Tax

Do you have a mileage log that will survive an IRS audit? If so, good for you! If not, get ready to give up all (not some, but all) of your vehicle tax deductions for not just one year but three years, as you will see in this true story.

The story is about Therone Johnson, president of Diversified Innovative Products Co, Inc. (Dip Co), a corporation in Colorado that manufactures and sells disposable ink pans for printing presses.

Mr. Johnson and the rest of Dip Co’s management work from home offices because the manufacturing facility does not have enough office space for all of them to work there regularly.

Need for the Mileage Log

Tax code Section 274 imposes strict substantiation requirements for business mileage.

As the court noted in this case, for expenses such as the pickup truck Mr. Johnson used for business purposes, he had to substantiate the following with adequate records or with sufficient evidence corroborating his own statement: 

• The amount of the expense
• Mileage for each business use of the pickup, as well as the total mileage for all purposes during the taxable period 
• The time and place Mr. Johnson used the pickup 
• The business purpose of the use

Planning note. Don’t latch on to the “with sufficient evidence corroborating his own statement” thinking that you have a real alternative to keeping a good mileage log. From the myriad court cases we have read regarding the mileage log, this is an impossible task.

The Outlook Calendar

The primary evidence Mr. Johnson submitted to the court (and previously to the IRS) in support of his claimed travel-related and car and truck expense deductions was a Microsoft Outlook calendar reflecting his travel during the periods at issue, supplemented by his testimony.

He used the calendar for all appointments and events, including those related to his work at the ranch, his work for Dip Co, and his personal activities. 

But many of the entries in his calendar noted only that he traveled to and/or from a ranch; they did not note the purpose for his visit (hay farming business, Dip Co work, property maintenance, or personal).

The Court’s Take on the Calendar

The court noted that without the business purpose information, it could not determine which of Mr. Johnson’s trips were for business purposes as required by tax code Section 162. It then cited various cases that disallowed the expenses because the taxpayer

• could not establish the business purpose for each expense,
• did not differentiate between business travel purposes and personal travel purposes, or
• gave broad testimony and receipts that were insufficient to establish the business purpose of travel.

Ruling

Because the court could not determine that Mr. Johnson’s business use of the truck for Dip Co and the ranch exceeded 50 percent of Mr. Johnson’s total use as required by Section 179, it simply denied the entire Section 179 deduction and the other car and truck expenses for the three years before the court.

Takeaways

The failed mileage log cost Mr. Johnson all of his car and truck deductions, not just in Year Three when he purchased and expensed the pickup truck. Also gone were all his deductions for depreciation of his prior vehicle—and all gas, insurance, and repair deductions for a combined three years.

So the vehicle deduction equation for you is clear: if you want to keep your vehicle deductions, you need a good mileage log.

If you would like my help with your mileage log, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 13, 2020

Do you operate your business as an S or a C corporation?

Do you drive a vehicle titled in your personal name for corporate business? 

Beware. The Tax Cuts and Jobs Act (TCJA) changed the rules for tax years 2018-2025.

Before the TCJA, you had to pay attention to the use of your personal vehicle for corporate business in order to avoid losing deductions to the 2 percent miscellaneous itemized deduction rule and the alternative minimum tax. 

But now, because of the TCJA, you face a narrow road during tax years 2018-2025 if you want tax benefits for the corporate business use of your personal vehicle.

Big Picture

1. The personal vehicle used for corporate business is a business vehicle to the extent of corporate use.
2. If you don’t want to lose your rightful tax benefits from your business use, your corporation must reimburse you for your business use.
3. Your corporation may reimburse you using the IRS standard mileage rate or actual expenses.
4. When you trade in or sell the vehicle you used for corporate business, you will report a taxable gain or claim a deductible loss on IRS Form 4797.
5. To obtain your reimbursements from your corporation, you submit expense reports under the accountable plan rules.

Make Sure to Do This

You need a mileage log. The mileage log defines the dollar amount of the corporate reimbursement—regardless of whether you seek reimbursement using (a) actual expenses or (b) the IRS mileage method. The mileage log saves you in an IRS audit.

