The cost of commuting to work.

Has the IRS established a link between the home-office and transportation expense deduction that goes beyond its authority?

Most taxpayers cannot deduct the cost of commuting to and from work.

But for those who can, the standards developed for deducting transportation expenses between a taxpayer's residence and work locations have reached a new level of confusion. Varying treatments of these expenses in the Internal Revenue Code, in two Internal Revenue Service revenue rulings and in a Tax Court holding put the IRS in an unfavorable position.

The IRS disallowed a deduction for transportation expenses, claiming a taxpayer's residence did not qualify as his "principal place of business." The Tax Court, however, found the taxpayer in compliance with the "regular place of business" requirement and allowed the deduction.

To try to correct the problem, the IRS issued revenue ruling 94-47, which established a permanent link between the home-office requirements of IRC section 280A and the deductibility of transportation expenses under IRC section 162(a). That link, however, may be beyond the IRS's interpretive authority.

EARLY DEVELOPMENTS

In 1953, the IRS issued revenue ruling 53-190 (1953-2 CB 303), which allowed a deduction for daily transportation expenses between a taxpayer's residence and a temporary work location outside the taxpayer's metropolitan area if the taxpayer has no specific regular place of business or employment. In 1980, in Curphey v. Commissioner, 73 TC 766, the Tax Court held that daily transportation expenses resulting from a taxpayer's travel between an office in his or her residence and other work locations were deductible if the home office qualified as the taxpayer's "principal place of business" under section 280A(c)(1)(A). The IRS issued revenue ruling 90-23 (1990-1 CB 28) in 1990. It provided that a taxpayer with one or more regular places of business could, under section 162(a), deduct daily transportation expenses paid or incurred going between the taxpayer's residence and temporary work locations.

THE WALKER CASE

In C. W. Walker v. Commissioner, 101 TC 537 (1993), a logger drove daily from his residence to several job sites. Walker worked approximately six to seven hours per day cutting trees and approximately seven hours per week at his residence on tool repairs and maintenance. He also stored his equipment and supplies and took calls for logging jobs from his residence. The IRS disallowed Walker's transportation expenses between job sites and his residence, reasoning that these expenses were nondeductible commuting expenses because Walker's residence was not established as his principal place of business according to the standards in section 280A.

While Walker's residence was not established as his principal place of business under the home-office deduction standards, it was established as his regular place of business under the language of revenue ruling 90-23. The Tax Court found the standards used in establishing a residence as a regular place of business were not the same as those for determining a principal place of business. Therefore, since Walker's residence was a regular place of business and his job sites were temporary work locations, the transportation expenses were deductible under revenue ruling 90-23.

The IRS issued revenue ruling 94-47 (1994-2 CB 18) on July 18, 1994, in an attempt to clarify under what circumstances daily transportation expenses between a taxpayer's residence and a work location were deductible under section 162(a). The ruling said the IRS would not follow the Tax Court position in Walker and provided three situations when transportation expenses between a residence and work locations were deductible:

1. Daily transportation expenses paid or incurred between the taxpayer's residence and a temporary, work location outside the metropolitan area where the taxpayer lives and normally works.

2. When the taxpayer has one or more regular work locations away from his or her residence, daily transportation expenses paid or incurred between the taxpayer's residence and one or more temporary work locations in the same trade or business, regardless of the distance traveled.

3. When a taxpayer's residence qualifies as his or her principal place of business under section 280A(c)(1 )(A), daily transportation expenses paid or incurred between that residence and another work location in the same trade or business, regardless of whether the other work location is regular or temporary and regardless of the distance traveled.

Contrary to the Walker decision, revenue ruling 94-47 holds that a taxpayer's residence will be considered a business location for purposes of revenue ruling 90-23 only if the residence satisfies the principal place of business requirements of section 280A(c)(1)(A). Thus, an inseparable link between the section 280A home-office requirements and the deductibility of transportation expenses under section 162(a) is established. Although the standard applied to home-office deductions under section 280A was used in Curphey as a basis for substantiating the deduction of transportation expenses, the courts failed to establish that the section 280A rules were the requisite standards for deductibility of daily transportation expenses under section 162(a).

