Recent U.S. Tax Court Case Finds Taxpayers' Reliance on Accountant was Unreasonable and Denies Request for Penalty Abatement

US Tax Court

    As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists taxpayers with representation and tax examinations, tax audits, appeals, and civil litigation with the Internal Revenue Service and the Ohio Department of Taxation. As part of that representation, our tax attorneys routinely advise taxpayers regarding potential penalty abatement requests relating to penalties assessed by the IRS and the Ohio Department of Taxation. Many times when a taxpayer’s return is examined by an IRS Revenue Agent, the IRS will assess accuracy-related penalties under Internal Revenue Code Section 6662 on any underpayment of income tax attributable to a taxpayer’s negligence or disregard of rules and regulations, or to a substantial understatement of income tax. Generally, the IRS will abate these penalties if the taxpayer can show that the taxpayer’s failure to file an accurate return was based upon reasonable cause and not willful neglect.

IRS Assesses Accuracy-Related Penalties for Improper Deductions Regarding Life Insurance Plan Payments

    In a recent U.S. court tax case, Jerry L. Keenan, et ux v. Commissioner, the taxpayers participated in a Benistar 419 plan. Further, the taxpayers deducted the Benistar 419 plan payments, totaling over $3 million, on their federal income tax return. But, the accountants listed the deductions as cost of goods sold, rather than reporting as an employee benefits on their return. After the IRS’s examination of the taxpayers’ 2003 Form 1040, U.S. Individual Income Tax Return, the IRS issued a Notice of Deficiency for $882,936.00, and assessed an Internal Revenue Code Section 6662(a) penalty of $176,587.20. Ultimately, the IRS disallowed the deductions claimed by the taxpayers as a pass through loss from their S corporation. In Keenan, the U.S. Tax Court found that contributions made by the participating company were not ordinary necessary business expenses deductible under Internal Revenue Code Section 162(a). Further, in cases regarding the same issue of improper deductions relating to Benistar 419 plan payments, the IRS has held that the taxpayers are liable for the Section 6662(a), accuracy-related penalties.

            Taxpayers Argue They Relied Upon Accountants in Good Faith

    Here, the taxpayers argued that they relied, in good faith, on the advice of their accountants. But, the U.S. Tax Court held that reliance on a professional advisor is, not by itself, an absolute to negligence. Further, the U.S. Tax Court confirmed that there was little reason for the taxpayers to believe that their accountants were authorities on the tax treatment of welfare benefit plan contributions, or that they had sufficiently researched the issue. In fact, according to the U.S. Tax Court, the accountants advised the taxpayers that the accountants had solely relied on a letter that was included in promotional materials for the Benistar 419 plan. The letter included in the promotional materials specifically stated that the IRS may disallow taxpayer deductions based upon a finding that the contributions is not necessary and ordinary expenses. The U.S. Tax Court found that the taxpayers did not conduct the necessary investigations sufficient to avail themselves of a good faith defense.

    The taxpayers argued that they did not graduate high school or attend college, and had no tax background. Further, the taxpayers discussed the plan with their estate planning lawyer and licensed insurance sales man. Ultimately, the taxpayers relied on their accountant, as well as their lawyer, in making a decision to adopt a Section 419 plan and to deduct the contributions regarding the same on their tax return. The accountants deducted the payments relating to the 419 plan as cost of goods sold, rather than the employee benefit on the return. Further, the accountant acknowledged that they deducted the payments as cost of goods sold to lessen the chance of an audit by an IRS revenue agent.

    Ultimately, the U.S. Tax Court found that the taxpayers’ arguments failed to demonstrate that they acted with reasonable cause and in good faith. According to the U.S. Tax Court, the most important factor is the extent of the taxpayer’s effort to assess his proper tax liability in light of all the circumstances. See Brinkly v. Commissioner, 838 F.3d 657,669. The U.S. Tax Court held that the taxpayers blindly delegated their responsibility relating their 419 plan, including the deductions regarding the same, to their accountants and lawyers. The taxpayers did not review the 419 plan, promotional materials, and did not review their tax returns. At the end of the day, the U.S. Tax Court held that the taxpayers did not show any genuine attempt to assess their proper federal tax liabilities for the year at issue. Thus, the U.S. Tax Court upheld the IRS’s assessment of the Section 6662, Accuracy-related Penalties against the taxpayers.

Nardone Limited Recommendation

    In light of the Keenan case, taxpayers should ensure that the professionals they hire are experienced in the subject area that the taxpayers are hiring the tax professionals for. Thus, if the taxpayer is seeking guidance relating to employee benefit plans, it is important that the taxpayers hire professionals who have experience in employee benefit plans. At the end of the day, reliance on professional advice is not, in and of itself, an absolute defense to negligence. If there is little reason for the taxpayers to believe that the tax professionals are authorities in a particular subject area, or that the tax professionals have not sufficiently researched the issue, then—according to the U.S. Tax Court—the taxpayers have not relied in good faith on the advice of their tax professionals. And, if the taxpayers did not act with reasonable cause and in good faith, then the IRS, and the U.S. Tax Court, will likely deny the taxpayer’s request for a penalty abatement.

    In sum, it is important for taxpayers to hire knowledgeable and experienced tax professionals, when doing any type of tax planning, as well as for preparing their tax returns. Further, it is important that the taxpayers rely on their tax professionals in good faith. Generally, all taxpayers are not required to understand complicated tax issues, when it comes to preparing their tax returns; however, taxpayers are required to conduct the necessary due diligence in hiring qualified professionals and asking the necessary questions. At the end of the day, it is the taxpayer’s responsibility to file an accurate tax return to avoid further scrutiny by Revenue Agents during IRS examinations.

July 31, 2018

IRS, Including Revenue Agents and Appeal Officers, Closely Scrutinize Settlement Agreements

Settlement-taxable-income

    As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists taxpayers with representation in tax examinations, tax audits, appeals, and civil litigation with the Internal Revenue Service (“IRS”). As part of that representation, our tax attorneys routinely advise clients, and their advisors, to be proactive and anticipate unintended tax consequences of entering into a transaction or settlement. By being proactive and anticipating unintended tax consequences, we avoid the scrutiny of the revenue agent or IRS Appeals Officer when being examined or audited by the IRS.  One area where we see taxpayers, and their advisors, fail to be proactive and fail to anticipate unintended tax consequences, is in the area of settlement agreements dealing with both physical and emotional injuries and damages.

