The Tax Law Report

Taxpayer Discarded Day Planner, Mileage Deduction Denied

Menzies v. Commissioner, T.C. Summ. Op. 2009-196 (2009).

Question for the Tax Court

May Mr. Menzies deduct unreimbursed employer expenses for business use of his personal vehicle even though he discarded the day planner that he recorded his mileage in?

Background

Mr. Menzies held two jobs during 2005 interspersed with two periods of unemployment.  (2).  During the first half of 2005, he worked as a fire restoration field technician. (2).  During the second half of 2005, he worked as a field operations supervisor for a security company. (2).  Both jobs required Mr. Menzies to use his personal vehicle to travel during the day to various jobsites. (3).

The taxpayer deducted $18,649 in unreimbursed employee business expenses on schedule A of his 2005 tax return. (4).  The expenses consisted of $12,249 for business use of his personal vehicle, $400 for travel, and $6,000 for other miscellaneous unreimbursed employee business expenses. (4).

The IRS disallowed the taxpayer's entire deduction for lack of substantiation. (5).

Law for Unreimbursed Employee Business Expenses

Section 162(a) allows a deduction for ordinary and necessary expenses incurred during the taxable year in carrying on a trade or business. (6).  Generally, the performance of services as an employee constitutes a trade or business.  Primuth v. Commissioner, 54 T.C. 374, 377 (1970). (6).  For such expenses to be deductible, the taxpayer must not have received reimbursement and must not have the right to obtain reimbursement from his employer.  See Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), affg. T.C. Memo. 1984-533. (6).

If a taxpayer establishes than an expense is deductible but is unable to substantiate the precise amount, the Court may estimate the amount, bearing heavily against the taxpayer whose inexactitude is of his own making.  Cohan v. Commissioner, 39 F.2d 540, 543-44 (2d Cir. 1930) (the Cohan rule or simply Cohan). (6).

Section 274(d), however, supersedes the Cohan rule with regard to certain expense.  Section 274(d) requires stricter substantiation for . . . travel, meals, and listed property such as personal automobiles. (7).

Answer from the Tax Court: no record, no deduction

[Here], the taxpayer calculated the amount of the deduction ($12,249) by multiplying the business mileage by the standard mileage rates in effect during 2005. (8).  Each workday, the taxpayer recorded the mileage from his first worksite to the last worksite of the day in a "day planner". (8).  He noted all the sites he visited during the day; however, he did not record the mileage between sites. (8).

Mr. Menzies testified that he discarded his day planner in 2007, sometime after filing his 2006 return and receiving his refund, because he felt the documentation was no longer necessary. (8).  He was therefore unable to produce any records to substantiate the business mileage, and, further, he did not attempt to reconstruct a record of his business mileage. (8).

The Court believes Mr. Menzies incurred unreimbursed vehicle expense related to his work . . . during 2005.  However, the Court may not estimate vehicle expenses under Cohan.  Therefore, we must sustain the IRS's determination. (9).

NOTE:  The Court also sustained the IRS's determination with respect to the $400 in travel expenses, but did allow 50% of Mr. Menzies' $6,000 in other miscellaneous unreimbursed items; subject to the 2% floor of course.  I think they felt sorry for him!

Blog Comments

Ouch! This was a very harsh lesson for the taxpayer.  Taxpayer's should keep records supporting the amounts on their tax returns for at least three years.  The IRS makes this very clear on page 91 of the Form 1040 instructions.  Of course, I am sure taxpayers thoroughly read the Form 1040 instructions before preparing their tax returns, all 174 pages!

Having read several tax court opinions over the last six months, it has become very apparent that the IRS's "go to" argument against taxpayers is lack of substantiation for their deductions.  Given the importance of record keeping, the three-year guidance should be front and center on the instructions to every tax form, not buried 91 pages into a 174 page document.

Moreover, Mr. Menzies claimed his unreimbursed employee business expenses on Form 2106-EZ.  The instructions for this form do not even mention the three-year record keeping requirement, only that records must be kept.  As applied here, Mr. Menzies did keep records, he just did not keep them long enough.

Charitable Contributions, Detrimental Reliance, and Notice of Deficiency

Ragassa v. Commissioner, T.C. Summ. Op. 2009-166 (2009).

This case was recently featured on TaxProf Blog because of the Tax Court's novel application of the Cohen rule to Mr. Raggassa's charitable contribution deductions.

