TAX COURT OPINION

Case: Earl A. Skarky
Docket Number: 1727-18
Judge: Thornton
Opinion Type: bench
Filed: 12/05/2019
Pages: 19

UNITED STATES TAX COURT WASHINGTON, DC 20217 EARL A. SKARKY, Petitioner, v. ) ) ) ) Docket No. 1727-18. COMMISSIONER OF INTERNAL REVENUE, 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 herewith to petitioner and to respondent a copy of the pages of the transcript of the trial in the above case before Judge Michael B. Thornton in Louisville, Kentucky, containing his oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fact and opinion, a decision will be entered for respondent. (Signed) Michael B. Thornton Judge Dated: Washington, D.C. December 5, 2019 RECEIVED 11/19/19 IN THE UNITED STATES TAX COURT ALS In the Matter of: EARL A. SKARKY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ) . ) ) ) Docket No. 1727-18 ) ) ) ) ) ) ) ) Pages: 1 through 17 Place: Louisville, Kentucky Date: November 13, 2019 (973) 406-2250|operations@escribers.net J www.escribers.net IN THE UNITED STATES TAX COURT In the Matter of: EARL A. SKARKY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ) ) ) ) Docket No. 1727-18 ) ) ) ) ) ) ) ) Gene Snyder Cthse. 601 W. Broadway Street Room 440, 4th Floor Louisville, Kentucky 40202 - Custom House November 13, 2019 The above-entitled matter came on for bench opinion, pursuant to notice at 2:47 p.m. BEFORE: HONORABLE MICHAEL B. THORNTON Judge APPEARANCES: For the Petitioner: No Appearance For the Respondent: No Appearance 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 973)4d6-2256]operat nscescribérs.net .ww esaibersaiet P R O C E E D I N G S 2 (2:47 p.m.) THE CLERK: Recalling from the calendar docket number 1727-18, Earl A. Skarky. (Whereupon, a bench opinion was rendered.) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 73)406.2.250]operations@escribers;netiwww.escribersaet Bench Opinion by Judge Michael B. Thornton 3 November 13, 2019 Earl A. Skarky v. Commissioner Docket No. 1727-18 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. Except as otherwise provided by Rule 152(c) of the Tax Court Rules of Practice and Procedure, the oral findings of fact and opinion shall not be relied upon as precedent in any other case. This bench opinion is made pursuant to the 1 2 3 4 5 6 7 8 9 10 11 12 13 authority granted by section 7459(b) and Rule 152. 14 Hereinafter in this bench opinion, section references are 15 to the Internal Revenue Code (Code) in effect for the 16 taxable year at issue. All Rule references are to the Tax 17 Court Rules of Practice and Procedure. All monetary 18 19 amounts are rounded to the nearest dollar. This case was tried on November 13, 2019, in 20 Louisville, Kentucky. Petitioner appeared pro se. Ms. 21 22 23 Laura Leigh Bates appeared on behalf of respondent. FINDINGS OF FACT Petitioner is an attorney who commenced 24 practicing law in 1973, when he joined the law firm of 25 Crowe & Dunlevy, PSC, in the firm's Oklahoma City, (973) 406-2250| operations®escribersaet l www.escribers.net Oklahoma, office. He practiced law there full-time until July 2014, when, upon reaching mandatory retirement age, 4 he became of counsel to the firm. In that capacity, he would spend about one week a month working at the firm representing a client, the Oklahoma Development Finance Authority, as well as doing some work remotely. In 2016 Petitioner started his own law firm, but his work still emanates from Oklahoma, where he is licensed to practice law. He is not licensed to practice law in Kentucky. In 2011 petitioner purchased a 55-acre farm, known as Four Winds Farm, in Lexington, Kentucky, for $2.7 1 2 3 4 5 6 7 8 9 10 11 12 million. His intention was to start a horse-breeding 13 business, to breed horses for eventing (rather than for 14 15 racing). In February 2012 he and his wife moved into a house on the farm. About once a month petitioner would 16 travel from Kentucky to Oklahoma City for his work with 17 Crowe & Dunlevy. Petitioner still retains a residence in 18 Oklahoma City, where he generally stays when he is working 19 in Oklahoma City. 20 In 2013 petitioner renovated an existing tobacco 21 barn at the farm to create nine paddocks and made other 22 23 24 improvements. In late 2013 he started work on a 15-stall horse barn that was finished by August 2014. In the fall of 2012 petitioner had acquired 13 25 horses from the Humane Society. He did not intend to sell (973) 0642250 operati nseescribers.neijwwwascribersnet 5 1 2 these horses, and by November 2013 he had disposed of all but one of these horses and had acquired two Tennessee 3 Walkers. At that time he also had five horses that had 4 been retired from his wife's therapy business in 5 Washington State. Of these five horses only one was a 6 7 8 9 10 11 potential breeder but because of health issues it had to be gelded. In late 2013 petitioner also bought two mares in foal. These horses foaled in late 2014. In 2015 petitioner brought in a trainer to start bridle work on these foals, to make them more desirable for potential eventing. sometime in mid-2014 petitioner also bought a 12 stallion. In later years petitioner bought additional 13 horses, including some retired geldings from the local 14 police department and two Clydesdales. 15 16 As of 2014 petitioner had not yet sold any horses from his breeding activity. In fact, as of 2014 17 petitioner was still uncertain what type of horses would 18 be best to breed and was still investigating different 19 possibilities. As of the time of trial, petitioner has . 20 not entered into any breeding agreements and has not 21 22 23 24 received any fees for breeding horses. Petitioner testified that he hoped his horse-breeding activity would become operational by 2020. During 2014 petitioner boarded four horses for a 25 neighbor, who ultimately gave him two of the horses and - (973)406-22501operations@escribetsnet|wwwascribesmet paid him $3,250 for boarding the two other horses. On February 26, 2016, petitioner filed his Form 1040, U.S. Individual Income Tax Return, for taxable year 6 2014, reporting total tax of $112,745 and claiming a refund of $286,383. On petitioner's tax return he reported wage income of $41,739, taxable Individual Retirement Account distributions of $1,982,083, and a farm loss of $1,434,160, resulting in adjusted gross income of $594,654. On the Schedule F, Profit or Loss From Farming, 1 2 3 4 5 6 7 8 9 10 attached to his 2014 return he listed as his principal 11 activity "Horse Breeding". With respect to this activity 12 13 14 15 he reported gross income of $3,250 from "Sales of livestock, produce, grains, and other products you raised", and claimed deductions totaling $1,437,410, including depreciation and section 179 expenses of 16 $1,105,674, resulting in a net loss of $1,434,160. On 17 Schedule A, Itemized Deductions, attached to his 2014 18 19 return he claimed a deduction for, among other things, unreimbursed employee business expenses of $79,901 for 20 travel expenses from Lexington, Kentucky, to attend board 21 meetings at Crowe & Dunlevy in Oklahoma City. 22 23 By notice of deficiency issued October 27, 2017, respondent disallowed in full petitioner's claimed 2014 24 Schedule F expenses and 2014 Schedule A unreimbursed 25 employee expenses. Additionally, the notice of deficiency (973)40s-2250 fopentionseestHbers.net| wwwascrbers.net · determined that the $3,250 of income reported on Petitioner's 2014 Schedule F from the purported sale of 7 livestock should be reclassified as "other income". Respondent also determined that pursuant to section 6651(a)(1) petitioner was liable for an addition to tax of $67,173 for failure to timely file his 2014 tax return, as well as an accuracy-related penalty of $111,015 pursuant to section 6662(a). Respondent's initial determination to impose the section 6662(a) accuracy-related penalty was personally approved in writing by the examiner's immediate supervisor on May 22, 2017, before the issuance of respondent's 1 2 3 4 5 6 7 8 9 10 11 12 13 Revenue Agent Report on May 23, 2017, which granted 14 Petitioner the right to protest the adjustments and 15 Penalty determinations. 16 17 OPINION The Commissioner's determinations in a notice of 18 deficiency are generally presumed correct, and the 19 taxpayer generally bears the burden of proving those 20 determinations erroneous. Rule 142(a); Welch v. 21 Helvering, 290 U.S. 111, 115 (1933). Petitioner has not 22 alleged that the burden of proof should shift to 23 24 25 respondent nor shown that he has satisfied the requirements of section 7491 to shift the burden of proof to respondent. Deductions are a matter of legislative 1973)406-2250loperationscescribers.netlwww.escribers.net grace, and the taxpayer bears the burden of proving entitlement to any deduction or credit claimed. Deputy v. 8 du Pont, 308 