T.C. Sum m ary Opi ni on 20 14 -6 7

UNITED STAT ES TAX COURT

LEONARD B. SIMPSON AND JENNIFER A. SIM PSON, Pet it io ne rs v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 41 22 -1 2S . Fi le d J ul y 10 , 20 14 . D. Dou gl as Titus , forpe ti ti on ers . Pat sy A. Cla rk e, fo r res po nd en t.

SUMM ARY OPINION DEAN, Speci al Trial Ju dg e: Thi s ca se was h eardpu rs uantto th e p ro vi si on s of sec ti on 74 63 of t he Int ern al Rev enue Co de ineffe ctwhenth e p et it io n was fil ed . Pu rs ua ntto sec ti on 74 63 (b ), th e d eci si on to be en te redis no t re vi ewab le by any ot he r co urt, an d t hi s o pi ni on sh al l n otbe tre at edas p rece de ntforan y ot he r cas e. Unl es s o th erwi se in di cat ed , subs eque ntsec ti on refe ren ces are t o t he Int ern al- 2 -

Rev enue Co de ineffe ctforth e y ears at i ss ue , andRu le refe ren ces are t o t he Tax Co urt Ru le s o f Prac ti ce an d P ro cedur e. Res po nd en t i ss ue d ast atut ory no ti ce o f de fic ie nc y

to pe ti ti on ers de te rm in in g d efi ci en ci es inin co m e ta x o f $1 3,5 22 for 20 08 an d $ 10 ,48 8 fo r 20 09 . Res po nd en t al so de te rm in edaccu racy-rela te d p en al ti es un de r se ct io n 6 66 2( a) o f $2 ,52 4.4 0 fo r 20 08 an d $ 2,0 97 .60 for20 09 . Pet it io ne rs ha ve co nc ed edth atth ey rece iv eda pr em atur e d is tri bu ti on fro m anin di vi du al ret ire m en t ac co un t (I RA) i n 2 00 8. Th ey ha ve als o c on ced edva rio us it em s re la te d t o Leo na rdB. Sim ps on ’s (Mr. Si m

ps on ) act iv it y

rep orte d o n Sch edul es C, Pro fitor Lo ss Fro m Bu si ne ss , andpe ti ti on ers ’ act iv it ie s re po rte d o n Sch edul es E, Sup pl em en ta l In co m e an d Lo ss , th atwil l b e d is cu ss edbe lo w. The is su es rem ai ni ng forde ci si on are wh ethe r pe ti ti on ers are en ti tl edto de du ct : (1 ) 1 fo r 20 09 “po in ts ” p ai d i n c on ne ct io n wi thacqui rin g re al est at e; (2) ex pe ns es rep orte d o n S ch edul es C fo r bo th y ears ; an d (3 ) expe ns es rep orte d o n S ch edul es E fo r bo th y ears an d wh ethe r pe ti ti on ers are l iabl e fo r th e acc ur acy-rela te d p en al ty un de r se ct io n 6 66 2( a) fo r bo thy ears . The am ou nt s o f pe ti ti on ers ’ stud en t l oa n i nt eres t d educ ti on , sel f- 1 em pl oym en t t ax , andsel f-em pl oym en t t ax de du ct io n fo r eac h year are co m pu ta ti on al an d wi ll be res ol ve d b y th e d eci si on of t he Co urt o n t he ot he r is su es .- 3 -

So m e o f th e fac ts ha ve be enst ip ul at edan d a re s o fo un d. Th e st ip ul at io n o f fact s an d t he ex hi bi ts rece iv edinev id en ce ar e in co rp or at edhe rei n b y refe ren ce. Pet it io ne rs res id edinth e St at e o f W as hi ng to n wh enth e p et it io n was fil ed . Bac kg ro un d Mr. Si m ps on was e m

pl oyed fu ll ti m e as a se cu rit y gu ardin20 08 an d 2 00 9, an d h e rep orte d wag es fro m Int er-C on Secu rit y

an d Gu ard sm ark , LLC, for ea ch of th e y ears at i ss ue . Jen ni fer Si m ps on work edforpa rt o f 20 08 an d t he n b ecame un em pl oyed. Sh e li st edhe r oc cupa ti on on th ei r in co m e ta x re tu rnfor20 08 as un em pl oyed an d re po rte d wag es fro m MDS, In c., as anInt ern etm ark et in g m an ag er. On J anua ry

9, 2 00 8, M rs . Sim

ps on fil edforba nkrupt cy un de r ch ap te r 7 of th e Ban krup tc y

Co de an d was di sc ha rg edfro m ba nkrupt cy

on June 12 , 20 08 . 2 In20 09 Mrs . Sim

ps on rem ai ne d u ne m

pl oyed an d wi th dr ew $6 ,00 0 fro m anIRA. 3 20 08 “ Po in ts ” At tria l p et it io ne rs pro du ceda co py of two pa ge s o f a thr ee-p ag e se tt le m en t st at em en t, Fo rm

