T.C. Memo. 1996-432

UNITED STATES TAX COURT

JAMES B. MILLER, JR., Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 7900-94. Filed September 24, 1996.

James B. Miller, Jr., pro se.

Alison W. Lehr, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

SWIFT, Judge: Respondent determined deficiencies and

accuracy-related penalties relating to petitioner's 1990 and 1991

Federal income taxes as follows:

Accuracy-Related Penalty

Year Deficiency Sec. 6662(a) 

1990 $21,617 $4,323

1991 $18,156 $3,631
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After settlement of some issues, the issues for decision

are: (1) Whether petitioner is entitled to deduct expenses

relating to a home office; (2) whether petitioner has adequately 

substantiated claimed business expenses relating to his scrap

metal recycling business; and (3) whether petitioner is liable

for the accuracy-related penalties.

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.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. At

the time he filed his petition, petitioner resided in Lake Worth,

Florida. 

During 1990 and 1991, petitioner owned and operated as a

sole proprietorship a scrap metal recycling business. Suppliers

would deliver scrap metal to the warehouse petitioner rented for

his business, or petitioner or his employees would pick up scrap

metal from suppliers and bring it to petitioner's warehouse. 

None of the scrap metal was ever brought to petitioner's

residence in which petitioner maintained an office (home office)

for the performance of administrative and management work

relating to his scrap metal recycling business. 
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At petitioner's warehouse, scrap metal was prepared for

resale and shipped or delivered personally by petitioner or his

employees to wholesalers throughout southern Florida. 

 Petitioner maintained the home office because there was no

suitable space in the warehouse for him to perform necessary

administrative and management work relating to his scrap metal

recycling business. Most of the time during which petitioner

worked on his scrap metal recycling business, petitioner was

physically located in his home office. 

Petitioner used the home office mainly to place telephone

calls to potential customers and to maintain data and

spreadsheets on his computer relating to operation of his scrap

metal recycling business. Over the telephone from his home

office, petitioner generally made arrangements for the purchase

and resale of scrap metal. Telephone calls received at the

warehouse were routed first to the home office and then, if not

answered at the home office, were transferred to the warehouse. 

Petitioner prepared at his home office advertising material,

brochures, and fliers to mail to customers. On such material,

the address indicated for petitioner’s business was the warehouse

address, not petitioner’s home address. 

Petitioner often would meet with customers at their places

of business. Other than for entertainment, petitioner never met

with customers in his home office.
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Petitioner visited the warehouse frequently in order to,

among other things, check on employees and operations at the

warehouse, deliver supplies, and pick up and deliver cash -- the

form of payment typically used in petitioner’s scrap metal

recycling business. 

During most of 1990, petitioner lived in a rented residence

with two of his daughters and his girlfriend at 7350 Estrella

Court, West Palm Beach, Florida (Estrella residence). The

Estrella residence consisted of a kitchen, a combined living and

dining room area, a family room, four bedrooms, 3.5 bathrooms, an

attached garage, and a swimming pool. Petitioner often

entertained personal and business guests at dinner parties at the

Estrella residence.

From the end of 1990 through 1991, petitioner lived in a

condominium that petitioner owned at 614 N.W. 13th Street, Boca

Raton, Florida (condominium). The condominium consisted of a

kitchen, a combined living and dining room area, two bedrooms and

1.5 bathrooms. Two of petitioner's daughters occasionally lived 

with petitioner in the condominium.

During 1990 and 1991, petitioner’s home office relating to

his scrap metal recycling business was located in the combined

living and dining room area of both the Estrella residence and

the condominium. Petitioner furnished the living and dining room

area with desks, file cabinets, a computer, and calculators. The

record does not indicate what other furniture was located in the
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living and dining room area. Petitioner had six telephone lines

running into the home office. 

