This one is not so much a procedure case but its facts jumped out at me and is worthy of a blog. In Avery v Commissioner, the Tax Court sustained the IRS’s denial of over $300,000 of a lawyer’s claimed advertising expenses that the taxpayer allegedly incurred during 2008–2013.
This is a different twist on cases where taxpayers try to overcome the Section 183 hobby loss limitations which shoehorn nonprofit related hobby type expenses into a narrow category of expenses that can (at least prior to 2018) offset that activity’s income, if any. Here, the taxpayer argued that his car racing was essentially done to promote his legal practice.
read more…Avery is a CDP case where the underlying liability was at issue because the IRS agreed that he had not received the stat notice even though it was sent to his last known address. As readers may recall, and as we have discussed before (see Carl Smith discussing Godfrey v Comm’r), CDP differs from deficiency cases where the 90-day period in which to file a Tax Court deficiency petition begins when the notice of deficiency is mailed to the taxpayer’s last known address, regardless of its non-receipt. In CDP cases, as here, a taxpayer can challenge an assessed underlying liability where the taxpayer “did not receive any statutory notice of deficiency . . . or did not otherwise have an opportunity to dispute such tax liability”
After overcoming that hurdle, the Avery case turns to the merits. The opinion notes that Avery moved to Indiana starting in around 2005 and did not practice in Indiana. But he did have a practice in Colorado that ramped up when he returned there in 2010.
Part of the costs that Avery claimed as advertising included his purchase price for a Dodge Viper (actually depreciation), as well as parts and labor associated with maintaining the car. IRS essentially agreed that about $50,000 of expenses were substantiated but claimed that the expenses were personal non deductible expenses under Section 262.
The taxpayer argued that car racing would help him meet people who could help his career, and claimed that it would help him obtain personal injury clients who may have seen his law firm decal on the car that he occasionally raced.
The Tax Court, while also noting that Avery failed to race the car much when he returned to Colorado, found that he failed to introduce sufficient evidence that connected the racing to his law practice:
Petitioner allegedly believed that being involved in car racing would enable him to meet lawyers, doctors, and other professionals who could help his career. But he could identify only one instance–involving a Pizza Hut franchisee–in which his racing activity actually intersected with his law practice. And that relationship did not lead to any personal injury litigation, but only to “consultation” about a vendor dispute.
Petitioner testified that he found car racing to be a good “conversation starter” when meeting with other professionals. But innumerable sports and hobbies could serve the same function–a pastime that a person might enjoy and share with other people, possibly leading to eventual business relationships. That possibility does not convert the costs of pursuing a hobby into deductible advertising expenses.
Conclusion
This case joins one of my favorites in my tax class, Henry v Commissioner, which Paul Caron blogged about a couple of years ago. In that case an accountant attempted to deduct insurance and maintenance costs from his purchase of a yacht on which he flew a red, white, and blue pennant with the numerals ‘1040‘ on it. Henry, like Avery, failed to provide enough evidence to sustain the connection between obtaining clients for his accounting practice and his yachting, and the Tax Court disallowed those expenses as personal nondeductible expenses under Section 262.
All is not lost for some professionals who might want to deduct racing expenses–and maybe even the costs of yacht ownership. Avery notes that the case “is distinguishable from prior cases—e.g., involving car dealerships, construction companies, and companies engaged in the sale and leasing of aircraft—in which we found car or motorcycle racing expenses to be deductible advertising costs.” In those case the taxpayer, through more than vague testimony, established a proximate relationship between the expenses and the business of the taxpayer.
This case reminded me of my and Keith’s late colleague at Villanova, Michael Mulroney. Michael raced his classic British Morgan sports car for his one-man Phlexed Sphincter Racing Team. I recall Michael festooning a bumper sticker on an old Karmann Ghia that he occasionally raced that said “Villanova Graduate Tax Program: Not A Passive Activity.” I do not believe Michael attempted to deduct any of his car racing expenses, but I know he would have enjoyed reading this opinion and sharing it with his students.
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As with much of advertising, this can be a foresight-hindsight issue. You do it and pay for it holing that it will produce results; maybe you do a small trial run first and based on that, if the results look good, you expand it and hope for results. But there are no guarantees that there will be results. Obviously, if you pay for an ad on late-night TV, the IRS will not assert that that was a hobby. But when you do something that is often (or usually) done by people for purely personal reasons, there may be a higher “what were you thinking?” hurdle if no results came about.
The tension arises even when you attend a convention or visit a client in another city: was it really a personal vacation trip or a trip to visit your relatives or parents in that city, with a drop-in at the convention or the business meeting as eyewash, especially if you did not pay much to attend the event? Decades ago, I heard an elementary school teacher claim that her annual vacations were deductible because they made here a better geography and history teacher. The convention rules have been tightened over the years, but the tension remains in general.
Indeed, as soon as I saw the headline for this post I thought of our late colleague Michael Mulroney. And I wondered what he would have said had he lived long enough to read this opinion. Somewhere I still have on of those bumper stickers.