Is paying an employee with real estate a legal loophole to avoid income tax?

[Sig]

To qualify for a home office, the area in question must be used exclusively as an office. So the answer is potentially yes, if the closet space and the entire bedroom are used only for trading. In the old days when traders and other business people had mountains of paper records, it would have made sense to use the closet as a storage space, e.g., filing cabinets. With everything in digital format, I think it would be harder to justify today, unless you are using the closet as a dedicated secure space for a server or backup computer.

If you get audited on the home office, an IRS agent will actually visit your home, or they will ask for photos. The real point is that if you do this, you better not have a bed or dresser in your home office, and you better have a bed and dresser in a different bedroom.

The bathroom is more subjective. You would have to take the position that you only use that bathroom while you are conducting business in the home office. It would be an easier sell if the home office was for someone like a financial planner, an insurance agent or a psychotherapist who actually meets with clients in the home office, because then you have a dedicated bathroom for the clients, so you can keep them out of your personal living space.



The short answer is no, because the home office deduction for employees was effectively eliminated a couple years ago. Most unreimbursed employee business expenses are no longer deductible, under rules that went into effect at the beginning of 2018.

What might work is to have the S corp rent the space, so it would be deductible as an expense on the corporate tax return.

But that is what is known as a self-rental, when a corporation rents property from one of its shareholders. The rules are complicated, and you have to charge fair market value rent. And the rent becomes taxable to you as rental income on your individual tax return. That might neutralize any real benefit, because the expense on the corporate tax return will not reduce your salary. As a working shareholder, you still have to get reasonable compensation, i.e., a minimum salary that reflects the work you are doing. So the rental expense would only reduce the investment income that flows to you on the Schedule K-1. It could work against you. You could end up paying tax on the rental income, at regular income tax rates, instead of having the income treated as qualifying capital gain on the K-1.

The real solution is probably to have the corporation reimburse you for the cost of your home office. With that approach, it is a deductible expense for the S corp, but it is not income for you. But it has to be an accountable expense reimbursement plan. You have to explore this carefully with an experienced accountant.

https://proconnect.intuit.com/articles/home-office-deductions-expenses/

BMK

Great response, and all this highlights the amount of both work and risk involved for a gain of ??? When you do the math you'll see you're greatly increasing your audit risk, the expected value you'd have to pay to go through the audit even if you came back clean, and doing a bunch of work, all for just a few dollars in tax savings. It just isn't worth it, unless you value your time at sub-$5/hour and your peace of mind at nothing.

Much more productive uses of your time toward minimizing your tax bill:
1. Set up a 401K for yourself
2. Set up a health savings plan for yourself
3. Set up a dependent care FSA if you have any child (or parent) care costs for yourself

 

[kmgilroy89]

To qualify for a home office, the area in question must be used exclusively as an office. So the answer is potentially yes, if the closet space and the entire bedroom are used only for trading. In the old days when traders and other business people had mountains of paper records, it would have made sense to use the closet as a storage space, e.g., filing cabinets. With everything in digital format, I think it would be harder to justify today, unless you are using the closet as a dedicated secure space for a server or backup computer.

If you get audited on the home office, an IRS agent will actually visit your home, or they will ask for photos. The real point is that if you do this, you better not have a bed or dresser in your home office, and you better have a bed and dresser in a different bedroom.

The bathroom is more subjective. You would have to take the position that you only use that bathroom while you are conducting business in the home office. It would be an easier sell if the home office was for someone like a financial planner, an insurance agent or a psychotherapist who actually meets with clients in the home office, because then you have a dedicated bathroom for the clients, so you can keep them out of your personal living space.



The short answer is no, because the home office deduction for employees was effectively eliminated a couple years ago. Most unreimbursed employee business expenses are no longer deductible, under rules that went into effect at the beginning of 2018.

What might work is to have the S corp rent the space, so it would be deductible as an expense on the corporate tax return.

