T.C. Memo. 2001-186

UNITED STATES TAX COURT

PAUL E. AND JANE ANNE GLADDEN EMERSON, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 10221-99. Filed July 23, 2001.

Paul E. and Jane Anne Gladden Emerson, pro se.

Joanne B. Minsky, for respondent.

MEMORANDUM OPINION

PAJAK, Special Trial Judge: Respondent determined a 

deficiency in petitioners' Federal income tax in the amount of

$6,046 and a section 6662(a) penalty in the amount of $1,209.20

for the taxable year 1995. Unless otherwise indicated, section

references are to the Internal Revenue Code in effect for the

year in issue, and all Rule references are to the Tax Court Rules

of Practice and Procedure.
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This Court must decide: (1) Whether petitioners

substantiated Schedule A medical expenses of $6,393, Schedule A

interest expenses of $3,165, a net operating loss carryover of

$16,505, Schedule C expenses of $6,260 related to an

attorney/sales consultant activity, Schedule C expenses,

including cost of goods sold, of $3,433 related to an antiques

and jewelry activity, and Schedule C expenses of $26,927 related

to an oil and gas activity; (2) whether petitioners are liable

for self-employment tax on the income from their Schedule C

activities and are entitled to the corresponding deduction; and

(3) whether petitioners are liable for the accuracy-related

penalty. If petitioners' itemized deductions are less than the

standard deduction, petitioners will be entitled to the standard

deduction under section 63(b).

Some of the facts in this case have been stipulated and are

so found. Petitioners resided in Bradenton, Florida, at the time

they filed their petition. 

In 1995, Paul Emerson (petitioner), an attorney, was engaged

in the business of an "Attorney/Sales Consultant" and in the

business of "Sales-Antiques & Jewelry". As an attorney/sales

consultant, petitioner worked with others and anticipated

becoming the general counsel of an Ohio corporation. Petitioner

worked from home. During 1995, Jane Emerson (Mrs. Emerson) was
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not employed outside the home. Petitioners also had an oil/gas

operating interest. 

Respondent contends that petitioners did not provide

adequate substantiation for the disallowed items. Petitioner

presented numerous receipts into evidence. Petitioner also tried

to submit evidence at trial, which we excluded as it was not

presented to respondent within 15 days of trial as required by

our Standing Pre-Trial Order. Schaefer v. Commissioner, T.C.

Memo. 1998-163, affd. in unpublished opinion 188 F.3d 514 (9th

Cir. 1999).

Deductions are strictly a matter of legislative grace. 

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New

Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). 

Taxpayers must substantiate claimed deductions. Hradesky v.

Commissioner, 65 T.C. 87, 89 (1975), affd. per curiam 540 F.2d

821 (5th Cir. 1976). Moreover, taxpayers must keep sufficient

records to establish the amounts of the deductions. Meneguzzo v.

Commissioner, 43 T.C. 824, 831 (1965); sec. 1.6001-1(a), Income

Tax Regs. Generally, except as otherwise provided by section

274(d), when evidence shows that a taxpayer incurred a deductible

expense, but the exact amount cannot be determined, the Court may

approximate the amount bearing heavily if it chooses against the

taxpayer whose inexactitude is of his own making. Cohan v.

Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). The Court,
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however, must have some basis upon which an estimate can be made. 

Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). 

Respondent disallowed $6,393 of petitioners' claimed medical

expenses. Section 213(a) provides that a deduction is allowed

for expenses paid during the taxable year, not compensated for by

insurance or otherwise, for medical care of the taxpayer, his or

her spouse, or a dependent to the extent that such expenses

exceed 7.5 percent of adjusted gross income. The term "medical

care" means amounts paid for the diagnosis, cure, mitigation,

treatment, or prevention of disease, or for the purpose of

affecting any structure or function of the body or for insurance

covering the aforementioned items. Sec. 213(d)(1)(A), (C). 

"Medical care" also includes expenses for medicine and drugs. 

Sec. 1.213-1(a)(1), Income Tax Regs. A deduction is allowable

only to individuals and only with respect to medical expenses

actually paid during the taxable year. Sec. 1.213-1(a)(1),

Income Tax Regs. 

Petitioner testified that he had high blood pressure for

which he took medicine. He spent $81.35 for his prescription

every 90 days. Mrs. Emerson was on five different medications. 

The medicines were for blood pressure, fibromyalgia, and

hormones. At the time of trial, Mrs. Emerson was undergoing

radiation treatments for cancer. 

Petitioner presented canceled checks and credit card

statements for purchases from Phar-Mor, Walgreens, and Park West
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Pharmacy in the amount of $1,255.13. Petitioner testified that

these expenses were for prescriptions. He admitted that it was

possible that some of these amounts were for items other than

prescriptions.

Petitioner presented canceled checks made out to Golden Rule

Insurance in the amount of $5,473.37 and Liberty Fund Inc. in the

amount of $40.50 The checks made out to Golden Rule Insurance

were paid quarterly. Petitioner testified that they were for

health insurance. Petitioner was not sure whether Liberty Fund

Inc. was for health insurance. Petitioner also presented checks

in the amount of $343 made out to doctors and medical

laboratories.

 It is clear that petitioners incurred medical expenses. 

Under the Cohan doctrine, we estimate the allowable amounts of

expenses as follows. We allow $880 for prescription expenses,

all of the insurance payments to Golden Rule Insurance of

$5,473.37, and all of the doctor and medical laboratory expenses

of $343, for a total of $6,696.37, which is more than the $6,393

petitioners claimed on their return. This deduction is subject

to a floor of 7.5 percent of adjusted gross income.

