The Tax Court in Brief – July 25th – July 29th, 2022
For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.
Tax Litigation: The Week of July 25th, 2022, through July 29th, 2022
- Elstein v. Comm’r, T.C. Summary Opinion 2022-14 | July 18, 2022 | Panuthos, J. | Dkt. No. 18272-17S
- Hall v Commissioner, T.C. Memo. 2022-82 | July 28, 2022 | Marshall, J.| Dkt. No. 8541-20
Kinney v. Comm’r, T.C. Memo. 2022-81 | July 28, 2022 | Weiler, J. | Dkt. No. 17664-19
Short Summary: From 1975 until 2014 Charles Kinney worked as an attorney licensed in California. In 2008, he was declared to be a vexatious litigant for commencing unmeritorious litigations, primarily against his neighbor. On June 24, 2016, he was officially disbarred. This Tax Court opinion regards the IRS’s disallowance of Kinney’s claimed deductions for business expenses reported on Schedule C, Profit or Loss From Business for tax year 2016. On his return, Kinney reported that he was a consultant, but during the IRS’s audit proceedings, Kinney changed his “business” to “Data Entry, Consulting, Tech. Serv., [and] Whistle-Blower.” Kinney claimed deductions for car and truck expenses, insurance expenses (other than health), utilities expenses, and other expenses. The Schedule C business activities did not generate a profit and the business activities and associated expenses predominantly stemmed from litigation relating to challenging Kinney’s disbarment and lawsuits that would otherwise personally benefit him. The Tax Court opinion provides much detail on Kinney’s litigation proclivities and lawsuit losses because the expenses incurred by Kinney in various matters were reported on his Schedule C. While colorful, the details of those litigation matters are not relevant for this blog. For “other expenses,” Kinney claimed deduction for life insurance, personal liability umbrella insurance policy, and water sports accidents and injuries insurance.
- Whether Kinney was entitled to deduct Schedule C (1) other expenses and (2) car and truck expenses reported on his 2016 tax return?
- While the documentation Kinney provided showed that certain expenses were paid, there was no credible evidence introduced as to the business purpose of the expenses or that the expenditures were ordinary and necessary for the purpose indicated. The litigation expenses were personal and nondeductible since they were associated with Kinney’s disbarment, vexatious litigant declaration, and prior property disputes with his neighbors. The insurance expenses were likewise personal and thus nondeductible.
Key Points of Law:
- Burden of Proof and Rules of Review. In general, the IRS’s determinations set forth in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving otherwise. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions are a matter of legislative grace, and the taxpayer generally bears the burden of proving entitlement to any deduction claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). The taxpayer is required to maintain records that are sufficient to enable the Commissioner to determine his correct tax liability. I.R.C. § 6001. The taxpayer bears the burden of substantiating the amount and purpose of the claimed deduction. Higbee v. Commissioner, 116 T.C. 438, 440 (2001).
- Cohan When a taxpayer establishes that he or she paid or incurred a deductible expense but fails to establish the amount of the deduction, the Tax Court may sometimes estimate the amount allowable as a deduction. Cohan v. Commissioner, 39 F.2d 540, 543–44 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742–43 (1985). However, there must be sufficient evidence in the record to permit the Court to conclude that a deductible expense was paid or incurred in at least the amount allowed. Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957). The burden of proof may shift to the IRS if the taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the proper tax liability and establishes that he or she complied with the requirements of section 7491(a)(2)(A) and (B) to substantiate items, to maintain required records, and to cooperate with the IRS’s reasonable requests. I.R.C. § 7491(a)(1) and (2).
- Different Business Components. Having a business with various different components does not, in and of itself, preclude a taxpayer from arguing that they constitute one business for purposes of section 183. See Reg. § 1.183-1(d)(1). However, if a taxpayer’s claimed expense deductions are personal or otherwise excluded under the Code, the Tax Court need not consider whether the activities—either individually or collectively—were entered into with the requisite profit motive. See Treas. Reg. § 1.183-2(a).
- Section 162 Business Expense Deduction. Section 162(a) allows as a deduction “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” The taxpayer must show that he or she engaged in the activity with an “actual and honest objective of making a profit.” Hulter v. Commissioner, 91 T.C. 371, 392 (1988); see Vest v. Commissioner, T.C. Memo. 2016-187, at *10, aff’d, 690 F. App’x 210 (5th Cir. 2017). No deduction is allowed for “personal, living, or family expenses.” I.R.C. § 262(a). Whether an expenditure satisfies the requirements for deductibility under section 162 is a question of fact. See Commissioner v. Heininger, 320 U.S. 467, 475 (1943).