Background and General Law

    When dealing with settlements of both physical and emotional injuries, we have to closely scrutinize and determine whether or not the damages awarded are included in the taxable income of the person harmed. If we wait until the settlement agreement has been executed, and the case settled, we likely missed our opportunity to plan, and certainly missed our opportunity to ensure that the settlement was entered into in the most tax-efficient manner.  The determination of whether or not the damages awarded are included in the taxable income of the person harmed, requires us to analyze Internal Revenue Code Sections 61 and 104.

    Section 61 provides, in general, that gross income means all income from whatever source derived. Section 104(a)(2) provides that except in the case of amounts attributable to (and not in excess of) deductions allowed under Section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include the amount of any damages (other than punitive damages) received (whether by suit or agreement) on account of personal physical injuries or physical sickness.  Section 104 also provides that for purposes of Section 104(a)(2), emotional distress shall not be treated as a physical injury. But, Section 104 also provides that the preceding sentence shall not apply to an amount of damages not in excess of the amount paid for medical care (described in Section 213(d)(2)(A) or (B)) that is attributable to emotional distress.

    Treasury Regulation Section 1.104-1(c) provides, in part, that the term "damages received (whether by suit or agreement)" means an amount received through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosecution.  In Commissioner v. Schleier, 515 U.S. 323 (1995), the Supreme Court of the United States ("Court") held that two independent requirements must be met for a recovery to be excluded from income under former Section 104(a)(2):

  • First, the underlying cause of action giving rise to the recovery must be "based upon tort or tort type rights." In United States v. Burke, 504 U.S. 229 (1992), the Court concluded that in order for the first requirement to be met, the relevant cause of action must provide the availability of a broad range of damages, such as damages for emotional distress, pain, and suffering.
  • Second, the damages must be received "on account of personal injuries or sickness." In Schleier, the Court illustrated the application of the second requirement by way of an example in which a taxpayer who is injured in an automobile accident sues for (1) medical expenses, (2) pain, suffering, and emotional distress that cannot be measured with precision, and (3) lost wages. The Court explained that the second requirement would be met for recovery of (1) the medical expenses for injuries arising out of the accident, (2) the amounts for pain, suffering and emotional distress, and (3) the lost wages as long as the lost wages resulted from the time in which the taxpayer was out of work due to the injuries sustained in the accident.

    Rev. Rul. 85-97, 1985-2 C.B. 50, concerns a taxpayer who received damages in settlement of suit for injuries he suffered when he was struck by a bus. The taxpayer’s complaint alleged that as a direct result of being struck by the bus he had been unable to pursue normal employment activities and had lost wages, had suffered and would continue to suffer great pain of body and mind and loss of earning capacity, and had incurred and would continue to incur hospital and doctors' bills. The ruling concludes that the entire amount of the settlement received by the taxpayer was excludable from gross income as amounts received on account of personal injuries under former Section 104(a)(2).

Change in the Law Regarding Settlement Agreements

    Section 1605 of the Small Business Job Protection Act of 1996 (the "1996 Act") restricted the exclusion from gross income provided by Section 104(a)(2) to amounts received on account of personal physical injuries or physical sickness. [Emphasis added.] H.R. Conf. Rep. No. 737,104th Cong., 2d Sess. 301 (1996), provides the following explanation of the amendment made by the 1996 Act:

“The House bill also specifically provides that emotional distress is not considered a physical injury or physical sickness. Thus, the exclusion from gross income does not apply to any damages received (other than for medical expenses as discussed below) based on a claim of employment discrimination or injury to reputation accompanied by a claim of emotional distress. Because all damages received on account of physical injury or physical sickness are excludable from gross income, the exclusion from gross income applies to any damages received based on a claim of emotional distress that is attributable to physical injury or physical sickness. In addition, the exclusion from gross income specifically applies to the amount of damages received that is not in excess of the amount paid for medical care attributable to emotional distress.”

    Footnote 56 of the Conference Report states, "It is intended that the term emotional distress includes symptoms (e.g., insomnia, headaches, stomach disorders) which may result from such distress." H.R. Conf. Rep. No. 737 at 301.

    The term "personal physical injuries" is not defined in either Section 104(a)(2) or the legislative history of the 1996 Act. But, we believe that direct unwanted or uninvited physical contacts resulting in observable bodily harms such as bruises, cuts, swelling, and bleeding are personal physical injuries under Section 104(a)(2). See Black's Law Dictionary 1304 (Rev. 4th ed. 1968) which defines the term "physical injury" as "bodily harm or hurt, excluding mental distress, fright, or emotional disturbance."

Recommendations from Nardone Limited

    Recognizing that the term “physical” is very important to the ultimate determination of the proper tax treatment, we have to be cognizant of the original claim raised by the plaintiff at the earliest aspect of the case and properly and consistently communicate with all parties involved regarding the proper terminology. The origin of the claim must be a physical injury. So, the wording involved, both orally and in writing, throughout the controversy and settlement stages, needs to ensure that we are discussing and focusing on the physical aspects of the injury, to the extent they exist. And, we have to ensure we properly evaluate and allocate the damages based upon the actual facts and circumstances, after involving the necessary experts, and not relying solely on what we would like the tax treatment to be in a particular instance.   It is all about the objective and proper documentation after considering all the facts and circumstances.  We do not want to wait until after the transaction is complete.  It needs to happen from the outset.

Contact Nardone Limited

    Nardone Limited frequently represents individuals and businesses in state and federal tax matters, including taxpayers who are subjected to an IRS audit or examination. If you are facing an IRS tax audit or examination, or if you wish to learn more about proper documentation regarding settlement agreements to avoid the inclusion of income, contact one of our experienced tax attorneys today. We will thoroughly review your case to determine what options and alternatives are available. 

July 06, 2018

Maintaining Mileage Logs relating to Business Travel Expenses – There is an App for That!

