Rev. Proc. 2013-13: A New Option for the Home Office Deduction 

    EXPENSES & DEDUCTIONS 
    by Michaele Morrow, Ph.D., CPA, Timothy Rupert, MST, Ph.D., and Ronald C. Zullo, CPA, MST 
    Published August 01, 2013

     

    EXECUTIVE
    SUMMARY

    • Photo by iStockphoto/ThinkstockThe home office expense deduction is available for self-employed individuals and for employees who can establish that their home office is for their employer’s convenience.
    • The regular method for calculating the deduction requires detailed recordkeeping and can be time-consuming and burdensome for many taxpayers.
    • In January, the IRS released a new revenue procedure that allows taxpayers who otherwise qualify for the deduction to use a simplified safe-harbor method that reduces the recordkeeping generally involved under the actual-expense method.
    • While the safe-harbor method is easier to use, the deduction under it is limited to $1,500. Many taxpayers will find that using the actual-expense method yields a significantly higher deduction, so the results of using both methods should be compared to determine which is best for a taxpayer.

    In January, the IRS issued Rev. Proc. 2013-13,1 detailing an optional safe-harbor method available to individual taxpayers when calculating a home office deduction. For years, taxpayers and tax practitioners have struggled with the recordkeeping required to claim a deduction for expenses generated by a home office. However, beginning with the 2013 tax year, taxpayers can use the safe-harbor method, which requires much less recordkeeping than the traditional actual-expense method of calculating the deduction.

    The announcement of a new method might have come as a surprise to practitioners who are knowledgeable about the home office deduction, but according to an IRS spokesman, the idea for simplifying the deduction has been on the table for a number of years. While the spokesman declined to identify any particular impetus for the newly issued revenue procedure, he acknowledged that the IRS has long been aware that the effort necessary to compute the home office deduction can be unnecessarily time-consuming and overly burdensome.2

    Although Sec. 61 provides for a broad, all-inclusive definition of income, deductions are said to be granted by “legislative grace” and are not allowable unless specifically enumerated by statute.3 In determining what is deductible, taxpayers and tax practitioners can face significant challenges with expenses that have both personal and business characteristics. While business expenses are allowed as deductions under Sec. 162, most personal expenses (other than itemized deductions reported on Schedule A, Itemized Deductions) are disallowed as deductions under Sec. 262, forcing taxpayers to segregate the two types of expenses.

    The home office deduction is particularly tricky because it requires taxpayers to track expenses for business use of the home, which often intertwine with personal expenses that are either nondeductible or deductible only on Schedule A of Form 1040, U.S. Individual Income Tax Return. Depreciation and income limitations only add to the confusion surrounding home office expenses. At first review, Rev. Proc. 2013-13 provides welcome relief to taxpayers and tax practitioners, and this article sheds light on the revenue procedure and its anticipated effects on calculating and claiming the home office deduction.

    The next section provides a brief history of the home office deduction before continuing with an explanation of the pre-Rev. Proc. 2013-13 rules. The article then explains in detail the changes on the horizon considering the revenue ruling, with numerical examples that illustrate the differences between pre-Rev. Proc. 2013-13 rules (which can still be used) and the revenue procedure treatment. The article closes with some potential pitfalls and unintended consequences resulting from the application of Rev. Proc. 2013-13.

    Legislative History

    The legislative history of the home office deduction is relatively sparse. In fact, it was not specifically codified until 1976.4 Until that time, the authority allowing a deduction for the business use of a home was Regs. Sec. 1.262-1(b)(3), which states that “if, however, he [the taxpayer] uses part of the house as his place of business, such portion of the rent and other similar expenses as is properly attributable to such place of business is deductible as a business expense.” As mentioned before, Sec. 162 allows a deduction for “ordinary and necessary expenses…in carrying on any trade or business,” with interpretation of the terms “ordinary” and “necessary” resulting in wide variation from one taxpayer to the next. Lack of detailed procedures, along with creative arguments from taxpayers defending so-called ordinary and necessary home office expenses, eventually prompted Congress to consider legislation specifically addressing these expenses.

