Many people defer taking the home office deduction tax write-off because they are scared it will trigger an IRS audit. Put simply, the home office deduction audit is a myth.
In this article, we'll go over how this is a common misconception for people who work from home. This article will review what the home office deduction audit really means and how you can take advantage of this tax benefit without any fears.
Let's first dive into why the myth exists among taxpayers in the first place.
The IRS has allowed self-employed workers to deduct a portion of their home office from their taxes for quite some time. The tax break has gotten a bad reputation over the years by taxpayers to be an automatic red flag for investigation by the Government.
Many self-employed workers are scared of the requirements for record-keeping in order to claim the home office deduction.
Although some individuals who take this deduction may be audited, you really have nothing to worry about if you qualify for the tax deduction and keep clean records.
The myth really started because of a tax code change. The Tax Reform Act of 1976 added Section 280A which allowed business owners to deduct expenses like utilities, home insurance, home repairs, and depreciation on home. The home office tax deduction was simply misused in the past, which made it known for IRS scrutiny.
Folks who thought they qualified for the deduction, had to pay the write-off amount back from the prior year.
If you are able to qualify for the tax deduction, that doesn't mean you'll be audited every year. The IRS has a lot of audits going on as it is without adding this one to their list so they don't target home office deductions specifically in order to expand their audit pool.
Let's discuss when the Internal Revenue Service identifies sketchy tax returns.
The fact that a return has been selected for review does not always imply that the taxpayer has made an error or has been dishonest.
Some investigations even result in the taxpayer receiving a refund or the return being accepted as is.
The Internal Revenue Service uses a system called the Discriminant Information Function (DIF) to flag tax returns that appear to have significant deviations from the averages of others in your profession. I'll show you what I mean.
If the average tax deduction for someone in your line of work deducts 10% of their income for business meals and you write-off 35%...the discrepancy from the average could trigger a closer examination by the IRS. This really goes for all the 1099 deductions, really.
When it comes to the home office tax deduction, this just means you have to file for a reasonable deduction and everything is properly recorded or you track all 1099 expenses.
First off, you must be a self-employed worker or independent contractor to file for this tax deduction. Employees cannot qualify for this deduction.
As a self-employed worker or partner, you may be able to deduct some expenses for the part of your home that you use for business if you meet the following qualifications.
There are many rules that apply to this deduction. The rules are fairly straightforward. To write-off expenses for business related use of the home, you must use part of your home as one of the following:
It is important that your office is regularly for business and the area or space is exclusive. If you are an employee and you pick up gig work on the side, you can still qualify for the deduction. You must meet the requirements of a self-employed person and not just an employee.
Here are some other IRS-approved ways you can write off a home office.
According to the IRS, the rules for what qualifies as a "home" is:
This does NOT include any part of the taxpayer's property used exclusively as a hotel, motel, inn, or similar business.
If your deduction is examined, auditors will check to see if your small business meets all the criteria of the law. Your office space must be your principal place of business. The government will also check to see how important the tasks or activities were for your business and where they were performed.
Be careful of including decorations or anything that would indicate you are doing something personal in the office space. Decorations that may be flagged for using your office for personal use could be a dartboard, stereo, or anything else that may seem like a personal item. The safest precaution you can take is moving any personal items out of your office area to somewhere else.
You cannot claim the deduction if you use your bedroom or family room to conduct your business. These areas aren't viewed as regular business use or primary place of business.
If you qualify for the home office deduction, the IRS provides two ways you can claim the write-off: the regular method and the simplified method.
Let's break down each of them.
In order to use this method, you'll need to fill out and attach Form 8829 to your tax return. This form is for expenses and business usage of your home.
In order to calculate the deduction amount using this method, you'll need to sum up all of your actual expenses related to maintaining or operating your workstation. You can track your expenses with our home office deduction spreadsheet.
These home office actual expenses include:
Then, you'll need to multiply the total by the "business use" percentage or how often you use the space for business and personal use. So, keep track of how much time you spend in the section of your house for business. You could also use a 1099 expense tracker to help you record these expenses.
For example, if you use a whole room or section of a room for conducting your business, you'll need to figure out the percentage of time you use it for your business activities.
It should be noted that if you move houses or home office spaces, you'll need to fill out a separate Form 8829.
After January 15, 2013, the IRS introduced the home office Simplified Method to write-off a home office space where you conduct business. All you need to do is measure the space of your home office and multiply it by the sure footage rate provided by the Internal Revenue Service.
Currently, the rate is $5 per square footage of home used for business (maximum 300 square feet or $1,500). Remember, you can only deduct the square feet for regular and exclusive use as a home office.
You can only use this method if no other deductions like home repairs, mortgage interest, or utilities are taken. If you sold your home after taking the home office deduction, there is a depreciation recapture provision which could mean paying higher taxes. The recapture rule can surprise many small business owners who take the home office deduction.
Which method can lead to a higher deduction for you? I believe that the actual expenses method generally helps businesses get a higher deduction. Sure, although it may require more documentation and is not as easy as the Simplified Method, you can save a lot of money on your taxes by claiming the Actual or Regular Method. Due to the coronavirus pandemic, many employees forced to work from home can claim a home office reimbursement.
You should still calculate the total write-off amount of both methods to decide which one is better for you.
If you have questions about how to write-off for an office room from your taxes, contact a legal or tax professional.
A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.
Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.
Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.
The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.
Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.
For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.
If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.
That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.
There are some types of contracts which must be in writing.
The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:
Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.
Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.
Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?
Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!
If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.
Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.
Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.
So, ultimately, the question is: written or verbal agreements?
Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.
Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.
Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.
There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.
A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.
Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.
With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.
Why not secure your business today and sign up for a free trial?