T.C. Memo. 2014-257
UNITED STATES TAX COURT
OLIVER BARR MCCLELLAN AND CECILE WILLIAMS MCCLELLAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 25565-12. Filed December 22, 2014.
Oliver Barr McClellan and Cecile Williams McClellan, pro sese.
Janet F. Appel, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
JACOBS, Judge: Respondent determined deficiencies in petitioners’
Federal income tax and accuracy-related penalties as follows:1
1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. -2-
[*2] Penalty Year Deficiency sec. 6662(a)
2006 $40,732 $8,146.40 2007 37,240 7,448.00 2008 25,874 5,174.80
After concessions, the issues for decision are: (1) whether petitioners are
entitled to various deductions claimed on Schedules C, Profit or Loss From
Business, for 2006, 2007, and 2008 (years at issue) in excess of those respondent
allowed; (2) whether petitioners are entitled to various deductions claimed as
losses for 2006; and (3) whether petitioners are liable for the section 6662
accuracy-related penalty for each of the years at issue.2
FINDINGS OF FACT
Some of the facts have been stipulated, and they are so found. The
stipulation of facts and the attached exhibits are incorporated herein by this
reference. At the time of filing their petition, petitioners resided in Mississippi.
2 Petitioners concede that they received $96 of taxable interest in 2006; that they received $5,000 of gross receipts in 2006 and 2008; and that they did not report these amounts on their 2006 and 2008 returns. Respondent concedes that for 2007, petitioners are allowed the following Schedule C deductions: (1) $201.48 for delivery costs; (2) $100.69 for office expenses; and (3) $570.11 for books and references. Respondent also concedes that for 2008 petitioners are allowed to claim a $52.51 deduction for books and references. -3-
[*3] I. Background
Petitioner husband Oliver McClellan received a bachelor of arts degree in
1961 and a bachelor of laws degree in 1964, both from the University of Texas in
Austin. After graduating from law school petitioner husband practiced as an
attorney with a law firm in Austin, Texas, assisting clients in general legal matters.
He stopped practicing law in order to start and operate a call center business in
Houston, Texas, with his wife, who had prior experience in the call center
industry.
In 1998 petitioners sold their Houston call center business and created
BCMC, a consulting business for call centers. From 1998 until approximately
2004, petitioners individually or collectively engaged in multiple business
activities, including a real estate business, a general consulting business, and
writing books.
II. BCMC’s Agreement With Messages, Inc.
In 2004 BCMC entered into a temporary working arrangement with
Messages, Inc., which was the flagship company of a consortium of call centers
based in Princeton, New Jersey, Boston, Massachusetts, Willow Grove, -4-
[*4] Pennsylvania, and Los Angeles, California.3 Pursuant to the terms of their
arrangement BCMC received $10,000 per month plus reimbursement of certain
expenses4 from Messages, Inc., in exchange for BCMC’s providing business
management and advisory services to Messages, Inc., and the other above-
mentioned call centers. After an initial six-month period, BCMC agreed to
continue their arrangement with Messages, Inc., and the other call centers month
to month. During the years at issue, petitioners traveled and worked together
conducting the activities of BCMC primarily in Manhattan and Staten Island, New
York; Westborough and Boston, Massachusetts; Orange, Princeton, Ocean,
Covington, and Kendall Park, New Jersey; and Philadelphia, Willow Grove, and
King of Prussia, Pennsylvania. Petitioners spent approximately 80% of each year
3 Messages, Inc., was purportedly the largest call center in Manhattan, New York. Each of the other call centers was independently owned by various companies, including the Robertshaw companies, the Answernet companies, and the Signius companies, and individuals. Petitioners performed consulting services for these other companies through BCMC’s arrangement with Messages, Inc. 4 More specifically, Messages, Inc., agreed to reimburse petitioners for subway, bus, taxi, and limousine expenses that petitioners incurred while traveling to the sites of the various consortium members and to the sites of prospects of the consortium members; for expenses petitioners incurred for parking their vehicle when on business (but not for garage purposes); and for gasoline expenses petitioners incurred while traveling on company business. Petitioners paid all maintenance and repair expenses for their vehicle. -5-
[*5] at issue at these various locations conducting consulting services on behalf of
BCMC.
BCMC’s arrangement with Messages, Inc., was not exclusive, and on at
least one occasion during the years at issue BCMC provided consulting services
for another entity or person not associated with Messages, Inc.
III. The Gulfport Home and the New York City Apartment
In 1994 petitioners purchased a single-family home in Gulfport, Mississippi,
to provide housing for petitioner wife’s mother and father. In 2001 petitioners
moved into this home after petitioner wife’s parents passed away, using the home
for personal and business purposes including operating BCMC and their real
estate business and conducting petitioner husband’s writing activities.
Beginning in 2004 and throughout the years at issue, Messages, Inc., rented
petitioners a two-bedroom apartment in New York City for $1,000 per month.
Although petitioners occupied one bedroom of the apartment, other independent
contractors hired by Messages, Inc., periodically occupied the second bedroom of
the apartment and shared common living space with petitioners approximately
one-third of each year. Living in the New York City apartment permitted
petitioners to work onsite at the various call center locations Messages, Inc.,
temporarily assigned to BCMC for consulting services. -6-
[*6] During the years at issue petitioners traveled to their Gulfport home for
personal and business purposes, spending approximately 20% of each year at issue
in Gulfport.5 Petitioners continued to pay mortgage principal and interest on, as
well as other expenses associated with, the Gulfport home while staying in New
York City.
IV. Petitioner Husband’s Writing Activities
Petitioner husband began writing books in 1976; he is the author of Blood,
Money & Power: How L.B.J. Killed J.F.K. (Hannover House 2003); Made in the
USA: Global Greed, Bad Tax Laws and the Exportation of America’s Future
(Hannover House 2010); San Antonio Conservation Society v. Texas Department
(Gale MOML 2011); and The Verdict: Justice for John Kennedy, Justice for
America (Hannover House, release pending).
During the years at issue petitioner husband conducted his writing activities
under the name Orchis Publications. He used both the New York City apartment
and the Gulfport home in conducting his writing activities.
