T.C. Memo. 1997-132

UNITED STATES TAX COURT

MARK D. AND SHELDON C. MORGAN, Petitioners

v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15590-94. Filed March 13, 1997.

Lewis R. Wiener, for petitioners.

Daniel J. Parent, for respondent.

MEMORANDUM OPINION

JACOBS, Judge: By separate notices of deficiency, both dated

May 27, 1994, respondent determined the following deficiencies and

accuracy-related penalties with respect to petitioners' Federal

income taxes:
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Accuracy-Related Penalty

Year Deficiency Sec. 6662(a)

1988 $ 1,351 ---

1989 19,046 $3,809

1990 16,430 3,286

1991 16,436 3,287

Pursuant to an amended answer, filed October 10, 1995, respondent

seeks a $9,864 increase in the deficiency for 1988, so that the

total amended amount of the proposed deficiency for that year is

$11,215.

Following concessions by petitioners, the issues for decision

are:

(1) The proper characterization (loans, as contended by

petitioners, or wages, as contended by respondent) of monthly

payments received by petitioner Mark D. Morgan from Robert Randall

Co. We hold that such payments are wages, includable in

petitioners' income.

(2) Whether petitioners are entitled to claimed employee

business expense deductions (for 1989, 1990, and 1991) for

automobile expenses. Because of petitioners' failure to provide

sufficient substantiation, we hold they are not.

(3) Whether the increased deficiency asserted by respondent

for 1988 is time-barred. We hold that it is not.

(4) Whether petitioners are liable for the accuracy-related

penalty under section 6662(a) for 1989, 1990, and 1991. We hold

they are.
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All section references are to the Internal Revenue Code for

the years under consideration. All Rule references are to the Tax

Court Rules of Practice and Procedure. All dollar amounts are

rounded.

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

stipulation of facts and the attached exhibits are incorporated

herein by this reference.

General Findings

Petitioners, husband and wife, resided in Carmichael,

California, at the time they filed their petition challenging

respondent's determinations. Petitioners timely filed joint

Federal income tax returns for each of the years under

consideration. On June 1, 1992, petitioners were issued a refund

of $1,351 for tax year 1988. The refund resulted from

petitioners' request for a tentative refund based upon a claimed

net operating loss carryback from 1991.

For convenience and clarity, we have combined additional

findings of fact and opinion with respect to each issue.

Issue 1. Characterization of Advances From Robert Randall Co.

Petitioner husband Mark D. Morgan (hereinafter referred to as

petitioner) has been involved for many years in real estate

activities, particularly the construction of real estate. In June

1988, he began working for Robert Randall Co. which is in the

business of developing and managing apartment complexes.

Previously, petitioner had been employed by Gibraltar Community
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1 The record is not clear on this point. Robert Randall

testified that he was "the chief executive officer, the

president, the chairman, and the owner" of Robert Randall Co.

2 The use of the word "advances" is not meant to give a

legal characterization of the monthly payments.

Builders, Inc. (Gibraltar). During 1987, petitioner received wages

from Gibraltar totaling $123,671; for the first 5 months of 1988,

petitioner received wages from Gibraltar totaling $66,382.

On June 21, 1988, petitioner and Robert Randall, the president

and apparently the sole or at least the majority shareholder1 of

Robert Randall Co., entered into an agreement (called and

hereinafter referred to as the Sunbelt Project Working Agreement),

pursuant to which petitioner agreed to be the regional manager

responsible for locating, acquiring, and developing properties in

the Sacramento area for multifamily housing on behalf of

partnerships or other entities to be controlled by Robert Randall

or his affiliate. In accordance with the provisions of the Sunbelt

Project Working Agreement, beginning in June 1988, and throughout

all years under consideration, Robert Randall Co. made monthly

payments, labeled "advances", to finance petitioner's living

expenses. In addition to these advances2, Robert Randall Co. paid

wages to petitioner. FICA (Social Security tax) was withheld on

these wages, but Federal income taxes were not.

The amount of wages and advances paid to petitioner were as

follows:
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Amount of Amount of

Year Wages Advances 

1988 $11,008 $40,950

1989 18,000 75,600

1990 18,000 84,600

1991 18,000 87,600

The advances include the following amounts designated as an

automobile allowance:

1988 $1,300

1989 2,400

1990 5,550

1991 6,600

The advances were paid on a monthly basis as follows:

June 1988 $3,150

July 1988-Mar. 1990 6,300

Apr. 1990-Dec. 1991 7,300

Robert Randall Co. did not withhold for income tax or FICA tax

on the advances.

