Disclaimer: Information contained below was accurate as of the date of publication. Due to frequent tax law changes, information may no longer be accurate. For the latest tax information, please contact a member CPA.

HOME OFFICE REVISITED

by Andrew D. Schwartz, CPA

Whether or not claiming the home office deduction is a red flag with the IRS is an ongoing debate.  Even so, most of the recent tax law changes involving the home office rules have gone in the taxpayer's favor.

Two Beneficial Changes

Prior to 1999, not many people qualified for the home office deduction.  That's because you were required to perform the income producing activity within the home office to be eligible.  Doctors had to see patients, lawyers had to meet with clients, and realtors could only make their sales over the phone.

Everything changed effective in 1999.  As long as you use a portion of your home regularly and exclusively in connection with your trade or business you now qualify to claim the home office deduction.

For renters, this was great news.  Since rent isn’t otherwise deductible on your federal tax return, being able to claim the home office deduction made a portion of your rent tax deductible.

For homeowners, however, there was a potential pitfall when you sold your home.  Assuming you sold your home for a gain, you would generally be taxed on the portion of your home that you claimed as your home office.  This pitfall caused many homeowners to forego this deduction.

A recent tax law change eliminated this pitfall.   Under the current rules, if the office is located within your home (and not a separate structure on your property), you will no longer be taxed on the portion of the gain attributable to your home office when you sell your home.  All you need to do is pay taxes on the depreciation you claimed over the years.

Additional Tax Breaks

Looking for more reasons to claim the home office deduction on your tax return?

Claiming a home office limits the impact of the dreaded Alternative Minimum Tax (AMT).  While your real estate taxes are allowable as an itemized deduction when calculating your "regular" tax liability, they don't count when calculating the AMT.  The portion of your real estate taxes allocated to your home office, however, are not limited by the AMT if you're self-employed.

And if you have more than $1.1 million of total mortgage debt outstanding on your principal residence and vacation home, your mortgage interest deduction is capped.  By claiming the home office deduction, you'll deduct a portion of the excess interest as part of this deduction.

Are You Eligible?

To claim the home office deduction, a portion of your home must be used regularly and exclusively in connection with your trade or business.  According to the IRS, "to qualify under the exclusive use test, you must use a specific area of your home only for your trade or business [including for managerial and administrative tasks].  And to qualify under the regular use test, you must use a specific area of your home for business on a continuing basis." 

If your home office is used for any non-business purpose during the year, or only sporadically in connection with your business, no deduction is allowed. 

How To Claim This Deduction

To claim the home office deduction, you need to complete and attach a Form 8829, Expenses for Business Use of Your Home, to your federal income tax return.  On that tax form, you'll prorate your allowable household costs by the percentage of your home that is used in connection with your business.  You make this calculation by dividing the square footage of your office by the total square footage of your home.

Allowable costs include mortgage interest, real estate taxes, utilities, repairs and maintenance, and insurance.  You'll also include the rent you pay, or depreciation based on the amount you paid for the home (reduced by the value of the land) plus improvements.

You'll then deduct those costs directly against net self- employment income on the Schedule C or as a miscellaneous itemized deduction on the Schedule A if you're compensated as an employee. 

Are you self-employed? If so, the home office deduction also reduces the self-employment taxes you pay.

More Info

More information about the home office deduction can be found at the IRS' website, where you can download Form 8829 along with instructions, as well as IRS Publication 587, Business Use of Your Home.

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RE: 2006

by Andrew D. Schwartz, CPA

Requesting Reasonable and Realistic Returns?

Managing your personal finances is a year round process.  Even so, New Year’s is a time to see how close you came to meeting your 2005 financial resolutions, and to get a jump on your 2006 financial planning. 

Here are some helpful financial steps to take for 2006.

• REset your retirement savings:  Most people find it easier to max out their retirement contributions by budgeting a set amount each month.  Instruct your employer to withhold $1,250 per month for your 401(k) or 403(b) plan to ensure that you hit the max of $15,000 in 2006.  Self-employed?  You can sock away up to $44,000 next year into a SEP, Keogh or Solo 401(k), which equals $3,667 per month.  And if you'll be 50 or older by December 31st, the limit jumps to $20,000 for 401(k) and 403(b) salary deferrals, and $49,000 for Solo 401(k)'s.

• REbalance your investment portfolio:  2005 was no different than any other year; some financial sectors performed better than others.  Chances are that the sectors that did the best this year won’t repeat in 2006.  By rebalancing your portfolio to it's original or updated asset allocation, you lock in gains from the sectors with the best returns, and purchase shares in the sectors that have a good chance of outperforming last year's winners.

• REvise your savings and debt reduction goals: Take a few minutes to set new savings goals including how much you’d like to put away towards your retirement, a child’s education, and the down payment on a home, and also to reset how much you plan to pay down your student loans, personal debt, and home mortgage. 

• REvisit your life and disability insurance needs: As you move through your career, your life and disability insurance needs change. Give some thought to how much of these insurances you need versus how much you currently get through your employer’s benefit package. 

• REsolve errors on your credit report:  Now that you’re entitled to three free credit reports each year, there’s no excuse to not look at this important financial report annually, especially since errors are not uncommon.  Order your free report at www.annualcreditreport.com.

Questions about financial planning steps you should take for 2006? Please check out our listing of CPAs and Financial Advisors to find a professional familiar with the financial planning issues that affect you and your colleagues.

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Tax and Financial Planning Calendar for January, 2006

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2005 & 2006 Tax Facts

• For 2005 the standard deduction for a single individual is $5,000 and for a married couple is $10,000. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes (or sales taxes), real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses.
• For 2005, the personal exemption is $3,200. Individuals will claim a personal deduction for themselves, their spouse, and their dependents. 
  
• The maximum earnings subject to social security taxes is $94,200 in 2006, up from $90,000 in 2005.
  
• The standard mileage rate is $.485 per business mile as of September 1, 2005 (after being $.405 per mile through August 31, 2005), and will be $.445 per mile for 2006.
  
• The maximum annual contribution into a 401(k) plan or a 403(b) plan is $15,000 for 2006.  And if you'll be 50 or older by December 31, 2006, you can contribute an extra $5,000 into your 401(k) or 403(b) account this year. 
• The maximum annual contribution to your IRA is $4,000 for 2005 and 2006.  And once you turn 50, you can contribute an extra $500 into your IRA for 2005 and an extra $1,000 for 2006.  You have until April 15, 2006 to make your 2005 IRA contributions. 

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