What’s Up in Washington, D.C.
It’s reported that the IRS may release additional PPP guidance soon regarding forgiveness-related expense deductibility. However, according to the AICPA’s VP of Taxation, Edward Karl, the guidance may not be taxpayer friendly in that it would disallow such expenses if a borrower has a reasonable expectation of loan forgiveness, regardless of when the loan is forgiven.
In a summary of the issue, Ed Zollars explained that many disagree with this treatment due to the Supreme Court’s holding in Bliss Dairy which allows a current deduction with a corresponding inclusion in income in the following year under the tax benefit rule of §111. In this case, a taxpayer took a current year deduction in full, even though it was likely known an event would occur after yearend to recoup some of those costs. The Court found proper treatment was to take a deduction in the year incurred and subsequently pick up income when the related event later occurred.
Using this ruling, an argument could be made that if no PPP forgiveness is actually provided by yearend, a full deduction of forgiveness-related expenses could be taken. And when or if forgiveness is granted in a later year, the taxpayer would then recognize income on those now disallowed expenses.
But to make things more complicated, in Notice 2020-32, the IRS argues that PPP forgiveness is tax-exempt income, which is a different concept than a reimbursed expense, and also references case law denying deductions for reimbursed expenses. It’s unclear what should be done at this point as far as taking a deduction for PPP related expenses, and Congress has long been indicating their desire to make these expenses deductible.
Make sure to discuss potential outcomes and consequences with your clients before taking action.
SALT Cap Workaround Given Green Light
Big news for states considering a passthrough entity (PTE) level tax as a SALT cap workaround for PTE owners. Notice 2020-75 allows PTEs to deduct “Specified Income Tax Payments”, state income taxes assessed on and paid for by the entity, as non-separately stated deductions in computing income or loss.
The entity level tax giving rise to such a deduction can be either mandatory or elective and partners or shareholders may receive a related state level deduction, exclusion, credit, or other tax benefit. In addition, qualifying deductions will not be included for partners or shareholders in calculating their state and local income tax limitation. Payments that qualify are those made as of the date of the notice or after 12/31/17, if the state had a program in place before the notice.
States have been hesitant to implement such programs given the quick shutdown of the charitable deduction for state tax credit workaround attempt, but this Notice should give the go ahead. Proposed regulations to further implement the principals of are forthcoming.
Business tax transcripts will soon have sensitive information masked, just as individual ones do, in attempts to prevent identity theft. Beginning on December 13, new business transcripts will limit EINs, SSNs, and telephone numbers to the last four digits, as well as shortening names and addresses to the first few characters. A Customer File Number may be created to allow third parties to match a transcript to a taxpayer. Check the e-Services page after December 13 for more information.
CASE OF THE MONDAYS
Get Your Documentation Ducks in a Row – Deductions Lacking Proper Substantiation are Disallowed
A taxpayer who worked as a carpenter for a construction company claimed itemized deductions for unreimbursed employee business expenses. The expenses totaling $26,969 in 2015 and $31,372 in 2016 consisted of transportation, uniforms, professional dues, and other business expenses.
The taxpayer did not work from his company office, rather he would receive a dispatch giving a work project and location and he would drive directly there from his home, at times required to stay overnight at a hotel near the project site until completion. His company’s travel reimbursement policy kicked in on projects that required a drive of two hours or more, with an option of declining long distance work. Reimbursed travel was not included in the taxpayer’s wages.
As for uniforms and professional equipment purchased to perform his work, his employer’s policy provided that employees were not expected to incur any expenses other than travel expenses and dues, uniforms, and tools would be reimbursed.
The taxpayer did not submit reimbursement requests for any expenses other than for a few travel dates.
The IRS disallowed the taxpayer’s unreimbursed employee expense deductions because of the taxpayer’s failure to:
Substantiate the reported expenses,
Prove that the taxpayer was required to incur the expenses in the course of his employment, and
Prove that expenses were not reimbursable by his employer.
To substantiate his costs, the taxpayer offered credit card and bank statements, with Excel spreadsheets listing dates and amounts of certain expenses but no contemporaneous indication of the business purpose for any of the expenses. His records also failed to identify which, if any, of the expenses were covered by travel reimbursements received from his employer. He also did not establish that he requested reimbursement pursuant to his employer’s reimbursement policy and that none was provided.
Substantiation under §274(d): Meals, Travel, and Lodging
Strict substantiation requirements under §274(d) for travel costs trump the Cohan rule, which means reasonable estimates cannot be used. For passenger auto business expenses, Reg. §1.274-5(j)(2) states taxpayers must provide adequate records or evidence corroborating:
The amount of each separate expense using either actual cost or the standard mileage rate;
The mileage for each business use of the passenger auto and the total mileage for all purposes during the taxable period;
The date of the business use; and
The business purpose of the use.
The taxpayer did not maintain a contemporaneous log of miles driven, on what dates, or the purpose of any trip. Credit card statements showed only payments for gas and vehicle repairs. Therefore, the Court sided with the IRS in that the taxpayer failed to meet the strict substantiation requirements of §274(d) and disallowed the vehicle related expenses.
The taxpayer also claimed travel expenses for hotel stays as well, again using bank and credit card statements has his only substantiation. However, Reg. §1.274-5T(b)(1) and (2) require taxpayer records to include:
Cost of lodging;
Dates of departure and return for each trip away from home and number of those days spent on business;
Name of the city or town or other similar destination; and
Business reason for travel.
The Tax Court found that §274(d) substantiation requirements were not met for lodging costs, the taxpayer did not provide evidence to establish business reasons for his stays, and also that costs were not or could not have been reimbursed by his employer. As such, lodging costs were disallowed as well.
Similarly, the Court denied the taxpayer’s meals and entertainment costs as stated on bank and credit card statements because of insufficient substantiation under §274(d) and a lack of proof his employer would not have reimbursed the expenses.
Remaining business expenses included union and professional dues, uniforms, laundry, and cellphone. These type of expenses do not have to meet the §274(d) substantiation rules and estimates may suffice if they can be made on a reasonable basis. However, the taxpayer did not testify about or offer any evidence to support various “business expenses” or union dues and so they remained disallowed.
His clothing and tool expenses were substantiated by his Excel spreadsheets, bank/credit card statements, and credible testimony as to their business purpose. Clothing for work may be deductible if a required condition of employment and not usable as ordinary clothing, and these items appeared to qualify for a deduction. The problem in this instance was the taxpayer’s failure to prove his company did not or would not have reimbursed him when they did have a general reimbursement policy in place. For this reason, his clothing and tool expenses were disallowed.
As for his cell phone expenses, the taxpayer provided bank statements to substantiate the total cost, but failed to provide an estimate of his business versus personal use. For this reason, as well as the overall failure to prove his company would not have reimbursed him, these expenses were denied too.
The moral of the story? Know the documentation requirements for different types of expenses and get reimbursed from your company if a policy permits!
Santillan v. Commissioner, T.C. Summary Opinion 2020-28
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Information provided is for educational purposes only and not to be used as tax advice.