Freeman Law | The Tax Court in Brief

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Freeman Law | The Tax Court in Brief

The Tax Court in Brief

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering this week’s Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

 

The Week of May 18 – 22, 2020

 

Nesbitt v. Comm’r, T.C. Memo. 2020-61 | May 18, 2020 | Lauber, J. | Dkt. No. 8296-19L

Short SummaryThe IRS issued a notice of proposed levy, and the Taxpayers timely requested a CDP hearing with Appeals.  During the CDP hearing, the Taxpayers failed to provide requested financial information and failed to submit copies of unfiled tax returns for prior years.  On this basis, Appeals issued a Notice of Determination sustaining the proposed levy.

Key Issue:  Whether Appeals abused its discretion in sustaining the proposed levy.

Primary Holdings

  • Because the underlying tax liability was not at issue, the Tax Court reviewed Appeals’ determinations for an abuse of discretion. Under this standard, Appeals abuses its discretion when it makes a determination that is arbitrary, capricious, or without sound basis in fact or law.
  • Here, there was no abuse of discretion because: (1) Taxpayers failed to make a concrete collection alternative proposal; (2) Taxpayers failed to supply requested financial information after being given sufficient time to do so; and (3) Appeals may reject proposed collection alternatives where a taxpayer is not in compliance with prior tax year filing obligations.

Key Points of Law:

  • R.C. § 6330(d)(1) does not prescribe the standard of review that this Court should apply in reviewing an IRS administrative determination in a CDP case. The general parameters for such review are marked by our precedents.   Where (as here) the underlying tax liability is not at issue, the Court reviews the IRS decision for abuse of discretion.  Goza v. Comm’r, 114 T.C. 176, 182 (2000).
  • A taxpayer must properly present an underlying liability challenge at the CDP hearing in order to preserve that challenge for judicial review. See Giamelli v. Comm’r, 129 T.C. 107, 113 (2007); Treas. Reg. § 301.6330-1(f)(2), Q&A-F3, Proced. & Admin. Regs.
  • Abuse of discretion exists when a determination is arbitrary, capricious, or without sound basis in fact or law. See Murphy v. Comm’r, 125 T.C. 301, 320 (2005), aff’d, 469 F.3d 27 (1st Cir. 2006).
  • In deciding whether the SO abused her discretion in sustaining the proposed levy, we consider whether she: (1) properly verified that the requirements of any applicable law or administrative procedure have been met; (2) considered any relevant issues petitioners raised; and (3) determined whether “any proposed collection action balances the need for the efficiency collection of taxes with the legitimate concern of * * * [petitioners] that any collection action be no more intrusive than necessary.”  R.C. § 6330(c)(3).

InsightAs the Nesbitt case shows, Appeals does not abuse its discretion and can sustain a proposed IRS collection action if a taxpayer fails to provide requested financial information and is not in compliance with prior year tax obligations.

 

Pope v. Comm’r, T.C. Memo. 2020-62 | May 18, 2020 | Lauber, J. | Dkt. No. 3411-19

Short SummaryThe IRS disallowed Taxpayer’s withholding credits of $7,856.  In conjunction with the disallowance, the IRS issued a notice of deficiency for 2017 of “$.00.”  Although the notice erroneously referred to adjusting Taxpayer’s earned income tax credit, Taxpayer had not claimed the earned income tax credit on his return.  After Taxpayer filed a petition with the Tax Court, the IRS moved to dismiss the case for lack of jurisdiction under I.R.C. § 6213.  On these facts, the Tax Court granted the IRS’ motion.

Key IssueWhether the Tax Court has jurisdiction to redetermine an adjustment to withholding credits under I.R.C. § 31.

Primary Holdings:

  • Adjustments in a notice of deficiency to withholding credits under I.R.C. § 31 lie outside the Tax Court’s deficiency jurisdiction.
  • Because the correct tax for the year and the tax shown on the return are both determined “without regard to credit under section 31,” withholding credits (and overstatements thereof) are necessarily excluded from “deficiencies” as defined by I.R.C. § 6211(a)(1). And because the Tax Court’s jurisdiction relevant to this case was limited to “redetermination of the deficiency” determined by the IRS, it lacked jurisdiction to redetermine an adjustment to withholding credits.