    In 1976, Congress enacted Sec. 280A in an attempt to provide objective criteria to evaluate the appropriateness of home office deductions.5 As Sec. 280A is a disallowance statute, it states that unless a deduction is specifically provided for in that Code section, no business deduction is allowed for the use of a taxpayer’s residence.

    The statute remained relatively unchanged until 1993, when the Supreme Court ruled, in Soliman, that a home office used solely for administrative tasks did not qualify for the home office deduction under the definition of “principal place of business” in Sec. 280A.6 This ruling led to a substantive revision of Sec. 280A, with the addition of Sec. 280A(c)(1), which includes use of a home office for “administrative or management activities” as a principal place of business when there is no other fixed location to perform these activities.7 Until the beginning of 2013, the remainder of Sec. 280A was rarely addressed.

    Current Rules Under Section 280A

    General Provisions

    Given that Sec. 280A is a disallowance provision, the general rules that allow for the home office deduction are found in the exceptions of Sec. 280A(c). In particular, the section allows a deduction for certain business use for an allocable portion of a dwelling unit that is “exclusively used on a regular basis: (1) as the principal place of business…; (2) as a place of business used in meeting with patients, clients, or customers…; or (3) in the case of a separate structure which is not attached to the dwelling unit, in connection with the taxpayer’s trade or business.” The business use allocation percentage is typically calculated by dividing the square footage of the claimed “business use” area by the square footage of the entire dwelling unit.

    It is usually straightforward to justify a home office deduction for a self-employed taxpayer. However, for a taxpayer who is an employee, the exclusive use of the office must be for the employer’s convenience.8 This requirement is most easily met if an employee who works from home part time or full time has no office space set aside elsewhere by the employer. Special rules apply for providing day care services or for use of the space to store inventory, but a home office deduction is also allowable in those scenarios.9

    A typical fact pattern might involve an individual taxpayer who is a sole proprietor with an unincorporated business. Such an individual would be required to report his or her income and expenses on Form 1040, Schedule C, Profit or Loss From Business (Sole Proprietorship). In addition, if the taxpayer works from a home office, Form 8829, Expenses for Business Use of Your Home, would be used to determine any deduction allowable for the business use of his or her residence. The current version of Form 8829 has 43 lines and can require a significant time commitment by the taxpayer to compile the required information. This form cannot be used by employees or partners.

    The expenses reported on Form 8829 are considered “dual-purpose” expenses and require allocation between business and personal use. In addition, the expenses may be limited by the business income limitation in Sec. 280A(c)(5). If a taxpayer’s gross income from the business use of his or her home equals or exceeds the taxpayer’s total business expenses (including depreciation), the taxpayer can deduct all the business expenses related to the use of the home. If a taxpayer’s gross income from the business use of his or her home is less than his or her total business expenses, the deduction for certain expenses for the business use of the home is limited.

    Because of the limitation, a taxpayer with a net loss from his or her business must consider all business expenses as well as the type of home office expenses to determine his or her final home office expense deduction. A taxpayer can deduct expenses in the following order:

    1. The taxpayer is first allowed to deduct business expenses not related to the business use of the home (e.g., wages and supplies);
    2. Next, to the extent of the income remaining after step 1, the taxpayer is allowed to deduct expenses also deductible elsewhere (specifically mortgage interest and taxes, discussed below) that would potentially be deductible on Schedule A whether or not the home was used as the principal place of business;
    3. Third, to the extent of income remaining after the first two steps, the taxpayer is allowed to deduct allocable household expenses, such as the portion of utilities allocated to the business use space; and
    4. Finally, to the extent of income remaining after the first three steps, the taxpayer is allowed to deduct allocable depreciation expense (discussed below).10

    In practice, the taxpayer calculates net Schedule C income before the home office deduction (step 1 above). Those ordinary and necessary business expenses unrelated to the home office and referred to in step 1 are fully deductible to the extent allowed by law. This net income is then used to determine the allowable home office deduction on Form 8829 (steps 2 through 4 above). Due to the limitation, the home office deduction can result in Schedule C income of zero, but it cannot cause a net loss.

