Petitioner: Philip Jensen
Memo Number: 2010-143
Decision Date: June 28, 2010
Burden of Proof: Taxpayer
Case in a Nutshell:
IRS claims entitlement to a tax deficiency as well as various penalties. Taxpayer seeks to mitigate by compelling the court to allow deductions related to his body shop business.
Discussion in a Nutshell:
The Taxpayer failed to file a tax return in 2005 so IRS prepared a return based on 1099s sent to taxpayer. The Taxpayer implicitly admitted receipt of the 1099 income and did not produce any receipts or reliable substantiation, not even bank statements or utility bills. He did not attempt to explain his failure to maintain records. He presented estimates of what he had spent based on percentages of his income, basing his assertion of entitlement to deductions and photographs of his operation taken in 2009. He claimed a lack of records justifies use of estimates. The Taxpayer “attached a form containing a hodgepodge of frivolous, irrelevant, and spurious arguments.” (I.e. the tax code is too confusing, etc.)
Decision in a Nutshell:
Estimates and speculation are not permissible as evidence of expenditures. The tax court may estimate deductible amounts of expenditures if an exact amount is not known due to a rational reason. The court may only construct estimates but only after the taxpayer has proven that the expenses were incurred. (Photographs of the shop taken several years later don’t quite cut it!) The taxpayer did not offer any reasonable basis for estimates to be constructed such as proof of all: number of vehicles painted, average gallons used to paint a vehicle, paint prices in 2005.
Take Aways:
•Since it is obvious that the taxpayer incurred some costs to operate this business, the tax court noted that the petitioner’s failure to seek competent tax advice caused him to forego the legitimate tax deductions, even significant ones such as the 179 election.
• Failure to retain records of the cost of equipment acquisition precludes the depreciation deduction in all future years for equipment placed in service during the disputed years.
Sunday, August 1, 2010
The “And Here They Come….” Case
Petitioner: Willard Michael Christine & Patricia Ethel Borgia
Memo Number: 2010-144
Decision Date: June 30, 2010
Burden of Proof: Taxpayer
Case in a Nutshell:
IRS disallowed unreimbursed employee expense and home office expense deductions on Schedule A resulting in a deficiency. Taxpayer seeks to mitigate by compelling the court to allow deductions.
Discussion in a Nutshell:
Mr. Christine was a horse racing reporter for the L.A. Times. The paper reimbursed him for significant expenses. Taxpayers may deduct all ordinary and necessary unreimbursed expenses incurred in the course of trade or business but must maintain records and prove entitlement to claimed deductions. Deductions must always be directly connected or pertaining to the business. To deduct expenses for travel away from home, entertainment/recreation, and use of listed property (computers, etc.) a taxpayer must have corroborating evidence with a “high degree of probative value” to support testimony as to the amount, time/place, business purpose and, business relationship to the taxpayer. Nearly all of taxpayer’s claimed deductions were in these categories.
• Ordinary: common or frequent in occurrence for that business
• Necessary: appropriately and helpful for that business.
The Taxpayer submitted mailed IRS more than 700 pages of receipts, etc. much of which was illegible and unorganized. Further examination showed that at least some of the unreimbursed expenses had in fact been reimbursed.
In order for expenses allocable to a home office to be deductible the space must be regularly and exclusively used as the taxpayer’s PRINCIPAL place of business. In the case of an employee, it must also be for the convenience of the employer. Principal place of business means the most important and significant place based on importance of tasks completed at each place and time spent at each place. There can be only one PRINCIPAL place of business for each trade. The taxpayer had deducted 100% of cable TV expenses due to their use of 2 horse racing channels for business. The taxpayers allocated 1/3rd of all their home expenses to business but provided no evidence to support the correctness of this calculation.
The IRS argued that any allowed expenses should have been allocated in part to a hobby since the taxpayer was concurrently authoring a book. Hobby expenses are limited to the income derived from the hobby. The IRS also contended that any expenses related to authoring a book should have been amortized as start-up expenses since his book was not yet complete and available for sale.
Decision in a Nutshell:
Taxpayer in some cases met some or most of the four substantiation requirements but not all so these deductions were disallowed. The Taxpayer had attempted to claim mileage deductions for miles driven on a rental car. This deduction only applies to personally owned or leased automobiles. He should have deducted the actual cost of the rental, if not reimbursable. Taxpayers did not prove that dry cleaning is a customary expense in their trade or that the items cleaned were unsuitable for everyday wear. The expenses were disallowed.
The court allowed deductions for an LA Times subscription and mailing expenses that would have been paid by the paper if he had gone to the office of the paper which was 20 miles one way from his home office. Although the taxpayer proved that the LA times had inadequate office space to accommodate all writing staff, that alone was not enough to carry the burden of proof in regard to the office in part due to failure of the taxpayer to introduce a record of how much time was spent working in the office.
