A recent bankruptcy case gave me pause. The case is Cannon v U.S.
The Cannons did not file tax returns for 1999 through 2001. The IRS audited and made income tax assessments based on the audit. This is known as a substitute return.
The Cannons later filed for bankruptcy. The IRS said that their taxes for 1999 through 2001 were nondischargeable.
What is the issue here? To be dischargeable in bankruptcy, a debtor’s taxes must meet several tests:
* The returns are due more than three years before bankruptcy
* The tax must be assessed more than 240 days before bankruptcy
* A return must have been filed more than 2 years prior to bankruptcy
* The return must not be fraudulent
* The taxpayer must not have attempted to evade tax
The issue is the definition of “return.” In 2005 the Bankruptcy Code was amended to include the following gem of wordsmithing:
...the term ‘return’ means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements.) Such term includes a return prepared pursuant to § 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to § 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.”
So a return under IRC Section 6020(a) will qualify. What does Sec 6020(a) say?
6020(a) Preparation of Return by Secretary.—
If any person shall fail to make a return required by this title or by regulations prescribed thereunder, but shall consent to disclose all information necessary for the preparation thereof, then, and in that case, the Secretary may prepare such return, which, being signed by such person, may be received by the Secretary as the return of such person.
The Bankruptcy Code will accept the above but will not accept the following under Sec 6020(b):
6020(b)(1)Authority of secretary to execute return.—
If any person fails to make any return required by any internal revenue law or regulation made thereunder at the time prescribed therefor, or makes, willfully or otherwise, a false or fraudulent return, the Secretary shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise.
The problem is that a substitute return is a Sec 6020(b) return. If you owe tax with this IRS-prepared substitute return, you are facing the possibility that this tax is nondischargeable, even if the 2-year period has expired.
The question I have is whether amending an IRS-prepared Sec 6020(b) return will constitute filing a tax return and thereby begin the 2-year period. I am looking at Judge Easterbrook’s language in Payne, and Payne’s descendants, such as Creekmore and Links. I must admit, it as clear as mud.
The tax planning for this is pretty straightforward however: file your returns before the IRS catches you.
Tuesday, June 21, 2011
Senators Question IRS Gift Tax Enforcement
You may have read that the IRS has decided to pursue Section 501(c)(4) organizations. This beggars the question: what is a 501((c)(4) organization?
The (c)(4) is a tax-exempt. That is not saying much, as there are over two dozen types of tax-exempts in the Internal Revenue Code. So what is different about this flavor of tax exempt?
The( c)(4) must not be organized for profit and must be operated exclusively for the promotion of social welfare. Examples of (c)(4)s are AARP and the National Association for the Advancement of Colored People. You may also remember MoveOn.org and America Coming Together.
A (c)(4) may further its social welfare purposes through lobbying without jeopardizing its exempt status as long as it is consistent with the organization’s purpose. It cannot however be the organization’s primary activity. If it is, then one should consider a Section 527 organization.
Are donations to a (c)(4) deductible? That depends. Donations to 501(c)(4)s that are public entities (such as a volunteer fire station) are deductible. Donations to other (c)(4)s are not deductible.
So what has happened to draw the IRS’ attention? Tax advisors such as me have known for a long time that donations to a (c)(4) are not deductible, and we make adjustments when a client includes these amounts in a list of contributions. The IRS has now decided to pursue the (c)(4)s with the argument that contributions are taxable gifts by the donors.
A taxable gift? This is a new issue to me, and I have been at this for a while.
It has caught the Senate’s attention. Six senators from the Finance Committee recently wrote a letter to IRS Commissioner Shulman. The Finance Committee writes tax law in conjunction with the House Ways and Means Committee. The Senators wrote (in part):
The applicability of gift taxes to 501(c)(4) contributions is ambiguous. Historically, the IRS has deliberately opted against vigorous enforcement of the gift tax on 501(c)(4) contributions. There are good reasons for this. First, it is unclear if contributions to these organizations are eligible for the gift tax given their gratuitous nature, and the fact that the donations are made with the expectation that the organization will work to advance the donor’s policy views. Moreover, these contributions are clearly not designed for tax planning purposes or to avoid the estate tax. Most importantly, however, enforcement of gift taxes on contributions to 501(c)(4) organizations engaged in public policy debate runs an unacceptable risk of chilling political speech, which receives the highest level of constitutional protection under the First Amendment
This pattern of nonenforcement over a period of nearly three decades, coupled with the troubling issues regarding the adverse impact that enforcement might have on the exercise of constitutionally protected rights, raises important questions regarding the timing of the decision to enforce the gift tax on these contributions. Retroactive enforcement of the gift tax in this highly politicized environment raises legitimate concerns and demands further explanation."
