The 0~jice#.z?0~ Doduetion

Allen Ford, University of MissourXolumbia

It is not unusual for taxpayera to maintain an off&at-home for purposes of performing duties associated with their employment. While; employers have been reasonabIy successful in claiming a tax deduction for the expenses of maintaining such an office, employees generally find it more difficult to take a similar deduction. This is trne despite the fact that the primary authority for such a deduction makes no distinction between employers and employees [ll]. As a result of recent litigation in this area, the possibility of an employee success- fully claiming a tax deduction for an office-at-home has been enhanced

The Internal Revenue Service regularly .&es on requirements promulgated in Revenue &ling 62.180 to defeat the taxpayer’s claim for an office-at-home deduction (191. Basicrdly, these require- ments are:

1. As a condition of employment, the taxpayer must he required to pro- vide hii OWII space and facilities for perfornrss~ of his duties.

2. The portion of the ysonsl residence used as an office must be used on a regular basis.

The fact that au employer provides an adequate office has beeu used to justify the disallowance of an office-at-home deduction [Z], However, the deduction was grantad to a college professor whom off& was inadequate for research 1171, a high school principal who per- formed administrative tasks at home 1141, and a commercial artist whose business office was improperly heated and air-conditioned [g].

Probably the most siguifi~~t case from the taxpayer’s vautage pomt is the 1970 case of Newi v. Commksioner [15]. In Newi, the tax- payer used his den approximat.ely three hours per night to review his work, plan and schedule future work, and view television advertise-

volame 2, Nwnbr 4 October. 1974

4!s4 Journal of ~Bwincss Research

menta. He was an outside salesman of television time for the American Broadcasting Company and fmmd it helpful to view television adver- tisements of ABC and competitor networks. The den was an “L”-shaped room partitioned off from the living room with a separate door and was not used for personal entertainment or television viewing by either the taxpayer or bie wife.

The Commissioner stressed the fact that ARC did not require the taxpayer to set aside a portion of his apartment ;Jr work, and further- more the ABC building was open in the evening with office space and television equipment available. However, the court noted the taxpayer’s difficulty in returning to the office in view of considerable traffic and possible shortage of taxi transportation. In essence, the taxpayer would be forced to miss many programs of considerable importance to him while enroute to tbe office,

The Netui case is extremely significant since the deduction was allowed despite the fact that it was not necessary for the employee to maintain an office-at-home as a ccndition of employment and the employee had access to employer-furnished facilities.

When appealing the Netsi case in the 5econd Circuit, the Corn- missioner argued the case “would open the doors for a business deduction to any employee who would voluntarily choosa to engage in an activity at home which could conceivably be helpful to his employer’s business” [l, p. lOOO].

In reference to this concern of the Commissioner, the court noted that tbe case “opens the door just long enough to enable this taxpayer to pass through it into his cloistered study” [15, p_ KKiO]. There seemed to be a concerted attempt by tbe court to regard this as a special case with only limited application and not as a panacea for all tax- paying empJoyaes.

Applicathw of the Newt the

The Newi case has been relied upon by others to successfully justify an office-at-home deduction. In Dietrich [7], Marvin was employed as a firsbyear resident physician and his wife was employed as a registered nurse and instrnctor. They maintained a small office in their-basement for purposes of grading, preparing lessons, and pro- fess&al reading. They were not required by their employer to main- tain such an office but found the office to be the most convenient place to efficiently accomplish some of their work. Marvin had no office nor any periods of uninterrupted time for accomplishing these tasks at the various hospitals.

In Ro//ercy [18], a licensed professional engineer rented an apart- ment in IIicJrsviUe, New York in order to be near his place of em- ployment. On weekends, he returned to his partially-owned home

The Ojficcdi’ome Oeduttin 45.5

in Ulster County, New York. Rafferty kept techuical magazines, filing cabinets, drawing boards, special lighting fixtures, some technical notebooks, and a desk at his apartment. His employer did not provide an office at his place of employment. While the deduction was granted, it was reduced in sire due to the taxpayer’s failure to clearly establish the portion of the apartment used as an office.

The Denisons [6] used Newi to justify a deduction for an office used for grading, preparing and storing classroom materiels. Both were teachers. In challenging the deduction, the Commissioner used state- ments by other teachers concerning their ability to perform their work during school hours. James did have one free class hour each day in which to prepare. It is interesting to note that the court gave little weight to th, comments of the Denisons’ peers.

We are not concerned with the manner in which James’ colleagues accomplish their t&s. It may well be that the method of presentation, tbe material to be corrected, and the sincere desire to teach a subject well. distinguisha, Jamen from his fellow tea&era [6, p. 10781.

Johnson Cl31 was an outside salesman who rented a one-room efficiency apartment where he performed business work, made business calls and kept inventory. Since he WCS not required to maintain au office as a condition of employment, the Neuri case was beneficial in establishing his deduction. As in the Diecrich case, the court specifi- cally referred to the lack of a reason for imposing a stricter standard upon a taxpayer whose trade or business is that of being an employee.

