Home office: need advice on how to best structure for tax purposes

[Slav4ikMD]

So I am in a somewhat unique situation (I think... maybe not) and was hoping to brainstorm together with you guys.  In addition to my employed W2 work, I now have a home office (this is new this year), where I actually have a legit separate office that is attached to my own home, where I will be seeing some patients, in addition to doing other work related to independent consulting.  It is truly legit, in a sense of having a separate entrance, a waiting room, a bathroom etc (so not your "typical" home office for paperwork).  My malpractice carrier is aware, so in that sense I am all good.  I am just naive as to how to best organize this situation for maximize tax deductions (in our old home I had an office for paperwork but never used that deduction).

The question is what is the best way to organize office/business related deductions for taxes.  The way I see it, I have three options: 1) deduct all home-related expenses based on %/ratio of office square footage (amounts to around 12% I think) 2) use the newly available "simplified option" (300 sq ft max x $5) - likely won't give me a very high yield OR 3) have my "business"/PLLC rent the office from me as an individual, then not be able to deduct anything and I will also have to pay individual taxes on that income.

When I first discussed it with my accountant (we haven't finalized the plans), he suggested option #3 as he thought it was just be most hassle-free, but I am doubting whether this is best and just feels sort of like an odd thing to do.  I am leaning toward option #1.  Any thoughts?  Other options?  Things I am missing or need to consider?

Also what I find somewhat confusing is this:  if I do option #1, and then say need to do some construction/improvements on the office per se, do I pay that out of business expenses, or do I now have to pay out of personal and just deduct the %?

Thanks!

[chrisCD]

My wife has a day care so the home-office deduction is handled a little differently, but I do know it isn't just a % of the square feet, but also a percentage of the hours of operation.  So if the office is open 8 hours of the day, it is 33% x your 12% (4%).

[Slav4ikMD]

ChrisCD, that's interesting, I had no idea about that!  Although how would one define "open."

What do people think about my accountant's idea of my business renting office space from me as an individual at a fair market value for the space?

If you guys need any additional info to help me with this, feel free to ask!

[Slav4ikMD]

No one has an answer for me?     :?   Or everyone isn't back from their siesta?

[jfoxcpacfp]

You don't really have the choices you think you do as a PLLC. I could go into a long explanation, but this article probably explains it (even) better. And even if you were a sole proprietor, btw, it is a huge stretch of the imagination to think of any situation in which using the simplified square foot method would yield anywhere near the deduction of the "actual expense" method.

@ChrisCD - daycare operations have their own unique home deduction rules because the whole house is often in play, the washing machine/dryer are used, kitchen to prepare snacks and meals, etc.

When I hear an accountant wanting to choose among options based upon keeping things "hassle-free", I get skeptical about who is going to benefit most from the deal.

I'll try to answer any followup questions, but you need to read the article first. Hope this helps.

[EnjoyIt]

Johanna,

I seam to have a very hard time understanding this safe harbor rule and why it is not a good idea.  Lets just for arguments sake say I have a 300sqft office in a 3,000sqft home.  According to the safe harbor rule I can deduct $1500 for the year.  Option 2 is actual expenses at 10% since 10% of my home is my house. I would need to have a minimum of $15,000 in expenses for the year for actual expenses to beneficial.  Am I mis-understanding something?

Plus I still get to deduct property tax and home mortgage in full.

[Slav4ikMD]

JoAnna, thanks for article. I'll have to read it again (and again) but so far it only confused me further. Could you run through some hypothetical numbers with me? What do you think might be the way way for me to handle this to be most cost effective? I'll be happy to answer any questions to help understand the situation better.

Basically it sounds like deducting mortgage and property taxes is a moot point as one can deduct that anyway. Now what about tons of other stuff like the toilet paper used for the office, all the other supplies, construction done specifically for the office, etc etc.

I am having a hard time separating stuff stuff that's purchased for office, say a computer, which would be a usual business expense vs stuff purchases for the home office like percentage of toilet paper or percentage of fees paid for snow removal etc etc

Essentially my goal is to "double check" that what my accountant will suggest is both the best for my situation and is also 100% legal.

Thanks!

[Slav4ikMD]

And to sort of play devil's advocate: if I were to rent same office from someone else I would pay say $1500 a month - a huge chunk of cash. So why is it that I can't rent from myself and pay a tax on that income?

By the way, my business is structured as a PLLC and I file as an S Corp if it matters.

I just re-read your comment... So are you suggesting to use the actual expense method?

[Slav4ikMD]

Ok I read the article again and I think I am clearer on this now.  But I guess what I don't understand is what they mean by "reimbursing yourself" on a monthly or quarterly basis.  How is that different from essentially paying rent (other than using a different word for it) and why are we talking about monthly or quarterly reimbursements as opposed to using a deduction at the end of the year?

I am sorry that I am probably confusing some terminology, I am FAR from an expert on this, but want to learn on a super basic 101 level.  Thanks again

[The White Coat Investor]

Reading that article from Johanna (first time I've seen that), I don't think # 3 is an option any more. I'd do # 1.

[jfoxcpacfp]

Slav4ikMD wrote:

No one has an answer for me?        Or everyone isn’t back from their siesta? " />

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LOL, siesta my assets. Some of us have day jobs that include tax season. Promise to get back to you this morning! 

