KEENAN v. COMMISSIONER
This text of 1989 T.C. Memo. 300 (KEENAN v. COMMISSIONER) is published on Counsel Stack Legal Research, covering United States Tax Court primary law. Counsel Stack provides free access to over 12 million legal documents including statutes, case law, regulations, and constitutions.
Opinion
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER,
| Additions to Tax | ||||
| Year | Deficiency | Sec. 6653(a) 1 | Sec. 6659 | Sec. 6661 |
| 1979 | $ 8,943.00 | $ 447.00 | $ 2,683.00 | -- |
| 1980 | 20,933.00 | 1,047.00 | 6,280.00 | -- |
| 1981 | 25,421.51 | * 1,271.00 | 7,626.00 | -- |
| 1982 | 51,779.00 | * 2,589.00 | 4,318.00 | $ 11,023.00 |
| 1983 | 7,191.00 | * 360.00 | -- | 1,798.00 |
| 1984 | 5,821.00 | * 291.00 | -- | 1,455.00 |
Respondent also determined that petitioner was liable for the increased interest rate on tax motivated transactions regarding the entire underpayments for 1979, 1980 and 1981, $ 39,717 of the underpayment for 1982 and $ 2,799 for 1983.
FINDINGS OF FACT
Petitioner Robert B. Keenan resided in Camarillo, California, when the petition was filed in this case. The stipulation of facts and attached exhibits are incorporated herein by this reference.
During 1982, petitioner was employed by United Airlines as a pilot. Facing retirement, petitioner began to look for income producing investments to provide for himself and his wife, who required a full-time nurse due to advancing*317 Huntington's disease.
Petitioner relied on the advice of Donald Karr (Karr), an insurance salesman friend, who counseled petitioner concerning different investments. Karr had obtained information about the OEC investment from Charles Reitz, president of Western Financial Management (WFM) and leasing agent for OEC. Karr prepared a profitability analysis of the OEC program for petitioner. It showed the investment to be economically profitable using figures supplied by the OEC prospectus. Petitioner and Karr also visited another individual in Santa Barbara to discuss the OEC investment.
The OEC transactions, as will be discussed in more detail below, involved the lease by a taxpayer of an energy management device from OEC Leasing, followed by its installation by a service company in the facility of an end user. Any energy savings would be split by the end user, the taxpayer, the service company and OEC.
On December 27, 1982, petitioner entered into a lease agreement for an Energy Minder System III. He agreed to pay $ 25,000 first year's advanced rental.
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MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER,
| Additions to Tax | ||||
| Year | Deficiency | Sec. 6653(a) 1 | Sec. 6659 | Sec. 6661 |
| 1979 | $ 8,943.00 | $ 447.00 | $ 2,683.00 | -- |
| 1980 | 20,933.00 | 1,047.00 | 6,280.00 | -- |
| 1981 | 25,421.51 | * 1,271.00 | 7,626.00 | -- |
| 1982 | 51,779.00 | * 2,589.00 | 4,318.00 | $ 11,023.00 |
| 1983 | 7,191.00 | * 360.00 | -- | 1,798.00 |
| 1984 | 5,821.00 | * 291.00 | -- | 1,455.00 |
Respondent also determined that petitioner was liable for the increased interest rate on tax motivated transactions regarding the entire underpayments for 1979, 1980 and 1981, $ 39,717 of the underpayment for 1982 and $ 2,799 for 1983.
FINDINGS OF FACT
Petitioner Robert B. Keenan resided in Camarillo, California, when the petition was filed in this case. The stipulation of facts and attached exhibits are incorporated herein by this reference.
During 1982, petitioner was employed by United Airlines as a pilot. Facing retirement, petitioner began to look for income producing investments to provide for himself and his wife, who required a full-time nurse due to advancing*317 Huntington's disease.
Petitioner relied on the advice of Donald Karr (Karr), an insurance salesman friend, who counseled petitioner concerning different investments. Karr had obtained information about the OEC investment from Charles Reitz, president of Western Financial Management (WFM) and leasing agent for OEC. Karr prepared a profitability analysis of the OEC program for petitioner. It showed the investment to be economically profitable using figures supplied by the OEC prospectus. Petitioner and Karr also visited another individual in Santa Barbara to discuss the OEC investment.
The OEC transactions, as will be discussed in more detail below, involved the lease by a taxpayer of an energy management device from OEC Leasing, followed by its installation by a service company in the facility of an end user. Any energy savings would be split by the end user, the taxpayer, the service company and OEC.
