T.C. Memo. 1998-451

UNITED STATES TAX COURT

STEVEN AND JENNIE JACOBS, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15664-95. Filed December 23, 1998. 

Steven and Jennie Jacobs, pro sese.

Milton B. Blouke, for respondent.

MEMORANDUM OPINION

BEGHE, Judge: Respondent determined a deficiency of $12,930

in petitioners' 1992 Federal income tax. In so doing, respondent

disallowed for lack of substantiation all deductions claimed by

petitioners as expenses of the advertising business carried on by

petitioner Steven Jacobs (petitioner), as sole proprietor, under
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the name of "Jacobs Creative Group". Those deductions claimed by

petitioners, in the amount of $40,612, exceeded the gross income

of $21,876 reported on Schedule C as the income of Jacobs

Creative Group, which respondent did not dispute, and reduced the

taxable income from the salary of petitioner Jennie Jacobs

(Ms. Jacobs) reported on their joint return. 

After making some findings of fact of general application,

reciting the procedural history of the case, and providing an

introductory exposition of applicable law, we shall, for

convenience, combine our findings, discussion and holding under a

separate heading for each type of expense in issue. 

Petitioners timely filed an electronic joint return for

1992. At the time petitioners filed their petition, they resided

in Reno, Nevada. Petitioners were divorced in 1996. 

The case was continued from the Court's May 20, 1996, and

May 4, 1997, Reno, Nevada, general trial sessions on petitioners'

motions on the ground of petitioner's asserted inability to

prepare for trial by reason of “Chronic Fatigue Immune

Dysfunction Syndrome (CFIDS)” and a spinal injury. 

In due course, the case was placed on the Court's May 4,

1998, Reno, Nevada, general trial session. During the week

immediately preceding the session, in response to petitioner's

telephone message that he wished to request another continuance,

the Court informed petitioner and respondent that no more
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continuances would be granted. Petitioner and respondent

thereupon entered into a bare bones stipulation of facts,

agreeing only that petitioners resided in Reno, with attached

hard copy of petitioners' return and copy of the statutory notice

of deficiency. The only documentation that was presented by

petitioner and admitted into evidence at trial were examples of

brochures and other printed materials that petitioner produced

for clients of his advertising business during the taxable year. 

Petitioner asserted over the years prior to trial and at trial

that he had documentary evidence to support the claimed

deductions. Although a day or two before trial petitioner had

finally obtained from storage the boxes in which--he told

respondent and the Court--his records were located, at trial

petitioner produced no profit and loss statements, no journals or

ledgers reflecting income and expenses, and no invoices,

receipts, or canceled checks documenting payments to vendors of

goods or services received by his business during the taxable

year. Nor did petitioner produce and submit any such documentary

evidence to respondent for inclusion in a supplemental

stipulation of facts during the 30-day period following the trial

that the record was held open to allow him to do so. 

The Court set a seriatim briefing schedule, with respondent

to file the first brief. On August 10, 1998, following enactment

of the IRS Restructuring and Reform Act of 1998, Pub. L. 105-206,
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1 Unless otherwise stated, all Rule references are to the

Tax Court Rules of Practice and Procedure, and all section

references are to the Internal Revenue Code in effect for the

taxable year in issue. 

112 Stat. 685, ___, respondent and Ms. Jacobs filed a stipulation

of settled issues, agreeing that Ms. Jacobs "is entitled to

relief from liability under the innocent spouse provisions of

I.R.C. § 6015 for the 1992 taxable year." 

On November 16, 1998, following the filing of respondent's

opening brief, petitioner filed a motion to dismiss on the ground

that his ailments were preventing him from preparing and filing a

reply brief, and that "if the Court would see fit to grant a

dismissal it would be an act of mercy for which [petitioner]

would be eternally grateful". The Court denied petitioner's

motion in an order explaining that under the Court's Rule 1231

the granting of petitioner's motion would require entry of a

decision in favor of respondent. The order informed the parties

that the case was fully submitted and excused them from filing

any additional briefs. 

Petitioner had an advertising business, creating story

boards for radio and TV advertisements and placing those

advertisements, and creating layouts for print brochures and

folios. On Schedule C, petitioner reported gross income from the

business of $21,876, which was allocated (rounded off) as

follows:
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Radio & TV ads $15,000

Brochures & folios 3,500

Other print ads 3,000

 Total 21,500

The $40,612 of expenses claimed by petitioner on Schedule C

and disallowed by respondent was as follows:

1. Advertising $2,500 

2. Bad debt 1,700 

3. Car and truck 8,400 

4. Legal and professional 3,342 

5. Office 6,360 

6. Travel 1,829 

7. Entertainment 754 

($942 - $188 (20 percent) = $754) 

8. Publications 427 

9. Printing 15,300

 Total 40,612 

Respondent's determination in the notice of deficiency is

presumed correct, and petitioner bears the burden of proving that

it is incorrect. Rule 142(a). 

