T.C. Memo. 2010-15

UNITED STATES TAX COURT

SIVATHARAN NATKUNANATHAN, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 17291-07. Filed February 1, 2010.

R determined a deficiency and an addition

to tax under sec. 6651(a)(1), I.R.C., for failure

to file on time. In response, P claimed a

qualified business stock exclusion under sec.

1202, I.R.C., deductions for uncollected software

development invoices under sec. 165, I.R.C., as

business losses or, alternatively, under sec. 166,

I.R.C., as bad debt losses, and deductions for

meals and entertainment, advertisement, rent, and

utilities expenses under sec. 162, I.R.C.

Held: P may not claim a sec. 1202, I.R.C.,

qualified business stock exclusion to shield from

tax any part of the proceeds from the sale of

stock acquired upon exercise of employee stock

options where P has not established that either

the options or the stock constituted qualified

small business stock within the meaning of sec.

1202, I.R.C.
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1All section references are to the Internal Revenue Code

(Code) of 1986, as amended and in effect for the tax year at

issue. All Rule references are to the Tax Court Rules of

Practice and Procedure.

2Petitioner conceded the following amounts of previously

unreported income items: $90 (interest), $460 (dividend), and

$25,182 (State refunds, credits, or offsets). Respondent

(continued...)

Held, further, P may not deduct billed and

unreceived amounts that have not been previously

included in income.

Held, further, P may not deduct as business

expenses meals and entertainment, advertisement,

rent, and utilities expenditures that are

substantiated solely by a log of such expenditures

and in the absence of any primary evidence of

having made such expenditures.

Held, further, P is liable for the late

filing addition to tax where he has admitted to

having filed his return late and has failed to

provide any reasons for the delay.

Sivatharan Natkunanathan, pro se.

Robert H. Berman, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

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

for redetermination of deficiency, an addition to tax under

section 6651(a)(1)1 for a failure to file on time, and an

accuracy-related penalty under section 6662(a) that respondent

determined for petitioner’s 2003 tax year. After mutual

concessions,2 the issues for decision are: 
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2(...continued)

conceded various losses and deductions that were previously

disallowed. These included an S corporation loss of $7,706

claimed on Schedule E, Supplemental Income and Loss, a $26,919

deduction for unreimbursed employee expenses claimed on Schedule

A, Itemized Deductions, and the following deductions claimed on 

Schedule C, Profit or Loss From Business: $7,787 (car and truck

expenses), $2,106 (travel expenses), $3,257 (legal and

professional services expenses), $5,250 (depreciation and section

179 expenses), $2,559 (office expense), $500 (repairs and

maintenance expenses), $1,200 (taxes and license expenses),

$1,849 (telephone expenses) $90 (bank charges), $593 (dry

cleaning expenses) and $455 (DSL expenses). In a posttrial

brief, respondent also conceded the accuracy-related penalty

under sec. 6662(a). Finally, petitioner and respondent have

agreed upon a Schedule A itemized deduction of $8,523 for cash

charitable contributions instead of the previously claimed

$17,374, with petitioner conceding the remainder.

(1) Whether petitioner is entitled to the qualified small

business stock exclusion of section 1202;

(2) whether petitioner is entitled to business loss or bad

debt deductions for contracted payment amounts for software

development that he was unable to collect;

(3) whether petitioner is entitled to business expense

deductions for meals and entertainment, advertisement, rent, and

utilities expenditures in excess of those respondent allowed or

conceded; and

(4) whether petitioner is liable for an addition to tax

under section 6651(a)(1).

FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are
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incorporated herein by this reference. Petitioner resided in

California at the time he filed the petition.

Petitioner became an employee of Cognet Microsystems

(Cognet), a domestic C corporation, before 2001. Some time

during his employment at Cognet, petitioner received options to

purchase Cognet stock as compensation for services rendered to

that corporation. Petitioner retained these options until after

Cognet merged with Intel Corp. (Intel), another domestic C

corporation, in 2001. As part of the merger agreement,

petitioner’s options to purchase Cognet stock converted into

options to purchase Intel stock. Petitioner exercised his

options to purchase Intel stock sometime in the fourth quarter of

2003 and on the same day sold the Intel stock that he had

received upon exercise for a gain of $295,285. This amount was

reported on a Form W-2, Wage and Tax Statement, that petitioner

received from Intel for 2003.

