Posts Tagged ‘Section 274’

If you are going to forge your travel calendar, at least get the year right.

Tuesday, July 16th, 2013 by Joe Kristan

perryheadThe tax law has strict rules for supporting travel expenses.  You need to be able to document your travel with records showing the date, amounts, and business purpose.  For mileage, the tax law likes a contemporaneous diary.

The IRS audited the travel expenses of a Florida real estate agent.  They disallowed about $10,000 in vehicle expenses, and it ended up in Tax Court, where things went badly in a tax nerd Perry Mason moment:

Under cross-examination by respondent’s counsel, Ms. [real estate agent] acknowledged that some of the entries in the notebook had been altered (i.e., the portion of the date indicating the year was obliterated) and that one of the entries is for a date in 2010. In addition, the day planner included an order form which provided a convenient way for the owner to purchase a new day planner for the coming year. In this case, the order form was for the calendar year 2014, a fact that completely undermined Ms. [real estate agent]‘s testimony that she recorded information in the day planner contemporaneously in 2008.

Oops.  The IRS won, with penalties.

The moral: There are a lot of ways the IRS can trip you up if you try to cook up your mileage diary retroactively.  If you really want the deduction, record your travel as you go, either on an old-fashioned auto log or one of those smartphone mileage apps.

Cite: Hardnett, TC Summary Opinion 2013-56

Thanks to Lileks for the Perry Head.

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Teaching by bad example, Nebraska-style.

Friday, February 22nd, 2013 by Joe Kristan
Hall County Courthouse, Grand Island, Nebraska (Wikipedia image)

Hall County Courthouse, Grand Island, Nebraska (Wikipedia image)

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.

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Why the tax law is so picky about documenting travel deductions

Wednesday, September 19th, 2012 by Joe Kristan

Any entrepreneur who has ever been audited knows that the IRS agent will be a stickler for documentation of your travel and entertainment expenses.  That’s because the tax law (Code Section 274) requires you to substatiate with receipts and records:

  • the amount of the expense;
  • the time and place of the travel, meal or entertainment,
  • the business purpose of the expense, and
  • the business relationship of other taxpayers involved.

Why is the tax law so picky?  Why are these requirements stricter than those for other expenses?  A Tax Court case yesterday provides a hint.

An airline pilot had a side business as a real estate broker/advisor.  That business didn’t go so well, according to his Schedule C; it showed a loss of $23,124 in 2007.  The IRS came along and disallowed some expenses.  The Tax Court takes up the story (my emphasis):

Petitioner reported hotel, rental car, and meal expenses relating to a trip to Hawaii in February 2007 which lasted approximately 11 days. Petitioner did not claim a business expense deduction for the cost of his airline ticket to or from Hawaii; however, he did claim as a business expense deduction the cost of an airline ticket for a third party. No explanation was given as to who this person is or what business purpose was furthered by this expenditure. Petitioner’s records reflect that he paid for multiple hotel rooms for the same nights and that there were multiple occupants in the rooms. Some of the expenses were not evidenced by receipts or reflected in the bank records. Petitioner’s explanation for the travel to Hawaii was that he was scouting potential properties for an unnamed client. On the basis of the record, petitioner has not established that these expenditures were ordinary and necessary business expenses, and we disallow all claimed business expense deductions relating to this travel.

Of course.  Scouting properties for an unnamed client, who never paid him.  With a whole squad of assistants.  No wonder he lost money.

Petitioner claimed deductions for hotel and meal expenses relating to travel to Yosemite National Park on December 23, 2007. Petitioner did not provide the Court with any evidence as to his real estate brokerage activity in his travel to Yosemite.

Yogi Bear needed a new home?

The case also shows deductions for trips to Tahoe in February, Phoenix in March and trips to San Francisco, as well as one to his parents’ hometown, Dayton, Ohio.  All expenses were disallowed for lack of adequate substantiation.

