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What Are The Rules On Unreimbursed Employee Expenses? Freeman Law Tax Court In Brief

What Are The Rules On Unreimbursed Employee Expenses? Freeman Law Tax Court In Brief

PEEPLES v. Comm’r, Summary Op. | May 19, 2021 | Paris, J. | Docket No. 17117-17S.

Short Summary: Mr. Peeples deducted unreimbursed employee business expenses on his 2014 federal income tax return. The IRS disallowed the deductions and issued a notice of deficiency. Mr. Peeples filed a petition with the United States Tax Court challenging the proposed adjustments in the notice of deficiency.

Key Issues: Whether Mr. Peeples is entitled to deduct (1) certain unreimbursed employee business expenses and (2) tax preparation fees (under Section 162) for 2014.

Primary Holdings: No, Mr. Peeples is not entitled to deduct either because he failed to provide the Court adequate documentation or information that would have substantiated either the application of the Cohan rule for the deductions or the tax preparation expense.

Key Points of Law:

  • The Commissioner’s determinations in a notice of deficiency are generally presumed correct and the taxpayer generally bears the burden to prove them incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
  • Because deductions are a matter of legislative grace, the taxpayer must satisfy the specific requirements for any deductions claimed. See INDOPCO, Inc. v. Comm’r, 503 U.S. 79 , 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435 , 440 (1934).
  • Section 162(a) allows for the deduction of all ordinary and necessary business expenses paid or incurred during the course of any trade or business for the taxable year. “Ordinary and necessary” expenses must be directly connected with or pertaining to the taxpayer’s trade or business.
  • Section 212 generally allows the deduction of ordinary and necessary expenses paid or incurred during the tax year for the production of income so long as the expenses are a reasonable amount and bear a reasonable and proximate relationship to the production of income. Sec. 1.212-1 (d), Income Tax Regs.
  • Section 262(a), however, generally disallows the deduction of personal expenses. As a general rule, expenses related to traveling between one’s home and one’s place of business or employment constitute commuting expenses and are nondeductible personal expenses. See 262(a); Fausner v. Comm’r, 326 U.S. 465 (1946); Feistman v. Comm’r, 63 T.C. 129 , 134 (1974).
  • Generally, a taxpayer must maintain records sufficient to substantiate items underlying their claimed deductions. 6001; Treas. Reg. § 1.6001-1(a).
  • If a taxpayer establishes that a deductible expense has been paid but is unable to substantiate the precise amount, the Court generally may estimate the amount of the deductible expense, bearing heavily against the taxpayer and dependent upon the taxpayer presenting sufficient evidence to serve as a basis for said estimate. See Cohan v. Comm’r, 39 F.2d 540 , 543-544 (2d Cir. 1930); Vanicek v. Comm’r, 85 T.C. 731 , 743 (1985). This estimation process is often referred to as the ‘Cohan Rule.’ Id.
  • Section 274(d) supersedes the Cohan Rule for certain categories of expenses and establishes higher substantiation requirements for expenses related to travel, other activities, and “listed property” as defined in Section 280F(d)(4). The definition of listed property includes passenger automobiles. See Sanford v. Comm’r, 50 T.C. 823 , 827-828 (1968), aff’d per curiam, 412 F.2d 201 (2d Cir. 1969). Sec. 280F(d)(4)(i).
  • To satisfy the 274(d) requirements regarding a passenger automobile, as at issue in Peeples, a taxpayer must keep a contemporaneous mileage log, calendar, or other adequate record that substantiates the extent to which the vehicle was actually used for business rather than personal purposes. See Michaels v. Comm’r, 53 T.C. 269 , 275 (1969); Larson v. Comm’r, T.C. Memo. 2008-187 ; sec. 1.274-5T (c)(2)(i) , Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985)
  • In short, the Cohan Rule may only be applied so long as the petitioner provides the Court adequate documentation of the relevant and questioned information and the Court may not apply the Cohan rule to approximate expenses covered under Section 274(d). See Sanford v. Comm’r, 50 T.C. 823 (1968).

Insight: The Peeples decision reaffirms the importance of maintaining expense records for all business-related events and expenditures. In the event that a taxpayer can establish that a deductible expense has been paid but relevant records are lost, damaged, or otherwise insufficient, the court generally may estimate an expense­—however, the court will bear heavily against the taxpayer and the estimation will be dependent upon the presentation of sufficient evidence to provide the court a basis for said estimate.

Have a legal question? Contact Jason Freeman, Freeman Law, Texas.

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