T.C. Memo. 2018-102
UNITED STATES TAX COURT
MARC WHITE AND KELLY WHITE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10181-15. Filed July 3, 2018.
Betty J. Williams, Richard T. Luoma, and Matthew D. Carlson, for
petitioners.
Nicholas R. Rosado, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
PUGH, Judge: In a notice of deficiency dated March 24, 2015, respondent
determined the following deficiencies, additions to tax, and penalties:1
1 Unless otherwise indicated, all section references are to the Internal (continued...) -2-
[*2] Addition to tax Penalty Year Deficiency sec. 6651(a)(1) sec. 6662(a) 2011 $84,179 -0- $16,836 2012 46,951 $11,738 9,390
After concessions,2 the issues for decision are: (1) whether petitioners’
business constituted a partnership for tax purposes; (2) whether petitioners had
unreported gross receipts for the 2011 and 2012 tax years; and (3) whether
petitioners are entitled to deduct expenses reported on Schedules C, Profit or Loss
From Business, for the 2011 and 2012 tax years.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. Petitioners resided
in California when they timely filed their petition. They were married and filed
joint Federal income tax returns for the taxable years at issue.
1 (...continued) Revenue Code of 1986, as amended and in effect for the years at issue. Rule references are to the Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar. 2 On brief petitioners conceded “the remaining adjustments to Schedule C expenses [apart from advertising expenses and rent expenses], itemized deductions, pension and annuity income, computational adjustments, and additions to tax and penalties (to the extent of any deficiencies).” -3-
[*3] I. Background
Petitioner Marc White spent most of his career in automobile sales. He was
employed by the Mercedes Benz dealership in Sacramento, California, for over 20
years, ultimately serving as the manager of the dealership. Towards the end of
2010 after losing his position with Mercedes Benz, Mr. White was approached by
his ex-wife April Van Patten about forming a mortgage company. Mrs. Van
Patten and her husband Kevin Van Patten had experience in real estate, and Mrs.
Van Patten held a real estate broker license in California and also held a mortgage
lending originator license regulated by the National Mortgage Licensing System.
Mr. White observed the Van Pattens’ success in real estate and believed real estate
and mortgage lending to be a profitable business.
II. Business Formation
Mr. White and Mrs. Van Patten, along with their respective spouses--
petitioner Kelly White and Mr. Van Patten--ultimately agreed to work together in
the real estate business in late 2010 or early 2011. This business had two separate
components under two separate names: Mortgage Lending Services of California
was the mortgage lending business, and Homebuyers Resource Center was the real
estate transaction business. Its business address was 7996 California Avenue -4-
[*4] Suite C, Fair Oaks, California 95628 (Fair Oaks address). The couples did
not reduce the terms of their business relationship to writing.
A. Capitalization
During the 2011 tax year petitioners withdrew $211,746 from Mr. White’s
retirement account. Petitioners used a substantial part of this distribution to
support the new business. The Van Pattens did not make similar financial
contributions to the business. While Mr. Van Patten testified that he also made
capital contributions to the business, we do not find his testimony credible. When
Mr. White was asked what contributions the Van Pattens made, he responded: “I
mean, they really didn’t have any money, I mean, to speak of when we all
partnered up.” We found his testimony on this point more credible than Mr. Van
Patten’s.
B. Bank Accounts
Petitioners’ personal checking account with Golden 1 Credit Union was
used for the business’ banking during the first few months of operation. The Van
Pattens explained to Mr. White that they had had problems with bad checks in a
prior business and could not open business bank accounts. However, as we
discuss below in Section IV, the record includes a check written on a Bank of
America account listing Camille Straughn “DBA The Van Patten Group” dated -5-
[*5] June 24, 2011, and a check dated November 30, 2012, written on a TD
Ameritrade account listing Mrs. Van Patten “DBA Mortgage Lending Services of
California (a Sole Proprietorship)” at the Fair Oaks address.
On November 2, 2010, three bank accounts were opened with Bank of
America: a personal checking account ending in 5398, opened under Mr. and Mrs.
White’s names; a business savings account ending in 3053; and a business
checking account ending in 3906. Records of both business bank accounts listed
“Mortgage Lending Services of California” as the account title and “corporation”
as its legal designation. Three signatories were authorized for the two business
accounts: Mr. White as president, Mrs. White as treasurer, and Camille Straughn
as secretary. On December 2, 2010, Mr. White opened a fourth bank account with
Bank of America: a business checking account ending in 3381. Mr. White was
the only officer listed on the account--as president and secretary.
