PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE. T.C. Summary Opinion 2013-56
UNITED STATES TAX COURT
TORAINO HARDNETT AND MARVELL PRESTON-HARDNETT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3459-12S. Filed July 15, 2013.
Toraino Hardnett and Marvell Preston-Hardnett, pro sese.
Derek P. Richman, for respondent.
SUMMARY OPINION
GUY, Special Trial Judge: This case was heard pursuant to the provisions
of section 7463 of the Internal Revenue Code in effect when the petition was -2-
filed.1 Pursuant to section 7463(b), the decision to be entered is not reviewable by
any other court, and this opinion shall not be treated as precedent for any other
case.
Respondent determined a deficiency of $7,948 in petitioners’ Federal
income tax for 2008 and an accuracy-related penalty of $1,590 under section
6662(a). Petitioners, husband and wife, resided in Florida at the time they filed
their petition for redetermination with the Court.
The issues for decision are whether petitioners: (1) are entitled to
deductions of $4,725 for professional fees and $10,328 for vehicle expenses
reported on Schedule C, Profit or Loss From Business, (2) are entitled to a
$25,000 loss reported on Schedule E, Supplemental Income and Loss, and (3) are
liable for an accuracy-related penalty under section 6662(a). To the extent not
discussed herein, other issues are computational and flow from our decision in this
1 Unless otherwise indicated, section references are to the Internal Revenue Code (Code), as amended, for the year in issue, and Rule references are to the Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar. -3-
Background
Some of the facts have been stipulated and are so found. The stipulation of
facts and the accompanying exhibits are incorporated herein by this reference.
During 2008 Mr. Hardnett was employed as a police officer, and
Ms. Preston-Hardnett, a real estate agent, was employed as an independent
contractor by Remax Hometown, Inc. (Remax).
I. Petitioners’ 2008 Tax Return
Petitioners timely filed a joint Form 1040, U.S. Individual Income Tax
Return, for 2008.
A. Schedule C
Petitioners attached to their return a Schedule C for a business operated as a
sole proprietorship identified as JM Partners Realty (JM Partners). The Schedule
C identified Ms. Preston-Hardnett as the proprietor of JM Partners and reported
gross receipts of $11,102, various expenses totaling $20,583 (including $4,725 for
professional fees and $10,328 for vehicle expenses), and a net loss of $9,481.
1. Professional Fees
Ms. Preston-Hardnett obtained her real estate sales license in 2002 and
began working as a real estate sales agent for Remax in December 2005. She
testified that Remax required its sales agents to pay a monthly fee of $350 to -4-
maintain an affiliation with the firm. The record includes monthly statements
from Remax indicating that Ms. Preston-Hardnett paid a total of $4,809 to the firm
during 2008. The statements list the balance due each month and the dates and the
amounts of payments, but they do not describe the nature or source of any of the
individual charges. The statements show that Remax routinely charged $350 to
Ms. Preston-Hardnett’s credit card account, on the 24th or the 25th day of each
month, for the 10 months including January through September and December
2008. The October and November statements, however, varied from this pattern
in both the amounts of the charges and the timing of the payments.
2. Vehicle Expenses
Ms. Preston-Hardnett reported on Schedule C that she drove 20,451 miles
while conducting real estate sales and supervising repair work on an investment
property (described below), 28,871 miles while commuting, and 8,420 miles for
“other” activities. On part IV of Schedule C, she checked the box for “NO” in
response to the question whether she had records to support the reported vehicle
expenses. Applying a rate of 50.5 cents per mile, Ms. Preston-Hardnett reported
total vehicle expenses of $10,328.2
2 The Commissioner generally updates the optional standard mileage rate annually. See sec. 1.274-5(j)(2), Income Tax Regs. Rev. Proc. 2007-70, sec. 5.01, (continued...) -5-
Ms. Preston-Hardnett testified that she maintained an “At-A-Glance” day
planner and a notebook to record the mileage that she drove for business purposes
during 2008. The day planner and the notebook include entries listing the dates
that Ms. Preston-Hardnett met with real estate clients, the names of the clients, and
the number of miles driven for each meeting. Ms. Preston-Hardnett testified that
she normally recorded information in the day planner and the notebook
contemporaneously, i.e., on a daily basis after the meetings took place.
