Tax Court in Brief | Scholtz v. Commissioner | Itemized Deductions, Charitable Contributions and Unreimbursed Employee Expenses

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Tax Litigation:  The Week of April 4th, 2022, through April 8th, 2022

Scholz v. Comm’r, T.C. Summary Opinion 2022-5 |April 4, 2022 |Panuthos, J. | Dkt. No. 20743-19S

Short Summary: Suzanne Scholz taught courses at multiple higher education institutions throughout California. She also worked as a sales consultant for various companies. For the tax year in issue (2016), Scholz claimed $44,198 of itemized deductions, including deductions for charitable cash and noncash contributions made to individuals and organizations, vehicle repair expenses, and unreimbursed employee expenses, such as travel, meals, and entertainment expenses. The IRS disallowed about $23,000 of the claimed deductions and issued an accuracy-related penalty of $1,012. Scholz petitioned the Tax Court for redetermination.

Primary Holdings: 

  • Scholtz failed to provide appropriate substantiation of the claimed cash and noncash charitable contributions that the IRS disallowed for deduction. Contributions to individuals do not qualify as charitable contributions as defined by the Code. As for claimed unreimbursed employee expenses, Scholtz likewise failed to meet the IRS’s substantiation requirements for vehicle repair expenses and for travel, meals, and entertainment expenses. None of the work trips were required by her employers; the trips were personal, rather than business-related.
  • The record supported the accuracy-related penalty because, among other reasons, Scholtz failed to adequately support substantial amounts of claimed deductions and, while she hired H&R Block to prepare her tax return, she failed to show that she provided necessary and accurate information to her return preparer.

Key Points of Law:

