With the onset of COVID, many PR firms are working remotely from their homes. For example, Buchbinder is a three-office CPA firm with offices located in New York, New Jersey and Maryland. I personally work from our New Jersey office; the last time I went to the office there were three professionals working including me. So, where did everyone go? They’re working from home. This includes the partners who are considered self-employed. The question then is who can deduct home office expenses?
Office in the Home
Most expenses for personal use assets are not deductible. The exception is primarily interest and taxes. While interest is generally deductible, taxes are limited to a maximum deduction of $10,000. However, self-employed persons are allowed a deduction for office in the home expenses. Unfortunately, owners of a regular corporation (a C corporation) or a Subchapter S corporation aren’t considered self-employed and the office in the home deduction will not apply. However, self-employed individuals are allowed a deduction for home office expenses if a portion of their home is used exclusively on a regular basis as either the principal place of business for the firm, or a place of business used by clients.
From 2018 through 2025, employees aren’t allowed an office in the home deduction because these expenses are considered miscellaneous itemized deduction that aren’t deductible until possibly 2026. (This assumes Congress doesn’t extend the provision eliminating itemized deductions.)
A principal place of business includes a place of business that satisfies the following requirements: the office is used by the taxpayer to conduct administrative or management activities of the business; and there’s no other fixed location of the business where the taxpayer conducts these activities. This could be a difficult requirement to meet. However, it may be possible to argue that that the office isn't available for conducting business because of COVID. Time will tell.
The exclusive use requirement means that part of the home must be used solely for business purposes. The following example should clarify any questions on this subject.
Assume that John is a self-employed PR professional and makes an office in his home for business purposes. The office is also used by his wife to pay family bills and by their children to remote into their school classes and do homework assignments. Unfortunately, the exclusive use requirement isn't met, and no office in the home deduction will be allowed.
How is the office in home deduction determined?
The office in home deduction can be determined in either of two ways: the regular method or the simplified method.
When using the regular method—actual expenses—expenses must be categorized as direct or indirect. Direct expenses benefit only the business part of the home and are deducted in full. Indirect expenses are for maintaining and operating the home such as utilities and insurance. Indirect expenses benefit both personal use, as well as business use and allocations between the two, are therefore necessary. This allocation is determined by the floor space involved, dividing the business area involved by the total area of the home.
Home office expenses of a self-employed person
The allocation of the home office expenses can’t exceed the gross income from the business less all business expenses. What this means is the home office deduction cannot create a loss. If it does, the loss can be carried forward to future years and used subject to the same limitations.
Employees can’t benefit from the home office deduction because it’s considered an itemized deduction which is no longer allowable. However, mortgage interest is deductible and taxes up to $10,000 are also allowable if total itemized deductions exceed the standard deduction.
Finally, the home office deduction includes an allowable portion of cost recovery (depreciation) on the personal residence.
A home office deduction is also available to those who rent rather than own. In this case, the business percentage is applied to the rent being paid and utilities if paid for.
Because of the complexity of the regular method, the IRS established an optional simplified method for calculating the home office deduction. Taxpayers using this method are allowed a deduction of $5 per square foot of space devoted to the office. However, because no more than 300 square feet can be counted, the maximum deduction is limited to $1,500.
Taxpayers can choose between the simplified method and regular method each year. However, once a choice is made for a year, it can’t be changed.
So, what should you choose?
- Both methods require exclusive and regular use of the office.
- The simplified method requires fewer calculations and less record keeping.
- Because no depreciation is allowed, the simplified method will avoid the 25 percent tax on real estate gains when the home is sold.
- With a maximum deduction of $1,500, the simplified method, in most cases, will result in a smaller deduction than the regular method.
- Under the simplified method, the taxpayer isn't permitted to carry over unused deductions to the following year.
- Once a choice is made for a year, the choice can't be changed.
Next month I'll discuss the tax implications of having a principal or employee working from home in a state in which the PR firm never conducted business. I'll also discuss the home office deduction when a C or S corporation is involved.
Richard Goldstein is a partner at Buchbinder Tunick & Company LLP, New York, Certified Public Accountants.