Taxing Lessons From Court Decisions

Decisions — Carrying On

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In order to deduct ordinary and necessary business expenses paid or incurred during a taxable year, you must be carrying on a trade or business. That’s internal revenue code section 61(a), and it sounds deceptively simple. Yet that sentence contains at least six requirements for an expense to be deductible. 

The tax court considered three cases this week involving the deductibility of expenses.

1.

In T.C. Memo. 2014-235 (Powell), the court considered what “carrying on a trade or business” means.

According to the court, a taxpayer is not carrying on a trade or business under section 162(a) until the business is functioning as a going concern and performing the activities for which it was organized. Business operations must actually have commenced.

In this case, the taxpayer worked full time (approximately 45 hours per week) in a business specializing in petroleum acquisition and sale, merger consulting, and valuation. He also bought 79 acres of land and built a warehouse on part of it. He intended to use the warehouse to store hops for distribution to local craft breweries.

During 2008 and 2009 he spent 10-15 hours per week developing the land activity. He planted hops, but weather problems impeded their growth. He called local breweries to gauge interest in buying hops. There was no evidence the taxpayer was successful in harvesting or selling any hops during 2008 or 2009. The only income from the activity arose from a sale of part of the property to a national discount chain.

When the taxpayer completed his return, he deducted expenses for the land activity as a sole proprietorship business. The IRS disallowed the expenses, saying the taxpayer was not operating a business because the business had not actually commenced.

What do you think?
Make your selection, then hover your mouse over “The Court’s Decision.”

or

The case: T.C. Memo. 2014-235 (Powell)

2.

In T.C. Memo. 2014-237 (Evans), the court looked at the ordinary and necessary requirement for deducting business expenses.

The taxpayer, a construction firm, paid motocross-racing-related expenses for one of the shareholder’s five children, who eventually advanced to racing at a professional level.

The expenses totaled $86,619 and $74,579 for tax years 2006 and 2007 respectively, and were deducted as promotional costs. Apart from these costs, the taxpayer engaged in limited promotional activities. Advertising costs totaled $4,571 in 2006 and $1,388 in 2007 for payments for signs and radio and newspaper advertising.

The taxpayer also received income totaling $19,940 and $23,500 in 2006 and 2007, respectively, from the motocross racing activity.

The taxpayer stopped paying the motocross-racing-related expenses after the child began racing on the professional circuit.

The taxpayer said the expenses improved the company’s community relations and attracted more clients. In addition, sponsoring the motocross activity attracted investors for construction projects, helped secure a major source of financing and strengthened relationships with local subcontractors, giving an advantage over competitors in securing the best local subcontractors for construction projects and occasionally getting discounted rates.

The IRS said the taxpayer sponsored the motocross racing for personal reasons, and the expenses were personal. In addition, the IRS said the taxpayer operated the construction activity in Idaho, and most of the races took place outside of that area, so the promotional value was nonexistent.

What do you think?
Make your selection, then hover your mouse over “The Court’s Decision.”

or

The case: T.C. Memo. 2014-237 (Evans)

3.

In T.C. Memo. 2014-236 (Van Malssen), the court considered the business aspect of expenses (as opposed to nondeductible personal, living or family expenses).

In 2007, the taxpayer purchased a vacation condominium. He used the condominium 81 days in 2008 and 45 days in 2010.

The taxpayer also rented the condominium to vacationers. The average rental period of the condominium was approximately 10 days in 2008 and 7 days in 2010.

The taxpayer contracted with a rental management company to provide sales and management services, including booking rentals and cleaning and maintaining the unit between rentals. The management company estimated it spent 57 hours in 2008 and 69 hours in 2010 performing services with respect to the condominium.

The court considered the number of personal days the taxpayer spent at the condominium during 2008 and 2010 to decide whether the expenses the taxpayer claimed on his return were allowable business deductions.

The court found the taxpayer used the property for personal purposes 24 days in 2008 and 16 days in 2010. The taxpayer did not dispute that 14 days is greater than 10% of the number of days the condo was rented during 2008 and 2010.

Here’s the rule: If the taxpayer used the condo for personal purposes the greater of 14 days or 10% of the days the condo was rented at a fair rental value, then the condo was his residence, and the expenses were nondeductible. (Internal revenue code section 280A(d)(1))

Based on the numbers, what would you decide?
Make your selection, then hover your mouse over “The Court’s Decision.”

or

The case: T.C. Memo. 2014-236 (Van Malssen)

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the links provided to read the entire case.

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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1. Ordinary

2. Necessary

3. Business expense

4. Paid or incurred

5. During the taxable year

6. Carrying on a trade or business

The court also says the element of reasonableness is inherent in the phrase ordinary and necessary.

Sorry, wrong answer :(
Right answer!
For the IRS.

The taxpayer failed to show he conducted the land activity with sufficient continuity and regularity. In 2008 and 2009 the taxpayer worked full time approximately 45 hours per week and received income from that work. The taxpayer spent approximately 10 to 15 hours per week developing the land activity. Weighing the facts, we find that the land activity was not a trade or business within the meaning of section 162(a).

Right answer!
Sorry, wrong answer :(
For the Taxpayer.

Motocross racing is a popular and high profile sport within the area and especially within the local construction industry. Motocross racing’s local popularity, coupled with the child’s success in the sport during the years in issue, earned the child a certain celebrity status.

By sponsoring the child and having logos placed prominently on the trailer, motorcycles, and promotional posters, the taxpayer was able to capitalize on this celebrity status, which naturally led to increased exposure amongst potential clients, investors, and subcontractors.

We are convinced the development of business relationships with members of the construction industry had a positive effect on the taxpayer’s bottom line. Accordingly, we find that the motocross racing activity expenses were ordinary and necessary.

Editorial note: The court considered other factors as well. This case includes facts and issues not presented here. Please use the link provided to read the entire case.

Sorry, wrong answer :(
Right answer!
For the IRS.

Given the above analysis, we find the taxpayer personally used the condominium for a total of 24 days in 2008 and for a total of 16 days in 2010. Therefore, the limitations of section 280A apply for both 2008 and 2010.

Editorial note: The case contains a good discussion of what constitutes personal days, including a consideration of travel time, days spent maintaining the condo, and use by the taxpayer’s brother.

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