Attorney’s racing activities fall short of the finish line

The Tax Court held that an attorney’s race car costs did not constitute deductible advertising expenses. In particular, the court found that the taxpayer failed to properly substantiate a portion of those expenses and that none of the expenses met the required criterion of being ordinary and necessary business expenditures under Sec. 162(a).

Facts: In the late 1980s, James Avery started his own law firm in Colorado, specializing in personal injury law. In 2003, Avery moved to Indiana, where he also became licensed to practice law. He moved back to Colorado in 2010.

In 2005, while living in Indiana, Avery started participating in car shows, having purchased a 30-year-old Ferrari and another collector car. He believed that the car shows could provide an opportunity to meet potential clients. Avery, however, found the car shows “a little bit boring” and by 2008 began to participate as a driver in car racing instead. To this end, he purchased two Dodge Vipers. On the back of one he raced, he affixed a decal for the Avery Law Firm, his “sponsor,” saying that he believed that it functioned as advertising for his law firm. Most of his racing activity occurred between 2008 and 2010.

Despite Avery’s stated belief that his racing activities might allow him to meet people who could help his law career, he could only point to two such contacts. In one instance, he consulted with a Pizza Hut franchisee regarding a dispute with a vendor. He also met a surgeon at an Indiana car show (not a race event) who later acted as an expert witness in a case Avery tried in Denver.

Avery failed to file timely income tax returns for 2008 and 2009, and the IRS prepared substitutes for return for those years. In 2013, he filed delinquent returns for 2010 and 2011. He timely filed a 2012 return, but the IRS again prepared a substitute for return for 2013. The IRS issued him a notice of deficiency for 2008, 2009, and 2013 and examined his returns for 2010 through 2012, issuing a notice of deficiency for them as well.

In 2016, Avery submitted delinquent returns for 2008, 2009, and 2013 and amended returns for 2010 through 2012. He claimed a total of $355,000 of deductions related to advertising expenses on his Schedules C, Profit or Loss From Business (Sole Proprietorship), for the years in question. Of that total, the IRS accepted $51,634 as properly documented after it disallowed any racing expenses. Avery petitioned the Tax Court to determine issues including whether deductions of his additional claimed advertising expenses of $303,366 should be allowed, including those for car racing.

Issues: Sec. 162(a) allows a deduction for all ordinary and necessary expenses paid or incurred during a tax year in carrying on any trade or business. Taxpayers, however, bear the burden of proving their entitlement to the deduction (INDOPCO, Inc., 503 U.S. 79 (1992)) and the burden of substantiating the expenses (Sec. 6001; see also Roberts, 62 T.C. 834 (1974)).

The court disallowed $167,027 of expenses that Avery “failed to provide any substantiation whatsoever for.” The court then assessed whether the remaining $136,339 of claimed expenses were ordinary and necessary within the meaning of Sec. 162(a).

An expense is ordinary if “the transaction which gives rise to it [is] of common or frequent occurrence in the type of business involved,” the court noted (quoting Deputy v. du Pont, 308 U.S. 488 (1940)). A necessary expense is one that is “appropriate and helpful” in carrying on a taxpayer’s profit-seeking activity (Welch v. Helvering, 290 U.S. 111 (1933); Heineman, 82 T.C. 538 (1984)). Furthermore, the courts have looked to a taxpayer’s primary motive for incurring the expense and whether there is a reasonably proximate relationship between the expense and the taxpayer’s occupation (O’Connor, 653 F. App’x 633 (10th Cir. 2016); Henry, 36 T.C. 879 (1961); Berry, T.C. Memo. 2021-42). Finally, an expense that is motivated primarily by personal considerations is not allowed as a deduction (Berry, T.C. Memo. 2021-42 at 14).

Holding: The court concluded that Avery’s racing-related costs were neither necessary nor common expenses for an attorney to incur. The court stated that both his car collecting and racing activities constituted hobbies, for which Sec. 262 prohibits a deduction as “personal, living, or family expenses.” The court also was not persuaded that his racing activities while living in Indiana “had any synergy with his Denver-based litigation practice.” Furthermore, upon returning to Colorado in 2010, the court indicated, if Avery had genuinely believed in the advertising potential of his racing activities, he would have increased or at least maintained those activities, but he did not. In addition, the court noted that even if Avery had raced in relevant markets, the decals with his name and law firm were in relatively small print, which it considered to be on the “opposite end of the spectrum from (say) a billboard or newspaper ad.”

The court also noted that Avery’s racing activities produced only one occasion that led to a consultation about a vendor dispute. Similarly, although Avery testified that car racing was a “good conversation starter,” the court did not find that to be particularly compelling, stating that the possibility of eventual business relationships “does not convert the costs of pursuing a hobby into deductible advertising expenses.” The court thus found that Avery raced primarily for personal enjoyment, not to advertise his legal services. As such, he failed to carry his burden of showing any proximate relationship between the two, the court concluded.

The Tax Court concluded that under Sec. 162(a) Avery was not entitled to deduct any of the $303,366 in advertising costs in excess of those allowed by the IRS.

■ Avery, T.C. Memo. 2023-18

— John McKinley, CPA, CGMA, J.D., LL.M., is a professor of the practice in accounting and taxation in the SC Johnson College of Business, and Matthew Geiszler, Ph.D., is a lecturer in accounting in the College of Human Ecology, both at Cornell University in Ithaca, N.Y. To comment on this column, contact Paul Bonner, the JofA’s tax editor.