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Tax Court: In Order to Take A Worthless Debt Deduction, the Debt Need Actually Be Worthless

Posted in Uncategorized, tagged , , , , , , , , on October 10, 2012 | 1 Comment »

Guillermo Arguello worked for Guggenheim Investments, a conglomerate of entities of uncertain purpose. Mr. Guggenheim struck up a business relationship with another corporation, Netrostar, that was intended to be symbiotic: Guggenheim Investments would share customer lists and provide financing, while Netrostar would provide web development work to the Guggenheim entities.

Times got tough at Netrostar, and Arguello, who performed some small bookkeeping services for the company, was asked to help bail it out.

First, Arguello spent $24,000 on a used Alfa Romeo that was needed — for some odd reason — to keep Netrostar alive, and sold it to the company in exchange for a note.

In addition, Arguello cosigned Netrostar credit card debt in excess of $35,000.

At the end of 2007, Arguello was still owed $21,000 on the Alfa Romeo note, and he was justifiably getting antsy with his precarious position as creditor of a dying corporation. As a result, Mr. Guggenheim worked up an agreement by which Netrostar would pay Arguello an additional $2,000 towards the note, and then Arguello would “forgive” the remaining $19,000 balance in exchange for his release as cosigner of the credit card debt.

On his 2007 tax return, Arguello claimed a worthless debt deduction of $19,000. The IRS promptly denied the debt, arguing that it had not become worthless during 2007.

Relevant Law

Under Section 166, a taxpayer is entitled to a deduction for a debt, business or nonbusiness, that becomes wholly or partially worthless during the taxable year. There is no standard test for determining worthlessness; whether and when a ebt becomes worthless depends on all the facts and circumstances.[i] In general, the year of worthlessness must be established by identifiable events constituting reasonable grounds for abandoning any hope of recovery.[ii]

The Tax Court concluded that Arguello’s receivable from Netrostar did not become worthless during 2007, primarily because the debt was not forgiven due to Netrostar’s inability to pay, but rather in exchange for getting Arguello off the hook for this co-signed credit card debt:

We cannot assume, and do not find, that as of the close of 2007, Netrostar’s financial condition, although shaky, prompted petitioner to relinquish his rights to collect the balance on the note. The evidence shows, and we find, that the debt was extinguished not so much on account of Netrostar’s ability or inability to pay, but rather pursuant to an arrangement that allowed petitioner to avoid potential liabilities in connection with the credit card accounts.

The court summarized its decision thusly:  “A debt is not worthless where the creditor for considerations satisfactory to himself voluntarily releases a solvent debtor from liability.”

The takeaway lesson, of course, is that in today’s economy, where debts are being forgiven left and right, when you are on the creditor side there is a distinction between a debt becoming uncollectible and simply forgiving the debt in exchange for some form of noncash consideration. Under the tax law, the debtor must establish that the debt has become wholly or partially worthless in order to secure a bad debt deduction.

[i] Dallmeyer v. Commissioner, 14 T.C. 1282, 1291 (1950).

[ii] See Crown v. Commissioner, 77 T.C. 582, 598 (1981).

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Sixth Circuit Rules Severance Pay is Not Subject to Employment Taxes. Get Your Refund Claims Ready.

Posted in Uncategorized, tagged , , , , , , , , , on September 10, 2012 | Leave a Comment »

In a case with far-reaching implications — including the potential for refund claims to be filed by any employer making severance payments to terminated employees during the recent economic downturn — the Court of Appeals for the Sixth Circuit concluded on Friday that severance pay pursuant to an involuntary layoff was not subject to FICA employment taxes.

First, a bit of history: The treatment of certain supplemental unemployment compensation benefits (“SUB”) for FICA purposes has long been clouded. SUB payments were created in the 1950s as a way to supplement the state unemployment compensation benefits received by employees upon involuntary termination, and were defined in Section 3402(o) as amounts:

1) Which are paid to an employee, 2) Pursuant to an employer’s plan; 3) Because of an employee’s involuntary separation from employment, whether temporary or permanent, 4) Resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and 5) Are Included in the employee’s gross income. [Ed note: this will encompass most involuntary severance payments.]

