Rental income treatment by owner/employee of C Corp

[Joanne]

Employee of 100% owned C Corp moved entire office to his home. If C Corp pays a fair rental value, should the income and related expenses be reported on Sch E?

If so, should expenses be calculated the same as if the taxpayer were using form 8829 for office in home--that is, using the square footage to determine the deductible amount of allowed expenses?

Can form 2106, Employee business expenses, be avoided altogether?

Thank you.

Joanne

[Bees Knees]

TTB, page 5-13: You cannot deduct office in home expenses if you rent your office to your employer. That rule applies to C corporation shareholder/employees renting their office to their corporation as well. If you do, the rental income goes to the Schedule E, but no expenses on the Schedule E are allowed.

The way to handle office in home used by the employee/shareholder of their corporation (whether C or S) is to set up an accountable plan to reimburse employee business expenses. The employee/shareholder submits receipts to the corporation for things such as utilities and insurance, and the corporation then reimburses the employee. The corporation deducts the payment and the employee excludes the reimbursement from income.

You don't have to do this for taxes and mortgage interest because those expenses are deductible on the Schedule A regardless of the office in home usage. Depreciation is the only other expense you can't do anything with because depreciation is not an out-of-pocket expense.

[Joanne]

Rental income/expense

Thank you!

[OldJack]

The way to handle office in home used by the employee/shareholder of their corporation (whether C or S) is to set up an accountable plan to reimburse employee business expenses. The employee/shareholder submits receipts to the corporation for things such as utilities and insurance, and the corporation then reimburses the employee. The corporation deducts the payment and the employee excludes the reimbursement from income.

IRS Pub 587, "Business Use of Your Home", Page 24 Worksheet states it is for use of an employee. Completing this worksheet and submitting it (with receipts) to your C-corp or S-corp should document under an accountable plan for reimbursement.

You don't have to do this for taxes and mortgage interest because those expenses are deductible on the Schedule A regardless of the office in home usage.

I disagree. The form 8829 and the Pub 587 page 24 worksheet requires the allocation of taxes and mortgage interest to properly compute the deduction. Of course you should get the full deduction of taxes and interest in one place or the other on the tax return but not more than the total actual cost.

Depreciation is the only other expense you can't do anything with because depreciation is not an out-of-pocket expense.

I disagree that depreciation is not "out-of-pocket expense" as it was out-of-pocket or you would have no depreciation. Depreciation is only a method of accounting for out-of-pocket expenses. Also, the Pub 587 worksheet for an employee or partner allows the depreciation and it should be allowed as a reimbursement the same as depreciation factor is allowed in a auto mileage reimbursement.

[JON]

Misunderstanding maybe????

Deductions available for and "employee" and an "employee shareholder" for office in the home are different. Employee just has to get the letter from the employer that says they require the office in the home. If it works sure they will get to depreciate. You lose the 2% if you take the mortage interest and real estate taxes on 2106 to employee business expense-miscellaneous itemized deduction....

None of that works for for the shareholder/employee.... Unless it is pursuant to a lease in effect prior to 1988(?), or whenever it went into effect.....

[OldJack]

I was not using the name "employee" with regards to the form 2106 deduction and my comments were not related to form 2106 filing, rather as accountable plan reimbursement as an employee.

[Bees Knees]

I disagree. The form 8829 and the Pub 587 page 24 worksheet requires the allocation of taxes and mortgage interest to properly compute the deduction.

Yes, for purposes of the deduction limitation only. That doesn’t mean the employer has to reimburse such expenses under an accountable plan. If you want to take a deduction for unreimbursed expenses on Form 2106, then you would need to use that worksheet and include mortgage interest and taxes. But we are talking about the accountable plan rules here.

IRS Pub 587, "Business Use of Your Home", Page 24 Worksheet states it is for use of an employee. Completing this worksheet and submitting it (with receipts) to your C-corp or S-corp should document under an accountable plan for reimbursement.

The accountable plan rules say the employee must:
1) Have paid or incurred deductible expenses while performing services as an employee.
2) Adequately account to the employer for these expenses within a reasonable period of time, and
3) Return any excess reimbursement or allowance within a reasonable period of time.

The issue with depreciation is whether or not it is a reimbursable expense. In order for the reimbursement to be excluded from employee wages, you have to meet the above accountable plan rules. Do you incur depreciation expense when using your home office for your employer?

Not everyone agrees on this issue. There is little guidance. The Small Business Quickfinder on page P-3 makes the comment: “There is little case law or other authoritative guidance giving specific approval to the reimbursement plan presented above. The statute that disallows a deduction for an employee renting home office space to an employer applies specifically in cases where the employer pays rent to the employee….Some commentators suggest that depreciation of the home may also be an allowable tax-free reimbursement.”

I tend to believe you are pushing it too far if you try to reimburse depreciation tax free. The IRS allows it in the case of a car through the standard mileage rate. But you don’t see any guidance from the IRS on how to reimburse actual car expenses including depreciation. So until they come out with a standard office in home expense deduction, I think you are treading on thin ice.