Taxpayer was able to prove that his PRIMARY or PRINCIPAL objective in engaging in the activity was for profit because: he did not manage the endeavor in an unbusiness-like fashion, employed an agent to help him sell his book, had expertise in the field, spent sufficient time on the trade, had some past success/profits at a similar endeavor and the book being authored in the disputed year did subsequently sell. The tax court recognized that a person can carry on a trade with a profit motive even if working full-time at another trade.
• The tax court recognized that some element of personal pleasure by itself does not preclude an activity from being legitimately for-profit.
• The tax court recognized that a trade may result in a loss that is used to offset other income and still be for-profit.
• The IRS held that the taxpayer’s sale of a book decades earlier qualified the writing as an active trade.
Take Aways:
• Only expenses for which a taxpayer could not have been reimbursed may be deducted. In other words, if a taxpayer is entitled to reimbursement but fails to seek it, the expenses are not deductible. The expense/inconvenience that the taxpayer would need to endure in order to meet company policy to be reimbursed was a factor favoring the taxpayer.
• The taxpayer’s time working in hotel rooms while on the road was a factor favoring the IRS in relation to whether his home office was his principal place of business.
• The taxpayers were not assisted much by the court’s lack of support for the IRS’s hobby or start-up disallowance arguments because most expenditures were disallowed due to their inability to provide adequate substantiation.
• In relation to the hobby issue, the court inferred that if the taxpayer’s profit objective was bona fide that may be enough to satisfy the court, even though most people might consider the expectation a profit from a given activity unreasonable.
Memo Number: 2010-144
Decision Date: June 30, 2010
Burden of Proof: Taxpayer
Case in a Nutshell:
IRS disallowed unreimbursed employee expense and home office expense deductions on Schedule A resulting in a deficiency. Taxpayer seeks to mitigate by compelling the court to allow deductions.
Discussion in a Nutshell:
Mr. Christine was a horse racing reporter for the L.A. Times. The paper reimbursed him for significant expenses. Taxpayers may deduct all ordinary and necessary unreimbursed expenses incurred in the course of trade or business but must maintain records and prove entitlement to claimed deductions. Deductions must always be directly connected or pertaining to the business. To deduct expenses for travel away from home, entertainment/recreation, and use of listed property (computers, etc.) a taxpayer must have corroborating evidence with a “high degree of probative value” to support testimony as to the amount, time/place, business purpose and, business relationship to the taxpayer. Nearly all of taxpayer’s claimed deductions were in these categories.
• Ordinary: common or frequent in occurrence for that business
• Necessary: appropriately and helpful for that business.
The Taxpayer submitted mailed IRS more than 700 pages of receipts, etc. much of which was illegible and unorganized. Further examination showed that at least some of the unreimbursed expenses had in fact been reimbursed.
In order for expenses allocable to a home office to be deductible the space must be regularly and exclusively used as the taxpayer’s PRINCIPAL place of business. In the case of an employee, it must also be for the convenience of the employer. Principal place of business means the most important and significant place based on importance of tasks completed at each place and time spent at each place. There can be only one PRINCIPAL place of business for each trade. The taxpayer had deducted 100% of cable TV expenses due to their use of 2 horse racing channels for business. The taxpayers allocated 1/3rd of all their home expenses to business but provided no evidence to support the correctness of this calculation.
The IRS argued that any allowed expenses should have been allocated in part to a hobby since the taxpayer was concurrently authoring a book. Hobby expenses are limited to the income derived from the hobby. The IRS also contended that any expenses related to authoring a book should have been amortized as start-up expenses since his book was not yet complete and available for sale.
Decision in a Nutshell:
Taxpayer in some cases met some or most of the four substantiation requirements but not all so these deductions were disallowed. The Taxpayer had attempted to claim mileage deductions for miles driven on a rental car. This deduction only applies to personally owned or leased automobiles. He should have deducted the actual cost of the rental, if not reimbursable. Taxpayers did not prove that dry cleaning is a customary expense in their trade or that the items cleaned were unsuitable for everyday wear. The expenses were disallowed.
The court allowed deductions for an LA Times subscription and mailing expenses that would have been paid by the paper if he had gone to the office of the paper which was 20 miles one way from his home office. Although the taxpayer proved that the LA times had inadequate office space to accommodate all writing staff, that alone was not enough to carry the burden of proof in regard to the office in part due to failure of the taxpayer to introduce a record of how much time was spent working in the office.
