T.C. Memo. 2021-89
UNITED STATES TAX COURT
JACOB BERGER AND EVELYN R. BERGER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 17196-18. Filed July 15, 2021.
Kenneth P. Fehl, for petitioners.
Michael Skeen, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
NEGA, Judge: By notice of deficiency dated June 6, 2018, respondent
determined deficiencies in petitioners’ Federal income tax and accuracy-related
penalties under section 6662(a)1 as follows:
1 Unless otherwise indicated, all section references are to the Internal (continued...)
Served 07/15/21 -2-
[*2] Penalty Year Deficiency sec. 6662(a) 2013 $32,167 $6,433 2014 18,237 3,647
After concessions,2 the issues remaining for decision are whether:
(1) petitioners are entitled to deduct certain Schedule F expenses for the years at
issue; (2) petitioners received Schedule F gross receipts of $15,000 and $5,000 for
the years at issue, respectively; (3) petitioners are entitled to deduct alimony
payments of $16,800 and $15,500 for the years at issue, respectively; and
(4) petitioners are liable for accuracy-related penalties of $6,433 and $3,647 for
the years at issue, respectively.
1 (...continued) Revenue Code (Code), in effect for the years at issue, and all Rule references are the Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar. All percentages are rounded to the nearest whole number. 2 Petitioners concede that they are not entitled to deduct $55,000 and $18,000 claimed for contract labor expenses on their Schedule F, Profit or Loss From Farming, for tax years 2013 and 2014 (years at issue), respectively. As will be discussed below, petitioners assert instead that they are entitled to deductions of $17,000 and $8,000 for equipment expenses for the years at issue, respectively. Additionally, petitioners do not dispute that they received and failed to report $72 of taxable interest for 2013. -3-
[*3] FINDINGS OF FACT
Some of the facts are stipulated and are so found. The stipulation of facts
and supplemental stipulation of facts with exhibits attached thereto are incorpo-
rated herein by this reference. Petitioners resided in California at the time the
petition was filed.
A. Cannabidiol Oil Extraction Venture
Jacob Berger (petitioner husband) obtained a bachelor’s degree in biochem-
istry and a master’s degree in pharmaceutical chemistry in Jerusalem, Israel. After
completing his education abroad, petitioner husband and Evelyn Berger moved in
1981 to Palo Alto, California, when petitioner husband obtained employment at
Syntex Corp. (Syntex), a pharmaceutical company. Petitioner husband remained
employed at Syntex until 2010 when the company decided to close the Palo Alto
site at which he worked. Upon termination of petitioner husband’s employment,
Syntex provided him with retirement benefits and a severance package.
In the process of closing its Palo Alto site, Syntex decided to sell some of its
technical equipment. Since petitioner husband had developed an expertise in
fixing technical equipment used for manufacturing pharmaceutical drugs while
working at Syntex, the company asked him to fix and prepare the equipment for
sale. Petitioner husband prepared the equipment for sale and, as compensation for -4-
[*4] his services, received several pieces of equipment, which were stored unused
in his garage until some point in the years at issue.
At a time not specified in the record, petitioner husband and Nadav Berger
(petitioners’ son) decided to enter into a business venture that involved the
cultivation of cannabis plants for the purpose of extracting cannabidiol (CBD) oil
and selling the CBD oil for medicinal use. Petitioner husband and petitioners’ son
entered into the venture with the understanding that petitioner husband would
supply the necessary funding and, when the venture eventually became profitable,
petitioner husband would recuperate the funds he had invested before profits were
otherwise distributed to petitioner husband and petitioners’ son.
During the years at issue petitioner husband provided the funds to purchase
the equipment used to grow and maintain the cannabis and to pay the venture’s
other expenses, which included rent for a greenhouse in Santa Nella, California,
electricity, water, and phone bills. Petitioner husband funded these expenses by
either paying them directly or giving cash and checks to petitioners’ son for him to
do so. Petitioners also provided petitioners’ son with a car to drive the 83 miles -5-
[*5] between their home in Sunnyvale, California, and the greenhouse where the
cannabis plants were to be cultivated in Santa Nella.3
In addition to funding the venture, petitioner husband also intended to
develop and implement an improved method for extracting CBD oil. Before
petitioner husband was able to implement the improved extraction method at the
greenhouse, however, petitioners’ son unexpectedly died on August 22, 2014. As
a result of petitioners’ son’s death, petitioner husband ceased all operations of the
venture.
B. Alimony
On September 15, 1998, Merav Berger (petitioners’ daughter) and Vardi
Moscovitch (Mr. Moscovitch) married in Israel, where they resided with their two
children. On May 22, 2003, petitioners’ daughter and Mr. Moscovitch divorced,
and on June 21, 2011, they executed a divorce agreement to that effect.
