Tax Consequences for Poor Mileage tracking

Know This

1. You can spend much more time with the IRS by submitting an inadequate business mileage log. 
2. You can spend an inordinate amount of time trying to recreate a mileage log that looks really good, but will fail.
3. The I.R.S. prohibits the deduction of automobile expenses if you do not maintain adequate records of your business miles traveled.
4. The tax code prohibits the courts from giving you vehicle deductions if you can’t prove your mileage.
5. If you fail to keep a mileage log or other record to substantiate your business mileage and the IRS finds out, you may be deducted less than your actual business mileage and may not be able to deduct your vehicle expenses at all.
6. Owner-operators need to keep a mileage log book.
7. An owner-employee of a corporation must keep a mileage log and submit it to the corporation.

Golden Rule

Keep a mileage log.

The Fraud Case

 In Flake, the IRS claimed income tax deficiencies of $16,240 and $58,094 and Section 6663 fraud penalties of $12,180 and $43,571.1  

In this case, the court was asked to decide

• Whether Jim and Martha Flake were entitled to deduct more car and truck expenses than the IRS allowed,
• whether they were liable for tax fraud penalties under section 6663, and
• (in the alternative to the fraud penalties) whether Jim and Martha were liable for accuracy-related penalties under section 6662(a).

The Audit

This tax case began when an IRS revenue officer audited the Flakes’ tax returns, requested certain documentation, and met with Jim and Martha at their residence every two weeks until the examination ended about a year later.

During the audit examination, Jim and Martha provided odometer readings, credit card statements, fuel receipts, appointment book notes, and invoices as well as reconstructed calendars based on these documents. They asserted that these records met the strict substantiation requirements of Section 274(d) for vehicle deductions and that, accordingly, they were entitled to their full vehicle deductions.2

Section 274(d)

Before Section 274(d), you could estimate your business mileage and the IRS and the courts could accept your estimates.

Section 274(d) did away with estimates of business mileage. Today, you need to substantiate the amount of your mileage, your time, and the purpose of each use.3 The courts may not estimate your vehicle deductions.4

In Court

Jim and Martha did not get any help in court for their car deductions because of the following:

• They did not create their mileage records until after the fact, during the IRS audit.
• The mileage on the submitted records contained math errors and did not tie back to the tax return.

To summarize, the Court held as follows:

1. It did not find the calendars reliable or helpful in determining how much Jim and Martha spent on driving and trucking.
2. Jim and Martha failed to meet the adequate records requirement because they did not substantiate the mileage, time, and purpose of each car and truck used.
3. The IRS is correct in its allowance of the mileage. Jim and Martha are not receiving more mileage than the IRS has allowed.

No Fraud Penalty….Why? 

Jim and Martha accumulated in a fireproof box a cash reserve of at least $177,000 during the 20 years before the audit. They likely triggered the audit when they took that $177,000 from their fireproof box and deposited it in the bank.

Key point. The Internal Revenue Code and the Bank Secrecy Act require information reporting of most cash deposits and cash disbursements exceeding $10,000.

In court, the IRS argued that Jim and Martha had to fraudulently understate their taxable income to accumulate $177,000 in cash reserves. The court disagreed, finding that Jim and Martha’s accumulation of cash was due to their frugality.

The court also found that, despite the IRS’s bi-weekly audit visits to Jim and Martha’s home for almost a year, the IRS had failed to present clear and convincing evidence of fraud. As a result, the court did not impose a penalty for fraud.

Accuracy Penalty Assessed….Why?

On the accuracy-related penalty, however, the Flakes were not so lucky. The court ruled that because Jim and Martha were unaware of the law and failed to keep accurate records of, among other things, their vehicle deductions, they were liable for the 20 percent accuracy-related penalty.

5 Important Takeaways!

1. To reduce your chances of a visit from the IRS, don’t make large cash deposits in a U.S. bank. (Checks are fine; cash is the problem.)
2. Keep a mileage log to document the miles you drive for business.
3. Have a basic understanding of tax law.
4. Hire a professional to help you with your taxes and accounting.
5. Operate your business as a business, with business books, checks, records, and receipts to support your business income and expenses.

You want to follow the five steps above to avoid being Jim and Martha – meeting with an IRS agent every two weeks for almost a year, then going to court in the hopes of defeating the IRS’s claims and keeping at least some of your deductions.

If you need assistance with an IRS audit, tax preparation, or tax consulting, give is a call at 832-303-3995 or click here to set an appointment and we would be happy to speak with you.

1    Flake v Commr., T.C. Memo 2014-76.

2    IRC Section 274(d).

3    Reg. Section 1.274-5(j)(2).

4    Sanford v Commr., 50 T.C. 823.