    If the result of taking a deduction for the full amount of the otherwise deductible home office expenses would be a net loss on Schedule C, the deduction is limited to the portion that reduces income to zero. The amount of the deduction stemming from household expenses and allocable depreciation (steps 3 and 4 above) may then be carried forward to subsequent years. Any mortgage interest and real estate taxes not used on Form 8829 are deductible on Schedule A as itemized deductions rather than on Schedule C as a home office deduction. Employees who qualify for the deduction (and other non-Schedule C filers who work at home) calculate their actual expenses using the “Worksheet to Figure the Deduction for Business Use of Your Home” in IRS Publication 587, Business Use of Your Home (2012).

    Mortgage Interest and Property Taxes

    The option of a deduction for mortgage interest and real estate taxes on either Schedule A (itemized deductions allowable under Sec. 163 and Sec. 164, respectively) or on Form 8829 requires a closer look. If the bulk of the home office deduction for a particular taxpayer consists of mortgage interest and real estate taxes, should a taxpayer bother to prepare a Form 8829? Ignoring the recordkeeping issues, the answer is generally “yes,” for three reasons.

    First, for a taxpayer filing Schedule C, deductions claimed on Form 8829 (even if otherwise deductible on Schedule A) immediately reduce the taxpayer’s net income from self-employment and the related self-employment tax. Beginning Jan. 1, 2013, this tax burden was increased by the 0.9% Medicare surtax on higher-income taxpayers,11 making this reduction more valuable. Second, the home office deduction on Schedule C reduces the taxpayer’s adjusted gross income (AGI), which is used as a threshold for other deductions, specifically medical expenses and 2% miscellaneous itemized deductions. Finally, for those higher-income taxpayers subject to the overall phaseout on itemized deductions under Sec. 68 (the phaseout applies to married taxpayers filing jointly beginning at AGI of $300,000 for 2013), which was recently resurrected, deductions on Schedule A could be partially disallowed with no carryforward permitted.

    Provisions for Depreciation

    Under Sec. 167, a taxpayer is authorized to deduct “a reasonable allowance for the exhaustion, wear and tear…of property used in the trade or business.” Once a taxpayer successfully demonstrates that a portion of his or her principal residence meets the requirements of Sec. 280A, a deduction for depreciation is allowed for the allocable portion. Importantly, Sec. 1016(a)(2) requires that the basis of depreciable property be reduced by the amount of depreciation allowed or allowable—resulting in a basis reduction whether or not the taxpayer takes the depreciation deduction.

    The basis-reduction rule has effects beyond the current tax year, specifically when the taxpayer decides to sell the residence in which the taxpayer had his or her home office and the sale results in a gain. Recall that Sec. 121 excludes gain of up to $250,000 ($500,000 for married filing jointly status) from the sale of a taxpayer’s principal residence if certain ownership and use tests are satisfied. A taxpayer may be aware of this exclusion and assume that if the gain on the home’s sale is below the exclusion amount, no tax is due as a result of the sale. However, gain resulting from a basis decrease because of depreciation taken for business use of a home is not excludable under the general rule of Sec. 121. More specifically, under Sec. 121(d)(6), gain exclusion is not available to the extent of any depreciation taken after May 6, 1997. Instead, this gain is taxed as unrecaptured Sec. 1250 gain, subject to a maximum rate of 25%. This may come as a surprise to clients and should be discussed when the home office is first established.

    A more tax-savvy client might ask to claim only the allocable portion of mortgage interest, real estate taxes, and other expenses but forgo the depreciation deduction. Unfortunately, Sec. 1016(a)(2) requires a reduction in basis whether or not a depreciation deduction is taken during the period in which a portion of the residence had been used for business purposes.12 Prior court cases have addressed this issue, and taxpayers arguing against the “allowed or allowable” provision were unable to avoid taxable gain by declining to claim a depreciation deduction.

