Home Office

In Actor Speak

HOME OFFICE

At one time the IRS worked from the following basis on the use of a Home Office:

"The Supreme Court held that only when the more essential aspects of the taxpayer's work are performed in the home office may the taxpayer deduct the cost of an office in the home. For entertainers, most of whom mainly perform in clubs, theaters, etc., this effectively eliminates any home office deduction.

Although the rules have been significantly loosened for this deduction to be acceptable, the IRS usually starts working from the above premise until you prove your right to take this deduction.  As a result we urge all of our clients to first consider the actual value of using the home office deduction on their tax return before doing so.

  • There aren't many performers who earn the bulk of their entertainment income performing at home.

  • The use of this deduction may well attract unwanted attention (i.e. "Red Flag") and/or help to determine whether you are audited or not.

In general we usually tell our clients that considering all of the requirements you must fulfill versus the actual monetary "benefits" of using this deduction, you typically find the tax savings that it actually generates is not worth the additional risk of an audit and/or ultimately losing the deduction in an audit.

We take that position because in most cases we aren’t talking about the use of a second bedroom used exclusively for their business (which might be a typical 10 foot by 10 foot room or 100 square feet). Instead it’s usually a smaller space in their apartment, the size of a desk and chair or perhaps only about 6 feet by 6 feet (36 square feet), where they get this work done.  

It's because these spaces are typically so small we question the overall gain of using the deduction; not to mention having an area set aside for your computer where you read your email and check out what your friends are doing on Facebook doesn’t constitute an office.

There are now Two Methods for making use of this deduction. As it is explained on the IRS website:

Simplified Option
For taxable years starting on, or after, January 1, 2013 (filed beginning in 2014), you now have a simpler option for computing the business use of your home (IRS Revenue Procedure 2013-13, January 15, 2013). The standard method has some calculation, allocation, and substantiation requirements that are complex and burdensome for small business owners. This new simplified option can significantly reduce recordkeeping burden by allowing a qualified taxpayer to multiply a prescribed rate by the allowable square footage of the office in lieu of determining actual expenses.

Regular Method
Taxpayers using the regular method (required for tax years 2012 and prior), instead of the optional method, must determine the actual expenses of their home office. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Generally, when using the regular method, deductions for a home office are based on the percentage of your home devoted to business use. So, if you use a whole room or part of a room for conducting your business, you need to figure out the percentage of your home devoted to your business activities.

 

Simplified Option for Home Office Deduction


Beginning in tax year 2013 (returns filed in 2014), taxpayers may use a simplified option when figuring the deduction for business use of their home.  

There are some who feel this new “Simplified Method” helps to eliminate the “red flag” aspect of the use of this deduction, using the deduction in this way helps to eliminate additional attention that may be called to your return thus creating a higher possibility of an audit. However, to quote the IRS,

“This simplified option does not change the criteria for who may claim a home office deduction. It merely simplifies the calculation and recordkeeping requirements of the allowable deduction.”

Highlights of the simplified option:

  • Standard deduction of $5 per square foot of home used for business (maximum 300 square feet).
  • Allowable home-related itemized deductions claimed in full on Schedule A. (For example: Mortgage interest, real estate taxes).
  • No home depreciation deduction or later recapture of depreciation for the years the simplified option is used.

Perhaps the greatest benefit of this method is you can receive a possible deduction of $1500 (300 square feet times $5.00 a square foot) PLUS, if you own a home, the on-going deduction of your interest and real estate taxes paid on your home.