Section 162 allows a deduction for ordinary and necessary

business expenses. Whether an expense is deductible under

section 162 is ultimately a question of fact. Commissioner v.
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Heininger, 320 U.S. 467, 475 (1943). An expense is ordinary

under section 162 if it bears a reasonably proximate relationship

to the operation of the taxpayer's business. Deputy v. du Pont,

308 U.S. 488, 495-496 (1940); Gill v. Commissioner, T.C. Memo.

1994-92, affd. without published opinion 76 F.3d 378 (6th Cir.

1996). An expense is necessary if it is helpful and appropriate

in promoting and maintaining the taxpayer's business. Carbine v.

Commissioner, 83 T.C. 356, 363 (1984), affd. 777 F.2d 662 (11th

Cir. 1985). 

Taxpayers must substantiate amounts claimed as deductions by

maintaining the records necessary to establish their entitlement

thereto. Sec. 6001; Hradesky v. Commissioner, 65 T.C. 87, 90

(1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976). 

Where a taxpayer establishes his entitlement to a deduction,

but does not establish the amount because of the lack of

documentary evidence, the Tax Court should estimate the amount

allowable, Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir.

1930), provided there is enough evidence in the record to provide

a rational basis for an estimate, Williams v. United States, 245

F.2d 559, 560 (5th Cir. 1957); Vanicek v. Commissioner, 85 T.C.

731, 743 (1985). 

In Cohan v. Commissioner, supra at 543, the Court of Appeals

for the Second Circuit recognized that the expenses of an

impresario in entertaining actors and crew members were
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legitimate and deductible. The taxpayer, however, did not

produce any of the receipts substantiating such expenses. The

Court of Appeals directed the Board of Tax Appeals to estimate

such expenses "bearing heavily if it chooses upon the taxpayer

whose inexactitude is of his own making". Id. at 544. 

Section 274(d) overrides the Cohan doctrine with respect to

expenses of travel away from home (including meals and lodging)

and entertainment. Sanford v. Commissioner, 50 T.C. 823, 827

(1968), affd. per curiam 412 F.2d 201 (2d Cir. 1969); sec. 1.274-

5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6,

1985). Under section 274(d), a taxpayer must substantiate the

amount, time, place, and business purpose of the expenditures and

furnish adequate records or sufficient evidence corroborating his

own statement. Sec. 1.274-5T(c)(1), Temporary Income Tax Regs.,

50 Fed. Reg. 46016 (Nov. 6, 1985). Adequate records are defined

as an account book, diary, log, statement of expense, trip

sheets, or similar records, plus "documentary evidence". Sec.

1.274-5T(c)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46017

(Nov. 6, 1985). Examples of documentary evidence include

receipts, paid bills, or similar evidence to support an

expenditure, except that, with respect to any expenditure of less

than $25 incurred prior to October 1, 1995, or transportation

charges "documentary evidence will not be required if not readily

available, provided, however, that the Commissioner in his
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discretion may prescribe rules waiving such requirements in

circumstances where he determines it is impracticable for such

documentary evidence to be required." Sec. 1.274-5T(c)(2)(iii)

(B), Temporary Income Tax Regs., 62 Fed. Reg. 13990 (Mar. 25,

1997). 

"Listed property", the use of which for transportation

purposes must meet the substantiation requirements of section

274(d)(4), includes passenger automobiles and trucks. Sec.

280F(d)(4)(A)(i) and (ii); sec. 1.280F-6T(b)(2)(i), Temporary

Income Tax Regs., 49 Fed. Reg. 42713 (Oct. 24, 1984). However,

section 1.274(d)-1, Income Tax Regs., authorizes the Commissioner

to prescribe rules for mileage allowances for ordinary and

necessary expenses for local transportation, see Dehr v.

Commissioner, T.C. Memo. 1998-441, and such rules were prescribed

for the year 1992. See Rev. Proc. 91-67, 1991-2 C.B. 887. 

1. Advertising Expense of $2,500

Petitioner claimed and testified that he paid a total of

$2,500 in cash for advertising his advertising business at the

rate of $100 per ad in two local publications published monthly

by Matson Publications, "Nevada Today" and "Nevada Woman". 

