PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE. T.C. Summary Opinion 2014-67
UNITED STATES TAX COURT
LEONARD B. SIMPSON AND JENNIFER A. SIMPSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4122-12S. Filed July 10, 2014.
D. Douglas Titus, for petitioners.
Patsy A. Clarke, for respondent.
SUMMARY OPINION
DEAN, 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 any other case.
Unless otherwise indicated, subsequent section references are to the Internal -2-
Revenue Code in effect for the years at issue, and Rule references are to the Tax
Court Rules of Practice and Procedure.
Respondent issued a statutory notice of deficiency to petitioners
determining deficiencies in income tax of $13,522 for 2008 and $10,488 for 2009.
Respondent also determined accuracy-related penalties under section 6662(a) of
$2,524.40 for 2008 and $2,097.60 for 2009.
Petitioners have conceded that they received a premature distribution from
an individual retirement account (IRA) in 2008. They have also conceded various
items related to Leonard B. Simpson’s (Mr. Simpson) activity reported on
Schedules C, Profit or Loss From Business, and petitioners’ activities reported on
Schedules E, Supplemental Income and Loss, that will be discussed below. The
issues remaining for decision1 are whether petitioners are entitled to deduct: (1)
for 2009 “points” paid in connection with acquiring real estate; (2) expenses
reported on Schedules C for both years; and (3) expenses reported on Schedules E
for both years and whether petitioners are liable for the accuracy-related penalty
under section 6662(a) for both years.
1 The amounts of petitioners’ student loan interest deduction, self- employment tax, and self-employment tax deduction for each year are computational and will be resolved by the decision of the Court on the other issues. -3-
Some of the facts have been stipulated and are so found. The stipulation of
facts and the exhibits received in evidence are incorporated herein by reference.
Petitioners resided in the State of Washington when the petition was filed.
Background
Mr. Simpson was employed full time as a security guard in 2008 and 2009,
and he reported wages from Inter-Con Security and Guardsmark, LLC, for each of
the years at issue. Jennifer Simpson worked for part of 2008 and then became
unemployed. She listed her occupation on their income tax return for 2008 as
unemployed and reported wages from MDS, Inc., as an Internet marketing
manager. On January 9, 2008, Mrs. Simpson filed for bankruptcy under chapter 7
of the Bankruptcy Code2 and was discharged from bankruptcy on June 12, 2008.
In 2009 Mrs. Simpson remained unemployed and withdrew $6,0003 from an IRA.
2008 “Points”
At trial petitioners produced a copy of two pages of a three-page settlement
statement, Form HUD-1, concerning Mrs. Simpson’s 2004 purchase of a
residential property in Newcastle, Washington (Newcastle property). The
2 See 11 U.S.C. secs. 701-767 (2006), so-called liquidating bankruptcy. 3 There is no explanation in the record for the apparent discrepancy between Mrs. Simpson’s testimony that she withdrew $6,000 from her IRA and respondent’s $282 adjustment to her income. -4-
settlement document reflects a first mortgage of $969,500 and a second mortgage
of $346,200. With leave of the Court, petitioners provided a Form 1098,
Mortgage Interest Statement, for 2004 sent to Mrs. Simpson at an address in
Seattle, Washington, reflecting a “loan discount” or “points” of $19,938.25 paid
with respect to the “purchase of a principle [sic] residence”.
Petitioners then introduced as evidence for 2008 a Form 1040X, Amended
U.S. Individual Income Tax Return (version 2), showing an increase in “itemized
deductions or standard deductions” of $17,038 to reflect the deduction of
unamortized points, or prepaid interest, that petitioners assert was paid with
respect to their home.
Sports Unlimited
In 1995 Mr. Simpson began an activity he called Sports Unlimited
International (Sports). Petitioners reported net losses on Schedules C for Sports
for 2005, 2006, and 2007. Petitioners filed with their Federal income tax returns
Schedules C for Sports reporting net losses of $45,800 for 2008 and $18,630 for
2009.
