My students—especially those with accounting backgrounds—come to class expecting that tax law is all about bright line rules and lots of calculations. They are either disappointed, frustrated, or relieved to find that tax law is like other law: it’s words, words that are generally complex, often opaque, and frequently mysterious. That’s why taxpayers need competent tax practitioners to advise them!
Some tax practitioners are more aggressive and some are more cautious. Today’s lesson is for the more aggressive ones. In Raul Romana and Maria Corazon Romana v. Commissioner, T.C. Sum. Op. 2022-9 (June 16, 2022), Judge Carluzzo generously allowed a taxpayer to deduct the cost of a her “scrublike clothing.”
Those of us who are more cautious will disregard this decision. It’s an outlier and, no, I certainly would not advise my client to start deducting the cost of this type of clothing! At the same time, however, the opinion may well provide aggressive taxpayers and their advisors protections from penalties if and when they try this trick at home. The substantive tax lesson is short and sweet. The penalty lesson is more complex, opaque, and mysterious.
Details below the fold.
The tax year at issue is 2014. That year, Ms. Romana was employed as a nurse in a plastic surgery clinic operated by Kaiser Permanente (Kaiser). When she was required to be in the operating room, she was required to wear scrubs provided to her by Kaiser. Otherwise, Kaiser did not require her to wear any particular type of clothing; it just had a general policy that she should wear “comfortable clothes” (Op. at 2) and dress “in a manner that reflected her profession as a nurse.” (Op. at 2). Ms. Romana chose to meet that requirement by wearing what Judge Carluzzo calls “scrublike clothing.” Heck, that’s not even actual scrubs! It’s just “clothing that resembled scrubs that she purchased at her own expense from local department stores.” Op. at 2. (emphasis supplied).
Lesson 1: Deducting Scrubs. The Power of Fact Finding
Remember this is 2014, when the standard deduction was much lower and when taxpayers could still deduct miscellaneous itemized expenses such as unreimbursed employee expenses. The Romanas claimed over $8,000 in such expenses, $2,000 of which they claimed for “uniforms and protective clothing.” And, apparently, almost all of that was for purchase and dry cleaning (!) of Ms. Romana’s scrublike clothing.
Clothing is generally not deductible because it’s a personal expense. See Classic Lesson From the Tax Court: Sex and Deductions, TaxProf Blog (Oct. 11, 2021). But some work clothing can be a business expense. Judge Carluzzo here does a terrific job summarizing the rules for deducting work clothes:
“Generally, the cost of a business wardrobe, even if required as a condition of employment, is considered a nondeductible personal expense within the meaning of section 262. See, e.g., Hynes v. Commissioner, 74 T.C. 1266, 1290 (1980). Those costs are not deductible even when it has been shown that the particular clothes would not have been purchased but for the employment. Id. Clothing costs are deductible as ordinary and necessary business expenses under section 162 only if (1) the clothing is of a type specifically required as a condition of employment, (2) it is not adaptable to general use as ordinary clothing, and (3) it is not so worn. See Yeomans v. Commissioner, 30 T.C. 757, 767 (1958).” Op at 5-6 (links added).
Alert readers will quickly see that whether clothing is of a type not adaptable to general use is going to be a factual determination. Judge Carluzzo is very much aware of this and exercises his considerable fact-finding discretion in Ms. Romana’s favor: “Because the clothing resembled scrubs, we find that the clothing was not adaptable to general use as ordinary clothing outside of her employment. Consequently, the cost of the clothing and the cost to dry clean the clothing are deductible.” Op. at 4. He elides that first requirement. These items were not “specifically required” by Kaiser. The policy just said “dress appropriately.” I cannot find a single case where such a vague clothing policy met the first of the three requirements for deductibility. If your research skills are better than mine, I encourage you to put a citation in the chat.
But let's ignore that for the moment.
I’m not sure Judge Carluzzo's finding on suitability for everyday wear would survive even a clear error review on appeal. After all, scrubs are routinely promoted as suitable for everyday wear. It’s why they are sold in normal department stores and not simply in medical supply stores. It's why they are sold in children's sizes. They are even the subject of fashion advice articles. And, by the way, even those websites giving advice on how to clean actual scrubs (the kind that get stained with blood, iodine, vomit and other unpleasant substances) don’t say anything about dry cleaning them!
