T.C. Memo. 2003-326
UNITED STATES TAX COURT
ROBERT W. TSCHETTER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
WOLF CREEK FARM, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 5271-01, 5272-01. Filed November 25, 2003.
Douglas Bleeker, for petitioners.
Douglas Polsky and Charles Berlau, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
JACOBS, Judge: These cases have been consolidated for
trial, briefing, and opinion. In separate notices of deficiency,
respondent determined deficiencies in petitioners’ Federal income - 2 -
tax and accuracy-related penalties under section 66621 for 1995,
1996, and 1997 as follows:
Robert W. Tschetter, Docket No. 5271-01:
Year Deficiency
1995 $1,185 1996 1,136 1997 1,095
Wolf Creek Farm, Docket No. 5272-01:
Penalty Year Deficiency Sec. 6662(a)
1995 $1,190 $238 1 1996 1,234 247 1 1997 992 198
1 Amounts are rounded to the nearest dollar. The issues for decision are:
(1) Whether amounts paid by Wolf Creek Farm, Inc. (Wolf
Creek Farm or the corporation), to provide medical care, food,
and lodging to Robert W. Tschetter (Mr. Tschetter), one of its
shareholders, are (a) constructive dividends, as respondent
maintains, or (b) employee medical care expenses and/or
reimbursed employee expenses that are excluded from Mr.
Tschetter’s gross income and deductible by Wolf Creek Farm as
ordinary and necessary business expenses, as petitioners
maintain; and
1 All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. - 3 -
(2) whether Wolf Creek Farm is liable for the accuracy-
related penalty under section 6662(a) for the taxable years ended
November 30, 1995, 1996, and 1997.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference.
When the petitions were filed in these cases, the residence
of Mr. Tschetter, as well as the principal place of business of
Wolf Creek Farm, was in Bridgewater, South Dakota.
A. Mr. Tschetter
Mr. Tschetter has lived with his parents his entire life
(approximately 47 years). The family residence (the farmhouse)
has been in the Tschetter family for over 70 years. On or about
July 7, 1993, Mr. Tschetter’s parents gave him the farmhouse and
79 acres of farm land on which the farmhouse is located (the
homestead).
Since 1988, Mr. Tschetter has owned another 156 acres (the
Tschetter farm). The Tschetter farm is approximately 1 mile from
the homestead. - 4 -
B. Wolf Creek Farm
On December 29, 1993, Wolf Creek Farm was incorporated under
the laws of the State of South Dakota.2 Wolf Creek Farm was
organized primarily (1) to buy, distribute, sell, lease, and deal
in all kinds of farmland and real estate, and (2) to carry on the
business of farming. On January 27, 1994, Mr. Tschetter conveyed
the homestead, including the farmhouse, to Wolf Creek Farm.
Mr. Tschetter has owned 50 percent of the common stock, and
100 percent of the preferred stock, of Wolf Creek Farm since its
incorporation. His mother, Anna Tschetter, owned the remaining
50 percent of the common stock. During the taxable years at
issue, Mr. Tschetter was president, treasurer, and a director,
and his mother was vice president, secretary, and a director, of
Wolf Creek Farm.
The first meeting of the board of directors of Wolf Creek
Farm was held on December 30, 1993. At that first meeting, the
directors adopted a medical reimbursement plan covering all
“employees and officers executing management responsibilities”
and their spouses and dependents. The medical reimbursement plan
provides for the payment of all medical care costs that would be
“deductible on Form 1040” (before considering limitations).
2 Douglas Bleeker, counsel for petitioners, prepared the articles of incorporation, bylaws, minutes of meetings, and other corporate documents for Wolf Creek Farm. - 5 -
Under the plan, each participant is entitled to a maximum
reimbursement of $12,500 per year.
At a meeting of the directors held on January 4, 1994, the
board of directors of Wolf Creek Farm adopted the following
resolution:
RESOLVED that all officers and employees shall be required to repay to the corporation any monies for whatever source which may at any time be disallowed as a proper expense expenditure by the Internal Revenue Service within two (2) years at an interest rate of 3% below the New York Prime Rate, of the final determination of such matter.
In addition, at that meeting the directors adopted the following
RESOLVED that the Corporation’s officers and employees shall be required to live at the worksite of the Corporation to ensure security for the Corporation property and operations. The officers and employees shall be required to live on the worksite to supervise the care and feeding of the livestock of the corporation. The Corporation shall supply said officers and employees all of their food and lodging while living at said worksite. That all of the officers and employees shall be considered “on duty” when at the worksite and therefore entitled to such benefits.