The divorce agreement included a visitation arrangement, which provided
for travel arrangements in the event that petitioners’ daughter moved to the United
States with the children. Under the visitation arrangement, petitioners’ daughter
would be required to pay for the children to travel to Israel twice a year to visit
Mr. Moscovitch and for Mr. Moscovitch to travel to the United States three times
3 During the years at issue petitioners’ son lived with petitioners. -6-
[*6] a year to visit the children. With respect to Mr. Moscovitch’s travel, petition-
ers’ daughter was obliged to provide a round trip airplane ticket, lodging at a hotel
of her selection, access to a vehicle, and a stipend of $100 per day for up to 14
days. In addition, petitioners’ daughter would be required to provide for three
additional people, such as Mr. Moscovitch’s mother, his girlfriend, and his girl-
friend’s son, to travel to the United States once a year. In the event that petition-
ers’ daughter or petitioners, who were also bound by the divorce agreement, could
not fulfill these obligations, the visitation arrangement stated that petitioners’
daughter and the children would be required to return to Israel.
At a time not specified in the record, petitioners’ daughter and her two
children moved to the United States. During the years at issue petitioners’
daughter and her children lived with and were financially supported by petitioners.
Because petitioners’ daughter was unable to fulfill her obligations under the
visitation arrangement, petitioners provided the necessary financing on her behalf.
As per the visitation arrangement, petitioners paid for the children to travel to
Israel and for Mr. Moscovitch, Mr. Moscovitch’s mother, and Mr. Moscovitch’s
girlfriend and her son to travel to the United States and petitioners provided the
agreed-upon vehicle and stipend. -7-
[*7] C. Tax Returns, Notice, Petition, and Trial
Petitioners filed joint tax returns for the years at issue. On each return they
claimed an alimony deduction for the travel expenses they paid to satisfy petition-
ers’ daughter’s obligations under the visitation arrangement. They also attached to
each return a Schedule F reporting “medici[n]al herbs” as the principal crop or
activity of the venture. Petitioners reported the following alimony deductions and
Schedule F gross receipts and expenses for the years at issue:
Schedule F gross receipts and expenses Tax return deduction-- Sale of livestock and Car and truck Utility Contract Year alimony other resale items expenses Rent expenses labor 2013 ($16,800) $15,000 ($16,950) ($15,000) ($12,000) ($55,000) 2014 (15,500) 5,000 (11,200) (10,000) (9,600) (18,000)
By notice of deficiency dated June 6, 2018, respondent determined tax
deficiencies of $32,167 and $18,237 for the years at issue, respectively. Respon-
dent also determined that petitioners were liable for section 6662(a) accuracy-
related penalties of $6,433 and $3,647 for the years at issue, respectively, for
underpayments due to substantial understatements of income tax or negligence or
disregard of rules or regulations for both years. Attached to the notice of defi-
ciency was a Form 886-A, Explanation of Items, in which respondent explained -8-
[*8] why he disallowed the claimed alimony deductions and Schedule F gross
receipts and expenses.
On August 31, 2018, petitioners filed a petition with this Court seeking
redetermination of the deficiencies set forth in the notice of deficiency. On
December 11, 2019, this case was tried at the Court’s trial session in San Fran-
cisco, California. At trial the parties jointly submitted a stipulation of facts and a
supplemental stipulation of facts, which included copies of, inter alia, petitioners’
joint tax returns for the years at issue, four checks that petitioners assert were
payments for rent, three checks that petitioners assert were payments for water,
and checks and withdrawal statements that petitioners assert were payments to
petitioners’ son to cover the venture’s expenses.
These stipulations also included a copy of a Letter 950--dated August 17,
2017, and signed by the acting group manager of the revenue agent assigned to
petitioners’ case--with an attached Form 4549-A, Income Tax Examination
Changes, which asserted the penalties against petitioners, as well as a copy of a
Civil Penalty Approval Form, dated and signed in October 2017.4
4 The Civil Penalty Approval Form is dated October 2, 2017. Although it appears to be signed on October 10, 2017, the date is difficult to read; indeed, the “17” for “2017” appears like a giant “D”. Consequently, the Court will simply find that the form was dated and signed in October 2017. -9-
[*9] OPINION
I. Burden of Proof
As a general rule, the Commissioner’s determinations are presumed correct,
and the taxpayer bears the burden of proving otherwise. Rule 142(a)(1); Welch v.
Helvering, 290 U.S. 111, 115 (1933). Section 7491(a)(1) provides that the burden
of proof will shift to the Commissioner when the taxpayer has introduced credible
evidence with respect to any factual issue relevant to ascertaining the liability of
the taxpayer for any tax. However, the burden of proof does not shift to the
Commissioner unless the taxpayer complied with all substantiation requirements,
maintained all required records, and cooperated with reasonable requests by the
Internal Revenue Service. Sec. 7491(a)(2); Higbee v. Commissioner, 116 T.C.
