Is Your Home Office Deduction Legal?
By Raul Rivera
Today, most ministers have an office in their home. For some ministers, their home office may be a converted spare bedroom, and for others it may simply be a table or desk in the corner of some room in the house. Regardless, one of the many questions we receive on a daily basis pertains to the home office deduction. We often get asked, “How does the home office deduction pertain to me as a minister?”, and “Can any of my expenses associated with my home office be deducted as a business expense?”
Unfortunately, seldom are there questions pertaining to IRS compliance that can be answered in a simple sentence or two. Therefore, I want to use today’s blog post to address these very questions.
It is my prayer that when you finish reading this blog post, you will feel empowered with the knowledge to know how the home office deduction pertains to you as a minister.
The Deason rule
In order to fully understand the provision of the home office deduction as a minister, it is first necessary to understand what is commonly known as the “Deason rule”. This rule is based upon the court case Deason v. Commissioner.
In this case, the tax court’s ruling prohibited a minister from deducting a portion of his unreimbursed expenses to the extent that they were for tax-exempt income such as housing allowance. The court based its ruling on section 265(a)(1), which states that no deduction shall be allowed for expenses that are allocable to tax-exempt income.
In essence, this is telling us that income that is already exempt from income tax (such as a housing allowance exclusion) cannot be used toward another income tax deduction. Another way to put this is that there is no “double dipping” allowed. However, your mortgage interest and property taxes are not subject to the “no double dipping” rule, and can be claimed as an itemized deduction on your personal income taxes using Schedule A of Form 1040.
Now, in order to help further our understanding of the Deason rule, let us take a look at an example.
Example: Minister A receives a salary of $40,000 annually, $10,000 of which has been deemed a housing allowance, or exclusion. Minister A incurs unreimbursed expenses of $4,000 for the year. Since 25% of Minister A’s salary is tax-exempt income ($10,000 of the $40,000), then Minister A is not permitted to deduct 25% of the $4,000 in unreimbursed expenses since they are “allocable” to tax-exempt income. Therefore, Minister A will only be allowed to deduct $3,000 of the $4,000 in unreimbursed expenses.
Ministers who receive a housing allowance and have a home office, may have a difficult, if not impossible, time claiming a home office deduction because of the Deason Rule. Regardless of whether or not you are receiving a housing allowance, the requirements that must be met, in order to claim a home office deduction, can be quite difficult to meet.
An exception to the rule
In some instances a minister’s designated housing allowance may actually be less than his actual home expense. Therefore, some of the housing expenses are not “covered” in the minister’s housing allowance exclusion, and might be able to be claimed through a home office deduction.
However, regardless of whether or not you receive a housing allowance, the requirements that must be met in order to claim a home office deduction can be quite difficult to meet. Let us take a look at those requirements next.
Home office deduction requirements
According to IRC § 280A and IRS Publication 587, in order for ministers to be eligible for the home office deduction, there are four requirements that must be met. These four requirements are as follows:
4 Requirements for home office deduction
1. Exclusive Use: The area of the home must be used only for trade or business. It cannot be used for any other purpose. If your home office is used by you to prepare sermons and it is also used by your children to complete homework, then your “home office” does not meet the exclusive use test.
2. Regular Basis: The specific area of your home must be used on a regular basis for business use. Incidental or occasional business use is not regular use.
3. Convenience of the employer: This is especially important to ministers of churches, since as a minister you are considered both employed and self-employed for tax purposes. This means that the home office must do more than make the employee’s job easier. The employee’s home office must be essential to the performance of his job.
4. Principle Place of Business: The home must be the principle place of business. Most often for ministers, the principle place of business is the church. However, the minister may be eligible for the home office deduction if he uses his home office for the church’s administrative tasks. Furthermore, the home will qualify as the principle place of business if there is no other fixed location where administrative tasks are substantially conducted.
Establishing a principle place of business
Now as a minister, establishing that your home is the principle place of business can get kind of tricky; however, I do not believe it has to be. Let me explain.
According to the IRS Minister Audit Technique Guide, “In order for the home to qualify as the principle place of business under IRC section 280A(c)(1)(A), the functions performed and the time spent at each location where the trade or business is conducted are the primary considerations and must be compared to determine the relative importance of each.” Moreover, the IRS states, “The church often provides an office on the premises for the minister, so the necessity of an office in the home should be questioned closely.”