U.S. 488,493 (1940). Unreimbursed Employee Expenses As a general rule, personal living expenses are nondeductible. Sec. 262; secs. 1.162-2(a), 1.262-1(b)(5), Income Tax Regs. Because an employee's trade or business ! is deemed to consist of the performance of services for an employer, taxpayers may deduct expenses that are: (a) nonreimbursable; (b) related to the employee's trade or business of rendering services to the employer; and (c) 1 2 3 4 5 6 7 8 9 10 11 12 ordinary and necessary expenses of such a trade or 13 business. See Lucas v. Commissioner, 79 T.C. 1, 6-7 14 15 16 17 (1982). Traveling expenses, including amounts expended for meals and lodging, may be deducted under section 162(a)(2) if they are: (1) ordinary and necessary; (2) incurred while away from home; and (3) incurred in pursuit 18 of a trade or business. Commissioner v. Flowers, 326 U.S. 19 465, 470 (1946). 20 Under section 162, the term "'home' does not 21 have its usual and ordinary meaning." Henderson v. 22 Commissioner, 143 F.3d 497, 499 (9th Cir. 1998), aff'g 23 T.C. Memo. 1995-559. For purposes of section 162(a)(2), a 24 taxpayer's home generally means the vicinity of his 25 principal place of employment. Mitchell v. Commissioner, (973) 406-2 250| operations@escribers.net | www.escribers.net · 74 T.C. 578, 581 (1980). As an exception to this general 9 rule, a taxpayer's residence may be treated as the taxpayer's tax home, even though it is outside the vicinity of the principal place of employment, if the taxpayer's employment is "temporary" and not "indefinite". Peurifoy v. Commissioner, 358 U.S. 59, 60 (1958). Employment is "indefinite" rather than "temporary", if "its termination cannot be foreseen within a fixed or reasonably short period of time." Stricker v. 1 2 3 4 5 6 7 8 9 10 Commissioner, 54 T.C. 355, 361 (1970), aff'd, 438 F.2d 11 12 1216 (6th Cir. 1971). Petitioner has not demonstrated that Lexington, 13 Kentucky, was his "tax home" in 2014. From 1973 until he 14 15 started his own firm in 2016, petitioner worked continuously for the law firm of Crowe & Dunlevy in 16 Oklahoma City. According to his testimony, in 2014 he 17 worked there full-time until July 2014, when he became of 18 counsel and started coming to the office only about once a 19 month for a week at a time. All of his wage income during 20 21 2014 came from this work. He still maintains a residence in Oklahoma City, where he stayed when he was working for 22 Crowe & Dunlevy in 2014. Within the meaning of section 23 162(a)(2), petitioner's tax home throughout 2014 was in 24 the vicinity of his place of employment in Oklahoma City, 25 Oklahoma. See Kroll v. Commissioner, 49 T.C. 557 (1968). 19733406-2250|operati nseescribers.net|wwwascribers.net 10 Accordingly, petitioner's travel expenses between Kentucky and Oklahoma City are personal travel expenses rather than ordinary and necessary business expenses. Schedule F Activity Section 162 generally allows a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business". Such expenses, however, must be directly connected with or pertain to the taxpayer's trade or business that is functioning as a business at the time the expenses were incurred. Woody v. Commissioner, T.C. Memo. 2009-93, aff'd, 403 F. App'x 519 (D.C. Cir. 2010). Until 1 2 3 4 5 6 7 8 9 10 11 12 13 the activity is functioning as a going concern and 14 performing the activities for which it was organized, 15 expenses related to that activity, including depreciation 16 expenses, are not "ordinary and necessary" expenses 17 currently deductible under section 162 (nor are they 18 deductible under section 212) but rather are "start-up" or 19 "pre-opening" expenses. See Hardy v. Commissioner, 93 20 T.C. 684, 687-688 (1989); Piggly Wiggly Southern, Inc. v. 21 Commissioner, 84 T.C. 739, 745-746 (1985) (citing Richmond 22 Television Corp. v. United States, 345 F.2d 901 (4th Cir. 23 1965), aff'd, 803 F.2d 1572 (11th Cir. 1986)). "Start-up 24 expenditures"--i.e., expenses incurred "before the day on 25 which the active trade or business begins," sec. (973)406-2250|operationseerribers.netjwww.escribersnet 195(c) (1) (A) (iii)--may be deducted only over time under section 195. The costs of starting up a new traSe or 11 business or a new income-producing activity are inherently capital because they are expenses of creating or acquiring a capital asset. See Johnsen v. Commissioner, 794 F.2d 1157, 1162 (6th Cir. 1986), rev'g, 83 T.C. 103 (1984). Petitioner has failed to show that his horse- breeding activity was functioning as a going concern in 2014. Although petitioner took steps toward establishing 1 2 3 4 5 6 7 8 9 10 a horse-breeding business, his plans were not realized by 11 12 the end of 2014. In fact, he testified at trial that he hopes for his horse-breeding activity to become 13 operational by 2020. Even as of the time of trial 14 Petitioner had not yet sold any horses from his breeding 15 activity. As of 2014 petitioner had not yet finally 16 17 decided what type of horses would be best to breed. As of the time of trial, petitioner has not entered into any 18 breeding agreements and has not received any fees for 19 breeding horses. In 2014 the farm's only proceeds of 20 $3,250 came from a neighbor's payment as board for two 21 22 23 horses. Petitioner's actions to ready his farm for a horse-breeding business exemplify steps taken to set up a business, not those of a business that had commenced and 24 was presently operating as a going concern in 2014. 25 3y406-2250 operóïl nseescribersmet érwvr.eidibersinet We hold that the amounts reported on 12 Petitioner's 2014 Schedule F are start-up expenses and may 6 not be deducted pursuant to section 162(a). Consequently, we sustain respondent's determination disallowing Petitioner's claimed 2014 Schedule F expenses and also sustain his determination reclassifying the $3,250 of income reported on petitioner's 2014 Schedule F from the Purported sale of livestock as "other income". Section 6651(a)(1) Addition to Tax Respondent determined that petitioner is liable for a section 6651 (a) (1) addition to tax for failing to file his 2014 Federal income tax return on time. Section 6651(a) (1) provides for an addition to tax for failure to file a return by the date prescribed unless the taxpayer 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 establishes that the failure is due to reasonable cause 16 and not willful neglect. The Commissioner bears the 17 burden of production with respect to whether it is 18 appropriate to impose the section 6651 (a) (1) addition to 19 tax, see sec. 7491(c), and the burden of proof is on the 20 taxpayer to establish reasonable cause and the absence of 21 willful neglect, United States v. Boyle, 469 U.S. 241, 245 22 (1985). Reasonable cause exists when a taxpayer exerc1ses 23 ordinary business care and prudence and is nonetheless 24 unable to file his return by the date prescribed by law. 25 Sec. 301.6651-1(c) (1), Proced. & Admin. Regs. Willful 73)406-2250|operationseescribers.net|www.escribers.net 13 neglect connotes "conscious, intentional failure or reckless indifference." Boyle, 469 U.S. at 245. Petitioner's 2014 tax return was due April 15, 2015 . He did not file it until February 26, 2016. Respondent has met his burden of production under section 7491(c). Petitioner failed to show reasonable cause for not timely filing his 2014 tax return. We sustain the addition to tax under section 6651(a)(1). Section 6662(a) Accuracy-Related Penalty 1 2 3 4 5 6 7 8 9 10 Respondent determined that for taxable year 2014 11 petitioner is liable for a 20% accuracy-related penalty 12 13 14 15 pursuant to section 6662(a). Under section 7491(c), respondent bears the burden of production with respect to the section 6662(a) penalty. Generally, this means that he must come forward with sufficient evidence indicating 16 that it is appropriate to impose the relevant penalty. 17 See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). The 18 Commissioner's burden of production under section 7491(c) 19 20 includes establishing compliance with the supervisory approval requirement of section 6751(b). Graev v. 21 Commissioner, 149 T.C. 485, 493 (2017), supplementing and 22 overruling in part 147 T.C. 460 (2016). Once the 23 Commissioner has met his burden of production, the burden 24 of proof is upon the taxpayer to show that he is not 25 liable for the penalty. See Higbee v. Commissioner, 116 · $7h406-2250|operations®escribersnet j www.esaiberswet T.C. at 449. 