Deduct Work Expenses When Working From Home

The timing could not have been worse for remote workers. The Tax Cuts and Jobs Act of 2017 nixed the deduction for work from home expenses and other unreimbursed employee business expenses. 

Prior to the TCJA it wasn’t the best deduction in the world either. You had to itemize to get the deduction and it was combined with several other deductions and then reduced by 2% of your adjusted gross income. But it was at least available and with some planning could provide modest tax relief.

Self-employed people can still deduct these expenses on their or Schedule C. Same for farmers (Schedule F) and income property owners (Schedule E). 

For employees, the deduction is now gone, unless you know the rules. With proper planning you can benefit by working from home, getting a tax benefit for work related expenses. The home office, the pro-rata share of utilities, insurance, property taxes and/or rent and mortgage interest can get tax-free treatment. Same for office supplies and equipment. And don’t forget business travel expenses.

Working from home has plenty of benefits: no office politics, no fighting traffic and every day is casual day. The downside is you have expenses at home that can’t be deducted on your tax return. We are going to fix that right now.

 

 

Deducting Work From Home Expenses

Just because work expenses are not deductible on your tax return doesn’t mean they aren’t deductible on somebody else’s return. Yes, I am talking about your employer. 

It’s called an accountable plan and they are easy to set up and maintain. It requires your employer’s cooperation, but when the employer sees how much they will save in taxes they will want to be on board. (Send them to this article, if necessary. Accountable plans are a win/win with an IRS blessing.)

An accountable plan is where the employer reimburses the employee for work related expenses. The employer then takes the deduction and the employee is not allowed to deduct the expense, something employees can no longer do anyway.

There are three requirements to an accountable plan under IRC §62(c):

  1. Business connection: The expense must be an actual job related expense; personal expenses are not allowed.
  2. Substantiation: Within a reasonable period of time the employee must provide receipts or other documentation substantiating the expense.
  3. Return of excess reimbursement: If the employer provided an advance or over-reimburses the employee, the employee must return the excess within a reasonable time. Money not returned is added to the W-2 wage.

Now we need to determine what a reasonable period of time is. Here is what the IRS considers reasonable:

  1. The employer can reimburse the employee when receipts or other documentation is provided. 
  2. The employee can receive funds up to 30 days in advance. This means the employer can provide an advance on the first of the month for expected expenses for that month. This can be a flat stipend with accounting afterwards to determine if the employee had more qualified expenses for reimbursement or owes the employer a refund for an excess advance.
  3. The employee has 60 days from the time the expense was incurred or was paid to make an account with the employer. This means the employee needs to submit expenses to the employer for reimbursement within 60 days or, in the case of an advance, provide an accurate account of the work related expenses.
  4. Excess reimbursements must be returned to the employer within 120 days of the expense being paid or incurred.
  5. The employer needs to provide a quarterly statement at minimum tallying the advances, and receipts and other documentation submitted. The employer needs to ask the employee to return any excess advance not covered by qualified expenses. The employee has 120 days from the statement date to comply. If more qualified expenses were submitted than the advance the employer can reimburse the employee at the time of the statement or the employer’s choosing.
Deduct work expenses.

The rules for an accountable plan are straight forward and simple. Follow the rules and get something even better than deducting work related expenses.

Qualified Work Expenses

Not every expense is straight forward. For example, it is easy for an employer to understand a reimbursement for office supplies; the employee turns in receipts for paper and printer toner and the employer reimburses the employee. 

Other expenses have options. Actual expenses can be used, but per diems and safe harbors also exist for easier recordkeeping.

The home office is a good example. The employee can be reimbursed for a pro-rata share of their home expenses (insurance, property tax or rent, utilities, internet, repairs and maintenance and mortgage interest to name the most common). If the home office is a 10×10 room (100 square feet) and the entire home is 2,000 square feet, 5% of the home expenses can be reimbursed. Or, you can use an annual per diem which is $5 per square foot up to a maximum of 300 square feet. The maximum annual home office per diem is $1,500. 

Travel is another area where actual expenses are not required:

  1. Instead of actual expenses for auto travel you can take the standard mileage rate. The standard mileage rate is the simplest method when it comes to autos and trucks; a mileage log (with details on the business purpose of the miles) is all you need. Under actual expense a mileage log is still required, plus, all expenses related to the vehicle (gas, oil, repairs, insurance…). Then you only get the business percent of all miles for reimbursement. Actual expense might get a bigger deduction, but with a bigger recordkeeping headache. You and your employer can decide.
  2. Business travel is a recordkeeping nightmare. The IRS makes it easier by providing per diems for meals and incidentals and lodging. (Self-employed persons cannot use the per diem for lodging; only meals and incidentals.) The per diem means you only need to provide documentation for the days traveling. The employer provides a reimbursement up to the per diem and the employee does not record the reimbursement as income, even if the reimbursement exceeds the actual expense. The GSA has a handy tool for determining how much the per diem is for each area of the U.S. Travel expenses under $75 do not require a receipt for deduction/reimbursement (except for lodging). A record is required stating the time, place and business purpose of the expense. (Note: You are allowed the per diem “or” actual expense per business trip. You are not locked into one method for the entire year.)
  3. Meal expenses also have easier recordkeeping rules, even when not traveling. Meals under $75 do not require a receipt. A record of time, place and business purpose of the meal is required. Note: Home office snacks or meals on your own are not a deductible or reimbursable business expense. 

