Tax Court

Hey Vance, can I deduct my car expenses?

That’s not an unusual question.  The exchange continues often like this.

Vance:  Do you have contemporaneous records that document (1) the amount of the expense; (2) the time and place of the travel or use; and (3) the business purpose of the expense?

Client:  Well . . .

Vance:  How about an after-the-fact reconstruction of such information to a high degree of probative value that rises to the level of credibility of a contemporaneous record?

Client:  Huh?

Bottom line, you have to keep good records to deduct auto expenses.

In a recent Tax Court Memorandum decision, the result of failure to keep good auto expense records is well illustrated.  Mr. Powell owned an S corporation that was involved in several aspects of the petroleum marketing business.  He had several problems with his personal tax return, some of which he blamed on his tax preparation software.  (By the way, blaming TurboTax did not get him out of his understatement penalties.)

One of the issues before the court was his business auto expenses.  The need for the regular use of an auto in the business is pretty convincing.  No problem there.  But, it seems that Mr. Powell was a sporadic auto record-keeper.  Sometimes, he kept detailed contemporaneous records.  Sometimes, he was able to assemble after-the-fact convincing records.  Sometimes, he seems at some late date to have thrown together some pretty questionable information to document the auto use he had claimed on his tax return. For example, the Tax Court noted that one particular destination seemed to have varied in round-trip distance from 325 miles to 600 miles (with no further explanation by Mr. Powell for the difference).

So, the Tax Court let him deduct the auto expenses (based on the per-mile allowance method) for which he had good records and denied the auto expense deductions for which he did not have good records.

If the IRS audits your auto expenses and you don’t keep good records – preferably contemporaneous – you’ll lose every time.  If you want to increase your chances of debating the issue with the IRS, deduct 100% of the costs of an automobile.  Except for a vehicle that wouldn’t be used for personal transportation of any kind – maybe a front end loader, for example, deducting 100% of an automobile’s expenses as business seems to be an IRS audit red flag.

VKM

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Tax Court

OUCH!

I agree with the IRS’ and Tax Court’s interpretation of the law, but Mr. Udeobong sure paid through the nose – twice, to be exact.  I’ll save you the gory details.  In fact, they might make you a little less sympathetic.  In any case, Mr. Udeobong still took a lickin’.  Here is the summary and sanitized version of the recent Tax Court Memo decision.

Mr. Udeobong had a medical supply and equipment business that reported its taxable income on the cash basis of accounting.  Sometime before 2005, Mr. Udeobong reported as income receipts from Cigna in the amount of about $260,000.

Mr. Udeobong had a dispute with Cigna.  Sometime between 2005 and 2010, Mr. Udeobong repaid the $260,000 to Cigna and did not deduct the repayments.

In 2010, Cigna repaid the $260,000 to Mr. Udeobong.  Since he had already taken into income the payments and had not deducted them when he returned the money, Mr. Udeobong thought he had taken care of his tax liability.

In 2012, the IRS issued a deficiency notice to Mr. Udeobong based on the omission of about $152,000 of the $260,000 that he received in 2010 and did not report as income.  Of course, Mr. Udeobong had already paid taxes on this income once before.  That does not matter.  In general, a cash basis taxpayer reports receipts as income.

The statute of limitations had already run for the year he first reported the income and for the year in which he may have taken, but did not take, a deduction for paying the money back.  He could not amend his returns for these years.  The Tax Court ruled that he had to pay tax on the $152,000 again in the year of receipt – 2010.

So, Mr. Udeobong paid taxes on $152,000 twice.  The IRS said he was also was liable for the substantial understatement penalty of 20% of the tax underpayment in 2010.

Mr. Udeobong did have a small victory in this bruising battle.  After filing its paperwork with the Tax Court, the IRS caught the difference between the $260,000 received and the $152,000 on which it computed the tax deficiency.  It amended its answer to the taxpayer’s Tax Court petition and asked for more money from Mr. Udeobong.  The Tax Court replied that it is within the rights of the IRS to ask for more in such a situation and it is within the rights of the Tax Court to reject the request.  So, the Tax Court rejected the IRS’ amendment to its answer.  I guess the court thought that the law and the IRS had beaten up on Mr. Udeobong enough.

However, the Tax Court upheld the 20% penalty.  It said that paying your taxes on the amount in a prior year did not represent “reasonable cause” or “good faith” for not paying the taxes again. Yep, you read that right.

Just a small advertisement here.  Mr. Udeobong apparently prepared his own tax returns.  He represented himself without legal counsel before the Tax Court.  This is one of those times that some professional help would have been well worth the cost.

VKM

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