As we enter 2021, there is a lot for nonprofit managers and their employees to consider. Working from home widely became a necessary requirement for many employees and has raised many questions as to treatment of certain situations from a tax perspective. Many policies and frameworks implemented during the year as temporary will now be viewed more closely through the prism of individual taxation as employees look to gather information necessary for their 2020 Form 1040. What are some questions presented?
Working from Home: Can I take that deduction?
For many employees, a portion of their home became their office during 2020. A common question posed is: “Can I deduct the expenses used to purchase items needed or other expenses for the home office?” Unfortunately, due to changes implemented by the Tax Cuts and Jobs Act of 2017, deductions for employees’ out of pocket expenses are no longer permitted as an itemized deduction.
Should an individual be an independent contractor, the ability to deduct certain expenses was expanded. The Internal Revenue Service (IRS) even released a reminder of the rules this past September. However, employees of an organization simply do not meet this requirement.
So, can I be an independent contractor, then?
The short answer is no, probably not. If someone has been an employee historically, the case for the person now being an independent contractor will have little to do with their relocation to a remote home office. The rules around determining whether a person is an independent contractor or employee have not been updated due to COVID-19.
Making the determination of whether someone is a contractor or employee requires an analysis of the type of relationship between the business and the individual. If the business has the control over how the worker does the job or what the worker does, that implies employee status. There are other factors such as how the worker is paid and how contracts are written that might also affect determination.
Nonprofit employers should not be attempting to change the designation of employees. This would open a pandora’s box of payroll tax issues and penalties.
A wrinkle to this is that some states do still allow for a deduction of certain employee expenses when filing an individual income tax return.
What about a stipend to my employees?
If you provide a flat amount to your employees with no requirement of substantiation for the expenditures made, then any amount paid to your employees will be considered taxable to them. However, if you implement a plan that is specific to each employee and is based on substantiated costs that you as the employer approve to be reasonable and necessary, these can be considered expense reimbursements.
The hard part is when you dig into the types of expenditures covered. All home-office expenditures are not created equal, and items such as internet, which might be used for both personal and business uses, will be complex at first to determine. Investments in equipment such as monitors or desks might have complexity when an employee leaves or working remotely ends.
Regardless of what you choose to do for your employees, there should be a detailed policy in place prior to any payments. Another wrinkle worth mentioning is that certain states, take California as an example, will require that you reimburse your employee for certain expenses.
And in California, you will be required to reimburse for entire monthly expenses such as a phone plan, even when there is a percentage that might be covering personal use. That doesn’t impact the federal treatment discussed above but has certainly added to the expenses for employers in those states in 2020 as more workers went to remote work.
Federal rules do allow for reimbursement for cell phones as long as they are not for compensatory purpose and the employee needs to be available when away from the office. Situations like this were most likely in place prior to the need to work remotely, but if they have arisen, it is important to recognize the difference.
The important thing to remember is a flat and unsubstantiated stipend will increase your employee’s taxable wages. An accountable plan based on actual expenditures and substantiated amounts can help justify amounts being reasonable and necessary business expenses to the employer, and not taxable wages to the employee.
What about emergency relief payments?
Per the IRS Special Issues for Employees release, section 139(c)(2) of the Internal Revenue Code provides that for purposes of section 139 of the Code, the term “qualified disaster” includes a federally declared disaster. On March 13, 2020, the President of the United States issued a proclamation declaring a national emergency concerning the Novel Coronavirus Disease (COVID-19) outbreak, stating that the ongoing COVID-19 pandemic warrants an emergency determination.
A “qualified disaster relief payment” is defined by section 139(b) of the federal tax code to include any amount paid to or for the benefit of an individual to reimburse or pay reasonable and necessary personal, family, living or funeral expenses incurred as a result of a qualified disaster. Qualified disaster relief payments do not include income replacements such as sick leave or other paid time off paid by an employer. These payments are not taxable to the employee.
What if the employee now works from another state?
This alone is a topic for an entire article, and the answer to the question is dependent on the state. The issues to be concerned with are:
- What state is the employee now working from?
- What state is the employer located in?
- Is the employee intending to make their remote work a permanent status, or is it still temporary? And if so, when did that intention change to permanent?
States initially hoped to keep matters uncomplicated by not implementing rules or interpretations that would put unnecessary strain on employers and employees in the early stages of COVID-19 relief. However, as temporary arrangements have become or seem to become permanent and states experienced their own financial hardships during 2020, that landscape is more uncertain.
In some places it is even turning bizarre as states battle for the income tax. Depending on the state in which your employee is now located, there might be withholding necessary in the employee’s home state, and there may be some instance of double taxation.
This is an area on which nonprofit managers should spend considerable time to understand to protect your employees from a bigger surprise when they file their individual tax return. The employee is responsible for knowing their complete tax situation and seeking specific advice for themselves, but of course the employer should be concerned with alerting the employee of any potential complications they are aware of.
Each state has its own rules on whether it taxes the income earned by an employee even if they didn’t step foot in the state during the year. In addition, each state has rules on how it treats income earned by an employee that worked in their state, but for an employer in another state. It is critical that the employer understand where their employees are located and what those rules currently are so they properly withhold and educate their employee on what states’ taxes their employee’s wages are subject to.
The Year 2020 has brought about many complications that extend far beyond tax consequences. However, the year-end close will require many to reconcile different payments and transactions for their organization and employees. Take time to understand what occurred during the year, gathering facts about the organization and the employees and then proceed with seeing how to treat these specific items if you have not done so already.
Michael Peterson, CPA, is a senior manager with Wipfli, a top 20 accounting and business consulting firm. His email is MJPeterson@wipfli.com