2020 was a challenging year that drastically impacted the traditional American business environment.
A Stanford University study found that roughly 40 percent of the U.S. workforce now works from home full time due to COVID-19. This has led many to question the effect this could have on their taxes.
Do you now qualify for the home office deduction? Did the CARES Act account for this wave of remote workers? Does my state follow the federal tax law?
In 2017, the Tax Cuts and Jobs Act (TCJA) brought sweeping changes to the federal income tax law. One notable change was to the home office deduction. Prior to TCJA, W-2 employees could potentially receive a tax deduction for unreimbursed employee business expenses, including qualified home office expenses, if they itemized their deductions and met the two percent (2%) adjusted gross income (AGI) threshold for miscellaneous expenses.
Under TCJA, miscellaneous expenses were suspended completely. In other words, the number of taxpayers that could benefit from the home office deduction was severely restricted. W-2 employees can no longer benefit from a federal home office deduction, even if their employer requires them to work from home.
Instead, post-TCJA, qualified home office expenses are available only for self-employed individuals or those who own partnership interests and use their home “regularly and exclusively” for business during the tax year.
Unfortunately, there have been no revisions to the TCJA home office rules included in the 2020 CARES Act or the 2021 Consolidated Appropriations Act.
OWNERS OF PARTNERSHIP INTERESTS
According to the IRS, partnership expenses are only deductible on a personal return if the partnership agreement expressly states that the partner must pay the expenses personally. Therefore, if you wish to take a home office deduction related to your partnership activity, be sure that your partnership agreement includes language stating that each partner must pay for these expenses personally without reimbursement.
Such language includes the following:
▪ Expenses that are directly allocable to the home office area — for example, repair and maintenance costs made in the home office — are fully deductible up to the business income limitation;
▪ Indirect expenses need to be allocated between personal and business use and are also subject to the business income limitation. Some examples of common indirect expenses include property taxes, rent, depreciation on a home you own, homeowner association fees, utilities and casualty insurance premiums. A reasonable method of allocation must be used. While a ratio based on the square footage of the home office vs. the total home is the most common method, the number of rooms used for personal vs. business use has also been allowed; and
▪ The home office expense deduction is limited to the gross income generated by the activity the home office is used for. This is known as the business income limitation. Deductions that are limited can be carried forward in subsequent years.
Though the pandemic seems to be subsiding and life for many has begun to go back to a version of the normal we are used to, working from home is likely to continue as many corporations make the shift to accommodate this interest.
Being aware of the latest IRS-allowed deductions will be important for employees this year, so consulting a tax professional for further guidance is always advisable.
Cesar Ravan, CPA, is managing partner at Ravan + Co., a certified public accounting firm. He can be reached at 786-574-2367 or firstname.lastname@example.org