As of the date of trial, petitioner had not repaid any of the

advances. The advances were not evidenced by notes, nor was

collateral given. Nor did Robert Randall Co. inquire into

petitioner's ability to repay the advances. There were no specific

repayment terms or fixed maturity dates. Rather, the advances were

to be charged against petitioner's share of profits of partnerships

to be formed between petitioner and Robert Randall.

Respondent determined that the advances petitioner received

from Robert Randall Co. constitute taxable compensation for

services. Petitioners claim that the advances were nontaxable

loans. Except for 1988, petitioners bear the burden of proving
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their characterization of the advances. Rule 142(a); Welch v.

Helvering, 290 U.S. 111 (1933). If petitioners meet their burden

of proof, then the advances are not includable in their income. 

See Falkoff v. Commissioner, 62 T.C. 200, 206 (1974); Arlen v.

Commissioner, 48 T.C. 640, 648 (1967). For 1988 only, respondent

bears the burden of proving the advances constitute taxable income

inasmuch as that is a new matter, first raised in respondent's

amended answer. Rule 142(a).

Whether the advances should be characterized as loans or

payments for services is a factual determination. Beaver v.

Commissioner, 55 T.C. 85 (1970); Haber v. Commissioner, 52 T.C. 255

(1969), affd. 422 F.2d 198 (5th Cir. 1970). For a payment to

constitute a loan, at the time the funds are transferred, the

recipient must intend to repay the advance, and the transferor must

intend to enforce repayment. Haag v. Commissioner, 88 T.C. 604,

615-616 (1987), affd. without published opinion 855 F.2d 855 (8th

Cir. 1988). Further, the obligation to repay must be unconditional

and not contingent upon a future event. United States v.

Henderson, 375 F.2d 36, 39-40 (5th Cir. 1967); Bouchard v.

Commissioner, 229 F.2d 703 (7th Cir. 1956), affg. T.C. Memo. 1954-

243. An intent to repay a purported loan by the performance of

services in the future does not result in the exclusion of the

underlying funds from the recipient's income. Beaver v.

Commissioner, supra at 91. In such a case, the purported loan

proceeds are nothing more than an advance salary or other payment
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for services which are includable in the recipient's income when

received.

Various objective factors are used in deciding whether an

advance payment is a loan or compensation. See Haag v.

Commissioner, 88 T.C. at 616 n.6., for a listing of some of these

factors. In the instant case, the following factors lead us to

conclude that the advances petitioner received from Robert Randall

Co. should be characterized as compensation, rather than loans:

1. The advances were from an employer to an employee.

2. Petitioner's wage compensation from his previous

employment with Gibraltar was significantly higher than the Form W2 wages petitioner received from Robert Randall Co.

3. The monthly advances began as soon as petitioner started

working for Robert Randall Co.

4. The amount of the advances was pre-set.

5. The advances were paid in regular monthly intervals.

6. There were no set repayment terms or fixed maturity date

at the time the advances were made.

7. There was no stated interest.

8. Petitioner had not repaid any of the advances as of the

date of trial.

9. There was no indication that petitioner could repay the

advances from his own resources.

10. The transferor did not inquire into petitioner's

financial status before making the advances.
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11. There was no collateral for the advances.

12. Petitioner would not have taken the position with Robert

Randall Co. if the latter had not paid him a substantial amount in

addition to his Form W-2 salary.

13. The value of services petitioner rendered was far in

excess of his Form W-2 salary.

14. Robert Randall Co. could not have hired someone with

petitioner's qualifications for the amount of Form W-2 salary paid

to petitioner.

15. The transferor would have caused the advances to

petitioner to stop if petitioner had stopped providing services.

Based on our determination that the advances were not loans,

but rather represent compensation for services, the advances are

includable in petitioner's income in the year paid.

Issue 2. Automobile Expenses

On petitioners' tax returns for 1989, 1990, and 1991,

petitioners claimed employee business expense deductions with

regard to petitioner's purported business use of an automobile, as

follows:

Year Amount

1989 $4,375

1990 5,200

1991 4,950

Respondent disallowed these deductions.

At trial, petitioner failed to provide any evidence or

substantiation (such as a log or diary) for the claimed expenses
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other than his own testimony that he "feels" that he drove

approximately 20,000 miles a year for business purposes.

