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Optional Safe Harbor Method for Claiming Home Office Deduction for 2013

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On January 15, 2013, the IRS today announced a simplified option for claiming home office deduction (i.e. deduction for the business use of a home). The new optional deduction, capped at $1,500 per year based on $5 a square foot for up to 300 square feet, will reduce the paperwork and recordkeeping burden on small businesses by an estimated 1.6 million hours annually.

Background Information

Internal Revenue Code (IRC) Section 280A generally deals with the tax treatment of home office expenses. Generally, IRC Section 280A(a) disallows any deduction for expenses related to a dwelling unit that is used as a residence by the taxpayer during the taxable year. However, Provisions 280A(c)(1) through (4) allow a deduction for expenses related to certain business or rental use of a dwelling unit, subject to the deduction limitation in § 280A(c)(5).

Section 280A(c)(1) permits a taxpayer to deduct expenses that are allocable to a portion of the dwelling unit that is exclusively used on a regular basis (A) as the taxpayer’s principal place of business for any trade or business, (B) as a place to meet with the taxpayer’s patients, clients, or customers in the normal course of the taxpayer’s trade or business, or (C) in the case of a separate structure that is not attached to the dwelling unit, in connection with the taxpayer’s trade or business.

Section 280A(c)(2) permits a taxpayer to deduct expenses that are allocable to space within the dwelling unit used on a regular basis for the storage of inventory or product samples held for use in the taxpayer’s trade or business of selling products at retail or wholesale, if the dwelling unit is the sole fixed location of the trade or business.

Section 280A(c)(3) permits a taxpayer to deduct expenses that are attributable to the rental of the dwelling unit or a portion of the dwelling unit.

Section 280A(c)(4) permits a taxpayer to deduct expenses that are allocable to the portion of the dwelling unit used on a regular basis in the taxpayer’s trade or business of providing day care for children, for individuals who have attained age 65, or for individuals who are physically or mentally incapable of caring for themselves.

Optional Safe Harbor Method

After recognizing that Section 280A(c)(1) imposes a substantial compliance burden on taxpayers (and, perhaps, with the desire to cut its own enforcement costs), the IRS decided to provide for the very first time a new method of calculating home office deductions – the optional safe harbor method.

Under this safe harbor method, taxpayers determine their allowable deduction for business use of a residence by multiplying a prescribed rate (currently set at $5 per square foot) by the square footage of the portion of the taxpayer’s residence that is used for business purposes (“allowable square footage”). The allowable square footage is the portion of a home used in a “qualified business use” of the home, but not to exceed 300 square feet.

“Qualified Business Use” is a term of art. Under the Rev. Proc. 2013-13, this term means (1) business use that satisfies the requirements of § 280A(c)(1), (2) business storage use that satisfies the requirements of § 280A(c)(2), or (3) day care services use that satisfies the requirements of § 280A(c)(4) (see above).

The safe harbor method provided by this revenue procedure does not apply to an employee with a home office if the employee receives advances, allowances, or reimbursements for expenses related to the qualified business use of the employee’s home under a reimbursement or other expense allowance arrangement (as defined in § 1.62-2) with his or her employer.

Note that the current restrictions on the home office deduction, such as the requirement that a home office must be used regularly and exclusively for business and the limit tied to the income derived from the particular business, still apply under the new option.

Advantages and Disadvantages of the New Optional Safe Harbor Method

The new option provides eligible taxpayers an easier path to claiming the home office deduction. Currently, they are generally required to fill out a 43-line form (Form 8829) often with complex calculations of allocated expenses, depreciation and carryovers of unused deductions. Taxpayers claiming the optional deduction will complete a significantly simplified form.

The new option does not affect business expenses unrelated to the home (such as advertising, supplies and wages paid to employees). Such expenses are still fully deductible.

The down side of the new option is that the homeowners cannot depreciate the portion of their home used in a trade or business. However, they can still claim allowable mortgage interest, real estate taxes and casualty losses on the home as itemized deductions on Schedule A. These deductions need not be allocated between personal and business use, as is required under the regular method.

A taxpayer using the safe harbor method for a taxable year cannot deduct any depreciation (including any additional first-year depreciation) or § 179 expense for the portion of the home that is used in a qualified business use of the home for that taxable year. The depreciation deduction allowable for that portion of the home for that taxable year is deemed to be zero.

Switching the Methods

The election of whether to use safe harbor method is made on a annual basis. Therefore, in one year, a taxpayer may use the safe harbor method, while the next year he can choose to calculate and substantiate actual expenses for purposes of § 280A. A change from using the safe harbor method in one year to actual expenses in a succeeding taxable year, or vice-versa, is not a change in method of accounting and does not require the IRS consent.