Petitioner provided no invoices, no copies of the ads, and no

other witness who established that the ads were placed. 

Subsequent to trial, he failed to produce copies of the ads,

either from his retained boxes of records, or from the Reno
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Public Library's copies of the publications in which the ads

appeared. Nevertheless, the Court is satisfied from petitioner's

testimony that he incurred advertising expenses of this type. 

Applying Cohan v. Commissioner, supra, and "bearing heavily" on

petitioner, we allow an advertising expense deduction of $1,200. 

2. Bad Debt of $1,700

Under section 166, a deduction is allowed for a debt which

becomes worthless during the taxable year. Petitioner claimed a

bad debt deduction of $1,700 by reason of the failure of Roger

Wright, for whom he prepared brochures detailing Mr. Wright's

expertise in tracing horse bloodlines, to pay petitioner’s

agreed-upon fee of $1,700 for preparing the brochures. The

unpaid fee for preparing the brochures, like wages or salary,

would have been ordinary income to petitioner upon payment;

petitioner did not report as income, for 1992 or any prior year,

any of the fee alleged to be owed. 

Under applicable law, the unpaid fee is not deductible as a

bad debt. Sec. 1.166-1(e), Income Tax Regs. provides: 

Worthless debts arising from unpaid wages, salaries,

fees, rents, and similar items of taxable income shall

not be allowed as a deduction under section 166 unless

the income such items represent has been included in

the return of income for the year for which the

deduction as a bad debt is claimed or for a prior

taxable year. 

Inasmuch as petitioner did not report the fee income, he is not

entitled to a bad debt deduction for the unpaid fee for 1992. 
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Koenig v. Commissioner, T.C. Memo. 1998-215; sec. 1.166-1(e),

Income Tax Regs. 

Even if we had determined that petitioner had included the

unpaid fee in income, he has failed to establish that the debt

was worthless at the end of the taxable year in issue. 

Petitioner testified that in 1998 he was still attempting to

collect the debt.

3. Car and Truck Expenses of $8,400

Petitioner claimed car and truck expenses of $8,400, which

respondent disallowed in full in the statutory notice. However,

respondent conceded on brief that "petitioner * * * should be

allowed a mileage expense deduction for his trips to Virginia

City." 

Petitioner testified that he traveled to meet his production

assistant, who was located in Virginia City, about 40 miles away

from Reno, and that he did this on an average of three or four

times a week. Petitioner also testified that he had records of

his other expenses that made up the total of $8,400, but he

failed to produce them at trial or subsequently, while the record

was held open. Respondent has made no concession with respect to

any other claimed expenses in this category. 

Relying on respondent's concession as a waiver under sec.

1.274-5T(c)(2)(iii)(B), Temporary Income Tax Regs., 62 Fed. Reg.

13990 (Mar. 25, 1997) and Rev. Proc. 91-67, 1991-2 C.B. 887,
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we find that petitioner made trips to Virginia City on an average

of three times per week during 20 weeks during the year, for a

total of 4,800 miles. At the standard business mileage rate of

28 cents per mile in effect for 1992 under Rev. Proc. 91-67,

supra, petitioner is entitled to a mileage allowance deduction

for local travel of $22.40 per day, or a total of $1,344. We

sustain the balance of respondent's disallowance of petitioner's

claimed car and truck expense deduction. 

4. Legal and Professional Expenses of $3,342

Petitioner testified that "primarily" the $3,342 was paid

for production costs and that a "small amount" was for legal

expenses. Petitioner testified that the production costs

included both amounts paid to the production assistant in

Virginia City and amounts paid to sound engineers. Petitioner

testified that he worked with the production assistant to

determine a budget and how much of the fee petitioner would keep

and how much the production assistant would keep. However,

petitioner presented no invoices or other documentation showing

how the services of the production assistant were billed and paid

for. Although petitioner testified that he reported the gross

amounts paid under the contracts, it is not clear--indeed it

seems unlikely--that the production assistant's share was part of

the gross income reported by petitioner. We do not believe that
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petitioner included the amounts paid to the production assistant

in the $21,876 of income reported on Schedule C. 

Nor are we inclined to give petitioner the benefit of the

doubt--much less consider that he has carried his burden of

proof--that any part of the amount claimed was paid for services

provided by sound engineers. Petitioner admitted that he usually

paid for such services in cash because he was thereby able to

obtain discounts from market rates charged by service providers

who were moonlighting after hours from their regular jobs. We

are sufficiently familiar with the operations of the underground

economy to say that a taxpayer who makes payments in cash to

facilitate income tax underreporting and unauthorized use of

employer facilities by employee service providers does not

thereby convince us, without documentation, that he has incurred

and paid deductible expenses. 

