Simplifying home office deductions for self-employed taxpayers

Home Office Deductions

Equity and Fairness

Appropriate Government Revenues

Certainty

Simplicity

Minimum Tax Gap

Convenience of Payment

Economic Growth and Efficiency

Transparency and Visibility

Possible Home Office Deduction Improvements

Home Office Deductions

For those who are self-employed or otherwise work from home, home office deductions can save money on federal income taxes. However, many people do not understand all of the nuances that surround these deductions. That can lead them to either miss deductions that they could have taken or take deductions that were not really legal for them to take. The first scenario will just cause them to lose some money in taxes. The second scenario could get them into trouble with the IRS, especially if they get audited and/or if they have been taking improper deductions (either deceitfully or out of ignorance) for some time. Being able to deduct some of the costs of having a home business does not mean that a person can deduct everything, though, and not everyone will qualify.

In order to qualify for a home office deduction, tax law requirements must be specifically met. Once that has been established, one has to determine how much of his or her residence is being used exclusively for a home-based business, whether that is the case all year round or only for a portion of the year, and how many qualifying expenses (and in what portions) can be deducted based on that information.

A large number of people who are technically eligible for the home office deduction do not take it, because they are too confused by the requirements. The calculations are complicated, and the directions for determining how much of a deduction can be taken take up more than 35 pages. The result of that confusing and large number of pages means that many home-based businesses miss out on their deductions, even though they are lawfully entitled to take them.

A survey that was conducted in 2006, for example, indicated that only 15% of the home business owners who responded had an adequate understanding of the rules.

That occurred despite the fact that more than 75% of the respondents said that their business would legally qualify for the deduction. The survey was taken by the National Federation of Independent Business Research Foundation. There are several key reasons cited when home-based business owners are asked why they do not take the deduction to which they may be legally entitled. These reasons include the complexity of the instructions and the forms, the strict requirements and rules that have to be followed, and the fear of their home office deductions triggering a flag that would result in an IRS audit.

In 2009, the Small Business Administration's Office of Advocacy placed the simplification of this deduction at the top of its published tax reform recommendations.

The proposals that it created stated that taxpayers would have the option to avoid the calculation method they found so daunting and take a standard home office tax deduction, instead. The rationale behind that simplification recommendation was that the deduction would be easier for many people to take, which would save both money and time for the IRS and also for the taxpayers. There have been several bills that have also been introduced to Congress in an effort to see the home office tax credit deduction simplified.

These have included H.R. 3615 (111th Congress) and H.R. 3056 (111th Congress).

These bills would have created a standard home office deduction of $1,500 and relaxed the requirements for the physical presence of clients in the home office in order for the deduction to be legal, respectively.

The second of those bills would also relax the exclusive use requirements, meaning that the home office could also be used for other things and still qualify for some of the deduction that would have previously only been given to offices with exclusive use. While it is unlikely that the IRS would come to a person's home in order to verify that he or she was using a specific portion of that home exclusively for an office, claiming an office that does not fit realistic guidelines for size and other factors can trigger an audit - something that the majority of taxpayers would be happy to avoid, even if that meant losing out on deductions for which they might have been eligible. While a standard home office deduction does not yet exist, evaluating one and comparing it to the current, confusing way of addressing the home office deduction is significant.

Equity and Fairness

Many issues must be considered where a home office tax deduction is concerned, and one of these issues is the concept of equity and fairness. It is important to ask oneself whether taxpayers who are similarly situated financially are actually being taxed in a similar manner. If they are not, then there is a serious discrepancy which should be addressed. Where taxpayers live and what kind of income level they have can have different effects, and these should also be considered in order to make sure that the tax system for home office deductions is truly equitable. Overall, a standard deduction would be one of the best ways to increase fairness for every small business.

For example, corporations are capable of fully deducting their operating costs in the majority of cases, and home-based businesses are not able to do this.

By changing that and allowing home-based businesses to deduct all of their operating costs, more fairness would be built into the system.