On December 27, 1982, petitioner entered into a lease agreement for an Energy Minder System III. He agreed to pay $ 25,000 first year's advanced rental. He paid this amount, plus interest, with two checks. The first, dated December 27, 1982, was in the amount of $ 10,000. The*318 second, dated June 28, 1983, was in the amount of $ 15,750. Petitioner also entered into a service agreement with Control Technology, Inc. (Control), agreeing to pay $ 3,000, plus some share of the energy savings. On December 27, 1982, $ 750 of the service fee was due, another $ 750 when Control found a suitable location, and the remainder when Control completed installation. An invoice dated July 23, 1983, for $ 750, which petitioner paid, notified petitioner that a location had been found at West Covina Hospital in West Covina, California.
Sometime in early or mid-1983, OEC or Control invited petitioner to the West Covina Hospital to inspect his unit prior to installation. Before he could go out to inspect the device, he was told that the unit had been returned to the manufacturer for modifications. This was the first indication that the promotion was having some difficulty.
Petitioner received more disturbing news commencing in 1984. He received a letter from Control alleging that OEC had not delivered the units to Control (for placed-in-service purposes) prior to December 31, 1982. OEC denied such allegations. In response to the allegations and counter-allegations, WFM*319 contacted lessees asking them to fill out a questionnaire about their units, asking whether the unit was installed, whether it was faulty, whether it was saving energy, etc. Apparently, the energy management devices, including the one leased by petitioner, had not been installed due to incompetent service or malfunctioning equipment. WFM's counsel informed petitioner they had instituted a class action suit against OEC and its affiliates, alleging securities fraud, and, in a letter dated March 16, 1984, asked investors to contribute $ 250 to its prosecution. Petitioner signed and executed a power of attorney in favor of WFM and contributed $ 250 to the "OEC Lessee Action Fund."
In correspondence dated October 24, 1984, OEC informed petitioner that he would be in default under his lease agreement if he did not pay insurance premiums on the unit. OEC had purportedly obtained a master policy for all lessees, for which petitioner had been billed his pro rata share. Petitioner paid $ 458.40 for insurance and wrote to OEC that to his knowledge the unit had not been delivered or installed, that OEC had never intended to perform their contractual commitments and "It would appear as though*320 you want me to default on my lease agreement in order to somehow achieve relief from your obligations."
As late as 1985, petitioner was receiving letters from OEC blaming the service companies for the program's difficulties. Petitioner wrote a letter to OEC, Control and WFM "appalled at the seemingly apparent lack of constructive effort to resolve the situation." WFM replied that petitioner had been dealing with criminals and had been ripped off, that the lawsuit was progressing, and that neither the deductions nor the credits taken for 1982 could be substantiated. The result of any such lawsuit is not known.
Petitioner has never seen the unit he leased from OEC. The unit has not generated any income. Petitioner was aware of the effect of the energy and investment tax credits when he invested in the OEC program.
On his joint return for 1982, petitioner claimed deductions of $ 25,000 for advanced rental, $ 3,000 for installation and $ 25 for travel expenses related to the OEC leasing venture. He also claimed investment and energy tax credits based on the purported $ 280,000 purchase price OEC paid for the EMS III. On his 1983 return, petitioner claimed a $ 605.40 business*321 interest deduction and $ 1,500 service fee related to the OEC venture. On his 1984 return, petitioner claimed $ 250 legal services and $ 458 insurance expense deductions related to OEC.
The mechanics of the OEC transaction are identical in most respects to the transactions described in
| End-User: | 50 percent |
| Service Company: | 7.5 percent |
| Lessor (OEC): | 31.88 percent |
| Lessee (Keenan): | 10.62 percent |
The end user was not required to make any payments, *322 other than sharing energy savings, in connection with their use of the devices. Prior to installation, the service company would conduct an "energy audit" to determine a suitable end-user location. The investor would also pay initial amounts for the first year's rental and an installation charge. The investor/lessee claimed tax deductions for advanced rental and installation charges, and investment tax credits, under section 48(d), based on the purchase price OEC paid for the units.
The units themselves are electronic devices designed to regulate oil, gas, steam and electrical usage, thereby conserving energy to the end user. There are a number of such devices on the market. The cost of such a system is based upon its capabilities and the number of functions it can perform. The report prepared by respondent's expert 2 explains these factors in greater detail and we quote from it below:
EXPLANATION OF ENERGY MANAGEMENT SYSTEM TERMS
a.
on-off control of a fan motor starter
on-off control of a pump motor starter
on-off control of a lighting contactor
status input of a fire alarm
status input of a fan failure
temperature measurement of the outdoor air
temperature measurement of the space.
b.