As indicated, petitioner paid employees of his scrap metal

recycling business in cash. Employees of petitioner’s scrap

metal recycling business were generally hired on a temporary

basis by petitioner’s warehouse foreman. The employees generally

were transient or homeless individuals and worked in the

warehouse. Employees of petitioner’s scrap metal recycling

business were required to sign a written agreement, but there was

no line on the agreement to indicate an employee's Social

Security number or personal address, and neither petitioner nor

the warehouse foreman generally obtained Social Security numbers

or addresses of the employees. 

Petitioner did not prepare and submit Forms W-2 or 1099 with

respect to wages paid to employees of his scrap metal recycling

business, and petitioner withheld no Federal or State taxes with

regard to wages paid to his employees.

At the end of each day, petitioner’s warehouse foreman would

prepare a written cash report and would indicate thereon amounts

paid and received that day from the purchase and resale of scrap

metal, wages paid to employees, and expenses paid at the

warehouse. Generally, at the end of each day the warehouse

foreman also would call petitioner and provide petitioner with

information concerning the cash received and spent at the

warehouse that day.
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The cash reports that were prepared each day by the

warehouse foreman would be reviewed every few days by petitioner,

who would enter data from the cash reports onto spreadsheets

petitioner maintained on the computer located in his home office. 

Prior to trial, the majority of the written daily cash reports

relating to petitioner's scrap metal recycling business were lost

or misplaced. Petitioner's computer spreadsheets with regard to

employee wage expenses incurred at the warehouse generally

correspond with information with regard thereto as reflected in

the limited number of daily cash reports that are in the record.

According to petitioner's computer spreadsheets, the

warehouse foreman received total wages of $19,798 in 1990 and

$20,956 in 1991. 

Petitioner’s employees occasionally incurred traffic fines

for speeding and other traffic violations while picking up or

delivering scrap metal.

During 1990 and 1991, petitioner's warehouse was broken into

and burglarized several times. Reports were made to the police,

but petitioner did not retain copies of the police reports or

other records indicating what was stolen from petitioner’s

warehouse. 

In late 1990, due apparently to pending litigation involving

a former employee and to a child custody dispute with his former

spouse, petitioner filed for bankruptcy and paid legal fees in

connection with the bankruptcy proceeding.
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In 1991, petitioner paid medical expenses relating to his

daughters, to employees of his warehouse, and to his own medical

needs. 

Petitioner often traveled in his automobile to meet with

customers and prospective customers. Petitioner provided

refreshments for customers at his warehouse, and occasionally

petitioner purchased lunch for employees, for customers, and for

himself during meetings at restaurants.

On his 1990 and 1991 Federal income tax returns, petitioner

claimed deductions for alleged expenses relating to his scrap

metal recycling business. The deductions claimed include alleged

miscellaneous expenses relating to petitioner's home office, rent

and utilities relating to petitioner's home office and to the

warehouse, employee wages, fines and losses from burglaries,

legal fees, employee benefits, medical expenses, travel expenses,

and meal and entertainment expenses. 

Allegedly due to a loss of many of petitioner’s books and

records during the bankruptcy proceeding, the only records

relating to petitioner's scrap metal recycling business that

petitioner produced to respondent’s revenue agent during the

audit and at trial were: (1) Copies of the computer spreadsheets 

reflecting alleged daily and monthly expenses by category for all

of 1990 and 1991 except for one month of 1990; and (2) some of

the daily cash reports and receipts for 1990 and 1991.
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On audit, respondent determined that petitioner's claimed

home office expenses did not qualify for a deduction and that

petitioner’s books and records did not adequately substantiate

many of the claimed cash expenses relating to petitioner’s scrap

metal recycling business, and respondent generally disallowed all

expenses claimed as deductions where the nature and amount of the

expenses could not be substantiated by specific receipts or

billing statements. 

