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Written by: Julie Welch

Published: 10 January 2012

Generally, the only expenses you can deduct for your home are interest and real estate taxes. However, if you use part of your home for business, you can deduct part of your utilities, insurance, and repair costs. You can also deduct depreciation on the portion of your home you use for business. Depreciation is an expense you can deduct for the wear and tear on your home when you use your home to produce income. 

You do not have to own your home to benefit from deductions for the business use of your home. If you rent a home, condo, or apartment, you can deduct the portion of your rent, utilities, and insurance that relates to the business use of your home. However, you cannot take a deduction for depreciation. 

Six situations when you can deduct business expenses for using your primary home.

1. As your main place of business for any business you run. If you use a room, usually an office, in your home only for business on a regular basis, you can deduct the expenses related to the room. Thus, if you are a writer or an artist and you use your home office as your place of work, you probably can take a home office deduction. You also can use your home office as an administrative office and do your work someplace else, as long as you have no other fixed location to do administrative work. Thus, doctors (who perform their primary duties in hospitals), salespeople (who spend time in customers’ offices), and painters and other tradespeople (who spend most of their time at job sites) can probably take a home office deduction. 

2. As a place to meet or deal with patients, clients, or customers in the normal course of your business. You must physically meet with people in your home office and not use the room for personal purposes. Making business phone calls from your home is not enough.

3. As a place to store inventory you use in your business. If you regularly use an area of your home to store inventory that you sell from your home by mail or delivery, you can deduct expenses for the portion of your home you use to store the inventory. Storing old records from a business you conduct elsewhere does not qualify.

4. As a place to store product samples for your trade or business.

5. As a day care facility.  You must use your home regularly to provide day-care services for children, persons 65 or older, or persons who are physically or mentally incapable of caring for themselves. Your day care facility must be certified or exempt from certification. Generally, if you use your home to provide day care, your deduction is based on the portion of your home that is used, as well as the amount of time in a day the home is used.

6. Use of an unattached , separate building you use only for business. Garages and barns are examples of separate structures that frequently qualify for deduction of expenses. To calculate your deduction, you first gather your home expenses.

You can deduct all the expenses that relate directly to the business area of your home. Examples include the cost of repairs to the room and the cost of painting the room. You can also deduct the portion of your indirect expenses that relate to the business-use portion of your home. Indirect expenses include mortgage interest, real estate taxes, insurance, security, utilities, and repairs and maintenance.

Many people calculate the business use portion by dividing the square footage of the business area by the total square footage of the home. It is also acceptable to base your business percentage on the number of rooms used for business compared to the total number of rooms in your home. Use the method that gives you the higher business-use percentage.

You use a room in your home as an office. The room measures 14 x 16

(224 square feet). The room is one of eight rooms in your home. The total square footage of your home is 2,240 square feet. Using the square footage method, you can deduct 10% (224/2,240) of your indirect expenses. Using the number of rooms method, you can deduct 12.5% (1/8) of your indirect expenses. You can deduct more expenses using the number of rooms method.

If you own your home, you can also depreciate the portion of your home you use for business based on the business-use percentage. Multiply the cost of your home, not including land, by your business-use percentage.

This is the business-use portion of your home. You can depreciate the business-use portion of your home over 39 years (31.5 years if you started to use your home for business before May 13, 1993).

Your deductions for the business use of your home cannot be more than the income from your business. If your deductible home expenses are greater than your business income, then two things happen.

First, you must prioritize the home expenses you can deduct. The ones deductible first are itemized deductions that you can deduct anyway, such as mortgage interest and real estate taxes. Next are home expenses that usually are not deductible and do not affect the basis of your home, such as repairs and utilities. The last expense you deduct is depreciation.

Second, you carry forward the expenses you cannot deduct this year because you do not have enough income. You can use this carry forward against future income from your home business.

You are employed full-time and also operate a second business from your home. You use a room in your basement, which is 15% of the home’s square footage, on a regular basis exclusively for your second business.

Your income from the second business is $10,000. Your business expenses, other than home office expenses, total $7,000. For the year, you pay the following home-related expenses:

-  Real property taxes of $2,000

-  Mortgage interest of $8,000

-  Utilities and other operating expenses of $1,500

-  Repair of the wall in your home office of $1,000.

