The home office deduction under IRC §280A has been a willing participant and giver of headaches for most taxpayers since its early adoption in 1976 as part of the Tax Reform Act of 1976. However due to the various abuses of the deduction and colorful history most tax professionals have given an early burial to an alive and vibrant tax deduction. In 1993, the Supreme Court case of Commissioner v. Soliman, 506 U.S. 168 (1993) changed the landscape and perception of the deductibility of the deduction by tax professionals. In the Soliman case, the Commissioner challenged the home office deduction taken by Dr. Soliman, an anesthesiologists working as a subcontractor for various hospitals. Dr. Soliman claimed as an independent contractor that his home was used as his principal place of business because the hospitals he contracted with did not offer office space for him to conduct his administrative paperwork. Commissioner v. Soliman, (1993). Moreover Dr. Soliman contended the office he used in is three-bedroom apartment was used exclusively for business purposes and included administrative duties, conducting medical research and consulting with other medical professionals. All of the mentioned activities met the exclusive-use test however a different result was reached with regard to the principal place of business test.
The Court used a facts and circumstance test stating the inquiry is more subtle with the ultimate determination of the principal place of business being dependent upon the particular facts of each case. Commissioner v. Soliman, (1993). Thus an analysis of the relative importance of the functions performed at each business location depends upon an objective description of the business in question. The Court further stated if the nature of the trade or business requires the taxpayer to meet or confer with a client or patient or to deliver goods or services to a customer, the place where that contact occurs is often an important indicator of the principal place of business and can be called the “focal point” of the business. Commissioner v. Soliman, (1993).
The Court held in favor of the Commissioner citing the practice of anesthesiology requires the medical doctor to treat patients under conditions demanding immediate, personal observation which is so exacting all patients are treated at hospitals, facilities with special characteristics designed to accommodate the demands of the profession. The actual treatment was the essence of the professional service and the most significant event in the professional transaction. The home office activities from an objective standpoint must be regarded as less important to the business of the taxpayer than the tasks he performed at the hospital. It is clear from the Court’s ruling that the principal place of business must indeed be the place where one performs in significant part all of his/her duties of value. In this particular case that is the operating room of the hospital and not the home office.
This ruling effectively eliminated the home office deduction for small business owners conducting work outside of their home and made it virtually impossible to take. Whether this was the intended impact by the Commissioner is not clearly known but the court did mention the result is compelled by the language of the statute and Congress must change the statute’s words if a different result is desired as a matter of tax policy. Commissioner vs. Soliman, (1993). The effect of the Soliman ruling was disastrous for self-employed individuals. Individuals such as handymen, realtors, building contractors, landscapers and many others were no longer entitled to the deduction. The Service quickly issued Notice 93-12 to cement its monumental high Court win. For the next six years after the ruling the home office deduction all but vanished, if attempted it was rejected by the Service to the dismay of many self-employed persons. Most CPA’s stopped advising clients on taking the home office deduction as there was just no viable way to meet the new arbitrary narrow standard enounced in the Soliman case. For every gray cloud there is a silver lining which for small business owners came in 1999. Under the home office deduction provisions of the Taxpayer Relief Act of 1997 effective for January 1, 1999, the home office deduction was given new life. Congress realized the ruling in Soliman effectively estopped small business owners from the deduction and hence changed its policy and direction regarding the deduction.
The Taxpayer Relief Act of 1997 effectively retracted the arbitrary standard of Soliman and expanded the interpretation by adding two additional criteria that allowed more taxpayers to meet the principal place of business test. Under the new home office rules one can qualify for the deduction if 1) the taxpayer uses the home office to conduct administrative or management activities of his or her trade or business and if 2) the trade or business has no other fixed location where the taxpayer conducts substantial administrative or management activities. The two-part test will allow the deduction if the office is exclusively used on a regular basis as a place of business by the taxpayer and in the case of an employee, only if such exclusive use is for the convenience of the employer. In essence, these rules now recognize administrative and management services as a valuable component of all services offered by customers.
The Joint Committee on Taxation JCS-23-97 Section 932 offered four examples to help elucidate the once
enigmatic deduction: 1) taxpayers may take a home office deduction if they do not conduct substantial administrative or management activities at a fixed location other than the home office, even when those activities (billing) are performed by other people at other locations, any insubstantial administrative or management activities may be performed at fixed locations other than the home office: 2) taxpayers performing administrative and management activities at sites that are not fixed location of the business (such as cars or hotel rooms) in addition to performing the activities in a home office may still secure the deduction, i.e. taxpayer does not have to perform all there administrative and management services at home to qualify for the deduction: 3) taxpayers who conduct an insubstantial amount of administrative and management activity at a fixed location other than the home office, occasionally doing minimal paperwork at another fixed location may still take the deduction, this stipulation recognizes that as a practical matter, businesspeople often perform minimal paperwork at other locations. For example, a medical doctor may do a limited amount of paperwork at a hospital or clinic: and 4) Taxpayers conducting substantial nonadministrative or nonmanagment business activities at fixed locations other than their home offices will not be prevented from taking the deduction. For example, meeting with customers, clients or patients at another fixed location will no longer preclude the deduction. JCS-23-97 Section 932. Example 4 addresses the issues argued in Commissioner v. Soliman, (1993) thus a home office will be deemed the principal place of business if the taxpayer uses it for administrative or management activities of any trade or business and there is no other fixed location where the taxpayer conducts a substantive portion of these activities. This essentially disregards the importance of other nonadministrative and nonmanagment activities the taxpayer may engage in outside the home office. G Fleischman and T Payne. 1999. The New and Improved Home office deduction. Journal of Accountancy. March 1999.
In Conclusion, the home office deduction has been given new life by Congress based on the passage of the Taxpayer Relief Act of 1997. Congress believed that the Supreme Court’s decision in Soliman unfairly denied a home office deduction to a growing number of taxpayers who manage their business activities from their home. JCS-23-97 Section 932. Thus the statutory modification adopted by Congress will reduce the prior-law bias in favor of taxpayers who manage their business activities from outside their homes, thereby enabling more taxpayers to work efficiently at home, save commuting time and expenses, and spend additional time with their families. Moreover, the statutory modification is an appropriate response to the computer and information revolution, which has made it more practical for taxpayers to manage trade or business activities from a home office. JCS-23-97 Section 932. Self-employed taxpayers are not taking the deductions for a number of reasons but mostly because their CPA’s are advising it will raise a red flag with the IRS. Whether that is true or not is irrelevant depending on your level of documentation for the deduction. However what is important is that it is Congress’ intent that more self-employed people take the deduction and hopefully as with time CPA’s will become more practical and start advising their client to take this well deserved and beneficial deduction. The TIMES HAVE CHANGED.
