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The Pennsylvania Department of Revenue (“Department”) released an article discussing the deduction of home office expenses. Since many residents are working from home due to the pandemic, it may be tempting to claim such deductions – yet, taxpayers should be aware of the potential ramifications of claiming home office deductions.
In order to qualify to take a home office deduction, a taxpayer must work through a three-part analysis. First, the taxpayer’s employer must either not provide a suitable work area, or the taxpayer must be prohibited from reporting to work due to COVID-19. Second, the taxpayer’s employer must require the employee, as a condition of employment, to maintain a suitable work area away from the employer’s office; the office or work area must be the principal place where the taxpayer performs duties of employment; and the office or work area must be used to regularly perform the duties of employment. Finally, there must be exclusive use of the area for which the home office deduction expense is claimed.
Assuming a taxpayer can meet each of the above requirements, the taxpayer may claim a home office deduction. The taxpayer must be sure to gather and retain all expense information. However, before eagerly claiming the deduction, taxpayers should be aware of the unintended tax implications of claiming home office deductions.
First, the taxpayer will owe use tax on the utility expenses claimed as part of the home office deduction. While there is an exemption from sales and use tax on utilities for residential use, business use of utilities is taxable. Thus, where a taxpayer claims a home office deduction, a pro-rata portion of utilities will need to be deducted with other expenses.
Second, the taxpayer will owe Pennsylvania Personal Income Tax on the gain from the future sale of his/her home on the portion of the home that is claimed as a home office. The Department’s article provides an example the helps to illustrate the potential impact this could have on a taxpayer:
A taxpayer owns a home and is working from home due to the COVID-19 pandemic from March 2020 until June 30, 2021. The taxpayer later sells the home in 2022.
2020 Tax Year
$150,000 is paid for the home in 2010 and 10% of it is used for a home office in 2020 for 9 months.
- The utilities expense for the year were $4,000. 9 months of that amount is $3,000. The home office portion is $300 ($3,000 x 10%).
- The real estate taxes, mortgage interest paid, homeowner's insurance and maintenance costs for the year is $7,000. 9 months of that amount is $5,250. The home office portion of those expenses is $525 ($5,250 x 10%).
- The home has a useful life of 30 years. If the home were to be depreciated, the yearly depreciation would be $5,000 ($150,000 ÷ 30). The home office portion of the depreciation is $500 ($5,000 x 10%). 9 months of that amount is $375.
- The total of the home office expenses allowable as a deduction is $1,200.
- This deduction is worth $37 ($1,200 x 3.07%) in PA personal income tax. However, use tax of $18 must also be paid on the $300 ($300 x 6%) utilities expense portion deducted.
- The net tax savings for the deduction is $19 ($37 - $18).
2021 Tax Year
For 2021, the home office expenses were the same, but the home office was only used for half the year.
- The total home office expenses for half the year is $800, with a PA personal income tax savings of $25 ($800 x 3.07%)
- Use tax is $12 ($2,000 x 10% x 6%). Therefore, there is only a net savings of $13 ($25 - $12) in taxes.
2022 Tax Year
- If the property is sold in 2022 for $200,000, the net gain would be $50,625 [$200,000 less $149,375 basis ($150,000 - $625 depreciation)].
- The PA tax of $155 would be due on 10% of the gain ($5,062.50 x 3.07%).
- Even though claiming the home office deduction would save $32 total for 2020 and 2021, it would end up resulting in an additional $123 ($155 - $32) in net tax when the home is sold.
Note: To the extent a taxpayer lives in Allegheny County or Philadelphia, use tax would be owed at 7% or 8%, respectively.
During 2020, more taxpayers than ever before worked from home due to the pandemic. The allure of claiming a home office deduction could prove a trap for the unwary. As taxpayers begin filing taxes for the 2020 tax year, be sure to look at the whole picture to determine the tax implications of claiming a home office deduction.