    Rev. Proc. 2013-13: A New Safe-Harbor Option

    Rev. Proc. 2013-13 offers taxpayers a simplified approach to claiming the home office deduction. As noted in the comparison of the safe-harbor rules and the actual-expense rules in Exhibit 1, taxpayers must still meet the basic requirements of Sec. 280A under the safe-harbor rules, including the regular and exclusive use requirements as well as the requirement that the home office be for the employer’s convenience (for employees claiming the deduction). However, this safe-harbor method substantially simplifies the treatment of expenses compared with the actual-expense method. To claim home office expenses, taxpayers can elect to multiply the allowable square footage by a prescribed rate. The revenue procedure provides that the allowable square footage is the portion of the home that the taxpayer uses for a qualified business use, but the maximum allowable square footage is limited to 300 square feet. The revenue procedure also states that the prescribed rate is $5 for each square foot, resulting in a maximum deduction of $1,500 under this safe harbor.13



    Taxpayers can elect to use the simplified method on a year-by-year basis, with the election being made by simply using the safe-harbor method to calculate the deduction for the qualified business use of the home on a timely filed tax return. Once the taxpayer elects to use the method, it is irrevocable for that particular year. However, making a change back to actual expenses in a subsequent year is not considered to be a change in accounting method and does not require the IRS’s consent.

    While taxpayers can switch between the actual-expense method and the new safe-harbor rules, choosing which method is preferable may involve more than simply comparing which method yields the greater deduction and considering the benefits of simplified recordkeeping. More specifically, taxpayers who may have had home office expenses in excess of the income limitation of Sec. 280A(c)(5) in previous years that they are carrying forward will want to consider the potential value of using the excess expenses in the current year. When using the new safe-harbor rules, taxpayers are unable to use any disallowed expenses that they are carrying forward from a previous year. While taxpayers are allowed to continue to carry these disallowed expenses forward to a year in which they will use the actual-expense method, this will mean a continued deferral of the tax benefits of these expenses.

    Special Situations

    While the basic calculation of the safe-harbor deduction is simple, the revenue procedure also provides some guidance for more complex situations. For example, taxpayers who use the home office for only a portion of the year (for example, a taxpayer operating a seasonal business or either starting or ending the use of the home office during the current year) need to determine the average monthly square footage for the year. In calculating the average monthly square footage, the taxpayer can include any month in which the home office was used for at least 15 days. In no case may the taxpayer count more than 300 square feet for any particular month.

    For example, assume that a taxpayer begins a business that uses a 400-square-foot home office on Sept. 10, 2013. The taxpayer would include 300 square feet for four months equal to 1,200 square feet. This is then divided by 12 months in the tax year for an average annual use of 100 square feet, and the total annual use of 100 square feet would then be multiplied by the $5 allowance for a $500 deduction. Taxpayers who either increased or decreased the size of their home office during the year must determine an average square footage for the year in a similar fashion.

    Two taxpayers who are sharing a home (e.g., spouses or roommates) may both use the safe-harbor method, but not for the same portion of the home. Instead, they are each eligible to use the safe-harbor method for up to 300 square feet for different qualifying portions of the home.

    If a taxpayer has qualified use of a home office in more than one home during the year, he or she may use the safe-harbor method for only one home during that tax year. However, the actual expenses can be claimed for any other homes that qualify during the year. If a taxpayer has more than one qualified business use of the same home during the year, he or she can elect to use the safe-harbor method, but the method must be used for each qualified business use. Importantly, the maximum square footage across the different business uses is still 300 square feet. If the actual usage is more than 300 square feet, the taxpayer must allocate the square footage across different qualified uses.

    Limitations on Use of the Safe-Harbor Method

    The simplified safe-harbor method offered under Rev. Proc. 2013-13 includes some limitations on its use. The revenue procedure indicates that this method cannot be used if an employee receives an allowance, advance, or reimbursement from an employer for any expenses related to the qualified use of the home. Further, as with taxpayers who claim actual expenses for the qualified business use of a home, the deduction under the safe-harbor method cannot exceed the gross income from the qualified business use of the home after taking into account any business deduction unrelated to the qualified business use of the home. Unlike with the actual-expense method, any excess expense for which a deduction is disallowed cannot be carried over to other years.