Right now, there are some equitable areas of the tax code as it relates to home-based businesses, and there are some areas where there is a serious lack of equity. Because that is the case, ideas like the standard home office deduction have been proposed. Unfortunately, these ideas have not caught on. Some home business owners use tax return software to determine whether they can take a deduction for a home office, but not all home business owners can afford this - and many of them cannot afford a tax professional, either. With that being the case, they must rely on instructions provided through the IRS for guidelines as to whether they can take the home office deduction.

When it comes to determining equity and fairness with a home office deduction, it is important for the business owner to clearly understand what constitutes a home office. Many people spend time setting up their business and creating a workspace in their home from which they can use their computer and telephone, and organize their paperwork so that they can keep their business moving.

If they are using that space for anything else, or if they do not meet the rest of the guidelines set out by the IRS, they will not be eligible to take the home office tax deduction. More often than not, however, it is not about people who cannot take the deduction doing so anyway. Instead, it is about people who are eligible to take the deduction not being aware that they can do so because of the confusing guidelines with which they are presented. By simplifying the guidelines and rules, or allowing for a standard home office deduction, the IRS could provide help to millions of people who own home-based businesses throughout the United States.

Appropriate Government Revenues

One of the concerns with the home office deduction is the revenue. The government is getting a lot of money from home business owners who are paying more in taxes because they are not taking the deductions to which they are entitled for their home offices. However, if there was a standard deduction available instead of only the complicated way of taking the deduction that is currently available, it is possible that the government would make the same amount or even more than before. Yes, people would take the deduction, but some of them who are taking too much of a deduction would no longer be doing that. The process would be simpler, and that would allow more people to take the standard deduction - which could add up to less than the incorrect deductions that were being taken in the past.

That is not the only issue that would help government revenue.

Another way that government revenue would be increased by the use of a standard home office deduction would be based on the fact that there would be fewer IRS workers needed to ensure that the deductions were being correctly taken. Paying fewer people means more revenue for the IRS overall. Between the benefits for the taxpayers and the benefits for the IRS, it is easy to see why a standard deduction may be better than the current method. However, right now the current method is what is available, and a large majority of taxpayers get that method wrong when they file their taxes, because they do not understand how to properly take the deduction and for what kinds and levels of deductions they actually qualify.

Paying taxes to the government is something that all businesses have to do, and that has not been something that has changed throughout the years.

How businesses pay taxes, though, and whether they pay their fair share of those taxes to the government is one of those areas that is often up for debate. The government cannot function without enough revenue on which to operate. There are plenty of home business owners (and others) who feel as though the government is spending money that it does not have and should not be spending. These individuals may feel as though their tax dollars are being wasted - and that can make them frustrated with the government. In their frustration, they do not want to sort through pages and pages of information on a deduction that they might be considering. Even people who are not frustrated with the government do not want to look through that much material.

They wonder what would happen if they get it wrong, and they are fearful of an audit, because the government has many rules and regulations for the self-employed, like the home office deduction and health insurance deductions.

Because of the large number of regulations, and because of the complexity of deductions such as those for a home office, many small business owners end up giving more of their revenue to the government than they would actually need to. If they had a simplified system, they would be able to take their deductions - and there are more than 5 million people who would be eligible for the home office deduction.

A standardized option would help to ensure that they were taking the deduction properly, and that would help the IRS keep better track of who was paying their taxes correctly and who was not paying correctly.

Reducing man hours needed by the IRS would save that agency a large sum of money, and everyone would benefit from a tax system where deductions were easier to manage and where taking deductions would make more sense because the instructions for them were not complex. Many home business owners are not familiar enough with the tax codes to take the deduction for a home office. Of those who do take the deduction, many end up getting it wrong - meaning that they are either still overpaying, or they are not paying enough. That could subject them to an audit, or to back taxes, fines, fees, interest, and penalties if they are audited or the IRS flags their return for a closer look. On the other hand, the IRS will not let those who have overpaid or may be eligible for the home office deduction know that they should take that deduction. It is the taxpayers' responsibility to get the deductions right and make sure that his or her taxes are paid correctly.

Certainty

Self-employed individuals must report their income from self-employment on Schedule C.

If they are taking the home office deduction, they will also complete form 8829. The main problem that they face with the home office deduction, though, is that they do not have any kind of certainty as to what they are supposed to do and how they are supposed to take the deduction, specifically.