Duty cycling: periodically switch equipment off for short periods of time
Time-of-day: switch equipment on/off on a scheduled basis using the calendar, day of week or time of day
Demand limiting: switch equipment off for short periods in order to avoid excessive (peak) electrical usage
Temperature compensation: duty cycling and demand limiting can be enhanced by compensating for room temperatures
*324 Record keeping: maintaining data on utility or temperature measurements
Optimum start-stop: using measured outdoor and indoor temperatures to determine the optimum equipment startup or shutdown
Remote access: interface to the EMS by telephone using a terminal and modem
Enthalpy optimization: controlling outdoor dampers on air handling units to minimize cooling
Load prediction: anticipate cycling of loads and its effect on electrical demand
Low level user programing [sic]: allow for the user to define a few unique sentences using an internal language
Simple building security: monitor alarms on a secondary basis and notify appropriate terminals
Custom applications: special sequences established to control large equipment such as chillers and boilers
Maintenance management: provide equipment database, work orders, manning reports and other related reports
Full HVAC [Heating Ventilation Air Conditioning] control (Direct Digital Control (DDC)): closed loop control using a sensor and analog output to maintain temperatures
Full Fire and Security: approved primary monitoring of fire and security sensors
Higher level programming: Fortran, Basic or other higher level*325 language programming.
c.
LED 3 with Keypad: The most basic user interface is a keypad with the digits 0-9 and a few other function keys and a two to six digit LED display. Often with such an interface LED point lights are used to indicate on-off status or indicate the next programming operation to take place.
ASCII terminal: An ASCII terminal is a standard computer terminal with a QWERTY keyboard and CRT display or hardcopy display. This type of interface typically allows for prompting for program inputs and simple reports.
Multi-terminals: This type of system allows more than one person to be using the system at a time. For example, one person may be checking the status of equipment and the other may be changing schedules.
Colorgraphics terminals: A colorgraphics terminal displays equipment schematically with realtime temperatures and status in appropriate locations.
The salient features*326 and stated cost of the EMS III (1982 model) are tabulated below:
| EMS III | |
| Points: | 24 loads, 3 temperatures, demand input |
| Functions: | Duty cycling |
| Time-of-day | |
| Demand limiting | |
| Optimum start-stop | |
| Temperature compensation | |
| Remote access | |
| Recordkeeping | |
| Interface: | LED w/keypad |
| ASCII Terminal | |
| Designated Cost: | $ 280,000 |
| Cost per Point: | Approximately $ 10,000 |
The average cost per point for a random sampling of small units (4-125 points) is $ 305; medium units (50-750 points) averaged $ 230 per point; large custom (500-2000 + points) units vary from $ 500 to $ 1,200 per point. 4 In the general market place, the most expensive units were $ 8,213 (small) and $ 20,000 (medium). Large units must be custom built and may cost $ 50,000 or more. Installation charges may double the cost of a system.
The energy management system market is a large market, heavily advertised in the trade. A unit comparable to the EMS III could have been purchased for approximately $ 4,800 in 1982. The fair market value of the*327 EMS III (1982 model) is $ 4,800.
The ultimate profitability of the venture to OEC and its lessees was dependent upon a number of factors, including the initial advanced rental and installation expenditures, annual energy bill, actual cost savings to the end user, the rate of inflation for energy costs, and useful physical and economic life of the equipment. The advanced rental for an EMS III was $ 25,000 per unit, while installation was $ 2,150. 5 The minimum annual energy bill that would justify use of the EMS III was $ 90,000. Based on a 1982 Department of Energy (DOE) report, energy costs were forecast to increase, on the average, 3.8 percent (electricity -- 2.0 percent, gas -- 9.1 percent, oil -- 4.3 percent). This is a weighted average for the typical industrial/commercial fuel combination. Considering a 7-percent inflation rate, the annual rate of energy cost increase would be 10.8 percent. DOE reports for earlier periods had projected cost increases of some 20 percent.
*328 Actual energy savings to a particular end user may vary significantly, depending on physical characteristics of the facility and energy conservation measures which may already have been taken. Industry reports predicted 5 to 12 percent savings with a maximum of approximately 20 percent. Actual savings are often less than projected. We agree with respondent's expert that 10 percent is a reasonable assumption.
We must also evaluate the useful physical and economic life of the devices. Optimistic estimates of the engineering useful life of these units is 20 to 25 years. Engineering or physical useful life is the length of time the unit may remain operational with normal repairs. The units in question were warranted for only 1 year. Electronic equipment is also subject to obsolescence (economic useful life); while the unit is still operative, it may nonetheless be more cost-effective to replace it with newer, more efficient technology. These units are also subject to obsolescence or failure of the underlying climate control units (central heating or air-conditioning units). When these are replaced the new units often incorporate internal energy management control systems. *329 Thus, we conclude, as did respondent's expert, that these devices have a useful life of approximately 10 years.
Using these assumptions, one can obtain projected cash flows for the lease of an EMS III unit. Discounting this future cash flow to present value, to take into account the time value of money, is a way we have used to measure the economic viability of these transactions. See
*331
On December 27, 1982, petitioner entered into an "Agreement for Appointment of Advertising Agency" (Agreement) with MTA and Associates, Inc. (MTA). Under the Agreement, petitioner acquired five units of the promotion at $ 14,000 per unit, for a total cost of $ 70,000. Under the Agreement, petitioner was to pay $ 17,500 cash as a down payment and sign a 5-year promissory note for the balance of $ 52,500. On December 27, 1982, petitioner issued a check for $ 7,000 and signed a promissory note for the balance of the down payment, $ 10,500. Petitioner consulted with Karr and an individual in Santa Barbara before investing. Karr recommended and "signed up" 27 to 30 people in the MTA program, and received a commission for each one.
