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Who Should Take a Home-Office Tax Deduction?

According to data compiled in tax year 2009, more than 4 million Americans claimed the home-office deduction on their tax returns. That’s about 3 percent of the total 140 million returns filed in 2010. The number is likely to increase this year, with business startup rates having increased substantially in 2011.

Kathy Pickering, executive director of the Tax Institute, research and analysis division of tax-services provider H&R Block (HRB), says the average home-office deduction is valued at more than $2,600. Yet many taxpayers are unclear about how to claim the deduction, or they worry that if they do, they’ll face an IRS audit. Pickering says that although the home-office deduction is scrutinized closely, it should be used by those who are eligible. She spoke recently about home-office deductions and other overlooked tax opportunities with me; edited excerpts of our conversation follow.

What advice do you give individuals running home-based businesses when it comes to accounting for their expenses—particularly home-office expenses?

We try to remind them of the things that are important. For instance, you have to be very precise that a hobby is not your business. A home office needs to be just that—an office. It can’t double as a kids’ playroom or a video game room where you happen to do your crafts.

Now, there’s an exception if you’re a licensed day-care operator and you have the children using the living room and the playroom. In that case, you can deduct all that space as part of operating your business.

According to the IRS, the home office has to be not only exclusively used for business but it also has to be your principal place of business. What does that mean in practical terms?

The office has to be where you conduct most of your business and it has to be in your house—or garage or guest house on your property. It can’t be at somebody else’s place. And if you primarily work in an office building but you check your e-mail at night in a room in your home, that doesn’t work. In that case, your home is not your principal place of business.

If you call on clients or conduct meetings off-site, but you administer the business from your home office and you have no other place to do that administrative work, you can take the home-office deduction. Just be aware that eligibility rules are very strict and we absolutely recommend that people err on the side of being conservative about taking this deduction.

How does it actually work?

It allows you to deduct a percentage of your home expenses, based on the square footage of the office as compared to the size of the entire home. So you can deduct a portion of your home’s expenses, including depreciation, rent, insurance, utilities, maintenance, and general repairs, based on the business use of that part of your home.

What caveats do you give clients on this topic?

First, the deduction for the home office cannot exceed the net annual income from the business. And second, it’s important to document. If you’re legitimately entitled to take the home office deduction, keep records that show how you use your home office and take pictures of your work space and keep them with your tax records.

What credits and tax deductions do you find are frequently overlooked by small business owners and the self-employed?

A: The small business health-care tax credit is in effect and if you’ve got 25 or fewer employees and you’re paying 50 percent of their insurance premiums, you’re eligible to take it. We have a calculator where you can go plug in your numbers and see whether it will work for you.

Unfortunately, probably a lot of small employers are not eligible for the credit the way it’s written now, because either they’re not providing insurance or they’re not paying enough of the premium.

Are there other benefits that taxpayers routinely miss out on?

We pulled in a bunch of individuals as part of a marketing campaign and looked over their previous years’ tax returns. One that we caught a lot of people missing, whether they were self-employed or not, was the American opportunity tax credit. This is the best and most generous credit for people paying higher-education costs.

You can get a credit of up to $2,500 per student for the first four years of college costs, including tuition, fees, and course materials. This can mean saving $10,000 per student and you can claim it for multiple students at the same time if you’re a parent paying for your children’s college educations.

Caffeine Zone, an App for Coffee Drinkers

I am an irregular coffee drinker. I don’t need it to get up in the morning, but I do need it after a rough night or a heavy lunch. I am also, though, an irregular sleeper. Some nights I find myself wide awake at 3 a.m. Could it have been that last cup of coffee? Should I have had tea instead? Would that have been enough to get me through the afternoon?

