Financial advisors have used the home office deduction as a valuable tax-reducing tool for qualifying clients with home offices, allowing them to deduct certain work-related home expenses on their tax returns. However, as COVID-19 has led to a dramatic increase in the number of individuals working from home, client questions about the home office deduction have become more common than ever before. Accordingly, advisors should have conversations with clients who work from home to ensure they understand (and make proper use of!) the home office deduction rules.
In order to claim the deduction, a home office must generally pass three key tests. The first is the Exclusive Use Test, which requires that the portion of the home used as the home office is used exclusively for business purposes… 100% of the time; the second is the Regular Use Test, which requires the home office to be used on a regular, ongoing basis; and the third is the Principal Place of Business Test, which requires the home office to be the taxpayer’s principal place of business.
While employees are never allowed to claim the home office deduction, self-employed taxpayers can claim the deduction subject to certain Net Operating Loss (NOL) limitations, provided they pass the three requisite tests. Partners can also benefit from a home office deduction by claiming Unreimbursed Partner Expenses (UPEs) on Schedule E of Form 1040. However, partners seeking to do this should ensure that their partnership agreement expressly states that they are personally responsible for the payment of such expenses.
And while employees per se can’t claim the home office deduction, taxpayers who are both the owner and an employee of the same corporation can instead use Accountable Plans to shift what would otherwise be non-deductible (unreimbursed) employee expenses (e.g., expenses related to a home office) into expenses that can be deducted by the corporation at the entity level.
To calculate the home office deduction, qualifying taxpayers can use either the Regular (Actual Expense) Method or the Simplified Method. With the Regular (or Actual Expense) method, taxpayers eligible for the deduction can claim 100% of the actual cost of direct expenses (i.e., expenses entirely attributable to the home office) and a ratable amount of indirect expenses (i.e., expenses attributable to both the home office and personal, non-home office portions of the home such as taxes, rent, and utilities) associated with the home office. Alternatively, the Simplified Method allows taxpayers simply to deduct $5 for each square foot of the Home Office, up to a maximum of $1,500.
Ultimately, the key point is that financial advisors with clients who are self-employed (or who are partners of a partnership) can determine if those clients qualify for the home office deduction (by passing the three requisite home office deduction tests) and whether they have eligible expenses to claim (and if so, how much of those expenses can be claimed). And given the effect of COVID-19 on taxpayers who have adapted to a work-from-home environment, questions about the home office deduction have become increasingly prevalent. Financial advisors who understand how the home office deduction works can help eligible clients make use of a valuable tax break – potentially freeing up resources for those clients to use towards more enjoyable goals!