The Best Way to Claim a Home Office Tax Deduction for the Owner of a Corporation - Philadelphia CPA
264
post-template-default,single,single-post,postid-264,single-format-standard,ajax_fade,page_not_loaded,,qode_grid_1300,footer_responsive_adv,qode-content-sidebar-responsive,qode-child-theme-ver-,wpb-js-composer js-comp-ver-5.1.1,vc_responsive
 

The Best Way to Claim a Home Office Tax Deduction for the Owner of a Corporation

The Best Way to Claim a Home Office Tax Deduction for the Owner of a Corporation

When you operate your business as a corporation, knowledge is critical to claiming the best tax deduction for an office in the home.

Technically, the owner of a corporation can claim tax deductions for a home office in one of three ways, two of which are pitiful and need rejection.

Reject 1. Rent Office to the Corporation

Whether you operate as an S corporation or a C corporation, you get minor, zero, or negative benefit when you rent an office in the home to your corporation.

IRC Section 280A(c)(6) disallows tax deductions for the home office on rentals by employees to their employers. 1 Thus, owner-employees do not achieve home-office deductions on the rental of an office in the home to their corporations.

S Corporation Example
Henry Jackson rents his home office to his S corporation for $9,600 a year. The results are:

1. $9,600 tax deduction for the S corporation

2. $9,600 in taxable income to Mr. Jackson reported on Schedule E of his Form 1040

3. No deductions for the home, except otherwise already deductible mortgage interest, property taxes, and personal casualty losses

Thus, the S corporation deducts the rent, reducing the income reported on the K-1 to the owner-employee; and then the owner-employee reports the rent as income, producing a wash of the rent and income on Schedule E of the tax return.

If you itemize deductions, you already benefit by your deductions for mortgage interest, property taxes, and personal casualty losses.

Allocating the business part of mortgage interest and property taxes to Schedule E does not increase your deductions, but the placement on Schedule E moves the deduction above the line and that reduces adjusted gross income, which can produce some minor benefit.

C Corporation Example

Assuming the same facts as above, the C corporation deducts the $9,600 and the owner-employee reports the rent as rent income.

Since the C corporation is not a pass-through entity, the rental may or may not produce a wash.

Let’s look at an example. Say the rent is $10,000 for the year, you are in the 25 percent bracket, and your C corporation is in the 35 percent bracket. The result is:

Assuming the same facts as above, the C corporation deducts the $9,600 and the owner-employee reports the rent as rent income.

Since the C corporation is not a pass-through entity, the rental may or may not produce a wash.

Let’s look at an example. Say the rent is $10,000 for the year, you are in the 25 percent bracket, and your C corporation is in the 35 percent bracket. The result is:

1. you pay $2,500 in taxes on the $10,000 of rental income, and

2. your corporation gets a $3,500 tax benefit from the $10,000 rental expense.
At this point, you and your C corporation have a net tax benefit of $1,000, but $3,500 is trapped inside your C corporation. Say the corporation pays you a $3,500 dividend. Your federal tax on the dividend is $525 ($3,500 times 15 percent).

The net result: You have $475 in tax benefit from this rental before considering the movement of the rental part of mortgage interest and property taxes to Schedule E where it will have a minor effect. Here’s how the $475 came about:

1. You paid $2,500 in tax.

2. Your corporation received a $3,500 tax benefit.

3. Your corporation sent the $3,500 to you as a dividend.

4. Your paid $525 in taxes in the dividend.

In conclusion, having your corporation rent the home office from you is not the best way to achieve tax benefits.

Reject 2. Claim the Home Office as an Employee Business Expense

You face two unfair rules when, because you are an employee of your corporation, you claim the office-in-the-home deduction as an employee business expense:

1. You deduct your employee business expenses as miscellaneous itemized deductions where tax law reduces your miscellaneous deductions by 2 percent of adjusted gross income. 3

2. Miscellaneous deductions subject to the 2 percent floor are not deductible for that unbelievably nasty and downright unfair alternative minimum tax (AMT). 4

The 2 Percent Unfairness

I will explain this through an example. Say you and your spouse claim $10,000 in employee business expenses and report $150,000 in adjusted gross income.

