To deduct, or not to deduct… - home office tax deductions - Small Business Financial Adviser: Home Business

Nation's Business, Nov, 1994 by Albert B. Ellentuck

If you lost your home-office deduction because of the Supreme Court's 1993 decision in a case on the subject, relief may be on the way--although it may come slowly. Legislation that would restore the deduction for many home-based professionals stalled this yea rin Congress, but it is almost certain to be introduced again next year.

Before the court's decision, expenses of a home office were generally deductible if (1) the office was used regularly and exclusively, either as the owner's principal place of business or as a place for meeting with clients or customers in the normal course of business, and (2) the business generated enough income to cover the deductions.

But the requirement that the home office be the taxpayer's principal place of business has proven to be the most difficult. In its January 1993 decision in Commissioner vs. Soliman, the court held that an anesthesiologist who worked in three hospitals but used his bedroom as a home office to make telephone calls to patients and other doctors and to keep his records could not treat his home office as his principal place of business because it was not the most important location.

The Supreme Court's determination was based on two primary considerations: the relative importance of the activities performed at each location and the amount of time spent at each.

The Internal Revenue Service, in interpreting the decision, says that it will first apply the "relative importance" test, comparing the activities performed at each business location to determine a taxpayer's principal place of business.

If that test provides no clear answer, the IRS will then look to the "time spent" test.

These new tests add considerable confusion and impose additional paperwork burdens on business owners. More important, though, they will severely curtail the home-office deduction. Consider the following example given by the IRS:

A self-employed plumber spends about 40 hours a week at various job sites and about 10 hours in a home office arranging appointments and dealing with suppliers. The IRS says that the plumber's work at his home office, although essential, is less important and takes less time than his service calls to customers. Therefore, the home office is not a principal place of business, and the plumber cannot deduct home-office expenses.

The legislation introduced this year by Sen. Orrin G. Hatch, R-Utah, and Rep. Peter Hoagland, D-Neb., would ease the "principal place of business" test (which in effect encompasses the IRS's "relative importance" and "time spent" tests). Essentially, their legislation would allow a deduction if the portion of the house is (1) used exclusively for business; (2) used on a regular basis; (3) used to perform tasks not easily performed elsewhere; and (4) is essential to the taxpayer's business.

The protracted debate over health-care reform bumped the legislation from committee agendas this year, but sponsors say they will try again in 1995. The proposal has broad support from professional organizations.