Many self-employed individuals who operate as sole proprietors take advantage of the home-office deduction to cover expenses related to using their homes for business purposes. This deduction is available to those who regularly and exclusively use a portion of their homes for conducting business, with their home serving as their primary workplace. Claiming the home office deduction is relatively straightforward for self-employed individuals who file Schedule C. In such cases, you simply indicate the percentage of your home used for work and the costs associated with maintaining that space on IRS Form 8829. The deduction amount is then reported on Schedule C.
However, there are additional criteria to consider if you use a home office as an employee. Technically, when a business is structured as an S corporation rather than a sole proprietorship or partnership, the business owner will have an employment relationship with the corporation. These additional criteria include the requirement that the business use of the property is for the employer's convenience and that the employee does not rent any part of the home to the employer.
For shareholders of an S corporation or members of a partnership or multi-member LLC, the calculation of the deduction amount is similar to that of a sole proprietorship. However, the way it is treated on the shareholders' or members' personal tax returns differs. If you are a member of a partnership or multi-member LLC, you deduct the expenses as unreimbursed partnership expenses on Schedule E of your personal tax return, below the line where you report your activity from the partnership or LLC.
S corporation shareholder-employees may deduct home-office expenses as miscellaneous itemized deductions on Schedule A of their personal tax returns. However, these deductions are generally of limited value due to the 2% income floor imposed on miscellaneous itemized deductions and the add-back of such deductions when computing alternative minimum taxable income. For many taxpayers, this renders the home-office deduction essentially useless.
Instead of claiming a home-office deduction as a miscellaneous itemized deduction, an S corporation shareholder-employee can have the corporation reimburse the expenses directly related to the business use of the home. The reimbursement of business expenses is permitted under Internal Revenue Code Section 132, and regulations applicable to Section 132 require that out-of-pocket business expenses be documented and reimbursed on a monthly basis. To follow this approach, we recommend that S corporation shareholders take the following steps:
Draft an accountable plan agreement for your company, outlining the eligible expenses for reimbursement and the payment process.
Calculate the percentage of your home exclusively used for business purposes by dividing the square footage used for business by the total square footage of the home and multiplying by 100.
Use IRS Form 8829 to calculate the total amount of eligible reimbursable expenses. Multiply each amount by the percentage of business use calculated in the previous step and enter the results on the expense form for your accountable plan.
As the employee, prepare expense reports and submit them regularly to your company. Attach receipts or other supporting documentation to substantiate the expenses.
The reimbursement amount should be transferred from the business account to your personal account. Attach a copy of the check as documentation for the payment.
Record the reimbursement in your S corporation's financial records as a reimbursement for employee expenses. Allocate each claimed expense to the appropriate expense account to deduct these expenses from the corporation's income on its tax return.
By following these steps, you have created a tax-deductible business expense for the S corporation, and you are not required to report the reimbursement as income.
There is one limitation to consider: the deduction the business can take is limited to the net income generated by the business. Therefore, if your business incurs a loss in a given year, you won't be able to claim the deduction. However, you can carry it forward to a future year.
If you are an employee of your own S corporation, you have several options to consider regarding the costs associated with a qualifying home office.
Here are two primary approaches:
To qualify as a home office, the space (which doesn't have to be an entire room) must be used regularly and exclusively for your trade or business. It should be your principal place of business or a location where you frequently meet with clients, patients, or customers. Administrative or management activities performed in the space contribute to it being considered your principal place of business. Additionally, the home office must be for the convenience of your employer, meaning it is necessary for your work or business to function properly.
When it comes to expense reimbursement plans, they need to meet certain criteria to be considered "accountable." The expenses being reimbursed must be actual job-related expenses, and you, as the employee, must provide your employer with receipts or other documentation to substantiate the expenses.
Consider creating a monthly "Employee Expense Report" form for your corporation, even if you don't have a home office. This form can help you track various business expenses, such as mileage, office supplies, postage, parking, tolls, meals, entertainment, and more. Make sure to include a specific section for home office expenses. Calculate the "business use percentage" of your home office and list the relevant expenses incurred during the month, such as real estate taxes, homeowner's insurance, utilities, security services, general repairs and maintenance, and mortgage interest. For each expense, attach the corresponding receipts to the report.
It's essential to note that the amount reimbursed by your corporation for real estate taxes and mortgage interest will reduce your itemized deductions for these expenses. For example, if your corporation reimbursed you $2,000 for real estate taxes, your itemized deduction for the year would be reduced accordingly.
General Guidelines for S-Corp Home Office Deductions or Reimbursements
Deducting or being reimbursed for a home office no longer impacts the tax implications when selling your personal residence, as it did in the past. If the home office is part of the same "dwelling unit" as the residential portion of your home, you are considered to be using the entire home as your principal residence. Therefore, when you sell your home, you won't owe income tax on the portion of the gain attributed to the home office. Instead, you can exclude the entire gain, up to the limits of $250,000 or $500,000, if you qualify.
Please keep in mind that the information provided here should not be construed as legal, tax, accounting, or valuation advice. It is essential to seek appropriate professional advice and thoroughly assess your specific situation before taking any action.
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