Equifax Finance Blog » Tax

Tax Tips: How Long Should You Keep Records?

Eva Rosenberg — Wed, 16 May 2012 01:42:58 +0000

Tax tips for small business owners. Excerpt from Small Business Taxes Made Easy by TaxMama Eva Rosenberg. Get more advice for filing taxes from TaxMama’s posts on the Equifax Finance Blog.

Keep all tax returns forever. Ignore what anyone else tells you. There have been too many times that the IRS or the state has made demands on tax returns filed 8 or 10 years ago, saying they were never filed. If you have a copy, you can insist it was filed.

If you send money in with those tax returns, keep a copy of the canceled check in the file with the returns. If you got a refund, make a copy of that, too. If the IRS grabbed your refund, you wont have any check copies, but you’ll have a letter saying it grabbed the refund from a given year. One of these three items will prove that your return was filed.

Keep copies of all asset purchases for the life of the asset plus 10 years or for the life of the loan on the asset plus 10 years. If it’s real estate, keep the paperwork until you sell it, plus 10 years.

Basically, keep everything for at least 10 years after its useful life or tax return filing date is past.

You realize, of course, there is this rule in the universe: As long as you keep it, you won’t need it. The minute you throw it out, everyone will need it.

Until two years ago, I kept all my client records, from way back in the 1970s. Finally, I got bold and decided to give the records to the clients whose addresses I still had – and to shred the files of people I couldn’t reach. I only shredded the files that were at least five years old, plus my own personal records.

One hour after I finished shredding, a client who’d filed bankruptcy a couple of years earlier, owing me money, called. He wanted the paperwork on the money he owed me so he could pay it off. (He had never listed my debt in the bankruptcy.) Well, I didn’t have the papers, so I couldn’t prove what he owed me. If it had been anyone else, I could have waved good-bye to that money. Luckily with Adam, he just shrugged and sent me what he thought he owed me.

Eva Rosenberg, EA is the publisher of TaxMama.com , where your tax questions are answered. Eva is the author of several books and ebooks, including the new edition of Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com and tax courses you might enjoy at http://www.cpelink.com/teamtaxmama.

After Filing Taxes: Responding to Letters from IRS

Eva Rosenberg — Wed, 09 May 2012 01:37:01 +0000

You sent off your tax return last month, expecting to be done filing taxes. But what do you do when you receive a letter back from the IRS? Don’t panic. Often, communication from the IRS can be resolved quickly.

However, there are some people who don’t even open mail from the IRS. They are so afraid that the letters sit there, gathering dust, sometimes for years. What’s the end result? Bad things—bank accounts cleared out, wage levies, or even the IRS emptying out your home.

I said “don’t panic”—yet, I’m also saying that terrible things can happen? Bad things generally happen only to people who don’t open their mail. Not you. When you receive a letter from any taxing agency, open it immediately. Correspondence from tax agencies is time-sensitive. Responding within the time frame specified in the letter gives you options. For this reason, if you’re a frequent traveler, have a friend, family member, or employee monitor your mail while you’re gone and open any letter that may arrive from such an agency.

Understand the letter from the IRS

If you don’t understand the letter you have received, have someone help you. If you’re already working with a tax professional, fax (or scan and transmit) a copy to him or her, immediately, and ask for an interpretation.

On your own? The IRS website provides a list of the codes that may appear in the top-right corner of your letter. These codes will help to explain the letter’s purpose. Click on the appropriate code on the IRS site for instructions on what to do next.

You’d rather call the IRS? Go ahead and call the phone number on the notice. (Tip: Call in the middle of the week, either early in the morning or in the early afternoon.)

When you reach someone on the phone, ask for that person’s name (ask him or her to spell it) and employee badge number. Write down the date and time of the conversation. Be prepared to identify yourself with your name, Social Security Number, date of birth, and info from the relevant tax return, so have that all handy.

Be polite. Don’t be angry. The person with whom you are speaking didn’t cause the problem, but he or she might be able to solve it. If not, perhaps that person can tell you who can. If you speak to someone who is rude or hostile, request a supervisor. If the person hangs up on you, well, you got a name and employee number at the beginning, right? File a complaint with the TIGTA (Treasury Inspector General for Tax Administration). And call again—you’ll get someone else who just might help you!