C. Wolf Creek Farm’s Business
During the years at issue, Wolf Creek Farm leased the
homestead to Mr. Tschetter under a written agreement titled “Farm
Lease”, dated December 1, 1994 (the 1995 lease). The initial
term of the lease was for 1 year (to November 30, 1995);
thereafter, the lease continued year to year until otherwise
canceled. Under the lease agreement, Wolf Creek Farm was to - 6 -
receive 30 percent of the “calf crop” and 40 percent of the “crop
produced” on the homestead. Mr. Tschetter was entitled to the
remaining crops and all amounts received under Federal
conservation programs (or any other Federal, State, or local
governmental programs).
Mr. Tschetter agreed (1) to farm the land; (2) to provide
all labor and other items required in producing, harvesting, and
marketing the crops; (3) to furnish all tools, farm implements,
machinery, hired help, fertilizer, chemicals, and seed necessary
to cultivate and manage the farm; (4) to protect the crops from
injury and waste; (5) to till the land after harvesting the
crops; and (6) to rotate the crops from year to year. Wolf Creek
Farm agreed to furnish all necessary materials, and Mr. Tschetter
agreed to supply all necessary labor, to maintain all fences and
other improvements on the farm.
During the years at issue, Wolf Creek Farm conducted farming
activities on property it rented from others, such as Mr.
Tschetter’s parents. Mr. Tschetter, as an employee of Wolf Creek
Farm, did the actual farming of those other properties.
D. Mr. Tschetter’s Separate Business
During the years at issue, Mr. Tschetter(as a self-employed
farmer) farmed the Tschetter farm. On August 29, 1997, Mr.
Tschetter acquired an additional 79 acres; this property was
approximately 1 mile from the homestead. - 7 -
Mr. Tschetter owned cows, bulls, and heifers. He took care
of the livestock and was in charge of the grain produced on the
homestead and the Tschetter farm. Mr. Tschetter’s
responsibilities with respect to the livestock included feeding
(most times once a day but on occasion, twice a day), routine
care, and treatment of any sick animals. Once a year (usually in
the winter), Mr. Tschetter took care of the livestock at calving
time which ran 2-3 months and required that the calves be checked
several times day and night.
Mr. Tschetter’s responsibilities with respect to the
production of grain included harvesting the grain, storing the
grain in bins, and making the sure the grain did not spoil. Most
of the grain produced was used for feeding the livestock.
E. Compensation and Payment of Food, Lodging, and Medical Expenses
Mr. Tschetter was the only employee of Wolf Creek Farm. He
kept the corporate books and paid its bills. For his services,
Mr. Tschetter received $400 in 1995, $1,000 in 1996, and $2,000
in 1997.
Following the transfer of the homestead to Wolf Creek Farm,
Mr. Tschetter and his parents continued to use the farmhouse as
their residence. Wolf Creek Farm paid for (1) the food consumed
by Mr. Tschetter (Mr. Tschetter’s parents paid for their own - 8 -
food) and (2) the utilities, property tax, and insurance for the
farmhouse. In addition, Wolf Creek Farm paid Mr. Tschetter’s
medical care expenses.
Wolf Creek Farm did not pay dividends for its fiscal years
ended November 30, 1995, 1996, and 1997.
F. Income Tax Returns
Mr. Bleeker (petitioners’ counsel) prepared Mr. Tschetter’s
Forms 1040, U.S. Individual Income Tax Return, and Wolf Creek
Farm’s Forms 1120, U.S. Corporation Income Tax Return, for the
years at issue.
1. Wolf Creek Farm
Wolf Creek Farm filed timely its Forms 1120 for its fiscal
years ended November 30, 1995, 1996, and 1997. On these returns,
Wolf Creek Farm reported total income and total deductions as
follows:
11/30/95 11/30/96 11/30/97
Total income $38,269 $53,676 $46,793 Total deductions 38,114 52,963 43,405 Taxable income 155 713 3,388
Included in the total expenses deducted by Wolf Creek Farm
were the following items for food, lodging, and medical expenses
provided to Mr. Tschetter (amounts are rounded to the nearest
dollar): - 9 -
11/30/95 11/30/96 11/30/97 Food & lodging Property tax--house $257 $208 $190 Property insurance--house 667 631 -- Food for officers 2,692 2,722 2,441 Utilities--house 1,991 2,016 2,081 Depreciation--house 569 587 575 Food & lodging expenses 6,176 6,164 5,287 Medical Health insurance 72 908 Doctor & prescriptions 339 465 417 Hospital 1,345 1,426 -– Glasses –- 170 -- Medical costs 1,756 2,061 1,325
2. Mr. Tschetter’s Returns
Mr. Tschetter timely filed his income tax returns for 1995,
1996, and 1997. On these returns, Mr. Tschetter reported his
wages from Wolf Creek Farm. He reported farming income
(including his share of all crops grown on the homestead) as
self-employment income. He did not report any income
attributable to his food, lodging-related, and medical expenses
paid by Wolf Creek Farm. On Schedule F, Profit or Loss from
Farming, Mr. Tschetter reported gross income, total expenses, and
net loss from his separate farming activities for 1995, 1996, and
1997 as follows:
1995 1996 1997
Gross income $94,029 $115,921 $106,775 Total expenses 94,429 117,479 107,745 Net loss (400) (1,558) (970) - 10 -
G. Notices of Deficiency
On January 31, 2001, respondent timely mailed to Mr.