5 Petitioners also kept their business records with respect to BCMC at their Gulfport home. -7-
[*7] V. Petitioners’ Returns
On October 10, 2007, October 18, 2008, and October 21, 2009, petitioners
filed joint Forms 1040, U.S. Individual Income Tax Return, for 2006, 2007, and
2008, respectively, reporting that their total tax due was zero for each year. On
attached Schedules C, petitioners reported the following expenses from BCMC
and Orchis Publications:6
Expense 2006 2007 2008
Utilities $10,800 $1,560 $7,778 Travel 4,800 2,400 2,721 Taxes and licenses 120 --- --- Repairs and maintenance 9,600 --- --- Office 6,000 1,800 --- Insurance (other than health) 460 360 5,070 Car and truck 22,580 21,900 35,466 Other 2,117 3,570 2,987 Rent/lease--other business property 12,000 --- 12,000 Business use of home 5,084 20,696 2,686 Legal and professional services 11,200 --- --- Interest--other 14,400 --- --- Meals and entertainment 19,200 35,800 36,640 Depreciation and sec. 179 24,439 34,094 1,675 Total 142,800 122,180 107,023
On their 2006 Schedule D, Capital Gains and Losses, petitioners reported a
$172,000 net long-term capital loss with respect to a “real estate office”, which,
6 Petitioners combined the business income and expenses relating to BCMC and Orchis Publications on one Schedule C for each year. Additionally, petitioners wrote “Estimated” on the front of their 2006 return. -8-
[*8] because of the section 1211(b) limitation, gave rise to a $3,000 capital loss
deduction.
Respondent selected petitioners’ returns for examination. During the
examination, petitioners submitted Form 1040X, Amended U.S. Individual Income
Tax Return, for each year at issue.7 These returns reported amounts of expenses
substantially different from the amounts shown on the originally filed Schedules
C. Respondent did not process the amended returns.
VI. Notice of Deficiency
On July 19, 2012, respondent issued a notice of deficiency to petitioners
with respect to 2006, 2007, and 2008, disallowing almost all of petitioners’
Schedule C expense deductions claimed for each year, allowing petitioners with
respect to their BCMC business only the following deductions:
Expense 2006 2007 2008
Insurance (other than health) $278 $278 $278 Car and truck 1,876 568 2,583 Other 180 478 360 Total 2,334 1,324 3,221
In connection with petitioner husband’s writing activities respondent
allowed petitioners a $382 deduction for newspaper publication purchases for each
7 On their Forms 1040X for tax years 2006 and 2007, petitioners wrote “Estimated” on the front of each return. -9-
[*9] of the years at issue and deductions of $3,905 and $4,618 for home office
expenses with respect to 2006 and 2008, respectively.
Respondent disallowed in full petitioners’ claimed 2006 capital loss
deduction of $172,000. Other adjustments respondent made in the notice of
deficiency are computational and will be resolved by the Court’s determination on
other issues.
OPINION
I. Burden of Proof
We consider as a preliminary matter petitioners’ contentions that the burden
of proof should shift to respondent pursuant to section 7491(a). Generally, the
Commissioner’s determinations in a notice of deficiency are presumed correct and
the taxpayer bears the burden of proving the determinations are incorrect. Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Section 7491(a)(1)
provides an exception that shifts the burden of proof to the Commissioner as to
any factual issue relevant to a taxpayer’s liability if: (1) the taxpayer introduces
credible evidence with respect to that issue, and (2) the taxpayer satisfies other
conditions, including substantiation of any item and cooperation with the
Government’s requests for witnesses, documents, other information, and meetings.
Sec. 7491(a)(2); see also Rule 142(a)(2). The taxpayer bears the burden of - 10 -
[*10] proving that he or she has met the requirements of section 7491(a). Rolfs v.
Commissioner, 135 T.C. 471, 483 (2010), aff’d, 668 F.3d 888 (7th Cir. 2012).
As discussed infra, petitioners have failed to present credible evidence
sufficient to substantiate most items. On those issues, the burden of proof remains
with petitioners. With respect to a few factual issues, petitioners presented
credible evidence sufficient to substantiate their expenses. Because we decide
those issues in petitioners’ favor on the preponderance of the evidence, the
allocation of the burden of proof in those instances is immaterial. See Knudsen v.
Commissioner, 131 T.C. 185, 189 (2008). We therefore need not decide whether
petitioners have met the conditions of section 7491(a)(2) required to shift the
burden of proof to respondent with respect to those issues.
II. General Principles Governing Substantiation
Deductions are a matter of legislative grace, see New Colonial Ice Co. v.
Helvering, 292 U.S. 435, 440 (1934), and a taxpayer is required to maintain
records sufficient to substantiate deductions claimed on his or her return, sec.
6001; sec. 1.6001-1(a), Income Tax Regs. If the taxpayer is able to establish that
he or she paid or incurred a deductible expense but is unable to substantiate the
precise amount of such expense, the Court generally may approximate the
deductible amount, but only if the taxpayer presents sufficient evidence to - 11 -
[*11] establish a rational basis for making the estimate. See Cohan v.
Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); see also Vanicek v.
Commissioner, 85 T.C. 731, 742-743 (1985). Without such a basis, any allowance
would amount to unguided largesse. See Williams v. United States, 245 F.2d 559,
560 (5th Cir. 1957).
Generally, no deduction is allowed for traveling expenses (including meals
and lodging while away from home), entertainment expenses, and listed property
expenses unless the taxpayer meets stringent substantiation requirements.8 Secs.
274(d), 280F(d)(4); Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968), aff’d,
412 F.2d 201 (2d Cir. 1969). To deduct such an item, the taxpayer must
substantiate through adequate records or other corroborative evidence the
following elements: the amount of the expense, the time and place of the expense,
and the business purpose of the expense.9 Sec. 274(d). A taxpayer satisfies the
“adequate records” test if he or she maintains an account book, a diary, a log, a
statement of expense, trip sheets, or similar records prepared at or near the time of
the expenditure and documentary evidence of certain expenditures, such as
8 Listed property includes, among other things, passenger automobiles. See sec. 280F(d)(4)(A)(i). 9 For entertainment expenses, the taxpayer must also substantiate the business relationship to the taxpayer of persons being entertained. Sec. 274(d)(4). - 12 -
[*12] receipts or bills, that show each element of each expenditure or use. See sec.