Key Points of Law:

  • This Court is a court of limited jurisdiction and may exercise jurisdiction only to the extent expressly authorized by Congress. Naftel v. Comm’r, 85 T.C. 527, 529 (1985); Breman v. Comm’r, 66 T.C. 61, 66 (1976).  “Jurisdiction must be shown affirmatively, and petitioner, as the party invoking our jurisdiction * * *, bears the burden of proving that we have jurisdiction over * * * [the] case.”  David Dung Le, M.D., Inc. v. Comm’r, 114 T.C. 268, 270 (2000), aff’d, 22 F. App’x 837 (9th Cir. 2001).
  • R.C. § 6212(a) authorizes the IRS to send the taxpayer a notice of deficiency, and I.R.C. § 6213(a) grants this Court jurisdiction to make a “redetermination of the deficiency” determined by the IRS. A “deficiency” is defined as the amount by which the tax imposed for the year (i.e., the correct amount of tax) exceeds “the amount shown as the tax by the taxpayer upon his return” plus any “amounts previously assessed * * * as a deficiency.”  I.R.C. § 6211(a)(1).  I.R.C. § 6211(b)(1) in turn provides that the “tax imposed * * * and the tax shown on the return shall both be determined * * * without regard to credit under section 31.”  I.R.C. § 31, captioned “Tax withheld on wages,” provides:  “The amount withheld as tax [by an employer] under chapter 24 shall be allowed to the recipient of the income as a credit against the [income] tax.”  I.R.C. § 31(a)(1).
  • Because the correct tax for the year and the tax shown on the return are both determined “without regard to the credit under section 31,” withholding credits (and overstatements thereof) are necessarily excluded from “deficiencies” as defined by I.R.C. § 6211(a)(1). And because our jurisdiction as relevant here is limited to “redetermination of the deficiency” determined by the IRS, we lack jurisdiction to determine an adjustment to withholding credits.  See Bregin v. Comm’r, 74 T.C. 1097, 1102 (1980).
  • That withholding credit adjustments lie outside our deficiency jurisdiction is confirmed by I.R.C. § 6201(a)(3). It provides that if an “overstatement of the credit for income tax withheld” appears on a tax return, then the amount of the overstatement “may be assessed by the Secretary in the same manner as in the case of a mathematical or clerical error.”    Adjustments for mathematical and clerical errors typically are assessed summarily outside deficiency procedures.  I.R.C. § 6213(b)(1).

Insight:  The Pope case demonstrates the fundamental principle that the Tax Court is a court of limited jurisdiction.  Its jurisdiction is therefore limited to that expressly provided by Congress.

 

Richlin v. Comm’r, T.C. Memo. 2020-60 | May 18, 2020 | Halpern, J. | Dkt. No. 16301-16L

Short SummaryTaxpayer and her late husband, MS, had entered into a premarital agreement in which MS agreed to be liable for any and all taxes, interest, penalties and other costs related to taxes incurred during the marriage excluding certain income generated by the separate property of the Taxpayer or income generated directly by Taxpayer’s efforts during the marriage.  Taxpayer and MS filed a joint income tax return for 2005, which reported an overpayment and which was applied to their 2006 tax year.  In addition, for 2006 and 2007, MS sent the IRS checks from a trust in which he was trustee, which had correspondence providing Taxpayer and MS’s name and Social Security Numbers.

In 2007, a Nevada court entered a divorce decree, dissolving the marriage between MS and Taxpayer.  Thereafter, MS made an additional extension tax payment with respect to his 2006 return.  During the divorce proceedings, MS had made several filings with the divorce court requesting Taxpayer “pay her portion of the parties’ 2006 taxes.”

