HOME-OFFICE DEDUCTION

More taxpayers will be eligible for the home-office deduction after 1998. Under the new law, a home office satisfies the requirement that it be the taxpayer's "principal place of business" if the taxpayer uses the office to conduct administrative or management activities for a business and does not conduct substantial administrative or management activities at any other fixed location. This change addresses the problem faced by many service professionals and other taxpayers who cannot now qualify for a home-office deduction because, even though they manage their businesses from home, they do not meet clients or customers there.

To qualify for a deduction, a taxpayer still must use the home office exclusively on a regular basis as a place of business, or, in the case of an employee, the taxpayer must use the home office for the convenience of the employer. The change is effective for tax years beginning after 1998. (Act section 932; section 280A)

The following is a Revenue Ruling outlining and describing the Government's position on Home Office Expenses. This Ruling is in effect for 1997 and is modified by the recent legislation as described above under the caption "Home-Office Deduction".

Rev. Rul. 94-24 1994-1 C.B. 87 Section 280A -- Business Use of Home Summary

IRS EXPLAINS APPLICATION OF SOLIMAN TESTS FOR HOME OFFICE DEDUCTIONS.

The Service in Revenue Ruling 94-24 and IR-94-26 has explained how it will apply the "relative importance" and "time" tests set forth in Commissioner v. Soliman, 113 S.Ct. 701 (1993), to determine whether an office in the home is the taxpayer's principal place of business for purposes of section 280A(c)(1)(A).

The Supreme Court in Soliman held that an anesthesiologist, who was not provided with an office by the hospitals at which he performed his services, was not entitled to a deduction for home office expenses because his home office was not his principal place of business. (For a summary of the Soliman decision, see Tax Notes, Jan. 18, 1993, p. 313; for the full text, see 93 TNT 9-1 or H&D, Jan. 13, 1993, p. 1071.)

In Soliman, the Service points out, the Court identified two primary factors in determining whether a home office is the taxpayer's principal place of business: (1) the relative importance of the activities performed at each business location; and (2) the amount of time spent at each location. The Court also noted that, in some cases, the application of the relative importance and time tests may result in a determination that there is no principal place of business for purposes of section 280A(c)(1)(A).

The Service says in Rev. Rul. 94-24 that it will follow the Supreme Court's approach, first applying the relative importance test and then, if that test does not yield a definitive answer, applying the second, "time," test. The Service will recognize that the tests may not yield a "principal place of business" in all cases.

Rev. Rul. 94-24 offers four examples illustrating how the Service will apply the Soliman tests. Each of the examples assumes that the office in the home is used regularly and exclusively for the taxpayer's trade or business.

The first example considers a self-employed plumber who installs and repairs plumbing in customers' homes and offices. The plumber spends about 40 hours a week at customer locations and about 10 hours a week in his home office talking with customers on the telephone, deciding what supplies to order, and reviewing the business books. He also employs an individual full-time in the office to perform administrative services.

In the ruling, the Service concludes that the plumber's home office is not his principal place of business, and he cannot deduct expenses for the business use of the home. The essence of the plumber's business, the Service says, requires him to perform services and deliver goods at his customers' locations. The activities that he performs at the home office, although essential, are less important and take less time than the service calls to customers. According to the Service, the fact that the plumber's employee performs administrative activities at the home office doesn't alter the result.

In the second example, a school teacher maintains a home office for use in class preparation and for grading papers and tests. She also has a small shared office at the school. The teacher spends about 25 hours a week at the school and 30 to 35 hours of work time a week in the home office.

Again, the Service concludes that the home office is not the principal place of business. The activities performed in the home office, although essential and more time consuming, are less important than the teacher's activities at the school, the IRS says. Because the office in home isn't the teacher's principal place of business, the Service notes, it's not necessary to determine whether she maintains the office for the convenience of her employer.

The third example considers an author who spends from 30 to 35 hours a week writing in her home office. She also spends another 10 to 15 hours a week at other locations conducting research, meeting with her publishers, and attending promotional events.

