http://www.ustaxcourt.gov/InOpHistoric/BLACKBURN.SUM.WPD.pdf
Barely into 2012 and we already see vehicle deductions being disallowed. This is a no brainer folks – keep a log or don’t bother fighting the deficiency notice! TP who clearly drove his automobile a substantial number of miles as part of his employment (as a traveling sales person) was denied $19k of unreimbursed employee expenses deductions. Although he provided some contemporaneous records regarding his automobile expenses, they were insufficient to substantiate the number of miles driven and when and where he drove for business. He provided no documentation regarding his meals and entertainment expenses or his nonautomobile expenses and failed to establish the portion of his home which was devoted to his employment.
Take Aways:
• It is a common misconception that if you deduct actual vehicle expenses, it is not necessary to keep a mileage log. This is absolutely incorrect. Another misconception is that if you incorporate you no longer need to keep a mileage log – also incorrect. If you have vehicle use deductions you must have a log: date, business miles driven, and business purpose for the driving - every day (even if it is always the same) plus start and end odometer readings for the year to calculate total miles.
• Use of office in home is so uncommon for an employee that it is often not worth the increased scrutiny to claim this deduction. Against schedule C income, the home office saves SE as well as income tax but not so when taken on a 2106.
Sunday, January 15, 2012
Saturday, January 14, 2012
The ‘I'm in Love with the Sound of My Own Theory’ Case
http://www.ustaxcourt.gov/InOpHistoric/HamGeorge.SUM.WPD.pdf
Taxpayer unsuccessfully fought the full inclusion of dividends in his taxable income under his self-developed “return of capital” theory. (A theory that the court deemed “without statutory basis” by the way.) TP claimed that a portion of the purchase price represented “accrued dividends” that had accumulated since the last record date. In TP’s view, these portions are treated as “returns of capital” and are not be includable in gross income.
Take Aways:
• Under TP’s theory he would have had to painstakingly reduce his basis in these shares by the part of the purchase price he recaptured through designating a portion of dividends as tax free returns of capital. This would result in higher taxable gains down the line when the shares were sold.
• What a surprise that his return was self-prepared!
• There is ample guidance on who recognizes dividends so it is sort of odd that he spent Lord knows how much time calculating accrued dividends and no time researching code. It is not as though this is a rare situation!
Taxpayer unsuccessfully fought the full inclusion of dividends in his taxable income under his self-developed “return of capital” theory. (A theory that the court deemed “without statutory basis” by the way.) TP claimed that a portion of the purchase price represented “accrued dividends” that had accumulated since the last record date. In TP’s view, these portions are treated as “returns of capital” and are not be includable in gross income.
Take Aways:
• Under TP’s theory he would have had to painstakingly reduce his basis in these shares by the part of the purchase price he recaptured through designating a portion of dividends as tax free returns of capital. This would result in higher taxable gains down the line when the shares were sold.
• What a surprise that his return was self-prepared!
• There is ample guidance on who recognizes dividends so it is sort of odd that he spent Lord knows how much time calculating accrued dividends and no time researching code. It is not as though this is a rare situation!
Friday, January 13, 2012
The ‘Close but no Cigar’ Case
http://www.ustaxcourt.gov/InOpHistoric/Oros.TCM.WPD.pdf
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.
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.
Thursday, January 12, 2012
The ‘I’m from the Govt and I’m here to help’ Case
TP conveyed an easement to 501(c)3 conservation fund. Generally the difference between the value of the property with the easement vs. without the easement constitutes a charitable deduction for the conveyor. TP is permanently sacrificing that value even though they still own the property. (Note that this is an exception to the general rule that only the contribution of an enitre interest will qualify as a charitable contribution.) It is normal for the contribution deductions resulting from conservation easements to be in the hundreds of thousands of dollars and so one should expect increased IRS scrutiny. In this instance the transaction failed as a matter of law because the contract contained the following wording:
Extinguishment – If circumstances arise in the future such that render the purpose of this Conservation Easement impossible to accomplish, this Conservation Easement can be terminated or extinguished, whether in whole or in part, by judicial proceedings, or by mutual written agreement of both parties, provided no other parties will be impacted and no laws or regulations are violated by such termination.
This ran afoul of the following parts of the code which provide for the ability to obtain a charitable contribution:
“A contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.” And “interest in the property retained by the donor ** * must be subject to legally enforceable restrictions * * * that will prevent uses of the retained interest inconsistent with the conservation purposes of the donation.”
This case is a bit scary because one would assume the conservation 501(c)3 attorneys would have drafted an appropriate contract. You know the contributors were not the ones to write the contract.
Take aways:
• The court ruled that the remoteness of the likelihood of this clause ever being exercised was neither here nor there as far as the outcome of this case was concerned.
• TP argued that the gift constituted the creation of a charitable trust. The court noted that State law determines the nature of the property rights, and Federal law determines the appropriate tax treatment of those rights. There was no evidence to indicate that their State considered contributions to conservation easements to be de facto trusts. Nor was there any language in the conservation easement deeds to evidence either the creation of a trust or the intention to create a trust.
