But You Might Have Offsetting Expenses
Did Armando and Yadira make money? Yes. Did they report what they made? No, says IRS, but it doesn’t matter, says Judge Vasquez in Armando Sandoval Lua and Yadira A. Sandoval, 2011 T.C. Mem. 192, filed 8/11/11.
The issue is $19K that Sandy gave back to his independent contractor installers for extra work they did installing the satellite dishes Sandy was in the business of selling. Sandy sold the dishes and subscription services. He hired independent contractors to put in the dishes. He paid them for the base installation, but when the customer wanted extras, Sandy would split the override with the installers. Mrs. Sandy kept the books, noted the bank deposits for the sales commissions from the satellite content providers and the base charges for installation and extras, but didn’t note the overrides the installers either kept or were given by Sandy.
Sandy and Mrs. Sandy got nailed for unreported rental income and exaggerated deductions on their real estate rental operations, but that they conceded. They fought the revenue agent’s assertion they had unreported income to the extent of what they gave the installers.
Judge Vasquez explains the deal with the installers: “Future Satellite [Sandy’s d/b/a] also received compensation from its customers when the installers performed certain installation services (additional services). The installers collected the fees for the additional services from the customers upon completion of the work. If the customers paid for the additional services in cash, Future Satellite allowed the installer who performed the additional services to keep the cash (up to the amount Future Satellite compensated the installer for the job), as his compensation for services rendered. If the customers paid for the additional services by check or the installer received cash in excess of his compensation, the installer brought the checks and/or excess cash to Future Satellite’s office. Petitioners [Sandy and Mrs. Sandy] then deposited the checks and/or cash into one of their bank accounts and issued the installer a check in the amount of his or her remaining compensation.” 2011 T.C. Mem 192, at pp. 4-5 (footnotes omitted).
So while Sandy didn’t treat the installers’ overrides as income, he didn’t deduct what he gave, or let the installers keep, either. The revenue agent who audited Sandy’s and Mrs. Sandy’s return noted that Sandy confessed to not reporting as income what he had given, or the installers kept, and only took a cursory look at Sandy’s bank statements before noting unreported income.
As to unreported income, the ordinary presumption in favor of an IRS determination doesn’t hold. IRS must show taxpayer’s connection to some income-producing activity, and then the burden shifts to the taxpayer to show that all income was reported. Here Sandy definitely had income-producing activity. And Sandy didn’t report the installers’ overrides that were kept or given back.
However, the overrides that were kept or given back would have been deductible offsets against the unreported income, so “no hurt, no foul”; or as Judge Vasquez put it more elegantly: “Petitioners admit that they did not report as income the cash portion of the $19,207 that Future Satellite earned for the additional services and allowed the installers to keep as their compensation. They argue, however, that they did not deduct as compensation paid the amounts of cash the installers kept as their compensation, and therefore any increase in income should be offset by the unclaimed deduction for compensation paid. Respondent counters that petitioners cannot substantiate the exact amount of the cash the installers kept as their compensation for services rendered.” 2011 T.C. Mem. 192, at pp. 10-11.
While giving deference to the old rule that where taxpayer incurs deductible expenses in an unspecific amount, Tax Court can estimate them, bearing heavily against the taxpayer whose inexactitude is of his own making, Judge Vasquez finds that the $19K is the right offsetting amount. “Petitioners have established that the cash Future Satellite earned and allowed the installers to keep constituted the installers’ compensation for additional services rendered and therefore was an ordinary and necessary trade or business expense deductible under section 162(a)(1). Respondent is correct that petitioners cannot determine exactly how much of the $19,207 they allowed the installers to keep as their compensation for services rendered; however, based on the record petitioners have proved that they would be entitled to an offsetting deduction in the exact amount of the portion of the $19,207 kept by the installers as their compensation. Accordingly, petitioners have shown that they incurred unclaimed offsetting deductible expenses in the exact amounts of the income they failed to report and therefore owe no tax on the unreported income.” 2011 T.C.. Mem 192, at pp. 11-12. (footnotes omitted).
Oh, by the way, the footnote number 17, which I omitted, makes an interesting arithmetic error. Footnote number 17 states “We note that $19,207 is less than 1 percent of Future Satellite’s reported gross income of $995,438.” 2011 T.C. Mem 192, at p. 12. Sorry, Judge Vasquez, it’s less than two percent. One percent is $9954.38. Do we need a Rule 155 computation here?