    As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists taxpayers with representation in tax examinations, tax audits, appeals, and civil litigation with the Internal Revenue Service and the Ohio Department of Taxation. As part of that representation, our tax attorneys routinely advise sole proprietors regarding when taxpayers may deduct certain transportation expenses relating to business travel on Schedule C of their Form 1040 U.S. Individual Income Tax Return. This article is a follow-up to our prior articles, including our most recent article, Recordkeeping Relating to Business Travel Expenses. Specifically, this article addresses various smartphone apps that a taxpayer can use to maintain proper documentation for their business travel expenses. As discussed in our prior articles, it is important for a taxpayer to maintain the proper records to avoid additional scrutiny by Revenue Agents during an IRS examination.

Tracking Business Mileage Expenses

    As discussed in our most recent article, Recordkeeping Relating to Business Travel Expenses, to deduct travel expenses on their tax returns, including business mileage and expenses, taxpayers are required to keep adequate records to substantiate the expenses. Generally, a taxpayer must prepare a written record for the documentation to be considered adequate. But, many times taxpayers fail to maintain the proper documentation, including a mileage log. As a result, taxpayers do not have the necessary documentation to properly report mileage deductions on their tax returns.

Nardone Limited Comment: From Nardone Limited’s perspective, the mileage expense and the business owner’s use of the vehicle, is one of the biggest abuses that exists when it comes to taxpayers.  They routinely fail to maintain the proper documentation and the tax return preparers routinely ignore this issue.  In fact, when you talk with many tax return preparers, they are concerned about losing clients if they do not deduct the automobile expenses regarding mileage, even if the taxpayers do not have proper documentation.  According to the tax return preparers, the clients routinely advise the tax return preparers that other accountants will do this for them.  But, we should be wary of those particular clients.

In our prior article, we provided detail regarding using the Standard Mileage Rate versus actual expenses, when deducting business mileage expenses. For both methods, it is important that the taxpayer maintains the proper documentation and records to avoid further scrutiny by IRS Revenue Agents. Fortunately, with updates in technology, there are apps that a taxpayer can download to his smart phone to make keeping the proper documentation relating to business travel expenses easier.

Apps for Tracking Business Mileage

    For a practical and easy way to track mileage, there are several apps that a taxpayer can download to their smart phone to track their mileage. Many of the apps, including MileIQ, are applications that you can download on your phone that run on the background of your phone. Then, the apps will note each time that you get into your car, and automatically track the mileage as you drive, without the taxpayer having to even open the app. Further, several of the apps give the taxpayer the option to swipe right or left to categorize the drive as a personal or business trip. The app will track the details regarding the taxpayer’s various trips, and then the taxpayer will be able to download monthly or annual mileage reports. The taxpayer simply has to input certain data, after downloading the app, including the odometer readings, to get started. Ultimately, some apps give you the option to edit and add additional information regarding each separate trip, including the specific purpose of the trip and any other necessary notes. We would certainly recommend that taxpayers add detail regarding the business purpose of each trip, to avoid further scrutiny by Revenue Agents during an IRS examination. Additionally, some of the apps give the taxpayer the option to take photos of receipts to keep track of other expenses, such as gas. This option would be helpful if you were using the actual expense deduction method when preparing your tax return instead of the Standard Mileage Rate method, as discussed further in our prior article.

Mileiq_dashboard
An example of the MileIQ dashboard.

    At the end of the day, whether a taxpayer is manually keeping a log or using an app, it is important for the taxpayer to maintain the proper documentation. That documentation should specify the business purpose of the trip, the addresses where you started and stopped, the date, and the odometers readings. Again, an app on a smart phone would track that information automatically for you.

    Further, the option to download an app and keep track of mileage is a great option for many business owners. That is, business owners have a host of other items to focus on, including running their business. Thus, if an app can be used to properly maintain documentation, as well as to make a business owner’s life a little easier, then we would encourage a taxpayer to use an app. Many apps have free versions. But, there are also premium options available for a monthly or annual fee. At the end of the day, an investment into an app, to maintain the proper documentation, is well worth it. We would encourage taxpayers to look into various apps used to track business mileage expenses, including MileIQ, TripLog, Hurdlr, or Mileage Expense Log. These are just a few of the apps that are available to taxpayers to use on their smart phone.

Conclusion

    In sum, it is important for a taxpayer to maintain proper documentation when deducting business travel expenses, including mileage expenses. That is, it is important for sole proprietors to understand what business travel expenses are deductible and to maintain proper documentation regarding the expenses, to avoid further scrutiny by Revenue Agents during IRS examinations. If you have been contacted by the IRS or the Ohio Department of Taxation, contact the Nardone Limited tax attorneys at 614-223-0123.

June 14, 2018

Withdrawing a Notice of Federal Tax Lien Filed by the IRS

form_12277

    The tax attorneys at Nardone Limited in Columbus, Ohio routinely advise taxpayers who have been contacted by an Internal Revenue Service (“IRS”) Revenue Officer. If a taxpayer neglects to pay a federal tax liability, the IRS has broad authority and tools to collect delinquent taxes, which includes the filing of a Notice of Federal Tax Lien. A Notice of Federal Tax Lien can cause a taxpayer significant financial harm, so it is crucial that taxpayers are aware of the various ways to obtain relief when an IRS Revenue Officer files a Notice of Federal Tax Lien.

What is a Notice of Federal Tax Lien?

    A Notice of Federal Tax Lien is the notification to a taxpayer’s creditors that a lien has been placed by the U.S. Government on all of the taxpayer’s current and future assets. See Internal Revenue Code (“I.R.C.”) §6321. Unless the IRS files a Notice of Federal Tax Lien, the existence of the lien is kept private. A Notice of Federal Tax Lien can impact a taxpayer in a number of ways, such as disrupting the taxpayer’s employment or business, negatively affecting credit scores, and preventing the taxpayer from securing loans or lines of credit. Despite the negative impact a Notice of Federal Tax Lien may have, the IRS is reluctant to withdraw a Notice of Federal Tax Lien because the Notice of Federal Tax Lien protects the IRS’s interests in bankruptcy or litigation and ensures secured-creditor standing for the IRS. Ultimately, there are several ways for a taxpayer to resolve a lien issue, including: (i) paying your tax liabilities in full, then the IRS will release your lien within 30 days; (ii) requesting a Certificate of Discharge of Notice of Federal Tax Lien for specific property; (iii) requesting a Certificate of Subordination of Notice of Federal Tax Lien; and (iv) requesting a withdrawal of a Notice of Federal Tax Lien. We will be following up with additional articles to discuss the various resolutions relating to Notice of Federal Tax Liens. This article focuses on a withdrawal of a Notice of Federal Tax Lien.

