The benefits are generally well understood: Telecommuting conserves energy by reducing gas consumption, eases traffic congestion and reduces pollution.
It also helps employers by improving productivity and reducing requirements for office space — and employees by eliminating commutes and enhancing the ability to balance personal and work commitments. One study even found that a flexible work environment promotes healthier lifestyle habits.
These benefits, combined with technological advances and a changing financial climate, make work outside of a traditional office environment possible and practical, and have made full-time and part-time telecommuters increasingly common.
But while the environmental, economic and personal benefits are well understood, the tax implications of telecommuting are often less so.
For the millions of employees who telecommute on a part-time or full-time basis, tax reporting has become increasingly complex. Among the more common tax issues are those related to home office deductions, employer-provided goods and services, expense reimbursements and transportation costs. Understanding these tax rules is critical.
Home Office Deduction for Telecommuting Employees
If you are an employee who works full-time or part-time from home, you may qualify for a home office deduction—a miscellaneous itemized deduction on your federal income tax return.
Whether or not you qualify for this deduction as a result of telecommuting is very dependent on your specific facts and circumstances, including whether you telecommute full-time or part-time. It is important to discuss your situation with your tax advisor before claiming the deduction.
To qualify for a home office deduction, you don’t have to actually own a house. The IRS defines a home as a “house, apartment, condominium, mobile home, boat, or similar property which provides basic living accommodations. It also includes structures on the property, such as an unattached garage, studio, barn or greenhouse.”
Also, the portion of your home used for business can be a room or other separately identifiable space. It doesn’t require a permanent partition to qualify. However the space cannot be used for any other purpose.
But if you want to qualify for the deduction, you can’t rent a portion of your home to your employer and then use that portion of your home to perform work for your employer.
To claim a home office deduction, you must use a part of your home exclusively and on a regular basis for one or more of the following:
your principal place of business
a place to meet customers, clients or patients in the normal course of business
in connection with your activities as an employee, if your home office is a separate structure that is not attached to your home — for example, an unattached garage or workshop
As an employee, this exclusive and regular use of your home must be for the convenience of your employer and not for your own. You won’t meet this requirement if the use of your home office is simply appropriate and helpful for your work. And you’re unlikely to meet it if your employer also provides you with an office as, under the circumstances, you have no imperative need for a home office.
You will generally meet this requirement under any of the following circumstances:
maintaining a home office is a condition of your employment
your home office is necessary for the functioning of your employer’s business
your home office is necessary to allow you to perform your duties as an employee properly
It is difficult to satisfy these requirements as an employee and therefore qualify for the home office deduction.
If you qualify for the home office deduction, the total amount of your deduction includes a combination of unreimbursed expenditures that are fully deductible and others that are prorated based on the percentage of your home that is used for business.
Fully Deductible Expenditures
You can deduct the total amount of those business expenses that stem exclusively from the business use of your home, including such things as business insurance, repairs to the business portion of the house, and a separate phone line used exclusively for your business.
Partially Deductible Expenditures
You can also deduct the business portion of expenses related to your entire home, such as insurance, utilities, real estate taxes, a security system, mortgage interest and depreciation. The portion of these expenses that is eligible for the deduction is calculated based on the percentage of your home that you used for business.
Before you can deduct these home office expenses, however, you’re subject to an additional test. Your gross income from the business use of your home — i.e., your salary stemming from your telecommuting work — must exceed the total expenses, including depreciation, from the business use of your home. Assuming you’re like most telecommuters and easily satisfy this test, you can include all of your telecommuting business expenses as miscellaneous itemized deductions.
Significantly, the total of all your miscellaneous deductions is also subject to a limitation — only that portion of your total miscellaneous deductions that exceeds two percent of your adjusted gross income is deductible on your federal income tax return.
If your gross income from the business use of your home does not exceed the related business expenses — a relatively uncommon situation for telecommuters — your deduction for certain of these expenses is limited. However, you can carry over the excess deductions to the next year.
To document your expenses, you must keep records such as canceled checks and receipts for as long as required for tax purposes — generally the later of the three years after the return was filed or two years after the tax was paid.
Employer-Provided Products and Services
If your employer provides you with products or services — for example, supplies, internet access or office equipment, the value of these products and services may qualify for tax-free treatment as working condition fringe benefits.
To qualify for this tax-free treatment, you must be eligible to deduct the cost of the products or services if you were to pay for them yourself. Generally, this means you must also be eligible for the home office deduction.
Expense reimbursements may also qualify for tax-free treatment if the underlying expenses were otherwise tax-deductible.
You must adequately account to your employer for any reimbursed expenses within a reasonable period of time. Any reimbursements or other cash payments from your employer must include a requirement that the funds be used for a specific deductible purpose, and any excess payments must be returned within a reasonable period of time.
Generally, commuting costs are not deductible. However, expenses for travel between one workplace and another are deductible. As a result, if your home office is your principal place of business for your employer, the costs of traveling between your home office and client sites or other workplaces associated with your employment are deductible.
Effect of the Home Office Deduction on the Sale of Your Principal Residence
There’s one more important tax consideration: If you take a home office deduction that includes depreciation for your home office, the total amount you’ve depreciated for tax purposes is not eligible for the $250,000/$500,000 exclusion for gain on a principal residence.
Telecommuting to work can be a great option.