To be deductible by a business, promotional and advertising expenses must have an “ordinary connection” to the company. This means that these costs cannot simply serve as entertainment or personalization for employees, but instead, they should carry out some function connected with the business. Businesses must provide clear evidence for why these costs were incurred.
The IRS has created specific rules which determine what can qualify as “ordinary” when it comes down to claiming deductions at tax time.
The Tax Court has recently dealt with a case that could have implications for construction business owners who claim deductions related to their race car expenses. The decision in Berry, T C Memo 2021-42 determined whether these claims were appropriate.
When a business engages in promotional and advertising activities outside the scope of usual expenses, it may encounter legal issues. The IRS will often identify these as unrelated to active conduct or intended generation of revenue/goodwill for their company; however, it’s not uncommon that courts determine otherwise when mixed results arise from such litigation-including successful outcomes!
The Story
This case features a father-son duo with a passion for race cars. The father owns a construction and real estate business, and the two began restoring cars when the son was just 16 years old. In 2013, the company purchased a classic race car to restore, claiming nearly $122,000 in deductions for their taxes. Because the racing activities used a different name, the company didn’t claim any expenses on their 2013 taxes. A photo on record of the 1968 Camaro shows that it was without any advertising or branding on the car.
The IRS successfully argued that the firm’s promotional expenses relating to racing cars should not have been deductible because they were primarily used for competitive purposes and did not represent legitimate business use. The Tax Court sided with this decision.
Reasons Behind the Tax Court’s Ruling
The company has not met its obligation to prove that these expenses were ordinary and necessary promotional activities. All of the son’s racing activities were conducted under the name “Berry Racing,” a term unrelated to the business.
Despite what the taxpayers claim, there is no evidence that any of their car’s features or presence at racetracks led to business opportunities for them in construction.
The Court ruled that the firm didn’t treat car racing expenses as advertising on its 2013 return. Instead, it buried them among many construction-related costs and failed to disclose these investments in any way. The taxpayers failed to demonstrate that these expenses were ordinary or necessary for the firm, resulting in the Court’s final decision.
