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In Houchin v. Commissioner, T.C. Summary Opinion 2014-29, the U.S. Tax Court concluded that truck expenses were not deductible as the mileage log did not note the locations the taxpayer traveled to.
The facts and procedural history are as follows:
- Mr. Houchin worked as a truck driver, but was unemployed in 2010.
- He collected unemployment compensation.
- Mr. Houchin also engaged in a business activity of picking up old newspapers and selling them to a recycling company. He drove his truck to whatever locations he could find that had available newspapers. He maintained a mileage log wherein he recorded the date, starting and ending odometer readings, business mileage, and personal mileage for each trip with his truck during 2009 and 2010.
- By the latter part of 2010, Mr. Houchin had secured a job as a truck driver with UPS.
- The IRS audited Mr. Houchin’s 2010 Form 1040 and disallowed his truck expenses of $17,978.
- Mr. Houchin petitioned the tax court to redetermine his tax liability.
Business expenses are deductible. Expenses associated with listed property require additional substantiation to be deductible. This additional substantiation requires the taxpayer to establish the amount of the expense, the time and place of travel, and the business purpose of the expense.
Vehicles used by truck drivers are normally not listed property, as they qualify for the exception that excludes “property substantially all of the use of which is in a trade or business of providing to unrelated persons services consisting of the transportation of persons or property for compensation or hire.” Personal vehicles are listed property.
Given the facts here, the court concluded that the expenses were subject to the additional substantiation requirements. Unfortunately, Mr. Houchin’s mileage log did not meet these requirements as it did not indicate the places where he traveled to. Mr. Houchin attempted to amend his mileage log to include this information, but, as noted by the court, this would not be sufficiently reliable. Accordingly, the court did not allow Mr. Houchin to deduct his vehicle expenses.
In In re Cherwenka, the U.S. Bankruptcy Court for the Northern District of Georgia concluded that house flipping activities in a self-directed IRA and shared ownership of property with the IRA and the account holder were not prohibited transactions.
The facts and procedural history are as follows:
- Mr. Cherwenka was in the business of flipping houses.
- Mr. Cherwenka established a self-directed IRA to engage in this activity.
- To invest, Mr. Cherwenka would identify the property and, in conjunction with a real estate agent, would submit a proposed offer to the IRA custodian.
- The IRA custodian would then review the proposal and could accept it or reject it.
- If accepted, the custodian would sign the paperwork and take title to the property as trustee.
- The property would then be held and sold or held, renovated, and sold.
- The renovations were performed by a third party contractor.
- Mr. Cherwenka was not compensated for the services he provided to the IRA.
- Mr. Cherwenka filed Chapter 7 bankruptcy and reported his self-directed IRA as an exempt asset.
The bankruptcy trustee challenged the classification, arguing that the IRA was not exempt as Mr. Cherwenka had engaged in prohibited transactions by identifying the subject properties, appointing and approving work on the properties, and overseeing payment from the custodian for such work.
The Bankruptcy Court looked to the definition of the term “transaction” as found in the dictionary, which is “an exchange of goods or services.” The court concluded that Mr. Cherwenka did not engage in a “transaction,” as required by the prohibited transaction rules. The court was also not troubled by Mr. Cherwenka making investment decisions for the IRA. The court concluded that this would be the case regardless of what asset the IRA invested in.
The bankruptcy trustee also argued that Mr. Cherwenka personally co-owning property with the IRA was a prohibited transaction because it showed that he used IRA assets for his personal interest or benefit. The court did not agree, as there was no evidence that Mr. Cherwenka shared a joint tenancy or tenancy in common ownership interest with his IRA. The evidence seemed to indicate that the property was divided, with Mr. Cherwekna and his IRA each owning a specific percentage of the property. Thus, there was no evidence that Mr. Cherwenka benefited from the part of the property that the IRA owned.
The Large Business & International or LB&I division of the IRS recently announced significant changes to the way its IRS auditors gather information from taxpayers. These announcements were made by directives issued by the LB&I Commissioner to all LB&I agents, which makes it mandatory for IRS agents to follow the directives.
