• Key point: Clergy can claim a deduction for an office in their home only if the office is their principal place of business. A recent Supreme Court decision considerably narrows the availability of this deduction.

• The United States Supreme Court has issued a ruling making it much more difficult for taxpayers to deduct the costs of an office in their home. Prior to 1976, taxpayers could deduct the costs of maintaining a home office so long as the office was “appropriate and helpful” to the taxpayer’s business. This generous standard allowed many taxpayers to a claim a home office deduction even though few business tasks were performed in the home office. As a result, Congress narrowed the home office deduction in 1976 by adding section 280A to the Internal Revenue Code. This section permits a home office deduction only if a taxpayer uses a part of his or her home “exclusively and regularly” (1) as the principal place of business for the taxpayer’s trade or business, or (2) as a place to meet or deal with patients, clients, or customers in the normal course of the taxpayer’s trade or business. Most ministers with home offices do not use their office exclusively and regularly as a place to meet with parishioners, and accordingly a minister’s home office expenses will be deductible only if the office is used exclusively and regularly as the minister’s principal place of business. Under what circumstances will a minister’s home office be his or her principal place of business? Prior to 1990, the Tax Court interpreted this requirement to mean that a taxpayer’s home office must be the “focal point” of the taxpayer’s activities—meaning that it is the place where most of the taxpayer’s income is generated and where the taxpayer performs most of his or her services. This meant that nearly all taxpayers who performed significant services outside their home were denied a home office deduction, even if the home office was necessary and used exclusively for business, since taxpayers can have only one principal place of business. In 1990 the Tax Court liberalized the “principal place of business” requirement in the case of Soliman v. Commissioner, 94 T.C. 20 (1990), and its new test was later upheld by a federal appeals court. Under the new rule, a home office deduction would not be disallowed merely because the taxpayer performed services and earned income at another location than his or her home, so long as the following three conditions were met: (1) the home office is essential to the taxpayer’s business, (2) the taxpayer spends substantial time working in the home office, and (3) there is no other location available to perform the office functions (i.e., a minister does not have an office in the church). If these three conditions were met, then the “facts and circumstances” of each case would determine whether or not a taxpayer’s home office was his or her principal place of business. Factors to consider, according to the Tax Court, included the time spent in the home office; the importance of the duties performed there; and the cost incurred in establishing the home office. In a recent ruling, the United States Supreme Court overturned the Soliman decision, and rejected the more liberal “principal place of business test” that had been adopted by the Tax Court and a federal appeals court. The Court concluded that “there are two primary considerations in deciding whether a home office is a taxpayer’s principal place of business: the relative importance of the activities performed at each business location and the time spent at each place.” The Court stated that “the point where goods and services are delivered must be given great weight in determining the place where the most important functions are performed.” It continued: “Though not conclusive, the point where services are rendered or goods delivered is a principal consideration in most cases. If the nature of the business requires that its services are rendered or its goods are delivered at a facility with unique or special characteristics, this is a further and weighty consideration in finding that it is the delivery point or facility, not the taxpayer’s residence, where the most important functions of the business are undertaken.” While many taxpayers engage in planning, preparation, and study in their home office, these activities have “very little weight” in determining entitlement to the deduction. In addition to measuring the relative importance of the activities undertaken at each business location, the Court suggested that one should also compare the amount of time spent at home with the time spent at other places where business activities occur. Further, “this factor assumes particular significance when comparison of the importance of the functions performed at various places yields no definitive answer to the principal place of business inquiry.”

What is the relevance of this case to clergy? It means that it will be even more difficult for clergy to claim a home office deduction. Not only must the home office be exclusively and regularly used for business purposes, but it also must satisfy the Court’s narrow definition of a taxpayer’s “principal place of business.” According to the Supreme Court’s new test, the place where services are rendered is “the principal consideration in most cases.” Where do clergy render their services? There is little doubt that most courts and the IRS would conclude that a minister’s primary services are rendered at his or her church. The Court further noted that “if the nature of the business requires that its services are rendered … at a facility with unique or special characteristics, this is a further and weighty consideration in finding that it is the delivery point or facility, not the taxpayer’s residence, where the most important functions of the business are undertaken.” This statement is relevant to clergy. Again, most courts would assume that a minister’s duties, and the “business” of the church, be conducted on the church’s premises. Worship services, sacraments, religious instruction—all of these duties of clergy are uniquely associated with a church’s premises. According to the Court, this is a “weighty consideration” indicating that the principal place of business of the minister is the church rather than an office in the minister’s home.

Justice Stevens dissented from the Court’s decision. He observed: “Nothing in the history of this statute provides an acceptable explanation for disallowing a deduction for the expense of maintaining an office that is used exclusively for business purposes, that is regularly so used, and that is the only place available to the taxpayer for the management of his business. A self-employed person’s efficient use of his or her resources should be encouraged by sound tax policy …. In my judgment, the Court’s contrary conclusion in this case will breed uncertainty in the law, frustrate a primary purpose of the statute, and unfairly penalize deserving taxpayers. Given the growing importance of home offices, the result is most unfortunate.” Commissioner v. Soliman, U.S. (1993).

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