Accountable Plan Quick Build

Almost every dollar that runs through a small business Accountable Plan comes from three places. We spend most of the session here.

Home Office

IRC Section 280A(c)(1) is the operative rule, and it requires the space to be used regularly and exclusively for business. Measure the office space, divide by total square footage, and apply that percentage to rent or mortgage interest, property tax, utilities, HOA dues, insurance, repairs and depreciation.

Here is where it gets interesting. Mortgage interest and property tax may already be deductible on Schedule A, so reimbursing those is mostly a wash, and you reduce your Schedule A amounts by the portion that was deductible there. No double dipping. The real money is in insurance, utilities, HOA dues and depreciation, none of which you would otherwise deduct at all.

For a typical owner, that is $200 to $350 in tax savings. Modest. What is not modest is the commute. Once your home office qualifies as your principal place of business, trips from it to clients, job sites and other business locations generally become business mileage rather than nondeductible commuting. That is usually worth several times the reimbursement itself.

One additional rule applies because you are an employee of your own S corporation. The home office has to be maintained for the convenience of the employer, not merely because you prefer working from home. For an owner-operated business that is usually straightforward, but we still document the business reason, and it helps if the corporation has no other fixed location available to you. Tiny detail, but during a challenge from the IRS or the state, details matter.

One more angle. If your Schedule A deductions are getting squeezed by the state and local tax limit (SALT) or by alternative minimum tax, moving these expenses to the business entity tax return preserves deductions that would otherwise evaporate.

Do You Itemize or Take the Standard Deduction?

This one question roughly doubles the answer, and almost nobody asks it.

Everything above assumed you itemize. If you take the standard deduction, nothing comes off anything, because there is no Schedule A to reduce. That means the entire reimbursement is new money, mortgage interest and property tax included.

The Form 8829 instructions say this directly. A taxpayer claiming the standard deduction puts no mortgage interest or real estate taxes on lines 10 and 11, and instead claims the entire business use portion on lines 16 and 17.

Here is the same house both ways. A 2,500 square foot home with a 150 square foot office, which is 6%, and a $400,000 depreciable building basis excluding land, which produces $10,256 of annual depreciation over 39 years.

Same house, same office, and the standard deduction client comes out with roughly double the benefit. At a 37% marginal rate that is $734 instead of $345.

Given where the standard deduction sits now, this describes a lot of business owners. If the version of this you have read elsewhere assumed itemizing, it was understating your number. We will dig into this during our Accountable Plan Quick Build session.

A Large Mortgage Does Not Cap Your Reimbursement

First, the limit itself, since everyone talks around it. You can deduct interest on up to $750,000 of acquisition debt on Schedule A, or $375,000 married filing separately. Debt taken on before December 16, 2017 is grandfathered at $1 million. The One Big Beautiful Bill made the $750,000 figure permanent, so it is not reverting.

If your mortgage is larger than that, part of your interest is simply not deductible on Schedule A. Here is the question worth getting right.

Your business use percentage applies to the total interest you paid on debt used to buy, build or substantially improve the home. Not to the smaller amount that survives the $750,000 cap. This is wonderful news.

The mechanics come from Form 8829, Expenses for Business Use of Your Home. Line 16 of that form is labeled Excess Mortgage Interest and exists for exactly this. The instructions give the example outright: pay $15,000 of home mortgage interest but only get to deduct $12,000 on Schedule A because of the limits, and the remaining $3,000 goes in column (b) of line 16.

One wrinkle. Form 8829 is a Schedule C form and an S corporation shareholder-employee does not file it for this reimbursement. We use the same IRC Section 280A allocation mechanics the form models, including its treatment of excess mortgage interest and of taxpayers claiming the standard deduction, and we build the workpaper accordingly. The allocation rule under IRC Section 280A is the same whether you are an employee or self-employed.

The statute lines up with the form. IRC Section 163(h)(2)(A) carves interest properly allocable to a trade or business out of personal interest entirely, and qualified residence interest is a separate category under IRC Section 163(h)(2)(D). The cap limits your personal itemized deduction. It was never a limit on what IRC Section 280A lets you allocate to business use.

The difference is not small. Take $1.5 million of acquisition debt at 6%, so $90,000 of interest. Only half that debt is under the cap, so only $45,000 of the interest is deductible on Schedule A.

