PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE. T.C. Summary Opinion 2013-28
UNITED STATES TAX COURT
EVERARDO GARCIA, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11987-11S. Filed April 3, 2013.
Everardo Garcia, pro se.
Linette B. Angelastro and Jordan Scott Musen, for respondent.
SUMMARY OPINION
PANUTHOS, Chief Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in effect when the
petition was filed. Pursuant to section 7463(b), the decision to be entered is not
reviewable by any other court, and this opinion shall not be treated as precedent for -2-
any other case. Unless otherwise indicated, subsequent section references are to the
Internal Revenue Code (Code) in effect for the year in issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
In a notice of deficiency dated May 12, 2011, respondent determined a
deficiency in petitioner’s Federal income tax of $9,729 and a section 6662(a)
accuracy-related penalty of $1,938 for tax year 2008. After a concession,1 the
issues for decision are: (1) whether petitioner is entitled to deductions claimed on
Schedule C, Profit or Loss From Business; (2) whether petitioner is entitled to
deductions claimed on Schedule E, Supplemental Income and Loss, in excess of the
amounts allowed by respondent; (3) whether petitioner is subject to restrictions
under section 32(k)(1)(B)(ii) from receiving an earned income tax credit for tax
years 2009 and 2010; and (4) whether petitioner is liable for the accuracy-related
penalty under section 6662(a).
Background
Some of the facts have been stipulated, and we incorporate the Stipulation of
Facts, Supplemental Stipulation of Facts, and the accompanying exhibits by this
1 Respondent concedes that petitioner did not receive $128 of unreported income from OmniLife USA in 2008. -3-
reference.2 Petitioner resided in California when his petition was filed. Petitioner’s
testimony was given through an interpreter at trial.
Petitioner timely filed a joint Federal income tax return for tax year 2008.
Although petitioner filed a joint return, he was single during 2008. Petitioner’s 2008
return was prepared by JIR Business Management Service.3
In 2008 petitioner was self-employed as a performer in a mariachi group.
Petitioner also owned two rental properties. One property was an apartment
complex in Lompoc with four apartments (Lompoc apartment complex), and the
other was a single-family residence. Petitioner filed with his 2008 return a Schedule
C on which he reported gross receipts and claimed car and truck expenses for his
business activity. Petitioner also filed a Schedule E on which he reported rental
income and expenses for the two rental properties.
2 Many of the documents petitioner submitted were attached as exhibits to the Supplemental Stipulation of Facts, which was filed after trial. Respondent objected to introduction of a number of those exhibits on the grounds of relevancy, authenticity, and hearsay. We need not and do not rule on the admissibility of those exhibits because any additional deductions we allow are not allowed on the basis of documents to which respondent objects. 3 Respondent asserted at trial that petitioner’s return preparer was under indictment for filing fraudulent returns and for identity theft. -4-
On May 12, 2011, respondent issued a notice of deficiency to petitioner
disallowing certain deductions that petitioner claimed on Schedules C and E as
follows:
Schedule C
Amount Expense Amount claimed disallowed Amount allowed Car and truck $8,100 $8,100 ---
Schedule E
Amount Expense Amount claimed disallowed Amount allowed Utilities $4,719 $2,721 $1,998 Repairs 3,033 2,134 899 Depreciation expense or depletion 26,908 22,545 4,363 Management fees 2,400 2,400 --- Legal and other professional fees 5,890 5,890 ---
The notice of deficiency also determined that petitioner recklessly or intentionally
disregarded rules and regulations when he claimed the earned income tax credit for
2008, and he is therefore subject to the restrictions in section 32(k)(1)(B)(ii) for
2009 and 2010. Respondent also determined an accuracy-related penalty under
section 6662(a). -5-
Discussion
The Commissioner’s determination set forth in a notice of deficiency is
presumed correct, and a taxpayer generally bears the burden of proving otherwise.
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions are a
matter of legislative grace, and the taxpayer bears the burden of proving entitlement
to any deduction claimed. Rule 142(a); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934).