The statement by IRS spokeswoman Michelle Eldridge did not assuage these concerns and left us with only more questions. According to Eldridge, “[a]ll of the decisions involving these cases were made by career civil servants without any influence from anyone outside the IRS.” We would expect that decisions regarding particular enforcement actions would be made by career civil servants. The more pressing question, not answered to date, is whether political appointees inside or outside the IRS were involved in any way in the decision to prioritize this category of cases."
I understand that (c)(4)s are not supposed to be piggybanks, but are there really enough tax dollars here for the IRS to prioritize this issue?
I was too young, but I have understood that President Nixon used the IRS as a political weapon against his opponents. In a country where half the population does not trust the current President to do the right thing, it is unfortunate to have the IRS call its neutrality into question. You can accept or hate the IRS, but it is imperative that the IRS act and be perceived as a neutral entity.
One can argue that perhaps there is no good time for this type of action, but the observation remains that this is not a good time.
I will come back in a separate post with more detail on the tax issues raised by (c)(4)s.
The (c)(4) is a tax-exempt. That is not saying much, as there are over two dozen types of tax-exempts in the Internal Revenue Code. So what is different about this flavor of tax exempt?
The( c)(4) must not be organized for profit and must be operated exclusively for the promotion of social welfare. Examples of (c)(4)s are AARP and the National Association for the Advancement of Colored People. You may also remember MoveOn.org and America Coming Together.
A (c)(4) may further its social welfare purposes through lobbying without jeopardizing its exempt status as long as it is consistent with the organization’s purpose. It cannot however be the organization’s primary activity. If it is, then one should consider a Section 527 organization.
Are donations to a (c)(4) deductible? That depends. Donations to 501(c)(4)s that are public entities (such as a volunteer fire station) are deductible. Donations to other (c)(4)s are not deductible.
So what has happened to draw the IRS’ attention? Tax advisors such as me have known for a long time that donations to a (c)(4) are not deductible, and we make adjustments when a client includes these amounts in a list of contributions. The IRS has now decided to pursue the (c)(4)s with the argument that contributions are taxable gifts by the donors.
A taxable gift? This is a new issue to me, and I have been at this for a while.
It has caught the Senate’s attention. Six senators from the Finance Committee recently wrote a letter to IRS Commissioner Shulman. The Finance Committee writes tax law in conjunction with the House Ways and Means Committee. The Senators wrote (in part):
The applicability of gift taxes to 501(c)(4) contributions is ambiguous. Historically, the IRS has deliberately opted against vigorous enforcement of the gift tax on 501(c)(4) contributions. There are good reasons for this. First, it is unclear if contributions to these organizations are eligible for the gift tax given their gratuitous nature, and the fact that the donations are made with the expectation that the organization will work to advance the donor’s policy views. Moreover, these contributions are clearly not designed for tax planning purposes or to avoid the estate tax. Most importantly, however, enforcement of gift taxes on contributions to 501(c)(4) organizations engaged in public policy debate runs an unacceptable risk of chilling political speech, which receives the highest level of constitutional protection under the First Amendment
This pattern of nonenforcement over a period of nearly three decades, coupled with the troubling issues regarding the adverse impact that enforcement might have on the exercise of constitutionally protected rights, raises important questions regarding the timing of the decision to enforce the gift tax on these contributions. Retroactive enforcement of the gift tax in this highly politicized environment raises legitimate concerns and demands further explanation."
The statement by IRS spokeswoman Michelle Eldridge did not assuage these concerns and left us with only more questions. According to Eldridge, “[a]ll of the decisions involving these cases were made by career civil servants without any influence from anyone outside the IRS.” We would expect that decisions regarding particular enforcement actions would be made by career civil servants. The more pressing question, not answered to date, is whether political appointees inside or outside the IRS were involved in any way in the decision to prioritize this category of cases."
I understand that (c)(4)s are not supposed to be piggybanks, but are there really enough tax dollars here for the IRS to prioritize this issue?
I was too young, but I have understood that President Nixon used the IRS as a political weapon against his opponents. In a country where half the population does not trust the current President to do the right thing, it is unfortunate to have the IRS call its neutrality into question. You can accept or hate the IRS, but it is imperative that the IRS act and be perceived as a neutral entity.
