Work from home? Rent to the company and salvage a tax benefit
The rules for home-office deductions are particularly tough for corporate employees. Even if you legitimately use a home office for business purposes, you may not be entitled to a deduction. It doesn’t matter if you’re the owner of the company.
Strategy: Rent the office to the company. In this case, the company can deduct the rent payments as a business expense. Although you must pay income tax on the rent payments, you don’t owe employment taxes.
This tax strategy may be used by C corporations because they aren’t subject to the usual home-office deduction rules. But it won’t work for an S corporation (see box below).
Here’s the whole story: To qualify for home-office deductions, you must use a separate area of your home regularly and exclusively as your place of business or as a place to meet or deal with customers, clients or patients in the normal course of business. If you’re an employee, the home office has to be used for the convenience of the employer.
Frequently, one of those requirements trips up the taxpayer. But taxes still can be saved by renting space at home to the company.
Example: You frequently use a room at home to finish up work. But you don’t qualify for deductions because your company’s main office is downtown.
In lieu of a $10,000 salary increase, you rent the home office to your firm for $10,000 a year. The company deducts the rent on its annual return. You must pay income tax on the $10,000, but neither you nor the company has to pay employment tax. This can save both you and the company as much as $765 (7.65% of $10,000). Total tax savings: $1,530.
Make sure the company pays you a reasonable rent. It should be the same rate that would be charged to a third party. Otherwise, the IRS might recharacterize the rent payments as nondeductible dividends.
Tip: You must show a legitimate business need for the rental arrangement.
4 steps for S corps
An S corporation can’t deduct the rent for a home office in the situation we’ve described (see article). Consider this four-step approach:
- Make the S corp require you to provide office space as a condition of employment.
- Establish an accounting reimbursement plan to reimburse you for costs incurred in performing work.
- Submit adequate documentation of those costs.
- Have the S corp reimburse the costs.
Result: The S corp may include the reimbursement as a business expense flowing through to you, the owner. There is no additional tax reporting.
