Tuesday, June 21, 2011

Another Warning on Deducting Auto Expenses

There is a very recent case concerning tax deductions for business use of a vehicle that I am considering as mandatory reading for many of our clients.

The pattern is repetitive. Either the business provides the car or the employee uses his/her car for business and is not reimbursed. Tax time we ask the following questions: what is your mileage? What do you have as documentation to support that mileage? We review the danger associated with this tax deduction (the IRS will disallow it if you cannot back it up), to which it seems most of the clients roll their eyes and go “yea, yea.”

Well, Jessica Solomon just got schooled. It’s a shame, too, as it sounds like Jessica was trying to do the right thing, but she just didn’t know what that meant. Let’s look at Jessica Solomon v Commissioner.

Jessica Solomon moved from Illinois to Missouri in 2006. First, let me say that I went to the University of Missouri, so I approve of her move. Second, she started work as a commission-only salesperson for seven months – June through December. She was peddling office supplies. Every day she started the morning at the company office in St Louis, and at the end of the day she finished with an evening meeting there. She only made $3,307 in commissions. Considering that she was reimbursed for NOTHING, it sounds to me like this was a waste of her time.

She kept a log in her car. At the start of the day she wrote down her mileage, and at the end she noted her mileage. Unfortunately, there was no other information, such as the towns, prospects or customers she was visiting. It was bare-boned, but it was something.

At the end of the year she went to H&R Block. They deducted her business expenses, including 18,741 business miles.

In January, 2009 the IRS issued a statutory notice disallowing all her mileage and employee expenses for 2006. Jessica, bless her heart, went to Tax Court representing herself (this is called “pro se”). It did not go well for Jessica.

Unfortunately, the court was right. Let’ go through this…

* It is an axiom in tax practice that deductions are a matter of legislative grace. This is fancy way of saying that there is no deduction just because you really, really want there to be one.
* If a taxpayer presents credible evidence on a factual issue concerning tax liability, Code Section 7491(a) shifts the burden of proof to the IRS.
* If Section 7491(a) kicks in, the IRS (or Court) may even estimate the amount of expenses, if the supporting documentation is poor or even nonexistent.
* There are some expenses where the burden of proof does not shift under Section 7491(a).
* A car is one of those expenses. Car expenses are addressed under Section 274(n).
* Section 274(n) says that no deductions are allowed with respect to listed property (think a car) unless very specific documentation requirements are met:

** The amount
** The time and place
** The business purpose
** The taxpayer’s relationship with the persons involved

The Court looked at her log. The court had several problems;

(1) The log noted only the beginning and ending mileage for each day

(2) The log included a 27 mile commute

(3) The log may have included personal trips

So far, I could have worked with this. I would ask Jessica for a Day Runner or some other record of who she visited, where and etc. In fact, had she submitted contact reports to the company, I would ask the company to provide copies for her tax audit. I need corroborating evidence. The evidence does not have to be on the same sheet of paper. In truth, it need not even had been created at the time, although that would of course carry more weight.

Unfortunately Jessica could not do this. Here is the Court:

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…”

But the court KNEW that she had to use her car – right? Surely the Court would spot her something.

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 reasons discussed …, petitioner’s mileage log does not satisfy the adequate records requirement of Section 274(d).”

No mileage deduction for Jessica.

As I said, perhaps this case should be mandatory reading for many of our clients.

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