Tax advice from social media influencers can have some BAD outcomes. For a few months now, we’ve seen people who are neither attorneys nor accountants recommending that business owners start renting out their homes to take advantage of the Augusta Rule. Sounds great, right? Who doesn’t love tax-free income? As you might guess – details (and documents) matter. According to the US Tax Court, the details really matter.
In Sinopoli v. Commissioner, the outcome demonstrates how bad things can happen when businesses attempt tax strategies without a lawyer. While companies can deduct reasonable and necessary business expenses, getting too creative with the numbers can backfire. A recent case shows why an ounce of prevention with an experienced lawyer could be worth millions, stopping these problems before they arise.
What is the Augusta Rule?
Internal Revenue Code (IRC) §280A(g) allows a taxpayer to omit certain rental income from the lease of their home as long as the home was rented for no more than 15 days of the year. The provision is commonly called the “Master’s” Rule or Augusta Rule due to its use during the Master’s Golf Tournament.
The Augusta Rule 280A(g) provision requires:
- The dwelling must be in the U.S.
- The taxpayer uses the rented dwelling as a residence during the taxable year.
- The dwelling is rented for less than 15 days (per property) during the taxable year.
- No other deductions are taken for the rental use of the dwelling.
It’s worth noting that the dwelling doesn’t have to be the taxpayer’s primary residence; vacation homes can also be subject to the Augusta Rule. The rule could also be applied whether the entire house or a portion of the house is rented.
S-Corp Claims Deduction for Business Meetings in Private Homes
In 2023, the perils of the Augusta Rule were highlighted in Sinopoli v. Commissioner, a battle between the IRS and an S-corporation of fitness centers. The operators of the S-corp attested that scheduling meetings was difficult due to the members’ locations and work conflicts. To ensure all three members could attend, they used the Augusta Rule to rent part of their homes to their S-corporation as meeting space.
The problem arose when calculating the rental value of their residences. One member determined that meeting spaces near the area cost about $2 per square foot, which was used to calculate the rental space for each home. As a result, the S-corp began paying each member a monthly rent of $3,000.
Augusta Rule Rental Deduction Raises Red Flags at IRS
The IRS assigned a Revenue Agent (RA) to audit the S corporation, which paid out just under $300,000 to its members for three years’ monthly meetings. It appeared that the members didn’t just fail to keep business and personal property separate; they were paying themselves thousands of dollars tax-free each year.
The amount of the deduction was further complicated by:
- Comparable rates. The RA found locally available meeting space at a rental price of $500 per day, much less than the deducted amount.
- Inconsistent reporting. Two members reported the rental income and excluded it from their gross income, but the third failed to report it for one of the years on record.
- Lack of meeting documentation. Although they collected tax-free rental income for three meetings per month (once at each residence), the members failed to provide meeting minutes, recordings, or adequate evidence that all reported meetings took place.
Was the Rental Rate an Ordinary and Necessary Expense?
All business expenses, including the Augusta Rule, must meet the “ordinary and necessary” standard of IRC §162. For a cost to be considered valid, it must be:
- Ordinary (usual or customary in the taxpayer’s trade or business)
- Necessary (appropriate or helpful in carrying on the trade or business)
- Reasonable (equitable in amount, even if the expense is ordinary and necessary)
Although definitions of “reasonable” may vary, the IRS applies the standards of “ordinary and necessary” to determine reasonableness. In this case, the members failed to pass the reasonable requirement based on how much other companies in the area pay for rental space.
Court Decision Finds S-Corp in Violation of Augusta Rule Requirements
The RA presented evidence to the Court that the rental income for each meeting was unreasonable, particularly since meetings happened only once per month and with three participants. He proposed a maximum deduction of $500 for each meeting that could be substantiated with agendas, calendars, or minutes.
The Court’s final decision stated that the members adopted the Augusta Rule as a tax savings scheme, attempting to pay themselves a greater share of the business’s earnings without incurring income tax. In the end, the S-corp was allowed a deduction at a rate of $500 for one meeting per month.
We See the Fine Print of the Augusta Rule and Other Deductions
This case underlines a fundamental principle: when it comes to tax planning for your business, you need to meet with a corporate attorney early and often. Some deductions—such as the Augusta Rule—are highly scrutinized by the IRS due to the high potential for abuse. In addition, IRS rules for business deductions can overlap and conflict with one another, leading to simple errors with massive consequences. Keep in mind that proving deductions is the taxpayer’s responsibility!
The surest way to avoid showing up on the IRS’s radar and risking an expensive legal battle is to get advice from a corporate attorney who knows the tax law inside and out. Email us at email@example.com today or schedule a 15-minute call to see how we can help protect your company.