These SUB payments have always been subject to federal income tax withholding by virtue of that same Section 3402(o), which provides that for purposes of determining whether a SUB payment is subject to withholding, it “shall be treated as if it were a payment of wages by an employee to an employee for a payroll period.”

In the most important court decision on this issue prior to last Friday, the Court of Appeals for the Fifth Circuit had concluded in CSX Corporation v. United States, 518 F.3d 1328 (5th Cir., March 2008), that this language did not mean that SUB payments were treated as wages only for purposes of determining whether they were subject to federal income tax withholding. Rather, the court held that SUB payments were also wages for purposes of FICA taxes, stating:

…because we have rejected the first part of CSX’s argument-that the reference to the term “wages” in section 3402(o) necessarily implies that all payments falling within the definition of SUB in that subsection are non-wages, we reject CSX’s statutory argument.   Based on that analysis, we disagree with the trial court’s conclusion that all payments that qualify as SUB under the statutory definition in section 3402(o)(2)(A) are non-wages for purposes of FICA. We therefore reverse those portions of the trial court’s judgment that were based on the trial court’s adoption of that theory of the case.

On Friday, the 6th Circuit took a different approach, and reached a different conclusion, in Quality Stores, Inc. v United States, holding that severance payments were not subject to FICA.

Quality Stores was an agricultural-specialty retailer who filed for Chapter 11 during 2001. Prior to November, 2001, Quality Stores involuntarily terminated 75 employees, with all remaining employees terminated after November 2001 when Quality Stores closed its doors and went out of existence.

As part of the severance packages offered by Quality Stores, employees were paid based on years of service, and the payments were not tied to the receipt of any state unemployment compensation.Because SUB payments clearly represent income that is subject to federal income tax withholding pursuant to Section 3402(o), Quality Stores reported the payments on the recipients’ Forms W-2, and remitted over $1,000,000 in FICA tax to the IRS. Soon after, Quality Stores filed a claim of refund for the FICA taxes, arguing that the severance payments were not subject to FICA as they were not “wages” for those purposes.

In an initial hearing, a bankruptcy court ruled in favor of Quality Stores in 2005, and late last week, the 6th Circuit affirmed the bankruptcy court’s decision, holding that the SUP payments were not wages subject to FICA tax.

The 6th Circuit reached its conclusion by first looking to the legislative history of Section 3402(o). When the provision was enacted in 1969, Congress recognized that SUB payments “are not subject to federal income tax withholding because they do not constitute wages or remuneration for services.” Because SUB payments represent taxable income to the recipient, however, Congress wanted to take the income tax burden of the recipient by requiring withholding at the source, adding:

Although these benefits are not wages, since they are generally taxable payments they should be subject to withholding to avoid the final tax payment problem for employees.

Having established that SUB payments were not wages for federal income tax purposes, the Sixth Circuit then looked to prior case law, which held that Congress intended for the definition of wages for federal income tax and FICA purposes to be one and the same.[i]

Congress imposed federal income tax withholding on SUB payments because they qualify as gross income, not because they are “wages.” Reading the definitions of “wages” found in the FICA and federal income tax statutes consistently, SUB payments do not constitute “wages” under either statutory scheme.

What’s the lesson? With the Fifth and Sixth Circuit Court of Appeals disagreeing on such an impactful issue, the determination of whether SUB severance payments are wages subject to FICA is likely heading to the Supreme Court. In the meantime, it may behoove any employers who recently paid FICA tax on SUB payments to file a  protective claim for refund.

[i] See Rowan Cos. v. United States, 452 U.S. 247 (1981)

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Arkansas Tax Preparer Could Use a Good Tax Preparer

Posted in Uncategorized, tagged , , , , , , on August 21, 2012 | 1 Comment »

Kerry Kerstetter conducted an accounting and tax preparation business out of his Arkansas home. When preparing his Schedule C for his personal tax return, Kerstetter made a litany of mistakes, among the more egregious of which were:

  • Deducting depreciation on his entire home, rather than the portion used exclusively and regularly for business as permitted under Section 280A.
  • Deducting all of his personal credit card interest and mortgage interest on Schedule C, rather than on Schedule A or — in the case of the credit card interest — nowhere.  
  • Deducting pet food as “supplies.”

