1 Hereafter, unless otherwise noted, all section references

are to the Internal Revenue Code in effect for the years in

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

Practice and Procedure. All dollar amounts have been rounded to

the nearest dollar.

T.C. Summary Opinion 2008-40

UNITED STATES TAX COURT

RANDALL G. AND SHERYL S. KNOWLES, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 9401-06S. Filed April 21, 2008.

Randall G. and Sheryl S. Knowles, pro se.

Peter N. Scharff, for respondent.

HALPERN, Judge: This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect

when the petition was filed.1 Pursuant to section 7463(b), the

decision to be entered is not reviewable by any other court, and
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this opinion shall not be treated as precedent for any other

case.

By notice of deficiency, respondent determined deficiencies

in petitioners’ Federal income taxes of $1,565 and $3,174 for

their taxable (calendar) years 1999 and 2000, respectively. The

issues for decision concern certain amounts petitioners deducted

in computing petitioner Randall Knowles’s net profit from his

sole proprietorship.

Background

Introduction

Petitioner Sheryl Knowles was married to Mr. Knowles

throughout 1999 and 2000. During those years, Mr. Knowles was

the sole proprietor of an insurance sales business (the

business).

In September 1991, Mr. and Ms. Knowles signed an employment

contract (the employment contract) effective September 1, 1991.

Among other things, the employment contract provides that Ms.

Knowles is employed to be an office manager and for accounting

services, she is to be paid $200 a month, and Mr. Knowles is to

establish a medical reimbursement plan.

On September 1, 1991, Mr. Knowles executed the plan document

for a medical reimbursement plan (the medical plan) effective

that date. All employees were eligible to participate in the

medical plan. Under the terms of the medical plan, eligible
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employees are entitled to reimbursement for certain medical

expenses they incur, including major medical and hospital

insurance premiums for the employee and family, accident

insurance premiums for the employee only, and uninsured medical

expenses, without specifying whether for the employee or the

employee and family.

On September 2, 1991, Ms. Knowles executed an employee

application provided by Mr. Knowles for the medical plan,

electing to be covered for major medical insurance premiums for

employee and family, accident insurance premiums for employee

only, and uninsured medical expenses, without specifying whether

for the employee or the employee and family. On that same date,

Mr. Knowles executed a document, “Change of Primary

Policyholder”, directed to Life Investors, regarding Health

Insurance Policy No. 110-011546701 (the Life Investors policy),

changing the name of the primary policyholder from himself to Ms.

Knowles and listing himself as “dependent”.

Mr. Knowles executed a revised plan document for the medical

plan effective January 1, 1997, under which only full-time

employees are eligible to participate in the medical plan. Fulltime employees are defined as employees who work 20 hours or more

a week.
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In 1999 and 2000 Mr. Knowles paid the premiums for a medical

insurance policy (the medical policy) that covered both him and

Ms. Knowles.

During 1999 Mr. Knowles was insured under a disability

insurance policy (the disability policy) providing monthly

payments if Mr. Knowles was disabled and unable to work. Mr.

Knowles paid the premiums for the disability policy in 1999. 

Mr. Knowles did not track or record any hours that Ms.

Knowles worked for him during 1999 or 2000.

In 1999 and 2000 petitioners maintained one joint checking

account for which Ms. Knowles was the primary account holder. 

Petitioners used this account both for personal and business

purposes. Among the items shown in that account for 1999 and

2000 are payments to Life Investors for premiums. Similarly, in

1999 and 2000 petitioners maintained one joint credit card

account that was used to pay both personal and business expenses.

Ms. Knowles received no paychecks from Mr. Knowles in either

1999 or 2000.

During 1999 and 2000 Ms. Knowles was employed full time by

Montana State University.

Schedule C Deductions

For both 1999 and 2000 petitioners reported Mr. Knowles’s

profit from the business on a Schedule C, Profit or Loss From
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Business, attached to their Form 1040, U.S. Individual Income Tax

Return.

On the 1999 Schedule C petitioners deducted $1,788 for 

disability policy premiums, $2,020 for medical policy premiums,

and $3,005 for wages paid to Ms. Knowles.

On the 2000 Schedule C petitioners deducted $2,614 for 

medical policy premiums, $8,078 for out-of-pocket medical

expenses, and $3,120 for wages paid to Ms. Knowles.

Tax Reporting

Forms W-2, Wage and Tax Statement, issued by Mr. Knowles

reported that Ms. Knowles received wages of $2,980 and $3,120

from him in 1999 and 2000, respectively. Petitioners included

those amounts in gross income on their Forms 1040. Mr. Knowles

paid Social Security and Medicare taxes on the wages reported for

Ms. Knowles.

Discussion

Wages and Medical Expenses

Respondent argues that the wages attributed to Ms. Knowles

were not ordinary and necessary expenses of the business in 1999

and 2000 because Ms. Knowles was not a bona fide employee. 

Respondent claims that the wages and medical expenses are not an

ordinary and necessary business expense because Ms. Knowles was

not a bona fide employee of Mr. Knowles in those years. 

Respondent further claims that, even if Ms. Knowles was a bona
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fide employee, the medical expenses are not an ordinary and

necessary business expense because Ms. Knowles did not work at

least 20 hours a week in 1999 and 2000 as required to be covered

by the medical plan. Finally, respondent claims that, if Ms.

