Small Business
Accounting - The Tax Court in Powell, TC Memo 2014-235 ,
held that the married taxpayers were not entitled to deduct business expenses
for an activity that did not qualify as a trade or business. Also, they were
not entitled to deductions for bad debts, vehicle expenses, country club
membership fees, and miscellaneous expenses. Further, the court increased their
net capital gain and stated that a portion of their Social Security benefits
may be includable in their gross income.
The husband was the sole owner of an S
corporation engaged in petroleum acquisition and sale, merger consulting, and
valuation. In 2004, he purchased 79 acres of property in North Carolina on
which he built a warehouse to store hops for distribution to local craft
breweries. In 2008 and 2009, he spent approximately 10 to 15 hours per week on
this activity. He began to plant seeds to grow hops, but growth was stalled by
the weather. Also, he called local breweries to gauge their interest in
purchasing hops. The taxpayers sold 1.19 acres to a discount store at a reduced
price so that the store could pay the cost of constructing roads. They paid for
a survey on the property before the sale.
The taxpayers filed joint returns for 2008 and
2009 and claimed a business loss on Schedules E, Supplemental Income and Loss
relating to the husband's S corporation. They also attached Schedules C for the
activity conducted in North Carolina. The S corporation filed Forms 1120S on
which it claimed business losses and deductions. The IRS disallowed various
deductions claimed by the taxpayers and the S Corporation.
The court determined that the taxpayers were
not entitled to a Section 162 deduction for the North Carolina activities. The
taxpayers argued that they operated a business, but they failed to prove that business
operations began in 2008 or 2009. They did not show that they were successfully
harvesting or growing hops during this time, and the only income they received
was from the sale of land to the discount store. Therefore, the activities were
not functioning as going concern.
The taxpayers also failed to show that they
conducted the North Carolina activities with sufficient continuity and
regularity when the husband worked full-time for and received income from the S
corporation. The North Carolina activities were not a trade or business.
However, the court further concluded that the taxpayers were entitled to deduct
some of the expenses as personal expenses related to an investment activity.
The court also found that the IRS properly
disallowed various deductions claimed by the S corporation, and as a result,
disallowed the corresponding pass-through business losses that the taxpayers
claimed on their returns. Although the husband testified that the S corporation
took on high-risk business and was not paid for work performed, its bad debt
deduction was properly denied. The S corporation did not include the fees for
services that remained unpaid in its income because it used the cash method of
accounting.
The court determined that the IRS correctly disallowed
deductions claimed by the S corporation for vehicle expenses because it did not
provide an account book, log, or other evidence sufficient to substantiate the
expenses under Section 274(d). Also, the court upheld the IRS's disallowance of
claimed deductions for the taxpayers' country club membership under Section
274(a)(3). In addition, the S corporation did not adequately substantiate
miscellaneous expenses. However, the court found that the S corporation was
entitled to deduct health insurance benefits it paid on the husband's behalf.
The court also held that the taxpayers' net
capital gain should be reduced by the cost of the survey performed on the
property sold to the discount store. Also, if, after Rule 155 computations, the
taxpayers' modified adjusted gross income plus half of the Social Security
benefits they received during the tax years at issue exceeds $32,000, a portion
of such benefits will be includable in their gross income under Section 86.
If you'd like to discuss
with me how these complex rules apply to your business, to make sure that none
of your workers are misclassified, please call to set up an appointment to
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