19 May 2016
Wow! Almost a month since I have published a blog post. I've been rather busy getting the financial planning side of the business set up. Additionally, there were some management changes with the office I rent and I had to spend some time figuring out if I would be able to stay here at 582 Lynnhaven Pkwy or if I was going to have to find a new office. (That's all settled, and I am staying right here!) And lastly, I had a kidney stone. A big, nasty 7 mm one that attacked during the evening of the last day of tax season! That had me out of commission for a while, but now I am back at full stride. Time to start posting again.
I thought I'd ease back into the tax blog with a little history on the ordinary and necessary requirement for business expenses.
This is a little tax story that I find interesting. I hope you do, too.
Harold Lloyd Jenkins made a significant impact on the federal tax code when he won his lawsuit against the Commissioner of the IRS. In its ruling favoring Jenkins the tax court defined the standard for Internal Revenue Code section 162 ordinary and necessary business expenses. That standard is still in effect today. If none of this seems interesting, keep reading – it gets better.
Harold Lloyd Jenkins was much better known by his stage name Conway Twitty. As a singer, songwriter, and producer Twitty collaborated on 55 number one country, pop, and R&B music records during his career. He may be best known for a series of country duets he did with Loretta Lynn in the early 1970s. What he is not remembered for is Twitty Burger.
Twitty Burger was a string of hamburger restaurants Jenkins/Twitty opened with investor backing in 1968. By 1971 it was evident the restaurants had no future and were closed. In 1973 and 1974 Twitty repaid some of his Twitty Burger investors with money he earned as a recording artist. He deducted those payments to investors as an expense to his business of being a recording star.
The IRS disagreed that repayments to investors for a previous failed business were an ordinary and necessary business expense for a recording artist and demanded Twitty adjust his tax returns and pay the taxes on that money. Twitty and his lawyers took the case to Tax Court where they argued that a country music singer’s reputation was essential to the success of his business/career, and that failing to repay the Twitty Burger investors would have damaged Twitty’s reputation within his industry. Therefore, the repayments met the standard for being ordinary and necessary business expenses for a country music singer.
The tax court agreed. The court ruled that two questions need to be taken into consideration when determining ordinary and necessary:
1) What is the motive for making the payments
2) Is there is a sufficient connection between the expenditure and the business from which it is deducted
In Twitty’s case the court ruled that Twitty made the repayments to investors to protect his reputation, and that his reputation was essential to his business as a recording artist.
In short, the court set the standard that being ordinary and necessary was dependent on the particular profession. Expenditures that are not ordinary and necessary in one profession may be ordinary and necessary in another. An insurance salesman can’t claim fire-proof pants are an ordinary and necessary expense, but a fire fighter can. This ordinary and necessary standard remains in effect today.
As an odd footnote to this story, the Tax Court concluded their written ruling on the case in the form of a country music ballad.
"Ode to Conway Twitty"
Twitty Burger went belly up
But Conway remained true
He repaid his investors, one and all
It was the moral thing to do.
His fans would not have liked it
It could have hurt his fame
Had any investors sued him
Like Merle Haggard or Sonny James.
When it was time to file taxes
Conway thought what he would do
Was deduct those payments as a business expense
Under section one-sixty-two.
In order to allow these deductions
Goes the argument of the Commissioner
The payments must be ordinary and necessary
To a business of the petitioner.
Had Conway not repaid the investors
His career would have been under cloud,
Under the unique facts of this case
Held: The deductions are allowed.