Taxing the Home Office

Meetings & Conventions: Planner's Portfolio February 1999 Current Issue



Taxing the Home Office

The IRS comes down hard on those who claim their house is their workplace

Thinking of taking a home office as a tax deduction? Not so fast. Just because you can walk 20 feet from your bedroom to your work area and conduct business in your bathrobe doesn’t mean the nook with the computer qualifies as a bona fide office. The IRS is suspicious of these deductions because audits turn up ample evidence of taxpayers taking advantage. But if you can clear the distinct hurdles and claim a legitimate home office, you will be entitled to deduct a portion of your home-insurance premiums, utility bills and depreciation for home owners or a percentage of your rent.

The first test requires that you use your home office regularly and exclusively for business. Generally, that means a separate room. The IRS concedes that it can be part of a room if the division is clear and you can show no personal activities take place there.

IRS regulations disqualify a dual-purpose room, however. Suppose you conduct a full-time operation from a room, putting in 12 hours a day, but when you are elsewhere, your youngsters occasionally use the office PC to play some games. Result: The kids erase your deduction.

Regulations don’t stomp down on all personal activity, though. According to IRS sources, the agency neither prohibits personal conversations on an office phone nor insists that you rush outside when family members want to ask questions. As a guideline, allow personal activities only to the extent they would be permitted in an office building.

What constitutes regular use? Usually, it’s sufficient to work in the office a couple of hours every day. But the IRS would dispute a deduction if you use an empty room infrequently for a purpose incidental to your business. Just how the IRS construes such use depends on the particular circumstances.

Interestingly, there is no requirement that it be a full-time endeavor. Deductions can be taken when you have a full-time job elsewhere and moonlight from your home office.

A tougher standard applies when you bring work home from your “real” office. You must show that the at-home work is required by your employer and is justified by the nature of your job. You might have to prove this with a letter from your boss saying, essentially, “No home office, no job.”

There’s no write-off allowed when you use part of your place to read financial publications or clip bond coupons, for instance. The only exception, cautions the IRS, is for someone whose investing activities qualify as a trade or business, a stipulation that few investors satisfy.

Even if you’ve passed these “exclusive and regular” tests, you’re not home free. In IRS-speak, your home office also has to be the principal place of your business. That means you have to meet clients or customers there regularly or spend most of your business hours and conduct actual work there not just paperwork and phone calls do not count. That’s how the law stands through the end of this year. Beginning with Form 1040 for 1999, to be filed in 2000, less stringent rules kick in.

The current standard resulted from a 1993 Supreme Court decision that drew heavy criticism from the growing number of people who use technology to work from home, including downsized employees who became their own bosses and started home-based businesses. In the lawsuit, the Supreme Court upheld the IRS’s disallowance of a deduction for Dr. Nader Soliman, a self-employed anesthesiologist. He spent two or three hours a day in the spare bedroom of his McLean, Va., apartment, where he kept billing records and patient logs. The Court said it was irrelevant that the converted bedroom was Dr. Soliman’s only office. It held that his home office was not his principal place of business because the chores he took care of there were less important than his real work, i.e., administering anesthesia at three local hospitals.

Tucked into the 1997 tax act is a provision liberalizing the home-office deduction, starting with returns filed in 2000. Under the expanded definition, a principal place of business includes a home office used for key administrative or management activities, provided there is no other fixed location where you conduct such activities for that business.

Thus, assuming the other requirements are met, the deduction remains available to someone who (1) carries out administrative or management activities while traveling (e.g., from a hotel room or car), or (2) does occasional paperwork or administrative tasks at a fixed location.

Julian Block is a tax attorney based in Larchmont, N.Y. This article was adapted from Frequent Flyer magazine, a sister publication of M&C.

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