These changes are intended to remedy situations where the IRS agent and the taxpayer are not communicating effectively, which results in the audit being prolonged or closed prematurely with unfavorable and unsupportable adjustments. Thus, the changes encourage an open dialogue between IRS agents and taxpayers.
The IRS will still issue written IDRs to request information from the taxpayer. However, the directive says that the IRS agent must:
- Discuss the issue to which the IDR relates with the taxpayer;
- Discuss the relationship of the information requested to the issue under consideration and explain why the information is necessary;
- Ensure that the IDR clearly indicates the issue under consideration and that the IDR only requests information relevant to the stated issue;
- Prepare one IDR for each issue;
- Ensure that the IDR is customized to the taxpayer or the taxpayer’s industry;
- Provide a draft of the IDR and discuss its contents with the taxpayer;
- Determine a reasonable timeframe for the taxpayer to provide a response to the IDR, based on consultation with the taxpayer; and
- Determine a date by which the examiner or specialist will review and provide a response to the taxpayer as to whether the information received satisfies the IDR.
The directives also clarify that IDRs issued at the beginning of the audit that request the taxpayer’s books and records or general information about the taxpayer’s business are not subject to the above-requirements. Also, the directives clarify that the above-requirements will not apply where taxpayers who refuse to provide info without a summons (i.e, in the case of a friendly summons).
The directive also describes how the IRS will enforce IDRs. Specifically, the directives explain that the IRS will follow these steps:
- Issue a Delinquency Notice;
- Issue a Pre-Summons Letter; and
- Issue a Summons.
The delinquency notice is new. It is basically a letter to the taxpayer explaining that the IDR was not responded to timely. The pre-summons letter is not new, but prior to the directives, IRS agents were not necessarily obliged to issue pre-summons letter. IRS agents would often skip the letter and simply issue the summons.
While these directives only apply to IRS agents who work for LB&I (the IRS’s LB&I division audits corporations, subchapter S corporations, and partnerships with assets greater than $10 million), LB&I’s policies are also generally adopted or followed by the Small Business/Self-Employed Division of the IRS (which audits most taxpayers who are not large enough to be audited by LB&I). Thus, these rules will influence how all IRS audits are conducted in the future.
The IRS de-coordinated its remaining Coordinated Issue Papers yesterday. This is the final step in the IRS ending its coordinated issue or tiered program.
The IRS’s coordinated issue or tiered program was how the IRS was identifying and working challenging tax issues that presented compliance problems. Coordinated Issue Papers were instructions for IRS auditors on how to handle specific tax issues. The IRS issued these papers for various tax issues that presented challenges for the IRS to audit. The goal was to ensure that IRS auditors were applying the law consistently in these cases across the country.
The coordination of issues and labeling them by tier (or severity) cast a shadow over the tax issues, which lead many IRS agents, practitioners, and taxpayers to view the issues and the taxpayers who had the issues as being problematic or trouble.
The research tax credit is a good example. The IRS issued several coordinated issue papers for the tax credit. The result was that the tax credit–which was enacted into law by Congress–was viewed as a tax credit that only troublesome taxpayers would claim.
The IRS replaced this coordinated issue system with its internal group and network system. This new system is supposed to be akin to the pre-coordinated issue system whereby the IRS made technical guidance employees available to IRS agents for more complicated tax issues. The IRS is expected to start releasing the publications or reports from these groups and networks soon. Hopefully these reports will present a more balanced view of the tax issues.
In Berks v. Commissioner, Docket No. 26883-11S, the U.S. Tax Court concluded that promissory notes held by self-directed IRAs were not worthless because the taxpayers could not establish that the notes were actually worthless.
The facts and procedural history are as follows:
- The Berks rolled over money from pre-existing IRAs to self-directed IRAs, with the intention of making loans to real estate-related partnerships.
- The partnerships issued promissory notes to the self-directed IRAs.