Under cross-examination by respondent’s counsel, Ms. Preston-Hardnett
acknowledged that some of the entries in the notebook had been altered (i.e., the
portion of the date indicating the year was obliterated) and that one of the entries
is for a date in 2010. In addition, the day planner included an order form which
provided a convenient way for the owner to purchase a new day planner for the
coming year. In this case, the order form was for the calendar year 2014, a fact
that completely undermined Ms. Preston-Hardnett’s testimony that she recorded
information in the day planner contemporaneously in 2008.
2 (...continued) 2007-2 C.B. 1162, 1164, established a standard mileage rate of 50.5 cents per mile effective for transportation expenses incurred on or after January 1, 2008. The standard mileage rate was modified midyear, however, by Announcement 2008- 63, 2008-2 C.B. 114, which increased the standard rate to 58.5 cents per mile for transportation expenses paid or incurred on or after July 1, 2008. -6-
B. Schedule E
Petitioners attached to their return a Schedule E for a residential property
(duplex) which petitioners purchased as an investment property in December
2007. Petitioners reported that they received no rents from the duplex during 2008
but incurred expenses totaling $37,211, including insurance charges of $1,800,
management fees of $360, mortgage interest of $9,251, repairs of $21,800, and
supplies of $4,000. Petitioners reported a deduction of $25,000 for a rental real
estate loss on Schedule E and on Form 8582, Passive Activity Loss Limitations.
Ms. Preston-Hardnett testified that the duplex was in need of substantial
repair when they purchased it and that she spent a good part of 2008 overseeing its
renovation. In this regard, she stated that she hired and supervised various
contractors as they performed electrical and plumbing work, replaced drywall,
windows, and doors, installed new flooring, renovated the kitchen and a bathroom,
and repaired the roof. The record includes numerous receipts from hardware and
plumbing supply stores totaling approximately $1,429 for miscellaneous items
purchased from January through March 2008. Petitioners did not produce
invoices, receipts, or canceled checks in respect of repair work performed on the
duplex, nor did they offer any records to substantiate the insurance charges,
management fees, or most of the supplies expense reported on Schedule E. -7-
Respondent acknowledged at trial that petitioners paid mortgage interest of $9,251
on the duplex during 2008.
Although petitioners testified that they attempted to rent the duplex in the
latter half of 2008, they did not produce any direct evidence to substantiate the
claim. Ms. Preston-Hardnett listed the property for sale on a multiple listing
service on August 6, 2008, and the listing expired on September 30, 2008.
Petitioners eventually rented the duplex to a tenant in early 2009.
II. Tax Return Preparation
Petitioners’ return was prepared by Ortem Tax Florida Services, Inc.
Although petitioners believed that their return preparer was a certified public
accountant, they later learned that he was not. Ms. Preston-Hardnett did not
provide the return preparer with any mileage logs but instead provided a summary
of the number of miles she purportedly drove for business purposes.
Petitioners signed the return at the preparer’s office, and it was filed
electronically. The return preparer did not review the return with petitioners, nor
did they review the return for accuracy on their own before signing it.
III. Notice of Deficiency
Respondent disallowed the deductions for (1) professional fees of $4,725
and vehicle expenses of $10,328 that petitioners reported on Schedule C, and (2) -8-
the $25,000 rental real estate loss they reported on Schedule E. In addition,
respondent determined that petitioners are liable for an accuracy-related penalty
under section 6662(a).
Discussion
As a general rule, the Commissioner’s determination of a taxpayer’s liability
in a notice of deficiency is presumed correct, and the taxpayer bears the burden of
proving that the determination is incorrect. Rule 142(a); Welch v. Helvering, 290
U.S. 111, 115 (1933).3
Deductions are a matter of legislative grace, and the taxpayer generally
bears the burden of proving entitlement to any deduction claimed. Rule 142(a);
INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co.
v. Helvering, 292 U.S. 435, 440 (1934). A taxpayer must substantiate deductions
claimed by keeping and producing adequate records that enable the Commissioner
to determine the taxpayer’s correct tax liability. Sec. 6001; Hradesky v.
Commissioner, 65 T.C. 87, 89-90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir.
1976); Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965). A taxpayer
3 As discussed in detail below, petitioners did not comply with the Code’s substantiation requirements and have not maintained all required records. Therefore, the burden of proof as to any relevant factual issue does not shift to respondent under sec. 7491(a). See sec. 7491(a)(1) and (2); Higbee v. Commissioner, 116 T.C. 438, 442-443 (2001). -9-
claiming a deduction on a Federal income tax return must demonstrate that the
deduction is allowable pursuant to a statutory provision and must further
substantiate that the expense to which the deduction relates has been paid or
incurred. Sec. 6001; Hradesky v. Commissioner, 65 T.C. at 89-90.
