Can you still get a deduction for your home office if you are an S corporation shareholder? The answer is yes.
There are two options. Either you rent a portion of your home to the S corporation as office or storage space, or the S corporation reimburses you for the home office use under an accountable plan.
First option: renting a portion of your home office to the S corporation
If you rent a portion of your home to the S corporation, you must do it so at fair market value. Otherwise, the IRS may reclassify the excess rent over the fair market value as wage income, resulting in additional payroll taxes and penalties. Or, the IRS can argue that the rent is a disguised distribution.
The rental income must be reported on schedule E on your personal tax return. However, due to the fact that you lease your home space to your employer, there are limitations on the deductions you can take. You can only claim the deductions that would be deductible in the absence of any business use, generally mortgage interest and real estate taxes.
In addition, because you rent property to a business in which you materially participate, the “self-rental” rules apply, which re-characterise the rental income as active income, while the rental loss remains passive.
The advantage of renting your home office to the S corporation is that it reduces the net income of the S corporation, thus reducing the “reasonable salary” threshold, giving you some savings on the self-employment tax.
Second option: reimbursement under an accountable plan
The company must have an accountable plan in order to take advantage of this options.
Per the IRS, “to be an accountable plan, your employer’s reimbursement or allowance arrangement must include all of the following rules:
- Your expenses must have a business connection — that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer.
- You must adequately account to your employer for these expenses within a reasonable period of time.
- You must return any excess reimbursement or allowance within a reasonable period of time.”
See IRS Publication 463 for more information.
You must use your home office exclusively and regularly for business.
You have to comply with all the requirements for the home office deduction, including the principal place of business test.
When you have multiple work locations, to determine whether or not your home office is your principal place of business, “you must consider:
- The relative importance of the activities performed at each place where you conduct business, and
- The amount of time spent at each place where you conduct business.
Your home office will qualify as your principal place of business if you meet the following requirements:
- You use it exclusively and regularly for administrative or management activities of your trade or business.
- You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.”
See IRS Publication 587 for more details about the business use of your home.
With this option you save, not only on self-employment taxes, by reducing the “reasonable salary” threshold, you also save on income taxes, because you don’t have to pick any income on the personal return, as was the case with the rental scenario.
In addition, if you have a qualified home office and another work space, like a shop, the commuting miles between your home and your other work place are now becoming deductible. Actually you can deduct the cost of any trips you make from your qualified home office to another business location, like meeting clients, for example. Don’t forget that you also need to reimburse these miles under the Accountable Plan.
To learn more about tax rules and regulations, request a free consultation or call us at 832-919-8448.