Erik M. Jensen is the David L. Brennan Professor of Law at Case Western Reserve University.
Jensen criticizes the recent Tax Court decision in Bulas, which denied an accountant deductions associated with a bathroom used almost exclusively by clients visiting the accountant's home office. Employing no bathroom jokes -- Tax Notes has standards -- the author argues that the court interpreted the requirement in section 280A(c) that the bathroom be used "exclusively" for business purposes in a way that was (1) unrealistically narrow; (2) inconsistent with standards imposed on business-related deductions generally; and (3) inconsistent with the standards the judge applied to the taxpayer's home office across the hall, a former bedroom for which deductions were available.
On August 17 Tax Court Judge Harry A. Haines handed down his decision in Bulas v. Commissioner.1 Because the case involved the question whether a bathroom was eligible for the home office deduction -- answer: no, on the facts -- Bulas became the subject of bathroom humor within a matter of days. Tax Notes is a serious publication, however, and this is a serious article. Let's get our minds out of the sewer and evaluate Bulas on the merits.
Bulas is a self-employed accountant, primarily a return preparer, who works out of a home office, a room that had been a bedroom. Section 280A(a) generally precludes deductions associated with "the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence." But section 280A(c)(1) provides an exception (the home office deduction) to that general rule:
Subsection (a) shall not apply to any item to the extent such unit is allocable to a portion of the dwelling unit which is exclusively used on a regular basis --
(A) As the principal place of business for any trade or business of the taxpayer, [or]
(B) As a place of business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of his trade or business.2
The bedroom-office was held to meet the requirements for the home office deduction.3
So far, so good for Bulas. But, as Judge Haines described events, Bulas had "built a bathroom across the hall for his clients' use,"4 and it was the qualification of that space for the deduction -- call it the home bathroom deduction -- that was the primary issue in the case. Judge Haines noted that "family members and personal guests used this bathroom on occasion,"5 and in his conclusion, he reemphasized that point: "Petitioner testified . . . that his children and other personal guests occasionally used the bathroom. Accordingly, the hallway and the bathroom were not used exclusively for business purposes."6
I don't get that "accordingly."
Of course the term "exclusively" in section 280A(c)(1) might suggest that any nonbusiness use precludes the home office deduction, and maybe some cases support that understanding.7 But that's a crazy way to interpret a statute that is supposed to have real world effect (and, as I will argue in a moment, it appears to be inconsistent with the way Judge Haines analyzed the bedroom-office). Interpreting exclusively in that way leaves the home office deduction with almost no scope.8 Oh, I suppose an occasional home office (or bathroom) is locked up and is completely off-limits to the kids and other random persons -- when a doctor uses part of the house to see her patients, she's going to secure the narcotics -- but that isn't the norm.
A home office will almost always involve some personal use.9 Is it really the case that if toddler Suzy walks into accountant Dad's home office to get a hug, the deduction is lost? Surely Suzy's being Suzy doesn't automatically violate the exclusivity requirement.10 At a minimum, there needs to be a hug exception to exclusivity. And should it matter if Suzy uses the potty while she's there? Of course not.11
For that matter, there will almost always be some personal use of any office and, as far as I know, no one expects "exclusive" use, as Judge Haines understands the term, in the outside-the-home context.12 If every once in a while Nanny takes Suzy to see accountant Dad in his downtown office, the rent for the office, including the office bathroom, will still be deductible, won't it?13
Yes, section 280A(c)(1) uses the term "exclusively," and there's no equivalent language in section 162, the ordinary and necessary business expense provision. That linguistic difference might make a difference, and I concede that the standard for deductibility should be no lower for a home office than for a traditional, out-of-the-home office. But should it be higher? Maybe the burden of proof should be higher because we have every reason to be skeptical about deductions claimed for space in a dwelling unit. But I see no reason for the underlying substantive requirements for deductibility to be fundamentally different.14
The point is this: The word "exclusively" has to have some give in it, or section 280A(c)(1) is close to a nullity. And Judge Haines apparently accepted that point when it came to the bedroom-office. On cross-examination, the government attorney had pressed Bulas about the nonbusiness use of the bedroom-office:
Q. So isn't it also true that they used your room?
A. Yes. People walk into the room, yeah. I'm doing the tax returns, of course.
Q. But your family.
A. Everybody walks through the whole house. How can you . . . tell me that because somebody that's my family walks into my room, which is an office, makes the office not deductible is ridiculous, which is what probably you're trying to get to.15
It is pretty clear what the government attorney was trying to get to, but Judge Haines accepted the home office deduction (subject to some computational issues) and made no mention whatsoever of this possible violation of the exclusivity requirement. What is it that distinguishes bedroom-offices from bathrooms for purposes of the exclusivity requirement?16
If Bulas really did build the bathroom specifically for use by clients, a fact Judge Haines accepted, and that is how the bathroom was in fact used, occasional use by others shouldn't have been fatal.17 Imagine poor little Johnny at home, squirming with a full bladder while the bathroom he usually uses is occupied. He asks if he can use Daddy's office bathroom upstairs and is told: "No, Johnny, you can't do that because it would call into question the exclusivity requirement in section 280A(c)(1) of the Internal Revenue Code." If I were Johnny and were told that, I'd let it fly right in the living room.