HUD-1, co nc ern in g M rs . Sim ps on ’s 20 04 pu rch as e o f a res id en ti al pro pe rty in Ne wcas tl e, W as hi ng to n (Ne wcas tl e p ro pe rty). The See 1 1 U.S.C. s ecs . 70 1- 76 7 (2 00 6) , so -cal le d l iqui da ti ng ba nkrupt cy . 2 The re i s n o e xp la na ti on inth e rec or d fo r th e ap pa ren t d is crep an cy be twee n 3 Mrs . Sim ps on ’s tes ti m on y

th atsh e wit hdrew $ 6,0 00 fro m he r IRA an d res po nd en t’s $ 28 2 a dju st m en t t o h er i nc om e.- 4 -

se tt le m en t d oc um en t re fle ct s a f irs t m ortg ag e o f $9 69 ,50 0 a nda se co ndm ortg ag e of $3 46 ,20 0. With lea ve of t he Co urt, p et it io ne rs pro vi de d aFo rm 10 98 , Mo rtg ag e In te res t St at em en t, fo r 20 04 sen t t o M rs . Sim ps on at a n a dd res s i n Seat tl e, W as hi ng to n, re fle ct in g a“ lo andi sc ou nt ” o r “po in ts ” o f $1 9,9 38 .25 pa id with re sp ectto th e “pu rch as e o f a p rin ci pl e [s ic ] res id en ce”. Pet it io ne rs th enin tro du cedas e vi de nc e fo r 20 08 a Fo rm 10 40 X, Am en de d U.S. Ind iv idua l In co m e Tax Return (v ers io n 2 ), sh owi ng anin crea se in“ it em iz ed de du ct io ns or s ta nd ardde du ct io ns ” o f $1 7,0 38 to refl ectth e d educ ti on of un am orti zedpo in ts , or p rep ai d i nt eres t, tha t p et it io ne rs ass ertwas p ai d wi th res pe ctto th ei r ho m e. Sp orts Unl im it ed In19 95 Mr. Si m

ps on be ga n a n a ct iv it y

he cal le d S po rts Unl im it ed In te rn at io na l (S po rts ). Pet it io ne rs rep orte d n etlo ss es on Sch edul es C fo r Sp orts fo r 20 05 , 20 06 , and20 07 . Peti ti on ers fil edwith the ir F ed eral in co m e ta x re tu rn s Sch edul es C fo r Sp orts rep orti ng ne t l os se s o f $4 5,8 00 for20 08 an d $ 18 ,63 0 fo r 20 09 . Altho ug h p et it io ne rs rep orte d g ro ss in co m e o f $1 0,5 00 on Sch edul e C fo r 20 08 , th e p art ie s ag ree t ha t p et it io ne rs di d n otearn any Sch edul e C g ro ss in co m e in 20 08 . Duri ng Mr. Si m ps on ’s tes ti m on y , pet it io ne rs in tro du cedin to ev id en ce a- 5 -

Fo rm 10 40 X for20 08 (ve rs io n 1 ) al on g wi th a rev is edSch edul e C fo r 20 08 th at refl ect s ch an ge s t o t he ori gi na l Sc he du le C fo r Sp orts . The v ers io n 1 Fo rm 10 40 X refl ect s t he de le ti on of $ 10 ,50 0 o f gr os s i nc om e an d t he de le ti on of b oth a de du ct io n fo r adve rti si ng expe ns es of $ 43 ,20 0 a nda de du ct io n fo r m eal s an d en te rta in m en t ex pe ns es of $ 2,7 00 , all of wh ic h wer e rep orte d o n t he ori gi na l Sch edul e C fi le d wi th res po nd en t. Altho ug h p et it io ne rs rep orte d S ch edul e C g ro ss in co m e o f $4 ,80 0 fo r 20 09 , th e p art ie s ag ree t ha t p et it io ne rs earn edzero Sch edul e C g ro ss in co m e in 20 09 . Dur in g M r. Sim

ps on ’s tes ti m on y

pe ti ti on ers in tro du cedin to ev id en ce a Fo rm 10 40 X for20 09 alo ng with arev is edSch edul e C tha t re fle ct s ch an ge s t o h is or ig in al Sch edul e C fo r Sp orts forth aty ear. Th e Fo rm 10 40 X for20 09 refl ect s th e d el et io n o f gr os s i nc om e o f $4 ,80 0 a ndth e d el et io n o f a d educ ti on foran adve rti si ng ex pe ns e o f $1 7,5 00 rep orte d o n the ori gi na l Fo rm 10 40 fil edwith res po nd en t. Sch edul e E Pet it io ne rs li st edon th ei r Sch edul e E for20 05 eig htreal est at e p ro pe rti es . In20 07 , ho wev er, the y

be ga n h av in g d iff

ic ul ty “ se cu rin g l in es of c red itan d refi na nc in g o n t he pro pe rti es .” They were th en“pr et ty m uc h u nd erwat er o n m os t of th e p ro pe rti es .” Mo stof t he pro pe rti es were i n M rs . Sim ps on ’s nam e. By

