When your workplace is as close as your basement or spare room, the boundary between home and business probably gets blurry at times. If for no other reason than your taxes, however, it's important to separate the two. What's Deductible? As the owner of a home-based business or professional practice, you may be able to deduct various expenses related to using your home for business purposes. Some examples: Heat, air conditioning, electric Homeowners insurance Trash removal Cleaning services Building depreciation Since many expenses relate to the entire home, the calculation of the business portion is usually accomplished using square footage. Example. The square footage of Meredith's home office is 10% of her home's total square footage. Last year, Meredith paid $1,200 to heat her home. She may deduct $120 (10%) as a business expense, provided she meets the tax law's requirements for a home office deduction. Off Limits Deductions for an “office” in the home are generally available only if the space is used regularly and exclusively for business. The exclusive-use rule can be particularly difficult to follow. Example. During business hours, Derek's home office is used strictly for business. But Derek also uses it as a bedroom when his kids visit. Derek's office doesn't qualify as a home office, even though there is no personal use of the room during the workday. Selling the Home Ordinarily, you may exclude up to $250,000 of capital gain ($500,000 if married) from your income when you sell your home, provided you have owned and used it as your principal residence for at least two of the five years before the sale. When you have a home office, however, you have to pay tax (at a 25% rate) on capital gain up to the amount of prior depreciation on the home. Any additional gain can qualify for the $250,000/$500,000 exclusion. Example. The Garcias made a $100,000 profit when they sold their principal residence. Although they meet the tax law's requirements for a capital gain exclusion of up to $500,000, they will have to pay tax on $15,000 of their profit — the amount they previously deducted as home office depreciation. back to top

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The spirit of volunteerism is alive and well in the U.S. According to the Bureau of Labor Statistics, about 64.5 million Americans volunteered at least once between September 2003 and September 2004. If you did volunteer work for a charitable organization in 2005 and you itemize deductions on your tax return, you may be able to count some of your expenses as charitable donations for the year. You may not, however, deduct the cost of your time, even if the organization would have to pay someone else to do the same job. Here are some expenses that are deductible: Car expenses As long as you don't receive reimbursement, you can deduct out-of-pocket expenses incurred in traveling to and from the place where you volunteer or in the driving you do on behalf of a charitable organization. You can deduct either the actual cost of gas and oil used in these activities, or use the standard mileage rate of 14 cents a mile. The costs of repairs, maintenance, tires, and insurance are not deductible, nor are registration fees or depreciation. Parking fees and tolls are deductible. Just make sure you keep appropriate records so you can back up your deduction. Mileage rate increase for Katrina relief The standard charitable mileage rate has been raised to 70% of the business mileage rate for taxpayers using a vehicle to provide donated services for Katrina relief. The higher rate applies from August 25, 2005, through December 31, 2006. Overnight travel expenses If you travel on behalf of a charitable organization (to a conference, for example), you may be able to deduct your unreimbursed transportation costs and reasonable lodging and meal expenses. None of the expenses can be for your personal entertainment or for accompanying family members. Office supplies If you purchase materials (paper, envelopes, ink cartridges, etc.) and use them for volunteer work you do for a qualified organization, you can deduct any unreimbursed expenses. Volunteers often do not realize they may be able to count some of their expenses as charitable donations. If you have questions, please let us know. To find an organization in your area to start volunteering, check out ... back to top
The new deduction for U.S. domestic production activities allows businesses to deduct a percentage of their “qualified production activities income” (subject to limits). The IRS recently issued additional details regarding the new deduction. Here are some highlights: Timing The deduction is based on qualifying domestic production gross receipts, less related costs and a share of overhead. In computing income eligible for the deduction, businesses should take receipts and costs into account in the year they are recognized for general tax purposes. In some situations, such as where an advance payment is received, this treatment could result in receipts for the sale of a product being accounted for in one year and costs related to its production being accounted for in another year. Item-by-item basis Businesses have to determine what constitutes qualified production activities income on an item-by-item basis, rather than by division or product line. An “item” can be a portion of property offered for sale. As an example, the IRS describes a company that manufactures software in the U.S., attaches the software to a router manufactured outside the U.S., and sells the combined product. Here, the software has to be treated as an item separate from the router. While the gross receipts from selling the software qualify as domestic production gross receipts, the receipts from selling the router do not. Embedded services Charges for delivery, distribution, or installation of qualifying production property generally may not be included in domestic production gross receipts. The IRS will make an exception where, in the normal course of business, the charge is included in the sales price and the charge is neither separately offered nor bargained for with the customer. Land Gross receipts from the sale of land may not be treated as domestic production gross receipts from the construction of real property. However, receipts related to the construction of infrastructure such as sewers and roads can qualify (requirements apply). To find out more, click below: http://www.irs.gov/businesses/small/article/0,,id=150439,00.html back to top
