AVAILABILITY OF HOME OFFICE DEDUCTION FOR VARIOUS BUSINESSES AND OCCUPATIONS
The current test of whether a taxpayer's home office qualifies as her principal place of business is found in Code Section 280A(c)(1) and is effective for tax years beginning after December 31, 1998. See Section 81.5 for a discussion of this test. Due to its recent effective date, this test has not been litigated yet. However, a large body of case law exists interpreting the Soliman test (in effect before January 1, 1999) and the prior focal point test. The following discussion examines court cases that decided on whether taxpayer's engaged in various businesses qualified for a home office deduction under the prior rules.
(a) HOME SALES BUSINESSES
Many taxpayers sell products, such as cleaning supplies and cosmetics, by calling on customers at the customers' homes. Under the Soliman test, the home office should not be considered the principal place of business because even though the taxpayer may spend more time at the home office than at any other business location and perform several significant functions there, such as record-keeping, setting up appointments, taking telephone orders, studying sales materials, and ordering inventory, the taxpayer performs his most important function -- selling the product -- at the customer's home.
Under Code Section 280A(c)(1), effective for tax years beginning after December 31, 1998, however, the result should be different. The test applicable to such years makes clear that a principal place of business includes a place of business used by the taxpayer for the administrative or management activities of the trade or business as long as there is no other fixed location where substantial administrative or management activities are being conducted. Code Section 280A(c)(1) (flush language).
Indeed, the Tax Court has specifically indicated that the amended Section could bring about a different result. In a case involving a floor covering business conducted exclusively from the taxpayer's home, the court denied a home office deduction, citing Soliman, indicating that the principal place of business was in the homes where the floor coverings were installed, even though the records were kept and the management of the business was performed in the taxpayer's home office. However, the court noted that the case was decided for the 1995 tax year and intimated that the amended language of Code Section 280A(c)(1) could bring a different result in the future. Cole v. Commissioner, T.C. Memo. 1999-207.
(b) LAUNDROMAT MANAGEMENT
In Meiers v. Commissioner, 782 F.2d 75 (7th Cir. 1986), the Seventh Circuit held that the home office was the principal place of business of a laundromat manager who spent on the average more time working in the home office than at the laundromat. The taxpayers, the manager and her husband, were the sole shareholders in a corporation that operated a laundromat. The manager's duties included drafting work schedules for the laundromat's five part-time employees, collecting monies from machines and filling the coin changer, assisting customers, and performing bookkeeping, and other managerial tasks. The manager usually spent one hour per day at the laundromat and two hours per day at the home office. It was undisputed that the home office was used exclusively for administrative work on behalf of the laundry.
In determining the taxpayer's principal place of business, the major consideration was the length of time the taxpayer spent in the home office as opposed to other locations, but that was not necessarily the only consideration. Other factors included the importance of the business functions performed by the taxpayer in the home office, the business necessity of maintaining a home office, and the expenditures of the taxpayer to establish a home office. In applying these standards, the court pointed out that the manager spent most of her time in the home office, that she performed her most important functions there, and that it was also undisputed that the taxpayers made a legitimate business decision not to create office space at the laundromat. The result should be the same under the Soliman test and under Code Section 280A(c)(1), as in effect after December 31, 1998.
(c) ARTS AND CRAFTS
Many artists and craftspeople work in their homes but make few, if any, sales there. Instead, they exhibit their creations at various locations, such as auctions or arts and crafts fairs. In some situations, the sales occur at a fixed retail location, such as an art gallery, operated by an unrelated person. Under the Soliman test or Code Section 280A(c)(1), the home office should be the principal place of business because the majority of the taxpayer's time is spent there, and the creation of the product occurs there.
A home-based catering business usually entails a substantial amount of time in food preparation at the taxpayer's home, and the caterer does not typically spend substantial time at a single location away from the home office or kitchen. Under the Soliman test, the home office or kitchen should not be considered the principal place of business, since the most important functions, i.e., the sale of food, occurs at a place other than the taxpayer's home.
In Baie v. Commissioner, 74 T.C. 105 (1980), the taxpayer prepared food in her home kitchen for sale at her hot dog stand. The Tax Court, using the abandoned focal point analysis, held that the hot dog stand, and not her home, was her principal place of business. The change to Code Section 280A made by the Taxpayer Relief Act of 1997 does not change the requirement that to be eligible for the deduction, the home office must be the principal place of business, and since the court held that the hot dog stand was the principal place of business, the result would likely remain the same even under amended Code Section 280A(c)(1).