Solve the problem

Most issues are easy to solve. For example, the letter may report a math error. In that case, there’s nothing to do.

If the letter says you omitted something from the return, carefully review the information the IRS has provided. If the IRS is right, pay the bill. But do not sign the letter agreeing to anything because the IRS is often wrong. The information may be somewhere on your tax return, but the computer couldn’t find it. Or the 1099 may be a duplicate or in error. In any of these cases, write a brief, clear explanation of the error. Provide copies of proof, if available, and ask the IRS to cancel the proposed assessment.

If you get a levy notice, you’ve waited too long and ignored too many notices. However, even this can be fixed. At this point, though, you may need professional help. You can find an Enrolled Agent through the National Association of Enrolled Agents website. You can also find a CPA via your state society’s website or the CPA directory.

Learning from Your Mistakes when Filing Taxes

Eva Rosenberg — Wed, 02 May 2012 02:19:56 +0000

During the last two weeks of tax season, TaxMama got some heartbreaking requests for information from people who had done things in 2011 that couldn’t be fixed when filing taxes.

Perhaps these are things you’re also thinking of doing right now? Let’s learn from their mistakes.

First-time homebuyer credit errors

The first-time homebuyer credit had tight strings attached. The home for which you received the credit must then be your personal residence for 36 months.

People have said they moved out, or rented out the home, or were evicted. Those things bring about a required repayment to the IRS. There’s no reduction for living in the home for 22 months instead of 36 months.

Only one person called me before selling her home to find out the restrictions on this credit. She opted to stay for several more months instead of taking the hit when filing taxes.

How can you avoid the repayment? The credit must be repaid up to the amount of the profit. Selling at a loss, or being evicted, might mean either no repayment or repaying a smaller amount. Beware—if your loan(s) were for more than the price of the house, you may find you owe more of that credit than you expected.

If you simply cannot afford the house, consider remaining in it but renting out rooms. There’s no law to prevent you from renting out part of your house.

Drawing money from a 401(k) or retirement plan

You probably know that you can draw money from your IRA for things like a down payment on a home or to cover medical insurance when you are unemployed.

However, these situations only enable you to avoid early withdrawal penalties. The taxes are still due.

Worse—those penalty waivers only work for IRAs, not for funds drawn from a job-related retirement plan, like a 401(k) or 457 plan. It’s quite a shock getting hit with these penalties when filing taxes.

But if you need money badly, what are your options to avoid paying penalties?

1) While you are still employed, borrow the money from your retirement plan, if possible. You can borrow 50 percent of the account balance, up to $50,000. You pay no taxes, and you repay yourself over several years.

2) Roll the money from your retirement plan over into an IRA first. You’ll avoid the early withdrawal penalties for certain uses of the funds.

3) Get a loan. Credit card loans are cheaper than paying the highest federal and state tax bracket plus penalties—usually close to 45 percent by the time you’re done.

Getting your spouse’s retirement funds in a divorce

A special provision in the Tax Code allows the penalties and taxes to be waived when the court orders a distribution from one spouse’s retirement plan to be paid to the ex-spouse: a QDRO, or qualified domestic relations order.

But taking the money and cashing it all out or putting into your bank account is a mistake. While you’ll avoid the 10 percent early withdrawal penalty, you’ll pay taxes on money you don’t really need presently.

The solution: Split the distribution into two funds. Draw the money you absolutely need for current expenses. Put the rest into an IRA you open specifically for this purpose.

If the account has a lot of money in it, arrange to draw out the funds like an annuity using a special formula. That gives you a budget and avoids the early withdrawal penalties.

Cancellation of debt

Yippee! Your credit card company cancelled your balance. Your mortgage was modified. You’ve cut your debt by a fortune.

Oops! That’s all taxable income. Read this blog post to learn how to avoid paying taxes.

Bottom line when filing taxes

Before taking any major financial steps, please, please, please get advice from a competent tax professional, an estate attorney, or whoever is the right person for the job.

