August 2019

Home Office Tax Deductions Are Fantastic: Learn How To Do It

August 24, 2019 | By: Robert A. Green, CPA | Read it on

Since 1999, the home-office deduction is no longer a red flag — millions of Americans benefit from this deduction each year. Countless taxpayers run businesses from home, and the IRS understands this. The income-requirement rule also limits the use of this deduction for profitable enterprises, which appeases IRS concerns about abuse and hobby-loss businesses. Before the IRS liberalized home-office deduction rules in 1999, a more stringent requirement was that business taxpayers needed to meet clients in their home office. Now, the only requirement is administration work, and another principal office outside the home doesn’t negate the deduction.

Many small-business owners, including traders eligible for trader tax status (TTS), operate from a home office. Some of them also conduct their business from job locations using cloud computing, apps, and mobile devices. They can qualify for the home office expense deduction in this situation, as well. The IRS does not permit investors to take a home office deduction.

Convert personal home costs into business expense deductions. This same concept applies to many other items such as phone, Internet, furniture, fixtures, and more. Keep in mind that business income or TTS trading gains are needed to unlock most home-office deductions. If a business doesn’t have sufficient net income, the otherwise allowable home office deductions are carried over to the following tax years. (In this situation, hopefully, the person remains in the business and has net income in subsequent years to use the carryovers.)

There are several special requirements and rules for the home office deduction. A home office must be exclusively and regularly used for business, meaning children and guests can’t use this room. Report “indirect expenses” on Form 8829 and include every expense and cost related to the home. For example, include depreciation or rent, utilities, insurance, repairs and maintenance, security, cleaning, lawn care, and more.

Include mortgage interest and real property taxes, too, and this home-office portion doesn’t require income. The remaining part of mortgage interest expense and real property taxes are Schedule A itemized deductions.

Real property taxes on Schedule A are part of the new tax law (TCJA) SALT limitation. However, the home office portion or real property tax is not subject to the SALT limitation.

To calculate the home-office deduction, take the square footage of the home office (and all related business areas such as storage, hallways, and bathrooms). Divide that by the total square footage of the home (10-15% is customary). Alternatively, taxpayers can do the apportionment based on the room’s method. Form 8829 multiplies the home-office percentage by the indirect expenses. If the business files a partnership return, report home-office expenses as unreimbursed partnership expenses (UPE) on Schedule E. For S-Corps, use an accountable reimbursement plan before year-end.

Per Thomson Reuters/Tax & Accounting Client Letter (see list below):

“Sales of homes with home offices. If you sell-at a profit-a home that contains, or contained, a home office, the otherwise available $250,000/$500,000 exclusion for gain on the sale of a principal residence won’t apply to the portion of your profit equal to the amount of depreciation you claimed on the home office.”

Depreciation expenses on the home office over the years save taxes at ordinary income tax rates. Recapture of depreciation on a sale of the principal residence is taxed up to a 25% capital gains rate, which is unique to Section 1250 property. Tax deferral is another value. The rest of the home enjoys the exclusion of capital gain up to the limit.

If a taxpayer sells his principal residence at a loss, the net loss is not deductible. However, the recapture of depreciation income might not exceed the loss amount, meaning there is no taxable income from depreciation recapture to report on the tax return.

TCJA capped state and local income taxes, sales taxes, real property taxes, and personal property taxes (SALT) itemized deductions on Schedule A at $10,000 per year (any combination thereof), and $5,000 for married filing separately. TCJA also reduced itemized deduction limits on mortgage interest expenses and casualty losses.

Home office tax benefits for employees
Employers require some employees to work from a home office. The new tax law (TCJA) suspended unreimbursed employee business expenses as itemized deductions. That leaves only one other way to arrange a tax benefit for home office expenses. An employee can seek reimbursement from an employer for home office expenses through an accountable reimbursement plan. The employer deducts home office expenses and does not include this payment on the employee’s W-2 as taxable income.

Our below Thomson Reuters/Tax & Accounting Client Letter for “telecommuting employees” states:

“The convenience of the employer requirement is satisfied if: you maintain your home office as a condition of employment-in other words, if your employer specifically requires you to maintain the home office and work there; your home office is necessary for the functioning of your employer’s business; or your home office is necessary to allow you to perform your duties as an employee properly. The convenience of the employer requirement means that you must maintain your home office for your employer’s convenience, and not for your own. This requirement isn’t satisfied if your use of a home office is merely “appropriate and helpful” in doing your job.”

