HOME OFFICE DEDUCTION DENIED
Tax Court Agrees with IRS –
Home Office Deduction for Storage Denied
IRS Sees Through the Smog &
Taxpayer Strikes Out
Mohammed Najafpir (US Tax Court, Dkt. No. 9660-16, TC Memo 2018-103) owned a smog prevention business that he operated as a sole proprietorship. The IRS found that he had unreported gross receipts from his business. Since the taxpayer failed to maintain adequate records to establish his gross revenues, the IRS used the bank analysis method where it reconstructs the gross receipts from bank statements.
Strike one! The taxpayer argued that the IRS’s method resulted in non-taxable bank deposits being erroneously included as business gross receipts. However, since the burden of proof rests upon the taxpayer to prove the nature of the deposits, which the taxpayer was unable to do with respect to all of the deposits the IRS classified as unreported income, the IRS’s findings were affirmed by the court.
Strike Two! The IRS also denied the taxpayer claiming a home office deduction for storage of inventory. The taxpayer had contended that the use of his garage to store business records made him eligible for the claimed home office deduction. The court again found for the IRS stating that the taxpayer did not meet the conditions of the Internal Revenue Code which requires that a taxpayer have a trade or business of selling products at retail or wholesale to claim a storage deduction. The fact that the taxpayer may have stored his business records in his garage failed to constitute inventory.
Strike Three! Taxpayer argued that he should not be assessed a penalty for failure to timely file his returns because he was unable to find a reliable accountant in a timely manner. The court found that the taxpayer’s argument lacked reasonable cause and affirmed the penalty assessment.
What Can We Learn from this Case?
Taxpayers are entitled to claim every legitimate expense to reduce their tax liability to the lowest possible amount. Much can be learned by reading court cases . . . while the reasons why the IRS chose to audit this taxpayer is not public knowledge, let’s consider some factors that may have perked the IRS’s interest.
- Fact: Schedule C filers – sole proprietorships – are the most audited business tax returns.
- Claiming a home office increases the likelihood of an IRS audit.
- The IRS compares a business’s expenses to its gross revenues. Is it possible that the expenses claimed in this case, compared to the gross revenues reported, made the IRS suspicious that the gross receipts were underreported?
- Some taxpayers who self-prepare their tax returns may be more aggressive in claiming dubious tax deductions that those prepared by a tax professional.
- During the examination, the IRS learned that the taxpayer had a cash slush fund of $60,000.
- The taxpayer represented himself in Tax Court. Why? Didn’t wish to spend attorney fees? Attorneys interviewed by the taxpayer told him that his chances of prevailing were slim to none? The taxpayer thought that the courts are pro-taxpayer? Or, did he simply want his day in court to show the injustice of the tax system?
TAX SAVINGS ALERT: When preparing a tax return, it is important that claimed tax deductions are substantiated by the facts and by documentation. Taxpayers who fail to substantiate claimed tax deductions can find themselves subject to the 20% accuracy-related penalty.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
Copyright © 2018 Keystone Financial Solutions, P.C. All rights reserved. BE SURE TO READ THE DISCLAIMER PAGE: Content in this blog is for educational purposes only and should not be considered as the rendering of tax, legal or investment advice. The publisher of this blog makes no representations as to the accuracy or completeness of any information herein, will not be liable for any errors or omissions, and shall not assume liability for any losses, injuries, or damages from the display or use of this information.
About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.