Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.
The 10th U.S. Circuit Court of Appeals recently affirmed a U.S. Tax Court decision holding that a lawyer could not claim expenditures on car racing activities as ordinary and necessary business expenses to promote his law practice. In Avery v. Commissioner,1 the court found that the taxpayer’s personal enjoyment of car racing was relevant to determining the primary motive for incurring the expenses and whether they were deductible.
Background James William Avery was a solo practitioner in Colorado with a practice focused mostly on representing plaintiffs in personal injury cases. In 2005, Avery moved to Indiana and became licensed there but retained his practice in Colorado. Starting in 2005, Avery tried to develop more business in Indiana by participating in car shows and eventually became a race car driver. He bought a Dodge Viper, placed a decal on the car for Avery Law Firm as his “sponsor,” and competed in road racing events at tracks in several states, including Indiana and Colorado. Avery said he believed car racing might enable him to meet other professionals like lawyers and doctors who could help his career. In 2010, Avery separated from his wife, moved back to Colorado, and stopped racing due to lack of funds.
According to the court, Avery was an inconsistent tax filer, and the IRS examined his 2008-2013 tax years. Upon the examination, he filed returns for some of these years and amended previously filed returns. On each of these returns, Avery filed a Schedule C to document the income and expenses of his law practice. For the 2008-2011 returns, he included expenditures on the race car as Schedule C business expenses.
The IRS denied Avery’s Schedule C deductions for the race car expenses, and Avery appealed to the U.S. Tax Court. The court sustained the IRS findings with respect to race car expenses, stating that these expenses were not ordinary and necessary expenses incurred in carrying on any trade or business. Avery then appealed to the 10th U.S. Circuit Court of Appeals.2
10th U.S. Circuit Court of Appeals analysis and decision Avery claimed the tax court impermissibly considered his enjoyment of car racing in determining if his racing expenses were deductible. The 10th Circuit started its analysis of this claim by restating the tax court’s standard for determining if a claimed deduction is an ordinary and necessary business expense: "A taxpayer must show, not only that he incurred the item in question, but also that it was an ordinary and necessary expense of the particular business in which he was engaged. An expense is ordinary if the transaction which gives rise to it is of common or frequent occurrence in the type of business involved. A necessary expense is one that is appropriate and helpful in carrying on the taxpayer’s profit-seeking activity.
“In determining whether an expense is ordinary and necessary within the meaning of section 162(a), the courts have focused on the taxpayer’s primary motive for incurring the expense and on whether there is a reasonably proximate relationship between the expense and the taxpayer’s occupation. If an expenditure is primarily motivated by personal considerations, no deduction is allowed.”3
The court then noted Avery’s assertion of error related to the following paragraph in the tax court decision: “We agree with [the Commissioner of Internal Revenue] that [Avery’s] racing-related costs were not ordinary and necessary expenses of his business as an attorney. It is neither “necessary” nor “common” for attorneys to incur such costs. [Avery] greatly enjoyed car racing, which he found more exciting than his previous hobby of acquiring collector cars and participating in car shows. But we find that both activities were hobbies. No deduction is allowed for personal expenses of this kind.”4
Avery argued the commissioner and tax court should not be allowed to consider a taxpayer’s enjoyment of a marketing activity in this context and further argued it creates a subjective and unduly vague test. He posited an example where expenses in maintaining a work vehicle are later denied by the commissioner simply because the owner enjoys driving the vehicle.
The 10th Circuit described Avery’s position as a due process legal argument without supporting authorities. The court however found no error in the tax court’s consideration of personal enjoyment as one factor among others in the context of determining the taxpayer’s primary motivation for incurring an expense. The 10th Circuit found Avery’s enjoyment of car racing activities relevant to his primary motive for incurring the related expenses, and the court did not see a realistic threat to due process as long as personal enjoyment is considered as one factor among others in determining primary motivation.5
Based on these findings, the 10th Circuit rejected Avery’s arguments regarding personal enjoyment and other procedural matters and affirmed the tax court’s decision.6
ConclusionThe 10th Circuit decision in Avery confirms that courts will consider personal enjoyment as one factor in determining the deductibility of marketing and other expenditures related to a trade or business. Importantly, this case demonstrates a potential area of audit interest by the IRS, and the importance of lawyers establishing a primary business motivation for incurring deductible expenditures.
Original source can be found here.