Claiming Home Office Deductions On 1120S

can you put a home office on 1120s

Many taxpayers find the home-office deduction to be one of the scariest provisions in tax laws due to fears of triggering an IRS audit. For business owners who set up their businesses as S corporations, the home-office deduction is even more complicated, and many conclude that they simply can't take it. However, there are ways to benefit from the expenses of having a home office.

If you are an employee of your own S corporation, you have a few choices for handling the costs of a qualifying home office. The S corporation can pay you rent for the home office, or it can pay you for the costs of a home office under an accountable plan for employee business expense reimbursement. Being reimbursed under an accountable plan provides the greatest tax savings and is an excellent way to get money out of your S corporation tax-free. The corporation can deduct the reimbursement amount, and you do not need to report the payment on your personal income taxes.

Characteristics Values
Home office deduction Can be claimed by self-employed individuals whose businesses are set up as sole proprietorships or business entities treated as partnerships for tax purposes
Is more complicated for S corporations
Ways to get a deduction for S corporations Claim a miscellaneous itemized deduction for unreimbursed employee expenses
Have the S corporation reimburse the expenses that are allocable to the business use of the home
The S corporation can pay rent for the home office
The S corporation can pay for the costs of the home office under an accountable plan for employee business expense reimbursement
Home office qualifications The space in question must be used on a continuous basis
The space must be exclusive, meaning the office cannot be used for personal reasons and must be used for business and trade only
The location must be the primary place of business where meetings with customers, clients, or patients take place physically and regularly
The place must be the primary place where administrative tasks and appointments are established
There should be no other location where the same tasks are conducted

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Home office deductions for S-Corps

If you are an employee of your own S-corporation, you have several options for handling the costs of a qualifying home office. Firstly, you can deduct the costs of a home office if you are filing a Schedule C. However, under the Tax Cuts and Jobs Act (TCJA), employees working remotely can no longer deduct home office expenses on their tax returns to the extent that they exceeded 2% of adjusted gross income (AGI). Secondly, the S-corporation can pay you rent for the home office, although you must report this rent as income on Schedule E. Thirdly, the S-corporation can pay you for the costs of a home office under an "accountable" plan for employee business expense reimbursement.

The third option, being reimbursed under an accountable plan, provides the greatest tax savings. The corporation can deduct the amount of the reimbursement, and you do not have to report the payment on your personal income taxes. To qualify as a home office, the space does not have to be an entire room, but it must be used regularly and exclusively for your trade or business, and it must be your principal place of business. This means that you do not have any other fixed location where you perform administrative or management activities such as billing, bookkeeping, ordering supplies, setting up appointments, and writing reports. As an employee, the home office must be for the convenience of your employer. This means that the home office is required as a condition of employment, it is necessary for the business to function, or it is necessary for you to properly perform your duties as an employee.

To qualify as an accountable plan, the expenses that are reimbursed must be for actual job-related expenses, and you, as the employee, must substantiate the expenses by providing your employer with receipts or other documentation. You should create a monthly "Employee Expense Report" form for your corporation, which includes lines for business mileage and other out-of-pocket business expenses, such as postage, office supplies, parking, tolls, meals, and entertainment. You should also include a Home Office section in the report, where you calculate the "business use percentage" of your home office by dividing the square footage of the office area by the total square footage of your home. You can then list each item of expense paid during the month, such as homeowner's insurance, utilities, alarm or security services, general repairs and maintenance, and mortgage interest. Multiply the total of these expenses by the business use percentage to determine the amount to be reimbursed.

It is important to note that if you are reimbursed for home office expenses by your S-corporation, you must reduce the amount of your itemized deduction for real estate taxes and mortgage interest by the amount of the reimbursement. For example, if your real estate taxes for the year are $10,000, but you were reimbursed $2,000 by the corporation, you can only deduct $8,000 in real estate taxes on Schedule A.

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Qualifying for a home office

To qualify for a home office deduction, you must meet the following criteria:

Exclusive and Regular Use:

The space for your home office must be used exclusively and regularly for business. This means that the area cannot be used for personal reasons and must be solely dedicated to business and trade. It should be used on a continuous, ongoing, or recurring basis.

Principal Place of Business:

Your home office must be either the principal location of your business or a place where you regularly meet with customers, clients, or patients. This means it should be where you primarily conduct your business activities, such as administrative or management tasks like billing, bookkeeping, ordering supplies, setting up appointments, and writing reports.