Petitioner relied on Karr and a booklet entitled "The MTA Opportunity" (prospectus) in investing. The tax opinion in the prospectus stated that the cost of a unit was fully deductible by an accrual basis taxpayer as an advertising expense. The prospectus promised that an investor could "Make a cash investment of as little as $ 3,500, yet realize no less than $ 14,000 in income tax deductions this year, as well as the opportunity*332 to take tax deductions in the future for much of your personal entertainment, travel, auto expenses, phone bills, etc."
The Agreement was purportedly part of a marketing program for products manufactured by Adventures in Health (AIH). Petitioner was to receive a list of 766 "members." Petitioner was purportedly entitled to 7 percent of gross sales of AIH products purchased by members on his list. Any payments by members were to be put into an escrow account to be applied against required payments on the $ 52,500 note, with any remainder going to petitioner. It has not been shown how AIH products would be advertised or marketed to petitioner's members, although it likely involved petitioner and a videotape machine.
Under the Agreement, petitioner was not obligated to make any payments on the $ 52,500 note until the member list was furnished. No member list was ever furnished. Therefore, petitioner had no obligation under the Agreement. Petitioner has not recruited any members or generated any sales. No videotape machine was ever furnished to petitioner.
Petitioner claimed a $ 70,000 deduction in connection with the MTA program on his 1982 joint return. He also claimed*333 a $ 100 travel and entertainment expense deduction for the cost of traveling to Santa Barbara for investment advice related to the MTA venture. With respect to the MTA business, petitioner chose the accrual method of accounting. For his employee and his claimed airplane leasing business (see below), petitioner was on the cash method of accounting.
In November 1977, petitioner purchased an Aerotek-Pitts S-2A aerobatic airplane. Petitioner leased the aircraft to Kenneth Johnson, doing business as Johnson School of Aerobatics, for use in training pilots to do aerobatic flying. Johnson also owned the dealership from which petitioner purchased the plane. Johnson paid petitioner varying amounts for use of the aircraft, ranging from $ 35 to $ 61 per hour. Johnson conveyed the lease to another individual to continue the business, who operated it from late 1981 until July of 1982, when Johnson took over again. Later, petitioner terminated this arrangement and leased the aircraft to Leigh Manelski, who agreed to pay $ 50 per hour for use of the aircraft. Under the various leases, petitioner paid for oil, gas, maintenance, hangar rent, insurance and other expenses.
*334 During 1981 or 1982, fuel and insurance costs for airplanes increased drastically, making it difficult for either aircraft owners or lessees to operate at a profit.
Petitioner did not maintain a separate bank account for the airplane leasing activity. Petitioner's records consist of canceled checks from his personal checking account. Some of the checks contain notations that they were for the leased aircraft, while many do not. He kept no records of income. The airplane had a meter of time spent in the air, from which the lessees would compile a log. The log was used to calculate income due petitioner. Records kept by Johnson reflect that petitioner received at least $ 8,741 in income in 1982 from airplane leasing. Meter readings for 1983 and 1984 generally corroborate the income amounts shown by petitioner on his returns for those years. The amounts would not exactly coincide because petitioner did not receive checks at regular intervals from the lessees during 1983 and 1984.
During the period at issue, the plane did not appreciate or depreciate in value. The value of the plane might increase somewhat due to declines in airplane manufacturing.
For the years 1979 through*335 1984, petitioner reported the following income, deductions, including depreciation, and losses with respect to his airplane lease activity:
| Year | Income | Deductions | Depreciation | Net Loss |
| 1979 | $ 9,698 | $ 24,483 | $ 7,362 | $ 14,785 |
| 1980 | 12,822 | 23,130 | 9,339 | 10,308 |
| 1981 | 18,646 | 30,213 | 6,678 | 11,567 |
| 1982 | 5,000 | 18,047 | 6,616 | 13,047 |
| 1983 | 9,750 | 24,352 | 5,926 | 14,602 |
| 1984 | 2,812 | 14,243 | 6,699 | 11,431 |
The various lessees kept flight logs of time spent in the airplane. Each month, or for longer periods after 1982, the lessee would calculate the hours flown, multiply that by the hourly rate, and send a check to petitioner. When the lessee incurred expenses, such as for hangar rent, he would bill petitioner, or deduct it from the lease payment. With respect to fuel, petitioner had an account with Shell Oil, to which the lessees could charge gasoline, and petitioner would be sent the bill. Petitioner very rarely flew the plane for his personal use.
