If you filed your business income and expenses as a proprietor and reported $100,000 or more in gross receipts, your chances of IRS audit were 3.68%.  Had you reported this income as a corporation or a partnership (including an LLC), your chances of an audit were only 0.30%.

You have probably read that the home office increases your chances of IRS audit.  We’ve read that, too, but we don’t believe it.  Regardless, let’s assume that you’re a little paranoid about audits, and you want to claim the home office in a way that doesn’t attract the attention of the IRS.

 If you operate as a corporation, your home-office deduction does not show up on either your personal return or your corporate return if you have the corporation reimburse the office as an employee expense.  With reimbursement, the corporation claims the deduction for the expenses it reimburses to you.  The corporation probably puts the reimbursement into a category called “office expenses” or something similar.  Thus, the home-office deduction does not appear in the corporate return.

 You receive the reimbursement from the corporation as a reimbursed employee expense.  You do not report employee-expense reimbursements as taxable income on your personal return.  Thus, you do not identify the home office on your personal return.

 The easy method to find the reimbursement amount for the corporation is to complete the IRS home-office deduction Form 8829.  With this form, the corporate reimbursement to you includes the home-office percentage of amounts you spend for mortgage interest and property taxes.  Because the corporation reimburses the amounts to you, you do not deduct them on your personal return. 

 Example:  Your mortgage interest for the year is $10,000, and 10% of your home is office.  Your corporation reimburses $1,000 (10% times $10,000), so your net mortgage interest expense for the year is $9,000 ($10,000 minus $1,000).  You deduct the $9,000 as an itemized deduction on Schedule A of your 1040.

 When you sell your home, you treat it as though you had taken the home office as a personal deduction. Your corporation reimbursed you for depreciation, and since depreciation is subject to the recapture tax, you must consider the depreciation recapture problem in your home-selling strategy.

 The corporation may reimburse expenses only if it has adequate proof of the expenses.  Therefore, make your corporation demand proof that substantiates your administrative use, regular use, and exclusive use of the home office.  Think of your corporation as an IRS auditor who’s making sure that the expenses meet the requirements of the law.  If you fail the adequate-proof part, your corporation will have to include the expense reimbursement in your W-2 income.  You do not want that.

 With proper proof, your corporation gets the tax deduction and you, the employee, get an employee reimbursement that is not taxable income to you.  A win-win situation!

 If you want the home-office deduction but are paranoid about claiming it, consider the corporate form of business.  It does a fantastic job of hiding the deduction.

 However – remember – we do not consider the home office to he an audit flag at all.  Thus, we would not incorporate just to remove the home office from your tax returns.

 We also understand and appreciate a certain amount of IRS-induced paranoia.