Filing Taxes: Learning from Others’ Mistakes

Eva Rosenberg — Tue, 01 May 2012 13:03:00 +0000

Women are caring and nurturing creatures, but we can sometimes be taken advantage of. Read on to learn about two ladies who fought their own tax battles and the lessons we can learn from the mistakes they made in filing taxes.

Crazy cat lady takes on the IRS

Ms. Jan Elizabeth Van Dusen is a woman whose passion is the care and feeding of feral cats. She was audited for her charitable contributions tax deductions relating to her work with cats. Not happy with the IRS for denying her those tax deductions, she had her day in court. She represented herself—and did a pretty good job. The Tax Court took 42 pages to explain that it agreed with her position and allowed her to take some of the deductions she had originally been denied.

She would have won on ALL her tax deductions if only she had gotten receipts for all items over $250 from the organization with which she worked—Fix Our Ferals, an IRS-recognized 501(c)(3) nonprofit organization dedicated to providing free spay/neuter clinics for feral cats in San Francisco’s East Bay area. Without those receipts, she lost out.

What do we learn from Ms. Van Dusen’s story? Three things:

Volunteers’ out-of-pocket expenses are deductible if the organization keeps detailed records and receipts for your expenditures.
When your volunteer costs are $250 or more for any set of expenses, submit the information to your non-profit organization. Have it issue a receipt to you—before filing taxes.
Don’t let the IRS bully you into accepting its audit determination. Ms. Van Dusen’s story proves that even a private individual can take her fight all the way to Tax Court—and win.

Ex-husband runs business under ex-wife’s Social Security Number

Oley opened a business for her husband using her Social Security Number while they were married. (It is unclear as to why he didn’t just use his own SSN.) They got divorced about a year later, and Oley asked him to stop using her SSN. Naturally, he said he would, but unfortunately this was not true.

Oley found out that he was still using her SSN two years later, when she was filing taxes and the IRS started sending her unpleasant notices. This problem is not unique; it happens all the time.

This is a tough problem that Oley will be battling for about a year, but it could have been prevented easily, before reaching this point. Her divorce attorney should have taken some common-sense actions before the divorce was finalized. (It’s nonsense like this that inspired TaxMama’s course “A Tax Checklist For Knotty Divorces.”)

What can we learn from Oley’s story? Six things:

Never open a business for someone else using your SSN. Not even when you are married to that someone, and especially if you have a sense that the marriage is ending.
If your spouse needs your SSN because he or she has prior tax problems, you need to think that he or she is capable of creating new problems—for you.
If your spouse can’t start a business without your SSN, suggest that he or she gets a job rather than getting you into trouble too.
Ensure that she or he gets a new business ID number before the divorce is final. Include this as part of the divorce transactions. Have the Court instruct your ex to issue new W-9 forms with his or her SSN to all those who pay the business.
To be safe, upon separation from your ex, write to the IRS to notify it that you are not operating [BUSINESS NAME] under [SSN]. Any income generated under that business name and your SSN rightfully belongs to [EX-SPOUSE’S NAME and SSN]. Send a certified copy to your ex and his or her attorney.
Notify all companies that normally send your spouse a 1099 using your SSN. If you don’t know who those companies are, file a request for copies of W-2s and 1099s for the last two years using Form 4506-T. Simply check box 8. You will get copies of the 1099s with your SSN, along with the companies’ names and addresses.

You never need to feel powerless or abused by the tax system or former spouses. There’s always a way to help yourself—and for people to help you.

Avoid Paying Penalties on Estimated Taxes

Eva Rosenberg — Wed, 11 Apr 2012 02:09:39 +0000

It’s bad enough having to face paying a fortune in taxes—there’s no reason to also get stuck paying penalties when filing taxes. Yet many people just don’t review their financial status or withholding during the year—and they end up coming up short over and over again.

Although the IRS offers a delicious menu of penalties you might have to pay when filing taxes, today we’ll focus on the penalty for underpaying your estimated tax payments.

