Presentation:
Federal Income Taxation
Chapter 12 Personal, Family or Living Expenses
Professors Wells
October 13, 2015
Business & Investment
vs. Personal Expenses
p.677
Fundamental issue: How distinguish between business and personal
when expenses are for consumption purposes?
Include in gross income the value of the personal satisfaction
element?
Allow corporate officers to fund large personal expenses disguised as
business expenses? Equitable to workers?
Irwin case: deduct “life experiences” because they help your writing
career? Is this fair to the rest of us that must spend after-tax
earnings on consumption items.
2 Child-Care Expenses
Smith v. Commissioner
p.677
Facts: Mr. and Mrs. Smith were both employed and hired a
nursemaid to care for their young child while they worked. They
claimed a deduction for the child-care expense, as a business
expense.
Held: No deduction. The expenses are personal and not ordinary (in
the sense that they are not incurred by all people who work).
But, this matter addressed legislatively as follows:
§21 – qualifying child care credit (up to $1,050/$600 for one child)
§24 – child tax credit ($1,000 per child but phased out)
§32 – earned income credit (# of children, but phased out)
§129 –exclusion from GI for dependent care cost covered by
employer
§45F –employer credit for child care facilities
3 Clothing Expenses
Pevsner v. Commr.
p.681
Employee of upscale clothing store required to buy and
wear high fashion clothing at work- “projecting the
image.” She did not wear A
this clothing after-hours. BB
A
ISSUE: §162 business
expense or §262 personal
cost?
Subjective (personal
preference) or objective
test (general
acceptability of this
clothing)?
Held: Objective 3-Part
test (5th Cir., reversing
Tax Court).
L
A
D
Y
G
A
G
A
4 Traveling: §162(a)(2)
United Stats v. Correll
p.684
§162(a)(2) allows deduction for travel expenses incurred “while
away from home in the pursuit of a trade or business.”
Correll decision (p.684) – the “sleep or rest” or “overnight” rule
applies to enable eligibility to deduct food and lodging costs.
What is away from home? How far must one go to be “away
from home”?
5 Commuting vs. Travel Expenses
Commissioner v. Flowers
p.688
Facts: Flowers was a lawyer who took a job with a railroad with its
offices in Mobile, Alabama. At the time he took the job, Flowers had
settled in Jackson, Mississippi and was unwilling to move away from
there. So he traveled between Jackson, where he kept both his home
(in the nontax sense) and an office where he worked some of the
time, and Mobile, where he needed to work some of the time. He had
a railroad pass, so all that was at stake was his living costs in Mobile,
for which he claimed a deduction.
Held: No deduction. The Court avoids the question of the location of
Flowers’ tax home. It concludes simply that the expense was not
attributable to the exigencies of the business. He just had a long
commute.
6 Hantzis Case
§162(a)(2)
Summer Law Clerk
p.693
Home in Boston but worked during summer in NYC as summer
clerk in a law firm.
Apartment cost in NYC for during the week and Boston-NYC
transportation cost.
Tax Court says deduction is available.
§262 disallows a personal cost deduction.
The temporary employment rule necessitates business location at
the primary home.
One year rule of Rev. Rul. 93-86
7 Commuting Expenses
Handout
Transportation expenses are deductible when traveling for business
purposes. Commuting, however, is a nondeductible personal cost.
A.  Commuting to a temporary employment situation
– Rev. Rul. 99-7
B.  Further travel after reaching business?
Metro Area
Tax
Reg. W.S.
Turtle
Temp. W.S.
A
B
Is “home” PPB?
B
Home
A
C
Reg. W.S.
Temp. W.S.
C
Additional cost of transporting tools is deductible.
8 Entertainment and Travel Expenses
Rudolph v. United States
p.699
Facts: Rudolph was an insurance agent employed by Southland Life
Insurance Company, in Dallas. The company sent Rudolph and his
wife, with other agents and their wives, to New York City on a oneweek trip that was devoted mostly to pleasure. The district court
ruled that the value of the trip (measured by the pro rata cost) must
be included in the Rudolphs’ income because its purpose was
primarily pleasure. The court of appeals affirmed.
Held: The petition for writ of certiorari is dismissed as
improvidently granted. Justice Harlan writes an opinion defending
the result, agreeing that the value of the trip should be treated as
income to the employees and observing that there should be no
deduction under §162(a). Justice Douglas, joined by Justice Black,
dissents.
9 Entertainment and Travel Expenses
p.703
Sanitary Farms Dairy v. Commissioner
Facts: Majority shareholder and wife took African safari (from May
through November) that was paid for by their controlled
corporation, Sanitary Farm Dairy. The corporation claimed a
deduction for the safari as “corporate advertising expense.” IRS
asserted deficiency against the Brocks as well.
Question: What was the IRS theory for asserting a disallowance at
the corporate level and income at the owner level?
Holding: Court allowed deduction and not income to the Brocks.
“They admittedly enjoyed hunting, but
enjoyment of one’s work does not make
Cecil the Lion
that work a mere personal hobby or the
cost of a hunting trip income to the hunter.