For the 2006 tax year, Taxpayer filed her own income tax return, claiming, as amended, a filing status of married filing separately.  In addition, the return claimed credits equal to half of: (1) the overpayment shown on the 2005 joint return she filed with MS; (2) the estimated payments MS made in 2006 and 2007; and (3) the extension payment MS made in 2007.

The IRS filed a Notice of Federal Tax Lien against Taxpayer for her 2006 tax year.  In response, Taxpayer filed a CDP hearing request, and Taxpayer and the IRS executed a Form 12257, Summary Notice of Determination, Waiver of Right to Judicial Review of a Collection Due Process Determination, and Waiver of Suspension of Levy Action (the “2012 Summary Notice”).  In the 2012 Summary Notice, it indicated that Appeals had determined that Campus had inappropriately transferred credits back to Taxpayer’s deceased husband’s taxes for the same year.  In addition, the 2012 Summary Notice determined that “the correct resolution is to credit the taxpayer with these amounts.”

Notwithstanding the 2012 Summary Notice, the IRS sent Taxpayer a notice of intent to levy in 2013, which covered her 2006 and 2012 tax years.  In response, Taxpayer requested another CDP hearing, which led to the execution of a second Form 12257 in August 2014 (the “2014 Summary Notice”).  The 2014 Summary Notice stated:  “Appeals does not sustain the proposed levy action as a collection alternative has been reached.”  The 2014 Summary Notice then refers to the determination already made in the 2012 Summary Notice.

In response to the 2012 Summary Notice determination, MS’s estate claimed entitlement to the credits and sought the assistance of the Taxpayer Advocate Service (TAS).  TAS received advice from IRS counsel, which supported the claim of MS’s estate.  Appeals concluded that the determination in the 2014 Summary Notice was erroneous and offered Taxpayer a “continuation” of the CDP hearing concerning the levy notice.

The continuation hearing was held in 2016.  At the CDP hearing, Taxpayer did not raise any collection alternatives.  Rather, Taxpayer reiterated her claim that she was entitled to the credits for 2006.

Appeals issued a notice of determination concluding that Taxpayer’s and MS’s 2005 joint overpayment should be allocated entirely to MS in accordance with the premarital agreement.  In addition, Appeals determined that MS was entitled to credit for the estimated tax payments in 2006 and 2007 in addition to the extension payment MS made in 2007.  The stated basis was Appeals’ determination that MS intended those payments to have been made for his own account.

Key IssueWhether Appeals abused its discretion in sustaining a proposed levy.

Primary Holdings:

