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That means, in terms of Test #1, the new rules allow that your primary function does not necessarily have to take place in your home office as long as your office at home is used to conduct the administrative or management activities of your business and you have no other office where you can conduct such activities. Thus, if you keep your logs, do your paperwork, listen to sales tapes, make business calls, create business materials, etc., out of a set place in your home, you will be legally eligible for the home office deduction.

But what about Test #2? Do the new laws Congress passed help overcome the difficulties of this test? Well, not directly, but the way this test is worded can be a bit misleading. Note that what Test #2 is actually saying is “do you perform any significant services in another office?” If you don’t, you qualify for the exception. Let’s look at some examples:

• John and Mary have W-2 jobs, but they also have a part-time network marketing business. They have no other office for this business. They do all paperwork and greet all clients in their home. Their home qualifies as a principal place of business under either the Soloman ruling or the exception.

• David and Cari are real estate agents. Although their broker
provides them an office, they rarely use it other than to drop off
contracts and attend sales meetings. All calls, mailings, and real
estate research is done at home. Their home qualifies as a principal
office because they don’t perform significant services out of the other office.

If you keep good records, and work the 50 percent required time in
your home in order to operate your side business, you will have no problem taking the home office tax deduction. Moreover, even if you don’t meet the 50 percent test, if you meet the exception to Soloman, that is, you conduct your significant administrative activities for your business at home and don’t have another office where you can conduct those activities, then your home constitutes a “principal office” for purposes of the home office deduction.

Taken from : Money Mastery “10 Principles That Will Change
Your Financial Life Forever

Test #2: “Do you use your home office for more than 50 percent of your at-work time? Take the total amount of hours you work in a week, Dr. Solomon,” said the Supreme Court, “and divide by two. Does that yield more than 50 percent of your hours physically spent in your home?”

In Dr. Solomon’s case, he spent 15 hours a week at home and 35 hours a week in the hospital, so he obviously didn’t qualify. He was not entitled to the home office deduction under either rationale.

You will be happy to know, however, that there is now an exception to the “Doc Solomon” decision, especially as it applies to test #1. Remember Money Mastery Principle 6, “The Rules Are Always Changing”? Due to tremendous complaints about the effect of this case on small business, Congress passed a special exception that took effect in 1999. This exception provides two new rules that help small businesses escape the clutches of the Solomon decision:4

• New Rule #1: Your office at home is used to conduct the administrative or management activities of your business.
• New Rule #2: There is no other office where you conduct substantial and administrative activities for your business.

Taken from : Money Mastery “10 Principles That Will Change
Your Financial Life Forever

Criteria #1: Principal Place of Business.
What constitutes a principal place of business? A famous case called the “Doc Solomon” decision explains.3 Dr. Solomon was an anesthesiologist. He worked in three different hospitals in Fairfax, Virginia for 30 to 35 hours a week. In his condominium, he converted one of his bedrooms into an office where he worked another 10 to 15 hours a week. He did his billing and medical logs from home, read X-ray film from home, and, more interestingly, he had no other office. The hospitals for which he worked would not provide him one.

Naturally, Dr. Solomon felt justified in claiming the home office deduction on his tax returns. His argument was, “My home has to be my principal place of business because I don’t have another office.” Dr. Solomon was audited and the IRS took him to court because they disagreed with his reasoning. A tax court heard the case and said, “Dr. Solomon, you are right.” The IRS didn’t like that answer so they took the case to an appellate court. The appellate court said, “Dr. Solomon, you are right.” Of course, the IRS didn’t like that either, so they went all the way to the Supreme Court. And as you know, that’s always where the buck stops. The Supreme Court said: “Dr Solomon, you are wrong. We have two tests we use to determine whether a home property is a principal place of business for a home office.”

Test #1: “Where do you do your most important functions?” To that,
Dr. Solomon’s response was, “My most important function is done at home. That is where I do my billing.”

“No,” said the Supreme Court, “that is not your most important function, Dr. Solomon. You are a doctor of anesthesiology, so your most important function is done where you deliver your anesthesia—in a hospital. You don’t do that out of your home. Now lets look at another way to qualify using test number two.”

Taken from : Money Mastery “10 Principles That Will Change
Your Financial Life Forever

Myth #4: My accountant says that the home office
deduction is limited to my income so if I don’t make enough profit in my business, it isn’t worth taking it.
This is partly true. Your home office deduction is, indeed, limited to the net income from your business after taking all your other business deductions. Consequently, if you are not working your business, or if you are not making any kind of substantial income, you do not get an immediate benefit.

