Sunday, September 2, 2018

Oh Henry!

It is a classic tax case.

Let’s travel back to the 1950s.

Let us introduce Robert Lee Henry, both an attorney and a CPA.  He was a tax expert, but he did not restrict his practice solely to tax.

He was also an accomplished competitive horse rider. After he returned from military service, the Army discontinued its horse show team. In response, he organized the United States horse show civilian team.

He met the wealthy and influential, benefiting his practice considerably.

Then he had to give up riding. Heart issues, I believe.

But he was quite interested in continuing to meet the to-do’s and well-connected.

He bought a boat.

He traded it in for a bigger boat.

He bought a flag for the boat. It was red, white and blue and had the numbers “1040.”

People would ask. He would present his background as a tax expert. He was meeting and greeting.

His doctor told him to relax and take time off. Robert Lee called his son, and together they took the boat from New York to Florida. They then decided to spend the winter, as they were already there.

Robert Lee deducted 100% of the boat expenses.
QUESTION: Can Robert Lee deduct the expenses?
NERDY DETAIL: The tax law changed after this case was decided, so the decision today would be easier than it was back in the 1950s. Still, could he deduct the boat expenses in the 1950s?
The key issue was whether the boat expenses were “ordinary and necessary.” That standard is fundamental to tax law and has been around since the beginning. Just because a business activity pays for something does not mean that it is deductible. It has to strain through the “ordinary and necessary” colander.

In truth, this is not a difficult standard in most cases. It can however catch one in an oddball or perhaps (overly) aggressive situation.

Robert Lee was an accomplished rider, and he had developed a book of business because of his equestrian accomplishments. He monetized his equestrian contacts. He now saw an opportunity to meet the same crowd of folk by means of a boat.

Problem: Robert Lee did not use the boat to entertain or transport existing clients or prospective contacts.

And there is the hook. Had he used the boat to entertain, he could more easily show an immediate and proximate relationship between the boat, its expenses and his legal and accounting practice.

He instead had to argue that the boat was a promotional scheme, akin to advertising. It was not as concrete as saying that he schmoozed rich people in the Atlantic on his boat.

He had to run the “ordinary and necessary” gauntlet.

Let’s start.

He continued to have a sizeable equestrian clientele after he left competitive riding.


He was however unable to provide the Court a single example of a client who came to him because of the boat, at least until years later. Even then, there still wasn’t much in the way of fees.


So what, argued Robert Lee. How is this different from buying a full-page ad in an upscale magazine?

Quite a bit, said the Court. You gave up riding for health reasons. There is no question that you derived tremendous personal enjoyment from riding. You have now substituted boating for riding. Enjoyment does not mean that there is no business deduction, but it does mean that the Court may look with a more skeptical eye. It would have been an easier decision for us if you had bought a full-page ad. There is no personal joy in advertising.

As a professional, I have to develop and cultivate many contacts – business, social, personal, political – retorted Robert Lee. One never knows who one will meet, and it takes money to meet money. That is my business reason.

Could not agree with you more, replied the Court. Problem is, that does not make every expenditure deductible. What you are doing is not ordinary. Let’s be frank, Robert Lee, the average attorney/CPA does not keep a yacht.

They would if they could, muttered Robert Lee.

Even if we agreed the expenses were “ordinary,” continued the Court, we have to address whether they are “necessary.” This test is heightened when expenses may have been incurred primarily for personal reasons. You did sail from New York to Florida, by the way. With your son. And you deducted 100% of it.

I am meeting rich people, countered Robert Lee.

Perhaps, answered the Court, but there must be a proximate relationship between the expense and the activity. What you are talking about is remote and incidental. It is difficult to clear the “necessary” hurdle with your “someday I’ll” argument.

Robert Lee shot back: my point should be self-evident to any professional person.
COMMENT: Folks, do not say this when you are trying to persuade a Court.
The Court decided that Robert Lee could not prove either “ordinary” or “necessary.”
The conclusion that the expenditures here involved were primarily related to petitioner’s pleasure and only incidentally related to his business seems inescapable.”
The Court denied his boat deductions.

Our case this time for the home-gamers and riders was Henry v Commissioner.

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