In short, the tax law realizes that taxpayers will be tempted to try to claim leisure travel as “business” expenses.  “Scouting property” is one of the oldest, and lamest, ways to explain otherwise inexplicable “business trips” to resort destinations.

The Moral?  If you want to deduct travel, meal and entertainment expenses, keep your receipts.  If you use your own car, log your miles.  For all expenses, write down who you are meeting with and the business purposes.  Even when the expenses are legitimate, if you fail to document them properly, they are gone.

Cite: Wallach, T.C. Summ. Op. 2012-94

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Queen Mary deductions take a Titanic detour

Friday, March 9th, 2012 by Joe Kristan

Are Schedule C 1040s an audit red flag? Would you be better off incorporating and filing an S corporation return? While Pretty Pappas is passionately in favor of incorporation, I don’t think it’s worth the trouble for very small businesses. I think the real issue is whether you can back up your return when the IRS comes calling, whatever return you file.
A Tax Court case yesterday would have turned out just as badly for the taxpayer if he had filed a corporation return. A man who organizes events on the Queen Mary, now permanently docked in Los Angeles, reported his income on his Schedule C.
20120309-2.jpg
Image via Wikimedia Commons. Click to enlarge
It was a very simple filing, one probably not worth the time and expense of preparing a corporate return. It apparently had only three items: Gross receipts of $6,000, $5,180 of mileage expenses, and $2,600 for Sec. 179 expense — for a loss of $1,780.
But when the IRS came to visit, the taxpayer, Mr. Hyche, couldn’t prove his deductions. From the Tax Court:

Mr. Hyche kept track of the miles he drove with a calendar on which he documented the miles driven weekly. There are several problems with this. First, Mr. Hyche admitted that he sometimes included commuting miles in the total. Second, he did not document the purpose of each trip he took or the business relationship to the persons visited, although he testified generally as to places he visited. We have no doubt Mr. Hyche used his car for business in November and December, but we have no choice but to deny his deduction for mileage expenses. We appreciate Mr. Hyche’s truthfully testifying that he documented both commuting miles and business miles. Unfortunately, we have no way to ascertain which of the documented miles were driven for business purposes and which for commuting.

The judge pointed out that the tax law doesn’t allow you to guesstimate what the right business mileage is — you have to have adequate records to prove what you are entitled to. The judge found that the taxpayer’s records weren’t good enough.
The judge also said the taxpayer provided no evidence of any expenditure qualifying for the Section 179 deduction. That left only the $6,000 of revenue for the Schedule C.
The Moral? The tax law requires you to show the date, time, amount and business purpose of travel and entertainment expenses with adequate records. You have to distinguish between deductible travel and non-deductible commuting. Here the judge believed that the taxpayer did have business expenses that could have been deductible, but the taxpayer records weren’t good enough to support a deduction.
Cite: Hyche, T.C. Summ. Op 2012-23
Related: Why the IRS audits Schedule C’s

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How not to document your business travel

Tuesday, February 14th, 2012 by Joe Kristan

The tax law has very specific requirements you must meet before you can deduct your business travel. A Tax Court case yesterday shows how not to meet them:

Mr. Lysford’s entries in his spiral notebooks are wholly inadequate. They merely list the date and destination of airplane and automobile trips. No business purpose for the trips, no names of clients visited, and no description of business scheduled, conducted, or attempted is provided. A list of dates representing Mr. Lysford’s airplane and automobile trips with no identification of the people visited, the locations visited, the nature or purpose of the trips, or the business actually conducted falls well short of the substantiation required by section 274(d)


Flickr image courtesy jxandreani under Creative Commons license
Time and place, amount, persons met and business relationship, and business purpose: if you can’t show these for your travel costs, Section 274 says you lose.
Cite: Lysford, T.C. Memo 2012-14.