There are two basic rules to follow if you want to avoid this penalty:

Pay in enough to owe less than $1,000 by the April filing deadline.
Pay taxes on a quarterly schedule or through payroll withholding.

Easy ways to avoid an underpayment penalty

Look at your 2011 tax liability on line 61 of Form 1040 or line 35 of Form 1040A. Pay in at least that amount for 2012. If your income is increasing substantially, pay in at least 110 percent.

If you pay your taxes via payroll withholding, even if the withholding is all paid in December, the IRS regards the payment as being made evenly throughout the year. Use this to your advantage by reviewing the year-to-date withholding column on your paystub to see how much you’ve had withheld so far. Based on last year’s tax liability, how much more will you have to pay in this year to avoid the underpayment penalty?

Folks with jobs have two choices on how to handle this:

Spread the additional cost evenly through the rest of your checks.
Wait until late in the year, then dramatically increase your withholding for the last four paychecks to pay it all before December 31.

Folks owning corporations have another option. (Note: The IRS hates it when you do this—but it is legal.) In late December, write yourself a big paycheck. Deduct the entire year’s federal and state income taxes all at once. Your net paycheck may be $5, but the gross paycheck might be $150,000.

Suppose you owe the IRS $35,000 and your state $12,000. Your year-end check would look like this:

*That’s the CA rate for state disability. Look up your own state’s rate and local taxes in your state’s payroll tax tables.

You use the money all year and pay the IRS and your state in early January of the following year. This saves about $1,000 in IRS and state underpayment penalties.

Folks without payrolls must pay estimated taxes on time to avoid penalties. That means you make your payments quarterly. You can do this easily with the EFTPS system, which gives you a way to pay electronically with no fees. Get proof of the date and time of your payment, as well as to what year and form the payment should be applied. You can also pay by credit card using an approved service—but by doing so, you’ll pay convenience fees of 1.89 percent to nearly 4 percent.

Suppose your income is earned mostly at the end of the year—from big bonuses or dividends, or from a Christmas shop that you run. There’s a special—but complicated—calculation on page four of the penalty form, Form 2210. In situations like this, your best bet is to seek professional help for filing taxes.

Incidentally, the IRS has a special new form to eliminate your penalties for six months, just for this year: Form 1127A. Be aware, however, that it works only if you can pay in full by October 15—and if you meet certain other tax requirements.

File Your Taxes for Free

Eva Rosenberg — Mon, 09 Apr 2012 13:48:25 +0000

A good friend once told me, “Free is worth the paper it’s written on.” You’ve likely heard all the warnings about how there’s no such thing as a free lunch. Is this equally true when it comes to free tax preparation and tax filing services?

Let me give you some good news—there really are some terrific free services available in the tax preparation community!

In-person free tax filing

The folks who volunteer in the VITA and TCE community are enthusiastic, dedicated, and well trained to prepare the level of tax returns supported by this program. Volunteers include tax professionals (like enrolled agents), attorneys, CPAs, and accounting students, as well as amateurs who have gotten hooked on helping—and on taxes in general.

Seniors and low-income taxpayers can get face-to-face help at the VITA and TCE facilities. The AARP’s Tax-Aide team operates thousands of TCE facilities You will find sites all over the place—at colleges, libraries, religious institutions, community centers, and more. To locate one near you, call the IRS at 1-800-906-9887 or the AARP at 1-888-227-7669.

To locate special sites for members of the armed services who wish to receive free help with tax filing, contact the Armed Forces Tax Council to find a location on a base near you.

Online tax filing with commercial software

All the major tax services offer free federal tax return preparation for simpler tax returns (though you will have to pay for your state return). This year, most of your favorite tax software providers will even allow you print the return and/or e-file for free. Once you have the printed copy of your federally e-filed tax return, you can check your state’s tax department website to see if it has a way for you to e-file directly on its site. Many do.

In addition, the IRS’s Free File Alliance (FFA) is still alive and well—but you can probably find more free services on the participants’ main websites than on their FFA sites. Also, if you start a tax return on a participant’s FFA site and it exceeds the free level, you will have to start over and re-enter the information on the participant’s main site anyway.