Petitioner owned two other airplanes during 1982, 1983 and 1984. Neither was operating during that period, although they did incur expenses*336 for repairs.
During 1982, petitioner contributed at least $ 100 to qualified political organizations, and $ 885 to qualified charitable organizations. During 1983, petitioner contributed $ 771 to qualified charitable organizations.
In addition, during both years petitioner's wife was a member of Alcoholics Anonymous. She went to several meetings per week, and at some donated an amount of cash.
On their joint returns for 1982 and 1983, petitioner and Edna Keenan claimed $ 1,500 and $ 1,457 in charitable contributions, respectively.
Petitioner had $ 10,547 in state income tax withheld in 1982. Petitioner also paid $ 755.27 in late filing penalties to the California Franchise Tax Board. Also in 1982, petitioner paid $ 48 to the Department of Motor Vehicles, $ 26 of which was a tax.
Petitioner paid $ 181.37 to the city of Oxnard during 1982 for the Ventura County sewer district. Petitioner paid an amount each month. Included in the $ 181.37 are the following amounts represented by petitioner's checks to the city of Oxnard:
| January 2, 1992 [sic] | $ 17.48 |
| March 8, 1982 | 14.22 |
| April 18, 1982 | 15.80 |
| May 28, 1982 | 17.40 |
| August 30, 1982 | 17.40 |
| September 18, 1982 | 17.13 |
| November 2, 1982 | 16.05 |
| November 29, 1982 | 16.59 |
*337 Petitioner deducted $ 14,013 on Schedule A of his 1982 income tax return for state and local taxes.
Petitioner was employed by United Airlines as a pilot and later as a flight engineer. Pursuant to various collective bargaining agreements, United provided a fixed rate reimbursement for expenses while traveling, such as meals. Petitioner was supplied meals on some flights.
Petitioner has a log that purports to be an accurate summary of expenses for meals and miscellaneous expenses each day. For almost all days listed there is an entry for breakfast, lunch, dinner and a snack. Entries for breakfasts ranged from $ 8 to $ 15. Most of the entries exceeded $ 10. Entries for lunch ranged from $ 13 to $ 20. Entries for dinner ranged from $ 20 to $ 27. Entries for snacks ranged from $ 5 to $ 13, with most entries exceeding $ 8. The meal expenses in his log for 1983 total approximately $ 7,900. The meal expenses in his log for 1984 total approximately $ 10,800. Petitioner's log reflects $ 76 in phone calls for 1984.
Petitioner also delivered airplanes for a company called Southern Cross Aircraft Delivery when he was not flying for United. He*338 deducted, among other things, the following amounts, represented by checks to the following payees:
| Island Colony Hotel, Waikiki | $ 365.00 |
| Cherry Creek Inn | 507.72 |
| Rains Shoe Co. | 74.15 |
Petitioner did not report any income from Southern Cross in 1983 or 1984.
On his tax return for 1983, petitioner claimed an adjustment to income of $ 1,838 for employee business expenses and $ 7,768 as a miscellaneous deduction for employee business expenses. Petitioner calculated his expenses for meals on Form 2106 attached to his return at $ 35 per day for 143 days, or $ 5,005. Respondent disallowed all of the adjustment to income and $ 2,887 of the miscellaneous deductions.
On his return for 1984, petitioner claimed an adjustment to income of $ 3,456 for employee business expenses and $ 7,992 as a miscellaneous deduction for employee business expenses. Petitioner calculated his expenses for meals on Form 2106 attached to his return at $ 40 per day for 153 days, or $ 6,120. Petitioner also claimed $ 717 in phone expenses. Respondent disallowed all of the adjustment to income and $ 6,192 of the miscellaneous employee business expenses.
In 1982, petitioner*339 wrote a check for $ 7,000 to Gloria Greenamyer so that she could obtain additional flight training. Petitioner did not receive a note or other evidence of indebtedness. Petitioner anticipated that he would be repaid within 60 to 90 days.
Greenamyer apparently moved to Denver, and petitioner attempted to contact her by contacting her employer, Continental Airlines, in 1984. Continental would not give petitioner her address or number. Airlines customarily do not give out information about employees.
On his return for 1984, petitioner deducted the $ 7,000 as a nonbusiness bad debt loss.
OPINION
The first issue involves the propriety of deductions and credits claimed with respect to petitioners' lease of an energy management device, and the additions to tax related thereto. As previously noted, the transactions herein are similar to those already dealt with by this Court in
A common threshold for the claimed tax benefits is that the taxpayer must be engaged in a trade or business or in a transaction entered into for profit. Otherwise, no credits or losses are allowed. Sec. 183. Essential to such a showing is a demonstration that petitioners had an actual and honest objective of making a profit, giving greater weight to objective facts than petitioners' mere statements of intent.