Withdrawing a Notice of Federal Tax Lien

    A withdrawal removes the public Notice of Federal Tax Lien and assures that the IRS is not competing with other creditors for your property, however, you are still liable for the amount due. The IRS may withdraw a Notice of Federal Tax Lien under certain circumstances despite the existence of outstanding taxes. See I.R.C. §6323. Specifically, these circumstances are limited to:

  • If the notice was filed prematurely or not in accordance with IRS procedures;
  • The taxpayer entered into an installment agreement to satisfy their liability for which the lien was imposed, and the agreement did not include the filing of a Notice of Federal Tax Lien;
  • Withdraw of the Notice of Federal Tax Lien would help facilitate the collection of the tax liabilities owed; or
  • Withdraw of the Notice of Federal Tax Lien is in the best interest of the taxpayer and the government.

    A request for withdraw of a Notice of Federal Lien may be made by using Form 12277, Application for Withdrawal of Filed Form 668(Y), Notice of Federal Tax Lien. But, because of the protection the Notice of Federal Tax Lien provides, the IRS will likely be reluctant to withdraw a Notice of Federal Tax Lien. To increase the likelihood that the IRS will withdraw the Notice of Federal Tax Lien, a professional should carefully review the taxpayer’s specific facts and circumstances. Specifically, the taxpayer’s professionals should review applicable ethics standards, employment agreements, business dealings or any other business or personal situation, which demonstrates that the Notice of Federal Tax Lien will directly negatively impact the taxpayer’s ability to pay the IRS. If the IRS agrees, then the IRS will issue Form 10916(c), Withdrawal of Filed Notice of Federal Tax Lien. See Internal Revenue Manual (“I.R.M.”) §5.12.9.2. Ultimately, a withdrawal only removes the effect of a Notice of Federal Tax Lien and does not extinguish the underlying tax lien.

    If the IRS ultimately withdraws the Notice of Federal Tax Lien, then upon the taxpayer’s written request, the IRS will also make reasonable efforts to notify credit reporting agencies, and any financial institution or creditors of the withdrawal, when their names and addresses are specified in the taxpayer’s request of the withdraw. I.R.C. §6323(j)(2). But, it is a good idea for the taxpayer to ultimately follow up with any credit reporting agencies and financial institutions to ensure they received the necessary correspondence from the IRS.

Contact Nardone Limited

    Nardone Limited represents individuals and businesses with federal tax matters, including resolving issues relating to a Notice of Federal Tax Lien. If you have been contacted by an IRS Revenue Officer, contact one of our experienced tax lawyers today.

June 08, 2018

Recordkeeping relating to Business Travel Expenses

     Car_travel

    As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists taxpayers with representation in tax examinations, tax audits, appeals, and civil litigation with the Internal Revenue Service and the Ohio Department of Taxation. As part of that representation, our tax attorneys routinely advise sole proprietors regarding when a taxpayer may deduct certain transportation expenses relating to business travel on Schedule C of their Form 1040 U.S. Individual Income Tax Return. This article is the last in a series that addresses deductible travel expenses for sole proprietors. See our prior articles in this series: Deductible Business Travel Expenses for Sole Proprietors, Deductible Transportation, Lodging, and Meal Expenses for Sole Proprietors, and Deductible Business Travel Expenses for Spouses & Family Members. Specifically, this article addresses recordkeeping relating to business travel. It is important for a taxpayer to maintain the proper records to avoid further scrutiny by a Revenue Agent during an IRS examination.

Recordkeeping

    To deduct travel expenses, including business mileage and expenses, taxpayers are required to keep adequate records to substantiate the expenses. Generally, a taxpayer must prepare a written record for the documentation to be considered adequate. When deducting mileage relating to travel to and from meetings or events for business purposes, the taxpayer should prepare a diary or log supporting the mileage deductions. Please click here for an example of the daily business mileage and expense log that a taxpayer should keep.

    The taxpayer should keep a record of the mileage and expense log simultaneously with the business trip. A taxpayer may not, however, deduct the mileage to and from his home and his normal place of work. That is, a taxpayer may not deduct commuting expenses. But, if a taxpayer is traveling from his regular place of work to another business meeting, even if the business meeting is at a local place, the taxpayer may deduct the mileage relating to that travel. Again, it is important that the taxpayer maintains the proper documentation relating to the business travel and keep a mileage log, to avoid further scrutiny by a Revenue Agent during an IRS examination.

Standard Mileage Rate

    One option a taxpayer has when it comes to deducting mileage expenses is to use the standard mileage rate. The taxpayer may use the standard mileage rate to figure the deductible costs of operating a car for business purposes. For 2017, the standard mileage rate for the costs of operating a car for business use is 53.5 cents per mile. Generally, a taxpayer may use the standard mileage rate whether or not the taxpayer is reimbursed, and whether or not any reimbursement is less or more than the amount figured using the standard mileage rate. But, if a taxpayer chooses to use the standard mileage rate for a year, the taxpayer may not deduct his actual car expenses for that year. Specifically, when using the standard mileage rate, a taxpayer may not deduct depreciation, lease payments, maintenance and repairs, gasoline, oil, insurance, or vehicle registration fees, as examples. If a taxpayer decides not to use the standard mileage rate, then the taxpayer may deduct the actual car expenses.

Deduction of Actual Car Expenses

    If a taxpayer does not use the standard mileage rate, the taxpayer may be able to deduct actual car expenses. Actual car expenses include: (i) depreciation; (ii) licenses; (iii) gas; (iv) oil; (v) tolls; (vi) lease payments; (vii) insurance; (viii) garage rent; (ix) parking fees; (x) registration fees; (xi) repairs; and (xii) tires, as examples. Ultimately, if a taxpayer uses his car for both business and personal purposes, the taxpayer must divide the expenses between business and personal use. The taxpayer may divide his expenses based upon the mileage driven for each purpose. If the taxpayer deducts actual car expenses, then the taxpayer is required to maintain documentation, including receipts and proof of payment relating to the actual car expenses incurred. Maintaining the proper documentation will avoid further scrutiny by a Revenue Agent during an IRS examination.