Free tax filing from the IRS

The IRS has two more ways for you to file your taxes for free. First, you can access many forms on the IRS’s “Free Fillable Files” page. Second, for people who don’t have access to their own computers, the IRS provides a service at a number of community sites, called Facilitated Self-Assistance Sites, where you can use its computers instead—and perhaps even get a little personal guidance. The IRS website offers a complete list of the locations of these sites.

Is filing taxes for free a good idea?

For relatively simple tax returns, absolutely! For tax returns involving earned income tax credits or elderly-related benefits and issues? You bet!

And when it comes to military issues? It’s important to know that there are rules related to state taxes that give members of the armed forces special benefits. Volunteers may have the answers, but perhaps, for state issues, you’ll want to get help from an expert tax professional instead.

Filing Taxes: Paperwork For Your Tax Professional

Eva Rosenberg — Fri, 06 Apr 2012 03:28:01 +0000

After 20 years of working with the same clients, it still astonishes me that every year the very same people forget to bring the very same documents to me when they are filing taxes.

One of the nice things about working with a tax pro is the organization that he or she can offer you. That organization includes a few nifty things:

A list of questions about changes in your life and finances.
A checklist of forms to bring.
Many pages of information for you to enter data, as well as a column that will show you last year’s amounts.

That column with last year’s information is a valuable tool. It can help determine if you have included all the same sources of income and tax deductions (banks, employers, mortgage companies, etc.). Typically, when your amounts are significantly different, something has been omitted.

For instance, if your interest income is half of last year’s, perhaps you are missing a 1099-INT from one of your banks. After all, banks change names or ownership very often. Of course, this also could mean that one of your higher-paying CDs matured earlier in the year—and you had to reinvest it for 1 percent or less.

Similarly, when mortgage interest appears far too low, it might be a red flag that you are missing a mortgage statement. On the other hand, you might have been lucky enough to refinance that 6 percent loan and snag a 3.5 percent rate.

Your tax pro will help analyze the changes in your income and expenses to ensure everything is included when you’re filing taxes for the current year.

What should you be sure to bring when filing taxes?

Every W-2 you have received.

If you are missing a W-2, bring the last paystub with the year-to-date information, or bring enough information so we can reconstruct your wages and withholding.

Every 1099 you received from your banks and brokerages.

Every 1099-B from your investments showing the sales of securities. Generally overlooked is the purchase information, which you can usually get from your broker.

Get a printout from the investment house showing the purchase prices and dates for those securities or a summary from your records.
If you sold pages and pages worth of stocks, include a spreadsheet showing all stocks, including the purchase prices and purchase dates, with the corresponding sales prices and sales dates and a profit/loss column.

Every 1098 you receive from your lenders.

Your property tax statement for both installments during the year.

Copies of the cancelled checks for your estimated tax payments for all four quarters for 2011 or a list of the amounts paid and the dates they were paid.

Your fourth quarter estimated state tax payment for 2010, if it was made in January 2011. That might be deductible this year.

The HUD-1 statement or the equivalent if you sold any property.

These are some of the basic documents you should be bringing with you. Naturally, if you are unsure if an item is deductible, bring along all of the information you have so that your tax pro can figure it out.

READ MORE:
Filing Taxes: Take the Office-In-Home Tax Deduction
Organize Your Paperwork Before Filing Taxes
Filing Taxes: Smart Things to Do with Your Tax Refund
Make a Game Out of Filing Taxes
Eva Rosenberg, EA is the publisher of TaxMama.com , where your tax questions are answered. Eva is the author of several books and ebooks, including the new edition of Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com and tax courses you might enjoy at http://www.cpelink.com/teamtaxmama.

Moving and Changing Your Tax Withholding

Eva Rosenberg — Thu, 05 Apr 2012 13:47:38 +0000

A couple of months ago, someone wrote to TaxMama®, utterly shocked when he got his W-2. Early in the year, his company had relocated him from his home state to a different state. Somehow, the payroll department never changed his state withholding to his new location. This meant he hadn’t paid anything to his current state at all, and he now will be facing penalties when filing taxes.