Questions for the Tax Court

1. Does lack of substantiation preclude deductions for charitable contributions?
2. Is a preliminary notice from the IRS, for example a 30-day letter, required before the IRS can assess a valid deficiency?
3. Is the IRS bound by the communications of its representatives, even if the taxpayer relies on those communications to their detriment?

Background

Mr. Regassa claimed the following deductions on his 2005 Tax Return. (4).  The IRS disallowed a large portion because Mr. Regassa could not substantiate the deductions taken.

 

Mr. Regassa claims that he did not receive any preliminary notices, such as the so-called 30-day letter, that the IRS normally sends to taxpayers.  Therefore, depriving him of an opportunity to discuss the adjustments with the IRS before they determined his deficiency. (5).

He also claims that the IRS representative, Mr. Theodore, misled him during a conversation when Mr. Theodore said, the IRS was "all set" with respect to the adjustments.  Mr. Regassa interpreted Mr. Theodore's comments to mean he did not owe anything to the IRS.  Consequently, Mr. Regassa nearly missed the deadline to file a petition with the Tax Court upon discovering he still owed $1,575. (7-8).

Holding

The Tax Court answered "No" to question 2

Preliminary notices and administrative meetings may be courteous and may allow taxpayers to resolver early misconceptions by the Commissioner, but section 6212(a) (setting forth the requirements for issuing a notice of deficiency) or any other section does not require them. (6-7).  As long as the notice of deficiency reveals on its face that the Commissioner has made a determination for a particular year, in a particular amount, and after reviewing the information specific to the particular taxpayer, then barring unusual facts or circumstances not present here, the notice of deficiency is valid. (6).

The Tax Court answered "No" to question 3

[T]he Commissioner is empowered to retroactively correct mistakes of law, even where a taxpayer has relied to his detriment on the Commissioner's mistake.

The Tax Court answered "No" to question 1 (but see Blog Comments at the end of this post)

For each charitable contribution of money less than $250 made before 2006 the pertinent regulation requires that the taxpayer substantiate the contribution with a canceled check, a receipt, or other reliable evidence showing the name of the donee, the date of the contribution, and the amount of the contribution.

[P]recedents exist to all a Cohan estimate for charitable contributions, especially where we find the taxpayer was candid, forthright, and credible.  Stockwell v. Commissioner, T.C. Memo. 2007-149 (stating unconditionally that "We may estimate cash charitable contributions under the Cohan rule").

Mr. Regassa provided no substantiation of his charitable contributions.  However, the IRS's blanket disallowance goes too far.  Mr. Regassa's religious commitment appears genuine.  In summary, for charitable contributions, using our best judgment on the entire record before us, and under Cohan bearing heavily against Mr. Regassa's own inexactitude, we find it credible that at least once a month throughout 2005 Mr. Regassa attended and mad a cash contribution of at least $25 to a qualified Ethiopian Orthodox Church in Washington, D.C.

Blog Comments

While this decision might seem to give taxpayers a break, please take note the Tax Court recognizes Mr. Regassa's charitable deductions pertained to years before 2006.  Why is this important? Because the Pension Protection Act of 2006 added paragraph (f)(17) to section 107 of the Internal Revenue Code.  That paragraph reads as follows:

No deduction shall be allowed under subsection (a) for any contribution of a cash, check, or other monetary gift unless the donor maintains as a record of such contribution a bank record or a written communication from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution.

This new provision provides no wiggle room and will mostly likely preclude taxpayers from arguing the Cohen rule in the future, at least with respect to charitable contributions.  The Tax Court should have pointed this out, or at least addressed it.

As a final note, the Tax Court also disallowed the insurance, auto and truck, and cost of goods sold deductions.  Mr. Regassa was apparently unaware of how his tax preparer had calculated these amounts.  And, gambling losses are only deductible to the extent of gambling winnings.

Courier Allowed Deduction for 234 Miles Per Day (i.e. 58,250 per year)

Freeman v. Commissioner, T.C. Memo. 2009-213 (T.C. 2009)

Question for the Tax Court

[Is] Mr. Freemen entitled to a deduction under section 162 for his mileage between his personal residence and job locations . . . .(3).

Background

During the tax years 1999 and 2000, Mr. Freeman . . . was a courier for Parts Distribution Xpress, Inc. (PDX), and auto parts delivery company. (4).  During the years at issue, Mr. Freeman was an independent contractor with respect to PDX. (7).

Mr. Freeman's job as a courier involved picking up auto parts at PDX's warehouse in Baltimore, Maryland, and delivering those parts to 15 or more of PDX's customers on a route that went through several cities in Maryland and Delaware. (4)

Mr. Freeman made these deliveries for PDX 5 days each week, 50 weeks each year, during the tax years at issue.  He used is own vehicles to make these deliveries and was not reimbursed by PDX for his mileage. (4-5). 

