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This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal legal adviser.

HOME OFFICE DEDUCTION

(Previously courts had disallowed deductions for musicians, actors, and athletes who practice at home without compensation and are highly paid for performances; the focal point of the business was making money at the performance, not practicing at home: NO home office deduction was allowed.)

Many independent contractors do not make money at home; their home office deductions have been disallowed for many years.

In 1997, reacting to Soliman, Congress changed the law effective 1/1/99 to also allow a deduction for a home office used to conduct substantial administrative or management activities if the taxpayer has no other fixed location where the administrative or management functions are carried out.

Now, starting 1/1/99, for home office expenses to be deductible, the home office must be used:

1. exclusively, and

2. regularly, and

• 3A) as the taxpayer's principal place of business for any trade or business (the focal point test is still used); or

• 3B) as a place where patients, clients, or customers regularly meet or deal with the taxpayer in the normal course of business [this does not include telephone calls or paperwork]; or

• 3C) to conduct administrative or management activities for his trade or business, if there is no other fixed location of the trade or business where the taxpayer conducts substantial administrative or management activities of such trade or business (regardless of whether others perform such activities at other locations).

"EXCLUSIVE:"
The Tax Court held that the exclusive use of a home office during business hours is insufficient, if the space is put to occasional personal use after hours. In Sengpiehl, the taxpayer used his dining room for business but on weekends, birthdays and holidays he used it personally: NO deduction. In another case, business use was not exclusive where space was used for one day each year for personal use.

"REGULAR:"
In Jackson v. Comr., 76 T.C. 696 (1981) the taxpayer was a licensed real estate sales representative with an office at the broker's place of business and a home office; although some clients visited taxpayer's home office, no "regular" use where clients did not usually visit the home office and taxpayer could not recall or estimate how many clients actually came to the home office.

A special rule allows deductions for home storage areas if the home (or a portion) is used regularly, but not necessarily exclusively, for storage of inventory or product samples in the taxpayer's trade or business. This special rule applies only if the dwelling unit is the sole fixed location of the taxpayer's trade or business.

This does not help many independent contractors! Storing old books, closed files, equipment, etc does not allow deductions for qualified storage.

• Lawyer who stored his law library and files in a room in his home...
• Orthodontist stored inactive dental records...
• Insurance salesman storage of files, books, and sales materials...

The bottom line is documentation. Build a case now to be able to prove later that you are entitled to the deduction. Take pictures and keep a log or diary showing when and where work is done.

Once you qualify, what is deductible on your Schedule C? First compute what percentage of the home constitutes the home office. Do this on a number of rooms basis (1 room out of 6 usable rooms [exclude kitchen, bathrooms, and garage]), or square footage, whichever is more favorable.

Home mortgage interest and taxes, insurance, heat and electric, depreciation, and all other expenses of maintenance are proportionally deductible based on the area used for business compared to the whole home. These deductions cannot reduce your business income below zero.

A deduction on Schedule C is more valuable (than a mortgage deduction on Schedule A) since it reduces Self-Employment tax as well as income tax. This is at least 2.9%. (It may save over 15% if your total income is less than $67,000.)

However, there is some worry that even legitimate home office deductions may trigger audits by the IRS. Audits are no fun, even if you win. At best, they are like a stressful trip to the dentist when you have no cavities.

2003 UPDATE: IRS Issues favorable Home Office Seller Regulations

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