(This is a guest post from Barbara Weltman, a top tax expert.)
My friend owns Cruise Planners, a franchise, that she runs from home. If you’re like her and operate your franchise from home, you may be able to treat what would otherwise be nondeductible personal expenses as a business deduction called the home office deduction. Do you qualify for this tax break?
To claim a home office deduction, you must meet two tests:
Test one: You must use the space in your home regularly and exclusively for business. Your kitchen table won’t do because you use it for personal purposes, such as eating or gathering with family.
Test two: The space must be:
- Your principal place of business. If you conduct business at clients’ or customers’ locations, the home can still meet this test if you use it for substantial administrative or ministerial activities (keeping books and records, billing for your work)
- A place to meet or deal with customers/clients/patients in the normal course of business. Making phone calls isn’t enough.
- A separate structure used for business (e.g., a greenhouse, or separate garage used to store inventory).
If your franchise business is incorporated, things get complicated. As an employee your home office deduction can only be claimed as a personal miscellaneous itemized deduction (you have to itemize and miscellaneous deductions must exceed 2% of your adjusted gross income). And you have to show that working from this space is for the convenience of your employer (your corporation). But this option isn’t a good solution because the 2% floor and other restrictions on itemized deductions.
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A better way is to arrange to be reimbursed for business expenses in the office (e.g., Internet access). The corporation can set up an accountable plan and reimburse you for the costs. The reimbursements become tax free to you, with the expenses deductible by the corporation.
Don’t even think about renting your home office to the corporation. You would have to report the rent and are barred from taking deductions for renting the space to your employer. Remember that if you own your home, you already benefit from itemized deductions for mortgage interest and property taxes and don’t need to pick up additional income.
Legit Tax Deductions for Home-Based Franchise Owners
How to figure the deduction
It’s important to realize that you have a choice of how to do this: claim your actual expenses related to the portion of the home used for business or rely on an IRS-set rate. First determine the square footage of your business space; then decide on the method for figuring the deduction.
- Actual expenses. Add up all direct expenses, such as the cost of painting a spare bedroom that you use as the office, and a portion of indirect expenses, which are costs related to the entire home (utilities, homeowners’/renters’ insurance, rent, mortgage interest, etc.). If you use 10% of the home for business, then 10% of these costs are taken into account.
- Simplified method. Instead of tracking each expense, you can opt to deduct $5 per square foot up to 300 square feet of space (top deduction of $1,500). You can still take certain personal expenses (e.g., mortgage interest, property taxes) in full as itemized deductions on Schedule A of Form 1040.
Learn more about the home office deduction in IRS Publication 587 (https://www.irs.gov/pub/irs-pdf/p587.pdf) and in the instructions to Form 8929, Expenses for Business Use of Your Home (https://www.irs.gov/pub/irs-pdf/i8829.pdf).
(My friend, Barbara Weltman is an attorney, a prolific author with such titles as J.K. Lasser’s Small Business Taxes and J.K. Lasser’s Guide to Self-Employment, and a trusted advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and Big Ideas for Small Business® at www.barbaraweltman.com and hosts a monthly radio host. She works with Fortune 500 companies seeking to reach the small business community. Barbara has been named one of the 100 Small Business Influencers in the U.S. five years in a row. Follow her on Twitter @BarbaraWeltman)