APPEAL OF PROPOSED DEFICIENCY

Business Expense

TAXPAYER NAME

Submitted by:

Student’s name, Student Attorney

Philip C. Cook Low-Income Taxpayer Clinic

P.O. Box 4037, Atlanta, GA 30302-4037

Ph. (404) 413-9230

Fax (404) 413-9229

e-mail:

TABLE OF CONTENTS

Relief Requested .3

Procedural Background Of Matter .3

Statement Of Facts .4

Applicable Law 5

Application Of The Law To The Facts.............................................................7

Conclusion..…………………………………………………………….……..……10

Exhibits

A. Form 2848 - Power of Attorney

B. Account Transcript 2009

C. Tax Returns for 2007-2009

D. IRS Notice dated June 4, 2012

E. Notice of proposed changes dated August 13, 2012

F. Protest Letter from Ms. TAXPAYER dated September 28, 2012

G. Wage and Income Transcripts for 2007-2009

H. Statement from Ms. TAXPAYER

I. Roster of Customers

J. Log Book

K. Customer profile cards

L. Map of customers by zip code

M. Map of downstream recruits by zip code

N. Leased car odometer disclosure form

O. Direct Sales provided 1099 Income information for 2009

P. Receipts for advertising purchased in 2009

Q. Description of Direct Sales “Income Opportunities”

R. Commission payment statement from Direct Sales for 2009

APPEAL OF PROPOSED DEFICIENCY

RELIEF REQUESTED

Briefly state the Taxpayer’s name, what you are requesting the IRS to do, and the Code section(s) applicable.

TAXPAYER’S NAME respectfully requests the Internal Revenue Service to reconsider its disallowance of her business expenses for tax year 2009 and eliminate the proposed deficiency for that year. Ms. TAXPAYER was entitled to claim ordinary and necessary business expenses paid in the operation of her Direct Sales business under I.R.C. § 162. (If IRS challenges that the client was even in a business then include this issue.) If Ms. TAXPAYER is found not be engaged in a trade or business, under I.R.C. § 183 she should be allowed to deduct expenses up to the amount of her gross income from her Direct Sales activity.

PROCEDURAL BACKGROUND OF TAX MATTER

Include the following information in this section:

· Filing history of the year or years at issue

· Brief discussion of issues that gave rise to the liability.

· Discussion of the issuance of the notice or IRS correspondence that triggered this memo and who in the IRS issued it (Examination, Appeals, Collections). Include a copy

· Discussion of whether the client or the Clinic filed something to give rise to this memo, e.g. who filed or entered an appearance in Tax Court, the date of Counsel’s Answer, etc… and whether the Clinic entered an entry of appearance and the date of Counsel’s Answer.

· Discussion of where current jurisdiction lies (Appeals, Counsel or Collections or Taxpayer Advocate) and what transpired at lower level of IRS.

Ms. TAXPAYER filed a return for tax year 2009 on February 18, 2010 (see Exhibit B which includes an Account Transcript for 2009). On her 2009 Form 1040 Schedule C, Ms. TAXPAYER reported income of $6,593 from the sale of cosmetic products. She also claimed business expenses in the “Car and Truck” and “Other” categories of $7,456 and $624, respectively (see Exhibit C which is her 2009 return). In an examination notice dated June 4, 2012, the IRS notified Ms. TAXPAYER that her 2009 Schedule C was under review (see Exhibit D which includes the notice). Ms. TAXPAYER requested additional time to gather supporting documents. (see Exhibit D which is a letter dated July 3, 2012). Before Ms. TAXPAYER could gather the documents and prepare a response, the IRS issued an examination report dated August 13, 2012 disallowing the business expenses entirely, without giving credit for the deductions to the extent of the Direct Sales gross income, increasing her adjusted gross income by $8,080 and proposing changes in the amount of income tax due (see Exhibit E which includes form 4549 – Income Tax Examination Changes). Ms. TAXPAYER disputes the proposed changes and is providing documentation to support and substantiate her claims. The settlement jurisdiction for the 2009 tax return lies with Appeals.

STATEMENT OF FACTS

Use this section to provide the applicable facts addressing the issue, as well as contextual information to help the IRS understand the Client’s personal and financial situation. Use exhibits to substantiate your claims, and make reference to all exhibits (e.g., “see Exhibit xx which is a ____ showing _____.

