T.C. Mem o. 2 01 4- 23 5

UNITED STAT ES TAX COURT

JAM ES CLEMENT POW ELL AN D LUCY HAMRICK POWEL L, Peti ti on ers v.

COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 83 49 -1 3. Fi le d No ve m be r 17 , 20 14
.
Ja m es Cle m en t Po well an d Lu cy Ham ric k P owe ll , pro ses e. Mat th ew S. Red di ng to n, fo r res po nd en t.

MEMORANDUM FINDINGS OF FACT AND OPINION KERRIGAN, Ju dg e: Res po nd en t d et erm in edde fic ie nc ie s an d p en al ti es with re sp ectto pe ti ti on ers ’ Fed eral in co m e ta x a s fo ll ows :- 2 - [* 2] Year Defi ci en cy Pen al ty se c. 66 62 (a) 20 08 $1 7,0 08 $3 ,40 2 20 09 28 ,44 6 5,6 89 Unl es s o th erwi se in di cat ed , all sec ti on refe ren ces are t o the Int ern al Rev enue Co de (Co de ) in effe ctforth e ta x years i n i ss ue , andall Ru le refe ren ces are t o the Tax C ou rt Rul es of P ract ic e an d P ro cedur e. W e ro un d a ll m on et ary am ount s t o the ne ares t d ol lar. Afte r co nc es si on s, the is su es forco ns id erat io n a re (1 ) whe th er p et it io ne rs are e nt it le d t o d educ t v ari ou s ex pe ns es rep orte d o n the ir S ch edul es C, Pro fitor Los s Fr om

Bu si ne ss , fortax y ears 20 08 an d 2 00 9; (2) whet he r pe ti ti on ers are en ti tl edto de du ctflo wth ro ug h b us in es s l os se s re po rte d b y th ei r S co rp or at io n o n it s Fo rm s 1 12 0S , U.S. Inco m e Tax Return fo r anS Co rp or at io n, fo r ta x years 2 00 8
an d 2 00 9; (3) whet he r pe ti ti on ers rep orte d p ro pe rly the ir g ai n o r lo ss fro m th e sa le of a pi ece o f th ei r pr op erty

inNort h C aro li nafortax y ear 2 00 9; (4) whet he r pe ti ti on ers ha d t ax ab le So ci al Secu rit y in co m e o f $1 an d $ 26 ,43 3 fo r ta x years 20 08 an d 2 00 9, re sp ect iv el y ; (5 ) whe th er p et it io ne rs are l iabl e fo r acc ur acy-rela te d pe na lt ie s und er s ect io n 6 66 2( a) fo r ta x years 2 00 8 a nd20 09 ; an d (6 ) whe th er we- 3 -

[* 3] ha ve juri sd ic ti on to he ar p et it io ne rs ’ cl ai m th atres po nd en t i s l iabl e fo r da m ag es un de r se ct io n 7 43 3. 1 FINDINGS OF FACT So m e o f th e fac ts are s ti pu la te d a ndare s o fo un d. Pet it io ne rs res id edin 2 Virg in iawhen th ey

fil edth e p et it io n. Pet it io ne r hu sb an d wo rk edforExx on Mo bi l Co . for37 y ears . Pet it io ne r hu sb an d i s the so le own er o f anS co rp or at io n, WPL, Inc. WPL ha s a b us in es s o ffi ce i n Vi rg in ia . WPL is en ga ge d i n p etro le um acqui si ti on an d
sa le , m erg er co ns ul ti ng , andva lu at io n. In20 08 an d 2 00 9 p et it io ne r hu sb an d
worke d fu ll ti m e fo r WPL. On av erag e h e worke d app ro xi m at el y 45 ho ur s p er week
. In20 04 pe ti ti on er hus ba ndbo ug hta 79 -acr e p arce l o f pr op erty inNort h Caro li na(North Caro li napro pe rty) for $ 31 0,0 00 . Peti ti on ers co m pl et ed

Pet it io ne rs di d n otco nt es t tha t the y ha d u nr ep orte d ro y al ty inc om e o f $6 4 1 an d $ 24 fortax y ears 20 08 an d 2 00 9, re sp ect iv el y , andun rep orte d i nt eres t i nc om e of $4 9 fo r ta x year 20 09 . Res po nd en t h as co nc ed edth atpe ti ti on ers are en ti tl edto reduc e th e cap it al ga inon th e sa le of api ece o f th ei r pr op erty inNort h C aro li naby $7 ,08 1. Pet it io ne rs att ach eda nu m be r of ex hi bi ts to th ei r res po ns e to m em or an du m 2 of law. Th es e d oc um en ts are n otev id en ce. See Ru le 14 3( c); Sh ep he rdv. Co m m is si on er, 1 15 T.C. 37 6, 3 98 n.2 2 (2 00 0) , aff’d, 2 83 F.3d12 58 (11 th Cir
. 20 02 ); Al le n v . Comm is si on er, T.C. Mem o. 2 00 6- 11 , sl ip op . at 1 1.- 4 -