When a taxpayer establishes that he or she paid or incurred a deductible
expense but fails to establish the amount of the deduction, the Court normally may
estimate the amount allowable as a deduction. Cohan v. Commissioner, 39 F.2d
540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743
(1985). There must be sufficient evidence in the record, however, to permit the
Court to conclude that a deductible expense was paid or incurred in at least the
amount allowed. Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957).
Under section 162(a), a deduction is allowed for ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any trade or
business. The determination of whether an expenditure satisfies the requirements
for deductibility under section 162 is a question of fact. See Commissioner v.
Heininger, 320 U.S. 467, 475 (1943). A deduction normally is not available for
personal, living, or family expenses. Sec. 262(a).
Section 274(d) prescribes more stringent substantiation requirements before
a taxpayer may deduct certain categories of expenses, including expenses related - 10 -
to the use of listed property as defined in section 280F(d)(4). See Sanford v.
Commissioner, 50 T.C. 823, 827 (1968), aff’d, 412 F.2d 201 (2d Cir. 1969). As
relevant here, the term “listed property” includes passenger automobiles. Sec.
280F(d)(4)(A)(i). To satisfy the requirements of section 274(d), a taxpayer
generally must maintain records and documentary evidence which, in
combination, are sufficient to establish the amount, the date, and the business
purpose for an expenditure or business use of listed property. Sec. 1.274-5T(b)(6),
Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).
I. Schedule C
A. Professional Fees
Petitioners claimed a deduction of $4,725 for professional fees that Ms.
Preston-Hardnett purportedly paid to Remax to maintain her affiliation with the
firm. Professional fees paid or incurred in carrying on a trade or business
generally are deductible pursuant to section 162(a). See, e.g., Westby v.
Commissioner, T.C. Memo. 2004-179.
The record includes monthly statements indicating that Ms. Preston-
Hardnett paid a total of $4,809 to Remax during 2008. The statements list the
balances due and the dates and amounts of payments, but they do not describe the
nature or source of any of the charges. The statements reflect that during the 10 - 11 -
months including January through September and December 2008 Remax
routinely charged $350 to Ms. Preston-Hardnett’s credit card on the 24th or 25th
day of the month. The October and November statements, however, varied from
this pattern in both the amounts of the charges and the timing of the payments.
Respondent contends that Ms. Preston-Hardnett failed to prove that the
charges listed on the Remax statements were for professional fees. Although the
statements do not describe the nature or the source of the charges in question, Ms.
Preston-Hardnett testified credibly that she paid $350 per month to Remax to
maintain her affiliation with the firm. With the exception of the statements for
October and November, the record supports her testimony. Considering all the
facts and circumstances, we hold that petitioners are entitled to a deduction of
$3,500 for professional fees.
B. Vehicle Expenses
A taxpayer is entitled to deduct transportation expenses incurred in carrying
on a trade or business. Commuting expenses, however, incurred in going from a
taxpayer’s residence to his or her place of business and returning are
nondeductible personal expenses. Commissioner v. Flowers, 326 U.S. 465 (1946).
When a taxpayer uses a vehicle for personal as well as for business purposes, he or
she must allocate expenses between personal and business use in accordance with - 12 -
the strict substantiation requirements of section 274(d). Sec. 280F(d)(4)(A)(i);
sec. 1.274-5T(d)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg. 46025 (Nov. 6,
1985).
Ms. Preston-Hardnett reported that she drove 20,451 miles for business
purposes during 2008. Although we have little doubt that Ms. Preston-Hardnett
incurred vehicle expenses to meet with real estate sales clients, we give no weight
to the notebook or the day planner as evidence of the miles that she actually drove
for these purposes. Ms. Preston-Hardnett’s testimony that she recorded mileage in
the notebook and the day planner contemporaneously during 2008 was wholly
discredited on cross-examination. In sum, we conclude that petitioners failed to
satisfy the strict substantiation requirements for vehicle expenses imposed by
section 274(d). See sec. 1.274-5(j)(2), Income Tax Regs. (providing that the
heightened substantiation requirements for vehicle expenses must be met even
where the standard mileage rate is used). Consequently, respondent’s
determination disallowing the vehicle expenses petitioners reported on Schedule C
is sustained.