20 08- 6 -

pe ti ti on ers own edon ly pro pe rty onW oo dl an d Av enue inKans as Cit y (W oo dl an d Ave nu e). Pet it io ne rs off

eredno in fo rm at io n e xp la in in g t he cir cu m st an ces of t he ir di sp os al of a ny of th e o th er p ro pe rti es . 4 Pet it io ne rs fil edSch edul es E repo rti ng lo ss es of $ 5,8 57 for20 08 an d $2 2,7 09 for20 09 . Peti ti on ers in tro du cedat tria l a c op y of aSch edul e E for20 08 with “ co rrec ti on s” : a d educ ti on form ortg ag e in te res t p ai d t o b an ks of $ 1,9 48 was el im in at edan d t he de pr eci at io n e xp en se de du ct io n was in crea se d fr om $1 ,70 9 t o $2 ,58 2. Pet it io ne rs als o i nt ro du cedat t ria l a r ev is edSch edul e E for20 09 . The rev is edSch edul e E for20 09 de le te d $ 24 ,00 0 t ha t h adbe enrep orte d a s a d educ ti on fo r rep ai rs to W oo dl an d Av enue . The ch an ge was m ad e b ecau se pe ti ti on ers are

“ no lo ng er d educ ti ng $2 4,0 00 inon e y ear” bu t “ de pr eci at in g a ndtak in g t he de du ct io n e ach y ear f

or27 1⁄2 y ears ”. Pet it io ne rs in crea se d t he ir d ep reci at io n ex pe ns e d educ ti on on th e 2 00 9 S ch edul e E fro m $1 ,70 9 t o $ 2,5 82 . Pet it io ne rs all eg e th atth e Fo rm s 1 04 0X fo r 20 08 an d 2 00 9 i nc or po rat e th e ch an ge s re po rte d o n t he rev is edSch edul es C an d E.

Altho ug h M rs . Sim

ps on wentth ro ug h aba nkrupt cy pro ceed in g i n 2 00 8, the 4 Co urt was no t p ro vi de d wi th an y de ta il s ab ou t tha t p ro ces s. Th ere was no th in g i n th e rec or d d oc um en ti ng a ba nkrupt cy pro ceed in g c on cern in g M r. Sim ps on .- 7 - Dis cu ss io n Gen eral ly, th e Co m

m is si on er’s d et erm in at io ns ina no ti ce o f de fic ie nc y are pr es um edco rrec t, an d t he tax pa y er h as th e b ur de n o f pr ov in g t ha t tho se de te rm in at io ns are erro ne ou s. See Ru le 14 2( a); W el chv. Hel ve rin g, 2 90 U.S. 11 1, 11 5 (1 93 3) . In s om e cas es th e b ur de n o f pr oo f wit h re sp ectto rel ev an t fa ctua l is su es m ay

sh iftto th e Co m

m is si on er u nd er s ect io n 7 49 1( a). The Co urt fi nd s t ha t pe ti ti on ers ha ve no t ar gu edor s ho wn tha t the y have m etth e requi rem en ts of se ct io n 7 49 1( a) an d t he bu rd enof p ro of do es no t s hi ft t o re sp on de nt .

“ Po in ts ” Deduc ti on for20 08 In te res t i s co m

pe ns at io n fo r th e u se or f orbe aran ce o f m on ey . Depu ty v. du Po nt , 30 8 U.S. 4 88 , 49 8 (1 94 0) . “ Po in ts ” p ai d fo r th e u se or f orbe aran ce o f m on ey m ay be de du ct ib le as p rep ai d i nt eres t. Cao v. Co m m is si on er, T.C. Mem o. 1 99 4- 60 , aff’d wit ho utpubl is he d o pi ni on , 78 F.3d59 4 (9 th Cir . 19 96 ). Pet it io ne rs co nt en d t ha t the y are en ti tl edto de du ctfor20 08 pre pa idin te res t pa idinco nn ect io n wi th th e 2 00 4 a cqui si ti on of “ th ei r ho m e” b ecau se th e h om e was subjec t t o fo recl os ur e p ro ceed in gs in20 08 . As pe ti ti on ers di d n otrep ort fo r 20 08 an y ga in or l os s fr om