[* 4] co ns tru ct io n o f a ware ho us e o n p artof t he Nort h C aro li napro pe rty. T he wareh ou se was b ui ltto st or e h op s fo r di strib ut io n t o l oc al craf t b rewer ie s (No rth Caro li naact iv ity ). In 2 00 8 a nd20 09 pe ti ti on er hus ba ndsp en t ap pr ox im at el y 10 to 15 ho ur s p er weekde ve lo pi ng th e North Caro li naact iv ity . He beg anto pl an t se ed s t o g ro w ho ps , bu t wea th er p ro bl em s s ta ll edth ei r gr owt h. He al so be ga n t o cal l l oc al craf

t b rewer ie s t o g au ge th ei r in te res t i n p ur ch as in g h op s. On J ul y 9, 2 00 9, p et it io ne rs so ld1.1 9 a cres of t he Nort h C aro li napro pe rty to Pro sp ectHil l DG, LLC (Dol lar Gen eral ), fo r a p ur ch as e p ric e o f $6 0,0 00 . The pu rch as e p ric e was reduc edby $15 ,00 0 t o h el p Do ll ar Gen eral pa y th e co stof
co ns tru ct in g ro ad s. Pet it io ne rs rece iv eda ch eckfor$4 4,6 88 , th ei r ne t p ro ceed s, at th e cl os in g. Pe ti ti on ers pa idMi ch ael A. Neal & As so cs . $7 ,08 1 fo r a s urve y of t he pr op erty be fo re the sal e to Dol lar Gen eral
. Pet it io ne rs fil edti m el y

th ei r joi ntFo rm s 1 04 0, U.S. In di vi du al Inc om e Tax Return, fo r ta x years 2 00 8 a nd20 09
. On the ir 2 00 8 F orm

10 40 pe ti ti on ers rep orte d $ 18 4 o f ta xabl e in te res t, $ 64 of ord in ary di vi de nd s, an d $ 77 ,49 6 o f Sch edul e C i nc om e an d d educ te d a$2 5,0 45 bu si ne ss lo ss rep orte d o n S ch edul e E, Sup pl em en ta l In co m e an d Lo ss , rel at in g t o W PL. Peti ti on ers rep orte d $ 29 ,48 1 o f So ci al Secu rit y be ne fit s as no nt ax ab le
.- 5 -

[* 5] Pet it io ne rs att ach eda Sch edul e C fo r th e North Caro li naact iv ity . Pet it io ne rs in di cat edon th ei r am en de d S ch edul e C tha t the bu si ne ss us edth e cas h
m etho d o f acc ou nt in g. 3 On the ir 2 00 9 F orm

10 40 pe ti ti on ers rep orte d $ 4,5 06 of S ch edul e C i nc om e, $2 1,5 00 of I RA di st rib ut io ns , and$3 6,2 95 of u ne m pl oym en t i nc om e an d d educ te d a $ 64 ,41 7 b us in es s l os s re po rte d o n S ch edul e E rel at in g t o WPL. Peti ti on ers rep orte d $ 36 ,29 5 o f So ci al Secu rit y be ne fit s as no nt ax ab le . Peti ti on ers att ach eda Sch edul e C fo r th e North Caro li naact iv ity rep orti ng $7 3,8 19 of g ro ss rece ip ts an d $6 9,3 12 of t ot al ex pe ns es . The ex pe ns es co ns is te d o f $1 5,0 00 forco m m is si on s an d fe es , $7 ,48 5 fo r de pr eci at io n, $ 44 2 fo r in su ran ce, $ 42 1 fo r ot he r in te res t, $7 ,08 2 fo r le ga l an d p ro fes si on al servi ces , $1 2 fo r rep ai rs , $2 ,06 0 fo r supp li es , $1 ,62 9 fo r ta xe s an d l ic en se s, $ 2,2 14 forut il it ie s, $ 30 ,67 3 fo r “ ot he r” ex pe ns es , an d $ 2,2 95 forex pe ns es forbu si ne ss us e o f pe ti ti on ers ’ ho m e. Of th e “ ot he r”
ex pe ns es , $3 0,0 00 was a ttrib ut ab le to a “ lo ss on th e sa le of a ss et s” . This “ lo ss on th e sa le of a ss et s” rel at edto pe ti ti on er’s s al e o f 1.1 9 a cres of t he Nort h C aro li na pr op erty to Dol lar Gen eral
. W PL fil edti m el y

Fo rm s 1 12 0S fortax y ears 20 08 an d 2 00 9. Onit s 2 00 8 Fo rm 11 20 S W PL rep orte d a n o rd in ary bu si ne ss lo ss of $ 25 ,04 5 re su lt in g fr om Pet it io ne rs ’ or ig in al 20 08 Sch edul e C i s n otpa rt o f th e rec or d. 3- 6 -

[* 6] $2 14 ,95 2 o f rep orte d i nc om e an d $ 23 9,9 97 of c la im edde du ct io ns . The de du ct io ns in cl ud ed$3 6,6 21 for wage s, $ 14 ,33 4 fo r ba d d eb ts , $5 ,67 0 fo r ren ts , $1 ,23 6 fo r in te res t, $ 80 3 fo r adve rti si ng , $5 ,83 2 fo r em pl oyee be ne fitpro gr am s, an d $ 17 5,5 01 forothe r de du ct io ns . On it s 2 00 9 F orm 11 20 S W PL rep orte d a n or di na ry bu si ne ss lo ss of $ 64 ,41 7 re su lt in g fr om $1 59 ,14 8 o f rep orte d i nc om e an d $2 23 ,56 5 o f cl ai m edde du ct io ns . The d educ ti on s i nc lu de d $ 36 ,16 6 fo r wag es , $3 1,4 11 forba d d eb ts , $5 ,94 0 fo r ren ts , and$1 50 ,04 9 fo r ot he r de du ct io ns . On it s Fo rm s 1 12 0S WPL in di cat edth atpe ti ti on er h us ba nd ’s pro rat a sh ares of WPL’ s or di na ry bu si ne ss lo ss es for20 08 an d 2 00 9 wer e $ 25 ,04 5 and$6 4,4 17 , res pe ct iv el y , andpe ti ti on ers cla im edlo ss de du ct io ns forth es e am ount s o n the ir in di vi du al in co m e ta x re tu rn s fo r 20 08 an d 2 00 9. Onit s 2 00 9 F orm 11 20 S W PL in di cat edth atitus es th e cas h m etho d o f acc ount in g. On J anua ry

