TAX COURT OPINION

Case: Building Inspectors & Consultants
Docket Number: 9493-11
Judge: Marvel
Opinion Type: bench
Filed: 05/08/2012
Pages: 16

UNITED STATES TAX COURT WASHINGTON, DC 20217 BUILDING INSPECTORS & CONSULTANTS, Petitioner , v. COMMISSIONER OF INTERNAL REVENUE, ) ) ) ) ) Docket No. 9493-11 ) ) Respondent. ) ORDER Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit to petitioner and to respondent a copy of the pages of the transcript of the proceedings of the above case before Judge L. Paige Marvel at San Diego, California, on April 19, 2012, containing her oral findings of fact and opinion. In accordance with the oral findings of fact and opinion, decision will be entered under Rule 155. (Signed) L. Paige Marvel Judge Dated: Washington, D.C. May 8, 2012 SERVED MAY -9 2012 2 1 Bench Opinion by Judge L. Paige Marvel April 19, 2012 2 Building Inspectors & Consultants v. Commissioner 3 Docket No. 9493-11 4 5 6 7 8 9 THE COURT: The Court has decided to render oral findings of fact and opinion in this case, and the following represents the Court's oral findings of fact and opinion. This bench opinion is made pursuant to the authority granted by section 7459(b) of the Internal 10 Revenue Code of 1986, as amended, and Rule 152 of the Tax 11 Court Rules of Practice and Procedure. Unless otherwise 12 13 14 15 16 17 18 19 20 indicated, subsequent section references made in this bench opinion are to the Internal Revenue Code of 1986, as amended, in effect for the relevant period, and Rule references are to the Tax Court Rules of Practice and Procedure. Michael Benoit, Petitioner's president, appeared as Petitioner's agent. Karen Walkenhorst appeared on behalf of Respondent. On February 7, 2011, Respondent mailed to 21 Petitioner a notice of deficiency for 2007, in which he 22 23 determined a deficiency of $38,406 and an accuracy- related penalty under section 6662(a) of $7,681.20. 24 Petitioner timely filed a petition contesting 25 Respondent's determinations. In the petition, Petitioner Heritage Reporting Corporation (202) 628-4888 3 1 2 3 4 5 6 7 8 9 10 11 12 13 14 alleged that the notice of deficiency was fabricated in response to Petitioner's request that the Internal Revenue Service (IRS) comply with the Privacy Act of 1974 (Privacy Act), 5 U.S.C. sec. 552a (2006). The issues for decision are whether Petitioner is liable for the income tax deficiency and the section 6662(a) penalty, as determined by Respondent. Facts Petitioner is a subchapter C corporation, which had its principal place of business in California when it petitioned the Court. Michael Benoit is the president and sole shareholder of Petitioner. The IRS initially.selected Mr. Benoit's return for 2007 for examination because it had no record that Mr. 15 Benoit had filed a Federa·l income tax return for that 16 17 18 year, and it so advised Mr. Benoit by letter dated January 25, 2010. The audit was assigned to revenue agent Beatrix Poh, who scheduled a meeting with Mr. 19 Benoit for February 10, 2010. After Mr. Benoit sent a 20 21 22 23 letter to Ms. Poh stating that he was "pretty certain" he did not have any tax liability for 2007, Ms. Poh wrote back stating that the IRS was suspending Mr. Benoit's audit and that it had selected Building Inspectors & 24 Consultants, Inc. (Petitioner), Mr. Benoit's wholly owned 25 corporation, for audit. By letter dated February 9, Heritage Reporting Corporation (202) 628-4888 4 1 2 3 2010, Ms. Poh advised Petitioner of the audit and asked him to contact her by February 19, 2010, to talk about the audit and the documents that would be needed. Again, 4 Mr. Benoit responded by alleging, among other things, 5 6 7 8 9 10 11 12 13 14 15 that the corporate audit was "an absolute violation of due process". He sent a second letter dated February 13, 2010 that requested the statute, regulations, and delegation of authority order that authorized Ms. Poh to act and advised Ms. Poh of her obligation to comply with the Privacy Act. By letter dated February 25, 2010, Ms. Poh again requested that Petitioner call her about the audit, and she enclosed Form 4564, Information Document Request (IDR), which enumerated the documents she required for the audit. Among other documentation, the IDR required 16 Petitioner to produce documentation to substantiate a 17 18 19 20 21 22 23 rent deduction of $6,128, taxes deducted of $3,246, a depreciation deduction of $945, an advertising expense deduction of $14,184, a deduction for other expenses of $90,389, and a wages deduction of $144,672. Petitioner, through Mr. Benoit, refused to produce any of the documentation requested, claiming that the request for documentation violated the law, specifically the Privacy 24 Act. 25 When Petitioner failed and refused to produce the Heritage Reporting Corporation (202) 628-4888 5 1 2 3 4 documentation requested to verify the items claimed on its 2007 return, Ms. Poh prepared an examination report showing proposed changes to Petitioner's 2007 tax return, which she mailed to Petitioner by a letter dated 5 March 11, 2010. The report proposed to disallow all of 6 7 8 9 10 11 12 13 14 15 the deductions claimed on Petitioner',Ó 2007 return for failure to substantiate and also proposed a section 6662(a) penalty. Again, Mr. Benoit refused to address the proposed adjustments on the merits and continued to complain about the IRS's allegedly arbitrary and abusive actions. By notice of deficiency dated February 7, 2011, Respondent determined that Petitioner was liable for an income tax deficiency of $38,406 and an accuracy-related penalty under section 6662(a) of $7,681.20. Petitioner timely petitioned for a review of 16 Respondent's determinations in the notice of deficiency. 