Conclusion

    In sum, it is important for a taxpayer to maintain proper documentation when deducting business travel expenses, including mileage expenses. A taxpayer must generally keep these records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means that you must keep the records to support your deductions three years from the date when you filed the related income tax return on which you claimed the deduction. Ultimately, it is important for sole proprietors to understand what business travel expenses are deductible and to maintain proper documentation regarding the expenses to avoid further scrutiny by Revenue Agents during an IRS examination. If you have been contacted by the IRS or the Ohio Department of Taxation, contact the Nardone Limited tax attorneys at 614-223-0123.

May 31, 2018

Deductible Business Travel Expenses for Spouses & Family Members

Plane travel

    As tax attorneys in Columbus, Ohio, Nardone Limited routinely advises sole proprietors on when a taxpayer may deduct certain business expenses on Schedule C of their Form 1040 U.S. Individual Income Tax Return. Many sole proprietors seek to maximize their business expense deductions; however, sole proprietors must be cognizant of what may and may not be deducted to potentially avoid further scrutiny by Revenue Agents during Internal Revenue Service (“IRS”) audits and examinations. When the IRS audits or examines a tax return, one of the items the Revenue Agent will scrutinize and look for is deductions relating to business travel expenses. This is the third article of a three-part series that addresses deductible travel expenses for sole proprietors. Specifically, this article provides a discussion of when traveling expenses relating to spouses and family members may be deducted. See the first article of the series, Deductible Business Travel Expenses for Sole Proprietors, for a general overview of deductible traveling expenses, and the second article of the series, Deductible Transportation, Lodging, and Meal Expenses for Sole Proprietors, for an overview of deductible transportation, lodging, and meal expenses.

Separating Personal and Business Expenses

    As discussed in our prior articles, when a trip combines both business and personal activities, then a taxpayer may only deduct travel expenses if the trip is primarily for a business purpose. Treas. Reg. §1.162–2(b)(1). If the trip is primarily personal in nature, then travel expenses are not deductible, even if the taxpayer conducts some business activities during the trip. Further, when the trip is primarily for business purposes, a taxpayer may deduct travel expenses that are: (i) reasonable and necessary in conducting business and (ii) directly attributable to conducting business. Treas. Reg. §1.162–2(a).

    One issue that many sole proprietors face when preparing their Form 1040 U.S. Individual Income Tax Return is allocating travel expenses between business and personal expenses.  This issue is further complicated when a spouse or family member accompanies the sole proprietor on a business trip. In general, a spouse’s or family member’s travel expenses are personal expenses and therefore, are not deductible. But, travel expenses relating to a spouse or family members may be deducted in limited circumstances.

Requirements to Deduct Business Travel Expenses Relating to a Spouse or Family Member

    For a sole proprietor to deduct the travel expenses of a spouse or family member, the spouse or family member must: (i) be an employee or business associate who has a bona fide business purpose for traveling and (ii) otherwise be allowed to deduct the travel expense. See Internal Revenue Code (“I.R.C.”) §274(m)(3); Treas. Reg. § 1.162-2(c).

    A bona fide business purpose exists when a sole proprietor can prove a real business purpose for the spouse’s or family member’s presence on the business trip. See Treas. Reg. § 1.162-2(c). But, the bona fide business purpose cannot entail mere incidental business services, such as taking notes or entertaining customers. The spouse or family member’s presence on the trip must be necessary to the sole proprietor’s business. Treas. Reg. § 1.162-2(c). If the spouse or family member is not a business associate or employee with a bona fide business purpose for traveling, who would otherwise be able to deduct the travel expenses, then the sole proprietor must strictly separate the spouse’s or family member’s expenses from the deductible business travel expenses. Treas. Reg. § 1.162-2(c). For example, a sole proprietor may believe that an invitation for a spouse or family member to attend a business meeting or convention establishes their bona fide business purpose. But, simply being invited to, and then attending the meeting, is not enough. Rather, the spouse or family member must also meet the requirements under I.R.C. §274(m)(3), including that the spouse or family member has a bona fide business purpose for attending, to have deductible travel expenses. That is, the spouse’s or family member’s presence must be necessary to conduct the sole proprietor’s business. Ultimately, a sole proprietor who brings a spouse or family member on a business trip must remain cognizant of the circumstances in which the spouse’s or family member’s travel expenses may be deducted.

Conclusion

    Nardone Limited routinely represents individuals and businesses in federal tax matters, including taxpayers who are subjected to an IRS audit or examination by a Revenue Agent. If you are facing an IRS tax audit or examination, or if you wish to learn more about how to adequately maintain your records, contact one of our experienced tax attorneys today.

May 25, 2018

Deductible Transportation, Lodging, and Meal Expenses for Sole Proprietors

89585481

As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists taxpayers with representation in tax examinations, tax audits, appeals, and civil litigation with the Internal Revenue Service and the Ohio Department of Taxation. As part of that representation, our tax attorneys routinely advise sole proprietors regarding when a taxpayer may deduct certain business expenses on Schedule C of their Form 1040 U.S. Individual Income Tax Return. This is the second article of a series that addresses deductible travel expenses for sole proprietors. Specifically, this article provides an overview of the allowable deductions for transportation, lodging, and meal expenses incurred while traveling for business. See our first article, Deductible Business Travel Expenses for Sole Proprietors, for a general overview of deductible business travel expenses. An upcoming article will discuss deductible spouse and family member business travel expenses.

Deductible Transportation Expenses

A sole proprietor may deduct travel expenses on Schedule C of their Form 1040 relating to transportation expenses for a business trip away from home. Treas. Reg. §1.162–2(a). Specific transportation expenses may include airfare, train or bus fare, rental cars, or any similar sort of expense incurred when the sole proprietor or his employee are traveling to a destination for business purposes. We will be following up with a later article detailing the requirements for maintaining a proper mileage log, and proper deductions relating to mileage. When traveling by car, toll and parking fees are deductible. Other deductible transportation expenses include baggage fees, taxi fare, and local transportation costs at the destination. When deducting the travel expenses on Schedule C of the Form 1040, the sole proprietor must substantiate the transportation expenses by keeping adequate records, including receipts and invoices that list details of the cost of each separate transportation expense, the date of the expense, the business destination, the business purposes for the expense, as well as proof of payment. It is very important that a taxpayer has this documentation available during an IRS examination by a Revenue Agent.

