Everything About The Work from Home Tax Deduction
2020 was a strange year for many taxpayers who were forced to from home but a fairly normal year for self-employed individuals who are used to working from home and claiming the home office deduction. As you prepare for the 2020 tax season the big question is what deductions are available and who qualifies for them. Here is everything you need to know about the work from home tax deduction.
Reviewing the Impact of the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (TCJA) tax reform made significant changes to tax deductions available to people working from home. Prior to the TCJA unreimbursed expenses attributable to the business of being an employee were deductible as a miscellaneous itemized deduction. This means if you were an employee and worked from home (had a home office) the related home office expenses were deductible.
One result of the Tax Cuts and Jobs Act is these deductions have been suspended for tax years 2018 through 2025. This means the home office tax deduction for taxpayers will not be available until 2025 assuming no retroactive changes are made to the tax regulations for 2020.
W-2 Employees – Federal Tax Implications of Working from Home Due to the Coronavirus
Following the TCJA, W-2 employees lost the ability to deduct home office expenses. Prior to the Tax Cuts Jobs Act, W-2 employees could itemize their deductions for unreimbursed business expenses if it exceeded 2% of gross income. This included the cost of maintaining a home office.
Under the current tax laws, there are three possible income tax return implications if you are a W-2 employee.
Your Employer Purchased Home Office Items and Gave Them to You
If your employer purchased materials for you, for example a laptop computer, desk, or chair, this purchase is of employer-owner materials. As a result, this is only a deductible expense for your employer. Assuming this equipment was provided for non-compensatory business reasons (which means it is still technically the businesses property) you will not pay any taxes on these items. This includes items that you may also use for personal use – such as a cellphone or computer.
You Purchased Home Office Items and Your Employer Did Not Reimburse Your Expenses
Unfortunately for employees, this situation does not provide any tax benefits. If you purchase needed supplies or equipment but do not expect to be reimbursed there are no federal tax benefits. Prior to the Tax Cuts and Jobs Act you would be able to deduct any expenses that exceed 2% of your income but this rule will not become active again until tax year 2026. TCJA suspended this deduction for tax years 2018 through 2025.
You Purchased Home Office Items and Your Employer Reimbursed the Expenses
If your employer is reimbursing you for home office expenses, they like have an “accountable plan”. An accountable plan is one where you submit expenses to them with a receipt and they reimburse the receipt amount. If your reimbursement is made through an accountable plan the reimbursement amount is not considered taxable income.
An accountable plan is a set of policies that clearly state what type of items qualify as a reimbursable expense when employees are not working in the office. If your employer does not have an accountable plan there is a high likelihood your reimbursement will be considered taxable income – although you typically retain ownership of the items purchased, even if you change jobs.
How Do You Know if the Employer Has an Accountable Reimbursement Plan?
An accountable plan follows the IRS regulations regarding reimbursements which means the reimbursements do not count as income.
There are several requirements for an accountable plan.
- The expenses must be business-related
- The employee expenses must be adequately accounted to the employer (receipts must be provided).
- Any excess reimbursement must be returned to the employer.
W-2 Employees – State Work from Home Tax Deductions and Tax Breaks
Every state has different tax laws, so it is always important to look at your specific state’s laws. While there is no longer a federal tax benefit for W-2 employees that work from home, there are some states which still allow for this type of deduction.
Several states provide a deduction for unreimbursed employee business expenses. Depending on the state, you may even be treated like freelancer or sole proprietor in terms what you can deduct. This can include rent, mortgage interest, and utility bills based on the space of your home office.
In these states your unreimbursed employee expenses must be itemized. This means the deduction must exceed your standard state deduction. Unfortunately, most people will not have enough reimbursed expenses to meet this threshold, but it is worth keeping track of your home office expenses just in case. The standard state deduction varies by state and it is likely less than the federal standard deduction.
The Potential Double-Taxation Quandary If You Work Remotely
Due to more W-2 employees working from home due to the coronavirus there have been a lot of questions about the potential issue of double taxation. If you work in one state but live in another there may be a tax liability in both states, but a tax credit is used to eliminate the potential for double taxation of your income.
Working from Home Due to COVID
If this is your first time working from home, then the impact of telecommuting may be at the forefront of your mind during tax season. The first step is determining if you meet the governments definition of a remote worker. A remote worker is employed by a business, but your official worksite is outside of the geographical location of the business. In this case, you may work for a company in one state but now that you are working from home, due to COVID precautions, you could be in another state.