To make matters worse, Kerstetter failed to file his 2001 and 2003 returns on time. When he did get around to filing them, the returns reflected large net operating loss carryforwards that wiped out his income, but that Kerstetter could not substantiate.

As you might expect, the Tax Court expected more from someone holding themselves out to the public in such an esteemed, trusted position as a tax advisor:

Petitioners’ arguments in this case have not been supported by evidence or by authority. Instead petitioners make assertions based only on their generalized testimony and on petitioner’s claimed years of experience in dealing with the IRS on behalf of clients. Particularly in view of petitioner’s experience, the absence of corroboration of his testimony by organized and reliable records leads us to conclude that petitioners have not carried their burden of proof as to the disputed deductions.

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Wells Fargo Denied Deduction in District Court, Immediately Raises All ATM Fees to $17 to Make Up Difference*

Posted in Uncategorized, tagged , , , , , , , , , on August 16, 2012 | 1 Comment »

Citation: Wells Fargo & Company v. U.S, (DC MN 8/10/2012) 110 AFTR 2d ¶ 2012-5188

Gather round children, whilst I tell a tale of the most widely-read but poorly-written book of all time, 50 Shades of Grey the Internal Revenue Code.

Our story is set in the destitute great state of California.  Our central figure is the national banking chain of Wells Fargo. Like all corporations operating in California, Wells Fargo pays taxes each year for the privilege of doing business within the state.  The tax is based on the income earned in Year 1, but is paid for the privilege of doing business within the state in Year 2.  Importantly, the tax is actually paid in Year 1 in the form of estimated payments.

Under California state law as it has existed since 1972, the tax Wells Fargo pays based on its Year 1 income for the privilege of doing business in Year 2 is not refundable. To illustrate, even if Wells Fargo pulled out of California on Day 1 of Year 2, it is still required to pay the tax for the right to conduct business in Year 2.

As an accrual basis taxpayer, this led Wells Fargo to believe that it could safely accrue the state tax deduction at the end of Year 1, as it would have satisfied the “all-events” test at that time.

As a reminder, meeting the all-events test is required under I.R.C. § 461 in order for an accrual basis taxpayer to deduct a liability. The all events test requires an accrual basis taxpayer to jump through three hoops:

1. The fact of the liability must be fixed. In simple terms, this means that whatever event that is necessary to give rise to Well Fargo’s requirement to make payment has occurred by the end of Year 1.

2. The amount can be determined with reasonable accuracy, and

3. Economic performance has occurred.

Wells Fargo, quite naturally, took the position that all three prongs of the all-events test were met. The fact of the liability was fixed at the end of Year 1, it argued, because the amount due could not be refunded in Year 2, regardless of whether or not Wells Fargo conducted business within California. Furthermore, the amount of the liability could be determined with reasonable accuracy, as the liability was based on Year 1, rather than Year 2 income. And finally, economic performance had occurred, because under Regulation Section § 1.461-4(g)(6), economic performance occurs with respect to a liability for taxes as it is paid, which Wells Fargo did during Year 1 in the form of estimated payments.

Unfortunately for Wells Fargo, their deduction was not to be. And why not? Because of an arcane remnant left over the in the statute at I.R.C. § 461(d). Section 461(d) provides:

In the case of a taxpayer whose taxable income is computed under an accrual method of accounting, to the extent that the time for accruing taxes is earlier than it would be but for any action of any taxing jurisdiction taken after December 31, 1960, then, under regulations prescribed by the Secretary, such taxes shall be treated as accruing at the time they would have accrued but for such action by such taxing jurisdiction.

That’s a bit confusing, so allow me to clarify: this rule provides that if a state changes its tax laws after 1960 — and, as a result of that change, the accrual date of the payment of state taxes is moved up to an earlier year — then the change in the state tax laws is ignored for purposes of federal tax law. In other words, it is the state law that was in place in 1960 that governs the timing of a deduction for federal income tax purposes. If that state law is changed post-1960 to a allow for a more favorable, accelerated deduction, the change is ignored. As the District Court explained in reaching its decision, “Time stands still in this tiny corner of the federal tax world.”