1.274-5T(c)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985).
Contemporaneous logs are not required, but corroborative evidence to support a
taxpayer’s reconstruction of the elements of an expenditure or use must have “a
high degree of probative value to elevate such statement” to the level of credibility
of a contemporaneous record. Sec. 1.274-5T(c)(1), Temporary Income Tax Regs.,
50 Fed. Reg. 46017 (Nov. 6, 1985).
In the absence of adequate records to establish each element of an expense
under section 274(d), a taxpayer may alternatively establish each element: “(A)
By his own statement, whether written or oral, containing specific information in
detail as to such element; and (B) By other corroborative evidence sufficient to
establish such element.” Sec. 1.274-5T(c)(3)(i), Temporary Income Tax Regs., 50
Fed. Reg. 46020 (Nov. 6, 1985).
III. Loss of Records
Petitioners assert that their tax documents for 2006, 2007, and 2008 were
either lost or destroyed in one of three hurricanes: Katrina, Rita, or Gustav.10 If a
taxpayer’s records are lost or destroyed through circumstances beyond his or her
10 We take judicial notice that Hurricanes Katrina, Rita, and Gustav hit the continental United States in August 2005, September 2005, and September 2008, respectively. - 13 -
[*13] control, the taxpayer may substantiate expenses, including those underlying
section 274(d) deductions, through reasonable reconstruction. See Malinowski v.
Commissioner, 71 T.C. 1120, 1125 (1979); see also Boyd v. Commissioner, 122
T.C. 305, 320 (2004); sec. 1.274-5T(c)(5), Temporary Income Tax Regs., 50 Fed.
Reg. 46022 (Nov. 6, 1985). The burden is on the taxpayer to show that the
documentation was actually lost or destroyed because of circumstances beyond his
or her control. See Adler v. Commissioner, T.C. Memo. 2010-47, aff’d, 443 Fed.
Appx. 736 (3d Cir. 2011). We conclude that petitioners have not met this burden.
Hurricanes Katrina and Rita, both of which occurred in 2005, could not have
destroyed petitioners’ 2006-08 Schedule C tax records, and petitioners have not
offered any corroborating evidence, such as insurance claim forms, to show that
their Gulfport home suffered any major damage on account of Hurricane Gustav,
which occurred in 2008.
In any event and assuming, for the sake of argument, that petitioners’ tax
records were lost or destroyed by hurricane, we would still conclude that
petitioners have failed to provide sufficient secondary evidence to substantiate
many of the expenses that are in dispute. Petitioners’ secondary evidence consists
of worksheets, which, similar to a tax return, show only a list of certain types of
expenses and amounts petitioners purportedly paid or incurred next to those - 14 -
[*14] expenses. Petitioners have not explained how they computed these
numbers, and the numbers shown do not correspond with the amounts of expenses
reported on their original or amended returns.
In sum, petitioners are not entitled to summarily reconstruct their expenses
for purposes of sections 6001 and 274(d).
IV. Section 162 Expenses
Section 162(a) authorizes a deduction for “all the ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any trade or
business”. A trade or business expense is ordinary for purposes of section 162 if it
is normal or customary within a particular trade, business, or industry and is
necessary if it is appropriate and helpful for the development of the business.
Commissioner v. Heininger, 320 U.S. 467, 471 (1943); Deputy v. du Pont, 308
U.S. 488, 495 (1940). Conversely, “personal, living, or family expenses” are
generally nondeductible. Sec. 262(a).
A. Lodging Expenses
Respondent contends that New York City was petitioners’ tax home during
each year at issue; hence, petitioners’ lodging expenses incurred in New York City
are not allowable. Petitioners disagree; they contend they performed consulting - 15 -
[*15] services in 12 different cities across the Northeastern United States and that
their tax home was in Gulfport.
Section 162(a)(2) permits taxpayers to deduct traveling expenses, including
amounts expended for lodging and meals, if such expenses are: (1) ordinary and
necessary; (2) incurred while away from home; and (3) incurred in the pursuit of a
trade or business. See Commissioner v. Flowers, 326 U.S. 465, 470 (1946). The
purpose of this deduction is to alleviate the burden on taxpayers whose business or
employment requires them to incur duplicate living expenses. See Tucker v.
Commissioner, 55 T.C. 783, 786 (1971); Kroll v. Commissioner, 49 T.C. 557, 562
(1968). In order to deduct travel expenses a taxpayer generally must show that he
or she was away from home overnight when the expenses were incurred. See
United States v. Correll, 389 U.S. 299 (1967); Strohmaier v. Commissioner, 113
T.C. 106, 115-116 (1999). This Court has held that for purposes of section
162(a)(2) a taxpayer’s “home” is generally the vicinity of the taxpayer’s principal
place of employment. Mitchell v. Commissioner, 74 T.C. 578, 581 (1980); Daly
v. Commissioner, 72 T.C. 190, 195 (1979), aff’d, 662 F.2d 253 (4th Cir. 1981). If
a taxpayer does not have a principal place of employment, however, the situs of
the taxpayer’s permanent residence may be considered his or her tax home. See
Johnson v. Commissioner, 115 T.C. 210, 221 (2000); Rambo v. Commissioner, 69 - 16 -
[*16] T.C. 920 (1978); Dean v. Commissioner, 54 T.C. 663 (1970). A taxpayer
who has neither a permanent residence nor a principal place of employment is an
itinerant without a tax home. See Johnson v. Commissioner, 115 T.C. at 221;
Wirth v. Commissioner, 61 T.C. 855, 859 (1974).
Additionally, a taxpayer’s residence, when different from the vicinity of the
taxpayer’s principal place of employment, may be treated as the taxpayer’s tax
home if the taxpayer’s employment is “temporary” rather than “indefinite”.
