With working remotely more common now, many business owners are looking closely at how they might deduct some of the costs associated with maintaining their home offices. Although the Tax Cuts and Jobs Act (TCJA) of 2017 eliminated the home office expense deduction for most employees until 2026, business owners may still be able to deduct such expenses—but only if they meet a number of conditions. These conditions vary depending on how the business entity is structured.
Self-employed taxpayers who file as sole proprietors could still deduct certain home office expenses on Schedule C of their Form 1040 (Profit or Loss From Business), provided they use the designated space regularly and exclusively for business purposes. The space does not necessarily need to be separated by walls, but it must be a separately identifiable space that is not used for personal purposes.
In addition, the space must be used for business on a regular basis, not just occasionally. IRS rules do not define exactly how much time must be spent, but recent court cases suggest a minimum of 10 hours per week is a good rule of thumb. Special rules apply to certain daycare facilities and to inventory or product samples storage sites.
If the space qualifies, self-employed taxpayers may choose one of two ways to calculate the deduction. The regular method allocates a portion of various household expenses such as mortgage interest, utilities, insurance, and repairs based on the percentage of the home’s square footage that is used exclusively for business. Taxpayers must file Form 8829 (Expenses for Business Use of Your Home) to show how they calculated the deduction.
As an alternative, the IRS allows sole proprietors to choose a simplified method in which they deduct a flat $5 per square foot for the designated business space, up to a maximum of 300 square feet ($1,500). Taxpayers must choose either the regular or simplified method for the entire year, but they may change their choice every year.
Owners of partnership interests may also deduct home office expenses on their Form 1040, recording the expense as an “unreimbursed partner expense” on Schedule E (Supplemental Income and Loss). Under IRS rules, the partnership agreement must expressly state that the partner is required to pay the expense personally.
The deduction is subject to the same conditions regarding exclusive and regular use of the space that applies to sole proprietors. Unlike sole proprietors, partners are not required to file Form 8829, but they can use the form as a tool for calculating the deduction.
S Corporation Shareholders
Because shareholders in S corporations are also considered employees, the TCJA’s suspension of employee business expense deductions means the home office deduction is unavailable. Fortunately, there is an alternative for S corporation shareholders.
By establishing what is known as an “accountable plan,” an S corporation can reimburse shareholders for home office expenses, as well as other out-of-pocket business expenses. Without an accountable plan in place, these reimbursements need to be reported as taxable income to the shareholders. With a plan, the shareholders’ reimbursement is tax free, and the corporation gets a deduction for the reimbursed amount. The corporation may also choose to reimburse other select employees for their home office expenses but does not need to offer this benefit to all employees.
To set up an accountable plan, the corporation must modify its employment contracts so that working from home is a condition of employment and is being done at the convenience of the employer. In addition, shareholders must keep timely records that show the exclusive and regular use of the in-home office. This is most easily done by maintaining a weekly log or appointment calendar.
Here again, IRS Form 8829 can be used to calculate the amount to be reimbursed. It also gives employees a form they can submit as part of their reimbursement request. The corporation should issue reimbursement checks on a regular basis and keep the Form 8829 as proof of deductions.
Although the documentation and record-keeping requirements that enable business owners to claim a home office deduction are relatively straightforward, the specific requirements and qualifications for the various types of entities are quite detailed. Regardless of the type of business structure, business owners should consult with their accountants to be sure they are in full compliance.
If you have questions on this matter, please reach out to Holbrook & Manter for assistance.