Congress is back at work after being out for more than one month and lawmakers have a full agenda of tax legislation to tackle. Congress recessed in December before taking action on some important temporary tax breaks for individuals and businesses, some of which expired at the end of 2005. Although it's very likely that Congress will extend these tax breaks and make them retroactive to January 1, 2006, nothing is certain as Democrats and Republicans continue to spar over the size of tax cuts and how to tame the rising federal budget deficit. Temporary tax breaks in limbo On December 31, 2005, a host of temporary tax cuts expired. These included: AMT relief Work Opportunity and Welfare to Work credits Indian employment credit Teacher's classroom expense deduction Tax incentives for the District of Columbia Research tax credit Tax breaks for brownfields remediation and more With the exception of AMT relief, most of these tax incentives are not controversial. It's not so much a question of if they will pass Congress but when they will pass. They could be attached to a larger tax bill, such as a tax reconciliation bill, or be enacted as stand-alone legislation.   AMT relief AMT relief is a different story. The House and Senate are far apart on whether to extend the higher AMT exemption amounts and allow individuals to use the nonrefundable personal credits to offset regular and AMT liability. The House voted in December not to extend the higher AMT exemption amounts. The Senate voted to extend them. Ultimately, the House and Senate will have to iron-out their differences in a conference. As of press time, neither the House nor the Senate had named conferees to a conference.   Dividend and capital gains rate cuts The House and Senate also took different approaches to the dividend and capital gains tax rate cuts enacted in 2003. House Republicans want to extend these rate cuts even though they aren't scheduled to expire this year. In a narrow vote in December, the House approved extending the dividend and capital gains tax rate cuts one more year. Senate Republicans aren't sold on the idea and Senate Democrats are very opposed to extending these cuts.  Like AMT relief, a House-Senate conference will have to come to some agreement. Senator Charles Grassley, R-Iowa, chairman of the Senate Finance Committee, recently said that a major hurdle for a conference to overcome is determining whether the Senate will have enough votes to approve a bill that contains an extension of tax breaks for capital gains and dividends.  "If we have got the votes for that, it will go very quickly in a very good bill," Grassley said.  "If we don't have the votes for those things, which we didn't in the Senate in the first place when the bill went through, we'll still pass a very good bill but it won't be as good as if we included capital gains and dividends." Federal deficit projected to grow in 2006 Looming over the tax debate is the huge federal budget deficit. In January, the Treasury Department announced that federal tax receipts in 2005 increased roughly 15 percent from 2004. The rise in federal tax revenues helped to lower the federal budget deficit to approximately $318 billion. While the budget news was better for 2005, it's not so good for 2006. According to the White House, the federal budget deficit will exceed $400 billion in 2006. The war in Iraq and the cost of rebuilding after Hurricane Katrina are the two costliest items in the federal budget. The White House announcement that the deficit would top $400 billion in 2006 was greeted with calls by Democrats to put the brakes on tax cuts, especially the dividend and capital gains tax rate cuts.  "Balanced budgets, which were achieved under Democratic leadership in the 1990s, have been replaced by more tax cuts for the wealthy, cuts to vital programs and record deficits, Democratic National Committee Press Secretary Josh Earnest said. What's ahead? The next few weeks should give some indication of where Congress is going with tax cuts in 2006, especially if House and Senate leaders name conferees to a conference. Our office will stay on top of developments and keep you posted as soon as Congress acts. back to top
