Temporary Out of Work? Self employed? some expenses are Tax deductible
Business Expenses
If a taxpayer was previously engaged in a trade or business but is not engaged in the business during the current tax year, expenses incurred related to the business may be deductible. Sec. 162(a) provides for the deductibility of all the ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business. The expenditures must be directly connected to the taxpayerâ??s trade or business, and business expenses are deductible in full, even if they exceed business income.2 A taxpayer may be entitled to claim business deductions for carrying on a trade or business even though unemployed at the time he or she incurs the expenditures.
Is the Unemployment Temporary?
In order to take advantage of the hiatus principle, taxpayers must at least show that during the hiatus they intended to resume the same business.7 In Davis, a self-employed insurance agent retired on disability due to health problems but continued to claim business expenses.8 Davis testified that initially upon his retirement he had intended to resume his insurance business as soon as he could, but health problems had prevented him from doing so. The court concluded that Davisâ??s intent to return at some indefinite future time had become, in view of the state of his health and the passage of time, more of a wish and that his hiatus was no longer temporary.
Expenses Related to Existing Occupation
Regs. Sec. 1.162-6 provides that a taxpayer engaged in a profession may deduct the cost of supplies used in the practice of the profession as well as other professionally related expenses. The U.S. Supreme Court stated that in order to qualify for the business deduction, the expenses must relate to the existing, as opposed to the future, occupation of the taxpayer.9 In Rev. Rul. 77-32, expenses an anesthesiologist incurred to maintain his professional competence were not deductible because he incurred the expenses in preparation for a possible return to medical practice at some indefinite future date and they were not related to an existing business. The fact that an individual maintains his or her professional license during a period of employment transition is not a sufficient basis for finding that the individual is carrying on a trade or business. In Canter,10 a nurse who maintained her nursing license while going back to school full time was denied business deductions.
Self-employed taxpayers whose businesses have slowed down as a result of the current economic recession as well as unemployed individuals should be alert to these rules. Business expenses may be deductible regardless of the lack of income if the taxpayerâ??s cessation of business is temporary. Examples of potentially deductible costs include equipment storage expenses, property taxes, utilities, depreciation, advertising, travel, education, insurance, and job-seeking expenses. If the taxpayer was engaged in a trade or business but the business ceased for other than a temporary period, certain costs incurred in resuming a business must be capitalized and amortized as start-up expenses under Sec. 195.
Employment Changes
The Tax Court has held that a taxpayer may be in the trade or business of being an employee or of holding a particular job, such as a corporate executive or manager.12 The courts have generally allowed taxpayers to deduct expenses related to seeking employment in the same trade or business. However, in cases such as Rockefeller,13 the courts have insisted on a high degree of identity in deciding the issue of sameness. Nelson Rockefeller incurred expenses for legal and other professional services in connection with the confirmation hearings for his nomination to become vice president of the United States. The term â??trade or businessâ? includes the performance of the functions of a public office.14 By comparing the duties and responsibilities of the vice president of the United States with the duties of Rockefellerâ??s prior positions, the court determined that they were not the same trade or business. Thus, Rockefellerâ??s confirmation hearing expenses were not deductible.
Primuth15 presents a situation in which the court concluded that the taxpayer was in the trade or business of being a corporate executive. In this case, the taxpayer was secretary-treasurer of a small corporation, and he enlisted the aid of a â??headhunterâ? organization that helped him find a job as secretary-controller with a larger company. The court noted that the fee was directly related to the taxpayerâ??s business of being a corporate executive, which did not change or cease merely because he began to work for a different employer.
Education Expenses
Individuals, whether unemployed or currently employed, may decide to go back to school full time in an effort to improve their future job prospects. This section examines the tax treatment of education expenses incurred between jobs. Education-related expenditures are deductible if they maintain or improve skills required in the taxpayerâ??s business.16 However, expenditures for education that qualifies the taxpayer for a new position are not deductible.17 For example, in the previously discussed Canter case, the court denied the taxpayer a business expense deduction when she resigned her job and became a full-time nursing student because she was not on temporary leave of absence at the time she incurred the expenses. Likewise, in Goldenberg,18 the taxpayer was a licensed attorney and CPA working with the IRS who resigned and was unemployed while he completed his LL.M. degree on a full-time basis. Goldenberg did not have a leave of absence from the IRS and upon graduation practiced law full time for two years before returning to work for the IRS. The court found that because Goldenberg left his position with the IRS and had neither a connection with his former job nor a clear indication of an intention to carry on the same trade or business upon graduation, he was not carrying on a trade or business, and the deduction for the education expenses was denied.
On the other hand, in Furner,19 a junior high school teacher who resigned from her teaching position to enroll in full-time graduate study for one year was allowed to deduct her education expenses. According to the appellate court, the key question turned on whether the course of study related to the taxpayerâ??s intended future performance as a teacher in such a way that the expenses could reasonably be considered ordinary and necessary in carrying on the business of teaching. In this case, the education enabled Furner to keep up to date, expand her knowledge, and improve her understanding of the subjects she taught. The court also mentioned that it was more advantageous for Furner to take the courses in her program of study in a single year rather than spread them out over several summers because some of the courses were not regularly available during the summer; in addition, she returned to teaching for the academic year immediately following the year of graduate study. In Rev. Rul. 68-591, the IRS stated that it would follow the Furner decision in cases in which taxpayers, in order to undertake education to maintain or improve skills required in their employment or business, temporarily cease to engage actively in employment or business. Suspension for a period of a year or less, after which the taxpayer resumes the same employment or business, will be considered temporary.
In a similar case,20 a teacher was allowed a business expense deduction for the cost of travel, books, food, and lodging incurred while taking graduate courses in Norway. The graduate study lasted only one academic year, the taxpayer was employed as a teacher before and after the graduate study, and the coursework improved the taxpayerâ??s teaching skills. However, another teacher was denied a deduction for graduate education expenses because the teacher was away from teaching for four years, had personal reasons for resigning from the teaching job, had not been actively seeking employment as a teacher, and had been temporarily employed in both law and business throughout the period.21
As these cases show, education expenses may be deductible by unemployed individuals if they return to the same type of work immediately after the education and if the education improves their job skills. Teachers returning to school full time and not on a leave of absence should provide evidence, if available, that the courses are not offered on a part-time basis and should return to teaching as soon as possible after completion of the coursework in order to increase the likelihood of a deduction. However, having a leave of absence does not by itself satisfy the criteria for deduction. In fact, there are quite a few cases in which the taxpayer remained employed throughout the time the education was undertaken and still lost the deduction because the education qualified the taxpayer for a new trade or business.
09/10/2010
