Home office deduction limited to self-employed

This article is part of a series of special reports appearing in the Sept. 14, 2020, edition of InvestmentNews.

Millions of Americans have been forced to work from home during the COVID-19 pandemic — including many financial advisers. But that doesn’t mean that they're eligible to claim a tax deduction for their home office.

If you're an employee, meaning a worker who receives a W-2 form from an employer, you cannot claim a home office deduction. Only self-employed workers and independent contractors can still claim a home office deduction as a Schedule C business expense.

To qualify as a deductible business expense, the home office must be the principal place of business or a place to meet clients. Most importantly, the taxpayer must use the home office exclusively for business.

In the past, it was possible for employees to claim a home office deduction if their employer required them to work from home. But the Tax Cut and Jobs Act of 2017 changed those rules.

“Before 2017, there was an itemized deduction available for unreimbursed employee expenses if you itemized, but the TCJA eliminated that,” said Mark Luscumbe, principal federal tax analyst at Wolters Kluwer Tax & Accounting. “As an employee, it is no longer possible to deduct unreimbursed expenses.” The 2017 tax law eliminated miscellaneous itemized deductions for 2018 through 2025.

The key is “unreimbursed” expenses. “Employees can still try to get their employers to reimburse their expenses,” Luscumbe said.

In fact, a few states require employers to reimburse their employees’ necessary out-of-pocket expenses as a result of their job duties. Those states include California, Illinois, Iowa, Massachusetts, Montana, New Hampshire, New York, Pennsylvania, South Dakota and the District of Columbia.

There is also a state income tax issue that may catch some newly minted telecommuters by surprise if their employer is located in one state and they work from home in another state.

In normal times, employees who telecommute from a home office on a regular basis create a business connection, known as a “nexus,” for their employer. As a result, the states where the employees perform the work can tax that income even if the business is based elsewhere.

“Several states have announced that their normal nexus rules for taxation will not change the taxation of an employee temporarily working remotely due to the COVID-19 pandemic,” Luscombe said.

Those states include Alabama, Georgia, Indiana, Iowa, Maryland, Massachusetts, Minnesota, Mississippi, New Jersey, North Dakota, Pennsylvania, Rhode Island, South Carolina, Vermont and the District of Columbia.

New York is a notable exception. New York-based businesses must withhold state income taxes on the wages of out-of-state workers. In those cases, employees will have to file two state income tax returns next year: one to document taxes paid in New York, where their employer is based, and the other to claim a tax credit in the state where they live.

More articles from the special issue:

Is working from home the new normal? — Jeff Benjamin

How advisers can use tech to attract assets — Nicole Casperson

Keeping an eye on chats — Bruce Kelly

Enforcement, arbitration proceedings move online — Mark Schoeff Jr.

Pandemic's financial, emotional toll prompts early retirements — Emile Hallez

The digital shift is here — and it’s uncomfortable — Sean Allocca

10 unexpected ways COVID-19 is changing wealth management — Brittney Grimes