Pursuant to section 7491(a), the burden of proof may shift to the
Commissioner if the taxpayer produces credible evidence with respect to any
relevant factual issue and meets other requirements. Petitioner does not contend
that section 7491(a) shifts the burden of proof to respondent, nor does the record
establish that petitioner satisfies the section 7491(a)(2) requirements.
Section 162(a) allows a deduction for ordinary and necessary expenses paid
or incurred during the taxable year in carrying on any trade or business. In order for
an expense to be “necessary”, it must be “appropriate and helpful” to the taxpayer’s
business. Welch v. Helvering, 290 U.S. at 113. An expense will be considered
“ordinary” if it is a common or frequent occurrence in the type of business in which
the taxpayer is involved. Deputy v. Du Pont, 308 U.S. 488, 495 (1940). To be
engaged in a trade or business, an individual must be involved in an activity with -6-
continuity and regularity and the primary purpose for engaging in the activity must
be for income or profit. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).
Taxpayers must keep sufficient records to substantiate any deductions
claimed. Sec. 6001. As a general rule, if the trial record provides sufficient
evidence that the taxpayer has incurred a deductible expense but the taxpayer is
unable to adequately substantiate the precise amount of the deduction to which he is
otherwise entitled, the Court may estimate the amount of the deductible expense and
allow the deduction to that extent, bearing heavily against the taxpayer whose
inexactitude in substantiating the amount of the expense is of his own making.
Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). We cannot estimate
the amount, however, unless the taxpayer proves that he or she paid or incurred
some deductible expense and provides some basis from which we can develop a
reasonable estimate. Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957).
In the case of expenses paid or incurred with respect to listed property, e.g.,
passenger automobiles or other property used as a means of transportation, section
274(d) overrides the Cohan doctrine and provides that these expenses are deductible
only if the taxpayer meets stringent substantiation requirements. Secs. 274(d), -7-
280F(d)(4); see Lewis v. Commissioner, 560 F.2d 973, 977 (9th Cir. 1977), rev’g
on other grounds T.C. Memo. 1974-59; Sanford v. Commissioner, 50 T.C. 823,
827-828 (1968), aff’d per curiam, 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a),
Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).
I. Schedule C Car and Truck Expenses
Petitioner claimed, and respondent disallowed, a deduction for Schedule C
car and truck expenses of $8,100. Petitioner submitted a document titled “Mileage
Travel” to substantiate the amount claimed on his Schedule C; but when he was
asked at trial about the amount of car and truck expenses he claimed, petitioner
stated: “I have no idea.”
Passenger automobiles are “listed property” under section 280F(d)(4).
Section 274(d) disallows any deduction with respect to listed property unless the
taxpayer adequately substantiates: (1) the amount of the expense, (2) the time and
place of the travel or use of the property, (3) the business purpose of the expense,
and (4) the business relationship of the persons using the property.
Although petitioner introduced a mileage log to document the amount of
travel, he did not introduce evidence of the business purposes for which he used the
vehicle. We find that petitioner has not satisfied the strict substantiation -8-
requirements of section 274(d), and we conclude that he is not entitled to any
deduction for car and truck expenses for 2008.
II. Schedule E Deductions
A. Utilities
Petitioner claimed a deduction of $4,719 for utilities related to the Lompoc
apartment complex, and respondent disallowed $2,721 of that amount. Petitioner
testified that he had all the receipts to substantiate the claimed deduction, but he was
uncertain whether he submitted all of the receipts as exhibits. He provided copies of
utility bills, canceled checks, and bank statements to substantiate his claimed
deduction for utility expenses.
Many of the receipts that petitioner submitted to substantiate his deduction
duplicated amounts respondent previously allowed. Respondent allowed a $1,998
deduction for utility expenses, which corresponds to the City of Lompoc utility bills
attached to the Stipulation of Facts as pages 9 through 20 of Exhibit 18-P.