Accountable Plan

Because your corporation is reimbursing you for your personal vehicle, using either IRS mileage rates or actual expenses, it needs an accountable plan.

Reimbursements from the Corporation

A corporation can reimburse an employee for all expenses allowable under sections 161 to 199 of the tax code—which includes Section 179 expensing and Section 168 bonus and other depreciation. 

Here’s what happens when your corporation properly reimburses you for the expenses:

1. You, as the employee, receive the cash reimbursement from the corporation but do not have taxable income from the reimbursement.
2. The corporation gets the full deduction for the reimbursed expenses.
3. If the corporation is an S corporation, then those expenses reduce the corporate income and the corporation passes that reduced income to you—say, as the sole shareholder of your S corporation.

If you are using a personal vehicle for corporate business, please call me on my direct line at 408-778-9651, because we should discuss what’s required.

• By Leon Clinton
• November 11, 2020

With the COVID-19 pandemic still going on, you may be spending more time working from your home office. 

You may have taken some extra rooms for your business use. Is that okay?

Section 280A(c) states that you may claim a home office based on the portion of the dwelling that you use exclusively and regularly for business. Thus, the law dictates no specific number of rooms or particulars regarding the size of the office.

The courts make this rule clear, as you can see in the Mills (less than one room) and Hefti (lots of rooms) cases described below. 

The Mills Case

Albert Victor Mills maintained an office in his apartment from which he conducted his rental property management business. The apartment was small, totaling only 422 square feet. In the office area of the apartment where Mr. Mills had his desk, he also kept tools, equipment, paint supplies, and a filing cabinet.

The court agreed with Mr. Mills’s allocations and awarded the home-office deduction based on his claimed 23 percent business use of the 422-square-foot apartment. 

Planning note. Mr. Mills did not have a single room dedicated to a home office. He had only an area of the apartment where he grouped his office furnishings, equipment, and supplies. If you have a similar situation, make sure your business assets are located in a group.

The Hefti Case

Charles R. Hefti lived in a big house, totaling 9,142 square feet. He claimed that more than 90 percent of his home was used regularly and exclusively for business. 

Based on its review of the rooms, the court concluded that 13 rooms, totaling 19 percent of the home, were used exclusively and regularly for business. 

Insights

The deductible portion of your home for an office includes the area used exclusively and regularly for business. 

Let’s say you have an office in one room and your files in a second room, and you never use these rooms for personal purposes. Further, let’s say you use the office area on a daily basis and the file area in connection with that daily work. 

Both rooms would meet the exclusive and regular use requirements, just as Mr. Mills’s and Mr. Hefti’s offices met these rules.

But Not This

“Exclusive use” means that you must use a specific portion of the home only for business purposes. You must make no other use of the space. 

Exception. One exception to the exclusive use rule is storage of inventory or product samples if the home is the sole fixed location of a trade or business selling products at retail or wholesale.

Example 1. Your home is the only fixed location of your business, which involves selling mechanics’ tools at retail. You regularly use half of your basement for storage of inventory and product samples. You sometimes use the area for personal purposes. The expenses for the storage space are deductible even though you do not use this part of your basement exclusively for business.

Example 2. In Pearson, Dr. Pearson practiced orthodontics in a downtown medical building but retained the dental records of more than 3,000 patients in 36 file drawers (each measuring 26 inches by 14 inches by 12 inches) and had 1,461 boxes containing orthodontic models (each box measuring 10 inches by 6 inches by 2 1/2 inches).

He stored the records in the attic and basement of his home. The areas used for such storage were not separate rooms, and the remaining portions of the attic and basement were used by Dr. Pearson and his family for personal purposes.

The court ruled that Dr. Pearson may not treat the storage areas as home-office expenses because the records were not inventory or samples and Dr. Pearson did not operate a wholesale or retail trade or business from his home.

If you would like to discuss your home-office deduction, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 6, 2020