Taxpayer was able to prove that his PRIMARY or PRINCIPAL objective in engaging in the activity was for profit because: he did not manage the endeavor in an unbusiness-like fashion, employed an agent to help him sell his book, had expertise in the field, spent sufficient time on the trade, had some past success/profits at a similar endeavor and the book being authored in the disputed year did subsequently sell. The tax court recognized that a person can carry on a trade with a profit motive even if working full-time at another trade.
• The tax court recognized that some element of personal pleasure by itself does not preclude an activity from being legitimately for-profit.
• The tax court recognized that a trade may result in a loss that is used to offset other income and still be for-profit.
• The IRS held that the taxpayer’s sale of a book decades earlier qualified the writing as an active trade.
Take Aways:
• Only expenses for which a taxpayer could not have been reimbursed may be deducted. In other words, if a taxpayer is entitled to reimbursement but fails to seek it, the expenses are not deductible. The expense/inconvenience that the taxpayer would need to endure in order to meet company policy to be reimbursed was a factor favoring the taxpayer.
• The taxpayer’s time working in hotel rooms while on the road was a factor favoring the IRS in relation to whether his home office was his principal place of business.
• The taxpayers were not assisted much by the court’s lack of support for the IRS’s hobby or start-up disallowance arguments because most expenditures were disallowed due to their inability to provide adequate substantiation.
• In relation to the hobby issue, the court inferred that if the taxpayer’s profit objective was bona fide that may be enough to satisfy the court, even though most people might consider the expectation a profit from a given activity unreasonable.
The “Unmeritorious Pensioner” Case
The “Unmeritorious Pensioner” Case
Petitioner: Elmer Jon Buckardt
Memo Number: 2010-145
Decision Date: July 1, 2010
Burden of Proof: Taxpayer
Case in a Nutshell:
IRS claims entitlement to a tax deficiency as well as various penalties. Taxpayer seeks to mitigate by compelling the court to support his claim that reported pension income was not taxable because it was not from a “taxable specific source.”
Discussion in a Nutshell:
In January of 2008 the taxpayer filed forms 1040 for the years 2003, 2004, and 2005 with zeros in every box except for standard deduction and exemption. To support his positions the taxpayer utilized arguments that have been repeatedly held by the tax court to be frivolous and groundless.
Decision in a Nutshell:
Although the IRS prevailed in the deficiency assessment, several penalties were disallowed because the IRS failed to meet the burden of production of evidence supporting the assessments. A zero income return is not considered a valid return for the purpose of avoiding failure to file penalties.
Take Aways:
The IRS bears the burden of proof with respect to additions to tax for failure to file, late payment, and failure to pay estimated taxes. A taxpayer’s challenge to these will prevail unless the IRS produces evidence that the addition is appropriate.
Petitioner: Elmer Jon Buckardt
Memo Number: 2010-145
Decision Date: July 1, 2010
Burden of Proof: Taxpayer
Case in a Nutshell:
IRS claims entitlement to a tax deficiency as well as various penalties. Taxpayer seeks to mitigate by compelling the court to support his claim that reported pension income was not taxable because it was not from a “taxable specific source.”
Discussion in a Nutshell:
In January of 2008 the taxpayer filed forms 1040 for the years 2003, 2004, and 2005 with zeros in every box except for standard deduction and exemption. To support his positions the taxpayer utilized arguments that have been repeatedly held by the tax court to be frivolous and groundless.
Decision in a Nutshell:
Although the IRS prevailed in the deficiency assessment, several penalties were disallowed because the IRS failed to meet the burden of production of evidence supporting the assessments. A zero income return is not considered a valid return for the purpose of avoiding failure to file penalties.
Take Aways:
The IRS bears the burden of proof with respect to additions to tax for failure to file, late payment, and failure to pay estimated taxes. A taxpayer’s challenge to these will prevail unless the IRS produces evidence that the addition is appropriate.
The “Don’t Go Breakin’ My Heart” Case
Petitioner: Ronald W. Parkinson
Memo Number: 2010-142
Decision Date: June 28, 2010
Burden of Proof: Taxpayer
Case in a Nutshell:
IRS claims entitlement to a tax deficiency as well as the accuracy-related penalty. Taxpayer claims entitlement to:
1. exclude from income proceeds from a lawsuit against employer for intentional infliction of emotional distress
2. refund of taxes withheld from disability payments
Discussion in a Nutshell:
The taxpayer’s brought a lawsuit against his former employer and two of its employees alleging that the two coworkers engaged in “extreme and outrageous misconduct” that caused him to suffer a second heart attack, rendering him unable to work. A settlement was reached in which the employer paid the taxpayer $34,000 during the disputed year, none of which was reflected on his tax return. The settlement didn't characterize the payment or specifically identify what injury it was for other than using the descripton of “noneconomic damages.” (Under that state's law noneconomic damages do not include punitive damages.)