In this case, the Service concludes that the home office is the author's principal place of business, and she can deduct expenses for the business use of the home. The essence of the author's business is writing, the Service says, and the outside activities, although essential, are less important and take less time than the writing.

In the fourth example, a self-employed retailer orders costume jewelry from wholesalers and sells it at craft shows, on consignment, and through mail orders. He spends about 25 hours a week in his home office filling and shipping mail orders, ordering supplies, and keeping the books of the business. The retailer also spends about 15 hours a week at craft shows and consignment sale locations. He generates a substantial amount of income from each type of sales activity.

Applying the time test in this case, the Service concludes that the retailer's home office is his principal place of business. Because the most important activities of the business -- sales to customers -- are performed in more than one location, the Service says, the principal place of business can't be determined definitively based on a comparison of the relative importance of the activities performed at the home office and at other business locations. Therefore, the time spent "at each business location assumes particular significance."

Full Text

Rev. Rul. 94-24

ISSUE

How will the Internal Revenue Service apply the "relative importance" and "time" tests set forth in Commissioner v. Soliman, 113 S. Ct. 701 (1993), to determine whether an office in the taxpayer's home is the taxpayer's principal place of business for purposes of section 280A(c)(1)(A) of the Internal Revenue Code?

FACTS

In each of the following situations, the taxpayer uses the office in the home regularly and exclusively for the taxpayer's trade or business.

Situation 1. A is a self-employed plumber who installs and repairs plumbing in customers' homes and offices. A spends approximately 40 hours of A's work time per week at these customer locations, with approximately 10 hours of A's work time per week spent in an office in A's home talking with customers on the telephone, deciding what supplies to order, and reviewing the books of the business. A also employs E, a full-time unrelated employee, in that office to perform administrative services such as answering the telephone, scheduling A's appointments, ordering supplies, and keeping A's books.

Situation 2. B is employed as a teacher. B is required to teach and meet with students at the school, and to grade papers and tests. In addition to a small shared office at the school, B maintains a home office for use in class preparation and for grading papers and tests. B spends approximately 25 hours per week of B's work time at the school, with an additional 30 to 35 hours of B's work time per week spent in B's home office.

Situation 3. C is a self-employed author who uses a home office to write. C spends 30 to 35 hours of C's work time per week in the home office writing. C also spends another 10 to 15 hours of C's work time per week at other locations conducting research, meeting with C's publishers, and attending promotional events.

Situation 4. D is a self-employed retailer of costume jewelry. D orders the jewelry from wholesalers and sells it at craft shows, on consignment, and through mail orders. D spends approximately 25 hours of D's work time per week in D's home filling and shipping mail orders, ordering supplies, and keeping the books of D's business. D also spends approximately 15 hours of D's work time per week at craft shows and consignment sale locations. D generates a substantial amount of income from each type of sales activity.

LAW AND ANALYSIS

Section 162(a) provides a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Section 262 provides that no deduction is allowed for personal, living, or family expenses.

Section 280A(a) generally prohibits otherwise allowable deductions with respect to the use of a dwelling unit which is used by a taxpayer as a residence. This deduction prohibition does not apply to any deduction, such as interest or taxes, that is allowable without regard to its connection with the taxpayer's trade or business. Section 280A(b).

Under section 280A(c)(1), the section 280A deduction prohibition does not apply to the portion of a dwelling unit which is exclusively used on a regular basis --

(A) as the principal place of business for any trade or business of the taxpayer,

(B) as a place of business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of the taxpayer's trade or business, or

(C) in the case of a separate structure which is not attached to the dwelling unit, in connection with the taxpayer's trade or business.

In the case of an employee, the preceding sentence applies only if the exclusive use is for the convenience of the employer.

In Commissioner v. Soliman, 113 S. Ct. 701 (1993), the Supreme Court identified two primary factors in determining whether a home office is the taxpayer's principal place of business for purposes of section 280A(c)(1)(A):

(1) the relative importance of the activities performed at each business location; and

(2) the amount of time spent at each location.