During tax years 1999 and 2000, Mr. Freeman's delivery route took the form of a loop through Delaware and Maryland, with 15 or more stops at automobile dealers and repair shops. (5).

Mr. Freeman apparently drover more than 148 miles to make his individual stops; but as we explain below, he did not substantiate the greater number of miles he actually drove on this route. (6).

Mr. Freeman kept a daily log of [his] delivery route . . . by recording daily his vehicles' odometer readings and his stops in a spiral-bound logbook. (8).  On November 13, 2004, Mr. Freeman's house . . . was destroyed by an accidental fire. (8).  Mr. Freeman credibly testified . . . that the logbook was destroyed along with his house in the 2004 fire. (8).

Mr. Freeman claimed deductions for 193,000 business miles on his Schedule C for 1999, and 129,000 business miles for 2000. (10).  [T]he IRS disallowed Mr. Freeman's claimed deductions for car and truck expenses . . . . (10).

Rule for Deducting Travel Expenses

In general, the cost of daily commuting to and from work is a nondeductible personal expense.  See Commissioner v. Flowers, 326 U.S. 465, 473-474 (1946); sec. 1.162-2(e), Income Tax Regs.  However, 'certain types of business-related travel have been found to be deductible', including 'local travel incurred while performing a job . . . and travel between jobs or job locations. (11).

In Lopkoff v. Commissioner, T.C. Memo. 1982-701, we observed that '[i]f traveling between two businesses is an allowable section 162(a) deduction, traveling within a business is most assuredly so.' (12).  A '[delivery] business is the travel itself.'  Id. (12).Therefore, any transportation expenses incurred in delivery business is travel within a business, and 'is most assuredly' deductible. Id. (12).

Miles are Deductible...

We find that Mr. Freemen is entitled to a deduction for his mileage, except for the mileage added by his commute to and from his residence. (3).  It is clear that [the] mileage [from Mr. Freemans' delivery route] arose from travel between two job locations . . . and travel within a business, and is deductible under either rationale if substantiated. (14).

Therefore, Mr. Freeman is entitled to deduct--if substantiated--the costs of 234 miles per workday, which represents (i) the 148 miles . . . on his delivery route; and (ii) the 86 miles between his last stop and PDX's warehouse.  The additional 24 miles . . . from his last stop to home and back [to the warehouse] constitute nondeductible commuting that arose from his personal choice to live off his route. . . . (16).

...If Substantiated

[S]ection 274(d) imposes stringent substantiation requirements for claimed deductions relating to the use of 'listed property', which is defined under section 280F(d)(4)(A)(i) to include passenger automobiles. (17) (see here for requirements).

'It is well established that the Tax Court may permit a taxpayer to substantiate deductions through secondary evidence where the underlying documents have been unintentionally lost or destroyed.' (18)

[T]he regulations under [section 274] allow a taxpayer to 'substantiate a deduction by reasonable reconstruction of his expenditures or use' when records are lost through circumstances beyond the taxpayer's control, including a fire. Sec. 1.274-5T(c)(5), Temporary Income Tax Regs. (19).

Having observed Mr. Freeman's appearance and demeanor at trial, we find him to be credible with respect to the route he drove . . . [and] that Mr. Freeman at one time possessed adequate documentation . . . to establish the required elements under section 274(d). (19).

Therefore, we hold that Mr. Freeman is entitled to deductions under section 162 for 234 miles for each of his 250 workdays (i.e. 58,250 miles) in both 1999 and 2000 using the applicable standard mileage rates. (22).

Comments

You have to wonder why the IRS put Mr. Freeman through the wringer.  Especially since it was 'clear' to the tax court his miles were deductible if substantiated. (14).

The more interesting issue here is whether Mr. Freeman was truly an independent contractor rather than an employee, particularly in light of the recent news that FedEx is challenging the IRS on this very issue (here).  If FedEx loses, all those drivers's unreimbursed mileage expenses (assuming that is the case) will go from fully deductible for independent contractors, like Mr. Freeman, to partially deductible subject to the 2% of adjusted gross income limitation. See IRS Publication 463. In other words, the Treasury has a lot of money on the table here besides employment taxes. 

Vehicle Expenses & Substantiation Requirements

The Tax Court provides a thorough explanation of the section 274(d) substantiation requirements for vehicle expenses otherwise deductible under section 162(a).

