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Near v. Commissioner (T.C. Memo. 2020-10)

On January 14, 2020, the Tax Court issued a Memorandum Opinion in the case of Near v. Commissioner (T.C. Memo. 2020-10). The issue presented in Near was whether the petitioner, an attorney for a public utility in California, could deduct unreimbursed employee business expenses incurred while travelling for work when the employee had a right to seek reimbursement from his employer.

Ordinary and Necessary Business Expenses under IRC § 162

A taxpayer may deduct all ordinary and necessary expenses paid in carrying on a trade or business. IRC § 162(a). An ordinary expense is one that commonly or frequently occurs in the taxpayer’s business, and a necessary expense is one that is appropriate and helpful in carrying on the taxpayer’s business. See Deputy v. du Pont, 308 U.S. 488, 495 (1940) (ordinary expenses), Commissioner v. Heininger, 320 U.S. 467, 471 (1943) (necessary expense); see also Treas. Reg. § 1.162-1(a). A taxpayer may not deduct a personal, living, or family expense unless the Code expressly provides otherwise. See IRC § 262(a).

Because the determination of whether an expenditure is ordinary and necessary is a question of fact, a taxpayer must persuade the Tax Court that there is a bona fide business purpose for the expenditure and a proximate relationship between the expenditure and his business. Heininger, 320 U.S. at 475; Challenge Mfg. Co. v. Commissioner, 37 T.C. 650, 660 (1962). Where personal benefit is distinctly secondary and incidental to a profit motive, the expense may be deducted under IRC § 162(a). Int’l Artists, Ltd. v. Commissioner, 55 T.C. 94, 104 (1970). The Tax Court requires more than a taxpayer’s averment to establish that the expense was incurred in pursuit of a trade or business. Ferrer v. Commissioner, 50 T.C. 177, 185 (1968), aff’d per curiam, 409 F.2d 1359 (2d Cir. 1969).

Cohan” Rule not Available for Expenses Falling Under IRC § 274

The Court may estimate the amount of a deductible expense if a taxpayer is unable to substantiate the precise amount.  However, the Tax Court will only do so if a taxpayer has first established that an expense was incurred and is deductible. See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985); Estate of Reinke v. Commissioner, 46 F.3d 760, 764 (8th Cir. 1995), aff’g T.C. Memo. 1993-197. Further, there are certain expenses that are specified in IRC § 274, which are subject to strict substantiation rules and therefore are not permitted to be estimated by the Tax Court. A taxpayer must substantiate the amount of the expense, the time and place of the expense, and the business purpose through adequate records or by sufficient evidence. IRC § 274(d). This includes providing a log or a similar record, as well as documentary evidence corroborating the taxpayer’s testimony. Treas. Reg. § 1.274-5T(c)(2)(i); Treas. Reg. § 1.274-5T(c)(3)(i) (evidence corroborating taxpayer’s statement). Such corroborating evidence includes receipts, bills, or the like. Treas. Reg. § 1.274-5(c)(2)(iii). Car and truck expenses are subject to the strict substantiation rules of IRC § 274(d). IRC § 274(d)(4); IRC § 280F(d)(4)(A)(i); IRC § 280F(d)(4)(A)(ii).

Unreimbursed Business Expenses When Employee Could Have Been Reimbursed by Employer

Ordinarily, a taxpayer may deduct unreimbursed employee business expenses as ordinary and necessary under IRC § 162, subject to the 2% floor of IRC § 67(a). Lucas v. Commissioner, 79 T.C. 1, 6-7 (1982). However, employee business expenses paid on behalf of an employer who reimburses such costs may not be converted into trade or business expenses because the employee failed to seek reimbursement. Stolk v. Commissioner, 40 T.C. 345, 356 (1963), aff’d per curiam, 326 F.2d 760 (2d Cir. 1964); Podems v. Commissioner, 24 T.C. 21, 22-23 (1955). Stated differently, if the employer offers to reimburse the expense of an employee, but the employee does not take the employer up on the offer, the employee cannot later claim that the expense was “unreimbursed” for purposes of the taxpayer’s return. The Tax Court has taken this position, because when an employee has a right to reimbursement for expenditures related to his status as an employee but fails to claim such reimbursement, the expenses are not deductible because they are not “necessary”. Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), aff’g T.C. Memo. 1984-533.

Original opinion: (T.C. Memo. 2020-10) Near v. Commissioner

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