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Barbara, Enrolled Agent
Category: Tax
Satisfied Customers: 2652
Experience:  18+ years of experience in tax preparation; 25+ years of experience as a real estate/corporate paralegal.
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I have an income tax question that I need to get answered.

Customer Question

I have an income tax question that I need to get answered. I have a client whose 2010 tax return is being audited by IRS (by mail). The client is a self-employment consultant to the health care industry. In prior years my client was an employee of several health care companies, United Healthcare, etc. holding high level positions with them. On the 2010 return, after having been unemployed for 2 years, my client attempted to earn his living as a consultant, having many contacts in that industry. The 2010 Sch. C showed $1,500.00 in income received, $6,500.00 in expenses other than automobile expenses and $15,000.00 in automobile expenses. All of this resulted in a net loss of $20,000.00 (all figures are rounded). We furnished the IRS with documentation of receipts, etc for the $6,500.00 of other expenses and the speedometer readings, beginning and ending, to establish the total miles drived during the year and applied a percentage for business to that.

The IRS has returned a notice of adjustment to the taxpayer. In that notice they agreed that we had the information necessary to substantially support the $6,500.00 in other expenses. Because no log was sent to them, they would not allow the automobile expenses.

All that being said, in addition to disallowing the $15,000.00 in automobile expenses, they only allowed a deduction of the other expenses of $1,500.00 - limiting the deduction to the amount of income generated - reducing the net income to $-0-! In all my years in practise I have never encountered this reasoning other than dealing with hobby type businesses. We need to respond by 12/11/12 and are preparing specific dates and mileage to accomodate the backup of the autumobile expenses.

I am looking for any information that you can provide or suggest to remove the $1,500.00 limitation that they are placing on the deductions. It has always been my understanding that the potential to earn a profit was the governing principle in determining allowable profits and losses on tax returns (other than hobby activities). There is no question that my client has the ability to earn a profit based on his experience and all the contacts he has and that he made in 2010, all of which were documented in the receipts, etc. that were sent to IRS in the in initial response.
Submitted: 3 years ago.
Category: Tax
Expert:  Barbara replied 3 years ago.

bkb1956 :

Thank you for allowing me to answer your question. However, I must agree with you that there should be no such limitation on the Schedule C. In doing so, that defeats the whole purpose of the Schedule C, doesn't it? Perhaps the person who reviewed the return at the IRS was not knowledgeable. (I'm sure you know that happens.) Have you tried calling the IRS and speaking to someone to go over the notice of adjustment with you? I have found that sometimes when I call the IRS the person I am speaking to can spot errors made and correct them while I am on the phone. I would still assemble the documentation for the automobile expenses and submit it by the 12/11/12 deadline. Please let me know if I can assist you further. Thank you.

Customer :

Nothing further needed. I got the answer i was looking for on my own.

bkb1956 :

I guess you realize that the IRS will disallow expenses to correspond with the income generated, but based on the information you supplied, I was under the impression that you have all of the backup documentation for the expenses. I would appreciate it if you would take a moment to revise your service rating of my answer as this is an important component of being an expert on this website. Thank you.

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