The Tax Court’s recent decision in Simmons v. Commissioner, T.C. Memo. 2026-34, takes aim at incomplete substantiation of business expenses. We fear that substantiation of ordinary business deductions will become a more prominent area of dispute between businesses and the Service. That shift will put a premium on tax advisors helping their clients comply with substantiation requirements on the front end—not just hoping that clients will never be audited, or that the Cohan rule will bail them out when they are.
In Simmons, the Court addressed a series of substantiation failures by two sisters who co-owned a small boutique, and the opinion reads like a cautionary checklist for closely held businesses and the advisors who serve them.
The Facts: A Small Business with Big Recordkeeping Problems
Ms. Simmons and her sister co-owned Stuff, LC, a Kansas City boutique that sold handmade and specialty goods since 1996. Separately, Ms. Simmons also owned two rental units. Stuff used QuickBooks to track its expenses, and on its 2017 partnership return the business claimed deductions for automobile expenses ($12,939), “non-reimbursed food” ($11,377), interest expenses ($16,901), and advertising and promotion ($47,732). Ms. Simmons also claimed deductions for rental property utilities and repairs on her individual returns. The IRS disallowed most of these deductions for lack of substantiation, assessed an accuracy-related penalty for 2017, and determined that Ms. Simmons’s distributive share of Stuff’s 2017 income should have been $224,078 rather than the $5,970 reported.
Closely Held Businesses and the Cost of Ignoring Formalities
Simmons is a case that will resonate with anyone who advises closely held businesses. The sisters did not seem to appreciate how the formalities of business relationships matter—not just for state law or governance purposes, but for federal tax substantiation. This is a recurring theme in tax litigation.
Interest Expenses: When the Entity’s Debt Is Not Really the Entity’s Debt
On its 2017 return, Stuff claimed $16,901 in interest expenses. The Court disallowed the deduction in full, for two independent reasons. First, the sisters had personally borrowed money from family members and then lent it to Stuff, but there were no “loan papers” establishing Stuff’s indebtedness to the sisters. Although promissory notes existed between the sisters and a family trust, none documented a legal obligation running from Stuff to the sisters or anyone else. The Court cited Hradesky v. Commissioner for the principle that “unverified oral testimony” cannot substitute for documentation of a debtor-creditor relationship.
Second, the credit card interest and finance charges were similarly personal. The sisters had applied for credit cards in their own names because Stuff could not obtain credit on its own, and while the sisters attempted to segregate business and personal spending, six of the seven cards reflected only Ms. Simmons’s name with no reference to Stuff. The Court found that Ms. Simmons “fails to show that any credit card interest and finance charges constituted Stuff’s own indebtedness rather than her personal indebtedness.” Even assuming the credit cards could be treated as Stuff’s debt, the sisters “failed to establish the amounts and business purposes of the underlying expenditures that resulted in the interest and finance charges at issue.” The Commissioner pointed out questionable transactions and inconsistencies between QuickBooks entries and credit card statements, and Ms. Simmons offered no response.
The lesson here is one we have seen before: if you want to deduct interest on money borrowed and contributed to the business, you need loan documents between the parties. Paperwork matters.
Automobile Expenses and the Section 274(d) Wall
Stuff’s $12,939 automobile expense deduction was subject to the strict substantiation requirements of Section 274(d), which applies to “listed property” including passenger automobiles. Under Section 274(d), no deduction is allowed unless the taxpayer substantiates by adequate records or sufficient corroborating evidence the amount, time and place of use, business purpose, and business relationship of the person using the property. Ms. Simmons offered only three pages of QuickBooks entries with labels such as “gasoline,” “car lease,” and “mileage,” along with two vehicle lease agreements, but the record was “devoid of any evidence substantiating Stuff’s business purpose.”
Critically, the Cohan rule—which allows a court to estimate the amount of a deductible expense when the taxpayer can prove an expense was incurred but cannot establish its precise amount—does not apply to expenses subject to I.R.C. § 274(d). That makes I.R.C. § 274(d) a wall, not a hurdle. There is no fallback.
This is worth underscoring for practitioners. In cases where I.R.C. § 274(d) applies, having a way to substantiate expenses is not optional—it is essential. Even where traditional documentation is incomplete, there can be creative ways to corroborate that expenses were incurred. For instance, we had a case where automobile expenses were substantiated through a series of gas station receipts that told a story of regular trips being made along the same route. While we still had to establish business purpose, demonstrating that the expenses were incurred regularly was helpful in resolving the case at Appeals. The point is that something is better than nothing, and receipts that paint a picture can sometimes carry the day where a bare ledger entry cannot.
