Don't Mess With Taxes

The late Robin Williams said that cocaine is God's way of telling you that you are making too much money. 

I think you can add luxury autos to that list.

The hubby and I spotted this McLaren MP4-12C in our local shopping center's parking lot. Note to self: get to know my obviously much wealthier neighbors!

Here in Austin, I regularly see high-dollar cars. A lot of them. On just the roads I routinely travel I've spotted Teslas, Ferraris, Lamborghinis, Mercedes-Benz G-Wagons, Maseratis, Lotuses and even that McLaren pictured above.

Yes, I am jealous. While I am happy with my Chevy Malibu, I admit that if I ever come into a windfall, I'm buying a luxury auto.

But to get back to the American mid-sized sedan reality of here-and-now, my point, per the insightful Williams, is that if you have enough discretionary money to buy or lease a luxury auto, good for you.

Don't try, however, to park an expensive car in your driveway by claiming a tax deduction that you can't prove.

That's not just auto envious me talking. It's the United States Tax Court.

Court nixes most auto deductions: In the summary judgment issued on Nov. 15, U.S. Tax Court Judge Joseph W. Nega ruled that the owner of a Long Beach, California-based aerospace consulting/technical writing business didn't meet the strict substantiation requirements to deduct vehicle expenses and depreciation for an Aston Martin he claimed to use for business.

As such, the court denied taxpayer Gary Frederick Roy most of the legal and professional expense deductions that he had claimed on his 2012 tax return.

How much is most?

Accfg to the court filing, Roy had claimed $21,747 for car and truck expenses (mostly relating to the Aston Martin), $21,636 for depreciation for the Aston Martin and $41,410 for legal and professional services expenses.

The Internal Revenue Service audit of Roy's 2012 filing determined he did not properly substantiate his car and truck expenses, depreciation expense and legal and professional services. Disallowing those deductions ultimately produced a tax deficiency per the audit's calculations of $22,418, to which the IRS also added accuracy-related penalty of $4,483.

That total of $26,901 is this week's By the Numbers figure.

Deduction demands driver documentation: There are lots of lessons to be learned from this tax court case. Since deductions related to an Aston Martin -- yes, the James Bond car -- were a key component, let's start there.

The Tax Court noted that when you want to claim a deduction for auto related business expenses in connection with your passenger vehicle, you must " substantiate by adequate records or by sufficient evidence corroborating the taxpayer's own statement (1) the amount of the expense, (2) the time and place of the travel or use, and (3) the business purpose of the expense."

Although the judge noted that a contemporaneous log is not required, I still suggest doing so. The reason why is spelled out in Roy's case. The decision pointed out that "a taxpayer's subsequent reconstruction of his or her expenses does require corroborative evidence with a high degree of probative value to support such a reconstruction, in order to elevate that reconstruction to the same level of credibility as a contemporaneous record."

Basically, as Judge Nega points out, it takes much more work to recreate the vehicle's business use substantiation to meet tax law requirements than to record the expense at the time it is incurred.

This was also touched on in the court decision's discussion of Roy's claim that he used the Aston Martin solely for business purposes. Nega writes:

Although we believe petitioner's testimony that he used the Aston Martin for business purposes, we do not believe his testimony is sufficient to establish that he used it solely for business purposes. Petitioner provided no credible evidence to show that he used the Aston Martin strictly as a business vehicle, and we find it very unlikely that he did not use it for occasional personal excursions. Without more, petitioner's self-serving testimony does not meet the strict [Internal Revenue Code] substantiation requirements … for vehicles used in a trade or business. Accordingly, we sustain [IRS'] determination with respect to this issue.

The ruling also noted that Roy could have alternatively used the IRS-established standard mileage rate method to calculate his auto's deductible business usage.

You can find more about these two methods in my earlier post that explores whether you should use the actual auto expenses or standard mileage deduction method.

Ordinary business costs: The decision in this case also as addressed a couple of other key business deduction claims, ordinary and necessary deductions and the responsibility of a taxpayer in providing information to a paid tax preparer.

When it comes to claiming a business deduction, the expense must be ordinary and necessary. But there is not a set standard for this requirement.

It varies from profession to profession.

And yes, the "and" is bold-faced for a reason. Both are required.

Tax pro vs. taxpayer responsibility: Then there's the matter of tax responsibility, which the Nega decision reiterated falls squarely on the taxpayer's shoulders.

To counter the penalty assessed by the IRS for under-reporting of income and underpayment of tax, the ruling noted that a taxpayer must "come forward with persuasive evidence that the penalty is inappropriate--for example, by showing that he or she acted with reasonable cause and in good faith."

The advice of a tax professional sometimes is used as a reasonable cause/good faith argument if it can be shown that the filer relied on a competent tax adviser's professional judgment as to tax obligations

But the decision noted that in this case the taxpayers "failed to demonstrate that he provided his return preparer with all the relevant information regarding his tax liability. Petitioner merely gave his return preparer an envelope full of receipts with a spreadsheet summarizing his expenses. This does not constitute providing a return preparer with all of the relevant information."

Yes, that sound you hear across the internet is the cheering of tax professionals who regularly must deal with clients who simply dump myriad data on them, expecting filing miracles to come out of the mess.

Don't do that. It's your responsibility to provide your tax pro with all the necessary information to properly file your return.

If you don't, even if you're not claiming expenses connected to a luxury auto on your return, you'll likely end up in the same place. On the losing end of a Tax Court ruling.

You also might find these items of interest:

• 5 things to check when hiring a tax preparer
• Tax Court awards whistleblower pair $178 million
• Former Tax Court judge indicted on tax evasion charges