• Pay a CPA and a tax attorney dummy! I had a call once from a farmer seeking an appointment to discuss the tax treatment of conservation easements. He refused to come in unless the consult would be free. Really? Trust me when I tell you, screwing this up may be life changing. It is worth the money to get professional advice.
• In the future I will require that clients in this situation retain a tax attorney to review the contract and issue an opinion letter re: the legitimacy of the charitable contribution prior to preparing the return – or even better before they sign the contract so the recipient can be made to change the wording. (My opinion is that CPAs should not be interpreting contracts. That is a legal service.)
Extinguishment – If circumstances arise in the future such that render the purpose of this Conservation Easement impossible to accomplish, this Conservation Easement can be terminated or extinguished, whether in whole or in part, by judicial proceedings, or by mutual written agreement of both parties, provided no other parties will be impacted and no laws or regulations are violated by such termination.
This ran afoul of the following parts of the code which provide for the ability to obtain a charitable contribution:
“A contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.” And “interest in the property retained by the donor ** * must be subject to legally enforceable restrictions * * * that will prevent uses of the retained interest inconsistent with the conservation purposes of the donation.”
This case is a bit scary because one would assume the conservation 501(c)3 attorneys would have drafted an appropriate contract. You know the contributors were not the ones to write the contract.
Take aways:
• The court ruled that the remoteness of the likelihood of this clause ever being exercised was neither here nor there as far as the outcome of this case was concerned.
• TP argued that the gift constituted the creation of a charitable trust. The court noted that State law determines the nature of the property rights, and Federal law determines the appropriate tax treatment of those rights. There was no evidence to indicate that their State considered contributions to conservation easements to be de facto trusts. Nor was there any language in the conservation easement deeds to evidence either the creation of a trust or the intention to create a trust.
• Pay a CPA and a tax attorney dummy! I had a call once from a farmer seeking an appointment to discuss the tax treatment of conservation easements. He refused to come in unless the consult would be free. Really? Trust me when I tell you, screwing this up may be life changing. It is worth the money to get professional advice.
• In the future I will require that clients in this situation retain a tax attorney to review the contract and issue an opinion letter re: the legitimacy of the charitable contribution prior to preparing the return – or even better before they sign the contract so the recipient can be made to change the wording. (My opinion is that CPAs should not be interpreting contracts. That is a legal service.)
Wednesday, January 11, 2012
The ‘Columbian Laundry-ing?’ Case
http://www.ustaxcourt.gov/InOpHistoric/GAITAN.TCM.WPD.pdf
Taxpayers were assessed a deficiency on the total disallowance of all $134k of cost of good sold expenses claimed against $161k of income because they did not keep adequate records. Taxpayers’ business was to buy clothing in the US and export it to Columbia.
Take Aways:
• The IRS filed the notice of deficiency about 2 years after the return was filed so just because you file a return and don’t hear anything for awhile, it is not correct to assume everything is copasetic.
• The court found TP’s receipts bad evidence because they: did not indicate which purchases of clothing were for export and which purchases were for the Gaitans’ personal use; in some cases, were illegible/did not clearly identify the purchaser, or had been deducted on their other schedule C. (If you are a retailer, it is probably best to show some withdraw of inventory for personal use vs. none at all.)
• The court would not admit credit card statement evidence because she was without the supporting receipts or other evidence corroborating that the purchases reflected on the American Express statements were purchases of business inventory. In addition, some months were missing which may have reflected credits/refunds. (We regularly advise our clients that they need to retain the actual merchant receipt – not just the statement. That is like having cancelled checks with no record of the invoices you paid.)
• The court would have been able to estimate all but vehicle expense if she had brought more to the table. She did not even have evidence of any clothes being shipped out of the US. (Husband owned a car wash by the way. Hmmm…Saul from Breaking Bad is coming to mind here…)
• The TP also lost the much smaller deduction for travel because she failed to prove that the trips were PRIMARILY for business. Many people think if they do any business on a trip it is deductible, but the burden of proof (for within the contiguous US) is the PRIMARY purpose. There can be many purposes but only one PRIMARY purpose.
Taxpayers were assessed a deficiency on the total disallowance of all $134k of cost of good sold expenses claimed against $161k of income because they did not keep adequate records. Taxpayers’ business was to buy clothing in the US and export it to Columbia.
Take Aways:
• The IRS filed the notice of deficiency about 2 years after the return was filed so just because you file a return and don’t hear anything for awhile, it is not correct to assume everything is copasetic.
• The court found TP’s receipts bad evidence because they: did not indicate which purchases of clothing were for export and which purchases were for the Gaitans’ personal use; in some cases, were illegible/did not clearly identify the purchaser, or had been deducted on their other schedule C. (If you are a retailer, it is probably best to show some withdraw of inventory for personal use vs. none at all.)
• The court would not admit credit card statement evidence because she was without the supporting receipts or other evidence corroborating that the purchases reflected on the American Express statements were purchases of business inventory. In addition, some months were missing which may have reflected credits/refunds. (We regularly advise our clients that they need to retain the actual merchant receipt – not just the statement. That is like having cancelled checks with no record of the invoices you paid.)
