As taxpayers are preparing their 2020 income tax returns, several will face questions related to remote working. Can they deduct employment related expenses for new furniture, new equipment, and other items to facilitate working remotely? Can they take a home office deduction? In what state(s) should they file income tax returns? These questions are nothing new. However, the volume of taxpayers facing these issues certainly will be at an all-time high for the 2020 tax filing season.
Employment Related Expenses
While working from home, many people have incurred costs to better accommodate their work needs. This may consist of new furniture or equipment such as a work desk, printer, network device, and other items. The turning point of whether these items are deductible primarily turns on whether the taxpayer is an employee or self-employed (including as an independent contractor).
Traditionally, employees have qualified to deduct unreimbursed business expenses to the extent those expenses exceeded 2% of their adjusted gross income.[1] These expenses would be taken as personal expenses on Schedule A of their personal income tax return. However, the Tax Cots and Jobs Act of 2017 eliminated these miscellaneous itemized deductions for tax years starting in 2018.[2] As a result, for employees, the ability to deduct these expenses is not available for the 2020 tax year.[3] Employers may provide tax-free reimbursement of some of these expenses through an accountable plan[4] or making qualified disaster relief payments.[5] However, to the extent the expenses are not reimbursed, they will not be deductible for an employee.
Self-employed individuals (including independent contractors) can obtain more favorable treatment than employees in this regard. A full description of determining “trade or business” status, what constitutes “ordinary and necessary,” or capitalized expenses is beyond the scope of this article. However, at a basic level, a self-employed individual who is carrying on a trade or business[6] qualifies to deduct “ordinary and necessary” business expenses under IRC § 162. An ordinary expense is one which is customary or usual in a particular trade, industry, or community.[7] A necessary expense is one that is appropriate and helpful, rather than actually necessary or essential.[8] Typically, a taxpayer’s judgment as to what is necessary will be accepted.[9] Due to these broadly defined terms and deference to a taxpayer’s judgment, it is expected that self-employed individuals should broadly be granted deductions from expenses related to remote working understanding that certain expenses may be subject to capitalization, depreciation, or amortization.
Home Office Deduction
Like other expenses, the home office deduction is only available to self-employed individuals. This does not mean that a taxpayer who is an employee will not qualify for the home office deduction, but the deduction must relate to a separate activity that rises to the level of constituting a “trade or business.”[10] For self-employed individuals who have dedicated a portion of their home into a remote office location, the home office deduction may be available.
Generally, a home office deduction is available if the home office meets any of the following criteria:[11]
- Constitutes the principal place of business for any trade or business of the taxpayer;
- Is a place of business to meet or deal with patients, clients, or customers in the normal course of business; or
- In the case of a separate structure not attached to the dwelling unit, is used in connection with the taxpayer’s trade or business.
In the context of the current pandemic, it is expected that most taxpayers will look to meet the test as the “principal place of business” which requires that the home office not be a secondary business location and, when there is more than one business location the principal place of business must be determined.[12] The home office must be “exclusively used on a regular basis”[13] for the qualifying business purpose. There must be “no use of that portion of the unit at any time during the taxable year other than for business purposes.”[14] As a result, for example, using the dining room table as a home office will not allow the space to qualify for a home office deduction.
If the requirements are met, then typically deductible expenses include mortgage interest, insurance, utilities, repairs, maintenance, depreciation, and rent (typically the ratable portion of the home used for qualifying business purposes). Beyond the scope of this writing, but important, is that there are reporting obligations, reporting options, and other consequences to electing to deduct a part of the home. These consequences include reducing the value of the IRC § 121 exclusion for gains from the sale of a personal residence.[15] As such, before a taxpayer considers taking a home office deduction, other planning concerns should be considered.
State Income Tax Returns
Taxpayers who typically work in one state may have increased their time working in another state during the current pandemic. This includes taxpayers who live in one state but work in another while remote working, who moved in with family in other states during the pandemic, who are working from second or vacation homes, or any number of other arrangements where they may be working remotely in a different state than where they customarily provide services. There are several implications of these arrangements. Some are for the taxpayer, such as where their “tax home” is located for deducting travel expenses, what is their residence for mortgage interest deductions or §121 home sale exclusions, etc. Also, employers need to consider important tax issues involving withholding, nexus, and apportionment. Of course, beyond tax issues, there can be any number of other important consequences relating to state business registration, workers compensation, state employment laws, licensure, and the like.
One of the many important issues employees must consider is in which state, or in some cases states, to report their income. State income tax laws are widely varied. Some states have no income tax. Of the states with an income tax, how they tax that income and who is required to file in their state are different from state-to-state. For example, someone who typically lives in New York state may have relocated to their Florida vacation home for the pandemic. New York taxes individuals who either are domiciled in the state (generally the location where the taxpayer intends to return whenever they are absent) or who maintain a permanent place of abode and spends at least 184 days in the state.[16] Florida, on the other hand, has no income tax. If that person spent 182 days in Florida and is not a New York domiciliary, which is a fact-based analysis, then he or she may avoid state income tax. However, if he or she is a New York domiciliary, then New York state will continue to tax his or her income. Issues such as whether the taxpayer gave up their expensive Manhattan apartment will be relevant. Some states require income tax reporting with as little as one day worked remotely in the state. This is just an example, but physical presence in a state (or lack thereof) often will affect state income taxation. Several facts are important in that analysis.