Well, now, as they say, there’s an app for that: Caffeine Zone, based on research on the “pharmacokinetics of caffeine.” You enter how much coffee or tea you’ve had, when you had it, and how quickly you drank it, and the app sends you an alert when you might need another cup to keep you sharp. It also warns you when the coffee you’re about to have might keep you up at night. On a graph, it maps the amount of caffeine in your body against color-coded zones corresponding to the compound’s metabolic effects.

Caffeine Zone alerts users when they're over- or under-caffeinatedCaffeine Zone alerts users when they’re over- or under-caffeinated

What are those effects? Frank Ritter, the Penn State cognitive scientist who thought up the app, concedes that the scientific literature on the cognitive impact of coffee is thin; the numbers that undergird Caffeine Zone’s real-time graphs are averages and estimates. Still, there is evidence that the compound improves memory and mental processing speed a bit. And it certainly makes people feel more alert.

One of the lessons Caffeine Zone teaches is that the first coffee of the day should be the biggest, and drunk the fastest for a big bump. The rest of the day’s doses should be smaller and ingested more slowly to stay in that optimum range. It’s trajectory management: Launch rocket, achieve desired altitude, maintain orbit with tweaks.

According to my Caffeine Zone app, as I write these words 35 minutes after my first sip of Starbucks (SBUX), I have just entered the forest-green band of optimum cognition. If I don’t recaffeinate within the hour, I will leave the zone. I tell Caffeine Zone 45 minutes later that I am about to redose with a 16 oz. coffee. The app warns me this will propel me past the “Max Optimal” boundary—the point of diminishing cognitive returns (200 mg of caffeine in my bloodstream). It will also keep me wired past 11:30 p.m., which I entered as my bedtime.

I opt instead for a Cherry Coke with lunch. There is no button for caffeinated soda (there is, strangely, one for caffeinated gum), but there is a custom feature that allows me to enter Cherry Coke’s dose information and my intake speed (usually the time it takes me to walk from the upstairs soda machine to my desk, which I round up to five minutes). My Coke’s measly 34 mg of caffeine, it turns out, will barely keep me above the 150 mg lower bound of the optimum zone. So I add a medium cup of tea after lunch, which keeps me in the zone for much of the afternoon but will, Caffeine Zone predicts, keep me up for an extra half-hour tonight. That’s all right, 11:30 was sort of an aspirational bedtime anyway.

Ritter says he hasn’t received any money from Starbucks, Coca-Cola (KO), or any other corporate caffeine peddlers, though he’d take it if offered. He understands that this might compromise the perceived objectivity of the app, but the money would allow him to add new features: People have been asking for a soda button and a menu that allows users to input their smoking habits—nicotine makes the body process caffeine faster.

Of course, the next step might be just to connect the iPhone to a caffeine drip and have it pump a few dozen milligrams directly into a vein when I begin to flag. Or maybe I could rig the app to sync with my workstation and track my typing speed, dosing me when I slow. Where do these strange, idle thoughts come from? My iPhone chimes as Caffeine Zone warns me that I have dropped out of the optimum zone. Time for that cup of tea.

Editor’s Note: This story has been changed because of a programming error in the version of Caffeine Zone that it described. The app’s main graph calculated caffeine dosages in milligrams, but labeled the graph in milligrams per kilogram of body weight (mg/kg).

The error did not affect any of the app’s calculations or caffeine intake recommendations. However, as an alert reader pointed out, it meant that the dosage estimates given by the app were off by orders of magnitude: 150 mg, the lower bound of the app’s “optimal” caffeination zone, is the amount of caffeine in one cup of coffee. 150 mg/kg, on the other hand, is a fatal dose of caffeine equivalent to drinking around 100 cups of coffee in quick succession.

The error has now been corrected in the free version of the app, and according to Caffeine Zone’s creator, Frank Ritter, should be fixed in the pay version within 10 days.

(Updates with Camp statement and additional comment starting in sixth paragraph.)

Feb. 22 (Bloomberg) — The Obama administration called for reducing the corporate tax rate to 28 percent from 35 percent, eliminating tax breaks and changing core features of the tax code such as interest deductibility.