• The court would have been able to estimate all but vehicle expense if she had brought more to the table. She did not even have evidence of any clothes being shipped out of the US. (Husband owned a car wash by the way. Hmmm…Saul from Breaking Bad is coming to mind here…)
• The TP also lost the much smaller deduction for travel because she failed to prove that the trips were PRIMARILY for business. Many people think if they do any business on a trip it is deductible, but the burden of proof (for within the contiguous US) is the PRIMARY purpose. There can be many purposes but only one PRIMARY purpose.
Tuesday, January 10, 2012
The ‘Of All People’ Case
http://www.ustaxcourt.gov/InOpHistoric/HAND.SUM.WPD.pdf
Was there a full moon on 1/3? Taxpayers were assessed the deficiency plus the extra penalty for drastic understatement because they failed to keep adequate records and properly substantiate the flight lesson expenses they claimed. The taxpayers were a couple that included a highly compensated CPA employed by a corporation AND a 20 year financial planner/commercial realtor with an MBA. They claimed that A) they did not know they needed to keep receipts for business deductions and B) their tax preparer told them they did not need to keep receipts. They should be ashamed of themselves! The court noted humorously that they were “skeptical” of their “alleged” lack of knowledge. Tee hee.
Take Aways:
• This is why CPA firms must now require an engagement letter in order to prepare a tax return. You’d think that a couple with these credentials would not try to dishonestly throw you under the bus to save a few thou but, sadly, this is the world we live in currently!
• To deduct education costs the course must maintain or improve your skill for your current position only. The court was not convinced that pilot skills go hand in hand with being a commercial realtor. Even though the TP did submit evidence that he used aerial photos in sales brochures he created, the court noted that he was able to obtain these in the past without actually needing to know how to pilot a plane. Doh! (They admitted he did not make an effort to persuade them so who knows what would have happened if he had?)
Was there a full moon on 1/3? Taxpayers were assessed the deficiency plus the extra penalty for drastic understatement because they failed to keep adequate records and properly substantiate the flight lesson expenses they claimed. The taxpayers were a couple that included a highly compensated CPA employed by a corporation AND a 20 year financial planner/commercial realtor with an MBA. They claimed that A) they did not know they needed to keep receipts for business deductions and B) their tax preparer told them they did not need to keep receipts. They should be ashamed of themselves! The court noted humorously that they were “skeptical” of their “alleged” lack of knowledge. Tee hee.
Take Aways:
• This is why CPA firms must now require an engagement letter in order to prepare a tax return. You’d think that a couple with these credentials would not try to dishonestly throw you under the bus to save a few thou but, sadly, this is the world we live in currently!
• To deduct education costs the course must maintain or improve your skill for your current position only. The court was not convinced that pilot skills go hand in hand with being a commercial realtor. Even though the TP did submit evidence that he used aerial photos in sales brochures he created, the court noted that he was able to obtain these in the past without actually needing to know how to pilot a plane. Doh! (They admitted he did not make an effort to persuade them so who knows what would have happened if he had?)
Monday, January 9, 2012
The ‘Not a Leg to Stand On’ Case
http://www.ustaxcourt.gov/InOpHistoric/ROUMI.TCM.WPD.pdf
I cannot fathom why the taxpayer went to court. He filed three schedule C forms, one with less than $2k of income and lots of mileage, one with zero income and almost $70k of expenses including $12k of vehicle deductions. He was just asking to be audited. The court noted that he introduced “no evidence of any sales efforts that could lead to customers” and “no credible evidence to substantiate that the claimed expenditures were ordinary and necessary to his business, or showing that they even exist.” He lost and was also assessed the additional penalty for significantly understating his tax liability without reasonable cause.
Take Aways:
• TP claimed that his records were destroyed by fire. If someone is able to materially reconstruct the vast majority of their records after a bona fide tragic occurrence the court would fill in the rest but in most cases the taxpayers just arrogantly say – “Sorry I don’t have anything – it was all destroyed” Trust me, this has been tried before. You have got to pull out all the stops to reconstruct your records to the very best of your ability if they are lost in a fire.
• A schedule C with no income and lots of mileage is a big audit risk.
I cannot fathom why the taxpayer went to court. He filed three schedule C forms, one with less than $2k of income and lots of mileage, one with zero income and almost $70k of expenses including $12k of vehicle deductions. He was just asking to be audited. The court noted that he introduced “no evidence of any sales efforts that could lead to customers” and “no credible evidence to substantiate that the claimed expenditures were ordinary and necessary to his business, or showing that they even exist.” He lost and was also assessed the additional penalty for significantly understating his tax liability without reasonable cause.
Take Aways:
• TP claimed that his records were destroyed by fire. If someone is able to materially reconstruct the vast majority of their records after a bona fide tragic occurrence the court would fill in the rest but in most cases the taxpayers just arrogantly say – “Sorry I don’t have anything – it was all destroyed” Trust me, this has been tried before. You have got to pull out all the stops to reconstruct your records to the very best of your ability if they are lost in a fire.
• A schedule C with no income and lots of mileage is a big audit risk.
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