One of the perks of freelancing is being able to work from home in your favorite pair of sweatpants (no shame, we do it too). Another perk is that your business gets to deduct some of the costs of using space in your personal residence, which may help lower your taxes.
The home office deduction is pretty straightforward for sole proprietorships, but it gets a little more complicated for S Corps.
Imagine a complete stranger asking you to run his business out of your spare bedroom! That’s essentially what’s happening here, from a tax and legal standpoint. If you’re like most people, you’d expect some form of compensation, like rent. That means having a lease, collecting rent payments, and reporting that rental income on your taxes… It’d be a complicated mess for you!
Because Hyke helps freelancers run S Corps every day, we can help you maximize your potential home office deduction and understand how it works. This article explains how our clients take advantage of running their businesses from home.
How do I know how much my home office deduction will be?
Remember how in your Schedule C/Sole Proprietor past life you had to enter the square footage of your home office, the square footage of your entire home, and a bunch of other numbers into that “Home Office” form? The same form that magically spit out an awesome tax deduction for you?
S Corps don’t have that form - but the same principles hold true. All methods of figuring out a home office deduction, for any business, is based around one idea:
“What’s the fair market value of the space that you use for work?”
The trick is how we figure it out. There are lots of ways, but at Hyke we break it down into two choices: simple method and direct method. Try the simple method first before moving on to the direct method. We recommend you do this exercise once a year.
- Calculate the square footage you use exclusively for business (yes, this could just be the size of your desk). This is your business square footage.
- Multiply your business square footage by $5.\ We didn’t come up with $5, this is an IRS standard. For example, if your business square footage is 100 feet, it would look like: $5 x 100 = $500.
- This figure is the amount your business would deduct annually. In our example, your deduction is $500.
If you think the Simple Method underestimates the value of your workspace you may consider using the Direct Method.
- Calculate the square footage you use exclusively for business (again, this could just be the size of your desk).
- Find the fair market value (cost per square foot per month) of office space in your area. (Remember, this is the fair market value of office space, not how much that portion of your apartment costs you in rent).
- Multiply your business square footage by the monthly fair market value. For example, if your home business space is 100 square feet and the monthly fair market value is $7 per square foot, it would look like this: 100 x $7 = $700 per month.
- Is your deduction higher than $1,500 for the year? It’s not a hard limit, but it can raise eyebrows at the IRS. Ask yourself this: if your business were seeking space to use on the commercial market, would it get a corner office on 5th Avenue? Or would it get a monthly subscription to a communal workspace like WeWork? Can you still justify the amount above $1,500?
- This calculated amount, with giving consideration to point #4, is the amount your business would deduct.
Ok, so I know the deduction amount, but how do I make it happen?
With an S Corp, your business doesn’t file a Schedule C anymore and the tax form it uses doesn’t have that home office deduction line. This is because your business is now a separate taxable entity.
Luckily, simple solutions exist: direct payment and accountable plan reimbursement.
You could have your business directly pay expenses that match the deduction amount you calculated. For instance, your S Corp could start paying the gas bill. But, this can be difficult for some people to execute because their utilities vary month to month or their utility provider doesn’t allow accounts in the company’s name.
If this method does work for you, then you would categorize these expenses as ‘utilities’ in the QuickBooks Online bank review window.
Accountable Plan Reimbursement
The other option is called an accountable plan. This lets your business reimburse you for the part of your home you use for business without creating taxable income for you. Your business gets the deduction and you don’t have to report the reimbursement as income on your tax return.
An accountable plan is a brief document that formalizes how your business will reimburse you for basic and common expenses. If you’ve been employed before, you probably used an accountable plan to get your business travel expenses reimbursed and didn’t even realize that’s what you were using.
If writing up legal documents makes you queasy, don’t worry, we have an accountable plan template that our professionals will help you fill out! All we need is information about your living space and the expenses related to your residence (like rent or mortgage interest, utilities, property taxes, etc.).
If you use this method, your business writes you a monthly check for the amount calculated and your Hyke bookkeeper creates a journal entry to record this as a ‘home office expense.’ Then, your business gets to write off the home office expense as a tax deduction, which lowers your overall taxable profits.
Either way, before you know it, you’ll have a documented process in place that helps you save time, reduce your taxes, and enjoy the benefits of running your business from the comfort of your own home (and sweatpants)!