Peurifoy v. Commissioner, 358 U.S. 59, 60 (1958). When a taxpayer accepts
temporary work in a place away from his residence, he may deduct the living
expenses incurred at the temporary post of duty because it would not be
reasonable to expect him to move his residence under such circumstances.
See Tucker v. Commissioner, 55 T.C. at 786. Both the location of a taxpayer’s tax
home and whether a taxpayer’s employment was temporary rather than indefinite
are questions of fact to be decided on the entire record. See Peurifoy v.
Commissioner, 358 U.S. at 60-61; Commissioner v. Flowers, 326 U.S. at 470. The
record supports a finding, and we so find, that during each year at issue petitioners
had no principal place of employment and their tax home was their permanent
residence in Gulfport. - 17 -
[*17] Petitioners moved into their Gulfport home in 2001 after petitioner wife’s
parents passed away. From 2001 through 2004 petitioners worked from their
Gulfport home. In 2004 petitioners began working for Messages, Inc., on a
temporary basis, providing services to not only Messages, Inc., but also a
consortium of call centers. Specifically, they provided consulting services to
various call center companies in 12 different cities across the States of New York,
Massachusetts, New Jersey, and Pennsylvania during the years at issue. The
record does not reveal where petitioners stayed while providing consulting
services in the 12 different cities, but we deem it fair to assume it was not
Gulfport. Although petitioners lived in a New York City apartment rented to them
by Messages, Inc., petitioners were required to share that apartment with other
independent contractors. Petitioners agreed to provide consulting services to
Messages, Inc., and the other call center companies month to month, and
petitioners were not required to work for Messages, Inc., exclusively. In fact,
petitioners performed consulting services for at least one other party during one or
more of the years at issue. Because of our findings that petitioners maintained a
permanent residence in Gulfport and had no principal place of employment during - 18 -
[*18] the years at issue, we hold that Gulfport was petitioners’ tax home during
those years.11
Respondent argues that petitioners’ work assignments from Messages, Inc.,
were indefinite rather than temporary within the purview of the flush language in
section 162(a), which provides that a “taxpayer shall not be treated as being
temporarily away from home during any period of employment if such period
exceeds 1 year.” We disagree. As discussed supra, petitioners provided
consulting services month to month and they were required to travel to 12
different cities across the Northeastern United States. Contrary to respondent’s
contention, we do not find it appropriate to group all of petitioners’ work
assignments from separately owned call centers to form one period of employment
during the years at issue. Rather, we view each of petitioners’ work assignments
as a separate period of self-employment. We therefore conclude that petitioners’
work assignments away from Gulfport did not exceed the 1-year threshold in
section 162(a). See Mitchell v. Commissioner, T.C. Memo. 1999-283.
11 We also conclude that petitioners were not itinerants during any of the years at issue because they paid or incurred substantial, continuing, and duplicative living expenses on account of their apartment in New York City and their expenses for their Gulfport home. See Henderson v. Commissioner, T.C. Memo. 1995-559, aff’d, 143 F.3d 497 (9th Cir. 1998). - 19 -
[*19] Petitioners and respondent agree that petitioners paid $1,000 per month, or
$12,000 per year, to rent the New York City apartment. Petitioners submitted
substantiation for utility expenses they paid or incurred each tax year for their
New York City apartment that are duplicative of the utility expenses they paid
with respect to their Gulfport home. Specifically, petitioners paid utility expenses
totaling $1,464.62, $2,511.98, and $2,614.34 for 2006, 2007, and 2008,
respectively. We thus hold that petitioners are entitled to deduct $13,464.62,
$14,511.98, and $14,614.34 for lodging expenses with respect to 2006, 2007, and
2008, respectively.
B. Meals and Entertainment Expenses
Petitioners claimed deductions of $19,200, $35,800, and $36,640 for meals
and entertainment expenses with respect to 2006, 2007, and 2008, respectively.
Respondent contends that petitioners are not entitled to these deductions because
they have failed to meet the strict substantiation requirements of section 274(d).
Petitioners submitted bank statement and receipts in support of their meals
expense deductions claimed on their 2006, 2007, and 2008 returns. For the most
part the entries on these bank statements are vague and not self-explanatory, often
listing only the name of the business or the address where the purchase or services
were provided. Moreover, many of petitioners’ receipts are illegible. However, - 20 -
[*20] some of the receipts are legible, and because of our finding that petitioners
were away from Gulfport for business purposes, we conclude that petitioners are
entitled to $103.05, $9,603.20, and $4,708.07, before the section 274(n) limitation
is applied for each of the years at issue, in deductible meals expenses for 2006,
2007, and 2008, respectively.12
Petitioners claim that they are entitled to deduct an undetermined amount of
entertainment expenses that they paid or incurred during each of the years at issue.
In order to be allowed a deduction for entertainment expenses, the taxpayer must
establish that the expenditure was either: (1) directly related to the active conduct
of the taxpayer’s trade or business, or (2) associated with the active conduct of a
12 To the extent petitioners assert that they are entitled to a per diem amount for meals and incidental expenses for the years at issue, we disagree. It is true that self-employed individuals, such as petitioners, may use an optional per diem method in lieu of using actual expenses to compute their deductible meal and incidental expenses paid or incurred in the course of employment-related travel. See Rev. Proc. 2005-67, 2005-2 C.B. 729; Rev. Proc. 2006-41, 2006-2 C.B. 777; Rev. Proc. 2007-63, 2007-2 C.B. 809; Rev. Proc. 2008-59, 2008-2 C.B. 857. Use of this optional method, however, does not relieve the taxpayer of substantiating the elements of time, place, and business purpose of the travel for that day. See Rev. Proc. 2006-41, sec. 4.03, 2006-2 C.B. at 780; Rev. Proc. 2007-63, sec. 4.03, 2007-2 C.B. at 811-812; Rev. Proc. 2008-59, sec. 4.03, 2008-2 C.B. at 860. As mentioned supra, the record does not show the specific dates that petitioners were working in each of the 12 different cities, but rather petitioners were temporarily assigned to Manhattan and Staten Island, New York; Westborough and Boston, Massachusetts; Orange, Princeton, Ocean, Covington, and Kendall Park, New Jersey; and Philadelphia, Willow Grove, and King of Prussia, Pennsylvania, on unspecified dates. - 21 -
[*21] trade or business where the expenditure was incurred directly before or
directly after a substantial and bona fide business discussion. Sec. 274(a)(1)(A);
see also sec. 1.274-2(a)(1), Income Tax Regs. Petitioners submitted numerous
theater tickets in support of their claimed deductions for entertainment expenses,
but they have failed to show that these expenses were directly related to, or
associated with, either BCMC or Orchis Publications.13 Petitioners are not entitled
to these claimed entertainment expense deductions.