[OldJack]

I believe that you are treading on thin ice to not reimburse for depreciation as the depreciation may be "allowed or allowable" when disposing of the residence as the home office was clearly used for such purpose or it would not be allowable to the employer under the accountable plan. The employer can't simply give all his employees a tax-free reimbursement of home office expenses without justification of its use [ (1)Have paid or incurred deductible expenses while performing services as an employee].

Relating reimbursement to "rental" of space were it not for the specific code disallowance provision of expenses you would have required depreciation deduction on Sch-E.

[Bees Knees]

Accountable plans can be selective. An employer can say they will reimburse certain specified expenses, but nothing else. And I doubt your depreciation allowed is going to exceed 2% of AGI to have any affect on basis.

[OldJack]

And I doubt your depreciation allowed is going to exceed 2% of AGI to have any affect on basis.

You and I are obviously talking about different subjects. 2% of AGI is only related to 1040 Sch-A type misc deduction and not relevent to my comments. I agree the employer can be selective in reimbursement but when the employer (ie: S-corp) is also the owner of the home the full deduction is normally desired.

[Bees Knees]

I understand what you are talking about. You want the S corp employer to reimburse all office in home expenses, including depreciation, which would be deductible in full on the 1120S and excludable from W-2 wages. I understand that approach and agree it can be done, with the exception of depreciation. I don’t know if there is any case law or justification for claiming depreciation as a reimbursable expense.

Then you made the point that if you don’t reimburse the depreciation under an accountable plan, basis in the home may still need to be reduced under the allowed or allowable rules. However, if depreciation is not reimbursed under the employer’s accountable plan, then the employee can only deduct the unreimbursed expense on Form 2106 which flows to Schedule A, subject to the 2% AGI limitation.

Given that approach, I made the point that I doubted whether the unreimbursed depreciation would exceed 2% of AGI on the Schedule A. And under Regulation Section 1.1245-2(a)(7), it makes the point that basis reduction for depreciation allowable is limited to depreciation allowed. In other words, if depreciation is not allowed due to the 2% AGI limitation, then no basis reduction is required for depreciation allowable.

So therefore, you would not be walking on thin ice by ignoring depreciation under an accountable plan because you would be taking little risk of it getting thrown out in an audit, and no basis reduction in the home is required for the un-claimed depreciation. However, if you do choose to include depreciation under an accountable plan, the lack of guidance seems risky to me. I don’t know of any other instance besides per diem or standard mileage rate allowances where you can throw depreciation into the reimbursable category.

[OldJack]

I understand your point and agree that the basis is not really a problem. Likewise, reimbursing for depreciation is a small amount and not that much of a tax cost if it was disallowed on audit. No big deal.

[rosieea]

I am in synch with OldJack in regard to the depreciation issue, with one caveat. The home office deduction is guided by IRC 280A, which is specifically applicable to sole proprietors and S Corp owners. I have been "treading on thin ice" with regard to a few S Corp clients and am comfortable with a reimbursement for depreciation. While I see no reason why a C Corp shareholder could not participate in an accountable plan which includes reimbursement for expenses incurred in the use of a home office, I'm not sure if the rules are the same. I don't have any C Corps headquartered in an owners residence, and I have not researched the issue. Any thoughts?

[Bees Knees]

I don’t see anything in Section 280A that would treat C corporation shareholder/employees any different than S corporation shareholder/employees.

I also think the accountable plan route is un-tested waters. Section 280A was designed to limit your ability to generate losses from the business use of a home, whether it be an office in home or a vacation home. Limitations were also put in to restrict an employee’s ability to deduct office in home expenses. It seems to me that using an accountable plan is merely a loophole to side step these rules. What was the purpose for not allowing deductions when an office in home is rented to the employer? Why did Congress put that in there? And why would accomplishing the same thing through an accountable plan reimbursement be OK? It is a planning issue that has yet to be tested in the courts.

[OldJack]

I also think the accountable plan route is un-tested waters......
.....It seems to me that using an accountable plan is merely a loophole to side step these rules.

When your employer pays for your expenses using a
reimbursement or allowance arrangement, the payments
generally should not be on your Form W-2 if all the follow-
ing rules for an accountable plan are met.

1. You adequately account to your employer for the
expenses within a reasonable period of time.
2. You return any payments not spent for business
expenses (excess reimbursements) within a reasonable
period of time.
3. You must have paid or incurred deductible expenses while
performing services as an employee.

If you meet the accountable plan rules and your busi-
ness expenses equal your reimbursement, do not report
the reimbursement as income and do not deduct the ex-
penses.

Reimbursement under an accountable plan is an established method, for an employee, discussed in the IRS publication on the subject of "Business Use of Your Home" and I don't think the IRS would consider it a loophole. It is simply a form 2106 filing if you don't meet the requirements in the quote from their publication above.