Now, that provision on its own wouldn’t be problematic. But as indicated above, the general rule that the tax paid by California corporations such as Wells Fargo in Year 1 for the right to do business in Year 2 was not refundable didn’t come to be until 1972. Prior to 1972, if a business pulled out of California in Year 2, it could be refunded the tax paid in Year 1, either in part or in full.

In other words: Before 1972 = California state law said the Year 1 tax could be refunded.

                                After 1972 = California state law said the Year 1 tax could not be refunded.

And for some reason no one can explain, the Internal Revenue Code continues to provide that when determining whether a liability to pay California taxes is fixed at the end of Year 1, it is the state law in effect in 1960 that governs, despite the rather relevant fact that we currently reside in the year 2012.

Faced with these facts and the language in I.R.C. § 461(h), the District Court had no choice but to hold that the all-events test had not been met at the end of Year 1. Because under the state law in place in 1960, if Wells Fargo left California  on Day 1 of Year 2 it would receive a refund of the entire liability, the Year 2 liability was not fixed at the end of Year 1. The fact that a new law had been in place for 40 years providing that the Year 1 tax was not refundable was irrelevant.

The lesson? Cut us tax people some slack. When you ask us a question and we don’t feel comfortable giving an off-the-cuff answer, it’s not an indication that we’re not knowledgeable. Rather, our trepidation is the the result of being burned enough by outdated or inexplicable sections of the Code and regulations to know that we’d better check things out before we commit to a response.

*second thing may not have happened.

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Congress Takes First Step Towards Reviving Expired Tax Breaks

Posted in Uncategorized, tagged , , , , , , , , , on August 1, 2012 | 1 Comment »

Now that we’re more than halfway through 2012, Congress has decided it’s an appropriate time to make some serious inroads towards extending the 55 tax provisions that expired as of December 31, 2011.  From Bloomberg:

The U.S. Senate Finance Committee has reached a bipartisan agreement to revive lapsed tax breaks, including the credit for corporate research. The committee will vote on the proposal in Washington tomorrow, according to a statement by Chairman Max Baucus, a Montana Democrat, and by Orrin Hatch of Utah, the top Republican on the panel. [Ed note: No work on whether the committee took Donald Marron's sage advice, discussed here.]

Chief among the expired provisions are the R&D credit, the optional deduction for state sales taxes, accelerated depreciation for certain restaurants and the ability for financial-services companies to defer U.S. taxation on overseas income. (for a complete list, see here) Details of the bill — including the list of provisions being extended and the length of the extensions — have not been released, but Bloomberg is reporting that 25% of the “extenders package” will not be given new life.

Importantly, the bill is also expected to include an AMT patch that would increase the exemption for 2012, sparing millions of Americans from being forced to pay an additional minimum tax on their 2012 tax returns.

Exhausted from a summer of mud-slinging, bickering, and running in place, Congress is slated to take a well-deserved recess for the next month,  so no further action will take place on the bill until September at the earliest, though in all likelihood, no new legislation of any kind will be passed until after the November election.

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Illinois Public Servant Repeatedly Pleads the Fizzif, Gets Busted by Tax Court

Posted in Uncategorized, tagged , , , , , , , , on July 31, 2012 | 1 Comment »

Betty Loren-Maltese was the well-known president of a Chicago suburb before being convicted of attempting to defraud the town out of $10,000,000 in an insurance scheme, which is apparently frowned upon. 

Maltese is a free woman now, having paid her debt to society in a federal corrections facility. But that doesn’t mean the IRS is done with her; to the contrary, after Maltese was released from prison, the Service accused her of underreporting her 1994 taxable income by nearly half a million dollars in misappropriated campaign funds,assessing tax, penalties and interest on the alleged deficiency.

