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How S Corporation clients can use an accountable plan to deduct home office expenses

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Do your S corporation clients have home offices where they perform some or all of the work for their businesses? Since S corporation shareholders are considered employees of their businesses, they are limited in the ways they can deduct home office expenses.

One of the consequences of the 2017 Tax Cuts and Jobs Act is that employees can no longer deduct home office and other miscellaneous business-related expenses on Schedule A. This limitation will continue through the end of 2025 or possibly longer if this provision is renewed. In contrast, partners in a partnership can deduct unreimbursed expenses directly on Schedule E as unreimbursed partnership expenses.

However, if you help your clients set up an accountable plan, everyone wins. The shareholder gets a tax-free reimbursement for the home office and other out-of-pocket expenses, while the S corporation gets a deduction for the reimbursed amount.

An accountable plan must meet three requirements to pass IRS muster:

  1. The expenses must have a business connection. The expenses must be incurred while the employee is performing work for the company, and must be ordinary and necessary expenses. These can include mileage for business-related driving, meals with clients, and out-of-pocket travel expenses. They can also include a portion of mixed-use expenses–that is, those with a personal and business component, such as home office expenses, cell phones and home internet.
  2. There must be substantiation to support the deduction. This can be easily accomplished by submitting a detailed monthly or quarterly expense report with the relevant documentation attached. Apps, such as Expensify and Dext, simplify this and sync with QuickBooks® Online.
  3. Any excess reimbursements over actual expenses must be repaid promptly. If the S corporation provides an advance to the shareholder for travel expenses, any excess over actual expenses must be repaid within 120 days.

Setting up an accountable plan is quite simple. Here’s a sample agreement you can adapt for your clients and have them sign. Then, once a quarter or once a month, the shareholder files a detailed expense report and the S corporation cuts a check to the shareholder. The S corporation gets a deduction and the shareholder gets a tax-free reimbursement.

For home office expenses, shareholders can be reimbursed for an allocated portion of their home maintenance expenses, including mortgage interest, property tax, insurance, utilities, home internet, trash, and repairs and maintenance. Any portion of mortgage interest and property taxes that’s reimbursed through an accountable plan must be deducted from the amounts reported on Schedule A.

To qualify as a home office, the area must be used regularly and exclusively for business. The home office portion of household expenses is allocated according to relative square footage. Some employees include a floor plan of the home, with a calculation of the square footage with their expense reports, to add additional credibility to their assertion.

An allocated portion of depreciation for the house should also be included in the reimbursed amount. When the house is sold, the “allowed or allowable” portion of the home office depreciation expense will be recaptured as ordinary income, so clients may as well receive a benefit now.

For some mixed expenses, such as cell phone or internet, allocation on a square footage basis may not be appropriate. The IRS allows a “reasonable” allocation method for these expenses. This can be the actual business percentage calculated on a sample period of a few days or weeks, or another method that can be consistently applied.

Without an accountable plan in place, these reimbursements are taxable income to the shareholder and should be reported on their W-2.

Setting up an accountable plan is one of the best methods for a shareholder to get cash out of their corporation. Rent, distributions, and wages are the other main methods. But in contrast to those methods, accountable plan reimbursements are tax-free to the shareholder (as are distributions) and deductible to the S corporation, as are rent and wages. Accountable plans are truly a win-win all around for your S corporation clients.

Editor’s note: This article was originally published Sept. 22, 2017, and updated with new content on April 10, 2023.

2 responses to “How S Corporation clients can use an accountable plan to deduct home office expenses”

  1. Good question. This is a bit controversial. Many experts, including the folks over at the Bradford Tax Institute say yes, you can. The regs governing accountable plans, Reg. Section 1.162-2(d)(1) allow as reimbursements the expenses that are in Section 161, subchapter B, chapter 1. These expenses include depreciation. Here’s analysis by the Bradford Tax Institute: http://www.bradfordandcompany.com/2011/PDF/2011Update1b.pdf

    Depreciation is allowed as a normal home office deduction. Home office expenses are allowed under accountable plans. I have not been able to find anything from the IRS that specifically states that reimbursement for depreciation is not allowed under an accountable plan.

    But many other experts say you simply can’t, including the Watson CPA Group:

    If you’re using the simplified method for home office deductions, then no, depreciation is not allowed. But if you’re using the regular method, then, yes, everything I’ve seen indicates that depreciation is allowed.

    My advice is to do your own research and make your decision based on what you find.