If you’re lucky enough to qualify for it, the home office deduction allows you to deduct many of the costs associated with working from home, like your rent or mortgage, utility bills, homeowners’ or renter’s insurance, and home maintenance and repairs. Ordinarily, these costs are considered personal expenses and are not deductible (except for mortgage interest).
However, if you qualify for the home office deduction, such costs are deductible to the extent they are related to the business use of your home. Most teleworkers don’t qualify for the home office deduction.
The “convenience of the employer” requirement
You may take the home office deduction only if you maintain your home office for the convenience of your employer. This is a tough one for most people who request the option of teleworking. An employee’s home office is deemed to be for an employer’s convenience only if it is:
- a condition of employment
- necessary for the employer’s business to properly function, or
- needed to allow the employee to properly perform his or her duties.
You’ll fail this IRS test if you’re using a home office simply because it’s convenient for you or because you can get more work done at home. For example, you won’t pass the test if your company provides you with an office at its main location but you choose to work at home most of the time to avoid a long commute.
The only way you can pass the convenience of the employer test is if your employer has no suitable office space for you, you work in a location where your employer has no office, or if there is some other valid business reason why you must work at home. If, for example, you live in Tucson, Arizona, and your company has offices only in Chicago, you will pass the test.
If you manage to qualify for the home office deduction, the IRS imposes limits on how much you can deduct. As a result, your home office expenses are deductible only to the extent that they (along with your other miscellaneous deductions) exceed 2% of your adjusted gross income. You can deduct the costs on your own tax return.
Need more information on the home office deduction? If you’re lucky enough to qualify for the home office deduction, see “Claiming the home office deduction” in Chapter 6 for detailed information on the rules about qualifying for—and claiming—the deduction.
Renting your home office to your employer
If you qualify for the home office deduction but the 2% of AGI rule reduces your deduction too much (or eliminates it entirely), you have another option. Forget about the home office deduction and rent your home office to your employer. You won’t save any income tax this way because your rental income will be subject to income tax, but you can still save on Social Security and Medicare taxes.
Here’s how it works. You rent your home office to your employer for a fair market value, and your employer reduces your salary by this amount. Your employer then deducts the rent as a business expense on its tax return. You report the rent you receive as ordinary income on your personal tax return and pay income tax on it. But you don’t pay Social Security or Medicare taxes on this rental income, which you would have to pay if it was part of your salary.
Ordinarily, a landlord may deduct rental expenses such as mortgage interest, depreciation, and utilities. However, a special tax rule prohibits an employee who rents part of his or her home to an employer from deducting these types of expenses. So, you can forget about taking any deductions for your rental expenses to reduce your income taxes. But
you still save on Social Security and Medicare taxes, because the rental income you receive is not subject to these taxes. Your employee share of Social Security and Medicare taxes is 7.65% up to an annual ceiling ($97,500 in 2007), plus a 1.45% Medicare tax on all your remaining employee income.