Substantiation of business expenses - Cohan rules


Deductions are a matter of legislative grace, and the taxpayer must maintain adequate records to substantiate the amounts of any deductions or credits claimed. Sec. 6001; INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); sec. 1.6001-1(a), Income Tax Regs.

Generally, the Court may allow for the deduction of a claimed expense (other than those subjected to the strict substantiation requirements of section 274) even where the taxpayer is unable to fully substantiate it, provided the Court has an evidentiary basis for doing so. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985); sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). In these instances, the Court is permitted to approximate the allowable expense, bearing heavily against the taxpayer whose inexactitude is of his or her own making. Cohan v. Commissioner, supra at 544.

Barry L. Morris v. Commissioner.

Dkt. No. 14487-05 , TC Memo. 2008-65, March 17, 2008.



P failed to file Federal income tax returns for 1999, 2000, 2001, and 2002. R determined deficiencies and additions to tax pursuant to sec. 6651(a)(1), I.R.C. After concessions, P and R dispute only whether P is entitled to certain additional deductions.

Held: P is not entitled to deductions in excess of those conceded by R.


MEMORANDUM FINDINGS OF FACT AND OPINION

WHERRY, Judge: This case is before the Court on a petition for redetermination of Federal income tax deficiencies and additions to tax under section 6651(a)(1) that respondent determined with respect to petitioner's 1999, 2000, 2001, and 2002 taxable years.1

Before trial, the parties resolved a number of issues and filed a stipulation of settled issues, which is hereby incorporated by reference into our findings. After concessions, the issues remaining for decision are:

(1) Whether petitioner is entitled to numerous additional deductions claimed on Schedule C, Profit or Loss From Business, for all 4 taxable years at issue;

(2) whether petitioner is entitled to a deduction for state taxes paid in 2000; and

(3) whether petitioner is entitled to a deduction for alimony payments in 2001.


FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated facts and accompanying exhibits are hereby incorporated by reference into our findings. Petitioner failed to file Federal income tax returns for the 1999, 2000, 2001, and 2002 taxable years. Respondent issued notices of deficiency on May 6, 2005. Petitioner then filed a timely petition with this Court. At the time he filed his petition, petitioner resided in Hayward, California. A trial was held on May 22-23, 2007, in San Francisco, California.

Before proceeding, it is noteworthy that Mr. Morris is an experienced attorney specializing in criminal law. This case was initially set for trial in August 2006. At petitioner's request, he was granted two continuances. The second continuance was granted in March 2007 over respondent's objection.

Despite the additional time he was granted and his representations to the Court that if the continuances were granted he would promptly find and provide respondent with relevant documents demonstrating his entitlement to additional deductions, petitioner failed to do so. To make matters worse, petitioner violated the Court's standing pretrial order by providing respondent with documents less than the required 14 days before trial. He also showed up for trial without records pertaining to 3 of the 4 taxable years at issue on the basis that his "computer wasn't printing." The case was nevertheless tried, although 3 of the 4 taxable years at issue had to be tried on the following day in order to permit petitioner to finalize and print the rest of the accounting records that he was relying on and to provide them to respondent.

Because petitioner's records were discovered, during trial, to be fraught with errors, the Court concluded that respondent was prejudiced by petitioner's violation of the pretrial order. The Court therefore sustained respondent's objection to the admission of those documents into evidence. However, the record was held open until July, 9, 2007, to offer petitioner an opportunity to confer with respondent in order to reach an agreement concerning the filing of additional documents. Such documents could have included corrected versions of the documents that were not admitted into evidence at trial and additional supplemental stipulations of the parties. Petitioner failed to confer with respondent and then inexplicably failed to file a brief or a reply brief. In the end, although provided ample opportunity, petitioner has done little to help himself prevail on the remaining issues.


OPINION




I. General Deduction Rules

Deductions are a matter of legislative grace, and the taxpayer must maintain adequate records to substantiate the amounts of any deductions or credits claimed. Sec. 6001; INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); sec. 1.6001-1(a), Income Tax Regs.

Generally, the Court may allow for the deduction of a claimed expense (other than those subjected to the strict substantiation requirements of section 274) even where the taxpayer is unable to fully substantiate it, provided the Court has an evidentiary basis for doing so. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985); sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). In these instances, the Court is permitted to approximate the allowable expense, bearing heavily against the taxpayer whose inexactitude is of his or her own making. Cohan v. Commissioner, supra at 544.

The taxpayer bears the burden of proving entitlement to any claimed exemptions or deductions; the taxpayer's burden includes the burden of substantiation. Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), affd. 540 F.2d 821 (5th Cir. 1976). Although section 7491(a) may shift the burden of proof to the Commissioner in specified circumstances, petitioner has not established that he meets the requirements under section 7491(a)(1) and (2) for such a shift.



II. Business Expense Deductions

Section 162(a) authorizes a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business". A trade or business expense is ordinary for purposes of section 162 if it is normal or customary within a particular trade, business, or industry and is necessary if it is appropriate and helpful for the development of the business. Commissioner v. Heininger, 320 U.S. 467, 471 (1943); Deputy v. du Pont, 308 U.S. 488, 495 (1940). In contrast, "personal, living, or family expenses" are generally nondeductible. See sec. 262(a).

