JCR January 1999: Tax Season: What you need to know
by Joseph Stack
The Taxpayer Relief Act (TRA) of 1997 has added language to Internal Revenue Code Section 280A that will make it easier for many court reporters to qualify for the office-in-home deduction in 1999. The new language deals with what constitutes the "principal place of business" of a taxpayer. The original text of the section is still in place, so court reporters will still need to meet the same basic tests in order to qualify for the deduction. (See "The Office-in-Home Deduction and Court Reporters," JCR, January 1995, for information on how to qualify for 1998 income tax returns.)
The development of high-speed modems, fax machines and cellular telephones has made a home office a necessity for many taxpayers, especially court reporters. Unfortunately, the mere "necessity" of a home office has not been sufficient to allow the deduction. To understand the requirements of the office-in-home deduction, it's helpful to consider how the legislative history of the code section has developed as the technology of our economy has changed, making home offices more common.
Prior to 1976, the courts tended to allow office-in-home deductions in cases where the office was "appropriate and helpful" to the taxpayer's business. This invited abuse by taxpayers, so Congress enacted Section 280A. This section allows the deduction in five distinct cases, four of which do not normally apply to court reporters. Therefore, for court reporters to be eligible for the office-in-home deduction, they must fall under the "principal place of business" exception as modified by the '97 TRA.
Under this exception, Section 280A provides that a deduction is allowed "for the portion of a dwelling unit which is exclusively used on a regular basis as the principal place of business of the taxpayer." Therefore, a court reporter must meet the three requirements of:
- Exclusive use
- Regular use
- Principal place of business
The "exclusive use" element is a strict standard. The home office area cannot be used for any personal purposes whatsoever. In fact, the mere presence of furniture or appliances that would ordinarily be considered personal (for example, bedroom furniture) may jeopardize the deduction. Also noteworthy is the fact that the office can be a separate area of a room as long as the area used for business is clearly delineated and identifiable.
The "regular use" element is a little easier to satisfy. Frequent and repetitive use of the office is normal for a court reporter who is actively working. However, if all of your work is performed in a courtroom or agency office, and the home office is only used occasionally, the regular use test will not be met.
The "principal place of business" element is the most complicated. It has been challenged and litigated through various trial and appellate courts since the section's enactment in 1976 until the United States Supreme Court's decision in Soliman v. Commissioner in 1993. Since 1993, taxpayers and the IRS have had to follow the Supreme Court's definition of what constitutes a "principal place of business." Remember, as stated above, the Supreme Court's definition must still be followed for 1998 returns.
A New Definition
The Supreme Court's definition made it difficult for most taxpayers to qualify for the deduction, and heavily weighted the advantage toward the IRS. Consequently, anyone claiming a home-office deduction ran a high risk of audit and disallowance of the deduction. Fortunately, Congress and the United States Tax Court have always favored the office-in-home deduction for taxpayers. The only way to trump the United States Supreme Court is to write a new law, which is exactly what Congress did in the '97 TRA. The following language has been added to Section 280A:
The term "principal place of business" includes a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer if there is no other fixed location of such trade or business where the taxpayer conducts substantial administrative or management activities of such trade or business.
This new language would seem to suggest that activities such as billing, editing, transcription, research, bill paying, etc., if conducted in a home office, will qualify that office as the "principal place of business." Note that this appears to be true even if your agency or court provides office space for your use, as long as you use it only occasionally or not at all to conduct administrative or management activities.
This is all subject to judicial review, of course. Courts will once again have to decide what constitutes a "fixed location" and a "substantial activity." Expect the IRS to fight tooth and nail against us.
Independent Contractor or Employee
In recent years, the Internal Revenue Service has scrutinized more carefully the business practices of the reporting industry, primarily in terms of whether a firm's reporters are legitimately classified as independent contractors rather than employees. For example, in the March 1998 JCR, NCRA Director Judy Everman wrote about her firm's audit by the IRS, and how the IRS eventually dropped the matter because, among other things, she was able to show that the use of independent contractors is common industry practice.
And, in IRS Publication 15A, Employer's Supplemental Tax Guide, it states that "public stenographers" are generally not employees. Of course, the IRS does not state what it means by public stenographer. Still, determining whether a court reporter is an employee or independent contractor depends on the facts of each individual case. Generally, a court reporter is considered an independent contractor if the payer has the right to control or direct only the result of the work and not the means or methods of accomplishing the result.
Making a Judgement
Publication 15A explains that the information which will determine the degree of control and independence falls into three categories:
Behavioral control. Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of:
- Instructions the business gives the worker. An employee is generally subject to the business's instructions about when, where and how to work.
- Training the business gives the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.
Financial control. Facts that show whether the business has a right to control the business aspects of the worker's job include:
- The extent to which the worker has unreimbursed expenses. Independent contractors are more likely to have unreimbursed expenses than employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important.
- The extent of the worker's investment. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. For the court reporter, that would include his or her steno machine, CAT/realtime software and other necessary equipment.
- The extent to which the worker makes services available to the relevant market. If a reporter only works for one freelance agency, and will not accept work from any other firm, then that reporter may be considered an employee.
- How the business pays the worker. An independent contractor is usually paid by the job, as is the case for most freelance reporters. However, it is common in some professions to pay independent contractors hourly.
- The extent to which the worker can realize a profit or incur a loss. An independent contractor can make a profit or loss.
Type of relationship. Facts that show the parties' type of relationship include:
- Written contracts describing the relationship the parties intended to create. This one factor demonstrates why it's critical for freelance agencies and reporters to base their relationship on a written independent contractor agreement. (See "Independent Contractor Agreements" in the March 1998 JCR, page 26.)
- Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan or vacation and sick pay. In most independent contractor relationships, the agency will not offer any of these benefits to reporters who take assignments.
- The permanency of the relationship. If you engage a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that your intent was to create an employer-employee relationship.
- The extent to which services performed by the worker are a key aspect of the regular business of the company. If the worker provides services that are a key aspect of your regular business activity, it is more likely that you will have the right to direct and control his or her activities.
A Safe Haven
Nevertheless, Section 530 of the tax code does offer some relief from federal employment taxes if certain requirements are met. Publication 1976 states that to receive relief under this safe-harbor provision, you must meet the following three requirements:
Reasonable basis. To establish that you had a reasonable basis for not treating workers as employees, you can show that:
- You reasonably relied on a court case about federal taxes or a ruling issued by the IRS, or o Your business was audited by the IRS at a time when you treated similar workers as independent contractors and the IRS did not reclassify those workers as employees, or
- You treated the workers as independent contractors because you knew that was how a significant segment of your industry treated similar workers, or
- You relied on some other reasonable basis. For example, you relied on the advice of a business lawyer or accountant who knew the facts about your industry.
A survey conducted by NCRA indicates that 86 percent of freelance reporters are treated as independent contractors.
Substantive consistency. You must have treated the workers, and any similar workers, as independent contractors.
Reporting consistency. You must have filed Form 1099-MISC for each worker, unless the worker earned less than $600.
The IRS will determine whether the workers are independent contractors or employees if you do not meet these relief requirements. If the IRS decides that the reporters are actually employees, then the firm may be held liable for employment taxes for those workers.
About the Author: Joseph R. Stack is a certified public accountant in Newport Beach, Calif. (949-723-1829). He specializes in tax preparation for court reporters.