This Is a Tax Break? : IRS Decides Not to Prosecute Taxpayers Who Followed Its Advice

The Internal Revenue Service for years has been luring taxpayers into violating its own rules on deductibility of home-office expenses.

Now, in the wake of a recent Supreme Court ruling, the tax-collecting agency has admitted its error and is giving taxpayers a break.

The IRS said Monday that it will no longer go after certain taxpayers who, in the past, violated its rules by following its advice on deducting home-office expenses.

Taxpayers who relied on erroneous advice from IRS Publication 587, “Business Use of Your Home,” will not be prosecuted, the agency said. The publication, by citing a reasonably simple “test” of deductibility, encouraged those who used home offices on a part-time basis to deduct office expenses.

Indeed, in an example of what was allowed with home-office deductions, the publication cited the case of an outside salesman, Joe Smith, who used his home office to do paperwork and set up appointments. One room in Smith’s home was used exclusively for that purpose and he spent a “substantial amount of time” there, so Smith’s home “qualifies as his principal place of business . . . he can deduct expenses for the business use of his home,” the booklet said.

What’s ironic is that the agency penalized people who took such deductions based on these erroneous instructions. Taxpayers who took home-office deductions were frequently told in an audit--home-office deductions are widely believed to trigger closer IRS scrutiny--that they couldn’t deduct home-office expenses unless they were meeting customers at home or could prove that the work done at home was much more important than the work done elsewhere.

If the taxpayers balked, citing Publication 587, the IRS would take them to court, because this stricter definition is technically the law. The stricter rule is published in the Master Tax Guide--a bible to professional tax preparers that’s rarely seen by the public.

After much battling in court, the Supreme Court last month agreed with the IRS--despite Publication 587. And now, apparently emboldened by the ruling, the IRS says it is willing to forgive and forget.

Taxpayers who used those old guidelines to file claims for home-office deductions prior to the 1992 tax year will not be challenged, according to the IRS. That could mean thousands of taxpayers who took the deductions will avoid audits--and save thousands of dollars in taxes and penalties.

But the IRS will publish a new booklet on home-office deductions later this month. All returns filed for the 1992 tax year (those due this April 15) and for future years are expected to comply with the tougher standards.

The old example of what’s allowable--Joe Smith, a salesman using his home office only for paperwork and making appointments--will be replaced with a salesman who makes most of his sales via telephone in the home office. This salesman, Mr. Jones, spends 30 hours a week in the home office and only 12 hours delivering goods outside of the office.

Still, professionals say the real lesson in all this is that you can’t depend on the IRS.

“This reveals a lot about the problems that ordinary taxpayers have when dealing with the IRS,” said Bernard Oster, a tax attorney with the law firm of Cohen Primiani & Foster in Los Angeles. The reliability factor of IRS publications and verbal representations “is zero,” he said.

Indeed, IRS spokesman Rob Giannangeli says you can’t legally depend on what the agency tells you in print or over the phone. “When you come down to it, these publications we put out have no standing in law,” Giannangeli said. “The only thing that means anything is the Internal Revenue Code.”