Petitioner’s original Federal income tax return for 2003 was

prepared and signed on October 15, 2004, and received by

respondent on October 21, 2004, more than 6 months after its due

date of April 15, 2004. This return showed a tax liability of

$50,850, taxes withheld of $26,437, and, after adding a selfreported estimated tax penalty of $554, a balance due of $24,967. 

Petitioner has subsequently sought to amend this return on at
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3Amended income tax returns on Forms 1040X, Amended U.S.

Individual Income Tax Return, for 2003 for petitioner were

received by respondent on Nov. 10, 2005, and Apr. 22, 2008,

respectively. Subsequently, after the record in this case was

closed upon the filing of reply briefs, petitioner sought to file

another amended return on Form 1040X for 2003 dated Apr. 15,

2009. 

4In this notice of deficiency, respondent also determined an

accuracy-related penalty under sec. 6662(a) of $12,998.80 that he

subsequently conceded. See supra note 2.

least three separate occasions.3 Working from petitioner’s

original 2003 return, respondent determined a deficiency of

$126,089. Respondent also imposed an addition to tax of

$19,279.55 for late filing. On May 3, 2007, respondent sent

petitioner, who resided in California at that time, a statutory

notice of deficiency.4 Petitioner, who continued to be a

California resident, filed a timely mailed petition with this

Court on August 2, 2007, requesting a trial in Los Angeles,

California. The trial was held on October 23, 2008.

OPINION

At the trial and in his posttrial briefs and other filings,

petitioner claims that he is not liable for the deficiency but

is, in fact, owed a refund of at least $26,437, the entire amount

of Federal income tax withheld for 2003. In support of this

claim, petitioner advances three broad arguments. First, he

contends that the qualified small business stock exclusion of

section 1202 applies to his sale of Intel stock and, therefore,

he is entitled to exclude 50 percent of the resulting gain. 
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Second, petitioner argues that his failure to collect on invoiced

amounts under software design and development contracts

constitute business losses or bad debt losses. Therefore, he is

entitled to deduct such amounts. And third, petitioner claims

that a “business purpose log” listing expenditures for meals and

entertainment, advertisement, rent, and utilities, that “contains

generic points of discussion relating to business * * * should

satisfy the substantiation requirements” of section 162 and,

where applicable, section 274. Consequently, he is entitled to

deduct the expense amounts shown on the log. For the reasons

discussed below, we reject each of these arguments.

We note initially that petitioner has neither argued nor

established that section 7491(a) applies to shift the burden of

proof to respondent on any of the three arguments that he makes. 

Consequently, petitioner bears the burden of proof for each of

these arguments. See Rule 142(a).

I. Section 1202 Qualified Small Business Stock Exclusion

Section 1202(a)(1) provides that “In the case of a taxpayer

other than a corporation, gross income shall not include 50

percent of any gain from the sale or exchange of qualified small

business stock held for more than 5 years.” Section 1202(d)(1)

defines “qualified small business” as “any domestic corporation

which is a C corporation if * * * the aggregate gross assets of

such corporation immediately after the issuance (determined by
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taking into account amounts received in the issuance) do not

exceed $50,000,000”. To qualify for the exclusion under section

1202, the C corporation that issued the stock must have satisfied

the gross assets test and constituted a qualified small business

“as of the date of issuance” of such stock. Sec. 1202(c)(1)(A). 

Stock in such a C corporation, which “is acquired by the taxpayer

at its original issue * * * as compensation for services provided

to such corporation”, constitutes “qualified small business

stock” for purposes of section 1202. Sec. 1202(c)(1)(B).

Petitioner seeks to invoke section 1202 to exclude from his

gross income 50 percent of the gain he realized on the sale of

Intel stock that he had received by exercising his Intel options. 

