In the face of the corona virus, just about everyone I know has been working from home for quite some time. Home can be Stateside or overseas. Many are now asking if they are entitled to take a tax deduction for their “home office”. Here’s everything you need to know.
The home office tax break was severely cut back with enactment of the Tax Cuts and Jobs Act of 2017 (TCJA). Under the current rules if the individual is an “employee” he or she is no longer able to benefit from the home office deduction at all, even if the work from home is carried out on a full time basis. A taxpayer must have self-employment income to benefit from the home office deduction under current law. “Self-employed” individuals (for example, free-lancers, sole proprietors) are able to deduct some home office expenses and this has been the case even before advent of the novel corona virus.
Despite the TCJA cutback, there may be a possible workaround for “employees” to obtain tax-free employer provided funds for costs associated with COVID-19 and working from home (among other things). This novel possibility is discussed in next week’s blog post.
Taking the home office deduction has been a red flag for the Internal Revenue Service (IRS) since it has been misused by many taxpayers. As such, claiming it has traditionally prompted the possibility of an audit. With the pandemic, this may be less likely since many individuals have lost jobs and are working as free-lancers or sole proprietors and many must work from home. Remember, a W-2 “employee” cannot qualify, COVID-19 notwithstanding.
Given the economic situation caused by COVID-19, many individuals will now start their own business and we can expect to see a surge in small businesses on the immediate horizon. Small business owners and self-employed individuals already know that each penny counts. This means leveraging every available opportunity including using the home office deduction if one qualifies.
In order to qualify to deduct expenses for business use of one’s home, the individual must use part of the home:
- Exclusively and regularly as the principal place of business; or
- Exclusively and regularly as a place where the individual meets or deals with patients, clients, or customers in the normal course of the individual’s trade or business; or
- In the case of a separate structure which is not attached to the home, in connection with the individual’s trade or business (not discussed in today’s post).
Let’s look more closely at these requirements. A helpful guide is IRS Publication 587, but remember, like so many other things announced or published by the IRS, it cannot be relied upon as authority.
Exclusive Use – To qualify under the “exclusive use” test, the individual must use a specific area of the home only for the individual’s your trade or business (exceptions apply for daycare facilities and for inventory/samples storage). The area used for business can be a room or other separately identifiable space. The space does not need to be marked off by a permanent partition (but I would suggest if not partitioned off, that some other demarcation boundaries be used, for example, by the placement of furniture). The requirement will not be met if the area in question is used both for business and for personal purposes. The IRS provides an example. “You are an attorney and use a den in your home to write legal briefs and prepare clients’ tax returns. Your family also uses the den for recreation. The den is not used exclusively in your trade or business, so you cannot claim a deduction for the business use of the den.” However, I would think it may be possible that this attorney could take a deduction for part of the den, if it was a “separately identifiable space” that clearly looked like a workspace and was not used for any other purposes (e.g., for a child to do his homework).
Regular Use – To qualify under the regular use test, a specific area of the home must be used for business on a regular basis. Incidental or occasional business use is not regular use. One must consider all facts and circumstances in determining whether the use is on a regular basis. The taxpayer should keep track of how much the home office is used by making simple notations on a calendar.
Trade or Business Use – To qualify under the trade-or-business-use test, part of the home must be used in connection with a “trade or business”. Trade or business is not defined in tax law, but generally means any activity carried on for the production of income from selling goods or performing services. It must be distinguished from a profit-seeking activity that is not a trade or business. For example, using a part of the home exclusively to follow the stock market and trade in one’s personal stock portfolio is not a trade or business, even though it is a profit-seeking activity. The case would be viewed differently if the individual were carrying out these activities in his/her role as a broker or a dealer working for the public at large.
Principal Place of Business – Determining what qualifies as the “principal place of business” gets tricky for someone who is carrying on business in multiple locations. The home office will qualify as the principal place of business if it is used exclusively and regularly for administrative or management activities of the trade or business and there is no other fixed location where substantial administrative or management activities of the trade or business are conducted. Thus, even if the individual does not spend the majority of work time in the home office, it can be considered the principal place of business if it is used regularly and exclusively for certain distinct activities that do not take place at any other fixed location. For example, a marketing agent who spends significant time outside the home office visiting clients might still qualify to take a home office deduction for the area in the home which is used regularly and exclusively for carrying out administrative activities (billing, arranging appointments, preparing records and reports). Overall, one must consider the relative importance of the various activities and where they are conducted.
Meeting Clients, Patients and Customers – If the individual physically meets with clients in the home office, but the principal place of business is elsewhere, the home office deduction may still be claimed if the use is “substantial and integral” to conducting the business. Sporadic / occasional meetings held in the home will not cut it. For example a self-employed architect who meets clients in her home office two days a week but works out of another office for three should qualify for a home office deduction, even though her other office might be considered her principal place of business.
Posted: June 11, 2020
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