WORKING AT HOME? HERE’S WHAT YOU NEED TO KNOW

In response to the COVID-19 pandemic many individuals are now working at home.  Here are some important things to understand if you are one of these individuals.

* Just because you are working from home does not make you “self-employed”.  If you have been a W-2 employee and you are working at home, either for your personal health or convenience or because your regular office is closed and your employer requires you to work at home, you will continue to be a W-2 employee.

* An employee receiving a W-2 cannot deduct any unreimbursed out of pocket “employee business expenses” anywhere on their federal Form 1040.  This includes the allocated expenses of a home office.  New York does still allow the deduction of employee business expense, subject to the 2% of AGI exclusion, if you itemize on your NY state income tax return.

* You cannot be both an employee and a self-employed sub-contractor for the same employer/company if you are doing the exact same work.  You cannot legally receive both a W-2 and a 1099-NEC from the same employer/company for doing the exact same job.

* The exclusive-area and exclusive-use requirements for a deductible home office for self-employed sub-contractors still apply.

* A self-employed sub-contractor receiving a Form 1099-NEC is not eligible for any employee benefits such as employer-provided health or life insurance, employer contributions to a retirement plan or HSA, or accrued sick or vacation pay. 

* A self-employed sub-contractor receiving a 1099-NEC must pay both halves of the applicable FICA (Social Security and Medicare) tax.  A W-2 employee pays half and the employer pays half. 

* A self-employed sub-contractor cannot collect state unemployment benefits under “normal” circumstances.

See my earlier post “Don’t Expect a Home Office Deduction for Employees on Your 2020Form 1040”.  

Any questions?

TTFN

DON’T EXPECT A HOME OFFICE DEDUCTION FOR EMPLOYEES ON THE 2020 FORM 1040

A post to an email tax preparer group asked -

“Do you guys think the Government will give all these work from home W2 workers a home office deduction this year?”

My answer is NO.

Assuming that the home office in question would qualify – taking into consideration the “exclusive use” rule – why should it be allowed?  It does not cost an employee who temporarily works from home due to his "normal" office being closed anything to so do.  He, or she, does not incur any “out of pocket” expense – other than perhaps a slight increase in the electric bill.

To be perfectly honest, an employee forced to work at home is actually saving money – i.e. no commuting costs, eating lunch at home every day, and perhaps reduced dry cleaning bills for work clothing.

The traditional home office deduction for a self-employed person – remember that the home office deduction for an employee is an employee business expense and employee business expenses are no longer deductible on Schedule A – applies a percentage of all home expenses, including property taxes, acquisition debt mortgage, homeowners insurance, utilities, security, and depreciation, based on the size of the office.

These costs for an employee forced to temporarily work at home, except perhaps utilities, do not change or increase because he or she is working at home.  The mortgage payment, the insurance premium, and the home security bill are the same as they would be if the employee did not work at home.

An employee who works at home may incur additional costs for software or computer upgrades, but these expenses can, and should, be reimbursed by the employer under an “accountable plan”.

This is obviously just my opinion on the issue.  It is possible that Congress will allow some kind of modified home office deduction in certain situations, regardless of how stupid and unnecessary it is.  Congress has been known to do stupid and unnecessary things in the past.

So, what do you think?

TTFN

MORE ON THE NEW “SAFE HARBOR” HOME OFFICE DEDUCTION

The lead article of the April 2013 issue of the National Association of Tax Professionals’ TAX PRO MONTHLY discusses the details of the new “safe harbor” home office deduction, which is in effect for tax year 2013.

This new option allows taxpayers with a qualified home office to deduct $5.00 per square foot, up to a maximum of $1,500 (therefore the maximum allowable area of the home office is 300 square feet), instead of using actual expenses.

Normally one would determine the square footage of the home office and divide it by the total square footage of the home to come up with a business use percentage.  The total costs of the home – real estate taxes, mortgage interest (on money borrowed to build, buy or substantially improve the home), homeowners and flood insurance, utilities (gas and electric, heating oil, water), alarm system, etc. – are added up and multiplied by this business use percentage.  Depreciation is also allowed on the home office area.  

This new “safe harbor” deduction is an option – not a requirement.  It is similar to the standard mileage allowance, which can be claimed instead of the business use percentage of the actual costs of operating a car.  However the choice is less restrictive than that of electing to use the standard mileage allowance.  As the article points out, “Taxpayers may switch from the safe harbor method to actual expenses from year to year as they wish”.

This new option does not simplify the calculation of the home office deduction.  It actually makes it more complicated by adding another step to the process.  One of the major rules of tax preparation, which I point out in "My Best Tax Advice", is – “If you find yourself faced with choices you should review each option and do separate tax calculations to see which one will result in the lowest tax”.

You must calculate the home office deduction under the “normal” method, using actual expenses, and compare this to what you are allowed under the “safe harbor” method.