th e d is po si ti onof p ro pe rty in 2 00 8, the Co urt i nf ers th atth e fo recl os ur e m ay

ha ve tak enpl ace a s p artof M rs . Sim ps on ’s ban krup tc y pr oc eed in gs . If th e fo recl os ur e to okpl ace dur in g t he bankrupt cy pro ceed in gs , th e- 8 -

ba nkrupt cy

est at e b or e th e ta x c on se qu en ces of t he for ecl os ur e, in cl ud in g t he de du ct io n o f acc ru edin te res t an d p oi nt s, ab se ntanab an do nm en t o f th e p ro pe rty by the est at e. See C at al an o v . Comm is si on er, T.C. Mem o. 2 00 0- 82 , rev ’d on ot he r gr ou nd s, 2 79 F.3d68 2 (9 thCir . 20 02 ); B erg m anv. Co m mis si on er, T.C. Mem o. 19 85 -2 56 . As no te d e arl ie r, no de ta il s ab ou t M rs . Sim ps on ’s ban krup tc y pr oc eed in gs were p ro vi de d t o t he Co urt, an d n o i nf orm at io n abo utan y

for ecl os ur e pr oc eed in gs on pe ti ti on ers ’ “ ho m e” was pro vi de d. Pet it io ne rs di d p ro vi de two pa ge s o f a thr ee-p ag e se tt le m en t s ta te m en t, Fo rm HUD-1, co nc ern in g t he 20 04 pu rch as e b y Mrs . Sim ps on of t he Newcas tl e pr op erty sh owi ng th atth e “ Loan Di sc ou nt ” p ai d t o Am eri can Hom e Equ it y Co rp . was $1 9,9 38 .25 . The ad dr es s o f th e p ro pe rty is s ta te d a s 1 52 22 SE 82 ndCo urt, Newcas tl e, W as hi ng to n. No tabl y , no ne of t he tax form s i n e vi de nc e (fo r th e ta xabl e y ears at i ss ue , as wel l as for20 05 an d 2 00 7) li st s t hi s ad dr es s- -n otas a m ai li ng ad dr es s fo r pe ti ti on ers , no t as anad dr es s o n a ny of Fo rm s W-2, Wage an d Tax Sta te m en t, Fo rm s 1 09 8, o r Fo rm s 1 09 9, M is cel la ne ou s In co m e, an d n otas a ren ta l p ro pe rty onan y

of t he Sch edul es E. Noth in g i n t he reco rdsu gg es ts , let al on e es tabl is he s, tha t the pro pe rty for wh ic h p et it io ne rs m ay ha ve pa idth es e po in ts was o wne d b y

eit he r of th em at a ny po in t b ey on d i ts acqui si ti on in20 04 .- 9 -

W it ho utm or e in fo rm at io n c on cern in g t he ho m e’s own ers hi p, i ts st atus as ei th er a re si de nc e o r in ve st m en t p ro pe rty, or it s s al e o r ot he r di sp os it io n, the Co urt is un ab le to pe rm itpe ti ti on ers th e d educ ti on th ey no w see k. Sch edul e C an d E Ex pe ns es Res po nd en t co nt en ds th atpe ti ti on ers ha ve no t s ho wn, fo r th e y ears at i ss ue , th atth e Sp orts act iv it y

an d the ren ta l ac ti vi ty, if a ny, w ere a ctua ll y co nduc te d fo r pr of itor a s b us in es se s. Bu t i f th ey were s o c on du ct ed , res po nd en t co nt en ds th at pe ti ti on ers ha ve ad equa te ly sub st an ti at edne it he r th e am ou nt s o f th e ex pe ns es de du ct edas ares ul t o f th e act iv it ie s n orwhet he r th e ex pe ns es were o rd in ary an d ne ces sa ry . Deduc ti on s ar e al lo wedun de r se ct io n 1 62 forth e o rd in ary an d n eces sa ry ex pe ns es of c arrying onanact iv it y th atco ns ti tu te s t he tax pa y er’s trad e o r bu si ne ss . Dedu ct io ns are al lo wedun de r se ct io n 2 12 (1 ) an d (2 ) fo r expe ns es pa id in co nn ect io n wi th anact iv it y en ga ge d i n fo r th e p ro du ct io n o r co ll ect io n o f in co m e, or

forth e m an ag em en t, co ns erv at io n, o r m ai nt en an ce o f pr op erty he ldfor th e p ro du ct io n o f in co m e. Gen eral ly, no de du ct io n i s al lo wedforpe rs on al , li vi ng , or fa m il y ex pe ns es . See s ec. 2 62 . The t ax pa y er m us t s ho w th atan y

cla im edbu si ne ss ex pe ns es were pa idpri m ari ly for b us in es s ra th er tha n p ers on al , li vi ng , or fa m il y reas on s. See- 10 -

