IRS Practice and Procedure News Briefs for February 2020

Why this Case is Important: This case provides a good explanation as to what is required for a tax court petition to be filed on a timely basis and resulted in a rare taxpayer victory. 

Facts: In Seely, the IRS issued the taxpayers notices of deficiency with respect to their 2013, 2014, and 2015 federal income tax returns on March 28, 2017. The taxpayers had 90 days from the notices (until June 26, 2017) to file Tax Court petitions contesting the deficiencies. The taxpayers’ attorney prepared a petition and mailed it to the IRS, which received it on July 17, 2017, 21 days after the 90-day deadline. The envelope received by the IRS was addressed correctly, sealed, and contained the proper postage, but bore no postmark. The IRS filed a motion to dismiss the taxpayers’ petition on the grounds that it was not filed on time. The taxpayers responded that their attorney mailed the petition on June 22, 2017, before the filing deadline, and submitted an affidavit from their attorney confirming this.

Law and Conclusion: To protect taxpayers who mail a document on time only to have that document delivered after a filing deadline, Section 7502(a)(1) of the Internal Revenue Code provides that if a document is received by the IRS, it will be deemed to have been delivered on the document’s postmark date. While the statute and related regulations do not address mailings that do not have a postmark date, case law directs the Court to use extrinsic evidence to determine the mailing date, with the burden being on the taxpayer to prove that the petition was mailed on time. In support of their position, the taxpayers relied on their attorney’s affidavit. In opposition, the IRS contended if the petition had been mailed on June 22, given normal USPS delivery times, it would have been delivered to the IRS before the date it was actually received. Acknowledging that the 4th of July holiday may have slowed USPS delivery times, the Court did not find the IRS’s argument to be persuasive and found that the taxpayers met their burden of proof with respect to the mailing date. Therefore, the Court denied the IRS’s motion to dismiss.

Why this Case is Important: While new business owners generally understand that their companies are entitled to tax deductions for the expenses of operating their businesses, they often are not aware of the proper way to handle start-up expenses (expenses incurred before their business starts operating). This case explains how these expenses should be treated for tax purposes and, more importantly, when and how they can be deducted.

Facts: In Provitola, Mr. Provitola was the sole owner of his law firm, an S corporation that specialized in patent law. In 2003, he began developing a product to enhance television viewing. By 2016 he had been awarded several patents related to the product. The taxpayers formed an LLC to own and market the product, with Mrs. Provitola as its sole owner. In 2013, Mr. Provitola’s law firm invoiced the LLC $60,000 for legal services related to the product. The taxpayers made a $36,000 capital contribution to the LLC and the LLC wrote a check to the law firm for $36,000 in partial payment of the invoice. This happened again in 2014. The law firm reported the payments as income, most of which was offset by deductible expenses on the firm’s tax return. The taxpayers also took deductions for the LLC’s payments to the law firm on their 2013 and 2014 returns, reducing their taxable income. While the LLC manufactured products during these years, it did not attempt to make any sales or otherwise market its product. The IRS examined the returns and disallowed the deductions on the basis that they should have been characterized as start-up expenses and capitalized. The taxpayers filed a Tax Court petition contesting the disallowances.

Law and Conclusion: Section 162 of the Internal Revenue Code allows taxpayers to deduct the ordinary and necessary expenses incurred in carrying on a trade or business - deductions are not allowed until the taxpayer actually “carries on” the business. Because taxpayers often incur business-related expenses before actually operating a business, Section 195 allows them, once they start operating, to deduct any pre-operational start-up expenses up to a specified limit, with any excess start-up expenses being amortized. The Tax Court has generally held that a business is operational once it has begun to perform those activities for which it was organized. In this case, the question was whether the LLC was “operational” during 2013 and 2014. Because the LLC had not made any efforts to market or sell its product by the end of 2014, the Court determined that the LLC’s business was not operational during 2013 or 2014 and found in favor of the IRS.

If you would like more details about these cases, please contact me at 312-888-4113 or jnesser@lavellelaw.com.