Home Office Deductions for S-Corp Owners

A company can reimburse an employee for a qualifying home office under an accountable plan and exclude the reimbursement from wages if three conditions are met: (1) the reimbursement has a business connection (it would be a deductible business expense to the employee), (2) the employee substantiates the expense within a reasonable period, and (3) any advance in excess of substantiated expenses is timely returned. If any condition is not met, the payment is treated as made under a nonaccountable plan and must be included in wages and subjected to withholding and employment taxes. These rules are governed by Internal Revenue Code § 62(c) and the accountable plan regulations, with parallel employment tax treatment in the FICA/FUTA and withholding regulations (IRC § 62; Treas. Reg. § 1.62-2; 26 CFR § 31.3401(a)-4; 26 CFR § 31.3121(a)-3; 26 CFR § 31.3306(b)-2).

For home office expenses to be “business connected,” the workspace must itself qualify under the home office rules (exclusive and regular use, and principal place of business or other qualifying use), and only the allowable business portion of home expenses may be reimbursed tax‑free. The IRS home office rules and calculation methods are explained in Publication 587 and the Simplified Method FAQs.

Accountable Plan Essentials Applied to Home Office

• Business connection: Reimburse only the employee’s expenses that would be deductible under the home office rules (see “Qualifying home office” below). Paying or reimbursing personal or nondeductible amounts fails this requirement (Treas. Reg. § 1.62-2(d)).

• Substantiation: Require the employee to substantiate the elements of the home office (exclusive and regular use; square footage; business‑use percentage; nature and amount of direct and indirect expenses; and, if using depreciation, basis and method). Substantiation must occur within a reasonable period; safe harbors include the “fixed date” method (30/60/120 days) or “periodic statement” method (quarterly with 120 days to settle) (Treas. Reg. § 1.62-2(e), (g)).

• Return of excess: Require prompt return of any allowance or advance exceeding substantiated expenses within a reasonable period; otherwise the excess must be treated as wages (Treas. Reg. § 1.62-2(f)–(g)).

Qualifying Home Office: Threshold Tests
To qualify, a portion of the home must be used:

• Exclusively and regularly as the principal place of business for the trade or business, or

• Exclusively and regularly as a place to meet or deal with patients, clients, or customers, or

• In a separate structure used exclusively and regularly for business; and

• Certain storage/daycare uses have special rules (exclusive use not required for storage of inventory where the home is the sole fixed location, or for daycare, with time allocation) (Publication 587).

“Exclusive use” requires that the area be used only for business; a room used for both business and personal purposes fails the test. “Principal place of business” can be met by using the space for administrative or management activities if there is no other fixed location where those activities are substantially conducted (Publication 587).

Methods to Compute the Reimbursable Amount
For accountable reimbursements to be excludable, the company should cap reimbursements at the amount the employee could deduct using one of the recognized methods. Two methods exist in IRS guidance:

A) Regular (actual expense) method

• Determine the business‑use percentage (generally square feet of the home used for business divided by total livable area; daycare providers use hours‑of‑use allocation). The space must pass the exclusive and regular use tests (Publication 587).

• Classify expenses:

  • Direct expenses (e.g., painting or repairs limited to the office space) are fully allocable to the office.

  • Indirect expenses (e.g., rent, utilities, insurance, general repairs) are prorated by the business‑use percentage (Publication 587).

• Apply the gross income limitation: home office expenses cannot create or increase a net loss from the business use of the home. Disallowed amounts under the regular method can be carried forward to the next year if still eligible (Publication 587).

• Substantiation: Require invoices/receipts and the home office percentage computation (with floor plan or measurements), plus documentation of direct vs. indirect expenses (Treas. Reg. § 1.62-2(e); Publication 587).

B) Simplified method (safe harbor)

• Amount = allowable square footage (up to 300 sq. ft.) × prescribed rate ($5.00), limited by business gross income; no depreciation is claimed and there is no carryforward of disallowed amounts. A separate calculation applies to daycare (time‑based factor) (Simplified Method FAQs).

• Elections are made annually and you may switch methods in different years (but not within the same year). If you use the simplified method for a year, the “depreciation deduction allowable” for the home for that year is deemed to be zero (which avoids future recapture for that year) (Simplified Method FAQs).

• Substantiation: Document exclusive and regular use, qualifying use (e.g., principal place of business), the average monthly allowable square footage used (and daycare hours, if applicable), and the business gross income limit (Simplified Method FAQs).

Important distinction: the “deemed substantiation” rules that exist for per diem travel allowances do not exist for home office. If a company uses the simplified method as a convenient allowance benchmark, it should still require the employee to substantiate the eligibility (exclusive use, principal place, square footage, and business gross income limit) and reconcile to prevent excess reimbursements. Amounts paid in excess of the allowable simplified amount are taxable wages under the nonaccountable plan rules (Treas. Reg. § 1.62-2(c)–(h)).

Owned vs. Rented Homes: What Changes in the Calculation
The qualifying space and the percentage computation are the same for owners and renters. The differences lie in which indirect expense categories apply and how depreciation is handled.

If the home is owned

• Indirect costs includable (prorated by business‑use percentage) typically include: utilities, homeowners insurance, general repairs/maintenance affecting the whole home, and depreciation of the home’s building (not land). Property taxes and mortgage interest are included in the home office calculation under § 280A rules, but they also remain deductible on Schedule A; the employee cannot deduct the same amounts twice—however, for accountable plan purposes, reimbursing the allocable business portion (subject to limits) ties to the employee’s business expense under § 280A (Publication 587).