(e) MANAGEMENT OF RENTAL PROPERTIES
In Curphey v. Commissioner, 73 T.C. 766 (1980), the Tax Court permitted a home office deduction where the taxpayer owned several rental properties and managed them from his home office. The issue in Curphey was whether the taxpayer's rental activities rose to the level of a trade or business. The IRS conceded that the taxpayer was entitled to a home office deduction if the trade or business issue were resolved in the taxpayer's favor.
The Tax Court's opinion did not express its view with respect to the principal place of business question. However, the language added by the Taxpayer Relief Act of 1997 to Code Section 280A(c)(1) would clearly indicate that such a home office would qualify as the principal place of business as long as there were no other fixed location where the administrative or management activities were carried out.
In applying the Soliman test, one would assume that a taxpayer in this situation spends more time at the home office than at any one of the rental properties, even if the taxpayer personally performs all the maintenance on the properties. In addition, the taxpayer performs important functions at the home office, including record-keeping, payment of expenses, planning, and dealing with tenants, service people, and real estate agents by telephone. Therefore, under the Soliman test, the home office should be considered the principal place of business.
(f) LAW AND ACCOUNTING PROFESSIONALS
In Roth v. Commissioner, T.C. Memo. 1981-699, the Tax Court held that an attorney's home office was not his principal place of business because, on average, the attorney spent more time in his downtown office than in his home office.
PRACTICE TIP: Do not use the law office part of the residence for family use on weekends and holidays. Even where it was the attorney's principal place of business, the deduction was barred. Cook v. Commissioner, T.C. Memo. 1997-338.
In Trussel v. Commissioner, T.C. Memo. 1982-680, a judge was unsuccessful in getting his home office to be treated as his principal place of business even though his employer, the court system, did not provide office facilities, a secretary, clerk, or typist, and the courthouse area was too dangerous to remain in after dark. The Tax Court concluded, using the abandoned focal point test, that although the judge spent a great deal of time drafting and researching at his home, the courthouse was the focal point of his employment.
It seems unlikely that a court would hold that a place other than the courthouse is the principal place of business of a judge. Under the Soliman test, the judge could attempt to show that, like the concert musicians, a great deal of work at home was expected of him. See Drucker v. Commissioner, 715 F.2d 67 (7th Cir. 1983); Kahaku v. Commissioner, T.C. Memo. 1990-34. While the language added by the Taxpayer Relief Act of 1997, Pub. L. 105-34, makes it clear that a principal place of business may include a place of business used for administrative or management activities, it does not state that any place so used is necessarily the principal place of business.
Teachers and professors have frequently attempted to utilize the home office deduction. The courts, especially the Tax Court, have been quite strict in permitting the home office deduction. Even if a teacher does most of the work at home, the court decisions are almost uniform in finding that, as long as the teacher or professor was employed as a teacher and not as a researcher and did some teaching at the school, the principal place of business will be considered the school and not the home. Chauls v. Commissioner, T.C. Memo. 1980-471.
The IRS ruled that where a teacher used a portion of the house to prepare lesson plans, store textbooks, and construct charts and other materials, the house was neither the principal place of business nor a separate structure attached to the home. PLR 7734023. On the other hand, the Second Circuit allowed a college philosophy professor a home office deduction since the professor lacked a private on-campus office where he could spend time researching and writing. Weissman v. Commissioner, 751 F.2d 512 (2d Cir. 1984).
The results should be the same under the Soliman test. The language added by the Taxpayer Relief Act of 1997, Pub. L. 105-34, may at least provide an additional argument for teachers for tax years beginning after December 31, 1998, but it still seems likely that the principal place of business for teachers would be held to be in the schools.
OBSERVATION: Accordingly, teachers continue to be barred from claiming the deduction. The legislative history notes that an employee's failure to use suitable office space provided by the employer will be taken into account in determining whether the home office is maintained for convenience of the employer. H. Rep. 148, 105th Cong. 407-408, 1997.
The Second and Seventh Circuits have allowed concert musicians a deduction for business use of the home. Drucker v. Commissioner, 715 F.2d 67 (7th Cir. 1983); Kahaku v. Commissioner, T.C. Memo. 1990-34. The courts concluded that the principal place of the musicians' business was the practice area at their homes, since practice was central to the musicians' profession, and the employer did not provide practice space.
Contrast this with Dempsey v. Commissioner, T.C. Memo. 1982-580, a decision under the abandoned focal point test, wherein the Tax Court denied a music professor a deduction even though the professor spent more hours on a weekly basis practicing at home in a studio that was used exclusively for practicing.
