Maximizing business transportation expense deductions

The costs of commuting from a personal residence to places of business or employment generally are nondeductible personal expenditures. The deduction for commuting costs is disallowed regardless of the distance involved.

However, taxpayers whose residences qualify as their principal place of business can deduct transportation expenses incurred in going between their residence and other work locations in the same trade or business (including regular or temporary work locations), regardless of the distance. In the landmark Soliman case, the Supreme Court identified two factors for determining whether a home office qualifies as the taxpayer’s principal place of business: (1) the relative importance of the activities performed at each business location and (2) the time spent at each place.

A taxpayer can meet other tests to qualify his or her residence for the home office deduction. But, the principal place of business test must be met for transportation costs between the residence and other work locations to be deductible.

For an employee to deduct daily transportation costs between a residence and other work locations in the same trade or business, the home office must be for the convenience of the employer in addition to being used exclusively and regularly as the principal place of business.

Whether telecommuters (i.e., employees who work from their residence much or all of the time) can deduct their local transportation costs depends on the particular facts. However, their home offices often will fail to qualify as their principal place of business for tax purposes because they do not satisfy the criteria mentioned above. Thus, if they also maintain an office at their employer’s place of business, the cost of going between their residence and the employer’s office is nondeductible.

Example: Management consultant with home office.

Jack is a self-employed management consultant for a variety of small businesses. He maintains a home office used regularly and exclusively to set up appointments, store client files, and develop management reports for his clients. Jack does most of his consulting work by telephone, email, or mail from his home office. He routinely uses his personal auto to travel from his home to meet with prospective and current business customers or their representatives. His home office qualifies as his principal place of business.

Because Jack meets the principal-place-of-business/home-office criteria, his mileage traveling from his residence to see clients, to work at other regular or temporary work locations, or to perform other business duties is a deductible business expense.

Taxpayers who do not have a home office that qualifies as their principal place of business can still deduct the cost of daily transportation expenses incurred in going from their residence to temporary work locations in the following circumstances: (a) when the location is a temporary work site outside the metropolitan area where he or she lives and normally works (because there is no fixed place of business, the entire metropolitan area is deemed the workplace) or (b) a taxpayer who has one or more regular work locations away from home can deduct the cost of transportation from the home to a temporary work site in the same trade or business, regardless of the distance or whether the site is inside or outside the residential metropolitan area. Generally, a metropolitan area includes the area within the city limits and the suburbs that are considered part of that area.

Note: When a taxpayer has two or more regular work locations (whether in the same business or differ-ent businesses), the daily transportation costs of going between these work locations are deductible.

Working may decrease your social security benefits

Many taxpayers currently underemployed due to recent economic conditions may consider applying for social security retirement benefits earlier than they previously planned to supplement their income. But, continuing to work while receiving those benefits may cause their benefits to be reduced below the anticipated amount. If you are a social security beneficiary under the full retirement age (currently age 66), an earnings test determines whether your social security retirement benefits will be reduced because you earned more from a job or business than an annual exempt amount (discussed below). A different earnings test applies to individuals entitled to disability benefits.

As a general rule, the earnings test is based on income earned during the year as a whole, without regard to the amount you earned each month. However, in the first year you receive benefits, they are not reduced for any month in which you earn less than one-twelfth of the annual exempt amount.

One of the provisions of the Senior Citizens’ Freedom to Work Act is that the social security retirement earnings test is eliminated in the calendar year in which you reach your full benefit retirement age for the month of, and months after, such attainment. In other words, once you reach your full benefit retirement age, there is no longer an earnings test to reduce your social security retirement benefits. However, the earnings test still applies for the years and months before the month you reach your full benefit retirement age.

Social security beneficiaries under the full benefit retirement age who have earnings in excess of the annual exempt amount are subject to a $1 reduction in benefits for each $2 earned over the exempt amount (currently $14,160) for each year before the year during which they reach the full benefit retirement age (see the example). However, in the year beneficiaries reach their full benefit retirement age, earnings above a different annual exempt amount ($37,680 in 2010) are subject to a $1 reduction in benefits for each $3 earned over the exempt amount. Social security benefits are not affected by earned income beginning with the month the beneficiary reaches full benefit retirement age.

You use the first exempt amount (currently $14,160) from the year you reach age 62 through the year before the year you reach your full benefit retirement age. The second exempt amount (currently $37,680) is used in the year you reach your full benefit retirement age. (However, social security benefits are not affected by earned income beginning with the month you reach your full benefit retirement age.)

Example: Applying the annual earnings test.

Charles, age 62 and a commissioned salesperson, currently averages $2,000 per month in commissions. He has recently experienced a decrease in his income due to lower sales and is considering applying for social security benefits to supplement his reduced income. Charles’s social security retirement benefits will be $1,200 per month, so he expects to receive benefits totaling $14,400 per year. However, since he will earn $9,840 over the $14,160 first exempt amount ($24,000 – $14,160), his benefits will initially be reduced by half that amount, or $4,920. Therefore, he will receive only $9,480 in social security benefits ($14,400 – $4,920). The results would be the same if Charles was self-employed, rather than an employee.

As you plan your retirement, be mindful that, as the example shows, working during retirement may reduce your social security benefits. This, in turn, could have a negative impact on your financial plans.

Please call us if you have questions on the taxability of social security benefits or any other tax planning or compliance issue.