This time we are talking about an office-in-home. Many of us have one, but few of us can actually claim a tax deduction for it.
The office-in-home deduction has five main rules, two of which are highly specialized. The remaining three require one to:
- Use the office exclusively and regularly as a principal place of business
- Use the office exclusively and regularly as a place to meet or deal with patients, clients or customers in the normal course of business
- Use the office in connection with a trade or business – but only if the office is a separate structure
If you are an employee, then you are in the trade or business of being an employee. If your office is in a separate structure, you are home-free under test (3).
OBSERVATION: I suppose a converted, oversized shed could meet this test.
I have a CPA friend who practices out of her basement. She would qualify under test (2), as she regularly meets with her clients there. I however almost always meet clients either at their office or mine, so I would not qualify.
That leaves us with test (1), which is an almost impossible standard to meet if one has an office elsewhere. Fortunately there was a Supreme Court decision a number of years ago (Soliman), which allowed one to consider administrative or management duties for purposes of this test.
Soliman was an anesthesiologist, and the three hospitals where he worked did not provide him with an office. He used a spare bedroom for work-related activities, such as contacting patients and billing. The IRS had previously taken a very hard line with test (1) and denied the deduction. The IRS reasoned that Soliman’s job was to put people to sleep, and he did that job at the hospital. This meant that the hospital was his “principal” place of business. The IRS was not going to be persuaded otherwise, at least until the Supreme Court told them to knock it off and allow Soliman his deduction.
Great. So I can do administrative work at home – such as scheduling or billing – and have my office qualify for a deduction, right?
Not so fast.
There are two more tests if one is an employee. The one that concerns us is the requirement that the office be for the convenience of the employer.
Those words sound innocuous, but they are not.
For most of us, having an office at home is for our convenience. In fact, the IRS takes this farther, arguing that – if your employer provides you with an office – then it is virtually impossible for the home office to be for the employer’s convenience. The IRS reasons that the employer would not care if you showed up, as it had an office waiting. There are some exceptions, such as telecommuting or requiring work hours when the office is closed, but you get the idea. For the vast majority of employees, one cannot get past that convenience-of-employer test.
What if one is self-employed? Forget the convenience test. There is no employer.
Let’s look at McMillan v Commissioner. There will be a quiz at the end.
Denise McMillan had a couple of things going on, but what we are interested in is her home office. She was self-employed.
She claimed an office-in-home deduction on her 2009 return. I am not certain of her housing situation, but her office was 50% of her home. I cannot easily visualize how this is possible, especially given the requirement that the office space not be used for any other purpose. That is a lot of space that she is not using for another purpose – like living there.
She lived in a condo. She had gotten into it with the homeowners association over construction defects related to mold and noise, dogs running wild, dogs barking incessantly and leaving dog memorabilia as dogs will when running wild and barking nonstop.
The condo association would do nothing, so she sued them.
The condo association – highlighting the quality of its Board – sued her back.
Wow, send me a flyer so I can consider buying at this bus station to paradise.
All in all, she was out over $26 thousand in legal fees and expenses.
And she deducted 50% of them through her office-in-home deduction.
QUIZ: Is this a valid tax deduction?
She sued because of events which were interfering with her use and enjoyment of her property. Had this property been exclusively her residence, the conversation would be over. But one-half of it was being used for business purposes.
She next had to show that the litigation also had an effect on her business activity.
QUESTION: Have you decided yet?
The Court observed that she was suing over noise, animal waste and similar issues. She argued that they were affecting her ability to work. Makes sense to me.
The IRS did not challenge her argument.
NOTE: My hunch is that the IRS was relying upon an origin-of-claim doctrine. The lawsuit originated from a personal asset – her residence – so the tax consequences therefrom should remain personal. In this case, personal means nondeductible.
Since the IRS did not challenge, the Court could not – or would not - conclude that there was no effect on her ability to work.
The IRS had not challenged the 50% percentage either.
So the Court decided that she was entitled to a tax deduction for 50% of her legal expenses.
By the way, how did you answer?
About the author
Steven D. Hamilton is a career CPA, with extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.