9, 2 01 3, re sp on de ntis su edpe ti ti on ers a no ti ce o f de fic ie nc y for ta x years 2 00 8 a nd20 09
. OPINION I. Bu rd enof P ro of Gen eral ly, th e Co m

m is si on er’s d et erm in at io ns ina no ti ce o f de fic ie nc y are pr es um edco rrec t, an d the tax pa y er b ears th e b ur de n o f pr ov in g tha t tho se de te rm in at io ns are erro ne ou s. Ru le 14 2( a)(1 ); Welc h v . Helv eri ng , 29 0 U.S. 1 11 ,- 7 -

[* 7] 11 5 (1 93 3) . Und er s ect io n 7 49 1( a), i n c ert ai n c irc um st an ces , th e b ur de n o f pr oo f m ay

sh iftfro m

th e ta xp ay er t o the Co m

mis si on er. Pet it io ne rs ha ve no t cl ai m edor s ho wn tha t the y m eetth e sp eci fic at io ns of s ect io n 7 49 1( a) t o s hi ft t he bu rd enof p ro of

to res po nd en t as to an y

rel ev an t fa ctua l i ss ue . Deduc ti on s ar e a m at te r of leg is la ti ve gra ce, an d atax pa y er m us t p ro ve hi s orhe r en ti tl em en t t o ade du ct io n. INDOPCO, In c. v. Co m m is si on er, 5 03 U.S. 79 , 84 (19 92 ); Ne w Col on ia l Ic e Co . v. Hel ve rin g, 2 92 U.S. 43 5, 4 40 (19 34 ). II. Sch edul e C fo r NorthCaro li naActi vi ty Sect io n 1 62 pe rm it s a t ax pa y er t o d educ t o rd in ary an d n eces sa ry ex pe ns es pa idor i nc urreddurin g the tax ab le y ear i n c arrying on a tr ad e o r bu si ne ss . For a ta xp ay er t o d educ t ex pe ns es un de r se ct io n 1 62 (a), the ex pe ns es m us t re la te to a tra de or b us in es s fu nc ti on in g a t the ti m e th e ex pe ns es are i nc urred . Hardy v. Co m m is si on er, 9 3 T.C. 6 84 , 68 7 (1 98 9) , aff’d i n p art , rem an de d i n p art , 19 90 U.S. App . LEXIS 19 67 0 (1 0t h C ir. Oct . 29 , 19 90 ); Gl ot ov v. Co m m is si on er, T.C. Mem o. 2 00 7- 14 7, s li p o p. at5. A ta xp ay er i s n otcarry in g o n atra de or b us in es s un de r se ct io n 1 62 (a) u nt il th e b us in es s i s fu nc ti on in g a s a g oi ng co nc ernan d pe rfo rm in g the act iv it ie s fo r whi chitwas o rg an iz ed . Rich m on d Tel ev is io n C or p. v. Un it edSta te s, 3 45 F.2d90 1, 9 07 (4t h C ir. 1 96 5) , vac at edan d re m an de d o n ot he r gr ou nd s, 3 82 U.S. 68 (19 65 ); Gl ot ov v. Co m m is si on er, s li p o p. at5.- 8 -

[* 8] Carry in g o n atra de or b us in es s re qu ire s a s ho win g o f m or e th anin it ia l
res earc h i nt o o r in ve st ig at io n o f bu si ne ss po te nt ia l. Dean v. Co m m is si on er, 5 6 T.C. 89 5, 9 02 (19 71 ); Gl ot ov v. Co m m is si on er, s li p o p. at5. Bu si ne ss op erat io ns m us t h av e actua ll y

co m m en ced . Glo to v v . Commis si on er, s li p o p. at5; McKel ve y v. Co m m is si on er, T.C. Mem o. 2 00 2- 63 , aff’d, 7 6 F ed . App x. 8 06 (9t h C ir. 2 00 3)
. Pet it io ne rs ha ve th e b ur de n o f pr ov in g the y be gan o pe rat in g the Nort h C aro li na act iv ity in20 08 . See Ru le 14 2( a); Glo to v v . Comm is si on er, s li p o p. at5. Res po nd en t d is al lo wedpe ti ti on ers ’ Sch edul e C ex pe ns e d educ ti on s fo r 20 08 an d 2 00 9. Pe ti ti on ers co nt en d tha t the y op erat eda bu si ne ss . Peti ti on ers ha ve fai le d t o p ro ve th atth ey be ga n o pe rat in g the North C aro li naact iv ity in20 08
or20 09 . Peti ti on er h us ba ndtes ti fie d tha t h e d idpl an t s eed s t o g ro w ho ps , bu t weathe r pr ob le m s s ta ll edth ei r gr owt h. He al so be ga n t o c al l l oc al craf t b rewer ie s to gaug e th ei r in te res t i n p ur ch as in g h op s. Pet it io ne rs di d n otpro vi de an y ev id en ce tha t the y

were s uc ces sf

ul inha rv es ti ng or s el li ng an y ho ps in20 08 or 20 09 . The o nl y

in co m e fro m

th e NorthCaro li naact iv ity was the sal e o f th e p arce l of lan d t o Do ll ar Gen eral . W e fi ndth atth e North Caro li naact iv ity was n ot func ti on in g a s a g oi ng co nc ernin20 08 or 2 00 9. Se e Mc Kelv ey v. Co m m is si on er, T.C. Mem o. 2 00 2- 63
.- 9 -

