When you run your trading business through an S Corporation, LLC, or Partnership, you really need to be aware of the IRS rules in order to maximize your tax deductions for the home office.
Every year I review tax returns of traders, looking for areas to reduce their taxes. I always look for the home office deduction because 90% of the time it has been deducted in the least advantageous way, or not at all!
There are actually three ways an owner of an S Corporation, LLC, or a Partnership can claim the home office deduction. Two of them should be discarded because they are not beneficial to the owner. The last one is the least known of the three but is absolutely the best way to claim the deduction. Let’s review:
RENT OFFICE TO THE ENTITY
This method may seem like the logical choice at first but it provides no benefit to the owner of the business. Internal Revenue Code 280A(c)(6) disallows tax deductions for the home office on rentals by employees to their employers. Unfortunately, this means that as the owner/employee, you do not achieve home office deductions on the rental of an office in the home to your entity.
Joe Trader rents his home office out to his S corporation for $12,000 for the year. The end results at tax time are:
1. $12,000 tax deduction for the S corporation
2. $12,000 in taxable income to Joe, reported on Schedule E of his 1040
3. No deductions for the home, except those already deductible on Schedule A
The end result is a wash. You get the $12,000 deduction for the S corporation but create $12,000 of taxable income as a result. Clearly this method is not the way to go.
DEDUCT AS AN EMPLOYEE BUSINESS EXPENSE
This method requires you to take the deduction as an employee business expense on Schedule A of your Federal 1040. While this method is better than the first example, there are two unfair rules working against you.
1. This deduction falls under miscellaneous itemized deductions on Schedule A where it is reduced by 2% of your adjusted gross income (AGI)
2. Miscellaneous itemized deductions are NOT deductible for AMT!
Using the same information as above, Joe Trader takes the $12,000 deduction on Schedule A. Joe’s AGI is $150,000, therefore he loses $3,000 of his deduction due to the 2% floor (150,000 x 2%). That’s not good but the AMT can make it much worse. AMT does not allow miscellaneous itemized deductions therefore Joe loses the $9,000 home office deduction!
BEST WAY TO EXPENSE THE HOME OFFICE
The entity should reimburse employee/owners for the business use of the home. As the employee/owner, you submit an expense report that contains the home office and the entity reimburses that employee business expense. The reimbursement is NOT taxable income to you, the employee!
In order to comply with IRS regulations, you will need to establish an accountable plan. The accountable plan requires that you, the owner, must:
1. incur the expense in the performance of your duties for the entity and
2. substantiate the expense to the corporation in accordance with the requirements imposed by the tax law
I find an easy way to meet the requirement for number 2 above is to complete Form 8829 and submit it with your expense reimbursement form.
Joe sets up an accountable plan for his S corporation. Joe then submits a reimbursement form for $12,000 for the business use of his home. The S corporation reimburses Joe and takes a deduction for $12,000. Joe has no taxable income for the employee expense reimbursement!
Clearly, the way for you to deduct the home office expense if you are trading through an entity is through an accountable plan. The business gets the deduction and you get the full reimbursement tax free. I call that a win-win in my book!
For additional information on accountable plans and other topics, please visit my website at http://www.ShrinkMyTaxes.com If you have any topics you’d like me to cover in a future article, you can email me at info@ShrinkMyTaxes.com
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Stay tuned for Tax Corner —in the soon to be released Fall TraderPlanet Journal. Steve Ribble gives you more tips on how to save money on your taxes now. Subscribe for free to this educational trading publication here.
Read another story by Ribble here: Disclosing Your Foreign Bank Account