Client Letters from Thomson Reuters/Tax & Accounting:

  • Home office expense deduction for a self-employed taxpayer
  • Exclusion of gain on sale or exchange of principal residence
  • How the home sale exclusion applies to a residence used for residential and business (nonresidential) purposes or to produce rental income
  • Office at home for telecommuting employees
  • Converting a home into rental property

For access to these Client Letters from Thomson Reuters/Tax & Accounting, please join our email list. We send bulk emails a few times per month and include links to Client Letters.


How To Be Eligible For Independent Contractor Tax Status

August 17, 2019 | By: Robert A. Green, CPA | Read it on

There are significant tax advantages for independent contractors (IC) vs. employees.

  • ICs deduct business expenses, whereas, the new tax law (TCJA) suspended “unreimbursed employee business expenses” as miscellaneous itemized deductions.
  • ICs are eligible for TCJA’s 20% qualified business income (QBI) deduction, whereas, employees are not.
  • ICs owe 100% of social security and Medicare taxes (SE tax) on net business income, whereas employers and employees share social security and Medicare taxes 50/50 on salaries.
  • ICs are not enrolled in employer health insurance and retirement plans, whereas employees are. ICs can have individual health insurance and retirement plan AGI-deductions.

You cannot make this determination of IC vs. employee status based on your preference alone. Learn the IRS rules on worker classification. (See IRS resources and Client Letters below.)

Current developments
Some “self-employed individuals” (SEI) hire “professional employer organizations” (PEOs), known as employee leasing companies, to join the PEO payroll and employee benefit plans. The SEI reimburses the PEO for these employment costs, plus a fee. The IRS recently balked at this practice for SEIs.

IRS Chief Counsel Advice (CCA) 201916004 dated April 19, 2019, stated that PEOs could not treat SEIs as employees. PEOs should issue SEIs a Form 1099-MISC for non-employee compensation; not a W-2. This reclassification precludes the SEI from participation in a PEO employee benefit plan. The IRS does not permit sole proprietors, and partners to pay themselves wages. A partnership reports “guaranteed payments” to partners.

Trading income is unearned income. TTS traders use an S-Corp to have officer compensation for arranging employee benefits, including health insurance and retirement plans.

The IRS recently released draft 2020 Form 1099-NEC (non-employee compensation). For the 2019 tax year, a business should continue to report non-employee compensation on Form 1099-MISC box 7. The 2020 Form 1099-NEC will give the IRS more capability to track non-employee compensation. I expect the IRS to examine more companies and challenge their worker classification. Get on the right side of this issue now.

IRS Independent Contractor (Self-Employed) or Employee?
Understanding Employee vs. Contractor Designation

For access to this full blog post, which includes the above-listed Client Letters from Thomson Reuters/Tax & Accounting, please join our email list. We send bulk emails a few times per month and include links to PDFs with Client Letters.

Darren Neuschwander CPA contributed to this blog post.


How To Avoid Taxes On Wash Sale Losses

August 5, 2019 | By: Robert A. Green, CPA | Read it on

Many securities traders incur significant tax bills on phantom income caused by “wash sale losses disallowed” on form 1099-Bs. Traders are often surprised because most brokers don’t report wash sale (WS) loss calculations during the year. In this blog post, learn how to deal with WS loss adjustments and how to avoid them in the first place.

WS loss reporting on 1099-Bs is confusing
Broker 1099-Bs report “wash sale loss disallowed” (box 1g), and it’s not uncommon to see an enormous amount for an active securities trader. The 1099-B also reports “proceeds” (box 1d), “cost or other basis” (box 1e) and several other related amounts. For example, $10M proceeds minus $9.9M cost or other basis, plus $150,000 of wash sale loss disallowed, equals $250,000 of taxable capital gains. The 1099-B cover page has summary numbers, and supplemental schedules include each securities trade for all of these boxes.