438, 440-441 (2001). Section 7491(c) provides that the Commissioner shall have
the burden of production with respect to any penalty. See Higbee v. Commis-
sioner, 116 T.C. at 446-447.
A taxpayer who provides only self-serving testimony and inconclusive
documentation is not considered to have provided credible evidence. Geiger v.
Commissioner, T.C. Memo. 2006-271, aff’d, 279 F. App’x 834 (11th Cir. 2008);
see Blodgett v. Commissioner, 394 F.3d 1030 (8th Cir. 2005), aff’g T.C. Memo.
2003-212; Higbee v. Commissioner, 116 T.C. at 445-446. Credible evidence is - 10 -
[*10] evidence that, “after critical analysis, the court would find sufficient upon
which to base a decision on the issue if no contrary evidence were submitted”.
Higbee v. Commissioner, 116 T.C. at 442 (quoting H.R. Conf. Rept. No. 105-599,
at 240 (1998), 1998-3 C.B. 747, 994). Evidence is not credible if the Court is not
convinced that it is worthy of belief. Id.
Petitioners argue that they have satisfied the requirements of section
7491(a)(1) and respondent should bear the burden of proof. We disagree. On the
basis of the record before us, we conclude that petitioners have not introduced
credible evidence with respect to the factual issues presented. Petitioners provided
only incomplete and inconclusive documentation, along with uncredible testi-
mony. Because petitioners did not introduce credible evidence with respect to
those factual issues, the burden of proof does not shift to respondent under section
7491(a)(1). Accordingly, we need not decide whether petitioners have complied
with the requirements of section 7491(a)(2), and petitioners retain the burden of
proving they are entitled to the Schedule F deductions claimed. See Rule 142(a).
With respect to the Schedule F gross receipts, petitioners also bear the burden of
proving that they received the reported income. See sec. 6001. - 11 -
[*11] II. Schedule F Deductions
Deductions are a matter of legislative grace, and the taxpayer bears the
burden of proving his or her entitlement to any deductions claimed. Rule 142(a);
Deputy v. du Pont, 308 U.S. 488, 493 (1940); New Colonial Ice Co. v. Helvering,
292 U.S. 435, 440 (1934). This burden requires the taxpayer to demonstrate that
the claimed deduction is allowable pursuant to some statutory provision and to
substantiate the expense giving rise to the deduction claimed by maintaining and
producing adequate records to enable the Commissioner to determine the tax-
payer’s correct liability. Sec. 6001; Higbee v. Commissioner, 116 T.C. at 440;
Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), aff’d per curiam, 540 F.2d 821
(5th Cir. 1976).
A taxpayer must further substantiate that the expense to which the deduction
relates has been paid or incurred. See sec. 6001; Hradesky v. Commissioner, 65
T.C. at 90; sec. 1.6001-1(a), Income Tax Regs. In the event that a taxpayer
establishes that a deductible expense has been paid but is unable to substantiate
the precise amount, we generally may estimate the amount of the deductible
expense, bearing heavily against the taxpayer whose inexactitude in substantiating
the amount of the expense is of the taxpayer’s own making. Cohan v. Commis-
sioner, 39 F.2d 540, 543-544 (2d Cir. 1930). We cannot estimate a deductible - 12 -
[*12] expense, however, unless the taxpayer presents evidence sufficient to
provide some basis upon which an estimate may be made. Vanicek v. Commis-
sioner, 85 T.C. 731, 742-743 (1985).
Section 162(a) allows a taxpayer to deduct all ordinary and necessary
expenses paid or incurred during the taxable year in carrying on a trade or busi-
ness. An expense is “ordinary” if it is “normal, usual, or customary” in the tax-
payer’s trade or business or arises from a transaction “of common or frequent
occurrence in the type of business involved.” Deputy v. du Pont, 308 U.S. at 495.
An expense is “necessary” if it is “appropriate and helpful” to the taxpayer’s
business, but it need not be absolutely essential. Commissioner v. Tellier, 383
U.S. 687, 689 (1966) (quoting Welch v. Helvering, 290 U.S. at 113). However, a
taxpayer may not deduct a personal, living, or family expense unless the Code
expressly provides otherwise. Sec. 262(a). The determination of whether an
expense satisfies the requirements of section 162 is a question of fact. Cloud v.
Commissioner, 97 T.C. 613, 618 (1991) (citing Commissioner v. Heininger, 320
U.S. 467, 473-475 (1943)).