But that is what is known as a self-rental, when a corporation rents property from one of its shareholders. The rules are complicated, and you have to charge fair market value rent. And the rent becomes taxable to you as rental income on your individual tax return. That might neutralize any real benefit, because the expense on the corporate tax return will not reduce your salary. As a working shareholder, you still have to get reasonable compensation, i.e., a minimum salary that reflects the work you are doing. So the rental expense would only reduce the investment income that flows to you on the Schedule K-1. It could work against you. You could end up paying tax on the rental income, at regular income tax rates, instead of having the income treated as qualifying capital gain on the K-1.

The real solution is probably to have the corporation reimburse you for the cost of your home office. With that approach, it is a deductible expense for the S corp, but it is not income for you. But it has to be an accountable expense reimbursement plan. You have to explore this carefully with an experienced accountant.

https://proconnect.intuit.com/articles/home-office-deductions-expenses/

BMK

Thank you for this information. I'm currently a W2 trader having by far my greatest year ever only 2 months into the year lol. My current share is around 900k already. Thank you Reddit lol. I'm going to allocate a bunch to a risk bank to keep growing, but I'm looking for anything I can to deduct taxes (minus moving to Puerto Rico). I'm in FL so effectively my top income tax bracket is 39.35% (Federal+Medicare) on income over $518,400. I've heard about S-Corps, dunno if I can take advantage of them to pay a lower tax rate. I remember that the item that would have reduced taxes by 20% for S-Corp income was shot down during tax reform.

 

[Sig]

Thank you for this information. I'm currently a W2 trader having by far my greatest year ever only 2 months into the year lol. My current share is around 900k already. Thank you Reddit lol. I'm going to allocate a bunch to a risk bank to keep growing, but I'm looking for anything I can to deduct taxes (minus moving to Puerto Rico). I'm in FL so effectively my top income tax bracket is 39.35% (Federal+Medicare) on income over $518,400. I've heard about S-Corps, dunno if I can take advantage of them to pay a lower tax rate. I remember that the item that would have reduced taxes by 20% for S-Corp income was shot down during tax reform.

The Qualified Business Income (QBI) exemption for S corporations has been in effect since the tax giveaway so you can get the 20% reduction, it's just subject to some restrictions so you may not qualify for it as a single person trading entity or you may be limited to something less than the full 20%. It's pretty complicated, as is all of this. Green Trader Tax is probably well worth your money to make sure you take advantage of everything you can without screwing anything up. A very small mistake on taxes can wipe out years of what you saved, again just not worth it if you aren't an expert or using the services of an expert.

 

[kmgilroy89]

Great response, and all this highlights the amount of both work and risk involved for a gain of ??? When you do the math you'll see you're greatly increasing your audit risk, the expected value you'd have to pay to go through the audit even if you came back clean, and doing a bunch of work, all for just a few dollars in tax savings. It just isn't worth it, unless you value your time at sub-$5/hour and your peace of mind at nothing.

Much more productive uses of your time toward minimizing your tax bill:
1. Set up a 401K for yourself
2. Set up a health savings plan for yourself
3. Set up a dependent care FSA if you have any child (or parent) care costs for yourself

I'll look into a health savings plan. I prefer to manage my own money rather than use a 401k though. I only like to invest in growth companies. I might buy some TIPs to hedge against what I think is going to be incoming inflation though.

 

[Sig]

I'll look into a health savings plan. I prefer to manage my own money rather than use a 401k though. I only like to invest in growth companies. I might buy some TIPs to hedge against what I think is going to be incoming inflation though.

So a 401K is just a tax structure, not something that requires someone else manage your account. You can set up a 401K at Schwab, for example, and buy whatever you want in the account subject to the limitations on short sales and margin use. There are even ways to get around that.

Not to be a jerk, but you seem to be as naive at this as I would be about brain surgery. I'd definitely hire a doctor if I needed brain surgery, maybe hiring a professional in this area would be wise as well?

 

[kmgilroy89]

So a 401K is just a tax structure, not something that requires someone else manage your account. You can set up a 401K at Schwab, for example, and buy whatever you want in the account subject to the limitations on short sales and margin use. There are even ways to get around that.