Convenience of the Employer:

If you are an employee of your own S-Corporation, the home office must be for the convenience of your employer. This means that the home office is required as a condition of employment, it is necessary for the business to function, or it is essential for you to properly carry out your job duties.

Additional Requirements:

  • The space does not have to be an entire room but can be a designated area or section of a room.
  • You can have multiple work locations, including a home office, as long as you use the home office for substantial administrative activities.
  • You must be able to prove that your home office is your primary workplace through expense receipts and documentation.
  • If you provide daycare services or use your home for inventory storage, you may still qualify for the deduction even if the space is used for personal activities at other times.

Calculating the Deduction:

There are two methods to calculate the home office deduction: the standard method and the simplified option.

The standard method involves determining the square footage of your home office as a percentage of your total home square footage. This percentage is then applied to various expenses, such as homeowner's insurance, utilities, repairs, mortgage interest, and property tax.

The simplified option uses a standard deduction of $5 per square foot of the portion of your home used for business, with a maximum of 300 square feet and a maximum deduction of $1,500.

Additional Considerations:

  • You must reduce your itemized deductions for real estate taxes and mortgage interest by the amount reimbursed by your corporation for these expenses during the year.
  • If you sell your home, the home office deduction today will not affect you, as you are treated as using the entire home as a principal residence.
  • If you are reimbursed for depreciation on your home office, this will be considered income when you sell your home, and you may have to pay capital gains tax on the reimbursed amount.
  • Keep accurate records of your deductions in case of an audit.

Please note that the above information is not exhaustive and may not cover all specific scenarios or requirements. It is always recommended to consult with a tax professional or refer to the IRS website for the most up-to-date and comprehensive guidelines regarding home office deductions.

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Reimbursement for home office expenses

The home office deduction allows taxpayers to deduct certain home expenses when they file their taxes. However, employees are not eligible to claim the home office deduction. Only self-employed or independent contractors can claim the home office deduction.

If you are a business owner, there are two ways to get a tax benefit for your home office expenses:

Claim a miscellaneous itemized deduction for unreimbursed employee expenses.

The problem with this option is that miscellaneous deductions are only deductible if they exceed 2% of your adjusted gross income.

Have the business reimburse the expenses that are allocable to the business use of the home.

By doing so, the business can claim a deduction for necessary business expenses, while the taxpayer is allowed to exclude the reimbursements from income under the fringe-benefits provisions of the tax law.

Requirements for home office reimbursements:

The home office must be for the convenience of the employer. This means that the home office is required as a condition of employment, it is necessary for the business to function, or it is necessary for the employee to properly perform their duties.

The space must be used regularly and exclusively for trade or business and must be the principal place of business or a place where the employee physically meets with patients, clients, or customers on a regular basis.

The space will be considered the principal place of business if it is used for performing administrative or management activities, and there is no other fixed location where these duties are conducted.

How to calculate home office reimbursement:

Calculate the "business use percentage" of your home office by dividing the square footage of the office area by the total square footage of the home.

List each item of expense paid during the month, such as:

  • Homeowner's insurance
  • Utilities
  • Alarm or security service
  • General repairs and maintenance
  • Mortgage interest

Multiply the total of these expenses by the business use percentage to determine the amount to be reimbursed.

State laws on reimbursement for home office expenses:

While federal law does not require employers to pay for work-related expenses incurred by employees working from home, many state laws do. These states include California, Washington D.C., Illinois, Iowa, Massachusetts, Minnesota, Montana, New Hampshire, New York, North Dakota, Pennsylvania, and South Dakota.

Tax implications of reimbursement:

If the reimbursement is done through an accountable plan, it is not considered wages and is therefore not subject to taxation. It is also deductible by the employer as a business expense.

If the reimbursement is done through a nonaccountable plan, it is treated as supplemental wages and is subject to applicable taxes. It will also need to be reported on the employee's W-2 form.

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Home office expenses and S-Corp taxation

The home office deduction is one of the scariest provisions in tax laws for taxpayers, as it may trigger an audit by the IRS. For business owners who set up their businesses as S corporations, the home-office deduction is even more complicated, and many end up concluding that they simply can't take it. However, by being careful in how you structure the relationship between yourself and your S corporation, there's a way you can benefit from the expenses of having a home office.