Respondent disallowed $3,165 of interest expense. A

deduction for interest paid on indebtedness during the year is

generally allowed under section 163(a). However, section

163(h)(1) provides that no deduction is allowed for personal

interest. "Personal interest" does not include any "qualified
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residence interest". Sec. 163(h)(2)(D). "Qualified residence

interest" means interest which is paid during the year on

acquisition indebtedness or home equity indebtedness with respect

to any qualified residence of the taxpayer. Sec. 163(h)(3)(A). 

A "qualified residence" may be the principal residence of the

taxpayer. Sec. 163(h)(5)(A)(i)(I).

In this case, petitioners had a mortgage on the home they

lived in. Petitioners paid "interest payments" on their 

mortgage to "Retirement Account Inc., F.O.B. Allen S. Lewis IRA"

(Allen Lewis). During 1995, petitioners wrote 11 checks which

were written out to or referenced Allen Lewis and totaled

$16,425. Petitioners also had a mortgage on their home with West

Coast Bank. During 1995, petitioners wrote 32 checks for the

"interest payments" to West Coast Bank in the total amount of

$21,698.71. Petitioners claimed $3,165 of mortgage interest

expense on their 1995 return, which petitioner prepared himself. 

On their 1994 return, petitioners claimed $8,450 of mortgage

interest expense. Petitioners’ 1994 return was prepared by an

accountant. While we believe that petitioners' payments did not

consist solely of interest expense, we find that a portion of

these payments must have been for mortgage interest on their

home. Although the interest portion of the payments probably was

higher than the amount claimed on the 1995 return, petitioners

did not provide sufficient evidence of the amount which was
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interest. We allow petitioners to deduct only the $3,165 of

mortgage interest expense that they claimed on their 1995 return. 

On their 1995 return, under "Other income", petitioners

included $16,505 as negative income for a net operating loss

carryover. Under section 172(b), a net operating loss may be

carried back to the 3 preceding taxable years and thereafter

carried forward to the next 15 taxable years. Petitioner did not

provide any evidence, other than the 1994 return, to support the

claimed net operating loss carryforward. The fact that a return

is signed under penalty of perjury is not sufficient to

substantiate deductions claimed on the return. Wilkinson v.

Commissioner, 71 T.C. 633, 639 (1979). We find the evidence

insufficient. Accordingly, we uphold respondent's disallowance

of the net operating loss in full.

In regards to petitioners' Schedule C activities, petitioner

presented canceled checks and credit card statements for amounts

paid for: telephone services; office supplies; an accountant's

services for preparing taxes; professional dues and fees; postal

service; a computer rental; insurance on the home; electric

service in the home; travel expenses such as out-of-town motels,

restaurants, and gas; truck rental; and auto maintenance. 

Petitioner testified that he conducted his legal services, the

antiques business, and the oil and gas activities out of 700

square feet of his home. Petitioner testified that the above

expenses were for his businesses, but with the exception of the
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travel expenses, petitioner did not state to which Schedule C

business the receipts for the expenses related.

We believe that some of these expenses were personal

expenses. Moreover, petitioner did not adequately substantiate

his travel, car and truck, and computer expenses under the strict

requirements of section 274(d). Travel, car and truck, and

computer expenses cannot be estimated under Cohan. Sanford v.

Commissioner, 50 T.C. 823, 827-828 (1968), affd. per curiam 412

F.2d 201 (2d Cir. 1969). Based on the record, we allow

petitioners to claim $2,000 of expenses on the Attorney/Sales

Consultant Schedule C, $1,000 of cost of goods sold and $100 of

expenses on the Sales-Antiques & Jewelry Schedule C, and $12,000

of expenses on the Oil/Gas Operating Interest Schedule C. 

Section 1401 imposes a tax upon a taxpayer's self-employment

income. Self-employment income includes the net earnings from

self-employment derived by an individual during the taxable year. 

Sec. 1402(b). Net earnings from self-employment consist of gross

income derived by an individual from any trade or business

carried on by such individual, less the allowable deductions that

are attributable to such trade or business, plus certain items

not relevant here. Sec. 1402(a). A deduction for one half of

the self-employment tax is allowed under section 164(f). We find

that petitioners are liable for self-employment tax on the income

earned from the Schedule C businesses and are entitled to the

corresponding deduction.
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Respondent contends that petitioners are liable for the

accuracy-related penalty under section 6662(a). Section 6662(a)

provides for an accuracy-related penalty in the amount of 20

percent of the portion of an underpayment of tax attributable to,

among other things, negligence or disregard of rules or

regulations. Sec. 6662(a) and (b)(1). Negligence is defined to

include any failure to make a reasonable attempt to comply with

the provisions of the Internal Revenue laws. Sec. 6662(c); sec.

1.6662-3(b)(1), Income Tax Regs. Moreover, negligence is the

failure to exercise due care or the failure to do what a

reasonable and prudent person would do under the circumstances. 

Neely v. Commissioner, 85 T.C. 934, 947 (1985). Disregard is

defined to include any careless, reckless, or intentional

disregard of rules or regulations. Sec. 6662(c); sec. 1.6662-

3(b)(2), Income Tax Regs. Petitioners presented no evidence

regarding the accuracy-related penalty. They failed to keep

adequate records as required by section 6001. We find that

petitioners are liable for the accuracy-related penalty which

must be recalculated under Rule 155.

To the extent that we have not addressed any of the parties'

arguments, we have considered them and find them to be without

merit. 

Decision will be entered

under Rule 155.