Rather than repeat our discussion in the
There would be wide variability in energy savings based on factors not in petitioner's control, including rate of energy savings, energy prices, and the installation site. Petitioner did not take an active interest in this all-important part of the investment. Rather, he passively relied*342 on Control, and did nothing after the initial investment. He did not see or inquire about the results of the energy audit, by which Control purportedly found a suitable end user. We would expect some minimal supervision activity, some care in assigning duties to others, in order to find a bona fide profit objective. See
Petitioner did not obtain independent appraisals or other reports, nor did he do much, if any, outside investigation.7 Petitioner was a pilot, having no expertise in energy equipment leasing. In addition, neither petitioner nor Karr attempted to verify or substantiate the figures provided by the promoters. Some independent indicator of profitability would be a most probative element in finding a profit objective, and that is lacking in this case. See
*343 The units ultimately did not generate any income for petitioner. See
Petitioner's case also contains other defects, similar to
Because no installation ever occurred, no energy credits would be allowed. Specially defined energy property must be installed in connection with an existing industrial or commercial facility. Sec. 48(1)(5). In addition, paying one year's advance rent in an amount in excess of the value of the entire system is not an ordinary or necessary business expense within the meaning of section 162.
Therefore, as in
Respondent*346 also determined additions for negligence, overvaluation and substantial understatement with respect to deficiencies related to the OEC transaction. Negligence, within the meaning of section 6653(a), is the lack of due care or the failure to do what a reasonable or ordinarily prudent person would do under the circumstances.
Petitioner claimed substantial deductions and credits based solely upon values asserted by the promoters. In addition, petitioner is a pilot, not experienced in the field of energy management equipment leasing, and did not seek advice from anyone with such experience. Petitioner did not attempt to independently verify the assumptions and claims made by the promoter, including valuation of the unit, which exceeded 5,000 percent of fair market value. While petitioner argues the credits were not an important consideration, as previously indicated, he claimed the credits on his return and he is responsible for such valuation. In light of the extraordinary inflation of the units*347 and the large market for such devices, he was negligent with respect to the underpayments caused by the OEC transaction.
We next consider the addition to tax determined for valuation overstatements. Section 6659 provides for an addition to tax equal to 30 percent of the underpayment of tax attributable to an overvaluation of more than 250 percent. The underpayment must be more than $ 1,000. Two hundred-eighty thousand dollars is substantially more than 250 percent of $ 4,800, the value of the EMS units. The disallowed credits for 1982 result in underpayments of more than $ 1,000. The overvaluation, exceeding 5,000 percent, was an integral part of our finding that the taxpayer lacked the requisite profit objective. See
Respondent also determined additions to tax under section 6661 for substantial understatement of income tax liability. Section 6661 imposes an addition equal to 25 percent of a substantial understatement of income tax. Sec. 6661(a);
Petitioner argues that because
On his tax return for 1982, petitioner deducted $ 70,000 advertising expense and $ 100 travel expense with respect to his investment*351 in five units of the MTA marketing program. Petitioner has failed to meet his burden of proving that any amounts were deductible. Rule 142(a).
The $ 100 expense was incurred in obtaining investment advice with respect to the program. As this was incurred prior to petitioner's entering business (assuming there was a business), for investigation, it was not deductible.
Petitioner has also failed to prove the theoretical underpinnings of the $ 70,000 advertising expense deduction. Petitioner purportedly "acquired" five units of something, we think the right to sell AIH products to 766 members. Because petitioner purportedly acquired something, the useful life of which extended beyond the taxable year, it would not be deductible in the first year.
Further, petitioner has not established*352 that he was in a trade or business. Merely acquiring a license or right to market a product does not put one in a trade or business of distributing that product.
Finally, in any case, no deductions would be allowed in connection with the recourse note. Petitioner had no obligation in connection with the note until the membership list was provided. This was not provided. Therefore, no liability existed, and no deduction would be allowed.
From our perspective, considering the claims made in the prospectus, this was no more than a transparent attempt to trade dollars for tax deductions. There is no evidence in the record that any of the parties did any advertising or selling, and petitioner has not met his*353 burden of proof.
As with the OEC transaction, the threshold issue with respect to the airplane lease is whether petitioner entered into and continued the activity with the actual and honest objective of making a profit.
The first factor is the manner in which the taxpayer carried on the activity. Petitioner maintained an informal record keeping system. His expense records consisted of canceled checks. Meter readings for 1983 and 1984 corroborate his reporting of income. However, according to records kept by the lessee, petitioner underreported his income by approximately $ 3,700 in 1982. Petitioner's system provides the minimum financial information necessary to make business decisions.
The second factor is the expertise of the taxpayer or his advisors. Petitioner was a pilot, experienced in flying planes. In addition, the lessees were also skilled pilots, and Kenneth Johnson also*355 owned a Pitts dealership. It would appear that petitioner knew what he was getting into when he leased the aircraft. Johnson also had some business expertise selling airplanes, but, apparently, he only leased one aircraft for the flying school.