Although petitioners reported gross income of $10,500 on Schedule C for
2008, the parties agree that petitioners did not earn any Schedule C gross income
in 2008. During Mr. Simpson’s testimony, petitioners introduced into evidence a -5-
Form 1040X for 2008 (version 1) along with a revised Schedule C for 2008 that
reflects changes to the original Schedule C for Sports. The version 1 Form 1040X
reflects the deletion of $10,500 of gross income and the deletion of both a
deduction for advertising expenses of $43,200 and a deduction for meals and
entertainment expenses of $2,700, all of which were reported on the original
Schedule C filed with respondent.
Although petitioners reported Schedule C gross income of $4,800 for 2009,
the parties agree that petitioners earned zero Schedule C gross income in 2009.
During Mr. Simpson’s testimony petitioners introduced into evidence a Form
1040X for 2009 along with a revised Schedule C that reflects changes to his
original Schedule C for Sports for that year. The Form 1040X for 2009 reflects
the deletion of gross income of $4,800 and the deletion of a deduction for an
advertising expense of $17,500 reported on the original Form 1040 filed with
respondent.
Schedule E
Petitioners listed on their Schedule E for 2005 eight real estate properties.
In 2007, however, they began having difficulty “securing lines of credit and
refinancing on the properties.” They were then “pretty much underwater on most
of the properties.” Most of the properties were in Mrs. Simpson’s name. By 2008 -6-
petitioners owned only property on Woodland Avenue in Kansas City (Woodland
Avenue). Petitioners offered no information explaining the circumstances of their
disposal of any of the other properties.4
Petitioners filed Schedules E reporting losses of $5,857 for 2008 and
$22,709 for 2009. Petitioners introduced at trial a copy of a Schedule E for 2008
with “corrections”: a deduction for mortgage interest paid to banks of $1,948 was
eliminated and the depreciation expense deduction was increased from $1,709 to
$2,582.
Petitioners also introduced at trial a revised Schedule E for 2009. The
revised Schedule E for 2009 deleted $24,000 that had been reported as a deduction
for repairs to Woodland Avenue. The change was made because petitioners are
“no longer deducting $24,000 in one year” but “depreciating and taking the
deduction each year for 27 ½ years”. Petitioners increased their depreciation
expense deduction on the 2009 Schedule E from $1,709 to $2,582.
Petitioners allege that the Forms 1040X for 2008 and 2009 incorporate the
changes reported on the revised Schedules C and E.
4 Although Mrs. Simpson went through a bankruptcy proceeding in 2008, the Court was not provided with any details about that process. There was nothing in the record documenting a bankruptcy proceeding concerning Mr. Simpson. -7-
Discussion
Generally, the Commissioner’s determinations in a notice of deficiency are
presumed correct, and the taxpayer has the burden of proving that those
determinations are erroneous. See Rule 142(a); Welch v. Helvering, 290 U.S. 111,
115 (1933). In some cases the burden of proof with respect to relevant factual
issues may shift to the Commissioner under section 7491(a). The Court finds that
petitioners have not argued or shown that they have met the requirements of
section 7491(a) and the burden of proof does not shift to respondent.
“Points” Deduction for 2008
Interest is compensation for the use or forbearance of money. Deputy v. du
Pont, 308 U.S. 488, 498 (1940). “Points” paid for the use or forbearance of money
may be deductible as prepaid interest. Cao v. Commissioner, T.C. Memo. 1994-
60, aff’d without published opinion, 78 F.3d 594 (9th Cir. 1996).
Petitioners contend that they are entitled to deduct for 2008 prepaid interest
paid in connection with the 2004 acquisition of “their home” because the home
was subject to foreclosure proceedings in 2008. As petitioners did not report for
2008 any gain or loss from the disposition of property in 2008, the Court infers
that the foreclosure may have taken place as part of Mrs. Simpson’s bankruptcy
proceedings. If the foreclosure took place during the bankruptcy proceedings, the -8-
bankruptcy estate bore the tax consequences of the foreclosure, including the
deduction of accrued interest and points, absent an abandonment of the property
by the estate. See Catalano v. Commissioner, T.C. Memo. 2000-82, rev’d on other
grounds, 279 F.3d 682 (9th Cir. 2002); Bergman v. Commissioner, T.C. Memo.
