Insights

Home Office Deductions for Owners of LLCs and S Corporations

Self-employed individuals whose businesses are set up as sole proprietorships routinely use the home-office deduction for expenses related to the business use of their homes. The deduction is available to those who use a portion of their homes regularly and exclusively for conducting business and for whom the home is their principal place of business. Taking the home office deduction is fairly simple when you’re a self-employed individual and file Schedule C. In those instances, you simply indicate on IRS Form 8829 the percentage of your home that is used for work and the costs to maintain your space, and that amount will go on your Schedule C as a deduction.

However, there are additional tests that those who use a home office in their role as an employee, and technically, when a business is set up as an S corporation rather than a sole proprietorship or partnership, the business owner will have an employment relationship with the corporation. The additional tests include a requirement that the business use of the property be for the convenience of the employer and that the employee must 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, while the calculation of the dollar amount is pretty much the same as the sole proprietorship, how it is treated on the shareholders’ or members’ personal tax returns differs. If you are a member of a partnership or multi-member LLC, then you deduct the expenses as unreimbursed partnership expenses on Schedule E of your personal tax return, below the line that you report your activity from the partnership or LLC.

S corporation shareholder-employees may deduct office-in-the-home expenses as miscellaneous itemized deductions on Schedule A of their personal tax returns. But these deductions are of little or no value because of the 2% income floor imposed on miscellaneous itemized deductions, and the add back of such deductions in computing alternative minimum taxable income. For many taxpayers, that makes the home-office deduction essentially useless.

Rather than claiming an office-in-the-home deduction as a miscellaneous itemized deduction, an S corporation shareholder-employee could have the corporation reimburse the expenses properly allocable to the business use of the home. Reimbursement of business expenses is provided for under Internal Revenue Code Section 132. Pursuant to regulations applicable to Section 132, out-of-pocket business expenses should be documented and reimbursed on a current, monthly basis. To accomplish this, we recommend that shareholders of the S corporation submit an expense report as part of what is called an “accountable plan”. Take these steps to follow this path:

• Draft an accountable plan agreement for your company. It will outline what expenses are eligible for reimbursement, how they will be paid, etc.
• Calculate the percentage of your home that is used exclusively for business purposes. Divide the square footage used for business by the total square footage of the home and multiply by 100.
• Calculate the total amount of eligible reimbursable expenses using IRS Form 8829. Multiply each amount by the percentage of business use calculated in the step above and enter the results on the expense form that you use for your accountable plan.
• Prepare expense reports as the employee and turn them in to your company on a regular basis. Attach receipts or other documentation to the form to substantiate them.
• Cut the check from the business account and deposit it into your personal account. Attach a copy of the check to the form as documentation that these were paid.
• Enter the amount of the payment into your S corporation’s records as a reimbursement for employee expenses. Post each expense claimed to the appropriate expense account so that these expenses may be deducted from the corporation’s income on its tax return.

You have now created a tax-deductible business expense for the S corporation, and you don’t have to report the reimbursement as income.

There is one catch to this treatment: the deduction that the business can take is limited to the net income that the business generates. Therefore, if you have a loss for a given year, then you won’t be able to claim the deduction. What you can do is carry it forward to a future year. If you earn a profit in the future, you will be able to claim it then.

By documenting reimbursements from a corporate bank account to your personal account, you will be able to establish records to support your position to the IRS. That will make it easier for you to get the tax benefit of your home-office expenses without potentially triggering red flags.