We are delving into some frequently asked questions from our clients on our blog all summer. Up first- S Corps and home offices!
If you recently transitioned from a Schedule C Sole Proprietor to an S-Corp, you may be wondering what you should do about your home office deduction. While in the past, you created a line item on your personal taxes, you now have some new options as an S Corp shareholder.
When you own 2% or more of an S-Corp, it is important to take care as to how you treat your car deductions and home office as you want to avoid being unnecessarily taxed on these as income.
The IRS recommends (see Publication 587) using reimbursements under an "employee accountable plan"- one where the employee must report their expenses to be reimbursed-, rather than cutting a rent check to yourself. Because you are both a shareholder and an employee as an S Corp member, you are eligible to determine the amount of expenses you are paying for office use of your home and have the company reimburse you monthly. The great thing about this option is that you also avoid depreciation recapture when you sell your home (something you do have to worry about with the standard Schedule C home office deduction).
To calculate the reimbursement, first determine the percentage of business use of the home- the area used exclusively for business- by dividing the business sq. footage by the total sq. footage. This percentage of your rent, mortgage interest, real estate taxes, HOA dues, home insurance, utilities, etc. is then calculated for your reimbursement. However, you then must reduce the amount of mortgage interest and real estate tax on your itemized Schedule A deductions, so first have your accountant run the numbers to see if the savings is high enough. If you are in a high tax bracket, this deduction is probably worth your time.
If this deduction doesn't hold water for your situation, you still have the option of taking the safe harbor office deduction on Form 2106 on your personal return, though this is a limited deduction.
Make sure you evaluate this deduction each year with your accountant.