    The calculation of the deduction under the actual-expense method was previously discussed and is revisited in Exhibit 2. When the taxpayer chooses to use the safe-harbor method instead of the actual-expense method, the process of calculating the deduction is similar, but with some key differences. As with the actual-expense method, the taxpayer begins by deducting the business expenses that are unrelated to the use of the home. However, the next category, expenses related to the home that would be deductible elsewhere (such as mortgage interest and real estate taxes), cannot be used to offset business income. Instead, they are fully allocated to Schedule A.


    Depending on the taxpayer’s situation, claiming these expenses on Schedule A instead of Schedule C may mean higher self-employment taxes, as a portion of these expenses will not be reducing net self-employment income. In addition, depending on the taxpayer’s income level, the expenses on Schedule A could be subject to the recently reinstated Sec. 68 phaseout of itemized deductions, whereas those expenses allocated to Schedule C under the actual-expense method are not subject to this phaseout.

    Finally, the safe-harbor amount effectively replaces the last two categories of expenses (i.e., the expenses related to the home that are not deductible elsewhere and depreciation). If these expenses are substantially greater than the safe-harbor maximum of $1,500, then the taxpayer may forfeit considerable tax benefits by using the safe-harbor method. Further, if the safe-harbor deduction amount exceeds the business income limitation, the taxpayer loses the excess under the safe-harbor method, whereas he or she may carry it over to future years under the actual-expense method.

    Navigating the New Rules

    Potential Issues

    Despite the safe harbor’s taxpayer-friendly nature, three potential issues arise with applying the new rules. The first two issues are familiar to taxpayers and tax practitioners who use a vehicle for business—they both stem from switching between the actual-expense method and the safe-harbor method for calculating the home office deduction.

    When opting to deduct actual expenses, the rules under Sec. 280A require the same recordkeeping, substantiation, and allocation as usual. But the safe-harbor option allows an automatic deduction of $5 per square foot for up to 300 square feet. For many clients, the advantages of the safe harbor may vary from one year to the next, prompting them to use the actual-expense method in some years. If this is the case, it is important to note that a carryover generated in an “actual expense” year cannot be used in a “safe harbor” year and cannot be used until the next time a taxpayer uses actual expenses for the home office deduction. The value of this carryover diminishes over time and forces the taxpayer to closely track carryovers.

    Depreciation calculations are also complicated by inconsistency in the choice of a method. In a year in which the safe harbor is chosen, depreciation is not allowed. However, when the actual-expense method is chosen in a future year, the taxpayer must calculate depreciation for the current year based on the year placed in service. In addition, keep in mind the rules for “allowed vs. allowable” that stipulate that depreciation decreases the basis of the asset regardless of whether depreciation is actually taken each year. In this instance, the revenue procedure specifies that allowable depreciation in a safe-harbor year is zero. The taxpayer needs to track closely when depreciation is taken or allowed. This was discussed in detail above, and it could potentially complicate calculation of basis when the home is sold.

    The third potential pitfall of the safe harbor relates to its effect on earnings from self-employment (Schedule C income). While the recordkeeping and calculation requirements might be burdensome, many self-employed taxpayers rely on the home office deduction to reduce Schedule C income. Although the safe-harbor option is simpler, if actual expenses are much higher than the maximum deduction of $1,500, there will be an adverse effect on taxes owed for self-employment. Below are two examples illustrating potential complications of switching between deducting actual expenses and choosing the safe harbor.

    Example 1. Electing actual expenses in year 1: B is a therapist who exclusively uses a portion of his home to see patients on a regular basis in the normal course of his trade or business during 2013. He determines that the room is 400 square feet and has an allocable cost basis of $15,000. The room was placed into service in January 2013, and during the year B earned $39,000 of gross income from the business. His business expenses are as shown in Exhibit 3. B also pays expenses related to his home office (allocable portion) in 2013, as shown in Exhibit 4.

    To calculate depreciation, B uses the depreciation table that corresponds with the general depreciation systemnonresidential real property, midmonth convention, straight-line over 39 years. For year 1, the applicable percentage is 2.461%, resulting in a depreciation deduction of $369.15 ($15,000 cost basis × 2.461%).

