S-Corp Home Office: Claiming Deductions

As a business owner, you can deduct a portion of your home's rent, utilities, mortgage interest, and property taxes through a home office deduction. This deduction is commonly claimed on Form 8829 of an individual's 1040 tax return. However, if your business is an S-corporation, a different approach is required. Here's an overview of how to claim a home office deduction as an S-corporation owner.

Create an accountable plan

To create an accountable plan for claiming a home office deduction as an S-corporation, there are several key steps and considerations to keep in mind. Here are the paragraphs outlining the process:

An accountable plan is a powerful tool for S-corporations to provide tax-free reimbursements to their employees, including shareholders, for home office expenses. This plan ensures that the reimbursed expenses are not considered compensation and offers tax benefits to both the employee and the corporation. To set up an accountable plan, the following three rules must be adhered to:

• Business Connection: Expenses must be directly related to the business and incurred while performing work for the company. This includes a range of expenses such as home office expenses, mileage, meals with clients, and out-of-pocket travel expenses.
• Substantiation: Proper documentation is essential. Employees should submit detailed monthly or quarterly expense reports, attaching relevant receipts or using apps like Expensify and Dext for convenience and compliance.
• Timely Repayment of Excess Advances: If the corporation provides advances for expenses, any amounts not used for their intended purpose must be returned promptly, typically within 120 days.

When it comes to claiming a home office deduction, there are specific requirements that must be met. The space used for the home office must be exclusively and regularly for business purposes, with no personal use. It should be either the principal place of business or a location where patients, clients, or customers are met regularly. Additionally, the home office should be necessary for the business to function or for the employee to properly perform their duties.

To calculate the reimbursement amount, determine the "business use percentage" of the home office by dividing the square footage of the office area by the total square footage of the home. This percentage is then applied to eligible expenses, such as mortgage interest, property taxes, insurance, utilities, repairs, and depreciation. Remember to reduce any itemized deductions, like mortgage interest and property taxes, by the reimbursement amount received from the corporation.

It's important to note that employees cannot use the simplified method for home office deductions when reimbursed through an accountable plan. They must use actual expenses. This ensures compliance with IRS requirements and helps maximize tax benefits for both the employee and the S-corporation.

By following these guidelines, S-corporations can effectively create an accountable plan to claim a home office deduction, providing tax advantages for both the business and its employees.

Calculate the home office reimbursement

To calculate the home office reimbursement, you must first determine the "business use percentage" of your home office. This is done by dividing the square footage of the office area by the total square footage of your home.

Once you have the business use percentage, you can calculate the reimbursement amount by multiplying it against the expenses incurred for that month. These expenses may include:

• Homeowner's insurance
• Utilities (oil heat, gas, electric)
• Alarm or security service
• General repairs and maintenance
• Mortgage interest (taken from the monthly mortgage billing statement)

For example, if your business uses 10% of your home and your total expenses for the month amount to $1,000, you would be reimbursed $100 by the corporation.

It is important to note that you must reduce your itemized deduction for real estate taxes and mortgage interest by the amount reimbursed by the corporation during the year. For instance, 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.

Substantiate the expense incurred

To substantiate the expense incurred, you must document the dollar amount, business purpose, and date of the expense. All reimbursable amounts need to be supported by receipts or other documentation. This documentation and substantiation must be completed within 60 days of the expense. For example, if you are being reimbursed for the first quarter of the year (January 1 to March 31), the documentation and reimbursement must be completed by May 31.

You should also create a monthly "Employee Expense Report" form for your corporation. This form should include lines for business mileage and other out-of-pocket business expenses, such as postage, office supplies, parking, tolls, meals, and entertainment. You can then staple the receipts for these items to the report.

Additionally, include a "Home Office" section in the report to calculate the "business use percentage" of your home office. To do this, divide the square footage of the office area by the total square footage of your home. Then, list each item of expense paid during the month, such as homeowner's insurance, utilities, 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.

Record the expense and claim the deduction

Recording the expense and claiming the deduction is the final step in the process of claiming a home office deduction as an S-corporation. This step involves properly documenting and reporting the reimbursement as an expense, ensuring that you have met all the requirements for a valid claim. Here is a detailed guide on how to do this:

Firstly, it is important to understand the concept of an "Accountable Plan". An Accountable Plan is a reimbursement arrangement that allows employees to be reimbursed tax-free for expenses incurred on behalf of the business. This is the recommended approach by the IRS for handling home office deductions for S-corporations.

To record the expense, you will need to complete the reimbursement process by transferring the calculated amount from your business bank account to your personal account. It is recommended that each payment or transfer covers a specific expense, such as rent, utilities, mortgage interest, real estate taxes, or depreciation. For example, if you rent your home, you would have two separate transfers each quarter: one for rent reimbursement and the other for utilities.

After the reimbursement is complete, record the expense in your accounting records, classifying it under the appropriate category (rent, utilities, interest, taxes, or depreciation). This step ensures that you have a clear paper trail and that the reimbursement is properly accounted for in your financial records.

Next, you will need to substantiate the expenses incurred on behalf of the business. This involves documenting the dollar amount, business purpose, and date of each expense. All reimbursable amounts must be supported by receipts or other valid documentation. Proper substantiation is crucial for demonstrating that the expenses were indeed business-related.

Timing and deadlines are also important considerations. The IRS requires that documentation and substantiation of expenses be completed within 60 days of the expense being incurred. For example, if you are seeking reimbursement for the first quarter of the year (January 1 to March 31), the documentation and reimbursement must be finalised by May 31.

Finally, you can claim the deduction on your tax return. As an S-corporation owner, you cannot use the simplified method (safe harbor method) of $5 per square foot for the home office deduction. Instead, you must use actual expenses for reimbursement and deduction purposes. This involves calculating 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. This percentage is then applied to expenses such as rent, mortgage interest, property tax, utilities, insurance, and repairs to determine the total reimbursement amount.

It is important to note that you must reduce your itemised deduction for real estate taxes and mortgage interest by the amount of reimbursement received from your S-corporation during the year. For example, if you received a reimbursement of $2,000 from your corporation and your real estate taxes for the year are $10,000, you can only deduct $8,000 in real estate taxes on Schedule A.

S corporation shareholder-employees may deduct office-in-home expenses

S corporation shareholder-employees can deduct office-in-home expenses as miscellaneous itemized deductions on Schedule A of their personal tax returns. However, due to the 2% income floor imposed on miscellaneous itemized deductions, and the add-back of such deductions in computing alternative minimum taxable income, these deductions are of little to no value.

A more tax-efficient way to handle the costs of a qualifying home office is to have the S corporation reimburse the shareholder-employee for the costs of the home office under an "accountable" plan for employee business expense reimbursement. This option provides greater tax savings as the corporation can deduct the reimbursement amount, and the employee does not need to report the payment on their personal income taxes.

To qualify as a home office, the space must be used regularly and exclusively for trade or business purposes and must be the principal place of business. 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. Additionally, there should be no personal use of the space.

To be reimbursed under an accountable plan, the expenses must be for actual job-related expenses, and the employee must provide receipts or other documentation to substantiate the expenses. The reimbursement amount is calculated by determining the "business use percentage" of the home office by dividing the square footage of the office area by the total square footage of the home. This percentage is then applied to eligible expenses, such as homeowner's insurance, utilities, repairs, and mortgage interest.

It is important to note that the reimbursement amount may need to be reduced from the itemized deductions for real estate taxes and mortgage interest on the employee's personal tax return.

Frequently asked questions