The issue of when education expenses represent deductible business expenses involves an analysis of the specific facts for each taxpayer. Reg. §1.162-5 outlines the rules that apply in such cases.

Reg. §1.162-5(a) allows a deduction for ordinary and necessary business education expenses, even if the education may lead to a degree, if the education

• Maintains or improves skills required by the individual in his employment or other trade or business, or

• Meets the express requirements of the individual’s employer, or the requirements of applicable law or regulations, imposed as a condition to the retention by the individual of an established employment relationship, status, or rate of compensation.[1]

However, such expenses will not be allowed as a deduction, even though they otherwise meet one of the two prior conditions, if:

• The education meets the minimum education requirements for qualification in the trade or business,[2] or

• The education program being pursued will qualify a taxpayer for a new trade or business.[3]

In Chief Counsel Advice 202003004[1] the IRS Chief Counsel’s office looked at the impact of the burden of proof imposed on the agency when it asserts that payments are to disallowed under IRC §165(c) as illegal kickbacks, bribes, and the like.

Online tax discussion groups, many of which are sponsored by state CPA societies for their members, offer useful places to discuss tax issues and become aware of what is going on in taxes.  It was when participating in such a group discussion that I became aware of a theory being proposed to allow working around the state and local tax deduction cap based on the proposed regulations[1] issued by the IRS in December regarding payments to charitable organizations not treated as charitable contributions under Proposed Reg. §1.162-15.

A taxpayer could not show that payments he made represented interest on purported loans and, while he was able to deduct some commission expenses, the amount was limited due to issues with his records in Moore v. Commissioner, TC Memo 2019-100.[1] 

The IRS has published on their website a frequently asked question page dealing with a deduction for legal fees under IRC §162(q) (Section 162(q) FAQ).

For those who may not have memorized the Internal Revenue Code, IRC §162(q) is a provision added by the Tax Cuts and Jobs Act.  This provision provides:

(q) Payments related to sexual harassment and sexual abuse No deduction shall be allowed under this chapter for—

(1) any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or

(2) attorney’s fees related to such a settlement or payment.

The experience of tax advisers over the years suggests that most often the key disputes in tax exams arise not so much over the arcane issues in the tax law as over the state of the taxpayer’s records to support the facts in the case.  The case of Dasent v. Commissioner, TC Memo 2018-202 is just such a case.  While the question of hobby loss does arise for a portion of the deductions (and the activity clearly met that test), the Court pointed out that even had that not been an issue, none of the taxpayers’ deductions could be allowed due to lack of adequate records.

The taxpayers in the case of Pacific Management Group et al. v. Commissioner, TC Memo 2018-131, were upset that they were being taxed twice on the income of their C corporation, once at the corporate level and a second time if the earnings were distributed to the shareholders.  But the IRS and, eventually, the Tax Court found the solution they were sold was too good to be true.

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While the tax law allows deductions for expenses incurred in a trade or business, it does not allow a taxpayer to claim a current deduction while the taxpayer is merely investigating the possibility of entering into a trade or business.  In the case of Samadi v. Commissioner, TC Summary Opinion 2018-27 the Tax Court determined the taxpayer was in just such an investigatory stage and not actually conducting a trade or business.

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The IRS has yet again extended the relief it provided for Hurricane Harvey to cover Hurricane Irma.  In Notice 2017-52 the IRS has provided the same relief for employees and employers when a leave donation program to benefit victims of Hurricane Irma as Notice 2017-48, the details of which were covered in an earlier blog post.

Generally, an employer can allow employees to donate leave time of any sort to a program where the employer then pays an amount equal to the value of that time to a §170(c) charity to be used for relief for victims of either hurricane.  The IRS will not treat the payment as taxable income for the employee, but will treat the amount as compensation expense, rather than a charitable contribution, for the employer.

The payment to the charitable organization must be made before January 1, 2019.

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The IRS in Notice 2017-48 provided guidance on the use of leave-based charitable donation programs that employers can use to provide Hurricane Harvey relief.  Under such programs, employees give up certain amounts of vacation, sick or personal leave in exchange for which the employer makes a cash donation to a qualified charitable organization for Hurricane Harvey relief.

Normally such an arrangement would arguably be taxable to the employee, followed by a charitable contribution deduction for the employee or, in the alternative, that the payments are charitable contributions of the employer which would be subject to the appropriate limits on charitable contribution deductions.  This notice provides that the IRS will not assert that position for programs that meet the requirements of this notice.

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The IRS has recently indicated a level of “unhappiness” with the concept of a microcaptive insurance company, adding them to the agency’s “dirty dozen” tax scams list in 2015 and declaring them a transaction of interest in Notice 2016-66.  In the case of Avrahami, et al v. Commissioner, 149 TC No. 17 we have the first time the Tax Court scrutinized this particular structure.