The disallowed trade or business expense deductions at issue here can be
divided into two categories: (1) those that are subject to the more general substan-
tiation requirements of section 6001, such as rent, utilities, and equipment, and - 13 -
[*13] (2) those that are subject to the strict substantiation requirements of section
274(d), such as car and truck. We will first consider the disallowed trade or
business expense deductions subject to the general requirements of section 6001
and then turn to those deductions subject to the stricter requirements of section
274(d).
A. Deductions Subject to the General Substantiation Requirements of Section 6001
1. Rent
Petitioners claimed deductions of $15,000 and $10,000 for rent expenses for
tax years 2013 and 2014, respectively, which respondent disallowed because
petitioners failed to establish that these expenses were, in fact, paid or incurred
during the tax years at issue and that the expenses were ordinary and necessary to
the venture. To substantiate these expenses, petitioners submitted only four
checks purportedly representing payments for the months of January, February,
March, and April 2013. Each check was payable to “S. Salvador” (Mr. Salvador)
in the amount of $1,250 but did not bear any indication that it was a payment for
rent. During trial, petitioner husband stated that he and petitioners’ son rented the
greenhouse from Mr. Salvador, who wished to be paid in cash, and that they
signed a written lease, but that Mr. Salvador refused to give them a copy of it. - 14 -
[*14] Beyond these four checks and petitioner husband’s testimony, however,
petitioners failed to provide any additional evidence to corroborate that these
checks were, in fact, payments for rent. Petitioners did not provide a lease or, at a
minimum, an address for the greenhouse to evince that they were actually renting a
greenhouse to grow cannabis and extract CBD oil. Petitioners also failed to
introduce any bank statements to show consistent monthly withdrawals of $1,250
to corroborate their assertion that they paid Mr. Salvador during the years at issue.
On the basis of the scant facts and evidence presented, we conclude that petition-
ers have failed to provide credible evidence to substantiate these deductions, and
the Court sustains respondent’s determinations to disallow the claimed Schedule F
deductions for rent expenses for the years at issue.
2. Utilities
Petitioners claimed deductions of $12,000 and $9,600 for utility expenses,
which included payments for water, electricity, and a cell phone, for the years at
issue, respectively. Respondent disallowed these claimed deductions because
petitioners had failed to establish that the expenses were, in fact, paid or incurred
during the tax years at issue and that the expenses were ordinary and necessary to
the venture. To substantiate the water expenses, petitioners submitted only copies
of three checks in the amounts of $100, $100, and $150 made payable to the - 15 -
[*15] “Santa Nella Water District” (Water District) and purportedly representing
water payments for the months of January, March, and May 2013.
Notwithstanding these three checks to the Water District and petitioner
husband’s testimony, petitioners failed to provide any further evidence to corrobo-
rate that the checks were, in fact, payments for water for the venture or to other-
wise corroborate their assertions that they made payments for electricity and a cell
phone for the venture. With respect to the water expenses, petitioner husband
testified during trial that he incurred $200 per month in water expenses for 12
months in 2013 and 8 months in 2014; yet the three checks that petitioners
produced reflect payments of $100 for January 2013, $100 for March 2013, and
$150 for May 2013. Petitioner husband asserted that he procured a copy of an
invoice from the Water District, but he failed to submit it as evidence or provide
bank statements showing monthly payments to corroborate his position.
On account of the inconsistency between other evidence presented and
petitioner husband’s testimony, especially in the light of the fact that petitioners
failed to establish that they were even renting a greenhouse, we conclude that
petitioners have not provided credible evidence to substantiate the claimed water
expense deductions. With respect to the payments for electricity and a cell phone,
petitioners similarly have failed to produce credible evidence to substantiate these - 16 -
[*16] expenses. Accordingly, the Court sustains respondent’s determinations to
disallow the claimed Schedule F deductions for utility expenses for the years at
issue.
3. Equipment
Petitioners claimed “contract labor” expense deductions of $55,000 and
$18,000 for the years at issue, respectively, which respondent disallowed for lack
of substantiation. Petitioner husband initially testified that these expenses com-
prised the costs of equipment, which ranged from $20,000 to $30,000 for 2013
and $30,000 to $40,000 for 2014, and contract labor. However, petitioners later
conceded during trial that, after a subsequent review of the expenses for audit
purposes, the cost of equipment was instead $17,000 for 2013 and $8,000 for
2014. Included in these amounts was the cost of the technical equipment that
petitioner husband received as compensation from Syntex. Following trial,
petitioners appear to have abandoned their argument that they are entitled to
expense deductions related to contract labor, focusing instead on their entitlement
to the revised equipment expense deductions.
To substantiate the revised equipment expenses, petitioners submitted a
table for each tax year listing the type of equipment, number of units, unit price,
and total cost. Petitioners also submitted copies of checks and withdrawal - 17 -
[*17] statements, which they contend represent the money they gave to petition-
ers’ son to pay the venture’s expenses.
