T.C. Memo. 2011-4

UNITED STATES TAX COURT

ERNESTINE FORREST, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 24971-08. Filed January 4, 2011.

R determined a deficiency in P’s income tax for the

2005 tax year based on P’s unreported dividend income and a

disallowed deduction for an IRA contribution. In an amended

answer, R increased the determined deficiency by disallowing

an income tax withholding credit of $20,060.89 and Schedule

C business expense deductions of $29,942.74 for the 2005 tax

year.

Held: This Court does not have jurisdiction to decide

the withholding credit issue. P is liable for the

deficiency arising from the disallowed Schedule C business

expense deductions. 

Ernestine Forrest, pro se.

Michael K. Park, for respondent.
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MEMORANDUM FINDINGS OF FACT AND OPINION

WHERRY, Judge: This case is before the Court on a petition

for redetermination of a Federal income tax deficiency that

respondent determined for petitioner’s 2005 tax year. After

concessions by petitioner,1 the issues left for decision are: 

(1) Whether petitioner is entitled to a Federal income tax

withholding credit of $20,060.89 for the 2005 tax year; 

(2) whether petitioner is entitled to business expense

deductions claimed on Schedule C, Profit or Loss from Business,

of $29,942.74 for the 2005 tax year;2 and

(3) whether petitioner is entitled to a deduction under

section 1341 for amounts subtracted from her pension

distributions during the 2005 tax year.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated

facts and the accompanying exhibits are hereby incorporated by

this reference. At the time she filed her petition, petitioner

resided in California.

1Petitioner conceded receiving unreported dividend income of

$90 for the 2005 tax year and that she is not entitled to an IRA

contribution deduction of $4,500 for the 2005 tax year, which

entirely disposes of the original issues in the notice of

deficiency.

2Unless otherwise indicated, all section references are to

the Internal Revenue Code, as amended and in effect for the year

at issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure. 
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Respondent issued a notice of deficiency on July 7, 2008,

determining an income tax deficiency for petitioner’s 2005 tax

year of $459. Petitioner filed a timely petition with the Court

on October 14, 2008, alleging a “substantial deduction which will

wipe out the alleged deficiency”. By an amendment to the answer,

served on petitioner by respondent on April 29, 2009, respondent

disallowed a withholding tax credit of $20,060.89 and Schedule C

deductions of $29,942.74. 

The State of California withheld $20,060.89 for Federal

income tax from a termination of employment lawsuit settlement it

made with and paid to petitioner. It also issued to petitioner a

Form W-2, Wage and Tax Statement, for 2005 reflecting the

withheld tax of $20,060.89 and the $172,071 settlement payment. 

Petitioner claimed a credit for the $20,060.89 of allegedly

withheld tax on her 2005 Federal income tax return. She did not,

however, include any of the $172,071 payment in her taxable

income shown on her 2005 Federal income tax return.

Respondent’s examining agent initially sought to tax the

$172,071 settlement payment by increasing petitioner’s 2005

Federal taxable income by that amount. Although the evidentiary

record is sparse, it is apparent from each party’s statements in

Court and filed documents that petitioner eventually convinced

respondent that, notwithstanding the Form W-2, she did not

actually receive the $172,071 until 2006. Therefore respondent
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did not, at the conclusion of the examination, seek to increase

petitioner’s 2005 Federal taxable income by the $172,071 amount

of the settlement payment.

Respondemt’s decision to exclude the $172,071 amount of the

settlement payment from petitioner’s 2005 Federal taxable income

would seem to have the consequence of rendering petitioner’s

claimed $20,060.89 withholding credit on her 2005 Federal income

tax return to be “an overstatement of the credit for income tax

withheld at the source” within the meaning of section 6201(a)(3).

If so, then, as we note below, “the amount so overstated which

* * * [was] allowed against the tax shown on * * * [petitioner’s

2005] return” could have been summarily assessed by respondent

without being subject to deficiency procedures pursuant to

section 6201(a)(3). However, respondent apparently neglected to

do this. To address this evident oversight respondent instead

sought to amend his answer to challenge the claimed $20,060.89

withholding credit for 2005.

Petitioner started collecting unemployment compensation in

2005. She also considered starting a solo law practice, a

process that apparently began as far back as 2003. See Forrest

v. Commissioner, T.C. Memo. 2009-228. She claimed, in connection

with efforts to find work as a contract attorney, expenses for

office supplies and other items. The claimed expenses were

initially reported on Schedule A, Itemized Deductions, of her
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2003 Federal income tax return but were subsequently claimed on

Schedule C of her 2005 Federal income tax return as a business

expense. 