Respondent refused to accept petitioner’s computer

spreadsheets as adequate substantiation of expenses incurred by

petitioner in his scrap metal recycling business because

respondent determined that the backup documentation was

inadequate. For example, during the audit and at trial,

respondent did not allow or concede deductions for claimed

expenses for employee wages where petitioner could not identify

either Social Security numbers or addresses of the employees, but

respondent did allow or concede deductions for wage expenses

indicated on the computer spreadsheets for employees for whom

petitioner provided Social Security numbers or addresses. 

Respondent also disallowed claimed expenses for wages of the

warehouse foreman as reflected on the computer spreadsheets in

excess of $12,000 for each year.

The schedule below sets forth the expenses at issue herein

as reflected in petitioner’s computer spreadsheets, as claimed by

petitioner on his 1990 and 1991 Federal income tax returns, and
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the portions thereof now deemed by respondent to be allowable or

not allowable. Note that some of the categories of expenses are

different for each year:

1990

 Computer Expenses Allowed By Disallowed By

 Category Spreadsheets* Per Return Respondent Respondent 

Rent $ 8,220 $ 11,765 $ 1,190 $ 9,855

Utility 3,687 21,279 19,604 1,675

Office 7,079 7,640 1,202 6,438

Wages 77,191 82,299 57,743 24,556

Fines & Losses 3,770 3,770 1,623 2,147

Legal 9,232 9,732 744 8,988

Emp. Ben. 0 1,320 414 906

 

 $109,179 $137,805 $82,520 $54,565

* The 1990 spreadsheet totals are based on 11 out of 12 months.

 As explained, one month of the 1990 spreadsheets was not put 

 into evidence.

1991

 Computer Expenses Allowed By Disallowed By

 Category Spreadsheet Per Return Respondent Respondent 

Home Office $ 0 $ 2,291 $ 0 $ 2,291

Utility 2,115 2,115 1,944 171

Office 4,109 4,109 946 3,163

Wages 81,958 81,958 56,665 25,293

Fines & Losses 4,875 2,689 1,501 1,188

Legal 3,711 3,711 252 3,459

Medical 1,188 1,188 414 774

Travel 2,880 2,880 0 2,880

Meals & Ent. 5,303 4,244 2,582 1,662

 

$106 ,139 $105,185 $64,304 $40,881

The disallowed portion of the rent, utility, and office

expenses claimed for 1990 and of the utility and office expenses

claimed for 1991 relate to petitioner's home office.

OPINION

Under section 162(a), a taxpayer is permitted to deduct all

ordinary and necessary expenses paid or incurred in carrying on a

trade or business. Under section 280A, however, deductions
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associated with a home office are generally disallowed unless the

home office was used exclusively and regularly as the principal

place of business for the taxpayer. 

Where a taxpayer’s business is conducted in part in the

taxpayer’s residence and in part at another location, the

following two primary factors are analyzed in determining whether

the home office qualifies under section 280A(c)(1)(A) as the

taxpayer’s “principal” place of business: (1) The relative

importance of the functions or activities performed at each

business location; and (2) the amount of time spent at each

location. Commissioner v. Soliman, 506 U.S. 168, 175-177 (1993).

Whether the functions or activities performed at the home

office are necessary to the business is relevant but not

controlling, and the location at which goods and services are

delivered to customers generally will be regarded as the

principal place of a taxpayer’s business. Id. at 176. The

relative importance of business activities engaged in at the home

office may be substantially outweighed by business activities

engaged in at another location. The Supreme Court has explained

as follows: 

If the nature of the business requires that its

services are rendered or its goods are delivered at a

facility with unique or special characteristics, this

is a further and weighty consideration in finding that

it is the delivery point or facility, not the

taxpayer's residence, where the most important

functions of the business are undertaken. Id. at 176.
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The principal activities relating to petitioner's scrap

metal recycling business consist of the collection, processing,

and resale of scrap metal, the principal aspects of which are

performed at petitioner's warehouse. The warehouse appears to be

a facility with unique or special characteristics capable of

processing and storing scrap metal. These activities are not

performed in petitioner's home office. 