In addition to the amounts respondent already allowed, petitioner submitted
documents that substantiate a portion of the disallowed deduction for utility
expenses. Petitioner established that he paid an additional $159.10 for utilities to
the City of Lompoc, which petitioner was billed for on November 14, 2007, but did
not pay until January 9, 2008. -9-
Petitioner also substantiated utility payments made to the Southern
California Gas Co. Petitioner submitted a gas bill dated October 19, 2007, for the
Lompoc apartment complex. Although that bill does not relate to the year at issue,
it does provide the account number that corresponds to the Lompoc apartment
complex. The bank statements and canceled checks that petitioner submitted
establish that petitioner paid $1,610.54 to the Southern California Gas Co. in
2008.
On the basis of the documents petitioner submitted to substantiate his
claimed deduction for utility expenses, petitioner is entitled to an additional
$1,770 deduction for utility expenses above the $1,998 respondent allowed for
B. Repairs
Petitioner claimed a deduction of $3,033 for repairs related to the Lompoc
apartment complex, and respondent disallowed $2,134 of that amount. To
substantiate the deduction he claimed, petitioner submitted plumbing bills from
W.M. Rieck Plumbing, bank statements, and copies of canceled checks.
Respondent allowed a deduction of $899 for repairs, and some of the plumbing bills
that petitioner submitted duplicated the amount already allowed. - 10 -
In addition to the amounts respondent already allowed, petitioner submitted
documents that substantiate a portion of the disallowed deduction for repairs.
Petitioner established that he paid an additional $156.96 to W.M. Rieck Plumbing
on January 8, 2008, for which he is entitled to a deduction. Petitioner’s documents
also established that he made payments totaling $938.45 in 2008 to Mid-Coast
Glass Co., Home Depot, and Ace Hardware and for pest control services. Petitioner
did not testify about these amounts, and it is not clear from the substantiating
documents that these expenses related solely to the Lompoc apartment complex. It
is clear from the record that petitioner did incur repair expenses for the Lompoc
apartment complex, and we find that most of these payments related to the Lompoc
apartment complex. Using our best judgment we estimate that petitioner is entitled
to additional deductions of $157 for the plumbing expense and $626 for the
remaining repairs, for a total deduction of $783 above the $899 respondent allowed
for 2008.
C. Schedule E Depreciation
Petitioner claimed $26,908 in depreciation deductions for both the Lompoc
apartment complex and the single-family rental home in 2008. Of that amount,
$22,545 was for the Lompoc apartment complex. The amount was determined by
using the straight-line method, a cost basis of $620,000, and a recovery period of - 11 -
27.5 years. Respondent disallowed the $22,545 depreciation deduction for the
Lompoc apartment complex and contends that petitioner did not establish the cost or
other basis of the building or that it is depreciable.
A taxpayer is allowed to deduct a reasonable allowance for the exhaustion
and wear and tear of property used in a trade or business or held for the production
of income. Sec. 167(a). Pursuant to section 168(a), the depreciation deduction for
any tangible property is generally determined by using the applicable depreciation
method, the applicable convention, and the applicable recovery period. The period
for depreciation of an asset begins when the asset is first placed into service. Sec.
1.167(a)-10(b), Income Tax Regs.
Generally, depreciation is computed by using the cost of the property as its
basis. Secs. 167(c), 1011, 1012; sec. 1.167(g)-1, Income Tax Regs. If depreciable
property and nondepreciable property such as real property with improvements are
bought for a lump sum, the cost must be apportioned between the land and the
improvements. United States v. Hill, 506 U.S. 546, 559 (1993); sec. 1.167(a)-5,
Income Tax Regs. Under section 1.167(a)-5, Income Tax Regs., the depreciation
allowance must be based on the proportionate value of the building in relation to
that of the land at the time of acquisition. - 12 -
To establish the basis for the disallowed portion of his claimed depreciation
deduction relating to the Lompoc apartment complex, petitioner submitted a Buyer’s
Estimated Settlement Statement, an Asset Life History worksheet, and an Asset
Entry Worksheet. The estimated settlement statement is dated March 1, 2007,
provides an estimated closing date of March 6, 2007, for petitioner’s purchase of
the Lompoc apartment complex, and lists the purchase price as $620,000. The
Asset Life History worksheet uses $620,000 as petitioner’s basis in the property to
calculate the yearly allowable depreciation, and the Asset Entry Worksheet states
that 100% of the property is used for business.
