Sometimes the best role models are those who show us what happens when we do everything wrong. A lawyer in Grand Island, Nebraska featured yesterday in Tax Court takes up this underappreciated but essential chore for us. We’ll let the Tax Court take up the story for us (my emphasis):
Petitioner, a self-employed attorney, failed to pay his Federal income tax for 1996 to 2002 after notice and demand for payment. Consequently, liens in favor of the United States arose and attached to all his property, including his personal residence. The Internal Revenue Service (IRS) filed notices of Federal tax lien on March 4, 2003, March 5, 2004, and June 19, 2007, in Hall County, Nebraska, and on December 19, 2006, and June 19, 2007, in Hitchcock County, Nebraska. On June 26, 2008, petitioner made a payment of $132,580 to the IRS, which included interest of $46,308 and penalties of $16,683 with respect to the unpaid tax liabilities.
During 2007 and 2008 petitioner operated a law practice in Nebraska as a sole proprietorship. He drove a BMW in 2007 and the first six months of 2008. On July 1, 2008, he traded in the BMW for a Lexus, which he drove for the second half of the year. He used the automobiles in his law practice and for his personal needs, but he did not keep any records separating the uses.
So in 2008 he finally gets around to paying seven years worth of taxes, and he gets a Lexus. After paying $16,000 in penalties, he still fails to track his business use. That plays poorly in Tax Court, where they enforce the strict substantiation rules for business mileage of Sec. 274:
Petitioner claimed deductions of $15,200 and $11,700 for car and truck expenses on Schedule C for 2007 and 2008, respectively. He testified that he incurred expenses each year of approximately $9,000 for depreciation, $3,500 for fuel, $1,200 for insurance, and $1,000 for maintenance. He further testified that he drove approximately 20,000 miles per year and “figured just slightly more than half of * * * [the] miles are driven for * * * work”. The only documents that he introduced into evidence to substantiate the expenses are copies of the sales invoices for the BMW and the Lexus and a sales tax receipt for the Lexus. Except for some vague testimony, he did not introduce any evidence to establish the elements of time and place or business purpose. Furthermore, his testimony as to the mileage is just an approximation and is not corroborated by any other evidence. We do not doubt that petitioner incurred car and truck expenses for the years in issue; however, we find that he has not met the strict substantiation requirements of section 274(d). Accordingly, petitioner is not entitled to deduct the car and truck expenses for 2007 and 2008.
So what should he have done? He should have kept a log recording his business miles with information showing time, date, and business purpose for the trip, including the persons and places visited.
The attorney also took a creative position with respect to the IRS interest. Because the IRS had liens against his house, he deducted interest on his late-paid taxes as home mortgage interest. That didn’t work either. The judge sums it up:
Petitioner failed to keep adequate records and to properly substantiate the car and truck expenses and the expenses that he conceded. He failed to report income on Schedule F, and he disregarded rules or regulations in claiming a deduction for the interest and penalties with respect to his Federal income tax liabilities for 1996 to 2002. Therefore, we find that respondent has met his burden of production. Petitioner offered no evidence that he acted with reasonable cause and in good faith. Accordingly, we find that petitioner is liable for the 20% accuracy-related penalty for 2007 and 2008.
You can learn a lot from this example, starting with the value of paying your taxes on time. Skipping payment on the 1996-2002 returns made it a lot more likely that the IRS would look at his later returns, and it cost a bundle in interest and penalties. Even though he had to have been in regular contact with the IRS by 2007 and 2008, he still didn’t keep track of his business miles or report all of his farm income. He apparently didn’t hire out his tax work to somebody who actually knows taxes, or he wouldn’t have tried to deduct interest on unpaid taxes as home mortgage interest.
The moral: You might be driving the nicest car in town, but you still have to document your business miles. File timely, report all of your income, track your mileage, and hire the tax help appropriate to your needs. The long arm of the tax law reaches even to Grand Island.
Cite: Wagoner, T.C. Summary Opinion 2013-14.