  • A taxpayer’s challenge to the IRS’ crediting of tax payments is reviewed for an abuse of discretion because the challenge does not relate to the existence or amount of the tax liability. Under the abuse of discretion standard, the Tax Court will not overrule Appeals’ determinations unless they are arbitrary, capricious, clearly unlawful, or without sound basis in fact or law.  
  • Generally, in the CDP context, Appeals and/or the IRS will be bound by contract if they enter into an installment agreement under I.R.C. § 6159, a closing agreement under I.R.C. § 7121, or an offer-in-compromise under I.R.C. § 7122. But, Appeals’ determinations reflected in other agreements, such as Forms 12257, are not final and binding.
  • After a CDP case is docketed with the Tax Court, the case can be settled by means of an agreement that does not have to meet the requirements of a closing agreement under I.R.C. § 7121. Prior to the filing of a petition, however, I.R.C. §§ 7121 and 7122 provide the exclusive means of effecting a binding settlement agreement.
  • Even if the Tax Court were to accept the parties’ execution of Forms 12257 as binding contracts, the Tax Court would not conclude that either notice precludes the IRS from reaching a determination contrary to that described in the Forms 12257. Rather, the Forms 12257 in this case merely describe the disposition of the CDP proceeding.
  • Taxpayer’s argument that the Appeals abused its discretion in not complying with IRM pt. 8.22.9.13 in that Appeals cannot rescind a Form 12257 is misplaced. That provision applies only to the issuance and rescission of a Notice of Determination.
  • The Government is not equitably estopped from proceeding with collection action against Taxpayer. Under the doctrine of equitable estoppel, Taxpayer must show: (1) a false representation or wrongful, misleading silence by the party against whom the estoppel is claimed; (2) an error in a statement of fact and not in an opinion or statement of law; (3) the taxpayer’s ignorance of the truth; (4) the taxpayer reasonable reliance on the acts or statements of the one against whom estoppel is claimed; and (5) adverse effects suffered by the taxpayer from the acts or statements of the one against whom estoppel is claimed.
  • Appeals did not abuse its discretion in crediting MS’s 2007 extension payment to MS. Reg. § 1.6654-2(e)(5)(ii)(A) provides that if a couple makes a joint payment of estimated tax in regard to a year for which they end up filing separate returns “the payment made on account of the estimated tax for that taxable year may be treated as a payment on account of the tax liability of either the husband or wife for the taxable year, or may be divided between them in such manner as they may agree.” In the absence of such an agreement, the estimated payments are allocated between the two taxpayers in proportion to their separate tax liabilities.  Treas. Reg. § 1.6654-2(e)(5)(ii)(B).  However, Treas. Reg. § 1.6654-2(e)(5)(i) provides that “a joint payment of estimated tax may not be made if the husband and wife are separate under a decree of divorce or of separate maintenance.”  Because MS made the payment when a decree of divorce had already been entered, MS is credited with such payment.
  • But, the grounds cited by Appeals in the Notice of Determination do not support its factual finding that MS intended the estimated tax payments he made in 2006 and 2007 prior to the divorce decree to be for his individual account rather than joint payments of estimated tax.  Generally, under these circumstances, the Chenery doctrine precludes the Tax Court from upholding a determination on grounds other than those Appeals relied upon.  Instead, the Chenery doctrine generally requires the Tax Court to allow the agency (here, the IRS) to address, in the first instance, matters committed to its administrative discretion.

 

Frantz v. Comm’r, T.C. Memo. 2020-64 | May 19, 2020 | Urda, J. | Dkt. No. 15440-18W

Short SummaryPetitioner sought review of the IRS Whistleblower Office’s decision to deny a whistleblower award for an alleged understatement by a chapter 7 bankruptcy trustee of the bankruptcy estate’s tax liability.  The Tax Court granted summary judgment against the Petitioner.

Key Issue:  Whether the IRS Whistleblower Office’s determinations to reject and deny Petitioners respective whistleblower claims was an “abuse of discretion?”

Primary Holdings

  • The Whistleblower Office’s determinations were not an abuse of discretion. It performed its evaluative function, and its conclusions did not appear to lack a sound basis in fact or law.
  • While Petitioner argues that the Whistleblower Office abused its discretion by failing to launch a thorough investigation into the claims, the Tax Court has no authority to review the IRS’s decision not to act on the allegations—that decision is reserved to the discretion of the IRS.

Key Points of Law:

  • The Tax Court reviews the WBO’s determinations regarding a whistleblower award for abuse of discretion.
  • Abuse of discretion exists when the IRS’s determination is arbitrary, capricious, or without sound basis in fact or law.
  • Section 7623(b) provides the circumstances in which the IRS is required to give an award to a whistleblower. Before an award can be paid, section 7623(b)(1) requires that the IRS first proceed with an “administrative or judicial action” and collect proceeds from the target taxpayer.
  • Section 7623(b)(4) grants the Tax Court jurisdiction to review any determination regarding such an award, including rejections and denials.
  • A whistleblower claim may be “rejected” or “denied.” The WBO may reject a claim outright in its initial evaluation if it determines that the claim on its face does not meet the applicable criteria.  A denial of a claim occurs when the WBO does not reject the claim at the outset as a threshold matter, but nonetheless determines not to grant an award.

InsightThe Frantz case illustrates the need for a whistleblower to prepare a thorough whistleblower claim that provides the IRS with specific, credible information and documentation and otherwise satisfies the criteria to trigger a whistleblower award.  The case further demonstrates the deference that is accorded to the IRS under the abuse-of-discretion standard of review.

