Soliman was an anesthesiologist employed by three hospitals, none of which furnished him office space. As a result, he performed the managerial and administrative duties of his profession at home and claimed a home office deduction on his income tax return.

The home office deduction has been the subject of disagreement between the Internal Revenue Service and taxpayers for many years. Directly at the heart of this controversy is what constitutes the "principal place of business." The IRS (and the Tax Court, until this case came before it) had always utilized the "focal points" test to determine the principal place of business. Taxpayers and the Court of Appeals generally favored the "facts and circumstances" test.

The focal points test considers the place where goods and services are provided to customers and where revenues are generated as being the principal place of business.

The facts and circumstances test allows a deduction when management and administrative duties are essential to the taxpayer's trade or business, the only place of business is in the taxpayer's home, and he spends substantial time there.

The Tax Court had always applied the focal points test to determine the principal place of business, but it abandoned that long-standing position in favor of the facts and circumstances test after hearing the case of Soliman. The Court of Appeals, which already had a history of applying the facts and circumstances test, affirmed the Tax Court's decision.

The case then came before the Supreme Court. Little did anyone know at the time, but a surprise was in store for taxpayers. Since both the Tax Court and the Court of Appeals were now in agreement regarding utilization of the facts and circumstances test, the Supreme Court hearing appeared to be only a matter of formality. The high court would rule that the lower courts were in fact correct -- or so everyone expected!

The Supreme Court decided to hear the case, to determine once and for all what constitutes the principal place of business. Does the focal points test apply? Does the facts and circumstances test apply? Is it neither?

The Court decided that to determine the principal place of business, two primary considerations must be taken into account:

1) What is the relative importance of the activities performed at each location when the taxpayer transacts his trade or business?

2) What is the actual amount of time spent at each location?

The first step requires the decision-maker to determine the relative importance of the functions performed at each business location for the trade or business in question. This is done by listing an objective description of the particular characteristics of the trade or business and comparing them with the activities conducted by the taxpayer at various business locations.

In other words, what are the income-generating functions of the trade or business in question? Where are these functions being performed? Does the nature of the job require that the taxpayer meet or deal with clients or patients or deliver goods and services?

If so, then where these meetings or transactions take place will be given more weight in the analysis of what constitutes the principal place of business because, in a general sense, that is where the income-producing activities will normally take place. If those meetings take place at a facility with unique or special characteristics, then this will be given even greater weight. The Soliman case dealt with the latter, i.e., a hospital.

Taxpayers claiming a home office deduction are well-advised to keep good records in regard to these activities. With whom did the activity occur? Customer, client, patient, etc.? What type of business activity was transacted? It should be income-generating primarily, but if the analysis of step one does not provide a definitive answer (explained in the next step), then non-income-generating activities may also come into play.

When did the activity take place? Indicate the date and time for the appropriate tax year. Where did the activity take place? This is very important. Indicate at which business location the activity took place. How much time was actually spent there? This is the demand placed on the tax-payer in step two.

Step two of the analysis is to determine the actual amount of time spent at each business location. This step is given more significance if the analysis in step one does not provide a definitive answer. In that case, then the amount of time spent at the respective location(s) will be "controlling," meaning it determines where the principal place of business is and, consequently, whether or not the home office qualifies.

Note that what has been addressed so far is the issue of income-generating activities as being of relative importance. What about the administrative and managerial functions of the trade or business? Do these come into play at all?

ALL PLAY ROLE

While these functions are not of relative importance as required in step one, they do play a role in the analysis. The Court itself stated, "Whether the functions (management and administrative duties) performed in the home office are necessary to the business is RELEVANT to the determination of whether a home office is the principal place of business in a particular case, but it is not CONTROLLING ."

It appears, then, that these functions can be of RELEVANCE but will never be RELATIVELY IMPORTANT. So it seems we can use them in step two in instances where there is no definitive answer from step one, but they are not enough on their own for a determination to be reached.

The question then arises, where is the majority of the time actually spent? If it is in the home office, then a home office tax deduction should be allowable.

As indicated earlier, the Court asks whether or not the nature of the business requires the taxpayer to meet or deal with clients or patients or deliver goods and services. It then goes on to say that the answer to this question is not conclusive, further confusing the issue.

Based on the Court's transcript of the Soliman case, one could come to the conclusion that "not conclusive" refers to the time issue of the secondary step in the Court's analysis. In other words, the tax-paver does not get a tax deduction if he spends only a few hours in the home office meeting and dealing with clients, while the majority of time is spent elsewhere.

The Court apparently rationalized this sentiment when it stated, "We agree with the ultimate conclusion that visits by clients, patients and customers are not a required characteristic of a principal place of business, but we disagree with the implication that whether or not those visits occur is irrelevant."

If the trade or business in question is one in which income-generating activities are done outside the home, then chances are a deduction will not be allowed under these new guidelines. There are two exceptions, however, that were not affected by this change: the deduction for day care providers and, in certain instances, the storage of retail inventory.

Code Section 280A also provides that a deduction can be taken in the case of "a separate structure which is not attached to the dwelling unit, in connection with the taxpayer's trade or business."

However, caution must be taken. The structure does not have to be an essential part of the dwelling unit or attached to it to be considered an appurtenant to it. In a 1984 decision, the Tax Court ruled that a particular home office could not be considered separate because it was in fact an appurtenant to the dwelling unit.

It based its decision on these facts: the office building was on the same residential lot as the house, with only 12 feet separating the two buildings; both buildings were in an area enclosed by a fence; and all of the expenses for the property, taxes, utilities, interest and insurance were included in common bills.