Petitioner reported no income from work as a contract

attorney in either 2003 or 2005. The 2003 expenses which she had

sought to recast as Schedule C business deductions at trial were

rejected on account of the Court’s finding that her work as a

contract attorney was not an active trade or business. See

Forrest v. Commissioner, supra. On Schedule C of her 2005

return, petitioner reported no income and claimed deductions of

$29,942.74. Petitioner’s planned solo law practice never made it

past the startup phase to fruition. She acknowledged that none

of her referrals in 2005 resulted in paying clients and that she

never purchased malpractice insurance.

During 2005 petitioner was engaged in extensive litigation

in connection with the decision by the California Department of

Corporations to again terminate her employment in February 2004.3

Petitioner explained that the State of California “had active

litigation trying to get money back.” Petitioner has incurred

expenses arising from this litigation. Her claimed $29,942.74

Schedule C business expense deduction for 2005 included a $15,778

3We note that petitioner had previously been terminated from

the California Department of Corporations in 2000 and was

subsequently reinstated in March 2003 after filing suit against

the State of California in 2003. We take judicial notice of

these facts. See Forrest v. Commissioner, T.C. Memo. 2009-228. 
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deduction for “Litigation re: clear name and Establish Self

professionally”.

 A trial was held in Los Angeles, California. Following

trial, the Court, with agreement of the parties, set a

simultaneous briefing schedule of September 9, 2009, for opening

briefs, and October 26, 2009, for reply briefs. On September 11,

2009, petitioner filed a motion for an extension of time to file

a brief. The Court granted her motion and gave her until October

20, 2009, to file her opening brief and gave both parties until

December 7, 2009, to file a reply brief. 

On October 26, 2009, petitioner filed yet another motion

requesting to extend time to file briefs and stating that she

intended to “submit a Brief by Express Mail over the weekend for

delivery on Monday, October 26, 2009”. The Court had still not

received a brief from petitioner by November 16, 2009, when it

denied her motion. Subsequently, on February 1, 2010, petitioner

filed a status report indicating she would soon complete her Los

Angeles Superior Court trial matters and address her tax matters. 

On April 16, 2010, the Court, still having received no opening

brief from petitioner, entered an order that it would no longer

wait for or accept briefs from petitioner in this case.4

4As she did in her companion Federal income tax case for

2004, Forrest v. Commissioner, docket No. 11513-08, tried

separately at the same trial session, petitioner has followed a

practice of requesting repeated extensions of time and then

failing to file a brief. We caution petitioner against abusing

(continued...)
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OPINION

I. Burden of Proof

As a general rule, the Commissioner’s determination of a

deficiency is presumed correct, and the taxpayer bears the burden

of proving that the determination is improper. See Rule 142(a);

Welch v. Helvering, 290 U.S. 111, 115 (1933). However, the

withholding credit and Schedule C deduction issues were not

raised in the statutory notice of deficiency and are therefore

new matters within the meaning of Rule 142(a). Thus, as

respondent has conceded, with respect to those issues, the burden

of proof lies with respondent. Because petitioner raised the

issue related to the deductions for her pension repayments, she

carries the burden of proof as to that issue. 

II. Whether Petitioner Is Entitled to a Federal Income Tax

Withholding Credit of $20,060.89 for the 2005 Tax Year

Section 6213(a) allows the taxpayer to seek judicial review

of a proposed deficiency before this Court. Under section

6211(b)(1) a deficiency is determined “without regard to payment

on account of estimated tax, without regard to the credit under

4(...continued)

our processes and remind her that sec. 6673(a)(1) allows us in

our discretion to require the taxpayer to pay to the United

States a penalty not in excess of $25,000 whenever it appears

that “(A) proceedings before it have been instituted or

maintained by the taxpayer primarily for delay, (B) the

taxpayer’s position in such proceeding is frivolous or

groundless, or (C) the taxpayer unreasonably failed to pursue

available administrative remedies”. 
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section 31”. Section 31 generally allows the taxpayer to claim a

credit for Federal income tax withheld from wages for that

taxable year. The amount of an overstated credit may be

summarily assessed and is not subject to deficiency procedures. 

