The tax code allows you to deduct expenses of your office at home only if you qualify under strict tests. One test allows a deduction if your office at home is the principal place of business for the business you conduct there.
The meaning of "principal place of business" has been the source of many disputes between IRS and taxpayers. Taxpayers have tended to interpret the term expansively, while IRS has opted for a narrower reading.
In its January 1993 decision in Soliman, the Supreme Court tried to define "principal place of business." It said that the principal place of business is the place where (1) the most important activities are performed and (2) the most time is spent.
The Soliman decision, which was widely reported in the media, was supposed to resolve once and for all the nagging question of when an office at home is the taxpayer's principal place of business. But IRS is still sorting out the consequences of the Supreme Court's decision.
The most recent IRS pronouncement deals with the relationship between the Supreme Court's two tests, namely the "relative importance" test and the "time" test. IRS says that it will first apply the "relative importance" test by comparing the activities performed at home with those carried on elsewhere. If this comparison clearly shows where the principal place of business is, there's no need to look further.
For example, consider a self-employed plumber who spends about 40 hours per week doing plumbing work in customers' homes and offices, and about 10 hours a week in an office in his home talking with customers by phone, deciding what supplies to order, and reviewing the books of the business.
IRS won't allow the plumber to deduct expenses for his office at home. The essence of the plumber's business is the work he does at his customers' homes or offices. The activities he performs at home are less important.
Or take the case of a self-employed author who spends 30 to 35 hours a week writing in her office at home, and another 10 to 15 hours a week at other locations doing research, meeting with her publishers, and attending promotional events.
Here, IRS concedes that the office at home is the author's principal place of business, since writing is the essence of her trade. Her other activities, while important, take second place to the actual writing.
In some cases, however, the "relative importance" test doesn't give a clear answer. Then, says IRS, the "time" test comes into play.
For example, take a retailer of costume jewelry who sells her wares at craft shows and by mail. She spends about 25 hours a week in her office at home filling mail orders, ordering supplies, and keeping her books. She also spends about 15 hours a week at craft shows. Both activities generate a substantial amount of income.
IRS says that the essence of the retailer's business is selling jewelry to customers. But the most important selling activities are performed in more than one location. Since the "relative importance" test doesn't resolve this case, the "time" test must be used. Here, since the retailer spends more working time at home than at craft shows, her office at home is her principal place of business.
As this example shows, proper planning can be the key to nailing down the deduction for office at home expenses. By understanding the rules and what IRS is looking for, you can increase your deductions to the legal maximum.
We are prepared to assist you with advice about this and other tax issues that you encounter in your business. Please call our office and schedule an appointment if you would like to discuss these matters.