 

Peacock v. Comm’r, T.C. Memo. 2020-63 | May 19, 2020 | Vasquez, J. | Dkt. No. 11728-17

Short SummaryAfter the IRS selected the Petitioner’s tax return for audit and proposed to disallow all “other” expenses on Schedule C, the Petitioner hand-delivered a check to the IRS revenue officer along with a letter stating that he “disagree[d] completely with [her] determination.”  After exercising appeal rights, the Petitioner wrote a letter to the IRS appeals officer referencing his prior submission of a check and stating that “I made it crystal clear that this payment was made in protest, and that I completely disagreed with the IRS determination.”  The evidence shows that the IRS received the remittance and recorded it as an “[a]dvance payment of tax owed” with transaction code 640.  The IRS issued a notice of deficiency.  While the IRS moved to dismiss the case for lack of jurisdiction, the Tax Court held that because, in light of the surrounding facts, the payment was a deposit, rather than a payment, there was a deficiency and the Tax Court had jurisdiction.

Key Issue:  Whether Petitioner’s remittance, which was made before the mailing of the IRS’s notice of deficiency, deprived the Tax Court of jurisdiction?

The IRS contended that the notice of deficiency was invalid because the Petitioner’s remittance extinguished the tax deficiency before the notice was issued.  Petitioners, on the other hand, argued that the remittance was not a payment, but rather a deposit, which would preserve their right to petition the court under Rev. Proc. 2005-18, sec. 4.02(2), 2005-1 C.B. 798, 799.

Primary Holdings

  • The Petitioner’s written statements along with the remittance of payment indicated that he submitted the payment as a deposit, rather than a payment. As a result, the Tax Court had deficiency jurisdiction.

Key Points of Law:

  • The Tax Court is a court of limited jurisdiction, and we may exercise jurisdiction only to the extent provided by Congress. 7442
  • The Tax Court has jurisdiction to redetermine a deficiency if a valid notice of deficiency is issued by the Commissioner and if a timely petition is filed by the taxpayer.
  • If a deficiency is paid in full by the taxpayer before a notice of deficiency is issued, there is no deficiency, such that the notice of deficiency is invalid and the Tax Court lacks jurisdiction.
  • The Tax Court does have jurisdiction if the Commissioner treats a remittance as a deposit and does not assess additional tax equal to the amount of the remittance before issuing the notice of deficiency.
  • Section 6603(a) permits taxpayers to “make a cash deposit with the Secretary which may be used * * * to pay any tax imposed under subtitle A or B * * * which has not been assessed at the time of the deposit.”
  • The making of a deposit stops the running of interest on a deficiency.
  • A taxpayer may make a deposit by remitting to the Commissioner a check or money order, accompanied by a written statement designating the remittance as a deposit.

InsightThe Peacock case illustrates an important distinction between a “payment” and a “deposit” of a tax.  The submission of a check to the IRS in a manner that does not comply with Rev. Proc. 2005-18 may constitute a “payment,” rather than a deposit, and deprive the Tax Court of deficiency jurisdiction.  Notably, the court found the IRM to be persuasive authority supporting the Petitioner’s position that the submission was a “deposit.”

 

Joseph v. Comm’r, T.C. Memo. 2020-65 | May 19, 2020 | Halpern, J. | Dkt. No. 27759-15

Short SummaryThe IRS issued substitutes for return (SFRs) for 2011, 2012, and 2013 pursuant to sec. 6020(b)(1).  Thereafter, the Petitioner filed returns in which he claimed deductions from partnerships and S corporations.  The parties entered into several stipulations, one of which appeared to result in a duplication of income.  The Tax Court modified that stipulation to eliminate the double counting, and allowed some unsubstantiated deductions under the Cohan rule.