• Depreciation: Under the regular method, the business portion of the home’s basis is depreciated over time; this reduces the employee’s basis and creates potential depreciation recapture on sale. If the simplified method is used for a year, the depreciation “allowable” is deemed zero for that year (i.e., no recapture tied to that year) (Publication 587; Simplified Method FAQs).

• Substantiation considerations: proof of ownership, basis/allocation to building vs. land, depreciation method, and maintenance/utility records commensurate with the business‑use percentage (Publication 587).

If the home is rented

• Rent is an indirect expense and is prorated by the business‑use percentage; there is no depreciation of the home by the renter. Utilities, renter’s insurance, and general repairs are handled similarly to owners (prorated if indirect) (Publication 587).

• Substantiation considerations: lease/rent statements, utility bills, and documentation of direct vs. indirect repairs, plus home office percentage (Publication 587).

Direct Expenses (Owners and Renters)
Repairs or improvements made solely to the office area are typically fully allocable to the home office; improvements that benefit the entire home are indirect and must be prorated (Publication 587).

Gross Income Limitation and Its Effect on Reimbursement

• Regular method: total home office deductions (especially those beyond otherwise deductible items like mortgage interest/taxes) are limited by the gross income from the business use of the home; disallowed amounts can be carried forward and deducted in future years using the regular method (Publication 587).

• Simplified method: the deduction is limited by business gross income, there is no carryover, and using the simplified method for a year precludes any home office depreciation for that year (Simplified Method FAQs).

Accountable plan implication: a company should not reimburse more than the employee’s allowable home office amount (after applying the gross income limitation). If the business gross income limitation caps the deduction, any reimbursement above that cap would not be a deductible business expense to the employee and, therefore, would be taxable wages under the nonaccountable rules (Treas. Reg. § 1.62-2(c)–(h); Simplified Method FAQs).

Substantiation Checklist and Timing

• Eligibility: exclusive and regular use; principal place of business (or other qualifying use); daycare/storage exceptions where applicable (Publication 587).

• Area and percentage: measurements of total home and office area; floor plan or measurement worksheet; average monthly allowable footage if using simplified method (Publication 587; Simplified Method FAQs).

• Expenses: receipts/invoices for direct/indirect costs; lease/rent statements (renters); mortgage statements, tax bills, insurance, utilities, repairs (owners); basis and depreciation schedules if applicable (Publication 587).

• Gross income test: documentation of business gross income to apply the limitation and (for daycare) time‑of‑use calculation (Publication 587; Simplified Method FAQs).

• Timing safe harbors: fixed date (advance within 30 days; substantiate within 60 days; return excess within 120 days) or periodic statement method (quarterly statement and substantiation/return within 120 days) (Treas. Reg. § 1.62-2(g)(2)).

Payroll and Form W‑2 Reporting

• Accountable amounts: Excluded from wages if the plan satisfies the accountable plan rules; if reimbursements are combined with wages in a single payment, the reimbursement must be separately identified to remain excludable (26 CFR § 31.3401(a)-4(a)).

• Nonaccountable or excess: Amounts paid without adequate substantiation or exceeding the allowable home office amount (after the gross income cap) must be treated as wages no later than the first payroll period after the end of the reasonable period, and are subject to withholding and employment taxes. Report taxable amounts in boxes 1, 3, and 5 of Form W‑2; accountable reimbursements are generally reported in box 12 with code L when applicable (e.g., when using allowance-type reporting), while excluded amounts are not wages (26 CFR § 31.3401(a)-4(b); Publication 5137).

Practical Plan Design (Owned vs. Rented)

• Policy selection: Choose either (a) reimburse actual expenses under the regular method, or (b) reimburse a capped allowance based on the simplified method, with year‑end reconciliation to the allowable amount. Because there is no “deemed substantiation” rule for home office, any allowance should be trued up to actual eligibility, or the excess becomes taxable (Treas. Reg. § 1.62-2; Simplified Method FAQs).

• Owned home nuances: If reimbursing depreciation under the regular method, require basis support and apply the business‑use percentage. Remind employees that using the simplified method for a year makes depreciation “allowable” equal to zero for that year (affecting future recapture) (Publication 587; Simplified Method FAQs).

• Rented home nuances: Reimbursable categories generally center on rent, utilities, renter’s insurance, and indirect repairs, plus direct office‑only repairs. No building depreciation applies for renters (Publication 587).

• Documentation standards: Require proof of exclusive and regular use; square footage; business‑use percentage; expense receipts; and for simplified method, allowable footage and any daycare time factor, plus the gross income limit (Publication 587; Simplified Method FAQs).

• Timing and reconciliation: Use the Reg. § 1.62‑2 safe harbors for advances and settlements; reconcile any allowance to the computed allowable amount (regular or simplified) before the end of the reasonable period to avoid wage treatment of excess (Treas. Reg. § 1.62-2(g)).

Bottom Line
For both owned and rented homes, a company can exclude home office reimbursements from wages only to the extent the employee’s home office is eligible and the reimbursed amount does not exceed the allowable home office amount computed under either the regular (actual) or simplified method, after applying the gross income limitation. Robust substantiation and timely reconciliation under an accountable plan are critical to maintain wage exclusion and avoid employment tax exposure (Treas. Reg. § 1.62-2; Publication 587; Simplified Method FAQs; 26 CFR § 31.3401(a)-4; Publication 5137).

This essay is not tax advice. Always consult a qualified tax professional for your specific situation.