The plan, which leaves many details up to Congress, would retain tax breaks for corporate research, manufacturing and renewable energy. Over the next decade, the proposal would raise $250 billion more than the current corporate tax system does, because expiring provisions would either be allowed to lapse or offset with revenue increases elsewhere.

“It is time to stop rewarding businesses that ship jobs overseas, and start rewarding companies that create jobs right here in America,” President Barack Obama said in a written statement.

The proposal includes ideas his administration has previously advanced and adds a few new ones. U.S.-based companies with overseas operations would face a new minimum tax on their global profits.

New taxes would be imposed on some insurance products, depreciation schedules would get longer and companies would face new restrictions on the deductibility of interest. Large companies that aren’t structured as corporations could face higher taxes, though the proposal isn’t specific on how that would happen.

‘Good Step’

Representative Dave Camp, the Michigan Republican who is chairman of the House Ways and Means Committee, said he appreciated the administration’s attention to corporate taxation even though there are disagreements over the taxation of income earned outside the country and Obama’s reluctance to offer a plan that also addresses individual taxation.

“While this is a good step by the administration,” he said in a statement, “I will borrow from the president’s own words to Congress from just yesterday: Don’t stop here. Keep going.”

Treasury Secretary Timothy F. Geithner released the proposal today in Washington. He called the current U.S. tax code “outdated” and “unfair.”

“The current tax code was written for a different economy in a different era,” he told reporters.

Geithner said he planned to meet with top congressional tax writers, including Camp, as early as next week.

The framework doesn’t detail how much of the new revenue would come from ending breaks and how much would come from changes to structural features such as the interest deduction.

‘Special Preferences’

“Today’s proposal falls short of the bold reforms that are sorely needed,” said Katherine Lugar, executive vice president for public affairs at the Retail Industry Leaders Association, a trade group in Arlington, Virginia, whose members include Gap Inc. and Target Corp.

In a statement, Lugar said the administration’s proposal preserves “special preferences” for some industries and doesn’t change international taxation to match what other countries have done.

The administration wants the manufacturing, research and clean-energy tax breaks to remain while other industry-specific tax breaks would end, officials told reporters in a briefing, on condition of anonymity.

“These subsidies distort choices about where companies should invest,” Geithner said.

Exemption for Hotels

Hotels and some other kinds of businesses with operations that by necessity exist offshore would be exempt from the proposed new minimum tax on global earnings, according to the officials.

Administration officials, members of Congress and business groups have been discussing a potential corporate tax overhaul for several years.

They disagree over how low the rate should go and on how income earned outside the U.S. should be taxed.

“This so-called framework is murky, ill-defined and contradictory to the goal of reducing complexity and making our tax code more efficient,” said Orrin Hatch of Utah, the top Republican on the Senate Finance Committee.

Camp has proposed a revenue-neutral overhaul of the corporate tax code that would drop the top rate to 25 percent and leave most foreign earnings of U.S. companies untaxed.

Foreign Profits

In contrast, the administration plan would continue to impose a U.S. tax on foreign profits and would make it harder for companies to defer that income.

The plan doesn’t include any mention of what would happen to the more than $1 trillion in untaxed offshore profits now held by U.S. companies. Some, including Apple Inc. and Google Inc., are calling for a tax holiday on repatriating that money. The administration officials said the treatment of untaxed earnings would have to be part of the conversation about imposing the minimum tax.

The Republican presidential candidates are all proposing to lower corporate taxes without eliminating many tax breaks. Mitt Romney, the former Massachusetts governor, wants a 25 percent rate. Rick Santorum, the former Pennsylvania senator, has proposed a 17.5 percent rate for most companies and a 0 percent rate for manufacturing.

Newt Gingrich, the former U.S. House speaker, has called for a 12.5 percent rate. Representative Ron Paul of Texas wants to set the corporate rate at 15 percent.