Though petitioner concedes that he “sold the Intel Options [sic]

on the same day he exercised them”, he argues “that the Intel

Options he exercised are in fact Qualified Small Business Stock

* * * since they were received by converting the Cognet Options,

during the M&A of Cognet with Intel.” In support, petitioner

cites section 1202(f), which provides:

If any stock in a corporation is acquired solely through the

conversion of other stock in such corporation which is

qualified small business stock in the hands of the 

taxpayer–-

(1) the stock so acquired shall be treated as qualified

small business stock in the hands of the taxpayer, and

(2) the stock so acquired shall be treated as having

been held during the period during which the converted stock

was held.
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5After the trial petitioner attached to his reply brief a

document purporting to be a statement by the chief executive

officer of Cognet at the time of its acquisition by and merger

with Intel declaring that “To the best of my recollection, the

company’s assets, including physical assets and total value of

outstanding shares did not exceed $50,000,000 before the

acquisition.” [Emphasis added.] Subsequently, after the record

had closed upon the filing of reply briefs, petitioner filed a

motion for leave to reopen the record in order to introduce a

notarized version of this and other documents. A notarized

(continued...)

Notwithstanding his citation of the provisions of section

1202(f) that allow for carryover treatment and tacking on of a

holding period upon conversion of small business stock into other

stock, petitioner does not assert that he ever held Cognet stock

that he subsequently converted into Intel stock. Instead,

petitioner seems to be arguing that references to the term

“stock” in section 1202 should be read to include options to

acquire stock. As we explain later, we do not believe that the

term “stock” in section 1202 includes options to acquire stock. 

Even if it did, however, petitioner has failed to establish that

Cognet constituted a qualified small business on the day or days

that he received his options and that he held such options for

more than 5 years.

There are no balance sheets or other financial statements of

Cognet in the record that establish the amounts of total assets,

total liabilities, or owner’s equity of Cognet at any time, and

petitioner made no attempt to introduce any such evidence at

trial.5 In the absence of any such evidence, we cannot determine
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5(...continued)

written statement from Cognet’s chief executive officer, even if

it were introduced at trial, could have been subject to a hearsay

objection and, absent concessions or stipulation by respondent,

would probably not have been admitted into evidence. But here,

where the purported statement constitutes an affidavit attached

to a brief, Rule 143(b) explicitly bars us from considering it as

evidence. We have previously issued an order denying

petitioner’s motion to reopen the record as inappropriate because

petitioner has not shown good cause for his failure to introduce

such evidence at trial.

the value of Cognet’s gross assets at the time that it issued

options to petitioner and, therefore, cannot conclude that Cognet

constituted a qualified small business within the meaning of

section 1202(d)(1) at that time.

The record is similarly devoid of facts that would establish

petitioner’s 5-year holding period for purposes of section

1202(a)(1). The only fact that can be ascertained in this

respect is that petitioner held Intel options from the time of

Cognet’s merger with Intel sometime in 2001 until he exercised

these options sometime in the fourth quarter of 2003, a period

that could not have exceeded 3 years. There is no mention in the

record of the date or dates when petitioner received Cognet

options or how long he had held these options before Cognet

merged with Intel. We are, therefore, unable to conclude that

petitioner satisfied the 5-year holding period requirement of

section 1202(a)(1).

Tax deductions are a matter of legislative grace, and a

taxpayer has the burden of proving that he is entitled to the
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deductions claimed. Rule 142(a)(1); INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v.

Helvering, 292 U.S. 435, 440 (1934). Petitioner has failed to

establish that Cognet was a qualified small business as specified

in section 1202(d)(1). Further, even assuming arguendo that

options are stock for purposes of section 1202(f), petitioner has

not shown that he held his Cognet and Intel options for a

combined duration of more than 5 years. Therefore, we hold that

petitioner may not avail himself of the qualified small business

stock exclusion of section 1202.

Even if Cognet was a qualified small business within the

meaning of section 1202(d)(1) and petitioner had held his options

for more than 5 years, on the facts we would remain unpersuaded

that petitioner is entitled to the benefits of section 1202. 