Section 167(a) allows, as relevant here, a deduction for “the exhaustion or
wear and tear” of property used in a trade or business. For some depreciable
property, a taxpayer can make an election under section 179(a) to accelerate
depreciation by deducting its cost as an expense for the taxable year in which the
property is placed in service. The election must specify the items of section 179
property to which the election applies and the portion of the cost of each which is
to be taken into account under subsection (a). Sec. 179(c)(1)(A). The election
must also be made on the taxpayer’s first income tax return for the taxable year or
a timely filed amended return. Sec. 179(c)(1)(B); sec. 1.179-5(a), Income Tax
Regs.
The record does not indicate that petitioners made an election under section
179(a) for either 2013 or 2014 to accelerate the depreciation of the equipment.
Indeed, the record lacks any documentation specifying each item of section 179
property to which the election applies. Accordingly, petitioners are not entitled to
deduct the equipment costs under section 179 as an expense for either 2013 or
2014 but, rather, must depreciate them under section 167, provided that they can
show their entitlement to such depreciation deductions. - 18 -
[*18] A taxpayer can claim depreciation deductions only for property it owns,
Arevalo v. Commissioner, 124 T.C. 244, 251-252 (2005), aff’d, 469 F.3d 436 (5th
Cir. 2006), and can start depreciating property only when it first places the
property into service in its trade or business, sec. 1.167(a)-10(b), Income Tax
Regs. To prove entitlement to a depreciation deduction, a taxpayer must also
establish the property’s depreciable basis by substantiating its cost, recovery
period, and any previous allowable depreciation. See Cluck v. Commissioner, 105
T.C. 324, 337 (1995).
Petitioner husband stated that he included the cost of the technical equip-
ment that he received from Syntex in the equipment expenses; however, he failed
to provide any documentation listing the cost of the property, its recovery period,
or any previous allowable depreciation on it. Furthermore, while petitioner
husband claimed to have used the equipment to develop and test an improved
method to extract CBD oil, he has not demonstrated when the equipment was
placed into service for purposes of section 167.
With respect to the equipment listed on the tables, petitioner husband
testified that he prepared the tables for audit purposes. Petitioner husband addi-
tionally avowed that the items listed were what he recalled “needed to be re-
placed” and what he and petitioners’ son anticipated were needed to begin the - 19 -
[*19] venture. Petitioner husband also averred that, because he had given money
to petitioners’ son to purchase the equipment during the years at issue, he went
online to a company that had supplied the listed items to find their prices.
These statements by petitioner husband indicate that: (1) the tables listing
the equipment expenses were prepared several years after petitioners filed their
joint tax returns for the years at issue, (2) the tables and the items listed therein
were reconstructed from petitioner husband’s memory, and (3) petitioner husband
lacks records, including receipts, of how much the items of equipment actually
cost when purchased. With respect to the copies of checks and withdrawal
statements that petitioners provided, these copies reflect money given to petition-
ers’ son for only eight months in 2013 and bear no indication as to how petition-
ers’ son used the money for the venture.
On the basis of the scant evidence that petitioners produced, we conclude
that they have not proven their entitlement to depreciation deductions under
section 167 for the years at issue. Accordingly, the Court sustains respondent’s
determinations to disallow the claimed Schedule F deductions for equipment
expenses for the years at issue. - 20 -
[*20] B. Deductions Subject to the Strict Substantiation Requirements of Section 274(d)
Petitioners claimed $16,950 and $11,200 in car and truck expense deduc-
tions for tax years at issue, respectively, which respondent disallowed for lack of
substantiation. In support of the underlying expenses, petitioner husband testified
that the greenhouse in Santa Nella was 83 miles from their home in Sunnyvale.
He asserted that he traveled to the greenhouse “once or twice a week” and that
petitioners’ son traveled to the greenhouse “three to four times a week”. Accord-
ing to petitioners, petitioner husband and petitioners’ son traveled to the green-
house a minimum of four to six times a week for 52 weeks in 2013 and four to six
times a week for 32 weeks in 2014. On the basis of these estimates, petitioners
advance that they are entitled to a car and truck expense deduction ranging from
$19,508 to $29,262 for 2013 and a deduction ranging from $11,899 to $17,848 for
2014. Petitioners also contend that these miles should not be characterized as
commuting miles because they represent travel between petitioner husband’s
“workplace in Sunnyvale” his home, and “the organic farm in Santa Nella”, the
greenhouse.
Section 274(d) imposes stricter substantiation requirements to be met before
a taxpayer may deduct certain categories of expenses, including, inter alia, - 21 -
[*21] expenses with respect to listed property as defined in section 280F(d)(4).
The term “listed property” includes passenger automobiles. Sec. 280F(d)(4)(A)(i).