After the Bank of America accounts were opened, a bad check was written
on one of the business accounts and the business was unable to satisfy the
financial obligations on that account. On October 6, 2011, Mr. White opened
three new business accounts with American River Bank: a business checking
account ending in 8711 opened under Mr. White DBA Mortgage Lending Services
of CA; a business checking account ending in 8728 opened under Mr. White DBA -6-
[*6] Homebuyers Resource Center; and a business checking account ending in
8735 opened under Mr. White DBA Mortgage Lending Services--Trust Account.
The American River Bank account agreements each list Mr. White as the sole
signatory, and the business designation selected for each account was “Sole
Proprietorship” with Mr. White listed as the sole proprietor.
III. Business Operations
A. Responsibilities
The two couples had different roles and responsibilities. Mr. White
oversaw office operations. Mrs. White oversaw the real estate agents, followed up
on agents’ leads, tracked agents’ progress in showing homes, and wrote offers.
She also satisfied the requirements necessary to re-establish her real estate
license.3 Following the reestablishment of her license, she served as a real estate
agent, providing backup support for the other real estate agents and helping show
properties herself. Mrs. Van Patten served as the broker of record because she
held the required professional licenses. Finally, Mr. Van Patten was responsible
for marketing, structuring loans, and overseeing loan processing.
3 At trial respondent orally moved for the Court to take judicial notice of the fact that Mrs. White had a salesperson license issued in 2003 that did not expire until 2015. Petitioners do not object to a finding that Mrs. White obtained her license in 2003. We, therefore, find this fact conceded and will deny as moot respondent’s oral motion to take judicial notice. -7-
[*7] B. Financial Activities
The business was run very informally. The couples did not consult or
employ any tax professionals. While for a time they did employ a bookkeeper,
who used QuickBooks software to maintain the company’s books and records, as
business declined they were unable to pay the bookkeeper. Those Quickbooks
files were no longer accessible, and petitioners did not call the bookkeeper to
testify at trial.
The business incurred advertising expenses at its inception. Mr. Van Patten
ordered 25,000 mailers from A-Applied Mailing Service, Inc., to advertise the
refinancing and home mortgage lending services and paid $10,228 for their
printing, packaging, and mailing. Mr. White then reimbursed Mr. Van Patten with
funds withdrawn from his Golden 1 Credit Union account. The record includes a
summary for 2011, prepared by Mrs. White during petitioners’ audit, titled “Rent--
Other Business Property”. That summary includes the following items: $27,450
for office rent, $3,500 for office furniture, $2,463 for “maintenance”, $537 for
business technology, and $450 for new office deposit.
C. Division of Profits
Petitioners controlled the business’ funds, used business accounts to pay
personal expenses and personal accounts to pay business expenses, and did not -8-
[*8] maintain books and records tracking these payments. They also used funds
from the business accounts to pay expenses for the Van Pattens--such as utility
bills and car payments--but the record does not include reliable evidence showing
how much they paid, with one exception discussed below.
While petitioners argue that the couples agreed to an equal division of
profits, Mr. White acknowledged at trial that this did not occur. The record shows
irregular cash withdrawals by petitioners and some payments to the Van Pattens
along with commission payments and “draws” to other associates. These cash
withdrawals exceed the documented payments to, or on behalf of, the Van Pattens.
During the tax years at issue petitioners made most of the mortgage
payments for the house where the Van Pattens lived. At trial Mr. White explained
the arrangement with the Van Pattens as follows:
We had a verbal agreement. The house was in my name. I moved out of the house because they really wanted to live there, because they had a big family. So I moved out. I moved into a different house. And because their credit was bad, I had a verbal agreement that, if they would pay the mortgage on it until they got squared away and could get good credit, that they had to pay me, but that I would take-- you know, we--together, however you want to look at it, we were partners. And then, once their credit got good and they got squared away, they would take over the mortgage on the house when they could actually qualify for it. -9-
[*9] Petitioners claimed deductions for mortgage interest paid on the home in
which the Van Pattens lived during both taxable years at issue.
As petitioners’ financial situation deteriorated, the lines between business
accounts and personal accounts were blurred even further. Mr. White described
the financial difficulties he faced, testifying: “I made payments from every
account I had before I went bankrupt. I grabbed money from any place that --
* * * I took money out of everywhere.”