Section 1202 refers to the “gain from the sale or exchange of

qualified small business stock”. Petitioner with his facts has

failed to establish that the term “qualified small business

stock”, as used in section 1202, should be read to include his

options to acquire such stock.

Section 1202 itself does not define the term “stock” or

otherwise specify what securities constitute stock for purposes

of the qualified small business stock exclusion. By comparison,

some provisions of the Code explicitly specify that the term

“stock” includes options to acquire stock. See, e.g., sec.
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305(d)(1) (“For purposes of this section, the term ‘stock’

includes rights to acquire such stock.”); sec. 1091(a) (same). 

We are unaware of any authority that has interpreted the term

“stock” for purposes of section 1202. However, we have

previously declined to extend the term “stock” beyond its plain

meaning in a statutory provision and construe it expansively to

include options to acquire stock. See Gantner v. Commissioner,

91 T.C. 713 (1988) (options to purchase stock are not “shares” of

“stock or securities” under the plain language of section 1091,

which was subsequently amended to explicitly provide otherwise),

affd. 905 F.2d 241 (8th Cir. 1990). Moreover, the legislative

history of section 1202 suggests that Congress did not intend

section 1202 to cover options to acquire stock.

Section 1202 was added to the Code by the Omnibus Budget

Reconciliation Act of 1993, Pub. L. 103-66, sec. 13113(a), 107

Stat. 422. The accompanying conference report included the

following statement: “Stock acquired by the taxpayer through the

exercise of options * * * is treated as acquired at original

issue. The determination whether the gross assets test is met is

made at the time of exercise * * * and the holding period of such

stock is treated as beginning at that time.” H. Conf. Rept. 103-

213, at 526 (1993), 1993-3 C.B. 393, 404 (emphasis added). The

second sentence of the excerpt from the conference report quoted

above, in the absence of any countervailing argument by
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petitioner, suggests to us that the original issuance

contemplated by section 1202 in petitioner’s case would be the

issuance of Intel stock to petitioner upon exercise of his

options. This conclusion seems appropriate since both the

application of the gross assets test and the commencement of the

holding period would occur at the time of such exercise.

Reading the term “stock” as used in section 1202 to exclude

petitioner’s options to acquire stock, we hold that petitioner

could not possibly have satisfied the 5-year holding period

requirement of section 1202(a)(1). Petitioner concedes that he

sold the Intel stock received upon exercise of his options on the

same day that he had exercised the options. Therefore, the

period during which petitioner could have held qualified small

business stock would, at most, have lasted 1 day. Moreover, for

the stock underlying petitioner’s options to constitute qualified

small business stock under section 1202(d)(1), the aggregate

gross assets of Intel on the date of exercise would have to have

been less than or equal to $50 million. Petitioner makes no such

claims with respect to Intel’s aggregate gross assets. 

Petitioner makes a second argument in an effort to alleviate

the tax burden of the gain he realized from the sale of the Intel

stock. He claims that he was a “partner of ‘Thanikai Partners’,

an unincorporated partnership formed under the laws of the State

of California on September 16, 1996”, that he continued to remain
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a partner of that partnership when he sold the Intel stock, and

that he distributed the resulting “gain of the partnership to its

partners, who wanted the distribution to be made according to

partners’ wishes.”

Petitioner’s argument flies in the face of a fundamental

principle of tax law, that income is taxed to the person who

earns it. Lucas v. Earl, 281 U.S. 111, 114-115 (1930). A

taxpayer entitled to receive income cannot avoid tax on that

income by assigning it to somebody else, even where the

assignment precedes the receipt of income. See also Helvering v.