Ru le 14 2( a); W al li se r v. C omm is si on er, 7 2 T.C. 4 33 , 43 7 (1 97 9) . To sh ow tha t th e ex pe ns e was no t fo r pe rs on al reas on s, the tax pa y er m us t s ho w th atth e ex pe ns e was pa idpri m ari ly to b en efi t h is bu si ne ss , andth ere m us t h av e b een a pr ox im at e rel at io ns hi p b etweenth e cl ai m edex pe ns e an d t he bu si ne ss . See Walli se r v. Co m m is si on er, 7 2 T.C. at43 7. W it h re sp ectto eit he r se ct io n 1 62 or s ect io n 2 12 th e ta xp ay er m us t de m on st rat e a p ro fitob

jecti ve forth e act iv it y

inord er t o d educ t as so ci at ed ex pe ns es . See J as io no wsk i v . Comm is si on er, 6 6 T.C. 3 12 , 32 0- 32 2 (1 97 6) ; s ec. 1.1 83 -2 (a), In co m e Tax Reg s. Th e p ro fitst an da rd s ap pl ic ab le forsec ti on 21 2 a re th e sa m e as th os e u se d fo r se ct io n 1 62 . See Ag ro Sci . Co. v . Comm is si on er, 9 34 F.2 d 5 73 , 57 6 (5 th Cir . 19 91 ), aff’g T.C. Me m o. 1 98 9- 68 7; Ant on id es v. Co m m is si on er, 8 93 F.2d65 6, 6 59 (4t h C ir. 1 99 0) , aff’g 9 1 T.C. 6 86 (19 88 ); Al le n v. Co m m is si on er, 7 2 T.C. 2 8, 3 3 (1 97 9) ; Randv. Co m m is si on er, 3 4 T.C. 1 14 6, 11 49 (19 60 ). Sect io n 1 .18 3- 2( b) , Inc om e Tax Reg s., s et s fo rth ni ne no ne xc lu si ve fact or s th atsh ou ldbe co ns id eredinde te rm in in g wh ethe r a t axpa y er i s en ga ge d i n a ve ntur e wit h apro fitob

jecti ve . A tax pa y er, i n o rd er t o s ho w th athe was e ng ag ed in a tr ad e o r bu si ne ss , m

us t s ho w no t o nl y

th athi s p rimary

pu rp os e fo r en ga gi ng in th e act iv it y

was fo r in co m e o r pr of

itbu t al so th athe en ga ge d i n t he act iv it y with- 11 -

“ co nt in ui ty andreg ul ari ty”. Com m is si on er v . Groe tz in ge r, 48 0 U.S. 2 3, 3 5 (1 98 7) . Whe re a t ax pay er h as est ab li sh edth athe ha s p ai d atra de or b us in es s ex pe ns e, fai lu re t o p ro ve th e ex actam ou ntof t he ot he rwis e d educ ti bl e it em m ay no t al way s b e fat al . Gener al ly, un le ss pre ve nt edby sect io n 2 74 , th e Co urt m ay es ti m at e th e am ou ntof s uc h a n e xp en se an d a ll ow the de du ct io n t o tha t ex te nt . See F in le y

v. Co m m is si on er, 2 55 F.2d12 8, 1 33 (10 th Cir . 19 58 ), aff’g 2 7 T.C. 41 3 (1 95 6) ; Co ha n v . Comm is si on er, 3 9 F .2d54 0, 5 43 -5 44 (2dCir . 19 30 ). In or de r fo r th e Co urt t o e st im at e th e am ou ntof a n e xp en se , ho wev er, the re m us t b e so m e b as is up on whi ch anest im at e m ay be m ad e. Vani cekv. Co m m is si on er, 8 5 T.C. 73 1, 7 42 -7 43 (19 85 ). W it ho utsu cha ba si s, an all owa nc e wou ldam ou ntto un gu id edlar ge ss e. W il li am s v . Comm is si on er, 2 45 F.2d55 9, 5 60 (5t h C ir. 1 95 7) . Befo re ex am in in g t he is su es of wh ethe r pe ti ti on ers have ad equa te ly subs ta nt ia te d t he am ou nt s o f th e ex pe ns es de du ct edon th ei r Sch edul es C an d E o r whe th er the ex pe ns es were o rd in ary an d n eces sa ry , itis ap pr op ria te th atth e Co urt co ns id er p et it io ne rs ’ ev id en ce o f th ei r carry in g o n atra de or b us in es s an d h ol di ng pr op erty forth e p ro du ct io n o f in co m e.- 12 -