Section 274(d) provides that no deduction shall be allowed

with respect to any listed property (as defined in section

280F(d)(4)) unless the taxpayer substantiates by adequate records

or sufficient evidence corroborating the taxpayer's own statement

the amount of such expense, the time and place of the expense, the

business purpose of the expense, and the business relationship of

the expense. A passenger automobile is considered listed property.

Sec. 280F(d)(4).

Because petitioner failed to satisfy the record keeping or

other substantiation requirements of section 274(d), petitioners

are not entitled to the claimed employee business deductions for

automobile expenses for 1989, 1990, and 1991.

Issue 3. Statute of Limitations Defense

The next issue for consideration is whether respondent is

time-barred from amending her answer to increase the amount of the

deficiency for 1988 by recharacterizing the advances petitioner

received in 1988 as wages. 

For 1988, petitioners reported a total gross income of

$82,034, consisting of wages ($77,388), interest ($3,318), and

unemployment compensation ($1,328). In addition, they reported the

sale of their home, but excluded the gain therefrom pursuant to

section 1034. The reported selling price for the home was $180,000;

the excluded gain was $14,050. 
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3 Even if the sale of petitioners' home is taken into

account, for sec. 6501(e) purposes, the $14,050 capital gain on

the sale, not the $180,000 gross sales price, is used in

(continued...)

Petitioners did not report in 1988 the $40,950 received in

advances from Robert Randall Co. As previously discussed, the

$40,950 constitutes compensation, which is includable in

petitioner's gross income.

Section 6501(e) provides: "If the taxpayer omits from gross

income an amount properly includable therein which is in excess of

25 percent of the amount of gross income stated in the return, the

tax may be assessed, or a proceeding in court for the collection of

such tax may be begun without assessment, at any time within 6

years after the return was filed." Further, section 6503(a)

provides for the suspension of the running of the period of

limitations if a proceeding is placed on the docket of this Court,

from the issuance of the deficiency notice until a decision of the

Court becomes final.

In the instant case, petitioners filed their 1988 return on

April 15, 1989. The notice of deficiency for 1988 was issued on

May 27, 1994. The petition requesting a redetermination of

respondent's deficiency determination for 1988 was filed on August

30, 1994. Sec. 6503.

The $40,950 which petitioners failed to include in their 1988

income is in excess of 25 percent of the amount of gross income

stated on the return.3 Thus, on the date respondent's notice of
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3(...continued)

computing the gross income reported on the return. See Burbage

v. Commissioner, 82 T.C. 546, 558 (1984), affd. 774 F.2d 644 (4th

Cir. 1985).

deficiency for 1988 was issued, the 6-year period of limitations

had not yet expired, and the omitted $40,950 could have properly

been included in respondent's deficiency notice. Accordingly,

respondent is not time-barred from asserting an increased

deficiency in her amended answer with respect to the omitted

$40,950 of wage income.

Issue 4. Accuracy-Related Penalty

Respondent determined an accuracy-related penalty under

section 6662(a) for 1989, 1990, and 1991. Section 6662 imposes a

penalty equal to 20 percent of the portion of an underpayment that,

among other things, is a substantial understatement of income tax.

An understatement of income is substantial if it exceeds the

greater of 10 percent of the tax required to be shown on the return

or $5,000. Sec. 6662(d)(1). The deficiencies here determined are

substantial understatements. 

The accuracy-related penalty does not apply with respect to

any portion of the underpayment if it is shown that there was

reasonable cause for such portion and that the taxpayer acted in

good faith with respect to such portion. Sec. 6664(c)(1).

Petitioners claim that they relied on their accountant to correctly

prepare their returns. Reliance by a taxpayer on the advice of a

qualified adviser will constitute reasonable cause and good faith
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if, under all of the facts and circumstances, the reliance was

reasonable and the taxpayer acted in good faith. Sec. 1.6664-

4(b)(1), Income Tax Regs. Considering all the facts and

circumstances presented, we do not find persuasive petitioner's

defense that he relied on his accountant to correctly prepare his

returns. The accountant did not testify. And we found

petitioner's self-serving testimony in this regard to be not

credible. In conclusion, we hold that petitioners are liable for

the accuracy-related penalty on the entire underpayment for 1989,

1990, and 1991.

To reflect the foregoing and because of the increased

deficiency for 1988,

Decision will be entered

under Rule 155.