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Tax Aspects of Telecommuting

What Employees and Employers Need To Know

November 09, 2009

A growing number of employees are telecommuting these days, some full time, others part time, instead of going into the office every day. Telecommuting can benefit both employers and employees.

It can reduce the amount of office space needed, enable employers to hire talented employees who aren’t available locally, and help employees balance their personal and professional lives. And because having some key employees work off-site on a regular or rotating basis makes a company less vulnerable to potential disruptions, telecommuting also can figure into corporate contingency planning.

Telecommuting does, however, raise tax issues for employees and employers alike. Here’s a review of the tax rules and possible opportunities for savings that apply when employees work from home offices.

Home-office issues. A key question is whether the employee may deduct the direct and indirect expenses of his or her home office (the space used for employment-related work). According to the IRS, direct expenses relate only to the home office, such as the cost of painting the room where the home office is located, or repairing the room’s leaking ceiling.

Indirect expenses relate both to the personal and home office portions of the home. Indirect expenses include things such as utilities, real estate taxes, home mortgage interest, rent or depreciation, homeowner’s insurance, and repairs benefiting the entire property.

Direct expenses and the business-use part of the indirect expenses relating to a home office within a residence are deductible only if part of the home is used regularly and exclusively as a principal place of business, or as a place to meet or deal with customers or clients in the ordinary course of business.

Taxpayers who are employees must meet an additional test—their use of the home office must be for the convenience of the employer.

Convenience of the employer test. The convenience of the employer test is met if the employer asks the employee to work out of his home, or if he’s not in the office on a regular basis because of the nature of his job (e.g., he’s a sales rep with a wide territory).

In general, if the employee asks the employer to telecommute instead of working at the office, this test probably won’t be met, and direct and indirect home-office expense deductions will be barred. However, the facts and circumstances may indicate that an employee is working at home for the employer’s convenience, even if the employee is the one choosing to telecommute.

For example, as part of its contingency planning to deal with disasters, a company may ask for two work-at-home volunteers from a staff of 11. Under these circumstances, those that volunteer would work from home for the employer’s convenience, even though they had a choice in the matter.

If the qualification test is met, and gross income from the business use of a taxpayer’s home equals or exceeds total business expenses (including depreciation), all expenses for the business use of the home can be deducted by the employee on Schedule A as a miscellaneous itemized deduction subject to the 2%-of-AGI limit. If, however, the taxpayer’s gross income from that use is less than total business expenses, home office deductions are limited under the gross income test. The deductions are limited to the excess of the gross income derived from business use of the home over the sum of the deductions allocable to business use that are allowable whether or not the dwelling unit (or portion of it) was so used (e.g., mortgage interest, real estate taxes, and casualty and theft losses), and the deductions (such as for supplies) allocable to the business activity in which business use of the home occurs, but which aren’t allocable to business use of the home.

Gross income test. The gross income test shouldn’t be a problem, assuming an employee’s home office qualifies under the above rules, because his or her salary allocable to telecommuting work (i.e., the gross income derived from working at home) should handily exceed the sum of otherwise allowable expenses allocable to the home office and deductions such as supplies allocable to the business activity in which business use of the home occurs.

Transportation expenses. If a taxpayer’s principal place of business is a home office, daily transportation expenses between the home office and other work locations related to the same business are deductible. So, a telecommuting employee whose home office is his or her principal place of business may deduct (subject to the 2%-of-AGI floor) the costs of roundtrip travel from home to the employer’s offices.

Employment-related business telephone calls. A taxpayer can’t deduct any charge (including taxes) for basic local telephone service with respect to the first telephone line provided to any of the taxpayer’s residences. However, long distance business phone calls on the first or second telephone line, as well as the cost of a second line used exclusively for business, are deductible business expenses - even if the taxpayer doesn’t qualify for a home-office deduction.

For employees, the deduction is a miscellaneous itemized deduction subject to the 2%-of-AGI floor.

Reimbursed expenses related to telecommuting. An employer may supply a telecommuting employee with office supplies and equipment or it may reimburse the employee for these expenses as well as for some or all of the utilities and maintenance expenses allocable to the home office.

Employer provided property and services qualify as tax-free working condition fringe benefits only if the employee would be entitled to a business expense deduction for the items had she paid for them herself. Additionally, a cash payment (which presumably includes a reimbursement) made to an employee won’t qualify as a fringe benefit unless the employee is required to use it for a specific or prearranged undertaking which is deductible.

Verify that the payment actually is used for the expenses specified in above and return to the employer any part of the payment not so used. Under these rules, a telecommuting employee reimbursed for some or all of the utilities and maintenance expenses allocable to his or her home office could treat the payment as a working condition fringe benefit only if the home office qualified as a principal place of business.

Computer and related equipment. An employer that supplies a telecommuting employee with a computer used 100% for business will deduct it the same way it would if the machine were located in the employer’s regular offices. That also applies for related equipment, such as a printer or copier.

If the telecommuting employee buys a computer for employment-related use, he or she can depreciate it or expense it only if it is required as a condition of employment and is used for the convenience of the employer.

Because many of the surrounding IRS regulations are complex and very specific, it is best to consult your tax advisor if you work from a home office.

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