If you are arguing that the activity was a business, use this space to explain why the Client started the business, why it was not successful, and why it ended. Later, you will argue that the Client had a good faith belief that the business would be profitable. Be sure to give reasons why that belief existed, even when the business lost money. You may want to have the client write and sign a statement attesting to their honest belief that they would make a profit. Try to find evidence that can be used to support each of the nine factors used by the Tax Court (described below).

If you are arguing that the IRS should allow business expenses, describe how the business worked and how the business expenses would lead the generation of income. Try to provide logs and records of the business activity (e.g., a calendar of sales calls, a roster of clients with addresses if you’re asking for travel expenses, etc.). The client can show that the activity was a legitimate business with his or her books and records, business licenses, invoices from client and invoices of business expenses.

Ms. TAXPAYER is a 36 year-old single mother of three who lives in Atlanta, GA. She came to the U.S. from Guatemala when she was seventeen years old, and she is now a U.S. citizen. Ms. Taxpayer began selling Direct Sales products on a part-time basis in September 2007. In July of 2008, she lost her full-time job as an administrative assistant for a shipping company, and she remained unemployed until October 2009. During that time, she had two sources of income – her Direct Sales commissions and unemployment benefits (see Exhibit G which are Wage and Income transcripts for 2007-2009).

Direct Sales is a company providing cosmetic products which are sold to the general public through independent sales representatives like Ms. TAXPAYER. The representatives receive commissions for their sales and a portion of the sales of any representatives they recruit (see Exhibit Q which is a copy of their website description).

While she started her Direct Sales business as a part-time supplement to her income, she worked at it full-time after she lost her job in 2008 (see Exhibit H which is a statement from Ms. TAXPAYER describing her work with Direct Sales). She was initially successful with Direct Sales, but as the economy deteriorated in late 2008 and throughout 2009, her sales decreased and her downstream recruits failed to meet their sales targets. Even so, in 2009 she received $6,593 in gross income from Direct Sales business (see Exhibit C which is a copy of her 2009 tax return). Ms. TAXPAYER also drew $11,985 worth of taxable unemployment compensation in 2009, and she earned $5,389 as a case worker at a homeless shelter from October through the end of 2009 (see Exhibit G which is a Wage and Income Transcript for 2009).

Ms. TAXPAYER reported losses for her Direct Sales activities in tax years 2007-2009. The majority of each loss was due to her deduction for Car and Truck expenses (see Exhibit C which includes transcripts of her returns for 2007-2009).

Describe the day-to-day activity in operating the business. Remember, for a deduction, you must show that the expenses are ordinary and necessary, and provide documentation.

From the beginning of her tenure with Direct Sales, Ms. TAXPAYER attended weekly Direct Sales-sponsored training seminars in the Atlanta area. Her business activities occurred over a wide geographic area that extended beyond metropolitan Atlanta. She drove extensively to meet with her existing clients and her downstream sales representatives, and to gain new customers and new sales representatives (see Exhibit I which is a roster of customers, see Exhibit K which is her customer profile cards, see Exhibit L which is a map of the location of Ms. TAXPAYER’s customers by zip code.). She kept a record of her trips to these meetings and sales calls in her log book (see Exhibit J which is a copy of her log book).

Ms. TAXPAYER attempted to increase her sales by advertising her products in local gyms and restaurants (see Exhibit P which are receipts for advertisements placed).

Explain why the Client persisted in a business even after she had a loss.

Because of the number of downstream recruits, Ms. TAXPAYER was recognized as a Sales Director in December 2008. This title came with access to a car leased by Direct Sales in her name, with the requirement that she or her recruits place orders for at least $5,000 of product each month. Ms. TAXPAYER picked up the car in January 2009 and returned it in October 2009 (see Exhibit N which is documentation of the lease, including a statement of the car’s mileage during the lease period).

Describe the end of the Client’s business as evidence that she undertook the activity to make a profit, and when it became evident that a profit would not be coming, she stopped.

Ms. TAXPAYER worked diligently at her Direct Sales business, but when she eventually stopped selling Direct Sales products and gave back the automobile they had provided her, the commissions from her remaining active recruits were garnished by Direct Sales to offset the wholesale purchases of product that Ms. TAXPAYER was unable to sell (see Exhibit R which is a statement of commissions paid by Direct Sales in 2009). She no longer sells Direct Sales products.

Ms. TAXPAYER is currently employed as a part-time sales clerk at a department store. She continues to look for a full-time job. Her family’s finances are strained (the family receives $200 per month in Supplemental Nutrition Assistance – food stamps).

