Substantiating Expenses: All or Nothing

Expenses & Deductions

Under Sec. 274(d), for certain expenses, taxpayers are required to be able to provide specific detailed information to substantiate the expenses. As the recent case of Garza, T.C. Memo. 2014-121, demonstrates, this is an all-or-nothing proposition. Without proper substantiation, no deduction is allowed for a Sec. 274(d) expense, even if the court believes that a legitimate expenditure was made.

Sec. 274(d) identifies four classes of expenses for which specific substantiation is required:

• Sec. 274(d)(1) for travel expenses (including meals and lodging while away from home);
• Sec. 274(d)(2) for any item with respect to an activity that is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity;
• Sec. 274(d)(3) for business gifts (which are limited to $25); and
• Sec. 274(d)(4) for expenses with respect to any listed property (as defined in Sec. 280F(d)(4)).

In Garza, the court said that “while we believe that petitioner had business travel expenses in relation to his employment, the Court must heed the strict substantiation requirements of section 274(d).” To support its ruling, the court cited DeLima, T.C. Memo. 2012-291, in which the Tax Court indicated that it had no doubt that the taxpayer used a vehicle for business purposes, but it was bound to deny the vehicle expense deduction because she failed to follow the requirements of Sec. 274(d) and the regulations.

Listed property, as defined in Sec. 280F(d)(4), covers assets that are used by the vast majority of closely held businesses: (1) any passenger car or other vehicle used for transportation; (2) property of a type generally used for purposes of entertainment, recreation, or amusement; (3) any computer or peripheral equipment (as defined in Sec. 168(i)(2)(B)); and (4) any other property of a type specified in regulations.

Certain vehicles that cannot be used for more than a de minimis amount of personal use are exempted from the substantiation requirements. However, it is important for businesses to discuss trucks, vans, and SUVs with a qualified tax professional to determine if the vehicles are exempt.

Sec. 274(d)(4) requires the taxpayer to substantiate “by adequate records or by sufficient evidence corroborating the taxpayer’s own statement”:

• The amount of the expense or other item;
• The time and place of the travel, entertainment, amusement, recreation, or use of the facility or property, or the date and description of the gift;
• The business purpose of the expense or other item; and
• The business relationship to the taxpayer of persons entertained, using the facility or property, or receiving the gift.

The impression from the above paragraph is that “a taxpayer’s own statement” by itself does not carry weight in the IRS’s consideration of whether to allow a deduction. As Garza and other cases show, the IRS and the courts look for contemporaneous records with the details listed above and, lacking it, they may disallow the deduction.

Garza demonstrates the importance of keeping detailed contemporaneous records for business vehicles that can be used for personal purposes and observing other Sec. 274(d) substantiation requirements. Taxpayers and their tax advisers need to understand what type of documentation is required to take a deduction on a tax return. As indicated above, the courts and the IRS will not allow any deduction without this documentation.

EditorNotes

Michael Koppel is with Gray, Gray & Gray LLP in Canton, Mass.

For additional information about these items, contact Mr. Koppel at 781-407-0300 or mkoppel@gggcpas.com.

Unless otherwise noted, contributors are members of or associated with CPAmerica International.