James Pinkerton, co-chairman of a coalition of companies advocating lower corporate tax rates, said the bipartisan agreement on a lower rate could signal a repeat of the 1986 overhaul of the tax code.

“We’re hopeful that the same larger spirit of public policy or the spirit of re-election — between those two spirits, something will prevail that will make them want to do it this year,” said Pinkerton, whose RATE Coalition includes Nike Inc. and Viacom Inc.

–Editors: Katherine Rizzo, Robin Meszoly

To contact the reporter on this story: Richard Rubin in Washington at rrubin12@bloomberg.net

To contact the editor responsible for this story: Jodi Schneider at jschneider50@bloomberg.net

Why Tax Cuts Won’t Help Small Business

President Obama today proposed eliminating corporate tax loopholes and using the money to cut the business tax rate to 28 percent from 35 percent. The tax code “is unnecessarily complicated and forces America’s small businesses to spend countless hours and dollars filing their taxes,” he said in a statement.

Strange, then, that a plan to simplify the business tax code and cut rates would spark a condemnation from small business groups. The chart above tells you why.

The lower rate would only apply to companies organized as C corps, which pay corporate income taxes. They make up less than 6 percent of business tax returns, according to IRS data. (They account for closer to two-thirds of all business revenue and income.) For the rest of the business world, including partnerships, sole proprietors, S corps, and limited liability companies, their business earnings flow through to owners’ personal income and are taxed at individual income tax rates.

Eliminating tax breaks without lowering individual income tax rates could effectively raise taxes on some small business owners, says Todd McCracken, president of the National Small Business Association, a Washington trade group. “The business deductions are relatively unified. A deduction’s a deduction, whether you’re a C corp or a sole proprietor, for the most part,” he says.

McCracken likes some parts of the Obama proposal: A plan to make permanent deductions for capital investment (such as equipment and software) and research and development. (Yes, the tax reform supposedly eliminating deductions includes plans to expand deductions.) Still, he says, reforming the corporate tax code and letting the Bush tax cuts expire could leave non-corporate business owners facing a federal income tax rate of over 40 percent next year on earnings over $250,000.

The National Federation of Independent Business, a frequent foe of the Obama White House, panned the proposal, saying in a statement that “the focus should be on individual rate reform.” Not every small biz lobby agrees. Small Business Majority, a group that generally supports Obama’s policies, praised the plan and noted that “reforming the tax code will eliminate dozens of loopholes that consistently leave small businesses paying an unfair share of taxes.”

McCracken says the plan is short on specifics but looks like a mixed bag. He favors reform that would tackle the individual tax code alongside corporate taxes. The chances of any major tax plan passing in Congress this year, he notes, are very slim. So even if corporate tax reform spells trouble for small businesses, they probably don’t have to worry about it any time soon.

Feb. 22 (Bloomberg) — Two top lawmakers on small business matters renewed calls for tougher enforcement of the rules in a program that steers government contracts to the socially and economically disadvantaged.

Some wealthy entrepreneurs have received hundreds of millions of dollars in federal contracts reserved for the disadvantaged by repeatedly qualifying for the one-time program, Bloomberg reported yesterday, based on a review of Small Business Administration and procurement data. The preference system, under Section 8(a) of the Small Business Act, accounted for $16.7 billion in government awards last year, more than the budget of the Commerce Department.

“It is unfortunate that news headlines and media reports continue to underscore the necessity for more vigorous oversight within the Small Business Administration’s 8(a) program,” said Senator Olympia Snowe of Maine, the ranking Republican on the Small Business and Entrepreneurship Committee. She sponsored legislation passed by the Senate last year that would tighten oversight of SBA contracting.

In the House of Representatives, which hasn’t taken up the measure, Missouri Republican Sam Graves, chairman of the Small Business Committee, said the Justice Department “is reluctant to use its resources to pursue small business fraud cases if the cost of prosecution will outweigh the costs of recovery.”