Horst, 311 U.S. 112 (1940). However, petitioner is actually

seeking to assign his income away after he has, in fact, received

it. As stated above, petitioner’s options to purchase Cognet

stock constituted compensation for services rendered to that

corporation. The Form W-2 petitioner received from Intel for the

year 2003 establishes that petitioner had both earned and

received the income representing the gain realized on the sale of

the Intel stock. Whether petitioner was a partner in a

partnership does not affect the fact that it was petitioner

alone, and no other person or entity, that had earned and

received this income. Petitioner cannot avoid tax on this income

by claiming that the proceeds have been distributed to his

partners.
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II. Software Design and Development Losses

Petitioner seeks deductions for losses that he claims to

have suffered in connection with three separate software design

and development agreements. He alleges that after having

delivered the contracted work he was left with unpaid invoices of

$137,106, $3,211, and $168,740. Petitioner argues that he

“sustained losses from the agreements, with the delivery of the

products and the non-payment of Invoices by the Customer”. 

Therefore, he should be allowed to deduct these uncollected

amounts “in full under any of the * * * Sections 165, 166, 174(a)

and 1060.” 

We consider in reverse order these four Code sections that

petitioner has cited. Section 1060 prescribes statutory

allocation rules to be applied to multiasset sales in computing

the seller’s gains and losses and the buyer’s basis and bears no

relevance to petitioner’s claimed losses.

Section 174(a) and (b) allows a taxpayer, at his election,

to either deduct or defer and amortize over a period of not less

than 60 months certain “research or experimental expenditures”

which are paid or incurred by the taxpayer in connection with the

operation of a trade or business. Expenditures covered by

section 174 include only costs for “research and development

* * * in the experimental or laboratory sense.” Sec.

1.174-2(a)(1), Income Tax Regs. This test is met if the
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activities are “intended to discover information that would

eliminate uncertainty concerning the development or improvement

of a product.” Id. Petitioner acknowledges that amounts

invoiced under the software design and development agreements

were for “unique customized functional software modules”. It is

unlikely, therefore, that expenditures made in connection with

these software development agreements were “intended to discover

information that would eliminate uncertainty concerning the

development or improvement of a product.” Expenditures made to

develop and deliver functional products for use by customers do

not usually constitute “research and development * * * in the

experimental or laboratory sense.” And though petitioner may

very well have engaged in extensive testing of these software

products in order to ensure compliance with customer

specifications, costs of “the ordinary testing or inspection of

materials or products for quality control” are excluded from the

definition of research and experimental expenditures in section

174. See sec. 1.174-2(a)(3)(i), Income Tax Regs. 

However, the Internal Revenue Service (IRS) has published

guidance that advises taxpayers that “costs paid or incurred in

developing software for any particular project, either for the

taxpayer’s own use or to be held by the taxpayer for sale or

lease to others” and without regard to “whether or not the

particular software is patented or copyrighted * * * in many
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respects so closely resemble the kind of research and

experimental expenditures that fall within the purview of § 174

as to warrant similar accounting treatment.” Rev. Proc. 2000-50,

sec. 5.01, 2000-2 C.B. 601, 601. Accordingly, the IRS “will not

disturb a taxpayer's treatment” of such costs, where all of them

either 

(1) * * * are consistently treated as current expenses

and deducted in full in accordance with rules similar to

those applicable under § 174(a); or

(2) * * * are consistently treated as capital

expenditures that are recoverable through deductions for

ratable amortization, in accordance with rules similar to

those provided by § 174(b) and the regulations thereunder,

over a period of 60 months from the date of completion of

the development * * *

Id.

 Pursuant to Rev. Proc. 2000-50, sec. 5.01(1), a cash basis

taxpayer could deduct “All of the costs properly attributable to

the development of software” in the year that the taxpayer makes

payment on such costs. An accrual or mixed basis taxpayer could

either deduct such costs in the year that they are incurred or,

alternatively, treat them as deferred expenses chargeable to

capital account and amortize them over a period of 60 months

after development of the software has been completed. In the

Schedules C filed with petitioner’s original Federal income tax

return for 2003 and its successive amendments, petitioner has

consistently checked the box for “cash” in the line item for the

taxpayer’s method of accounting. However, in a posttrial brief,
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petitioner claims that though he “was primarily a Cash Basis

taxpayer for 2003 * * *, some items which were reported qualify

under both Cash Basis, and Accrual Basis of Accounting.” As a

result, “Petitioner specifically demands to * * * report (deduct)

[such items] under the Accrual Method of Accounting.”