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Teacher’s cruise deductions miss the boat

Wednesday, November 2nd, 2011 by Joe Kristan

Lots of teachers use their own money to buy stickers, pencils and similar knickknacks for their students. The $250 above-the-line deduction for educator expenses is a nod to this. But some teachers go further for their students.
On a cruise liner.
The Tax Court takes up the story:

In April 2007 petitioner went on a 10-night cruise, sailing from Venice, Italy, to various locations in the Mediterranean. Including airfare, spa visits and other onboard expenses, and a passport and a visa, the total cost was $8,516.73. Petitioner did not take classes related to her employment while on the cruise.

We wouldn’t be talking about this if she hadn’t deducted the cruise. To be sure, she had receipts for her cruise expenses. Unfortunately, while receipts are needed to take travel deductions, they aren’t always enough:

Section 274(d) disallows deductions for traveling expenses, including meals and lodging, unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer’s own statement: (1) The amount of such expense, (2) the time and place such expense was incurred, and (3) the business purpose for which such expense was incurred.

The judge found that the teacher failed to solve the problem:

Petitioner produced receipts for the 10-day Mediterranean cruise, including receipts for airfare to and from Italy, onboard expenses, and the costs of obtaining a passport and a visa. The cruise involved sightseeing, spa visits, and other recreation. The receipts do not show any business purpose behind the expenses and do not satisfy the strict substantiation requirements of section 274(d). We conclude that the cruise and the associated expenses are nondeductible personal expenses.

The moral: while the teacher’s elementary students may be better people as a result of the cruise, it didn’t help her tax return one bit.
Cite: Farias, T.C. Memo. 2011-248
The TaxProf has more.

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Taxpayer spreadsheet wins car deductions

Tuesday, August 30th, 2011 by Joe Kristan

Many taxpayers come to grief at IRS exams because they didn’t bother keeping track of their business auto use they reported on their returns. A taxpayer turned the tables on the IRS yesterday in Tax Court.
The taxpayer worked for a Florida chain of Midas auto service franchises. The Tax Court explains where the auto use came in:

Her employment duties varied; as she describes her responsibilities, she did whatever the operations manager required. On any given day she routinely drove from one of the shops to another in order to attend managers’ meetings, check inventory, check paperwork, enroll employees in the company’s health insurance plan, and research customer complaints. She used her own automobile when it was necessary to drive between the shops.

She wasn’t reimbursed by her employer, so she claimed her auto mileage as an unreimbursed employee business expense on Schedule A. She used a computer spreadsheet program to maintain her mileage records. The IRS disallowed her deductions, and she ended up in Tax Court. The judge sided with the taxpayer on this issue (my emphasis):

Petitioner maintained and submitted her mileage log showing the use of her automobile for business purposes during 2006. The log shows the beginning and ending location of each trip, the date of the trip, and the mileage for each trip. Petitioner’s log does not show the total mileage for all use of the automobile during 2006, nor does it state the business purpose of the use of the automobile as required under section 1.274-5T(b)(6), Temporary Income Tax Regs., supra. Nonetheless, petitioner’s mileage log substantially complies with the “adequate records” requirement of section 1.274-5T(b)(6), Temporary Income Tax Regs., supra, and to the extent her log is deficient, she has provided corroborative evidence sufficient to establish the required elements. Accordingly, petitioners are entitled to a $6,675 vehicle expense deduction attributable to business miles.

The Moral: an imperfect auto mileage log might be just good enough — and it is sure better than nothing at all.
Cite: Diaz, T.C. Summ. Op. 2011-103

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That mileage log isn’t worth much if you don’t fill it out right

Tuesday, April 26th, 2011 by Joe Kristan

Life can be hard for a commission seller. Jessica tried it in 2006 for a St. Louis office supply business, working her territory in her 2001 Chevy Cavalier. Six months work earned her $3,307.
Tax time came around. The Tax Court takes up the story:

Petitioner brought her Forms W-2, Wage and Tax Statement, for all of the companies she worked for in 2006,4 as well as a shoebox full of receipts, to H&R Block, and a return preparer at H&R Block completed her return.