    For 2013, B elects to use the actual-expense method. Recall that he must allocate expenses based on the Sec. 280A(c)(5) ordering rules discussed above. His net Schedule C income before the home office deduction is $26,300 ($39,000 – $12,700). The home office deduction thus is limited to $26,300. Total home office expenses before depreciation equal $26,100 and are fully deductible on Form 8829. However, only $200 of the calculated depreciation is deductible in the current year, with $169.15 carried forward to 2014 or the next year that the actual-expense method is used.

    Example 2. Electing safe harbor in year 2: Now assume that in 2014, B has net Schedule C income of $24,000. Similar to 2013, assume that B has total home office expenses before depreciation of $24,300 (not shown). This year, B elects the safe harbor for his home office deduction. B’s home office measures 400 square feet, but the deduction is limited to 300 square feet × $5.00 per square foot, for a total home office deduction of $1,500. B can deduct the full $1,500 home office expenses since his net Schedule C income is greater than that amount.

    The mortgage interest and property taxes qualify as itemized deductions on Schedule A, subject to any phaseout of itemized deductions. Any other expenses related to the business use of the home (e.g., homeowners’ insurance, utilities, repairs, and cleaning) are not deductible this year. In addition, his depreciation deduction for the office is deemed to be zero. When B next elects actual expenses, depreciation will be calculated based on the year he originally placed the room in service (2013), not the number of years depreciation has been taken. Finally, the carryover from 2013 cannot be used in a safe-harbor year and will be carried forward to the next year in which actual expenses are claimed.

    Client Planning

    The safe-harbor provision is most beneficial to the client who meets one or all of the following criteria: (1) relatively low amounts of Schedule C income, (2) relatively low amounts of mortgage interest, property taxes, or other actual expenses, (3) not subject to the phaseout of itemized deductions (i.e., low income overall), and (4) unwilling to comply with the recordkeeping requirements.

    For many clients, the safe-harbor deduction is much lower than the actual expenses and thus is not a useful option. If a client is willing to comply with the recordkeeping requirements and meets one of the following criteria: (1) relatively high amounts of Schedule C income, (2) relatively high amounts of mortgage interest, property taxes, or other actual expenses, (3) subject to the phaseout of itemized deductions (i.e., high income overall), and (4) wants to use a large carryover from the prior year, then choosing the actual-expense method would likely be more beneficial. Clients should be made aware of the issues discussed above that arise when alternating between methods in different years.

    Example 3. Electing actual expenses vs. safe harbor: W is a hairdresser who exclusively uses a portion of her home to see clients on a regular basis in the normal course of her trade or business during 2013. She determines that the room is 500 square feet and has an allocable cost basis of $16,000. The room was originally placed into service in January 2011. During the current year, W earned $82,000 of gross income from the business. Her business expenses are shown in Exhibit 5. W also pays the expenses related to her home office (allocable portion) in 2013 as shown in Exhibit 6.



    To calculate depreciation,
    W uses the depreciation table that corresponds with the general depreciation systemnonresidential real property, midmonth convention, straight-line over 39 years. For year 3, the applicable percentage is 2.564%, resulting in a depreciation deduction of $410.24.

    In addition, W’s husband, H, has salary income of $250,000 in the current year.

    For 2013, W should elect to use the actual-expense method rather than the safe harbor. First, her actual expenses are relatively high compared with the safe-harbor allowance, and she has high amounts of Schedule C income. Also, her husband’s income level will subject them to the phaseout of itemized deductions ($300,000 for married filing jointly) rendering some of their mortgage interest and property taxes nondeductible on Schedule A. If she is willing to follow the recordkeeping requirements, the actual-expense method will result in lower Schedule C and lower taxable income.

    Recall that she must allocate expenses based on the hierarchy discussed above. Her net Schedule C income before the home office deduction is $67,550 ($82,000 – $14,450). Total home office expenses before depreciation equal $23,400 and are fully deductible on the Form 8829. In addition, all $410.24 of the calculated depreciation is deductible in the current year. The total home office deduction of $23,810 is substantially higher than the safe-harbor amount of $1,500 and thus a better choice. In fact, besides reducing her income tax, it reduces her self-employment tax by $3,153 when compared with the safe-harbor election. See the calculation in Exhibit 7.

