Hardening the rules on home offices – income tax deductions – includes advice from tax experts
John S. DeMott
The Supreme Court’s decision on the home-office deduction confuses some taxpayers but emboldens the IRS.
For a number of harried American taxpayers headed for the April filing deadline for Form 1040, the home-office deduction has generally been a “take-me-if-you-dare” proposition. This year, that will be especially true for the approximately 35 million Americans who do some or all of their work at home.
In a January decision that meshed conveniently with the 1993 tax-filing season, the Supreme Court made it easier for the Internal Revenue Service to clamp down on home-based entrepreneurs and business people who claim the home-office deduction without following the rules.
In an unequivocal 8-to-1 decision that surprised many tax observers for its lopsidedness, the court sided with the IRS and overturned lenient rulings by the U.S. Tax Court and the U.S. Court of Appeals for the 4th Circuit. The Supreme Court’s decision will have the practical effect of drawing hard lines around deductions for use of a home office.
Says Washington lawyer Donald C. Alexander, who was U.S. commissioner of internal revenue under Presidents Nixon, Ford, and Carter: “This is going to come as trouble for a lot of people.”
The court rendered its decision in the case of Nader Soliman, a self-employed Virginia anesthesiologist whose $2,500 home-office deduction for 1983 had been disallowed by the IRS. The justices affirmed what has long been specified in the federal tax code: The office in the home must be the “principal place of business” where revenue is generated.
The twist was that although the physician anesthetized patients at a number of Virginia hospitals, he did his billing and other paperwork as well as his professional reading in a spare bedroom of his McLean home and used expenses for that space as a basis for his home-office deduction. He was forced to do so, he claimed, because he had no office space at any hospital where he practiced.
The Supreme Court said that didn’t matter, and that previous courts that had upheld Soliman’s deduction had worried excessively about whether the home office was “essential” to the conducting of the business or whether Soliman had no alternative office space.
What did matter, Justice Anthony Kennedy wrote for the majority, was that Soliman earned his money at the hospitals, not at his home office. So, “from an objective standpoint,” he wrote, the expenses for the home office couldn’t be deducted.
Reaction came swiftly. ChipSoft of San Diego, a leading publisher of tax-preparation software (MacinTax, TurboTax), reported the court’s decision for its computer bulletin board on CompuServe and other online information services. But two days after the decision, ChipSoft went ahead as planned and shipped its final disks for 1992 tax returns to stores and client customers with no changes in its instructions for the home-office deduction. The instructions are already quite pointed: “The rules for claiming a deduction for business use of the home severely limit who may take this deduction.”
Self-employed, home-based individuals started telephones ringing in the offices of accountants around the country. Even relatives of self-employed people got involved. Within minutes after she heard of the decision, Kelly Syres in Dallas was on the phone to her father, Bob Syres, in suburban Westchester County, N.Y. She asked if his television syndication firm, which he runs from his 1825 farmhouse, would be harmed by the ruling.
Syres said that as far as he knew, no, but that he’d have to check with his accountant–just to be sure. He spent 200 days away from his office in 1992 on extensive international business travel, he says, but “I do my follow-up work by phone or fax from this office. So I don’t think I’m affected.” His business is in one of the 14 rooms in his house, and so he deducts 1/14 of his home expenses for his home office. “I don’t see how you can get more conservative,” he says.
In the view of former IRS Commissioner Alexander, “anybody who is an itinerant who works out of a particular location but can’t perform work at the location” would be adversely affected. For the moment, freelance writers seemed safe; they perform work for client editors in their home offices.
But what of traveling consultants, self-employed interior decorators, and freelance photographers? The latter may gather assignments from home-office telephones, but the actual photography–the earning of money–is done on the client’s site, so would that exclude the home-office deduction?
Says Sue Klemens, a freelance photographer near Washington: “That depends on how you define earning money. Freelance photographers spend a lot of time on the phone doing marketing, this sort of thing.” Says IRS spokesman Henry Holmes: “I think you have to look at what the home office is used for in relation to the business.”