  • Burdens of Proof. Generally, the IRS’s determinations are presumed correct, and the taxpayer bears the burden of proving the Commissioner’s determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Taxpayers bear the burden of proving (and substantiating with adequate records) their entitlement to any deductions claimed. Rule 142(a); INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992); 26 U.S.C. § 6001.
  • A taxpayer claiming a deduction on a federal income tax return must demonstrate that the deduction is provided for by statute and must further substantiate that the expense to which the deduction relates has been paid or incurred. 26 U.S.C. § 6001; Hradesky v. Comm’r, 65 T.C. 87, 89–90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976); Treas. Reg. § 1.6001-1(a). A taxpayer is required to maintain records sufficient to enable the IRS to determine the correct tax liability. See Reg. § 1.6001-1(a).
  • Charitable Contributions. A taxpayer may deduct charitable contributions made to qualifying organizations during the taxable year. 26 U.S.C. § 170(a)(1), (c). Substantiation requirements must be met. See ; Treas. Reg. § 1.170A-13. Subject to various exceptions, if property other than money is donated, then “the amount of the contribution is the fair market value of the property at the time of the contribution.” Treas. Reg. § 1.170A-1(c)(1).
  • A charitable contribution of money must be substantiated by at least one of the following: (1) a canceled check; (2) a receipt from the donee charitable organization showing the name of the donee, the date of the contribution, and the amount of the contribution; or (3) in the absence of a canceled check or receipt from the donee charitable organization, other reliable written records showing the name of the donee, the date of contribution, and the amount of the contribution. Treas. Reg. § 1.170A-13(a)(1); see 170(f)(17).
  • A charitable contribution of property must be substantiated by a receipt showing: (1) the name of the donee; (2) the date and location of the contribution; and (3) a description of the property in detail reasonably sufficient under the circumstances. Treas. Reg. § 1.170A-13(b)(1).
  • Additional information is required to support a deduction exceeding $500 for a charitable contribution of property: (1) the item’s manner of acquisition as well as either the item’s approximate date of acquisition or the approximate date the property was substantially completed and (2) the cost or other basis, adjusted as provided by section 1016, of property donated by the taxpayer during the taxable year. See 26 U.S.C. § 170(f)(11)(A)(i), (B); Treas. Reg. § 1.170A-13(b)(3)(i).
  • For contribution of a qualified motor vehicle with a claimed value that exceeds $500, the donee must provide a written acknowledgment that contains specific information required by the Code. See 26 U.S.C. § 170(f)(12)(A), (B).
  • For additional information, please see Freeman Law Insights Blog, Joint Committee on Taxation Report on Tax Treatment of Charitable Contributions (March 22, 2022).
  • Unreimbursed Employee Business Expenses. Section 162(a) allows the deduction of “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” The term “trade or business” includes performing services as an employee.
  • To deduct employee business expenses, a taxpayer must prove that he or she did not receive, and did not have had the right to receive reimbursement from his or her employer. Unless specifically enumerated in the Code, no deductions are allowed for personal, living, or family expenses. See 26 U.S.C. 262(a).
  • For expenses of travel, no deduction is allowed unless the taxpayer substantiates by adequate records or by sufficient and credible evidence corroborating the taxpayer’s statement of the amount, time and place, and business purpose for each expenditure. See id. at 274(d) (flush language); Temp. Treas. Reg. § 1.274- 5T(b)(2)(ii)-(iii) (defining “time” and “place” for these purposes). For trade or business expenses relating to property, such as an automobile, the taxpayer must also establish the amount of business use “based on the appropriate measure (i.e., mileage for automobiles . . .), and the total use of the listed property for the taxable period.” Temp. Treas. Reg. § 1.274-5T(b)(6)(i)(B).
  • Adequate records for this purpose include an account book, log, or similar record and documentary evidence, contemporaneously made with the expense, that together are sufficient to establish each element of the expenditure. See id. at § 1.274-5T(c)(2)(i)-(ii)(C).
  • Accuracy-Related Penalty. Section 6662(a) and (b)(2) imposes an accuracy-related penalty of 20% of the underpayment of tax attributable to a substantial understatement of income tax. An understatement as such is substantial if the amount of the understatement for the taxable year exceeds the greater of 10% of the tax required to be shown on the return or $5,000. 26 U.S.C. § 6662(d)(1)(A).
  • The IRS must first offer sufficient evidence to indicate that it is appropriate to impose the penalty. If that burden is met, the taxpayer must produce evidence sufficient to show that the determination is incorrect. The IRS must show that it complied with the procedural requirements of section 6751(b)(1). See 26 U.S.C. § 7491(c); Chai v. Comm’r, 851 F.3d 190, 217–18, 221–22 (2d Cir. 2017), aff’g in part, rev’g in partC. Memo. 2015-42.
  • Section 6751(b)(1) provides that no penalty shall be assessed unless “the initial determination” of the assessment was “personally approved (in writing) by the immediate supervisor of the individual making such determination.”
  • Once the IRS has met his burden, the taxpayer may avoid a section 6662(a) accuracy-related penalty to the extent the taxpayer can demonstrate (1) reasonable cause existed for the underpayment and (2) that the taxpayer acted in good faith with respect to the amount paid. 26 U.S.C. § 6664(c)(1).
  • To prove reliance on the advice of a professional tax preparer, the taxpayer must show that: (1) the adviser was a competent professional with sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the adviser, and (3) the taxpayer actually relied in good faith on the adviser’s judgment. Neonatology Assocs., P.A. v. Comm’r, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).
  • Statutory complexity alone does not constitute reasonable cause. Barnes v. Comm’r, T.C. Memo. 2012-80, 2012 WL 952760, at *15, aff’d, 712 F.3d 581 (D.C. Cir. 2013).

Insights: Tax deductions are a matter of legislative grace. To deduct employee business expenses, the taxpayer must have and maintain adequate records, contemporaneously made with the expense, to justify the available deduction. Travel logs, odometer readings, and other contemporaneous records to show the time, place, and business purpose for an expense are critical to appropriately substantiate entitlement to a deduction for an expense incurred in carrying on a trade or business. To deduct charitable contributions, the taxpayer must be prepared to substantiate the applicable contribution and qualification of the donee organization. Different substantiation rules apply to different forms (and amounts) of contributions. Cash contributions are substantiated differently than, for example, donations of a vehicle, and a taxpayer should take due care with the substantiation requirements to ensure the tax benefits of an act of charity remain available upon IRS audit.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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