Home Office Taxes - Closely Held Corporation & S Corp
If the business operated out of a taxpayer's home is organized as a corporation, direct and indirect expenses of the home office are the entity's expenses, not the owner-employees. From a tax standpoint, there are three ways to handle these expenses:
Payment of Rent
The Corporation can pay its shareholder-employee rent to offset home office expenses and supply him with an information return (Form 1099-MISC). The rent will be deductible by the corporation, assuming it's a reasonable amount for the space and services actually provided and will be taxable to the shareholder-employee.
Caution – Shareholder-employees need to avoid any appearance of trying to convert wages subject to Social Security tax to rental income not subject to Social Security tax. However, the shareholder-employee/homeowner won't be able to claim offsetting deductions. The rules allowing deductions for business use of a dwelling unit do not apply to any expense attributable to the rental of all or part of a taxpayer's dwelling unit to his employer during any period in which he uses the rented portion to perform services as an employee of the employer. For purposes of this rule, an independent contractor is treated as an employee, and the party for whom the independent contractor is performing services is treated as an employer. Where such a lease arrangement exists, the only deductions that are allowable are those that could be claimed in the absence of any business use, e.g., mortgage interest, real estate taxes and casualty losses (limited to losses attributable to federally declared disasters for 2018 through 2025).
Unreimbursed Employee Expenses (before 2018 and after 2025)
The shareholder-employee can satisfy the convenience of the employer test if he is working in the only location of the business. Assuming that he meets the other home-office requirements, the shareholder-employee can claim home office deductions as if he were a qualifying employee of an unrelated corporation, namely treat them as unreimbursed employee expenses on Schedule A. To ward off a possible IRS attack on the grounds that the shareholder-employee is paying expenses for which he could have sought reimbursement, there should be a written agreement to the effect that the shareholder employee is required to pay for expenses. Although this approach appears to be clean, neat and simple, there are a number of unattractive consequences:
The shareholder-employee can only deduct home office expenses to the extent the total of his miscellaneous deductions exceeds 2% of his AGI—this rule may bar home-office deductions altogether. In years 2018-2025 no deduction is allowed because of the TCJA’s suspension of miscellaneous itemized deductions subject to the 2% of AGI reduction.
Claiming home office deductions may increase the taxpayer's chances of being audited.
The deduction is not allowed against the AMT, which could reduce or eliminate the deduction if the individual is subject to the AMT.
Depreciation deductions claimed for the business-use portion of the home reduce the owner's basis in it, and any home sale gain representing depreciation adjustments attributable to post-May 6, '97 periods isn't eligible for the $250,000/$500,000 home sale gain exclusion.
Reimbursed Employee Expenses
The shareholder-employee can treat his home office expenses as if he were a regular employee, and then, by written pre-arrangement with the corporation, have it reimburse him for these and other employee business costs after he substantiates them in full (amount, time, place, and business purpose of each expense). The shareholder-employee should include on his or her monthly expense report a list of home office related expenses – for example, homeowner’s insurance, utilities (oil heat, gas and electric, water and sewer), alarm or security service, trash disposal, general repairs and maintenance, real estate taxes, and mortgage interest (obtainable from the monthly mortgage billing statement or a loan amortization statement). The total of the office related expenses multiplied by the business use percentage of the home will be the reimbursable amount by the corporation.
Results: Assuming the shareholder-employee could have claimed the expenses as business deductions the reimbursement for the expenses is fully deductible by the corporation and is a tax-free accountable-plan reimbursement to the employee. The shareholder-employee avoids having to claim attention-generating home-office deductions and doesn't have to struggle with depreciation deductions and basis adjustments. However, the shareholder employee can't deduct the business-related portion of his mortgage interest and property tax if the corporation gives him a tax-free accountable-plan reimbursement for these items. Otherwise, he would be getting a double tax benefit—a deduction and tax-free reimbursement—from the same expense.