- Ordinary and Necessary Expenses. An ordinary expense is one that commonly or frequently occurs in the taxpayer’s business, and a necessary expense is one that is appropriate and helpful in carrying on the taxpayer’s business. See Deputy v. du Pont, 308 U.S. 488, 495 (1940) (ordinary); Commissioner v. Heininger, 320 U.S. at 471 (necessary); Treas. Reg. § 1.162-1(a).
- Legal Fees and Attorney-Related Expenses. The deductibility of legal fees depends on the origin and character of the claim for which the expenses were incurred and whether the claim bears a sufficient nexus to the taxpayer’s business or income-producing activities. See United States v. Gilmore, 372 U.S. 39, 48–49 (1963). “[T]he origin and character of the claim with respect to which an expense was incurred, rather than its potential consequences upon the fortunes of the taxpayer, is the controlling basic test.” at 49. In order for a taxpayer’s legal fees to be deductible on Schedule C, they must have originated in the taxpayer’s work as a licensed attorney and not in personal matters. Section 162(a) does not allow for the deduction of fees paid and costs incurred to gain admission to a state bar. See Ryman v. Commissioner, 51 T.C. 799, 801–03 (1969). Expenses incurred with the goal of protecting one’s reputation are also irrelevant and nondeductible. See Vannier v. Commissioner, T.C. Memo. 1997-370, 1997 WL 459741, at *4.
- Section 262 Rules. Section 262 takes precedence over section 162. Commissioner v. Idaho Power Co., 418 U.S. 1, 17 (1974). If the origin of a claimed deductions is personal as defined under section 262, the Tax Court need not consider whether they are ordinary and necessary to Schedule C business activities. Section 274(d) prescribes more stringent substantiation requirements to be met before a taxpayer may deduct certain categories of expenses, including travel expenses, meals and lodging while away from home, and expenses with respect to listed property as defined in section 280F(d)(4). See Sanford v. Commissioner, 50 T.C. 823, 827 (1968), aff’d per curiam, 412 F.2d 201 (2d Cir. 1969).
- Section 274 Rules. Even if such an expense would otherwise be deductible, section 274 may still preclude a deduction if the taxpayer does not present sufficient substantiation. Temp. Treas. Reg. § 1.274-5T(a). “Adequate records” generally consist of an account book, a diary, a log, a statement of expenses, trip sheets, or a similar record made at or near the time of the expenditure or use, along with supporting documentary evidence. at § 1.274-5T(c)(2). The Court may not use the Cohan Rule to estimate expenses covered by section 274(d). See id. at § 1.274-5T(a). If a taxpayer does not satisfy the adequate records requirement with respect to one or more elements, he or she may substantiate those elements with his or her own detailed statement and with other corroborative evidence. See I.R.C. § 274(d); Temp. Treas. Reg. § 1.274- 5T(a), (b), and (c). The Tax Court is not compelled to accept a taxpayer’s unsubstantiated, conclusory, and self-serving statements without additional evidence. See Johnson v. Commissioner, T.C. Memo. 1999-127, aff’d, 246 F.3d 674 (9th Cir. 2000).
- “Listed Property.” “Listed property” as defined in section 280F(d)(4) includes passenger automobiles, which are defined as four-wheeled vehicles weighing under 6,000 pounds and manufactured primarily for use on public streets and highways. I.R.C. § 280F(d)(5)(A). A passenger automobile does not include any ambulance, hearse, or vehicle used by the taxpayer directly in a trade or business of transporting persons or property for compensation or hire. SeeR.C. § 280F(d)(5)(B); Hatte v. Commissioner, T.C. Memo. 2019-109, at *7 n.3.
- Life Insurance Premiums. Deductions are not allowed for premiums paid on any life insurance policy if the taxpayer is directly or indirectly a beneficiary under the policy or contract. I.R.C. § 264(a)(1); see Ong v. Commissioner, T.C. Memo. 2012-114; Minick v. Commissioner, T.C. Memo. 2010-12. Insurance designed to insure personal activities is also not deductible.
- Whistle-Blow Expenses. Whistleblowing expenses are nondeductible when the whistleblowing activities are merely a continuation of personal lawsuits. See R.C. § 1001, 262(a).
Insights: Kinney represents another case of a taxpayer failing the substantiation requirements for deductions of business expenses under sections 162 and 274. Kinney failed to appropriately establish that the expenses claimed for deduction were related to a legitimate trade or business. The expenses were personal in nature, even though some were incurred in Kinney’s effort to save his law license or to protect his property. Insufficient corroborating testimony was given, and generalized or self-serving testimony is insufficient to otherwise establish any of the required elements for deduction of the claimed expenses.