Taxing Lessons From Court Decisions

Decisions — Traveling with taxes

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Not all who wander are lost, but sometimes their tax deductions are.

1.

In Docket #5409-17S (Pulsipher), the taxpayer was a professional artist. He worked in fashion, as a musician, and in set design.

In 2015, he was employed on production sets, winding down his involvement in a band, and taking the initial steps toward pitching a reality television show about motorcycle touring. To develop the reality show, the taxpayer bought equipment and took motorcycle camping trips with cameras mounted to motorcycles. Nothing had come of the venture by trial date.

The taxpayer filed his 2015 federal income tax return and included a Schedule C listing his profession as “Artist: singer/writer/designer.” The Schedule C reported a few hundred dollars of income from the taxpayer’s work as a musician, and $26,907 of expenses. The expenses consisted of car and truck, travel, and meals related to the preliminary steps taken to develop the reality show, and “other expenses” that included $1,120 of musical equipment, lyric books, and studio rental.

The IRS disallowed all of the Schedule C expenses.

The tax court allowed the $1,120 of expenses related to the taxpayer’s music business, and disallowed the expenses related to the reality show.

Do you know why the expenses related to the reality show were not allowed?

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2.

In Docket #5699-17S (Lai), the taxpayer was a rocket scientist. He spent his career as an aerospace engineer working in southern California. After being laid off twice in 2012, he looked for another job and ended up working in a related field for an employer in northern California.

In late 2012, the taxpayer relocated to northern California to take up his new job. He also got married during 2012. His wife remained in southern California. While hoping to land something back in southern California that would be more in line with his work history, the taxpayer worked for the northern California employer for more than three years. He claimed $8,234 of expenses for working away from home in 2012.

By 2013, the taxpayer claimed he had made northern California his new tax home. But then his employer assigned him to work on a project in southern California for most of the year. He claimed $12,962 of expenses for working away from home in 2013.

The IRS disallowed the expenses for both years.

The taxpayer said his job in northern California was not permanent and the expenses were deductible.

The tax court disallowed the 2013 expenses because the taxpayer did not establish that he was not entitled to reimbursement from his northern California employer during the time he spent working in southern California. The court said an employee business expense is not ordinary and necessary if the employee is entitled to reimbursement from his or her employer, and found the taxpayer was entitled to reimbursement even if it was not in fact received.

The court also disallowed the expenses for 2012, but not because the taxpayer was entitled to reimbursement.

Here are the rules for deducting travel expenses while away from home.

Internal revenue code section 162(a)(2) allows a taxpayer to deduct travel expenses, including expenditures for meals and lodging, if the expenses are reasonable and necessary, incurred “while away from home,” and made in pursuit of a trade or business.

The term “home” (or “tax home”) in section 162(a)(2) normally means a taxpayer’s principal place of employment (and not the taxpayer’s personal residence).

An exception to this rule arises when a taxpayer accepts employment away from his or her personal residence and the employment is temporary rather than indefinite. The purpose underlying this exception is to relieve the taxpayer of the burden of duplicate living expenses while at a temporary employment location, since it would be unreasonable to expect her to move her residence under such circumstances.

Section 162(a) provides that “the taxpayer shall not be treated as being temporarily away from home during any period of employment if such period exceeds 1 year.” Employment is considered temporary if the engagement is expected to last for only a short period.

Temporary employment may become indefinite, however, if it is expected to last for a substantial, indefinite, or indeterminate duration or due to changed circumstances or the passage of time. Whether an employment opportunity is temporary or indefinite normally depends on the facts and circumstances of each case, and the burden of proving that employment was temporary rests on the taxpayer.

 

Do you know why the court disallowed the expenses for 2012?

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3.

In Docket #22908-16S (Cunningham), the taxpayer stopped working as an aviation engineer after a cancer diagnosis in 2000. In 2009, after his treatment, he purchased a cab and trailer and began work as a truck driver. He drove and carried loads for various large companies that were arranged through a broker.

During 2013, most of the taxpayer’s trips were from California to New York. In mid-September 2013, he had a roll-over accident in his truck in Missouri, in which he sustained serious injuries. He was treated on an outpatient basis and was charged with driving under the influence. He was incarcerated in Missouri from September 18 through October 2, 2013.

After he was released, he traveled back and forth to Missouri dealing with his criminal case. He was incarcerated again from May 15 through June 15, 2014. Upon his release, he returned to California and was treated for his injuries from the accident for about three months.

While the taxpayer was in jail and during his trips back and forth to Missouri, his wife tried to gather necessary documents that showed his expenses relating to the trucking operation in preparation for the filing of their 2013 federal income tax return. She was unable to obtain all of the records.

In addition, during this time, the taxpayer’s sister, who owned a tax preparation business and who had prepared his prior year tax returns, was under investigation. Her business records, which included the taxpayer’s records, were seized. The taxpayer’s wife was unable to get the seized records.

The taxpayer thought he might owe some taxes and did not request an extension to file the 2013 federal income tax return.

After the taxpayer was released from jail and after he received medical attention for his injuries, he hired a new tax return preparer. The taxpayers told the new preparer that their 2010 federal income tax return had been audited, and that they owed a small amount of tax for that year but that the majority of their Schedule C expenses were allowed. They also told the preparer they did not have all the records for the 2013 tax return. The preparer agreed to prepare the 2013 federal income tax return and to represent the taxpayers if the return was audited.