At least it was a shoebox. It’s the grocery bags that scare me. The preparer deducted employee business expenses in a big way. The IRS ended up challenging over $17,000 of them — not bad for $3,307 of income.
The Tax Court seems to question whether she got much value from her preparer:

It is not clear whether the return preparer made any attempt to distinguish deductible from nondeductible expenses or whether the return preparer simply added up the receipts and deducted the sum as unreimbursed employee business expenses.

The biggest expense was her Chevy. That deduction went awry:

Petitioner kept track of her automobile mileage using a daily mileage log. However, there are several problems with the mileage log. First, the mileage log simply notes the odometer reading on petitioner’s car at the beginning and end of each day and includes no information regarding where petitioner drove, the purpose of the trip, or petitioner’s business relationship to the persons she visited. Second, petitioner included in the mileage log the roughly 27 miles she drove each workday commuting to and from MV Marketing’s office. Finally, petitioner conceded that she may have included some personal trips in the mileage log. Petitioner did not present any evidence at trial, such as appointment books, calendars, or maps of her sales territories, to corroborate the bare information contained in the mileage log, nor did she testify with any specificity regarding her vehicle expenses in 2006.

Well, the Court made an estimate and gave her some of her expenses, right? Wrong:

Although we do not doubt that petitioner used her Chevrolet Cavalier for business between June and December 2006, we have no choice but to deny in full petitioner’s deduction for mileage expenses. For the reasons discussed in the preceding paragraph, petitioner’s mileage log does not satisfy the adequate records requirement of section 274(d), petitioner did not present any documentary evidence to corroborate the mileage log, and petitioner’s testimony was not detailed or specific enough to satisfy the requirements of section 274(d) and section 1.274-5T(c)(3), Temporary Income Tax Regs., supra. Moreover, we are not permitted to estimate petitioner’s mileage because section 274(d) supersedes the Cohan rule. Consequently, petitioner’s deduction for mileage expenses is denied in full.

The moral? The tax law has very specific substantiation requirements for deducting travel and entertainment expenses, including vehicle expenses. You must substantiate:
(1) the amount of the expense or item;
(2) the time and place of the travel, entertainment, or expense;
(3) the business purpose of the entertainment or expense; and
(4) the taxpayer’s relationship to the person or persons entertained.
The mileage log needs to include this information, or you need to be able to be able to support it with other items, like a travel calendar. The tax law doesn’t allow you to make a good guess. No substantiation, no deduction.
Cite: Solomon, T.C. Memo 2011-91

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IRS lays siege to Knight of Malta

Tuesday, December 14th, 2010 by Joe Kristan

20101214-1.jpgAn attorney took his tax greivances to Tax Court Judge Holmes, and the result is a history lesson on the Knights of Malta — and disallowance of thousands of dollars of expenses.
The taxpayer in this case was an attorney, a Mr. Pace, who specializes in “qui tam” work — compensated whistleblowing is the way I understand it. He attracted IRS attention with a rookie mistake — he earned a million dollars but didn’t file a return. Somehow his status as a member of the Knights of Malta had something to do with it, leading the court to explain a little history:

The Sovereign Military Hospitaller Order of St. John of Jerusalem, of Rhodes, and of Malta was established in the mid-eleventh century, when merchants from Amalfi founded the Benedictine Abbey of St. Mary of the Latins in Jerusalem. By 1080 the abbey built St. John’s hospital — located on the traditional site of the angel’s announcement of John the Baptist’s conception — which provided a place of refuge for poor and sick pilgrims visiting the Holy Land. Under the leadership of Brother Gerard, the Hospital of St. John grew to include several ancillary hospices in Palestine along the pilgrimage route. Pope Paschal II officially recognized the hospital in 1113, establishing the Order of St. John.
As the twelfth century wore on, the Hospitallers of St. John expanded their medical mission to preventive care by providing armed escort to pilgrims traveling the hostile route to Jerusalem. Crusading knights who stayed in Jerusalem began to join the Order, and by 1148 — the time of the Second Crusade — the Hospitallers of St. John were recognized as an essential part of the Holy Land’s defense…
The next several centuries did not go as well.