However, no “immediate benefit” is not the same as no benefit at all. If your deduction exceeds your net income from your business, you can carry it over into future income years indefinitely. So, as you make more money, you can offset those nice increases in income with carry-over deductions.
As you can see, a home office can be a very legitimate tax deduction.

Tax Strategy #4: If you are eligible for
a home office tax deduction, take it!
Here’s how to assess whether you can apply Tax Strategy #4:
The law states that a home office deduction is available only to the extent that a portion of the dwelling unit* is used exclusively and on a regular basis.1 That means that your home office must be:
1. Your principal place of business; and/or
2. The place of business where you meet and greet customers,
patients, or clients in the normal course of your business; and/or
3. Used for a second business you have; and/or
4. Used to display sample products or as storage space for inventory.

In addition, if you are using an office in your home to do work as a
regular W-2 employee, then the home office deduction is allowed only if the exclusive use of the office is for the convenience of your employer.2 Thus, your employer must require you to take work home, and not provide you with an office at work.
Let’s examine each of the criteria we have outlined above in more detail:

Taken from : Money Mastery “10 Principles That Will Change
Your Financial Life Forever

Know the rules. We have emphasized again and again how important
it is to heed this advice. So many people suffer when they take for granted the power of this Money Mastery principle. It can be applied in so many areas of our lives to bring peace, control, and stability. And when it comes to taxation, it’s especially critical that the rules of the tax game are known and understood. In Chapter 13, we outlined some very important rules that will help distinguish your
new home-based venture as a business, and not simply a hobby. You are now ready to learn some rules about the way to physically set up an office so you can be sure to run your business in a way that will ensure you the most tax savings.

Without question, a home office is one of the single biggest resources
for tax deductions to which you have access. Unfortunately, many people don’t understand the wealth of tax savings they can get from a home office because they have heard a few myths about the limitations placed on a home office. These need clearing up:

Myth #1: I can’t claim a home office
deduction because my house isn’t zoned commercially.
The truth is the IRS does not care at all about the zoning laws in your area. You can live in a commercial, rural, residential, or agricultural zone and it won’t make a bit of difference to the IRS.

Myth #2: I can’t claim a home office
because I don’t have a back entrance in my home.
The fact is that the IRS is not concerned about how many entrances you have in your house.

Myth #3: My accountant said
that the home office deduction isn’t worth the trouble.
Here’s what the numbers say, and these numbers are based on a $200,000 home: The value of an office in such a home is about $2,500 a year in cash, which if invested at 6 percent, makes the actual value of a home office (over a five-year period) worth almost $15,000 every five years! In our opinion, paying yourself $15,000 every five years because you operate your business in your home sounds pretty worth the trouble. Don’t you think?

Taken from : Money Mastery “10 Principles That Will Change
Your Financial Life Forever

1. This week, review the following checklist to ensure that your
venture will be conducted as a business and not a hobby:
? Try to have a profit in at least three out of five consecutive years, or two out of seven years if you are involved in animal breeding or racing, or automobile racing.
? Document your intent to make a profit; a business plan or a letter to your sponsoring company (if you are in networking marketing) will do.
? Document all business activities using a tax diary or daily planner.
? Keep business and financial records separate from your personal finances.
? Open a separate bank account for your business.
? If your business requires inventory, make sure you have enough to justify your business plan goals.
? Use advertising, business telephone listings, and marketing
materials as appropriate for your business, and change your advertising and marketing strategies form year-to-year if you are not making money.
? Investigate your business activity before entering it; document
that investigation.
? Obtain training continually; seek out expert advice; document
these efforts.
? Work your business regularly and document your activities daily.
? Keep a history of your business and show how you took steps to improve your bottom line.
2. This week, be sure to obtain a good tax diary or other method
or recording your daily activities. (Refer to the Appendix for information about various tax diary products.)

Taken from : Money Mastery “10 Principles That Will Change
Your Financial Life Forever

Rule #9: Keep in mind that income
from other sources can affect an IRS ruling.
The IRS also looks at the amount of income you have from other
sources.21 This may not seem fair; if you make $200,000 and you go into a side business, you are more suspect than someone making $20,000, but that’s the way it is. The greater your income from other sources, the less likely the loss from your other activity will be deemed a loss. This situation, however, does not mean all is lost. There are a lot of people who make hundreds of thousands of dollars and still claim losses from their side businesses. But certainly this situation requires that you dot your i’s and cross your t’s more carefully.