The administrative, management, and other activities

performed in petitioner's home office certainly constitute a

relevant part of petitioner's business, but because the scrap

metal is collected and processed at the warehouse, the warehouse

is to be regarded as the principal place of petitioner's scrap

metal recycling business. 

Petitioner argues that negotiations for the purchase and

sale of scrap metal that he conducts primarily over the telephone

from his home office constitute the principal activity of his

business. Petitioner, however, has not established in this case

that the actual purchase and sale of scrap metal is to be treated

as occurring in his home office, nor that negotiations for the

purchase and sale of scrap metal that are conducted over the

telephone from his home office constitute the principal activity

of the business. 

Further, for expenses of a home office to qualify for

deductibility under section 280A, no personal use may be made of

the particular area of a residence that is used as the home
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office. Sec. 280A(c)(1). Petitioner maintained his home office

in the living and dining room area of the Estrella residence and

of the condominium. We are not convinced that petitioner used

these areas solely for his home office. We conclude that all

expenses relating to petitioner's home office, including rent,

utilities, and office expenses, were correctly disallowed by

respondent.

Turning to the other claimed expenses that remain in dispute

on the grounds that petitioner has not adequately substantiated

the business nature and amount of the expenses, it is well

established that taxpayers generally bear the burden of proof

regarding claimed business deductions. Rule 142(a); Welch v.

Helvering, 290 U.S. 111 (1933). 

Under section 162, deductions are allowed for all ordinary

and necessary expenses paid or incurred during a tax year in

carrying on a trade or business. Cash basis taxpayers must

establish: (1) That the expenses were paid; (2) that they were

paid during the year in issue; (3) that they were paid in

furtherance of a trade or business; and (4) that they were

ordinary and necessary expenses of the trade or business. Sec.

1.162-1, Income Tax Regs.

Taxpayers are required to maintain adequate records to

substantiate business expenses and to enable respondent to

determine their correct tax liability. Sec. 6001. Where a

taxpayer does not have adequate records, the burden of proof
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bears heavily on the taxpayer. Ellis Banking Corp. v.

Commissioner, 688 F.2d 1376, 1383 (11th Cir. 1982), affg. in part

and remanding in part T.C. Memo. 1981-123; Cohan v. Commissioner,

39 F.2d 540, 544 (2d Cir. 1930). 

Where taxpayers establish that they are entitled to

deductions for trade or business expenses but are unable to

adequately substantiate the exact amount of the expenses, we may

estimate the amount of the deductible expenses. Cohan v.

Commissioner, supra at 543-544. In order, however, for us to

estimate the amount of deductible expenses, taxpayers have an

obligation to provide some rational basis upon which reasonable

estimates may be made. Vanicek v. Commissioner, 85 T.C. 731, 743

(1985). 

In this case, with regard to claimed wages of $24,556 for

1990 and $25,293 for 1991 that are still in dispute, both

petitioner and the warehouse foreman testified as to each of the

employees whose claimed wages are still in dispute. They

testified as to the employment relationship of each of these

employees with petitioner’s scrap metal recycling business during

1990 and 1991 and to the length of time employed. We find the

testimony of petitioner and of the foreman to be credible as to

these claimed employee wages. The wages paid to the employees

are also generally supported by the daily cash reports and

computer spreadsheets that are in evidence. 
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We sustain in full the deductions claimed by petitioner for

1990 and 1991 for employee wage expenses, including the wage

expenses of the warehouse foreman.

With regard to claimed fines and losses of $2,147 for 1990

and $1,188 for 1991 that are still in dispute, petitioner admits

that some portion of the claimed fines and losses includes

nondeductible traffic fines. Petitioners offer no basis on which

we can make an allocation between allowable and nonallowable

fines and losses. We sustain respondent's disallowance of these

items.