One can argue that perhaps there is no good time for this type of action, but the observation remains that this is not a good time.
I will come back in a separate post with more detail on the tax issues raised by (c)(4)s.
Tax Break for Exporters
We are taking a look at an Interest Charge – Domestic International Sales Corporation (IC-DISC).
As you can guess, this has to do with a company which exports. I remember the DISC as providing a tax deferral, but it has another tax feature that we like as much or more.
Here is quick breakdown of how the IC-DISC would work:
(1) There is an exporting company (ExCo)
(2) ExCo (or its owners) set up a second company (DISC) and elect to be treated as an IC-DISC.
(3) ExCo pays DISC a commission
(4) DISC pays no tax on the commission (up to a point) as long as 95% of its activities and assets are export-related.
NOTE: Do you see what is happening? DISC pays no tax on the commission. ExCo deducts the commission and reduces its tax.
(5) DISC may pay dividends to its shareholders.
(6) If DISC does not pay dividends, there will a charge to the shareholders. The charge will vary depending on whether the shareholders are individuals or a corporation. Individuals will pay interest (hence “Interest Charge – DISC”). There is a different tax treatment for corporations.
The DISC can be a “paper” company. That is, it does not have to perform any substantial economic functions. It does not have to have employees or office space, for example. Pretty much the only thing it has to do is keep its own books and records, which an accounting department can do. You incorporate, print some new stationary and continue doing what you were doing before. How much easier can this be?
There are of course limits on how to calculate the commission; otherwise you would have a product selling for $50 with a thousand dollar commission tacked onto it. The commission is 4% of the qualified export receipts or 50% of ExCo’s taxable income, whichever is greater.
The DISC can defer $10 million in commissions EVERY year. There is even a way to increase this limit.
The tax deferral is sweet, but Rick and I like the dividend treatment as much or more. We expect the DISC to be an S corporation, and its shareholders to be the same as those for ExCo. We can also see a wealth transfer opportunity here by having the younger generation as the owners of the DISC, while mom and dad (or grandmom and granddad) still own ExCo. We are thinking of having the DISC distribute every year. Under this scenario there is no deferral. We want to move money out of the main company (ExCo), which would otherwise be taxed at the maximum rate, and push it to DISC, whose dividends are taxable at 15 percent. This would be an immediate 20% tax savings.
As you can guess, this has to do with a company which exports. I remember the DISC as providing a tax deferral, but it has another tax feature that we like as much or more.
Here is quick breakdown of how the IC-DISC would work:
(1) There is an exporting company (ExCo)
(2) ExCo (or its owners) set up a second company (DISC) and elect to be treated as an IC-DISC.
(3) ExCo pays DISC a commission
(4) DISC pays no tax on the commission (up to a point) as long as 95% of its activities and assets are export-related.
NOTE: Do you see what is happening? DISC pays no tax on the commission. ExCo deducts the commission and reduces its tax.
(5) DISC may pay dividends to its shareholders.
(6) If DISC does not pay dividends, there will a charge to the shareholders. The charge will vary depending on whether the shareholders are individuals or a corporation. Individuals will pay interest (hence “Interest Charge – DISC”). There is a different tax treatment for corporations.
The DISC can be a “paper” company. That is, it does not have to perform any substantial economic functions. It does not have to have employees or office space, for example. Pretty much the only thing it has to do is keep its own books and records, which an accounting department can do. You incorporate, print some new stationary and continue doing what you were doing before. How much easier can this be?
There are of course limits on how to calculate the commission; otherwise you would have a product selling for $50 with a thousand dollar commission tacked onto it. The commission is 4% of the qualified export receipts or 50% of ExCo’s taxable income, whichever is greater.
The DISC can defer $10 million in commissions EVERY year. There is even a way to increase this limit.
The tax deferral is sweet, but Rick and I like the dividend treatment as much or more. We expect the DISC to be an S corporation, and its shareholders to be the same as those for ExCo. We can also see a wealth transfer opportunity here by having the younger generation as the owners of the DISC, while mom and dad (or grandmom and granddad) still own ExCo. We are thinking of having the DISC distribute every year. Under this scenario there is no deferral. We want to move money out of the main company (ExCo), which would otherwise be taxed at the maximum rate, and push it to DISC, whose dividends are taxable at 15 percent. This would be an immediate 20% tax savings.