The preparer completed the 2013 federal income tax return, including a Schedule C claiming the income and expenses from the trucking business. The taxpayer and his wife signed the 2013 tax return on March 19, 2015. The IRS processed the return on April 27, 2015.

The IRS examined the 2013 tax return and disallowed all of the deductions claimed on Schedule C that exceeded the amount of gross receipts reported. The IRS examiner concluded that the trucking operation was not conducted as a trade or business.

The taxpayer agreed with the disallowance of the deductions.

The IRS also assessed an addition to tax for failure to timely file and an accuracy-related penalty under section 6662(a) and (b)(2) for substantial understatement of tax.

The taxpayer requested abatement of both penalties due to reasonable cause.

In regard to the late-filing penalty, a taxpayer is not liable for an addition to tax if he or she shows that the untimeliness is due to reasonable cause and not due to willful neglect (internal revenue code section 6651(a)(1)).

The taxpayer can prove that he or she did not act with “willful neglect” if he or she can “prove that the late filing did not result from a ‘conscious, intentional failure or reckless indifference.'”
 

Do you think the court agreed the taxpayer had reasonable cause for the late filing of the 2013 return?

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In regard to the underpayment penalty, a taxpayer must have persuasive evidence that the IRS determination is incorrect. The taxpayer may meet this burden by proving that he or she acted with reasonable cause and in good faith with respect to the underpayment (internal revenue code section 6664(c)(1).

Circumstances that indicate reasonable cause and good faith include reliance on the advice of a tax professional or an honest misunderstanding of the law that is reasonable in light of all the facts and circumstances. Relevant facts and circumstances for the court to consider include the knowledge and experience of the taxpayer.
 

Do you think the court agreed the taxpayer had reasonable cause for abatement of the understatement penalty?

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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 in the post 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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The bulk of the taxpayer’s expenses are related to the preliminary steps he took to develop a reality show.

Generally, expenses under section 162 (allowing the deduction of “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business”) are deductible to the extent that they relate to a functioning business at the time the expenses were incurred. A functioning business is one that is performing the activities for which it is organized.

The bulk of the taxpayer’s expenses are related to the preliminary steps he took in developing a reality show, and not his income as a musician. Because those expenses are not related to a functioning business, they cannot properly be offset against his income as a musician.

To the extent his expenses relate to a new business, section 195 disallows business expenses for start-up expenditures. A start-up expenditure is any amount paid or incurred in connection with:

(1) investigating the creation or acquisition of an active trade or business,

(2) creating an active trade or business, or

(3) any activity engaged in for profit and for the production of income before the day on which the active trade or business begins in anticipation of such activity becomes an active trade or business.

In all instances, the amount in question must be allowable as a deduction in the case of an existing active trade or business.

Because the reality show was a new venture and not an active business, the taxpayer’s expenses are not deductible under section 195.

Some of the reported expenses appear to be directly related to the taxpayer’s work as a musician, which was the source of the income shown on his Schedule C, in particular, the expenses related to drumming (drum sticks, etc.), lyric books, and studio rental. Those expenses total $1,120. Those expenses do not require strict substantiation, and we are satisfied that those expenses were related to his business as a musician and in fact incurred.

Applying these rules to this case, it is apparent that the taxpayer’s employment in northern California was indefinite.

The taxpayer, in essence, takes the position that his northern California job was not permanent, but that is not the question. The issue is whether it was temporary or indefinite.

By his own testimony, and as events transpired, it was indefinite. He may not deduct the expenses for living away from home, because northern California became his work home, even if his heart lies elsewhere.

The taxpayers have shown reasonable cause for failing to timely file their 2013 tax return.

The taxpayer was seriously injured from his accident in late 2013, was incarcerated in late 2013, drove back and forth to Missouri in late 2013 and early 2014, was incarcerated again in early 2014, and underwent medical treatment upon his return to California in 2014.

Additionally, after his sister’s tax return preparation business came under investigation, the taxpayer hired a reputable tax return preparer.

Despite her efforts to obtain some documentation, the taxpayer’s wife was unable to do so. A reasonable person faced with such personal obstacles would have understandably been focused on the criminal charges and serious health concerns. The court finds the taxpayers truthful and sincere when they testified that they focused on these concerns before attending to their 2013 tax return.

Accordingly, the taxpayers had reasonable cause for filing their 2013 tax return late and are not liable for the section 6651(a)(1) addition to tax for 2013.

The taxpayers made efforts to obtain the records but could not do so because the records had been seized.

The taxpayers had previously been audited with respect to the same trucking operation in a prior year and their claimed expenses had been substantially allowed. Therefore, the taxpayers had a reasonable belief that their 2013 tax return, which claimed similar deductions, was correct.

During the time that the tax return was due, the taxpayer was being prosecuted for a criminal charge and was dealing with serious injuries. When the taxpayers were able to attend to the preparation of their return, they hired a reputable tax return preparer who assured them that they would represent them if the return was audited.

That assurance, in addition to their prior experience with an audit of their tax return that resulted in most of the claimed trucking operation expenses being allowed, formed a reasonable belief that the return as filed was correct.

The court finds the taxpayers credible and holds that they acted with reasonable cause and in good faith with respect to the substantial underpayment of their 2013 taxes.

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