The second step is determining whether this is a permanent or temporary situation. Fortunately for anyone who is working from home due to COVID restrictions, this is a temporary situation. As a result, you are not treated as a remote worker for tax purposes as long as it is expected that you will return to your normal worksite at some point.
Working Remotely as a Standard Practice
If you meet the government’s definition of a remote worker and are working from home, then you will file your personal income taxes in your state of residence. This is true if you are an independent contractor or a remote W-2 employee. It is important to check your state’s tax laws. A state where you have your primary residence can tax your worldwide income. A state you earn income in has a right to tax the income you earned in that state. A growing number of states have a tax credit to offset taxes paid in another state, but this is not true for all states. This is often referred to as a reciprocity agreement between states and is especially common for states that border one another.
Work from Home Tax Deduction for Independent Contractors or Self-Employed Individuals
If you work from home as an independent contract or self-employed individual then you can still benefit from the home office deduction. This deduction is calculated when filing taxes on Form 8829. The amount will typically flow through Schedule C to reduce your adjusted gross income. There are several steps to determining if you qualify for the deduction.
Do You Qualify for the Deduction?
You cannot deduct items directly related to your home, in total, but you can deduct expenses related to the business use of part of your home. To qualify for the deduction, you must use a portion of your home for at least one of the following:
- Exclusively and regularly as your principal place of business.
- Exclusively and regularly as a place where you meet patients, clients, or customers during the normal course of business.
- On a regular basis for certain storage uses (inventory).
- For rental use.
- As a daycare facility.
To simplify most situations the question is whether space is used “exclusively” and “regularly” for business purposes. Exclusive use mean you have a specific area of your home that is only used for your trade or business. Fortunately, this does not have to be an entirely separate room – just a dedicated space.
Determining regular use can be a bit trickier. To qualify under the regular use test, the IRS states you must “use a specific area of your home for business on a regular basis”. There is not a bright-line test as to what is or is not regular use so your judgement and the judgement of the tax preparer should be considered.
Defining Your “Principal Place of Business”
It is possible to have more than one business location and still qualify for the home office deduction. The key is determining if your residence is considered your principal place of business. To determine this, the Internal Revenue Service provides the following guidance. You must consider:
- The relative importance of the activities performed at each place you conduct business
- The amount of time spent at each place
Your home office will qualify as your principal place of business if:
- You use it exclusively and regularly for administrative or management activities
- You do not have any other fixed location where you conduct substantial administrative or management activities.
Keep in mind this applies to both renters and homeowners.
What If You Have More Than One Business?
If you have more than one business that you run out of home, then you can use the same principals. This is common for many freelancers or sole proprietors. A benefit to keep in mind is that only one business needs to qualify for the home office deduction. If you have multiple businesses, you do not need to have a dedicated home office space that you use regularly and exclusively for your trade or business.
You can also combine the space for multiple businesses when determining your tax write off. For example, if you have a service based business and use your spare bedroom exclusively and regularly for business and you have a business that requires you to store inventory in a dedicated space in your garage or shed, both of those spaces can be combined when determining the “space” of your home office.
What Types of Expenses Could be a Tax Write Off?
The IRS categorizes home office expenses into three distinct categories: Direct, Indirect, and Unrelated.
Direct expenses are expenses only for the business part of your home. For example, repairing the floor of your home office or repainting the room your home office is in. These expenses are not “whole house” expenses but are directed specifically to your office space. If your home office is only a portion of a room then the direct expenses can be applied proportionally.
Indirect expenses are related expenses that keep the whole house up and running. They are deductible based on the percentage of your home used for business. This includes the most common home office deductions including insurance, utilities, and general repairs.
Unrelated expenses are only for the parts of your home not used for business. These expenses are not deductible. A common example of an unrelated expense is lawn care.
If you do not want to track your actual expenses, the IRS also has a simplified method (which calculates by square footage) of computing your tax deduction.
An Easy-to-Understand Recap
If you are a W-2 employee who is working from home due to the COVID pandemic there is no additional work from home tax benefits for you to take advantage of on the federal level (but possible on the state level – depending on your state). If you are a small business, freelancer or self-employed individual, then you receive the same home office deductions as in previous years. Consult with a CPA or tax professional if you have any questions or concerns.
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