17 Although the case was referred to the IRS Appeals Office 18 for consideration after the petition was filed, neither 19 Petitioner nor Mr. Benoit produced any documentation or 20 21 22 23 24 25 cooperated in attempting to resolve the case. On April 17, 2012, we held a trial at which Mr. Benoit testified on Petitioner's behalf. Although Mr. Benoit insisted that he had documentation to substantiate the deductions that are still at issue, he did not produce any of the documentation at trial and he declined Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 the Court's offer to keep the record open to give him time to submit documentation to substantiate the deductions claimed.and to verify his testimony regarding them. During the trial, Respondent moved for the imposition of a penalty under section 6673. 6 Analysis 7 Adiustments to the Return 8 9 In the stipulation of facts, Respondent conceded the deduction for outside services expense, which 10 Petitioner claimed on the return under the other 11 12 13 14 15 16 17 18 category, and salary and wages . Respondent . also allowed an additional deduction of $451 for outside services that had not been claimed on Petitioner's 2007 return. In addition, in his pretrial memorandum, Respondent lists the deductions at issue as the deductions for advertising, rent, office expenses, telephone, and utilities. We construe the listing of deductions remaining at issue in Respondent's pretrial 19 memorandum and the concessions in the stipulation of 20 21 22 23 facts that Respondent is no longer challenging that part of the amount Petitioner deducted as other deductions attributable to accounting fees, bank charges, consultants/non 1099, insurance, legal and professional, 24 miscellaneous, and supplies, or the deduction for 25 depreciation. We deem Respondent to have conceded the Heritage Reporting Corporation (202) 628-4888 7 1 2 3 4 5 6 7 8 following deductions, which were disallowed in the notice of deficiency: depreciation, and that portion of the amount claimed as other deductions that is attributable to accounting fees, bank charges, consultant fees, insurance, legal and professional expenses, miscellaneous expenses, and supplies expense. Accordingly, the only deductions still at issue are the deductions Petitioner claimed for advertising, rent, office, telephone, and 9 utilities expensÅ As discussed below, Petitioner has 10 11 12 13 14 15 not adequately substantiated those deductions as required by section 6001 and related regulations. Petitioner does not seek to show that Respondent's adjustments were ln error. Rather, Petitioner asserts that the audit of its return was abusive and groundless and violated Petitioner's rights under the Privacy Act. 16 Generally, the Privacy Act requires Government agencies 17 18 19 20 21 22 23 24 25 that request information to disclose to those from whom information is sought the statute or order that authorizes such request for information. See Billman v. Commissioner, 83 T.C. 534, 539 (1984) . The Secretary of the Treasury (or his delegate) is empowered to request certain information with respect to the payment of taxes. See secs. 6001, 7602. Section 6001 allows the Secretary or his delegate to require any person ... to make such returns, render such statements, or keep such records, as Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 [[he] deems sufficient to show whether or not such Ai person is liable for tax under" the Code. Section 7602(a) (1) authorizes the Secretary or his delegate to examine any books, papers, records, or other data which may be relevant for the purpose of ascertaining the correctness of any return. These sections provide the 7 Secretary (and Respondent as his delegate) sufficient 8 authority to request information substantiating 9 Petitioner's deductions and ~to audit Petitioner's return. 10 11 12 13 We reject Petitioner's assertion that the Privacy Act is a defense to an audit, which in this case was reasonable, or that the Privacy Act is a relevant issue in a deficiency proceeding. In addition, to the extent that 14 Petitioner alleges that Respondent's agents failed to 15 16 comply with the Privacy Act, we note that the remedy for individuals seeking redress for a violation of the 17 Privacy Act is a civil action in a Federal district court 18 19 20 21 22 23 24 25 pursuant to 5 U.S.C. sec. 552a(g) (1) (2006). See Crowell v. Commissioner, 102 T.C. 683, 693 (1994). We now consider the adjustments to Petitioner's return. As discussed above, only the advertising, rent, office, telephone, and utilities expenses deductions remain at issue. The Commissioner's determination of a deficiency is presumed correct and the taxpayer bears the burden of Heritage Reporting Corporation (202) 628-4888 1 2 proving that the determination is erroneous . See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). 