APPLICABLE LAW

Under this section don’t put facts, only law. The section should begin with statutory references, then cases, then regulations, then other authority.

If you’re discussing deductions, look to the Code and Treasury Regulations for any limits that Congress or the IRS may have placed on categories of expenses (e.g., § 274 and limits on meals and entertainment).

Burden of Proof

In general, the IRS’s determination of the existence of a tax liability is presumed to be correct, and the burden is on the taxpayer to prove otherwise. Tax Court Rule 142; Welch v. Helvering, 290 U.S. 111, 11 (1933). However, the burden may shift where a taxpayer produces credible evidence with respect to any factual issue relevant to ascertaining his income tax liability. I.R.C. Section 7491 (a)(1); see also I.R.M. 35.4.1.6.1 (08-11-2004).

Business Expenses

I.R.C. § 162(a) provides a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year while carrying on any trade or business. Ordinary expenses are those that are common and accepted in the taxpayer’s trade or business. Deputy v. du Pont, 308 U.S. 488, 495 (1940). Necessary expenses are those that are helpful and appropriate for the trade or business. Commissioner v. Heininger, 320 U.S. 467, 471 (1943). Regulations § 1.162-1 further limits deductible business expenses as those “directly connected with or pertaining to the taxpayer’s trade or business.” These are said to include the “supplies. . . advertising and other selling expenses.” Further, Reg. § 1.162-1 specifically allows a deduction for “operating expenses of automobiles used in the trade or business.”

Regulations § 1.162-17(d) discusses the substantiation of ordinary and necessary business expenses. While Reg. § 1.162-17(d)(1) states that the Commissioner may require any taxpayer to substantiate expense in determining tax liability, Reg. § 1.162-17(d)(2) describes one method of substantiation as “ the preparation of a daily diary... maintained in sufficient detail to enable him to readily identify the amount and nature of any expenditure,” while also admitting that “it is often difficult . . . to maintain detailed records” for all expenses.

Because it is often difficult to maintain detailed records, courts have allowed approximations of business expenses under the Cohan rule. Cohan allows estimations of deductible expenditures by taxpayers who have not maintained sufficient definite proof of those expenses and might otherwise suffer the loss of the deductions. Cohan v. Commissioner, F. 2d 540 (2nd Cir. 1930), limited, though by Code section 274(d). Reg. § 1.162-17(d)(3) goes further and allows the amount of the expenditures to be established “by approximations based upon reliable secondary sources of information and collateral evidence” while giving “due consideration … to the reasonableness of the stated expenditures” in relation to the nature of taxpayer’s income and occupation.

Certain expenses do not fall under Cohan. For these, IRC § 274 requires actual substantiation. The following excerpt from a Tax Court opinion explains:

“For certain kinds of business expenses, section 274(d) overrides the Cohan rule. See Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968), aff'd, 412 F.2d 201 (2d Cir. 1969). Under section 274(d), a taxpayer must satisfy strict substantiation requirements before a deduction is allowable. These requirements apply to any traveling expense, including meals and lodging away from home, to any item with respect to an activity in the nature of entertainment, and to the use of listed property, as defined in section 280F(d)(4), including passenger automobiles and cellular phones.

“To satisfy the requirements of section 274(d), a taxpayer must maintain records and documentary evidence that in combination are sufficient to establish each element of an expenditure or use. Sec. 1.274-5T(c)(1) and (2), Temporary Income Tax Regs., 50 Fed. Reg. 46016-46017 (Nov. 6, 1985). While a contemporaneous log is not required, corroborative evidence created at or near the time of the expenditure to support a taxpayer's reconstruction "of the elements * * *. * * * of the expenditure or use must have a high degree of probative value to elevate such statement" to the level of credibility of a contemporaneous record. Sec. 1.274-5T(c)(1), Temporary Income Tax Regs., supra.”

Car & Truck expenses are not travel. Travel is “overnight travel for business while away from your tax home.” However, § 280F(d)(4) applies to the expense of operating most vehicles.

Section 162 deductions are limited to those expenses incurred and paid while carrying on a trade or business. The Internal Revenue Code does not define “carrying on a trade or business,” but the courts have given a definition, at least indirectly. The primary case is Higgins v. Commissioner, 312 U.S. 212 (1941), in which the Supreme Court held that the determination of whether a taxpayer is carrying on a trade or business requires an examination of all the facts and circumstances of each case. In general, courts have required some showing that: