The tax traps of working at home

By Jeff Schnepper

Many of us dream of working from home. Of being able to pad over to the office in T-shirts and jeans and work away on our laptops, with none of the hassles of commuting, office stress and dressing for success.

Some 19 million of us like the idea so much that we work from home, myself included. About 5% of the work force telecommutes -- that is, we work for someone else, but from home.

Working from your home would seem to offer some nice tax breaks, and it does. But watch out. The rules also can create some real tax terrors at the federal and state levels.

Consider the case of one New Jersey resident. We'll call him Bob. Bob worked for a company in New York City, but he did all his work from home. New York state tax officials audited Bob and found that the company was ready, willing and able to provide office space for him in its New York office. So New York forced the man to pay nonresident New York income taxes, which are higher than taxes in New Jersey. (His only break: a partial credit for the New York taxes on his New Jersey return.)

The reason: All of Bob's work from home was for his convenience, the courts have ruled, not his employer's.

Get a letter

There was a solution to the problem. Bob could have asked his boss to write a letter stating that Bob could work from home for the convenience of the company and that working from home was a condition of employment.

In fact, I recommend that anyone working from home get that letter. This issue will get hotter as telecommuting grows and states with high taxes scramble to protect their bases. Attach a copy to your tax return. If your return is kicked out by the IRS computer, it shows the human IRS auditor that you know the rules. That may actually decrease your chances of being audited.

It's also more prudent to obtain the letter now, while you're still working for that employer. You can normally be audited up to three years after the due date of your return. If you've left your former employer during that time, it may be more difficult to get that letter if you get an audit notice.

The rules on expenses

If you meet that standard or if you work for yourself, then we can talk about home office expenses. Again, the rules are precise. To qualify for a home office deduction, you must use an area of your home regularly and exclusively for business purposes and you must meet any of these conditions:

• You use the space as your principal place of business, and the business generates revenue. Under recent changes in the law, you can meet this qualification even if you perform only administrative and managerial functions there and if you have no other fixed principal place of business. That was the problem for our friend in New Jersey.

• You use the space to meet with clients, patients or customers.

• You use the area exclusively to store inventory or product samples for your business.

To claim the home office deduction, you complete and file Form 8829 and base your deductions on the square footage used for business compared to the total square footage in your house. For example, if you use a 20-by-10 room for business out of a 2,000 square-foot house, you're allowed to claim 10% of your qualifying expenses as home-office deductions (2000/200 = 10%).

Continued: Two potential problems

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