The business was never incorporated, was never profitable, and ultimately
failed. Towards the end of 2012 the couples agreed to part ways, and the Van
Pattens agreed to buy petitioners’ interests in the business.
IV. Income Tax Returns
Petitioners filed joint Forms 1040, U.S. Individual Income Tax Return, for
2011 and 2012. Petitioners timely filed their 2011 Form 1040 and filed their 2012
Form 1040 on May 23, 2014.
Mr. Van Patten prepared petitioners’ Forms 1040 for 2011 and 2012
although the returns indicate that they were self-prepared. Mr. Van Patten also
prepared the joint Forms 1040 he filed with Mrs. Van Patten. Mr. Van Patten was
not a tax professional and did not have a tax background. - 10 -
[*10] Both couples reported business income on Schedules C for the tax years at
issue as described below. No Form 1065, U.S. Return of Partnership Income, was
ever filed for the business.
Petitioners attached Schedules C and Schedules C-EZ, Net Profit From
Business, to their 2011 and 2012 Forms 1040. The Schedules C related to Mr.
White’s shares of the business income and expenses, and the Schedules C-EZ
related to Mrs. White’s shares. On their 2011 Schedule C, petitioners reported
$367,758 of income and claimed deductions of $32,698 for advertising expenses
and $34,200 for rent expenses. Petitioners also reported $6,807 of income on their
2011 Schedule C-EZ. Petitioners reported $320,310 of income on their 2012
Schedule C and $28,407 of income on their 2012 Schedule C-EZ.
The Van Pattens reported $48,617 of income for Mr. Van Patten’s “Real
Estate Marketing” activities and $245,102 of income for Mrs. Van Patten’s “Real
Estate” activities on their 2011 Schedules C. On their 2012 Schedules C the Van
Pattens reported $46,676 of income for Mr. Van Patten’s business activities and
$292,937 of income for Mrs. Van Patten’s business activities.
Mrs. Van Patten’s 2011 Wage and Income Transcript indicates that she was
issued six Forms 1099-MISC, Miscellaneous Income, related to her real estate
activities which were sent to the Fair Oaks address: five Forms 1099-MISC were - 11 -
[*11] issued to her, and one was issued to her on behalf of Mortgage Lending
Services of California. Mrs. Van Patten’s 2012 Wage and Income Transcript
indicates that she was issued four Forms 1099-MISC related to her real estate
activities and sent to the Fair Oaks address: two Forms 1099-MISC were issued to
her, one was issued to her on behalf of Homebuyers Resource Center, and one was
issued to her on behalf of Mortgage Lending Services.
Petitioners did not reconcile Mrs. Van Patten’s Forms 1099-MISC with
their business gross receipts. Nor could we. We could identify only two Form
1099-MISC payors from Mrs. Van Patten’s Wage and Income Transcript in
respondent’s bank deposits analysis. We could not reconcile the deposits with the
bank statements in the record. The gross receipts the Van Pattens reported on their
Schedules C exceeded the total gross receipts reported to Mrs. Van Patten on her
Forms 1099-MISC. Finally, petitioners never explained how the payments
reported to Mrs. Van Patten were transferred to the business. The record does
include two checks that may have represented transfers. The first check, dated
June 24, 2011, of $4,100 was made out to Mortgage Lending Services and was
issued by a Bank of America bank account held by Camille Straughn “DBA The
Van Patten Group”. The second check, dated November 30, 2012, of $6,000 was
made out to Mr. White and was issued by a TD Ameritrade bank account held by - 12 -
[*12] Mrs. Van Patten “DBA Mortgage Lending Services of California (a Sole
Proprietorship)” at the Fair Oaks address.4
V. Unreported Income
Respondent initially summoned petitioners’ bank records from their Bank of
America and American River Bank accounts. While reviewing these bank
records, respondent identified transfers to petitioners’ Golden 1 Credit Union
account and subsequently summoned petitioners’ bank records from this account.
Respondent began a bank deposits analysis to compute petitioners’ income but
was unable to complete it given the incomplete bank account records received. As
a result, respondent used the specific-item method for 2011 and 2012 to
reconstruct petitioners’ income. Respondent determined and classified deposit
sources from the descriptions of deposited items on petitioners’ account records.
