1 These cases were consolidated for trial, briefing, and

opinion by order of this Court on Aug. 19, 1999.

T.C. Memo. 2000-303

UNITED STATES TAX COURT

PATRICK C. BADELL AND LILLIAN A. BADELL, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

RONALD L. WILSON AND DONNA M. WILSON, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 14830-98, 14831-98.1 Filed September 26, 2000.

Ronald L. Wilson, for petitioners.

Timothy S. Sinnott, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COLVIN, Judge: Respondent determined deficiencies in

petitioners’ income tax and determined that petitioners are
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2 Badell & Wilson’s (B&W) fiscal year ended June 30.

liable for a penalty as follows:

Patrick C. Badell and Lillian A. Badell

Accuracy-related 

 penalty

Year Deficiency sec. 6662(a) 

1994 $10,253 $2,050.60

1995 66,815 13,363.00

1996 87,210 17,442.00

Ronald L. Wilson and Donna M. Wilson

Accuracy-related 

 penalty

Year Deficiency sec. 6662(a) 

1994 $9,550 $1,910.00

1995 59,181 11,836.20

1996 87,650 17,530.00

Petitioners Patrick Badell (Badell) and Ronald Wilson

(Wilson) are the sole shareholders of Badell and Wilson, P.C.

(B&W), an S corporation. B&W performed legal services for W.R.

Kelso Co., Inc. (Kelso), and Kelso constructed a roof on the

Badells’ residence in B&W’s fiscal year 1995.2 Kelso reported

$49,000 of income on its 1994 return based on the legal services

it received in lieu of payment of $49,000 it billed to B&W for

the roof construction. Kelso credited its accounts payable to

B&W in the same amount. B&W did not try to collect from Kelso

for the legal services B&W had performed in B&W’s 1995 fiscal

year or report as income the roofing services it received. After

concessions, the issues for decision are:

1. Whether B&W received barter income of $49,000 from
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Kelso in the form of roofing services Kelso provided to Badell in

B&W’s 1995 fiscal year. We hold that it did.

2. Whether B&W may deduct costs it advanced on behalf of

its clients of $24,680 for fiscal year 1995 and $37,799 for

fiscal year 1996. We hold that it may not.

3. Whether petitioners Patrick Badell and Lillian Badell

(the Badells) and petitioners Ronald Wilson and Donna Wilson (the

Wilsons) are liable for the accuracy-related penalty for

negligence under section 6662(a) for 1994, 1995, and 1996. We

hold that they are.

Section references are to the Internal Revenue Code in

effect during the years in issue. Rule references are to the Tax

Court Rules of Practice and Procedure. References to Badell and

Wilson are to Patrick Badell and Ronald Wilson, respectively.

FINDINGS OF FACT

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

A. Petitioners

The Badells lived in Indianapolis, Indiana, when they filed

their petition. The Wilsons lived in Rushville, Indiana, when

they filed their petition.

B. Badell & Wilson, P.C.

Badell and Wilson are attorneys. They each own 50 percent

of the stock of B&W, an S corporation incorporated on June 3,

1982. B&W’s office is located in Rushville. Badell was B&W’s
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president, and Wilson was its secretary-treasurer during the

years in issue. Badell and Wilson were the only attorneys B&W

employed during the years in issue.

B&W is engaged in the general practice of law, and is a

fiscal year, cash-basis taxpayer. B&W represents clients in

minor criminal matters, divorces, bankruptcies, and personal

injury cases. B&W also prepares income tax, Federal estate tax,

and Indiana inheritance tax returns for its clients. Wilson

usually prepares those tax returns.

C. B&W’s Payment of Client Costs

B&W paid various expenses for its clients during the years

in issue such as court fees, fees for court reporter services,

witness fees, and charges for medical records and inquiries to

the Indiana Bureau of Motor Vehicles. B&W recorded these

expenses on its books as “Costs Advanced.” B&W also made cash

advances during the years in issue to clients whom they believed

were destitute.