There is evidence that this trip represented
hard work on the part of the Brocks,
undertaken for the benefit of the Dairy,
10 rather than as a frolic of their own.”
Entertainment and Business Meals
Moss v. Commissioner
Moss is a partner in a defense
litigation law firm. Partners
met for lunch daily at Café
Angelo and discussed their
cases at lunch.
p.707
Consider:
a)  Code §262 (no deduction for personal
expenses);
b)  Code §119 (exclusion for meal
provided in kind on the premises); and,
c)  Code §162(a) (ordinary and necessary
business expenses are deductible)
11 Cohan v. Commissioner
p. 711
Board of Tax Appeals: Disallowed travel and entertainment expenses
because no vouchers or book keeping entries or documentation
existed to support the amount or nature of the expenditure.
Second Circuit: Reversed, holding that undocumented travel and
entertainment expenses should still be deductible.
Absolute certainty in such matters is usually impossible and
is not necessary; the Board should make as close an
approximation as it can, bearing heavily if it chooses upon the
taxpayer whose inexactitude is of his own making. But to
allow nothing at all appears to us inconsistent with saying
that something was spent. . . . It is not fatal that the result
will inevitably be speculative; many important decisions must
be such.”
12 Entertainment Expenses:
Response to Cohan
p. 712
Limitations on Code §162(a) deduction:
§274(a)(1)(A) activities.
(i) “directly related” requirement; or
(ii) “associated with” requirement &
“bona fide business discussion” of a possible transaction.
§274(a)(1)(B) entertainment facilities.
§274(a)(3) club dues.
13 Expense Substantiation: Response to Cohan
Code §274(d)
p.712
(1)Time, (2) place, (3) business purpose, (4) amount of the
expense, and (5) the relationship to any recipients of the
entertainment.
Must have adequate contemporaneous records. No estimates
permitted.
Cf., Cohan doctrine.
Certain per diem allowances OK in lieu of specific expense
recordkeeping.
Foreign Travel: §274(c) partially disallows deduction for foreign
travel for mixed business and pleasure.
Cruises; §274(h) disallows deduction for cruises and conventions
held outside N.A. unless business connection test met.
14 Limitations on the Deductibility of Meals
p.712
Code §274(k)
Entertainment meal expenses - not lavish or
extravagant and the taxpayer or a representative to
be present at the meal.
Code §274(n)(1)
Only 50 percent deductibility for meals. Who
economically bears the 50% limit burden?
Code §274(m)(3)
Spousal Travel is deductible if (i) spouse is an
employee, (ii) spouse had a bona fide business
purpose for trip, and (iii) the expense is otherwise
deductible.
15 Hobby Losses
Statutory Framework
Gross Income
(including Hobby income)
AGI
Less: Itemized Deductions*
(including Hobby Losses)
* Note:
•  §183(d) Hobby Losses
Limited to Hobby
Income
•  §67 Limitation on
Miscellaneous Itemized
•  §68 Overall Limitations
Taxable Income**
** Note:
•  NOL includes Hobby Losses
only to extent of Hobby
Income (§172(d)(4)
p.719
Gross Income
(including Hobby income)
* Note:
•  Trade or Business
Expenses deduct to
derive AGI
•  §469 Passive Loss Rules
AGI*
Taxable Income**
** Note:
•  §172 allows NOL to
includes all allowable
Trade or Business
expenses
16 Hobby Losses
Supp. pp. 66-70
Nickerson v. Commissioner
§183 provides for limitation on hobby losses. How determine that
an adequate profit motive exists?
FACTS: Nickerson lost money farming for 10 years.
Court Holding: Found that
Nickerson was in a trade or
business. Standard of review:
clearly erroneous for Tax
Court to have said anything
other than this person was in
a “trade or business.”
See Reg. §1.183-2(b) factors –
at p. 380.
17 Hobby Losses
Plunkett v. Commissioner
(Supp. pp. 71-73)
FACTS: Plunkett engages in mud racing in the “super modified
division.” Also, taxpayer competes as a truck puller.
Court Analysis. Applies the Reg. §1.183-2(b) factors – at p. 380.
Court Holding: Not in a trade or business as a mud racer, but is
in the trade or business of being a truck puller.
18 Loss on Sale
Weir v. Commissioner
p.726
Taxpayer bought preferred stock in corporation that owned apartment
building where taxpayer lived. IRS asserted that the subjective purpose
for this purchase was to have a voice in the manner in which the
building was run, thus promoting a personal living interest of the
taxpayer.
Court: Held for taxpayer that the stock loss was deductible under
§165(c)(2). The company was a going concern, and the stock was
expected to generate dividend income. Since dividends constitute
profits, the taxpayer’s “for profit” test was met.
But note Reg. §1.212-1(h); Reg. §1.262-1(b)(4).
19 Rental Losses for
Vacation Home
p.730
Code §163(h)(4)(A(i)(II) allows interest expense for one nonprincipal residence.