You purchased your home for $120,000, of which $20,000 is allocated to land. Your business income and home office deductions are determined as follows:

Business income $10,000

Less: Other business expenses (7,000)

Subtotal  3,000

Less:

Taxes (2,000 x 15%) (300)

Interest (8,000 x 15%) (1,200)

Subtotal  1,500

Wall repair (1,000)

Utilities and other expenses (225)

(1,500 x 15%)

Subtotal  275

Depreciation (275)

(($100,000 x 15%)/

39 years = $385) limited

to remaining income

Net business income $00,000

Depreciation expenses of $110 ($385 - 275) are not allowed in the current year. You can use the $110 of deductions to reduce your income from the second business in the following year if your income is greater than your deductions.

You calculate your home deductions using Form 8829. The deduction transfers to Schedule C of your Form 1040. The deductible home expenses reduce your self-employment tax and your adjusted gross income.

NOTE:  If you take depreciation on your home office and you later sell your home at a gain, you will have to pay tax on your gain up to the amount of any depreciation you deducted after May 6, 1997. Any remaining gain is eligible for the $250,000 ($500,000 if you are married filing a joint return) exclusion when you sell your home. Any gain up to the amount of depreciation you take on your home office is taxed at a maximum rate of 25%, whether or not the $250,000 ($500,000 if you are married filing a joint return) exclusion applies. On the other hand, if you sell your home for a loss, you should use part of the home for business, because you can deduct losses on business property but not personal-use property.

Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 9th Edition, published by Wealth Builders Press. To order ($27.95) call 816-561-1400.

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Written by: Julie Welch, CPA/PFS, CFP

Published: 20 November 2011

By: Julie Welch, CPA/PFS, CFP | Savings Incentive Match Plan for Employees (SIMPLE plans) are retirement plans that can be set up by small businesses with less than 100 employees that have no other retirement plan. The SIMPLE plan can be either an IRA or a 401(k), depending on which one you (if you are self-employed) or your employer set up.

Under a SIMPLE plan, you can choose to defer up to 100% of your current salary and have it put into a retirement plan. If you are self-employed, you can choose to defer a portion of your earnings from your business. Anything you choose to defer reduces your current income, and you will pay no tax on the earnings until you withdraw the money. However, the FICA tax, also known as the Social Security tax or self-employment tax, applies to the amounts you choose to defer.

The maximum amount of salary you can defer into a SIMPLE plan is $12,000 ($14,500 if you are 50+). This amount may be adjusted annually for inflation. If you are self-employed and have employees, you must offer this plan to your employees, but you can contribute to your plan even if your employees choose not to contribute to theirs.

If you make contributions to your SIMPLE plan, you (if you are self-employed) or your employer must also make contributions. There is a choice that your employer makes. Generally, your employer must match your contributions to your SIMPLE plan up to 3% of your pay. Alternatively, your employer can choose to contribute 2% of your pay even if you choose to make no contributions, as long as your pay is at least $5,000. Only $255,000 of your compensation can be taken into account for the calculation for 2013.

Unlike most pension and profit sharing plans, you immediately vest in any contributions that either you or your employer contributes to your SIMPLE plan. Thus, if your account balance is $12,000 and you terminate your employment, you will get the full $12,000.

Distributions you take from your SIMPLE plan can be subject to a 10% penalty unless you are at least age 59 ½ or meet another exception. Any distributions you make from your SIMPLE plan during the two-year period beginning on the first day you began participating in the SIMPLE plan are subject to a 25% penalty.

If you are self-employed or you are an employer, you can use either IRS Form 5304-SIMPLE or IRS Form 5305-SIMPLE to set up a SIMPLE plan. Use Form 5304-SIMPLE if you let each participant select where they set up their account. Use Form 5305-SIMPLE if you require all participants to use one financial institution for the accounts.

Example:

You make $24,000. Your employer has a SIMPLE plan and matches your contributions up to 3% of your pay. You choose to defer $4,000 into the SIMPLE plan.

Your contribution into the SIMPLE plan              $4,000

Your employer’s contribution ($24,000 x 3%)     + $720

Total contributions into = $4,720 your SIMPLE plan

Additionally, you may be eligible for the “saver’s credit” if you make a contribution of up to $2,000 to your IRA, 401(k) plan, or SIMPLE plan.

