“Toto, we’re home!” If you are working from home or thinking about working from home, you may be able to reduce your taxes by deducting otherwise nondeductible personal expenses attributed to your business.
When determining federal taxes, an individual generally cannot deduct personal, living, or family expenses from his or her income. However, section 280A of the Internal Revenue Code (IRC) provides an exception to this rule for individuals and S-corporations (pass-through entities in which individual shareholders are subject to taxes) that meet this section’s requirements. Section 280A(c) allows an individual to claim a home office deduction, by deducting expenses incurred in operating a home office.
Where and how the home office deduction is claimed depends on the type of business entity. The home office deduction will appear on Schedule C (attached to Form 1040), if the individual is either a sole proprietor or a member of a disregarded single-member limited liability company (LLC). Alternatively, home office expenditures will be reflected as an unreimbursed partnership expense on Schedule E (attached to Form 1040), if the individual is a partner from either a partnership or an LLC taxed as a partnership. The critical requirements are that these expenses are (1) ordinary (i.e., common and accepted) and necessary (i.e., helpful and appropriate) to the partner’s trade or business, and (2) required under the partnership agreement.
Importantly, section 280A does not allow C-corporations (entities that pay taxes separately from their shareholders) and LLCs taxed as a C-corporation to claim a home office deduction. This does not prevent a C-corporation from leasing home office space from an employee. However, a different set of rules apply to this arrangement. A C-corporation may deduct payments made for the lease of a home office, under IRC section 162, as rental payments – if they are ordinary and necessary to the corporation’s trade or business. In turn, employee lessors must report these rental payments as income on Schedule E (attached to Form 1040) without any offsetting home office deduction – due to the limitation under section 280A(c)(6).
This article briefly examines how the section 280A rules (the home office deduction) applies to self-employed individuals and to employees, as well as the section’s calculation methods.
Follow the Section 280A Road
Whether you are a renter or a homeowner, you may claim a home office deduction, as a self-employed individual or as an employee working at home (for the convenience of your employer) so long as you satisfy the requirements set forth in section 280A.
First, you must designate a specific area of your home exclusively for business use. This designated space must be separately identifiable from the personal (or recreational) area of your home. This requirement is an “all-or-nothing” standard: either it is used completely for business purposes or it is not.
Second, you must regularly use this designated area to perform your business. For example, you may use the designated space to talk with your clients on the telephone for several hours, five days a week. All the surrounding facts and circumstances are considered in determining whether you meet this condition.
Third, your home office must be one of the following:
- your principal place of business;
- a space where you meet or deal with clients, in the normal course of business; or
- a detached, separate structure (e.g., studio) used for your business.
Let us consider these requirements in more detail.
Use Your Brains: Make It Your Principal Place of Business
One possible way to be able to deduct your home office expenses is to use your home as your “principal place of business.” This means that your home is the most important, consequential, or influential place where you work. If your home office is the only place where you work, then you meet this prerequisite. However, if you conduct your work at other locations, then other factors, such as the following will be considered, on a case-by-case basis:
- the amount of time you spend at your home office (compared to time spent at all other work locations);
- the importance of the business functions you perform at your home office;
- the necessity of maintaining your home office; and
- the expenditures to establish your home office.
The first two factors are the most important, as set forth in Commissioner v. Soliman (1993) 506 U.S. 168, 175, 177. If you work in different locations, you may use a safe harbor for performing your business’s administrative or management activities (e.g., billing clients and keeping records) if your home office is the only fixed location where you perform these activities.
Have Heart: Meet Your Clients in the Normal Course of Business
A second possible way to qualify for the home office deduction is to demonstrate that (1) you physically meet or deal with clients at your home office; and (2) your clients’ use of your home is substantial and integral to the conduct of your business.
Thus, your home office does not need to be your principal place of business (you may conduct business in another location), as long as you regularly meet or deal with your clients in your home office, during the normal course of business. This means that you meet your clients in your residential office, more often than incidentally or occasionally. For example, in one case, the consultant taxpayer was disqualified to claim the home office deduction, because he met his clients at his home office 5 or 10 times a year.
Do Not Fear: You Can Always Use a Separate, Detached Structure, Exclusively and Regularly for Business
A third way to qualify for the home office deduction, is to designate a separate, free-standing structure (such as a detached garage), used exclusively and regularly in connection with your trade or business. The structure does not need to be your principal place of business or a place where you meet clients, as long as it is exclusively and regularly used in connection with your business. Because the “in connection” standard is less strict, you may find it easier to be qualified for a home office deduction, with a detached structure.
As an Employee, Respect Your Wizard: Your Home Office Must Be “For the Convenience of the Employer”
If you are an employee, there is an additional requirement: The use of your home office must be “for the convenience of the employer” – and not merely appropriate and helpful. This does not mean that you decide to choose to do some of your work at home; it must be part of your job requirements. The fact that an employer does not provide you with adequate office space is a factor in the consideration of this requirement, but it is not dispositive. On the other hand, if working from home is part of your employment contract, then this fact will be in your favor.
As explained above, the key restriction is that, if you are an employee who is renting a home office space to your employer, you cannot take the home office deduction for this same space. Your employer can take a rental deduction (under section 162) for payments made to you; but you must report this rental income on your Schedule E and not offset it with the home office deduction. In other words, there is no double dipping: either the corporation claims a section 162 deduction for the ordinary and necessary use of the office space in the employee’s home or the employee claims a home office deduction.
You may, however, deduct other expenses, such as mortgage interest and property tax, regardless of the business use of your house.