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The Return of the Home Office Deduction for W-2 employees

December 21, 2020

Working from home? You may qualify for a valuable tax deduction.

For many years the IRS had allowed the home office deduction to offset income from self-employment as well as income earned as a W-2 employee. With more people working from home than ever before, many taxpayers may be wondering if they can claim a deduction. Here’s what you should know.

What is the home office deduction?

The deduction is calculated either based on a flat dollar amount per square foot of the home office, or by taking all home expenses and allocating based on the size of the home office compared to the size of the entire home. While most W-2 employees weren’t able to take advantage of this deduction due to certain limitations on itemizing their deductions, there were some significant tax savings in the right set of circumstances.

Who qualifies for this deduction?

Due to the Tax Cuts and Jobs Act of 2017, which made significant changes to allowable itemized deductions starting in 2018, W-2 employees are no longer able to write off home office deductions as a miscellaneous itemized deduction. Only self-employed individuals are still eligible to deduct their home office expenses.

The requirements to take a home office deduction include:

  • Regular and exclusive use – the area in your home needs to be used for the business on a regular basis, and that is the only thing the space is used for.
  • Principal place of your business – the area must be substantially and regularly used to conduct business. Generally, an employee who was expected to work in the office could not meet this requirement.

There is now an opportunity for some W-2 employees to take advantage of this deduction once again. Since the COVID-19 lockdowns began this past March, many employers requested or required employees to work from home whenever possible. In some cases, this is being extended until at least the middle of 2021. Given this new set of circumstances, there are a couple of options available for receiving a tax benefit related to expenses of the home office for W-2 employees:

  1. Disaster Relief Payments
  2. Losses (if not reimbursed) incurred in federally declared disaster areas

Disaster Relief Payments

On March 13, 2020, COVID-19 was declared a nationwide emergency. All 50 states have been approved for major disaster declaration, effective January 20, 2020. Under the Internal Revenue Code Section 139, qualified disaster relief payments are not included in income. This means payments made by employers to their employees to cover actual expenses related to the pandemic, such as expenses of working from home, are deductible to the employer as an ordinary and necessary business expense, but are not included in the employee’s income. If an employer is making these payments, the employee should document the actual expenses for the home office in order to submit a reimbursement request.

Losses incurred in federally declared disaster areas

The IRS allows deductions for losses incurred in a federally declared disaster area. Expenses allocable to an area of your home that fits the criteria for a home office are included in this category. This is based on allocating the square footage of the home office over the square footage of the entire house. These expenses are reported on Form 4684, subject to a $500 Qualified Disaster Loss subtraction. The expenses are then reported as itemized deductions for taxpayers who itemize, or are added to the standard deduction for other taxpayers.

Please note, if expenses are reimbursed by the employer, the losses incurred in a federally declared disaster area would be reduced by those reimbursements, so no double dipping. In addition, the simplified home office deduction of $5 per square foot would not be allowed for deducting these losses.

As this may be a multi-year deduction with the right facts, these deductions could save thousands of dollars in taxes. Please reach out to a member of the KLR tax department if you would like to learn more.

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