The Collection Due Process Hearing
A client recently faxed me a Notice of Intent to Levy. His tax case is relatively simple, as we are not debating the amount of tax. Rather, he is in a position where he cannot pay-off his tax due. This requires a payment plan, which can blow up if the taxpayer misses a payment. He is self-employed with erratic income, so he is at ongoing risk of blowing up his payment plan. He unfortunately believes – or has believed – that we can reactivate a payment plan whenever he feels like missing a payment, but I believe we impressed upon him that this is not the case. The IRS becomes weary, and frankly so do we.
I thought this a good time to talk about the Collection Due Process hearing.
Once you receive a Notice of Federal Tax Lien (NFTL) or Intent to Levy, you have 30 days to request a CDP hearing. If so, the levy action will be suspended for the duration of the hearing. IRS Appeals conducts the hearing. The taxpayer can appeal a CDP hearing, if so inclined.
What happens if you miss the 30 days? Not all is lost. You can request an Equivalent Hearing as long as you file within one year of the NFTL or levy notice. The difference is that you cannot appeal an Equivalent Hearing.
You have to file a form (Form 12153) and state a reason for the hearing. In our case, we will request a collection alternative, such as an installment agreement. Our client does not qualify for an offer in compromise, which is another valid reason. Other reasons include requests to release or subordinate a lien, request for innocent spouse and a dispute over the amount of unpaid taxes. An important reason in today’s economy is financial hardship, which can include heavy medical bills, unemployment, and taxpayer’s reliance on social security or unemployment benefits.
An unfortunate note is that – even if the IRS accepts the collection alternative – interest and penalties will continue to accrue.
I thought this a good time to talk about the Collection Due Process hearing.
Once you receive a Notice of Federal Tax Lien (NFTL) or Intent to Levy, you have 30 days to request a CDP hearing. If so, the levy action will be suspended for the duration of the hearing. IRS Appeals conducts the hearing. The taxpayer can appeal a CDP hearing, if so inclined.
What happens if you miss the 30 days? Not all is lost. You can request an Equivalent Hearing as long as you file within one year of the NFTL or levy notice. The difference is that you cannot appeal an Equivalent Hearing.
You have to file a form (Form 12153) and state a reason for the hearing. In our case, we will request a collection alternative, such as an installment agreement. Our client does not qualify for an offer in compromise, which is another valid reason. Other reasons include requests to release or subordinate a lien, request for innocent spouse and a dispute over the amount of unpaid taxes. An important reason in today’s economy is financial hardship, which can include heavy medical bills, unemployment, and taxpayer’s reliance on social security or unemployment benefits.
An unfortunate note is that – even if the IRS accepts the collection alternative – interest and penalties will continue to accrue.
Losing Bankruptcy Protection On Your IRA
You probably know that monies in your IRA are protected from bankruptcy. No one intends to go there, but it’s nice to know that you have that safeguard.
What do you have to do to void that protection?
Enter Ernest Willis and his IRAs (Willis v Menotte).
Willis opened a self-directed IRA with Merrill Lynch in March, 1993. On December 20, 1993 he withdrew $700,000to help him with a real estate transaction. On February 22, 1994 he put the $700,000 back in the IRA.
NOTE: Let’s count the days… 12 + 31 +22 = 65 days. You may remember that you can withdraw money from your IRA and not have it count as a distribution IF you replace it within 60 days. Looks like Willis missed his count.
In January, 1997 Willis had problems with the stock market. He had to put money into his brokerage account (I presume he was on margin), so he wrote checks back and forth between his IRA and the brokerage account. The settlement takes a few days, so he could keep the brokerage account afloat by swapping checks. Since he was replacing the IRA monies within 60 days, he did not have a distribution.
Somewhere in here Willis partially rolled-over his Merrill Lynch account to AmTrust and Fidelity.
In February, 2007 Willis filed for bankruptcy. The creditor wanted his IRA. Willis said NO NO and NO. The IRA is protected by Bankruptcy Code Section 522(b) (4) (A). “Go away” says Willis.
The bankruptcy court takes a look at the IRA transactions. An IRA is not allowed to participate in certain transactions (called “prohibited transactions”) with its fiduciary. Guess what? If you direct a self-directed IRA, you are a “fiduciary.” Willis tapped into his IRA and did not replace the money within 60 days. The 60 days is not a suggestion; it is the statute. He didn’t make it. He put the money back in there, but this was not horseshoes. This was a prohibited transaction.