To satisfy the requirements of section 274(d), a taxpayer must generally maintain
adequate records or produce sufficient evidence corroborating his or her own
statement which, in combination, are sufficient to establish the amount, the time
and place of the travel, and the business purpose for each expenditure. See sec.
1.274-5T(b)(2), (6), (c)(1), Temporary Income Tax Regs., 50 Fed. Reg. 46014-
46017 (Nov. 6, 1985).
Sec. 1.274-5T(c)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46017-
46018 (Nov. 6, 1985), provides, in relevant part, that “adequate records” generally
consist of an account book, a diary, a log, a statement of expense, trip sheets, or a
similar record made at or near the time of the expenditure or use, along with
supporting documentary evidence. The Court may not use the rule established in
Cohan v. Commissioner, 39 F.2d at 543-544, to estimate expenses covered by
section 274(d). Sanford v. Commissioner, 50 T.C. 823, 827 (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).
Moreover, expenses that a taxpayer generally incurs in commuting between
his home and his place of business are personal and nondeductible. Commissioner - 22 -
[*22] v. Flowers, 326 U.S. 465, 473-474 (1946); Heuer v. Commissioner, 32 T.C.
947, 951 (1959), aff’d per curiam, 283 F.2d 865 (5th Cir. 1960); secs. 1.162-2(e),
1.262-1(b)(5), Income Tax Regs. Expenses incurred for traveling between two or
more places of business, however, may be deductible under section 162 if incurred
for business reasons. Steinhort v. Commissioner, 335 F.2d 496, 503-504 (5th Cir.
1964), aff’g and remanding T.C. Memo. 1962-233; Heuer v. Commissioner, 32
T.C. at 953; see also Fausner v. Commissioner, 55 T.C. 620 (1971) (permitting
section 162 deductions for travel between jobs or job locations). But if one of the
places of business is the taxpayer’s residence, the residence must be the taxpayer’s
principal place of business for the trade or business the taxpayer conducts at those
other locations. See, e.g., Strohmaier v. Commissioner, 113 T.C. 106 (1999).
Petitioners have not produced adequate records or, at a minimum, any
evidence to corroborate petitioner husband’s statements regarding the car and
truck expenses. They have not provided an account book, a log, or any other form
of documentary evidence prepared contemporaneously with any expenditure
detailing its amount, the time and place it was incurred, or its business purpose to
satisfy the strict substantiation requirements of section 274(d). Moreover, peti-
tioners have not introduced any documentation proving that their home in
Sunnyvale served as the principal place of business for the venture; nor does the - 23 -
[*23] record support a such a finding. See, e.g., Rehman v. Commissioner, T.C.
Memo. 2013-71, at *140. Accordingly, the Court sustains respondent’s determi-
nations to disallow the claimed Schedule F deductions for car and truck expenses
for the years at issue.
III. Schedule F Gross Receipts
Petitioners reported gross receipts of $15,000 and $5,000 on their Sched-
ules F for the tax years 2013 and 2014, respectively. In the notice of deficiency
respondent disallowed the reported gross receipts because petitioners failed to
provide any evidence that they had, in fact, received any proceeds from the
Gross income includes all income from whatever source derived, see sec.
61(a), and taxpayers are required to keep books and records sufficient to establish
their Federal income tax liabilities, see sec. 6001. Where taxpayers fail to main-
tain adequate records to establish that liability, the Commissioner may reconstruct
their income by any method that the Commissioner believes reflects income
clearly. See sec. 446(b); see also Palmer v. U.S. IRS, 116 F.3d 1309, 1312-1313
(9th Cir. 1997); Parks v. Commissioner, 94 T.C. 654, 658 (1990); Petzoldt v.
Commissioner, 92 T.C. 661, 686-687 (1989). The Commissioner’s method need
not be exact; however, it must be reasonable in the light of the surrounding facts - 24 -
[*24] and circumstances. See Petzoldt v. Commissioner, 92 T.C. at 687; see also
Cracchiola v. Commissioner, 643 F.2d 1383, 1384-1385 (9th Cir. 1981), aff’g T.C.
Memo. 1979-3 and three other cases.
