Tax Tip Tuesday: Five Tips Your Clients Need This Tax Season, Part 4

The American College of Financial Services
March 24, 2020

Once again, March has arrived, and for most people that means they’ve arrived squarely in the middle of tax season. With all tax materials due to the IRS by April 15, financial advisors are likely to field many more questions from their clients over the next few weeks about the finer points of taxation: how can I keep the most of my hard-earned money? What deductions might I qualify for? Are there better ways to organize and file my returns than I’m currently using? The list goes on and on.

In this series we’re calling “Tax Tip Tuesday,” we outline a series of insights that you as a financial advisor, or possibly even as a client or everyday taxpayer, can use to educate yourself on some of the finer points of taxation. While all financial experts may not agree on the subjects discussed, these tips are a collection of the biggest trending topics for tax season 2020 and are things you’ll likely want or need to consider when filing your return--or helping your clients perfect theirs.


#4: Check Out the Home Office Tax Deduction


With more and more people choosing to freelance or taking jobs that allow them to work remotely from home, and ongoing telework for many professionals during the current coronavirus crisis, an often-ignored piece of tax law could save your work-from-home clients a lot of money. The home office tax deduction has long been treated with caution by financial services professionals because conventional wisdom says it’s ripe for abuse, is easily misunderstood, and can be a red-flag for an IRS audit. However, the possible benefits speak for themselves: a middle-class taxpayer who pays $1,000 a month in rent for a two-bedroom apartment and uses one of those bedrooms as a home office can possibly save up to their rent amount in taxes every year. So how does one take advantage of this enticing opportunity?

First, it’s important to know the basics of this deduction so advisors and clients can make an informed decision. While the full rules for the home office tax deduction can be found on the IRS website, the bottom line is that a true “home office” has to fulfill three requirments:


  • The home office space is exclusively and regularly used. This means that whatever space you designate as your home office must be used often, and only for business purposes.


  • The home office must be your principal place of business: that is, it’s either the central location of the business, or is a space where you frequently meet or speak with customers and clients.


  • Your business for which you want a home office must qualify officially as a business. The definition of a business can be subjective, but the more time and effort a client invests and the more income they generate from their home office, the more likely it will be to pass the test.


Notably, the exclusive use test above does not apply if you use part of your house to provide daycare services for children, the elderly, or those with special needs. Also, storing home materials in a space also used for business or inventory storage doesn’t cancel out a home office deduction. All expenses associated with the portion of the home where a client potentially conducts their business can be potentially be written off, including rent, utilities, insurance, housekeeping, structural work, and others. How much of these costs are actually deductible comes down to how big the square footage of the home office area is compared to the total area of the house or apartment it’s in.

Even more importantly, a common feature of the home office deduction that caused advisors and clients headaches has been deleted. When selling a house or apartment with a home office in the past, if the office consisted of a certain percentage of the space, that percentage didn’t qualify as tax-free profit and could cut down on how much sellers were getting for their real estate. Now, however, the IRS has changed the rules to prevent a home office from bogging down the home’s value, though tax must still be paid on any profit coming from depreciation claimed for the home office after May 6, 1997 at a maximum rate of 25 percent (since depreciation produces taxable profits).

While the home office tax break may not be appropriate for all clients, familiarizing yourself with its requirements and benefits could potentially help clients in need of some relief.