Small Business Taxes & ManagementTM--Copyright 2014, A/N Group, Inc.
In several recent decisions the Tax Court has sided with the IRS in interpreting the requirement that an area of the home be used "exclusively" for business in order to qualify for the home office deduction. In this case Lauren Elizabeth Miller (T.C. Summ. Op. 2014-74) the Court's opinion reflected a less rigid approach allowing de minimus personal use. While the facts aren't unique, they are critical to the Court's decision.
The taxpayer worked for a company we'll call BIW. BIW is headquartered in Los Angeles, California, and provides public relations, marketing, and advertising services. In early 2008 BIW's owner and president, hired the taxpayer to serve as the company's account director in New York City. She was responsible for managing existing client accounts, hosting press events, producing style guides, and assisting clients with product line development and communications. She was also expected to attempt to recruit new clients. At the time she was hired, the taxpayer was BIW's only employee in New York.
BIW did not have an office space in New York City, and the taxpayer initially was required to work out of a client's showroom. BIW's relationship with that client ended shortly after the taxpayer was hired, and BIW then asked her to work from her studio apartment until he could obtain commercial office space.
BIW never obtained its own office space, and the taxpayer used part of her apartment as an office throughout 2009. BIW listed the taxpayer's apartment address and telephone number on its Web site as the address and phone number for its New York office. The taxpayer usually worked weekdays between 9 a.m. and 7 p.m., but she generally was expected to be available at all times.
The taxpayer's studio apartment was a single room with a total living area of 700 square feet. She provided a sketch of the apartment in which the space was divided into three equal sections: (1) an entryway, a bathroom, and a kitchen area; (2) office space, including a desk, two shelving units, a bookcase, and a sofa; and (3) a bedroom area including a platform bed and dressers. She had to pass through the office space to get to the bedroom area.
The taxpayer frequently met with BIW clients in the office space, and she performed work for BIW using a computer on the desk. The bookcase and shelving units were used to store books, magazines, supplies, and samples related to her work for BIW and its clients. Although she used the office space primarily for business purposes, she occasionally used the space for personal purposes.
She paid rent of $26,200 and cleaning service charges of $1,680 during 2009. She also paid $1,896 to TimeWarner Cable (TimeWarner) for a package of services that included cable television, a telephone line, and wireless Internet access. She used the cable television exclusively for personal use, the telephone line exclusively for business purposes, and the wireless Internet access for both personal and business purposes. She estimated that approximately 70% of her wireless Internet use was business related.
BIW did not maintain a formal employee expense reimbursement policy. The taxpayer understood that BIW was struggling financially, that the company's business was not growing, particularly in New York, and that she would be reimbursed only for expenses that BIW could itemize and bill directly to its clients. The record included three expense reports that she submitted to BIW for relatively modest expenditures (e.g., taxi fares and small gifts to clients) that she made in February, May, and August 2009.
Although the taxpayer had numerous conversations with BIW's president about the need for a formal office space, he repeatedly assured her that the company was on the verge of renting commercial space. BIW did not reimburse her for any of the expenses related to her apartment or her attempts to recruit new clients.
The taxpayer's monthly checking account statements for 2009 show that BIW normally paid her by wire transfer. A comparison of the amounts that BIW transferred to her account during 2009 and the wages that BIW reported on Form W-2, Wage and Tax Statement, for that year suggests that BIW did not reimburse her for many of her employment-related expenses.
The account statements show that she took numerous taxi trips around New York City, she occasionally dined out, and she purchased clothing and office supplies. The account statements corroborate most, if not all, of the expenses that she reported on her spreadsheets for rent, cleaning services, and TimeWarner and Verizon Wireless charges.
Securing a home office deduction as an employee requires that the exclusive use of the office space is for the convenience of the taxpayer's employer. The IRS and the courts have denied a deduction where a taxpayer could have the use of an office, even though it was inconvenient (e.g., after hours, etc.).
The Court noted that BIW listed the taxpayer's apartment address on its Web site as the address for its New York office. The taxpayer testified credibly that she regularly used one-third of her apartment space as an office to conduct BIW business, she met with clients there, and she was expected to be available to work well into the evening. On this record, we are persuaded that her apartment was her principal place of business, that she was obliged to use the space as an office for the convenience and benefit of BIW, and that BIW was not able or willing to reimburse her for any of her apartment-related expenses (including the TimeWarner charges discussed below).
Although she admitted that she used portions of the office space for nonbusiness purposes, the Court found that her personal use of the space was de minimis and wholly attributable to the practicalities of living in a studio apartment of such modest dimensions. Hughes (T.C. Memo. 1981-140). The Court held that she could deduct one-third of her apartment rent and cleaning services for the year. The Court did not allow any of electric expense in the absence of documentation substantiating the amount of the expense. It refused to apply the Cohan rule where there was no basis for estimating the amount.
Although the record was not entirely clear as to the precise allocation of the TimeWarner charges among the three services (cable television, telephone and interent), the Court found sufficient evidence in the record to justify dividing the charges equally among them.
The Court held she was not entitled to deduct the portion of the TimeWarner charges attributable to cable television. She testified credibly that the apartment telephone line was used exclusively for business purposes. Indeed, BIW listed the taxpayer's telephone number on its Web site as the contact number for its New York office. The Court concluded that maintaining the telephone line was an ordinary and necessary business expense.
The Court noted that Section 262(b) provides that any charge for basic local telephone service with respect to the first telephone line provided to a taxpayer's residence is not deductible. Although the taxpayer provided some information related to the breakdown of the TimeWarner charges for the telephone line, the record was silent regarding the exact charge, if any, for local telephone service. The Court applied the Cohan rule and estimated the amount allowable as a deduction. It allocated one-half of the charge for the telephone line to local telephone service.
The taxpayer got her home office deduction. But this was a Tax Court summary opinion and cannot be cited as precedent. The Court seems to have taken a liberal approach to the exclusive use requirement of the office space in the apartment, allowing the de minimus personal use. But that seems to be, at least in part, because of the size of the apartment. On a positive note, it appears that the exclusive rule might have a little bit of flexibility. You should probably continue to avoid any de minimus use just to be on the safe side. The IRS is likely to adhere to the exclusive use rule. Discuss your particular situation with your tax advisor and rely on his judgment.
You should also note that the office was clearly for the convenience of the employer. It's difficult to imagine a better set of circumstances to convince the IRS or courts that the office was required by the employer.
While not mentioned above, the Court disallowed a claimed deduction of $117 for office supplies. Although the taxpayer's checking account showed the purchases were made at office supply stores, there was nothing in the record describing the specific items purchased, nor did she refer to these items in her testimony.
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--Last Update 08/26/14