Revenooer Rants: How not to act in tax court
May 26, 2016
Check out the recent decision in the case of taxpayer Lisa A. Nkonoki for this lesson. You just have to wonder what some people are thinkin'.
This gal conducted business in 2009 under the name "Live Your Dreams Life Coaching and Family Advocacy." (Almost says all you need to know about this situation, but so be it.) For most of the year, our gal did not maintain a fixed office. Instead, she worked out of her car and hotel rooms. She represented herself before the Tax Court.
She did not submit a pretrial memorandum, and repeatedly failed to provide IRS with requested documents to substantiate expenses that she deducted on Schedule C of her return.
The Court ordered her to provide the documentation, which she failed to do until less than 14 days before the scheduled trial date. Then she failed to appear in court — both on the originally scheduled trial date and also on the rescheduled dates of which there were several.
To sanction the taxpayer for her violations of the Court's order that she provide documents substantiating her deductions, the Court eventually refused to allow introduction of those documents into evidence, thus allowing only the taxpayer's testimony regarding her deductions.
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And just let us say that her testimony left a whole lot to be desired. Needless to say, she lost virtually all of her claimed deductions.
We wonder what she expected.
And another recent Tax Court Decision (H.W. Johnson, Inc.) gives hope to folks battling the issue of the deductibility of "reasonable compensation") paid to sons of a corporation's founder. Indeed, in this case — deductions totaling millions of dollars.
The Ninth Circuit (to which this case would have been appealable) has defined five factors to determine the reasonableness of compensation, with no single factor being determinative:
The employee's role in the company.
Comparison with other companies.
The character and condition of the company.
Potential conflicts of interest (generally evaluated from the perspective of a hypothetical independent investor).
Internal consistency in compensation.
The Court, here, found the facts bearing well in favor of the sons' compensation as being "reasonable" in the circumstances, given that, among other things:
The business's revenues grew rapidly after the sons assumed control of daily operations.
The sons managed all operations, each supervising over 100 employees, and worked 10 to 12 hours per day, 5 to 6 days each week. They were readily available if problems at a job site arose and were known in the local industry for their responsive and hands-on management style.
They personally guaranteed loans whose proceeds the corporation used to purchase materials and supplies.
In short, the Court found the brothers "absolutely integral" to the corporation's successful performance, a performance that "included remarkable growth in revenues, assets, and gross profit margins during the years at issue."
Some taxpayers do it right; some don't.
Jeff Quinn is a CPA, recently retired from Ashley Quinn, CPAs and Consultants, Ltd., with offices in Incline Village and Reno. He welcomes comments at email@example.com.