It is important to remember that an election for any taxable year, once made, is irrevocable

More complications arise if the taxpayer depreciates his home subsequent (or even prior to) electing to use the safe harbor method.

Safe Harbor Method Available in 2013

The new simplified option is available starting the tax year 2013.

Pension Plan Limitations for 2012

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Due to the cost of living adjustments, many of the pension plan limitations will change for 2012, but others will remain the same.

Section 415 of the Internal Revenue Code provides for dollar limitations on benefits and contributions under qualified retirement plans. Section 415(d) requires that the Commissioner annually adjust these limits for cost of living increases. Other limitations applicable to deferred compensation plans are also affected by these adjustments under Section 415. Under Section 415(d), the adjustments are to be made pursuant to adjustment procedures which are similar to those used to adjust benefit amounts under Section 215(i)(2)(A) of the Social Security Act.

The following is the description of most of the changes:

Effective January 1, 2012, the limitation on the annual benefit under a defined benefit plan under section 415(b)(1)(A) is increased from $195,000 to $200,000.

The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is increased from $16,500 to $17,000.

The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are covered by a workplace retirement plan and have modified adjusted gross incomes (AGI) between $58,000 and $68,000, up from $56,000 and $66,000 in 2011. For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is $92,000 to $112,000, up from $90,000 to $110,000. For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $173,000 and $183,000, up from $169,000 and $179,000.

The AGI phase-out range for taxpayers making contributions to a Roth IRA is $173,000 to $183,000 for married couples filing jointly, up from $169,000 to $179,000 in 2011. For singles and heads of household, the income phase-out range is $110,000 to $125,000, up from $107,000 to $122,000. For a married individual filing a separate return who is covered by a retirement plan at work, the phase-out range remains $0 to $10,000.

The AGI limit for the saver’s credit (also known as the retirement savings contributions credit) for low-and moderate-income workers is $57,500 for married couples filing jointly, up from $56,500 in 2011; $43,125 for heads of household, up from $42,375; and $28,750 for married individuals filing separately and for singles, up from $28,250.

The limitation for defined contribution plans under Section 415(c)(1)(A) is increased in 2012 from $49,000 to $50,000.

The limitation under Section 402(g)(1) on the exclusion for elective deferrals described in Section 402(g)(3) is increased from $16,500 to $17,000.

The annual compensation limit under Sections 401(a)(17), 404(l), 408(k)(3)(C), and 408(k)(6)(D)(ii) is increased from $245,000 to $250,000.

The dollar limitation under Section 416(i)(1)(A)(i) concerning the definition of key employee in a top-heavy plan is increased from $160,000 to $165,000.

The dollar amount under Section 409(o)(1)(C)(ii) for determining the maximum account balance in an employee stock ownership plan subject to a 5 year distribution period is increased from $985,000 to $1,015,000, while the dollar amount used to determine the lengthening of the 5 year distribution period is increased from $195,000 to $200,000.

The limitation used in the definition of highly compensated employee under Section 414(q)(1)(B) is increased from $110,000 to $115,000.

The dollar limitation under Section 414(v)(2)(B)(i) for catch-up contributions to an applicable employer plan other than a plan described in Section 401(k)(11) or Section 408(p) for individuals aged 50 or over remains unchanged at $5,500. The dollar limitation under Section 414(v)(2)(B)(ii) for catch-up contributions to an applicable employer plan described in Section 401(k)(11) or Section 408(p) for individuals aged 50 or over remains unchanged at $2,500.

The annual compensation limitation under Section 401(a)(17) for eligible participants in certain governmental plans that, under the plan as in effect on July 1, 1993, allowed cost of living adjustments to the compensation limitation under the plan under Section 401(a)(17) to be taken into account, is increased from $360,000 to $375,000.

The limitation on deferrals under Section 457(e)(15) concerning deferred compensation plans of state and local governments and tax-exempt organizations is increased from $16,500 to $17,000.

The compensation amounts under Section 1.61 21(f)(5)(i) of the Income Tax Regulations concerning the definition of “control employee” for fringe benefit valuation purposes is increased from $95,000 to $100,000. The compensation amount under Section 1.61 21(f)(5)(iii) is increased from $195,000 to $205,000.

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for married taxpayers filing a joint return is increased from $34,000 to $34,500; the limitation under Section 25B(b)(1)(B) is increased from $36,500 to $37,500; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), is increased from $56,500 to $57,500.

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for taxpayers filing as head of household is increased from $25,500 to $25,875; the limitation under Section 25B(b)(1)(B) is increased from $27,375 to $28,125; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), is increased from $42,375 to $43,125.

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for all other taxpayers is increased from $17,000 to $17,250; the limitation under Section 25B(b)(1)(B) is increased from $18,250 to $18,750; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), is increased from $28,250 to $28,750.

