As of January 1, 1999 the criteria for claiming deductions for a home office and for transportation expenses from your home office to other work locations have been substantially liberalized. But there is some bad news - a 1999 Tax Court decision applies a very strict standard for deductions associated with an office in home for tax years before 1999. So if you have been taking deductions for an office in your home all along you can expect a fight if you are audited for any pre-1999 tax year. If you haven't taken deductions for a home office before 1999, then this may be the year to start. Assuming, of course, that you actually have an office in your home.

The Internal Revenue Code provides very few opportunities to deduct mixed personal and business expenses because §262 prohibits deductions for personal, living, or family expenses "except as otherwise expressly provided". Two of the most poplar exceptions are the deduction allowed for business use of a portion of a taxpayer's home (allowed by IRC §280A) and business use of a potion of a taxpayer's car (allowed under §162(a) and Rev. Rul. 55-109, 1955-1 C.B. 261). The rules for home office expense deductions and transportation expense deductions have gone through a substantial metamorphous since the enactment of the Internal Revenue Code of 1954.

Prior to 1976, expenses attributable to the business use of a personal residence were deductible whenever they were "appropriate and helpful" to the taxpayer's business. In 1976, Congress adopted §280A which placed stricter limits on the qualification for the home office deduction. As originally enacted, §280A generally allowed a deduction for business use of a personal residence only if a portion of the taxpayer's residence was used exclusively and regularly for business and the taxpayer's home was either: (1) the principal place of business for the taxpayer's trade or business; (2) a place of business used to meet with patients, clients, or customers in the normal course of the taxpayer's trade or business; or (3) the portion of the taxpayer's residence used for business constituted a separate structure not attached to the dwelling unit. See IRC §280A(c)(1).

The meaning of "principal place of business" has been the most litigated criterion of §280A. In Commissioner v. Soliman, 506 U.S. 168 (1993), the Supreme Court upheld an IRS interpretation of §280A that disallowed a home office deduction for a self-employed anesthesiologist who practiced at several hospitals but was not provided office space at the hospitals. Although the anesthesiologist used a room in his home exclusively to perform administrative and management activities for his profession, the Supreme Court held that the "principal place of business" for the taxpayer was not the home office because the taxpayer performed the "essence of the professional service" at the hospitals. (Because the taxpayer did not meet with patients at his home office and the room was not a separate structure, a deduction was not available under the second or third exception under IRC §280A(c)(1).)

Following the Soliman decision, the Tax Court has applied the "principal place of business" requirement of §280A by focusing on two factors: (1) the relative importance of the functions or activities performed at the taxpayer's home office compared to those performed at other business locations of the taxpayer; and (2) the amount of time spent at each location. The Tax Court has further refined the "relative importance" factor by treating the location at which goods or services are delivered to the taxpayer's customers as "as an important indicator of the principal place of a taxpayer's business, which must be given great weight and is a principal consideration in most cases." See Strohmaier v. Commissioner, 113 T.C. No. 5 (August 3, 1999), citing to Soliman at pp. 175, 176.

In 1997 Congress concluded that the Supreme Court's decision in Soliman unfairly denied a home office deduction to a growing number of taxpayers who managed their business activities from their homes. In the Taxpayer Relief Act of 1997, Congress amended §280A, effective January 1, 1999, by expanding the definition of "principal place of business" to include an office in home if: (1) the office is used by the taxpayer to conduct administrative or management activities of a trade or business and (2) there is no other fixed location of the trade or business where the taxpayer conducts substantial administrative or management activities of the trade or business. (The "exclusively and regularly" requirement was retained for all home office deductions, and the "convenience of the employer" requirement was continued for employees claiming home office expense deductions.) Thus, for tax years beginning after December 31, 1998, a home office can qualify as a taxpayer's principal place of business for purposes of §280A under the standards of the Soliman decision or the statutory "administrative or management activities" standard.

Expenses incurred by a taxpayer in commuting between his home and his place of business are personal and nondeductible. Commissioner v. Flowers, 326 U.S. 465, 473-474 (1946). The IRS, however, has long recognized that taxpayers can deduct the cost of traveling from one business location to another. See Rev. Rul. 55-109, 1955-1 C.B. 261. But the IRS will challenge deductions for local transportation expenses when one of those business locations is a taxpayer's office in home. In Curphey v. Commissioner, 73 T.C. 766 (1980), the Tax Court held that daily transportation expenses incurred in going between an office in a taxpayer's residence and other work locations were deductible where the home office was the taxpayer's principal place of business within the meaning of §280A(c)(1)(A). The court stated that:

Curphey v. Commissioner, 73 T.C. 766, 777-78.

