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Supreme Court gets tough with home-office deductions.

Dr. Soliman, a self-employed anesthesiologist, maintained a home office in the spare bedroom of his residence. He did not see patients there, treating them only at the hospitals where he rendered services. He did administrative work in the home office - managing paperwork, returning phone calls, reviewing charts, doing billing, etc. He claimed home-office deductions for the expenses of the office.

The Internal Revenue Service denied the deductions, claiming the home office was not Soliman's principal place of business (Internal Revenue Code section 280A(c) (1)(A)). Among other requirements, a taxpayer claiming deductions for home-office expenses must meet either of these tests:

1. The home office must be the principal place of business.

2. It must be used as a place for meeting customers or clients, even if the principal place of business is elsewhere.

The Tax Court allowed the deductions, adopting a more liberal test for determining what constitutes a principal place of business than had been used before (94 TC 20, 1990). Under the test, a home office was a principal place of business if all the following apply:

* It was essential to the business.

* The taxpayer spent a substantial amount of time there.

* No other location was available for performing the tasks done in the home office. (Under previous Tax Court rulings, the home office had to be the "focal point" of the business - the place where services were performed or income was generated. See JofA, "Lifting the Cloud on Home Office Deductions," July 91, page 41, for a review of home-office cases.)

The Tax Court was swayed by the following factors in Dr. Soliman's case:

* The hospitals did not provide Dr. Soliman with an office, so he had nowhere else to take care of administrative and other tasks.

* He spent a substantial amount of time in the home office-two to three hours per day.

* The administrative tasks were essential to his practice.

The Fourth Circuit Court of Appeals agreed with the Tax Court in a 1991 decision. The U.S. Supreme Court agreed to hear the case.

Result: For the IRS. The standard applied by the Tax Court and the Fourth Circuit in determining what constitutes a principal place of business is erroneous. If a taxpayer has more than one business location, a comparative analysis must be made. The principal place of a business is where the most important functions are performed. If comparing the most important functions yields no definitive principal place, the amount of time spent at the various locations should be compared.

The hospitals where Dr. Soliman treated patients clearly constituted his principal place of business. The administrative tasks may have been essential to his practice, but they were not the most important. The Supreme Court cautioned that merely maintaining a legitimate home office does not entitle the taxpayer to home-office deductions and said the courts should not "strain" to make the home office the principal place of business.

Note: This decision affects many self-employed taxpayers who render services outside their home offices and do not see patients or clients there. The IRS says it will not challenge pre-1992-year homeoffice deductions as long as the taxpayer's situation falls within Pub. 587, page 2, or proposed regulations section 1.280A-2(b)(3).
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Publication:Journal of Accountancy
Date:Mar 1, 1993
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