Sec. 6201(a)(3); Bregin v. Commissioner, 74 T.C. 1097, 1104-1105

(1980) (“[T]here is no indication that section 6214(a) was

intended to provide him with an alternative method for recovering

on such a claim. Furthermore, if the Commissioner is allowed to

raise his claim in this proceeding, he would be allowed to

recover on a claim that would otherwise be barred by the statute

of limitations.”). 

Since the withholding credit issue is not a factor in

determining the tax deficiency, we have no jurisdiction to

consider it and therefore may not decide whether petitioner is

entitled to a Federal income tax withholding credit of $20,060.89

for the 2005 tax year. We note that under section 6201

respondent may, if he acts timely, assess any overstated

withholding credit as “a mathematical or clerical error” in the

manner specified by section 6213(b). 

III. Whether Petitioner Is Entitled to $29,942.72 of Schedule C

Business Expense Deductions for the 2005 Tax Year

A. General Rules

Deductions are a matter of legislative grace, and the

taxpayer must maintain adequate records to substantiate the

amounts of any deductions or credits claimed. Sec. 6001 (the
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taxpayer “shall keep such records”); INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992); sec. 1.6001-1(a), Income

Tax Regs. Taxpayers must maintain records relating to their

income and expenses and must prove their entitlement to all

claimed deductions, credits, and expenses in controversy. See

sec. 6001; Rule 142(a); INDOPCO, Inc. v. Commissioner, supra at

84; Welch v. Helvering, supra at 115. However, as discussed

above the withholding credit and Schedule C deduction issues were

not raised in the statutory notice of deficiency, and, as

respondent has conceded, with respect to those issues, the burden

of proof lies with respondent.

Section 162(a) authorizes a deduction for “all the ordinary

and necessary expenses paid or incurred during the taxable year

in carrying on any trade or business”. A trade or business

expense is ordinary for purposes of section 162 if it is normal

or customary within a particular trade, business, or industry and

is necessary if it is appropriate and helpful for the development

of the business. Commissioner v. Heininger, 320 U.S. 467, 471

(1943); Deputy v. du Pont, 308 U.S. 488, 495 (1940). 

B. Petitioner’s Schedule C Other Expense Deductions

1. Startup Expenditures

On her tax return for 2005, in connection with her alleged

practice of law, petitioner claimed Schedule C other expense

deductions for, among other items: “Business use of Telephone”,
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“Postage”, “Supplies (toner cartridges, paper, clips, etc.)”,

“Copies”, “Publications, seminars, training, travel”, “Fees re:

travel legal conventions and meetings, hotels”, “Business

associations provide networking, equipment use re: travel and

other professional support”. On Schedule C of her 2005 tax

return, petitioner reported no income generated by her law

practice but claimed $29,942.74 of deductible expenses, producing

a loss of the same amount. Petitioner testified at trial that

her solo law practice was a “fledgling effort.” She wanted to

“figure out what kind of work * * * [she] was going to do. A lot

of it was making expenditures, making contacts, doing the

networking”. 

On the basis of the record, including petitioner’s

testimony, we find that the expenses reported on Schedule C of

her return for 2005, insofar as related to her legal practice,

were not incurred in “carrying on” a business. The expenses were

incurred before it became (if it ever did) a business or profitseeking activity. See sec. 162; Toth v. Commissioner, 128 T.C. 1

(2007). Although “Section 162 generally allows a deduction for

all the ordinary and necessary expenses paid or incurred during

the taxable year in carrying on any trade or business * * * [,] 

Such expenses must be directly connected with or pertain to the

taxpayer’s trade or business that is functioning as a business at

the time the expenses were incurred.” Woody v. Commissioner,
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T.C. Memo. 2009-93, affd. without published opinion No. 09-1193

(D.C. Cir., Dec. 16, 2010) (emphasis added).

Consequently, petitioner may not deduct any of those expenditures

for 2005.

2. Legal Fees

It is well established * * * that, even though a

taxpayer’s employee status may be regarded as a trade or

business, legal fees stemming from a taxpayer’s employee

status are not deductible in computing adjusted gross income

but are to be treated only as miscellaneous itemized

deductions, subject to the AMT and to a 2-percent floor. 

See sec. 62(a)(1) * * *. 

Kenton v. Commissioner, T.C. Memo. 2006-13. 