Sp orts Pet it io ne rs adm itth atth ey di d n otrece iv e an y

in co m e fro m

th e Sp orts act iv ity inth e y ears at i ss ue ev enth ou gh th ey in it ia ll y rep orte d t ha t the y

di d. Mr . Si m ps onde sc rib edhi s ac ti vi ty as a s po rts ag en t b us in es s. Mr . Sim ps on tes ti fie d th athe li ve d i n ane ig hb orho odwher e h e was “ su rro un de d b y ath le te s wh o p la y ed fo r th e Sea ha wks an d S up ers on ic s.” He t es ti fie d t ha t h e at te m pt edto si gn ath le te s to pro fes si on al co nt ract s an d a rran ge “ m ark et in g a ndadve rti se m en t an d en do rs em en t” de al s. Pet it io ne r te st ifi edth atinord er t o re cru ity ou ng m al e athl et es , he was requi redto in cu r ex pe ns es to go to ba rs , cas in os , clubs , and pa rti es an d t o t ak e li m ou si ne rid es an d b uy j ewel ry an d a irl in e ti ck et s. Pet it io ne rs subm it te d a s ev id en ce o f Mr. Si m ps on ’s Spo rts act iv it y : (1 ) bu si ne ss li cen se s fr om th e ci ty of Sea tt le inth e n am e o f Sp orts forth e y ears 19 98 th ro ug h 2 00 2 a ndfor20 07 ; (2 ) two Int ern at io na l Ba sk etba ll Ass oc ia ti on pl ay er co nt ract s fr om

19 96 sai d t o b e “ rep res en ta ti ve ” o f th e “ type o f co nt ract s h e he lp edsec ur e” al on g wi th ot he r m at eri al s fr om 19 96 ; (3 ) anin vo ic e is su edinth e na m e o f Sp orts da te d J anua ry 10 , 19 97 , alo ng with m is cel la ne ou s co rres po nd en ce da te d i n 1 99 7; (4) mis cel la ne ou s co rres po nd en ce d at edin19 98 an d 1 99 9; an d (5 ) th e o nl y it em co nt em po ran eo us with ay ear a t i ss ue , a Feb ru ary 8, 2 00 8, p ro po sa l- 13 -

by “ Pl at in um ” to pe rfo rm for Sp orts a m ark et in g andadve rti si ng cam pa ig n t ha t was att ach edto a pl ay er l is t fr om 19 97 . Mr. Si m ps on tes ti fie d t ha t h e d idno t s ig n a ny pla y er co nt ract s i n 2 00 7, 20 08 , or 2 00 9. In fact , pet it io ne rs off eredno ev id en ce o th er tha n t he ir o wn te st im on y th atMr. Si m

ps onwas c on du ct in g a ny spo rts ag en t ac ti vi ty in 2 00 8 a nd 20 09 . The Co urt i s n otrequi redto acce ptth ei r se lf- se rv in g t es ti m on y , parti cu la rly in th e ab se nc e o f co rro bo rat in g e vi de nc e. See Gei ge r v. C omm is si on er, 4 40 F.2d 68 8, 6 89 (9t h C ir. 1 97 1) , aff’g p er cu ria m T.C. Mem o. 1 96 9- 15 9; Urba n R ed ev . Co rp . v. Co m

m is si on er, 2 94 F.2d32 8, 3 32 (4t h C ir. 1 96 1) , aff’g 3 4 T.C. 8 45 (1 96 0) . Becau se of t he in co ns is te nc ie s an d e ccen tri ci ti es inth e rec or d t he Co urt de cl in es to acce ptth ei r te st im on y . Si nc e th e Co urt co nc lu de s t ha t Sp orts was c on du ct edne ithe r as a pr of it se ek in g a ct iv it y

no r as a go in g c on cern inth e y ears at i ss ue itis no t n eces sary to co ns id er wh ethe r th e d educ te d e xp en se s wer e o rd in ary an d n eces sa ry bu si ne ss ex pe ns es . Becau se pe ti ti on ers ha ve no t s ho wn fo r wha t p ur po se th e cl ai m ed ex pe ns es m ig htothe rwis e b e d educ ti bl e, th e Co urt s us ta in s re sp on de nt ’s de te rm in at io n o n t hi s i ss ue . 5 As p et it io ne rs earn edno gro ss in co m e fro m Sp orts inth e y ears at i ss ue , 5 th ey are n oten ti tl edto an y