1985-256. As noted earlier, no details about Mrs. Simpson’s bankruptcy
proceedings were provided to the Court, and no information about any foreclosure
proceedings on petitioners’ “home” was provided.
Petitioners did provide two pages of a three-page settlement statement,
Form HUD-1, concerning the 2004 purchase by Mrs. Simpson of the Newcastle
property showing that the “Loan Discount” paid to American Home Equity Corp.
was $19,938.25. The address of the property is stated as 15222 SE 82nd Court,
Newcastle, Washington. Notably, none of the tax forms in evidence (for the
taxable years at issue, as well as for 2005 and 2007) lists this address--not as a
mailing address for petitioners, not as an address on any of Forms W-2, Wage and
Tax Statement, Forms 1098, or Forms 1099, Miscellaneous Income, and not as a
rental property on any of the Schedules E. Nothing in the record suggests, let
alone establishes, that the property for which petitioners may have paid these
points was owned by either of them at any point beyond its acquisition in 2004. -9-
Without more information concerning the home’s ownership, its status as
either a residence or investment property, or its sale or other disposition, the Court
is unable to permit petitioners the deduction they now seek.
Schedule C and E Expenses
Respondent contends that petitioners have not shown, for the years at issue,
that the Sports activity and the rental activity, if any, were actually conducted for
profit or as businesses. But if they were so conducted, respondent contends that
petitioners have adequately substantiated neither the amounts of the expenses
deducted as a result of the activities nor whether the expenses were ordinary and
necessary.
Deductions are allowed under section 162 for the ordinary and necessary
expenses of carrying on an activity that constitutes the taxpayer’s trade or
business. Deductions are allowed under section 212(1) and (2) for expenses paid
in connection with an activity engaged in for the production or collection of
income, or for the management, conservation, or maintenance of property held for
the production of income.
Generally, no deduction is allowed for personal, living, or family expenses.
See sec. 262. The taxpayer must show that any claimed business expenses were
paid primarily for business rather than personal, living, or family reasons. See - 10 -
Rule 142(a); Walliser v. Commissioner, 72 T.C. 433, 437 (1979). To show that
the expense was not for personal reasons, the taxpayer must show that the expense
was paid primarily to benefit his business, and there must have been a proximate
relationship between the claimed expense and the business. See Walliser v.
Commissioner, 72 T.C. at 437.
With respect to either section 162 or section 212 the taxpayer must
demonstrate a profit objective for the activity in order to deduct associated
expenses. See Jasionowski v. Commissioner, 66 T.C. 312, 320-322 (1976); sec.
1.183-2(a), Income Tax Regs. The profit standards applicable for section 212 are
the same as those used for section 162. See Agro Sci. Co. v. Commissioner, 934
F.2d 573, 576 (5th Cir. 1991), aff’g T.C. Memo. 1989-687; Antonides v.
Commissioner, 893 F.2d 656, 659 (4th Cir. 1990), aff’g 91 T.C. 686 (1988); Allen
v. Commissioner, 72 T.C. 28, 33 (1979); Rand v. Commissioner, 34 T.C. 1146,
1149 (1960).
Section 1.183-2(b), Income Tax Regs., sets forth nine nonexclusive factors
that should be considered in determining whether a taxpayer is engaged in a
venture with a profit objective. A taxpayer, in order to show that he was engaged
in a trade or business, must show not only that his primary purpose for engaging in
the activity was for income or profit but also that he engaged in the activity with - 11 -
“continuity and regularity”. Commissioner v. Groetzinger, 480 U.S. 23, 35
(1987).
Where a taxpayer has established that he has paid a trade or business
expense, failure to prove the exact amount of the otherwise deductible item may
not always be fatal. Generally, unless prevented by section 274, the Court may
estimate the amount of such an expense and allow the deduction to that extent.
See Finley v. Commissioner, 255 F.2d 128, 133 (10th Cir. 1958), aff’g 27 T.C.
