Taxing Lessons From Court Decisions

Decisions — Nothing personal

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Image source: Own work --Cornava 09:42, 30 March 2007 (UTC) via WikiMedia Commons
Image source: Own work –Cornava 09:42, 30 March 2007 (UTC) via WikiMedia Commons

Whether you think everything is personal or nothing is, the general rule in tax law is that no deduction is allowed for personal, living, or family expenses (internal revenue code section 262(a)). But what happens when personal and business overlap?

Case 1

In T.C. Summary Opinion 2015-68 (Boring), the taxpayer was a motion control designer. His work involved semiconductors and signal directional and tracking devices, and focused on manned or unmanned drones for communication and battlefield purposes such as the detection of improvised explosive devices. The equipment he developed was very successful for both military and civilian use.

The taxpayer deducted expenses on his sole proprietorship tax form. He provided credit card statements and other records that documented living expenses, personal automobile expenses, costs of maintaining a personal residence, and costs of assisting relatives. He said these expenses were deductible because his work was “as close to twenty-four- seven as possible until there’s a positive outcome” with only Christmas, Easter, and Thanksgiving off.

In addition, the business assets comprised intangible assets, knowledge, and data, which were provided daily as an aspect of his employment. The taxpayer believed his daily expenses were often business expenses because his personal knowledge and abilities were intrinsic to these intangible assets and their operational survival in turn depended on his survival and his daily living expenses. He felt his personal living costs were ordinary and necessary to permit him to stay healthy, work, and convert the business intangible assets, composed of his knowledge, to tangible products and gross income.

The IRS disallowed the expenses, primarily due to lack of substantiation. The court considered also whether the expenses were personal and therefore nondeductible.

WHAT WOULD YOU DECIDE?

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THE COURT’S DECISION

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Case 2

In reaching a decision in Boring (above), the court looked to Green v. Commissioner, 74 T.C. 1229 (1980). In Green, the taxpayer had a rare AB negative blood type. Her blood plasma, which she could and did sell to users willing to pay her significant amounts for her plasma, was the source of her income, and she had been selling it for seven years.

The taxpayer claimed business expense deductions for medical insurance premiums, special drugs, high protein diet foods, and transportation to and from the laboratory where she donated her plasma. She also claimed as a business deduction a depletion allowance for certain minerals and antibodies in her blood. She said her body was similar to manufacturing equipment and that the deductions were incurred for the maintenance of her body and should be allowed.

The IRS said the deductions were not business deductions.

The court, however, found the taxpayer was in the business of selling her blood, and that she was selling a product as opposed to a service.

Which expenses, if any, do you think the court allowed in Green?

THE COURT’S DECISION

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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 link provided to read the entire case.

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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Right answer!

For the IRS.

The taxpayer’s apparent theory that personal living costs are ordinary and necessary to permit him to stay healthy, work, and convert the business intangible assets, composed of his knowledge, to tangible products and gross income is simply incorrect under federal tax law. See internal revenue code section 262.

In this case, the taxpayer, like the taxpayers in the current case, sought to deduct her daily living expenses. We explained:

Generally stated, the question presented by this case is whether the taxpayer may offset her taxable income by the expenses she incurred in obtaining payment for her blood plasma “donations.”

The ability to offset income with expenses incurred either under section 162, in carrying on a trade or business, or under section 212, for the production of income, requires by definition the existence of related income.

We concluded that only the extraordinary additional living expenses such as those for “special drugs” and supplements were deductible. Normal living expenses such as her health insurance were not deductible as business expenses although a portion of the health insurance was allowable as a Schedule A itemized medical expense deduction.

We explained that “[a]lthough the taxpayer attempts to justify the deduction by comparing her body to some insured manufacturing machinery, the instant set of facts prevents such a comparison; her body is not a replaceable, or easily repairable, machine maintained solely for the production of blood plasma. The unique nature of the “manufacturing machinery” in this instance makes the personal nature of the health insurance premiums unavoidable. Insuring against the costs of maintaining petitioner’s health is primarily a personal concern, not merely a business concern.”

Editorial note: The court disallowed the depletion allowance because the taxpayer’s body was not among the “natural deposits” contemplated by congress in the depletion provisions. The Green case also contains an interesting discussion of characterizing the nature of the blood the taxpayer sold as a capital asset, a service, or a product.

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