[jfoxcpacfp]

EnjoyIt wrote:

Johanna,

I seam to have a very hard time understanding this safe harbor rule and why it is not a good idea.  Lets just for arguments sake say I have a 300sqft office in a 3,000sqft home.  According to the safe harbor rule I can deduct $1500 for the year.  Option 2 is actual expenses at 10% since 10% of my home is my house. I would need to have a minimum of $15,000 in expenses for the year for actual expenses to beneficial.  Am I mis-understanding something?

Plus I still get to deduct property tax and home mortgage in full.

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You are oversimplifying the math - it doesn't work exactly like you articulated. The safe harbor does not allow depreciation. For simple illustrative purposes, if your 3,000 square foot house has a basis of $300k, $30k is allocated to the home office. You get to depreciate over 39.5 years, which is $760/yr, over 1/2 of the $1,500. 10% of your mortgage interest and 10% of your property taxes would likely put you way over the $1,500 and that's not counting any other expenses such as R&M, homeowner's insurance, cleaning, etc. The more expensive the house, the less sense it makes to use the safe harbor, and doctors tend to have nice houses. I've seen the safe harbor work better so far in a small home/home office cost less than $100k.

Note that if you sell the home, you'll have to recapture depreciation, which is only fair, as you've gotten the tax deduction. But if you never sell the home, the deduction saves you a lot of taxes.

As for "...I still get to deduct property tax and home mortgage in full"7, you are correct, but the deduction on your business saves you Medicare taxes and it doesn't on your schedule A. You get to deduct what's not used for your business on your schedule A. In addition, this deduction is "above the line" (on page 1, used to calculate your AGI) rather than "below the line" (an itemized deduction, subject to limitation).

[jfoxcpacfp]

Slav4ikMD wrote:

Ok I read the article again and I think I am clearer on this now.  But I guess what I don’t understand is what they mean by “reimbursing yourself” on a monthly or quarterly basis.  How is that different from essentially paying rent (other than using a different word for it) and why are we talking about monthly or quarterly reimbursements as opposed to using a deduction at the end of the year?

I am sorry that I am probably confusing some terminology, I am FAR from an expert on this, but want to learn on a super basic 101 level.  Thanks again " />

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No apologies necessary, the home office deduction is confusing, especially combined with an S-corp. What you must remember is that you are the employee and you work for the business. Think of it as working for an outside employer from your home. The employer is reimbursing you for using your office space to do work. In your case, you also own the business, so you (as the shareholder) are reimbursing yourself as an employee.

An accountable plan is required by the IRS to avoid taxing payments to employees to reimburse them for legitimate business expenses. According to the IRS, reimbursements must be made within a "reasonable" amount of time, which is why the author suggested to repay on a monthly or quarterly basis. Since you are an employee, if you simply take the deduction at the end of the year without using an accountable plan, you will report your deduction for your home office on your schedule A, subject to the 2% of AGI floor. Mileage is a good (and common) example. Employers who reimburse for mileage under an accountable plan require reports, usually monthly, and cut a check to the employee. I do this in my own office. The employee does not report the mileage checks as income and the employer deducts the payments. Any expenses I do not reimburse can be deducted by the employee as a miscellaneous itemized deduction on Schedule A, but, since you are limited to deductions in excess of 2% of your AGI, you may not get to deduct anything. I even do this for myself, even though I own the business. We recommend this to all of our business clients.

I'd like to discuss the self-rental issue. If you are renting from yourself, the rent you pay through the business is deductible there and taxable to you so that part is basically a wash. However, according to section 280A(c)6, rentals between employee-employer are limited beyond the wash. This article has a good mathematical example for you number wonks.

As for your other expenses, you really should be discussing this with your CPA. I don't mind answering, but you have the relationship with him and he is privy to all of your financial information and should be advising you on such as toilet paper  

[Slav4ikMD]

Ok so sounds like options #1 is the way to go and I just need to talk to my accountant as to how to do it and what I need to do about it.  Sounds good

I guess one thing I am sort of confused about is how to best separate the "house" expenses, % of which I will deduct vs office specific expenses that I would like to pay out of the business account to begin with.

In other words, if I am taking a home office deduction and now say building a new wall/floor/whatever in the office, can I pay for those expenses out of my business OR does that mean that I now have to pay for that out of personal and only deduct % of it?  Or say I am building lighting specifically for office, etc.

Hope my question makes sense.  I feel like I am going to have a lot of those "grey areas."  Thanks guys, thinking out loud about this, before I further speak to my accountant helps a lot.

[jfoxcpacfp]

Slav4ikMD wrote:

Ok so sounds like options #1 is the way to go and I just need to talk to my accountant as to how to do it and what I need to do about it.  Sounds good " />

I guess one thing I am sort of confused about is how to best separate the “house” expenses, % of which I will deduct vs office specific expenses that I would like to pay out of the business account to begin with.

In other words, if I am taking a home office deduction and now say building a new wall/floor/whatever in the office, can I pay for those expenses out of my business OR does that mean that I now have to pay for that out of personal and only deduct % of it?  Or say I am building lighting specifically for office, etc.

Hope my question makes sense.  I feel like I am going to have a lot of those “grey areas.”  Thanks guys, thinking out loud about this, before I further speak to my accountant helps a lot.

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Expenses specific to your home office space should be fully deductible/depreciable but that's what you pay your accountant to determine.