C. Car and Truck Expenses
Petitioners claimed deductions of $22,580, $21,900, and $35,466 for car and
truck expenses with respect to 2006, 2007, and 2008, respectively. Respondent
contends that petitioners are not entitled to more car and truck expense deductions
than those allowed in the notice of deficiency because petitioners have failed to
meet the strict substantiation requirements of section 274(d).
Petitioners submitted gasoline receipts, parking receipts, repair and oil
change receipts, and a handwritten log in support of the car and truck expense
13 On brief petitioners argue that “as a matter of fairness, the entertainment expenses for evening meetings to discuss business and creative opportunities should be acknowledged and allowed as valid deductions to the maximum extent previously allowed [by a 1998 audit examination].” We reject petitioners’ argument. Each tax year stands alone, and the Commissioner may challenge for a succeeding year what was condoned or agreed to for a prior year. See Rose v. Commissioner, 55 T.C. 28, 31-32 (1970). - 22 -
[*22] deductions claimed on their 2006, 2007, and 2008 returns. Many of the
entries in the log are indecipherable, bear question marks next to them, and more
significantly, fail to show the business purposes of the purported trips or specify
the point of origin and destination for each trip. See Fleming v. Commissioner,
T.C. Memo. 2010-60; Royster v. Commissioner, T.C. Memo. 2010-16.
Additionally, if a taxpayer’s traveling expenses are reimbursed or reimbursable,
then those expenses are not a necessary expense to the taxpayer and are therefore
not deductible under section 162(a). See Podems v. Commissioner, 24 T.C. 21
(1955); Orvis v. Commissioner, T.C. Memo. 1984-533, aff’d, 788 F.2d 1406 (9th
Cir. 1986). Petitioners were reimbursed for many of their gasoline purchases and
parking expenses by Messages, Inc., and they have failed to establish that the
expenses shown by receipts and invoices were not part of those reimbursements.
We thus sustain respondent’s determination on this issue and hold that petitioners
are entitled to no greater deduction for car and truck expenses for each tax year
than that allowed by respondent.14
14 We are uncertain as to whether petitioners intended to deduct car and truck expenses based on the actual expenses paid, since they submitted receipts for gasoline, or whether they intended to deduct car and truck expenses based on the standard mileage rate, since they also submitted a mileage log. Nonetheless, our holding as to the deductions for car and truck expenses would be the same under either the actual expense basis or the standard mileage rate basis. - 23 -
[*23] D. Depreciation and Section 179 Expenses
Petitioners claimed deductions of $24,439, $34,094, and $1,675 for
depreciation and section 179 expenses with respect to 2006, 2007, and 2008,
respectively. On their amended returns, petitioners claimed no depreciation and
section 179 expense deductions for Orchis Publications for 2006, 2007, and 2008,
no depreciation and section 179 expense deductions for BCMC for 2006 and
2007, and a $1,675 depreciation and section 179 deduction for BCMC for 2008.
Petitioners have not explained the variance between their 2006 and 2007 original
returns and their respective amended returns. Consequently, we treat the amended
returns as a concession that petitioners did not have depreciation and section 179
expenses in those years. See Badaracco v. Commissioner, 464 U.S. 386, 399
(1984); Scully v. Commissioner, T.C. Memo. 2013-229, at *2 (“Petitioner
conceded certain issues by introducing proposed amended returns into the trial
record that align with respondent’s determinations.”).
The $1,675 depreciation and section 179 deduction that petitioners claimed
for 2008 relates to depreciation on a “Ford Town Car”--i.e., listed property--that
they purportedly used 100% for business purposes in that year. To be entitled to a
depreciation deduction, petitioners must establish the vehicle’s depreciable basis
by showing the cost of the property, its useful life or recovery period, and the - 24 -
[*24] previously allowable depreciation.15 See Cluck v. Commissioner, 105 T.C.
324, 337 (1995). This requirement is in addition to the heightened substantiation
required by section 274(d) for proving the business use of the asset. See Dunford
v. Commissioner, T.C. Memo. 2013-189. Petitioners have failed to provide the
depreciable basis of the Ford Town Car or the allowable depreciation that they
may have claimed for previous years. Petitioners’ logs, mentioned supra, do not
meet the strict substantiation requirements of section 274(d). We thus sustain
respondent’s determination disallowing petitioners claimed deductions for
depreciation expenses.
E. Travel Expenses
Petitioners claimed deductions of $4,800, $2,400, and $2,721 for travel
expenses with respect to 2006, 2007, and 2008, respectively. Petitioners have not
explained why they paid or incurred these travel expenses except for expenses,
totaling $1,831.34, to attend a bankruptcy hearing in 2006 on behalf of a separate
corporate entity, 7017 Corporation.16 Respondent contends that petitioners are not
15 Petitioners have not argued that the $1,675 deduction was pursuant to sec. 179, nor have they shown that the Ford Town Car was placed in service during 2008. See sec. 179(a). We do not address the issue further. 16 The record is not clear as to petitioners’ exact equity percentage in 7017 Corporation. - 25 -
[*25] entitled to these travel expense deductions because the expenses were
incurred in connection with a corporate entity and not on behalf of petitioners’
individual trade or business. Respondent further contends that petitioners are not
entitled to deduct any remaining claimed travel expenses because they have failed
to meet the strict substantiation requirements of section 274(d).
