When the home office deduction for employees was disallowed effective in 2018, no one anticipated the transformation the 2020 pandemic would have on the workplace. Now, with so many people working remotely, employees are asking their employers whether they can be reimbursed for home office expenses.
For the tax-exempt employer, issues go beyond whether the reimbursement is taxable income to the employee. If the employer is an exempt organization, then reimbursements to employees also raise issues of excess benefits, private inurement, and self-dealing.
Employers are permitted to reimburse employees for tangible home office expenses such as computers, monitors, printers, and other equipment under an accountable plan if such expense meets the home office deduction requirements. To qualify as a home office deduction:
- the employee must regularly and exclusively use part of the home for a trade or business, and
- the home office must be for the employer’s convenience.
To be tax-free under an accountable plan, employees must:
- make an “adequate accounting” of the expense—that is, follow all the applicable recordkeeping and other substantiation rules for the expense,
- timely submit expense reports and receipts to the employer, and
- timely return any payments that exceed what the employee actually spent for job expenses.
Currently, employers are not able to reimburse employees under the home office deduction rules for non-tangible home office expenses, such as rent, as the home office deduction is disallowed until 2026. However, employers may reimburse expenses that do not qualify under the home office deduction rules so long as there is a bona fide business purpose for the expenses. The reimbursements will be treated as separate non-accountable plan reimbursements taxable to the employee (unless they qualify for a different exclusion). Reimbursement of business expenses where there is no bona fide business purpose may disqualify the entire accountable plan and are taxable to the employee. It is recommended not to reimburse the employee for these types of expenses.
Excess Benefits and Private Inurement – Public Charities
In considering reimbursements for home office expenses to officers or directors, one must also consider whether the reimbursement results in an excess benefit to the officer or director. Excess benefits to officers or directors can result in excise taxes imposed on both the organization and the recipient of the benefit. Unreasonably high compensation may result in an excess benefit.
If the compensation or other fee paid to the board member or officer is no more than what would normally be paid for similar services by comparable organizations in similar circumstances, and it is determined by independent persons with no conflict of interest, then it can be deemed reasonable. Thus, when reimbursing a home office, consider what comparable organizations are doing. Consider if the salary plus the reimbursed home office expenses is more than reasonable compensation.
In addition, errors in treating a reimbursement as nontaxable, when it should be taxable, can have dire consequences for an exempt organization. If the recipient is an officer or director of the organization or a family member of an officer or director, and the amount should have been included in taxable compensation, then the amount will be automatically deemed an excess benefit subject to an excise tax and the excess compensation must be paid back to the charity.
Self-Dealing – Private Foundations
Private foundations have a similar concern when reimbursing a disqualified person (officer, director, related persons, or entities). The concept of self-dealing for private foundations is similar, but not identical, to excess benefit transactions for public charities. In some ways the self-dealing rules are more onerous since it is possible for well-meaning board members to inadvertently engage in self-dealing. The regulations state it is immaterial whether the transaction results in a benefit or a detriment to the private foundation.
Private foundations may furnish goods and facilities to a disqualified person if it is reasonable and necessary to carry out the exempt purposes of the foundation and is part of the reasonable compensation of the recipient. Thus, they may reimburse expenses to a disqualified person (except a government official) so long as the expenses are necessary in performing the exempt activities of the foundation and the expense is reasonable. Expenses should be reimbursed only under an accountable plan.
If the foundation reimburses expenses not under an accountable plan, then it should be included in taxable compensation. Reasonable compensation is allowed, if necessary, to accomplish an exempt function. However, this applies only to professional and managerial services, such as executive director, legal, investment, or accounting services. This would not apply to janitorial or manufacturing, for example, or payments for property. In addition, private foundations may not pay rent to a disqualified person even if it is reasonable. If the private foundation is sharing space with disqualified persons, then it should pay rent directly to third party lessors.
If the foundation pays the disqualified person rent, or the reimbursement for a home office not under an accountable plan is either erroneously not included in compensation or results in unreasonable compensation, then this will be self-dealing. Self-dealing transactions can result in excise taxes on both the disqualified person and the foundation managers who participated in the decision.
The rules are complex, and considerations go beyond whether the amounts are taxable income to the employee. In addition, though not covered in this article, there are state tax issues when employees work in different states, affecting both the employee and the organization. Employees may be subject to income tax in the state where their home office is located, and the organization may establish income or sales tax nexus via the employee’s physical presence in that state.
Exempt organizations considering reimbursing employees for a home office, particularly employees in an executive or board position, should contact Clark Nuber or their tax advisor before doing so.
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