14 The taxpayer may meet this burden by proving that he acted with reasonable cause and in good faith with regard to the underpayment. See sec. 6664(c) (1). Section 6662(a) imposes a penalty of 20% of the portion of any underpayment attributable to, among other things, negligence or disregard of rules or regulations. see sec. 6662(b)(1). section 6662(a) and (b)(2) imposes the accuracy-related penalty on any portion of a tax underpayment that is attributable to any substantial understatement of income tax, defined in section 6662(d) (1) (A) as an understatement that exceeds the 1 2 3 4 5 6 7 8 9 10 11 12 greater of 10% of the tax required to be shown on the 13 14 15 16 return or $5,000. The total tax reported on petitioner's 2014 tax return was $112,745; the understatement of income tax determined in the notice of deficiency is $555,075. 17 Therefore, the amount of tax required to be shown on 18 Petitioner's 2014 tax return was $667,820. Petitioner's 19 understatement of tax of $555,075 exceeds $66,782, which 20 is 10% of the tax required to be shown on petitioner's 21 22 23 24 2 2014 tax return. Thus, petitioner's understatement of income tax is substantial for purposes of the section 6662(a) and (b)(2) accuracy-related penalty. The record includes a copy of the 30-day letter issued on May 23, 2017, which bears the signature of the • 197s)406-2250llaperationseescribers.net|www.escribersnet examiner's immediate supervisor and includes an 15 examination report proposing a penalty pursuant to section 6662(a). This satisfies respondent's burden of production under section 6751(b)(1). See Rose v. Commissioner, T.C. Memo. 2019-73, at *40; cf. Clay v. Commissioner, 152 T.C. , (slip op. at 44) (Apr. 24, 2019). We hold that respondent has satisfied his burden of production with respect to the section 6662 accuracy-related penalties for substantial understatement. Consequently, we need not 1 2 3 4 5 6 7 8 9 10 decide whether respondent has also met his burden of 11 Production for the accuracy-related penalty for 12 13 14 negligence.· Reasonable cause requires that the taxpayer exercise ordinary business care and prudence as to the 15 disputed item. Boyle, 469 U.S. at 246. The term "good 16 faith" has no precise definition but connotes, among other 17 things, (1) an honest belief and (2) the intent to perform 18 all lawful obligations. Sampson v. Commissioner, T.C. 19 Memo. 2013-212, at *18. The determination of whether a 20 taxpayer acted with reasonable cause and in good faith is 21 made on a case-by-case basis, taking into account all 22 facts and circumstances. Higbee v. Commissioner, 116 T.C. 23 at 448; sec. 1.6664-4(b)(1), Income Tax Regs. Generally, 24 the most important factor is the extent of the taxpayer's 25 effort to assess the proper tax liability. Sec. 1.6664- 973)406-2250|operatiòns@escribers.net|wwwascribers.net 4 (b) (1), Income Tax Regs. Other circumstances that may 16 indicate reasonable cause and good faith include an honest 1 2 3 misunderstanding of fact or law that is reasonable in the 4 5 6 7 8 9 light of all of the facts and circumstances, including the experlence, knowledge, and education of the taxpayer. Higbee v. Commissioner, 116 T.C. at 449; Sampson v. Commissioner, at *18; sec. 1.6664- 4(b)(1), Income Tax Regs. Petitioner has failed to establish that he acted 10 with reasonable cause and in good faith. Accordingly, we 11 12 sustain respondent's determination that petitioner is liable for the section 6662(a) penalty for an underpayment 13 attributable to a substantial understatement of his 2014 14 15 Federal income tax. Consistent with the foregoing, decision will be 16 entered for respondent. This concludes the Court's findings of fact and opinion in this case. (Whereupon, at 3:08 p.m., the above-entitled matter was concluded.) 17 18 19 20 21 22 23 24 25 (Ú3)406-22501ó rati ns@escribersnet www.escribers.net CERTIFICATE OF TRANSCRIBER AND PROOFREADER 17 CASE NAME: Earl A. Skarky v. Commissioner DOCKET NO.: 1727-18 We, the undersigned, do hereby certify that the foregoing pages, numbers 1 through 17 inclusive, are the true, accurate and complete transcript prepared from the verbal recording made by electronic recording by on November 13, 2019 before the United States Tax Court at its session in Louisville, KY, in accordance with the 1 2 3 4 5 6 7 8 9 10 applicable provisions of the current verbatim reporting 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 contract of the Court and have verified the accuracy of the transcript by comparing the typewritten transcript against the verbal recording. Meribeth Ashley, CET-507 Transcriber 11/18/19 Date Traci Fine, CDLT-169 Proofreader 11/19/19 Date 73)406-2250|óperations@escribetsnet|wwwascribersaid