[* 9] To b e en ga ge d i n atra de or b us in es s wi th in th e m ean in g o f se ct io n 1 62 (a),
anin di vi du al tax pa y er m

us t b e in vo lv edinth e act iv ity with c on ti nu ity , reg ul ari ty, an d the pri m ary pu rp os e o f de riv in g apro fit . Comm is si on er v . Groe tz in ge r, 48 0 U.S. 23 , 35 (19 87 ). In C al va o v . Comm is si on er, T.C. Mem o. 2 00 7- 57 , th e ta xp ay er cl ai m edde du ct io ns on hi s Sc he du le C rel at edto hi s g am bl in g a ct iv ity , an d h e worke d app ro xi m at el y 20 to 25 ho ur s p er weekpro vi di ng co ns ul ti ng se rv ic es to hi s wh ol ly owne d S co rp or at io n. Hi s p rimary in co m e cam e fro m

hi s sa lary an d p as sthr ou ghin co m e fro m th e S co rp or at io n, an d h e d idno t d ep en d o n hi s g am bl in g a ct iv it ie s fo r hi s l iv el ih oo d. Id ., sl ip op . at 9 . W e h el d tha t the se fact s wei gh edag ai ns t fi nd in g tha t the tax pa y er’s act iv it ie s wer e su ffi ci en tl y co nt in uo us an d re gu lar to be co ns id ereda tr ad e o r bu si ne ss . Id. at10
. Pet it io ne rs fai le d t o s ho w th atth ey co nduc te d the Nort h C aro li naact iv ity with s uf fic ie ntco nt inui ty andreg ul ari ty. In 2 00 8 a nd20 09 pe ti ti on er h us ba nd
worke d fu ll ti m e fo r WPL. On av erag e h e worke d app ro xi m at el y 45 ho ur s p er week . Peti ti on ers rece iv edin co m e fro m WPL. Peti ti on er h us ba ndsp en t ap pr ox im at el y

10 to 15 ho ur s p er weekde ve lo pi ng th e North Caro li naact iv ity . W ei gh in g the fact s as we di d i n C al va o, we fi ndth atth e North Caro li naact iv ity was no t a t rad e o r bu si ne ss withi n the m ean in g o f se ct io n 1 62 (a). As a res ul t,- 10 -

[* 10 ] pe ti ti on ers are n oten ti tl edto de du ctth e expe ns es th atth ey rep orte d o n the ir Sch edul es C fo r th ei r North Caro li naact iv ity . Altho ug h p et it io ne rs are n oten ti tl edto de du ctSch edul e C ex pe ns es for th ei r North Caro li naact iv ity , res po nd en t d et erm in edth atth ey are en ti tl edto de du ctso m e o f th es e ex pe ns es as p ers on al ex pe ns es rel at edto anin ve stm en t act iv ity on th ei r Sch edul es A, Item iz edDedu ct io ns . Res po nd en t al lo wed 4 pe ti ti on ers $3 2,7 32 an d $ 21 ,94 4 a s “ m is cel lane ou s d educ ti on s” fortax y ears 20 08
an d 2 00 9, re sp ect iv el y . W e su st ai n re sp on de nt ’s det erm in at io n. III. W PL Gen eral ly, anS co rp or at io n s ha reh ol de r de te rm in es hi s o r he r ta x l iabi li ty by tak in g i nt o a cco un t a p ro rat a sh are o f th e S co rp or at io n’s i nc om e, lo ss es , de du ct io ns , andcred it s. Sec . 13 66 (a)( 1) . Whe re a n ot ic e o f de fic ie nc y in cl ud es ad jus tm en ts forS co rp or at io n i te m s wi th othe r it em s, we h av e juri sd ic ti on to de te rm in e th e co rrec tn es s o f al l ad jus tm en ts . See Wint er v . Comm is si on er, 1 35 T.C. 23 8 (2 01 0) . W e m

us t d et erm in e whe th er WPL pro pe rly clai m edit s de du ct io ns for20 08 an d 2 00 9 b efo re we ca n d et erm in e whe th er p et it io ne rs are en ti tl edto de du ctflo wth ro ug h b us in es s l os se s fr om WPL fo r 20 08 an d 2 00 9.
Pet it io ne rs subm itte d a n a m en de d S ch edul e C fo r 20 08 th atin cl ud ed 4 ex pe ns es .- 11 -

[* 11 ] Res po nd en t d is al lo wedva rio us de du ct io ns th atWPL cla im edon it s 2 00 8
an d 2 00 9 F orm s 1 12 0S . As a res ul t, re sp on de ntdi sa ll owe d the co rres po nd in g flo w th ro ug h b us in es s l os s d educ ti on s tha t p et it io ne rs cla im edon th ei r 20 08 an d 20 09 Fo rm s 1 04 0. A. BadDebt s W PL cla im edde du ct io ns for$1 4,3 34 an d $ 31 ,41 1 o f ba d d eb ts for20 08
an d 2 00 9, re sp ect iv el y . Sect io n 1 66 all ows a de du ct io n fo r de bt s tha t b eco m e who ll y or p art ia ll y

wort hl es s dur in g the tax ab le y ear. Th e d eb t m us t ar is e fro m

a de bt or -cre di to r rel at io ns hi p. Se e Dix ie Dair ie s C or p. v . Comm is si on er, 7 4 T.C. 47 6, 4 93 (19 80 ); s ec. 1 .16 6- 1( c), In co m e Tax Reg s. Inad di ti on , “ [w]orthl es s de bt s ar is in g fr om