Included in petitioner’s $29,942.74 of claimed business

expense deductions was a Schedule C business expense deduction

for “Litigation re: clear name and Establish Self

professionally”. This litigation arose from the decision by the

California Department of Corporations to terminate petitioner’s

employment. Because petitioner’s litigation relates to her

status as an employee, she is not entitled to a Schedule C

business expense deduction. Instead, petitioner may be entitled

to a Schedule A miscellaneous itemized deduction for such

litigation expenses.5 See Kenton v. Commissioner, supra. 

5We note that under sec. 62(a)(20) as amended, effective

Oct. 22, 2004, “attorney fees and court costs” paid by the

taxpayer in connection with discrimination law suits “paid after

Oct. 22, 2004, with respect to any judgment or settlement

occurring after that date are allowed as a deduction in computing

adjusted gross income, with the result that they are not subject

to the AMT, and are not subject to the 2-percent floor.” Kenton

(continued...)
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IV. Whether Petitioner Is Entitled to a Deduction Under Section

1341 for Amounts Deducted From Her Pension Distributions

During the 2005 Tax Year

Section 1341 provides a deduction for an item of income that

was included in gross income in a prior tax year that was

required to be repaid in a subsequent tax year. The provision

has three basic requirements: (1) The item must have been

included as gross income for a prior taxable year because “it

appeared that the taxpayer had an unrestricted right to” it, (2)

the “deduction is allowable for the taxable year [at issue]

because it was established after the close of” the prior taxable

year that the taxpayer did not have an unrestricted right to it,

and (3) “the amount of such deduction exceeds $3,000”. Sec.

1341(a). If all of these requirements are met, the taxpayer may

deduct the item from the current years’ taxes. Id.

Petitioner reported pension distributions of $17,434.36 as

income for the 2005 tax year. She was required to make

repayments on pension distributions from earlier tax years out of

her current year’s distribution. Because petitioner claims that

she had previously included the pension distribution that she was

required to repay in some prior tax year and at which time it had

5(...continued)

v. Commissioner, T.C. Memo. 2006-13. However, as petitioner has

not included in her gross income for 2005 any proceeds from a

judgment or settlement of the litigation in which she incurred

the legal expenses, she is not entitled to deduct those fees

under sec. 62(a)(20). 
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appeared that she had an unrestricted right to it, she is

entitled to deduct, in 2005, the amounts repaid in 2005.

At trial petitioner proffered only three monthly

distribution statements. These statements do not indicate

whether the amounts listed under “recover overpayment”

highlighted by petitioner were included or excluded from the

gross pension distribution.6 If petitioner’s pension

distributions were gross amounts, she might be entitled to a

section 1341 deduction, provided she met the $3,000 deduction

floor. If, however, amounts to cover repayments were deducted

from or netted against petitioner’s pension payment and also

6Respondent objected to petitioner’s monthly distribution

statements’ being admitted into evidence on grounds of relevance.

We deferred ruling on the admissibility of those statements to

give petitioner more time to gather additional documentation of

the distributions as well as the statements for the missing

months. Petitioner failed to submit any such additional

documentation. 

Fed. R. Evid. 401 defines “Relevant evidence” as “evidence

having any tendency to make the existence of any fact that is of

consequence to the determination of the action more probable or

less probable than it would be without the evidence.” The

distribution statements are relevant to show that petitioner made

repayments on her pension distributions from earlier tax years. 

However, we note that these documents constitute hearsay; and

because they are not accompanied by any type of certification or

witness identification, they do not fall within the business

records exception to hearsay under Fed. R. Evid. 803(6) and

902(11). Respondent did not raise a hearsay objection at trial

and thus waived it. See Fed. R. Evid. 103(a)(1). We now

overrule the objection on the basis of relevance; however, we

note that had these documents been denied admission, it would not

have changed the result because petitioner failed to submit

additional documentation to clarify whether the deductions had

been included in gross distributions or had already been

deducted. 
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deducted from her total Form 1099 yearend tax statement or other

tax information reporting form, then she was already making the

repayment with pretax income and a section 1341 deduction would

in effect give her a second deduction. Petitioner presented no

evidence that she had included the prior pension distributions in

a prior tax year, nor that the deduction would have met the

$3,000 floor. As discussed above, the burden of proof for this

issue rests on petitioner. She has failed to carry her burden

and is not entitled to a deduction under section 1341.

The Court has considered all of petitioner’s contentions,

arguments, requests, and statements. To the extent not discussed

herein, we conclude that they are meritless, moot, or irrelevant.

To reflect the foregoing,

Decision will be entered

under Rule 155.