Interesting tax case regarding business expense substantiation--even the little guys are at risk
Longacre
Posts: 16,717 ✭✭✭
There are a lot of Ebay sellers on these boards, and sometimes I read comments regarding expense and income substantiation such as, "I'm small potatoes to the IRS; they won't bother with auditing me. They only go after the multimillionaires" or "I don't need no stinkin' receipts for expenses; the IRS can kiss my a$$ if they come knocking", etc.
Below is a recent Tax Court case where the taxpayer had a Schedule C business "on the side", that generated a princely sum of $1,200 in revenues. He got into a little fix, however, regarding his expense substantiation (see below). Although the numbers are small, I just wanted to pass this along to illustrate that there is really no materiality threshold that the IRS uses.
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Individual Not Entitled to Claimed Business Deductions
The Tax Court, in a summary opinion, has held that an individual is not entitled to any Schedule C deductions in excess of those already allowed by the IRS because he failed to provide documentation to corroborate his claim that payments of various expenses were made in connection with his business activity.
Citations: Robert J. Damron v. Commissioner; T.C. Summ. Op. 2007-24; No. 7430-05S
Date: Feb. 20, 2007
ROBERT J. DAMRON,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
UNITED STATES TAX COURT
Filed February 20, 2007
Robert J. Damron, pro se.
Catherine G. Chang, for respondent.
COUVILLION, Special Trial Judge: This case was heard pursuant to section 7463 in effect when the petition was filed.1 The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority.
Respondent determined a deficiency of $2,272 in petitioner's Federal income tax for the year 2001. The sole issue for decision is whether petitioner is entitled to deductions for certain expenses claimed on Schedule C, Profit or Loss From Business, for the year in question in excess of amounts allowed by respondent.
Some of the facts were stipulated. Those facts, with the annexed exhibits, are so found and are made part hereof. Petitioner's legal residence at the time the petition was filed was San Francisco, California.
During the year 2001, petitioner was an employee of the U.S. Postal Service. Petitioner was also engaged in a self-employed trade or business activity that he called Innovative Financial Services. The activity was described as "negotiation and other services for business/individuals".
On Schedule C, which petitioner included with his 2001 Federal income tax return, he reported the following gross income and expenses from this activity:
Income $ 1,200.00
Expenses:
Legal and professional $ 300.00
Office expenses 6,659.04
Rent (business property) 3,500.00
Taxes/licenses 200.00
Meals/entertainment 24.65
Utilities 544.78
Wages 3,600.00
Total Expenses 14,828.47
_____________
Loss ($13,628.47)
In the notice of deficiency, respondent disallowed the following expenses:
Rent $ 3,500
Wages 3,600
Office expenses 5,179
_______
Total $12,279
Respondent agrees that the activity is a trade or business activity engaged in for profit and disallowed the expenses for failure to substantiate the amounts claimed. During the trial, respondent conceded that petitioner was entitled to a deduction for rent of $700 and $400 for wages paid that had been disallowed in the notice of deficiency.
The nature of the activity is somewhat vague. At trial, petitioner gave examples of the services he provided, such as assisting businesses collecting debts from customers, searching courthouse records or newspapers that might provide information that could lead to assets of delinquent customers, negotiating with debtors, etc. Petitioner had engaged in this activity only for 2 or 3 years prior to the year at issue and had not realized a profit in any of the prior years. The sole issue in this case is whether petitioner substantiated the expenses disallowed.2
In general, deductions are a matter of legislative grace. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Taxpayers are required to maintain records sufficient to enable the Commissioner to determine their correct tax liability. Sec. 6001; Higbee v. Commissioner, 116 T.C. 438 (2001); sec. 1.60011(a), Income Tax Regs. Such records must substantiate both the amount and purpose of the claimed deductions. Higbee v. Commissioner, supra.
Section 162 allows a deduction for ordinary and necessary expenses that are paid or incurred during the taxable year in carrying on a trade or business. Sec. 162(a); Deputy v. duPont, 308 U.S. 488, 495 (1940).
At trial, petitioner offered into evidence copies of various checks that were issued purportedly for payment of expenses related to the activity; however, no documentation was offered to tie in or corroborate that such payments were in connection with the business activity. Petitioner claims he had such information at home and did not realize that such information was crucial to his case.
Section 6001 requires generally that every person liable for any tax keep such records, render such statements, make such returns, and comply with such regulations as the Secretary may from time to time prescribe. Section 1.6001-1(a), Income Tax Regs., provides, in pertinent part, that "any person subject to tax under subtitle A of the Code * * *, shall keep such permanent books of account or records, including inventories, as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return of such tax".
After careful consideration of the evidence presented, including petitioner's testimony and the concessions by respondent, the Court is not inclined to go beyond what respondent has conceded. Accordingly, this Court holds that petitioner is not entitled to any deductions in excess of the amounts allowed and conceded by respondent.
Reviewed and adopted as the report of the Small Tax Case Division.
Decision will be entered under Rule 155.