But Judge Carluzzo knows what he’s about. As (even more) alert readers will notice, this a Tax Court Summary Opinion. That means it’s not reviewable by any other court. §7463(b). So Judge Carluzzo has more latitude here to do his job, which is to use his best judgment to apply law that is complex, opaque and mysterious. It’s why he’s a “Judge.” And we’re just the peanut gallery.
So what does one do with this case? Why is it worth your attention? Well, it might just provide you or your clients with protection from penalties! Let’s take a look.
Lesson 2: Penalty Protection?
Law: Penalties on Taxpayers
Section 6662(a) imposes a penalty on taxpayers for certain types of errors. It's not a penalty for being bad. It’s a consequence for being inaccurate. The IRM tells us that its purpose is to promote voluntary compliance by “(1) defining standards of compliant behavior; (2) defining consequences for noncompliance, and (3) providing monetary sanctions against taxpayers who do not meet the standard.” Penalty Handbook, IRM 126.96.36.199.
Probably the two most common reasons for the accuracy-related penalty are “negligence or disregard of rules or regulations” in §6662(b)(1) and “Any substantial understatement of income tax” in §6662(b)(2). Section 6662(c) tells us that “the term ‘negligence’ includes any failure to make a reasonable attempt to comply with the provisions of this title, and the term ‘disregard’ includes any careless, reckless, or intentional disregard.” Section 6662(d)(1) tells us that an understatement is substantial when it exceeds the greater of $5,000 or 10% of what should have been reported on the return.
Taxpayers have two ways to escape these penalties.
The First Escape Route: Substantial Authority or Reasonable Basis. This one works only to escape the penalty for substantial understatements. Section 6662(d)(2) provides that certain understatements won’t count towards the penalty: (1) undisclosed positions for which taxpayer had “substantial authority,” §6662(d)(2)(B)(i); and (2) disclosed positions for which the taxpayer had a “reasonable basis,” §6662(d)(2)(B)(ii). However, these defenses do not apply to positions with respect to a partnership, entity, plan, or arrangement “if a significant purpose of such partnership, entity, plan, or arrangement is the avoidance or evasion of Federal income tax." §6662(d)(2)(C)(ii).
As you might expect, the substantial authority standard is more stringent than the reasonable basis standard. That is because if a taxpayer discloses a position, it increases the chances of audit. So the lesser standard is there to encourage disclosure. The regulations say taxpayers have substantial authority “for the tax treatment of an item only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment.” Treas. Reg. 1.6662-4(d)(3)(i). The regulation then gives a looooong list of what constitutes “authorities.” Treas. Reg. 1.6662-4(d)(3)(iii). As you might expect, “court cases” are among the list. So T.C. Summary Opinions are "authorities" for penalty purposes.
In contrast, the reasonable basis standard just means that the position “is reasonably based on one or more of the authorities set forth in § 1.6662-4(d)(3)(iii)” even though “it may not satisfy the substantial authority standard.” Treas. Reg. 1.6662-3(b)(3). (emphasis supplied). See where I'm going? In other words, if your position is based on a listed authority, then even if that authority is an outlier, you will likely meet the reasonable basis standard. But, remember, to get that standard you need to have disclosed the ultimately erroneous position. The regulations tell you how to do that. Treas. Reg. 1.6662-3(c)(2).
The Second Escape Route From §6662 Penalties: Reasonable Cause and Good Faith. Taxpayers can avoid any §6662(a) penalty by showing “there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.” §6664(c)(1). See also Treas. Reg. 1.6664-4(c), Reasonable cause generally requires that the taxpayer exercised ordinary business care and prudence. Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43 (2000).
Probably the most popular way to show reasonable cause is to point the finger, otherwise known as the reasonable reliance defense: “my preparer/accountant/tax advisor told me it was ok!” To win on this, taxpayers must show (1) the adviser was a competent professional with sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the adviser, and (3) the taxpayer actually relied in good faith on the adviser’s judgment. Rogerson v. Commissioner, T.C. Memo 2022-49 at p. 34 (May 12, 2022)(collecting cases); see also IRM 188.8.131.52.4.
