As a result of the Taxpayer Relief Act of 1997, taxpayers who use their home offices for management or administrative purposes may eventually qualify for a deduction, as long as they have no other fixed office location to substantially conduct those activities. However, this new rule doesn’t go into effect until 1999. All individuals working from a home office should gain an understanding of the current laws before the income tax deadline arrives. Currently, your ability to claim a home-office deduction is (with two exceptions, i.e. inventory storage and day care) contingent upon your using an area in your home exclusively and regularly as your principal place of business. That means that your office can’t double as a den or playroom when you’re not using it. To meet this requirement, a separate room in your home must be dedicated to your work activity, whether it’s a basement office or spare bedroom. You may not use the room for any other activity. You may deduct certain expenses of operating a separate structure not attached to your home if you use it regularly and exclusively for your trade or business. Keep in mind that although you must use the office “regularly” and “exclusively” for your business, you still can work part-time and claim the deduction. Moreover, if you are an employee who uses the office regularly and exclusively for the business of your employer, you may qualify for the deduction only if working from your home office is for the convenience of your employer and not just helpful in your job. The “regular and exclusive” tests remain the same under the new tax law. However, another rule currently in effect that will change with the advent of the new law is the “principal place of business” test. Currently, to meet this definition, your office must be the place where you spend a substantial number of your working hours, and most of your business income must be attributable to your activities there. Under this rule, salespeople and consultants who meet with clients outside the home but do all of their administrative work in a home office are not eligible to claim the deduction, even if they have no other fixed office location. In a landmark Supreme Court case, an anesthesiologist who worked in several different hospitals but prepared patient reports and other paperwork in a home office was denied a deduction. Currently and remember, these rules are in effect for another year if the activities of your home office are not as central in producing revenue as those conducted elsewhere, a home office deduction will not be allowed. The “principal place of business” rule will change for tax years beginning after Dec. 31, 1998, opening the door for more people to claim the deduction. As of that date, a home office may qualify as a principal place of business as long as it is used to conduct administrative or management activities. So, for example, the physician who does her paperwork in a home office would qualify for the deduction. In addition, to claim the deduction you will have to show that there is no other location where you conduct substantial administrative or management activities. You will still have to meet the exclusive use and regular basis tests. The new tax law does not change how you calculate the amount of the home-office deduction. First, you figure the percentage of your home used for business (i.e. compare the square feet of your office space to the total square feet in your home). Then, you apply this percentage to the total of each qualified expense. Generally, you may deduct a percentage of your real estate taxes, utilities, mortgage interest, depreciation on your home, home insurance premiums and even some repairs. For self-employed individuals, the home-office deduction cannot exceed the net income derived from the use of the home office. Disallowed expenses due to the net income limitation may be carried to subsequent years and treated as home-office expenses in a later year. Employee home-office deductions are considered miscellaneous expenses and are deductible to the extent that they, along with other miscellaneous expenses, exceed 2 percent of your adjusted gross income (AGI). Phase-out rules apply to employee deductions as they do to all itemized deductions. The best way to guarantee your deduction under the tax law is to have the documentation to back it up. Other tax changes Here are some additional things to keep in mind when preparing 1997 tax returns and planning for the upcoming year: ? Larger deductions for health insurance premiums. Under the new tax law, if you’re self-employed and paid for your own health care insurance in 1997, you may deduct from gross income 40 percent of health insurance costs you paid for you and your family. The deductible portion rises to 45 percent for 1998 and 1999 and continues to increase gradually until it reaches 100 percent in 2007. However, keep in mind that the deduction is limited to your earned income derived from your business for which the insurance plan was established. ? Coming out ahead with expensing. Businesses are eligible to write off immediately up to $18,000 for equipment and other depreciable property put in service in 1997 ($18,500 for 1998) rather than depreciate those costs over a period of years. To qualify for the deduction, the equipment must be put into service during the year for which you take the expensing deduction; purchasing and paying for eligible property is not enough to qualify for the deduction. Be aware that the expensing deduction is reduced dollar for dollar once the cost of property put into service in a year exceeds $200,000. ? Boost retirement savings and gain deductions. As an employer, take advantage of tax benefits associated with IRS-qualified retirement plans for you and your employees. Contributions to IRS-qualified retirement plans, such as SIMPLE plans and 401Ks, are deductible, and no tax is paid on the earnings that accumulate until benefits are collected, usually at retirement. There’s no better way to lower your tax bill while helping yourself and your employees save for retirement. ? Getting even on bad debts. If your business cannot collect on a receivable, you may be eligible to deduct the amount of the bad debt. Companies that use the accrual method of accounting must deduct a bad debt in the year it becomes partially or totally worthless. Be sure to keep a paper trail of your collection attempts in the event you need to substantiate your deduction. ? Travel, meals and entertainment expenses. Travel expenses that are necessary and ordinary to your business typically are fully deductible. Meals and entertainment expenses are 50 percent deductible, provided that the primary purpose of the meal or entertainment expense is to transact business. In other words, you must expect to gain some business benefit as a result of the expense. However, in some instances, employers may be able to deduct 100 percent of the meal cost. For years beginning after 1997, such deductions are allowed if the meal is provided on company premises for the convenience of the employer. Mel Poteshman is a certified public accountant and president of Poteshman Consulting International & Co., a West Los Angeles-based business consulting firm.