B&W required its personal injury clients to agree to

reimburse B&W for any costs advanced to them and to pay B&W a

percentage of any recovery. B&W’s personal injury clients agreed

to reimburse B&W for any costs it paid on their behalf,

regardless of the outcome of their case. B&W expected its

clients to reimburse B&W for these advances. However, B&W’s

clients did not always do so in the taxable year in which B&W
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paid the expense.

B&W deducted expenses for client costs of $24,680 for fiscal

year 1995 and $37,799 for fiscal year 1996.

D. W.R. Kelso Co.

1. The Relationship Between Kelso and Badell

William Kelso (Mr. Kelso) is the president and owner of

Kelso, an Indianapolis construction company. Badell has known

Mr. Kelso since before 1992.

Kevin Blume (Blume) has been the secretary/treasurer of

Kelso since September 1993. Badell has known Blume since about

1990 when Badell was corporate counsel for another company. 

Badell and Blume also know each other socially.

2. Legal Services Performed by B&W for Kelso

Badell has performed legal services, involving mostly

contracts and collection matters, for Kelso since 1992 or 1993. 

B&W billed Kelso monthly for legal services rendered. B&W billed

Kelso $43,998.86 for legal services provided from June 1994 to

October 31, 1996. Kelso made four payments totaling $1,224.50 to

B&W for legal services provided from October 25, 1994, to October

14, 1996.

B&W usually sues clients whose payments are in arrears if it

believes the bill is collectible. B&W did not try to collect

from Kelso from June 30, 1994, to October 31, 1996.
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3. Roofing Services Provided by Kelso

In 1994, Badell hired Kelso to construct a slate roof on the

Badells’ residence. Kelso usually gives estimates to customers

before beginning to work on projects. However, it did not give

B&W or the Badells an estimate of the cost of constructing the

roof on the Badells’ residence. Kelso began to construct the

roof in 1994.

Kelso billed B&W $49,000 on December 31, 1994, for

constructing the roof on the Badell residence. B&W made no

payments to Kelso until September 1997. Kelso did not try to

collect that amount for an extended period of time because its

personnel believed B&W was “working off” B&W’s charges for legal

services by constructing the roof on the Badell residence. Kelso

reported the $49,000 as income on its 1994 return, and on its

gross profit report for 1994. Kelso credited its accounts

payable to B&W for legal services by $49,000 as of December 31,

1994.

Kelso worked on the Badell residence from 1994 to 1999, for

which it billed B&W as follows:
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Date of bill Amount billed Work performed 

 12/31/94 $49,000.00 First house billing

 12/31/95 4,668.00 Second year bill

 1/22/97 4,222.86 1996 annual work

 3/9/99 1,640.63 Roof & gutter repairs

 3/17/99 288.75 Replace damaged slate; 

 clean gutters

Kelso performed roofing work on B&W’s office building, for

which it billed B&W $1,572.18 in 1997 and $765.27 in 1999. Kelso

had billed B&W $53,668 as of December 31, 1995, and $62,157.69 as

of March 17, 1999, for the work performed on the Badell residence

and the B&W roof from 1994 to 1999.

E. Preparation of B&W’s Tax Returns for 1995 and 1996

B&W used a computer program to prepare its Forms 1120S, U.S.

Income Tax Return for an S Corporation, for fiscal years 1995 and

1996. Wilson gathered the information for the return and

reviewed the return when it was completed. Badell signed B&W’s

returns as B&W’s president.

F. Audit of B&W’s Returns

A revenue agent began examining B&W’s returns in July 1996. 

The revenue agent also examined the returns of B&W’s

shareholders, Badell and Wilson, and met with them separately in

July 1996.

The revenue agent met with Mr. Kelso and Blume on October

21, 1996, to discuss the roofing job on the Badell residence. 

Mr. Kelso and Blume told the revenue agent that B&W intended to

“work off” the cost of the roofing job.
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G. B&W’s and Kelso’s Payments to Each Other

Kelso paid B&W $30,000 on October 31, 1996, $20,000 on

September 11, 1997, $25,000 on August 14, 1998, and $10,000 on

December 17, 1998.