Because they lack certainty in their tax situation, they tend to err on the side of caution and not take the deduction. It is not always about whether they feel they qualify, but about whether they can perform the calculations that will tell them how much they are supposed to deduct.

The standard home office deduction that has long been proposed would be $1,500.

This would be the amount that someone with a home business would be able to deduct, provided that they qualify for the deduction. Understanding whether one qualifies for the deduction is much easier than understanding how to take the deduction, so the qualification issue is not the part that needs to be simplified. Still, to add more certainty to the issue there has been talk of also simplifying the process of qualification. That can make it easier for anyone who may be able to take the deduction for a home office to make the determination of whether he or she qualifies for that.

If the rules were to be simplified, more people would be eligible - even if they did not use their home office full time, or even if the used their home office for other things besides their business activities. For example, having a home office that was used for both personal work and professional work would be able to qualify.

Because the rules would be more relaxed, it would be possible for anyone who qualified that way to get the deduction and to be able to take the standard deduction. So much of the confusion would be removed that there would be a much improved degree of certainty for anyone who has a home business. In addition, it would make things easier on the IRS because there would be fewer people who made mistakes on their returns. Whether those mistakes were accidental or deliberate in nature, the number of them would diminish.

Simplicity

Nearly 1/2 of all the taxpayers who claimed a home office deduction in 2001 made mistakes on their return.

That is a large number, when one considers how many millions of people that actually encompasses. Not only would a standard home office tax deduction make tax time much easier and less stressful for home business owners, but it would also raise the level of compliance because the rules for the deduction would be much better understood.

One of the main reasons that people do not comply with the current tax rules for home offices is because they do not understand those rules. Certainly there are some people whose mistakes are deliberate attempts to cheat the IRS, but most people who overpay or underpay their taxes do so because they honestly do not realize that they have the rules and regulations wrong and are not figuring their taxes correctly.

Having simplicity in the guidelines is a vital way to make sure that everyone who deserves the deduction will be able to take it and that those who should not be taking the deduction will clearly see that they do not qualify. Some of them may take the deduction anyway, but if they do and they are caught they will not be able to use the confusing guidelines as a reason to avoid penalties and punishment. In other words, the simplification of the guidelines will help the people who want to claim the home office deduction legitimately and will also help the IRS cut down on people who claim that they did not understand the guidelines correctly and took the deduction by mistake.

It can be difficult to prove that these people are lying or defrauding the government, and punishing honest mistakes by taxpayers who are trying to do the right thing seems unfair.

Minimum Tax Gap

The minimum tax gap is related to intentional non-compliance.

This is the number of people who will see the guidelines, realize that they do not qualify for the home office deduction, and take the deduction anyway. While these people may be few and far between, there are always people who will try to go against the system or take deductions for which they do not qualify.

This is something of which the IRS is aware, but it is not realistically possible to stop everyone who may do this from taking the chance that they will not get caught. With the exception of serious cases of actual tax evasion, there are many incorrect tax returns that are not noticed each year.

The issue when it comes to the tax code and whether it should be changed comes down to whether the current code or a new code would be better, and in what aspects it would be better. By changing over to a standard deduction for a home office, it is possible that more people who should not be taking the deduction will do so.

However, at the same time it will also make it much easier for those who really need the deduction - and legally qualify for it - to see that they can and should take that deduction. The addition of a questionnaire of some kind, under penalty of perjury, that would indicate the person has the right to take the deduction, has been suggested by some researchers.

Whether that would be acceptable to the IRS, and whether it would cut down on intentional misuse of the home office deduction, should it become a standard deduction, is difficult to address. There is no actual way to know whether it would correct any current or future problems without trying it, and the tax code changes frequently enough without making adjustments that might simply be changed back the following year. It is clear that the current tax code generally discourages the intentional misuse of the home office tax deduction, though, because there is so much confusion surrounding it. Some people will try to use the confusion to their advantage, but most of them will simply ignore the deduction because calculating it is too highly complicated for them.

Convenience of Payment

One of the arguments for a change to a standard home office tax deduction is the convenience of payment.