The essential point is that WS loss disallowed in box 1g is for the entire tax year. However, WS losses deferred at year-end cause phantom income in the current tax year. Many WS losses during the year might fade away by year-end (see how below). Unfortunately, brokers do not report WS losses deferred at year-end, and clients need that information. If a trader uses trade accounting software, they need this information to reverse WS loss deferrals from the prior year-end on January 1 of the current tax year.

For example, two different traders can have $1M of WS loss disallowed in box 1g. Trader A doesn’t have WS losses at year-end, and she is not concerned with those adjustments during the year. She sold all open positions by year-end and did not repurchase substantially identical positions in January. Trader B also sold all positions by year-end, but he made repurchase trades in January, which triggered $50,000 of WS losses deferred at year-end. Trader B delayed the December WS loss to the subsequent tax year.

Traders need ongoing WS loss information throughout the year to prevent this predicament. Some monthly brokerage statements include cost basis amounts for month-end open positions listed on the report, and other monthly brokerage statements do not.

Most traders don’t realize they have a WS loss problem until they receive 1099-Bs in late February. That’s too late to avoid WS losses. Some traders and tax preparers import 1099-Bs into tax preparation software. Others enter the amounts to Form 8949 and then attach the 1099-B for details. If the taxpayer has cost basis adjustments, the IRS requires Form 8949; listing each securities proceeds, cost basis, WS losses, and other cost basis adjustments. However, there’s a problem relying solely on 1099-Bs because IRS WS rules for taxpayers vary from WS rules for brokers in preparing those 1099-Bs.

WS rules for taxpayers and brokers are different
Taxpayers must calculate WS losses based on “substantially identical securities” (i.e., Apple equity vs. Apple options), across all taxpayer’s brokerage accounts, including IRAs and spousal accounts if married/filing joint. Conversely, brokers calculate WS based on “identical securities” (an exact symbol) per the one brokerage account. This apples vs. oranges is problematic since the IRS seeks to match broker 1099-Bs to Form 8949 prepared by taxpayers.

Trade accounting software can help
Traders should consider using an IRS-compliant trade accounting software or a professional service using such software. Contemporaneous use of the program allows traders to avoid WS loss adjustments with potential WS loss reports. The software/service also gives taxpayers a second opinion vs. broker 1099-Bs.

Taxpayers and accountants are entitled to depart from 1099-Bs and explain why in the tax return footnotes. For example, a 1099-B might treat an ETN prepaid forward contract (i.e., BATS: VXX) as a security with wash sales. However, an ETN structured as a prepaid forward contract (PFC) is not a security, so WS losses don’t apply. A CBOE-listed option on an ETN/PFC is a “non-equity option” in Section 1256, although most 1099-Bs treat these options as securities subject to WS losses. Many brokers rely on tax treatment provided by exchanges, who try to fit financial instruments into two boxes: securities vs. section 1256 contracts.

Traders should try to reconcile Form 8949 proceeds with 1099-B proceeds. However, they should not expect to match cost-basis information, if trade accounting software calculates WS losses differently.

Trade accounting software downloads all trades, and the program automatically calculates WS losses based on IRS rules for taxpayers, not brokers. The program explains the rationale and provides details on various tax reports.

The 1099-Bs might use FIFO or specific identification and try to reflect the same accounting method in a trade accounting program.

For the first year of using trade accounting software, traders should enter open positions from the prior year-end with original-cost basis. Additionally, traders should enter deferred WS losses applied to those open positions. Traders should also enter WS losses deferred on closed-positions repurchased within 30 days in January. Trade accounting programs do not download this information from the prior year.

It would come in handy if the broker provided the WS loss deferred at year-end. If that amount was available, you could enter it as a cost basis adjustment, in addition to open positions with an original cost basis.

In the second year of use, the trade accounting program will automatically carry over open positions and wash sale loss adjustments from the prior year. Consult the program vendor and or trade accounting expert.

Jason Derbyshire of TradeLog software says: “If brokers provide detailed reporting of WS loss deferrals at year-end, TradeLog could utilize that information to help automate input into the software. This information would enable traders to accurately track those deferred losses in the software, and make more informed decisions to capture those losses, if needed, in the following tax year.”