Respondent then excluded as nontaxable all transfers between bank accounts and
excluded rental payments, pension distributions, or unemployment compensation.
Respondent also excluded as nontaxable all cash deposits, given the nature of
petitioners’ businesses. Finally, respondent excluded as nontaxable deposits from
4 Given the timing this check also may have been the Van Pattens’ payment to petitioners for the business. - 13 -
[*13] the Van Pattens that petitioners indicated to the revenue agent were loan
repayments.
Respondent determined that petitioners’ deposits totaled $786,881 for 2011
and $766,761 for 2012. As a result of the specific-item method reconstruction,
respondent determined that petitioners had unreported Schedule C gross receipts
of $42,985 for 2011 and $121,053 for 2012.
OPINION
I. Burden of Proof
The taxpayer generally has the burden of proving that the Commissioner’s
determinations in a notice of deficiency are incorrect. Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933); see also Weimerskirch v. Commissioner,
596 F.2d 358, 361-362 (9th Cir. 1979), rev’g, 67 T.C. 672 (1977).5
5 Petitioners assert that they have provided complete and conclusive documentation and credible testimony to substantiate their income and claimed deductions sufficiently to shift the burden of proof under sec. 7491(a). Under sec. 7491(a)(1), “[i]f, in any court proceeding, a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B, the Secretary shall have the burden of proof with respect to such issue.” See Higbee v. Commissioner, 116 T.C. 438, 442 (2001) (“Credible evidence is the quality of evidence which, after critical analysis, the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted (without regard to the judicial presumption of IRS correctness.)” (quoting H.R. Conf. Rept. No. 105-599, at 240- 241 (1998), 1998-3 C.B. 747, 994-995)). We do not believe petitioners have (continued...) - 14 -
[*14] II. Unreported Income
Section 61(a) provides that gross income includes “all income from
whatever source derived”. See Commissioner v. Glenshaw Glass Co., 348 U.S.
426, 430-432 (1955). A taxpayer is responsible for maintaining adequate books
and records sufficient to establish the amount of his or her income. See sec. 6001.
If a taxpayer fails to maintain and produce the required books and records, the
Commissioner may determine the taxpayer’s income by any method that clearly
reflects income. See sec. 446(b); Petzoldt v. Commissioner, 92 T.C. 661, 693
(1989); sec. 1.446-1(b)(1), Income Tax Regs. The Commissioner’s reconstruction
of income “need only be reasonable in light of all surrounding facts and
circumstances.” Petzoldt v. Commissioner, 92 T.C. at 687.
A. The Specific-Item Method
The specific-item method is a method of income reconstruction that consists
of evidence of specific amounts of income received by a taxpayer and not reported
5 (...continued) satisfied the requirements for the burden to shift to respondent. Moreover, for issues we resolve on a preponderance of the evidence in the record, which party bears the burden is not relevant; it is relevant only where there is an evidentiary tie. See Knudsen v. Commissioner, 131 T.C. 185, 189 (2008); Schank v. Commissioner, T.C. Memo. 2015-235, at *16. - 15 -
[*15] on the taxpayer’s return. See Estate of Beck v. Commissioner, 56 T.C. 297,
353, 361 (1971).
Petitioners failed to maintain accurate books and records for the years at
issue. Respondent, therefore, was justified in using the specific-item method to
determine petitioners’ tax liabilities for the years at issue. See id. at 353-354.
Petitioners do not argue that the gross receipts computed by respondent are from
nontaxable sources. Instead, petitioners assert that the gross receipts were the
revenue of a partnership and should have been split among the partners. We,
therefore, must determine whether the couples’ business constituted a partnership
during the tax years at issue. Petitioners further argue that because business
profits should have been split, the gross receipts petitioners reported on their
returns were overstated and should be adjusted downward, not upward, to account
for the amounts attributable to the Van Pattens and reported on the Van Pattens’
Schedules C for these years.
B. Existence of Partnership
If, as petitioners assert, the couples’ business was properly classified as a
partnership for tax purposes, petitioners would be taxable on only their
distributive shares of the partnership’s income. See secs. 702, 704(a) (“A
partner’s distributive share of income, gain, loss, deduction, or credit shall, except - 16 -
[*16] as otherwise provided in this chapter, be determined by the partnership
agreement.”).
