The Tax Court in Brief – August 29th – September 2nd, 2022

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Tax Litigation: The Week of August 29th, 2022, through September 2nd, 2022

Butterfield v. Comm'r, T.C. Summ. Op. 2022-16| August 30, 2022 | Carluzzo, Chief SJT | Dkt. No. 2608-21S


Short Summary: George Butterfield (Butterfield) was employed as a construction superintendent. His employment required that he travel to various locations in multiple states to build or remodel truck service stations. In 2017, he spent 245 nights away from his home performing these services. The company that Butterfield worked for provided reimbursement for many of his travel expenses. In 2017, his company paid him a total of $18,375 as travel reimbursements based on a per diem method. Butterfield's tax preparer claimed $37,687 of unreimbursed employee expenses (after application of the 50% limitation under section 274(n)) on Butterfield's 2017 tax return. The IRS disallowed the unreimbursed employee expenses, and Butterfield sought Tax Court review.

Key Issues:

  • Whether Butterfield is entitled to claim the unreimbursed employee expenses as miscellaneous itemized deductions?

Primary Holdings:

  • Butterfield has substantiated $3,153 for meals and $8,242 for lodging through his credible testimony and summaries of his bank and debit card records. However, Butterfield may only claim these deductions if his reimbursable payments from the company were made under a "nonaccountable plan." Under Rule 155, the Tax Court reasoned that the parties should be able to determine themselves whether the reimbursements Butterfield received were through an accountable or nonaccountable plan and directed the parties to memorialize their agreement in the Rule 155 computations.

Key Points of Law:

  • Generally, the IRS's determination of a taxpayer's federal income tax liability in a notice of deficiency is presumed correct, and the taxpayer bears the burden of proving that the determination is wrong. Rule 142(a); Welch v. Helvering,, 290 U.S. 111, 115 (1933).
  • Deductions are a matter of legislative grace; accordingly, the taxpayer bears the burden of proving entitlement to any claimed deduction. Rule 142(a); INDOPCO, v. Comm'r, 503 U.S. 79, 84 (1992). This burden requires the taxpayer to substantiate expenses underlying claimed deductions by keeping and producing adequate records that enable the IRS to determine the taxpayer's correct tax liability. See I.R.C. § 6001; Hradesky v. Comm'r, 65 T.C. 87, 89-90 (1975), aff'd per curiam, 540 F.2d 821 (5th Cir. 1976).
  • 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 R.C. § 6001; Hradesky, 65 T.C. at 89-90; Treas. Reg. § 1.6001-1(a).
  • Taxpayers may deduct ordinary and necessary expenses paid in connection with operating a trade or business. R.C. § 162(a). Generally, the performance of services as an employee constitutes a trade or business. Primuth v. Comm'r, 54 T.C. 374, 377 (1970). If, as a condition of employment, an employee is required to incur certain expenses, then the employee is entitled to a deduction for these expenses unless entitled to reimbursement from his or her employer. See Foundation v. Comm'r, 59 T.C. 696, 708 (1973).
  • Under the Cohan doctrine, if a taxpayer provides sufficient evidence that the taxpayer has incurred a trade or business expense contemplated by section 162(a) but is unable to adequately substantiate the amount, the Court may estimate the amount and allow a deduction to that extent. Cohan v. Comm'r, 39 F.2d 540, 543-44 (2d Cir. 1930). But in order for the Court to estimate the amount of any expense, there must be some basis upon which an estimate may be made. Vanicek v. Comm'r, 85 T.C. 731, 742-43 (1985).
  • The Court may not, however, estimate expenses under Cohan in situations where section 274 requires specific substantiation. See R.C. § 274(d); Sanford v. Comm'r, 50 T.C. 823, 827 (1968), aff'd per curiam, 412 F.2d 201 (2d Cir. 1969). Deductions for expenses attributable to meals and lodging while traveling away from home, if otherwise allowable, are subject to strict rules of substantiation. See I.R.C. § 274(d). With respect to these types of expenses, section 274(d) requires that the taxpayer substantiate either by adequate records or by sufficient evidence corroborating the taxpayer's own statement (1) the amount of the expense; (2) the time and place the expense was incurred; (3) the business purpose of the expense; and (4) in the case of entertainment or gift expense, the business relationship to the taxpayer of each expense incurred.
  • Substantiation by adequate records requires the taxpayer to maintain an account book, a diary, a log, a statement of expense, trip sheets, or a similar record prepared contemporaneously with the expenditure and documentary evidence (e.g., receipts or bills) of certain expenditures. Reg. § 1.274-5(c)(2)(iii); Temp. Treas. Reg. § 1.274-5T(c)(2). Substantiation by other sufficient evidence requires the production of corroborative evidence in support of the taxpayer's statement specifically detailing the required elements. Temp. Treas. Reg. § 1.274-5T(c)(3).
  • Under section 62(a)(2)(A), an employee may deduct certain business expenses incurred in connection with the performance of services for an employer under a reimbursement or other expense allowance arrangement. If these expenses are reimbursed by the employer pursuant to an "accountable plan," then the reimbursed amount is not reported as wages on the employee's Form W-2 and is exempt from withholding and payment of employment taxes. Reg. § 1.62-2(c)(4). If the arrangement fails to meet the requirements of section 62 and the governing regulations, amounts paid under the arrangement will be treated differently as under a nonaccountable plan—i.e., such amounts are included as gross income in the employee's Form W-2 and are subject to withholding and payment of employment taxes. Only in the latter case may expenses be deducted, provided the employee can substantiate the full amount of his or her expenses.

Insight: The Butterfield summary opinion provides a reminder to taxpayers that maintaining records, even after a tax filing, is important. Taxpayers should strive to keep their records for at least 3 years after the return is filed (but, ideally, six years, if possible).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.