EXCESS ON PARADE: Watch an Entrepreneur’s Expenses Catch Fire
The Superior Court opinion coming down today in Reich v. Reich from Lancaster County looked like an everyday support exception case. But today we are starting to see cases affirmed based on trial court opinions. This one demonstrates just how far self employed “business owners” will go in pushing the expense plate on their income taxes.
If you open your Internal Revenue Service Hymnal and turn to Publication 535 you will find the definition of what expenses may be deducted from your gross business revenue to arrive at the net income on which you will be taxed. The statute is 26 U.S.C. 162. In sum, the rule is
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate to your trade or business. An expense does not have to be indispensable to be considered necessary.
Husband is in the cryptocurrency business. In fact, he is the Chief Executive Officers of Steam Monsters Corporation, in which he owns a minority interest. His 2022 salary was $96,000. He also owned 99% of a company we will shorten to PPF. That company had $455,000 in revenue. The court then started evaluating the expenses taken on the return to assess whether they were “ordinary and necessary” for someone in the cryptocurrency business. Here is where the fur began to fly.
Husband took deductions for his expenses at Costco. Now there are many products you can buy at Costco that qualify, e.g., pens, paper, toner, manila folders etc. But Mr. Reich deducts his groceries because he does sometimes make food available to his clients/customers. Mr. Reich also deducted food he ate or ordered from local restaurants. Essentially, you can do it if the person sitting with you eating is a client/customer. But even that deduction is 50% of the cost, the theory being that your meal is personal and not a business expense. Mr. Reich did not seem to feel constrained by those limitations.
Husband lives and does business in his 5,000 square foot residence where he resides with a girlfriend and four of his kids. The government will allow you to deduct that portion of your house that is devoted to your trade or business. Thus, if you have a 300 square foot home office (15×20 feet) you can deduct about 6% of the costs of running the household because 6% of the dwelling is dedicated to your business. (300/5,000 sq. ft= 6%). But it seems that this taxpayer wrote off most or all of his HVAC upgrade, his mortgage and his cleaning costs.
Next we step outside to the swimming pool. The taxpayer husband testified that he takes telephone calls related to business while in and around his swimming hole. He also offered that he might someday entertain his clients in that very same pool. Thus, it would only seem reasonable that he should deduct the pool costs from his business revenue in case someone should call or stop by wearing swimwear and looking for crypto. The Court wasn’t willing to abide that wade in the water.
Then there was the auto expense. What the IRS does is acknowledge that sometimes personal cars are used for business purposes. When you make those runs to visit clients, referral sources or go to seminars they allow you 65.5 cents per miles. They don’t let you deduct the whole rig unless the whole rig is devoted exclusively for business (e.g., a yellow cab and not your Uber).
Here’s the form and by the way, it’s not for use to go back and forth to your place of work.
Mr. Reich is not alone. We have seen lots of business people think that they can deduct their lawn care expense because if they mowed their own lawns that would detract from their time devoted to selling crypto, performing surgery or trying divorce cases. They suggest that they need to lease a Mercedes or some other luxury car on the basis that “No one buys crypto or hires a financial adviser driving a Ford or GM product.” Long ago this writer was in court when a fellow said his purchase of a Rolls Royce was a deductible expense. When that assertion was challenged he snapped: “Everyone in the scrap business has one.” Unfortunately for him the support court did not find a $400,000 car either “ordinary” or “necessary” to get back and forth to the dump.
Perhaps most concerning here is the fact that not only can we read these opinions on line but federal and state tax auditors can as well. If you have a return like this one, perhaps you need to settle your case before a judge writes about it. And, if you have filed jointly with someone who files these kinds of returns, don’t be surprised to learn that part of your handsome support order gets attached to pay income tax due on deductions that were improperly taken. The defenses of “I didn’t drive the Rolls or swim in the pool” don’t curry much favor at the tax office. These cases belong in arbitration where there is no record of testimony and no public official (i.e., judge) recording for posterity how many cases of Grand Cru Classe Bordeaux you got at Costco in case some cryptoclients came by for a swim and a snack.
Reich v. Reich 875 MDA 2023 (2/16/2024)
