Tax Court in Brief | Gonzalez v. Commissioner | Proving Up Business Expenses

The Tax Court in Brief – July 18th – July 22nd, 2022

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.

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Tax Litigation:  The Week of July 18th, 2022, through July 22nd, 2022

• Pettennude v. Comm’r, T.C. Memo. 2022-79 | July 18, 2022 | Buch, J. | Dkt. No. 636-21L
• Soler v. Comm’r, T.C. Memo. 2022-78 | July 18, 2022 | Marvel, J. | Dkt. No. 18639-19

Gonzalez v. Comm’r, T.C. Summary Opinion 2022-13 | July 18, 2022 | Panuthos, J. | Dkt. No. 1548-19S

Opinion

Short Summary:  In 2015, Petitioner lived in Palo Alto, working full time for an employer in that city.  She also worked with a patternmaker in Los Angeles to make patterns and samples, having become interested the previous year in starting a business there as a wholesaler designing children’s clothing. Every other weekend Petitioner would drive from Palo Alto to a workshop in southern California, a trip of around 400 miles one way. There, she would review the workshop’s progress, provide supplies, and give further direction to the patternmakers.

Petitioner reported wages from her employer on her Form 1040, U.S. Individual Income Tax Return for 2015. On her Schedule C (Form 1040), Profit or Loss from Business, Petitioner deducted advertising expenses, other business property expenses, utilities expenses, car and truck expenses, travel expenses, and other business expenses.

The Internal Revenue Service (“IRS”) allowed Petitioner’s Schedule C deductions for “Rent or Lease—Other Business Property”, advertising, and utilities. Nevertheless, the IRS issued a notice of deficiency disallowing her deductions for car and truck expenses, travel expenses, and other business expenses.

To substantiate her travel expenses, Petitioner submitted logs estimating the miles she traveled and other expenses. She also had receipts for two vehicle services in 2015 and 2016.  To substantiate her other business expenses, Petitioner submitted an invoice from her patternmaker stating that payments were made by cashier check for 25 patterns to a workshop in Los Angeles.

Key Issues

• Was Petitioner entitled to deduct the car and truck expenses, travel expenses, and other business expenses that she claimed on her 2015 return?

Primary Holdings

• The Tax Court found that Petitioner was entitled to deduct the car and truck expenses and travel expenses that she claimed on her 2015 return. However, Petitioner was not entitled to deduct the other business expenses that she had claimed.
  • The Tax Court determined that Petitioner’s tax home was in Palo Alto and that she was engaged in a trade or business in Los Angeles relating to the production of children’s clothing. As such, and after taking into account Petitioner’s testimony and the IRS’s determination that Petitioner could deduct certain other expenses in connection with this business, the Tax Court found that her traveling expenses were ordinary and necessary for her business in wholesale clothing design.
  • Furthermore, the Tax Court found that Petitioner had properly substantiated her car and truck expenses and therefore was entitled to deduct such expenses. Petitioner had submitted a mileage log detailing the dates traveled, distances traveled, and the purpose of each trip and had testified credibly about the business nature of her trips. Petitioner’s vehicle service receipts also corroborated the miles driven.
  • The Tax Court likewise determined that Petitioner had properly substantiated here travel expenses and therefore was entitled to deduct such expenses. Petitioner had submitted a log estimating her claimed meals and incidental expenses using the standard per diem rate for Los Angeles and had established the time, place, and business purpose of her travel.
  • However, the Tax Court found that Petitioner was not entitled to deduct other business expenses that she claimed for the year. Based on the invoice that Petitioner had submitted, the Tax Court was unable to determine when the payments at issue were made or for what purpose.

Key Points of Law

• The Commissioner’s determinations in a notice of deficiency generally are presumed correct, and the taxpayer bears the burden of proving that the determinations are in error. Welch v. Helvering, 290 U.S. 111, 115 (1933).
• Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving that she is entitled to any deduction claimed. See Tax Court Rule 142(a); Deputy v. du Pont, 308 U.S. 488, 493 (1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).
• If a taxpayer can show that she paid or incurred a deductible expense but is unable to substantiate the precise amount, the Tax Court generally may estimate the deductible amount, but only if the taxpayer presents sufficient evidence to establish a rational basis for making the estimate. See Cohan v. Commissioner, 39 F.2d 540, 543–44 (2d Cir. 1930).
• Section 162 generally allows a deduction for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Boyd v. Commissioner, 122 T.C. 305, 313 (2004).
• The taxpayer bears the burden of proving that expenses were of a business nature rather than personal and that they were ordinary and necessary. Rule 142(a); Welch v. Helvering, 290 U.S. at 115.
• Section 162(a)(2) allows taxpayers to deduct traveling expenses if they are: (1) ordinary and necessary, (2) incurred while away from home, and (3) incurred in the pursuit of a trade or business. See Commissioner v. Flowers, 326 U.S. 465, 470–72 (1946).
• A taxpayer’s “home” is generally considered to be his or her regular or principal place of business. Mitchell v. Commissioner, 74 T.C. 578, 581 (1980).
• When a taxpayer engages in business at multiple posts, his tax home is where he spends most of his time, engages in most of his business activity, and derives the greater proportion of his income. See Folkman v. United States, 615 F.2d 493, 496 (9th Cir. 1980) (citing Markey v. Commissioner, 490 F.2d 1249, 1255 (6th Cir. 1974), rev’gC. Memo. 1972-154).
• Certain expenses, including vehicle and travel expenses, require strict substantiation, through adequate records or by sufficient evidence corroborating the taxpayer’s own statement, of the amount, time, place, and business purpose of these expenditures. R.C. § 274(d).
• Substantiation by adequate records requires the taxpayer to maintain an account book, a diary, a log, a statement of expense, trip sheets, or a similar record prepared contemporaneously with the expenditure and documentary evidence (e.g., receipts or bills) of certain expenditures. Reg. § 1.274-5(c)(2)(iii); Temp. Treas. Reg. § 1.274-5T(c)(2).
• Substantiation by other sufficient evidence requires the production of corroborative evidence in support of the taxpayer’s statement specifically detailing the required element. Temp. Treas. Reg. § 1.274-5T(c)(3).
• A self-employed individual can deduct meal and incidental expenses computed at the federal standard per diem rate for the locality of travel for each calendar day of travel away from home. See Proc. 2011-47, § 1, 2011-42 I.R.B. at 520.
• An amount is deemed substantiated for purposes of section 274(d) if the taxpayer can substantiate the time, place, and business purpose of travel. See Treas. Reg. § 1.274-5T(b)(2), (c); Rev. Proc. 2011-47, § 4, 2011-42 I.R.B. at 522–23.

Insights: This case demonstrates the importance of keeping sufficient records to substantiate business expenses.  It may be tedious at the time, but it can really pay off in the long run.

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