Posted by Abundant Wealth Planning LLC

The Coronavirus & Home Office Deductions

The Coronavirus & Home Office Deductions

2020 was an extraordinary and challenging year. A Stanford University study found that around 40% of the U.S. workforce is now working full-time from home because of COVID-19. This has led several to question the effect this has on their taxes. Are you qualified for the home office deduction now? Does the CARES act account for this wave of remote workers? Does my state follow federal tax laws? In this piece, we tried to answer as many questions as possible.


Background

In 2017, the TCJA made drastic changes to federal income tax law. One notable change was the Home Office deduction. Before the TCJA, W-2 employees were eligible for a tax deduction for unreimbursed employee business expenses, including qualified home office expenses if they go with the itemized deductions, and meet up with the 2% adjusted gross income threshold for miscellaneous expenses.

With TCJA, miscellaneous expenses have been completely suspended. In other words, the number of taxpayers who could claim the home office deduction was restricted. W-2 employees are no longer eligible for a federal home office deduction, even if their employer requires them to work from home. In contrast, after the TCJA, qualifying home office expenses are only available to the self-employed or those interested in a partnership and use their home "regularly and exclusively" for business during the tax year.


Owners of Partnership Interest

According to the IRS, partnership fees are only deductible from the personal statement if the partnership agreement expressly provides that the partner must personally pay the expenses. Therefore, if you want to take a home office deduction relating to your partnership business, make sure that the partnership agreement has in writing stating that each partner must personally pay these expenses without reimbursement.


Calculating the Deduction

In general, household expenses should be classified as direct or indirect in calculating the deduction. There's also a simplified method that lets you calculate home office expenses.


Direct costs

Expenses directly attributable to the home office area, such as repair and maintenance costs incurred at the home office area, are fully deductible up to the company's income limit.


Indirect expenses

Indirect costs must be split between personal and commercial use and are also subject to commercial income restrictions. Some examples of indirect expenses include property taxes, rent, depreciation of a home you own, homeowners' association fees, utilities, and accident insurance premiums. A reasonable allocation method should be used. Although the most popular method is a ratio based on the square footage of the home office's versus the total home, the number of rooms used for personal versus business purposes was also allowed.


Business Income Limitation

The expense deduction for the home office is restricted to the business's gross income for which the home office is being used. This is called the limitation of business income. Limited deductions can be carried over to subsequent years.


Other important information

While the home office can offer a significant tax deduction, such a deduction can have a tax impact when you sell your home. When you use the home office deduction method, you will have to pay capital gains tax for office depreciation deductions, regardless of whether you have deducted depreciation each year. This is the annual deduction authorized for the annual deduction in value due to wear and tear on the part of the building that houses your office. These recaptured deductions are taxed at the rate of 25% (unless the level of income tax is less than 25%). The amount recaptured will not be taken into account, excluding the sale of your main residence.


Does your state allow Home Office Deduction?

Although employees cannot deduct home office expenses, state treatment may vary. The rules of each state and local jurisdiction regarding employee reimbursement costs should be reviewed, as the nature and allocation of the deduction may differ.

Pennsylvania allows certain deductions under the PA, Schedule UE program as unreimbursed business expenses. These expenses must be actual (not estimated), reasonable expenses necessary, a condition of employment (not a convenience), ordinary expenses directly related to the business, and which have not been reimbursed. Some examples of acceptable deductions are union fees, business license fees, and office expenses (primary place of work). Pennsylvania allows one of these allowable deductions for any compensation type and is not limited to self-employed workers.

Philadelphia has not followed the federal change under the TCJA, so all unreimbursed expenses are permitted as a deduction from compensation if the expenses are common, necessary, and reasonable. These expenses are authorized for any type of remuneration and are not limited to the self-employed. Philadelphia does not have its form for reporting these expenses, but it uses Pennsylvania's Schedule EU program to document allowable deductions. 

Without a doubt, the coronavirus pandemic has changed our lives and made remote working a norm for the near future. Speak to ABUNDANT WEALTH PLANNING, LLC. and they will determine how or if the home office deduction applies to you and your situation.


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