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Written by: Julie Welch

Published: 08 September 2011

Before 1986, parents shifted investments to children so that interest and dividend income from the investments would be reported on the children’s returns. Often, children paid little or no tax because they sheltered the investment income with their standard deduction and exemption deduction and paid tax at their low tax rates.

In 1986, Congress attacked this tax strategy in three ways. First, only one exemption deduction per person is allowed. If you claim your child as a dependent on your return, your child loses his or her personal exemption deduction.

Second, if you claim your child as a dependent on your return, your child’s standard deduction decreases to the greater of $950 or the compensation income of the child plus $300. Thus, if your child’s compensation income is $400, your child’s standard deduction is $950. If your child’s compensation income is $1,800 then your child’s standard deduction is $2,100. This increased standard deduction is one advantage of hiring your children to work for you.

Third, if your child is subject to the kiddie tax, your child’s investment income over $1,900 may be taxed at your tax rate. Dependent children with investment income greater than $1,900 may be subject to the kiddie tax if they are under the age of 19 or are full-time students ages 19 to 23 who do not earn more than one-half of their own support. You can use the chart at the end of this article to help determine if your child is subject to the kiddie tax.

You file jointly with your spouse and report $120,000 of taxable income on your 2011 return. Your tax rate is 28%. Your 10-year old son receives $5,000 of interest income from certificates of deposit (CDs) given to him by your spouse. Your child’s tax computation is shown below.

Interest income $5,000
Standard deduction (950)
Exemption deduction (0)
---------
Taxable income $4,050

Taxed at your rate:
($5,000 - 1,900) $3,100
Tax rate and tax x 28%
---------
$868

Taxed at your child’s rate:
($4,050 - 3,100) $950
Tax from Table 96
---------
Child’s tax on $5,000 in interest income $964

Your child reports this tax on his or her own tax return. Your tax does
not change.

Including your child’s income on your return

If you have children subject to the kiddie tax who must pay tax, you can choose to include this income on your return by completing Form 8814. To do so, you must meet the following requirements:

• The income must be only from interest and dividends. None of the income can be from wages or capital gains other than mutual fund capital gain distributions,
• Your child’s interest and dividends must be more than $950 and less than $9,500, and
• Your child must not pay separate estimated tax payments.

Including your child’s income in your return on a Form 8814 may be a bad idea. By including your children’s income in your own return, you increase your adjusted gross income (AGI). As a result, your deductions could decrease. First, your deductions for medical expenses, casualty losses, and miscellaneous deductions are limited based on your AGI. To illustrate, your miscellaneous deductions are limited to amounts over 2% of your AGI. If you increase your AGI by including $5,000 of your child’s interest income in your income, you reduce your miscellaneous itemized deductions by $100 ($5,000 x 2%).

Second, if your employer’s retirement plan covers you, you must reduce the amount of the individual retirement account (IRA) contribution you can deduct if you are single and your AGI is over $56,000 or if you are married and your AGI is over $90,000 ($89,000 for 2010). If you include your child’s investment income in your return, you may decrease your IRA deduction.

Third, you are eligible to make a full Roth IRA contribution if your AGI is under $105,000, if you are single and under $167,000 ($166,000 for 2010), if you are married filing a joint return. Including your child’s investment income may cause you to exceed these amounts.

Many parents include their children’s income in their returns
to avoid the hassle or cost of filing Federal and state returns for their children. Although this reasoning is understandable, you may pay
more tax if you include your children’s income in your return.

Strategies to avoid the Kiddie Tax

You can use several strategies to avoid paying tax on your child’s investment income at your tax rates. First, you do not even need to file
a return for your child if your child’s income is under $950 unless he or she has net earnings from self-employment of $400 or more.

Second, your child who is potentially subject to the kiddie tax can receive $1,900 of investment income in addition to compensation income before paying tax at your rate. For 2011, your dependent child’s standard deduction is the greater of $950 or your child’s compensation income plus $300 up to $5,800.

If your child has $1,400 of investment income and no compensation income, then your child’s taxable income is $450 ($1,400 - 950). The income is taxed
at your child’s tax rate.

If your child has $2,000 of investment income and $6,000 of compensation income, then your child’s taxable income is $2,200 ($2,000 + 6,000 - 5,800).
Of the $2,200, $100 ($2,000 - 1,900) is taxed at your tax rate and $2,100
($2,200 - 100) is taxed at your child’s 10% tax rate.

In other words, compensation income can increase your child’s standard deduction and it does not change the amount of investment income your child can receive before your tax rate applies to his or her income.

Third, when your child’s investment income reaches $1,900,
consider investments that do not increase your child’s taxable income. Examples include:

Tax-exempt municipal bonds,

Growth stocks which pay no current dividends,

Real property which appreciates in value, and

Tax-deferred U.S. Savings bonds.

Fourth, split your child’s income with a trust. A trust is a separate
tax entity. Trusts pay tax on income that is kept in the trust and not paid
to your child. The first $2,300 of trust taxable income is taxed at a 15% tax rate. Thus, up to $4,200 ($2,300 in the trust and $1,900 distributed to your child) of income is taxed at a 10% or 15% tax rate. Although this strategy is worth considering, few parents use it because of the initial cost of setting up a trust and the annual cost of filing trust returns.

Many parents shift income to their children so they can save money
for the child’s college costs at a lower tax rate. However, until the child gets older, the child may pay tax at the parent’s tax rate. You can avoid this higher rate of tax by knowing how much income your child can receive before your tax rate applies and choosing investments that do not increase your child’s taxable income.

NOTE: If you are investing money in a child’s name to save money
for college, you should consider qualified tuition plans. They are generally better vehicles for such savings, particularly when the child is potentially subject to the kiddie tax.

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Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 9th edition, published by Wealth Builders Press. To order ($27.95), call 816-561-1400, fax 816-561-6296 or email This email address is being protected from spambots. You need JavaScript enabled to view it..

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Written by: Julie Welch

Published: 29 July 2011

Many businesses would rather pay independent contractors (“contract labor”) than employees. This practice allows the company to avoid paying payroll taxes and to exclude the independent contractor from fringe benefit and retirement plans.

Many people would rather receive “contract labor” payments than wages. As discussed in Tax Saving Idea #69, this allows the person to deduct expenses in computing adjusted gross income.

The IRS has been focusing attention on independent contractors. The IRS thinks many independent contractors do not report all their income.

You can use the following 20 factors to structure your work arrangements with your customers and help prove you are an independent contractor. These factors are the tests applied by the courts in determining employment status. No single factor is controlling, nor is any particular weight given to any one of the factors.

Behavioral Control Factors

These factors measure whether there is a right to direct or control how the work is done.

• Few instructions are given to you about how, when and where you are to work.
• Little training is provided by the company.
• Your services are not integrated with the company’s operations.
• You are not required to perform the services personally.
• You hire, supervise and pay assistants.
• Your relationship with the company is not continuing or is infrequently recurring.
• You set your working hours.
• You do not work full-time for the company.
• You do not work at the company’s location.
• You set the steps in which the work will be done.
• You are not required to submit written or oral reports.

Financial Control Factors

These factors measure whether there is a right to direct or control how the business aspects of the worker’s activities are conducted.

• You are paid by the job rather than by the week 
• or month.
• You are not reimbursed for your business or traveling expenses.
• You provide your own equipment and supplies.
• You invest in the facilities you use for doing the work.
• You can realize a profit or suffer a loss as a result of 
• your services.
• You work for many different companies at the same time.
• Your services are available to the general public on a regular basis.

Relationship Factors

These factors measure how the parties perceive their relationship.

• You cannot be fired as long as you produce the requested work.
• You cannot terminate your relationship with the company until your work is complete.

You are writing and implementing a marketing plan for ABC Company. You work 15 hours per week at ABC Company’s office for $40 per hour. You use ABC Company’s computers, copiers, and phones. For the rest of the week, you serve a variety of other companies on a project-by-project basis. You may be an employee of ABC Company because you provide the services personally, work at ABC Company’s office and use ABC Company’s equipment.

If you wish to be an independent contractor, you may want to restructure your relationship. First, you might work at your office rather than at ABC Company’s office. Second, you might use your own computer and equipment. Third, you might arrange to be paid on a project basis. Fourth, you might have a written agreement with ABC Company. 

Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 9th edition, published by Wealth Builders Press. To order ($27.95), call 816-561-1400, fax 816-561-6296 or email This email address is being protected from spambots. You need JavaScript enabled to view it..