Section 262.—Personal, Living, and Family Expenses

(Also, § 280A.)

Frivolous tax returns; meritless home-based business deductions. This ruling emphasizes to taxpayers, and to promoters and return preparers who assist taxpayers with claiming frivolous deductions based on a purported home-based business, that there is no basis for claiming personal, living, and family expenses as business deductions. This return position has no merit and is frivolous.

Rev. Rul. 2004–32

PURPOSE

The Service is aware that some taxpayers are attempting to reduce their federal tax liability by claiming that otherwise nondeductible personal, living or family expenses are deductible because they relate to a purported home-based business of the taxpayer that, in fact, is not a bona fide home business. The purported business in these schemes is no more than an attempt to create the appearance of having a home-based business where none actually exists. The Service also is aware that promoters, including return preparers, are advising or recommending that taxpayers take frivolous positions based on this argument. Some promoters may be marketing a package, kit, or other materials, that claim to show taxpayers how they can avoid paying income taxes based on this and other meritless arguments. This homebased business scheme and the promotion of this scheme are described in more detail in this revenue ruling.

This revenue ruling emphasizes to taxpayers, and to promoters and return preparers who assist taxpayers with homebased business schemes, that they cannot avoid income tax by claiming otherwise nondeductible personal, living or family expenses as business deductions that supposedly relate to a purported home-based business that is not a bona fide trade or business. This argument has no merit and is frivolous.

The Service is committed to identifying taxpayers who attempt to avoid their tax obligations by taking frivolous positions. The Service will take vigorous enforcement action against these taxpayers

and against promoters and return preparers who assist taxpayers in taking these frivolous positions. Frivolous returns and other similar documents submitted to the Service are processed through its Frivolous Return Program. As part of this program, the Service confirms whether taxpayers who take frivolous positions have filed all of their required tax returns, computes the correct amount of tax and interest due, and determines whether civil and criminal penalties should apply. The Service also determines whether civil or criminal penalties should apply to return preparers, promoters, and others who assist taxpayers in taking frivolous positions, and recommends whether a court injunction should be sought to halt such activities. Other information about frivolous tax positions is available on the Service website at www.irs.gov .

DISCUSSION OF HOME-BASED BUSINESS SCHEMES

Several promoters are selling packages of materials (sometimes referred to as a “Tax Toolbox” or a “Tax Toolkit”) containing video or audio tapes, workbooks, record-keeping aids, or other materials that the promoters claim will assist taxpayers in taking tax deductions for a taxpayer’s personal, living or family expenses under the guise of conducting a business, usually out of the taxpayer’s home. The promoters of these packages typically make one or more of the following claims: (1) taxpayers can legally reduce or eliminate their federal income taxes by establishing a business, regardless of whether the business is a bona fide business conducted for profit; (2) operating a business will permit the deduction of personal expenses (such as weddings, children’s allowances, and vacations) as legitimate business expenses; (3) placing a calendar, desk, file cabinet, telephone, or other office-type item in each room of a home will allow taxpayers to deduct all or most of the costs of operating their personal residences; or (4) by using the materials that the promoter sells, taxpayers are guaranteed to receive a large federal income tax refund or to reduce their federal income tax liability by a substantial amount.

Whether an individual is carrying on a bona fide trade or business depends on the facts and circumstances. Nevertheless, the

actions taxpayers take as part of a homebased business scheme, such as the placing of a filing cabinet in a bedroom, invariably are taken for the purpose of claiming personal, living or family expenses as deductible business expenses, and not for the purpose of carrying on a bona fide trade or business. Home-based business schemes typically are used by taxpayers who perform all of their work at their employers’ place of business.

Section 262 disallows deductions for personal, living or family expenses, except as otherwise expressly provided by the Internal Revenue Code. Medical expenses, for example, are deductible only if the specific requirements of section 213 are satisfied. Similarly, the provisions of section 163(h) govern when an individual taxpayer may deduct interest on a mortgage or home equity loan. See I.R.C. §§ 163(h)(2) and (h)(3).

With respect to business expenses, only expenses paid or incurred during the taxable year in carrying on a trade or business may be deducted under section 162(a). A trade or business expense deduction under section 162, however, is not permitted with respect to a taxpayer’s residence unless specifically permitted in limited circumstances by section 280A. I.R.C. § 280A(a). For example, with respect to the business use of a taxpayer’s residence, section 280A provides that in order for allocable expenses to be deductible under that section, the portion of the taxpayer’s residence must be used exclusively by the taxpayer on a regular basis as a principal place of business for the taxpayer’s trade or business, or to meet or deal with patients, clients or customers in the normal course of the taxpayer’s trade or business. If the taxpayer is an employee, the exclusive and regular use of a portion of the taxpayer’s residence must be for the convenience of the taxpayer’s employer before any expenses relating to that part of the taxpayer’s residence may be deducted. I.R.C. § 280A(c).

Taxpayers participating in home-based business schemes invariably do not have a bona fide home-based business and are not using any portion of their residences exclusively and regularly for a work-related use. These schemes will not convert otherwise nondeductible personal, living or family expenses into legitimate deductions. Moreover, detailed recordkeep

2004-12 I.R.B. 621 March 22, 2004

frivolous positions will be liable for the actual tax due plus statutory interest. In addition, the Service will determine civil penalties against taxpayers where appropriate, and those taxpayers also may face criminal prosecution. The Service also will determine appropriate civil penalties against persons who prepare frivolous returns or promote frivolous positions, and those persons also may face criminal prosecution. Promoters and others who assist taxpayers in engaging in these schemes also may be enjoined from doing so under section 7408.

Even if a taxpayer is engaged in a bona fide trade or business or is conducting activities from his home for the convenience of his employer, the taxpayer must satisfy the specific requirements of the Internal Revenue Code, such as those contained in sections 162 and 280A, to be entitled to deduct expenses related to those activities. Personal, living or family expenses are not deductible except as otherwise expressly provided by the Internal Revenue Code. I.R.C. § 262(a).

DRAFTING INFORMATION

This revenue ruling was authored by the Office of Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this revenue ruling, contact that office at (202) 622–4910 (not a toll-free call).