What is My Tax Home
Posted July 27, 2018
We often get the question What is my tax home? It is a tricky question… and it is one that a lot of taxpayers are very interested in since your tax home is where you will generally pay taxes and commuting to your tax home is not deductible. There are three primary applications of the tax home definition and location.
Those people living in one taxing jurisdiction (let’s say a state), working in another and commuting back and forth. A great example is someone living in Pennsylvania and taking the train to New Jersey. Or Kansas City which straddles both Kansas and Missouri. There are several examples of this especially in congested areas where cities are bumping into each other such as Chicago, IL and Milwaukee, WI. Or, Washington, DC Bethesda, MD and Arlington, VA. Luckily many of these areas have some sort of tax treaty or reciprocity in place.
A business owner who has a home office where he or she does a lot of work, but also a singular client where on site work is being done in another taxing jurisdiction. This is very similar to the above examples of cities bumping into each other across state boarders, but with one big difference- work is being done in both places. Now what? We’ll talk about this too.
The last example is for expats which is short of expatriates. Those U.S. citizens working abroad but with significant family ties to the United States. Physical presence test will trump the family ties in the U.S., but those trying to claim the foreign earned income exclusion based on bona fide residency have trouble combing their tax home with their “abode.”
Tax Home Wages
With our first tax home application above, many people will have taxes withheld and have a tax obligation to the location you performed your labor. For example, you live in Bethesda but commute to Washington. In the absence of a tax treaty or agreement between these two states, you would pay taxes in the District of Columbia as a non-resident although you live in Maryland. A lot of these scenarios have tax agreements in place such that the District of Columbia (in this example) would honor the taxes paid in Maryland, and would not require a non-resident tax return.
Other scenarios are not as nice. For example, if a tax agreement did not exist between two neighboring states, each state fights to tax the dollars earned. Let’s say you lived in New York City but commute to Massachusetts each week. Massachusetts would rightfully tax your wages earned there, and you would probably have to a file a non-resident Massachusetts tax return.
But what about New York? New York would also tax those wages, but would give you a tax credit for the taxes paid to Massachusetts. So in general you cannot create tax arbitrage by living in a high income tax state while working in a lower income tax state. This is a huge generalization- each state is different, and how each state handles other states is also unique.
One of the best ways to illustrate the issue is a quick review of a recent Tax Court case, Barrett v. Commissioner, Tax Court Memo 2017-195. Barret was a video producer in Las Vegas, Nevada. His employer constructed offices in Washington, D.C., which required Barrett to travel to and from several times a year. His average stay in Washington was about two weeks.
Barrett claimed about $55,000 in travel expenses and the IRS challenged arguing that his tax home was in Washington and not Las Vegas. However, the Tax Court disagreed with the IRS because Barrett proved that he did substantial work for his employer in Las Vegas in addition to the work in Washington. As such, his tax home was considered Las Vegas and not Washington.
This allowed him to deduct his travel expenses including lodging and meals since he was not commuting to his tax home. A win for Barrett. But… he eventually lost since he could not substantiate his expenses. So while he was allowed to deduct associated expenses, his recordkeeping was shoddy.
There are other exceptions such as a temporary duty assignment or work location, where you travel to another place for an overall period that is under a year. Your travel expenses back and forth, lodging and meals are deductible since the work location is temporary. You must be able to demonstrate that the period away from your tax home was defined as being less than a year from the onset of the assignment; in other words, you technically cannot simply look back and show that it was under a year and therefore it is temporary. The IRS and the tax code would consider that an indefinite period of time negating your deductions.
As a side note, Barrett deducted these on Form 2106 as a miscellaneous deduction subject to the 2% adjusted gross income threshold. With the Tax Cuts and Jobs Act of 2017, these deductions are no longer allowed.
Tax Home Business Incomes
So now you understand the basic landscape, let’s shift gears to the business owner who works in multiple states. In multi-state scenarios, the word apportionment is used. Three primary factors are used to chop up the income and expenses between states, and they are revenue, property and payroll.
Property and payroll is fairly straightforward. Revenue can also be straightforward for service providers, but it can be a challenge for some since we live in an ecommerce world with fulfillment centers and other oddities. Where a sale occurs is something states and other taxing jurisdictions go around and around on. Cities really get worked up on this when it comes to the collection of sales tax. This blog post is about income tax, but you can easily see how it could translate into a sales tax issue as well.