The taxpayer is self-employed in the promotions and marketing business. She regularly travels to client sites changing out displays and advertising signs. She did not file a tax return for 2003, as a result the IRS prepared one for her pursuant to section 6020(b).

The are two issues for the Tax Court. First, is the taxpayer allowed a mileage deduction for vehicle expenses. Second, is she liable for penalties under 6651(a)(1) and (2), and 6654(a).

Section 162(a) allows a deduction for ordinary and necessary expenses incurred or paid in carrying on a trade or business. Section 274(d) disallows all travel expenses, including vehicle expenses, otherwise allowed under section 162(a), unless the taxpayer substantiates the expenses with adequate records. The taxpayer's records must include the amount, time and place, business purpose of the expense, and business relationship between the taxpayer and the person entertained, etc.

Acceptable forms of records include "an account book, a diary, a log, a statement of expense, a trip sheet, or a similar record and documentary evidence that in combination are sufficient to establish each element of expenditure or use." see Temp. Reg. 1.274-5T(c)(2)(i). Records should be made at or near the time of the actual expenditure or use. As elapsed time increases, the record's credibility decreases. see Temp. Reg. 1.274-5T(c)(2)(ii).

Here, the taxpayer testified that she kept a mileage booklet but unfortunately she could not find it for trial. She also provided a mileage trip list for 2003, but she stated at trial that she prepared the list in 2007 - after the IRS sent her the notice of deficiency at issue in the case. She also produced several different reports showing client names and the dates she serviced their accounts.

The Court holds for the Service because the taxpayer’s records were not made "at or near the time" she incurred the vehicle expense. Thus she did not meet the substantiation requirements. As such, she is not allowed a mileage deduction. There is nothing in the opinion regarding actual vehicle expenses.

The IRS also assessed penalties for failure to file her 2003 tax return, failure to pay the tax shown on the return, and failure to pay estimated taxes. The Tax Court (in fact the same Judge) dealt with this identical topic here. As was the case with Ms. Humes, the IRS did not produce evidence of the taxpayer's 2002 return, thus the Court abated the 6654(a) failure to pay estimated tax penalties. The failure to file and failure to pay penalties under 6651(a) were sustained.

This opinion is subject to section 7463 and may not be used as precedent for any other case.

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Travel Expenses & Tax Home

162(a)(2) allows a deduction for travel expenses away from home in the pursuit of a trade or business. A person's tax home for purposes of 162(a)(2) is their principal place of business (or employment). If it were otherwise, then commuting expenses would be deductible, but they are not.

Generally, a person's principal place of business or employment is obvious. Not so for Mr. and Mrs. Allen - see the table below. The first two columns show where the Allen's worked for the two-year period in question. The third column is where they lived, and the fourth column indicates when they started renting their residence in The Dalles.

Mrs. Allen really never had much of an argument. As the table shows, she always worked where she lived. The Tax Court held that when Mr. Allen started working in Pendleton it became his new "tax home." As a result, Mr. Allen could not deduct travel expenses from The Dalles to Pendleton. If Mr. Allen could establish that his work in Pendleton was temporary he might have had a chance, but on the facts here his work in Pendleton was not temporary.

You would think that this determination meant Mr. Allen could deduct travel from Pendleton back to The Dalles (Mr. Allen taught two nights per week in The Dalles while working full-time in Pendleton). But, the IRS argued Mr. Allen made a personal choice to stay in The Dalles overnight and could have driven back to his tax home in Pendleton after teaching. Pendleton is 125 miles from The Dalles.

Lastly, the Allen's tried to deduct travel expenses between their new rental home in Oregon City and their former residence in The Dalles (the Allen's were renting their former home in The Dalles). Generally, this type of travel expense is deductible. However, the Allen's were renting their The Dalles residence under the not-for-profit rules. see IRS Pub 527. This means that the Allen's could deduct expenses up to rental income, but all losses in excess of income are neither deductible nor carried forward

Unfortunately for Mr. Allen this is a harsh result. The record is not clear, but if Mr. Allen had left from his Pendleton employment and went straight to The Dalles to teach, then his travel expenses going  from one job to a second job should have been deductible. see Rev. Rul 99-7. Also under the same Revenue Ruling, Mr. Allen should have met the "going between the taxpayer's residence and a temporary work location outside the metropolitan area where the taxpayer lives and normally works" circumstance.

Finally, It is also interesting to note that the Tax Court allows a married couple to have two different tax homes. This is consistent with tax theory that the individual is the taxable unit.

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