The choice of language in revenue ruling 90-23 regarding a taxpayer's regular, instead of principal, place of business may have facilitated the Tax Court decision not to equate the two terms in Walker. It seems that if the IRS wanted consistency of standards in these separate areas, revenue ruling 90-23's language would be similar to that of section 280A. The IRS has, nonetheless, clarified its position and equated these standards by issuing the strict guidelines in revenue ruling 94-47.

CREATING NEW LAW?

The issue appears to be settled. But in trying to clarify its position on transportation expenses, has the [RS in fact attempted to create new law? By limiting the deductibility of transportation expenses to the three situations listed in revenue ruling 94-47, the IRS has established the requirement that a taxpayer qualify for the home-office deduction to deduct transportation expenses from his or her residence to work locations within his or her metropolitan area. This requirement is not found in statutory law but, rather, is created only under revenue ruling 94-47. Moreover, the IRS has limited taxpayers to a standard that is more stringent than the home-office deduction.

In some situations, taxpayers may not be able to deduct daily transportation expenses even if they qualify for the home-office deduction. Under revenue ruling 94-47, not only must a taxpayer have a home office under section 280A but also the office must qualify as such under section 280A(c) (1)(A). Revenue ruling 94-47 disqualifies home offices claimed under section 280A(c)(1)([3), which allows a deduction when the home is a "place of business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of his trade or business" or under section 280A(c) (1) (c), which allows a deduction if the office is a "separate structure which is not attached to the dwelling unit, [and is] in connection with the taxpayer's trade or business."

Who qualifies trader the principal place of business test? In Commissioner v. Soliman, 113 S. Ct. 701 (1993), the U.S. Supreme Court identified two primary factors for determining whether a taxpayer's home was his or her principal place of business when the taxpayer engaged in business activities in more than one location.

* The relative importance of the activities performed at each business location should be considered. The Court said the point where goods and services are delivered was significant in determining the place where the most important functions were performed.

* The time spent at home should be compared with the time spent at each of the other places where business was conducted. The Court further indicated that if after analysis it was determined there was no principal place of business, it should not be concluded a home office qualified by default.

There are, however, two parts to a home-office deduction under section 280A(c)(1)(A). The exclusive use test must be met first as a prerequisite to applying the principal place of business test or the other tests under section 280A(c)(1)(B) or (c). The exclusive use test provides that the home-office space must be used on a regular basis only for home-office activities. Logic says the exclusive use of space within a taxpayer's home has no bearing on his or her deductible transportation expenses. In applying the principal place of business test under section 280A(c)(1)(A), the IRS has in effect made the deductibility of transportation expenses dependent on how a taxpayer uses the space within his or her residence.

CLIENT PLANNING OPPORTUNITIES

When and how can CPAs help their clients take advantage of these rules.? The primary planning consideration lies in whether revenue ruling 94-47 is a valid interpretation of statutory law or an attempt to create new law. The requirement that a taxpayer qualify, for a home-office deduction to deduct daily transportation expenses to work sites within his or her metropolitan area is curiously absent from the IRC and Treasury regulations. Lacking a court ruling issued since the promulgation of revenue ruling 94-47, a well-founded argument exists that the IRS has assumed a lawmaking position. If so, it has stepped beyond the bounds of its authority, giving taxpayers ammunition for a .judicial challenge.

It also is interesting that the IRS did not withdraw revenue ruling 90-23, which is--at least in terminology--inconsistent with its apparent treatment of transportation expenses under revenue ruling 94-47. In recommending how clients should proceed, CPAs should consider if taxpayers can still qualify under either ruling.

Another planning opportunity for clients to make use of is how the term metropolitan area is defined. Currently; there is no definition in the IRC or the regulations. In one case, Burleson v. Commissioner, 68 TCM 288 (1994), the Tax Court intimated that this lack of definition could prove beneficial to taxpayers. The facts of Burleson were indistinguishable from those in Walker and were submitted to the Tax Court as such. Both cases involved loggers working in the Black Hills of South Dakota. The primary issue in both was whether the taxpayers could deduct transportation expenses between temporary cutting sites in the Black Hills National Forest and their homes, which also were located in the forest. The Tax Court allowed the expenses and held that Burleson correctly relied on revenue ruling 90-23, since revenue ruling 94-47 did not exist when the case was submitted.

