On August 19, 2020, the Tax Court issued a Memorandum Opinion in the case of Brashear v. Commissioner (T.C. Memo. 2020-122). The primary issue before the court in Brashear was whether the petitioners were entitled to various deductions on Schedule C (Profits and Loss from Business).
Business-Related Deductions 101 in Brashear v. Commissioner
The taxpayer’s burden of proof regarding entitlement to deductions requires the taxpayer to substantiate all expenses underlying the deductions claimed by keeping and producing adequate records that enable the IRS to determine the taxpayer’s correct tax liability. IRC § 6001; Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976); Meneguzzo v. Commissioner, 43 T.C. 824, 831-32 (1965). A taxpayer claiming a deduction on a Federal income tax return must demonstrate that the deduction is allowable pursuant to some statutory provision and must further substantiate that the expense to which the deduction relates has been paid or incurred. See IRC § 6001; Treas. Reg. § 1.6001-1(a); Hradesky, 65 T.C. at 89-90.
Taxpayers may deduct ordinary and necessary expenses paid in connection with operating a trade or business. IRC § 162(a); Boyd v. Commissioner, 122 T.C. 305, 313 (2004). To be ordinary, the expense must be of a common or frequent occurrence in the type of business involved. Deputy v. du Pont, 308 U.S. 488, 495 (1940). To be necessary, an expense must be appropriate and helpful to the taxpayer’s business. Welch v. Helvering, 290 U.S. at 113.
On the other hand, IRC § 262(a) generally disallows any deduction for personal, living, or family expenses. Whether an expenditure satisfies the requirements for deductibility under IRC § 162 is a question of fact. See Commissioner v. Heininger, 320 U.S. 467, 475 (1943). Further, deductions for expenses attributable to travel (including meals and lodging while away from home), entertainment, gifts, and the use of “listed property” (as defined in IRC § 280F(d)(4) and including passenger automobiles), if otherwise allowable, are subject to strict rules of substantiation. See IRC § 274(d); Sanford v. Commissioner, 50 T.C. 823, 827 (1968), aff’d per curiam, 412 F.2d 201 (2d Cir. 1969); Treas. Reg. § 1.274-5T(a).
Petitioners Testimony and Substantiation Don’t Pass Muster
In considering whether a taxpayer’s activity constitutes a trade or business within the meaning of IRC § 162(a), the Tax Court examines not only the taxpayer’s profit motive but also whether the business was conducted with continuity and regularity and as a means of earning a living. See Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). In Brashear, the petitioners vague, undisciplined, and sometimes contradictory testimony attempting to describe certain “development” projects did not pass muster under this profit motive / continuity test. Indeed, the Tax Court “wonder[ed] whether either project actually existed beyond [petitioner-wife’s] own intentions.” Even if either did, petitioners have failed to substantiate the amounts claimed or establish that the disallowed deductions relate to ordinary and necessary expenses of either project.
(T.C. Memo. 2020-122) Brashear v. Commissioner
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