The recent United States Supreme Court case involving Wayfair has opened the door to allow states to collect sales tax on interstate commerce. This will only help bolster the attempt to collect an income tax as well. Here about that case in our blog post here-
We field a lot of questions where the business owner wants to form a business in Nevada yet reside and do all the work in California in an attempt to avoid California income taxes. You can probably get away with it, but it is not correct. If it were that easy, every company from Apple to Google to Microsoft would be formed in Nevada. Shockingly, they are not because this does not avoid local income taxes.
Tax Home Business Expenses
Another variant of the tax home issue for business income is the deduction of business expenses. We have yet another Tax Court case that is eerily similar to the Barrett case above. In Bigdeli v. Commissioner, Tax Court Memo 2013-148, the taxpayer was an oral surgeon living in Pennsylvania who traveled 130 miles to New York where he worked at a dentist office.
His personal home was Pennsylvania and his tax home was New York. His $55,950 in travel expenses for the two years in question were disallowed because a) they were personal non-deductible commuting expenses and b) his work location and subsequent tax home did not meet the temporary work location rules.
What if Bigdeli had a home office where he performed administrative functions in addition to his primary work functions outside the home? No dice.
There is a derived 50 mile radius rule. It is derived from IRC Section 162(h) which defines the local area for state legislators as 50 miles. The federal government defines metropolitan area for IRS employees as 50 miles from an IRS office as detailed in the Internal Revenue Manual 6.522.214.171.124 (revised December 2009). There are other references to 50 miles, so it is a good rule of thumb to use.
How does the 50 mile rule factor into your home office world? To eliminate commuting using an administrative home office argument, your home office must be within 50 miles of your tax home. This is per Revenue Rulings 99-7 and 93-86, including Chief Counsel Advice 200027047 (CCA’s are the IRS’s own attorneys’ recommendation and interpretations).
Some caution here! This is an administrative home office argument… where you primarily do your work outside the home and regularly and exclusively use a space in your home for administrative duties such as accounting, speaking to your attorney, invoicing, reviewing contracts, etc.
If you perform your primary work functions in both your home office and a work location outside the home, then your tax home will be the location where you spend the most time, perform the most critical functions and earn the most revenue. This is referenced in Chief Counsel Advice 200020055 which refers to Revenue Ruling 93-86 and 75-432, plus Markey v. Commissioner, 490 F.2d 1249 (6th Circuit 1974). Yeah, some old references but current tax law.
So, if you want to deduct travel, lodging and meals expenses associated with multiple work locations, either a) have your home office be within 50 miles of your tax home, b) do the most work in your home office with the outside the home work being secondary or c) have the assignment be temporary (under one year in duration).
How about having a W-2 job in Worcester, MA and running a business in New York City? In Sherman v. Commissioner from 1951, the Tax Court ruled that Worcester was Sherman’s tax home and the expenses of travel, lodging and meals associated with his secondary business in New York City were deductible. Win for the taxpayer!
Tax Home Foreign Earned Income Exclusion
When considering foreign earned income exclusion, the location of your tax home is straightforward. For most taxpayers the tax home will be the location where the work is being performed, and in terms of the foreign earned income exclusion the tax home must be outside the United States. There are two ways to qualify for the foreign earned income exclusion.
The first is physical presence test. This is easy. You simply demonstrate that you were outside the United States for 330 out of a rolling 365 days and that your income was earned while away. Boom, done!
The second is bona fide residency. This is more difficult since it is more qualitative rather than quantitative. Taxpayers attempt to use bona fide residency when they cannot piece together the 330 days out of a rolling 365 day period. In a roundabout way, taxpayers are saying they are residents of a foreign country by their actions and not a numerical number of days.
The problem comes up when the taxpayer has immediate family that resides in the United States, including other connections such as driver’s license, voter card, etc. The Tax Court has used the term abode to refer to a domestic location and tax home to refer to a vocational location. If both of these are outside the United States, a taxpayer will generally qualify for the foreign earned income exclusion. But if it is determined that the abode is in the United States, the taxpayer can only rely on the physical presence test as a way to qualify for the exclusion.
More on this narrow issue including an IRS memorandum here-
Jason Watson, CPA is the Managing Partner of WCG (formerly Watson CPA Group), a business consultation and tax preparation firm, and is the author of Taxpayer’s Comprehensive Guide on LLC’s and S Corps which is available online.