I have great sympathy for this dilemma. Unfortunately, I see this kind of thing happening all too often—but I don’t understand how it can happen. It is your responsibility to take care of your own finances—not your employer’s. YOU have to look at your own paystub.

Can you think of ways to avoid a problem like this?

1) Don’t assume your boss or organization will notify the payroll department about your new location. Do it yourself.
2) Make sure to file a new set of W-4 forms—one for the IRS and one for your state. Include a cover sheet to the payroll department instructing it when to start withholding in the new state. Be sure to also tell the department to stop withholding in the old state. Incidentally, if you can’t find your state’s W-4 form, make a second copy of the IRS’s form. In BIG RED LETTERS at the top of the form, write the name of the state.
3) Don’t assume that the payroll department actually has done what you asked. Look at your paystub and make sure it is showing withholding in your new state. If it is not, contact the department immediately. Get the name of the person you speak to and write down the date, time, and email address or fax number. Follow up in writing so you have a record of the conversation.
4) Repeat step three with each paycheck until your withholding is correct.
5) If it takes a long time to get the change made, have the payroll department deduct a little extra for the new state in one of the paychecks.

Yes, you do have to wonder why someone in payroll doesn’t ask, “If we are sending a paycheck to one state, why does this person have withholding for another?”

The answer is that because payroll is, essentially, automated, the staff doesn’t routinely see the employee addresses on a week-to-week basis. They only see changes to a routine paycheck—like overtime hours, reimbursements, advances, bonuses, sick pay, or vacation pay. It won’t be readily apparent to payroll personnel that the withholding state and the mailing address state are different.

Temporary moves

What’s if this is just a temporary re-assignment for a few months or a year, after which you plan to return to your home state?

Even though the move is temporary, when working in a state, you should expect to pay taxes there. Make sure you have withholding for that state’s taxes while you’re working there. You will be filing taxes as a non-resident in that state and as a resident in your own state.

Consult with a tax professional at the outset to ensure you won’t be taxed by both states. If there is any conflict, you can negotiate with your employer to make an adjustment in your wages. You can’t do this when you get your W-2—by then, it will be too late.

Sure, there are a lot of things to do when you move. But please, remember your withholding, too.

Itemize or Take the Standard Tax Deduction?

Eva Rosenberg — Wed, 04 Apr 2012 12:52:10 +0000

The sweetest 90-year-old lady has been my client for years. She meticulously summarizes her potential itemized tax deductions and gives me a detailed list. But I can’t use a bit of it on Schedule A when I’m filing taxes. Why? Her standard tax deduction far exceeds any itemized tax deductions she could possibly generate.

What about you? Are you working too hard to itemize—for no benefit?

Your standard tax deduction for 2011 is as follows:

Single $ 5,800
Married, filing jointly or qualifying widow(er) $ 11,600
Married, filing separately $ 5,800
Head of Household $ 8,500

Folks who are over age 65 or who are blind can add $1,450 for each condition when filing as single or head of household. Add $1,150 to each condition if you are married or are a qualifying widow(er).

Let’s look at itemizing when filing taxes

Medical – Before you can deduct the first dollar of medical expenses, they must exceed 7.5 percent of your adjusted gross income (AGI). For most people, this hurdle is insurmountable. However, the average employee paying for his/her own insurance could exceed this threshold.

Medical expenses include certain child or dependent care costs, therapies of all kinds, and special schools. It also includes assisted care facility costs. If you have care provider costs, be sure those people are either on payroll as household employees or are working through an agency.

Taxes – High-income folks will have enough state tax withheld to be able to itemize. Deduct the cost of state disability insurance withheld on the paycheck. Often overlooked is the auto registration fee, which is tax deductible. Property taxes deductions are limited to actual taxes. When your property tax bill includes other assessments, those are not deductible.

There is an alternative to paying state income taxes—use sales taxes instead. That’s the option to use when your state has no income taxes. When you use sales taxes instead of income taxes, your state tax refund won’t be taxable income next year.

Interest – The home mortgage interest deduction is limited to the interest on acquisition debt, plus $100,000. As people refinance their loans to bring rates down to 3 percent to 5 percent, interest deductions drop accordingly.