Petitioners did not submit any evidence to establish that the venture re-
ceived gross receipts as reported on their Schedules F for the years at issue, as
required under section 6001. Thus, respondent determined that petitioners did not
receive the income. Because of the lack of evidence to support petitioners’
reported Schedule F gross receipts, we find that respondent appropriately disal-
lowed the income and, accordingly, sustain respondent’s determinations to
disallow the reported Schedule F gross receipts for the tax years at issue.5
IV. Alimony
Section 215(a) allows a taxpayer a deduction for alimony payments during
the taxable year. The term “alimony” is defined for purposes of section 215(a) as
any payment of alimony that is includible in the income of the recipient under
section 71. See sec. 215(b). In pertinent part, section 71(b)(1) defines “alimony”
as any payment in cash that satisfies four requirements: (1) the payment is
5 Respondent also had raised a challenge as to whether petitioners had established that they were carrying on a trade or business during the tax years at issue. With our decision to sustain respondent’s determinations to disallow the Schedule F gross receipts and expenses, however, we need not consider respondent’s additional challenge. - 25 -
[*25] received by (or on behalf of) a spouse under a divorce or separation instru-
ment; (2) the divorce or separation instrument does not designate the payment as a
payment that is not includible in gross income under this section and not allowable
as a deduction under section 215; (3) in the case of an individual legally separated
from his spouse under a decree of divorce or of separate maintenance, the payee
spouse and the payor spouse are not members of the same household at the time
the payment is made; and (4) there is no liability to make the payment for any
period after the death of the payee spouse, and there is no liability to make any
payment (in cash or property) as a substitute for such payments after the death of
the payee spouse. Secs. 71(b)(1), 215(b).
Petitioners claimed alimony deductions of $16,800 and $15,500 for 2013
and 2014, respectively, which respondent disallowed. Petitioners argue that they
should be entitled to the claimed alimony deductions because they were bound by
the divorce agreement as guarantors in the event that petitioners’ daughter was
unable to satisfy her obligations under the visitation arrangement. Petitioners
further assert that they paid more than 50% of her financial support during the
years at issue, making petitioners’ daughter their dependent and entitling them to
the alimony deductions. - 26 -
[*26] A deduction for alimony under section 215 is permitted only to the obligor
spouse; “[i]t is not allowed to * * * any other person who may pay the alimony
obligation of such obligor spouse.” Sec. 1.215-1(b), Income Tax Regs. Assum-
ing, arguendo, that the obligations required under the visitation agreement consti-
tute alimony, petitioners are not entitled under section 215 and the accompanying
regulations to deduct any payments made on behalf of their daughter. Accord-
ingly, the Court sustains respondent’s determinations to disallow the alimony
deductions for the years at issue.
V. Section 6662(a) Penalty
Section 6662(a) and (b)(1) and (2) authorizes a 20% accuracy-related
penalty on any underpayment of Federal income tax attributable to a taxpayer’s
negligence or disregard of rules or regulations or a substantial understatement of
income tax. “‘[N]egligence’ includes any failure to make a reasonable attempt to
comply with the provisions of * * * [the Code], and the term ‘disregard’ includes
any careless, reckless, or intentional disregard.” Sec. 6662(c). “‘Negligence’ also
includes any failure by the taxpayer to keep adequate books and records or to
substantiate items properly.” Sec. 1.6662-3(b)(1), Income Tax Regs. For individ-
ual taxpayers there is a substantial understatement of income tax if the amount of
the understatement for the taxable year exceeds the greater of 10% of the tax - 27 -
[*27] required to be shown on the return for the taxable year or $5,000. Sec.
6662(d)(1)(A).
As indicated above, the Commissioner bears the burden of production with
respect to an individual taxpayer’s liability for accuracy-related penalties. Sec.
7491(c); Higbee v. Commissioner, 116 T.C. at 446. In Frost v. Commissioner,
154 T.C. 23, 34 (2020), we held that the Commissioner’s initial burden of produc-
tion under section 7491(c) includes producing evidence that he has complied with
the procedural requirements of section 6751(b); and, once he has satisfied this
initial burden, the taxpayer must come forward with contrary evidence. Section
6751(b)(1) requires that the initial determination of certain penalties be “person-
ally approved (in writing) by the immediate supervisor of the individual making
such determination or such higher level official as the Secretary may designate.”
See Graev v. Commissioner, 149 T.C. 485, 492-493 (2017), supplementing and
overruling in part 147 T.C. 460 (2016); see also Clay v. Commissioner, 152 T.C.
223, 248 (2019) (quoting section 6751(b)(1)), aff’d, 990 F.3d 1296 (11th Cir.
2021).
Section 6664(c)(1) provides an exception to the imposition of a section
6662(a) accuracy-related penalty if it is shown that there was reasonable cause for
the underpayment and the taxpayer acted in good faith. As a general rule, “[t]he - 28 -
[*28] determination of whether a taxpayer acted with reasonable cause and in
good faith is made on a case-by-case basis, taking into account all pertinent facts
and circumstances.” Sec. 1.6664-4(b)(1), Income Tax Regs. In making that
determination, “the most important factor” is usually “the extent of the taxpayer’s
effort to assess the taxpayer’s proper tax liability.” Id.
