After conducting a two-year audit of a church volunteer and consultant, the Internal Revenue Service concluded that the individual being audited had understated her income tax liability by $55,000. The taxpayer appealed to the United States Tax Court. In Barnes v. Commissioner, T.C.Memo, 2016-212, the Tax Court addressed a number of issues, including the proper substantiation of car expenses, internet expenses, supplies, and charitable contributions. The Court’s treatment of these expenses is instructive and is summarized in this article.
Deductions for the business use of a car are subject to strict substantiation requirements described in section 274(d) of the tax code. Section 274(d) allows taxpayers to substantiate expenses incurred in the business use of a car either by tracking the actual expenses of using the car, or by multiplying business miles driven by a standard mileage rate set by the IRS.
If a taxpayer chooses to use the standard mileage rate, then he or she must be able to substantiate (1) the mileage of each business use and the total business and nonbusiness mileage during the taxable year, (2) the date of each business use of the vehicle, and (3) the “business purpose of each use” of the vehicle. All expenses must be substantiated using “adequate records or sufficient evidence corroborating the taxpayer’s own statement.”
To meet the “adequate records” requirements of section 274(d) for vehicle expenses, a taxpayer choosing the mileage-rate option must maintain:
(1) an account book, a diary, a log, a statement of expense, trip sheets, or similar records, and (2) documentary evidence (such as receipts or bills), which, in combination, are sufficient to establish the required information, including the mileage, the date, and the business purpose of each business use of the vehicle.
The mileage, the date, and the business purpose of each business use of the vehicle must be recorded “at or near the time” of each business use. Treas. Reg. 1.274-5T(c)(2)(ii). To be considered made “at or near the time” of each use, the record must be made when the taxpayer had “full present knowledge of the mileage, the date, and the business purpose of each business use of the vehicle.” A record made weekly “is considered to satisfy the full present knowledge requirement.”
In the absence of “adequate records,” a taxpayer choosing the mileage-rate option must substantiate the mileage, date, and business purpose of each business use of the vehicle by “sufficient evidence corroborating the taxpayer’s own statement.”
Substantiation by “sufficient evidence corroborating the taxpayer’s own statement” requires the taxpayer to establish these elements by
the taxpayer’s own statement, whether written or oral, containing specific information in detail as to such element; and by other corroborative evidence sufficient to establish such element. Treas. Reg. 1.274-5T(c)(3)(i).
The taxpayer in this case claimed car expense deductions of $6,930 and $6,544 for 2008 and 2009. The IRS disallowed these deductions in full due to insufficient substantiation, but later allowed deductions of about half what the taxpayer had claimed.
On appeal to the Tax Court, the taxpayer produced two spreadsheets allegedly showing her business miles. But the Court noted that these spreadsheets were compiled several years after the trips they describe, and so were not “contemporaneous with the trips they purport to record.” They were not recorded “at or near the time” of each business use. To be considered made “at or near the time” of each use, “the record must be made when the taxpayer had full present knowledge of the mileage, the date, and the business purpose of each business use of the vehicle.” As a result, the Tax Court denied any deduction beyond the lower amounts allowed by the IRS.
The taxpayer’s deduction for internet expenses was disallowed by the IRS because she “did not provide us with a reasonable evidentiary basis for estimating the portion of time that the internet at her personal residence was used for business purposes.”
The Tax Court noted that internet expenses “have been characterized as utility expenses rather than expenses related to the use of listed property (such as computer equipment),” meaning that the strict substantiation requirements described in section 274(d) of the tax code do not apply. Instead, taxpayers can use the “Cohan rule” to estimate business expenses. Under this rule, if a taxpayer establishes that an expense is deductible but is unable to substantiate the precise amount, the court may estimate the amount, “bearing heavily against the taxpayer whose inexactitude is of his or her own making.” Cohan v. Commissioner, 39 F.2d 540 (2nd Cir. 1930). Therefore, pursuant to the Cohan rule, the amount of deductible internet expenses can be estimated by a court, provided, however, that the court has a reasonable basis for making an estimate of the amount of the expense related to business use.
The taxpayer claimed that she used the internet, at home, for business purposes. But the Court concluded that she “did not provide us with a reasonable evidentiary basis for estimating the portion of time that the internet at her personal residence was used for business purposes. Accordingly, we hold that she is not entitled to a deduction … for any portion of her home internet expenses.”
The taxpayer claimed a deduction on her tax returns for “supplies,” which included a DVD player, toner, earphones, batteries, business equipment, several software programs, copy paper, surge protector, binders, and pens. This deduction was denied in full by the IRS due to lack of substantiation.
