by John Schachter, EA
Let’s say it’s a global pandemic and your regular workplace has shut down. You are working from home, or trying to, amid the distractions and stresses of truant children and wayward laundry. How will your taxes change as a result? Are there write-offs you can take? And what if your income has crashed? Are there supports for you in the Tax Code?
Here are some answers to those questions, and more, from the point of view of an employee or self-employed person, with a special comment for employers. As always, please let us know if you have questions about how any of the provisions discussed applies to you.
Try to get reimbursed for out of pocket expenses you incur in connection with your job or freelance business. Reimbursement is tax-free for an employee, provided the employee submits a proper expense report, and can be canceled out with deductions for a self-employed person. It puts the pain where it belongs, with the boss or client, and makes you whole.
Expenses that cannot be reimbursed can generate tax benefits, but not for payroll workers. Too bad! A self-employed person, on the other hand, can take deductions for ordinary and necessary expenses of carrying on a trade or business. So independent contractors should keep track of such expenditures: they help three ways at tax time, reducing federal and state income tax and self-employment tax.
Every business is different. But it is common for self-employed persons to pay for office supplies and connectivity, for trade publications and professional education, for health insurance, for hardware and software and for office-related costs. You can deduct a portion of the cost of operating your home to the extent you regularly and exclusively use a portion of the home as the principal place of business or for storage of inventory. Plopping your laptop on the kitchen table won’t count, since you don’t exclusively use the kitchen table for work. Employees can be reimbursed tax-free for home office costs if the home office is maintained for the convenience of the employer. That’s tax talk for, you must have the home office to do your job – typically, because there is nowhere else for you to work.
Workers and the companies they serve might have nasty surprises this year around state taxes. Say that, in the Great Before, you worked in Massachusetts, commuting from your home in New Hampshire. Now you must work from home exclusively. Massachusetts says you still owe tax on your salary, even though you are not working in the Bay State anymore. It gets worse. Let’s say you work in New York normally, but have decamped to Maine. Maine will tax you, because you are working in Maine. But New York will ALSO tax you, because New York has a law that taxes telecommuters whose employer is in New York. Usually, a state like Maine will give you a credit against its tax for tax paid on the same income in another state. But not this time: under Maine law, New York has no taxing jurisdiction, and so no credit is allowed. Maine and New York are far from the only pair of states in which this double tax could arise. Consider complaining vociferously to your government representatives about this. Also consider trying to get made whole by your company, if they sent you home to work and thus exposed you to double tax.
Employers can get their own shock upon learning that, by locating employees at their homes in a state, they have thus triggered their own state filing requirement there. It’s analogous to opening an office in a new state, even though the “office” is somebody’s living room and the telework was required by government shutdown. Some states are waiving taxing rights on employers in these situations, but not all of them. Check with us if you now have workers in new states.
Say you lose your job, or your hours are cut back. You should claim unemployment benefits, if you are eligible. Unemployment is taxable. It can be a big bummer to owe tax after a year of job loss. Consider having tax withheld from your benefit to manage the liability. Ask us if you want help figuring out the appropriate percentage for withholding, or the amount to put aside for the tax.
Workers at companies with fewer than 500 employees are entitled to special paid family and medical leave for 2020. Self-employed people can claim a tax credit for a parallel benefit. To qualify, you or a family member must be sick or quarantined or school or regular day care for a child under 18 must have closed because of the pandemic. The benefit is not tiny and can be claimed intermittently, i.e., for several hours a day, for times when you cannot work or telework because you must change diapers or manage homeschooling, or tend to a sick loved one. Your employer will be reimbursed for the full amount of the benefit.
The Economic Impact Payments that many taxpayers received earlier this year are not taxable at the federal level and by most states.
If you suffered adverse financial consequences because of COVID 19-related sickness, job loss, or other misfortunes as listed by the IRS, you can take money, up to $100,000, from your retirement plan on favorable terms. Usually, such withdrawals are taxable in the year received. And, for account holders under the age of 59 ½, a special 10% penalty tax applies, on top of regular tax. This year, eligible taxpayers won’t owe the 10% penalty tax. And they can spread the remaining, regular federal income tax out over three years. Or they can repay the money to the account over three years and end up having paid no tax. There are lots of twists to this program. Let us know if you are contemplating using it, so we can make sure it will work for you. Aside from tax, it’s not a great idea to raid your retirement account. That money will be needed for your older self. And it can’t grow if you pull it out and spend it, and won’t grow as much, even if you later replace it.
Once you hit a certain age, currently, 72, you must start receiving and paying tax on at least a minimum amount from your IRA or retirement account. But not this year. Congress suspended the requirement to receive these so-called Required Minimum Distributions for 2020. If you don’t need the money, don’t take it!
Self-employed people affected by the COVID 19 crisis – and who wasn’t? – were able to receive grants and loans from the Small Business Administration. So-called Economic Injury Disaster Loans (EIDLs) are not taxable to the extent they must be repaid. Indeed, the interest on the loans will be deductible. EIDLs can be partially grants, however. The grant will be taxable. But you should be able to cancel out the income with expenses.
Paycheck Protection Program (PPP) loans can turn into grants upon application to the lender. Under current guidance, to the extent PPP loans are forgiven, a corresponding amount of otherwise-deductible expenses will be disallowed. That, in effect, will make the grants taxable. There is much uncertainty about this, and ferment in Congress around the program. Legislators have vowed refresh the program, to clarify that forgiveness will be tax-free, and/or to forgive smaller loans automatically. Who knows what they’ll actually do. If you didn’t get a PPP loan, you should watch the news. If the program is revived, consider taking part. If you need help applying for forgiveness, let us know.
We will get through this crisis somehow. Maybe the world after the pandemic will be better than the one before – it’s something to hope for. Meanwhile, please stay safe and be well, and if there is any way we can help, please contact John Schachter + Associates.