Before you decide to rent a room in your home to your corporation, read along to avoid a huge and costly mistake.
If you operate your business as a corporation and you have a legitimate office in the home, you have three basic ways to claim the deduction. Doing it wrong produces zero dollar benefit from the office in the home and, in addition, can dramatically reduce vehicle deductions.
Business owners with an office in the home commonly use one of three tax-deduction methods in an effort to achieve tax benefits:
- One method provides no tax benefit; it’s just smoke and mirrors.
- The second method might create a small deduction or none at all.
- The third method is the correct choice, as it ensures the full tax deduction, possibly reduces your chances of an IRS audit, and ensures vehicle deductions.
Why do so many owners of corporations take the wrong road to the office in the home deduction?
There are two common reasons. Either they simply don’t understand the tax code, or they received incorrect advice. In this article, you as a corporate owner will find everything you need to recalibrate your deduction for an office in the home and start putting thousands in your pocket.
Why Renting an Office in Your Home to Your Corporation Is Smoke and Mirrors
The tax code is a murky place when it comes to renting an office in your home to your corporation. There is one big reason why renting is a no-tax-benefit, smoke-and-mirrors activity.
Big reason. Because the Tax Code says so. It’s hard to argue with this one. IRC Section 280A(c)(6) states that there shall be no landlord-type deductions for any expense attributable to the rental of the employee’s office in the home to his or her employer during any period in which he or she uses the home in performing services as an employee of the employer.
Example. Let’s say you rent your home office to your S corporation for $850 per month, or $10,200 per year. Of course, the S corporation can deduct the $10,200 as a business (rental) expense. But you, the employee, will have to report the rent you received from your S corporation as income on your Schedule E, and on that Schedule E you may not claim any rental expenses against the rental income.
So here’s why this is smoke and mirrors (using the S corporation example above):
- The S corporation deducts $10,200 as a rental expense.
- The S corporation’s $10,200 rent deduction flows to the bottom line, reducing the S corporation’s net income, and then that net income travels to the owner’s personal tax return via the K-1.
- On the owner-employee’s front, the owner reports $10,200 in rental income, but deducts zero rental expenses against that rental income.
Result. $10,000 income minus $10,000 deduction = zero benefit! (And the office in the home doesn’t exist as an office; accordingly, there’s no cancellation of vehicle commuting under the principal office rule.)
Why Claiming Your Home Office as an Employee Business Expense Stinks
As an employee of your corporation, you might be thinking, “Well, can’t I claim my home office as an employee business expense?” Sure you can, but you won’t want to once you learn how the Tax Code socks it to employee business expenses.
If you, as an owner-employee, claim the home-office deduction as an employee business expense, the Tax Code hits you with a triple whammy.
Whammy 1. You deduct employee business expenses as miscellaneous itemized deductions on your personal tax return. So to get any benefit, you have to itemize. If you don’t itemize, you get zero benefit.
Whammy 2. Let’s say you do itemize. In the miscellaneous itemized deductions category, the Tax Code allows deductions only to the extent that they exceed 2 percent of your adjusted gross income. [IRC Sections 67(a); 67(b)]
Example. Say you have $150,000 in adjusted gross income and $7,200 in home-office expenses (your only miscellaneous itemized deduction on your personal Form 1040). Two percent of $150,000 equals $3,000. Your Whammy 2 deduction is $4,200 ($7,200 – $3,000).
Whammy 3. Wait! It could get even worse. That $4,200 deduction could totally disappear. If you are subject to the alternative minimum tax (AMT), you lose all your miscellaneous itemized deductions. [IRC Sections 56(b)(1)(A); 67(b)] (Yep, that’s right, the same deductions allowed on your regular tax return are not allowed for the AMT.) In our example, the deduction for your
$7,200 of home-office expenses, which was reduced to $4,200 by the 2 percent rule on your regular tax return because of the AMT, turns into a zero deduction.
Win Your Rightful Deductions
Ready for some good news? Here’s how you get the full deduction for the office in your home when you operate your business as a corporation: have your corporation write you an expense reimbursement check for your use of the home office.
Yes, the employee expense reimbursement method is that easy, and it grants the full deduction to the corporation and zero taxable income to you.
In IRS Regulation 1.62-2(d), you find authorization for the corporation to reimburse you, the owner-employee, for all expenses of the office in the home, including depreciation. [Reg. Section 1.62-2(d).]
Here are the basic rules of the road to reimburse an employee’s office in the home:
- The office must be for the convenience of the employer.
- The corporation should reimburse you under the accountable plan rules (think expense report).
- When submitting the expense report for the home office, use IRS Form 8829 as a guide to the expense calculations. Make sure to include on the expense report an attestation that you meet the rules for the home-office deduction, including regular and exclusive business use.
For the paranoid. If you believe (which we don’t) that the home-office deduction is a red flag for IRS audit, you’ll be happy to know that the reimbursement method makes the home-office deduction disappear as a line item on both the corporate and the personal tax returns. For more on this, see Why Incorporation Makes Your Home-Office Deduction Less Subject to an IRS Audit.