Typically, the IRS would be barred from assessing a deficiency after the expiration of the statute of limitations: normally three years from the due date of the return pursuant to Section 6511. The statute can be extended indefinitely, however, when any portion of the underpayment is the result of fraud. Thus, under Section 6501, if the IRS could establish that Maltese “intentionally evaded a tax that she believed was due,” it would stop the clock on the statute and allow for a collection of taxes nearly twenty years after the return was filed.

While serving as town president, Maltese was also the town’s Republican committeeman, a role that granted her access to certain campaign funds. During 1994, Maltese used the campaign funds to purchase a Cadillac and invest in a luxury golf course, with both assets held in her individual name. It is well established that once Maltese converted the campaign funds for her personal use, they became taxable income to her… but did her actions rise to the level of fraud?

When grilled about the expenditures during trial, Maltese repeatedly sought the shelter of the Fifth Amendment, refusing to testify. Below is a courtroom sketch of the proceedings:

Faced with her silence, the Tax Court was forced to look to the facts and circumstances, keeping a careful eye out for the following  “badges of fraud:”

  • inadequate records,
  • implausible or inconsistent explanations of behavior,
  • concealing assets,
  • engaging in illegal activities, and
  • attempting to conceal activities.

The Tax Court quickly determined that enough of the necessary facts were present to conclude that Maltese had fraudulently evaded her 1994 income tax.

  • She used the campaign funds to hide her expenditures.
  • She falsified campaign disclosures.
  • She tried to hide the Cadillac once she found out she was the subject of a grand jury investigation, and
  • She offered less than credible testimony with regards to the golf course investment.

As a result, Maltese is now on the hook for over $100,000 in tax, a 75% fraud penalty, and twenty years worth of interest.

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Why Won’t Romney Release Prior Tax Returns?

Posted in Uncategorized, tagged , , , , , , , on July 27, 2012 | Leave a Comment »

Much ado has been made about the one tax return Mitt Romney has found fit to release to the public, as Democrats quickly made the 13.9% effective rate the Republican presidential candidate paid on $21,000,000 of adjusted gross income in 2010 the symbol of all that is wrong with the current tax regime. As a result, it’s little surprise that Romney has hesitated to release any additional returns, despite mounting pressure to do so. 

According to those geniuses over at The Onion, it’s probably in Romney’s best interest to keep those prior returns buried, as their experts believe his prior filings may contain additional damning revelations, such as the following:  

  • List of residences includes Caribbean property named “Skull Island”
  • Used Obama’s $6,500 homebuyer credit for six different houses in 2010
  • From 2002 to 2006, official occupation was listed as “masseuse”
  • Wrote off $10,000 in aftershave during 2004
  • Really shitty handwriting for someone who expects to be elected president
  • Years of filings in state of Delaware prove definitively that the candidate himself is a corporation
  • In 2009, thanks to clever accounting, the IRS actually paid Romney $25 million in taxes
  • Just doesn’t want people to see so many pages of official documents that list his first name as Willard

And while you’re over at The Onion, read this. It’s got nothing to do with taxes, but damn if it isn’t funny.

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Fail to File Your Tax Return = Kiss Your Itemized Deductions Goodbye

Posted in Uncategorized, tagged , , , , , , , on July 26, 2012 | Leave a Comment »

Let’s say you never got around to filing your 2006 tax return. By 2010, the IRS is likely to get tired of your tax truancy, and may well file a substitute for return (SFR) on your behalf based on information filed with the IRS by third parties: W-2s, 1099s, and the like.

Now, it’s extremely possible the IRS will assess a tax higher than what might have resulted had you filed your own return. Why? Because the IRS will not make the effort to determine what your itemized deductions might have been in 2006. They’re simply going to add up your income, take the standard deduction, and be done with the calculation.

Is it fair? Probably. After all, it’s not the Service’s fault you got so caught up in sprucing up your Myspace page and rocking out to your 1st generation iPod that you failed to file your 2006 tax return. But is it the law? Sure is. The Tax Court has held many times — the most recent being yesterday in Murray v. Commissioner, T.C. Memo 2012-213 — that:

“A taxpayer must file a return to claim an itemized deduction. If a taxpayer does not file a tax return and, as a result, the Commissioner prepares an SFR, then the taxpayer may not claim itemized deductions.”

