I am reading a case that made me grimace. The following is a total NO-NO if you are unfortunate enough to be selected for audit:
As part of the audit RA Chavez issued information document requests to petitioners requesting their accounting records for 2013, but petitioners did not respond. RA Chavez completed his audit without receiving any additional information from petitioners …”
The abbreviation
“RA” means revenue agent; those are the IRS folks who do the examinations.
This is not going to turn out well.
… respondent issued … revenue agent reports (RARs) to petitioners with proposed adjustments to tax and accuracy-related penalties. Petitioners did not respond to the … RARs.
Chances are very good that I would have resigned from
this representation or refused to accept the client in the first place.
We have, for example, a client who has not filed returns
for years. There are mitigating reasons, but not that many or reasons that persuasive for the number of years. My partner brought them in; I looked at their stuff and
gave them a list and timetable of what we needed. I reached out to the IRS,
explained that they had just hired tax representation and requested time.
I am not going to say that the IRS is always hospitable,
but in general they tend to be reasonable if someone is truly trying to get back
into the system (except during COVID; the COVID procedural issues have been extensive,
unrelenting and extremely frustrating. The IRS really should have stopped
issuing notices like government stim checks until it could at least open its
mail on a timely basis).
What did my partner’s client do?
They gave us nothing. Two weeks became two months. Two
months became three. I received exculpatory e-mails that read like a Grateful
Dead tour.
My - and our - credibility with the IRS took a hit.
If they were my client, I would have dismissed them.
They are not, however, so I did the next emphatic thing I could do: I will not
work with them. We have a younger tax pro here at Galactic Command, and he will
take this matter over. He has a nice background in preparation, and I would
like to expose him to the representation side of practice. He is somewhat
interested (at least, not uninterested), and if he remains in a CPA firm as a
career it will be a nice addition to his skill set.
Back to our case.
There is a lot going on, but I want to focus on one issue.
Two families own a construction S corporation
(Phoenix). The IRS disallowed $121,903 in 2013 related to car racing
activities. More specifically, the racing was by a son of the owners, and his
car of choice was a 1968 Camaro.
He started racing it in 2014.
One has to be very careful here. One is taking an activity with a high level of personal interest and gratification and jamming it into a profitable company. It would take minimal tax chops to argue that the racing activity is a hobby or is otherwise personal. The purported advertising cannot be “merely a thin cloak for the pursuit of a hobby.”
The company fired back with three arguments:
(1) The racing expenses were ordinary and
necessary advertising expenses.
(2) Phoenix purchased the car as an investment.
(3) Racing was a separate trade or business from
Phoenix and was engaged in for profit.
I do not know if these arguments existed when the
return was prepared or dredged-up after the fact, but still … kudos.
Except …
The racing was not conducted under the Phoenix name. There
was no company logo on the car, with the possible exception of something
minimal on the rear window. There were no photographs or videos of the car on
the company’s advertising.
One more thing.
Phoenix did not even separate the car racing expenses
as Advertising on its tax return. Instead, it just buried them with “Construction
Costs.”
Folks, the IRS does NOT like it when one appears to be
hiding something iffy in a big, enveloping category of other expenses. It is,
in fact, an indicium of fraud.
The first argument whiffed.
One BTW does not race a car that is held for
investment. One stores a car that is held for investment, perhaps taking it to
an occasional show.
The second argument collapsed.
That leaves a lot of pressure on the third argument:
that the car was its own separate trade or business.
You know what the car did not do in 2013 (the year of
examination)? It did not race, that is what it did not do. If one were to argue
that the car was a separate trade or business, then one would have to concede
that the activity started the following year – 2014 – and not in 2013. All
those expenses are what the tax Code calls “startup expenses,” and – with a
minimal exception - they have to be amortized over 15 years.
Let me check: yep, this is a pro se case, meaning that
the taxpayers represented themselves.
We have said it before: hire a pro, spend a few dollars.
You do not know what you do not know.
What would I have advised?
They should have posted photos and videos of that car everywhere
they advertised, and I would have recommended adding new advertising venues. I
am thinking a video diary: the purchase of the car, its modification,
interviews with principal parties, technical issues encountered and resolved, anticipated
future race sites and dates.
And yes, I would have put the company name on the car.
Our case this time is Berry v Commissioner,
T.C. Memo 2021-42.