Until the IRS directs otherwise, computing the new optional sales tax deduction requires following the rules prior to the 1986 Tax Reform Act. However, it is certain that the IRS will issue rules shortly that will repeat many portions of the pre-1986 law but also will add some unique twists of its own. Before the 1986 Tax Reform Act, taxpayers were allowed to deduct not only their state and local income taxes paid but also the amount of state and local general sales taxes paid. These amounts were deducted as itemized deductions on Schedule A of Form 1040. Taxpayers could either claim the actual amount of sales taxes paid or take a deduction based upon IRS-generated tables. The tables contained state-by-state estimates of tax liability for individuals at different income levels and the deductible amount was based on adjusted gross income and the number of individuals in a taxpayer's household (the taxpayer, his or her spouse, and dependents). The 1986 Reform Act repealed the sales tax deduction, but now it's back ... in an either/or option, however, rather than providing a double deduction for both state and local income tax and sales tax. The new election For tax years 2004 and 2005, individual taxpayers may now elect to deduct either state and local income taxes or state and local general sales taxes as an itemized deduction on their federal income tax returns. The amount to be deducted is either (1) the total of actual general sales taxes paid as substantiated by accumulated receipts or (2) an amount from IRS-generated tables plus, if any, the amount of general sales taxes paid in the purchase of a motor vehicle, boat, or other items as prescribed by the Secretary. The deduction is subject to the phase-out limitation on itemized deductions for taxpayers with adjusted gross income over specified amounts. Deductible amount Taxpayers may elect to deduct the actual amount of general sales taxes paid by either accumulating receipts showing general sales tax paid or using the amount from IRS-generated tables, as added by the 2004 American Jobs Act. Taxpayers who elect to use the tables are allowed, in addition to the table amount, to include any general sale taxes paid during the tax year for the purchase of a motor vehicle, boat, or other items to be prescribed by the IRS. The tables are to reflect average consumption by taxpayers and to take into account filing status, the number of dependents, adjusted gross income, and rates of state and local sales taxes. The tables do not reflect items, such as motor vehicles, boats, or other items specified by the IRS. Right now ... before the IRS issues rules under the new law, there are two points of advice. (1) Don't throw out any sales tax receipts if you reside in a no-income-tax or low-income-tax state since you may want to substantiate actual sales tax payments in 2005 rather than use the IRS tables; (2) look at your state income tax in comparison to the sales tax you pay and consider year-end planning techniques to load income tax payments in one year, and sales tax payments in another, to maximize deductions. One more tip: Unlike 1986, many more individuals use credit cards instead of cash these days, even for routine purchases. Many major credit cards now send out annual statements on purchases over the course of the year. Those may prove to be invaluable in claiming actual sales tax expenses as opposed to using the IRS tables. Click here to get our Sales Tax Deduction Worksheet back to top
Do you have an activity that you really enjoy - and also hope to make some money from?  Perhaps you have a full-time job, but you spend a lot of your spare time writing short stories or breeding dogs and you want to turn your project into a business.  In that case, you may be entitled to some tax deductions for your expenses.  You may even be able to deduct losses from your project, but the tax law has strict rules in that regard. If It's a Hobby Under the tax law's "hobby loss" rules, you can deduct a variety of expenses related to the pursuit of a hobby - but only to the extent of the income you receive from the activity and only as miscellaneous itemized expenses.  Deductions for miscellaneous expenses are limited to the amount that collectively exceeds 2% of your adjusted gross income. If It's a Business On the other hand, if your activity can qualify as a business, then all your allowable expenses will be deductible, even if they exceed the income you receive from the activity.  Your activity can qualify as a business if you show a profit in at least three out of five consecutive years (a two-out-of-seven-year rule applies where the breeding of horses is involved).  The other option is to operate in a way that shows that you intend to make a profit from the activity, rather than simply pursue it for pleasure. A Recent Case A recent U.S. Tax Court decision shows how the tax law can be applied in a hobby loss situation.  It seems that bank loan officer John had the "need for speed" and carried on a drag-racing operation during his free time.  From 1991 to 2001, he managed to lose money pretty consistently.  However, in 1998, he attracted a sponsor and made a profit of almost $600.  His losses from 1999 to 2001 averaged approximately $20,000, while his gross receipts totaled $800.  John then gave up drag racing, but he deducted his racing losses for the years 1999-2001. The IRS disallowed his deductions, insisting that he had not carried on the activity with the intention of making a profit.  John disagreed, and the dispute ended up in Tax Court.  The court concluded that John had, indeed, possessed an "actual and honest" intent to profit from his drag racing.  The court based its determination on a number of factors: John conducted the activity in a businesslike manner, preparing budgets, estimating expenses, seeking sponsorships, and the like. John had expertise in the activity - he was an experienced driver and mechanic - and he spent an adequate amount of time on the racing activity despite his banking job. Even though John's financial status was essentially stable, his income was not so substantial that it implied a great "tax incentive" to incur large losses from the drag racing to offset his other income. This particular taxpayer's situation may have "pushed the envelope" a bit, but the court's decision shows that under appropriate circumstances and with careful attention to the way you operate your hobby/business, it's possible to have some fun, carry on an activity you enjoy, and still garner some tax deductions. back to top