Petitioner’s claims advanced in a posttrial brief do not

constitute evidence, and we disregard them. See Rule 143(b). On

the basis of the method of accounting that petitioner declared on

his 2003 Federal income tax return, we treat him as a cash basis

taxpayer for tax year 2003. Consequently, under Rev. Proc. 2000-

50, supra, petitioner may deduct as software development expenses

only such expenditures attributable to his three software

development agreements that were paid by him in 2003 and that

were not otherwise allowed as deductions. However, petitioner

has failed to introduce any evidence of actual out-of-pocket

expenditures that he made in 2003 and that he has not thus far

deducted in connection with any one of the three software

agreements at issue. Instead, petitioner merely cites Rev. Proc.

2000-50, supra, and insists in self-serving conclusory fashion

that he “incurred losses from the sale of customized software”,

that the amount of such losses “is clearly evidenced in the

purchase orders and invoices”, and that this amount “is entitled

for a full deduction” because “he did not charge his capital

account or other expense accounts” for such losses. But at trial
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he did not call witnesses or introduce evidence that proved any

of these claims.

We further note that petitioner’s arguments for the

deductibility of software development expenses would remain

unavailing even if we were to accede to his demands in his

posttrial brief and treat him as an accrual basis taxpayer for

purposes of these three software development agreements. Under

Rev. Proc. 2000-50, supra, as an accrual or mixed basis taxpayer,

petitioner could deduct previously undeducted costs in connection

with the three software development projects that were incurred

in 2003 regardless of when the payments were made so long as such

costs were incurred or accrued during the 2003 tax year. Costs

incurred in an earlier year and capitalized in that year would be

subject to amortization over either 36 or 60 months, with any

unamortized balance becoming deductible in the year of

disposition or abandonment. However, petitioner provides no

evidence in the form of canceled checks, bank statements, bills

or receipts of having actually made any such payments that have

not been otherwise allowed as deductions. Nor does he show that

such costs were incurred or accrued in 2003 and are, therefore,

properly taken into account in the 2003 tax year.

For similar reasons, we remain unpersuaded by petitioner’s

sincere arguments under sections 165 and 166. These arguments

would have been persuasive to the extent petitioner established
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that he had a tax basis in the receivables or that the claimed

losses on the software agreements represented out-of-pocket

expenditures that he has made but not yet deducted. He has

established neither. For such expenditures, section 165(c)(2)

might have allowed an ordinary deduction for a business loss. 

Alternatively, subject to satisfaction of other applicable

conditions, section 166(d) might have permitted a short-term

capital loss deduction for a worthless bad debt. However,

petitioner has failed to introduce any evidence of actual

undeducted cash expenditures that he has made (i.e., costs that

he has incurred) in connection with any one of the three software

agreements at issue here. Instead, petitioner alleges in a

posttrial brief that “he provided to the Commissioner copies of

purchase orders, invoices, agreements, and letters * * * [and]

copies of collection letters that [he] had sent to the

customer[s]” in support of his contention “that the claimed

‘software design and development’ loss * * * should be allowed in

full”. 

“It is well settled that a taxpayer is not allowed to reduce

ordinary income actually received by the amount of income he

failed to receive.” Hendricks v. Commissioner, 406 F.2d 269, 272

(5th Cir. 1969), affg. T.C. Memo. 1967-140; see also Escofil v.

Commissioner, 464 F.2d 358, 359 (3d Cir. 1972), affg. T.C. Memo.

1971-131; Hutcheson v. Commissioner, 17 T.C. 14, 19 (1951).
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Indeed, it is axiomatic that a deduction cannot be claimed for

profits that will never be reported as income. Hort v.

Commissioner, 313 U.S. 28, 32-33 (1941); J.G. Boswell Co. v.

