Tax Wrinkles for Work-at-Home Employees During COVID-19

Are your home office expenses deductible? How does going out of state to work for a while affect your tax picture? There are some interesting wrinkles to iron out.

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Because of COVID-19, millions of people no longer go to the office but work from home instead, where they’ve had to set up workstations with desks, printers, high-speed internet and other pricey items — often paid for out of their own pockets. Can they deduct those expenses on their taxes?

Many other workers have temporarily (or maybe permanently) fled expensive big cities for cheaper, more remote locations, often sporting lower taxes. What does that mean for their tax returns?

COVID-19 has changed everything this year for American workers. Some changes have been good on the pocketbook, such as reduced expenses on commuting, lower auto insurance premiums and less money going toward work clothes and lunches. Others have presented some new financial challenges: things like higher utility expenses, buying a faster internet plan with a new Wi-Fi router to handle the upsized bandwidth, office furniture and equipment and anything else to enable your remote working. After the challenging year, it would be nice to know whether these expenses can at least be deducted on your tax return.

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In short, your eligibility to claim these expenses as deductions largely comes down to one question: Are you an employee or an independent contractor (opens in new tab)? Sadly, for employees now forced to work from home, the Tax Cuts and Jobs Act eliminated deductible expenses tied to maintaining a home office. On the other hand, independent contractors are in luck.

This article will walk through the tax treatment of home office-related expenses for employees and contractors as well as differences in taxes for those who relocate, permanently or temporarily, while working from home.

Employees Miss Out

After tax reform became law at the end of 2017, employees lost the ability to deduct expenses related to maintaining a home office. Previously, employees could claim an itemized deduction for unreimbursed business expenses that exceeded 2% of their adjusted gross income. This included any work-related expenses for business you conduct at home. For employees, those deductions are now gone.

Despite this unfavorable rule change, employees still need supplies and equipment to function effectively in their jobs at home. In a standard work environment, the employer provides these necessities. Now, many employees working from home will need to procure these items for themselves. If you find yourself in this situation, you face one of three outcomes with respect to the financial and related tax implications:

  1. Your employer purchases the items and provides them to you.
  2. You purchase items and receive reimbursement from your employer.
  3. You purchase items and do not receive reimbursement.

In the first situation, these items would qualify as an employer-owned supply and thus would be a deductible expense on their tax return. Assuming the employer provides these supplies and equipment for noncompensatory business reasons (opens in new tab), employees will not need to pay taxes on these items. This includes items that employees may also have available for personal use, such as a cellphone or computer, because the IRS deems these as “de minimis fringe benefits.”

The second situation is similar. If the expenses count as “ordinary and necessary,” or those which your industry considers commonly accepted for conducting your trade or business, these reimbursements will not count as taxable income to the employee. To avoid having employees count these expenses as taxable income, employers should lay out an “accountable plan,” or a set of policies that state what qualifies for reimbursement when employees need to purchase supplies and equipment at home.

In the final situation, employees purchase the needed supplies and equipment but have no expectation of receiving reimbursement from their employers. Prior to the Tax Cuts and Jobs Act, if these expenses exceeded 2% of employees’ adjusted gross income, they could claim these deductions on their tax return. This would offset some of the expense picked up by employees. Unfortunately, that’s no longer true. No federal tax benefits exist at the moment.

Independent Contractors Get a Break

For independent contractors who buy home office equipment and supplies without being reimbursed, the tax picture is brighter. Independent contractors often have no expectation of reimbursement from their contracting company. As a result, people working in this capacity have access to self-employment tax deductions to lower their taxable income. They can also claim expenses such as depreciation on certain types of property (opens in new tab), utilities, insurance and more.

In the event a company provides equipment to the independent contractor or reimburses expenses, these items would fall under the first and second situations above, respectively. This allows the company to claim these expenses as deductions on their business tax return, not the contractor.

Relocating to Pocket Tax Savings

Given the fact that many people can work from anywhere these days, it might not be news that many people have decided to relocate from higher cost of living areas (opens in new tab) to cheaper areas. Doing so might allow you to keep more of what you make through lower costs or tax savings.

In the event you’ve decided to relocate permanently to a locale different from the one you started in 2020, you might face a complex tax situation come 2021. If you’ve made a permanent move, you will need to file a tax return in both states this coming year. Going forward, you will only need to file a tax return in your new state as you would in any event where you move across state lines permanently. My wife and I relocated permanently prior to the pandemic, reasoning we stood to have a better quality of life elsewhere. In 2019, we paid state income taxes in Louisiana and California on account of living in both states a roughly equal amount of time during the year (we moved in mid-June 2019).

If you stay away longer than six months on a temporary relocation, you will likely face a tax obligation in your home state as well as your temporary location. That means you may be required to file tax returns in both states. You may want to consider consulting with a tax professional to understand the tax ramifications fully.

Given the substantial drops seen in tax revenues across the nation, states will be keeping a close eye out for people trying to game the system by claiming to have moved to a lower-tax state permanently or have chosen to make it their primary residence when they really haven’t. States look for definitive links connecting the state and the resident. Such examples could include individuals establishing residency, owning or leasing residential property assets that produced income (opens in new tab), making money (opens in new tab) from a job, or engaging in some other financial arrangement tied to a location. Saying you have permanently relocated will require you to prove your change of scenery comes as more than just a transitory decision. Most locations will require you to document this change by living in your new location for at least 183 days (opens in new tab). You can back this up by officially changing items like your voter registration and driver’s license.

Bottom line, because states will be keen to review any relocations, you will want to take extra precautions when it comes to legitimizing your relocation in the name of saving on taxes.

Now, if only employees could deduct those moving costs alongside their work-from-home related expenses. Sadly, tax reform put an end to claiming both as an employee.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Riley Adams, CPA
Owner, Young and the Invested

Riley Adams, CPA, is originally from New Orleans but now lives in the San Francisco Bay Area, where he works as a senior financial analyst at Google. He also runs the personal finance site called Young and the Invested (opens in new tab), a website dedicated to helping young adults invest, manage and plan their money with confidence.