413 (1956); Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). In
order for the Court to estimate the amount of an expense, however, there must be
some basis upon which an estimate may be made. Vanicek v. Commissioner, 85
T.C. 731, 742-743 (1985). Without such a basis, an allowance would amount to
unguided largesse. Williams v. Commissioner, 245 F.2d 559, 560 (5th Cir. 1957).
Before examining the issues of whether petitioners have adequately
substantiated the amounts of the expenses deducted on their Schedules C and E or
whether the expenses were ordinary and necessary, it is appropriate that the Court
consider petitioners’ evidence of their carrying on a trade or business and holding
property for the production of income. - 12 -
Sports
Petitioners admit that they did not receive any income from the Sports
activity in the years at issue even though they initially reported that they did. Mr.
Simpson described his activity as a sports agent business. Mr. Simpson testified
that he lived in a neighborhood where he was “surrounded by athletes who played
for the Seahawks and Supersonics.” He testified that he attempted to sign athletes
to professional contracts and arrange “marketing and advertisement and
endorsement” deals. Petitioner testified that in order to recruit young male
athletes, he was required to incur expenses to go to bars, casinos, clubs, and
parties and to take limousine rides and buy jewelry and airline tickets.
Petitioners submitted as evidence of Mr. Simpson’s Sports activity:
(1) business licenses from the city of Seattle in the name of Sports for the years
1998 through 2002 and for 2007; (2) two International Basketball Association
player contracts from 1996 said to be “representative” of the “type of contracts he
helped secure” along with other materials from 1996; (3) an invoice issued in the
name of Sports dated January 10, 1997, along with miscellaneous correspondence
dated in 1997; (4) miscellaneous correspondence dated in 1998 and 1999; and (5)
the only item contemporaneous with a year at issue, a February 8, 2008, proposal - 13 -
by “Platinum” to perform for Sports a marketing and advertising campaign that
was attached to a player list from 1997.
Mr. Simpson testified that he did not sign any player contracts in 2007,
2008, or 2009. In fact, petitioners offered no evidence other than their own
testimony that Mr. Simpson was conducting any sports agent activity in 2008 and
2009. The Court is not required to accept their self-serving testimony, particularly
in the absence of corroborating evidence. See Geiger v. Commissioner, 440 F.2d
688, 689 (9th Cir. 1971), aff’g per curiam T.C. Memo. 1969-159; Urban Redev.
Corp. v. Commissioner, 294 F.2d 328, 332 (4th Cir. 1961), aff’g 34 T.C. 845
(1960). Because of the inconsistencies and eccentricities in the record the Court
declines to accept their testimony.
Since the Court concludes that Sports was conducted neither as a profit-
seeking activity nor as a going concern in the years at issue it is not necessary to
consider whether the deducted expenses were ordinary and necessary business
expenses. Because petitioners have not shown for what purpose the claimed
expenses might otherwise be deductible, the Court sustains respondent’s
determination on this issue.5
5 As petitioners earned no gross income from Sports in the years at issue, they are not entitled to any deductions for an activity not engaged in for profit. (continued...) - 14 -
Rental Activity
Respondent disallowed petitioners’ deduction on Schedule E of expenses
for depreciation, mortgage interest, cleaning and maintenance, auto and travel, and
repairs related to Woodland Avenue. Mr. Simpson testified that petitioners rented
Woodland Avenue to his uncle, David Simpson, in 2008 and 2009, during which
time Mr. Simpson stated he also had a major renovation performed on Woodland
Avenue. According to Mr. Simpson, there was no written lease agreement and no
rent receipts were provided to his uncle for rental payments made. There were
also few receipts, if any, detailing petitioners’ expenses.
Petitioners, having claimed a mortgage interest expense deduction of
$1,948 on Schedule E for 2008, presented at trial a revised Schedule E deleting the
interest deduction without explanation. Petitioners deducted $6,800 of repairs
expenses that were changed on the revised Schedule E to “Painting and other
contracted maintenance” expenses of $6,800. Petitioners’ evidence that they paid
expenses for auto and travel was Mr. Simpson’s testimony that he had paid the
expenses in cash. Likewise, Mr. Simpson testified that the expenses for cleaning
5 (...continued) See sec. 183(b)(2). Petitioners did not deduct any sec. 183(b)(1) items on Schedule C. - 15 -
and maintenance were all paid in cash to his father, “Leonard Senior”, a general
contractor.