Not to be a jerk, but you seem to be as naive at this as I would be about brain surgery. I'd definitely hire a doctor if I needed brain surgery, maybe hiring a professional in this area would be wise as well?

There's a lot of jerks on ET and I don't see you as one at all lol. You're very helpful and you're right about that. I'm not an accountant and tax code is complicated as hell. In the past I've just taken the standard deduction, but now I'm in big boy league lol. I'll look into the cost. Creating my own 401k is news to me. All I knew was the one year rule for ST vs. LT capital gains. So yes, there's a lot for me to learn. I'm used to hearing the political talking point of the rich paying lower tax rates then their secretaries and I was looking for ways to find loopholes myself, but I guess I'm not in their category haha.

 

[BMK]

I'm currently a W2 trader [snip] I'm in FL so effectively my top income tax bracket is 39.35% (Federal+Medicare) on income over $518,400. I've heard about S-Corps, dunno if I can take advantage of them to pay a lower tax rate.

Is this a typo? If you've only "heard about" S-corps, then how are you currently a W2 trader? Do you already have an S-corp, and you don't understand how they work? Or do you have a C-corp? Or did you mean to say that you are currently a 1099/Schedule C trader?

BMK

 

[kmgilroy89]

Is this a typo? If you've only "heard about" S-corps, then how are you currently a W2 trader? Do you already have an S-corp, and you don't understand how they work? Or do you have a C-corp? Or did you mean to say that you are currently a 1099/Schedule C trader?

BMK

I work for a prop firm. I'm a W2 employee. I was surprised when I was told I would be one lol. However, my employer can switch me to 1099 if I wish. Our firm is mixed. I know most firms just do 1099.

 

[Sig]

There's a lot of jerks on ET and I don't see you as one at all lol. You're very helpful and you're right about that. I'm not an accountant and tax code is complicated as hell. In the past I've just taken the standard deduction, but now I'm in big boy league lol. I'll look into the cost. Creating my own 401k is news to me. All I knew was the one year rule for ST vs. LT capital gains. So yes, there's a lot for me to learn. I'm used to hearing the political talking point of the rich paying lower tax rates then their secretaries and I was looking for ways to find loopholes myself, but I guess I'm not in their category haha.

One other thing to think about if you haven't already is estimated taxes. If you made a lot more in Q1 than you usually do and it wasn't paid by W-2, then you'll need to pay estimated taxes for that both federal and if you're in a state with income tax, state. Otherwise you'll have to pay a penalty and interest for at least 9 months. Note you don't have to pay everything you owe, as long as you've paid 110% of what you paid in taxes last year you're safe harbored and don't have to worry about any more estimated tax. However you obviously will have to pay your full tax when you file your return or extension next year, but since you never know if you'll have a down year for the rest of the year it's best to pay the minimum in estimated taxes you can.

 

[BMK]

An s-corp can indeed use the 20% Qualified Business Income Deduction that was part of the TCJA legislation. But even without that, there is a much different, much more important benefit to an s-corp.

It is closely related to the idea that shareholders working for the company must get reasonable compensation, meaning that they must get a salary or wages on a W-2 that realistically reflects the work they are actually doing. Say a doctor operates his medical practice as the sole shareholder of an s-corp, and he has net profit of, say, $1 million, after all other expenses. He can't take a W-2 salary of $24,000 per year. The world doesn't work that way. He's not a front desk clerk at Motel 6. His salary has to be equivalent to whatever it would be if he was practicing medicine as a real employee and not a business owner. So that reasonable salary, for that doctor, might be, for example, $400,000 per year. It all depends on variables like what his specialty is, and what part of the country he's in. But the point is that if you do it right, in this example, the other $600,000 of profit does not go on the W-2, but rather on the K-1 as investment income. So that portion of the profit is not subject to social security, medicare, or self-employment taxes.

This is the main reason for using an s-corp. In this example, the outcome is much better than having $1 million of net profit on Schedule C.

And if it is done the right way, it can work for traders.

BMK