Any employer can reimburse all employees for work related expenses, not just remote workers. Uniform expenses (purchase, laundering, mending), work shoes or tools, for example, can also be reimbursed, even for employees working on the employer’s site.

Remote workers home office deduction.

Remote workers still have tax benefits after the loss of home office deductions.

Tax Benefits for the Employee and the Employer

The tax benefits to the employee are obvious. Previously nondeductible expenses are now reimbursed so the employee has no out of pocket expense. (The employer can choose to partially reimburse, as well. It’s not an all or none game.)

The employer usually gets a full deduction for the expenses and employee retention is higher when employees are not out money for work-related expenses. 

Then come the big tax advantages for both parties. 

 

Trading Wages for Reimbursements

I can see the wheels turning in your head. Wouldn’t it be easier to swap out wages for reimbursements? The IRS thought of that too and said “No!” in Revenue Ruling 2012-25

While an employer can’t reclassify wages or salary as a reimbursement, it doesn’t mean a reasonable compromise isn’t possible that saves all parties involved some tax dollars. 

Let’s say John works for XYZ Inc. His annual salary is $100,000. John works from his home office and has some typical expenses related to his work. If John’s employer will provide a $95,000 salary with work related expenses reimbursed (assuming John has over $5,000 in work related expenses each year), it might be a better deal for John than the higher $100,000 salary since John will pay income and FICA taxes on $5,000 less. The employer also saves the employer’s portion of the FICA tax, paying the tax on the $5,000 lower salary. Everyone wins!

You can offer one salary without reimbursement of work expenses and another salary with reimbursement as long as it isn’t a dollar for dollar exchange. Wages and salaries cannot be reclassified as a reimbursement!

 

One Last Tax Tip: Rent Your Home Office to Your Employer

If all else fails there is one more option. Employers don’t always want to reimburse mortgage interest expenses and so forth. The open ended nature of home office expenses can also scare an employer when it comes to reimbursement. 

If your employer has these concerns or is uninterested in an accountable plan, offer to rent your home office to them. (“Hey, I get paid when I rent my property to someone, Mister Employer!”) The rent must be reasonable. If your home office garners a $500 per month rent, then the employer should pay $500 rent per month for use of your property. 

Rent received is taxable income and reported on Schedule E. And expenses related to your rental are deductible! Keep in mind, only the expenses related to the office count in this instance (pro-rata share of utilities, insurance…); office supplies still require an accountable plan.

 

Things have changed ever since the pandemic arrived. Remote workers were a growing category before the pandemic, but world events pushed remote employment into overdrive. That doesn’t have to be a bad thing leading to a pay cut due to unreimbursed work expenses. Now you have a plan, and the tools, to solve the problem and move forward.

 

 

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Keith Taxguy

4 Comments

  1. Barron Rau on October 29, 2020 at 6:50 pm

    Doesn’t Section 280A(c)(6) specifically prohibit renting a home office to one’s employer?

    • Keith Taxguy on October 30, 2020 at 7:38 am

      Quite the opposite, Barron. It prohibits deducting personal expenses which is always the case. Here is an article focused on just this topic vs my more inclusive post. Be sure to read the first point under Potential Obstacles within IRC 280A in the linked article.

      This idea you can’t rent to your employer has been around for a while and is inaccurate. Can you imagine the yelling if the government actually passed allow forcing you to give your employer part of your home without compensation? In reality, rent income from your employer for a home office is reportable income on Schedule E with deductions related to the rental allowed. Personal expenses are not allowed, and as I stated in this post, you can’t divert unreimbursed employee business expenses to the office rental.

  2. Luke on October 30, 2020 at 8:47 am

    We have a consulting business LLC (taxed as an s-corp) with my wife as the sole employee. For the home office expense reimbursement that you mentioned, we previously were just accountable plan and reimbursing ourselves the pro-rata share of the home expenses. The office is 104 sq feet, or 3.8% of the house. In your example, you mentioned an annual per diem as an alternative. So in our case, that the max annual home office per diem would be $5/sq foot on 104 square feet, correct? Just trying to weigh which option would be most beneficial here.

    • Keith Taxguy on October 30, 2020 at 9:08 am

      Luke, The IRS alternative to actual expenses for a home office is $5 per square foot up to 300 square feet maximum per annum. You can use either the alternative safe harbor or actual expense. You can alternate each method between years as well. If you use the safe harbor you are still allowed to claim the property taxes and mortgage interest without adjustment for the home office (Schedule A adjustments may apply). In your example you can reimburse $504 per annum without additional documentation.

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