Figuring up a deduction based on complex instructions and calculations is not the logical way to make something convenient. For those who make money at home, the home office deduction can be a serious aggravation.

The more convenient it is to pay the taxes and calculate the deduction, the more likely people will be to take that deduction. Millions are currently missing out on a deduction that is rightfully theirs, simply because it is so terribly inconvenient for them.

By setting up the home office deduction as a standard deduction, convenience could be added to that area of the tax form. There is no issue with the convenience of the actual payment, because everything would be calculated when the tax return was completed and the total amount due would be paid when the tax return was filed. For those who did not owe tax, a refund would be requested at that time - and the home office deduction would simply be part of the calculations.

Possible Home Office Deduction Improvements

Now that all of the issues have been addressed when it comes to the concerns that home-based businesses face regarding the home office deduction, and the idea of a standard home office deduction has been discussed, it is important to look at ways in which the home office deduction could be improved. There are several improvements that could be made, but they would all involve changes to the tax code. While there are generally many changes to the tax code each year, these are small changes that often do not affect that many people and that do not require the majority of taxpayers to adjust a large portion of what they do with their taxes - either personal or business.

The first way in which the home office deduction could be improved has already been discussed: changing over to a standard home office deduction. While bills have been introduced into Congress several times proposing this very thing, and researchers have addressed it, it has never been done. It would require more radical changes to the tax code than what are commonly seen each year, but that is not necessarily a bad thing. More than 5 million people who were missing out on the home office deduction may be able to take that deduction if it went to a standard option instead of a required calculation.

That is a significant number of taxpayers who would benefit.

Of course, if taxpayers are benefitting in the form of taking more deductions, where does that leave the IRS? The government is out to make money, and it needs to make money in order to survive and to provide its citizens with the level of programs that they have available to them in the United States. While a change to a standard home office deduction would greatly benefit the majority of home-based business taxpayers, it would not necessarily provide a level of benefit to the IRS itself. This could be among the reasons why the change has not been implemented - the other main reasons being the tax code changes that would be required, the higher possibility of taxpayers cheating by taking a deduction for which they were not qualified, and the internal dynamics of the IRS and the workers that institution has available to oversee tax return difficulties.

If changing the tax code to reflect a standard home office deduction is not the answer to the current problems with the home office deduction complexities, than what is? That is a question that cannot be readily answered. The standard deduction option has been the most widely discussed, and the fact that it has not passed the Congress indicates an unwillingness by the government to make that drastic of a change.

While that makes sense from a logistical standpoint, it also leaves taxpayers and home-based business owners feeling frustrated and discouraged. They want to take all of the deductions they can legally take. In many cases, they need to be able to take those deductions so that they can stay afloat financially, and every little bit helps.

Another possible way to improve the home office deduction is through a relaxing of the rules surrounding it, which is another option that has been researched and discussed.

With this option, the home office deduction would not really be changed in a broad sense (i.e. It would not go to a standard deduction), but it would be changed in a fundamental way. The way this would work would be that the Congress would pass a bill that would relax the requirements as to what would qualify as a home office.

Right now, the rules are very strict for what qualifies. If more home offices qualified, more home-based business owners could take deductions that could help them financially.

For example, the rules could be relaxed to include home offices that were also used for other things - such as personal business. The rules could also allow for a deduction for a desk in a corner, or a multi-function room of which part was an office. There are many ways to make things easier and more efficient for home-based business owners to legitimately take the home office deduction and get a break on their taxes. The majority of home-based business people have a home office space, but it might not be an entire room that is completely dedicated to the office for that particular business. Currently, the deduction requires that level of dedication - and that is not realistic for many people.

Any home-based business that has at least some office space, or that has a room that is used as an office and also used for other things - could be included in the home office deduction if rules were more relaxed and guidelines were clearer.

Whether this will happen remains to be seen, but it is one of the best ways to be sure that everyone who legitimately deserved the home office deduction was able to take that deduction and save money on his or her taxes each year. Running a business from home is stressful enough without the complexities and aggravations of the tax code. That is why many home-based businesspeople miss deductions - because the potential deductions simply are not worth the hassle of hunting them down and then determining whether one qualifies and for how much.

