Poor Record-Keeping Can Put You in the Hole
Weatherington, Richard, Art Business News
* Both the courts and the IRS are skilled at spotting the signs of reconstructed records, so art dealers should think twice before slipping non-contemporaneous records by either the IRS or the courts.
* The tax code in section 162 allows a deduction for ordinary and necessary expenses paid or incurred during a taxable year in carrying on a trade or business.
* In order to successfully maintain a deduction, the taxpayer must maintain sufficient records, and while estimates are allowed, the taxpayer must present sufficient evidence to provide a basis for them.
Almost anyone who has ever bet on a horse race has at one time or another been poked in the ribs by a shady looking character offering to sell them a sure thing. Well, when it comes to taxes, the IRS and art dealers, the IRS can come up with a sure thing almost every time it audits a dealer's tax return.
A string of court cases play like a broken record, repeating the same song over and over again: a lack of adequate substantiation means no deduction. Yet, in spite of repeated losses in the courts, some dealers still roll the dice each year hoping their deductions will slip by with less than stellar records to back them up.
Recently, an owner whose deductions were slashed by the IRS faced a judge who was less than sympathetic to his claims. The owner claimed deductions for the disputed items totaling $24,500, but after an audit, the IRS allowed a mere $8,700. The IRS said that the various business deductions were disallowed because the owner had not established that each amount was for an ordinary and necessary business expense, or was expended for the purpose designated. Unable to settle the differences, the owner took the dispute to U.S. Tax Court.
The tax code in section 162 allows a deduction for ordinary and necessary expenses paid or incurred during a taxable year in carrying on a trade or business. The code also states that personal, living and family expenses are generally not allowed as a deduction. In order to successfully maintain a deduction, the taxpayer must maintain sufficient records, and while estimates are allowed, the taxpayer must present sufficient evidence to provide a basis for them.
However, for certain deductions, the burden of proof increases. Deductions for travel, including meals and lodging, entertainment and the use of listed property such as passenger cars, computers and cellular phones, all require additional information to sustain a deduction. For these items, adequate records include (1) the amount of the expense or use based on the appropriate measure; (2) the time and place of the expense or use; (3) the business purpose of the expense or use; and (4) in the case of entertainment, the business relationship to the taxpayer of each person entertained.
Having set the framework, the court looked at the owner's deductions still in dispute. The owner had claimed office expenses of $3,200. At trial, however, he produced receipts totalling only $400, which were for a computer printer and a cellular phone. Because both were listed as property, the owner was required to establish the amount of business use, as well as the total use of the property. Unable to do so, the tax court disallowed the $3,200, including the $400 for the items covered by the receipts.
The next deduction covered meals and entertainment in which the owner claimed $1,650 while the IRS allowed only $487. The owner presented the court with 67 pages of receipts and checks. However, most only provided partial details such as the word "meeting" or merely a person's name. The court said this did not meet even the minimum requirements of the code. The court further noted that it did not find the receipts presented to be credible evidence. Nearly all the notations were made not on the receipts themselves, but on the copies of the receipts. The owner admitted that the notations were made at the end of the year. …