Certain business expenses described in section 274(d) are subject to strict substantiation rules that supersede the Cohan doctrine. Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968), affd. 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary Income Tax Regs., supra. Section 274(d) applies to: (1) Any traveling expense, including meals and lodging away from home; (2) entertainment, amusement, and recreational expenses; (3) any expense for gifts; or (4) the use of "listed property", as defined in section 280F(d)(4), including passenger automobiles. To deduct such expenses, the taxpayer must substantiate by adequate records or sufficient evidence to corroborate the taxpayer's own testimony: (1) The amount of the expenditure or use, which includes mileage in the case of automobiles; (2) the time and place of the travel, entertainment, or use; (3) its business purpose; and in the case of entertainment, (4) the business relationship to the taxpayer of each expenditure or use. Sec. 274(d) (flush language).

Because petitioner has failed to file a brief, the nature of his arguments is not entirely clear. In any event, no evidence has been admitted that would tend to support any of the claimed business expense deductions that were not conceded by respondent. To make matters worse, petitioner's testimony was plagued by memory lapses and confessions of error with respect to some of his claimed deductions. The Court therefore concludes that petitioner has failed to demonstrate entitlement to deductions for any business expenses in excess of those conceded by respondent.



III. Deduction for State Tax Payments
State income taxes paid or accrued during the taxable year are generally deductible. See sec. 164(a)(3). At trial, petitioner asserted tersely that he made five payments of $310 to the California Franchise Tax Board in 2000. Aside from that assertion, there is no evidence of record to demonstrate that petitioner actually made those payments on behalf of his business. Because petitioner has failed to properly substantiate the claimed State tax payments, he has not demonstrated entitlement to a deduction for State tax payments with respect to his 2000 taxable year.



IV. Deduction for Alimony or Separate Maintenance Payments
Payments incident to a divorce that are characterized as alimony or separate maintenance are deductible by the payor. See sec. 215(a) ("In the case of an individual, there shall be allowed as a deduction an amount equal to the alimony or separate maintenance payments paid during such individual's taxable year."). For Federal income tax purposes, alimony is defined as any payment in cash that satisfies all of the following requirements: (a) Such payment is received by, or on behalf of, a spouse under a divorce or separation instrument; (b) the divorce or separation instrument does not designate such payment as a payment which is not includable in gross income under section 71 and not allowable as a deduction under section 215; (c) the payee spouse and the payor spouse are not members of the same household at the time the payment is made; and (d) there is no liability to make any such payment, or a substitute for such payments, in cash or property, after the death of the payee spouse. Sec. 71(b)(1)(A)-(D).

At trial, petitioner testified that he "paid $59,000 in spousal support in the year 2001." Respondent indicates, on brief, that respondent was willing to allow petitioner a deduction for alimony payments if petitioner provided adequate documentation to show the year in which alimony was paid. Petitioner attempted to do so at trial by submitting copies of computer records reflecting numerous transfers of funds ($850 per transfer) to his ex-wife in 2001. However, those amounts could also have been for child support and, in any event, those records were not admitted into evidence. As a result, we are left to guess if and when petitioner paid alimony. Petitioner has therefore not demonstrated entitlement to a deduction for alimony payments with respect to his 2001 taxable year.

The Court has considered all of petitioner's contentions, arguments, requests, and statements. To the extent not discussed herein, we conclude that they are meritless, moot, or irrelevant.

To reflect the foregoing,

Decision will be entered under Rule 155.

1 All section references are to the Internal Revenue Code of 1986, as amended and in effect for the taxable years at issue. The Rule reference is to the Tax Court Rules of Practice and Procedure.

A self-employed disc jockey was permitted limited Schedule C expense deductions for transportation, insurance, repairs, supplies and labor costs incurred in connection with his business. Although his testimony supported a portion of the claimed expenses, the evidence did not support the substantial amounts claimed for transportation, insurance and interest. He was denied deductions for claimed entertainment expenses because he offered no supporting evidence.

C. Simmons, 67 TCM 2979, Dec. 49,853(M), TC Memo. 1994-222.

Certain deductions claimed by a physician and his wife for expenses incurred in connection with their businesses were denied for lack of substantiation. The physician was not entitled to claimed automobile mileage expenses because he failed to provide sufficient evidence upon which a reasonable estimate of the expenses incurred for local business travel could be based. However, the court did allow a deduction for 1,000 miles because it was satisfied that the physician had some business mileage during the tax year. The taxpayers' arguments that they were entitled to deductions for business entertainment and expenses arising from rental activities, in addition to those allowed by the IRS, were rejected because many of the expenditures were personal in nature. Deductions claimed for expenses incurred in connection with a business trip were also denied, even though the taxpayer undertook the trip in his capacity as a physician adviser and the trip fell within the scope of his employment, because he failed to show that the expenses were not reimbursable. Substantiated expenses for educational courses and related travel, as well as charitable contributions, were deductible.