The $8,988 for 1990 and $3,459 for 1991 in disputed legal

fees represent either clearly personal expenses or the business

nature thereof is not adequately established in the record. At

trial, petitioner conceded that $2,500 to $3,500 of these claimed

legal expenses represent personal expense, and petitioner did not

adequately document the nature of the remaining claimed legal

expenses. We sustain respondent's disallowance of the legal fees

still in dispute. 

With regard to the $906 in claimed employee benefit expenses

for 1990 and the $774 in claimed medical expenses for 1991 that

are still in dispute, petitioner has failed to substantiate the

nature of these expenses. Petitioner admitted at trial that some

of these claimed expenses were incurred for personal medical care

of two of his daughters. We sustain respondent's disallowance of

the claimed employee benefit and medical expenses. 
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With regard to the $2,880 in travel expenses and the $1,662

in meal and entertainment expenses that are still in dispute for

1991, the standard of proof for business travel and for businessrelated meal and entertainment expenses is higher than the

standard of proof for other business expenses. Under section

274(d), deductions for business travel and business-related meal

and entertainment expenses are not allowable on the basis of

estimates and unsupported testimony of taxpayers. At a minimum,

taxpayer's records must show: (1) The amount of such expenses;

(2) the time and place such expenses were incurred; and (3) the

business purpose for which such expenses were incurred. Sec.

274(d). 

Petitioner has failed to meet the level of substantiation

required for the claimed business travel and business-related

meal and entertainment expenses that are in dispute for 1991. 

Petitioner did not present any receipts or underlying records

relating to these expenses. Mere entries on the computer

spreadsheets for "travel" and "meals/entertainment" do not

satisfy the substantiation requirements of section 274(d). We

sustain respondent's disallowance of the claimed travel, meal,

and entertainment expenses for 1991. 

With regard to the additions to tax, under section 6662(a),

a 20 percent accuracy-related penalty is applicable to an

underpayment of tax attributable to either negligence or to a

disregard of rules or regulations (section 6662(b)(1)). 
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Section 6662(c) defines "negligence" as any failure to make a

reasonable attempt to comply with the provisions of the Internal

Revenue Code. The term "disregard" includes any careless,

reckless, or intentional disregard of Treasury rules or

regulations. Sec. 6662(c). 

Taxpayers are expected to maintain adequate records to

substantiate claimed deductions, and failure to maintain adequate

records may constitute negligence. Sec. 6001; Schroeder v.

Commissioner, 40 T.C. 30, 34 (1963). Even though a taxpayer's

records may be lost, the burden is generally still on the

taxpayers to substantiate deductions claimed with receipts and

other sufficient documentation and evidence. Petitioner in this

case has failed to meet his burden with regard to the adjustments

that we have sustained and has failed to convince us as to the

cause for his inability to provide at trial additional books and

records relating to his scrap metal recycling business.

With the exception noted below, we sustain respondent's

determination of the accuracy-related penalties for 1990 and 1991

with respect to all adjustments that we have sustained. 

We believe, however, that the accuracy-related addition to

tax in this case is not properly attributable to those portions

of petitioner's tax deficiencies for 1990 and 1991 that relate to

the disallowed home office expense deductions that petitioner

claimed and that we have disallowed. Petitioner did not

demonstrate a careless, reckless, or intentional disregard for
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the law in claiming these deductions. We note that the Supreme

Court's decision in Commissioner v. Soliman, 506 U.S. 168 (1993),

was not made until 1993, and that prior thereto confusion existed

as to the proper legal standard to apply to home office expense

deductions. See, e.g., Soliman v. Commissioner, 935 F.2d 52 (4th

Cir. 1991), affg. 94 T.C. 20 (1990), revd. 506 U.S. 168 (1993);

Meiers v. Commissioner, 782 F.2d 75 (7th Cir. 1986), revg. T.C.

Memo. 184-607; Weissman v. Commissioner, 751 F.2d 512 (2d Cir.

1984), revg. T.C. Memo. 1983-724. 

Decision will be

entered under Rule 155.