II. Schedule E
Petitioners reported on Schedule E and on Form 8582 a $25,000 rental real
estate loss associated with the duplex. The $25,000 amount is a derivative of the - 13 -
expenses totaling $37,211 reported on Schedule E, comprising insurance charges
of $1,800, management fees of $360, mortgage interest of $9,251, repairs of
$21,800, and supplies of $4,000.
Petitioners failed to produce any bills, receipts, or bank records to
substantiate the insurance charges or management fees, and there is no evidence to
permit the Court to estimate the amounts of any deductions for those items.
Petitioners also failed to produce any bills, receipts, or bank records to substantiate
the repair expenses and most of the supplies expense. In any event, Ms. Preston-
Hardnett correctly acknowledged at trial that most, if not all, of the expenditures
made in connection with the general rehabilitation of the duplex were capital and
were not currently deductible in 2008. See sec. 263(a)(1); see also
Smith v. Commissioner, 300 F.3d 1023, 1036 n.14 (9th Cir. 2002), aff’g Vanalco,
Inc. v. Commissioner, T.C. Memo. 1999-265; sec. 1.162-4, Income Tax Regs.4
On the other hand, respondent acknowledged that petitioners paid mortgage
interest of $9,251 in respect of the duplex during 2008. Consequently, we must
consider whether petitioners are entitled to a deduction for that amount.
4 Petitioners did not offer any evidence that they were entitled to a depreciation deduction in respect of the duplex for 2008. - 14 -
Taxpayers are allowed deductions for certain business and investment
expenses under sections 162 and 212. Section 469(a), however, generally
disallows passive activity losses and credits. A passive activity loss is defined as
the excess of the aggregate losses from all passive activities for a taxable year over
the aggregate income from all passive activities for that year. Sec. 469(d)(1). A
passive activity is any activity that involves the conduct of a trade or business or
the expenses of which are deductible under section 212, in which the taxpayer
does not materially participate. Sec. 469(c)(1), (6)(B). A taxpayer shall be treated
as materially participating in an activity only if the taxpayer is involved in the
operations of the activity on a regular, continuous, and substantial basis. Sec.
469(h).
Although rental activity is generally treated as a passive activity regardless
of whether the taxpayer materially participates, see sec. 469(c)(2), (4), the Code
provides exceptions and special rules for taxpayers engaged in rental real estate
activities, see sec. 469(c)(7), (i).
Petitioners rely on section 469(i), which provides that a taxpayer who
actively participates in a rental real estate activity may deduct a maximum loss of
$25,000 per year related to the activity. The term “rental activity” is defined as
any activity where payments are principally for the use of tangible property. Sec. - 15 -
469(j)(8); sec. 1.469-1T(e)(3)(i), Temporary Income Tax Regs., 53 Fed. Reg. 5702
(Feb. 25, 1988). An activity involving the use of tangible property will not be
considered a rental activity for a taxable year, however, if for such taxable year the
average period of customer use for such property is seven days or less. Sec.
1.469-1T(e)(3)(i)(A), (ii)(A), Temporary Income Tax Regs., 53 Fed. Reg. 5702
(Feb. 25, 1988); see Scheiner v. Commissioner, T.C. Memo. 1996-554.
The record reflects that petitioners did not rent the duplex during 2008, nor
did they receive any payments for the use of the duplex that year. It follows that
petitioners were not engaged in a rental activity for purposes of section 469(c)(2),
and no deduction for a rental real estate loss is available to them under section
469(i). Sec. 1.469-1T(e)(3)(i)(A), (ii)(A), Temporary Income Tax Regs., supra;
see Hoskins v. Commissioner, T.C. Memo. 2013-36, at *10.
Under the circumstances, the duplex is considered a trade or business or an
income-producing activity. See Lapid v. Commissioner, T.C. Memo. 2004-222.
In this regard, petitioners may still be eligible to deduct losses associated with the
duplex if they materially participated in the activity within the meaning of section
469(c)(1). See Hoskins v. Commissioner, at *15-*16; Lapid v. Commissioner,
T.C. Memo. 2004-222. As previously discussed, that question turns on whether - 16 -
Ms. Preston-Hardnett was involved in the operations of the activity on a regular,
continuous, and substantial basis. See sec. 469(h).
Section 1.469-5T(a), Temporary Income Tax Regs., 53 Fed. Reg. 5725-
5726 (Feb. 25, 1988), establishes seven distinct tests for determining whether a
taxpayer has materially participated in an activity. Taxpayers can prove the extent
of their activity through any reasonable means, which may include, but are not
limited to, the identification of services performed over a period of time and the
approximate number of hours spent performing such services. Sec. 1.469-
5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988).
