One of the most misunderstood and neglected business deductions is the home office. Both tax professionals and clients oftentimes are reluctant to take this valuable deduction. It is unfortunate, because the home office deduction is both valuable and lawful.
Background: Nader Soliman, a self-employed anesthesiologist, consulted at three local hospitals in Maryland and Northern Virginia, none of which provided him with office space. He used a spare bedroom in his home for general administrative tasks, as well as record storage and continuing education. When he deducted a portion of his home expenses for the home office in his tax return, the IRS denied the deduction. Years of contentious litigation followed, which culminated in a U.S. Supreme Court decision striking down Soliman’s home office deduction. Commonly referred to as the Soliman Decision, the Supreme Court ruling was largely based upon the definition of “principal place of business”. The court ruled that because Soliman derived his income at hospitals, they were his respective principal places of business, not his home office as he had claimed.
Congress expanded the definition of principal place of business through the Taxpayer Relief Act of 1997, thereby reversing the Supreme Court’s decision. The new law clarified that the home office would pass the principal place of business test “if the taxpayer uses it exclusively and on a regular basis for administrative or management activities of any trade or business and there is no other fixed location where the taxpayer conducts a substantive portion of these activities. The principal place of business can also be a place to meet or deal with patients, clients, or customers in the normal course of a trade or business” (IRC Section 280A, IRS Publication 17).
Implications: The legislation resulted in a sea change for those who use an office in their home for conducting business. This is especially true for consulting professionals who have W-2 employment income and are self-employed. For starters, use of the home office allows the taxpayer to deduct a portion of mortgage interest, property taxes, insurance, utilities, repairs, depreciation, etc. Secondly, and of potentially greater impact, is deductible business mileage. If consulting and W-2 employment are in the same trade or business, and the home office qualifies as the principal place of business, transportation expenses between your home and the other work location are deductible (IRS Pub 17). To gain a rough appreciation of its value, add up your annual commuting mileage and multiply by the 2015 IRS standard mileage rate of 57.5 cents per mile.
Use of the home office can serve many purposes; reduced taxes, lowered housing costs, and increased saving potential. Plus, the pure joy of having greater control of your professional life.