de du ct io ns foranact iv it y no t en ga ge d i n fo r pr of

it . (co nt in ue d...)- 14 -

Ren ta l Act iv it y Res po nd en t d is al lo wedpe ti ti on ers ’ de du ct io n o n S ch edul e E of e xp en se s fo r de pr eci at io n, m ortg ag e in te res t, cl ean in g a ndm ai nt en an ce, au to an d trav el , and rep ai rs rel at edto W oo dl an d Av enue . Mr. Si m ps on tes ti fie d t ha t p et it io ne rs ren te d W oo dl an d Av enue to hi s u nc le , Davi d S im ps on , in20 08 an d 2 00 9, dur in g wh ic h ti m e Mr. Si m

ps on st at edhe als o h ada m ajorren ov at io n p erfo rm edon W oo dl an d Ave nu e. Acco rd in g t o M r. Sim ps on , th ere was no writ te n l eas e ag reem en t an d n o ren t re cei pt s wer e p ro vi de d t o h is un cl e fo r ren ta l p aym en ts m ad e. Ther e were al so few rec ei pt s, i f an y , det ai li ng pe ti ti on ers ’ expe ns es . Pet it io ne rs , hav in g c la im eda m ortg ag e in te res t ex pe ns e d educ ti on of $1 ,94 8 o n S ch edul e E for20 08 , pre se nt edat t ria l a r ev is edSch edul e E de le ti ng th e in te res t d educ ti on witho utex pl an at io n. Pe ti ti on ers de du ct ed$6 ,80 0 o f rep ai rs ex pe ns es th atwere ch an ge d o n t he rev is edSch edul e E to “ Pai nt in g andot he r co nt ract edm ai nt en an ce” e xp en se s o f $6 ,80 0. Pe ti ti on ers ’ ev id en ce tha t the y pa id ex pe ns es forau to an d t rav el was M r. Sim ps on ’s tes ti m on y

th athe ha d p ai d t he ex pe ns es incas h. Lik ewis e, Mr. Si m ps on tes ti fie d t ha t the ex pe ns es forcle an in g (...co nt inue d) 5 See s ec. 1 83 (b )(2 ). Pet it io ne rs di d n otde du ctan y sec . 18 3( b) (1 ) it em s o n Sch edul e C.- 15 -

an d m ai nt en an ce were all pa idincas h t o h is fathe r, “ Leo na rdSen io r”, a g en eral co nt ract or . As ev id en ce o f th e rep ai rs ex pe ns es for 20 09 pe ti ti on ers off

ereda se rie s o f co pi es of d oc um en ts ti tl ed“ Pro po sa l” an d “ In vo ic e”. The do cum en ts are s ta te d t o be fro m “ Ja m es Pet ers onRem od el in g” to Len C anBu il de rs , Inc ., th e co m pa ny own edby Mr. Sim

ps on ’s fathe r. Mr. Si m

ps on tes ti fie d t ha t the pro po sa ls an d in vo ic es were p as se d fr om Mr. Si m ps on ’s fathe r to Mr. Si m

ps onan d h is fathe r ov ers aw th e work. Mr . Sim ps ontes ti fie d t ha t h e p ai d t he in vo ic es incas h b y de li ve rin g i t “ph y si cal ly to wo rk ers ”. 6 Pet it io ne rs off

eredno ev id en ce o n t he se is su es ot he r th anth ei r te st im on y . The Co urt co nc lu de s t ha t p et it io ne rs ha ve no t s ho wn tha t Woo dl an d Av enue was he ldforren ta l i n 2 00 8 a nd20 09 an d i f itwas t he y ha ve no t s ub st an ti at edth e di sa ll owe d e xp en se s d educ te d o n S ch edul e E. Res po nd en t’s d et erm in at io n o n th es e is su es is su st ai ne d.

The Co urt n ot es th atpe ti ti on ers res id edinth e St at e o f W as hi ng to n a t the 6 ti m e th e p et it io n was fil edan d t ha t the no ti ce o f de fic ie nc y up on whi chth is cas e is ba se d was sen t t o t he m

inSeat tl e, W as hi ng to n. Th e in co m e ta x re tu rn s fi le d fo r th e y ears at i ss ue refl ectpe ti ti on ers ’ res id en ce t o b e in Seat tl e, W as hi ng to n. W oo dl an d Av enue is inKans as Cit y , Mis so ur i.- 16 -

