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How do I account for a startup that has a live / workspace? What are the tax implications for a startup that has a live / workspace?

Vanessa Kruze, CPA, is a leading expert in startup taxes and tax compliance. Her team at Kruze Consulting has filed thousands of tax returns for companies that have raised billions in VC funding, and her work has been diligenced by leading VCs, attorneys, and M&A teams at the largest technology companies.
Vanessa Kruze, a highly-experienced CPA, brings valuable tax expertise to startups, drawing from her rich background at Deloitte Tax and as a financial controller for a $20 million startup. As the leader of Kruze Consulting, recognized multiple times in the Inc 5000 list, she specializes in navigating the complex tax landscape for startups. Her firm is known for delivering precise and strategic tax solutions, delivering tax credits utilizing advanced tools to ensure compliance and optimize tax benefits for startups throughout the United States.

Table of contents

Workspace tax implications

We’ve seen a few startups rent a 4 bedroom house under the name of their startup as opposed to their personal names, believing that they could deduct the entire cost through the startup, hence allowing the whole team to save thousands in personal rent. It does not work like that. The IRS cares a lot about these types of arrangements because it can miss out on significant payroll tax revenue because the employees are receiving a free fringe benefit.

The Living Portion of a Live Workspace is Not Tax Deductible

For tax purposes, you can only deduct the pro rata percentage of your live/work space that is used both regularly and exclusively for work purposes.

The Qualifications: your live workspace must be….

  • Exclusively used for business. Not just workspace by day, living room by night.
  • Regularly used for business. Not just on the weekends.
  • Principal Place of business. This is where you regularly work, regularly meet up with clients, etc. The IRS spells out more on the details here.

The Math For Calculating Deductions:

  • If you have a 5,000 sq ft live / work space, you must measure the exact amount of space that used exclusively, regularly, and as your principal place of business. Let’s say that you use the “man cave” as your office, and that room measures 1000 sq ft. If you’re paying $10,0000/mo for the whole live / work space, then you may only count 1/5th of the total cost as your office space = $2,000
  • In a perfect world, the employees/tenants would pay $8,000 of their personal money and the startup would pay $2,000 to the landlord. Few landlords are keen to accept two checks, so you’ll have to write one. If the company is reimbursing the employees or vice versa, you now have highly sensitive accounting acrobatics to keep track of every month. Not fun.

The Hidden Costs:

  • No Privacy: your startup coworkers are going to know all about you… and your hygiene habits, and your dating life, and any other detail big and small.
  • Groupthink: if all the employees at the startup are spending 23 hours a day together, there’s a tremendous incentive to keep the peace. That means that when someone doesn’t agree with a new idea at work, they’re more likely to keep quiet on their opinions so as not to rock the boat. Not productive for a startup that needs to stay fluid and open.
  • Homogeneous experiences: if you’re living and working with your team all the time, chances are that you’re all having the same experiences. Some of the best innovations happen after hours - when you see things from a new perspective - as you’re socializing with people outside your industry. Give yourself and your startup team that mental break to experience new ideas.
  • Potential HR issues: heaven forbid two of your teammates to become, ahem, intimate. Super awkward.

Bottom line: don’t do it, get a legit coworking space

You are not saving money by opting for a live / work space. Save your sanity and go for WeWork office where you can get work done, mingle with other offices, then go home to a work-free sanctuary.

Coworking spaces, on the other hand, are a legitimate expense that a startup business can deduct. Let’s focus on coworking spaces and taxes now:

Are Co-working Spaces Tax Deductible?

Yes, a business like a startup can deduct coworking expenses as long as certain conditions are met. 

For Startups: A Viable Deduction

  • Startups Can Deduct Co-working Space Expenses: If your startup rents a co-working space, this cost is generally considered a deductible business expense. The IRS recognizes these expenses as part of your operational costs, similar to traditional office rent. 
  • Conditions for Deductibility: The key factor is that the space must be used for business purposes. As long as the co-working space serves as a primary or regular location for conducting business activities, the expenses associated with it – such as membership fees, rent, and utility costs within the space – can be deducted. 
  • Who Can Deduct: The business can deduct the co-working expenses from their corporate income. NOT the employee deducting from their personal tax return.

For Freelancers: A Conditional Deduction

  • For Business Use: Freelancers can also benefit from deductions associated with co-working spaces. However, the crucial criterion here is that the space must be used exclusively for business purposes. Mixed-use (both personal and business) does not qualify or cause a lot of complications. Just as we mention for a live/workspace, mingling working space and personal space is likely to make the expense not deductible.  
  • Documenting Use and Expenses: Maintaining clear records of the use of the space and related expenses is vital for freelancers to substantiate their claims during tax filings.
  • Who Can Deduct: Legitimate freelancers who get 1099’s, not W-2s. Now onto W-2 employees:

For Employees: Coworking Generally Not Deductible

  • Limited Scope for Employees: If you’re an employee using a co-working space to work for another company, it’s unlikely that these expenses are deductible on your personal taxes. This scenario typically does not meet the IRS criteria for a home office deduction, as the employee is not bearing this cost for self-employment purposes. So if you are getting a W-2, you should try to get your company to pay for the space instead of relying on a tax benefit that you, as an employee, probably can’t get. 

Conclusion: Consult a Professional

Given the complexity of tax laws and their frequent updates, it’s advisable for both startups and individuals to consult with a tax professional to understand the specific implications for their situation. Our firm specializes in advising startups on these and other tax-related matters, ensuring compliance and optimizing financial strategies.

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Startup Taxes

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