Deduction Alternatives

There are two ways S corporation owners can get a tax benefit for their home-office expenses:

  • Claim a miscellaneous itemized deduction for unreimbursed employee expenses. However, miscellaneous deductions are only deductible if they exceed 2% of your adjusted gross income, which makes the home-office deduction essentially useless for many taxpayers.
  • Have the S corporation reimburse the expenses that are allocable to the business use of the home. By doing so, the business can claim a deduction for necessary business expenses, while the taxpayer is allowed to exclude the reimbursements from income under the fringe-benefits provisions of the tax law.

Home Office Qualifications

To qualify your abode as a home office, you must adhere to the following:

  • The space in question must be used on a continuous basis.
  • The space must be exclusive, meaning it cannot be used for personal reasons and must be relegated for business and trade only.
  • The location must be your primary place of business where you meet with customers, clients, or patients physically, and the meetings must occur regularly.
  • In addition, the place must be a primary place where you engage in administrative tasks and establishing appointments.
  • You must have no other location where you conduct the same tasks.

Accountable Plan for S-Corporation Deductions and Reimbursements

Being reimbursed under an accountable plan provides the greatest tax savings. It is an excellent way to get money out of your S corporation tax-free. The corporation can deduct the amount of the reimbursement, and you do not have to report the payment on your personal income taxes. This option is better than having the corporation pay you rent for the home office, as you must report the rent as income on Schedule E.

General Guidelines for S-Corp Home Office Deductions or Reimbursements

Deducting, or being reimbursed for, a home office today will no longer turn around and bite you when you sell your personal residence, as had been the case in the past. If the home office is within the same "dwelling unit" as the residential portion of your home, you are treated as using the entire home as a principal residence.

For example, if the office space was 10% of the total area of your home, you do not have to pay income tax on 10% of the gain from the sale. You will be able to exclude the entire gain, up to the $250,000 or $500,000 limits, if you qualify.

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Home office expenses and selling your home

If you run a business out of your home, you may be able to claim tax deductions on expenses incurred from operating your business. This includes expenses such as utilities, mortgage interest, and property taxes.

Home Office Deductions

To qualify for home office deductions, your home office must meet the following criteria:

  • It is used exclusively and regularly as your principal place of business.
  • It is used exclusively and regularly as a place where you meet or deal with patients, clients, or customers.
  • It is a separate structure that is not attached to your home but is used in connection with your trade or business.
  • It is used on a regular basis for certain storage purposes.
  • It is used as a rental for your business.
  • You use your home as a daycare facility.

Calculating Home Office Expenses

There are two methods to calculate how much of your home constitutes a home office and how much of your incurred expenses are deductible:

  • The "regular" method: Calculate your actual expenses by determining which of your business expenses are direct, indirect, or unrelated. Then, figure out the percentage of your home used for business purposes.
  • The "simplified" method: This method is faster but may not yield as many deductions. Multiply the allowable area of your home used for business by $5 (or less if the qualified business use is for a daycare).

Selling Your Home

When selling your home, you do not need to allocate the gain (profit) on the sale of the property between the business part of the property and the part used as a home. This means that your entire profit qualifies for the special home sale tax exclusion from capital gains tax.

Under this exclusion, a substantial amount of the profit you make on the sale of your home is not taxable: up to $250,000 for single taxpayers and $500,000 for married taxpayers filing jointly. To qualify for this exclusion, you must have lived in your home for at least two out of the five years before the sale.

However, it is important to note that if you have claimed depreciation deductions for your home office, you will have to pay a capital gains tax on these deductions when you sell your home. This is because depreciation deductions are considered "recaptured" deductions, which are taxed at a rate of 25%.

Therefore, when selling your home, be sure to consider the tax implications of any home office deductions you have claimed. Consult a tax professional or use appropriate tax software to ensure you are complying with all relevant tax laws.

Frequently asked questions

The best way to claim a home office deduction for an S-Corp is to use an Accountable Plan and have the business reimburse the employee for any expenses related to the home office. This is a better option than having the corporation pay rent for the home office as the reimbursement can be made tax-free and without the need to report it as income.

To qualify as a home office, the space must be used regularly and exclusively for trade or business and it must be the principal place of business. This means that the space cannot be used for personal reasons and must be the primary place where administrative tasks are carried out and appointments are set.

Expenses that can be deducted for a home office include homeowner's insurance, heat, gas, electric, alarm or security services, general repairs and maintenance, and mortgage interest.

Written by
  • Lara Beck
  • Lara Beck
    Author Home Renovation Professional
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