Supreme Court develops new test for home office deductions.

• Author: Knight, Ray A.

Congress intended to severely limit home office deductions when it enacted Sec. 280A in the Tax Reform Act of 1976 (TRA).(1) Gradually, however, the courts broadened Sec. 280A's narrow passageway for deductibility by liberally interpreting, and ultimately abandoning, the restrictive focal point test often used to determine home office deductibility.(2) But before too many taxpayers stepped through this window of opportunity, the Supreme Court rendered its rule-tightening decision in Soliman.(3) Now, consultants, caterers, musicians and others who work at home because their businesses offer less than adequate office space must reassess their decisions to take home office deductions.

This article will revie'w the legislative and judicial development of the home office deduction; analyze the Supreme Court's recent decision in Soliman; determine if, and to what extent, taxpayers can still expect to benefit from the home office deduction; and discuss the judicially created focal point test used by the courts to determine home office deductibility - its development, erosion, abandonment and resurrection under a new name in Soliman.

The Home Office Deduction Under Pre-TRA Law

Before the TRA was enacted, no statute governed the deductibility of home office expenses. The courts allowed a taxpayer a deduction if the home office expenses were "ordinary and necessary" under Sec. 162(a), which the Tax Court interpreted to mean that maintenance of a home office was "appropriate and helpful" under the taxpayer's circumstances.

* Appropriate and helpful standard

The Tax Court first used the appropriate and helpful test in Newi.(4) Newi sold advertising time for the American Broadcasting Company (ABC). He attempted to deduct the rental, cleaning and lighting of a spare room in his apartment where he did work for ABC, claiming that these were "ordinary and necessary" business expenses under Sec. 162(a). Newi spent an average of three hours a night in his home office, and neither Newi nor his wife used this office for personal reasons. ABC did not request that Newi work at home; ABC's building was open and available for use during the evening hours. The Tax Court interpreted ordinary and necessary in Sec. 162(a) as meaning "appropriate and helpful"(5) and held that because Newi's home office was used for the business purpose of viewing and evaluating television programs and corresponding advertisements, the appropriate and helpful standard had been satisfied. The Tax Court noted that even if Newi's home office had been used on "rare and isolated" occasions for personal purposes, the outcome still would have been the same.

The Tax Court further liberalized the home office deduction requirements under the appropriate and helpful standard in Bodzin.(6) Bodzin, an IRS attorney, found that doing work at his home office in the evening and on weekends helped him expedite his case load. Bodzin's home office was not used to entertain friends or used by anyone other than Bodzin himself. He occasionally used the room for nonbusiness purposes, such as paying bills, reviewing bank statements and stamp collecting. As in Newi, Bodzin was not requested by his employer to maintain a home office and enjoyed access to his business office on evenings and weekends. The Tax Court determined that Bodzin's home office expenses directly related to his business and, thus, were allowable home office deductions.

The Fourth Circuit reversed the Tax Court's decision in Bodzin, holding that if a taxpayer could show that his work office was not suitable for the purposes for which he used his home office, or if the work office was unavailable on evenings and weekends, the taxpayer could possibly qualify for a home office deduction. Because Bodzin had access to his office in the evenings and on weekends, the Fourth Circuit disallowed his deduction of home office expenses.

Congress's Dissatisfaction with the Appropriate

and Helpful Standard: Enactment of Sec. 280A

The decisions in Newi, Bodzin and other home office cases(7) soon convinced Congress that the appropriate and helpful test was too subjective and should be replaced with more definitive standards. Congress believed the existing judicial trend was transforming "expenses otherwise considered nondeductible personal, living, and family expenses . . . into deductible business expenses simply because, under the facts of the particular case, it was appropriate and helpful to perform some portion of the taxpayer's business in his personal residence."(8) To illustrate this point, it used the following example:

[I]f a university professor, who is provided an office by his employer, uses a den or some other room in his residence for the purpose of grading papers, preparing examinations or preparing classroom notes, an allocable portion of certain expenses might be claimed as a deduction even though only minor incremental expenses were incurred in order to perform these activities.(9)

Thus, Congress clearly wanted to halt deductions of items that, although appropriate and helpful to the business, would have been used in the home regardless of whether a home office existed. To achieve this goal, Congress created what it believed was a more objective test in Sec. 280A.

Sec. 280A(a) provides that "no deduction . . . shall be allowed with respect to the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence." This general rule, however, does not apply if a portion of the dwelling unit is used exclusively and regularly (1) as the taxpayer's principal place of business, (2) as a place of business used by patients, clients or customers in meeting or dealing with the taxpayer in the normal course of his trade or business, or (3) in connection with the taxpayer's trade or business and the home office is in a separate structure not attached to the taxpayer's dwelling unit.(10) For an employee who maintains a home office, a deduction is available only if that home office is maintained "for the convenience of his employer."

The Treasury issued proposed regulations under Sec. 280A in 1980 defining the principal place of business and interpreting the exclusive and regular use requirement.(11) The Tax Court, however, basically ignored the proposed regulations relative to the principal place of business requirement and instituted its own test for determining whether a taxpayer qualified for the home office deduction under this provision: the focal point test.

Development of the Focal Point Test

The Tax Court first used the focal point test in 1980 in Baie.(12) Baie operated a small foodstand near her residence. Because of limited space at the foodstand, Baie used a room in her residence for bookkeeping and her kitchen to prepare food for the stand. Although the Tax Court found the activities conducted at Baie's residence beneficial to her business, it concluded that the foodstand itself, where all the...