use of this office must also be for the convenience of the employer (and not just your own).

Generally speaking, your home office expenses are subject to the 2% floor of your adjusted gross income. And it only applies to those taxpayers who itemize their deductions. There is an exception to this rule, only if your are classified as a statutory employee. This is not a common status for employees; but if it applies to you, the deduction is not subject to these limits.

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Taking Deductions for Your Leased Vehicle

If you use your vehicle for business purposes and you lease this vehicle, you may be wondering if you can deduct the lease payment on your business tax return. If you are a sole proprietor or single member LLC, you may choose to lease your business vehicle and the business percentage of use - and the lease amount - is deductible on your business tax return (Sched C).

But it doesn't end there! IRC Section 280F(c)(2) requires that the proprietor include the deduction amount as rental income for the vehicle (essentially as if you are renting that business portion to the business). It is sometimes referred to as an offset of that deduction or the "leased vehicle income inclusion."

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Independent Contractor vs. Employee

Independent Contractor vs. Employee?

If you have a small business that contracts with others for their services, the IRS requires that you pay attention to the specifics of their work relationship with your business.  In other words, contracting with a person to perform services for your business can be a cost-effective way of reducing administrative burdens – but you must carefully categorize these workers.

The IRS can reclassify workers you paid as independent contractors to employees.  This reclassification will bring forth the assessment of employment taxes, penalties and interest for the periods dating back to when the individual began working for the company.

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Featured

Hobby or Business?

So, you have a "side business" and it happens to be something you haven't made money on...yet.  Sure, you plan on making money someday.  But at the end of each year so far, your expenses turn out to be more than you took in.  If that goes on for too long, the IRS looks at your "side business" as really just a hobby and therefore subject to Hobby Loss rules.

Classifying what you do as a hobby really has little to do with what it is that you're doing - as long as it's legal, of course.  You could be making cupcakes or making cars; it doesn't matter.  What matters is the presumption of a profit-seeking motive. In other words, you are presumed to be engaged in an activity for profit if you can show a profit in at least three of the last five years, including the current year.

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