Accu racy-Rel at edPen al ty Sect io n 7 49 1( c) i m

po se s o n t he Co m

m is si on er the bu rd enof p ro du ct io n i n an y co urt p ro ceed in g wi th res pe ctto th e li ab il it y of any ind iv idua l fo r pe na lt ie s an d a dd it io ns to tax . Hig be e v . Comm is si on er, 1 16 T.C. 43 8, 4 46 (20 01 ); Trowb rid ge v. Co m

m is si on er, T.C. Mem o. 2 00 3- 16 4, af f’d, 37 8 F .3d43 2 (5 th Cir . 20 04 ). In o rd er t o m eetth e b ur de n o f pr oduc ti onun de r se ct io n 7 49 1( c), the Co m m is si on er n eedon ly m ak e a p rima facie cas e th atim po si ti onof t he pe na lt y

or ad di ti on to tax is ap pr op ria te . Hig be e v . Comm is si on er, 1 16 T.C. at 4 46 . Res po nd en t d et erm in edth atfor 20 08 an d 2 00 9 p et it io ne rs un de rp ai d a po rti onof t he ir i nc om e ta x b ecau se of n eg li ge nc e o r in te nt io na l d is reg ardof rul es an d re gu la ti on s an d t ha t the re i s a s ub st an ti al un de rs ta te m en t o f in co m e ta x. Sect io n 6 66 2( a) an d (b )(1 ) an d (2 ) im po se s a p en al ty equ al to 20 % of t he po rti on of th e und erp aym en t at tri bu tabl e to ne gl ig en ce o r di sr eg ardof rul es or r eg ul at io ns ora subs ta nt ia l u nd ers ta te m en t o f in co m e ta x. Neg li ge nc e is de fin edas a ny fail ur e to m ak e a rea so nabl e at te m ptto co m pl y with t he pro vi si on s o f th e In te rn al Rev enue Co de , andth e te rm “ di sr eg ard ” in cl ud es an y

care le ss , reck le ss , or i nt en ti on al di sr eg ard . See s ec. 6 66 2( c). Neg li ge nc e al so in cl ud es an y fai lu re b y

th e ta xp ay er t o k eep ad equa te bo ok s an d reco rd s o r to subs tant ia te it em s p ro pe rly. Sec. 1.6 66 2- 3( b) (1 ), In co m e Tax Reg s.- 17 -

A “ subs ta nt ia l u nd ers ta te m en t” in cl ud es anun de rs ta te m en t o f ta x t ha t ex ceed s the gre at er o f 10 % of t he tax requi redto be sh own on th e return o r $5 ,00 0. Se e se c. 66 62 (d ); s ec. 1 .66 62 -4 (b ), In co m e Tax Reg s. Th e ta x s ho wn o n pe ti ti on ers ’ joi ntreturn fo r 20 08 was $ 4,9 09 , andth e ta x s ho wn o n t he return fo r 20 09 was $ 62 8. Pe ti ti on ers ’ co rrec t t ax li ab il it y for20 08 is $1 6,9 31 , andfor20 09 itis $7 ,69 6. Pe ti ti on ers ha ve a subs ta nt ia l u nd ers ta te m en t o f ta x fo r eac h o f 20 08 an d 2 00 9 s in ce the un de rs ta te m en t am ou ntforeach y ear wi ll ex ceedbo th 10 % of th e ta x re qu ire d t o b e sh ownon th e return fo r th aty ear a nd$5 ,00 0. Th e Co urt co nc lu de s t ha t re sp on de ntha s p ro du cedsu ffi ci en t ev id en ce t o s ho w th atth e accu racy-rela te d p en al ty und er s ect io n 6 66 2 i s ap pr op ria te for20 08 an d 2 00 9. The accu racy-rela te d p en al ty w il l ap pl y un le ss a ta xp ay er d em on st rat es th at th ere was reas on ab le cau se forth e und erp aym en t an d t ha t h e o r sh e act edingo od fai th with re sp ectto th e und erp aym en t. See sec . 66 64 (c). Sec ti on 1.6 66 4- 4( b) (1 ), In co m e Tax Reg s., s pe ci fic al ly pro vi de s: “ Ci rcu m st an ces th atm ay in di cat e reas on ab le cau se an d g oo d fa it h i nc lu de anho ne stmis un de rs tand in g o f fac t o r la w th atis reas on ab le inli gh t o f * * * the ex pe rie nc e, kn owl ed ge , andeduc at io n o f th e ta xp ay er.” Th e m os t i m

po rta ntfact oris th e ex te ntof t he tax pa y er’s eff ort t o as se ss hi s p ro pe r ta x l iabi li ty for the y ear. Id .- 18 -

Pet it io ne rs di d n otsh ow tha t the re was reas on ab le cau se for , andth atth ey act edingo odfai th with re sp ectto , th e und erp aym en ts of t ax for20 08 an d 2 00 9. The refo re, res po nd en t’s d et erm in at io n o f th e acc ur acy-rela te d p en al ty und er se ct io n 6 66 2( a) fo r 20 08 an d 2 00 9 i s s us ta in ed . To re fle ctth e fo reg oi ng , Deci si on wil l b e en te redun de r Ru le 15 5.