So be warned: Leave the tax prep to the IRS, and you’re giving up your right to claim itemized deductions.

In other news, Joe Kristan at Roth & Company has an update on the Oregon woman who filed a false tax return claiming a $5.1M tax refund, received it on a prepaid debit card from Turbo Tax, and went on a bit of a spending spree. Spoiler alert: she’s going to jail.

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You Can’t Exclude COD Under the Insolvency Exception if You Can’t Prove You’re Insolvent

Posted in Uncategorized, tagged , , , , , , on July 25, 2012 | 1 Comment »

Sometimes in life, we say things because we think we’re supposed to say them, even if they may not always be 100% truthful. Things like:

“You have a beautiful home here!”

“What an adorable baby!”

“You’re a great girl. I’ll call you some time. Now can you help me find my pants?”

Such courtesies extend equally to the tax world. For example, many tax advisors, when explaining potential areas of exposure to clients on things like purchase price allocations, recite the old adage “the IRS doesn’t like to play the role of valuation expert.”

But as the Tax Court proved yesterday in Shepherd v. Commissioner, that’s not always the case. To the contrary, when the situation calls for it, the IRS is more than happy to play the role of valuation expert, or at least dabble in the valuation world just long enough to deny a deduction or exclusion from income.  

To wit: Bernard Shepherd owed $9,000 on a credit card. In 2008, he settled his debt for $5,000, and the credit card company issued a 1099-C indicating that Shepherd recognized $4,000 of cancellation of indebtedness (COD) income upon settlement of the debt.

On his 2008 tax return, Shepherd excluded the COD income under the belief that he qualified for the “insolvency exclusion” of I.R.C. § 108(a)(1)(B).  As a reminder, the insolvency exclusion permits a taxpayer to exclude COD to the extent the taxpayer was insolvent immediately prior to the debt discharge.

Section 108 further provides that the term “insolvent” means “the excess of liabilities over the fair market value of assets” immediately prior to the debt discharge. In Shepherd, it was stipulated that Shepherd had non-real estate assets valued at $30,000 and liabilities of $800,000. The center of the dispute, however, was the fair market value of Shepherd’s principal residence and beach home.

In computing his insolvency, Shepherd included his primary residence at a value of $380,000.  His only support for this value was 1) a letter from his mortgage lender stating that the value of the home in 2011 was $380,000, and 2) a property tax bill.

The problem with the lender’s letter, of course, was that the value of the home must be determined immediately prior to the discharge, which occurred in 2008.  Here, the lender provided the value of the home in 2011, rendering it irrelevant to the insolvency computation.

With regards to the property tax bill, the Tax Court concluded that “a value placed upon property for the purpose of local taxation, unsupported by other evidence, cannot be accepted as determinative of fair market value for Federal income tax purposes in the absence of evidence of the method used in arriving at that valuation.” In addition, because the home was located in New Jersey, where it is well established that the assessed value of property for property tax purposes is generally not equivalent to the FMV of the property, the Tax Court lent no credence to the $380,000 assessed value.

After applying the same logic to Shepherd’s beach house– whose value was supported only by a property tax bill — the court concluded that because of Shepherd inability to establish the FMV of his homes, he failed to establish that he was insolvent under the meaning of  I.R.C. § 108. The Tax Court didn’t need to determine the value of the homes, only that Shepherd hadn’t met his burden of proof in establishing his insolvency.

In an interesting ancillary aspect of the decision, the Tax Court also concluded that in computing his insolvency, Shepherd was required to include in his assets his pension fund to the extent he could borrow against the fund, even though the pension fund was exempt from the claims of creditors.

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Tax Treatment of Commuting Costs

Posted in Uncategorized, tagged , , , , , , , , on July 18, 2012 | 1 Comment »

I hate commuting. I mean, nobody likes commuting — what’s to like about crawling along in endless traffic with your only form of distraction the mind-numbing yammering from the lowest rung on the evolutionary ladder:  “wacky” morning zoo disc jockeys — but I’m going to go ahead and guess I hate commuting more than most. Back when I lived in New Jersey, I used to angrily send cell phone pictures of the bumper to bumper traffic on Rt. 1 to my wife in a desperate plea for her to allow us to move as far away from a mega-mall as humanly possible.