Tschetter a statutory notice of deficiency for 1995, 1996, and
1997 (the Tschetter notice of deficiency). Also on January 31,
2001, respondent timely mailed to Wolf Creek Farm a statutory
notice of deficiency for its fiscal years ended November 30,
1995, 1996, and 1997 (the Wolf Creek Farm notice of deficiency).
In the Wolf Creek Farm notice of deficiency, respondent
disallowed the food, lodging, and medical expenses deducted by
Wolf Creek Farm, totaling $7,932 for 1995, $8,225 for 1996, and
$6,612 for 1997. Respondent determined that (1) Wolf Creek Farm
failed to establish that the food and lodging expenses were
ordinary and necessary business expenses under section 162 and
(2) those items constitute Mr. Tschetter’s personal expenses.
Respondent further determined that Wolf Creek Farm was liable for
the accuracy-related penalty under section 6662(a).
In the Tschetter notice of deficiency, respondent determined
that payments by Wolf Creek Farm of Mr. Tschetter’s food,
lodging, and medical expenses resulted in constructive dividends
as follows: - 11 -
Food & lodging1 $6,163 $6,218 $6,001 Medical 1,756 2,061 1,325 Total dividends 7,919 8,279 7,326 1 The record does not explain why the amounts of dividends for food and lodging expenses included in Mr. Tschetter’s income exceed the amounts disallowed as deductions to Wolf Creek Farm.
OPINION
Issue 1. Expenses Incurred by Wolf Creek Farm To Provide Medical Benefits, Food, and Housing to Mr. Tschetter in 1995, 1996, and 1997
A. Positions of the Parties3
Respondent disallowed deductions taken by Wolf Creek Farms
for medical costs (health insurance premiums and other medical
care expenses), food, lodging (including property insurance,
property taxes, and utilities for the farmhouse), and
depreciation of the farmhouse. Respondent asserts that the
medical costs, food, and lodging expenses are Mr. Tschetter’s
3 Under certain circumstances, sec. 7491 places the burden of proof or production on the Commissioner. Sec. 7491 applies to court proceedings arising in connection with tax examinations beginning after July 22, 1998. Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. 105-206, sec. 3001(a), 112 Stat. 726. Petitioners timely filed their returns for the years at issue. Hence, all of the returns were filed on or before Apr. 15, 1998. The record does not disclose when the examination of petitioners’ tax returns began, and it is possible that the examination began before July 23, 1998. Petitioners do not contend that sec. 7491 applies in these cases, and they have not otherwise asserted that respondent has the burden of proof or production with respect to any issue presented in these cases. We therefore conclude that sec. 7491 does not apply, and petitioners have the burden of proof and production. - 12 -
personal, family, and living expenses and that payments of these
expenses by Wolf Creek Farm constitute constructive dividends to
Mr. Tschetter. On the other hand, petitioners assert that all
the expenditures are reasonable and necessary business expenses,
deductible by Wolf Creek Farm and excluded from Mr. Tschetter’s
income.
Petitioners contend that the medical costs are employee
benefits, deductible by the employer and excludable from the
employee’s income under sections 105 and/or 106. Petitioners
further maintain that Wolf Creek Farm provided food and lodging
to Mr. Tschetter in his capacity as an employee and that such was
done for the convenience of Wolf Creek Farm. Consequently,
petitioners assert that the food and lodging expenses are
employer-provided “meals and lodging”, the costs for which are
excluded from Mr. Tschetter’s income under section 119 and
deductible by Wolf Creek Farm. Petitioners further assert that,
as owner and lessor of the farmhouse, Wolf Creek Farm is entitled
to deduct (1) the expenditures for insurance on the farmhouse as
reasonable and necessary business expenses under section 162, (2)
the property taxes under either section 162 or 164, and (3) the
depreciation of the farmhouse under section 167. Petitioners
posit that these latter expenses are not Mr. Tschetter’s personal
expenses because he is not the owner of the property. - 13 -
B. Medical Expenses
We first shall decide whether the payments by Wolf Creek
Farm of the medical expenses are excludable from Mr. Tschetter’s
gross income under sections 105 and 106 and deductible by the
corporation as ordinary and necessary business expenses under
section 162(a).
