Simplify and modernize by removing exclusive use for a home office deduction

Yet more from the testimony I submitted for the written record of a Senate Finance Committee and Small Business and Entrepreneurship Committee roundtable held June 7, 2023 (see my posts of 7/9/23 and 7/2/23 and 6/25/23). Another way to simplify tax rules for small businesses (such as ones operating out of the owner's home) and modernize tax rules is to remove the exclusive use requirement for the home office deduction.

Modern life makes it unlikely that anyone uses a home office only for business activities. Most people, for example, have a smartphone in their hands and might get a personal call or text message or use a weather app while in their home office.

An alternative would be to allow a home office deduction only if the space is used over 50% for business and to reduce the deduction based on the percentage of personal use of the space, such as based on time. Offering a standard home office deduction, such as allowed by Rev. Proc. 2013-13, would be helpful, with the amount adjusted annually for inflation (and no exclusive use requirement, but adjusting the standard deduction for the percent of personal versus business use of the space based on an average week of use). 

What do you think?

Small Business Tax Reform

There is a growing number of small businesses. According to the US Census Bureau, in 2002 there were 17,646,062 "non-employer" firms. That is, firms with no employees, such as a sole proprietorship with no employees. In contrast, there were 5,697,759 employer firms. In 2004, the number of non-employer firms had grown by 10.6% while the number of employer firms had dropped by 3.3%.

Per a 12/07 Small Business Administration report (p. 1):

"In 2004, the most recent year for which firm size data are available, small firms with fewer than 500 employees accounted for all of the net new jobs. According to the U.S. Department of Commerce, Bureau of the Census, firms with fewer than 500 employees had a net gain of 1.86 million new jobs, while large firms with 500 or more employees had a net loss of 181,000 jobs. Small firms employed just over half of the private sector work force and generated more than half of nonfarm private gross domestic product. More than 99 percent of American businesses are small, and the average small employer had one location and 10 employees, compared with 62 locations and 3,313 employees in the average large business."

Of course, there are many ways to define small: gross receipts, number of employees, asset size, and capitalization. Also, definitions, such as those used by the SBA, can vary by industry. But, despite the definitional approach, small businesses are viewed as growing and providing employment. So policymakers tend to pay attention to small businesses to see if they can help them to help the economy.

In April 2008, the House Small Business Committee issued a report and held a hearing on ways to modernize the federal tax law to help small businesses to stimulate the economy. There are also several bills to help small businesses with tax compliance. Ideas include:

1. Increasing the IRC Section 179 expensing election.
2. Removing cell phone and laptops from listed property to ease recordkeeping.
3. To increase the meals and entertainment expense deduction in recognition that this is how small businesses generate new business in contrast to large businesses that use fully-deductible advertising.
4. A standard deduction option for the home office deduction and easing of the exclusive use requirement so that more businesses take a deduction that is truly a cost of doing business.
5. Improving health care deductions to make them comparable to corporate employees who treat health insurance contributions on a pre-tax basis.

It is questionable if anything will happen in the remaining days of the 110th Congress. I think the focus on small businesses tax modernization will resurface in the 111th Congress, but most likely in the context of overall reform of the federal tax system. Most of the ideas would help move the tax law into the 21st century. Really - should we have to keep detailed logs on cell phone usage when it has become such a low cost necessity of business people?

For more ideas and information links, I've got a short article on this topic in the August AICPA Corporate Taxation Insider.

What do you think?

Modernizing the Tax Law for Small Businesses

On April 10, 2008, the House Small Business Committee held a hearing - “Modernizing the Tax Code: Updating the Internal Revenue Code to Help Small Businesses Stimulate the Economy."

The Committee also issued its own report - “Seven Ways to Stimulate the Economy by Updating the Internal Revenue Code." In addition to having witness testimony online in written form, the Committee has videos on YouTube about the hearing. This can all be accessed at this summary of the hearing.

I think the ideas presented by witnesses and in the Committee's report fall into two categories:

• Tweaks to the federal tax law to make compliance and doing business easier for small businesses.
• Changes that reflect the fact that most of the federal tax law was written before we entered our global, interconnected, knowledge-based economy and society and thus is in need of modernization.

Examples of Category 1 suggestions:

• Repeal the AMT
• Make the 2001 and 2003 tax cuts permanent
• Allow greater choice of tax year for non-corporate businesses
• Increase meals deduction for small businesses

Examples of Category 2 suggestions:

• Allow non-resident aliens to be shareholders in S corporations
• Stop treating cell phones and PDAs as listed property for depreciation purposes since these are not luxury items, but necessities of operating a business; detailed recordkeeping of use is not productive
• Create a simpler tax systems, even with less incentives, due to the significant compliance costs small businesses face
• Simplify the home office deduction to be a standardized deduction
• Shorten some depreciation lives to be more in line with today's technology

The focus of the hearing was improving tax rules for small business to stimulate the economy, not just to modernize the tax law. However, there were several good ideas that remind us how out-of-date the tax law is (such as treating cell phones as questionable business items and giving personal computers a 5-year depreciation life).

What are your ideas to modernize the tax law to better help small businesses succeed in today's economy?