Nevertheless, until the government stops dragging its feet on teleportation technology, the daily commute is here to stay, so we may as well understand the tax treatment of any expenses incurred to get you to and from the cracker factory. Yesterday, the Tax Court decided Saunders v. Commissioner, which served little purpose other than to remind us just how ridiculously complicated these rules are. If you’ve ever wondered whether broadening the tax base by getting rid of a bunch of deductions would be a good thing, read the rules discussed below, and remind yourself just how much simpler this all could be.  

So let’s use Saunders as an opportunity to brush up on the tax treatment of commuting costs and clear up some of the confusion regarding when a taxpayer can deduct the cost of driving to work. On to the Q&A:

Q: Wait…are you saying I could have been deducting my mileage or actual travel expenses for my daily drive to the office all this time?

A: Sorry if I misled you, but no. The one rule that’s clear is this: Your cost of commuting between your residence and your regular place of business or employment is a nondeductible personal expense. Treas. Reg. §1.162-2(e) and 1.262- 1(b)(5). So if you’re a lawyer and every morning you wake up and head to your office in Newark, the cost to travel to and from Newark is not deductible.  

Q: What if I have multiple offices or work locations and I travel to and from each of them? What can I do with those costs?

A: Good question, and here’s where things get complicated. We’ve got to break these costs up depending on the direction your traveling and the nature of your work locations, and that’s gonna’ take a little explaining. But know this much: once you’ve started your day by heading from your house to the office, if you leave the office and head to a second (or third, or fourth…) work location, the costs of going between the first office and the other business locations are generally deductible. Rev. Rul. 55-109. So if our lawyer in the example above goes from home to the Newark office and then from the Newark office to the NYC office, the costs of traveling from the Newark office to the NYC office are deductible.

Q: OK, but what if I leave my house and don’t go straight to my main office, but rather go to a different work place. Are those expenses deductible, or is that still considered my daily commute?

A: Depends. And it depends on a couple of things, unfortunately. First, you have to decide if your various places of business are REGULAR or TEMPORARY work locations under the meaning of the tax law.

Q: What the hell does that mean?

A: Hey…don’t take that tone with me. I’m trying to help you out. The following tests are used to determine if a work site is TEMPORARY:

  • If employment at a work location is realistically expected to last (and does in fact last) for 1 year or less, the employment is temporary in the absence of facts and circumstances indicating otherwise.
  • If employment at a work location is realistically expected to last for more than 1 year or there is no realistic expectation that the employment will last for 1 year or less, the employment is not temporary, regardless of whether it actually exceeds 1 year.
  • If employment at a work location initially is realistically expected to last for 1 year or less, but at some later date the employment is realistically expected to exceed 1 year, that employment will be treated as temporary (in the absence of facts and circumstances indicating otherwise) until the date that the taxpayer’s realistic expectation changes, and will be treated as not temporary after that date.

So if you’re an auditor, and you get assigned to a job that expects to put you at a client site for more than 1 year, it is NOT temporary. If it’s expected to last less than one year, that audit site IS temporary. If it’s originally supposed to last less than one year but that expectation ends up changing…well, you get it. It’s temporary through that date, and regular after.

Q: So then a REGULAR work location is defined in the negative, right? As in…any work location that’s not TEMPORARY is REGULAR?

A: Yes. Believe it or not, the authorities on the subject don’t make that clear, and as a result, it’s a common source of confusion.

Q:  Is there any other guidance on TEMPORARY versus REGULAR?

A: Actually, in CCA 200026025, the IRS provided some additional guidance. In that Chief Counsel Advice, the IRS added that if there is an initial realistic expectation that an employee will perform services at a work location for a period exceeding 1 year, but for no more than 35 workdays (or partial workdays) during each of the calendar years within that period, then employment at that location may be treated as TEMPORARY (rather than REGULAR) for a calendar year in which the employee actually works no more than 35 workdays (or partial workdays) at that location.

Q: Got an example?