One key factor in the preceding cases seems to be whether or not the employee has convenient access to office facilities furnished by the employer. In Diet&h, Rafferty, and Johnson, the taxpayers’ em- ployers did not furnish office faeilities. In Denison, they were not encouraged to use classrooms at night, on weekends or during school vacations. The principal preferred that Mrs. Denison leave by 4:30 for safety reasons.

While aceess to employer-furnished facilities might be a question- able area, especially for aeademioians, the recent Bodzin [4] case is highly significant on that point as well as on others. Stephen Bodkin was employed as a lawyer for the Internal Revenue Service and worked independently without day-to-day supervision in ,the Interpretative Division of the Office of the Chief Counsel. He seldom faced deadlines concerning the handling of a case nor was he required to complete any specific number of cases. Neither was he required, requested, expected, or encouraged to work after normal working hours.

Neverthelas, petitioner’s duties and responsibilities were of such B natam that he freqtmntly deemed it desirable to work overtime in order to meet deadlines, self-imposed or otherwise, and to insure that work ~110

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performed to the best of hi abilities, In addition, petftionar liked to tlse oveniags and weekends to read widely about currant development in the lax law [4].

Bodzin lived about 10 rhiles from his office in Washington, D.C., and always had access to his Internal Revenue Service office. How- ever, he normally worked at home in a study or den two or three evenings during the week and for about four hours on weekends. Gen- erally, he wa6 rhe only one to use the study. Using the “appropriate and helpful” test as established in Net& the court allowed the de- duction.

While the above canes depict the successful use of Net& the O’Con- n&Z 1161 case illustrates an unsuccessful use. Paul O’Connell, an officer and employee of Natmar Inc., maintained an office in hie apart- ment where he performed a number of tasks, one of which related to the business of his employer. He bad unlimited access to an office in the company’s quarters. In disallowing the deduction, the court dis- tinguished this case from NE& on the basis that Newi had shown it was more practical to do his work at home than at the office, while O’Connell had not shown tbat he could do his work better at the apartment than at his corporate office.

Petitioner had established in his apartment comfortable offbe faailitits which he maintained for his otber business, charitable and personal trans. actions. It appears more reasonable to conclude that he found it more convenient sad pleasant to work fa his apartment than in the company offices. H<s work at the apartment ww voluntary and for his own con- venience rl.5, p. &IO].

In view of the lack of verification of his estimates, O’Connell seemed excessively l&era1 with his deduction. He allocated 40 per- cent of the total rent to his office-at-home deduction related to his employer’s business and &aimed depreciation on such items as a stereo and bed linen, Since the court concluded from the facts that his deduction, if meritorious, would amount to about one percent of the rent, it is possible that tbe court took a rather critical view of bis claim.

The Amount ef the Deduction

The deductible amount conaista of a pro rata portion of item4 such as rent, light, taxes, interest on mortgage and depreciation. For an employee, the deduction is from adjusted gross income u&as re- imbursed by the employer.

The cost of rfipairing, maintaining or painting the portion of the house unrelated to business I& is not deductible. Painting and repair- ing co&s for a room used exclusively for business purposes i8 fully deductible, but only a portion_ of the deduction would be allowed if the

The O~jic&Home Deducrion 457

roam also was used for personal masons. Part of the cost of painting or repairing the outside of the residence is deductible, Expenditures for items such as lawn care and landscaping are not deductible.

The basis for depreoiation is the lower of the residence’s fair market value or adjusted basis at time of conversion to business use. The useful life is the estimated number of years the employee will use a portion of his residence in his trade or business. Salvage value is the estimated amount of an assumed selling price attributable to the business portion of the residence at the end of the useful life for business purposes [19, p. 531.

For purposes of allocating, Revcnnc R&ng 62-180 sanctioned the use. of a ratio of business use to total time the house is available for use [19, p. NJ. Obviously, this is not a very favorable allocation for the taxpayer, and this procedure was used by tbe IRS in Haggard [lo] and Henderson [9] to sharply reduce the officeat-home deduc- tion.

Fortunately for the taxpayer, recent cases concerning the allocation question have been more favorable. In I~tenurtional Artists, Ltd. 1121, the court compared business use to time actually used for purposes of allocating the cost of the house. In Gino [S], the taxpayers used certain parts of their horns regularly for two hours per day in con- nection with their profession as teachers and used the same areas for personal purposes for not more than six additional hours per day. The IRS attempted to limit tbe allocation to a ratio of Z/24, but the court held the proper allocation ratio to bc 2/8.

ImpZfcatfa~ for Aeademieians

Those in the academic field who desire to maintain an office-at-home should be able to muster substantial support for their case. Some of the above-mentioned cases involve individuals engaged in academic pursuits. Peiss was a college professor; some of the Dietrich’s activities were related to teaching; and both the De&m and Gino casts in- volved teachers. For those academicians who spend considerable time at home in a cloistered study grading and preparing for classroom activities, the Newi case may easily be related to their activities and provide substantial support for justifying an office-at-home deduction+ Furthermore, most professors are subject to continuous pressure to con- duct research, and the office-at-school may not be an adequate place to perform such activities due to frequent interruptions and inadequate physical facilities in some cases.