Under section 106, “an employee’s gross income does not
include employer-provided coverage (e.g., accident and health
insurance premiums) under an accident and health plan.” Rugby
Prods. Ltd. v. Commissioner, 100 T.C. 531, 535 (1993). The
employer may provide coverage under an accident or health plan by
paying the premium (or a portion of the premium) on an accident
or health insurance policy covering one or more employees or by
contributing to a separate trust or fund. Sec. 1.106-1, Income
Tax Regs.
Under the general rule of section 105(a), amounts received
by an employee through accident and health insurance for personal
injury or sickness, to the extent attributable to nontaxed
employer contributions, are includable in the employee’s gross
income. Amounts received under an accident or health plan for
employees are treated as amounts received through accident or
health insurance. Sec. 105(e). An exception to the general rule
allows an employee to exclude from gross income amounts received
to reimburse the employee for expenses incurred by the employee - 14 -
for the medical care (as defined in section 213(d)) of the
employee and the employee’s spouse and dependents. Sec. 105(b).
For the reasons set forth below, we agree with petitioners
that pursuant to sections 105 and/or 106 payments by Wolf Creek
Farm for reimbursement of medical care costs (including
reimbursement for the health insurance premiums) need not be
included in Mr. Tschetter’s income for 1995, 1996, and 1997.
Section 105(e) requires first, that the benefits be received
under a “plan”, and second, that the plan be “for employees”,
rather than for some other class of persons such as shareholders
and their relatives. Larkin v. Commissioner, 48 T.C. 629, 635
(1967), affd. 394 F.2d 494 (1st Cir. 1968). After giving due
consideration to the record before us, we conclude that Wolf
Creek Farm’s medical reimbursement plan satisfies both the “plan”
and “for employees” requirements of section 105(e).
Section 1.105-5(a), Income Tax Regs., provides guidelines as
to what constitutes an accident or health plan. A plan may cover
one or more employees, and different plans may be established for
different employees or classes of employees. Sec. 1.105-5(a),
Income Tax Regs. The regulations do not require that there be a
written plan or that there be enforceable employee rights under
the plan, so long as the participant has notice or knowledge of
the plan. Wigutow v. Commissioner, T.C. Memo. 1983-620. - 15 -
In the instant cases, a plan (as defined in section
1.105-5(a), Income Tax Regs.) existed. Wolf Creek Farm adopted a
written medical reimbursement plan identifying who was eligible
to participate, what expenses would be reimbursed, and how
participants were to make claims for reimbursement. The plan was
adopted at the first meeting of the board of directors.
Mr. Tschetter had knowledge of the medical reimbursement
plan. Moreover, the medical reimbursements provided under the
written plan included reimbursement for all “medical care” costs
deductible on Form 1040, which include health insurance costs.
Sec. 213(d)(1)(D). And finally, we are satisfied that the
corporation’s medical plan was for Mr. Tschetter’s benefit as an
employee of Wolf Creek Farm, and not for his benefit as one of
the corporation’s shareholders.
Plans limited to employees who are also shareholders are not
per se disqualified under section 105(b). Larkin v.
Commissioner, supra at 635 n.5. In this regard, we have
sustained plans for corporate officers who were also shareholders
because those officers had central management roles in conducting
the business of the corporation. Wigutow v. Commissioner, supra;
Epstein v. Commissioner, T.C. Memo. 1972-53; Seidel v.
Commissioner, T.C. Memo. 1971-238; Smith v. Commissioner, T.C.
Memo. 1970-243; Bogene, Inc. v. Commissioner, T.C. Memo.
1968-147. - 16 -
Respondent has stipulated that during the years at issue Mr.
Tschetter was an employee of Wolf Creek Farm. Indeed, Mr.
Tschetter was the corporation’s only employee. And without Mr.
Tschetter’s involvement, Wolf Creek Farm could not have conducted
its farming operations.
Mr. Tschetter’s compensation for services rendered to Wolf
Creek Farm was his salary and employee benefits. Respondent does
not contend that Mr. Tschetter received excessive compensation.