Commissioner, 34 T.C. 539, 545 (1960), affd. 302 F.2d 682 (9th

Cir. 1962). Therefore, petitioner may not claim as a business

loss any part of the uncollected amounts on the three software

agreements. 

Similarly, petitioner’s claim of a worthless debt under

section 166 cannot be allowed. Section 166(d) allows “a taxpayer

other than a corporation” a deduction for “any nonbusiness debt

[which] becomes worthless within the taxable year.” However,

worthless debts arising from unpaid wages, fees, and similar

items of taxable income are not deductible as bad debts unless

the taxpayer has included the amounts in income for the year for

which the bad debts are deducted or for a prior tax year because

otherwise they have no tax basis.

The debts petitioners claimed are for unpaid fees for

petitioner’s services. Petitioners used the cash method for

reporting income and deductions; therefore, fees for

services that remain unpaid have not been included in

income. Such debts do not constitute “bad debts” within the

meaning of section 166 for which a deduction for

worthlessness may be claimed. * * *

Crosson v. Commissioner, T.C. Memo. 2003-170; see also Gertz v.

Commissioner, 64 T.C. 598, 600 (1975); Prowse v. Commissioner,

T.C. Memo. 2006-120.
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III. Trade or Business Expenses

A. General Deduction 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;

INDOPCO, Inc. v. Commissioner, 503 U.S. at 84; sec. 1.6001-1(a),

Income Tax Regs.

Generally, the Court may allow the deduction of a claimed

expense (other than those subjected to the strict substantiation

requirements of section 274) even where the taxpayer is unable to

fully substantiate it, provided the Court has an evidentiary

basis for doing so. Cohan v. Commissioner, 39 F.2d 540, 543-544

(2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743

(1985); sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed.

Reg. 46014 (Nov. 6, 1985). In these instances, the Court is

permitted to approximate the allowable expense, bearing heavily

against the taxpayer whose inexactitude is of his or her own

making. Cohan v. Commissioner, supra at 544.

B. Deductibility of Expenses Relating to Petitioner’s

Schedule C

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
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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). In

contrast, “personal, living, or family expenses” are generally

nondeductible. See sec. 262(a).

Certain business expenses described in section 274(d) are

subject to strict substantiation rules that supersede the Cohan

doctrine. Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968),

affd. 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary

Income Tax Regs., supra. Section 274(d) applies to: (1) Any

traveling expense, including meals and lodging away from home;

(2) entertainment, amusement, and recreational expenses; (3) any

expense for gifts; or (4) the use of “listed property”, as

defined in section 280F(d)(4), including passenger automobiles. 

To deduct such expenses, the taxpayer must substantiate by

adequate records or sufficient evidence to corroborate the

taxpayer’s own testimony: (1) The amount of the expenditure or

use, which includes mileage in the case of automobiles; (2) the

time and place of the travel, entertainment, or use; (3) its

business purpose; and in the case of entertainment, (4) the

business relationship to the taxpayer of each expenditure or use.

Sec. 274(d) (flush language).

Petitioner claims as trade or business expense deductions

under section 162 the following amounts: $14,701 for meals and
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6This was both the total amount of expenses reported and the

total amount of deductions claimed for meals and entertainment. 

Petitioner argued for an exception to the general rule under sec.

274(n)(1) that only 50 percent of meals and entertainment

expenses be allowed as deduction. As discussed infra, we

consider it irrelevant to examine whether such an exception

applies here.

entertainment;6 $1,509 for advertising; $1,000 for home office

rent; and $200 for utilities. Petitioner asserts that he

incurred these expenses on behalf of Thanikai Partners, of which

he is a partner. Meals and entertainment expenses claimed as

deductions under section 162 are, with limited exceptions,

subject to the substantiation requirements of section 274(d). 

Section 1.274-5T(c), Temporary Income Tax Regs., 50 Fed. Reg.