Sort of like the taxpayer’s case. You know the taxpayer has a problem when the discussion starts (my emphasis):

We begin by reviewing some of the basics of substantiation. The most important rule is that taxpayers have to keep records. Section 60014 and its accompanying regulations tell taxpayers to hold onto records that would enable the IRS to verify their income and expenses. See sec. 1.6001-1(a), Income Tax Regs. Unsophisticated taxpayers unfamiliar with the substantiation requirements often get extra leeway in their good-faith attempts to comply. See, e.g., Larson v. Commissioner, T.C. Memo. 2008-187. But sophisticated attorneys like Pace should know better.

The court disallowed many of the deductions, often on account of lack of substantiation:

Pace attempts to substantiate $1,711 in office expenses with a list of expenses containing check numbers, dates, and descriptions. He did not, however, introduce into evidence the underlying canceled checks, and the only testimony supporting the deduction was conclusory statements by Pace and his secretary that the office expenses were “incurred in the ordinary course of business.” Therefore, we disallow in full these office expenses.
Evaluating the remaining $6,698 in contested office expenses led to some engaging reading — nearly 150 pages of credit-card statements. Pace provided annotated statements to back up these deductions. But the majority of these expenses aren’t business related.

I like this:

Pace deducted custom-made shirts and a tie as office expenses. He explained that he found it difficult to buy some of his clothes off the rack because of his unusual physique. Our own observation makes us suspect that Pace was being modest, but no inspection could affect our necessary conclusion: expenses in this category are not deductible because Pace failed to establish that the clothing was not suitable for everyday wear. See, e.g., Hamilton v. Commissioner, T.C. Memo. 1979-186; Rev. Rul. 70-474, 1970-2 C.B. 35. And he wore one of his bespoke shirts to trial-showing without any doubt its suitability for everyday use.

Our taxpayer gave it his best:

The Commissioner has moved to impose a penalty under section 6673(a)(1), which authorizes us to impose a penalty not in excess of $25,000 whenever it appears that proceedings have been instituted or maintained by the taxpayer primarily for delay or that the taxpayer’s position in such proceedings is frivolous or groundless. Pace vigorously contested the Commissioner’s determination, resulting in a weeklong trial, 760 pages of trial transcript, and thousands of pages of credit-card statements, canceled checks, and other documents. But Pace’s aggressive advocacy doesn’t rise to the level of sanctionable behavior. He may be long winded – as many lawyers and even some judges are — but delay and frivolous positions were not the crux of his case.

But it wasn’t good enough; the court upheld a 20% “accuracy-related penalty” for a substantial understatement of tax without reasonable casue:

Pace offers a novel defense to the accuracy-related penalty in his opening brief — that it’s the IRS’s fault because it didn’t settle. Review of the caselaw fails to find any support for this penalties-don’t-apply-when-the-IRS-won’t-settle argument. And Pace never argued any of the valid defenses to the penalty. See secs. 6662(d)(2)(B), 6664(c)(1). We therefore find that he is subject to this penalty.

We’ll let Judge Holmes explain what it all means:

In the best of all possible worlds, perhaps, Pace’s pursuit of the unified life would be recognized and rewarded. See, e.g., Pope Paul VI, Pastoral Constitution on the Church in the Modern World — Gaudium et Spes sec. 43 (December 7, 1965). But the Code imposes a more exact and less merciful accounting: business expenses, charitable contributions, and the costs of everyday life must be identified, segregated, and substantiated by reliable documents and credible testimony.

Cite: Pace: T.C. Memo. 2010-272
Flickr image courtesy bazylek100 under Creative Commons license
UPDATE: The TaxProf has more.

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