unpa idwage s, s al ari es , fees , ren ts , andsi m il ar i te m s o f ta xabl e in co m e sh al l n otbe all owe d a s a d educ ti on un de r se ct io n 1 66 un le ss th e in co m e su chit em s re pr es en t h as be enin cl ud edinth e return o f in co m e fo r th e y ear f or whi chth e d educ ti on as aba d d eb t i s cl ai m edor f ora pr io r ta xabl e y ear.” Sec. 1.1 66 -1 (e), In co m e Tax Reg s.; see als o Gertz v. Co m m is si on er, 6 4 T.C. 5 98 , 60 0 (1 97 5) ; Sc hn el l v . Comm is si on er, T.C. Mem o. 2 00 6- 14 7, s li p o p. at4-5
. Pet it io ne r hu sb an d t es ti fie d tha t i n 2 00 8 a nd20 09 WPL to okon “ so m e h ig h ris k b us in es s” . WPL was n otpa idforall of t he workth atitpe rfo rm ed . WPL di d
no t i nc lu de init s i nc om e th e fee s fo r se rv ic es th atrem ai ne d u np ai d b ecau se itus ed- 12 -

[* 12 ] th e cas h m etho d o f acc ount in g. We su st ai n re sp on de nt ’s di sa ll owa nc e o f th e de du ct io ns forba d d eb ts . B. Em pl oyee Ben efi ts W PL cla im edde du ct io ns forhe al th in suran ce b en efi ts pa idonbe ha lf o f pe ti ti on er h us ba ndfor20 08 an d 2 00 9. Se ct io n 1 37 2 p ro vi de s tha t, fo r pu rp os es of ap pl y in g the in co m e ta x p ro vi si on s o f th e Co de rel at in g t o e m pl oyee fri ng e be ne fit s, an S co rp or at io n s ha ll be tre at edas apa rtn ers hi p a ndan y pe rs on who is a

“ 2- pe rcen t s ha reh ol de r” o f th e S co rp or at io n s ha ll be tre at edas apartn er o f a pa rtn ers hi p. Se e Hur stv. Co m m is si on er, 1 24 T.C. 16 , 35 (20 05 ); s ee al so Rev . Ru l. 9 1- 26 , 19 91 -1 C.B. 1 84 . Sect io n 1 37 2( b) de fin es a “ 2- pe rcen t s ha reh ol de r”
as an y pe rs on who own s (o r is co ns id eredas o wni ng withi n the m ean in g o f se ct io n 31 8) onan y

da y du rin g the tax ab le y ear o f th e S co rp or at io n (1 ) m or e th an2% o f th e o ut st an di ng st oc k o f th e co rp or at io n o r (2 ) st oc k h av in g m or e th an2% o f th e to ta l co m bi ne d v ot in g p owe r of

all st oc k i n the co rp or at io n. Se e al so Rev . Rul
. 91 -2 6, 1 99 1- 1 C .B. at 1 85
. Rev . Rul . 91 -2 6, 1 99 1- 1 C .B. at 1 85 -1 86 , pro vi de s: Em pl oyee fri ng e b en efi ts pa idor f urni sh edby an S co rp or at io n t o o r fo r th e b en efi t o f it s 2 -p erce ntsh areh ol de r-em pl oyees i n co ns id erat io n fo r se rv ic es ren de red , th eref or e, are t reat edforin co m e ta x p ur po se s l ik e p artne rs hi p g ua ran te edpa ym en ts un de r se ct io n 70 7( c). An S co rp or at io n i s en ti tl edto de du ctth e co stof s uc h- 13 -

[* 13 ] em pl oyee fri ng e b en efi ts un de r se ct io n 1 62 (a) i f th e requi rem en ts of t ha t s ect io n a re s at is fie d (t ak in g i nt o a cco un t the ru le s o f se ct io n 2 63 ). Lik e a p artne r, a 2 -p erce ntsh areh ol de r is requi redto in cl ud e th e v al ue of s uc h b en efi ts ingro ss in co m e und er se ct io n 6 1( a) an d i s n oten ti tl edto ex cl ud e su chbe ne fit s fr om gro ss in co m e und er p ro vi si on s o f th e Co de pe rm it ti ng th e ex cl us io n o f em pl oyee fri ng e b en efi ts (ex cep t t o the ex te ntth e Co de pro vi si on al lo win g e xc lu si on of afri ng e b en efi t s pe ci fic al ly pro vi de s tha t i t ap pl ie s t o p artne rs ). W PL cla im edde du ct io ns forhe al th in suran ce b en efi ts pa idonbe ha lf o f pe ti ti on er h us ba ndfor20 08 an d 2 00 9. WPL is en ti tl edto de du ct io ns forth os e be ne fit s. Pet it io ne rs m

us t i nc lu de th e v al ue of t ho se be ne fit s i n the ir g ro ss in co m e fo r 20 08 an d 2 00 9. Th e p art ie s s ho ul d c on si de r th e ap pl ic at io n o f se ct io n 1 62 (l) in th ei r Ru le 15 5 c om

pu ta ti on s. If the requi rem en ts of s ect io n 1 62 (l) are m et , pe ti ti on ers m ay

de du ctth e co stof t he pre m iu m s t o the ex te ntpro vi de d b y sec ti on 16 2( l). C. Veh ic le Exp en se s Tax pa y ers are re qu ire d t o s ub st an ti at e ex pe ns es un de rlyin g e ach cla im ed de du ct io n b y

m ai nt ai ni ng reco rd s s uf

fic ie ntto est ab li sh th e am ountof t he de du ct io n a ndto en ab le th e Co m m is si on er t o d et erm in e th e co rrec t t ax li ab il ity . Sec. 6 00 1; Hig be e v . Comm is si on er, 1 16 T.C. 43 8, 4 40 (20 01 ). Cert ai n e xp en se s sp eci fie d i n s ect io n 2 74 , su chas v eh ic le ex pe ns es , are s ub ject t o s tri ct subs tant ia ti on rul es . Secs . 27 4( d) (4 ), 28 0F (d )(4 )(A)(i ).- 14 -