    Example 4. Electing safe harbor vs. actual expenses: A few changes to W’s circumstances would make the safe-harbor option more appealing. Assume the following: during the current year, W earned $8,000 of gross income from the business. Her business expenses are shown in Exhibit 8. W also pays expenses related to her home office (allocable portion) in 2013 as shown in Exhibit 9.


    To calculate depreciation,
    W uses the depreciation table that corresponds with the general depreciation systemnonresidential real property, midmonth convention, straight-line over 39 years. For year 3, the applicable percentage is 2.564%, resulting in a depreciation deduction of $410.24.

    If it is assumed that W’s husband, H, has only $100,000 of salary income in 2013, the safe harbor is now more appealing. W and H can deduct the full amount of mortgage interest and property taxes on their Schedule A as itemized deductions. The other itemshomeowners’ insurance, utilities, repairs, cleaning, and depreciationare not deductible in 2013. Instead, W can claim a home office deduction of $1,500 (300 maximum square feet × $5.00 per square foot). See the calculation in Exhibit 10.

    Note that home office expense under the actual-expense method would be limited and carried forward to a future year when the actual-expense method was used. Under the safe-harbor method, no recordkeeping is required, and the resulting self-employment tax is only $586. Half of this is deductible for AGI, so the tax consequences likely are negligible to the taxpayer compared to the recordkeeping burden.

    Conclusion

    While claims of tax simplification have become all but cliché, tax professionals and taxpayers alike are always on the alert for opportunities to reduce compliance burdens. Rev. Proc. 2013-13 appears to offer an opportunity for simplified recordkeeping; however, this reduced compliance effort often comes with an incremental tax cost.

    The safe-harbor method will often be beneficial to lower-income taxpayers who may have neglected to keep adequate records during the year, who prepare their own tax returns (or rely on free tax preparation service), and who foresee regularly using this method over the long term. It also has the advantage, because the method does not permit depreciation deductions, of allowing taxpayers to avoid having to recapture depreciation when they sell their house.

    For taxpayers who want to switch between methods depending on the result each year, additional complexity may arise in trying to keep accurate records and keep track of depreciation deductions.

    In trying to ensure the best outcome for clients, tax professionals should include a cost/benefit analysis in terms of tax savings as compared to expended effort (and perhaps, the professional fees attached to that effort). By informing and educating clients about the significant changes in the IRS’s position on the home office deduction in Rev. Proc. 2013-13, CPAs can help them understand that the simplified method is neither a “free deduction” nor a magic bullet.

    Footnotes

    1 Rev. Proc. 2013-13, 2013-6 I.R.B. 478.

    2 Telephone conversation on Feb. 6, 2013, with Eric Smith, spokesman from the IRS Media Relations Office.

    3 New Colonial Ice Co. v. Helvering, 92 U.S. 435 (1934).

    4 Tax Reform Act of 1976, P.L. 94-455, §601(a).

    5 See H.R. Conf. Rep’t 94-1515, 94th Cong., 2d Sess. (1976).

    6 Soliman, 506 U.S. 168 (1993), rev’g 935 F.2d 52 (4th Cir. 1991).

    7 Taxpayer Relief Act of 1997, P.L. 105-34, §932.

    8 Sec. 280A(c)(1), flush language.

    9 Secs. 280A(c)(4) and (c)(2).

    10 See IRS Publication 587, Business Use of Your Home (2012).

    11 Sec. 3101(b)(2).

    12 See, e.g., Brock, T.C. Memo. 1994-177.

    13 An IRS spokesman indicated that the limit of 300 square feet and $5 rate were chosen because they were viewed as “typical amounts” among taxpayers who have historically claimed the home office deduction (telephone conversation on Feb. 6, 2013, with Eric Smith, spokesman from the IRS Media Relations Office).

     

    EditorNotes

    Michaele Morrow is an assistant professor of accounting, Timothy Rupert is a professor and Golemme Administrative Chair in Accounting, and Ronald Zullo is a lecturer in accounting. All three teach at the D’Amore-McKim School of Business at Northeastern University in Boston. For more information, contact Prof. Morrow at m.morrow@neu.edu.




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