If you have been claiming a home office deduction as a sole proprietor and are considering incorporating you business, be aware that you could lose the benefits of your home office deductions. The IRS rules limit the home office deduction for shareholders of a corporation even if you rent the office to your corporation.
As an employee of the corporation, if the office is maintained for the convenience of the employer and is a requirement of employment because the corporation provides no office, then generally the home office deductions are claimed on Schedule A as a Miscellaneous Itemized Deduction subject to the 2% floor on Adjusted Gross Income. For example, if your adjusted gross income is $200,000 and your home office deductions total $5,000 you would only be able to claim a $1,000 deduction for the amount that exceeds 2% of $200,000. Even worse, if you are subject to the Alternative Minimum Tax, you would get no benefit since Miscellaneous Itemized Deductions are not allowed for purposes of the Alternative Minimum Tax.
As a planning technique, you can have the corporation adopt what is called an “Accountable Reimbursement Plan” that meets certain IRS qualifications. Basically, it requires employees to submit expense reports and get reimbursed by the corporation on a dollar for dollar basis for IRS deductible business expenses, including home office deductions that meet the IRS requirements of a home office. When an accountable plan is used, the employee does not have to pick up the reimbursements as income on their W-2 wage statements, and the employer gets to deduct the expenses as if they were the expenses of the employer. Accordingly, the expenses are moved from the personal tax return to the corporation tax return as reimbursed employee business expenses rather than expenses of a corporate office rented from the shareholder.
So far this technique has not been challenged by the IRS and I recently successfully defended it on an IRS audit. This is good news when it comes time for your tax return preparation. If you have concerns about losing the benefits of your home office, please contact me for a consultation at 650-400-2539 or email me at firstname.lastname@example.org for more information. Visit www.diazconsulting.com.