Indeed, respondent contends that Mr. Tschetter was
undercompensated for his services. In addition, we are mindful
that Wolf Creek Farm did not pay medical expenses or health
insurance premiums of its other shareholder, Mr. Tschetter’s
mother.
On the basis of the record before us, we conclude that
medical payments made for the benefit of Mr. Tschetter were made
under a plan for employees and not for shareholders.
Accordingly, during the years at issue, the medical payments made
by Wolf Creek Farm pursuant to its medical plan are excludable
from Mr. Tschetter’s gross income under section 105(b).
Section 162(a) permits a taxpayer to deduct all ordinary and
necessary expenses incurred during the taxable year in carrying
on the taxpayer’s trade or business. An expense is ordinary if
it is customary or usual within a particular trade, business, or
industry or relates to a transaction “of common or frequent - 17 -
occurrence in the type of business involved.” Deputy v. du Pont,
308 U.S. 488, 495 (1940). An expense is necessary if it is
appropriate and helpful for the development of the business. See
Commissioner v. Heininger, 320 U.S. 467, 471 (1943).
When payments for medical care are properly excludable from
an employee’s income because they are made under a “plan for
employees,” they are deductible by the employer as ordinary and
necessary business expenses under section 162(a). Sec.
1.162-10(a), Income Tax Regs. Consequently, Wolf Creek Farm is
entitled to deduct the insurance premiums and other medical
reimbursement payments under section 162(a).
C. Food, Utilities, Property Insurance, Property Taxes, and Depreciation
1. Section 119: Employer-Provided Meals and Lodging
We next decide whether the food and lodging-related expenses
are employer-provided meals and lodging expenses, excludable from
Mr. Tschetter’s income under section 119 and deductible by Wolf
Creek Farm under section 162.
Meals and lodging furnished to an employee by his employer
are excluded from the employee’s gross income under section 119
if the meals and lodging are provided for the convenience of the
employer on the premises of the employer. In the case of
lodging, the employee must be required to accept the lodging on
the business premises of his employer as a condition of
employment. - 18 -
Meals and lodging are furnished for the “convenience of the
employer” if there is a direct nexus between the meals and
lodging furnished and the asserted business interests of the
employer served thereby. McDonald v. Commissioner, 66 T.C. 223,
230 (1976).
Petitioners assert that Mr. Tschetter, as the corporation’s
sole employee, was required to be available for duty 24 hours a
day.
Wolf Creek Farm leased the homestead to Mr. Tschetter. Wolf
Creek Farm contracted with Mr. Tschetter as a tenant, not as its
employee, to perform all necessary work.
It is well settled that “Ordinarily, taxpayers are bound by
the form of the transaction they have chosen; taxpayers may not
in hindsight recast the transaction as one that they might have
made in order to obtain tax advantages.” Framatome Connectors
USA Inc. v. Commissioner, 118 T.C. 32, 70 (2002) (citing Estate
of Leavitt v. Commissioner, 875 F.2d 420, 423 (4th Cir. 1989),
affg. 90 T.C. 206 (1988), and Grojean v. Commissioner, 248 F.3d
572, 576 (7th Cir. 2001), affg. T.C. Memo. 1999-425). Here,
inasmuch as Mr. Tschetter farmed the homestead as a tenant, and
not as an employee of Wolf Creek Farm, the food and lodging in
question were not furnished to Mr. Tschetter as a corporate - 19 -
employee for the convenience of his employer. Thus, the food and
lodging expenses at issue are not section 119(a) meals and
lodging expenses.
2. Deductibility of Expenses Related to the Leasing of the Homestead
During the years at issue, Wolf Creek Farm business
activities included leasing the homestead. It leased the
homestead, including the farmhouse, to Mr. Tschetter and received
rent in the form of a percentage of the crops grown on the farm.
Therefore, we look to the terms of the farm lease to determine
whether expenses for utilities, depreciation, and taxes are the
expenses of Wolf Creek Farm or Mr. Tschetter.
a. Property Insurance
Wolf Creek Farm deducted $667 in 1995 and $631 in 1996 for
property insurance. “Certain business-related insurance expenses
unquestionably are deductible under section 162(a).” Metrocorp,
Inc. v. Commissioner, 116 T.C. 211, 245 (2001) (citing section
1.162-1(a), Income Tax Regs.). The farm lease does not require
Mr. Tschetter to provide property insurance covering the
farmhouse or other improvements on the property. The property
insurance is an ordinary and necessary business expense of Wolf
Creek Farm (the owner of the property) and not a personal,
family, or living expense of Mr. Tschetter. We hold, therefore,
Wolf Creek Farm is entitled to deduct the insurance expenses as
claimed in each of the years at issue. - 20 -
b. Utilities
Wolf Creek Farm deducted utilities expenses of $1,991 in
1995, $2,016 in 1996, and $2,081 in 1997. Utilities expenses may
be deductible under section 162(a) if the expenses incurred are
ordinary and necessary in carrying on a trade or business.
