The Tax Court Expects a Tax Preparer to Know How to Substantiate Deductions

An unenrolled tax professional found herself in Tax Court yesterday. The IRS claimed that her claimed deductions weren’t valid; she felt she had even more deductions coming. The Court had to determine who was right.

First, I’m an enrolled tax professional; I’m in one of three professions with full rights to practice at the IRS. I’m an Enrolled Agent. The petitioner was identified as just a tax preparer, so she wasn’t an EA, CPA, or attorney. There are some good unenrolled preparers (Robert Flach, for example), so being unenrolled isn’t necessarily a bad thing.

However, if you prepare tax returns you are supposed to know the rules about what is and isn’t deductible. You do have to have substantiation for the deductions you take. And the first problem was her records.

Petitioner presented canceled checks, bank account statements, receipts, and invoices purporting to substantiate various items claimed as business expense deductions. These records are not well organized and have not been submitted to the court in a fashion that allows for easy association with the portions of deductions that remain in dispute. Nevertheless, we make what sense we can with what we have to work with and summarize our findings in the following paragraphs.

The petitioner claimed nearly $35,000 of contract labor expense but there was a problem. “None of
the numerous receipts petitioner offered in support of her claimed contract labor expense were for contract labor.” She did have a few receipts mixed in with the contract labor items that were deductible elsewhere, but that was a major misstep. She tried to get something at trial, but wasn’t successful:

At trial petitioner attempted to claim a deduction for additional contract labor expenses. Petitioner introduced photocopies of checks and a few pages of someone’s handwritten timesheet. The checks are photocopied such that the dates are missing or incomplete, and the full amount cannot be determined for one of the checks. These records are incomplete, and there is not enough information to permit a reasonable estimate. Accordingly, respondent’s complete disallowance of petitioner’s $34,880 deduction for contract labor is sustained.

There’s more on specific deductions, but you should get the picture. This tax preparer didn’t do a particularly good job with her own records. The IRS asked the Court to impose an accuracy-related penalty.

The accuracy-related penalty is not imposed with respect to any portion of the underpayment as to which the taxpayer shows that he or she acted with reasonable cause and in good faith. Sec. 6664(c)(1); Higbee v. Commissioner, supra at 448. Petitioner offered no evidence that she acted with reasonable cause and in good faith. Accordingly, we hold that petitioner is liable for a section 6662(a) accuracy-related penalty due to negligence or disregard of rules or regulations.

All tax professionals are held to a high standard if you end up at Tax Court: We are supposed to know the rules of substantiation. If we don’t, the Court isn’t going to be sympathetic at all.

Case: Linzy v. Commissioner, T.C. Memo. 2011-264

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