Why You Are 258% More Likely to be Audited
8th June 2015
By: EJ Rumpke
The IRS allows anyone who uses part of their home for businesses purposes to deduct certain expenses on their tax return. As a small business owner or someone who is self-employed, this tax deduction can be extremely beneficial come April.
However, taking this deduction opens you up to a higher probability of being audited by the IRS. According to Kiplinger, there is a less than 1% (1/300) chance of being audited. However, if you claim an employee business expense write-off (which the Home Office Deduction falls under), your odds of being audited jump to a 1/116.
This represents a 258% increase in the chances of having the IRS choose your return to review in depth. Even though your overall chances are still less than 1%, it’s important to fully understand the Home Office Deduction in the off chance you are selected for audit.
Does my home office qualify for the deduction? The biggest hurdle to taking the home office deduction is that your space must be used exclusively and regularly as your principal place of business. Basically, your office space has to be a complete separate area of your home designated solely work. You can’t claim the deduction for your kitchen if you work at the table regularly and you can’t claim the deduction on your spare bedroom if you work there during the week and then rent it out on Airbnb every weekend.
You must also pass a regular-use test, meaning that your home office needs to be the principal location of your business or a place where you regularly meet with customers and clients.
If you do have a designated space that is exclusive for business, document it! Take photos of the space so you can easily show the IRS this is your office because it looks like one. It also makes sense to keep a calendar handy showing the time you spent at the office and indicate when you have client meetings in the space. An easy way to do this is keep your Gmail or iCal up to date on meetings you regularly have (even if they weren't in your calendar to start with).
What expenses can I deduct on my taxes? So now that you know your home office qualifies for the deduction, the next step is figuring out what expenses you can deduct. The IRS lets you calculate the expense in two different ways: regular and simplified.
Regular In the regular method you take the percentage of your home that is used as a home office and then deduct the proportionate share of expenses for the space.
For example, say you have a 1,000 square foot home and your office space is 100 square feet. The office makes up 10% of your entire house (100/1000), therefore you can deduct 10% of your housing expenses. In this example you would be able to deduct 10% of your utility bills, homeowner’s insurance, and HOA dues. The IRS has a complete list of what can be deducted here along with worksheets that help you figure out what expenses are allowed.
Simplified In the simplified calculation, you are allowed to deduct $5 per square foot of space (up to 300 SF max). So using the same example as above, you would deduce $500 ($5 x 100 square feet) on your tax return.
This simplified way is the cleanest and easiest way to take the home office deduction, but remember, the space must still meet the general requirements above for exclusive and regular business use.
It makes sense for you to use the regular method if you have a larger home office, especially if it is a stand alone structure like a studio or garage space. The simplified method is going to be easiest if your home office is a small room located within your house.
In short, the home office deduction can be huge deduction for people that work from home. It does come with an added risk of being audited, but don't let it scare you away from taking the deduction if you document things clearly and correctly.
There is one alternative to taking this deduction, and that is renting out office space somewhere else. We at Kinglet are huge fans of renting out space in a collaborative environment and we believe there are benefits of NOT working at home. If you do rent out space somewhere besides your home, this is a direct business expense that will directly hit your bottom line on the income statement, thus lowering your tax liability as well.