The IRS argued that the taxpayer’s cause of action was only seeking compensation for emotional distress and not for his physical injuries and therefore none of the settlement proceeds were intended to compensate taxpayer for such. Howeer, the Taxpayer’s suit did mention that the defendant’s action had resulted in substantial medical bills.
On a separate matter, the taxpayer asserted that he had included in his taxable income disability payments which should not have been subject to tax and hoped the court would compel a refund resulting from removal of this income for years 2000-2009.
Decision in a Nutshell:
Settlement proceeds for emotional distress are excludable from gross income only to the extent received attributable to a physical injury or sickness caused by such emotional distress. Otherwise such settlement proceeds are taxable. The court took the position that it was reasonable to construe that the taxpayer’s physical injuries were a prominent component of his “noneconomic damages” and upheld the exclusion of ½ the proceeds from income.
On the other matterr, the court noted that the taxpayer would only be able to exclude the disability payments to the extent they represented a return of his own after-tax premium payments. Taxpayer failed to submit into evidence any record/proof of such payments.
The court refused to apply the accuracy related penalty sought by the IRS since the understatement resulted from a reasonable, good-faith misunderstanding of the tax code.
Take Aways:
• The taxpayer would have been entitled to further exclude any portion of the other ½ of the settlement that represented his medical care costs for emotional distress if he had submitted any such costs into evidence.
• Taxpayer could have further offset with legal fees but was silent about these.
• If settlement proceeds from a case brought for emotional distress include compensation for the resulting bodily harm from such distress then specifically allocating the amount attributable to such in the settlement agreement would be advantageous from a tax strategy perspective.
• The tax court does not have jurisdiction over any other year than the year for which a deficiency has been issued from which the taxpayer has petitioned for relief.
• The tax court inferred that in some cases a failure to seek professional advice to assist with understanding the tax code may count against the taxpayer in their decision regarding liability for the accuracy penalty.
Memo Number: 2010-142
Decision Date: June 28, 2010
Burden of Proof: Taxpayer
Case in a Nutshell:
IRS claims entitlement to a tax deficiency as well as the accuracy-related penalty. Taxpayer claims entitlement to:
1. exclude from income proceeds from a lawsuit against employer for intentional infliction of emotional distress
2. refund of taxes withheld from disability payments
Discussion in a Nutshell:
The taxpayer’s brought a lawsuit against his former employer and two of its employees alleging that the two coworkers engaged in “extreme and outrageous misconduct” that caused him to suffer a second heart attack, rendering him unable to work. A settlement was reached in which the employer paid the taxpayer $34,000 during the disputed year, none of which was reflected on his tax return. The settlement didn't characterize the payment or specifically identify what injury it was for other than using the descripton of “noneconomic damages.” (Under that state's law noneconomic damages do not include punitive damages.)
The IRS argued that the taxpayer’s cause of action was only seeking compensation for emotional distress and not for his physical injuries and therefore none of the settlement proceeds were intended to compensate taxpayer for such. Howeer, the Taxpayer’s suit did mention that the defendant’s action had resulted in substantial medical bills.
On a separate matter, the taxpayer asserted that he had included in his taxable income disability payments which should not have been subject to tax and hoped the court would compel a refund resulting from removal of this income for years 2000-2009.
Decision in a Nutshell:
Settlement proceeds for emotional distress are excludable from gross income only to the extent received attributable to a physical injury or sickness caused by such emotional distress. Otherwise such settlement proceeds are taxable. The court took the position that it was reasonable to construe that the taxpayer’s physical injuries were a prominent component of his “noneconomic damages” and upheld the exclusion of ½ the proceeds from income.
On the other matterr, the court noted that the taxpayer would only be able to exclude the disability payments to the extent they represented a return of his own after-tax premium payments. Taxpayer failed to submit into evidence any record/proof of such payments.
The court refused to apply the accuracy related penalty sought by the IRS since the understatement resulted from a reasonable, good-faith misunderstanding of the tax code.
Take Aways:
• The taxpayer would have been entitled to further exclude any portion of the other ½ of the settlement that represented his medical care costs for emotional distress if he had submitted any such costs into evidence.
• Taxpayer could have further offset with legal fees but was silent about these.
• If settlement proceeds from a case brought for emotional distress include compensation for the resulting bodily harm from such distress then specifically allocating the amount attributable to such in the settlement agreement would be advantageous from a tax strategy perspective.
• The tax court does not have jurisdiction over any other year than the year for which a deficiency has been issued from which the taxpayer has petitioned for relief.
• The tax court inferred that in some cases a failure to seek professional advice to assist with understanding the tax code may count against the taxpayer in their decision regarding liability for the accuracy penalty.
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