So that takes us to the second branch: tax return preparer penalties.
Law: Penalties on Tax Practitioners
Section 6694 imposes penalties on tax practitioners who advise taxpayers to take an unreasonable positions. Practitioners are also vulnerable to professional sanctions under Circular 230 §10.34. There are other penalties (nicely summarized on this IRS webpage) but today’s lesson is mostly relevant to the §6694 and Circular 230 sanctions. That is because Tax advisors basically have the same set of defenses as taxpayers: (1) the “substantial authority” defense for an undisclosed opinion, §6694(a)(2)(A),; (2) the “reasonable basis” defense for a disclosed position, §6694(a)(2)(B). See Dan Wise, “A substantial-authority scorecard....” The CPA Tax Advisor (Jan. 1, 2019). Those defenses are not, however, available for positions with respect to reportable transactions or tax shelters. Penalties there can only be avoided by showing that the erroneous position had a more-likely-than-not basis at the time it was taken. §6694(a)(2)(C). Good luck with that.
Application: Reasonable Basis But Not Substantial Authority
Let’s start with the caveat. While I’m not a particularly cautious person, neither am I an extremely aggressive. I would definitely not advise a client to deduct the cost of scrub-like clothing bought at a department store! In contrast, scrubs required in an operating theatre would likely be deductible. But you'd much rather have those provided to you, as Ms. Romana's employer did for her in the operating room, especially since evil §67(g) means you cannot actually deduct scrubs as an unreimbursed employee expense until 2026.
Today’s case does not help establish a substantial authority defense to either §6662 taxpayer penalties or §6694 return preparer penalties. The regulations tell us that substantial authority is a balancing test: it requires you to compare the authorities that support your position with authorities that do not support your position. Your side does not have to outweigh the other side, but it must move the scale. This is not just a counting exercise. You also have to consider the weight the authority (yes, pun intended).
Here, when one reads the classic cases, such as Pevsner v. Commissioner, T.C. Memo. 1979-311, rev’d by 628 F.2d 467 (1980), one quickly sees this case is but a feather on one side of the scale; the other side is heavy with contrary authorities, particularly on the issues of (1) required by employer and (2) suitable for wear outside the workplace. In particular, cases allowing deductibility for nurses uniforms have done so only when the clothing was pretty clearly not suitable for ordinary use. See Harsaghy v. Commissioner, 2 T.C. 484 (1943) (custom and usage forbade off-duty wearing of the clothing) Meier v. Commissioner, 2 T.C. 458 (1943) (sanitary considerations made the clothes unsuitable for general wear). Harsaghy is especially instructive: it allowed deduction for a regular nurse’s uniform that consisted of “a simple white dress, white shoes, white stockings and cap.” The Court said just because it could theoretically be worn when off-duty:
“it does not thereby follow that such uniform replaces clothing regularly worn by her when not on duty as a nurse. In this country, at least, we have come to regard clothing as constituting more than a mere covering for the human body. Especially among women, the suitability of raiment depends on such matters as style, color, and material. Women outside the nursing profession would hardly consider a nurse's uniform and accessories as incorporating such qualities as would make them either practical or desirable for any purpose, much less general and continued wear.”
That was then. This is now. Scrub-like clothing and even traditional scrubs are routinely worn when not on duty. So, no, today’s case is not substantial authority for deducting scrubs.
However, I think this case could well meet the regulation’s definition of reasonable basis! That is not a balancing test. The regulations tell us that a position has a reasonable basis so long as you can reasonably connect it to one of the permissible authorities, which include Tax Court Summary Opinions. So I think it could be useful if one is having to defend against penalties for some similar type of deduction. It may also support a disclosed return position if one wants to be aggressive. But remember, to get the easier reasonable basis defense, one must disclose the position.
What do you think? I welcome, as usual, all comments on what you would do, or on what errors you believe I may have committed!
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law. He does not wear scrubs to work. He invites readers to return to TaxProf Blog each week for anther Lesson From The Tax Court.