What exactly is a wash sale loss?
A wash-sales loss is a timing issue. If you sell a security for a loss and repurchase it 30 days before or after, you cannot deduct the economic loss immediately in a taxable account. You must add the WS loss to the replacement position’s cost basis, which kicks the can (loss) down the road.

WS loss adjustments made during the year in taxable accounts might not be a problem at year-end. Some fade away. For example, a trader can trigger a WS loss every month during the year but absorb it with a significant capital gain on that security toward year-end. Additionally, the trader can “break the chain” at year-end by selling the position and not repurchasing it for 30 days.

There are also permanent WS losses triggered by IRAs, which are catastrophic. When you sell a position at a loss in a taxable account and repurchase a substantially identical position within 30 days in an IRA, there is no way to record the WS loss. Brokers don’t report these types of WS losses since they don’t calculate WS across more than one account at a time. If you trade in an IRA only (i.e., you do not trade in taxable accounts), then you don’t have these WS loss issues.

Strategies to avoid wash-sale losses
Consider a “Do Not Trade List” to prevent permanent WS between taxable and IRA accounts. For example, a trader could trade tech stocks in his taxable accounts and energy stocks in his IRA accounts.

Taxpayers can “break the chain” on WS losses at year-end in taxable accounts to avoid deferral. If a trader sells Apple equity at a loss on December 20, 2019, consider not repurchasing Apple equity or Apple equity options until January 21, 2020. That avoids the 30-day window for triggering a WS loss. In December 2018, many traders realized tax losses before year-end with a market correction. Some didn’t want to wait 30 days and miss the January 2019 rally, thereby triggering significant WS loss deferral at year-end 2018. Deferral of WS losses can become a problem if it causes a capital loss limitation in the subsequent tax year.

WS loss adjustments during the year in taxable accounts can be absorbed if traders sell/buy those open positions before year-end with a profit.

Consider a Section 475 election. Traders eligible for trader tax status (TTS) are entitled to elect Section 475 mark-to-market (MTM) accounting, which exempts them from wash-sale loss adjustments and the capital-loss limitation. I call it “tax loss insurance.” Don’t enter Section 475 trades on Form 8949; use Form 4797 Part II (ordinary gain or loss). Although Section 475 extricates securities traders from the compliance headaches of Form 8949, it does not change the requirement for reporting each trade on Form 4797.

We recommend trade accounting software to generate Form 4797. If a taxpayer elects Section 475, she will need that software to calculate a Section 481(a) adjustment, too. Even with a Section 475 election, the trader still needs to make the manual entries for open positions and opening-year WS loss adjustments mentioned earlier. The 2019 Section 475 election due date for individuals was April 15, 2019, and March 15, 2019, for existing partnerships and S-Corps.

Section 475 ordinary income is “qualified business income” (QBI). A TTS trader with 475 income net of business expenses is eligible for a 20% QBI deduction, providing the trader is under the taxable income thresholds for a “specified service business.” QBI excludes capital gains, interest, and dividend income.

Consider a new entity. Trading in an entity account might help avoid ongoing WS loss problems. The company is separate from the individual and IRA accounts for purposes of wash sales since it is a different taxpayer. The IRS is entitled to apply related party transaction rules (Section 267) if the entity purposely tries to avoid wash sales with the owner’s accounts. If the company qualifies for TTS, it can consider a Section 475 MTM election exempting it from wash sales (on TTS positions, not investment positions). A “new taxpayer” entity is entitled to elect Section 475 by internal resolution within 75 days of inception. That comes in handy after missing the 475-election deadline for individuals by April 15.

Trade accounting for securities is less complicated with a new entity since there are no opening-year manual entries for WS losses deferred from the prior year-end.

Trade Section 1256 contracts and other financial instruments that are not considered securities for tax purposes. Learn about Section 1256 contracts in my blog post: Trading Futures & Other Section 1256 Contracts Has Tax Advantages.

The following financial instruments are not securities or 1256 contracts: ETN prepaid forward contracts, cryptocurrencies, precious metals, forex, and swap contracts. Only securities are subject to wash sale loss adjustments.

GNM CPAs Darren Neuschwander, Christie Kam, and Amanda Smitson contributed to this blog post.

Learn more about wash sale loss rules in Green’s 2019 Trader Tax Guide.


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