None of this is to say that a home bathroom deduction will often be available. Judge Haines's decision would have been right on if there had been reason to believe that family members were treating this particular bathroom like any other bathroom in the house. But that isn't how the judge characterized what was going on. He referred to "occasional" nonbusiness use, and that shouldn't matter. This was fundamentally a business facility, or at least it seemed to be.18
Let me finish by mentioning the other interesting issue in Bulas. Although he had not issued his college- and high-school-age daughters a Form W-2 or 1099 -- indeed, he had not even issued them paychecks -- Bulas had deducted compensation he claimed to have paid them. He said that when he paid their credit card bills, he was compensating them for services performed for his accounting business.
Because of lack of substantiation, Bulas quite rightly lost on this issue,19 but Judge Haines could have rejected most of the claimed deduction on a straightforward, alternative ground as well. Based on my experience, there is no possibility -- none! -- that the amount of a teenager's or a twenty-something's credit card bill could have constituted "a reasonable allowance" for compensation20 -- or for anything else. The amount is going to be unreasonable per se (as it would be to let a kid have a credit card to begin with).
1 T.C. Memo. 2011-201, Doc 2011-17762, 2011 TNT 160-9.
2 A third alternative in the statute, applying to separate structures, was not relevant in the case. See section 280A(c)(1)(C).
3 (A) and (B) are alternative requirements, only one of which needs to be satisfied, but Bulas presumably satisfied both. The home office was his principal place of business, and he regularly saw clients there.
4 Slip op. at 3-4.
5 Id. at 4.
6 Id. at 6. I'll leave the treatment of "home hallway deductions" for another article.
7 I don't pretend to have done exhaustive research on this question. In any event, I don't care (gasp!) what the cases say. I want to go back to first principles, trying to understand the statute in a way that makes sense.
8 Maybe, given the potential for abuse, there should be no home office deductions at all, but that's not the position Congress has taken.
9 Is even a doctor going to keep the kids out of the office all the time? I have a colleague who admits to visiting his doctor-father's home medical office. He nevertheless assumes that Dad was claiming the home office deduction. (The statute of limitations has run for all relevant years.)
10 In Popov v. Commissioner, 246 F.3d 1190 (9th Cir. 2001), Doc 2001-11147, 2001 TNT 76-6, rev'g T.C. Memo. 1998-374, Doc 98-30935, 98 TNT 200-8, the Ninth Circuit, in a crazy opinion, concluded that part of the living room of a one-bedroom apartment -- the apartment occupied by husband, wife, and 4-year old -- used by the wife, a professional musician, as a rehearsal space, was eligible for the home office deduction. It's hard to see exclusive business use there by any measure, but this important issue was ignored. (For the Tax Court, exclusivity was irrelevant anyway, given its conclusion that the space wasn't Popov's principal place of business.)
11 But see slip op. at 6 ("Combined personal and business use of a section of the residence precludes deductibility").
12 Admit it. You spent a few minutes today at the office paying personal bills and checking the weather reports, didn't you?
13 If that's not the case, we've just signed the death warrant for "Take Your Daughter to Work Day."
14 They are nevertheless different in some respects. Remember Dr. Soliman, the anesthesiologist who was unable to deduct expenses associated with a home office where he did his paperwork -- essential work for which he was provided no space by the hospitals with which he was associated? Commissioner v. Soliman, 506 U.S. 168 (1993), Doc 93-668, 93 TNT 9-1. No matter how essential the work, the office was neither Soliman's principal place of business nor a place where he saw patients. The home office therefore didn't meet the statutory requirements as they then existed, even though Soliman would certainly have been able to deduct rent for an office outside his home. A subsequent statutory fix dealt prospectively with Soliman's particular problem, but it didn't take care of all instances in which a home office is unquestionably being used exclusively for essential business purposes, but is not the taxpayer's principal place of business or a place to see patients, clients, etc. See section 280A(c)(1) (last sentence).
15 Transcript at 33.
16 Is there some intuitive sense that we "use" those spaces in different ways -- that doing our business in the bathroom is different from doing our business in a real home office? If there is a difference that has legal significance, we ought to be able to articulate it, and Judge Haines didn't do that.
17 When in his testimony Bulas conceded that his family members occasionally used the bathroom, he stressed that that wasn't usual practice: "Who wants to go into a bathroom that everybody goes in? I don't like it." Transcript at 32.
18 If I were a judge evaluating the merits of a claimed deduction for Bulas's bathroom, there's something else that I might pay attention to. Although Judge Haines didn't mention this in his opinion, the "bathroom" wasn't a bathroom (you know, with shower or tub). According to Bulas's testimony, "It's just half a bath. It's just a sink and a toilet." Id. at 8. If it were a full bathroom, I'd have a great deal of difficulty concluding that it's primarily for the use of clients. But if it's not a full-service operation -- a bathroom without the bath -- it's the sort of facility that might very well have been constructed and used primarily for business reasons.
19 To tie all this together: If the daughters really had provided services to the business, I assume that they would have been able to use the bathroom, at least during business hours, without calling the home bathroom deduction into question.
20 See section 162(a)(1) (including in the category of ordinary and necessary business expenses "a reasonable allowance for salaries or other compensation for personal services actually rendered").
END OF FOOTNOTES
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