Deductible Lodging Expenses

Another type of business travel expense that a sole proprietor may deduct on Schedule C of Form 1040 is for expenses related to lodging. See Internal Revenue Code (“I.R.C.”) §162. Lodging expenses are appropriate when the business trip is overnight or long enough that the sole proprietor or employee must stop to sleep to properly perform his duties. The facts and circumstances of the business trip will dictate whether lodging expenses are too lavish or extravagant. Lodging expenses that are too lavish or extravagant under the circumstances are not deductible. I.R.C. §162. Additionally, lodging expenses may not include expenses that are not a necessary and ordinary business expense. See Treas. Reg. §1.162–2(a). For example, if a sole proprietor or his employee spends seven nights at a hotel, attends a business convention for five days, and then spends the remaining two days as a personal vacation, only five days of the lodging expenses are deductible. To deduct lodging expenses on Schedule C of Form 1040, the sole proprietor must substantiate the expenses by keeping adequate records and documentary evidence, such as receipts and bills, that show details of the cost of each separate lodging expense, the dates of the lodging and number of days spent on business, the business destination, the business purposes for the expense, and proof of payment.

Deductible Meal Expenses

Sole proprietors may also deduct for certain meal expenses on Schedule C of the Form 1040. Meals that a sole proprietor or employee has on a business trip may be deducted in part. Treas. Reg. §1.162–2(a). These meals may include: (i) any meal necessary while on a business trip away from home; (ii) meals for entertaining business clients at a restaurant; and (iii) meals at business conventions, receptions, meetings, or luncheons. A sole proprietor may not, however, deduct for a meal that is considered too lavish or extravagant based upon the circumstances. I.R.C. §162. A meal expense deduction is generally subject to a 50% limit, meaning only half of the cost of the meal is deductible. I.R.C. §274(n). Ultimately, the sole proprietor must substantiate the expenses by keeping adequate records and documentary evidence, such as receipts and invoices that show details of the cost of each separate meal expense, the dates of the trip and number of days spent on business, the business destination, the business purposes for the expense, and proof of payment. Again, it is important for the taxpayer to have this documentation readily available for Revenue Agents as part of an IRS examination.

Conclusion

It is important for sole proprietors to understand what business travel expenses are deductible, and to maintain proper documentation regarding the expenses, to avoid further scrutiny by a Revenue Agent during an IRS examination. If you have been contacted by the IRS or the Ohio Department of Taxation, contact the Nardone Limited tax attorneys at (614) 223-0123.

May 17, 2018

Deductible Business Travel Expenses for Sole Proprietors


Travel photo

As tax attorneys in Columbus, Ohio, Nardone Limited routinely advises sole proprietors on when a taxpayer may deduct certain business expenses on Schedule C of their Form 1040 U.S. Individual Income Tax Return. Many sole proprietors seek to maximize their business expense deductions; however, sole proprietors must be cognizant of what may and may not be deducted to potentially avoid further scrutiny by Revenue Agents during Internal Revenue Service (“IRS”) audits and examinations. When the IRS audits or examines a tax return, one of the items the Revenue Agent will scrutinize and look for is deductions relating to business travel expenses.  This is the first article of a series which addresses deductible travel expenses for sole proprietors. Specifically, this article provides an overview of the travel business expenses that are generally deductible on Schedule C of the Form 1040. Future articles in this series will describe the deductibility of transportation, lodging, and meal expenses, and the deductibility of spouse and family member travel expenses.

General Requirements for Deducting Business Travel Expenses

Many sole proprietors and their employees travel for business. Thus, sole proprietors must consider whether the expenses relating to the travel are in fact deductible. Generally, for federal income tax purposes, travel expenses are the ordinary and necessary expenses of traveling away from home for your business, profession, or job. Further, when a sole proprietor’s business provides an advance, reimbursement, or allowance for expenses relating to travel for business away from home, the sole proprietor may deduct the related travel expenses. See IRS Publication 535, Business Expenses § 11 (2016). A person travels away from home when he is away from the general area of his tax home for substantially longer than an ordinary day’s work and needs to sleep or rest to meet the demands of the work. See IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses §1 (2016). A tax home is the person’s regular place of business or post of duty and includes both the entire city and general area in which the business or work is located. Accordingly, the daily cost of commuting to and from work is not a deductible travel expense. Treas. Reg. §§ 1.262-1(b)(5); 1.162–2(e).

Trip Must be Primarily for Business Purposes

When a trip combines both business and personal activities, then a taxpayer may only deduct travel expenses if the trip is primarily for a business purpose. Treas. Reg. §1.162–2(b)(1). If the trip is primarily personal in nature, then travel expenses are not deductible, even if the taxpayer conducts some business activities during the trip. Further, a taxpayer may deduct travel expenses that are reasonable and necessary in conducting business and are directly attributable to conducting business. Treas. Reg. §1.162–2(a).

Ordinary and Necessary Expenses

A sole proprietor must also consider whether the travel expenses are ordinary and necessary. An ordinary business expense is common and accepted in the industry; while a necessary business expense is one that is helpful and appropriate for the trade or business. IRS Publication 535, Business Expenses § 11 (2016). Ultimately, on a business trip, ordinary and necessary traveling expenses, such as transportation fares, lodging, meals, and related incidental expenses, are deductible. 26 C.F.R. § 1.162–2. When deducting within the IRS statutory and regulatory guidelines, sole proprietors may deduct 100% of transportation expenses, 100% of lodging expenses, and 50% of meal expenses that are incurred while traveling away from home for business. We will be following up with additional articles regarding deductible transportation, lodging, and meals travel expenses, and deductible spouse and family member travel expenses.

Conclusion

Nardone Limited routinely represents individuals and businesses in federal tax matters, including taxpayers who are subjected to an IRS audit or examination by a Revenue Agent. If you are facing an IRS tax audit or examination, or if you wish to learn more about how to adequately maintain your records, contact one of our experienced tax attorneys today.