Generally, an individual is precluded from claiming a deduction of a
corporation. Moline Props., Inc. v. Commissioner, 319 U.S. 436 (1943).
Payments made by a shareholder to his corporation or to a third person for the
benefit of the corporation are neither deductible business expenses of the
shareholder nor expenses incurred for the production of income. Markwardt v.
Commissioner, 64 T.C. 989, 995 (1975). Rather, such payments are treated as
contributions to capital by the shareholder and must be regarded as an additional
cost of the stock. Id. A deduction is allowable only if the expenditures are made
to protect or promote the shareholder’s own trade or business. Id. The trade or
business of the corporation must be considered separately from the trade or
business of the shareholder. Id.
Petitioners assert that they are entitled to deduct the traveling expenses
because 7017 Corporation was created for investment purposes and that the
corporation “was defunct and, as a matter of law, the business became an assumed - 26 -
[*26] name owned by petitioners as their business and debt.” On brief, petitioners
state: “The Texas corporation was started in 1998 and was dissolved before any
business was conducted. Reinstatement was made in 2006 for notice purposes;
however, it was totally inactive.” On the basis of petitioners’ admission that the
corporation was a separate entity in 2006, we conclude that petitioners are not
entitled to individually deduct the traveling expenses related to 7017
Corporation’s bankruptcy hearing.
Petitioners also maintain that they are entitled to deduct undetermined
amounts of travel expenses for the years at issue. The expenses of traveling away
from home, including transportation costs, are subject to strict substantiation
requirements. Sec. 274(d)(1). To deduct travel expenses the taxpayer must
substantiate the amount of each expense, the dates of departure and return for each
trip, the destination of travel, and the business reason for the trip. See sec. 1.274-
5T(b)(2), (c)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg. 46014, 46017
(Nov. 6, 1985). Petitioners submitted bank records and third-party invoices that
purport to show that they purchased airline tickets during the years at issue, but
they have failed to substantiate the amounts of these expenses or show that any of
these trips had a business rather than a personal purpose. We thus sustain - 27 -
[*27] respondent’s determination disallowing petitioners’ claimed deductions for
travel expenses.
F. Repairs and Maintenance and Interest Expenses
On their original 2006 return petitioners claimed deductions of $9,600 for
“Repairs and maintenance” and $14,400 for “Interest--Other”. On their amended
2006 return, petitioners did not claim these deductions. Petitioners have not
explained the variance, nor have they explained what repairs and maintenance and
interest expenses they paid or incurred during 2006; hence, we treat petitioners’
amended return as a concession. See Badaracco v. Commissioner, 464 U.S. at
399; Scully v. Commissioner, at *2. We thus sustain respondent’s determination
disallowing petitioners’ claimed deductions for repairs and maintenance and
interest expenses.
G. Taxes and Licenses
On their original 2006 return petitioners claimed a deduction of $120 for
taxes and licenses expenses. Petitioners have not explained what taxes and license
fees they purportedly paid or incurred during 2006. The record does show,
however, that petitioners were required to pay to the City of Gulfport in 2008 a
“Privilege License Renewal” fee of $71.60 with respect to BCMC and Orchis - 28 -
[*28] Publications. On the basis of this invoice, we find that petitioners are
entitled to deduct $71.60 for taxes and licenses expenses for 2008.
H. Office and Other Expenses
Petitioners claimed deductions of $8,117, $5,370, and $7,783 for office and
other expenses on their 2006, 2007, and 2008 returns, respectively. On brief,
respondent conceded that petitioners were entitled to deduct for 2007 $201.48 of
delivery costs and expenses and $100.69 of office expenses. See supra note 2.
Petitioners’ bank records and receipts show that they paid or incurred
$4,284.85, $3,240.40, and $3,236.76 of postage and delivery costs during 2006,
2007, and 2008, respectively. The bank records and receipts do not show whether
the postage and delivery costs were for personal or business purposes.
Nonetheless, we are convinced, on this record, that petitioners paid or incurred
the aforementioned postage and delivery expenses in part for business purposes.
After considering respondent’s 2007 postage and delivery costs concession, and
bearing heavily against petitioners whose inexactitude is of their own making, we
conclude that 20% of the postage and delivery costs were for business purposes
and thus petitioners are entitled to deduct $856.97, $849.56, and $647.35 of - 29 -
[*29] postage and delivery costs for 2006, 2007, and 2008, respectively.17 See
Cohan v. Commissioner, 39 F.2d at 543-544.
Petitioners’ bank records and receipts show that petitioners paid or incurred
office expenses, primarily from Staples and Office Depot, totaling $780.18,
$460.35, and $182.04 for 2006, 2007, and 2008, respectively, and we hold that
petitioners are entitled to deduct these office expenses as ordinary and necessary
expenses.
I. Legal and Professional Services
Petitioners claimed a deduction of $11,200 for legal and professional
services expenses on their 2006 return. These legal and professional services
expenses were purportedly paid for the bankruptcy hearing petitioners initiated on
behalf of 7017 Corporation and to assist petitioner wife in a suit against Discover
Card. As discussed supra, petitioners are precluded from deducting expenses
attributable to a corporation on their individual tax returns. See Moline Props.,
Inc. v. Commissioner, 319 U.S. 436. Petitioners have failed to show that the debts
petitioner wife incurred on her Discover Card were attributable to business as
opposed to personal purposes. Therefore, petitioners are also precluded from
17 The amount allowed for 2007 includes respondent’s $201.48 concession in petitioners’ favor on brief. See supra. - 30 -
[*30] deducting those attorney’s fees. See United States v. Gilmore, 372 U.S. 39,
46 (1963). We thus sustain respondent’s determination disallowing petitioners’
claimed deductions for legal and professional services.
J. Insurance (Other Than Health)
Petitioners claimed deductions of $460, $360, and $5,070 for insurance
(other than health) expenses with respect to 2006, 2007, and 2008, respectively.
Petitioners have not explained what insurance expenses they paid or incurred
during the years at issue, nor does the record support petitioners’ claimed
deductions. We thus sustain respondent’s determination on this issue and hold
that petitioners are entitled to no greater deduction for insurance (other than
health) expenses for each year than respondent has allowed.