Vanicek v. Commissioner, 85 T.C. 731, 742 (1985); Sengpiehl v.
Commissioner, T.C. Memo. 1998-23; Green v. Commissioner, T.C.
Memo. 1989-599.
Here, the farm lease did not contain any provisions
regarding the utilities for the farmhouse. Petitioners did not
produce any utility bills, canceled checks, or testimony to
identify that, if any, portion of the utility expenses related to
the corporation’s business. We have no basis for making any
allocation of the expenses. Thus, petitioners have failed to
establish that Wolf Creek Farm is entitled to any deduction for
utilities expenses.
c. Depreciation
Wolf Creek Farm deducted $569 in 1995, $587 in 1996, and
$575 in 1997 for depreciation of the farmhouse. Section 167(a)
allows a depreciation deduction from gross income for property
used in the taxpayer’s trade or business or held for the
production of income. Ordinarily, depreciation or amortization
is available to an owner of an asset with respect to the owner’s
basis in the asset. Wolf Creek Farm owned the homestead, - 21 -
including the farmhouse. One of the business activities of Wolf
Creek Farm was the leasing of the homestead, including the
farmhouse. Thus, the farmhouse is property used in the
corporation’s trade or business.
We hold that Wolf Creek Farm is entitled to a deduction for
depreciation of the farmhouse for each of the years at issue as
claimed.
d. Taxes
Wolf Creek Farm deducted property taxes of $257 in 1995,
$208 in 1996, and $190 in 1997 attributable to the farmhouse.
Wolf Creek Farm owned the homestead. Section 164(a)(1) allows
the owner of property a deduction for real property taxes
regardless of whether they are paid or incurred in a trade or
business. We hold, therefore, that Wolf Creek Farm may deduct
property taxes as claimed in the years at issue.
e. Summary of Food and Lodging Expenses
To summarize, Wolf Creek Farm may deduct the following
expenses for the years at issue:
Property tax--house $257 $208 $190 Property insurance--house 667 631 -– Depreciation--house 569 587 575 Total 1,493 1,426 765
Wolf Creek Farm may not deduct the following food and
lodging expenses: - 22 -
Food for employees $2,692 $2,722 $2,441 Utilities--house 1,991 2,016 2,081 Total 4,683 4,738 4,522
3. Inclusion of Payments in Mr. Tschetter’s Gross Income
When a corporation makes an expenditure that primarily
benefits the corporation’s shareholders, the amount of the
expenditure may be taxed to the shareholders as a constructive
dividend. Hood v. Commissioner, 115 T.C. 172 (2000); Magnon v.
Commissioner, 73 T.C. 980, 993-994 (1980); Am. Insulation Corp.
v. Commissioner, T.C. Memo. 1985-436. We have found that
expenses for food and utilities paid by Wolf Creek Farm are Mr.
Tschetter’s expenses. Petitioners contend that the payments are
not constructive dividends because Mr. Tschetter was required to
repay any amounts that Wolf Creek Farm could not deduct for
Federal income tax purposes. Petitioners cite Cepeda v.
Commissioner, T.C. Memo. 1993-477, to support their position.
Cepeda, however, is inapposite. In that case, the taxpayers
claimed that advances made by the corporation were loans rather
than employee compensation or constructive dividends.
Petitioners do not contend that the corporate payments of Mr.
Tschetter’s expenses were loans.
For Federal income tax purposes, a transaction will be
characterized as a loan if there was “an unconditional obligation
on the part of the transferee to repay the money, and an - 23 -
unconditional intention on the part of the transferor to secure
repayment.” Haag v. Commissioner, 88 T.C. 604, 616 (1987), affd.
without published opinion 855 F.2d 855 (8th Cir. 1988). In the
instant cases, when the payments were made there was no
unconditional obligation on the part of Mr. Tschetter to repay a
specific dollar amount to the corporation. His obligation to
repay any of the payments was in general terms. The amount of
repayment could not be determined when the payments were made.