Rule #10: Be more alert if you
are involved in inherently “suspicious” activities.
There are certain activities that seem to be inherently more suspicious to the IRS.22 These are business ventures that may have more potential for significant personal pleasure. Following are some examples:
• Antique Collecting.
• Stamp Collecting.
• Travel and Tourism.
• Writing.
• Ministerial Duties.
• Music Recording and Production.
• Raising Show Horses.
• Training and Showing Dogs.
• Automobile Racing.

If you are involved in one of these activities, you need to pay close attention to all the other rules we have outlined in this chapter.

While the rules that determine whether you are running a business or
doing a hobby may make starting a home-based business seem like a lot of work, we can assure you that learning these rules will make running your business a lot easier, and will bring peace of mind. It will also prepare you to take full advantage of the tax savings we will explain in upcoming chapters. Only by committing yourself to get organized as Money Mastery Principle 8 teaches, will you ever be ready to launch into a home-based business that will run smoothly and efficiently for you, even in the early stages. As you form new “tax habits” it will become easier and more automatic to do the
things we have discussed in this chapter. Plan to start your new business venture on the right foot by doing things right the first time.

Taken from : Money Mastery “10 Principles That Will Change
Your Financial Life Forever

Rule #8: Keep a history of income, losses,
and steps you have taken to improve the bottom line.
Maintaining this kind of history is a very important step. In any business, expenses can certainly exceed income.18 Businesses do have losses, and the hobby loss provisions aren’t based on the assumption that no decent businessperson ever had a loss. However, real businesspeople do everything necessary (and legal) to turn those losses into profits.19

You should watch out for expenses that are unreasonable. Expenses
should be in proportion to your income. For example, a case involving an Amway distributor showed that his accounting fees alone had exceeded his entire gross income from his business. Because of this, the court held that the distributor’s activities constituted a hobby.20 Marketing expenses are an exception to the principle of proportionality because they can be very costly in the early stages of a company’s existence.

This concept of using excessive and unreasonable expenses as a way
of assessing the lack of a business profit motive has been applied to a lot of cases. For example, a person who has a travel business and tries to deduct all her family trips, despite very little gross income, is going to have a tough time proving that these trips had a profit motive. This is especially true if each trip cost more than the gross income of the business venture itself!

Your main objective should be to show that you are really trying to make a profit or turn your losses around. You want to show that you do have a reason for spending a large sum of money in one area. The best way to do this is to document, document, document! Document all marketing activities and all reasons for trips, noting the business intent and the necessity for taking the trip in order to make money.

Note: Recent IRS cases indicate that there needs to be some gross income in order to be considered a business. If you are in a business that shows no gross income at all, the IRS is likely to see this as evidence that you are not in business and that you are conducting a hobby instead.

Taken from : Money Mastery “10 Principles That Will Change
Your Financial Life Forever

Rule #7: Devote regular time to your business.
Although you don’t have to devote your full time and attention to a side business, it is very important that you devote some time in a regular manner to your activity. Businesses are conducted in a regular and systematic manner; hobbies are not.

Nobody says that a home-based business must be a full-time duty, but the more time and effort you put in it, the better. At least one case on record has shown that an average of as little as one hour per day was substantial enough to prove a profit motive.16 One hour a day, four to five days a week is better than putting in eight hours every two weeks.17

Now you might be asking how the IRS would know whether you actually put in one hour every day. How do they know you are actually seeing people in your business and visiting prospects and doing marketing? They look at your tax diary, that’s how. A good diary is irreplaceable because it can go a long way toward proving that you are running a business, not engaging in a hobby.

Taken from : Money Mastery “10 Principles That Will Change
Your Financial Life Forever

Rule #6: Understand that your
prior business experience can help or hurt you.
If you have no prior business experience in a particular line of work, the IRS may decide that you are taking a big chance, and therefore find it questionable that you ever had a profit motive.14

The courts have long held that this strike against you can be overcome by making sure that you extensively study your line of business. Investigate the business you are going into before you launch it.15 Do a feasibility study; see how profitable the type of business you want to launch can be. Listen to training tapes, take seminars, attend training meetings. You can never get enough training, and it will serve to improve your bottom line at the same
time it helps to satisfy the IRS that you are really taking the business seriously. Document all your training, lectures, and outside reading using your daily tax diary. This is very important. Every time you receive training or go to a seminar, document it.

Thoroughly investigate your business venture before jumping into it:
• Get a credit report on the sponsoring company (for network
marketing).
• Check out the competition to see what they are doing.
• See how much money other distributors or business owners are making in the same business.
• If you can, review some financial reports related to your industry or business venture.

The more thorough your investigation, the better the chance that the IRS is going to believe you are in business to do business.

Taken from : Money Mastery “10 Principles That Will Change
Your Financial Life Forever