After reading last month's article, Working from Home? Can You Deduct It?, I had some additional thoughts about how we as bookkeepers manage our clients' home office expenses.
In the article, Cathy Roth describes who can deduct expenses for business use of a home, the forms used to take such deductions, and the types of expenses which can be deducted. Included in those expenses are “Expenses for keeping up and running your entire home (examples: insurance, utilities, and general repairs)” which are deductible based on the percentage of your home used for business. (See the article for in-depth details.)
As bookkeepers, we often see that our clients who work from home are using this deduction beyond the intended scope. For example, they are asking us to post 100% of their cell phone bill as a business expense, even though they have five family members on the plan. Or we are posting 100% of multiple utility bills as a business expense.
Since we know that our clients can only deduct a percentage of these expenses, how do we alert the accountant or tax preparer that what they see on the P&L might be overinflated and needs to be reduced accordingly?
Options for managing home office expenses for your bookkeeping clients
Option 1: Post 100% of the expense on the books, and let the tax preparer calculate the deductible amount to be used on the tax return.
Benefit: There are no arguments or unpleasant conversations with the client.
Drawbacks: If there are no year-end adjusting entries, the P&L expenses are overstated, and the tax return might be incorrect.
Option 2: Post each bill proportionally between expense and Owner Draw or Partner/Shareholder Distribution. To do so, find out from the tax preparer the actual percent used on the tax return for the business use of home deduction and then post the proportional expense and owner drawer. For example, if the percent used on the tax return for business use of home is 5%, when posting the bill you would use splits to post 5% as a business expense and 95% as Owner’s Draw or Partner/Shareholder Distribution
Benefit: The books accurately reflect the legally deductible amount.
Drawback: It is more work to enter each individual bill, and there may be multiple monthly bills (cell phone, utility bill-gas, utility bill-electric, etc.).
Option 3: Post 100% of the expense of each bill, and at year-end use a Zero Dollar check to make the 5% adjustment for cell phone, utilities, etc. If using this option, be sure to save backup documentation for the Zero Dollar check figures.
Benefit: There is less work for the entry of each bill during the year, but year-end books accurately reflect the true deductible amount.
Drawback: You must make sure that the tax preparer knows the P&L figure already represents the 5% business office allowable deduction (remember, 5% is just our sample figure; the actual percent will vary in real life), so no additional calculations are needed.
Option 4: Do nothing; post 100% of each bill.
Benefit: There is less data entry work.
Drawbacks: Those expenses on the books are overstated and you must make sure the tax preparer knows they need to be reduced when preparing the tax return. Also, for many bookkeepers, it just feels wrong.
Best practice for managing home office expenses for your bookkeeping clients
The best practice for managing home office expenses for your clients is to proactively discuss the topic with both the business owner and their tax preparer. During the conversation, you can point out your concerns about overstated business expenses, and then discuss an approach to ensure all lawful expenses are posted in the books - and that everyone knows how those expenses may or may not be adjusted, either in the books or on the tax return.