Tax Court Grounds Law Firm’s Travel Deduction for Use of Partner’s Private Planes
A law firm’s claim of travel expense deductions related to one of its partners’ use of two private aircraft fell apart because the firm lacked the proper documentation to prove that the flights were related to firm business. The US Tax Court‘s ruling in favor of the Internal Revenue Service stands as a stark reminder for taxpayers of all sizes about the need to keep clear, accurate, and contemporaneous expense records.
The unsuccessful taxpayer was Engstrom, Lipscomb & Lack, APC, a prominent personal injury and class action law firm in Southern California. The firm’s tax troubles arose after the IRS hit it with a deficiency of nearly $1.25 million across a period of three years, 2008-10. The IRS also hit the firm with an accuracy-related penalty. The dispute related to a carried-forward net operating loss from 2007. A main piece of that loss was the firm’s 2007 travel expense deduction, which was itself the crux of the IRS’s case. One of the firm’s owners, Walter Lack, also co-owned an aviation company, G&L Aviation, with Thomas Girardi. G&L owned an American Gulfstream jet and a Raytheon turboprop that Lack and his fellow G&L owners used to travel to various locations. Lack’s travels were, according to the firm, related to firm business. The law firm, however, never held any ownership interest in G&L or G&L’s aircraft.
The Tax Court upheld most of the deficiency and the penalty. The problem that befell the law firm’s case was a lack of proper contemporaneous documentation. The law firm needed records that showed: “(1) the amount of the expense; (2) the time and place of the travel; and (3) the business purpose of the expense.” While contemporaneous records are not required in order to prove entitlement to a deduction, they go a longer way than “after-the-fact reconstructions.”
The need for clear and, ideally, contemporaneous records is especially high if the travel that generates the deduction looks problematic on its face. On many of the flights for which the law firm claimed the deduction, Girardi, who had no affiliation with the law firm, was the only traveler. Without convincing records, there was no way for the firm to defend these flights as being related to firm business.
The same held true for expenses Lack paid out of his own pocket but for which the firm took a deduction anyway. The firm tried to defend the payments as deductible on the grounds that they were loans or capital contributions. However, without any paperwork to back up the contention that the firm had treated Lack’s payments as loans or capital contributions, the argument proved unpersuasive.
The failure of the law firm before the Tax Court reminds all taxpayers of the need to carefully and, if possible, contemporaneously document all business expenses. Not only did the law firm’s lack of proper records doom its deduction, its lack of an excuse for why it failed to keep those necessary records was the basis for the Tax Court’s upholding the IRS’ accuracy-related penalty.
For top-level advice about your income tax returns, and the documentation you need to go with them, talk to the tax attorneys at Samuel C. Berger, P.C. and CPAs at S.C. Berger, P.C. They can put their knowledge and experience to work for you to make sure you are protected. To consult our attorneys and CPAs, contact us online or call (201) 587-1500 or (212) 380-8117.
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Photo credit: Peter Bakema at Wikimedia Commons