The leasing activity, by its nature, put the onus of much of the work on the lessee. Petitioner was not required to spend large amounts of time overseeing the activity.
Petitioner leased the aircraft from 1977 to 1984 and never earned a profit. However, petitioner and Johnson testified that fuel and insurance expense escalated rapidly in 1981 and 1982, making it difficult to earn a profit. And, unlike the MTA andOEC activities, which did not earn any income, the airplane lease consistently generated amounts of gross income.
In*356 sum, petitioner's airplane activity was not recreational, nor did it produce disproportionately large noncash expenditures, such as depreciation, to shelter other income. Petitioner was an experienced pilot, with airplane experience. Therefore, we find that from 1982 to 1984 he continued the activity with an actual and honest profit objective.
Respondent also contends we should disallow the losses for lack of substantiation. Preliminarily, the lessee's records expressly show, and we have found, that petitioner underreported his income for 1982 by approximately $ 3,741. Thus, his income from the airplane activity for 1982 must be increased. Petitioner introduced canceled checks to substantiate the expense deductions other than depreciation for the airplane activity. Petitioner has adequately substantiated the deductions for 1982, even after subtracting out checks with notations for the other airplanes. For 1983, petitioner has substantiated and is allowed $ 19,355.31 of the $ 24,351.81 deductions claimed. For 1984, petitioner has substantiated and is allowed $ 13,352.97 of the $ 14,242.62 deductions claimed.
The next issue involves the amount*357 of charitable contributions to which petitioner is entitled under section 170. Petitioner claims that in addition to amounts either substantiated or conceded by respondent ($ 785 for 1982 and $ 771 for 1983), that petitioner's wife made cash donations of $ 1,040 to Alcoholics Anonymous each year -- $ 5 per meeting at four meetings per week 52 weeks a year.
Petitioner had no substantiation for the additional charitable contributions claimed, only his testimony. Nevertheless, we believe that petitioner's wife did make some cash contributions. We find that petitioner is entitled to additional cash contributions in the amount of $ 300 per year.
Section 164, during the years at issue, allowed a deduction for, among other things, state and local real and personal property taxes, state and local income taxes and state and local sales taxes. On Schedule A of his 1982 return, petitioner claimed a deduction for state and local taxes*358 of $ 14,013. In the notice of deficiency, respondent allowed $ 11,398, and at trial respondent conceded another $ 1,409. Remaining at issue is $ 1,206, consisting of the $ 755.27 late filing penalty, $ 181.37 sewer "tax," $ 22 for the Department of Motor Vehicles, and $ 247.36 of unknown origin.
Respondent conceded that $ 26 of $ 48 paid to the Department of Motor Vehicles was a tax. The remainder, it was suggested, was a filing fee. Petitioner brought nothing but a canceled check to trial, which was not placed in the record. Petitioner has failed to elicit any evidence that the $ 22 was a tax. Therefore, because he has the burden of proof, petitioner cannot deduct the other $ 22. Similarly, petitioner has failed to elicit any evidence with respect to the $ 247.36, and thus that amount is also not allowable as a deduction.
Next we consider the deductibility of the late filing penalty. Petitioner argues, based on the Internal Revenue Code and, supposedly, California law, that because late filing penalties are assessed and collected in the same manner as taxes, that they are taxes. Even if we could accept this premise (compare section 6662(b)), petitioner has not referenced*359 any California law to show the manner in which penalties are collected and assessed in California. In addition, we do not agree that the manner of assessment and collection is relevant to whether something is or is not a tax. In two previous cases, we have held that certain state late filing penalties are not taxes.
Finally, petitioner asserts that amounts paid to the city of Oxnard were deductible sewer taxes. Respondent contends that the bills were for sewer service. Petitioner did not bring the monthly bills, but only his canceled checks, to substantiate the deduction. Because the bills came on a monthly basis, and differed in*360 amounts each month, in the absence of the bills themselves we conclude that the bills were for sewer service, not taxes. While petitioner testified that everyone in the neighborhood paid the same amount each month, we have difficulty accepting his explanation on this issue, and there is not enough other corroborating evidence to meet petitioner's burden of proof. Therefore, amounts paid to the city of Oxnard are not deductible taxes.
Respondent allowed the full amount of sales tax deducted on petitioner's return. To the extent there are adjustments to income that may result in an increase or decrease in the allowable sales tax deduction, the parties may take that into account in the Rule 155 computation.
Section 162 permits the deduction of ordinary and necessary business expenses in connection with the performance of services as an employee. The regulations require any taxpayer whose expenses exceed the total amount of reimbursement from his employer and who claims such excess on his return to substantiate the expenses claimed.
