MEMORANDUM
Re:
Introduction
I have keenly assessed the memo recounting Sylvia Martinez’s current business activities. Sylvia operates a chain of dry cleaning stores within the Houston metro area. She is currently planning to do major renovations to two out of her five locations. Sylvia married Polino who is later employed by the dry cleaning business and pays the cost of Polino’s polo playing. She uses Polino’s polo playing as an opportunity to advertise her dry cleaning business by tagging the business logo on Polino’s polo uniforms and sandles. Sylvia also sells cleaning products alongside dry cleaning services. Sylvia suspects that some employees work illegally by using wrong social security numbers. In United States, its illegal to other persons social security number as stated in the New York Times dated 4th September 2006.
Tax Issues
There is several tax issues that Sylvia needs to address to ensure that she capitalizes on available tax benefits. First is to determine whether renovations to the two stores are deductible as a business expense. There is the question of whether the fees paid by Sylvia to support Polino’s polo activities should be deducted like any other business expenses. The third issue is to determine whether Sylvia can deduct salary expenses for her employees who are suspected to be illegally working in the United States. The question of whether Polino’s polo activity is a hobby or business should also be determined. The last question is whether Sylvia’s purchase of cleaning products should be an expense of her dry cleaning business or accounted for on an actual basis.
Business V. Hobby
Polino’s involvement in Sylvia dry cleaning services should be differentiated. Business is any activity that one undertakes with an aim to make a profit. However, sports can be taken by anyone talented on such games as ponies; Polino in these aspects is involved in business activities. Actually, Sylvia’s business and Polino’s polo can be rented and integrated as single activity. The evidence of logos on Polino’s uniform with Sylvia’s dry cleaning services; Polino is directly linked to promoting the company. Therefore, evidence suggested in Treas. Reg. 1.183-2 must be considered to support a finding that Polino indeed has a profit motive and thus is entitled to business deductions. There is also a possibility that Sylvia’s business and Polo playing is integrated to become one business hence reporting revenue together. Among the elements in the regulations that support profit motives are:
Profit motives can be evaluated based on the taxpayer’s actions and the result of the activity (Polino’s using polo sports platform to promote Sylvia dry cleaning service).
Polino’s expertise as a taxpayer.
The relative time and efforts that the taxpayer (Sylvia tagging the logo of her business on the sports uniforms with the intent of making profit).
Expectations the taxpayer is aspiring to attain from the activity (Sylvia expects to promote her dry cleaning business through Polino his sporting events).
According to Mendoza v. Commissioner [42 T.C. 314 (1994)], the court decided to investigate whether the sport activity was involved in profit making or not. Hobby and business are different things. Failure to meet the profit motives elements may result in loss of business status for many tax payers according to the United States internal revenue code. Polo activity is not a single activity since it is incorporated with Sylvia’s business; Sylvia does not keep its records so there are no supporting expenses. To that end, §274(d) states “taxpayers should be able to authenticate “by sufficient report” sports travels and sport related expenditures. The business should anticipate to make awareness to its client through advertisements hence should also provide advisements reports. Treas. Reg. 1.274-5T(c) anticipates that taxpayers will maintain and be able to produce such evidence. However, the preferred method to validate such evidence is in the printed or written form. Thus, Sylvia should be able to differentiate Polino’s activities (hobby) from business. Looking at the case cited it will guide Sylvia in coming up with the required documents to validate Polino’s activities.
The case cited suggests that Sylvia must provide evidence of profit intent in order to deduct Polino’s sport associated activities expense. Sylvia must also be able to produce clear, convincing and complete evidence in order to ensure the desired outcome.
Renovations V. Capitalization
Sylvia has several dry cleaning stores, she is trading on all of them the two to undergo renovations are leased while she maintains her dry cleaning business along with the polo business. The renovation of the two stores by Sylvia is deducted as expenses. This is simply because the store is a building which will be used for business purpose and profit making activities even in the future. According to Toledo home federal savings case, tax payer who builds, reconstructs, rehabilitates or constructs integral components related to business matters has to pay for the tax of such building.
Cleaning Product Retail V, Dry Cleaning Service Provision
In the article, we are told that for the past 8 years that Sylvia was a client, she had been operating on cash method of accounting. This is an accounting system that doesn’t record accruals but recognizes revenue only when payment is made. According to this method, the business books are kept in relation to how the cash flows. This method seems to ensure that the business evades paying tax.
In relation to In Williamson v. W. P. Bowers [54-2 USTC ¶9501], the Sylvia should clearly use other means of accounting that will ensure that her business is recognized by the tax collecting body. The cash method in accounting for inventory is appropriate for Sylvia’s decision to sell cleaning products alongside her dry cleaning business is well provided in the §1236 (b). The measures set in place to account for the store inventory would be fundamental for Sylvia in order to raise the required cash for the business.
Sylvia in the case should be able to provide creditable records of her two business deductions separately. Dry cleaning services and the selling of cleaning products should record different deductions as they earn differently.
Employee records V. employee qualifications
Generally, Sylvia is bound to deduct her employee’s wages according to the laws, though the employees are legal. Complete Auto Transit Inc. V. Brady, 430 U.S. 274 (1977) defines the ‘Commerce Clause’ that Sylvia is likely to face in the tax court in the United States. However, the cited case reflect effectively corporate and companies; Sylvia case is a commercial one since it is a business with ‘fraud employers’. As an employer, it should be obligatory to verify the employee’s identities even before employment considerations.
Based on the case it will aid Sylvia by providing clarity to the deductions of the employees who are suspected to be working in the United States illegally. Through the provision of the case, Sylvia can be able to solve her payroll issues and in case of IRS auditing she will be in a position to explain such deductions.
The case suggests that Sylvia should be able to produce a clear, simple record of her employee deductions. The employee’s current records portrays that they may be working illegally in U.S. however, the deduction should be made to social security fund as provided by the tax code. Sylvia should maintain systematic record for such deduction to sustain her claim in case of auditing.
Conclusions and Recommendations
The accounting system of Sylvia’s business should be succinct, described and separated. The cash accounting to the enterprise should be accorded with clear written records for the business to withstand the IRS scrutiny assessment favorably.
In the event, that Sylvia wants to claim the tax benefit through the use of Polino’s sports uniform for profit intend reason it is important that she maintains sound recording system. Documenting time, effort, and expertise will provide strong evidence to support her claim of business intent.
In conclusion, Sylvia should ensure that the employment qualification is well stated. Verification of the applications forms should be done before she can employ people. This should be done to avoid such case of other people social security used illegally. The internal audit of employees should be done on Sylvia’s locations in the efforts to withstand IRS scrutiny.
References
Lendad, J. (2006). Immigrants stealing U.S. Social Security numbers. New York Times.
McGovern, B. A. (2014). RECENT DEVELOPMENTS IN FEDERAL INCOME TAXATION. Texas.
Reuters, T. (n.d.). Findlaw. Retrieved APril Sunday, 2015, from U.S. Supreme Court web site: www.findlaw.com.
View, J. (2007). judicial review. Retrieved April Tuesdy, 2015, from Judicial Review website: www.judicialview.com