Captive insurance companies have been recognized as legitimate insurance arrangements by the courts in several cases (see Rent-A-Center, Inc. v. Commissioner, 142 TC 1 and AMERCO & Subs. v. Commissioner, 96 TC 18) so long as certain criteria are met that distinguish the arrangement as insurance rather than merely establishing a “set aside” of funds for potential liabilities.  These cases have generally involved large entities with the resulting captive being itself a relatively large organization.

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Taxpayers who seek deductions for employee business expenses will find the deduction barred if the taxpayer cannot show that he/she was not entitled to reimbursement from his/her employer for the expenses shown on the Form 2106.  This was the issue that tripped up the taxpayer in the case of Howard v. Commissioner, T.C. Summ. Op. 2017-65.

Employees are considered to be in a trade or business and thus are allowed a deduction for expenses incurred in pursuit of that trade or business if the expenses are “ordinary and necessary” expenses.[1]  However, if the employer offers to reimburse the expenses (such as via an expense reimbursement policy), but the employee does not take the employer up on the offer no deduction is allowed.  The expense in that case would not be “necessary” as the taxpayer had a source of reimbursement.

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Even though it may appear to taxpayers that mileage and meals are clearly related to their job, only in limited circumstances may deductions be claimed for such items.  In the case of Wooten v. Commissioner, TC Summ. Op. 2017-58, the taxpayers discovered that none of the expenses they had claimed met the requirements to be deductible.

In this case the taxpayer was employed as a plumber/pipefitter for a contractor.  In his job he had to work at various locations, some in Gulfport or Biloxi, Mississippi, which were 20-25 miles from his home and two in Hattiesburg, Mississippi which was about 56 miles from his home.  Mr. Wooten kept logs of his travel to/from his home to these locations.  He claimed a deduction for this mileage, along with a deduction for meals he consumed at these locations.

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Whether a taxpayer can claim a deduction for legal expenses generally depends on the origin of the claim giving rise to the legal expense.  This means that even if the legal expense might arguably have an impact on one activity (say, a new trade or business the taxpayer is establishing) it will not be deductible as part of that activity if the claim originated elsewhere.  The case of Dulik v. Commissioner, TC Summ. Op. 2017-51 deals with this issue.

In this case the taxpayer was negotiating a separation agreement from his former employer.  In doing so he paid $26,781 in legal fees related to various issues in negotiating that agreement, specifically looking to get removed from the agreement a reference to a secrecy agreement he had signed with a predecessor of his current employer which contained a non-compete agreement.

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The taxpayer corporation in this case had claimed deductions in 2011-2013 for management fees of $120,000, $36,000, and $42,000.  In each year, Home Team had transferred funds to Sacer Cor as it had cash available to transfer, and the funds were initially recorded as loans to Sacer Cor.  At the end of the year, some or all of the loans were reclassified as management fees.

The Court noted that the fees were based solely on Home Team’s ability to pay rather than being payments for specifically invoiced services.  Also, Sacer Cor had no employees for the years in question, although two of the Sacer Cor shareholders were employees of Home Team and were paid a salary by that organization.  The Court noted that Home Team did not produce any evidence of any services provided by Sacer Cor.

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Whenever taxpayers are paying for services between related entities the same interests control, the IRS is known to be skeptical of the reality of the arrangement.  The IRS questioned just such an arrangement in the case of Kauffman v. Commissioner, TC Memo 2017-38.

The taxpayer in this case was a realtor and cinematographer who operated several single member LLCs (all of which were treated as disregarded entities) and a C corporation.  The IRS was questioning payments made from one of the LLCs to the C corporation of $191, 000 for “consulting fees” and $75,000 in “commissions and fees.”

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Steve Backemeyer, a cash basis farmer, purchased seed, chemicals, fertilizer and fuel in 2010 which he intended to use when planting crops in 2011.  Being on the cash basis, these items were deducted on his 2010 income tax return, filing married filing joint with his wife.  However, Steve died in March 2011 and these supplies were inherited by his wife.  His wife took up the farming business, using these supplies to plant the crop in 2011.  She claimed these items, valued as of the date of Steve’s death, as a deduction on her 2011 return, also a joint return filed with her deceased husband.

In the case of Estate of Steve K. Backemeyer et al v. Commissioner, 147 TC No. 17 the IRS argued that the tax benefit should prevent this double deduction of the same expenses for the same crop, requiring the deduction to be removed from the taxpayers’ 2010 tax return.  But the Tax Court found that both deductions were allowed in this situation.

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With the growth of the “sharing economy” involving organizations like Uber and Airbnb, the IRS has determined there is a need for guidance for individuals who are involved in providing such services. 

Many of these individuals have not previously operated a business, nor may they even realize that they truly are operating a business that will trigger special tax issues and obligations.

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In order to claim deductions related to a trade or business, the taxpayer must be able to show not just that the expenditures were incurred by the taxpayer for a legitimate trade or business reason, but also that the trade or business in question has actually begun operation.  The IRS was not disputing that the taxpayer had an honest intent to operate a trade or business for which she incurred expenses, but rather that the business had not commenced operations in the case of Tizard v. Commissioner, T.C. Summ. Op. 2016-42.

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