FOOTNOTES
1 Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the year at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
2 Because of the year involved, the examination of petitioner's return at issue commenced after July 22, 1998. Therefore, sec. 7491, which under certain circumstances shifts the burden of proof to the Commissioner, applies. However, for the burden to be placed on the Commissioner, the taxpayer must comply with the substantiation and record-keeping requirements of the Internal Revenue Code. Sec. 7491(a)(2)(A) and (B). On this record, petitioner has not wholly satisfied that requirement; therefore, the burden has not shifted to respondent under sec. 7491. Higbee v. Commissioner, 116 T.C. 438 (2001).
END OF FOOTNOTES
Below is a recent Tax Court case where the taxpayer had a Schedule C business "on the side", that generated a princely sum of $1,200 in revenues. He got into a little fix, however, regarding his expense substantiation (see below). Although the numbers are small, I just wanted to pass this along to illustrate that there is really no materiality threshold that the IRS uses.
**************************************
Individual Not Entitled to Claimed Business Deductions
The Tax Court, in a summary opinion, has held that an individual is not entitled to any Schedule C deductions in excess of those already allowed by the IRS because he failed to provide documentation to corroborate his claim that payments of various expenses were made in connection with his business activity.
Citations: Robert J. Damron v. Commissioner; T.C. Summ. Op. 2007-24; No. 7430-05S
Date: Feb. 20, 2007
ROBERT J. DAMRON,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
UNITED STATES TAX COURT
Filed February 20, 2007
Robert J. Damron, pro se.
Catherine G. Chang, for respondent.
COUVILLION, Special Trial Judge: This case was heard pursuant to section 7463 in effect when the petition was filed.1 The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority.
Respondent determined a deficiency of $2,272 in petitioner's Federal income tax for the year 2001. The sole issue for decision is whether petitioner is entitled to deductions for certain expenses claimed on Schedule C, Profit or Loss From Business, for the year in question in excess of amounts allowed by respondent.
Some of the facts were stipulated. Those facts, with the annexed exhibits, are so found and are made part hereof. Petitioner's legal residence at the time the petition was filed was San Francisco, California.
During the year 2001, petitioner was an employee of the U.S. Postal Service. Petitioner was also engaged in a self-employed trade or business activity that he called Innovative Financial Services. The activity was described as "negotiation and other services for business/individuals".
On Schedule C, which petitioner included with his 2001 Federal income tax return, he reported the following gross income and expenses from this activity:
Income $ 1,200.00
Expenses:
Legal and professional $ 300.00
Office expenses 6,659.04
Rent (business property) 3,500.00
Taxes/licenses 200.00
Meals/entertainment 24.65
Utilities 544.78
Wages 3,600.00
Total Expenses 14,828.47
_____________
Loss ($13,628.47)
In the notice of deficiency, respondent disallowed the following expenses:
Rent $ 3,500
Wages 3,600
Office expenses 5,179
_______
Total $12,279
Respondent agrees that the activity is a trade or business activity engaged in for profit and disallowed the expenses for failure to substantiate the amounts claimed. During the trial, respondent conceded that petitioner was entitled to a deduction for rent of $700 and $400 for wages paid that had been disallowed in the notice of deficiency.
The nature of the activity is somewhat vague. At trial, petitioner gave examples of the services he provided, such as assisting businesses collecting debts from customers, searching courthouse records or newspapers that might provide information that could lead to assets of delinquent customers, negotiating with debtors, etc. Petitioner had engaged in this activity only for 2 or 3 years prior to the year at issue and had not realized a profit in any of the prior years. The sole issue in this case is whether petitioner substantiated the expenses disallowed.2
In general, deductions are a matter of legislative grace. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Taxpayers are required to maintain records sufficient to enable the Commissioner to determine their correct tax liability. Sec. 6001; Higbee v. Commissioner, 116 T.C. 438 (2001); sec. 1.60011(a), Income Tax Regs. Such records must substantiate both the amount and purpose of the claimed deductions. Higbee v. Commissioner, supra.
Section 162 allows a deduction for ordinary and necessary expenses that are paid or incurred during the taxable year in carrying on a trade or business. Sec. 162(a); Deputy v. duPont, 308 U.S. 488, 495 (1940).
At trial, petitioner offered into evidence copies of various checks that were issued purportedly for payment of expenses related to the activity; however, no documentation was offered to tie in or corroborate that such payments were in connection with the business activity. Petitioner claims he had such information at home and did not realize that such information was crucial to his case.
Section 6001 requires generally that every person liable for any tax keep such records, render such statements, make such returns, and comply with such regulations as the Secretary may from time to time prescribe. Section 1.6001-1(a), Income Tax Regs., provides, in pertinent part, that "any person subject to tax under subtitle A of the Code * * *, shall keep such permanent books of account or records, including inventories, as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return of such tax".
After careful consideration of the evidence presented, including petitioner's testimony and the concessions by respondent, the Court is not inclined to go beyond what respondent has conceded. Accordingly, this Court holds that petitioner is not entitled to any deductions in excess of the amounts allowed and conceded by respondent.