Any obligation to repay any amount could not arise before
respondent disallowed the deduction for the expenses; i.e, when
the Wolf Creek Farm notice of deficiency was issued in January
2001. Thus, the payments were not loans. Since the payments
when made by Wolf Creek Farm did not constitute business expenses
of the corporation or loans to Mr. Tschetter, the conclusion is
inescapable that the payments constituted distributions by Wolf
Creek Farm to Mr. Tschetter.
In N. Am. Oil Consol. v. Burnett, 286 U.S. 417, 424 (1932),
the Supreme Court stated:
If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent. * * *
It is clear, therefore, under the claim of right doctrine, the
amounts paid by Wolf Creek Farm in 1995, 1996, and 1997 were - 24 -
taxable to Mr. Tschetter in those years. See Pahl v.
Commissioner, 67 T.C. 286, 289 (1976).
If a taxpayer is required to repay income recognized under
the claim of right doctrine in an earlier tax year, section 1341
permits the taxpayer, in effect, to elect to compute his taxes
for the year of repayment in a manner that gives the taxpayer the
equivalent of a refund (without interest) of tax for the earlier
year. Specifically, section 1341(a)(5) permits the tax for the
year of repayment to be reduced by the amount of the tax paid for
the year of receipt that was attributable to the inclusion of the
repaid amount in that year’s gross income. United States v.
Skelly Oil Co., 394 U.S. 678, 682 (1969). Section 1341, however,
requires actual repayment, restoration, or restitution. Chernin
v. United States, 149 F.3d 805, 816 (8th Cir. 1998); Kappel v.
United States, 437 F.2d 1222, 1226 (3d Cir. 1971); Estate of
Smith v. Commissioner, 110 T.C. 12 (1998).
Although the directors of Wolf Creek Farm adopted a
resolution that required Mr. Tschetter to repay amounts for which
the corporation is disallowed a deduction, Mr. Tschetter does not
claim that he has repaid the disallowed amounts. Indeed, there
is no evidence in the record to show that he did. Therefore,
section 1341 does not apply. We hold that Wolf Creek Farm’s
payment of Mr. Tschetter’s food and utilities expenses
constitutes income to Mr. Tschetter. - 25 -
Petitioners argue that the expenses are meals and lodging
expenses excludable under section 119. We have found to the
contrary. Thus, the costs of food and utilities are Mr.
Tschetter’s personal living expenses.
Personal, family, or living expenses are not deductible
except as otherwise expressly permitted. Sec. 262. A taxpayer’s
expenses for his or her own meals and lodging are personal
because they would have been incurred whether or not the taxpayer
had engaged in any business activity. Christey v. United States,
841 F.2d 809, 814 (8th Cir. 1988); Moss v. Commissioner, 80 T.C.
1073, 1078 (1983), affd. 758 F.2d 211 (7th Cir. 1985). In order
for personal living expenses to qualify as a deductible business
expense under section 162(a), the taxpayer must demonstrate that
the expenses were different from, or in excess of, what he would
have spent for personal purposes. Sutter v. Commissioner, 21
T.C. 170, 173 (1953). Petitioners did not produce any bills,
canceled checks, or testimony to substantiate any portion of the
utilities expenses that relates to Mr. Tschetter’s separate
farming business. Thus, petitioners have failed to establish
that Mr. Tschetter is entitled to a deduction for any portion of
the expenses under section 162.4
4 Except as otherwise provided, an individual is not allowed a deduction with respect to the use of a dwelling unit that is used by the individual as a residence. Sec. 280A(a). The individual, however, may deduct expenses allocable to portions of (continued...) - 26 -
4. Rental Value of Residence
Mr. Tschetter leased the homestead, including the farmhouse,
from Wolf Creek Farm. Wolf Creek Farm received rent in the form
of 30 percent of the calf crop and 40 percent of the other crops
produced on the farm. Mr. Tschetter included only his 70/60
percent of the crop revenues in his income. He excluded the
entire 30/40 percent paid to Wolf Creek Farm as rent, including
the portion attributable to the farmhouse. In effect, he
deducted the portion of the rent paid for the farmhouse. The
rent of the farmhouse is his personal expense and is not
deductible. See sec. 262.
The farm lease does not specify that portion of the rent to
be paid for use of the farmhouse. Nor has Mr. Tschetter provided
any evidence to show that portion of the rent properly
attributable to the farmhouse.
The amount of the constructive dividends respondent
determined in the Tschetter notice of deficiency exceeds the
amount of the deductions disallowed in the Wolf Creek Farm notice
of deficiency. The record does not explain that excess.
