Technology makes it easy nowadays to hold conference calls at the kitchen table, check emails in the bathtub and type reports on the living room couch. But the taxpayer who tries to claim the kitchen, the bathroom or the living room as a home office on a tax return is apt to set off alarm bells at the IRS, experts say.
As the April 15 tax filing deadline looms, tax experts say misunderstandings about the home office deduction are highly common among the self-employed.
So are poor records of business-related expenses, says Bronx-based senior tax adviser Tara Olijarczyk of the Kansas City, Mo.-headquartered tax preparer H&R Block. "The most common thing I see is that many of my clients and other self-employed don't keep very good records as far as income and expenses," she said, "mainly because they don't know what's deductible and what's not deductible."
TECH BLURS THE LINES
It's a growing problem, experts say, because smartphones, laptops, tablets and other devices have made it easier than ever to conduct business from home. Experts say the home office needs, first and foremost, to be a place used exclusively and regularly for business. "If your kids' toys are in there, the cat's food is there, you watch TV and have your morning coffee in there, the IRS might be able to argue that it is not used exclusively for business," said Elizabeth Maresca, an associate professor at the Fordham Law School in Manhattan.
Some experts say, however, that it's kosher to deduct a portion of a multipurpose room -- the space occupied by a desk and chair, for example -- as long as the portion is used strictly for the business and not also by kids for doing homework or playing computer games. "It need not be a room, per se," said IRS spokesman Eric Smith in Washington.
Space used to store raw materials, supplies or finished product -- a portion of the garage or basement, for example -- might also be deductible.
But the home office has to be the only work space available to you -- not just a convenient alternative when the weather is bad. "It has to be the only place you can work," said attorney Jerry Reisman, a tax law expert and a partner at Garden City-based Reisman Peirez Reisman & Capobianco LLP.
LESS COMPLEX CALCULATION
For 2013, the IRS made it easier to calculate the home office deduction: $5 a square foot, up to a maximum of 300 square feet or $1,500. It's an alternative to adding up and then dividing expenses such as property taxes and utility bills.
Experts caution the self-employed to keep detailed receipts for business expenses. Certified public accountant Alan Materazo of Margolin, Winer & Evens LLP of Garden City advises a separate credit card for the business. "Combining business income and expenses and personal income and expenses becomes a problem later when you're trying to segregate it or you're audited and trying to prove to the IRS that certain items are business expenses," he said.
CPA Lisa Green-Lewis, based in San Diego for Intuit TurboTax, says it is critical also to keep a log of trips by car -- including the date, destination, mileage driven and purpose, such as "Meeting with client Jim Smith." Reisman said taxpayers can simply deduct 56.5 cents a mile for auto use or, if they prefer, deduct actual expenses such as gasoline, repairs and insurance, for the business portion of a car's usage -- a more complicated method.
PITFALLS OF UNDERREPORTING
Which leads, finally, to the elephant in the self-employed room: unreported income. One study, done in 2011 by economics professors from Florida and Wisconsin, estimated that 18-19 percent of all reportable income by all taxpayers isn't reported to the IRS.
People who underreport sometimes are tripped up by their luxury lifestyles, including expensive homes and cars out of keeping with their declared income, says Reisman, or by big purchases of raw materials from vendors that never seem to translate into products and sales. Said Maresca, "The IRS knows a lot about cash businesses."
While the IRS audited fewer than 1 percent of returns in the 2012 fiscal year, which ended Sept. 30, 2012, experts say the self-employed are more likely than wage earners to be audited.
Still, said IRS spokesman Smith, "There's no question that the basis for our system is voluntary compliance. It assumes most people are honest most of the time."