3 Moreover, deductions are a matter of legislative grace, 4 5 6 7 8 9 and the taxpayer bears the burden of proving that he is entitled to any claimed deduction. INDOPCO, Inc. v. Commissioner, 503 U. S. 79, 84 (1992) . Petitioner does not contend that section 7491(a) -shifts the burden of proof to Respondent, and the record establishes that the requirements of section 7491(a) (2) were not met. In sum, 10 Petitioner bears the burden of ,proof. 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Section 162 (a) permits a taxpayer to deduct the ordinary and necessary expenses paid or incurred during the taxable year in carr ing on a trade or business. See Commissioner v. Lincoln V. , & Loan t() , 403 ff U.S. 345, 352 (1971). 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 it is necessary if it is appropriate and helpful for the development of the business. Commissioner v. Heininger, 320 U.S. 467, 471 (1943) . Generally, the taxpayer must maintain adequate records to substantiate the amounts of his income and entitlement to any deductions or credits claimed. Sec. 6001; INDOPCO, Inc. v. Commissioner, 503 U.S. at 84; sec. 1.6001-1(a), Income Tax Regs. When a taxpayer Heritage Reporting Corporation (202) 628-4888 10 1 2 3 4 5 6 7 8 establishes that he paid or incurred a deductible expense but does not establish the amount of the expense, we may estimate the amount allowable in some circumstances (the Cohan rule). See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Circ. 1930). There must be sufficient evidence in the record, however, to permit us to conclude that the taxpayer paid or incurred a deductible expense in at least the amount allowed. See Williams v. United 9 States, 245 F.2d 559, 560 (5th Cir. 1957). 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 For certain kinds of business expenses, section 274(d) overrides the Cohan rule. See Sanford v. Commissioner, 50 T.C. 823, 827 (1968), aff'd per curiam, 412 F.2d 201 (2nd Cir. 1969). Under section 274 (d),.a taxpayer must satisfy strict substantiation requirements before a deduction is allowable. These strict substantiation requirements of section 274 (d) apply to any traveling expense, including meals and lodging away from home, any item with respect to an activity in the nature of entertainment, or the use of listed property, as defined in section 280F(d) (4), including passenger automobiles. Although Mr. Benoit testified that Petitioner paid deductible expenses for rent, advertising, office expenses, telephone, and utilities, and that Petitioner had records to substantiate many of the expenses Heritage Reporting Corporation (202) 628-4888 11 1 2 deducted, Mr. Benoit adamantly refused to produce the documents that would have permitted us to verify that Mr. 3 Benoit's testimony was credible and to find that 4 Petitioner had substantiated the deductions that are 5 still in dispute. Because of Mr. Benoit's stubborn 6 7 8 9 10 11 12 refusal to produce documentation regarding the claimed deductions, we have no choice but to disregard his testimony as self-serving and unverified, and we reject . it as not convincing or credible. See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). In addition, Respondent elicited testimony that suggests that other separate business activities were conducted at 13 Petitioner's principal office during 2007, raising a 14 15 possible issue regarding whether certain of the expenses claimed, such as rent, office expenses,.telephone, and 16 utilities, even if substantiated, should have been 17 18 19 20 21 22 23 24 25 allocated in part to a different business activity during 2007. Because Petitioner, through Mr. Benoit, failed and refused to produce and introduce at trial documentation it claimed it had that would have.substantiated the disputed deductions, the record is devoid of any credible evidence supporting the disputed deductions, and we have no choice but to conclude that Petitioner has failed to satisfy its burden of proof with respect to the disputed Heritage Reporting Corporation (202) 628-4888 12 1 2 deductions. Accordingly, we sustain Respondent's determination with respect to the deductions at issue. 3 Accuracy-Related Penalty 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Respondent determined that Petitioner's underpayment was attributable to negligence or disregard of rules or regulations under section 6662(b) (1) or substantial understatement of income tax under section 6662(b) (2). Generally, section 6662(a) and (b) (1) authorizes the Commissioner to impose a 20 percent penalty on the portion of an underpayment of income tax attributable to negligence or disregard of rules and regulations. The term "negligence" includes any -failure to make a reasonable attempt to comply with the provisions of the internal revenue laws, and the term "disregard" includes any careless, reckless, or intentional disregard. Sec. 6662(c); sec. 1.6662-3(b) (1) and (2), Income Tax Regs. 