As the COVID-19 pandemic continues, many people are still working from home. This arrangement raises important questions. May employees take advantage of tax breaks related to having a home office? Must the employer pay for the expenses of setting up a workspace at the employee’s home? What related information should employers and employees be aware of? Workers may be able to obtain tax deductions or tax-free reimbursements from their employer due to working at home, but they have to meet specific requirements as follows.
Home Office Tax Deductions for Independent Contractors and Self-Employed
First, a key legal point warrants upfront attention. A worker may only take a tax deduction for qualified business expenses of maintaining a home office if he or she is not an employee. For example, individuals who work for an organization as an independent contractor or are otherwise self-employed may deduct home office expenses, so long as they meet other requirements. Under the Tax Cuts and Jobs Act, which took effect in 2018, employees are not able to take a home office deduction on their taxes. (Notably, however, the itemized home office deduction for employees is slated to return in 2026, barring any additional changes to the law.)
For non-employees, the home office deduction applies under specific circumstances:
- The office must be used exclusively for business purposes: your kitchen table doesn’t count if it is also used for family game night.
- The office must be used regularly for business purposes: putting in a couple hours of work in a week might not count.
- The office must be the worker’s primary place of business: working from home one day a week while going into an office all other days will not be sufficient.
Remember, the “office” doesn’t have to be an entire room. Any space that is used regularly and exclusively as the primary place of business can be considered a home office.
If all of the above requirements are met, the non-employee worker can complete IRS Form 8829 in conjunction with an annual tax return to determine the amount of the home office deduction. This deduction can include items such as rent, mortgage interest, utilities, and property taxes in proportion to the amount of space the “office” takes up in the home. To the extent that such workers’ work-from-home arrangements began with the pandemic’s onset, they may be able to deduct home office expenses only for a portion of the tax year.
Tax-Neutral Employee/Employer Reimbursement
Second, while an employee may not deduct home office expenses from personal income taxes, the employee may accept reimbursements from an employer to cover such expenses. Reimbursements will be tax-neutral – i.e., not counted as taxable income or reported on employees’ IRS Form W-2s. For this tax benefit, the employee’s home office space must meet the same requirements as listed above for non-employee workers.
In order to qualify for reimbursement, an employee must be working from home for the convenience of the employer. This requirement means that simply choosing to work from home is not enough. But working from home because the organization’s office is shut down while the state is on coronavirus lockdown? That definitely qualifies. Many situations may fall somewhere in between. For example, even if an organization is not legally obligated to do so, its leaders may decide that a portion of its employees should stay home to provide for maximum social distancing, due to a COVID-19 outbreak among employees, or due to government warnings. Such situations could meet the “employer-convenience” standard. A detailed work-from-home employment policy, as addressed below may be helpful for satisfying this “convenience of the employer” standard.
In order for an employee to be properly reimbursed for home office expenses on a tax-free basis, the employee and employer must take the following steps to treat the reimbursements as part of an “accountable reimbursement plan” (as prescribed by the employer) to ensure that they are not treated as taxable income:
- The employee must keep records of the expenses;
- The employee must timely submit an expense report and receipts to the employer;
- The employee must timely return any excess payments above the allowable expenses.
The last element is particularly important if the organization provides a set amount each month based on pre-calculating the appropriate amount of the reimbursement. Generally speaking, such an approach is not recommended.
One way to determine the qualifying reimbursement amount may be to reference the types of deductible home office business expenses listed on IRS Form 8829, despite the fact that should only be filed by self-employed workers. Particularly with respect to these unprecedented pandemic times, Form 8829 may provide a helpful internal tool for employees in itemizing reimbursable expenses for their employers. One important caveat: employers’ accountable reimbursement plans may limit the types, amounts, and dollar costs of permitted reimbursable expenses, as well as requiring that some or all such expenses be preapproved. For example, while an employee may decide to purchase a new stand-up desk, lamp, and side table for optimal work efficiency, such purchases likely should be cleared with his or her employer first.
Employer Legal Compliance and Best Practices
Third, and in light of potential employee expense reimbursements, employers should scrupulously develop and follow a written accountable reimbursement policy. Such policy is often contained in employee handbooks or maintained on a stand-alone basis. A standard policy could begin with the following explanatory language:
Employer recognizes that its employees may be required to incur expenses, including travel, in the furtherance of Employer’s activities. It is the policy of Employer to reimburse only reasonable and necessary expenses actually incurred by employees for legitimate Employer activities. The purpose of this policy is to ensure that (a) proper accounting is made for such expenditures, (b) adequate cost controls are in place, and (c) sufficient guidance is provided to employees for expense reimbursement, all as set forth below.
The policy should then address expense reports, substantiation methods and timing, consequences for noncompliance, and equipment reimbursement (including any required preapprovals).
Significantly, many states now require employers to reimburse all employees for “necessary” job expenses. For example, the Illinois Wage Payment and Collection Act was amended in 2019 to require the reimbursement of all reasonable expenses that: (a) are required by the employer in the discharge of the employees’ duties; and (b) are primarily for the employer’s benefit. These elements involve potentially significant pitfalls and legal compliance considerations, so careful attentiveness is warranted. Notably, no employer reimbursement is owed to employees who fail to comply with the employer’s written accountable reimbursement policy. Additionally, reimbursement for personal expenses that are not sufficiently used for work purposes (e.g., a cell phone rarely used for work calls) may result in taxable income to employees. A simpler overall approach for cell phones, computers, and other equipment thus may be for the employer to provide employer-owned equipment, rather than to work through the details what personal expenses may or may not be legally reimbursable.
Keep in mind that the applicable state law depends on the location of the employee’s home office, so pay attention to any out-of-state remote workers. For this and other operational reasons, some employers may restrict employees’ work locations to within the employer’s state of operation. For additional guidance on out-of-state remote workers, check out our law firm’s companion blog that addresses the myriad of legal compliance requirements for remote work, the role of remote work policies, and related best practices considerations.
Remote work is here to stay for the foreseeable future, and perhaps forever changing the work environment in many fields. In some ways, more widely used remote work arrangements may reflect enhanced employer-employee approaches that were already available, thanks to technological improvements, with home office deductions and employee reimbursements applicable whether a pandemic exists or not. Legal compliance also remains paramount, as employment-related laws continue evolving in response to new challenges and shifting work landscapes.