As evidence of the repairs expenses for 2009 petitioners offered a series of
copies of documents titled “Proposal” and “Invoice”. The documents are stated to
be from “James Peterson Remodeling” to Len Can Builders, Inc., the company
owned by Mr. Simpson’s father. Mr. Simpson testified that the proposals and
invoices were passed from Mr. Simpson’s father to Mr. Simpson and his father
oversaw the work. Mr. Simpson testified that he paid the invoices in cash by
delivering it “physically to workers”.6
Petitioners offered no evidence on these issues other than their testimony.
The Court concludes that petitioners have not shown that Woodland Avenue was
held for rental in 2008 and 2009 and if it was they have not substantiated the
disallowed expenses deducted on Schedule E. Respondent’s determination on
these issues is sustained.
6 The Court notes that petitioners resided in the State of Washington at the time the petition was filed and that the notice of deficiency upon which this case is based was sent to them in Seattle, Washington. The income tax returns filed for the years at issue reflect petitioners’ residence to be in Seattle, Washington. Woodland Avenue is in Kansas City, Missouri. - 16 -
Accuracy-Related Penalty
Section 7491(c) imposes on the Commissioner the burden of production in
any court proceeding with respect to the liability of any individual for penalties
and additions to tax. Higbee v. Commissioner, 116 T.C. 438, 446 (2001);
Trowbridge v. Commissioner, T.C. Memo. 2003-164, aff’d, 378 F.3d 432 (5th Cir.
2004). In order to meet the burden of production under section 7491(c), the
Commissioner need only make a prima facie case that imposition of the penalty or
addition to tax is appropriate. Higbee v. Commissioner, 116 T.C. at 446.
Respondent determined that for 2008 and 2009 petitioners underpaid a
portion of their income tax because of negligence or intentional disregard of rules
and regulations and that there is a substantial understatement of income tax.
Section 6662(a) and (b)(1) and (2) imposes a penalty equal to 20% of the portion
of the underpayment attributable to negligence or disregard of rules or regulations
or a substantial understatement of income tax.
Negligence is defined as any failure to make a reasonable attempt to comply
with the provisions of the Internal Revenue Code, and the term “disregard”
includes any careless, reckless, or intentional disregard. See 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. - 17 -
A “substantial understatement” includes an understatement of 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. The tax shown on
petitioners’ joint return for 2008 was $4,909, and the tax shown on the return for
2009 was $628. Petitioners’ correct tax liability for 2008 is $16,931, and for 2009
it is $7,696. Petitioners have a substantial understatement of tax for each of 2008
and 2009 since the understatement amount for each year will exceed both 10% of
the tax required to be shown on the return for that year and $5,000. The Court
concludes that respondent has produced sufficient evidence to show that the
accuracy-related penalty under section 6662 is appropriate for 2008 and 2009.
The accuracy-related penalty will apply unless a taxpayer demonstrates that
there was reasonable cause for the underpayment and that he or she acted in good
faith with respect to the underpayment. See sec. 6664(c). Section 1.6664-4(b)(1),
Income Tax Regs., specifically provides: “Circumstances that may indicate
reasonable cause and good faith include an honest misunderstanding of fact or law
that is reasonable in light of * * * the experience, knowledge, and education of the
taxpayer.” The most important factor is the extent of the taxpayer’s effort to
assess his proper tax liability for the year. Id. - 18 -
Petitioners did not show that there was reasonable cause for, and that they
acted in good faith with respect to, the underpayments of tax for 2008 and 2009.
Therefore, respondent’s determination of the accuracy-related penalty under
section 6662(a) for 2008 and 2009 is sustained.
To reflect the foregoing,
Decision will be entered under
Rule 155.