18 Disregard of rules or regulations_is careless if "the 19 20 21 22 23 24 taxpayer does not exercise reasonable diligence to determine the correctness of a return position" and is reckless if "the taxpayer makes little or no effort to determine whether a rule or regulation exists, under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person 25 would observe." Sëc. 1.6662-3(b) (2), Income Tax Regs.; HeriÊage Reporting Corporation (202) 628-4888 13 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 see also Neelv v. Commissioner, 85 T.C. 934, 947 (1985). Section 6662(a) and (b) (2) also authorizes the Commissioner to impose a 20 percent penalty if there is a substantial understatement of income tax. An understatement.means the excess of the amount of tax required to be shown on the return over the amount of the tax imposed which is shown on the return, reduced by any rebate. Sec. 6662(d) (2) (A). An understatement is substantial in the case of a corporation other than an S corporation when it exceeds the greater of 10 percent of the tax required to be shown on the return or $10,000. Sec. 6662(d) (1) (A) and (B). The accuracy,related penalty does not apply with respect to any portion of the underpayment for which the taxpayer shows that there was reasonable cause and that he acted in good faith. Sec. 6664 (c) (1). Only one component of the accuracy-related penalty may apply with respect to any given portion of an underpayment. Sec. 1.6662-2(c), Income Tax Regs. In its petition, Petitioner did not assign error to Respondent's determination of the accuracy-related penalty. Accordingly, we deem Petitioner to have conceded any issue with respect to the penalty. See Rule 34 (b) (4). At trial, Petitioner's representative did not 25 argue that Petitioner was not negligent or that it had a Heritage Reporting Corporation (202) 628-4888 14 1 2 3 4 5 6 7 reasonable cause for the underpayment. Petitioner does not explain its failure to keep adequate records, substantiate items properly, or produce those records to Respondent upon a reasonable request for an audit. We hold that Petitioner is liable for the section 6662(a) penalty for negligence or, alternatively, substantial understatement of income tax if the calculations under 8 Rule 155 show that the understatement was substantial. 9 Respondent's Motion To Impose a Penalty Under Section 10 11 12 6673 At trial, Respondent moved the Court to impose a penalty under 6673. Section 6673(a) (1) provides that the 13 Court may, require the taxpayer to pay a penalty not in 14 15 16 17 18 excess of $25,000 whenever it appears to this Court that the proceedings were instituted or maintained by the taxpayer primarily for delay, the taxpayer's position is frivolous or groundless, or the taxpayer unreasonably failed to pursue available or administrative remedies. 19 Petitioner's position in this proceeding was groundless, 20 21 22 and its decision to stand on principle and refuse to produce documentation to substantiate the disputed deductions that it claimed it had was foolish and 23 misguided. The selection of a, return for examination is 24 25 not a declaration of war, and a taxpayer should not treat it as such. The IRS is authorized to examine returns Heritage Reporting Corporation (202) 628-4888 15 1 after returns are filed and to investigate alleged 2 3 4 5 failures to file return. Secs. 6001, 7601, and 7602. Taxpayers are required to keep records to substantiate positions claimed on their return, and the IRS is authorized to inspect those records. Sec. 6001. 6 Petitioner's adamant refusal to cooperate with the audit 7 of its 2007 return was unfortunate and unjustified. 8 Petitioner compounded its mistake by refusing to assist 9 this Court in substantiating the dispute deductions, 10 11 giving the Court no choice in sustaining the disallowance of the disputed deductions. The frustration generated by 12 Petitioner's conduct led Respondent to move for the 13 14 15 16 17 imposition of a section 6673 penalty. Petitioner certainly maintained several groundless positions by asserting the Privacy Act as a defense to the notice of deficiency and by refusing to produce required substantiation, even after the Court informed 18 Petitioner's representative that the documentation was 19 20 21 22 23 24 25 needed. In our discretion, however, we shall not impose a section 6673 penalty at this time. We warn Petitioner that if in the future it maintains frivolous or groundless positions in this Court, Petitioner runs the risk that it will be sanctioned in accordance with section 6673. We have considered the remaining arguments made by Heritage Reporting Corporation (202) 628-4888 1 2 the parties, and to the extent not discussed above, we conclude those arguments are irrelevant, moot, or without 3 merit. 16 . 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 To reflect the foregoing, decision will be entered under Rule 155. This concludes the Court's oral findings of fact and opinion in this case. (Whereupon, at 6:26 p.m., the bench opinion in the above-entitled matter was concluded.) // // // // // // // // // // // // // // // // Heritage Reporting Corporation (202) 628-4888