“I Don’t Need Proof: Since I Worked for the IRS and am a CPA, You Should Just Accept my Deductions.”August 16th, 2012 | Author: Russ
The title to this piece is not a literal quote…but it’s effectively what today’s petitioner told both the IRS and the Tax Court. Needless to say, that’s not a good strategy.
Bobby Perry worked for the IRS for a few years and is now a certified public accountant (CPA). Now, many CPAs know the Tax Code and rules quite well; however, many CPAs don’t practice in tax. Mr. Perry’s S-Corporation “prepar[ed] tax returns and provid[ed] consulting services.” He also sold insurance through a sole proprietorship.
The petitioner’s S-Corporation return was audited, and the IRS made many adjustments including disallowing travel expenses, depreciation, cost of goods sold, and rental payments. This led to a deficiency of $306,336 and an accuracy penalty of $41,365. Mr. Perry challenged this in Tax Court.
There were several items in dispute. First was travel expenses. While you can take deductions for ordinary and necessary business expenses you have, you must keep records. The Cohan rule allows the Court to make an estimate of the deduction. However, the Cohan rule doesn’t apply for certain expenses:
Deductions for travel expenses, gifts, and meals and entertainment, as well as for “listed property”, are disallowed unless the taxpayer substantiates them by adequate records or by sufficient evidence corroborating the taxpayer’s own statement. Sec. 274(d).
The petitioner is a CPA, worked for the IRS, and he prepares tax returns; surely he had backup for his deductions.
Petitioner did not substantiate that he met the requirements under section 1.274-5T(b)(2), Temporary Income Tax Regs., supra, by adequate records or sufficient evidence corroborating his testimony for each of the claimed travel expenses. Petitioner therefore is not entitled to deduct any of the claimed travel expenses for 2006.
Petitioner’s claim for depreciation expense didn’t fair better.
Here, petitioner failed to prove the adjusted basis of the portion of his home with respect to which he claimed the depreciation expense. There is no persuasive evidence in the record on the cost of the home (and the portion of that amount attributable to the underlying real property) or the cost of improvements. Nor is there any persuasive evidence in the record establishing the percentage of petitioner’s home that was actually used by the Company to conduct business…
While we are allowed to estimate the amount of an expense that we find to be deductible when the exact amount cannot be ascertained, for us to do so, petitioner had to supply us with some basis upon which an estimate could be made. See Vanicek v. Commissioner, 85 T.C. at 742-743. There is no evidence in the record on the adjusted basis of petitioner’s home other than his own self-serving and uncorroborated testimony. We are not required to accept such testimony and decline to do so.
Well, he must have had some proof of his cost of goods sold from his insurance business. After all, those expenses should be obvious. There’s a problem, though: What is he selling? He’s selling his services, and there isn’t a cost of goods sold with a service business.
We have held that a business must involve the sale of a material product to which direct cost may be allocated to reduce gross receipts by the costs of goods sold in computing gross income. More generally, we have held that gross receipts equal gross income where a business is primarily engaged in providing services; i.e., ability, know-how and experience. [citations omitted]
Then there were the rental payments. The petitioner supposedly rented a portion of his house for his business to his S-Corporation and received just under $33,000; the IRS thought that was compensation. No matter how those payments were characterized, they were income on the petitioner’s return. The difference is that if they were compensation, employment taxes would be owed. So the petitioner undoubtedly provided his rental agreement or other documentation or–well, I’m writing this so I think you know where this is headed:
Petitioner did not produce a rental agreement between himself and the Company for 2006. Petitioner did not provide any checks or documentation demonstrating that the Company paid him rent for use of his home. More generally, there is no documentation in the record reflecting that the Company rented a portion of petitioner’s home. The only evidence supporting petitioner’s claim that the Company rented a portion of his home is his testimony. This Court is not required to accept petitioner’s self-serving, unverified and undocumented testimony, and we decline to do so.
Then there was the accuracy-related penalty. Let me state what should be obvious: If I am ever in front of the Tax Court, I’m going to be held to a higher standard than the average taxpayer because I’m supposed to know the rules. The same was true for the petitioner:
Petitioner, a CPA and former IRS revenue agent, prepared the Form 1040 he filed for 2006 and the Form 1120S that the Company filed for the same year. Petitioner exercised a lack of care and reckless disregard for rules and regulations in reporting income and claiming deductions against income on the returns, resulting in the remaining underpayment. Petitioner failed to offer any persuasive evidence that he acted with reasonable cause and in good faith with respect to any portion of the remaining underpayment.
There isn’t much to add to what the Tax Court said. If you have expenses, document, document, and document some more. You will be happy you have done so. And if you’re a tax professional and you don’t, well, have your checkbook handy.