Revenue Ruling 94-24 interpreted the Supreme Court’s 1993 Soliman decision regarding home office deductions. Soliman v. Commissioner, 93-1 USTC ¶50,014 (1993). Largely reinstating an earlier position of the Tax Court, the Court held that home office deductions are statutorily permissible only in circumstances where the taxpayer spends a substantial amount of time in the home office, and then only if the “relative importance” of activities there exceeds that of other business locations.
The decision primarily reflects the interplay of two Code provisions: First, IRC Section 280A(a), which excludes from the universe of otherwise allowable business deductions those deductions which relate to the use of a home or “dwelling unit;” and second, IRC Section 280A(c)(1), which carves out a limited exception to the Section 280A(a) deduction prohibition, by allowing the taxpayer to deduct business expenses with respect to the portion of a dwelling unit which is exclusively used on a regular basis “as the principal place of business for any trade or business of the taxpayer…”
In reaching its determination, the Court reviewed the statute’s legislative history, and found that its purpose had been to “provide a narrower scope for the [home office] deduction.” The Court noted, however, that Congress had failed to define “principal place of business.” In looking at the “ordinary, everyday sense” of the phrase “principal place of business,” it concluded that such a determination could not be made without a “comparison of locations.” While ascribing some importance to “necessary” or “essential” functions performed at the home office, the Court expressly found they were not controlling in a comparison of the relative importance of business locations. While the “comparative analysis” formula as articulated seemed to resemble the “focal point” test (which had been enunciated by the Tax Court but which was later abandoned after being criticized by several Courts of Appeals), the Supreme Court also faulted that test for having a “metaphorical quality” that was “misleading.” The Court concluded that “no one test is determinative.”
If a comparison of the relative importance of each business location (taking into account the characteristics of the particular trade or business) does not identify a principal place of business (PPB), then Soliman directed that an inquiry be made into the relative amount of time spent at each location. While the Court steadfastly declined to articulate an “objective standard” as to exactly how much time must be spent in the home office, it allowed that Soliman’s “10 to 15 hours per week spent in the home office measured against the 30 to 35 hours per week at the three hospitals [w]ere insufficient” to justify the conclusion that the home office was a PPB.
Implicit in the decision seemed to be the revelation that few taxpayers who do not spend at least half their time devoted to business activities at the home office could ever qualify for the deduction. The Court’s narrow view of the deduction also manifests itself in guidance provided to the “decisionmaker” where a comparison of locations fails to identify a PPB: The courts and the IRS are admonished from “strain[ing]” to conclude that the home office is the PPB by “default.” Unlike the concept of “tax home,” a taxpayer may well be engaged in business activities at multiple locations including the home office, yet have no principal place of business.
Revenue Ruling 94-24 (1994 I.R.B. 1994-5) offers guidance in determining the taxpayer’s PPB. Taking its cue from the Supreme Court, the Ruling stipulates that the determination of the taxpayer’s PPB requires one, and possibly two, separate inquiries. The separation of these inquiries appears more pronounced in the Ruling than it does in Soliman. The first inquiry again involves a comparison of the “relative importance” of activities performed at each business location. The result of this inquiry will result in one of three determinations: First, the home office is the PPB; second, the home is office is not the taxpayer’s PPB; or third, a comparison of the relative importance of activities fails to identify the location of the taxpayer’s PPB.
A definitive finding with respect to whether the home office is (or is not) the PPB conclusively determines the propriety of the deduction. If a comparison of the relative importance of the activities performed at each location fails to identify a PPB (as may occur, according to the Ruling, where the taxpayer performs income-generating activities at both the office in the taxpayer’s home and at some other location), then the wheel spins again and the second inquiry, i.e., the “time” test, becomes dispositive. As in Soliman, this directs that a time comparison be made among all business locations
The taxpayer loses if the “time” test yields the determination that there is no PPB, or that there is a PPB — but it is not his home, and wins with a finding that the home office is the taxpayer’s PPB. The ruling, however — presumably following the high Court’s lead — fails to provide a “safe harbor,” or offer any other practical guidance, with respect to what fraction of hours the taxpayer must devote to business activities at the home office in order to satisfy the “time” test.
The Ruling contains four examples which illustrate its principles. A synopsis of those four examples:
The home office of a self-employed plumber who talks to customers, orders supplies, reviews books and even employs an administrator there fails to qualify as his PPB since the relative importance of activities performed on service calls exceeds that of the activities performed at home. Similarly, a teacher who grades test papers at home cannot claim the deduction even though the amount of time spent at that office actually exceeds the amount of time spent teaching, since the “essence” of his trade or business requires the teacher to meet with students at school. However, the relative importance scales are tipped in favor of a self-employed author who writes at home but who meets with publishers and conducts research away from the home office, since the “essence” of his trade or business is writing, and that is done exclusively at home.
In the case of a self-employed retailer of costume jewelry selling both at craft shows and through mail orders at home, the relative importance test is inconclusive, and resort to the time test is required. Since the taxpayers spends 25 hours at the home office and only 15 hours away from the home office, the example concludes that the home office is indeed the PPB.
Interestingly, mention is made in the analysis of the time spent at various locations even where the determination of a PPB is made without resort to the time test. This phenomenon reveals that the inherent overlap between the two tests may undermine in practice the application of the of the Ruling’s hierarchical and bifurcated approach. In the only example where actual resort to the time test is required, the home office is determined to be the PPB where 62.5% of the total work time is spent there. Although from this one might be tempted to infer the existence of a “safe harbor,” caution might counsel otherwise: First, it is doubtful (though not impossible) that the Ruling would, as a practical matter, relegate an item of such importance to an example; and second, express language in Soliman appears to deny the existence of a safe harbor.
In the end, it will be the IRS and the courts, and not the Supreme Court, which will be charged with implementing the Soliman decision. For practical reasons, as well as for reasons grounded in principles of equity in the administration of the tax laws, the IRS may find it necessary to tacitly observe informal guidelines, which, though not rising to the level of a true “safe harbor,” might nevertheless provide needed guidance in the area of home office deductions. For the moment, such guidelines could most plausibly be inferred from Revenue Ruling 94-24 and its examples.