After the Tax Court's Curphey decision, The IRS issued several Revenue Rulings with regard to deductions for transportation expenses associated with travel from a taxpayer's residence to the taxpayer's work locations. See Rev. Rul. 90-2, 1990-1 C.B. 28, Rev. Rul. 94-47, 1994-2 C.B. 18, and Rev. Rul. 99-7, 1999-5 I.R.B. 4. Pursuant to those rulings, daily transportation expenses incurred in going between a taxpayer's residence and a work location are deductible under the following circumstances:

Except for the limited circumstances described in items 1 and 2 above, the deductibility of expenses incurred for local transportation between a taxpayer's home and another work location depends on whether the taxpayer's home office qualifies under §280A(c)(1) as a principal place of business. For tax years prior to 1999, "principal place of business" is determined solely by the Soliman factors discussed above. Presumably, for tax years beginning after December 31, 1998, a home office can qualify as a taxpayer's principal place of business for purposes of §280A under the standards of the Soliman decision or the statutory "administrative or management activities" standard.

In Strohmaier v. Commissioner, 113 T.C. No. 5 (August 3, 1999) the United States Tax Court addressed the meaning of "principal place of business" for purposes of deductions associated with a home office and transportation expenses from the home office to other work locations. The taxpayer was an insurance salesman and a part time minister. With respect to his insurance sales, he used his home office for all aspects of his business other than meeting with potential and existing clients. He also used his home office to write his sermons which he delivered in various locations. He did not have any other office for performing those functions.

The Court held that Mr. Strohmaier could not deduct the expenses allocable to his home office and that he cold not deduct the transportation expenses for traveling from his home to his customer's locations or from his home to the places where he delivered his sermons because his home was not his principal place of business for either of those activities under the standards of Commissioner v. Soliman, 506 U.S. 168 (1993). The Court found that:

The Strohmaier decision might be largely ignorable except that it was issued as a regular opinion rather than a memorandum opinion. Regular opinions are generally reserved for cases which involve issues deemed to be novel or important by the Tax Court. Memorandum decisions are usually issued for cases that involve primarily factual situations or settled law. Both memorandum and regular decisions are appealable (decisions in "S" cases, however, are not appealable and are generally not reported.) The issuance of the Strohmaier decision as a regular opinion is peculiar because: (1) the Court claimed that it was merely applying the Soliman doctrine to the particular facts of the case before it; and (2) the Court had recently issued two memorandum decisions dealing with the same legal issues. See Cole v. Commissioner, T.C. Memo. 1999-207 (June 23, 1999) and Gosling v. Commissioner, T.C. Memo. 1999-148 (May 3, 1999).

In Cole v. Commissioner, T.C. Memo. 1999-207 (June 23, 1999), the Court applied the Soliman doctrine to a taxpayer engaged in a floor-covering business, finding that the:

The Court, however, noted that the taxpayer might be able to meet the home office standards as amended for 1999 and later tax years.

In Gosling v. Commissioner, T.C. Memo. 1999-148 (May 3, 1999), the Court reached an opposite conclusion with regard to a home office deduction claimed by a music conductor and director. The Court focused on the time the taxpayer spent in his home office preparing for his conducting and directing duties. The Court ignored the apparent fact that the "most important function" of his trade or business was his performance rather than his preparation for the performance. It appears that Gosling would have been decided differently under the "most important function" standard used by the Court in Strohmaier. At the very least, the Court would be hard pressed to distinguish the preparation of a sermon from the preparation of a musical performance. But if the Court thought the "most important function" approach was novel or important, then it seems it would have issued the Cole opinion, which was rendered two months before Strohmaier, as a regular rather than memorandum decision.

For tax years beginning before January 1, 1999, deductions for expenses associated with an office in home, and for the cost of transportation from the office in home to other work locations, will be very difficult to sustain on audit for taxpayers whose trade or business involves delivery of goods or services to customers away from the home office, unless they can establish that the great majority of their work was performed at their home office. For tax years beginning after December 31, 1999, home office and associated transportation expense deductions will be easier to sustain on audit if the taxpayer uses the home office to conduct administrative or management activities of a trade or business and there is no other fixed location where the taxpayer conducts substantial administrative or management activities of the trade or business.