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Business deduction mistakes that trigger penalties

Challenging an IRS determination can take years. If not successful, you may also face an accuracy-related penalty.

A couple learned these lessons the hard way. The basic facts contained in the Forbes article were that they claimed a business deduction in 2006 and 2007 on a motor home they used to attend RV rallies and sell insurance policies tailored to RV owners. After years and a trip to all the way up to the Ninth Circuit Court of Appeals, they lost and were assessed the accuracy penalty.

Personal use of more than 14 days

If a dwelling is used as a residence it does not qualify for a business deduction. Watching television or cooking would count as personal use. And it would be hard to portion off a space in an RV as an office. The taxpayers argued that showing up at these rallies in an RV was integral to their business.

The Ninth Circuit agreed with the Tax Court decision that no deduction was allowed. While the definition of ‘dwelling unit’ does not include RV, it is defined as “house, apartment, condominium, mobile home, boat or similar property.” A 1980 case had however found a mini-motor home fit into that “similar property” category.

Personal use for 14 days or more in a year also goes against a deduction. The appellate court upheld the Tax Court finding that the taxpayers used their RV for personal purposes for more than 14 days in both 2006 and 2007.

Twenty percent penalty

When understatements of income tax exceed $5,000 or 10 percent of the total, a 20 percent penalty applies to the portion of the underpayment.

Taxpayers can defend against this penalty by showing they acted in good faith and had reasonable cause. Even though one of the three judges on the appellate panel sided with the taxpayers, they were unable to avoid the extra penalty.

When a business deduction falls into a gray area, speak with a tax attorney for more counsel. Getting advice on the front end can save you the time and expense of a protracted battle against the IRS.

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