May 04, 2018

Trust-Fund Liability at the Federal Level: The Willfulness Requirement

    As tax attorneys in Columbus, Ohio, Nardone Limited routinely advises taxpayers about their potential personal liability relating to liabilities owed by a business as part of our tax controversy work. When an IRS revenue officer contacts you or your business, it is important that you understand your rights and obligations. The IRS has broad authority and tools available to collect delinquent taxes, including conducting a trust-fund investigation of responsible persons. Most companies operate as a business entity that shields owners from personal liability for the company’s obligations. But, a major exception exists to this rule, commonly referred to as trust-fund liability. If an employer fails to pay certain taxes on behalf of their employees, the IRS and the Ohio Department of Taxation have the right to collect monies due from a responsible party’s personal assets. This article focuses on trust-fund liabilities at the federal level and is the last in a series discussing trust-fund liability at the state and federal levels. See our prior articles relating to responsible persons’ potential liability in Ohio, including: (i) Personal Liability for Business’s Failure to Pay Ohio Sales Tax; (ii) Business Owners are Not Always Responsible Parties under Ohio Law relating to Sales Tax Liabilities; and (iii) Trust-Fund Liability at the Federal Level: Who Does the IRS Consider to be a Responsible Person?

What is the purpose of trust-fund liability?

    The Internal Revenue Manual discusses the liability of third parties for unpaid employment taxes, also known as trust-fund liability. The purpose of trust-fund liability is to encourage employers to pay withheld employment and income taxes by making any responsible person personally liable for 100% of any unpaid trust-fund taxes. To do so, the Internal Revenue Code (“IRC”) authorizes the IRS to collect the monies due from a person who may otherwise be shielded from liability. These otherwise-protected people only become liable, however, if they were both willful and responsible in the nonpayment of the trust-fund liability taxes as described in IRC §6672. This article focuses on the willfulness requirement.

What does it mean to be willful?

    Under IRC §6672(a), any failure to collect or pay trust-fund taxes must be willful. Willfulness does not require a bad motive or specific intent to defraud the government. Rather, willfulness is present if a responsible party had knowledge of the tax delinquency and willfully failed to rectify it when funds were available. Ross v. United States, 949 F.Supp. 536 (N.D. Ohio 1996)(holding that the president of a company was a responsible person for willfully failing to pay withholding taxes). But, both courts and the IRS have expanded the definition of what it means to be willful. The IRS stated in Revenue Ruling 54-158 that willfulness exists even if the money was used to pay operating expenses or for other legitimate business purposes, including intentionally paying other creditors before the federal government. Bell v. United States, 355 F.3d 387 (6th Cir.2004)(holding that an individual is a responsible person when they are aware of the delinquent tax liabilities and choose to pay creditors prior to paying the government). Additionally, courts have expanded the definition of willfulness to include any intentional, deliberate, voluntary, reckless, or knowing failure to pay the monies due. See Domanus v. United States, 961 F.2d 1323 (7th Cir. 1992)(finding a business’s chief accountant was personally liable for trust-fund taxes because he voluntarily paid other creditors before paying the government).

How much will the IRS attempt to recover?

    Generally, the IRS only attempts to recover the unpaid balance of the trust-fund tax. The amount is typically based on the unpaid income taxes that were required to be withheld by the employer, plus the employee’s unpaid portion of FICA taxes. While the IRC’s sections on trust-fund liability do not expressly provide for any additional penalties or fees, the IRS is permitted to pursue additional fines and penalties under other sections of the code. See IRC §6672. Thus, if you are concerned about your potential liability or have been contacted by an IRS revenue officer, it is highly recommended that you consult with a professional to discuss further.  

Contact Nardone Limited

    Nardone Limited frequently represents individuals and businesses in federal, state, and local civil tax matters, including appeals. If you or your business have been contacted by an IRS revenue officer or the Ohio Department of Taxation, or are struggling with tax liabilities, you should contact one of our tax attorneys today. We will thoroughly review your case to determine your potential personal liability, as well as what options and alternatives are available to you.

April 27, 2018

Trust-Fund Liability at the Federal Level: Who Does the IRS Consider to be a Responsible Person?

    As tax attorneys in Columbus, Ohio, Nardone Limited routinely advises taxpayers about their potential personal liability relating to liabilities owed by a business as part of our tax controversy work. When an IRS revenue officer contacts you or your business, it is important that you understand your rights and obligations. The IRS has broad authority and tools available to collect delinquent taxes, including conducting a trust-fund investigation of responsible persons. Most companies operate as a business entity that shields owners from personal liability for the company’s obligations. But, a major exception exists to this rule, commonly referred to as trust-fund liability. If an employer fails to pay certain taxes on behalf of their employees, the IRS and the Ohio Department of Taxation have the right to collect monies due from a responsible party’s personal assets. This article focuses on trust-fund liabilities at the federal level and is part of Nardone Limited’s series discussing trust-fund liability at the state and federal levels. See our prior articles relating to a responsible person’s potential liability in Ohio, including: (i) Personal Liability for Business’s Failure to Pay Ohio Sales Tax and (ii) Business Owners are Not Always Responsible Parties under Ohio Law relating to Sales Tax Liabilities.

What is the purpose of trust-fund liability?

    The Internal Revenue Manual discusses the liability of third parties for unpaid employment taxes, also known as trust-fund liability. The purpose of trust-fund liability is to encourage employers to pay withheld employment and income taxes by making any responsible person personally liable for 100% of any unpaid trust-fund taxes. To do so, the Internal Revenue Code (“IRC”) authorizes the IRS to collect the monies due from a person who may otherwise be shielded from liability. These otherwise-protected people only become liable, however, if they were both willful and responsible in the nonpayment of the trust-fund liability taxes as described in IRC §6672. This article focuses on who is considered a responsible person. A follow-up article will discuss the willfulness requirement.

Who may be deemed responsible?

    The IRS’s definition of a responsible person is broad and inclusive, and may include anyone responsible for collecting, accounting, and paying the taxes to the government. Responsible parties often include corporate officers and directors, partners, and employees, but may also extend to bookkeepers, accounting firms, parent companies, creditors, and purchasing companies. Because the definition is so expansive, courts often consider a variety of factors based on the facts and circumstances of each case. Factors often looked to by courts include:

  • Authority to sign checks;
  • Identification of the person as an officer, director, or principal shareholder of the corporation, a partner in a partnership, or a member of an LLC;
  • Duties of the officer as set forth in the by-laws;
  • Identification of the person as the one in control of the business’s financial affairs;
  • Authority to determine which creditors the company would pay and individuals who exercised that authority;
  • Authority to control payroll disbursements;
  • Whether the individual had authority to sign, and did actually sign, employment tax returns; and,
  • Authority to pay the taxes owed.