Kelso began trying to collect the amount owed from B&W after

the audit of B&W (discussed at paragraph F, above) began, and

after the revenue agent spoke to Mr. Kelso and Blume in October

1996. B&W paid Kelso $10,000 on September 10, 1997, and

$52,157.69 on August 4, 1998, for the work done on the Badells’

residence and on B&W’s office building.

OPINION

A. Whether B&W Received Barter Income of $49,000 From Kelso in

Fiscal Year 1995

1. The Issue

We must decide whether, as respondent contends, B&W received

barter income of $49,000 from Kelso in fiscal year 1995 in the

form of roofing services Kelso provided for the Badell residence.

Gross income includes the fair market value of property or

services received in exchange for other services. See sec.

61(a); Baker v. Commissioner, 88 T.C. 1282, 1288 (1987); sec.

1.61-2(d)(1), Income Tax Regs. The fair market value of goods

and services is normally the amount charged by the providers of

the goods and services. See Rooney v. Commissioner, 88 T.C. 523,

527-528 (1987).
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2. Petitioners’ Contentions

Petitioners contend that B&W did not receive barter income

in fiscal year 1995 because Kelso and B&W paid each other in full

after B&W’s fiscal year 1995.

Badell testified that he did not tell Mr. Kelso or Blume

that he would work off the cost of the roofing services. Badell

testified that B&W did not try to collect the debt Kelso owed it

because B&W expected that Kelso would pay B&W eventually. Badell

also testified that he did not know whether the work Kelso did on

his roof was a large or small project and that he did not

remember seeing roofing equipment or materials at his home

because he was not home during the day when the roofers were

there. We disagree. We decide whether a witness is credible

based on objective facts, the reasonableness of the testimony,

the consistency of statements made by the witness, and the

demeanor of the witness. See Quock Ting v. United States, 140

U.S. 417, 420-421 (1891); Wood v. Commissioner, 338 F.2d 602, 605

(9th Cir. 1964), affg. 41 T.C. 593 (1964); Pinder v. United

States, 330 F.2d 119, 124-125 (5th Cir. 1964); Concord Consumers

Hous. Coop. v. Commissioner, 89 T.C. 105, 124 n.21 (1987). We

may discount testimony which we find to be unworthy of belief,

see Tokarski v. Commissioner, 87 T.C. 74, 77 (1986), but we may

not arbitrarily disregard testimony that is competent, relevant,

and uncontradicted, see Conti v. Commissioner, 39 F.3d 658, 664
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(6th Cir. 1994), affg. 99 T.C. 370 (1992) and T.C. Memo. 1992-

616.

We found Badell’s testimony to be unconvincing and

inconsistent with more convincing evidence in the record. First,

Badell’s testimony was implausible and incredible. He claimed to

not know what roofing services Kelso had performed at his

residence and at the B&W office, despite the fact that he

testified that he did not pay Kelso until the roofing job at his

residence was completed to his satisfaction. Badell’s testimony

that he did not socialize with Blume is contradicted by Blume’s

testimony that they did occasionally socialize and that they

sometimes drove to football games together.

Second, Kelso treated the transaction as a barter. It

billed B&W $49,000 for the roof construction on the Badell

residence in 1994, credited its accounts payable to B&W by

$49,000, and reported $49,000 as income on its 1994 return even

though B&W made no cash payment to Kelso that year. Third,

although B&W billed Kelso $43,998.86 on October 31, 1996, and

Kelso billed B&W $53,668 on December 31, 1995, neither Kelso nor

B&W tried to collect those amounts until after the revenue agent

began the audit. Fourth, the parties did not pay each other in

full until several years after providing the roofing job and

legal services. B&W paid Kelso in Kelso’s fiscal years 1998 and

1999, and Kelso paid B&W in B&W’s fiscal years 1997, 1998, and
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3 The parties agreed that Mr. Kelso was unavailable to

testify.

1999. Fifth, B&W and Kelso had a longstanding business

relationship, and Badell and Blume were friends. Sixth, Mr.

Kelso and Blume told the revenue agent who conducted the audit of

B&W and petitioners individually that B&W intended to “work off”

the cost of the roofing job. Blume said he did not recall making

this statement. We see no reason to doubt the revenue agent’s

testimony because it was based on the statements of both Mr.