A: I thought you’d never ask:  

On January 1, Employee Green, who has a regular office at her employer’s headquarters, is assigned by her employer to manage 5 projects, each of which is expected to last 18 months. Projects 1 and 2 each require her presence at least once a week, but Employee Green only visits the other project sites on an “as needed” basis (35 times or fewer within a calendar year for each project).

  • Project sites 1 and 2 are not temporary work locations because Employee Green goes to each site for more than 1 year, and more than 35 times per year. These are REGULAR work places.
  • Project sites 3, 4, and 5 are TEMPORARY work locations, even though the employment is expected to span more than 1 year at each site, because she expects to go to each of these project sites no more than 35 times during each calendar year.

Q: OK, now that I know which of my work locations are TEMPORARY and which are REGULAR, what do I do with that information?

A: Well, if you’ve got at least one REGULAR workplace, you can deduct the costs to travel from your home to a TEMPORARY workplace. Rev. Rul. 94-47  So if you’re an attorney with a REGULAR office in Newark and TEMPORARY work locations in NYC and Princeton, the cost of traveling from your home to those temporary work locations are deductible.

Q: OK, but what if ALL my work locations are temporary?

A: Then, in general, you can only deduct the cost of going from home to one of your temporary work locations if that work location is OUTSIDE the metropolitan area where you normally work.  Rev. Rul. 99-7  I told you this was complicated.

To illustrate, say you work in construction as an employee. You never go to the main office, but rather spend your time at the various work sites, all for a period of time that meets the definition of TEMPORARY. You can only deduct the cost of going from home to one of the TEMPORARY sites if that site is outside the metropolitan area were you normally live and work.

Q: Great…now what’s considered my “metropolitan area?”

A: Funny you should mention that, as that was the thrust of the Saunders case. This won’t be a huge help, but in general, this is a facts and circumstances test: the courts will look to see if the temporary worksite is unusually distant from the area where the taxpayer normally lives and works. In Saunders, the Tax Court held that when the taxpayer lived in Manchester, Ohio, his “metropolitan area” was Cincinnati. Because his five temporary work sites were all located within 74 and 96 miles of both the taxpayer’s residence and Cincinnati, they were located within the Cincinnati “metropolitan area” and thus the costs to travel to each site were nondeductible commuting costs.

Q: Just thought of something…what if my home IS my primary work location; i.e., I have a home office under the meaning of I.R.C. § 280A of the Code?

A: Well, then today’s your lucky day. Expenses incurred in going from a taxpayer’s home office and other work locations are deductible provided the home office is the taxpayer’s principal place of business within the meaning of I.R.C. § 280A(c)(1)(A) for the trade or business conducted by the taxpayer at those other work locations. These expenses are deductible regardless of whether the other work locations are REGULAR or TEMPORARY and regardless of the distance. Curphey v. Commissioner, 73 T.C. 766 (1980).

Q: OK. I think I’ve got it all, but how about one more example to tie it all together?

A: Here goes. Let’s bring back our earlier example about Employee Green:

On January 1, Employee Green, who has a regular office at her employer’s headquarters, is assigned by her employer to manage 5 projects, each of which is expected to last 18 months. Projects 1 and 2 each require her presence at least once a week, but Employee Green only visits the other project sites on an “as needed” basis (35 times or fewer within a calendar year for each project).

  • Projects 1 and 2 are REGULAR work locations, as they last are expected to last more than 1 year AND Green spends more than 35 days there each year.
  • Projects 3, 4, and 5 are TEMPORARY work locations. Even though Green spends more than 1 year at each place, he spends less than 35 days per year. Thus:
  • Green cannot deduct any expenses for traveling between home and Project 1 or 2, as they are nondeductible commuting costs.
  • Once Green has arrived at one of the five work places, she can deduct the costs to travel from one project to another.
  • Because Green has at least one REGULAR place of business (Projects 1 and 2), she can deduct the costs of traveling from her home to any of the TEMPORARY work sites (Projects 3, 4 and 5) regardless of whether they are inside or outside of her normal metropolitan area.

I hope that helps. Now get out of the office so you can beat the traffic.

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