The court was also not too amused with the check swapping scheme and his brokerage account. The court observed that this had the effect of a loan between Willis and his IRA. An IRA cannot loan money, and it especially cannot loan money to its fiduciary. This was a prohibited transaction.
The bankruptcy court held against Willis. He appealed to the district court. That court sustained. Willis next appealed to the Eleventh Circuit, and the circuit court has just sustained the district court. Willis has lost.
How much money was in these IRAs? The Merrill Lynch account alone was over $1.2 million.
I have known clients to “borrow” from their IRA, and I especially remember one doing this while Rick and I worked together at another firm a few years ago. I remember counting down and sweating the 60 days. This was a sensitive client, and – if it blew up – I was going to take massive damage. Willis unfortunately did not keep it to 60 days. He must have been strapped, because he wound up borrowing from friends and family. He put the money back into the IRA, but he had missed the window. The later episode with the check swapping was just icing on the cake.
The court pointed out that once the IRA was tainted, the taint followed the partial rolls to the other two IRAs. His three IRAs were unprotected and could be actioned by his bankruptcy creditors.
Willis thought he was clever. He got schooled, and the tuition was expensive.
What do you have to do to void that protection?
Enter Ernest Willis and his IRAs (Willis v Menotte).
Willis opened a self-directed IRA with Merrill Lynch in March, 1993. On December 20, 1993 he withdrew $700,000to help him with a real estate transaction. On February 22, 1994 he put the $700,000 back in the IRA.
NOTE: Let’s count the days… 12 + 31 +22 = 65 days. You may remember that you can withdraw money from your IRA and not have it count as a distribution IF you replace it within 60 days. Looks like Willis missed his count.
In January, 1997 Willis had problems with the stock market. He had to put money into his brokerage account (I presume he was on margin), so he wrote checks back and forth between his IRA and the brokerage account. The settlement takes a few days, so he could keep the brokerage account afloat by swapping checks. Since he was replacing the IRA monies within 60 days, he did not have a distribution.
Somewhere in here Willis partially rolled-over his Merrill Lynch account to AmTrust and Fidelity.
In February, 2007 Willis filed for bankruptcy. The creditor wanted his IRA. Willis said NO NO and NO. The IRA is protected by Bankruptcy Code Section 522(b) (4) (A). “Go away” says Willis.
The bankruptcy court takes a look at the IRA transactions. An IRA is not allowed to participate in certain transactions (called “prohibited transactions”) with its fiduciary. Guess what? If you direct a self-directed IRA, you are a “fiduciary.” Willis tapped into his IRA and did not replace the money within 60 days. The 60 days is not a suggestion; it is the statute. He didn’t make it. He put the money back in there, but this was not horseshoes. This was a prohibited transaction.
The court was also not too amused with the check swapping scheme and his brokerage account. The court observed that this had the effect of a loan between Willis and his IRA. An IRA cannot loan money, and it especially cannot loan money to its fiduciary. This was a prohibited transaction.
The bankruptcy court held against Willis. He appealed to the district court. That court sustained. Willis next appealed to the Eleventh Circuit, and the circuit court has just sustained the district court. Willis has lost.
How much money was in these IRAs? The Merrill Lynch account alone was over $1.2 million.
I have known clients to “borrow” from their IRA, and I especially remember one doing this while Rick and I worked together at another firm a few years ago. I remember counting down and sweating the 60 days. This was a sensitive client, and – if it blew up – I was going to take massive damage. Willis unfortunately did not keep it to 60 days. He must have been strapped, because he wound up borrowing from friends and family. He put the money back into the IRA, but he had missed the window. The later episode with the check swapping was just icing on the cake.
The court pointed out that once the IRA was tainted, the taint followed the partial rolls to the other two IRAs. His three IRAs were unprotected and could be actioned by his bankruptcy creditors.
Willis thought he was clever. He got schooled, and the tuition was expensive.
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.
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.
Signing Up for Social Security?
Those applying for social security beginning Monday, May 2, will have to select an electronic payment option – either direct deposit or a debit card. The debit card can be reloaded every month. One has to be careful, though, as fees will apply. For example, there is a $1.50 charge for transferring from the card to a checking or savings account.
If you are already receiving social security, then you have two more years – until March, 2013 - to make this decision.
If you are already receiving social security, then you have two more years – until March, 2013 - to make this decision.
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