[* 14 ] To m eetth es e st ric t s ub st an ti at io n ru le s, a t ax pa y er m us t s ub st an ti at e b y ad equa te reco rd s o r by su ffi ci en t ev id en ce co rro bo rat in g the tax pay er’s o wn st at em en t (1 ) th e am ou nt , (2) th e ti m e an d p la ce o f th e tr av el or u se , and(3) th e bu si ne ss pu rp os e. Sec. 2 74 (d ). To s ub st an ti at e b y ad equa te reco rd s, the tax pa y er m us t p ro vi de (1) anacco un t b oo k, a l og , or asi m il ar re co rdan d (2 ) do cu m en tary ev id en ce, wh ic h t og ethe r are su ffi ci en t t o e st ab li sh each ele m en t o f an
ex pe nd itur e. Sec. 1 .27 4- 5T(c )(2 )(i ), Tem po rary Inco m e Tax Reg s., 5 0 F ed . Reg . 46 01 7 (No v. 6 , 19 85 ). Docu m en tary ev id en ce i nc lu de s re cei pt s, p ai d b il ls , or si mil ar ev id en ce. Sec . 1.2 74 -5 (c)( 2) (ii i), In co m e Tax Reg s. W PL cla im edde du ct io ns forex pe ns es rel at in g t o thr ee v eh ic le s fo r 20 08
an d 2 00 9. WPL fail edto pro vi de anacco un t b oo k, a l og , a si m il ar re co rd , or o th er su ffi ci en t ev id en ce t o s ub st an ti at e th e rep orte d v eh ic le ex pe ns es . WPL fai le d t o m eetth e st ric t s ub st an ti at io n re qu ire m en ts of s ect io n 2 74 (d ) with re sp ectto th e car an d tru ckex pe ns es . W e su st ai n re sp on de nt ’s di sa ll owa nc e o f th e d educ ti on s fo r th e v eh ic le ex pe ns es . D. Cl ub an d As so ci at io n Du es W PL cla im edde du ct io ns of $ 2,0 88 for20 08 an d 2 00 9 fo r pe ti ti on ers ’
m em be rs hi p a t the Sp ot swo odCo un try Club. Se ct io n 2 74 (a)( 3) pro vi de s “ no de du ct io n s ha ll be all owe d u nd er thi s ch ap te r fo r am ou nt s p ai d o r in cu rredfor- 15 -

[* 15 ] m em

be rs hi p i n a ny club o rg an iz edfor bu si ne ss , pl eas ur e, recr eat io n, o r ot he r so ci al pu rp os e.” Cl ub s o rg an iz edforbu si ne ss , pl eas ur e, recr eat io n, o r ot he r so ci al pu rp os e “ in cl ud e, bu t ar e n otli m it edto , cou nt ry clubs , go lf andath le ti c cl ub s, ai rli ne clubs , ho te l cl ub s, an d c lubs op erat edto pro vi de m eal s u nd er ci rcu m st an ces ge ne ral ly con si de redto be co nduc iv e to bu si ne ss di sc us si on .” Sec. 1.2 74 -2 (a)( ii i)( a), In co m e Tax Reg s. We hav e h el d tha t the se pro vi si on s p ro vi de
anou tri gh t b anon an y

de du ct io n fo r cl ub m em

be rs hi p due s. Dei hl v. Co m m is si on er, T.C. Mem o. 2 00 5- 28 7, s li p o p. at41 -4 2. We su st ai n re sp on de nt ’s di sa ll owa nc e o f th e d educ ti on s fo r m em be rs hi p due s. E. Mi sc el lane ou s Ex pe ns es W PL cla im edde du ct io ns form is cel lane ou s ex pe ns es of $ 11 ,89 6 and$7 ,58 0 fo r 20 08 an d 2 00 9, re sp ect iv el y . WPL di d n otpro vi de an y ex pl an at io n o f th e ex pe ns es or d oc um en ta ti on to subs tant iate th e ex pe ns es . W e su st ai n re sp on de nt ’s di sa ll owa nc e o f th e d educ ti on s fo r m is cel lane ou s ex pe ns es . IV. Cap it al Gain Sect io n 1 00 1( a) p ro vi de s tha t “ [t]he ga infro m th e sa le or o th er d is po si ti on of pro pe rty sh al l b e th e ex ces s o f th e am ou ntreal iz edth eref ro m ov er the ad

jus te d ba si s p ro vi de d i n s ect io n 1 01 1 fo r de te rm in in g g ai n” . Sect io n 1 00 1( b) pro vi de s th at“ am ou ntreal iz edfro m th e sa le or o th er d is po si ti on of p ro pe rty sh al l b e th e- 16 -

[* 16 ] su m of a ny m on ey

rece iv edpl us th e fai r m ark etva lu e o f th e p ro pe rty (othe r th anm on ey ) rec ei ve d.” Sect io n 1 01 1( a) p ro vi de s tha t ad jus te d b as is sh al l b e b as is
as de te rm in edun de r se ct io n 1 01 2 o r othe r ap pl ic ab le sec ti on s, ad jus te d a s pr ov id edinsec ti on 10 16 . Sect io n 1 01 2 g en eral ly pro vi de s tha t the “ba si s o f pr op erty sh al l b e th e co stof s uc h p ro pe rty”. Whe n o nl y pa rt o f a p ro pe rty is s ol d,