There is nothing in the record that apportions the $620,000 purchase price for
the Lompoc apartment complex between the land and the improvements at the time
of acquisition. Petitioner has not established that he is entitled to a depreciation
deduction under section 167, nor has he provided us a basis on which we might
estimate the claimed depreciation expense attributable to the Lompoc apartment
complex. See Cohan v. Commissioner, 39 F.2d at 543-544. Accordingly, we
sustain respondent’s determination that petitioner is not entitled to a depreciation
deduction in excess of that already allowed with respect to the 2008 taxable year. - 13 -
D. Schedule E Management Fees
Petitioner claimed, and respondent disallowed, a $2,400 deduction for
management fees for the Lompoc apartment complex. Petitioner did not provide
any receipts to substantiate the management fees, but he credibly testified that he
paid the manager $200 in cash per month. We allow petitioner the $2,400
deduction on the basis of his testimony.
E. Schedule E Legal and Other Professional Fees
Petitioner claimed, and respondent disallowed, a $5,890 deduction for legal
and other professional fees for the Lompoc apartment complex. When petitioner
was questioned about the deduction, he said: “I don’t know what that might be. I
have no idea.” Petitioner submitted several documents to try to substantiate the
deduction. Among the documents are a retainer agreement between petitioner and
Consumer Protection Legal Services, Inc., dated June 12, 2009, and a copy of a
check dated November 27, 2007 for $200, payable to First Housing of America.
Petitioner also submitted copies of two additional checks payable to First Housing
of America, dated February 12 and April 9, 2008, for $1,595 and $1,795,
respectively, and a check dated December 2, 2008, for $2,000, payable to Gary
Lane. - 14 -
Petitioner may have incurred legal and other professional fees during 2008 in
relation to the Lompoc apartment complex, but his testimony and the documents
submitted do not provide a basis to estimate the claimed expense. See Cohan v.
Commissioner, 39 F.2d at 543-544. Some of the documents relate to years other
than 2008, and the documents that do relate to 2008 do not establish that the
amounts paid were for legal or other professional fees. We sustain respondent’s
determination disallowing the deduction for legal and other professional fees.
III. Earned Income Tax Credit
The notice of deficiency determined on the basis of the adjustments
respondent made to petitioner’s earned income that petitioner was not entitled to
the earned income tax credit (EITC). The notice of deficiency also determined
that petitioner’s claim of the EITC for 2008 was due to reckless or intentional
disregard of the rules or regulations and is thus restricted under section
32(k)(1)(B)(ii).
A. Denial of EITC Under Section 32(i)
Section 32(a) provides a credit in “an amount equal to the credit percentage
of so much of the taxpayer’s earned income * * * as does not exceed the earned
income amount.” Section 32(i)(1), however, provides that “[n]o credit shall be
allowed under subsection (a) for the taxable year if the aggregate amount of - 15 -
disqualified income of the taxpayer for the taxable year exceeds $2,200.” This
amount is increased for inflation under section 32(j). “Disqualified income”
includes gross income from rent over the sum of the deductions allocable to that
gross income. Sec. 32(i)(2)(C).
Petitioner reported income of $2,946 on his Schedule E for 2008. This
amount did not exceed the allowable amount of disqualified income for tax year
2008. See sec. 32(i) and (j). Respondent, in the notice of deficiency, determined
that petitioner was not entitled to certain deductions claimed on his 2008 Schedule
E. Even after the additional deductions that we have allowed, petitioner’s
disqualified income exceeds the allowable amount for tax year 2008. See id.
Accordingly, petitioner is not entitled to the EITC claimed for tax year 2008.
B. Section 32(k)(1)(B)(ii) Restriction
Section 32(k)(1)(B)(ii) disallows the EITC for
the period of 2 taxable years after the most recent taxable year for which there was a final determination that the taxpayer’s claim of credit under this section was due to reckless or intentional disregard of rules and regulations (but not due to fraud).
