Proof of Payment is the First Step

Greta Hicks
March 3, 2014 — 2,481 views  
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The statements by themselves will not support a Sec. 274 entertainment, travel, gift, or transportation expense deduction. Sec. 274(d) reads: “unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer’s own statement (A) the amount of such expense or other item, (B) the time and place of the travel, entertainment, amusement, recreation, or use of the facility or property, or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of persons entertained, using the facility or property, or receiving the gift,” the expense is not properly documented.

P.L. 99-44 deleted the contemporaneous requirement in Sec. 274(d), which reads in part: “An Act to amend the Internal Revenue Code of 1954 to repeal the contemporaneous recordkeeping requirements…” Current tests for Sec. 274 requires “adequate records or other evidence corroborating the taxpayer’s own statement…” I.T. Reg §1.274-5T(c)(1) goes further: “A taxpayer must substantiate every element of an expenditure by adequate records supported by documentary evidence, or by sufficient evidence corroborating the taxpayer’s statement. The probative value of written evidence is greater than oral evidence, as is the value of written evidence that is recorded ‘at or near’ the time of the expenditure.”

Documentation for travel expense is covered under I.T. Regs. 1.274-5T(c)(2)(i) and (ii), “Documentary evidence, such as receipts, paid bills, or similar evidence sufficient to support an expenditure, is required for (1) Any expenditure for lodging while traveling away from home, and (2) Any other expenditure of $75 or more except, for transportation charges, documentary evidence will not be required if not readily available.” I.T. Regs § 1.162-17(d)(3) states, “Where records are incomplete or documentary proof is unavailable, it may be possible to establish the amount of the expenditures by approximations based upon reliable secondary sources of information and collateral evidence.”

What about the Cohan Rule? Is it possible to succeed by arguing that “it is reasonable to expect” certain types of expenses? Cohan is alive and well when it comes to Sec. 162, but not for Sec. 274. In Albert H. Payne, TC Memo 1986-93, the Tax Court approximated various deductions (including telephone charges and overnight travel expenses). In David W. Bauer v. Commissioner, TC Memo 2012-156, the Tax Court held that an independent contractor who provided moving services was, after a good faith attempt, entitled to deduct an estimated amount of contract labor expenses. The same sentiment is covered in I.T. Regs §1.274-5T(c)(5), “Where the taxpayer establishes that the failure to produce adequate records is due to the loss of such records through circumstances beyond the taxpayer’s control, such as destruction by fire, flood, earthquake, or other casualty, the taxpayer has the right to substantiate a deduction by reasonable reconstruction of his expenditures or use.”
As tax advisors and return preparers, we have the challenge to educate our clients that:

  • Bank statements or credit card statements are proof of payment ONLY.
  • Additional documentation is required for Sec. 274 type expenses. And to educate IRS employees that:
  • Sec. 274 does not require records to be contemporaneous.
  • Reconstructed records or approximations are adequate.
  • Cohan can apply when there is a reasonable basis for determining the amount of the non-Sec. 274 expenses.

If the agent/auditor does not follow IRS National Office Guidelines or court decisions, go to Appeals and propose a settlement. Most agents/auditors are trained to be very conservative in their decisions. Appeals goal is to settle cases. Give them a reason and a basis on which to settle in favor of the taxpayer.

Greta Hicks