Don’t expect IRS to take your word that ‘It’s for business’

Real Estate Tax Talk

Sea of forms image via Shutterstock.Sea of forms image via Shutterstock.

A recent tax court case shows how real estate agents and brokers can have trouble with the IRS, not because they did anything wrong, but simply because they don’t have the proper documentation.

Marvell Preston-Hardnett, a licensed real estate agent, worked as an independent contractor for Re/Max Hometown, Inc. In 2008, she earned $11,100 from her real estate business and had expenses of $20,580, resulting in a $9,480 net loss for the year.

As often happens when an independent contractor reports annual losses, Hardnett was audited by the IRS, which disallowed some of her claimed business expenses. Among these was $4,725 in fees she paid to Re/Max during the year.

Hardnett told the IRS that she had to pay a $350 monthly affiliation fee to Re/Max. Moreover, she had had monthly statements from Re/Max showing that she paid $4,800 to the firm for 10 months in 2008. The statements listed the balance due each month and the date and amount of each payment.

You’d think that would be enough to satisfy the IRS that the payments Marvell made to Re/Max were a legitimate business expense. After all, professional fees are deductible. You’d be wrong.

The IRS said that Hardnett failed to prove what the payments to Re/Max were for because the statements it gave her did not describe the nature or source of the charges. The IRS wouldn’t take Hardnett’s word that the payments were Re/Max affiliation fees.

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Hardnett appealed the audit and won on this issue in tax court. The tax court judge was far more reasonable than the IRS auditor, ruling that Hardnett’s testimony that the payments were for affiliation fees was credible. That, combined with the statements, was enough. Good for Hardnett. (Hardnett v. Comm’r, T.C. Summary 2013-56.)

This case provides a good lesson to all business owners: One of the elements you need to document when you have a business expense is what the expense was for. This is especially needed for expenses that might not be business related — for example, meals, travel or entertainment.

Sometimes the business purpose for an expense will be readily apparent from a statement or receipt. If not, you should make a notation on the receipt, statement or other document stating the business purpose.

In light of the trouble Hardnett had with the IRS, it would be wise if Re/Max and similar companies made clear on their statements that payments made to them by their independent contractor agents are affiliation fees.

Stephen Fishman is a tax expert, attorney and author who has published 18 books, including “Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants,” “Deduct It,” “Working as an Independent Contractor” and “Working with Independent Contractors.

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