However, as a minister, according to § 3401(a)(9), you are considered to be self-employed. I firmly believe that this means that, as a self-employed individual, you can declare your home office to be your principle place of business. Your church office, if you have one, would then be your secondary office.
On the flip side, as an employee of the church, I believe it is necessary for your compensation contract to require that you maintain a home office as your principle place of business. Additionally, you will need to keep in mind that because you are also considered an employee, you will need to make sure that the other three requirements are met.
Now, perhaps you are receiving a housing allowance exclusion that “covers” all of your housing expenses, and you are wondering what benefit the home office deduction would have to you. Next, I want to show you that whether you are or are not able to claim a home office deduction, there is another benefit to establishing your home office as your principle place of business.
Deduct business miles from your home
According to § 1.162-2(e) and § 1.262-1(b)(5), a taxpayer’s costs of commuting between the taxpayer’s residence and the taxpayer’s place of business or employment generally are nondeductible personal expenses.
However, according to Revenue Ruling 99-7, “if a taxpayer’s residence is the taxpayer’s principle place of business . . . the taxpayer may deduct daily transportation expenses incurred in going between the residence and another work location in the same trade or business, regardless of whether the other work location is regular or temporary and regardless of the distance.”
Therefore, 100% of all your miles from your home office to your church office are deductible. Furthermore, 100% of the miles from your home to the hospital, a prison, or a member's home that are for the purpose of doing the work of the ministry are deductible.
Before concluding this post, if you are eligible to claim a home office deduction, I want to briefly cover the two methods of figuring the deduction.
Figuring the deduction
After determining that you meet the requirements for the home office deduction, you can begin to figure how much you can deduct by either using 1. your actual expenses, or 2. the simplified method. Let us briefly look at each of these.
1. Using actual expenses
When deducting the actual expenses of your home, you will need to figure the percentage of your home used for business and the limit on the deduction.
To figure the percentage of your home used for business, you will need to compare the square feet of the space used exclusively for business purposes to the total square feet in your home. The deduction of home office expenses is limited to the gross income from the business use of your home minus the sum of the following:
- The business part of expenses you could deduct even if you did not use your home for business, such as mortgage interest, property taxes, and casualty losses.
- The business expenses other than those related to the business use of a home, such as office supplies, equipment, business phone, etc.
Using actual expenses to determine your home office deduction can be a burdensome process, and you should contact a qualified tax professional for further help. However, in order to ease the burden, the IRS created a simplified option for computing the home office deduction in 2013. (See Revenue Procedure 2013-13)
2. Using the simplified method
The simplified method is an alternative to the calculation, allocation, and substantiation of actual expenses for the purposes of determining your home office deduction. Using the simplified method, you will figure your deduction by multiplying $5, the prescribed rate, by the area of your home used exclusively for business use.
To figure your deduction for the business use of your home using the simplified method, you will need to know the following information for each qualified business use of the home.
- The allowable area of your home used in conducting the business.
- The gross income for the business use of your home.
- The amount of the business expenses that are not related to the use of your home.
To figure the amount you can deduct for qualified business use of your home using the simplified method, you will need to follow the following three steps.
- Multiply the allowable area by $5.
- Subtract the expenses from the business that are not related to the use of the home from the gross income related to the business of the home.
- Take the smaller of the amounts above. This will be the amount that you can deduct for the use of your home using the simplified method.
Again, if you are eligible for a home office deduction, it will be best to speak with a qualified tax professional for advice pertaining to your specific circumstances.
I believe that the pastoral profession is one of the most underpaid professions in America. It is not that the church does not want to adequately pay the pastor, but in most circumstances, the church is financially unable to do so. That is why I firmly believe that pastors should take advantage of the tax provisions afforded to them.
Because pastors are considered both an employee and a self-employed individual for tax purposes, ministerial compensation can sometimes be difficult to understand, which is why I want to invite you to one of our Ultimate Church Structure Conferences. During this one-day conference, we spend time addressing key strategies that allow ministerial compensation to work in favor of pastors, and not against them. Join us for a day of learning, empowerment, and impartation. I promise, you will not regret it!