Points are not deductible when you refinance, and you must spread the deduction over the life of the loan. Note that PMI insurance is still a deduction in 2011.

Charity – People who tithe (contribute 10 percent or more of their income) often generate enough expenses to push their itemized deductions over the top. If you do this, be sure you have receipts for all donations of $250 or more and prepare detailed schedules of non-cash donations totaling $500 or more. Use the free ItsDeductible software to help you define the values of the items you donate.

Casualty and Theft – Personal losses must exceed 10 percent of AGI plus $100. The form is complicated and may involve appraisals—and it generally generates an audit, after all your troubles. Whoopee!

Miscellaneous Itemized Deductions – This is sort of a catchall area for all other deductions. Most expenses are reduced by 2 percent of AGI. This is a valuable area for people who pay hefty union dues or who have lots of unreimbursed employee business expenses, including mileage and travel.

Tax Filing strategy tips:

Don’t get greedy with employee business expenses. This major area of abuse is regularly audited.
When itemized deductions are not much more than standard deductions, don’t itemize. This will reduce your chances for audit.

Filing Taxes: Take the Office-In-Home Tax Deduction

Eva Rosenberg — Tue, 03 Apr 2012 13:50:24 +0000

“Stay away from that. It’s a major red flag!”

That’s what I keep hearing from people as they’re filing taxes. “Oh no, I don’t want to risk an audit. Not on my return—no office-in-home deduction for me.”

Don’t be silly. Practically everyone is working from home these days. Thanks to special new security precautions and filing systems, even IRS staff can work from home.

Home office rules for both employees and business owners

In order to be considered a home office, a space must be your primary place of work—where you meet with clients, patients, or customers; where you do all your paperwork, make all your calls to schedule appointments, and keep all your business records; or where you store all of your inventory. You must have a specific, separate area where you work.

This means that using the dining room during the day and then using that area for the family meal at night doesn’t count. Instead, you must establish a permanent room or part of a room or garage for your desk, equipment, or inventory.

Home-office expenses are always limited to employees’ W-2 income or business owners’ profits. Tax-deductible expenses include the business percentage of:

Rent or mortgage interest and property taxes
Homeowners insurance
Utilities
Maintenance, gardening, and landscaping
Security systems
Homeowners association fees
Housekeeping

Naturally, all expenses directly related to the business space are fully deductible, including business insurance.

In addition, homeowners must depreciate the business part of the home. It does complicate things now and when you sell the house, but that’s another story.

Starting with employees

To claim office-in-home deductions, the employee must be using the home for the employer’s convenience. Get this in writing!

Sometimes, this is obvious—for example, a company is located in Ohio and the employee’s sales territory or customer base is in New Mexico and Texas. Or a company might be in the same town but might lack the office space for the employee to be on site.

It’s important that employees doing similar jobs receive the same treatment. If not, it could be asked why one employee is working at home while others work in the office. Define the reason, in writing. For instance, you might note that you work at night and it’s too costly for your employer to provide nighttime security at the office.

Employees report office-in-home costs on line 4 of Form 2106. To compute the expenses, there’s a worksheet in IRS Publication 587.

Being self-employed

Many people are running their businesses from home. It’s cheaper and more convenient—and definitely a green alternative.

Although losses are limited to business profits, business owners can apply the unused losses on future years’ tax returns. These losses reduce your future self-employment taxes, as well as income taxes.

Report your home office expenses on Form 8829. Note that there is a special area for daycare businesses to compute the business space based on hours used, rather than the exclusive business use of the space. The bottom of the form has the depreciation computation. That’s also where you’ll find the line for the unused depreciation to carry over to the next year.

Real red flags when filing taxes

Seemingly duplicate expenses on Schedule C will attract attention. Report all utilities on Form 8829; don’t take them as line items on Schedule C. When renting storage space, don’t put it on the rent line on Schedule C—put it on one of the blank lines on page two instead. Having both rent and a Form 8829 is a red flag.

Final tip

Since you’re not paying office rent, use the money you save to pay down your mortgage. This trick has helped many people be mortgage-free today.