Tax Court in Brief | Eze v. Commissioner | Schedules C and C2 Business Expense Deductions for a Sole Proprietorship | law of the free man
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Tax litigation: The week of August 1, 2022 to August 5, 2022
Eze v. Comm’r, TC Memo. 2022-83 | August 4, 2022 | Lauber, J. | Dkt. No. 21425-19
Short summary: During the 2015 and 2016 tax years, Petitioner Nnabugwu C. Eze (“the Petitioner”) reported income and expenses for two sets of activities on Schedule Cs: Health Care Consulting electronic health (“Schedule C1”) and residential construction (“Schedule C2”). ”). The claimant reported expenses on schedules C1 and C2 mainly related to car/truck expenses and other expenses. While Schedule C1 reported net profits in the 2015 and 2016 tax years, Schedule C2 reported significant net losses nearly offsetting Schedule C1 net profit.
The IRS selected the Petitioner’s 2015 and 2016 tax returns for review and issued the Petitioner with a notice of deficiency in a timely manner. The IRS disallowed all car/truck expenses on Schedules C1 and C2, 90% of other expenses on Schedule C1, and all other expenses on Schedule C2. In addition, the IRS has imposed certain accuracy-related penalties under Section 6662(a).
The petitioner filed his timely motion for a redetermination of the accuracy deficiencies and penalties. The IRS conceded the penalties for accuracy, pursuant to IRC § 6751(b)(1). After the Petitioner changed attorneys, eventually representing himself, and was granted extensions, the Petitioner’s case went to trial remotely on March 29, 2022.
- (1) Whether the claimant has substantiated the expenses allegedly incurred in the conduct of two sets of sole proprietorship activities.
- (1) The petitioner has failed to substantiate the expenses allegedly incurred in the conduct of two sets of sole proprietorship activities, with one exception.
Main points of law:
- The Commissioner’s determinations in a notice of deficiency are generally presumed to be correct, and the taxpayer bears the burden of proving them to be wrong. See Rule 142(a).
- The burden of proof may shift to the Commissioner if the taxpayer “presents credible evidence regarding [a relevant] question of fact” and satisfies three additional conditions: (1) the taxpayer must have “satisfied the requirements [Title 26] to substantiate any evidence”, (2) the taxpayer must have “kept all records required under [Title 26]and (3) the taxpayer must have “cooperated with the reasonable requests of the [IRS] for witnesses, information, documents, meetings and interviews”. See RC § 7491(a)(1), (2)(A)-(B).
- Deductions are a matter of legislative grace, and taxpayers bear the burden of proving their entitlement to any deduction claimed. See Rule 142(a); INDOPCO, Inc. v. Comm’r503 US 79, 84 (1992).
- A taxpayer must show that they have met all requirements for each deduction and keep books or records that support the underlying expenses. See RC § 6001; Roberts vs. Comm’r62TC 834, 836 (1974).
- If a taxpayer claims a deduction but cannot fully substantiate the underlying expense, the court may, in certain circumstances, approximate the authorized amount, “bearing heavily if it [so] chooses the taxpayer whose inaccuracy is his fault. Cohan vs. Comm’r39 F.2d 540, 543–44 (2d Cir. 1930).
- No deduction is allowed for vehicle expenses unless the taxpayer substantiates, by adequate records or sufficient evidence corroborating his own statements, the amount, time, place and business purpose of each expense. See Treasures. Reg. § 1.274-5T(c).
Insight: As this case suggests, taxpayers must be able to justify all expenses claimed on their tax returns. Failure to provide sufficient and accurate books and records, particularly with respect to car and truck expenses, will result in disallowance of such expenses by the IRS. Indeed, as the Court noted, the explanation of the taxpayer’s expenses must be plausible and credible. Additionally, taxpayers should be wary of claiming large expenses on Schedule C that result in large net losses. These situations can result in a greater likelihood of an IRS audit. Finally, although not the focus of public opinion, this case involved the IRS granting certain penalties, pursuant to IRC § 6751(b)(1), because the IRS did not could not demonstrate adequate sanction monitoring approval.