K. Home Office Expenses
Petitioners claimed deductions of $5,084, $20,696, and $2,686 for home
office expenses they paid or incurred with respect to 2006, 2007, and 2008,
respectively. On their amended tax returns, and with respect to BCMC, petitioners
claimed no home office expense deductions for 2006 and 2007 and a $66,618
home office expense deduction for 2008. On their amended tax returns, and with
respect to Orchis Publications, petitioners claimed home office expense
deductions of $3,509, $2,470, and $1,135 with respect to 2006, 2007, and 2008, - 31 -
[*31] respectively. Respondent conceded in the notice of deficiency that
petitioners were entitled to home office expense deductions of $3,509 and $4,618
for 2006 and 2008, respectively, with respect to Orchis Publications.18 Because of
respondent’s concessions and because we treat petitioners’ amended returns as a
concession, see Badaracco v. Commissioner, 464 U.S. at 399; Scully v.
Commissioner, at *2, we consider only petitioners’ claimed $2,470 and $66,618
home office expense deductions for 2007 and 2008, respectively.
Section 280A(a) disallows a deduction for business use of a taxpayer’s
personal residence, with a few limited exceptions. One such exception in section
280A(c)(1) provides that the general disallowance rules do not apply “to any item
to the extent such item is allocable to a portion of the dwelling unit which is
exclusively used on a regular basis * * * (A) as the principal place of business for
any trade or business of the taxpayer”. “Exclusively used” is narrowly construed
and requires that the taxpayer use “ ‘a specific part of a dwelling unit solely for the
purpose of carrying on his trade or business’”. Goldberger, Inc. v. Commissioner,
88 T.C. 1532, 1557 (1987) (quoting S. Rept. No. 94-938, at 148 (1976), 1976-3
18 Respondent apparently did not permit petitioners to deduct home office expenses for 2007 with respect to Orchis Publications because it did not have gross income in that year. See sec. 280A(c)(5). Respondent also apparently conceded that petitioners were entitled to deduct more home office expenses than they reported on their 2008 original and amended returns. - 32 -
[*32] C.B. (Vol. 3) 49, 186, and H.R. Rept. No. 94-658, at 161 (1975), 1976-3
C.B. (Vol. 2) 695, 853). A dwelling unit is used on a “regular basis” when used
more than occasionally or incidentally. See Fadeley v. Commissioner, T.C.
Memo. 2008-235. Generally, personal use of a room will preclude its use in
computing depreciation or other allocable expenditures. Id.
As another exception to the general disallowance rule of section 280A(a),
subsection (c)(2) allows a deduction for items that are allocable to space within the
home that the taxpayer uses on a regular basis to store inventory or product
samples. See, e.g., Hefti v. Commissioner, T.C. Memo. 1988-22, aff’d without
published opinion, 894 F.2d 1340 (8th Cir. 1989). To qualify for this exception,
the taxpayer must use the inventory or product samples in the taxpayer’s trade or
business of selling products at retail or wholesale, and the home must be the sole
fixed location of the taxpayer’s trade or business. Sec. 280A(c)(2).
Petitioners reported on their 2008 amended return that they incurred home
office expenses relating to BCMC and with respect to their personal residence in
Gulfport and their New York City apartment. Because we have held that
petitioners are entitled to deduct lodging expenses with respect to the New York
City apartment and because they have failed to provide any evidence that they
incurred additional home office expenses, they are not entitled to additional home - 33 -
[*33] office expense deductions for that apartment. See Scully v. Commissioner,
at *7; Wilhelm v. Commissioner, T.C. Memo. 1983-274. Regarding petitioners’
home office expense deductions for their Gulfport home, they reported on Form
8829, Expenses for Business Use of Your Home, that they used 32.35% of their
home exclusively for business purposes and that they are entitled to deduct
$33,116 of expenses. Petitioners have not substantiated the $33,116 of expenses
that they reported on Form 8829, nor have they shown that they used the 32.35%
portion of their home exclusively for business or inventory purposes. We thus
conclude that petitioners are not entitled to home office expense deductions for
BCMC for 2008.
Petitioners reported on their 2007 amended return that they incurred home
office expenses relating to Orchis Publications and their personal residence in
Gulfport. Section 280A(c)(5) provides a limitation on the amounts of deductions
allowed under various sections including section 280A(c)(1) and (2). Specifically,
section 280A(c)(5) provides that the deductions allowed shall not exceed the
excess of the gross income derived from the trade or business use for the taxable
year, over the sum of certain deductions such as interest and taxes. Because
Orchis Publications did not have gross income in 2007, petitioners are precluded - 34 -
[*34] by section 280A(c)(5) from deducting any home office expenses with
respect to Orchis Publications for that year.
We thus sustain respondent’s determination on this issue and hold that
petitioners are entitled to no greater deduction for home office expenses for each
year at issue than respondent has allowed.
V. Capital Loss and Capital Loss Carryover
On their original 2006 return, petitioners claimed a $172,000 long-term
capital loss from the sale of a “real estate office”. On their amended 2006 return,
petitioners claimed a $130,000 long-term loss from the sale of the real estate
office, a net short-term capital loss carryover of $33,000, and a net long-term
capital loss carryover of $230,000. Attached to the amended return on Form 4797,
Sales of Business Property, petitioners reported ordinary losses totaling $275,000.
Petitioners also contend that they are entitled to a $376,113.54 loss attributable to
the failed bankruptcy of 7017 Corporation in 2006.
A. Petitioners’ Capital Losses
Section 165(a) generally permits a taxpayer to claim as a deduction “any
loss sustained during the taxable year and not compensated for by insurance or
otherwise.” Losses from sales or exchanges of capital assets are allowed as
deductions only to the extent prescribed in sections 1211 and 1212. Sec. 165(f). - 35 -
[*35] Under those limitations, a taxpayer must first offset capital losses against
capital gains; if aggregate capital losses exceed aggregate capital gains, the
taxpayer may deduct up to $3,000 of the excess against ordinary income. Sec.