Federal tax law controls the classification of “partners” and “partnerships”
for Federal tax purposes. See sec. 301.7701-1(a), Proced. & Admin. Regs.; see
also Commissioner v. Tower, 327 U.S. 280, 288, 290 (1946). A partnership is a
business entity with two or more parties. See secs. 301.7701-1(a)(1), 301.7701-
3(a) and (b)(1)(i), Proced. & Admin. Regs. The hallmark of a partnership is that
“the participants carry on a trade, business, financial operation, or venture and
divide the profits therefrom.” Sec. 301.7701-1(a)(2), Proced. & Admin. Regs. In
determining whether a partnership exists, the Court considers the following
factors:
[(1)] The agreement of the parties and their conduct in executing its terms; [(2)] the contributions, if any, which each party has made to the venture; [(3)] the parties’ control over income and capital and the right of each to make withdrawals; [(4)] whether each party was a principal and coproprietor, sharing a mutual proprietary interest in the net profits and having an obligation to share losses, or whether one party was the agent or employee of the other, receiving for his services contingent compensation in the form of a percentage of income; [(5)] whether business was conducted in the joint names of the parties; - 17 -
[*17] [(6)] whether the parties filed Federal partnership returns or otherwise represented to respondent or to persons with whom they dealt that they were joint venturers; [(7)] whether separate books of account were maintained for the venture; and [(8)] whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise.
Luna v. Commissioner, 42 T.C. 1067, 1077-1078 (1964). Whether parties have
formed a partnership is a question of fact, and while all circumstances are to be
considered, the “essential question is whether the parties intended to, and did in
fact, join together for the present conduct of an undertaking or enterprise.” Id.
We will address each factor in turn.
1. Agreement of Parties and Conduct in Executing Terms
Petitioners and the Van Pattens did not reduce the terms of their agreement
to writing. A partnership agreement may be entirely oral and informal, but the
parties must demonstrate that they complied with its terms. See Strickland v.
Commissioner, T.C. Memo. 1986-85 (finding that a partnership existed even
though no written agreement existed during the years at issue) (citing Ayrton
Metal Co. v. Commissioner, 299 F.2d 741, 742 (2d Cir. 1962), and Seattle Renton
Lumber Co. v. United States, 135 F.2d 989, 991 (9th Cir. 1943)).
While the couples may have agreed orally to an equal division of profits,
Mr. White acknowledged that this division did not occur. Unlike the taxpayers in - 18 -
[*18] Strickland, petitioners withdrew varying sums of money from the business at
irregular intervals. See Azimzadeh v. Commissioner, T.C. Memo. 2013-169,
at *7. The Van Pattens could not withdraw money directly but instead received
irregular payments in amounts different from the withdrawals and payments by
petitioners. Nor can we count petitioners’ mortgage payments for the home
occupied by the Van Pattens as evidence of the Van Pattens’ right to partnership
profits. While petitioners argue that the Van Pattens owned the home, petitioners
deducted the interest payments on their own joint Forms 1040.
Petitioners direct us to the Van Pattens’ returns to show that the Van Pattens
already reported their shares of the business income. Petitioners, however, never
established that the Van Pattens did not receive income from other sources.
Moreover, petitioners never explained how payments reported on the Van Pattens’
Forms 1040 (and on Forms 1099-MISC issued to Mrs. Van Patten) made their way
into the business bank accounts or were accounted for otherwise. This factor,
therefore, weighs against finding that a partnership existed.
2. Parties’ Contributions to Venture
We found above that petitioners withdrew $211,746 from Mr. White’s IRA
and used these funds, in part, to capitalize the business, but we have no credible
evidence that the Van Pattens made any capital contributions. See Holdner v. - 19 -
[*19] Commissioner, T.C. Memo. 2010-175, 2010 WL 3036440, at *12, aff’d, 483
F. App’x 383 (9th Cir. 2012). The record suggests that petitioners and the Van
Pattens each performed services related to the business, however. We, therefore,
will weigh this factor as favorable. See Simmons v. Commissioner, 22 B.T.A.
1106, 1114 (1931); Wheeler v. Commissioner, T.C. Memo. 1978-208.
