The Insurmountable Sin in an IRS Audit: A True and Sad Story

Last month we wrote about the need for a good mileage log and showed you what it takes, in What Is the Unpardonable Sin in an IRS Audit?

Here we are going to tell you a true story of how keeping the mileage record in Microsoft Outlook proved inadequate.

The story is about Therone Johnson, president of Diversified Innovative Products Co, Inc. (Dip Co), a corporation in Colorado that manufactures and sells disposable ink pans for printing presses.

Mr. Johnson and the rest of Dip Co’s management work from home offices because the manufacturing facility does not have enough office space for all of them to work there regularly. We don’t know whether Dip Co reimbursed Mr. Johnson for his home office, which would have given both Dip Co and Mr. Johnson the best result. We also don’t know whether Mr. Johnson and Dip Co considered Mr. Johnson’s home office a principal place of business, as that would have turned all mileage from Mr. Johnson’s home to the office into business mileage. Of course, with inadequate mileage records, the principal place of business argument would not have been much help.

Need for the Mileage Log

Tax code Section 274 imposes strict substantiation requirements for business mileage.

As the court noted in this case, for expenses such as the pickup truck Mr. Johnson used for business purposes, he had to substantiate the following with adequate records or with sufficient evidence corroborating his own statement:
1.    The amount of the expense
2.    Mileage for each business use of the pickup, as well as the total mileage for all purposes during the taxable period
3.    The time and place Mr. Johnson used the pickup
4.    The business purpose of the use

Planning note. Don’t latch on to the “with sufficient evidence corroborating his own statement” thinking that you have a real alternative to keeping a good mileage log. From the myriad court cases we have read regarding the mileage log, this is an impossible task.

Section 179 Deduction

In addition to his position as the president of Dip Co, Mr. Johnson owned a ranch. He used the pickup truck for both Dip Co and his ranch. From the court record, it appears that Mr. Johnson deducted 100 percent of the $23,000 he paid for the pickup truck, using the Section 179 deduction. To qualify for and retain the Section 179 deduction, Mr. Johnson had to use the pickup truck more than 50 percent for business purposes.

The Outlook Calendar

The primary evidence Mr. Johnson submitted to the court (and previously to the IRS) in support of his claimed travel-related and car and truck expense deductions was a Microsoft Outlook calendar reflecting his travel during the periods at issue, supplemented by his testimony. He used the calendar for all appointments and events, including those related to his work at the ranch, his work for Dip Co, and his personal activities. But many of the entries in his calendar noted only that he traveled to and/or from the ranch; they did not note the purpose for his visit (hay farming business, Dip Co work, property maintenance, or personal).

The Court’s Take on the Calendar

The court noted that without the business purpose information, it could not determine which of Mr. Johnson’s trips were for business purposes as required by tax code Section 162. It then cited various cases that disallowed the expenses because the taxpayer
·       could not establish the business purpose for each expense;
·       did not differentiate between business travel purposes and personal travel purposes; or
·       gave broad testimony and receipts that were insufficient to establish the business purpose of travel.

Ruling

Because the court could not determine that Mr. Johnson’s business use of the truck for Dip Co and the ranch exceeded 50 percent of Mr. Johnson’s total use as required by Section 179, it simply denied the entire Section 179 deduction and the other car and truck expenses for the three years before the court.

Takeaways

The failed mileage log cost Mr. Johnson all of his car and truck deductions, not just in Year Three, when he purchased and expensed the pickup truck. Also gone were all his deductions for depreciation of his prior vehicle— and all gas, insurance, and repair deductions for a combined three years.

So the vehicle deduction equation for you is clear: if you want to keep your vehicle deductions, you need a good mileage log.