4 (...continued) the dwelling that are exclusively used for business purposes. Sec. 280A(c). Mr. Tschetter did not argue that the utilities expenses are deductible under sec. 280A. Therefore, we do not address the question of whether the utilities expenses may be deductible under that section. We note, however, that Mr. Tschetter made no showing that the farmhouse, or any portion thereof, was used exclusively for business purposes. - 27 -
Moreover, since the depreciation respondent disallowed as a
deduction to Wolf Creek Farm was not an expenditure, we assume
that adjustments in the Tschetter notice of deficiency did not
include the depreciation.
We have computed the fair rental value of the farmhouse that
was included in respondent’s adjustment to Mr. Tschetter’ income
as follows:
11/30/95 11/30/96 11/30/97 Wolf Creek Farm notice of deficiency Disallowed food & lodging deductions $6,176 $6,164 $5,287 Less depreciation on residence 569 587 575 Food & lodging expenditures 5,607 5,577 4,712
Tschetter notice of deficiency adjustment for food & lodging provided by corporation $6,163 $6,218 $6,001 Food & lodging expenditures 5,607 5,577 4,712 Adjustment for rental value of residence 556 641 1,289
Mr. Tschetter has not shown that the portion of the rent
attributable to the farmhouse is less than the amounts for the
years at issue, as computed above. We therefore hold that those
amounts are properly included in Mr. Tschetter’s income for the
5. Summary of Adjustments to Mr. Tschetter’s Income
Mr. Tschetter’s income from farming is increased by $556 in
1995, $641 in 1996, and $1,289 in 1997 to reflect the
disallowance of deductions for the rental value of the farmhouse.
In addition, payments by Wolf Creek Farm for food and utilities
are included in Mr. Tschetter’s income as constructive dividends - 28 -
in the amounts of $4,683 in 1995, $4,738 in 1996, and $4,522 in
1997.
Issue 2. Accuracy-Related Penalty Under Section 6662(a)
Respondent determined that Wolf Creek Farm is liable for the
accuracy-related penalty under section 6662(a). As pertinent
here, section 6662(a) imposes a 20-percent penalty on the portion
of an underpayment attributable to negligence or disregard of
rules or regulations. Sec. 6662(b)(1). Negligence includes any
failure to make a reasonable attempt to comply with the
provisions of the Internal Revenue Code. Sec. 6662(c); sec.
1.6662-3(b)(1), Income Tax Regs.
The penalty under section 6662(a) does not apply to any
portion of an understatement of tax if it is shown that there was
reasonable cause for the taxpayer’s position and that the
taxpayer acted in good faith with respect to that portion. Sec.
6664(c)(1). The determination of whether a taxpayer acted with
reasonable cause and in good faith is made on a case-by-case
basis, taking into account all the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. The most
important factor is the extent of the taxpayer’s effort to assess
his/her proper tax liability for the year. Id. The good faith
reliance on the advice of an independent, competent professional
as to the tax treatment of an item may meet this requirement.
Sec. 1.6664-4(b), Income Tax Regs. - 29 -
Despite the fact that petitioners have the burden of proof,
see supra note 3, petitioners have made no showing that they made
an attempt to comply with the tax rules and regulations with
regard to those deductions taken by Wolf Creek Farm for the years
at issue which have been disallowed. Hence, with respect to
those deductions, petitioners have failed to show that Wolf Creek
Farm was not negligent. Nor have petitioners showed that they
acted in good faith with respect to, or that there was reasonable
cause for, the position they took.
Further, petitioners do not claim that they relied on Mr.
Bleeker or any other professional as to the tax treatment of the
expenses for food and lodging.5 Petitioners simply assert that
the accuracy-related penalty does not apply because Wolf Creek
Farm properly claimed the deductions under section 162(a) and Mr.
Tschetter properly excluded the payments under section 119. We
have found to the contrary.
5 Before the trial in these cases, respondent filed a motion to disqualify Mr. Bleeker from his representation of petitioners. Respondent’s motion was based, in part, on the premise that, if petitioners contend that they reasonably relied on Mr. Bleeker’s advice with respect to the proper tax treatment of the payments at issue, then Mr. Bleeker would be required to testify as a witness in the trial of these cases. The Court held a telephone conference call with Mr. Bleeker and counsel for respondent to discuss respondent’s motion. During that call, Mr. Bleeker informed the Court that petitioners did not intend to raise reasonable reliance on a tax professional as a defense to the accuracy-related penalties. - 30 -
Under these circumstances, we are compelled to hold that
Wolf Creek Farm is liable for the accuracy-related penalty for
the years at issue.
To reflect the foregoing,
Decisions will be
entered under Rule 155.