The article explains that “Taxpayers using the safe harbor method may deduct 100% of mortgage interest and real estate taxes on Schedule A”.  So the safe harbor deduction does not include the business use percentage of real estate taxes and mortgage interest.  When making your comparison do not include real estate taxes and mortgage interest in the calculation of actual expenses.

For a self-employed taxpayer filing a Schedule C, the safe harbor home office deduction cannot exceed the net income, after expenses, of the business activity.  This is also true of the deduction for actual expenses, with one exception. 

There is a hierarchy of deductions when the actual expense method is calculated on IRS Form 8829.  One first deducts the business use percentage of real estate taxes and mortgage interest.  If there is any net business income left over, after deductions the appropriate amount of taxes and interest, you can deduct the business use percentage of “other expenses”, such as insurance, utilities, security, etc., up to the remaining net business income.  If there is net income left over after deducting “other expenses” you can claim depreciation, again up to the remaining net business income. 

A Schedule C filer can deduct the business use percentage of real estate taxes and mortgage interest in full, regardless of the net business income.  So a home office deduction can create a negative Schedule C.

If the net business income before the home office deduction is $1,000, and the business use percentage of real estate taxes and mortgage interest is $1,500, the Schedule C shows a net loss of $500, which is carried over to Page 1 of Form 1040.

One of the advantages of this is that it moves a portion of the deduction for real estate taxes and mortgage interest from Schedule A to Page 1 of the 1040 – from “below the line” to “above the line” – and reduces Adjusted Gross Income.  As we all know by now, there are a multitude of deductions, credits and exclusions that are affected by AGI, and reducing AGI can result in increasing, or allowing, deductions and/or credits, and reducing tax liability.

When comparing the tax benefit of the two home office deduction options you must take this into consideration.  While the safe harbor method may produce the greater overall tax deduction, using the actual expenses may provide the greater tax benefit due to the reduction of AGI.

There is another disadvantage to the safe harbor deduction when the allowable deduction exceeds net business income.  The NATP item tells us, “Any taxpayer using the safe harbor method may not carry over any disallowed safe harbor deductions to the next year”.

When a taxpayer claims actual expenses on Form 8829 any of the unused “other expenses” or depreciation, not allowed because they exceed net business income, can be carried over to future years.

You have a bad year in 2013, and your home office deduction is more than your net business income.  But you expect substantially increased income in 2014, and the carryover of unused other expenses and depreciation will reduce your income tax, and your self-employment tax, in 2014.  You should use actual expenses instead of the safe harbor for 2013.

One advantage of the safe harbor deduction, if it provides the greater overall tax savings, is that it does not include depreciation.  In a year when the safe harbor method is used “the depreciation deduction allowable for that portion of the home for that taxable year is deemed to be zero”.  So you do not increase the amount of depreciation that must be recaptured when you sell the home.  However you should still include depreciation in the calculation of actual expenses when you are comparing methods.

If you elect the safe harbor option and the home office applies to only part of the year, for example you start the business in April, the $5.00 per square foot/$1,500 maximum must be pro-rated based on the number of full months of business use during the year (15 or more days of use = a full month).

TTFN

THE RETURN OF A HOME OFFICE STANDARD DEDUCTION

Here is something that is new for 2013 returns - “Helping Small Business Owners and Home-Based Employees Claim the Home Office Tax Deduction”, explained by Deputy Secretary Neal S. Wolin and SBA Administrator Karen G. Mills. 

“The new option allows qualified taxpayers to deduct annually $5 per square foot of home office space on up to 300 square feet, for as much as $1,500 in deductions.  To take advantage of the new option, taxpayers will complete a much simpler version of the current 43-line form.

The new option for the home office deduction will be available starting with the Tax Year 2013 return, which most taxpayers file early in 2014.

Current restrictions on claiming the home office deduction, such as the requirement that a home office be used regularly and exclusively for business and the limit on the amount of the deduction tied to income derived from the particular business, still apply under the new option.”

Be aware that this option is NOT available for 2012 returns.

I commented on this when the idea was first proposed by National Taxpayer Advocate Nina Olsen a few years ago in my post “A Home Office Standard Deduction”.

My thoughts on this new option are along the same lines as those of Russ Fox, as outlined in his TAXABLE TALK post “Is A Simplified Home Office Deduction Better?” –

I looked at all of my clients who filed this form, and the simplified procedure would have cost every one of them money. Perhaps that’s because of my client base, but I don’t think so. Most taxpayers taking the home office deduction do keep good records, so the recordkeeping isn’t that big of a deal. After all, these are small business owners who have to keep good records anyway (or are supposed to). The reality is that $5 per square foot understates the cost of most home offices, especially when factoring in depreciation.

Simple in this case does not necessarily mean better.

As this is an option, taxpayers who qualify for a home office deduction in 2013 should calculate the deduction using both actual expenses and the optional method and choose the option that provides the bigger deduction.

One question – how will using the standard deduction option affect the Schedule A deduction for real estate taxes and mortgage interest (since these items are a component of the home office deduction)?

TTFN