First, to get any benefit, you must itemize deductions. Once you itemize, you then reduce your miscellaneous itemized deductions by $3,000 ($150,000 times 2 percent). Thus, your net deduction for employee business expenses is $7,000 ($10,000 minus $3,000), assuming employee expenses are your only miscellaneous deductions subject to the 2 percent adjustment.

Here’s the unfair part. Your real deduction is $10,000. The self-employed taxpayer deducts $10,000. But you, as an employee of your corporation, deduct only $7,000. That’s bad, but the AMT can make this much worse.

AMT Unfairness

The AMT allows a zero deduction for miscellaneous itemized deductions subject to the 2 percent adjusted gross income floor, like those employee business expenses.

Holy Mackerel the law allows the employee a home-office deduction for regular taxes and then eliminates that regular-tax deduction for purposes of the AMT. Yes, that’s how it works. Sad, but true!

Example. Using the same facts as above, you claim a $10,000 employee business expense deduction for your home office. Under the regular tax, the law gives you $7,000. However, for the AMT, you lose that $7,000 deduction and get a zero deduction for your home office. That’s most unfair and bad news!

Okay, enough for unfairness and the bad news: here’s good news.

Best Home-Office Deduction Method

As you have seen, neither the rental nor the employee business expense proves satisfactory.

The answer is for corporations to reimburse employee-owners for home office expenses. The concept is easy. The employee-owner submits an expense report that contains the home office, and the corporation reimburses that employee business expense.

The authorization to reimburse the employee is found in IRS Regulation Section 1.62-2(d)(1), which allows as reimbursements the expenses in part VI, subchapter B, chapter 1 of the Internal Revenue Code. Expenses allowed in this section of the Code include, among others, business expenses, depreciation, interest, and taxes.

Example. You operate your business as a corporation, incur $10,000 of office-in-the-home expenses, and submit an expense report to your corporation for $10,000 in home-office expenses. The corporation deducts the $10,000 as an office space expense. You, the employee-owner, have no taxable income for your employee expense reimbursement. (Presto: Full home-office deduction achieved.)

Accountable Plan

For this to work, you need to use an accountable plan.  The accountable plan requires that you, the owner-employee, must

• incur the expenses in the performance of your duties for the corporation  and

• substantiate the expenses to the corporation in accordance with the requirements imposed by the tax law.

To meet this requirement, your substantiation must show:

1. exclusive and regular use of your office in your home;

2. use of the office for the convenience of your employer;

3. use of the office as a principle place of business or other qualified use under the regulations; and

4. expenses to be reimbursed, including depreciation.

An easy way to accomplish the reimbursement is to complete IRS Form 8829 and attach it to your expense report.

Find a Little Extra

If you are in a situation where the expense reimbursement by your corporation is your best solution, make sure to spend the nine minutes or so needed to read the following articles:

• “Letter Requiring Home Office” for tips on meeting the convenience-of-employer test

• “Putting the IRS Audit Manual’s Home-Office Section to Work for You” for tips on how to use the office in the home, exclusive use, regular use, and how to prove expenses

• “Corporate Reimbursement of Depreciation on an Office in the Home” for tips on how depreciation works in the accountable plan arrangement

• “Why Incorporation Makes Your Home-Office Deduction Less Subject to an IRS Audit” for additional insights into how the reimbursement works

• “Home Office for Corporation” for some quick audit-proofing strategies

A Most Satisfactory Solution

You have to admit that the office-in-the-home expense reimbursement method has it all over the rental of the office to the corporation.

You also have to admit that the office-in-the-home expense reimbursement is far better than the employee business expense deduction that falls into the miscellaneous itemized deduction category where those deductions suffer either:

• reduction by 2 percent of adjusted gross income, or

• disappearance in the AMT calculation.

The reimburse-the-corporate-owner-employee achieves the full home-office deduction for the owner of his or her corporation.

1 IRC Section 280A(c)(6).
2 Chief Counsel Advice 200121070; also, see Private Letter Ruling 8819009
3 IRC Sections 67(a); 67(b)
4 IRC Sections 56(b)(1)(A); 67(b)
5 Reg. Section 1.62-2(d)(1)
6 Ibid
7 Reg. Section 1.62-2(c)(2)
8 Reg. Section 1.62-2(d)(1)
9 Reg. Section 1.62-2(e)