Kelso and Blume, Blume did not deny making the statement, and Mr.

Kelso did not testify.3

Petitioners contend that “work off” means that B&W and Kelso

agreed to pay the other in money for their services. We

disagree. We construe “work off” to mean that B&W intended to

trade legal services for Kelso’s roofing services.

Petitioners contend that respondent’s barter theory would

improperly convert B&W from a cash basis of accounting to an

accrual basis. We disagree. Respondent’s barter theory

accelerates into B&W’s 1995 fiscal year income which B&W reported

in its 1997, 1998, and 1999 fiscal years. All items of gross

income, including cash, property, or services, are included in

the taxable year of the cash basis taxpayer in which the amount

was actually or constructively received. See sec. 1.446-

1(c)(1)(i), Income Tax Regs. B&W and Kelso entered into a
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bartering transaction under which Kelso provided roofing services

to B&W in B&W’s 1995 fiscal year.

3. Conclusion

We hold that B&W must include the $49,000 of roofing

services in income in its 1995 fiscal year, the year in which

Kelso provided the services.

B. Whether B&W May Deduct Expenses Advanced on Behalf of

Clients for Fiscal Years 1995 and 1996

Petitioners contend that B&W may deduct as ordinary and

necessary business expenses for fiscal years 1995 and 1996

amounts it advanced on behalf of its clients for filing and

recording fees, court costs, and similar expenses in those years.

We disagree.

Expenses paid by a taxpayer under an agreement that he or

she will be reimbursed for those expenses are loans or advances

and are not deductible business expenses. See Herrick v.

Commissioner, 63 T.C. 562, 569 (1975); Canelo v. Commissioner, 53

T.C. 217, 224 (1969) (attorney’s reimbursable costs are not

deductible), affd. per curiam 447 F.2d 484, 485 (9th Cir. 1971);

Hearn v. Commissioner, 36 T.C. 672, 674 (1961), affd. 309 F.2d

431 (9th Cir. 1962); Patchen v. Commissioner, 27 T.C. 592, 600

(1956), affd. in part and revd. on other grounds 258 F.2d 544

(5th Cir. 1958).

Petitioners contend that B&W can deduct the costs advanced

for its clients because, according to petitioners, repayment of
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the advanced costs was contingent upon the outcome of the

underlying litigation (i.e., a gross fee arrangement). See

Boccardo v. Commissioner, 56 F.3d 1016, 1018 (9th Cir. 1995),

revg. T.C. Memo. 1993-224. We disagree. In Boccardo v.

Commissioner, supra, the U.S. Court of Appeals for the Ninth

Circuit held that an attorney’s payment of costs and charges in

connection with his or her client’s litigation is deductible if

the client is under no obligation to repay the money spent. 

Unlike the clients in Boccardo, B&W’s clients were obligated to

reimburse B&W for the costs it paid on their behalf regardless of

the outcome of the client’s case. Thus, Boccardo does not help

petitioners.

Similarly, B&W may not deduct as business expenses advances

it made to those clients it believed were destitute. See Hearn

v. Commissioner, supra (unreimbursed expenses advanced by

attorney to clients were nondeductible loans in year paid, even

though attorney believed it “doubtful” he would collect these

items).

Petitioners contend that, in the same tax year B&W advanced

costs, B&W was reimbursed by its clients in an amount greater

than conceded by respondent. We agree in part and disagree in

part. In fiscal year 1995, B&W’s clients reimbursed B&W $2,311

for costs paid in fiscal year 1995, over and above those conceded

by respondent, and B&W may reduce its gross receipts for that
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year accordingly. However, petitioners have not shown that B&W

was reimbursed in an amount greater than that conceded by

respondent for fiscal year 1996.

Petitioners contend that respondent’s disallowance of B&W’s

deduction of those costs would have the effect of improperly

putting B&W on the accrual method of accounting. We disagree. 

Although cash-basis taxpayers may deduct business expenses in the

taxable year paid, the costs advanced by B&W for its clients were

in the nature of reimbursable loans and were not deductible. 

Respondent’s disallowance of those deductions did not put B&W on

the accrual method of accounting.