Respondent determined section 6662(a) accuracy-related penalties of
$6,433 and $3,647 for the years at issue, respectively. Respondent contends that
petitioners are liable for the penalties as a result of negligence under section
6662(b)(1) or, in the alternative, substantial understatements of income tax under
section 6662(b)(2).6
We conclude that respondent has met his burden with respect to the accu-
racy-related penalties attributable to substantial understatements of income tax
under section 6662(b)(2) for the years at issue. Accordingly, we need not address
whether the underpayments of tax were also attributable to petitioners’ negligence
under section 6662(b)(1). Respondent has introduced evidence to establish his
revenue agent’s compliance with the procedural requirements of section
6751(b)(1) in obtaining supervisory approval to assert the penalty under section
6 Only one accuracy-related penalty may be applied with respect to any given portion of an underpayment, even if that portion is subject to the penalty on more than one ground. Sec. 1.6662-2(c), Income Tax Regs. - 29 -
[*29] 6662(a). See Flume v. Commissioner, T.C. Memo. 2020-80, at *34.
Petitioners have not claimed, nor does the record support a conclusion, that
respondent formally communicated his initial penalty determination before August
17, 2017, the date that the revenue agent’s acting group manager signed the Letter
950 with the attached Form 4549-A. See Frost v. Commissioner, 154 T.C. at 36;
Flume v. Commissioner, at *34-*35.
After concluding that respondent has established compliance with the
requirements of section 6751(b)(1), we now turn to the remainder of his initial
burden of production under section 7491(c)--namely, whether petitioners substan-
tially understated their income tax for the tax years at issue. As we conclude
above, respondent correctly determined that petitioners’ income tax was under-
stated by $32,167 and $18,237 for the years at issue, respectively. These amounts
exceed the greater of 10% of the tax that respondent determined was required to be
shown on petitioners’ joint tax returns for those years or $5,000. Therefore, we
hold that respondent has met his burden of production to show that petitioners’
underpayment for each of the years at issue was attributable to a substantial
understatement of income tax. Petitioners now bear the burden of showing that
they had reasonable cause for the underpayments and that they acted in good faith.
See sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at 446-447. - 30 -
[*30] Petitioners argue that they provided petitioners’ son with cash and checks to
purchase the raw materials and equipment and to pay the venture’s operating
expenses. They state that petitioners’ son was responsible for managing the
receipts supporting these expenses but his unexpected death, which occurred less
than two months before they filed their 2013 joint tax return on October 9, 2014,
hindered their collecting the receipts for the expenses reported for that year.
Petitioners submit that the death of petitioners’ son also hindered their collecting
the receipts for the expenses reported on their 2014 joint tax return, which they
filed on August 17, 2015. Petitioners advance that the death of petitioners’ son
and the resulting difficulty in collecting the necessary receipts to substantiate the
expenses constitute reasonable cause for the underpayments.
Notwithstanding petitioners’ personal tragedy, respondent contends that
petitioners failed to keep adequate books and records to substantiate their reported
expenses. Respondent highlights petitioners’ concession that they incorrectly
determined the amounts of equipment expenses for the tax years at issue as further
support of petitioners’ failure to determine their proper tax liabilities for the tax
years at issue. Accordingly, respondent argues that the penalty determinations
should be sustained. We agree. - 31 -
[*31] While we are sympathetic to the hardship that petitioners faced as a result of
their son’s unexpected death, that hardship does not constitute reasonable cause
for underpayments of Federal income tax within the meaning of section 6664(c).
See Martinez v. Commissioner, T.C. Memo. 2016-182, at *19-*20; see also sec.
1.6664-4(b), Income Tax Regs. Petitioner husband, who is an educated individ-
ual, testified that he was the financier of the venture and intended to recuperate the
money he expended to commence it. The facts and circumstances in this case
indicate, however, that petitioners did not attempt to keep adequate books and
records to detail the expenses incurred and assess their proper tax liabilities.
Respondent’s position that petitioners failed to assess their proper tax liabilities is
bolstered by their concession that their claimed Schedule F deductions for equip-
ment expenses were incorrect after later reviewing additional documentation, as
well as the fact that they do not dispute their receipt and failure to report $72 of
taxable interest for tax year 2013. The Court, therefore, holds that petitioners are
liable for the section 6662(a) penalties for the tax years at issue.
VI. Conclusion
For the reasons above, the Court sustains respondent’s determinations to
disallow petitioners’ alimony deductions, Schedule F gross receipts, and Sched-
ule F expense deductions. The Court further sustains respondent’s determinations - 32 -
[*32] relating to the accuracy-related penalties under section 6662(a) for the years
at issue. The Court has considered all other arguments made by the parties, and to
the extent not discussed above, find those arguments to be irrelevant, moot, or
without merit.
To reflect the foregoing,
Decision will be entered
for respondent.