3. Control Over Income and Right To Make Withdrawals
Petitioners argue that the Van Pattens had equal rights to withdraw funds
from the accounts, but the credible evidence before us indicates that petitioners
had sole financial control. Petitioners were the signatories on all of the business
accounts throughout the business’ existence; the Van Pattens never were. We also
note that while Camille Straughn also had signature authority for one of the initial
accounts, nowhere in the record do petitioners allege that Ms. Straughn was acting
on behalf of the Van Pattens. While the record shows that petitioners made
payments to or on behalf of the Van Pattens, no evidence shows that the Van
Pattens had rights to withdraw funds from the accounts aside from Mr. White’s
testimony that the Van Pattens had debit cards. But the account statements do not
indicate who made withdrawals, nor did petitioners tie any specific expenditures
to the Van Pattens. While, as we note above, the Van Pattens received some
payments related to the business, and petitioners paid the mortgage for the Van - 20 -
[*20] Pattens at least for part of the years at issue, this evidence is not enough for
us to conclude that the Van Pattens had joint control over the business’ income.
This factor, therefore, weighs against finding a partnership existed.
4. Coproprietor or Nonpartner Relationship
Respondent asserts that the Van Pattens had a separate business and were
independent contractors who were paid commissions. Petitioners assert that the
compensation of the couples was contingent on the proceeds from the business
and they did not have fixed salaries.
The record indicates that the Van Pattens played a role in the business, but
the evidence is not sufficient to show that their role was coproprietors rather than
independent contractors. Business owners, for example, may agree to compensate
key employees with a percentage of business income, or brokers may be retained
to sell property for a commission based on the net or gross sale price. See Comtek
Expositions, Inc. v. Commissioner, T.C. Memo. 2003-135, aff’d, 99 F. App’x 343
(2d Cir. 2004). Although these arrangements may result in a division of profits,
neither constitutes a partnership unless the parties become coproprietors. Id.
Indeed, in Luna v. Commissioner, 42 T.C. at 1079, we held that no partnership
existed even though the taxpayer was to receive percentage commissions in
exchange for the management services he provided. The record shows that - 21 -
[*21] payments to independent contractors were labeled commission payments
and draws, like payments made to the Van Pattens. The only evidence that the
Van Pattens received payments more akin to a partner’s share than an independent
contractor’s commission or draw is petitioners’ and the Van Pattens’
uncorroborated testimony. We do not find their story credible. This factor,
therefore, weighs against finding a partnership.
5. Whether Business Was Conducted in Joint Names
As the business’ bank records reflect, the accounts were held in either Mr.
White’s name alone or petitioners’ names together and included the names of the
businesses. The Van Pattens were not listed on any of the accounts. Further,
petitioners designated the business as either a sole proprietorship or a corporation,
not a partnership. And it appears that the Van Pattens had separate business bank
accounts. Mrs. Van Patten’s check showed “April Lynn Van Patten DBA
Mortgage Lending Services of California (a Sole Proprietorship)” at the Fair Oaks
address at least at some point in the business relationship. And another check to
Mortgage Lending Services lists Camille Straughn “DBA The Van Patten Group”.
These checks suggest that the couples both treated the business as their own sole
proprietorships--not a joint enterprise--not just on their Forms 1040, but also to - 22 -
[*22] financial institutions (and potentially check recipients). This factor,
therefore, weighs against finding a partnership existed.
6. Filing of Partnership Returns or Representation of Joint Venture
As petitioners acknowledge, they did not prepare and file a Form 1065 for
their business for either taxable year at issue. Instead, they reported the income
and expenses on their Schedules C and C-EZ. Petitioners assert that they
represented to others that they were joint venturers and informed respondent
during their examination that they operated a partnership. Respondent disputes
this characterization, alleging that petitioners characterized transfers from the Van
Pattens as loan repayments. We need not resolve this dispute. Petitioners’
uncorroborated testimony cannot overcome their reporting of income and
expenses on their returns and the bank account records in evidence. We find,
therefore, that this factor weighs against finding a partnership.
7. Maintenance of Separate Books and Accounts
Petitioners contend that they used QuickBooks to maintain separate books
and records at the entity level. Petitioners failed to produce any evidence that
separate books and accounts were maintained other than their uncorroborated
testimony. The business bank accounts were held in petitioners’ names (either Mr.
White or both Mr. and Mrs. White). Petitioners also admit that they used business - 23 -
[*23] accounts for personal expenses and personal accounts for business expenses.
This factor, therefore, weighs against finding that a partnership existed.