Code §280A(d) provides rules limiting deductions for costs of
vacation homes:
1) Under 15 days rental use - income and deductions both
ignored; §280A(g).
2) Over 14 days personal use - limit on % of deductions for
rental use; §280A(d)(1)& (4).
3) Rented more than 14 days, but personal use is less than
the greater of 14 days or 10% of period rented, then
get full deductions.
20 “Office in the Home” Deduction
Drucker v. Commissioner
p.733
Musicians claimed deduction for allocable costs of rent, electricity and
maintenance costs of apartment that related to practice room exclusively
used for practice.
Tax Court disallowed deduction, claiming that principle place of
business was the Lincoln Center where they provided services for their
employer.
Second Circuit: Reversed. The Met did not provide practice facilities,
and the appellate court determined that the musician’s principle place of
business was their practice studio.
21 Home Office
Commissioner v. Soliman
p.736
FACTS: Soliman was an anesthesiologist that worked at various
hospitals but used a home office to do his paperwork. Only work at this
office was administrative matters and not providing anesthesiology
services.
Tax Court: Held Soliman’s home office was his principal place of
business, thus abandoning its “focal point” test after Drucker.
Fourth Circuit. Affirmed.
Supreme Court reversed. Administrative chores were far less important
in comparison of anesthesiology activities.
Subsequent Event: Code §280A(c) disallows all §§162, 165, 167, 168 and 212 deductions
for a home office or work area in a personal residence. But, Congress provided a new
Code §280A(c)(1) that permits a home office deduction if exclusively used on a regular
basis, such as for meeting customers or it is the principle place of business for a trade or
business, or if a separate building, unattached to dwelling residence, used in connection
with trade or business. But note the flush language to §280A(c) that Congress added in
1997 post-Soliman.
22 Rev. Rul. 94-24
p.744
Situation 2: B is employed as a teacher. B is required to teach and meet with students
at the school and to grade papers and tests. In addition to a small shared office at the
school, B maintains a home office for use in class preparation and for grading papers
and tests. B spends approximately 25 hours per week of B’s work time at the school,
with an additional 30 to 35 hours of B’s work time per week spent in B’s home office.
Situation 3: C is a self-employed author who uses a home office to write. C spends 30
to 35 hours of C’s work time per week in the home office writing. C also spends
another 10 to 15 hours of C’s work time per week at other locations conducting
research, meeting with C’s publishers, and attending promotional events.
Situation 4: D is a self-employed retailer of costume jewelry. D orders the jewelry
from wholesalers and sells it at craft shows, on consignment, and through mail orders.
D spends approximately 25 hours of D’s work time per week in D’s home filling and
shipping mail orders, ordering supplies, and keeping the books of D’s business. D also
spends approximately 15 hours of D’s work time per week at craft shows and
consignment sale locations. D generates a substantial amount of income from eachtype
of sales activity.
23 Litigation Expenses
“Origin of Claim” Doctrine
p.745
U.S. v. Patrick (p. 751) & Code §212(2). What deductibility of the
husband’s expenses for attorney’s fees for his settlement of ex-wife’s
property claims against him? Held: origin of these attorney fees
was personal (not business related) and thus nondeductible.
Hunter v. U.S. (p.753): Attorney fees related to reduction of alimony
payments is not an expense incurred for the production of income.
Wild v. Commissioner (p.753): Fees incurred to collect alimony had
their origin in production of income. Alimony is gross income to the
recipient, so expenses incurred to collect alimony are expenses
incurred to produce income.
24 Education Expenses
Jorgensen v. Commissioner
p. 759
High School English teacher deducts trip to Greece (1995) and Southeast
Asia (1996) trips to attend foreign-abroad study programs. Taxpayer
deducted the costs of these trips as educational expenses that were
related to the trade or business of being a humanities teacher. IRS
disallowed expenses.
Court said amounts were deductible business expenses. Why?
25 Job Related Expenses to Enter Profession
p.770
Expenses to seek new employment in same trade or business are
deductible. Rev. Rul. 77-254.
However, expenses to become qualified to enter a new vocation are
not deductible or amortizable. See Denman v. Commissioner, 48
T.C. 439 (1967) (cost of getting engineering degree nondeductible).
What about cost for seeking one’s first job (e.g., after law school)?
At least permit amortization of any cost? See note 2 on page 770.
Sharon v. Commissioner, 78-2 USTD ¶9834 (9th Cir. 1978
(amortization of law school costs not allowed).
26 Education Expenses
Carroll v. Commissioner
p. 771
Note 4 “Carrying On Business”
Facts: Police officer obtains college degree. Employer wants Carroll
to get a college degree. Is this a deductible expense?
Holding: No. These are personal expenses.
Aside: Wassenar v. Commissioner - obtained LL.M. degree in
taxation. Deduct expense for tuition, etc., as an employee business
expense? IRS – never began the practice of law – which is essential
for the deduction. Not admitted to practice law before LLM. Reg.
§1.162-5(b)(3) – re new trade or business
27