“ th e co stor o th er b as is of t he en ti re p ro pe rty sh al l b e equi tabl y ap po rti on edam on g th e se ve ral pa rts ”. Sec. 1 .61 -6 (a), In co m e Tax Reg s. Pet it io ne rs rep orte d a$3 0,0 00 cap it al lo ss on th e sa le of p artof t he Nort h Caro li napro pe rty to Do ll ar Gen eral for 20 09 . In the no ti ce o f de fic ie nc y res po nd en t d et erm in edth atpe ti ti on ers ha d a$5 5,8 70 ne t capi ta l g ai n. Re sp on de nt co nc ed es th atpe ti ti on ers ’ cap it al ga in sh ou ldbe reduc edby $7,0 81 , th e co stof a
su rv ey of t he pro pe rty. Pet it io ne rs so ld1.1 9 a cres of t he Nort h C aro li napro pe rty to Do ll ar Gen eral fo r a p ur ch as e p ric e o f $6 0,0 00 . The p ur ch as e p ric e was reduc edby $15 ,00 0 t o pa y forth e co stof r oa d c on stru ct io n. Pe ti ti on ers rece iv eda ch eckfor $4 4,6 88 , th ei r ne t p ro ceed s, atth e cl os in g. Pet it io ne rs pa id$3 10 ,00 0 fo r th e North Caro li napro pe rty. A cco rd in g t o the
se ll er’s s tate m en t, the pl otof l an d tha t p et it io ne rs so ldto Dol lar Gen eral co ns is te d of 1.1 9 a cres . The 1 .19 -acr e p lo t re pr es en ts 1.5 % of t he 79 -acr e North Caro li na- 17 -

[* 17 ] pro pe rty. Peti ti on ers co ns tru ct eda wareh ou se on part o f th e North Caro li na pr op erty , bu t the y

di d n otpro vi de an y

in fo rm at io n re ga rd in g the co stan d l oc at io n of bu il di ng th e wareh ou se . W e su st ai n re sp on de nt ’s con cl us io n tha t the ne t g ai n sh ou ldbe reduc edby $7,0 81
. 5 V. So ci al Secu rit y

Inc om e Sect io n 6 1( a) p ro vi de s tha t “ [e]xce ptas o th erwi se pro vi de d * * * , gro ss in co m e m ean s al l i nc om e fro m what ev er s ource d eri ve d” . See Co m m is si on er v . Glen sh aw Glas s C o., 3 48 U.S. 42 6, 4 29 -4 30 (19 55 ). Sect io n 8 6 p ro vi de s fo r th e ta xabi li ty of So ci al Secu rit y be ne fit s p ur su an t t o a st atut ory

form ul a. If a t ax pa y er’s “ m od ifi edad jus te d g ro ss in co m e” p lu s o ne ha lf o f th e So ci al Secu rit y be ne fit s re cei ve d dur in g the tax ab le y ear e xc eed s the

“ba se am ou nt ”, th ena po rti on of t he tax pa y er’s So ci al Securit y be ne fit s i s in cl ud ib le ingro ss in co m e. Sec. 8 6( a) thr ou gh (d) ; s ee al so McAd am s v . Co m m is si on er, 1 18 T.C. 37 3, 3 75 -3 76 (20 02 ). The “ ba se am ount ” is $3 2,0 00 in th e cas e o f a joi ntreturn. Se c. 86 (c)( 1) (B). Pet it io ne rs rece iv ed$2 9,4 81 an d $ 36 ,29 5 o f So ci al Secu rit y be ne fit s fo r ta x y ears 20 08 an d 2 00 9, re sp ect iv el y . Res po nd en t d et erm in edth at$1 an d $ 26 ,43 3 o f
Howev er, we d o n otun de rs tandres po nd en t’s ca lc ul at io ns to de te rm in e th e 5 ne t g ai n.- 18 -

[* 18 ] pe ti ti on ers ’ So ci al Secu rit y be ne fit s wer e ta xabl e fo r ta x years 2 00 8 a nd 20 09 , res pe ct iv el y . If, aft er Ru le 15 5 c om pu ta ti on s, p et it io ne rs ’ m od ifi edad jus te d gr os s i nc om e p lu s o ne -h al f of th e So ci al Secu rit y

be ne fit s the y

rece iv eddu rin g each of 2 00 8 a nd20 09 ex ceed s $ 32 ,00 0, the n apo rti on of p et it io ne rs ’ So ci al Secu rit y be ne fit s wi ll be in cl ud ab le ingro ss in co m e as pro vi de d i n s ect io n 8 6. We
an ti ci pa te th atth e p reci se am ou ntof S oc ia l Se cu rit y be ne fit s i nc lu dabl e in pe ti ti on ers ’ gr os s i nc om e fo r 20 08 an d 2 00 9 wi ll be asc ert ai ne d b y th e p art ie s i n co nn ect io n wi th Ru le 15 5 c om pu ta ti on s. VI. Pen al ti es Res po nd en t d et erm in edth atpe ti ti on ers are l iabl e fo r anaccu racy-rela te d pe na lty purs uantto sec ti on 66 62 (a) fo r eac h year in is su e. Sect io n 6 66 2( a) im po se s a 2 0% p en al ty on any un de rp aym en t at tri bu tabl e to , am on g o th er thi ng s, ne gl ig en ce o r di sr eg ardof rul es or r eg ul at io ns withi n the m ean in g o f subs ect io n (b )(1 ), oran y

subs tant ia l und ers ta te m en t o f in co m e ta x wi th inth e m ean in g o f
subs ect io n (b )(2 ). Onl y

on e acc ur acy-rela te d p en al ty m ay be ap pl ie d wi th res pe ct to an y gi ve n p orti on of a n u nd erp aym en t, ev enif tha t p orti on is subjec t t o the pe na lty onm or e th anon e o f th e g ro un ds setou t i n s ub se ct io n (b ). Sec. 1 .66 62
- 2( c), In co m e Tax Reg s.- 19 -