Petitioners claim that they may deduct as business expenses

amounts advanced on behalf of clients just as farmers may deduct

their expenses for fertilizers, chemicals, and fuel. We

disagree. Tax rules for farmers do not make B&W’s payment of

client costs deductible.

Petitioners contend that respondent permitted B&W to deduct

as business expenses advances for client costs in prior years,

and claim that its identical treatment of client costs during the

years in issue must similarly be accepted. We disagree. First,

petitioners offered no evidence of a prior examination or audit

of B&W’s tax returns and thus have not shown that respondent

allowed B&W to deduct client advances in prior years. Second,

respondent is not precluded from raising an issue even if
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respondent did not raise it in a prior year. See Hawkins v.

Commissioner, 713 F.2d 347, 351-352 (8th Cir. 1983), affg. T.C.

Memo. 1982-451; Easter v. Commissioner, 338 F.2d 968, 969 (4th

Cir. 1964), affg. per curiam T.C. Memo. 1964-58.

Petitioners point out that the amounts B&W deducted as

advanced costs were less than 5 percent of its total income for

fiscal years 1994 and 1995 and argue that no material distortion

of income or expenses would result from deducting those costs. 

Petitioners’ argument misses the mark. Respondent did not

determine that B&W’s income was distorted by its deduction of

advanced client costs; instead, respondent determined, and we

agree, that B&W may not deduct advanced client costs because they

were nondeductible loans to its clients.

C. Whether Petitioners Are Liable for the Accuracy-Related

Penalty for Negligence

Petitioners contend that they are not liable for the

accuracy-related penalty for negligence for 1994, 1995, and 1996.

We disagree.

Taxpayers are liable for a penalty equal to 20 percent

of the part of the underpayment attributable to negligence or

disregard of rules or regulations. See sec. 6662(a) and (b)(1).

Negligence includes failure to make a reasonable attempt to

comply with internal revenue laws or to exercise ordinary and

reasonable care in preparing a tax return. See sec. 6662(c). To

avoid liability for negligence, the Badells and Wilsons must show
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that they acted reasonably and exercised due care in preparing

their 1994, 1995, and 1996 tax returns. See sec. 6664(c)(1).

Petitioners concede that B&W should not have deducted as

office expenses in fiscal years 1995 and 1996 the cost of buying

PTC Bancorp stock, that the Badells should have included in

income for 1994, 1995, and 1996 Badell’s fringe benefit income

from B&W in the form of personal use of corporate-owned

automobiles and health and life insurance for which B&W paid the

premiums, and that the Wilsons should have included in income

Wilson’s fringe benefit income from B&W in the form of personal

use of corporate-owned automobiles and life insurance for which

B&W paid the premiums. They contend that they should not be held

liable for negligence because they readily conceded these errors. 

We disagree. Petitioners provided no evidence as to the

reasonableness of their position regarding these items. They did

not explain how they decided to treat these items on their

returns or claim that they investigated the proper treatment of

or had authority for their treatment of these items. The fact

that they conceded their errors does not show they were not

negligent. See McCullen v. Commissioner, T.C. Memo. 1997-280.

Petitioners argue that B&W’s tax treatment of advanced

client costs was not negligent because B&W has used the same

method of accounting for costs since B&W was formed and

respondent had not previously challenged it. Finally,
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petitioners contend that, because (according to petitioners) B&W

did not receive barter income from Kelso, they are not negligent

for their failure to report that income.

In deciding whether Badell and Wilson were negligent, we

consider their legal education and their years of legal

experience. See Tippin v. Commissioner, 104 T.C. 518, 534

(1995); Glenn v. Commissioner, T.C. Memo. 1995-399, affd. 103

F.3d 129 (6th Cir. 1996). Petitioners have not shown that they

acted with reasonable cause and in good faith with respect to

these issues. They did not explain how they prepared their

individual returns for 1994, 1995, and 1996, or provide any

authority for the positions they took on those returns. We

conclude that petitioners are liable for the accuracy-related

penalty for negligence for 1994, 1995, and 1996.

Decisions will be entered

under Rule 155.