Tax Court in Brief | Spencer v. Commissioner | Itemized Business Deductions and Substantiation Requirements

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The Tax Court in Brief – June 6th – June 10th, 2022

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Tax Litigation: The Week of June 6th, 2022, through June 10th, 2022

Spencer v Commissioner, T.C. Memo. 2022-8 | June 7, 2022 | Marshall, J.| Dkt. No. 17106-19S

Opinion

Short Summary: This case involves the disallowance of taxpayer’s deductions regarding (1) contract labor expenses, (2) car and truck expenses, and (3) repairs, and maintenance expenses for not meeting substantiation requirements. In tax years 2016 and 2017, Brandon Spencer (Spencer) operated Home Comfort Transportation LLC (Home Comfort), a business that offered non-emergency transportation services to medical patients. As part of its business, Home Comfort purchased and maintained vehicles and had full-time and part-time drivers who were paid by check and cash, respectively. Cash compensation payments were not documented. Additionally, Spencer retained receipts for vehicle rentals, purchases and tolls, invoices from repairs, an insurance statement, and vehicle registration records. On his tax returns for years 2016 and 2017, Spencer claimed Schedule C itemized deductions for Home Comfort’s expenses, including contract labor and vehicle-related expenses. The IRS selected Spencer’s returns for examination and IRS issued a notice of deficiency (IRS CP3219A Notice) to him. Spencer filed a petition with the Tax Court and, after concessions by the IRS, the issue remaining for trial regarded deductions for expenses for contract labor and vehicle-related expenses.

Key Issues:

  • Whether, pursuant to 26 U.S.C. § 274(d) (substantiation requirements), Spencer presented sufficient substantiation to evidence entitlement to the business deductions claimed under Schedule C regarding contract labor and vehicle rental, repairs, and maintenance expenses?

Primary Holdings:

  • Yes, for some; and no, for most. Spencer was permitted a portion of the contract labor expense deduction. For vehicle-related expenses, Spencer failed to keep detailed evidence to support the times and places where the car rentals were used, to prove they were utilized for Home Comfort’s business purposes, and he did not provide enough information to substantiate he was entitled to additional deductions regarding repairs and maintenance expenses. Consequently, he failed to meet the higher substantiation requirements to be entitled to deduct vehicle-related expenses.

Key Points of Law:

  • The IRS’s determinations in a notice of deficiency are generally presumed correct, and the taxpayer bears the burden of proving by a preponderance of the evidence that the determinations are in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Section 7491(a) allows the burden of proof to the IRS if a taxpayer introduces credible evidence concerning to any factual issue relevant to ascertaining the liability of the taxpayer. If a taxpayer fails to provide such evidence, the burden remains with the taxpayer..
  • Section 26 U.S.C. § 162(a)(3) allows a taxpayer to deduct the ordinary and necessary expenses paid required to carry out any trade or business made within a taxable year. Taxpayers must maintain books and records sufficient to establish income and deductions. See 26 U.S.C. § 6001; Treas. Reg. § 1.6001-1(a), (e).
  • If the taxpayer is unable to substantiate the precise amount considered deductible, the Tax Court may estimate the amount of deductible expenses (Cohan rule). See Cohan v. Commissioner, 39 F.2d 540, 543–44 (2d Cir. 1930).
  • Section 274(d) overrides the Cohan rule for certain expenses. Section 274(d) provides that, for the taxpayer to deduct certain expenses under Section 162, including expenses for the use of listed property such as passenger automobiles must meet stricter substantiation requirements.
  • The taxpayer must substantiate by adequate records or by sufficient evidence corroborating the taxpayer’s testimony: (1) the amount of the expense or other item, (2) the time, place the date and description of the expense, (3) the business purpose of the expense or use, and (4) the business relationship. See 26 U.S.C. 274(d); Temp. Treas. Reg. § 1.274-5T(a).

Insights: This case is another example of a taxpayer failing to properly document and substantiate business expenses for deductions on Schedule C of Form 1040. To receive favorable tax treatment for itemized business expense deductions, Section 274 and related Treasury Regulations should be considered and honored by adequate and timely recordkeeping. For additional information on 26 U.S.C. Section 274(d) (substantiation requirements), see Freeman Law:

Tax Court in Brief | Valentine v. Commissioner | Taxability of Military Pension and Disability Payments and Business Expense Substantiation – Freeman Law

Tax Court in Brief | Harrison v. Commissioner | Itemized Deductions, Charitable Contributions, Passive Income – Freeman Law

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

For additional information on Notice of Deficiency, see Freeman Law attorney Matthew Robert’s What is an IRS Notice of Deficiency? | Income Tax Returns | Freeman Law

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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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