Helping Employees TaxWise Who Work from Home

According to GlobalWorkplaceAnalytics.com,* 3.7 million employees (2.8% of the workforce) now work from home at least half the time, and the number of work-at-home employees has grown 103% since 2005. If your business has employees who work from home, understand the tax rules they face for claiming a home office deduction and what you can do to help them.

Overview of the home office deduction

A home office deduction enables a person to treat otherwise personal costs as a deductible business expense. The deduction can be based on the actual costs allocated to the portion of the home used for business or on an IRS-set allowance of $5 per square foot up to 300 square feet (a maximum deduction of $1,500). The employee claims the deduction as a miscellaneous itemized deduction on Schedule A of Form 1040.

An employee working from home can qualify for the home office deduction only if he or she meets the following three tests:

1. The home office must be the principal place of business or a place to meet regularly with customers, clients, or patients (there's also a “separate structure” rule not discussed here).
2. The space must be used regularly and exclusively for business. The space cannot be used for personal purposes when not being used for business, so a kitchen won't qualify.
3. The use of the home office must be for the convenience of the employer and the employee does not rent the space to the employer

Special conditions for employees

Condition number 3, above, is only for employees; self-employed individuals working from home don't have this concern. An employee who chooses to work from home because it better suits his/her lifestyle and family responsibilities or believes he or she can get more work done at home may not be eligible for a home office deduction. The choice must be the employer's. Thus, an employee who finds it helpful and appropriate to do work in the evening at home probably can't take the deduction.

But if the employer requires an employee to work from home—all the time or at certain times—the employee may be eligible for the tax break. More specifically, working from home must be a condition of employment, necessary for the employer's business to function properly, or needed to allow an employee to perform his or her employment duties. Examples of situations where the use of a home office likely is for the convenience of an employer:

• The employer requires an employee to work from home because there is no office space for the worker.
• The office is locked at the end of the business day but the employer requires an employee to do work (e.g., be on call to answer customer questions) after hours or on weekends and holidays.

A company policy supporting an employee working at home can be reflected in a letter to the employee to this effect. For example, when I was an offsite part-time employee of a publishing company, I received a letter defining this work arrangement; there was no space for me at the company's office and I was not required to work there.

The employee cannot charge the company rent for his or her home office. Thus, if you are the owner-employee of an S corporation and work from home, you can't charge the corporation any rent if you want to take a home office deduction. Doing so means you must report the rent as income (and the corporation deducts the rent payment) but you can't take a home office deduction.

Accountable plan

While it's great to help an employee nail down a home office deduction, this write-off may be worth little or nothing to the employee. The employee must itemize to take the deduction. And assuming he or she does itemize, only miscellaneous itemized deductions over 2% of adjusted gross income are actually deductible. As an employer you can eliminate the need for a home office deduction by reimbursing the employee for home office expenditures. If you do this through an “accountable plan,” the reimbursements are not treated as compensation to the employee and there's no employment taxes involved. You can still deduct your reimbursements.

To be treated as an accountable plan, all of the following conditions must be met:

• The expenses must have a business purpose and are paid or incurred while performing services as an employee. Thus, paying an employee's home office costs must reflect company policy.
• The employee must account to the employer for costs within a reasonable time (usually within 60 days after the expense is paid or incurred).
• If the company advances payments, the employee must return any excess reimbursement within a reasonable time (usually within 120 days after the expense is paid or incurred).

Reimbursements must be limited to actual business costs of the employee, such as charges for Internet access. Reimbursements under an accountable plan cannot include payments for personal expenses.

While the tax law doesn't require any special type of written plan, it's highly advisable to craft your own. Be sure that it contains the elements of an accountable plan and that the working-from-home arrangement is reflected in the document.

Conclusion

Companies are increasingly offering telework opportunities to employees. For example, FlexJobs* found that there was a 36% increase in telecommuting job listings from 2014 to 2015. Helping employees with tax rules on their home office will be much appreciated. The home office deduction is explained in IRS Publication 587. Details about an accountable plan are in IRS Publication 463.

*Denotes a non-governmental website link