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How does Working from Home Affect your 2020 Taxes?

 

By Albina Demollari

 

 

In the shadow of COVID-19 pandemic, working from home has become the current reality. Millions of people are adjusting their living space to make it more appropriate for working from home. They are using their home for earning W2 income, for their small business operations, for freelancing, and for online schooling. Based on projections and thousands of work-from-home jobs available on the search engines, this may be the permanent post-COVID reality. In the light of recent developments, naturally, a question arises: Will people working from home be able to deduct their home office expenses in their 2020 taxes?

 

The answer is ‘Yes and No’, depending on the following:

 

When you work from home for an employer, you are not eligible for home office deduction. In other words, as an employee, you may not be able to claim federal income tax deduction for home office expenses. According to the IRS “Employees who receive a paycheck or a W2 exclusively from an employer are not eligible for the deduction, even if they are currently working from home”(IRS, Publication 587 (2020), Business Use of Your Home, for use in preparing 2020 Returns).

 

When you work from home as a sole proprietor, independent contractor, freelancer or gig worker, you are eligible for home office deduction. Under the Tax Cuts and Jobs Act for tax year 2018 through 2025, only self-employed, individual contractors, gig workers, and freelancers can deduct qualifying home office expenses. However, even if you are self-employed, you must meet the following requirements to be able to claim the home office deduction:

 

• Exclusive Use

 

You may be able to deduct expenses for the portion of your home that you use exclusively for conducting your business. In other words, if you have a room converted into an office, a dedicated space, even a separate section or structure in your home, which you use only for your business activity, expenses related to that portion of your home are tax-deductible. In contrast, you cannot deduct expenses related to any area in your home that you use both for your business and for personal purposes. For example, if you work from a living room or kitchen table, or an area that other family members use, the home office expenses are not tax-deductible.

 

• Regular Use

 

To qualify to deduct home office expenses, you must use a portion of your home for business on a regular basis. Incidental or occasional business use of your home does not qualify you to deduct the home office expenses. If you use your home for occasional meetings and phone calls, for example, you are not qualified to deduct expenses for the business use of your home.

 

• Principal Place of Business

 

To qualify to deduct home office expenses, your home office must be your principal location of your business. It should be an actual office, where you exclusively and regularly meet or deal with patients, clients, customers, or where you conduct “substantial administrative or management business activities” (IRS.gov/Pub587), such as calling customers, ordering supplies, or keeping records. In contrast, if you have a fixed location outside your home for conducting your substantial administrative or management business activities but you work from home just for convenience, you may not be able to claim your tax deduction.

 

                                                                                   

 

Also, you do not necessarily need to own your home to claim your home office deduction. Even when you rent your home, you can deduct home office expenses, including a percentage of the rent.

 

Moreover, when you work full-time for an employer but also own a part-time or side business, though you spend a few hours in your home office, you may be eligible to claim the deduction, as long as you meet the requirements set by the IRS.

 

Which expenses can you deduct for business use of your home?

 

As a self-employed, qualifying to deduct home office expenses makes you eligible to deduct direct expenses and indirect expenses.

 

• Direct Expenses

 

Direct expenses are expenses only for the business portion of your home. They are fully deductible. An example may be expenses related to repairing or painting only the portion of your home used for business, or expenses for a telephone line that you use only for business purposes. In this case, you can deduct 100% of these expenses.

 

• Indirect Expenses

 

Indirect expenses are expenses for keeping up and running your home. They can be deducted proportionally, based on the percentage of your home used for business. They are calculated according to the percentage of the office square footage compared to the total square footage of the home. For example, if your home is 2000 square feet and your home office is 200 square feet, your office space is 10% of the total area of your home. In this case, you can deduct 10% of your indirect expenses.  

 

Indirect expenses include:

 

• Mortgage interest
• Property taxes
• Homeowners insurance
• Utilities and services
• Repairs
• Home depreciation
• Security system

 

How can you calculate the deduction for the business use of your home?

 

You can calculate the deduction for the business use of your home in two ways:

 

• Using Actual-Expense Method

 

Using the actual-expense method, the home office deduction is calculated based on the actual expenses related to the business use of the home. You can use this method to deduct your direct expenses in full and indirect expenses proportionally, based on the percentage of your home used for business, as explained above. This method is the most complex one. It requires keeping well-organized records of your expenses, as evidence, usually for 3 years from the date you filed the return, to be able to provide answers in case of an IRS audit. However, with this method, you can calculate the exact amount of your home office deduction and as a result, you can get a larger tax deduction.  

 

• Using Simplified Method

 

 “The simplified method is an alternative to the calculation, allocation, and substantiation of actual expenses.” (IRS.gov/Pub587). With the simplified method, you can deduct $5 per square foot of your home office, up to a maximum of $300 square feet. For example, if your home office is 200 square feet, then the deduction would be $1000 ($200 x $5). Since the deduction is capped at $1,500 per year, if you have a larger home office space, the simplified method may produce a lower tax deduction. However, if you are not good at record keeping and lack the documents to prove the expenses in case of an IRS audit, then you may calculate the home office expenses with the simplified method, as it is the easiest one and does not require you to keep records of your expenses.

 

The Bottom Line

 

As of right now, W-2 employees working from home are not eligible to claim the home office deduction. Meanwhile, they are paying out of their pockets for setting up home offices, for desks, supplies, equipment, and internet fees, so that they can do their job effectively. As no federal tax benefits exist, if you are an employee working from home, make sure your employer reimburses the home office expenses to you, otherwise you will end up paying out of pocket.

 

On the other hand, self-employed are eligible to claim the home office deduction. If you are a self-employed, before claiming the home office deduction, make sure you meet the requirements set by the IRS, otherwise you will face penalties.

 

Claiming home office deduction is considered a complex tax situation; however, with due diligence, it can lower your business costs substantially, reduce the total amount you owe in federal taxes, or increase your tax refund from the IRS.

 

Given the upsurge in working from home full-time, this current reality may be transformed into a permanent reality, triggering changes to legislation. However, as things stand right now, only self-employed home office expenses are tax deductible.

 

About the author: Albina Demollari is the Founder of LifeUs Consulting. She helps people make smart financial decisions. This article is intended to provide general information and is based on IRS publications. For more information and exceptions on this topic, see Irs.gov/Pub587. The views expressed are as of the date indicated and the opinions provided are those of the author. The article does not give personalized tax, legal or other professional advice. Before taking any action, you should seek the assistance of a professional, who knows your particular situation.