In Dempsey, the taxpayers, a college music professor and his wife, were violinists with a quartet and in an orchestra, and they set aside a specially equipped room in their house for music practice. The Tax Court found that the room was not the principal place of business of either taxpayer and denied the deduction of expenses for the room. In so holding, the court noted that no quartet or orchestra performances were given in the practice room, no orchestra rehearsal was held in the practice room, and although many quartet rehearsals were held in the practice room, other such rehearsals were held at other places. Thus, the taxpayers had failed to persuade the court that the practice room was the principal place of business of either taxpayer insofar as they were performers with either the orchestra or the quartet.
In Genck v. Commissioner, T.C. Memo. 1998-105, the taxpayer, a self-employed jazz musician and band manager, managed to meet the stringent relative-importance test for determining the principal place of business required by the Soliman test. As the band's lead singer, the taxpayer spent an average of twelve hours per week performing. Her husband played bass guitar for the band and lived with the taxpayer in an apartment that was divided into roughly equal areas consisting of living quarters and an office. The taxpayer and her husband used the married filing separately filing status. As band manager, the taxpayer spent an average of 30 hours per week in the office, booking performances, negotiating contracts, maintaining files of lyrics, music books, and audio and video demos. The taxpayer reported gross receipts of $21,500 on her Schedule C for the year.
Taking into account the comparative analysis mandated by Soliman, the Tax Court determined that the taxpayer's activities in her role as band manager were sufficient to treat the home office as her principal place of business. The extensive time spent in the home office, which she used exclusively on a regular basis in performing business functions as band manager, entitled her to claim rent and utility expenses attributable to the home office. The Tax Court made clear that the deduction was allowed solely for the taxpayer's role as band manager; her role as lead singer would not have entitled her to a deduction.
Since the language in Code Section 280A(c)(1), added by the Taxpayer Relief Act of 1997, Pub. L. 105-34, relates to administrative or management activities, it is unlikely that it would change the result in any of the above situations.
(i) RESEARCH AND WRITING
A freelance writer who used a separate room exclusively for writing purposes was entitled to a home office deduction. Gestrich v. Commissioner, 74 T.C. 525 (1980), aff'd in an unpublished opinion (3d Cir. 1982). Researchers and scholars who are employees, however, generally cannot claim a home office deduction. For example, a scientist was denied a home office deduction in Doviak v. Commissioner, T.C. Memo. 1984-454, even though the taxpayer was not in the teaching business, but instead was solely a researcher. The court found that the principal place of business was the employer's office even though a substantial amount of research was done at home when the employer's office was closed or because the air conditioning would shut off in the evenings. The Tax Court held that the reasons for doing additional research at home were insufficient to convert the taxpayer's home into his principal place of business. This result should be the same under the Soliman test and under Code Section 280A(c)(1), as in effect after December 31, 1998.
Generally, the home office is not the principal place of business of a physician. This, of course, was the result in the Soliman case itself. Soliman v. Commissioner, 94 T.C. 20 (1990), aff'd, 935 F.2d 52 (4th Cir. 1991), rev'd, 113 U.S. 701 (1993). In Soliman, the taxpayer was a self-employed anesthesiologist who practiced at several hospitals and used his home office, located in a spare bedroom, exclusively to manage his practice. The taxpayer was denied the home office deduction because the home office was not his principal place of business, since he actually practiced anesthesiology in the various hospitals. <20>
Other cases applying the Soliman test have reached the same result. For example, in Chong v. Commissioner, T.C. Memo 1996-232, the Tax Court considered another case involving home office deductions claimed by an anesthesiologist. As in Soliman, the taxpayer was a self- employed anesthesiologist who administered anesthesia to patients at a local hospital. The hospital did not provide him with a private office, although it did provide an area where the taxpayer occasionally could do some of his paperwork. All of the taxpayer's fees were paid directly to him by patients; the taxpayer received no compensation directly from the hospital. For billing, the taxpayer maintained a home office and kept his records at that location. The taxpayer employed an office manager who worked 20 hours per week at the doctor's home office, and the taxpayer's wife also worked there.
The taxpayer claimed home office deductions, including depreciation, mortgage interest, property taxes, utilities, insurance, and repairs and maintenance expenses. The IRS denied the deductions, and the Tax Court agreed. According to the Tax Court, Soliman dictated that deductions would only be permitted if the home office were the taxpayer's principal place of business, which the court defined as the location where the most important or significant events pertaining to the business took place. As in Soliman, the Tax Court in Chong found that the most important or significant events took place at the hospital where patients were treated.
