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The Constitution has its uses, but sometimes you really need a receipt

February 11, 2011

A California taxpayer faced an IRS exam with a strategy that was as unorthodox as it was unwise. Tax Court Judge Vasquez explains:

Petitioner timely filed Forms 1040, U.S. Individual Income Tax Return, for 2006 and 2007, and attached Schedules C on which he reported gross income of $336,475 and $334,860, respectively, and business expenses of $252,013 and $253,490, respectively.
Respondent audited petitioner's 2006 and 2007 returns and requested that petitioner substantiate all of his Schedule C business expenses. Petitioner refused to substantiate any of his claimed business expenses, arguing that the substantiation requirement violates his Fifth Amendment rights under the U.S. Constitution. Respondent then issued petitioner a notice of deficiency disallowing petitioner's deductions for business expenses claimed on his Schedules C.

There are some obvious drawbacks to using your right to avoid incriminating yourself to document your Schedule C expenses. Not only is it useless -- they really want to see receipts, cancelled checks, and the like -- it pretty much dares the IRS to assign a criminal investigator to your case.

The Tax Court opinion doesn't say whether the IRS took up the dare, but it does make clear that the Constitution doesn't serve as expense documentation:

At trial the Court warned petitioner that his Fifth Amendment claim would not excuse him from his burden to substantiate his claimed business expenses and offered petitioner an additional opportunity to introduce evidence to satisfy his burden. However, petitioner continued to assert his Fifth Amendment privilege and offered no further evidence to substantiate his claimed business expenses. Accordingly, we sustain respondent's disallowance of petitioner's deductions for business expenses claimed on his Schedules C for 2006 and 2007.

Possible explanations of the taxpayer's behavior that come to mind:

1. There really is no documentation, and the expenses were made up.

2. There were some real doozies in the expense list.

Any other ideas, dear readers?

Cite: Raeber, T.C. Memo 2011-39

Tags: 5th amendment.audit strategy.Judge Vasquez.Tax Court.