I6 the Deduction lPorrh the3 Troubls? Some may view the deduction as not being substantial and thus not

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worthy of cocsideration. This may be especially true if the amotmt of the house used as an office. is inconsequential. Concerning the size of an office, it may be of interest to note that the IRS in at least one case [l] has argued that the size of the office is limited to the sire of aa average room in one’s house. In this particular case, the Tax Court overruled the IRS and allowed a deduction based on the actual size of the office.

When one depreciates a portion of the house as an office, the basis will decline. When the house is sold, the potential gain is greater. However, the gain will moat likely be treated as a capital gain and thus be subject to preferential tax treatment. Thus, the taxpayer may have a capital gain .lue to the fact that he has taken an annual deduction which u-88 used to offset ordinary income dollar for dollar. This should almost always be to the taxpayer’s advantage.

Many taxpayers defer the gain on the sale of their personal resi- dence by acquiring a new house at a cost greater than the adjusted selling price of the old one. If a depreciation deduction has been taken for an office, the house will need to be considered as two sepal ate assets. The gain on the office portion of the house will be taxed and the gain on tbe residence may be deferred.

Other depreciable items related to the office-at-borne include desks, ehaiw, file cabinets, bookcases, lamps and typewritera. Of course, a later sale of these items also may result in a taxable gain.

The ability to deduct a percentage of taxes and interest as an office-at-home expense yields no tax savings since these items are already deductible. However, there is a tax savings associated with deducting a portion of the utilities and repairs. Unlfkc depreciation, there is no future tax liability as a result of these deductions. Unless the size of the office is very small, it would seem worthwhile for the taxpayef to deduct his office-at-home expenses. In a case where tbe taxpayer is renting, the desirability of such a deduction would be greater since there would be no subsequent sale of the residence. Also, a portton of the interest and taxes which are included in the rental fee would be deductible a@ well. However, it is probably more common for a taxpayer who does not own his residence to use the standard deduction, and thus there would be no interest in an office-at-home deduction.

While there is a need for adequate record keeping for all tax deductible itema, it ie especially true with reepect to this deduetion. The Cohen [S] rub?, which ia frequeutly used to allow a reasonable deduction in those cases where costs have obviously been incmred but camrot he supported with sufficient recorda, has been applied in this area.

Although their position haa beon substantially weakened by casea

The O]jieeocHomc Deduction 4s

such es Newi, Gino, and Bodzin, the IRS may he expected to teuaoioualy resist d&ctiona in this area. Roth the Gino and Bad&z cases are on appeal. Unfortunately for the taxpayer, the IRS may soon be receiving help from Congreaa siuce e recent tentative decision of the House Ways end Meam Committee restricts the use of a home for business pur- poses. Shouii! this dccieion become law, a deduction would only be available if a room 01 section of the house was used exclusively for business purposes end as B condition of employment. While this is probably more rcstriclive then any change which may come about in the near future, it ia au area to be clearly watched by taxpayers now maintaining an office-at-home or planning to establish, such an office.

CO7&4&~

The plight of an employee seeking to deduct au expense for off&at- home has been substantially improved over the lest few years. Obviously, the closer one can parallel tbe NeG case, tbe gsi?ater the likelihood of e deduction. It is unlikely that the IRS will’lessen its efforts tc hold the line in this area. The taxpayer should nsider the fact that one of the requirements promulgated in REV & Rating 62-180 has not been rejected., It will still be necessary to qemonstrate that the office-et-home is used. on e regular basis rather thhai, occasion- ally or incidentally. Quite possibly, the emphasis on substanti’ation will be intensified. while the Co&n rule baa been applied in this area, verification of the expenses still should be considered es csse&L Furthermore, the employee who has access to employer-furnished facilities may be under extra pressure to show the need for an office- at-home for reasona other then mere convenience.

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References 1. tma M. An&ram, TC h&w X74.49. 2. Ydendnc 3. Anmlone. 33 P-H ct. Mem. 549. 3. Rcmwas E. BischM, 35 P-ii Tax Ct. Mem. 603. 4 Stephen A. Bodzin, 60 T.C. ., No. 36 (1973). 5. Cohan v. Comnitinw, 39 F.2d 541. 6. Inmes L. Deniron and Lou Anna Dcniwn, 30 TCbl 1071). 7. Marvin L. D&rid+ Tm 1971A59. 8. George #. Gina wcl Emile Gino, M) TC 304 (No. 37). 9. Ah&a E. Hen&non. TCX 1!X%22.

10. ?h.pa, 111 v. US” 20 AFTR 2d 5893. 11. Internal Revenw C&e of 1934, .%G. 162. 12. Wednd Art&s, Lk& 55 TC No. 12. 13. Richd Keith Johrwn, TC Memo 1912192. 14. Robert C. hfdhire, 34 P-H Tax Ct. &fern. 1286. 15. New.+ v. Conwniuioner. 432 Fzd 999 12d Cir. 1970). 16. Pmd I. O’ConneU, TC Mew 1972d71. 17. Claww 6. Peia 40 T.C. 70. 18. Christopher A. Ralferty, 30 TCM 848. !9. Rewnw Ruling, 62180. 1W-2, CR 52.