The taxpayer argued that the principal place of business determination had to be made on an activity-by-activity basis, rather than on the basis of an integrated business. The taxpayer maintained that the most significant event in the billing process took place in his home office. Therefore, he said, the home office was the principal place of his billing business. The Tax Court rejected this argument, treating the medical practice as a single trade or business, not one that could be bifurcated. Although the Chong case appears virtually identical to Soliman, there is a key area where the facts in Chong differed from the facts in Soliman. Dr. Soliman performed services at three different hospitals, so it could be more strongly argued (compared with Chong) that Soliman's principal place of business was his home office rather than at one of the hospitals. Dr. Chong, on the other hand, worked at only one hospital.
Another home office doctor case decided after Soliman, Novick v. Commissioner, T.C. Memo 1996-564, involved a doctor who was an employee of a medical group. On his 1989 to 1991 returns, the taxpayer claimed home office expenses. The deductions claimed were for a portion of his home used to store medical records and equipment relating to his dissolved professional corporation and to inactive patients. The IRS disallowed home office deductions and the Tax Court agreed, citing a stipulation that had been entered into between the government and the taxpayer prior to the Tax Court case. The stipulation, which had probably seemed harmless enough to the taxpayer, stated that the taxpayer's use of his home was not for the convenience of his current employer. The Tax Court noted that the items stored in the taxpayer's home did not fall within the exception under Code Section 280A(c)(2) (dealing with storage use by the taxpayer, which is meant to be a significantly more lenient standard than the principal place of business test that was the subject of the Soliman case).
Code Section 280A(c)(2) states that the prohibition of Code Section 280A(a) will not apply to space used on a regular basis as a storage unit for the inventory of the taxpayer held for use in the taxpayer's trade or business of selling products at retail or wholesale, but only if the dwelling unit is the sole fixed location of such trade or business. It is not clear what this storage exception means. At a minimum, Code Section 280A(c)(2) provides that storage has to relate to the business of selling products at retail or wholesale (which was, at the very least, debatable, in the taxpayer's case). <21>
Since the language in Code Section 280A(c)(1) added by the Taxpayer Relief Act of 1997 was a direct reaction to the result in the Soliman case, it can certainly be argued that the result in that case would be different for a case with similar facts in tax years beginning after December 31, 1998. It should be noted, however, that the language merely permits a place of business where the sole administrative or management activities are conducted to be considered the principal place of business, it does not mandate that such a place be considered the principal place of business.
(k) DAY CARE PROVIDERS
Day care providers can deduct expenses under Code Section 280A even though no rooms are used exclusively for the day care business. The services may be provided for children, for persons 65 or older, or for persons physically or mentally incapable of caring for themselves. Code Section 280A(c)(4).
The calculation for the amount of the deduction is computed by multiplying the total costs incurred during the year that are allocable to the use of the home by two fractions. Rev. Rul. 92-3, 1992-1 C.B. 441. The first fraction is the total square footage in the home that is available for day care use throughout each business day and that is regularly so used in that business, divided by the total square footage of the home. The second fraction is the total hours in the year that the day care is operated (including substantiated preparation and clean-up time), divided by the total number of hours in a year. This deduction is limited by Code Section 280A(c)(5). (The language in Code Section 280A(c)(1) added by the Taxpayer Relief Act of 1997, Pub. L. 105-34, relating to the definition of a principal place of business has no effect on the provision relating to day care providers.)
COMPLIANCE TIP: The second computation does not have to be made for any room or portion of a home that is routinely used in the day care activity and is available for such use throughout the business day. Rev. Rul. 92-3, 1992-1 C.B. 441.
20/ See Section 81.5(a)(2) for a full discussion of the Soliman decision. Although the Soliman decision rejected the focal point test, several decisions under the focal point test reached the same result as Soliman. See, e.g., Moriarty v. Commissioner, T.C. Memo. 1984-249 (principal place of business of a university professor of medicine was at the university where he was provided with office, patient interview, and examination space; there was no evidence that the professor held himself out to the public as practicing medicine in his home); Pomarantz v. Commissioner, T.C. Memo. 1986-461, aff'd, 860 F.2d 960 (9th Cir. 1988) (emergency room physician, an independent contractor, who treated patients only at a hospital and maintained an office in his home in which he kept his medical books, journals, and records was not entitled to a home office deduction since the home office did not qualify as the physician's principal place of business).
21/ For a further discussion of the storage of inventory and product samples exception, see Section 81.6 (From Kleinrock's TAX LIBRARY)