Clothing, Legal Expenses, Education

Clothing - Pevsner v. CIR

Rules for deductibility of clothing Must be of type specifically required as condition of employment Cannot be adaptable to general usages as ordinary clothing Cannot be worn as ordinary clothing

Legal costs - U.S. v. Gilmore

Tax as shizophrenia For tax purposes, Congress sees individuals as having two personalities: one is a seeker after profit who can deduct the expenses incurred in the search; the other is as a creature satisfying his needs as a human and those of his family, but who cannot deduct such consumption and related expenses.

Origin of claim test Tax treatment of litigation recoveries, settlements, and related fees (lawyers, accountants, appraiser) depends on the origin of the claim, not the consequences of the failure to defeat the claim.

Costs may be deductible, nondeductible or required to be capitalized, depending on whether they arise in connection with Business or income- producing activities, Personal activities Acquisition or disposition of a capital asset

Application of origin of claim test Rule does “not contemplate a mechanical search for the first in the chain of events which led the litigation, but rather an examination of all the facts.” “Consideration must be given to the issues involved, the nature and objectives of the litigation, the defenses asserted, the purpose for which the claimed deductions were expended, and the background of the litigation.”

Supreme Court: Under origin of the claim test, recovery should be taxed in the same manner as the item for which it is intended to substitute.

The expense of prosecuting a lawsuit is generally deductible to the extent damages would be included in income if recovered.

As a practical matter, how a complaint or settlement agreement is written can have crucial tax consequences.

Example: Defending claim to property When former spouse claims to own it: capitalize costs (that is add to basis and recover costs through depreciation or at time of sale). In divorce action: neither deduct nor capitalize costs, costs are considered pesonal.

Example: Suit to quiet title and collect accrued rents on use of land Capitalize lawyer’s fees attributable to suit to quite title. Deduct fees attributable to collection of rent.

Example: Auto accident Deduct costs if directly and closely connected to business. Neither deduct nor capitalize costs if personal or only incidentally connected to business.

Educational expenses – Carroll v. CIR

Categories of education expenses Personal, such as art history class that does not serve business or profit-oriented activities. Business expenses, such as lawyer or doctor taking a required continuing education class. Capital expenditure (long-term investment), such as costs of training to enter a new profession. Note: Investment in human capital not depreciable, amortizable or deductible upon retirement or death.

Under the regs, taxpayers must pass one of two positive tests to deduct educational expenses. Maintain or improve skills required by the taxpayer’s employment, trade or other business OR Meet the requirements imposed by employer, applicable law or regulations for retaining an established employment relationship, status or rate of compensation.

Under the regs, taxpayers must avoid two negative tests. Not meet minimum education requirements of the taxpayer’s employment or other trade or business; Not constitute part of a program qualifying the taxpayer for a new trade or business, WHETHER OR NOT the taxpayer intends to practice that trade or business.

Hardest distinction is between education for a new trade or business vs. education for new duties in the same trade or business. Lawyer and accountant – different Psychiatry and psychoanalysis – same Licensed public accountant and CPA – different Member of NY bar and member of CA bar - different

To deduct educational expenses, you must already be engaged in the business, profession or occupation.

Educational expense problems

Credits for Higher Education handout