This is a true story about how not to file your income tax return. I guarantee this case will have you shaking your head. For the sake of mercy, I am leaving leave out the real last name of the couple involved and will simply call them “Mr. and Mrs. Taxpayer.” (Psst: Don’t miss the punch line.)

Here are the facts: Mr. and Mrs. Taxpayer were self-employed and operated two small businesses. One was a party equipment rental and bartending service, the other company delivered newspapers. 

Small businesses are the heart of our economy. But they also offer the opportunity to play the game of “Hide-My-Income-and-Inflate-My-Deductions.” The IRS knows this, which is why individuals who file a “Schedule C” are audited more than most.

Eventually, Mr. and Mrs. Taxpayer’s luck ran out. The IRS didn’t like what it found on three years’ worth of tax returns, specifically, those filed in 2001, 2002 and 2003.

Among the things that got The Taxpayers in trouble was their failure to keep “contemporaneous” records for the use of their vehicles to deliver newspapers and for the bartending business.  It’s not acceptable to estimate how many miles you drove for business after the fact (such as at the end of the month or year).  The law requires you to log an expense on or close to the date it occurs.

For sloppy record-keeping, the Tax Court threw out nearly $15,600 in car and truck deductions.

Although The Taxpayers claimed to have paid their sons $8,500 to occasionally deliver newspapers,but had no records of the dates the sons worked. This amount was disallowed.

As was more than $2,000 Mr. Taxpayer said he spent to attend two bartending conferences.

The court also threw out $3,500 in legal expenses which The Taxpayers claimed were related to their bartending enterprise.  The judges didn’t buy the argument that Mr. Taxpayer’s arrest for driving under the influence was a legitimate business-related activity.

Mr. and Mrs. Taxpayer also didn’t get to deduct the $1,968.20 they spent on a new refrigerator because they couldn’t demonstrate that it was actually used in their business and not in their home.

Although you used to be allowed to deduct the interest you paid on credit card balance, that's not the case anymore. But  Mr. and Mrs. Taxpayer still tried to claim $4,000 in interest deductions.

They deducted rent expenses that weren't paid for in cash, and instead claimed “goods were used to pay rent invoices in lieu of monetary compensation.”

Finally, the Tax Court increased the amount of income The Taxpayers claimed their bartending business earned in 2001.Relying on the very same receipts Mrs. And Mrs. Taxpayer would have used to calculate this, the IRS came up with an additional $3,182.95.

What’s instructional in a case such as this one is that by no stretch of the imagination could The Taxpayers be described as sophisticated high-rollers. They were not stashing millions of dollars in secret off-shore accounts or claiming deductions for dry oil wells. The total amount of money they cheated the government out of over three years was $14,340. 

Penalties for underpayment of income tax due to lack of accuracy and negligence added another $2,868, bringing the grand total the couple owed to $17,208. 

This, of course, does not include the legal fees The Taxpayers incurred.

This case is significant because it demonstrates the lengths the IRS is willing to go to recover a relatively small amount of money.  Mr. and Mrs. Taxpayer were “regular” folks who--perhaps as many are tempted to do--exaggerated, imagined or “forgot” the facts. Their biggest mistake was not keeping accurate and timely records to substantiate the expenses they claimed.

As the Tax Court wrote in its decision, taxpayers “bear the burden of proving that they are entitled to the deductions claimed…We are not required to accept a taxpayer’s unsubstantiated testimony that he is entitled to a deduction.”

As promised, here’s the irony of this case: During tax season, Mr. Taxpayer was worked full-time for the Internal Revenue Service!