- The promissory notes accrued interest, but the interest would only be paid only if and when the underlying real estate was sold.
- All of the partnerships and the promissory notes became worthless.
- The self-directed IRA custodian requested information to establish that the promissory notes had become worthless, the Berks relied on their financial advisor to respond to the custodian, and the financial advisor did not provide sufficient information to the custodian.
- The custodian did close the IRA accounts as directed and distributed the promissory notes to the Berks.
- The custodian also issued Forms 1099-R to the Berks to report taxable distributions.
The IRS concluded that the amounts reported on the Forms 1099-R was to be included in the taxpayer’s income, as the taxpayers provided no evidence that the promissory notes had become worthless.
The taxpayers presented testimony from their financial advisor at trial to establish that the promissory notes were worthless. The court found that the testimony was vague and not supported by any corroborating documentation. As a result, the court agreed with the IRS and concluded that the taxpayers had not met their burden to show that the promissory notes were worthless. Thus, the taxpayers had to recognize the amounts in income as taxable distributions.
The court opinion does not specify whether the taxpayers were able to deduct the loss for the promissory notes on their individual income tax returns. Presumably the taxpayers–who now held the notes individually outside of the IRAs–could gather the evidence to establish that the notes were worthless and take this tax deduction.
In Aivatzidis v. Commissioner, T.C. Summary Opinion 2013-105, the U.S. Tax Court concluded that a professional driver could deduct expenses based on mileage, but not for actual expenses. This case provides an example of why drivers should compute car and truck expenses based on mileage if they do not have sufficient records.
The facts and procedural history are as follows:
- Mr. Aivatzidis was a limousine driver.
- Mr. Aivatzidis timely filed a joint federal income tax return for 2009.
- He deducted $16,992 of business car and truck expenses and $5,567 as repair and maintenance expenses for his limousine driver business on his on Schedule C.
- He also deducted $20,099 of unreimbursed employee business expenses on Schedule A.
- The IRS audited Mr. Aivatzdis’ 2009 federal income tax return.
- The IRS accepted all of the business car and truck expenses ($16,992) and a portion of the reimbursed employee business expenses ($3,257), but none of the $5,567 repair and maintenance expenses.
The IRS accepted the business car and truck expenses as determined by Mr. Aivatzidis. These expenses were for the SUV that Mr. Aivatzidis used in his limo business. The IRS accepted the amount of this deduction as Mr. Aivatzidis computed the deduction based on mileage rather than actual expenses. The law allows taxpayers to use a standard mileage rate as established by the IRS in lieu of substantiating actual expenses for the business use of a passenger automobile.
The $5,567 vehicle repair expenses were for a town car in Mr. Aivatzidis’ limo business. The costs were to repair the town car after it was involved in two accidents. Mr. Aivatizidis did not compute the deduction for the town car based on mileage, as he did with the SUV. The court concluded that Mr. Aivatizidis did not provide any substantiation for any automobile repair or maintenance expense paid in 2009 or that he even owned the town car. As such, the court disallowed the vehicle repair expenses.
In Brown v. Commissioner, T.C. Memo. 2013-275, the U.S. Tax Court denied an insurance salesman’s bonus depreciation deduction for his private jet as it was not placed in service in the tax year. The case highlights the highly factual nature of determining when an asset is deemed to have been placed in service for tax depreciation purposes.
- The facts and procedural history are as follows:
- Mr. Brown was in the insurance business.
- He focused on selling life insurance policies worth more than $10 million, having sold several insurance policies worth $300 million.
- Mr. Brown had to constantly prospect for clients given the high-end market he focused on.
- Mr. Brown needed to be able to travel to multiple states in a single day.
- He was not able to use chartered airplanes as they were too unreliable.
- His first private jet was not satisfactory as it could not travel across the U.S. without refueling.
- Mr. Brown searched for an airplane that could travel longer distances without refueling.
- Mr. Brown signed a contract to buy a Challenger airplane in December of 2003, which required delivery of the jet that month.
