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COVID-19: Work-at-Home Employees and the Home Office Deduction

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More taxpayers than ever before have transitioned to work-from-home arrangements during the COVID-19 pandemic. Does that make them eligible for a home office tax deduction? Probably not.

Miscellaneous Itemized Deductions – Suspended Due to Tax Cuts and Jobs Act (TCJA)

In an effort to pay for Trump’s tax cuts, the Tax Cuts and Jobs Act eliminated any miscellaneous itemized deductions subject to the 2% AGI floor. Prior to the TCJA, an employee could claim an itemized deduction for any unreimbursed employee business expenses, including home office expenditures, if the office was used for the convenience of the employer. This legislative change effectively barred the majority of taxpayers (anyone treated as an employee for tax purposes) from taking a home office deduction on their personal tax return, starting in tax year 2018.

Who Is Still Eligible to Claim a Home Office Deduction?

The home office deduction is still available to some self-employed taxpayers as the deduction is claimed as an unreimbursed business expense and reduces taxable income. Generally, a taxpayer is considered self-employed if they are a) an owner in an S-corporation, b) a partner in a partnership or member in an LLC taxed as a partnership, or c) carrying on a business as a sole proprietor, a one person owned LLC, or an independent contractor. However, owning a business will not guarantee that a taxpayer can claim this deduction; the treatment of unreimbursed business expenses differs based on the ownership and entity structure of a taxpayer’s business.

S-corporation shareholders cannot deduct unreimbursed business expenses, as corporate shareholders are categorized as employees when performing services for their business. Assuming these incurred expenses are not reimbursed by the corporation, they are considered miscellaneous itemized deductions subject to the 2% AGI floor – which, as specified above, are no longer available to taxpayers.

Partners in a partnership or members in an LLC taxed as a partnership receive more favorable treatment with regard to the home office deduction, in part because partnership income from trades or businesses is usually subject to self-employment tax. A taxpayer in this category can deduct expenses incurred on behalf of the partnership, but only if the partnership would not have allowed for reimbursement to the partner– in other words, if the partner paid the expenses out-of-pocket. If this criteria is met, the partner may be able to deduct expenses against the partnership’s income.

Self-employed individuals reporting income as a sole proprietorship or independent contractor are also eligible to deduct home office expenses, provided they meet the deductibility requirements detailed below.

Does My Home Office Qualify for a Deduction?

To claim a home office deduction as an unreimbursed business expense, a taxpayer must prove that their home office was used both “exclusively and regularly” for a “business purpose.” “Regular use” means the taxpayer must use the portion of the home in the business activity on a continuing basis. “Exclusive use” means the taxpayer must use a specific portion of the home only for business purposes – there can be no other use of the space.

“Business purpose” is further defined as “a principal place of business, or a place to meet with customers or clients.” The “principal place of business” test is what most taxpayers will need to consider in the context of COVID-19 and redefining personal residences as workspaces. The office must be used by the taxpayer to conduct administrative or management activities for the business, and there can be no other fixed location of the business where the taxpayer conducts these activities. If a self-employed taxpayer also has an office outside the home, the burden falls to the taxpayer to demonstrate that the work performed in their home office is exclusive to that office and there is no other fixed location where they conduct the same work responsibilities. If a company has completely shut its office doors due to “shelter in place” restrictions imposed by the government, there may be a case for a taxpayer to claim a home office deduction. However, it is important to consider the specific facts and circumstances related to temporary closures, partial re-openings, hybrid work schedules, etc. during 2020.

Should I Claim a Home Office Deduction?

The home office deduction is a very restrictive and difficult deduction to qualify for and the corresponding tax benefit is usually insignificant to a taxpayer’s return. This is because allowable expenses are divvied up based on a ratio of the home office square footage to the total square footage of the home, which usually results in a modest deduction for utilities, repairs, and insurance. A small percentage of the cost of the home is required to be expensed as depreciation under the home office deduction, but that depreciation must be recaptured (i.e. picked up as income) when the home is eventually sold. This rule is applicable even when the personal residence sale exclusion applies (allowing a married taxpayer to exclude up to $500,000 of gain on the sale of a personal residence ($250,000 for singles)). A portion of mortgage interest and property taxes is also allowable as a home office deduction, but if you itemize deductions, much of this is covered under other provisions of the law.

If you have questions about the application of this deduction on your 2020 tax return, please reach out to your tax professionals at Berntson Porter – we are happy to discuss the specifics of your situation.


     

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