Done the common way, the interest piece of your reimbursement produces nothing at all.

One condition. This only reaches debt used to buy, build or substantially improve the home, which is what the tax code calls acquisition indebtedness. The Form 8829 instructions specifically exclude interest on a loan that did not benefit the home, naming home equity loans used to pay off credit cards, buy a car or cover tuition. If you did a cash-out refinance and used the proceeds for something else, that portion does not count and it has to be traced.

One Shortcut That Is Off the Table

You may have heard about the simplified home office method, which lets you deduct $5 per square foot and skip the arithmetic entirely. It does not work here.

IRS Revenue Procedure 2013-13, section 4.02, closes that door. It says the safe harbor method does not apply to an employee with a home office who receives advances, allowances or reimbursements for home office expenses under a reimbursement or other expense allowance arrangement as defined in Treasury Regulation 1.62-2. An Accountable Plan is exactly that arrangement. For an S corporation shareholder-employee we use actual expenses and your business use percentage instead.

If the same home office also supports a Schedule C business, do not assume you can run actual expenses for the S corporation and the simplified method for the Schedule C. Revenue Procedure 2013-13 requires the same method across every qualified business use of the same home. We will work through it rather than guess.

Automobile

Bored with home office reimbursement already? Yeah, us too. Let’s move onto automobiles. The fun stuff.

Two common paths. Own the vehicle personally and have the business reimburse the business use, most commonly using the standard mileage rate, or have the business own the vehicle and deduct the business share of actual expenses and depreciation. A personally owned vehicle can be reimbursed on actual expenses including depreciation too where the facts favor it. We usually prefer mileage for personally owned vehicles because it is cleaner, but that is a preference rather than the only option.

Which one wins depends on how many miles you drive, how long you keep the vehicle and what it cost. High miles over a long hold usually favors personal ownership and mileage. A higher value vehicle traded every two or three years usually favors business ownership, because the value is dropping on time rather than on miles.

Either way, the mileage log is not optional.

One mechanic worth knowing. For shareholder-employees, we generally handle personal use of a company owned vehicle by limiting the deduction to the substantiated business portion and treating the personal portion as a shareholder distribution, rather than running a separate taxable fringe benefit through payroll. At 80% business use and $1,200 of gasoline, the business deducts $960 and the other $240 is a distribution.

That is about as far as we take vehicles here, because the ownership question deserves its own seventy five minutes. A few things you would learn there. Most cars cost less to run than the federal mileage rate pays, so the reimbursement can exceed what the driving costs you. The number on your door jamb matters more than the number on the window sticker. And the trade-in cycle is a treadmill that gets harder to step off of the longer you are on it.

If you are within six months of buying something, that is the session to book. It is the Company Car Quick Launch, and it runs the math on your actual vehicle rather than a hypothetical one.

Cell Phone and Internet

There are two ways to handle a phone, and most articles only mention one.

The first is an employer provided phone. IRS Notice 2011-72 allows a business to provide or pay for a cell phone when there is a substantial noncompensatory business reason for providing it, treating the business use as a working condition fringe benefit under IRC Section 132(d) and incidental personal use as a de minimis fringe. No income to you, full deduction to the business. Yay!

That rule reaches S corporation owner-employees, which surprises a lot of advisors. IRC Section 1372 treats a greater-than-2% shareholder as a partner for fringe benefit purposes, and the working condition fringe rules extend to partners performing services. It works best with a dedicated business line the business contracts for. It strains on a family plan with five lines.

The second is reimbursement, and for a personally owned mixed-use phone it is what we generally prefer. You pay the bill, the business reimburses a reasonable business portion. It keeps the treatment simple and the business books clean, and it avoids pretending the phone your spouse texts you on about milk and eggs is 100% business.

On the percentage, claim 100% and the IRS starts at zero and makes you prove otherwise. For most owner-employees we work with, a defensible percentage commonly lands somewhere between 50% and 80% depending on actual use. That is our experience rather than an IRS published range. Think about use density rather than clock hours, because dividing 40 work hours by 168 total hours understates the business share badly.

We land on your number together in the Accountable Plan Quick Build session, and more importantly we write down why, so you have something to point at later.