Sole Proprietors’ Use of the Home Office Tax Deduction is falling

 

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While a large fraction of U.S. businesses are home-based, few small business owners take advantage of the home office tax deduction, Internal Revenue Service (IRS) statistics show.

Nearly six-in-ten new businesses, and more than half of established small businesses, are home-based, recent data from the Global Entrepreneurship Monitor, a representative survey of entrepreneurial activity, reveals.

Census data indicate that most of these home-based businesses are small non-employers, organized as sole proprietorships. IRS data reveal that only 14 percent of the 23.4 million sole proprietorship returns filed in 2011 – the latest year data are available – took the home office tax deduction.

The use of the home office tax deduction fell in the most recent year data are available, despite an increase in the number of sole proprietors. The number of Schedule C filers increased by 423,000 in 2011, IRS data shows. But the number claiming the home office tax deduction dropped by 100,000, from 3.4 million in 2010 to 3.3 million in 2011.

The dollar amount of sole proprietors’ deductions for the business use of their homes also went down, declining by $400 million to just over $10 billion in 2011. This decline continues a pattern begun at the start of the Great Recession. Between 2007 and 2011, the home office tax deduction at the average sole proprietorship declined by 18.7 percent in inflation-adjusted terms, a drop larger than the fall in deductions overall.

The decrease in sole proprietors’ deductions for business use of their homes is in sharp contrast to the increase in the years leading up to the Great Recession. From 2002 to 2007, the dollar amount of the average sole proprietor’s deduction for business use of the home went up 23 percent in inflation-adjusted terms. That is surprising given that the period was when total deductions fell by 8.3 percent, and meals and entertainment and travel expenses were the only other categories of deductions that rose in inflation-adjusted terms at the average sole proprietorship (and even those increased by less than the home office tax deduction).

If and when the decline in the use of the home office tax deduction reverses is an open question. But the IRS recently made use of the deduction easier for sole proprietors. Beginning with tax year 2013, which most sole proprietors filed back in April of this year, the tax authority introduced a new simplified version of the home-based deduction. The new option is limited to $1,500 per year, but it allows taxpayers to avoid filling out the 43-line long Form 8829.

Because the IRS estimates that the new option will reduce sole proprietors’ collective paperwork burden by 1.6 million hours each year, chances are good that it will boost the number of sole proprietors taking advantage of the home office tax deduction. But since the dollar amount of deductions depends, in large part, on the biggest sole proprietors, who are unlikely to take the simplified option, the new version is less likely to reverse the downward trend in the dollar amount of the average home office deduction

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