The home-office deduction: don't worry, be happy

Home Office Computing, Feb, 1993 by Linda Stern

When you take the home-office deduction, are you waving a red flag in the eyes of Internal Revenue Service examiners? And if you are, what does that mean?

For years, tax sages have warned that claiming a home office increases your chances of being audited, and the IRS has tacitly gone along with those stories (maybe even exaggerating them, some suggest, to scare home-office workers out of taking the deduction).

In truth, there's good reason to believe that the home-office deduction flag is fading, as auditors target more fertile ground looking for hidden tax dollars. Self-employment income in excess of $100,000 can still get you a place on the IRS hit list, for example.

But, as the number of legitimate home-based businesses grows, the IRS's chances of finding fraud wherever it looks have slimmed. Recent rules and new forms have eliminated a lot of the gray areas that surrounded home-office claims at the same time that many more taxpayers have joined the ranks of home-office workers. If auditing home offices ever was like fishing in a barrel, the barrel has been washed away by the work-at-home tsunami. The IRS could waste a lot of energy and resources auditing the more than 20 million home-based businesses and find a lot of careful record keeping, a lot of legitimately deductible home offices, and not a lot of money owed the U.S. Treasury.

STOP THE PARANOIA

Many people (including my brother) have been so put off by the red-flag fear and the putative complexity of the home-office deduction that they have declined to take it, even though it can be worth hundreds or even thousands of dollars in saved taxes. By some estimates, only about four million Americans take the tax break, even though five or six times that number may work at home.

Rumors (largely unconfirmed) about the pettiness of IRS auditors have increased those fears. My personal favorite is the one about the auditor who found personal mail in the waste basket of a home office and disallowed the office because it wasn't used "exclusively" for business.

How realistic is this apocryphal story? Not very. Frederick Daily, a San Francisco home-based tax attorney and author of Stand Up to the IRS (Nolo Press), claims that in 20 years of representing small businesses, he has never had an auditor ask to examine one of his clients' home offices. The two homeworkers I know who did undergo sustained home audits say the IRS examiner never questioned the legitimacy of the home offices once he saw that the rooms looked like bona fide offices. In other cases where home offices were questioned at audits that took place away from the home, a few pictures or a photocopied floor plan were enough to save the office deduction from the clutches of the IRS.

My favorite home-office audit story comes from Scot Ogle, a Boulder, Colorado, television producer whose home office was featured on the cover of February 1990 issue of HOME OFFICE COMPUTING. Despite the fact that Ogle drew an "auditor from hell" who tied up his taxes for four months and even questioned the exclusivity of his stapler, the questions about the home office were kept to a minimum. Ogle had taken pictures of his home office, which his accountant passed on to the IRS, but it was our magazine cover story that sold the auditor.

"The guy was very impressed by that," says Ogle. "He said, 'Oh, I guess we don't have to question it.'"

THE EXCLUSIVITY TEST

The bugaboo for many home-based workers is the exclusivity test. If you take the deductions associated with having an office in your home, you are supposed to use the office exclusively for your business. It can't be a family game room or the dining room when it isn't being used as your business office.

Does this mean that you are not allowed to pay personal bills while sitting at your desk? Or should you not keep Tetris on your computer? A stickler would say yes, but a more practical person would note that even corporate employees sometimes bring their bills into work or play a quick computer game on their coffee break. "There is a certain blurring," says Ogle. "I bought my stapler for my office. I keep it there and use it in my business. But who is to say my wife didn't walk in one day and staple some papers together?"

Daily points out that even if you are the subject of a rare home audit, you'll have ample time to "cleanse" your office of offending paraphernalia before the auditor arrives. "What kind of idiot couldn't rearrange things to take the personal items out?" he asks.

This does not mean that you should run your home office out of an actively used family room or guest room, or that you should take a write-off for the kitchen table. The fact that it jeopardizes the legality of the home-office deduction is secondary; what's more important is that it's very hard to run a profitable business in a room that isn't set up and available to you as a place of business.

RECAPTURE YOUR TAX DOLLARS

There's a second reason why legitimate home-office workers sometimes decline to take the home-office deduction: They've been told that if they sell the house, they'll have a greater tax burden.