Friday, January 13, 2012

The ‘Close but no Cigar’ Case

The taxpayer was denied a deduction for the $19k of travel and meals expenses he claimed on a schedule C for the trade of being an author. TP had no experience working as an author, had not yet published a book, had a full-time W-2 position in a completely different field, and had no income from the trade in that year. The expenses were incurred on a 4 month worldwide trip he claimed was solely for book research. Although he had a business plan and kept a journal, all the facts and circumstances are considered and he did not meet the burden of proof. (He did dodge the accuracy penalty because he relied on the counsel of a CPA to whom had given all the information.)

Take Aways

• TP would need to prove he intended to earn a profit from the activity, that he was regularly and actively involved with the activity, and that the activity had commenced.

• Since the majority of the expenses were for travel and meals, TP was obligated to strict substantiation – no estimates allowed. A sweeping statement that ‘all’ the travel was for business would not fly. TP must establish the business purposes of EACH expenditure and substantiate it by a written statement.

• In general, any expenditures incurred before your business activity commences must be capitalized as start up expenses, although this was not mentioned in the case. Also, high expenses on a zero income schedule C create a red flag - especially T/E expenses.

• The checklist to prove profit motive for an endeavor contains many factors. It sounds as though TP had the checklist and he complied with a few line items but it was all very contrived.

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