At the end of August, the Board of Tax Appeals issued a painful reminder to a taxpayer regarding the burdens of substantiating deductible business expenses submitted on a tax return. The taxpayer had claimed several thousands of dollars in home office and travel expense deductions over a two-year period and was subsequently audited. After producing shoddy documentation during the audit and then delivering poorly prepared testimony during examination, the taxpayer lost his case and was forced to pay the judgment along with additional accuracy-related penalties. This case, Kilpatrick v. Commissioner (TC Memo 2016-166), provides valuable lessons for taxpayers claiming business and travel expenses. While the taxpayer in this case is a Certified Public Accountant and should have known better, the rules for documentation of business expenses apply to all taxpayers regardless of their education and training.
Much of the taxpayer’s supporting documentation was thrown out by the authorities because it was not timely prepared, was not credible, and did not reflect the underlying economic realities of each transaction that he claimed as deductible. Further, he delivered unpersuasive testimony that was full of hedges, guesses, and gross inaccuracies. Had he, or his company, operated under a properly structured and enforced expense policy, he would have had a much better chance at surviving the audit. He likely would have been able to support certain expenses that were may have been properly claimed on the return. Additionally, he could have relied on the documentation during testimony to bolster his claims, rather than be stuck speaking only in general speculation and conjecture.
The Internal Revenue Code contains various sections dealing with business expense and travel deductions. Further, the IRS has provided guidance on documentation considered necessary and adequate to support business-related expense deductions. There are also steps outside of the formal IRS requirements that a taxpayer may take to help protect the veracity and sustainability of deductions taken on a tax return. Employers, including those who are self-employed, would be wise to create, adopt, and enforce expense reimbursement policies that are in compliance with applicable tax law. Though this area of the law is not overly complex, it can be tricky to navigate and may leave uninformed taxpayers vulnerable to mistakes that may cost big dollars down the road. Everyone should appreciate that small businesses and self-employed individuals do not get a “break” from compliance with these rules. Being “too busy” to document travel and business expenses creates exposure to IRS audit adjustments.
Contact your attorney at McCarthy, Lebit, Crystal & Liffman today to discuss how we can assist you and your company in drafting an appropriate expense policy to help protect your business and your employees. Following an actual plan that has been crafted in compliance with the law provides you a much stronger position when the tax auditors appear.