The Tax Court agreed that no deduction was allowable: “The documentary evidence shows that the items were purchased but does not show that they were purchased for business purposes. The mere fact that an item was purchased does not mean the expense is deductible … . The expense must be an expense of the taxpayer’s business and not a personal expense.”
The Court concluded that the taxpayer “has failed to prove by a preponderance of the evidence that she is entitled to deductions for any of the disputed supplies expenses. Accordingly, we hold that she is not entitled to a deduction for supplies expenses.”
The taxpayer claimed a charitable contribution deduction of $5,112 on her 2008 tax return representing the expenses she incurred on a trip to Africa organized by her church. Part of the trip consisted of visits to orphanages and schools. However, she also went on at least one safari during this trip. The IRS disallowed any deduction in excess of $950.
The Tax Court noted that section 170 of the tax code allows a deduction for any “charitable contribution” made by the taxpayer during the taxable year. A “charitable contribution” is defined as “a contribution or gift to or for the use of” a charitable organization. One type of charitable contribution is donating money or property directly to a charitable organization. A second type of charitable contribution is placing money or property in trust for a charitable organization. Such a transfer is “for the use of” a charitable organization. A third type of charitable contribution may arise when a taxpayer performing services for a charitable organization incurs unreimbursed expenses. The regulations explain:
No deduction is allowable under section 170 for a contribution of services. However, unreimbursed expenditures made incident to the rendition of services to an organization, contributions to which are deductible, may constitute a deductible contribution. The expenses of rendering services are deductible because they constitute contributions “to” the charitable organization in the words of section 170(c). Treas. Reg. 1.170A-1(g).
The tax code specifies that no charitable contribution deduction is allowed for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgment of the contribution by the charitable organization that includes the following information:
- the charity’s name;
- the amount contributed;
- a description (but not value) of a noncash contribution;
- the donor’s name; and
- a statement whether the charitable organization provided any goods or services in consideration, in whole or in part, for the contribution, and a description and good-faith estimate of the value of any goods or services provided by the charity (if the only benefit a donor received was an intangible religious benefit (such as admission to a religious ceremony) that generally isn’t sold in a commercial transaction outside the donative context, the acknowledgment must say so and doesn’t need to describe or estimate the value of the benefit).
The donor must receive the written acknowledgment before the earlier of:
(1) the date he or she filed a tax return for the year the contribution was made, or
(2) the due date, including extensions, for filing the return.
The tax regulations clarify that a taxpayer who incurs unreimbursed expenses “incident to the rendition of charitable services” is treated as having obtained a contemporaneous written acknowledgment of the contributed expenses if the taxpayer (1) “has adequate records … to substantiate the amount of the expenditures, and (2) acquires a contemporaneous written acknowledgment from the charity containing (A) a description of the services provided by the taxpayer, (B) a statement of whether the charity provided any goods or services in consideration, in whole or in part, for the unreimbursed expenditures, and (C) a description and good-faith estimate of the value of any goods or services provided by the charity.” Treas. Reg. 1.170A-13(f)(10).
The IRS conceded that the taxpayer had traveled to Africa on a church-sponsored trip, and incurred $5,112 in expenses. But it insisted that parts of the trip were personal and that the taxpayer has not provided a contemporaneous written acknowledgment from her church satisfying the requirements summarized above.
The Tax Court agreed with the IRS:
The taxpayer did not contribute money or property directly to [her church] for this trip. Instead she paid a [travel agency] for the expenses associated with this trip. Thus she is entitled to a charitable contribution deduction only if these expenses were, in the words of … the tax regulations “expenditures made incident to the rendition of services” to the church. Treas. Reg. 1.170A-1(g). We assume, arguendo, that at least part of the trip was incident to the rendition of services to the church, and therefore a portion of the expenses of the trip would generally be considered deductible as expenses incurred by a church member on a church trip. However, even under this favorable assumption, the taxpayer would still need to satisfy the contemporaneous written acknowledgment requirement.
The taxpayer produced a letter from her church to the IRS which stated that the taxpayer paid $5,112 to go on this trip. This letter, concluded the Court, did not meet the tax code’s substantiation requirements since it did not contain
a description of the services provided by the taxpayer, a statement of whether or not the church provided any goods or services in consideration, in whole or in part, for the unreimbursed expenditures, or a description and good faith estimate of the value of any goods or services provided by the church. Treas. Reg. 1.170A-13(f)(10).
Application to churches
This case provides a helpful review of the substantiation requirements that pertain to auto expenses, internet expenses, business supplies, and charitable contribution deductions for unreimbursed travel expenses incurred in the course of performing services on behalf of a church or other charity. For more guidance on these topics, see chapters 7 and 8 of the 2018 Church & Clergy Tax Guide (ChurchLawAndTaxStore.com).