Key Issue:  Whether petitioner: (1) is bound by stipulations of the amount of his capital gain; (2) adequately substantiated deductions shown on returns of partnerships and S corporations that he claims should reduce his income from those entities; and (3) adequately substantiated itemized deductions and other losses and deductions shown on his returns.

Primary Holdings

  • Justice required modification of the parties’ capital gain stipulation to eliminate a manifest double counting of income but did not require any adjustment of the stipulated capital gain to reflect the IRS’s disallowance of deductions for depreciation.
  • If the bank statements and general ledger establish a plausible, though not fully substantiated, connection between an expense reported by one of Petitioner’s business entities and that entity’s business, a portion of the expense is deductible under Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).

Key Points of Law:

  • Shareholders of an S corporation, in determining their tax liability for the year, must take into account their share of specified tax items of the corporation and their share of its “nonseparately computed income or loss.” Sec. 1366(a)(1)(B).
  • The bank deposits method is an accepted method of income reconstruction when a taxpayer has inadequate books and records and large bank deposits.
  • The prospect of arithmetic errors in stipulated amounts that might result in a double counting of income does not require relieving a taxpayer from the stipulation.
  • Section 162(a) allows a deduction for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”
  • When called upon by the Commissioner, a taxpayer must substantiate his expenses.
  • Section 274(d) imposes heightened substantiation requirements for deductions or credits for traveling expenses, expenses for gifts, amounts with respect to “listed property,” and items “with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity.”
  • The Cohan rule allows the court to estimate acknowledged expenses that a taxpayer cannot fully substantiate.
  • Case law suggests a potential limit on Cohan’s scope, under which estimating unsubstantiated expenses would be inappropriate when proper recordkeeping is feasible and can reasonably be expected.
  • In Renkemeyer, the court held that an interest other than a limited partner interest could be treated as such for purposes of section 1402(a)(13) only if the holder is merely a passive investor in the entity who does not actively participate in the entity’s business operations.
  • Section 6651(a)(2) imposes an addition to tax for failure to pay timely the tax shown on a return.
  • Section 6654 imposes an addition to tax on a taxpayer who does not make estimated tax payments as required to satisfy the portion of his tax liability not covered by withholding.
  • The addition to tax for failure to file or failure to pay tax timely does not apply if the taxpayer shows that his failure “is due to reasonable cause and not due to willful neglect.”
  • The Commissioner bears the burden of production with respect to penalties. 7491(c).

InsightThe case demonstrates the usefulness of the Cohan rule, a rule with deep precedential roots that provides authority for estimating, in some circumstances, a taxpayer’s deductible expenses where a taxpayer cannot fully substantiate the expenses.  The case further demonstrates the perils of the Tax Court’s stipulation procedures.

 

Serrano v. Comm’r, T.C. Summ. Op. 2020-15 | May 20, 2020 | Gerber, J. | Dkt. No. 17836-18S 

Short SummaryThe Taxpayer worked two eight-hour jobs and also began to run and operate a farm in Mexico.  The IRS issued a notice of deficiency for the Taxpayer’s 2015 and 2016 tax years, which disallowed the Taxpayer’s Schedule F, Profit or Loss From Farming, and certain unreimbursed employee expenses and charitable contributions reported on Schedule A, Itemized Deduction.  The Tax Court held that the Taxpayer was entitled to deduct some of the expenses claimed on Schedule F and some of the unreimbursed employee expenses on Schedule A but none of the charitable contribution deductions on Schedule A.

Key IssueWhether the Taxpayer substantiated all of the deductions he claimed on Schedule F and Schedule A of his income tax returns.