Section 274 and the regulations require written records to substantiate expenditures*361 with respect to meals or lodging while traveling away from home, superseding the doctrine of
(i)
(ii)
(iii)
(iv)
To meet the adequate records requirement, a taxpayer must maintain an account book, diary, statement of expense*362 or similar record and documentary evidence which, in combination are sufficient to establish each element of an expenditure.
Petitioner's evidence, primarily his log book, fails for a number of reasons. Preliminarily, both the time and place of meals are not included in the log book. In addition, petitioner presented no additional corroborating documentary evidence for the meals, e.g., checks, bills or invoices. Further, petitioner could not remember the rate at which he was compensated for the meals by United. Finally, it does not appear that petitioner used the log book in preparing his return. For 1983, petitioner reported $ 5,005 for meal expenses when the log book total was approximately $ 7,900. For 1984, petitioner reported $ 6,120 in meal expenses when the log book total was approximately $ 10,800. For 1984, petitioner reported phone expense of $ 717, but only $ 76 was reported in the log book.
In addition, we do not think the log book accurately reflects petitioner's meal expenses, or was maintained at or near the time of each expenditure.
Petitioner also presented three checks at trial to substantiate employee business expenses. Two of the checks, to hotels, petitioner claims were expenses incurred while delivering planes for Southern Cross. However, there are no memorandums on the checks, except for a "DC-3 Delivery" on one check that appears to have been made after the fact. In addition, petitioner did not report any income from Southern Cross in 1983. Without more, we cannot find that these checks were for deductible expenditures. The last check is to Rains Shoe Co., and petitioner did not indicate what this was for, or how it was deductible. Moreover, even if petitioner incurred deductible employee expenses, he has failed to submit*364 evidence showing that he could not have been reimbursed by his employer for the expense.
Section 166(d) provides a short-term capital loss deduction for nonbusiness bad debts that become worthless during the taxable year. To qualify for the deduction, petitioner must show that the debtor intended to create a debtor-creditor relationship, that a genuine debt in fact existed, and that the debt became worthless during the taxable year.
We find that no valid debt was created. There was no note, no specific date of repayment, and no provision for interest. See
Even assuming there was a valid debt, we cannot find that the debt became worthless during 1984. The 60 to 90-day period expired in 1982. Sometime during 1983, petitioner lost or gave up any reasonable chance of finding Greenamyer. Petitioner did not attempt to locate her in 1983, and for all intents and purposes had abandoned hope of finding her. Therefore, no bad debt deduction is allowable.
Respondent also determined additions for negligence for the underpayments not related to the OEC venture. For the years at issue, section 6653(a)(1) provided an addition of 5 percent of the underpayment if
To reflect the foregoing,
Footnotes
1. All section references, unless otherwise indicated, are to the Internal Revenue Code of 1954, as amended and in effect during the years at issue. All rule references are to the Tax Court Rules of Practice and Procedure.
* Pursuant to section 6653(a)(1), plus 50 percent of the interest on the deficiency pursuant to section 6653(a)(2)↩
2. The reports of respondent's experts in this case,
Soriano, Heasley andKaba↩ are similar, and in many respects are identical.3. Light emitting diode. This is apparently similar to the red or green on black display on a calculator.↩
4. We use figures provided in respondent's expert's report. Costs are list price using 20 units (small) and 5 units (medium).↩
5. This figure, provided in the promotional materials by OEC, is $ 850 less than the price charged by Control in petitioners' service contract. However, this difference is not critical to the outcome of this case.↩
6. We will briefly explain the methodology used by respondent's expert in reaching his conclusions. Discounted cash flow equals lessee's discounted percentage of energy savings minus advanced rental and installation expenses. The starting point for total energy savings is the minimum annual bill. This is projected into the future using the anticipated energy inflation rate, i.e., $ 90,000 X 10.8 percent = $ 99,720 -- the energy bill for year 2; $ 99,720 X 10.8 percent = $ 110,490 -- the energy bill for year 3, and so on. The energy savings rate is then applied to each year's annual energy bill, resulting in total projected energy savings. The lessee is entitled to 10.62 percent of this figure. The lessee's portion of savings is then discounted to present value using a 20 percent rate of return. The projection is extended for 10 years into the future, the anticipated useful life of the machines. Because the rate of return is built-in to the discount rate, any discounted cash flow greater than or equal to zero produces an economic profit.↩
7. After trial, petitioner moved to reopen the record to introduce appraisals performed by George Lemonides and Nicholas Arteca. We denied petitioner's motion. Even if we had granted petitioner's motion, these are the same appraisals previously considered in the
Soriano case as part of the promotional materials, and would not alter the result reached in this case. SeeSoriano v. Commissioner, 90 T.C. 44, 46-47↩ (1988)
Related
Cite This Page — Counsel Stack
1989 T.C. Memo. 300, 57 T.C.M. 762, 1989 Tax Ct. Memo LEXIS 312, Counsel Stack Legal Research, https://law.counselstack.com/opinion/keenan-v-commissioner-tax-1989.