Physician's Expenses Were Properly Treated as Miscellaneous Itemized Deductions on Schedule A. (Parker Tax Publishing March 3, 2014)

Deductions for storage unit rental, travel, and legal expenses claimed on Schedule C by a practicing neurosurgeon should have been subtracted from her adjusted gross income and claimed on Schedule A as miscellaneous itemized deductions, subject to the 2-percent floor, because the expenses were incurred by virtue of her status as an employee. Vitarbo v. Comm'r., T.C. Summary 2014-11 (2/6/14).

Elizabeth Vitarbo, a licensed and practicing neurosurgeon, entered into a physician recruitment agreement with Wilson Medical Center (WMC) in 2004. The agreement was intended to induce Dr. Vitarbo to establish a neurosurgery practice in the geographic area that WMC served. In return for her doing so, the agreement provided that (1) Dr. Vitarbo would be guaranteed a minimum net income; (2) her moving expenses would be reimbursed; and (3) WMC would pay her student loan debt. Under the agreement, Dr. Vitarbo was obligated to repay those amounts if she failed to fulfill her obligations. Dr. Vitarbo also executed three promissory notes for her debts arising from the agreement. To conduct her medical practice, Dr. Vitarbo formed an S corporation, Wilson Neurosurgical Associates (WNA), of which she was the sole shareholder and employee. In 2006, Dr. Vitarbo began to conduct her medical practice as an employee of an educational institution and she dissolved WNA in 2007. Subsequently a dispute arose between Dr. Vitarbo and WMC. Dr. Vitarbo filed a lawsuit against WMC, claiming she was fraudulently induced to enter into the agreement. The lawsuit was settled in 2007. As part of the settlement, Dr. Vitarbo agreed to repay WMC $240,000. In connection with the lawsuit, Dr. Vitarbo incurred legal fees of $120,000. She paid $60,000 of those fees in 2008.

On her 2008 federal income tax return, Dr. Vitarbo attached Schedule C, Profit or Loss From Business. Her Schedule C showed a net loss of over $51,000, which was comprised of $15,000 of income attributable to her medical practice and deductions for the following expenses: legal fees from the WMC lawsuit ($60,000), rental fees for a storage unit for her medical records ($1,200), and travel to attend professional conferences ($1,000). After processing her return, the IRS treated the deductions for rent, travel, and legal fees as miscellaneous itemized deductions that should have been claimed on Schedule A, Itemized Deductions, instead of on Schedule C.

Under Code Sec. 62, an individual performing services as an employee may deduct expenses paid or incurred in the performance of services as an employee as miscellaneous itemized deductions on Schedule A to the extent the expenses exceed 2 percent of the taxpayer's adjusted gross income. Code Sec. 162 allows a taxpayer to deduct ordinary and necessary expenses paid or incurred in carrying on a trade or business. Code Sec. 212 provides that a taxpayer can deduct ordinary and necessary expenses paid or incurred for the production of income.

Dr. Vitarbo argued that she was not an employee of WMC and that the deductions were all related to her trade or business as a neurosurgeon and therefore should be subtracted from her gross income in arriving at adjusted gross income.

The IRS contended that the disputed deductions should be taken into account by subtracting them from her adjusted gross income because she did not practice medicine as a sole proprietor at any relevant time. Instead, the IRS stated, she was either an employee of WNA or an employee of the educational institution during the time she provided services to WMC.

The Tax Court held that Dr. Vitarbo should have reported the expenses on Schedule A because she was an employee of WNA until her employment with the educational institution began in 2006. The court noted that, under Code Sec. 62(a), adjusted gross income means gross income minus deductions from various categories. Trade or business expenses are included in the provision if the trade or business of the taxpayer does not consist of the performance of services by the taxpayer as an employee. In this case, Dr. Vitarbo failed to establish that, at any relevant time, she practiced medicine under circumstances other than as an employee or in a manner that required the income and deductions attributable to her medical practice to be shown on Schedule C.

For a discussion of unreimbursed employee expenses, see Parker Tax ¶85,105. (Staff Contributor Parker Tax Publishing)

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