- Mr. Brown made make it clear that he needed to have the airplane delivered in December of 2003 to take advantage of the favorable bonus depreciation tax rules.
- Mr. Brown also had several modifications made to the airplane, including replacing chairs with a conference table and replacing the standard 17-inch display screens with 20-inch screens so he could display power point presentations.
- Mr. Brown and the seller agreed that Mr. Brown would take delivery of the airplane before the end of the year and the plane would return to the seller on January 5 or 6 of the next year–which was the following month–to start the modifications.
- Mr. Brown signed the closing documents and accepted delivery of the Challenger on December 30th.
- Mr. Brown reported the airplane on his 2003 income tax returns and claimed almost $11.2 million of bonus depreciation for it.
Congress added the bonus depreciation rules to stimulate the economy. To qualify under these rules, the Challenger must have been both qualified property and qualified property that was acquired and placed in service that year.
The IRS disallowed the bonus depreciation deduction, asserting that the airplane was not placed in service in 2003.
Mr. Brown argued that he had not only taken delivery of the airplane in 2003, he had used it in his business. Mr. Brown testified in court to say that after fueling the plane around noon, a pilot certified to fly the Challenger flew Mr. Brown and his aviation attorney from Portland to Seattle, landing just before 1 p.m. He flew there to have a business lunch with a real-estate developer to whom he had sold a large insurance policy earlier in the year, and a couple that the developer wanted to introduce to him as potential clients.
Mr. Brown also introduced a letter from the real estate developer that seemed to confirm these details.
The IRS referred to these end-of-year trips as “tax trips,” suggesting that Mr. Brown and his tax attorneys had a plan to arrange the trips so Mr. Brown could qualify for the first year bonus depreciation deduction in 2003.
The tax court had this to say about Mr. Brown’s testimony and letter:
[W]e sense something doesn’t smell quite right with the whole Seattle visit. First, Brown’s testimony didn’t jibe with the flight logs he submitted at audit. Although Brown said his lunch meeting lasted between 90 minutes and two hours, the flight logs show that the Challenger was on the ground in Seattle for only 66 minutes. With respect to the timeframe, we find the flights logs submitted at audit more credible than Brown’s testimony.
We also give zero credence to the letter. Brown acknowledged that the letter was neither contemporaneous nor even prepared by Mastro. He admitted his CFO/CPA, Gary Fitzgerald, drafted the letter sometime much later and had Mastro sign it. Although at one point Brown said he thought he had told Fitzgerald to write the letter “several months” after year end, we find more credible his later testimony that one of Fitzgerald’s jobs is to write letters on behalf of Brown’s business associates “to get the substantiation for deductions when the IRS requests them.” (Emphasis added.) We therefore find that Fitzgerald didn’t write this letter until at least 2006 when the IRS began auditing Brown’s return for the 2003 tax year. We do not take it seriously as proof of anything but a reason to question Brown’s credibility.
And that leaves us with only Brown’s uncorroborated testimony about his lunch in Seattle. Brown didn’t produce a lunch bill, and neither Mastro nor the unknown couple testified on his behalf. We also find noteworthy that Schneider–who was on board the Challenger from Portland to Seattle (but not on any of the other flights discussed below)–worked at a law firm just outside of Seattle. We therefore find it more likely than not that there was no business lunch in Seattle.
In considering the issue, the court rejected the IRS’s argument that the airplane was in construction as the modifications were not complete, such that it was not fit for commercial flight.
The court concluded that the airplane was not ready and available for its specifically assigned functions for Mr. Brown, as Mr. Brown had testified that they were required for his business.
The court also noted that: “Just because a taxpayer uses an asset in his business sometime during the course of a year doesn’t necessarily mean that he placed it in service that year. Consumers Power tells us instead that the asset needs to be available on a regular basis for its specifically assigned function.”
Because the airplane did not meet this standard, the court concluded that the airplane was not placed in service in 2003 and it denied Mr. Brown’s bonus depreciation deduction.