1211(b). Capital losses exceeding the section 1211(b) limitation may then be
carried forward to subsequent tax years. Sec. 1212(b).
Petitioners reported on their 2006 Schedule D a net long-term capital loss of
$172,000, which they represented on their original return resulted from the sale on
April 1, 2004, for $78,000 of a “real estate office” that had been acquired on July
1, 1999, for $250,000. On their amended 2006 Schedule D, petitioners
represented that this same real estate office had been sold on May 1, 2006, for
$120,000 and that it had been acquired on August 8, 1999, for $250,000.
Petitioners have not explained this discrepancy. More significantly, petitioners
have not explained the events leading up to the purported sale of the real estate
office. There is nothing in the record--other than petitioners’ returns and self-
serving testimony--that substantiates the capital loss deductions petitioners
claimed on their original and amended returns. Taxpayers’ returns alone do not
substantiate deductions or losses. See Wilkinson v. Commissioner, 71 T.C. 633,
639 (1979); Thompson v. Commissioner, T.C. Memo. 2011-291. Given the
apparent inconsistencies in petitioners’ original and amended returns, and absent - 36 -
[*36] any corroborating evidence to substantiate the capital loss, we conclude that
petitioners are not entitled to the claimed capital loss deduction for 2006 for the
purported sale of the real estate office.
Petitioners additionally claimed a net short-term capital loss carryover
deduction of $33,000 and a net long-term capital loss carryover deduction of
$230,000 on their 2006 amended return. Section 172(a) allows a taxpayer to
deduct a net operating loss (NOL) for a taxable year that equals the sum of the
NOL carryovers plus NOL carrybacks to that year. A taxpayer claiming an NOL
deduction bears the burden of establishing both the existence of the NOL and the
amount of any NOL that may be carried over to the subject years. Rule 142(a)(1);
United States v. Olympic Radio & Television, Inc., 349 U.S. 232, 235 (1955);
Green v. Commissioner, T.C. Memo. 2003-244.
Petitioners have not explained what net operating capital losses they
incurred in previous years nor have they explained how they computed them. We
thus hold that petitioners are not entitled to deduct their claimed net short- and
long- term capital loss carryovers on their 2006 amended return.
B. Sale of Business Property
Petitioners reported on Form 4797, Sales of Business Property, filed with
their amended return for 2006, ordinary losses totaling $275,000 from the sale or - 37 -
[*37] disposition of four properties: “jewelry”, “real estate”, “BMP”, and “real
estate license”. There is nothing in the record to explain these sales or
dispositions, nor anything that explains how petitioners determined their bases in
these properties. We thus hold that petitioners are not entitled to their claimed
ordinary loss deduction for these properties.
C. Bankruptcy of 7017 Corporation
Petitioners contend that for 2006 they are entitled to a $376,113.54 loss
deduction with respect to personal guaranties that they purportedly gave with
respect to obligations of 7017 Corporation. As stated supra, 7017 Corporation
filed for bankruptcy in 2006. Petitioners submitted a “Summary of Schedules”
sheet from the U.S. Bankruptcy Court, Southern District of Texas, Houston
Division, that shows that 7017 Corporation claimed no assets and $376,113.54 of
liabilities when it filed for bankruptcy. Petitioners have offered no explanation for
how these purported liabilities arose, and they have not produced any evidence
that shows they are personally liable for or have paid the remaining debts of 7017
Corporation. We thus hold that petitioners are not entitled to any deductions for
these losses. - 38 -
[*38] VI. Accuracy-Related Penalties
Respondent determined that petitioners are liable for the accuracy-related
penalty under section 6662(a) for a substantial understatement of income tax for
each year at issue. Section 6662(a) imposes a 20% penalty on any portion of an
underpayment that is attributable to, among other things, a substantial
understatement of income tax. There is a “substantial understatement” of income
tax for any tax year where the amount of the understatement exceeds the greater of
(1) 10% of the tax required to be shown on the return for the tax year or (2)
$5,000. Sec. 6662(d)(1)(A). “Understatement” means the excess of the amount of
tax required to be shown on the return over the amount of the tax imposed which
is shown on the return, reduced by any rebate. Sec. 6662(d)(2)(A).
The Commissioner bears the burden of production with respect to the
accuracy-related penalty. See sec. 7491(c). Generally, this means that the
Commissioner must come forward with sufficient evidence indicating that it is
appropriate to impose the relevant penalty. Once the Commissioner has done so,
the burden of proof is on the taxpayer to show that the penalty does not apply. See
Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). In accordance with our
findings and conclusions in this opinion, petitioners’ understatement will exceed
$5,000 for each tax year. See sec. 6662(b)(2), (d)(1)(A)(ii). Therefore, we hold - 39 -
[*39] that respondent has met his burden of production regarding the accuracy-
related penalty pursuant to section 6662(a).
The accuracy-related penalty is not imposed with respect to any portion of
an underpayment as to which the taxpayer acted with reasonable cause and in good
faith. Sec. 6664(c)(1). The decision as to whether a taxpayer acted with
reasonable cause and in good faith depends upon all of the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. Circumstances that may
indicate reasonable cause and good faith include an honest misunderstanding of
fact or law that is reasonable in the light of the taxpayer’s experience, knowledge,
and education. Id.
Petitioners claim that they are not liable for the accuracy-related penalty
because they “made reasonable attempts to comply and did fully comply in the
reconstruction of records” and that they “expended considerable time and effort to
comply with the [Internal Revenue] Code.”
Petitioners omitted income and claimed deductions to which they were not
entitled and for which they failed to substantiate related expenses. Before and
during the years at issue, petitioners started and operated various businesses,
including a successful consulting business, and petitioner husband is a former
attorney. We find that petitioners have not shown reasonable cause and good faith - 40 -
[*40] with respect to their underpayment of tax for each year at issue.
Accordingly, and in accordance with our findings and conclusions in this opinion,
we hold that petitioners are liable for the section 6662(a) penalty for a substantial
understatement of income tax with respect to the underpayment of tax for each
year at issue.
To reflect the foregoing and the parties’ concessions,
Decision will be entered
under Rule 155.