HERE IS A TAX COURT CASE IN REFERENCE TO CLEINT RECORDS
This is a generalization of why you must keep accurate records
Client Recordkeeping Makes a Difference
All too often, taxpayers do not keep adequate records. Let’s take a look at some of the highlights in Tax Court Summary Opinion 2006-99 to see what happens when a taxpayer claims unsubstantiated deductions.
A taxpayer was employed doing auto repair work as well as being self-employed doing the same type of work. On Schedule A, line 21 from Form 2106 the taxpayer claimed $22,138 of unreimbursed employee expenses. Breaking that down, the taxpayer had the following expenses:
• $12,213 vehicle expenses;
• $725 parking fees, tools, etc.;
• $4,250 travel expenses away from home;
• $2,240 business expenses; and
• $2,710 meals and entertainment.
In regard to travel expenses, entertainment expenses, gifts, and listed property (such as a passenger vehicle), §274(d) imposes strict substantiation requirements to corroborate the claimed expenses.
Code section 274(d) indicates that no deduction will be allowed for those types of expenses unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer’s own statement. That evidence must show: 1) The amount of such expense or other item; 2) The time and place of the travel, entertainment, amusement, recreation, or use of the facility or property or the date and description of the gift; 3) The business purpose of the expense or other item; and finally, 4) The business relationship to the taxpayer of the person(s) entertained, using the facility or property, or receiving the gift(s).
Reg. §1 .274-5T(c) gives further advice on how the taxpayer can verify expenses, including this notable addition to the §274(d) substantiation requirement: An “account book, diary, log, statement of expense, trip sheet, or similar record must be prepared or maintained in such manner that each recording of an element of an expenditure or use is made at or near the time of the expenditure or use.†If a receipt shows any information that would normally be documented in any of the records mentioned above, it does not have to be duplicated again in those records as long as the receipt and record complement each other in an orderly manner.
The taxpayer in this case presented no documentary evidence to substantiate the expenses subject to the strict §274(d) requirements. Therefore, the court had no choice but to disallow them. The taxpayer claimed a rental expense associated with the self-employment activity on Schedule C. No documentary evidence was presented by the taxpayer, such as canceled checks or receipts, to substantiate the $12,000 rent deduction ($1,000 per month for 12 months). This type of expense is not listed under §274(d); therefore, it is not automatically barred if the taxpayer lacks the strict substantiation mentioned above.
In order to take a rent deduction, if a taxpayer can establish he or she is entitled to a deduction, then the court, in some circumstances, is allowed to estimate an amount. This is known as the Cohan Rule based on Cohan v. Commissioner, 39 E2d 540 (2d Cit 1930). The court allowed this taxpayer a $3,000 rental expense in the conduct of the self-employment activity; far below the $12,000 claimed.
The taxpayer also had $5,044 of vehicle expenses claimed on the Schedule C. Again the taxpayer did not maintain the necessary books and records relating to the use of the vehicles. Therefore, the requirements of §274(d) were not met and the deduction was denied by the court. One last issue on the Schedule C was the “other expenses†of $8,100 claimed. Of those expenses, the amounts that fell under §274(d) were not allowed because no proper substantiation was provided. Of the remaining expenses, the court was satisfied the taxpayer incurred them. Therefore, it allowed the taxpayer a deduction of $2,000 based on the Cohan Rule. -
Of the $47,282 expenses between Schedule A and C that were addressed in this case, only $5,000 was allowed. This case illustrates the old adage, “An ounce of prevention is worth a pound of cute.†Adequate recordkeeping goes a long way in immunizing against additional tax, penalty and interest the taxpayer has to pay.
So as you can see if you as a taxpayer do not keep records and you are audited you must so proof of your deductions.
Franklin Katz, ATP
Frank's Tax & Business Service
226 S Cherokee St
Kings Mountain, NC 28086
704-739-4039
Fax: 704-739-3934