The applicable dollar amount under Section 219(g)(3)(B)(i) for determining the deductible amount of an IRA contribution for taxpayers who are active participants filing a joint return or as a qualifying widow(er) is increased from $90,000 to $92,000. The applicable dollar amount under Section 219(g)(3)(B)(ii) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $56,000 to $58,000. The applicable dollar amount under Section 219(g)(7)(A) for a taxpayer who is not an active participant but whose spouse is an active participant is increased from $169,000 to $173,000.

The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(I) for determining the maximum Roth IRA contribution for married taxpayers filing a joint return or for taxpayers filing as a qualifying widow(er) is increased from $169,000 to $173,000. The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(II) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $107,000 to $110,000.

The dollar amount under Section 430(c)(7)(D)(i)(II) used to determine excess employee compensation with respect to a single-employer defined benefit pension plan for which the special election under section 430(c)(2)(D) has been made is increased from $1,014,000 to $1,039,000.

The following is the highlight of the items that remain unchanged:

The catch-up contribution limit for those aged 50 and over remains unchanged at $5,500.

The compensation amount under Section 408(k)(2)(C) regarding simplified employee pensions (SEPs) remains unchanged at $550.

The limitation under Section 408(p)(2)(E) regarding SIMPLE retirement accounts remains unchanged at $11,500.

The deductible amount under § 219(b)(5)(A) for an individual making qualified retirement contributions remains unchanged at $5,000.

Contact Sherayzen Law Office

If you have any questions with respect to the pension plans, contact Sherayzen Law Office. Our experienced tax firm will guide you through the complex web of various pension plans.

Tax Return Extension Deadline for Most Filers: October 17, 2011 and Some Exceptions

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October 17, 2011 is the deadline for most of those individual taxpayers who filed Form 4868 to request a six-month extension on filing of their tax returns. Traditionally, October 15 would have been the deadline, but it falls on Saturday this year. Therefore, the IRS extended the deadline until October 17, 2011.

Note that this deadline of October 17, 2011, includes U.S. taxpayers living abroad, even though their tax filing deadline is automatically extended to June 15. It is also important to emphasize that the extension to file your federal tax return does not in any way affect the obligation to file the FBARs by June 30, 2011.

Some taxpayers, however, are not subject to October 17, 2011 deadline this year. The two most prominent exceptions are qualified military personnel and victims of Hurricane Irene. Victims of Hurricane Irene will have until October 31, 2011 to file their tax returns. The new deadline primarily concerns residents of certain counties in Connecticut, Massachusetts, North Carolina, New Hampshire, New Jersey, New York, Pennsylvania, Puerto Rico, Texas, and Vermont.

It is important to emphasize that an extension of time to file is not equivalent to an extension of time to pay. It is generally true that, under the relevant Treasury regulations and IRS Notice 93-22, individual taxpayers still can file a valid Form 4868 and obtain an automatic extension without paying the properly estimated tax in full – this means, of course, that no late filing penalty is likely to be assessed. However, the taxpayers will still owe interest on any past due tax amount and may be subject to a late payment penalty if payment is not made by the regular due date of the return.

Tax Attorney Minneapolis | Keeping Tax Records After Filing Your Tax Return

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Once in a while, I get a question from my clients on how long and what type of records they need to keep after they file their tax returns.  Generally, you should keep any and all documents that may have an impact on your federal tax return. For example, it is a good idea to keep bills, credit card and other receipts, invoices, mileage logs, canceled, imaged or substitute checks, proofs of payment, and any other records to support deductions or credits you claim on your return.

If you are self-employed, you are probably likely to keep a much larger pile of documents than other individual clients.  The documents should generally include all revenue records, expense records, depreciation records, and so on.  You should consult a tax professional on what type of records you should keep and how long.

Most individual taxpayers will need to keep their tax records for at least three years.  Some documents –  such as those related to a home purchase or sale, stock transactions, business property records – should be preserved for a longer period of time.

Generally, I advise my clients to err on the side of keeping the documents.

If you have any questions on whether you should keep a given documents, you should consult your accountant or a tax attorney.

Tax Lawyers Minnesota | April 18, 2011 Filing Deadline

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This is a reminder to the individual taxpayers that they have until the April 18, 2011, to file their 2010 tax returns. Taxpayers have an extra weekend to file this year because of a District of Columbia holiday on April 15.

If you cannot meet the April 18 deadline, file an extension (Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return). Remember, however, that the six-month extension is to file a return only; it is not an extension to pay taxes due (see this article on the extension of filing deadline for individuals).

Also, remember that April 18, 2011, is the deadline for your first estimated tax payment this year (if you are supposed to pay any estimated taxes).