46016 (Nov. 6, 1985), requires a taxpayer to substantiate each

element of an expenditure by adequate record or by sufficient

evidence corroborating his own statements. Petitioner here has

made no attempt to do so. Instead, at trial, he sought to

introduce a printout of a self-created computer record of meals

and entertainment expenditures, a so-called meals and

entertainment substantiation log. This log was unaccompanied by

any primary evidence of the expenditures in the form of receipts,

paid bills, credit card receipts or cancelled checks. In his

posttrial briefs, petitioner does not argue that his claimed

deductions for meals and entertainment expenses are excepted from

the substantiation requirements of section 274(d). Instead, he

makes detailed and highly involved arguments on why the 50-
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percent limitation on meals and entertainment expenses under

section 274(n) does not apply.

In the absence of any showing as to when petitioner created

the record of these expenditures and of any primary evidence that

he had in fact incurred these expenditures, we hold that

petitioner has not met the standard of proof set forth in section

1.274-5T(c), Temporary Income Tax Regs., supra, for

substantiating deductions relating to meals and entertainment. 

We, therefore, disallow such claimed expenses in their entirety

and have no reason to address petitioner’s arguments regarding

the inapplicability of the 50-percent limitation on such

deductions.

Petitioner has also failed to substantiate the claimed

deduction for advertising. Petitioner’s substantiation was

limited to a printout of a computer record, a self-styled

“advertisement substantiation log” that purportedly listed

advertising-related expenditures, the majority of which actually

referred to meals. In his posttrial reply brief, petitioner has

sought to explain this reference by arguing that he is reporting

“advertisement related business meals under the Advertisement

substantiation log * * * and all other business meals under [the

separate] meals, and entertainment substantiation log”. The

substantiation requirements of section 274(d) for meals and

entertainment expenses do not allow for an exception merely
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because the expense was related to advertising. Thus, for the

reasons discussed above regarding the substantiation of meals and

entertainment expenses, we disallow the claimed deductions with

respect to business meals that petitioner describes as

advertisement related. 

We also disallow deductions for all other claimed

advertising expenses. Petitioner has presented no primary

evidence of having incurred such expenditures or shown how such

expenditures were related to his trade and business. He has,

therefore, failed to meet the adequate records requirement for

claiming these deductions.

Petitioner’s substantiation for rent and utilities is also

limited to a printout of a computer record or log of such

expenditures. In his posttrial briefs, petitioner argues that

the deductions for rent and utilities should be allowed for use

of a rental unit as a home office. For a home office deduction,

section 280A requires a showing that the portion of the dwelling

unit claimed as a home office be exclusively used on a regular

basis as the principal place of business of the taxpayer. 

Further, section 280A requires that, in the case of a taxpayer

who is an employee, the use of the dwelling be for the

convenience of the taxpayer’s employer. Petitioner was an

employee of Intel during the year 2003 and is presumably

referring to Intel when he states in a posttrial brief that “Due
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to space constraints at Employer Corporation, the Taxpayer with

verbal assurances from employer used his home office for research

purposes”. Petitioner also claims he used the home office for

administrative and management activities relating to his alleged

trade or business as an “Engineer”. However, other than such

self-serving allegations in his posttrial briefs that do not

constitute evidence under Rule 143(b), petitioner has introduced

no evidence, credible or otherwise, to establish the showing

required under section 280A. We, therefore, deny petitioner’s

claimed deductions for rent and utilities.

IV. Section 6651(a)(1) Addition to Tax

Petitioner filed his 2003 return over 6 months after its due

date. Respondent has, thus, met his burden of production under

section 7491(c), and in order to avoid the section 6651(a)(1)

addition to tax, petitioner has the burden of proving reasonable

cause and the absence of willful neglect for failure to file on

time. Petitioner, however, failed to offer any explanation at

trial for the delay. Instead, in a posttrial brief, petitioner

“admits Respondent’s stated filing dates [sic] for the Original

Tax Return” and goes on to boldly declare that “when the Court

finds that Petitioner does not owe on the Deficiency, the

penalties, and interest calculated as liabilities against the

Petitioner * * * would become zero.” Since the petitioner has

admitted to the late filing and failed to offer any reason, let
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alone an excuse, for the delay, we uphold the addition to tax

under section 6651(a)(1) for late filing.

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.