Good Tax News On Home Office Deductions

By Jeffrey A. Babener
©  1999

 Good Tax News Doesn't Happen Often.

Congress rescinded the damaging requirements of the Supreme Court and the IRS, which conditioned the home office deduction upon meeting customers in the home office.

The Home Office Deduction - A Valuable Right.

Many network marketing companies emphasize the tax advantages of a home-based business in the recruitment process. The tax advantage here is that many networkers' expenses may cross over between home lifestyle and business lifestyle resulting in deductions for meals and entertainment, travel, computers, automobiles, business gifts, etc. One of those important tax advantages has historically been the home office deduction in which individuals can deduct the cost associated with a home office. Assuming that the individual qualifies, he or she can deduct a proportion of expenses related to the entire home, such as mortgage payments, insurance, utility bills and home repair. Until a 1993 U.S. Supreme Court decision upholding an IRS ruling on the subject, workers and other home-based businesses could make the deduction of the home office if it was a "principal place of business" and used exclusively for the business. The ground rules, however, for this important deduction were changed for the worse in 1993.

IRS and Supreme Court Versus Home-Based Business.

In 1993, the U.S. Supreme Court upheld an IRS contention that a network marketer or home-based business owner could be denied a home office deduction, unless his or her home was also the principal meeting place with their clients and customers. Prior to the Supreme Court ruling, a home-based business qualified for a home office deduction if the home office was used exclusively for a business, if the business had produced enough income to cover the deduction and if there was no other office.

Then came the U.S. Supreme Court's decision in Commissioner v. Soliman. In the January, 1993 Supreme Court opinion, the Supreme Court ruled against the home office deduction of a taxpayer who was an anesthesiologist. He spent 30-35 hours per week administering anesthesia and post-operative care to three hospitals, none of which provided him with an office. Each day he spent two or three hours in a room in his home which was used exclusively as his office to perform all of the administrative work involved in his practice. In a spare bedroom in his residential condominium was an office where he kept patient records, correspondence, billing records, medical journals, texts and where he spent two-three hours per day speaking on the telephone with surgeons, patients, hospitals, keeping records, preparing for treatments and presentations, etc.

The Federal Appellate Court had held that the anesthesiologist was entitled to claim deductions for condominium fees, utilities and depreciation attributable to the home office because it was his "principal place of business." The Supreme Court, however, overturned the Appellate Court decision by holding that, since he performed most of his revenue-generating activity as an anesthesiologist at the hospitals, it was the hospitals that must be viewed as his "principal place of business" rather than his home. In spite of the fact that the doctor was provided with no office in any of the hospitals to do the administrative aspects of his business, it is easy to argue that the Supreme Court's decision unfairly penalizes the person who is legitimately using a portion of his home to conduct business. Nevertheless, this ruling became the law of the land.

The ramifications of this ruling were far-reaching for anybody with a home office. In particular, anyone who has a primary office outside the home would not be allowed a business deduction for an office in the home even if it is kept in a room which is used exclusively for business purposes.

The dissenting opinion by Justice Stevens probably set forth the sentiment of the American business community particularly in light of the fact that in today's economy so many new jobs are being created by small business and home-based business activity. "In my judgment, the Court's contrary conclusion in this case will breed uncertainty in the law, frustrate a primary purpose of the statute, and unfairly penalize deserving taxpayers. Given the growing importance of home offices, the result is most unfortunate."

Like many other home-based businesses, network marketers do their administrative work in their home office at home and see their customers and recruits in multiple locations outside the home. Under the Supreme Court ruling, network marketers wouldn't qualify for a home office deduction even for a home office that was exclusively used for the network marketing activity.

Tax Relief ... Finally.

Such was the state of affairs for nearly five years. In other words, unless network marketers used their home office as the principal meeting place with their customers, their home office deduction was gone. Various attempts were made to change the law, but networkers and home-based businesses finally got lucky and were rewarded for their patience in the Taxpayer Relief Act of 1997.

The Taxpayer Relief Act sought to put an end to this unfair treatment of home-based businesses and Congress enacted into law the following amendment to the Internal Revenue Code:

"SEC. 932. CLARIFICATION OF TREATMENT OF HOME OFFICE USE FOR ADMINISTRATIVE AND MANAGEMENT ACTIVITIES.

"<< 26 USCA ' 280A >>

"(a) IN GENERAL.--Paragraph (1) of section 280A(c) is amended by adding at the end the following new sentence:

"For purposes of subparagraph (A), the term <principal place of business' includes a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer if there is no other fixed location of such trade or business where the taxpayer conducts substantial administrative or management activities of such trade or business."

"<< 26 USCA ' 280A >>

"(b) EFFECTIVE DATE.--The amendment made by subsection (a) shall apply to taxable years beginning after December 31, 1998."

And, so, Congress rescinded the damaging requirements of the Supreme Court and the IRS, which conditioned the home office deduction upon meeting customers in the home office. From January 1, 1999 on, a home office can be eligible for deduction if a networker or home-based business conducted administrative or management activities in their home office. In other words, networkers are back in business as far as home-office deductions.

Lessons to be Learned.

Are there lessons to be learned here? Well, if you are patient and there are "enough of you" perhaps you can fight city hall. The home office deduction is significant for many networkers who treat their business seriously. They have it back. Common sense and persistence were their best allies in restoring an important incentive to Americans to operate a home-based business.

For more detailed information, including actual IRS tax rules for direct sellers, see Tax Guide for MLM/Direct Selling Distributors, Jeffrey A. Babener, Legaline Publications, (800) 231-2162.  You can also download an Acrobat  (PDF) file for Publication 911 - The IRS: Official Rules for Network Marketers

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