The planning opportunity may be found in this statement by the court: "Indeed, it is quite possible that petitioners would have declined to submit this case fully stipulated ,',and chosen to go to trial) had revenue ruling 94-47 already been in existence. For example, petitioners may have desired the opportunity to show the exact distances of Mr. Burleson's daily transportation, the type of terrain over which he traveled, and facts about the Forest. Such facts may have been used by petitioners to argue that their deductions met respondent's standards."

In Burleson, the Tax Court further said it had made no conclusive holding in Walker that the forest was a single metropolitan area, indicating it may have been convinced otherwise had the taxpayers tried to do so. This leaves a window of opportunity in determining what is a metropolitan area. The issue of whether the IRS will rely on the government's metropolitan statistical area (MSA) is unresolved and CPAs may be in a position to recommend CPAs use this gray area to their advantage.

The Office of Management and Budget defines an MSA as an area that includes a city of at least 50,000 population or an urbanized area of at least 50,000 with a total metropolitan area population of at least 100,000. This definition certainly does not describe a forest, which the IRS deemed to be the taxpayer's metropolitan area in Walker, nor does it address rural areas, or land area requirements. Taxpayers in cities of less than 50,000 population have only the guidance of the metropolitan forest determination in Walker, and if a forest qualifies as a metropolitan area, a small town or county could fall under the same definition. Under revenue ruling 94-47, transportation expenses from a residence to a place of business outside the taxpayer's metropolitan area are deductible. This could prove advantageous to clients who are consultants, engineers and even to tax practitioners themselves in smaller towns who work out of their homes, if the taxpayers travel outside of the subjective metropolitan areas.

EXERCISE CAUTION

While the current circumstances offer some planning options for CPAs to recommend, taxpayers also must be advised to exercise caution until the matter is resolved by Congress or the courts. It appears a taxpayer can legitimately deduct transportation expenses if the travel is outside his or her metropolitan area. However, the lack of a definition of metropolitan area could be troublesome.

Taxpayers with situations similar to Walker and Burleson who wish to challenge revenue ruling 94-47 should keep careful records documenting the exact distances traveled daily, the type of terrain over which they have traveled and any other distinguishing factors about the area in which the travel occurred. A taxpayer should attach form 8275 to his or her return disclosing that a position contrary to the revenue ruling is being taken. This will enable taxpayers to avoid the portions of the accuracy-related penalty (20%) attributable to disregard of the rules if the return position has a significant basis. The form should include a description of the relevant facts and the nature of the controversy affecting the tax treatment of the travel expenses and include a reference to the Burleson case.

A more fundamental question also remains: Has the IRS overstepped its bounds in linking the transportation expense deduction to the exclusive use test under section 280(c) (1)(A)? We believe that in issuing revenue ruling 9497, the IRS has in fact tried to create new' law rather than just interpret existing law. Until the matter is settled, practitioners must exercise due care as well.

EXECUTIVE SUMMARY

* MOST TAXPAYERS CANNOT DEDUCT commuting costs. Those who can will find the standards for deducting such expenses have reached a new level of confusion. Varying treatments in the Internal Revenue Code, in two revenue rulings and in a Tax Court case caused the Internal Revenue Service to issue revenue ruling 94-47, which permanently linked the home-office requirements of IRC section 280A and the deductibility of transportation expenses under IRC section 162(a).

* REVENUE RULING 53-190 ALLOWED a deduction for transportation expenses between a taxpayer's residence and a temporary work location outside the taxpayer's metropolitan area if he or she had no specific regular place of business or employment.

* IN C. W. WALKER V. COMMISSIONER, the tax court found the standards used in establishing a residence as a regular place of business were not the same as those for determining a principal place of business. Since Walker's residence was a regular place of business and his job sites were temporary work locations, his transportation expenses were deductible under revenue ruling 90-23.

* THE IRS ISSUED REVENUE RULING 94-47 to clarify the circumstances under which transportation expenses between a taxpayer's residence and work location are deductible. It said the IRS would not follow the Tax Court position in Walker. The link the IRS established with the ruling may be beyond the IRs's interpretive authority.

KAYE F. McCLUNG, CPA, is associate professor of business and economics at LaGrange College, LaGrange, Georgia. ROBERT D. IVY is an associate in the tax department of Arthur Andersen in Nashville, Tennessee. EDWARD E. MILAM, CPA, Phi), is professor of accountancy at Mississippi State University, Mississippi State. He is a member of the American Institute of CPAs task force that is developing a model tax curriculum for higher education.