The EITC petitioner claimed on his 2008 return was determined in the notice of
deficiency to be due to petitioner’s “reckless or intentional disregard of the rules
and regulations regarding the earned income tax credit under Internal Revenue Code - 16 -
section 32(k)(1)(B)(ii).” Respondent further asserted at trial that petitioner
recklessly or intentionally disregarded the rules and regulations because respondent
“think[s] what happened is [petitioner] went to a return preparer who essentially
disregarded the tax law in the preparation of the return because normal software
would have kicked out if you had Schedule E income that high.”
Though petitioner was unable to substantiate all of the disallowed
deductions, he did establish that he was entitled to deductions greater than
respondent allowed and provided credible testimony that he wanted to cooperate
and did not understand his return preparer’s legal problems. Although petitioner
is not entitled to the EITC for 2008 because of the adjustments to his earned
income, we are satisfied that petitioner’s claim of the EITC for tax year 2008 was
not due to a reckless or intentional disregard of rules and regulations. Thus,
petitioner is not subject to the restriction under section 32(k)(1)(B)(ii) for 2009
and 2010.
IV. Accuracy-Related Penalty
Section 6662(a) and (b)(1) and (2) imposes a penalty of 20% of the portion of
an underpayment of tax attributable to the taxpayer’s negligence, disregard of rules
or regulations, or substantial understatement of income tax. “Negligence” includes
any failure to make a reasonable attempt to comply with the Code, including any - 17 -
failure to keep adequate books and records or to substantiate items properly. See
sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. A “substantial
understatement” includes an understatement of income tax that exceeds the greater
of 10% of the tax required to be shown on the return or $5,000. See sec. 6662(d);
sec. 1.6662-4(b), Income Tax Regs.
With respect to a taxpayer’s liability for any penalty, section 7491(c) places
on the Commissioner the burden of production, thereby requiring the Commissioner
to come forward with sufficient evidence indicating that it is appropriate to impose
the penalty. Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). Once the
Commissioner meets his burden of production, the taxpayer must come forward
with persuasive evidence that the Commissioner’s determination is incorrect. See
id. at 447; see also Rule 142(a); Welch v. Helvering, 290 U.S. at 115.
Petitioner claimed some deductions on his 2008 return that he is unable to
substantiate. Furthermore, the underpayment of tax required to be shown on his
return is a substantial understatement of income tax because the understatement
exceeds $5,000, which is greater than 10% of the tax required to be shown on the
return. See sec. 6662(b)(2), (d)(1); sec. 1.6662-3(b)(1), Income Tax Regs.
Respondent’s burden of production under section 7491(c) has been satisfied. - 18 -
The section 6662(a) accuracy-related penalty does not apply with respect to
any portion of an underpayment if the taxpayer proves that there was reasonable
cause for such portion and that he acted in good faith with respect thereto. Sec.
6664(c)(1). The determination of whether a taxpayer acted with reasonable cause
and in good faith depends on the pertinent facts and circumstances, including the
taxpayer’s efforts to assess the proper tax liability; the knowledge and the
experience of the taxpayer; and the reliance on the advice of a professional, such as
an accountant. Sec. 1.6664-4(b)(1), Income Tax Regs. Reliance upon expert
advice will not exculpate a taxpayer who supplies the return preparer with
incomplete or inaccurate information. Lester Lumber Co. v. Commissioner, 14 T.C.
255, 263 (1950). Reliance on a preparer or software is not reasonable where even a
cursory review of the return would reveal inaccurate entries. See Pratt v.
Commissioner, T.C. Memo. 2002-279.
The underpayment at issue is attributable to the Schedule C and E
adjustments that respondent made. We are satisfied that petitioner, whose
command of the English language is limited, made a good-faith effort to properly
determine his 2008 Federal income tax liability and that the underpayment results
from reliance on the advice of a return preparer, combined with an honest
misunderstanding of fact or law that is reasonable in the light of his experience and - 19 -
knowledge. Accordingly, we hold that petitioner is not liable for the section
6662(a) accuracy-related penalty for 2008.
To reflect the foregoing,
Decision will be entered under
Rule 155.