Making the tax code surrounding the home office deduction less confusing and more transparent, even without actually changing any of the rules, is also something that could provide help to home-based business owners. Right now, the rules are relatively clear but they are buried in a lot of other information. The calculations to determine how much of a deduction one can take are confusing, and they should be clarified. When they are clearer, it will be far easier to come up with the correct deduction quickly. That would prompt more home-based business owners to make sure that they took their home office deduction, which would help them grow their business.

Transparency is not something for which the IRS is famous, but that does not mean that changes cannot be made. Ideally, the rules would be relaxed, the information would be more transparent, and the home office deduction would change over to a standard deduction instead of something that was calculation-based.

It does not appear likely that all of those changes will occur, and at the present time it does not even appear likely that any of the changes will occur. This could change in the future, of course, as Congress considers new bills and makes new rules and regulations that relate to home-based businesses and what kinds of deductions they are eligible to take on their tax returns.

Conclusion

As can be seen from the information contained herein, there are many issues that come up when discussing the tax code. The difficulties with deciphering it go far beyond the issue of a home-based business and the home office deduction for which that business may be eligible, although that has been the central theme here. The bottom line is that there are no easy answers for the way the tax code is now or what can and should be changed in order to make the tax code better. When issues like the home office deduction are considered, many taxpayers fail to realize that the IRS must also deal with the results of all of the rules and regulations by which the taxpayers must abide.

It is not always easy to understand why some of the deductions are so confusing to work through, or why some of the rules seem so particular. However, the IRS must be sure that everyone is paying his or her fair share of taxes. Unfortunately, there are many loopholes for big corporations and other large companies, meaning that many of them pay little to no income tax at all. That places the burden for paying taxes more heavily onto the shoulders of the small business owner. Millions of people in the United States today have home-based businesses, and that means that there are millions of reasons to make the tax code less complicated and friendlier toward these people.

Whether the IRS is inclined to do this is something that remains to be seen, of course, because major changes to the tax code take time. For many years, people have been calling for the closing of corporate tax loopholes and an easing of restrictions on small businesses and the taxes that they are required to pay. Changing the home office deduction to a standard deduction, or relaxing the rules for who and what qualifies are just two of the ways the IRS could help to ease the burden of taxes on small business owners while still ensuring that home-based businesses pay their fair share of income tax.

In order for the economy to grow, businesses have to be able to hire and train workers, and they have to be able to reinvest some money in the business for those kinds of things to take place. The more money that is needlessly leaving the pockets of these home-based businesspeople, the less money they have available for that growth and reinvestment. Clearly, that is a serious problem with no quick, overnight kinds of fixes. Careful thought and consideration is necessary, but there is also a time for action. Changes have been desired by many for some time, and still very little has changed for the home-based business owner in the United States in regard to how much he or she must pay in taxes.

Deductions such as those that are provided for home offices may seem insignificant, but they can be important to a struggling home-based business owner who needs every extra penny that he or she can get in order to keep going. The easier the deduction is to take, the more people will be helped by it. Of course, it also opens up the possibility of people defrauding the government by lying about having a home office. That is the case with just about any deduction of that nature, though. The odds of getting caught are slim, but the consequences if one does get caught are not worth the little bit of money saved.

The fear of an audit will deter most people from lying on their tax returns by claiming a deduction for a home office that they technically do not have. Unfortunately, the confusing rules and 35 pages of instructions and information will also keep people who deserve the deduction from taking it. These people may feel as though the amount of the deduction is not worth the work involved to acquire it. They may also feel that there is too much chance of making a mistake. Even after reading through everything, they may be unsure as to whether they qualify and they would not want to take the chance of being wrong - so they do not take the deduction to which they are entitled.

Every year, there is a lot of money lost by these home-based businesses because they miss out on their home office deductions. It is time that is changed, and it is something that Congress should address. Home-based business owners everywhere would be helped by the changes, and it would make things easier for so many of them. That is especially true in the current economy, because many small businesses have had to close up because they were not doing well enough to stay in business. While a tax deduction might not save them, it could certainly help - and it may be enough to keep a home-based business with low overhead and few expenses afloat until the economy improves enough for that business to get back into showing a profit and moving toward success.