Primary Holdings

  • The IRS’ determinations in a notice of deficiency are presumed correct and the taxpayer has the burden of showing entitlement to any claimed deductions. Moreover, the taxpayer must show that any work-related expenses were paid or incurred in a trade or business and/or for the production of income.  If the taxpayer can show that he incurred deductible expenses, but cannot fully substantiate the amount, the Court may estimate the amount of the expense under the Cohan rule.  But, there must be some basis upon which to make an estimate.
  • Schedule F (Farm Deductions)
  • Labor Expenses. The Taxpayer is entitled to claimed labor expenses of $6,000 related to his farm for 2015 and 2016.  He offered evidence showing the transfer of funds for that purpose that approximated the amounts claimed on the returns.  In addition, his testimony was credible.
  • Legal Expenses. The Taxpayer is entitled to claimed legal expenses of $500 for 2015.  He offered evidence that showed he purchased additional farm land in Mexico in 2015 and credibly testified that he incurred those fees in connection with the acquisition of the land.  However, he is not entitled to the same $500 legal expenses deduction for 2016 because he provided no evidence in the record that reflects the nature and purpose of those legal fees.
  • Depreciation Deductions. The Taxpayer is not entitled to any of his claimed depreciation deductions for his farm in the amounts of $12,109 and $18,105 for 2015 and 2016, respectively.  Although he was able to convince the Court that he built a warehouse and metal and wire fence on the property, he provided no evidence as to the cost of the warehouse or its useful life.
  • Schedule A Expenses
    • Travel Expenses. Travel expenses are subject to stricter substantiation rules under I.R.C. § 274(d) than other business expenses.  Because the Taxpayer provided documentation in addition to credible testimony to show that he spent $368.45 on deductible travel expenses for 2015, he is entitled to deduct that amount.  However, the remainder of his claimed travel expenses and all of his travel expenses claimed in 2016 are disallowed under I.R.C. § 274(d).
    • Charitable Contributions. The Taxpayer is not entitled to claimed charitable contribution deductions in the amounts of $5,320 and $5,420, respectively, for 2015 and 2016.  First, the $5,320 was paid to his sick sister in Mexico and does not qualify as a charitable deduction under I.R.C. § 170(a).  Second, the Taxpayer did not have an explanation for the purpose of the $5,420 expenditure in 2016.
    • Unreimbursed Employee Expenses. The Taxpayer is entitled to deduct one-fourth of his total family cell phone bill (related to four people) as an unreimbursed employee expense.  The IRS’ argument that the expenses were for personal purposes only is not credible in light of the Taxpayers’ workday schedule of two eight-hour jobs, which left him with less than 8 hours to be involved in personal activities.  However, the Taxpayer is not entitled to any remainder of claimed unreimbursed employee expenses for purchasing tools and safety equipment and purchasing and cleaning work clothing because he was unable to show that the tools, equipment, and work clothing were necessary business expenses in his employment and not personal expenses.

Key Points of Law:  

  • Generally, the IRS’ determinations are presumed correct and the taxpayer has the burden of showing entitlement to any deduction claimed. See Rule 142; New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); Welch v. Helvering, 290 U.S. 111, 115 (1933).  In addition, a taxpayer must show that his work-related expenses were paid or incurred in a trade or business and/or for the production of income.  See R.C. § 162(a), 212(1).  In instances where a taxpayer has incurred expenses but cannot fully substantiate them, the Court may estimate the amount of the expense.  See Cohan v. Comm’r, 39 F.2d 540, 543-44 (2d Cir. 1930).  For the Court to estimate the expense, there must be some basis upon which to make the estimate.  Vanicek v. Comm’r, 85 T.C. 731, 742-43 (1985).
  • To qualify as a Schedule A unreimbursed employee expense, the taxpayer must show that such expenses were necessary business expenses in his or her employment and not personal expenses. See, e.g., Yeomans v. Comm’r, 30 T.C. 757, 767 (1958).

InsightThe Serrano decision shows how difficult it can be for taxpayers to meet their burden of proof on issues of substantiation.  With respect to I.R.C. § 274(d) expenses (travel, meals and entertainment, etc.), this burden can be even more difficult to meet.  At trial, taxpayers should ensure they have documentary or other proof to provide to the Court to permit the Court at least some basis to find that the taxpayer did, in fact, pay or incur deductible expenses.  Ideally, taxpayers would maintain all of their documentary proof to substantiate their expenses, but as the Serrano decision illustrates, we do not live in an ideal world.