If you're a business owner hoping to deduct asset depreciation from your gross income, it's crucial to track the percentage of business use of assets.
In one case, a married couple were long-time farmers. They deducted large amounts of depreciation on farm equipment and vehicles over several years, but they failed to track the business use of the assets. Based on inadequate records, the IRS disallowed most of the deductions.
Fortunately, the U.S. Tax Court found a reasonable basis for redetermining proper depreciation, allowing higher depreciation of some assets. However, others were disallowed. Keeping good records from the start may allow you to avoid a lengthy battle with the IRS or in court. (TC Memo 2022-117)
If you're closing a business, there are important tax bases you may have to cover. Here's a rundown:
Contact us with questions about this important process.
Taxpayers can deduct all "ordinary and necessary expenses" paid in carrying on a trade or business. But they must prove that they're entitled to the deductions claimed. In one case, the U.S. Tax Court ruled a married couple wasn't entitled to deduct various business expenses for which they offered no valid or insufficient substantiation. For example, on international business trips, they didn't keep records about where meetings were held, the purpose of the trips or the individuals with whom they met.
Mileage expenses appeared to be nondeductible commuting expenses. Business owners can generally deduct their business-related vehicle expenses, but they bear the burden of proving they're entitled to the deduction. Taxpayers must keep detailed contemporaneous records of each trip (the date, time, miles driven and business purpose), even if the standard mileage rate is claimed. In this case, the married couple claimed $13,596 in car and truck expenses, supported only by mileage logs that weren't kept contemporaneously. The court disallowed the entire deduction, stating that "subsequently prepared mileage records don't have the same high degree of credibility as those made at or near the time the vehicle was used."
And the court found that airfare, meals and lodging expenses were partially for personal purposes and weren't supported by credible records. (TC Memo 2022-113)
Employers that withhold taxes from wages but don't pay them over to the IRS may face a penalty of 100% of the unpaid tax. The trust fund recovery penalty (TFRP) can be assessed personally against "responsible" parties.
In one case, a corporation owner's daughter/corporate officer was assessed a TFRP of $680,472 for unpaid payroll taxes. She argued that she wasn't a responsible party. She owned no stock and lacked the power to hire and fire employees. But she did have the power to write checks and pay vendors and was aware of the unpaid taxes. A U.S. Appeals Court found the "great weight of evidence" indicated she was a responsible party and the TFRP was upheld. (Scott, CA 11, 10/31/22)
Businesses can generally deduct related "ordinary and necessary" expenses on their tax returns. However, if there's doubt that a profit motive exists, the IRS may deny deductions. One married couple purchased solar lenses that were supposed to eventually be leased back to a company owned by the individual that sold them. The taxpayers claimed depreciation deductions and solar energy tax credits that allowed them to pay "little or no federal income taxes," according to tax documents.
The IRS found the taxpayers had a clear lack of profit motive. The couple hadn't acted in a businesslike manner, had no industry expertise and consulted no experts. The IRS concluded they were mostly focused on obtaining tax breaks. The U.S. Tax Court disallowed the couple's tax benefits in part because they lacked a profit motive. On appeal, a U.S. Appeals Court agreed.
The appeals court noted: "The need for a profit motive comes from the text of the tax code. Under the code, a taxpayer may claim a depreciation deduction only if the property is 'used in the trade or business' or 'held for the production of income.'" (Olsen, CA 10, 11/4/22)
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