Updated: Oct 29, 2018
Many S-corp owners work from home. Are they leaving potential deductions on the table, unused?
Sole proprietors have the luxury of deducting their home office expenses on their schedule c of their personal income tax return . How does an individual who owns an S-Corp get the same benefit?
S-Corp Owners have Options:
Least favorable - In the past, owners could deduct reimbursed home office expenses on schedule A as an itemized deduction. This deduction was subject to limitations such as 2% of their AGI, as well as limitations applying to all their Itemized deductions making it an unfavorable yet administratively easy. This option was lost, when in 2017 tax reform eliminated the reimbursed business expense deduction.
Most Favorable - The corporation can pay you for the costs of a home office under an "accountable" plan for employee business expense reimbursement. The plan must meet three requirements:
The expenses must have a business connection. The expenses must be incurred while the employee is performing work for the company, and must be ordinary and necessary expenses. These can include mileage for business-related driving, meals with clients and out-of-pocket travel expenses. They can also include a portion of mixed-use expenses – that is, those with a personal and business component, such as home office expenses, cell phones and home internet.
There must be substantiation to support the deduction. This can be easily accomplished by submitting a detailed monthly or quarterly expense report with the relevant documentation attached. - Keep your receipts.
Any excess reimbursements over actual expenses must be repaid promptly.
Setting up an accountable plan is quite simple. Here’s a sample agreement you can adapt for your Plan. Once a year, you file an "expense report" - basically an accounting of your home office expenses and the S corporation cuts you a tax deductible check.
But in practice, what does the accounting look like?
Our client would create an expense account in the books called Employee reimbursement expense. They would submit their "expense report" or their home office accounting of expenses such as utilities, internet, phone, taxes, repairs, etc. Before year end, a tax professional would go review their expense report and let tour client know how much they could reimburse themselves for the home office. They would then write themselves a check and classify it to the Employee reimbursement expense account.
What Amounts Qualify for reimbursement - The home office rules:
For home office expenses, shareholders can be reimbursed for an allocated portion of their home maintenance expenses, including mortgage interest, property tax, insurance, utilities, home internet, trash, and repairs and maintenance. Any portion of mortgage interest and property taxes that’s reimbursed through an accountable plan must be deducted from the amounts reported on Schedule A.
To qualify as a home office, the area must be used regularly and exclusively for business. The home office portion of household expenses is allocated according to relative square footage. Some employees include a floor plan of the home, with a calculation of the square footage with their expense reports, to add additional credibility to their assertion.
An allocated portion of depreciation for the house should also be included in the reimbursed amount. When the house is sold, the “allowed or allowable” portion of the home office depreciation expense will be recaptured as ordinary income, so clients may as well receive a benefit now.
For some mixed expenses, such as cell phone or internet, allocation on a square footage basis may not be appropriate. The IRS allows a “reasonable” allocation method for these expenses. This can be the actual business percentage calculated on a sample period of a few days or weeks, or another method that can be consistently applied.
Without an accountable plan in place, these reimbursements are taxable income to the shareholder and should be reported on their W-2.
Setting up an accountable plan is one of the best methods for a shareholder to get cash out of their corporation. Rent, distributions and wages are the other main methods. But, in contrast to those methods, accountable plan reimbursements are tax-free to the shareholder (as are distributions) and deductible to the S corporation, as are rent and wages. Accountable plans are truly a win-win all around for your S corporation clients.