 
Here is a comparison of the two methods from the IRS website:


Simplified Option

Regular Method

Deduction for home office use of a portion of a residence allowed only if that portion is exclusively used on a regular basis for business purposes

Same

Allowable square footage of home use for business (not to exceed 300 square feet)

Percentage of home used for business

Standard $5 per square foot used to determine home business deduction

Actual expenses determined and records maintained

Home-related itemized deductions claimed in full on Schedule A

Home-related itemized deductions apportioned between Schedule A and business schedule (Sch. C or Sch. F)

No depreciation deduction

Depreciation deduction for portion of home used for business

No recapture of depreciation upon sale of home

Recapture of depreciation on gain upon sale of home

Deduction cannot exceed gross income from business use of home less business expenses

Same

Amount in excess of gross income limitation may not be carried over

Amount in excess of gross income limitation may be carried over

Loss carryover from use of regular method in prior year may not be claimed

Loss carryover from use of regular method in prior year may be claimed if gross income test is met in current year

Selecting a Method

  • You may choose to use either the simplified method or the regular method for any taxable year.
  • You choose a method by using that method on your timely filed, original federal income tax return for the taxable year.
  • Once you have chosen a method for a taxable year, you cannot later change to the other method for that same year.
  • If you use the simplified method for one year and use the regular method for any subsequent year, you must calculate the depreciation deduction for the subsequent year using the appropriate optional depreciation table. This is true regardless of whether you used an optional depreciation table for the first year the property was used in business.

 

It's Your Choice

We know scores of actors and performers who make regular and very significant use of office space in their home to further their business. Many of them have literally built their career from the hours and hours on their computers and on the phone and there is no question they have used their office space incredibly effectively to make it all happen for themselves.

But in most cases we aren’t talking about a second bedroom used exclusively for their business; it’s usually a smaller space in their apartment, perhaps about 6 feet by 6 feet (36 square feet) where they get this work done.  It's not just because these spaces are typically so small we question the overall legitimacy of using the deduction; having an area set aside for your computer where you read your email and check out what your friends are doing on Facebook doesn’t constitute an office.

As valuable as the deduction can be, depending on the individual size of the space and your usage of the area, please don't think it should be "automatic" just because some other preparer let you use it in the past. Use some common sense because it really may not be worth taking in the first place.

We have provided a sample scenario to help you understand the value (or not) of using this deduction.  We know there are a lot of preparers who make use of a home office to improve your refund.  The end result helps them look better in your eyes and you are thrilled.  Regardless we urge you take great caution before you allow your preparer to place this on your return.  Make sure you are very aware of what the preparer is trying to do.

Example:

The actual working space for most actors in their home is usually no more than 100 square feet (or 10 x 10 space).

One person came to us after the IRS had denied this deduction in an audit complaining that the auditor was unfair.  We pointed out that her original preparer (outside of our office) had tried to claim she used 200 square feet of her 450 square foot studio apartment.  That resulted in her having more than a $3,000 deduction. 

Unfortunately if she has a kitchen area, her bedroom space, a bathroom and any closets in her apartment, that's impossible to believe.

She then complained that her preparer didn't say anything to argue with the auditor when this was denied. We had to tell her there was nothing he could say, he had been wrong to even try to claim that much space in the first place and he knew it at the time of the audit.

She ended up having to return her "tax savings" plus interest and penalties.

We have also been told that this tax preparation firm has since been fined by the IRS for rampant abuse on almost every return they have tried to include this deduction.

Here's how the regular deduction works


You must determine the amount of space in your home designated as an office and the percentage of your total home this space constitutes.  Then after adding all of the costs of maintaining this space (such as rent or mortgage, upkeep and utilities,) multiply that total times the percentage of the used space.

For example, if your costs were:

Monthly Rent: $750 + Monthly upkeep:  $25 + Utilities:  $50 = Total Monthly costs:  $825

Multiplied by 12 months for the year:  $9,900

Total space in Apartment:  900 sq. feet

Space Used for office:  100 sq feet 

(This would be a 10 foot by 10 foot room or space used SOLELY for your career.)

Percentage of Space used:  11%

$9,900 multiplied by 11% equals:  $1,089

What all these numbers mean:

In the 15% tax bracket (the tax rate on a single person's taxable income between $8,000 up to $34,000) this $1,089 write-off equals $163 in actual tax savings.

Using the simplified method the deduction in a similar situation would be about half ($500 dollar write-off worth $75).