    See IRM 5.17.7.1.2; citing Cook v. United States, 52 Fed. Cl. 62, 89 AFTR2d 2002-1541, 2002-1 USTC ¶ 50,328 (Fed. Cl. 2002)(holding that the controlling shareholder and president were personally responsible for unpaid employment taxes); Datlof v. United States, 252 F. Supp. 11, aff’d, 370 F.2d 655 (3rd Cir. 1966)(finding that the president and treasurer, who had control over corporation's financial affairs, could be held personally liable for the corporation’s failure to pay withholding and employment taxes collected from employees’ wages); and Purcell v. United States, 1 F.3d 932, 937 (9th Cir. 1993)(holding that a company president could be deemed a responsible person for failing to pay withholding taxes). While no one factor is determinative, courts have been more likely to hold secondary sources, including responsible persons, with the ability to pay the taxes personally liable for the unpaid trust-fund taxes.

How much will the IRS attempt to recover?

    Generally, the IRS only attempts to recover the unpaid balance of the trust-fund tax. The amount is typically based on the unpaid income taxes that were required to be withheld by the employer, plus the employee’s unpaid portion of FICA taxes. While the IRC’s sections on trust-fund liability do not expressly provide for any additional penalties or fees, the IRS is permitted to pursue additional fines and penalties under other sections of the code. See IRC §6672. Thus, if you are concerned about your potential liability or have been contacted by an IRS revenue officer, it is highly recommended that you consult with a professional to discuss further.  

Contact Nardone Limited

    Nardone Limited frequently represents individuals and businesses in federal, state, and local civil tax matters, including appeals. If you or your business have been contacted by an IRS revenue officer or the Ohio Department of Taxation, or are struggling with tax liabilities, you should contact one of our tax attorneys today. We will thoroughly review your case to determine your potential personal liability, as well as what options and alternatives are available to you.

April 20, 2018

Business Owners Are Not Always Responsible Parties under Ohio Law Relating to Sales Tax Liabilities

    The tax attorneys at Nardone Limited in Columbus, Ohio, routinely advise taxpayers about their potential personal liability relating to liabilities owed by a business, as part of our tax controversy work. The Ohio Department of Taxation has several tools available to collect delinquent taxes, including conducting a trust fund investigation of responsible persons. When the Ohio Department of Taxation issues an assessment to an individual relating to taxes owed by a business, it is important that you understand your rights and obligations. See our prior articles: Trust Fund Liability at the State and Federal levels and Personal Liability for a Business’s Failure to Pay Ohio Sales Tax.

    Most companies operate as a business entity that shields owners from personal liability for the company’s obligations. But, a major exception exists to this rule, commonly referred to as trust fund liability. If an employer fails to pay certain taxes on behalf of their employees, or fails to collect and pay Ohio sales tax, then under Ohio law, the Ohio Department of Taxation has the right to collect monies due from certain individual’s personal assets. The Ohio Department of Taxation will send a Notice of Personal Assessment to the individual for the amounts owed by the business. The individual then has the opportunity file a petition for reassessment and ultimately present their case as to why they are not a responsible person, under Ohio law.

Who May be a Responsible Party for Sales Tax Liabilities Owed on Behalf of a Business?

    Under R.C. 5739.33, if a business fails to collect and pay the necessary Ohio sales tax, then any of its employees having control or supervision of, or charged with the responsibility of filing returns and making payments, or any of its officers, members, managers, or trustees who are responsible for the execution of the corporation's, limited liability company's, or business trust's fiscal responsibilities, may be personally liable for the failure. Generally, the Ohio Department of Taxation will assess the individual business owners for monies owed by the business. But, simply because an individual has an ownership interest in a business does not necessarily mean they will be considered a responsible party under Ohio law.

Ohio Board of Tax Appeals Finds Minority Shareholder is Not a Responsible Party under R.C.  5739.33.

    In Peggy E. Gerard v. Roger W. Tray, Tax Commissioner of Ohio, the business’s majority shareholder had control over practically every aspect of the business. The petitioner in the case, Peggy Gerard (“Peggy”), a minority shareholder, would prepare the business’s sales tax returns. Then, Peggy would provide the sales tax returns to the majority shareholder for signature.   

    On a few occasions, Peggy mailed the sales tax return, with payment, and the majority shareholder became very upset that she had mailed the sales tax return with payment. The majority shareholder then sent a check to another creditor, which caused the check relating to the sales tax liabilities to bounce. When Peggy confronted the majority shareholder regarding the bounced check, the majority shareholder advised that the majority shareholder had full authority over the business’s payments to creditors. Thus, since the business was no longer meeting its sales tax payment requirements, Peggy advised that she no longer would sign checks. As a result, the majority shareholder fired Peggy.

    Ultimately, the Ohio Board of Tax Appeals found that an individual who is at best, a de facto officer, who had no control over filing and paying the business’s sales tax, and whose check writing authority was limited to a second signature with another officer’s signature as primary, is not responsible for the business’s sales tax obligation. Thus, even when a minority shareholder has check signing authority and periodically filed Ohio sales tax returns, the Ohio Board of Tax Appeals determined that the minority shareholder was not personally responsible for unpaid sales tax when the majority shareholder had authority over the business’s payments to creditors.

    At the end of the day, whether the Ohio Department of Taxation will hold an individual personally responsible for a business’s sales tax liabilities will depend upon the specific facts and circumstances of each individual’s involvement with the business’s finances and the business’s sales tax preparation and filing. But, simply because an individual has an ownership interest in a business does not necessary mean that the Ohio Department of Taxation will determine that the individual is a responsible person under Ohio law.

Conclusion

    Nardone Limited frequently represents individuals and businesses in federal, state, and local civil tax matters, including appeals. If you or your business have been contacted by the Ohio Department of Taxation, or are struggling with tax liabilities, you should contact one of our tax attorneys today. We will thoroughly review your case to determine your potential personal liability, as well as what options and alternatives are available to you.

July 31, 2018

July 06, 2018

June 14, 2018

June 08, 2018

May 31, 2018

May 25, 2018

May 17, 2018

May 04, 2018

April 27, 2018

April 20, 2018

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