Though it’s perceived as a red flag proclaiming “audit me!” to the IRS, the reality of the home-office deduction is a little less scary. About 1.6 million Americans took the deduction in 2992 for the tax year 1991, using the new Form 8829 for calculating it. But only a tiny fraction of those tax filers got the dreaded, politely worded letter from what tax lawyers call “the service.” Just 1 percent of the returns from all 114 million U.S. taxpayers, in fact, are audited.
Even on those returns that were audited, says Holmes, what probably attracted the IRS’s attention was not the home-office deduction alone but items that were listed along with it, such as enough additional deductions to create an income loss from self-employment on Schedule C.
Nevertheless, uncertainty has long characterized the home-office deduction. Taxpayers, professional tax preparers, and lawyers in many instances have been unsure about what was and was not legally deductible–and what should and shouldn’t be reasonably claimed–by the taxpayer who worked some or all of the time at home. So, in some instances, legitimate deductions went unclaimed because of timidness or ignorance. Bewilderment sometimes prevailed over what was and wasn’t a home office.
Even the physical characteristics of what constituted a home office were murky. At one time, it had to be a space isolated from the rest of the house, but the IRS no longer requires literal wails around the home office, only that the space be used exclusively for business.
At the same time, taxpayers were being asked for more information about the deduction. Form 8829, for example, asks filers for the number of square feet in a home used for an office, as well as a breakdown of specifics such as expenses for insurance and maintenance and assignment of a part of a house’s or condomimum’s depreciation as part of the deduction.
To many, the decision seemed insensitive to the situations of real people who work at, or from, home. Says one frustrated photographer: “What am I supposed to do, bring all my subjects to my home office?”
But others proclaimed the court as knowing precisely what it was doing when it selected Soliman’s case for review. One lawyer called it the perfect vehicle for distinguishing the home office from all other kinds of offices and for drawing clear legal lines between them.
Yet far from ending the controversy, the decision probably will stir more litigation. A number of lawmakers said after the decision that they would introduce legislation in Congress to effectively overturn the court’s ruling by setting up a broader definition of a home office that would not exclude such classes of workers as telecommuters. Says Alexander: “It’s not the end.”
Q&A: Home-Office Deductlbility
Here are questions on the home-office deduction and answers compiled from the opinions of various tax experts:
* Should I take the home-office deduction for 1992?
Yes, if you’ve been taking it legitimately all along. If you’ve qualified before, you should qualify again for 1992. Be sure to claim only what’s appropriate.
* When shouldn’t I take the deduction?
If you generate less than 50 percent of your income from your home office, steer clear of the deduction. A home office can’t be your “principal place of business” if you earn more than 50 percent of your income elsewhere.
* If I don’t qualify, does that mean that all is lost?
No. Home office is but one of several available deductions, and it’s not necessarily the biggest one, just the most complicated. You probably can still claim other expenses on Schedule C for such items as auto mileage or maintenance, telephone expenses, travel, subscriptions, and meals. Just keep thorough records.
* If I take the home-office deduction, will I be audited?
Probably not. But your return most likely will go into what the IRS calls a “higher selection category,” which means your chances of being audited are greater.
* If I took the home-office deduction in past years, will I be audited?
The IRS said in February that it would not audit pre-1992 returns because of the deduction.
* What’s the bottom line?
Says former U.S. Commissioner of the IRS Donaid C. Alexander: “A year ago, I might have said ‘take a chance’ on the home-office deduction. But not now.”
The Supreme Court’s decision is only one reason. With the national debt at a staggering $4 trillion, the IRS is under increasing pressure to collect what’s owed Uncle Sam, from taxpayers in home offices and everywhere else.
COPYRIGHT 1993 U.S. Chamber of Commerce
COPYRIGHT 2004 Gale Group