8. Exercise of Mutual Control and Assumption of Mutual Responsibilities
Petitioners and the Van Pattens testified that they each assumed separate
roles in the real estate and mortgage activities, and the record supports a finding
that they had a business relationship in which they had different roles. But the fact
that they may have performed separate functions does not convince us that they
exercised “mutual control” and “mutual responsibilities” indicative of a
partnership, notwithstanding their conclusory testimony. See Kazdin v.
Commissioner, T.C. Memo. 1969-75.
Considering the record as a whole, applying the Luna factors, and
considering the inconsistencies in the record, we conclude that the business is not
properly classified as a partnership for tax purposes. While the record indicates
that petitioners and the Van Pattens had some sort of relationship, the record does
not support a conclusion that the business was a partnership. Petitioners’
explanations for the inconsistencies between their story and the evidence have far
too many gaps. We understand that petitioners were trying to make ends meet in a - 24 -
[*24] challenging time, but their story cannot survive all of the gaps and
inconsistencies in the record without credible evidence to back them up.
Moreover, even were we to conclude that a partnership existed, we have no
reliable evidence of the partnership’s total receipts on which we could base an
allocation of income different from the amounts respondent calculated using the
specific-item method. We, therefore, hold that petitioners have unreported
Schedule C gross receipts of $42,985 and $121,053 for the 2011 and 2012 taxable
years, respectively.
III. Deductions
Deductions are a matter of legislative grace, and a taxpayer must prove his
or her entitlement to deductions. INDOPCO, Inc. v. Commissioner, 503 U.S. 79,
84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).
Taxpayers, therefore, are required to substantiate expenses underlying each
claimed deduction by maintaining records sufficient to establish the amount of the
deduction and to enable the Commissioner to determine the correct tax liability.
Sec. 6001; Higbee v. Commissioner, 116 T.C. 438, 440 (2001). Under the Cohan
rule, where a taxpayer is able to demonstrate that he or she has paid or incurred a
deductible expense but cannot substantiate the precise amount, the Court may
estimate the amount of the expense if the taxpayer produces credible evidence - 25 -
[*25] providing a basis for the Court to do so. Cohan v. Commissioner, 39 F.2d
540, 544 (2d Cir. 1930).
Section 162(a) provides that expenses are deductible if they were ordinary,
necessary, and paid or incurred during the tax year and were directly connected
with, or proximately resulted from, a trade or business of the taxpayer. See
Commissioner v. Lincoln Sav. & Loan Ass’n, 403 U.S. 345, 352 (1971);
Kornhauser v. United States, 276 U.S. 145, 153 (1928); O’Malley v.
Commissioner, 91 T.C. 352, 361-362 (1988).
A. Advertising Expense
Petitioners assert that they are entitled to a $10,228 advertising expense
deduction for the 2011 tax year. Mr. White credibly testified that the $10,228
expense relates to an advertising mailer designed to promote the new business.
Respondent argues that the expense was not for petitioners’ business. The record
includes a copy of the original invoice and a corresponding debit on an account
statement from petitioners’ Golden 1 bank account--the account initially used for
business expenses--and supports Mr. White’s testimony. We reject respondent’s
argument that these expenses were the Van Pattens’.
Having found that the bank account was solely for petitioners’ business and
that the business was not a partnership, we logically find that petitioners may - 26 -
[*26] deduct the advertising expense incurred by the business. We also find that
petitioners substantiated this expense and proved that it was ordinary and
necessary to their business.
We hold, therefore, that petitioners are entitled to deduct $10,228 of
advertising expenses for the 2011 tax year.
B. Rent Expense
Petitioners assert that they are entitled to deduct $34,400 in rent expenses
for the 2011 taxable year. Respondent allowed a deduction for $27,900 of rent
expenses and claims that this amount is greater than the amount of rent payments
shown on the summary prepared by Mrs. White of $27,450. We agree with
respondent that petitioners are not entitled to a greater amount. Petitioners did not
show that the remaining expenses described on Mrs. White’s summary as
maintenance, business technology, new office deposit, and office furniture are rent
expenses for the 2011 taxable year; nor did they provide documentation that
would support deductibility as another type of business expense.
We hold, therefore, that petitioners are entitled only to the $27,900 rent
expense deduction respondent allowed on their 2011 joint return. - 27 -
[*27] We have considered all of the arguments made by petitioners and
respondent and, to the extent they are not addressed herein, we find them to be
moot, irrelevant, or without merit.
To reflect the foregoing,
An appropriate order will be issued,
and decision will be entered under Rule
155.