SMITH BRAIN TRUST – Sometimes you read about the results of a tax court case and you wonder, “How did this even make it to court?” because the tax position is so egregious, says Maryland Smith’s Samuel Handwerger.
At least, that’s what Handwerger has been wondering since reading about Berry v. Commissioner of Internal Revenue. (Berry, TC Memo, 2021-42).
The case involves a home and real estate development construction company that was under audit by the Internal Revenue Service for 2013. During the course of the audit the company was found to have buried in its construction expenses over $121,000 of expenses related to the cost and parts for a ’68 Camaro that was used as a race car by the son of the company’s founder.
In 2013, the father and son were both owners of the S corporation, Handwerger notes, “with the father apparently indulging the son’s enjoyment of car racing.” However, no racing took place in 2013, all of it was relegated to happen in 2014. Nevertheless, the deduction was in 2013, the year of purchase and presumably restoration.
“Not surprisingly, the IRS denied the deductions and the tax court agreed,” said Handwerger, a CPA and an accounting lecturer at the University of Maryland’s Robert H. Smith School of Business.
In court, the taxpayers argued that the expenses were for advertising, Handwerger explains. “Alternatively and failing that,” he added, “they claimed that it was a separate for-profit venture conducted by the corporation.” Neither argument swayed the decision for the taxpayers.
“However, with the court’s decision, we do get a glimpse of what to do right the next time if you want to get a deduction for a racing car and its expenses as being for advertising,” Handwerger says.
Firstly, he notes, the court looked for evidence that the car was indeed being used in advertising for the company. The court noted that when the car raced, it raced under the name of the family, Berry Racing, and not the name of the construction company.
Secondly, he notes, in the photo of the car that was presented in court during the time in question, the car wasn’t emblazoned with the name of the construction company. In fact, it didn’t seem to have any names or logos on it.
The taxpayers told the court that business contacts were met at car races and that goodwill and possible future contracts were established there. But, says Handwerger, who notes that he loves a good tax argument, none of the contacts seemed to have any connection to any awarded contracts or real business.
As to the argument that it was a separate profit venture, the court merely declared that if so, then the expenses were startup expenses as the only real racing that occurred happened the following year, in 2014. Expenses prior to the conduct of real business are deferred startup costs and these are depreciated after the business starts. Since the company’s audit was only for 2013, the court left open if depreciation of the car and its startup expenses would have been appropriate in 2014.
“Notwithstanding the taxpayer’s loss, now we know how to deduct that $3.6 million Bugatti as an advertising cost,” Handwerger half-jokingly says. “For the company that can afford that car and attract all the onlookers, I do think it could be a legitimate advertising expense.”
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