While independent contractors have a lot of options for deducting business expenses on their 2020 tax returns, employees face limitations due to the 2017 tax reform. With more people than ever working remotely, what are the options going forward?
Tax deductions for employees vs. self-employed
When Congress passed the Tax Cuts and Jobs Act in December of 2017, the new law removed the ability of employees to deduct business expenses on their tax returns. Independent contractors, however, retained the ability to deduct expenses as self-employed business owners.
This change had a large impact on employees who operate personal vehicles on behalf of their employer. In the past, if they received a car allowance, they could deduct their business mileage (or actual expenses, based on receipts). With the coronavirus pandemic hitting in 2020, more people than ever have been working from home, incurring unforeseen business expenses that are not tax deductible.
Different employers have responded in different ways, some offering one-time checks to help workers purchase home office equipment, some offering a regular stipend to offset costs, and some even creating a remote work reimbursement plan. Others, however, have left it up to employees to eat the expenses, especially if the business did not officially require them to work from home.
The bottom line is, whether a remote worker (i.e. working from home) or a mobile worker (i.e. working from a vehicle), employees cannot deduct business expenses on their taxes; only independent contractors can. This is both a challenge and an opportunity for organizations with remote and/or mobile employees.
Employee allowance (stipend) vs. reimbursement
Moving forward, the key to understanding how to address business expenses incurred by remote and mobile workers requires differentiating between an allowance, or stipend, and a reimbursement. These take the form of non-accountable vs. accountable plans.
Non-accountable plans - allowances and stipends
An allowance or stipend is treated as taxable income by the IRS. Neither the employee nor the company has to provide proof that the payment was used for business purposes. A car allowance fits under this category, as does a stipend for home office expenses, such as a desk, chair, high-speed internet, or mobile plan.
These payments are considered non-accountable because no accounting is involved to demonstrate business use. These plans offer maximum freedom for employers and employees. But they also deliver the least "bang for buck" because so much of the payment goes to taxes (as much as 40%, depending on the employee's tax bracket).
Accountable plans - reimbursements for expenses
A reimbursement can be paid tax free as long as certain conditions are met. The essential quality that distinguishes a tax-free reimbursement from a taxable allowance or stipend is providing proof of business use.
For mobile workers, a cents-per-mile plan, mileage allowance, or FAVR allowance are all common forms of non-taxable reimbursement. For remote workers, companies can offer a reimbursement for or direct payment of home office expenses. This could be a recurring payment based on known recurring costs, or a reimbursement of receipts.
Organizations that make accountable payments are allowed to deduct these payments as expenses on their taxes, making business reimbursements an attractive option for both employers and employees. The key is to determine the most cost-effective accounting procedure.
Tax-free disaster relief payments for 2020
It is important to note that under Section 139 of the Internal Revenue Code, employers can designate payments for remote work as "disaster relief payments," keeping them tax-free for both the company and the employee.
Because the Covid-19 pandemic has been declared a disaster, the option of making relief payments is currently available. But it is not a long-term fix, especially as, moving forward, remote and mobile work becomes less of a requirement and more of a preference.
Are companies legally required to reimburse home office or vehicle expenses?
While federal law requires only that all employees receive at least the federal minimum wage, after all reasonable business expenses have been subtracted from wages/salary, many states have strict labor codes that require partial or full reimbursement of employees.
California, for example, has a law – Section 2802(a) of the CA Labor Code – that requires full reimbursement for all necessary and reasonable work expenses. Mobile workers are granted the right to full reimbursement of all vehicle expenses. Remote workers are also entitled to reimbursement of home office expenses, assuming they are required to work from home.
(It should be noted, though, that in California there is some controversy over who counts as an employee, with Assembly Bill 5 recategorizing most contractors as employees, and with Proposition 22 exempting app-based rideshare and food delivery drivers from that new categorization.)
Other jurisdictions, such as Massachusetts, Illinois, New York, and Washington, DC, also have employee-friendly laws that require full or partial reimbursement of employee work expenses. It is important to be aware of these laws, as well as any new legislation passed to address the effects of the pandemic on employees working from home or from a vehicle.
Employee business reimbursements vs. taxes moving forward
The bottom line is that it pays for companies to offer reimbursement of business-related expenses for employees, whether due to legal requirements or as a way to treat employees fairly and retain talent.
Employees cannot deduct vehicle expenses or home office expenses on their tax returns for 2020, and, unless the law changes, will not be able to again until 2026. While reimbursement for remote work remains a relatively new category for many organizations, reimbursement for vehicle travel is easily accomplished through a number of well-established accountable procedures.
To explore accountable vehicle reimbursement plans further, follow the link below.