Although Ms. Preston-Hardnett testified that she spent a considerable
amount of time during 2008 supervising contractors who were performing
renovation work on the duplex, she did not produce any records to substantiate the
repair expenses of $21,800 or most of the $4,000 of supplies expense reported on
Schedule E; nor did she offer the Court an approximation of the number of hours
she spent conducting the activity. Considering all the facts and circumstances, we
are unable to conclude that Ms. Preston-Hardnett materially participated in the
duplex activity within the meaning of section 469(h) and the temporary
regulations cited above. Consequently, petitioners’ real estate activity in respect - 17 -
of the duplex is subject to the passive activity loss limitations under section 469,
and we sustain respondent’s determination disallowing all losses related thereto.
III. Accuracy-Related Penalty
Section 6662(a) and (b)(1) imposes a penalty equal to 20% of the amount of
any underpayment attributable to negligence or disregard of rules or regulations.
The term “negligence” includes any failure to make a reasonable attempt to
comply with tax laws, and “disregard” includes any careless, reckless, or
intentional disregard of rules or regulations. Sec. 6662(c). Negligence also
includes any failure to keep adequate books and records or to substantiate items
properly. Sec. 1.6662-3(b)(1), Income Tax Regs.; see Olive v. Commissioner, 139
T.C. 19, 43 (2012).
Section 6664(c)(1) provides an exception to the imposition of the accuracy-
related penalty if the taxpayer establishes that there was reasonable cause for, and
the taxpayer acted in good faith with respect to, the underpayment. Sec. 1.6664-
4(a), Income Tax Regs. The determination of whether the taxpayer acted with
reasonable cause and in good faith is made on a case-by-case basis, taking into
account the pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax
Regs. - 18 -
A taxpayer may be able to demonstrate reasonable cause and good faith (and
thereby escape the accuracy-related penalty of section 6662) by showing reliance
on professional advice. See id. However, reliance on professional advice is not an
absolute defense to the section 6662(a) penalty. Freytag v. Commissioner, 89 T.C.
849, 888 (1987), aff’d, 904 F.2d 1011 (5th Cir. 1990), aff’d, 501 U.S. 868 (1991).
A taxpayer asserting reliance on professional advice must prove that: (1) the
adviser was a competent professional with sufficient expertise to justify reliance;
(2) the taxpayer provided the adviser necessary and accurate information; and (3)
the taxpayer actually relied in good faith on the adviser’s judgment. See
Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299
F.3d 221 (3d Cir. 2002). As a defense to the penalty, petitioners bear the burden
of proving that they acted with reasonable cause and in good faith. See Higbee v.
Commissioner, 116 T.C. 438, 446 (2001).
With respect to a taxpayer’s liability for any penalty, section 7491(c) places
on the Commissioner the burden of production, thereby requiring the
Commissioner to come forward with sufficient evidence indicating that it is
appropriate to impose the penalty. Id. Once the Commissioner meets his burden
of production, the taxpayer must come forward with persuasive evidence that the - 19 -
Commissioner’s determination is incorrect. Id. at 447; see Rule 142(a); Welch v.
Helvering, 290 U.S. at 115.
Respondent discharged his burden of production under section 7491(c) by
showing that petitioners failed to keep adequate records and properly substantiate
their claimed expenses. See sec. 1.6662-3(b)(1), Income Tax Regs.
Although petitioners relied on a paid tax preparer and trusted him to
properly prepare their tax return, there is no evidence in the record regarding the
return preparer’s experience or qualifications that would support the conclusion
that they reasonably relied on him. The record also shows that the return preparer
did not review the return with petitioners, nor did petitioners review the return on
their own. Taxpayers have a duty to review their tax returns before signing and
filing them, and the duty of filing accurate returns cannot be avoided by placing
responsibility on a tax return preparer. Metra Chem Corp. v. Commissioner, 88
T.C. 654, 662 (1987); Magill v. Commissioner, 70 T.C. 465, 479-480 (1978),
aff’d, 651 F.2d 1233 (6th Cir. 1981). Finally, the record indicates that petitioners
did not provide necessary and accurate information to their return preparer. In
sum, on the record presented, we are unable to conclude that petitioners acted with
reasonable cause and in good faith within the meaning of section 6664(c)(1). - 20 -
Accordingly, respondent’s determination that petitioners are liable for an
accuracy-related penalty under section 6662(a) is sustained.
To reflect the foregoing,
Decision will be entered
under Rule 155.