Knowles was otherwise eligible to receive benefits under the

medical plan, petitioners have failed to prove that Ms. Knowles

paid or incurred medical expenses in 1999 and 2000 for which she

was reimbursed by the medical plan.

Mr. Knowles testified convincingly as to his wife’s duties

as his employee under the employment contract:

She categorizes expenses for the preparation of Federal

and state tax returns. Reports data using Quicken

computer software. Provides counsel on business

decisions. Verifies deposits. Reconciles the business

checkbook. Reconciles credit card statements. 

Schedules invoice payments. Escorts * * * [me] to

business meetings and conferences. Chauffeurs * * *

[me] to business meetings and CLE Institutes. Prepares

data for CPA and other office duties as assigned. She

also acts as the medical plan administrator and

performs various duties such as processing claims and

maintaining records. * * * [she entertains] clients

through luncheons and dinners hosted at the office. 

The maintenance and physical upkeep of the 900 square

foot office and conference area are also part of her

responsibilities, and she used vacation time from her *

* * [Montana State University job] to perform some of

these duties.

Ms. Knowles also testified convincingly as to her duties. She

explained that, since she and Mr. Knowles maintained only one

checking account for their personal and the business expenses, it

made no sense for Mr. Knowles to write wage checks to her on that

account that she would then deposit back into the account. While
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we understand her reasons for that practice, it clouds a

situation that requires us to determine whether Ms. Knowles was

an employee in Mr. Knowles’s business. Mr. Knowles did, however,

report Ms. Knowles’s wages for withholding and wage tax purposes. 

On balance, petitioners have convinced us that Ms. Knowles was

employed in Mr. Knowles’s business during 1999 and 2000 and

received wages for her labor in at least the amounts reported on

the 1999 and 2000 Forms W-2, and we find accordingly.

We also believe that Ms. Knowles worked in the business at

least 20 hours a week in each of the years at issue. Mr.

Knowles’s failure to track or record Ms. Knowles’s work hours

weighs against petitioners, Ms. Knowles nevertheless credibly

testified that she worked approximately 20 to 22 hours a week. 

Respondent questions whether, generally, Ms. Knowles’s described

duties legitimately could occupy her for 20 hours a week. While

the question is close, we are persuaded that they could and find

that they did.

Petitioners were entitled to deduct wages reported as paid

to Ms. Knowles on the Forms W-2 issued by Mr. Knowles of $2,980

and $3,120, for 1999 and 2000, respectively.

At trial, respondent conceded that the amounts claimed on

petitioners’ 2000 Schedule C for premiums on the medical policy

and for out-of-pocket medical expenses were actually paid for

those purposes, and we find accordingly. We find the same for
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1999. While the evidence is sparse as to whether the Life

Investors policy is in fact the medical policy, petitioners’ bank

account records for 1999 and 2000 show payments to Life Investors

for premium payments, and we assume and find they are the same

policy. We also find that Ms. Knowles was the primary

policyholder under the medical policy during 1999 and 2000. We

further find that Mr. Knowles paid the premiums on the medical

policy for 1999 and 2000, thus entitling petitioners to deduct

the payments in determining the profits of the business, see sec.

1.162-10, Income Tax Regs., and entitling Ms. Knowles to exclude

the payments from gross income, see sec. 106(a). The 2000 outof-pocket expenses are a different story. There is no evidence

that they were paid solely for Ms. Knowles and, with respect to

the medical plan, while family members are included for purposes

of major medical and hospital insurance premiums reimbursement,

the medical plan fails to specify whether family members are

included for purposes of reimbursement of uninsured medical

expenses. Petitioners have failed to show that the 2000 out-ofpocket medical expenses were paid pursuant to the medical plan

and are therefore deductible under section 162. We sustain

respondent’s disallowance of $8,078 deducted on petitioners’ 

2000 Schedule C for out-of-pocket medical expenses.
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The Disability Policy

There is a question as to who owned the disability policy

during 1999. The parties have stipulated a copy of an undated

application for a disability insurance policy from Ohio National

Life Assurance Corporation/Cincinnati (the insurance

application). The insurance application shows Mr. Knowles as the

proposed insured and has three boxes under the heading “Owner

Information”, apparently allowing a check mark to show who the

owner shall be. The three boxes are labeled “Proposed Insured”,

“Applicant”, and “Other (Print Below)”. “Applicant” is checked,

although Ms. Knowles’s name and address are printed below the box

marked “Other (Print Below)”. There is no indication on the

insurance application as to who the applicant is. The parties

have also stipulated a document that contains the policy

specifications for a disability insurance policy from Ohio

National Life Assurance Corporation/Cincinnati (the policy

specifications) insuring Mr. Knowles and showing him as the owner

of the policy. The policy specifications show that the policy

was issued on January 16, 1996. The insurance application is

ambiguous as to who is the owner of the policy; i.e., the unnamed

applicant or Ms. Knowles. We therefore rely on the policy

specifications to find that Mr. Knowles was the policy owner

during 1999. We find that he was the owner during 1999 of the 
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disability policy. The policy premiums are nondeductible

personal expenses. See sec. 262.

Conclusion

To reflect the foregoing,

Decision will be entered

under Rule 155.