Food and Advertising Expenses: Testimony the Judge Does Not Believe
The Court made equally short work of Stuff’s $11,377 “non-reimbursed food” deduction, finding that Ms. Simmons “did not adduce any evidence detailing the nature of these expenses, much less establish her entitlement to any deduction.”
The advertising and promotion deductions raise an interesting issue. Stuff claimed $47,732 in “Advertising & Promotion” on its partnership return, which actually encompassed $17,278 in advertising expenses and $30,454 in expenses recorded in Stuff’s “Charitable Contributions” account. The Commissioner conceded $4,407 in advertising and promotion expenses and $20,668 related to Stuff’s charity parties, but disputed the rest.
The Court’s analysis of the charity expenses is worth attention. Stuff hosted parties for various charities, donating roughly 15% of sales during each event to a charitable organization—using its associations with charities to drive customer traffic and merchandise sales. The Court agreed that these charity party expenses were legitimate business expenses deductible under I.R.C. § 162 as ordinary and necessary, reasoning that “Stuff leveraged the milk of human kindness to encourage customers to visit its store and purchase its merchandise.” This is a meaningful holding: payments to charities can be deductible under Section 162 rather than Section 170, but only if the taxpayer can demonstrate a legitimate business purpose.
Where the taxpayers fell short was on the remaining advertising expenses. The Court found that Stuff’s QuickBooks entries suffered from “a dearth of information that would allow [the Court] to evaluate the nature of the alleged expenses or their business purposes,” and neither sister provided supporting documentation or detailed testimony. As for the charitable contributions beyond the party expenses, the QuickBooks entries “do not identify the donee organizations, much less establish compliance with substantiation rules governing charitable contributions.”
The takeaway: you have to have testimony the judge believes. The sisters appeared to have incurred real expenses, but they could not persuade the Court that those expenses were what they claimed them to be. The Court was clear that general statements about business purpose are not enough—you need specifics, documentation, and credible detail.
Rental Property Utilities: You Sleep in the Bed You Made
Ms. Simmons’s rental utility deductions present a frustrating result. She claimed $3,026 and $3,738 in utility expenses for 2017 and 2019, respectively, and provided utility bills showing the charges and that the accounts were in her name. The Court acknowledged that Ms. Simmons “actually paid the bills.” But the draft lease agreements in the record provided that tenants were responsible for reimbursing her for utility payments, and a spreadsheet for one 2017 tenant confirmed that the tenant had indeed made utility payments to Ms. Simmons. Although Ms. Simmons testified that she and her tenants often negotiated lease terms, she “failed to persuade [the Court] that any 2017 or 2019 leases deviated from the normal course,” and the deduction was disallowed entirely.
One could argue that if a tenant reimbursed Ms. Simmons for utilities, and she included the reimbursement in rental income, the net result should be the same whether the expense is treated as her deduction or as the tenant’s obligation—but the Court did not see it that way. Again, paperwork matters. If the lease says the tenant pays, then the tenant pays, and you sleep in the bed you made. A landlord who intends to bear utility costs should document that arrangement clearly rather than relying on informal negotiations that leave no paper trail.
The Accuracy-Related Penalty: When Substantiation Failures Compound
The Court upheld the Section 6662(a) accuracy-related penalty for the 2017 tax year. The Commissioner established negligence through Ms. Simmons’s failure to properly substantiate items claimed on the return, and Ms. Simmons’s “conclusory denial” that she had “demonstrated reasonable cause” was “insufficient.” This is the compounding effect of poor substantiation: not only do you lose the deduction, but the failure to substantiate can itself constitute negligence and trigger a 20% penalty on the resulting underpayment.
What This Means for Taxpayers and Their Advisors
Simmons is not a case about exotic tax planning or aggressive positions. It is a case about a small business that incurred real expenses but could not prove them to the satisfaction of the Court. That is a problem that is only going to become more common as the IRS shifts enforcement resources toward bread-and-butter business deduction issues.
With the burden of proof on substantiation issues normally imposed on taxpayers, there is reason to believe the Simmons sisters did not focus on these issues on the front end and relied on their ability to prove their deductions later—but without adequate documentation, that proved to be very hard to do years after the expenses were incurred. Memories fade, records go missing, and what seemed obvious at the time becomes impossible to reconstruct.
For tax counsel who defend these cases in controversy, the job is considerably more difficult when the tax advisors on the front end—if there were any—did not make their clients focus on maintaining records to substantiate expenses. That is not a fun conversation to have with a client, but it is far less fun to suffer a bad result when the IRS takes shots at a taxpayer who has no good way to substantiate expenses years after the fact. Even then, the Cohan rule cannot always help—and where I.R.C. § 274(d) applies, it cannot help at all. The message for practitioners is clear: substantiation is not a back-end problem. It is a front-end discipline. The time to build the record is when the expense is incurred, not when the notice of deficiency arrives.