A comparison of the relative importance of the activities performed at each business location depends on the characteristics of each business. If the nature of a trade or business requires a taxpayer to meet or confer with clients or patients or to deliver services or goods to customers, the place where that contact occurs must be given great weight in determining where the most important activities of the business are performed. If the nature of the business requires that its services are rendered or its goods are delivered at a facility with unique or special characteristics, this is a further and weighty consideration in determining where the most important activities of the business are undertaken.

In addition to comparing the relative importance of the activities performed at each business location, Soliman also directs that a comparison be made of the time spent on business at home with the time spent on business at other locations. This time test is particularly significant when a comparison of the relative importance of the activities performed at each business location yields no definitive answer to the principal place of business inquiry. This may happen when a taxpayer performs income-generating activities at both the office in the taxpayer's home and at some other location.

Consistent with the Supreme Court's analysis in Soliman, the Service will first apply the "relative importance" test, comparing the activities performed at each business location, to determine whether an office in the taxpayer's home is the taxpayer's principal place of business for purposes of section 280A(c)(1)(A). If the relative importance test yields no definitive answer to the principal place of business inquiry (which may occur, for example, if the taxpayer delivers services or goods to customers both at the office in the taxpayer's home and elsewhere), the Service will look to the "time" test. However, as the Supreme Court specifically noted in Soliman, in some cases the application of the relative importance and time tests may result in a determination that there is no principal place of business for purposes of section 280A(c)(1)(A).

Situation 1. The essence of A's trade or business as a plumber requires A to perform services and deliver goods at the homes or offices of A's customers. The telephone activities, supply ordering, and bookkeeping review that A performs at A's home office, although essential, are less important and take less time than A's service calls to customers. Therefore, A's office in the home is not A's principal place of business, and A cannot deduct expenses for the business use of the home. The fact that E, A's employee, performs administrative activities at A's home office does not alter this result.

Situation 2. The essence of B's trade or business as a teacher requires B to teach and meet with students at the school. The class preparation and grading of papers and tests that B performs at B's home office, although essential and more time consuming, are less important than B's activities at the school. Therefore, B's office in the home is not B's principal place of business, and B cannot deduct expenses for the business use of the home. Because B's office in the home is not B's principal place of business, it is not necessary to determine whether B maintains the office for the convenience of B's employer.

Situation 3. The essence of C's trade or business as an author is writing. C's research, meetings with publishers, and attendance at promotional events, although essential, are less important and take less time than C's writing. Therefore, C's office in the home is C's principal place of business, and C can deduct expenses for the business use of the home.

Situation 4. The essence of D's trade or business as a retailer of costume jewelry requires D to sell jewelry to customers. D does this at craft shows, at consignment shops, and through catalog orders filled from the office in D's home. D generates substantial income from the sales made at each of these locations. Because the most important activities of D's business, sales to customers, are performed in more than one location, D's principal place of business cannot be determined definitively based on a comparison of the relative importance of the activities performed at D's home office and at D's other business locations. In this circumstance, the time spent on business activities at each business location assumes particular significance. D spends approximately 25 hours of D's work time per week in the home office filling and shipping mail orders, ordering supplies, and keeping the books of D's business. D also spends approximately 15 hours of D's work time per week at craft shows and consignment shops. Accordingly, D's office in the home is D's principal place of business, and D can deduct expenses for the business use of the home.

HOLDING

To determine whether an office in the taxpayer's home is the taxpayer's principal place of business for purposes of section 280A(c)(1)(A), the Service will first apply the "relative importance" test in Soliman to compare the activities performed at each business location. If the relative importance test yields no definitive answer to the principal place of business inquiry (which may occur, for example, if the taxpayer delivers services or goods to customers both at the office in the taxpayer's home and elsewhere), the Service will look to the "time" test. However, as the Supreme Court specifically noted in Soliman, in some cases application of the relative importance and time tests may result in a determination that there is no principal place of business for purposes of section 280A(c)(1)(A).

EFFECT ON OTHER DOCUMENTS

Notice 93-12, 1993-1 C.B. 298, is amplified.

DRAFTING INFORMATION

The principal author of this revenue ruling is Marilyn E. Brookens of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Ms. Brookens on (202) 622-1585 (not a toll-free call).