CONCLUSION

We have concluded that the above scenario below would create a $163 refund.  However, is this risk worth the increased potential of an audit plus the subsequent trouble of proving the expense at the audit? 

Even if you doubled the numbers (higher rent, etc) the refund is just $326.  Although this is hardly peanuts to most actors, the additional risk of an audit is probably something you would like to avoid. 

Remember, even if you prove the home write-off during the audit, you have opened your entire list of expenses to examination by the IRS.  Should the auditor turn down any of your other write-offs you have to pay back the applicable taxes plus pay additional interest.

On the other hand, if the space you use is a higher percentage of the total home OR you find yourself in a higher tax bracket  (25% of taxable income from $28,400 to $68,800 for a single person) you may find this deduction valuable to you IF you can prove the specifics indicated in the opposite column.

We urge you to be very careful in making your choice to deduct your home office.

In the Words of the IRS:

In the entertainment industry the issue of home office frequently arises. Taxpayers usually claim their home office is used for keeping records, making telephone contacts, rehearsing, and a myriad of clerical chores.

While this may well be true, the issue of allowability remains [and] severely restricts the deduction for office in the home. The office must be used on a regular basis and exclusively for business.


Regular use means on a continuing basis, not just occasionally. In the entertainment industry regular use is not generally a problem.

Exclusive use means that the area that serves as an office must be a distinguishable area used only for qualified business use. Moreover, all use of the office must be qualified use. 


Qualified business use must be one of the following:

  1. As the principal place of business

  2. As a place to meet with patients, clients, or customers

  3. A separate structure not attached to the dwelling unit.

  4. A designated storage space for inventory in the trade or business of selling products at retail or wholesale.


Principal Place of Business

The most frequently heard of the above three arguments, in the entertainment industry, is the principal place of business. In Soliman v. Commissioner, 113 S.Ct. 701 (1993), the taxpayer claimed a home office for administrative duties essential to his practice. IRS's position was that the income the taxpayer received was for services performed at another site; and, therefore, the home office was not the principal place of business. The Supreme Court held that only when the more essential aspects of the taxpayer's work are performed in the home office may the taxpayer deduct the cost of a office in the home. For entertainers, most of whom mainly perform in clubs, theaters, etc., this effectively eliminates any home office deduction.

For designers, technicians, and others, there may still be a deduction, in certain cases; for example, freelance special effects creator whose workshop or studio is in his or her home.

For musicians, the principal place of employment is where the performance occurs, not the home practice area.


Employees

As with any industry, an employee will only be able to deduct office in the home when all requirements are met and the home office is required by and for the convenience of the employer.  


Personal Service Corporation

Individuals who have formed a personal service (C) corporation may still deduct business use of their home, but the creation of the corporate entity would give rise to separate issues, for example, the corporation would have to rent the premises from the taxpayer. This may, in turn, give rise to passive activity loss limitations for the rental activity. 


Multiple Business Activities

When a taxpayer has multiple business activities, all of the activities for which the office is used must meet the qualifications. If any of the activities uses the home office and does not meet the requirements, the exclusive use test is not met and no deduction is allowed.

This position was upheld by the Tax Court, in Hamacher, 94 T.C. No. 21. The taxpayer was an actor who performed on stage, screen, and radio as an independent contractor. He was also employed at one theater as an acting instructor and administrator. His employer provided him with an office at the theater, but the taxpayer also set up an office in his home. The home office was used in connection with both his employment and his self-employed activities.

The Tax Court found that the employer did not require the taxpayer to do any work at home. The home office may have been helpful but was not for the convenience of the employer. It was not necessary for the court to determine if the home office would have qualified solely in conjunction with the taxpayer's self-employment. Since the use with regard to the taxpayer's employment was not qualified, the exclusive use test was not met and no office in the home deduction was allowed.

In addition to the obvious expense for office in the home, this issue has impact on the allowability of business mileage for what would otherwise be commuting expense. 

 

2017