Reviewed and adopted as the report of the Small Tax Case Division.
Decision will be entered under Rule 155.
FOOTNOTES
1 Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the year at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
2 Because of the year involved, the examination of petitioner's return at issue commenced after July 22, 1998. Therefore, sec. 7491, which under certain circumstances shifts the burden of proof to the Commissioner, applies. However, for the burden to be placed on the Commissioner, the taxpayer must comply with the substantiation and record-keeping requirements of the Internal Revenue Code. Sec. 7491(a)(2)(A) and (B). On this record, petitioner has not wholly satisfied that requirement; therefore, the burden has not shifted to respondent under sec. 7491. Higbee v. Commissioner, 116 T.C. 438 (2001).
END OF FOOTNOTES
Always took candy from strangers
Didn't wanna get me no trade
Never want to be like papa
Working for the boss every night and day
--"Happy", by the Rolling Stones (1972)
Didn't wanna get me no trade
Never want to be like papa
Working for the boss every night and day
--"Happy", by the Rolling Stones (1972)
0
Comments
program check flagged the return and spit it out for an auditor to review. The auditor called the guy,
who didn't have receipts, so....
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Legal and professional $ 300.00
Office expenses 6,659.04
Rent (business property) 3,500.00
Taxes/licenses 200.00
Meals/entertainment 24.65
Utilities 544.78
Wages 3,600.00
Total Expenses 14,828.47
Doggedly collecting coins of the Central American Republic.
Visit the Society of US Pattern Collectors at USPatterns.com.
I don't think it was just the dollar amount that triggered the audit, but also the rent, wages, and WTH is up with those "office expenses" -- printer burning up ink carts? Or was a mahogany desk and plasma TV necessary to staple 2x2 flips and stuff bubble envelopes?
<< <i>because he failed to provide documentation to corroborate his claim that payments of various expenses were made in connection with his business activity.
......engaged in a self-employed trade or business activity that he called Innovative Financial Services. >>
The case is applicable since he had his own business regardless of the charges and how small his business was. And, he claimed the income as business income.
As for individuals who do not use Ebay as a business or main source of income it is not applicable. Ebay, for many individuals,
is no different than having a yard sale where a person can stockpile goods and have a yard sale. And, they can do it as
often as they wish. Many people have yard sales on a monthly basis. Ebay is just another avenue to sell their goods.
Really, then, the IRS should have no jurisdiction over individuals. Similar to Craig's List. Which they may target as well.
Corporations and government just keep finding more ways to enslave all of us to their greed and control.
When you show me the Tax Court case involving the guy who had $12,000 of income against $500 of expenses, then I might start to get a bit nervous. Of course, I do not file schedule C for my coin gains/losses; I use Schedule D and report them as capital gains/losses.
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Only the depreciation.
If you rent, there's no downside to taking the deduction, if it's legit.
Doggedly collecting coins of the Central American Republic.
Visit the Society of US Pattern Collectors at USPatterns.com.
<< <i>You should avoid deducting your home office, as I've heard it comes back as capital gains when the home is sold. >>
What you depreciated, yes. Not the pro-rated cost of insurance and utilities, for example, and not other home office expenses like a dedicated second business phone line, either. Just the depreciation needs to be recaptured.
Commems and Early Type
<< <i>I have to agree with planetsteve; think very carefully before calling any part of your home as a deductible "office". Many of my hospital-based fellow MD's used to do this (anesthesiologists, radiologists who might generate bills or review paperwork at home) and most of them got audited and have since dropped this deduction. This guy seems not to understand that you can't use these business losses against other ordinary income. >>
I think a big part of the problem is a lack of understanding when tax laws allow the home-office deduction.
if you're self-employed and work exclusively out of your home, you likely qualify. If you are employed and use part of your home as an office for your employer's convenience, again, you're likely fine. If you have an office with your employer and you have a home office for your convenience (i.e. to avoid commuting or spending more time in the office), you probably will NOT qualify.
Plus, the area has to be used exclusively for business purposes. A mixed-use personal and business room likely doesn't qualify. Not understanding the limitations and qualifications for the deduction can cause a lot of trouble come audit time. Not just ANY home office can qualify for the deduction.
San Diego, CA
Didn't wanna get me no trade
Never want to be like papa
Working for the boss every night and day
--"Happy", by the Rolling Stones (1972)
<< <i>I doubt it was the $1200 that caused the issue, but I'll bet this stuff raised some red flags:
Legal and professional $ 300.00
Office expenses 6,659.04
Rent (business property) 3,500.00
Taxes/licenses 200.00
Meals/entertainment 24.65
Utilities 544.78
Wages 3,600.00
Total Expenses 14,828.47 >>
Yeah, I have heard that the IRS actually watches for "self-employed"/"home business" where there is loss after loss or it just doesn't look legit since people like to play the "home business" con a bit too much on the deduction side of things.
I've been told I tolerate fools poorly...that may explain things if I have a problem with you. Current ebay items - Nothing at the moment
San Diego, CA