With respect to the legal fee portion of petitioners' claim,

petitioner failed to provide the Court with sufficient

information to determine if the legal expenses claimed were

related to the business or were personal in nature. Petitioner

testified that the legal fees were partly for a bankruptcy that

he had filed in the previous year and for the attorney to review

"contracts". 

Respondent's determination on this issue is sustained in

full. 
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2 Respondent did not determine or argue that any payments

that petitioner persuaded the Court he had made should be

capitalized and deducted under sec. 167 or sec. 168. 

5. Office Expenses of $6,360

The office expenses listed on the 1992 Schedule C allegedly

consisted of payments to Washoe Association for Retarded

Children, for which petitioner had previously worked as an

employee, of $5,000 for graphics equipment2 and $1,360 for office

supplies. The $5,000 allegedly consisted of a $2,500 lump-sum

payment in cash that petitioner made to the Association and a

$2,500 credit in exchange for his services. Petitioner testified

that he did not include in income the $2,500 credit for services

performed. This was a barter exchange; failing to include the

$2,500 credit in income prevents petitioner from obtaining a tax

basis in the property received and therefore disentitles him to a

deduction for the value of his services or the cost of the

property received. See Barter v. Commissioner, T.C. Memo. 1990-

142; Salon v. Commissioner, T.C. Memo. 1980-77. 

We find petitioner's testimony to be generally credible with

respect to his cash payments for the equipment and supplies. We

allow a deduction of $3,860 for the purchase of equipment and

supplies. 

6. Travel Expenses of $1,829

Petitioner has completely failed to meet the recordkeeping

and substantiation requirements of section 274(d) for the claimed
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deduction of $1,829 for travel expenses. Petitioner provided no

evidence at the trial; he was given additional time after the

trial to provide documentary evidence and he failed to do so. 

Respondent's determination on this issue is sustained in full. 

7. Meals and Entertainment Expenses of $942, Less the 20

Percent Limitation ($188) for a Deduction of $754

Petitioner has completely failed to meet the recordkeeping

and substantiation requirements of section 274(d) for meals and

entertainment expenses. Petitioner presented no evidence at the

trial; he was given additional time after the trial to provide

documentary evidence and he failed to do so. Respondent's

determination on this issue is sustained in full. 

8. Publications Expenses of $427

Petitioner purchased nonbusiness publications (Esquire,

Vanity Fair, Details) without providing any persuasive evidence

of business use. Petitioner failed to provide any substantiation

of his publications expense in the amount of $427, even though he

was given additional time after the trial to provide documentary

evidence. Respondent's determination on this issue is sustained

in full. 

9. Printing Expenses of $15,300

Petitioner's total Schedule C reported gross income amounted

to $21,876, of which only $3,500 was attributable to the creative

fees charged for the brochures and folios that he produced for

real estate brokers. 
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Petitioner testified that the $15,300 claimed as a deduction

for printing expenses was based upon the following costs of

producing the brochures and folios for the real estate brokers:

Petitioners’ Creative Production Total

 Exhibit Fees Costs Cost

 5 $1,500 $4,184.77 $5,684.77

 6 500 2,201.07 2,701.07

 7 500 3,427.10 3,927.10

 8 500 3,427.10 3,927.10

 9 500 2,201.07 2,701.07

 Exhibit totals 3,500 15,441.11 18,941.11

Examples of the brochures and folios, with an attached statement

of the production cost of each, were introduced into evidence. 

Attached to Exhibit 5 was an invoice to the client for

photography and printing costs reciting that a partial payment

had already been received. 

Petitioner has not persuaded us that he included in his

gross income any amounts corresponding to the $15,300 or more he

allegedly paid to printers and photographers. He claimed to have

the evidence but failed to provide it to the Court. We are

satisfied that the payments were made directly by the clients to

the printers or that, if petitioner acted as a conduit for the

payments, he did not include them in gross income. In either

case, he is not entitled to a deduction for them. It defies

credibility that petitioner would enter arrangements that would
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obligate him to incur and pay production costs more than four

times his $3,500 in fees without reimbursement by the clients. 

Respondent's determination on this issue is sustained in

full. 

To give effect to our partial allowance of some deductions

claimed by petitioner on his 1992 Schedule C for Jacobs Creative

Group, 

 Decision will be entered

 under Rule 155.