B.T. Schaeffer, 67 TCM 2989, Dec. 49,858(M), TC Memo. 1994-227.

A trial stipulation in which agreement was made on the amounts a drug trafficker expended for travel and entertainment, but which failed to stipulate that the other substantiation requirements had been satisfied, did not eliminate the claimed expense deductions as a trial issue. The time and place of the travel and entertainment, the business purpose of the expense and the business relationship of the persons entertained were not part of the stipulation and were also not proven at trial.

P.J. Ryan, 59 TCM 50, Dec. 46,437(M), TC Memo. 1990-118.

Business deductions claimed by a freelance voice actor on Schedule C were disallowed. He was not entitled to report his income and deduct his business costs on Schedule C because he qualified as an employee and did not demonstrate that he was entitled to treatment as an independent contractor.

A.S. D'Acquisto, 79 TCM 149, Dec. 53,981(M), TC Memo. 2000-239.

A taxpayer was not entitled to deductions for telephone expenses because he failed to demonstrate that his home and cellular telephone lines were used for solely in carrying on his Schedule C business and not for personal purposes.

Z. Brodsky, 82 TCM 505, Dec. 54,480(M), TC Memo. 2001-240.

Wage expense deductions claimed by married owners of a sewing business were limited to the amounts determined by the IRS. Their was no corroboration of the taxpayers' self-serving claims that cash payments were made during the year in issue, nor did the record provide any basis for a reasonable estimate of a deductible amount.

E.J. Xuncax, 82 TCM 455, Dec. 54,461(M), TC Memo. 2001-226.

A construction worker failed to produce any travel records or maintain a log for claimed mileage deductions and so was not entitled to deduct unreimbursed travel and living expenses that arose over a two-year period while he was employed at construction sites in other states.

G. Wilson, 82 TCM 899, Dec. 54,546(M), TC Memo. 2001-301.

A closely held corporation could not deduct unsubstantiated reimbursements of its sole shareholder's personal golf expenses in the absence of proof of their business purpose; the payments were deemed to be constructive dividends.

H.C. Boler, 83 TCM 1879, Dec. 54,791(M), TC Memo. 2002-155.

Married taxpayers could not avail themselves of the "adequate records" language of Code Sec. 274 with respect to deductions that were denied for automobile and travel expenses purportedly made in connection with the husband's law practice, rental properties or farming activities. Although the husband testified as to the business purpose of each claimed deduction and attempted to reconstruct the date, amount and proper categorization of the claimed expenses, the Tax Court determined that the evidence was not credible.

C. Reynolds, CA-7, 2002-2 USTC ¶50,525, 296 F3d 607.

Deductions for unreimbursed employee expenses for continuing education, books/subscriptions, uniforms/maintenance and telephone expenses were denied. The taxpayer failed to introduce any evidence in support of the deductions.

T.T. Daiz, 84 TCM 148, Dec. 54,831(M), TC Memo. 2002-192.

A married couple was not entitled to deduct various business expenses claimed on four separate Schedules C, Profit or Loss from Business, for one tax year. The taxpayers failed to substantiate any of the amounts claimed that were disallowed on the notice of deficiency. Moreover, the husband presented false invoices and his testimony lacked credibility and truthfulness.

C.K. Nunn, 84 TCM 403, Dec. 54,895(M), TC Memo. 2002-250.

A taxpayer was not entitled to deduct business expenses for her escort activity in amounts greater than determined by the IRS due to her failure to establish that she was entitled to larger deductions. In particular, bank service charge and local telephone expense deductions were granted in limited amounts. Home office, interest and meal and travel expense deductions were denied due to a lack of substantiation. Legal expense deductions were allowed in amounts that reflected fees incurred by her in defending against charges that she was using an apartment she rented for an illegal purpose, because they were incurred in connection with the preservation of her income-producing activities.

Z.A. Pappas, 83 TCM 1713, Dec. 54,754(M), TC Memo. 2002-127.

An individual was entitled to some of the deductions for various expenses that she claimed on her Schedule C, Profit or Loss from Business, in two tax years. Office expenses, including supplies and postage, that the taxpayer supported by adequate receipts, were related to her business and were, therefore, deductible. With respect to claimed office, business meeting, gifts, meals and entertainment, and cellular phone expenses for which she failed to provide adequate receipts, her claim failed for lack of substantiation or failure to show relationship to her business.

A. Gaylord, 86 TCM 385, Dec. 55,300(M), TC Memo. 2003-273.

The sole shareholder of an S corporation was not entitled to deductions for the company's rent expenses in excess of amounts allowed by the IRS due to lack of evidence. Similarly, travel, meal and entertainment deductions claimed by the individual through the company were not allowed in excess of the amount allowed by the IRS. The individual's evidence, in the form of receipts, bills, credit card statements, and one employee expense report, was not sufficient to support the deductions since he did not establish the business purpose for the expenses.

S.S. Abdelhak, 92 TCM 86, Dec. 56,579(M), TC Memo. 2006-158.