Aside from physical presence, some states tax income based on where services are performed. Here in North Mississippi, many people travel into Tennessee to work, commonly the Memphis, Tennessee area. They may have performed services remotely from home during the pandemic rather than at their office in Tennessee. Some states tax employees where their employer is located even if they work remotely. The potential situations where these issues can arise are too numerous to count as are the potential consequences of these varying scenarios. However, taxpayers should consider each state where there could be any basis for taxation including their domicile state, the state where they were physically present while performing services, and the state where their primary (i.e. non-remote) office is located. Some states have offered coronavirus relief from the effect of these provisions.[17]
To highlight the importance of this issue to states, two states are currently involved in litigation over the issue. New Hampshire has sued Massachusetts in the U.S. Supreme Court over the ability of Massachusetts to tax New Hampshire residents working remotely for their Massachusetts employers (under an emergency regulation for employees who worked in the state before pandemic related closures).[18] Several states have joined the case by filing amicus briefs. Clearly, issues of domicile, residency, remote work, due process, and related topics will become contested issues between the states and between taxpayers and states. This joins the handful of state tax issues that have come before the U.S. Supreme Court recently.[19] Many clients are unfamiliar with this complexity and their potential reporting obligations.[20]
Conclusion
While there are other unique tax issues that will arise for taxpayers because of working from home or remote working (travel expenses from a “tax home,” childcare, household employees, etc.), some of the most asked-about questions relate to the items described in this writing. In preparing 2020 individual income tax returns, taxpayers will have to face the potential of incurring significant non-deductible costs. Although some taxpayers may have saved some costs such as non-deductible commuting costs, this has the potential to further compound the effects of the pandemic.
Beyond that realization, many taxpayers will have to review the facts of their individual circumstances carefully. Items to be analyzed may include whether the taxpayer may qualify as an independent contractor versus employee or where the taxpayer considers his or her domicile. The time for 2020 planning may be largely in the past, but analysis will be required to determine what favorable, sustainable tax positions the taxpayer may take. Further, seeing that the current pandemic is stretching into 2021 and, regardless, that more-and-more individuals are working remotely, these issues should be considered in prospective planning. Making one seemingly beneficial tax planning choice can have other consequences. Taxpayers facing these situations should carefully analyze their positions and look beyond the current tax issue in front of them by also considering the other effects of those tax positions.
Also, tax professionals should understand a number of the issues and questions raised by remote working. We may work largely with clients in our state, but they have children who have moved back in with them, employees working remotely, vacation homes where they have potentially significant time during the year, etc. Those clients will need assistance navigating these issues. Many remote working habits also may become more permanent as businesses improve remote working capabilities and employees transition to a habit of working remotely. There are ways to relieve some of the tax pressures: Congress could return pre-TCJA law allowing deductions for unreimbursed business expenses, including an employee’s home office deduction; states can offer relief for forced closures or otherwise enact consistent tests for determining taxability; employers can offer qualifying reimbursement plans such as an accountable plan; and taxpayers can keep adequate records to substantiate their expenses. These tax issues may become more-and-more frequent in the future.
[1] IRC §§ 62 and 67(b)
[2] IRC § 67(g)
[3] This is subject to limited exceptions such as the $250 above-the-line deduction for educators under § 62(a)(2)(D).
[4] See Treas. Reg. § 1.62-2(c)(2)
[5] See Edmondson, Gray, “Refresher on Section 139 – Qualified Disaster Relief Payments,” April 15, 2020, https://esapllc.com/refresher-on-section-139-qualified-disaster-relief-payments/
[6] For what constitutes as “trade or business,” see Edmondson, Gray, “The Importance of Being a ‘Trade or Business’,” September 12, 2018, https://esapllc.com/the-importance-of-being-a-trade-or-business/
[7] Welch v. Helvering, 290 U.S. 111 (1933)
[8] Blackmer v. Commissioner, 70 F.2d 255 (2nd Cir. 1934)
[9] Supra note 7
[10] Supra note 6
[11] IRC § 280A(c)(1)
[12] Prop. Reg. §1.280A-2(b)
[13] Supra note 11
[14] Prop. Reg. §1.280A-2(g)(1). Note that, notwithstanding this language, part-year deductions may be allowed for the relevant portion of home if all of the other requirements have been met. See IRS Pub. 587. This could be the case where an office was the “principal place of business” prior to COVID-19 related closures shifting to a home office thereafter.
[15] Although taxpayers subject to this result may still qualify to engage in a § 1031 like-kind exchange for the portion that does not qualify under § 121 assuming the § 1031 requirements are satisfied.
[16] N.Y.S. Tax Law Section 605(b)
[17] To see a summary of state coronavirus relief, see the AICPA’s State Tax Filing Guidance for Coronavirus Pandemic
[18] See U.S. Supreme Court docket here: https://www.supremecourt.gov/search.aspx?filename=/docket/docketfiles/html/public/22o154.html
[19] See, e.g., South Dakota v. Wayfair, 138 S.Ct. 2080 (2018) and North Carolina Department of Revenue v. The Kimberly Rice Kaestner 1992 Family Trust, 139 S.Ct. 2213 (2019).
[20] Tosczak, Mark, “Some Teleworkers Could be Hit with Surprise Tax Bills,” Journal of Accountancy, Dec. 11, 2020, https://www.journalofaccountancy.com/news/2020/dec/surprise-tax-bills-for-some-teleworkers.html