[* 19 ] The Co m

m is si on er b ears th e b ur de n o f pr oduc ti on reg ard in g the tax pa y er’s li ab il ity for an y pe na lty . Sec. 7 49 1( c); see als o Hi gb ee v . Commis si on er, 1 16 T.C. at44 6- 44 7. On ce the Co m mis si on er h as m etth is bu rd en , th e ta xp ay er m us t pr ov id e p ers ua si ve ev id en ce tha t the Co m m is si on er’s d et erm in at io n was in co rrec t. See Rul e 1 42 (a); Hig be e v . Comm is si on er, 1 16 T.C. at 4 47
. Res po nd en t ca n m eetth is bu rd enby pro du ci ng ev id en ce tha t the
un de rp aym en t i s at tri bu tabl e to a subs tant ia l u nd ers ta te m en t o f in co m e ta x a s de fin edinsec ti on 66 62 (d )(1 )(A). See Jan is v. Co m m is si on er, T.C. Mem o. 2 00 4- 11 7, s li p o p. at28 , aff’d, 4 69 F.3d25 6 (2 d C ir. 2 00 6) . The p hr as e “ subs tant ia l
un de rs ta te m en t o f in co m e ta x” m ean s an un de rs tate m en t tha t ex ceed s the gre at er of $5 ,00 0 o r 10 % of t he in co m e ta x re qu ire d t o b e sh own on th e ta x re tu rnfor th e ta xabl e y ear. Se c. 66 62 (d )(1 )(A). Inth e n ot ic e o f de fic ie nc y res po nd en t de te rm in edde fic ie nc ie s o f $1 7,0 08 an d $ 28 ,44 6 fo r 20 08 an d 2 00 9, re sp ect iv el y . The se un de rs ta tm en ts ex ceed$5 ,00 0. If t he Ru le 15 5 c om pu ta ti on s co nf

irm a subs tant ia l u nd ers ta te m en t, p et it io ne rs are l iabl e fo r th e se ct io n 6 66 2( a) ac cu racyrel at edpe na lty . See Co op er v . Comm is si on er, 1 43 T.C. __ , __(sl ip op . at 4 4) (Sep t. 2 3, 2 01 4)
. The accu racy-rela te d p en al ty doe s n otap pl y with re sp ectto an y

po rti on of
anun de rp aym en t fo r whi chitis sh own th atth e ta xp ay er h adreas on ab le cau se an d- 20 -

[* 20 ] act edingo odfai th . Sec. 6 66 4( c)(1 ). Pet it io ne rs di d n otco nt en d tha t the y ha d re as on ab le cau se forth ei r fai lu re t o re po rt t he ir i nc om e p ro pe rly andsupp ort th ei r cl ai m edde du ct io ns . W e h ol d tha t fo r eac h year inis su e p et it io ne rs are l iabl e fo r th e p en al ty for
anun de rp aym en t at tri bu tabl e to a subs tant ia l und ers ta te m en t o f in co m e ta x u nd er se ct io n 6 66 2( a) an d (b )(2 ). W e n eedno t ad dr es s the ap pl ic ab il ity of t he pe na lty on th e g ro un ds of n eg li ge nc e o r di sr eg ardof rul es or r eg ul at io ns withi n the
m ean in g o f se ct io n 6 66 2( b) (1 ) fo r ta x years 2 00 8 and20 09 . See s ec. 1 .66 62 -2 (c), In co m e Tax Reg s. VII. Sect io n 7 43 3 Dam ag es Sh ortl y be fo re tria l p et it io ne rs fil edanam en dm en t t o p et it io n s eek in g $5 0,0 00 inda m ag es fro m res po nd en t u nd er s ect io n 7 43 3. Attri al res po nd en t fi le d
anan swe r to pe ti ti on ers ’ am en dm en t t o p et it io n. Se ct io n 7 43 3( a) p ro vi de s tha t a ta xp ay er m ay

bri ng a ci vi l ac ti on forda m ag es ag ai ns t the Uni te d S tate s fo r in te nt io na l, re ck le ss , or n eg li ge ntdi sr eg ardof a ny pro vi si on of t he Co de or a ny reg ul at io n p ro m

ul ga te d u nd er the Co de by any off ic er o r em

pl oyee of th e In te rn al Rev enue Serv ic e in co nn ect io n wi th an y co ll ect io n o f Fed eral tax . Sect io n 74 33 (a) fu rth er p ro vi de s tha t the tax pa y er m us t b rin g the civ il act io n i n aDis tri ct Co urt o f th e Uni te d S ta te s an d tha t (e xc ep t as pro vi de d i n s ect io n 7 43 2) th e ci vi l- 21 -

[* 21 ] act io n i n Di st ric t Co urt “ sh al l b e th e ex cl us iv e rem edy for reco ve rin g da m ag es res ul ti ng fro m

su chact io ns .” W e la ckjuri sd ic ti on to he ar p et it io ne rs ’
se ct io n 7 43 3 c la im . See, e.g ., Peti to v. Co m m is si on er, T.C. Mem o. 2 00 2- 27 1. Any con te nt io ns we ha ve no t ad dr es se d a re i rrel ev an t, m oo t, o r m eri tl es s. To re fle ctth e fo reg oi ng , Deci si on wil l b e en te redun de r Ru le 15 5.