Upon close inspection, you will notice a familiar theme throughout many of these cases. If you can’t substantiate a deduction, you lose it!
Alimony and separate maintenance payments
Not a divorce or separation agreement: Taxpayer and ex-spouse signed an agreement just between them to modify their divorce agreement. The Tax Court concluded that the taxpayers’ agreement was not a divorce or separation instrument, so the payments made under the agreement were not alimony because they were not mandated by a divorce or separation agreement.
Trade or business expenses
Substantiation: In another case, the IRS disallowed many of the deductions claimed by the taxpayers on their Schedule C. The taxpayers failed to provide documentation to support their claims for deductions and credits associated with several of the husband’s business endeavors. These claims included home office expenses, depreciation for a home computer, medical expenses, home mortgage interest, casualty losses, and charitable contributions. The husband provided limited documentation, and the court disallowed most of them. The court found the husband’s credibility lacking.
Business purpose: In a tax court case, a taxpayer was denied deductions for unreimbursed employee expenses and home office expenses. All unsupported expenses were disallowed. The taxpayer presented records of the travel but failed to prove its business purpose, so the court held that those expenses were nondeductible.
Legislation enacted on Sept. 29, 2017, provides benefits for victims of hurricanes Harvey, Irma, and Maria. For qualified disaster-related personal casualty losses from those hurricanes, the act removes the requirement that personal casualty losses must exceed 10% of the taxpayer’s AGI to be deductible and allows nonitemizers to increase their standard deduction by the amount of their net disaster loss.
In this case the taxpayer was denied a business bad debt deduction. The taxpayer advanced more than $80 million to a company. Promissory notes were executed for and interest was paid on the advances. In a subsequent year, the taxpayer decided to take a bad debt loss deduction for a portion of his advances to the company.
The court denied the deduction, determining that the advances were equity investments rather than bona fide debt. (Note: this should open the opportunity for a worthless security deduction – D.M.S., CPA).
Charitable contributions and gifts
Real estate: A partnership was denied a $33 million noncash charitable deduction for a contribution of an interest in real estate because the Form 8283, Noncash Charitable Contributions, attached to its tax return failed to include the original cost of the real estate interest.
Facade easement: A partnership was allowed a $7 million noncash charitable deduction for a facade easement. Although the written acknowledgment issued by the recipient charity did not indicate that “no goods or services were provided”, the deed stated that the charity supplied no goods or services in exchange for the gift of the easement, and that the deed reflected the entire agreement of the parties.
Valuation: An avid hunter’s noncash charitable deduction for donations of big-game specimens to an ecological foundation was reduced from $1,425,900 to $163,045. The Tax Court noted that the taxpayer’s donated specimens were neither world-class trophies nor of museum quality, and there was an active market in specimens like the taxpayer’s. The court concluded, therefore, that they should be valued at FMV rather than replacement cost. The court upheld the IRS’s valuation.
Substantiation: The Tax Court reduced a married couple’s noncash deduction for 20,000 items given to Goodwill Industries valued at a total of $145,250 to $250. The receipts from Goodwill did not describe any of the items or indicate how many items were donated or their condition, so the court found that the taxpayers’ records were not adequate to support their claimed deductions. The court further found that certain items would have required qualified appraisals since the taxpayer valued them at more than $5,000 each.
Activities not engaged in for profit
Gambling activity: FACTS: The taxpayer worked full time which generated almost all his annual earnings. The taxpayer claimed net losses on Schedule C of $89,116 and $85,783 from his activity as a professional gambler. Most of the expenses he claimed were for auto expenses, travel, and meals and entertainment incurred while on gambling trips. The Tax Court determined that the taxpayer failed to prove that his gambling activity was a for-profit business activity, and he could not deduct any expenses for his gambling activities on Schedule C.
Businesslike manner: In a tax court case, a taxpayer who had over 20 years of experience in car racing deducted losses from a car-racing activity. The Tax Court found that the taxpayer’s experience in the industry, the substantial time he spent on the activity, and the fact that it was his only significant source of income weighed in his favor. However, it found that these factors were heavily outweighed by his not running the activity in a businesslike manner, his lack of expertise in running a car-racing business (as opposed to racing cars), the prior failure of his previous similar car-racing business (which had caused the taxpayer to file for bankruptcy), and the personal pleasure he derived from the activity.