The Graves panel is considering a bill that would address fraud in government procurement, said D.J. Jordan, a spokesman for the committee, in an e-mail. The proposal by Representative Mick Mulvaney, a South Carolina Republican, “will make it easier to crack down on deceptive large businesses hiding behind small businesses,” Jordan said.

‘Worst Examples’

Snowe’s bill, known as the Small Business Contracting Fraud Prevention Act of 2011, would force the SBA to improve certification, surveillance and enforcement, she said. The measure passed the Senate with unanimous consent and has 13 co- sponsors.

Since 1990, the SBA has certified multiple companies at a single address more than 100 times, based on data compiled by Bloomberg. Twelve repeat participants have received $412 million in preferential contracts and more than $1 billion in total government awards, Bloomberg found. Under the rules, a qualifying small business should participate only once in the preference program, which should last just nine years.

“Tomorrow, the inspector general should look into not just terminating the contracts of the worst examples, but checking out the more than 100 times the SBA certified multiple companies at a single address,” said Charles Tiefer, who served on the U.S. Commission on Wartime Contracting.

Growing Rich

Officials should consider “a potential referral to the Justice Department for civil clawback proceedings,” said Tiefer, who is now a professor at the University of Baltimore Law School.

A Florida family grew rich on $256 million in federal contracts since 1993, in part through a web of closely held companies that allowed members to remain 18 years in the nine- year program for the disadvantaged, Bloomberg reported. Brothers Akhil Agrawal, 44, and Sukrit Agrawal, 46, participated in the SBA program from 1994 to 2003 and continue to win preferential contracts today through a joint venture with their father’s firm, APS Technologies Inc. The family denied any wrongdoing in a written statement.

“The story of how the Agrawals got rich by manipulating the system is a textbook example of why vigorous government oversight is needed before taxpayer dollars are handed over,” said Nick Schwellenbach, director of investigations at the non- profit Project on Government Oversight in Washington.

More Oversight Urged

The SBA defines the socially disadvantaged as “those who have been subjected to racial or ethnic prejudice or cultural bias,” such as women, blacks, Hispanics, Native Americans and Asian-Americans. Eligibility in the Section 8(a) program is limited to U.S. citizens whose net worth can’t initially exceed $250,000 and shouldn’t rise above $750,000 while in the program.

“If, in fact, the process can be circumvented to the extent that it appears that it has been, that would suggest to me that there needs to be a lot more oversight and perhaps rules need to be changed in order to ensure compliance,” said Rob Burton, a top U.S. procurement official under President George W. Bush. He is now a partner in the Washington office of the Venable LLP law firm.

Admission to the program for the disadvantaged gives entrepreneurs a passport to obtain federal contracts that typically aren’t subject to competition. The U.S. targets 23 percent of its $530 billion in buying each year for small companies through an array of assistance, of which the 8(a) designation is only one.

Business owners and members of their immediate families may participate only once, though the SBA spells out exceptions. These include approved mentoring relationships and joint ventures between past and current participants, or if participants are in different lines of business.

For More News and Information: Bloomberg U.S. Budget Function: {BUDG <GO>} News on the Small Business Administration: {NI SBA <GO>} Top Government News: {TOP GOV <GO>} U.S. Budget Deficit, Surplus: {FDDSSD <Index> <GO>}

–Editors: Robert L. Simison, Anne Reifenberg

-0- Feb/22/2012 18:22 GMT

To contact the reporters on this story: Elliot Blair Smith in Washington at esmith29@bloomberg.net; Danielle Ivory in Washington at divory@bloomberg.net. Gopal Ratnam in Washington at gratnam1@bloomberg.net;

To contact the editors responsible for this story: Robert Blau at rblau1@bloomberg.net; Mark Silva at msilva34@bloomberg.net ; Stephanie Stoughton at sstoughton@bloomberg.net

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