TAX COURT OPINION

Case: DKD Enterprises a.k.a. DKD Enterprises, Inc.
Docket Number: 24403-07
Judge: Chiechi
Opinion Type: memo
Filed: 01/31/2011
Pages: 68

T.C. Memo. 2011-29 UNITED STATES TAX COURT DKD ENTERPRISES a.k.a. DKD ENTERPRISES, INC., ET AL.,1 COMMISSIONER OF INTERNAL REVENUE, Respondent Petitioners v. Docket Nos. 24403-07, 24404-07, 10818-08, 10819-08. Filed January 31, 2011, James R. Monroe, for petitioners. Catherine S. Tyson, for respondent. Cases of the following petitioners are consolidated herewith: , Debra K. Dursky, docket Nos. 24404-07 and 10819-08; and DKD Enterprises "a.k.a. DKD Enterprises, Inc., docket No. 10818-08. EVED JAN 31 2011 - 2 - MEMORANDUM FINDINGS OF FACT AND OPINION CH ECHI, Judge: Respondent determined the following defi- ciencies in, additions under section 6651(a) (1)2 to, and accurac -related penalties under section 6662 (a) on each peti- tioner' s Federal income tax (tax) : Petitioner Year Deficiency Under Sec. 6651(a) (1) Addition to Tax Accuracy-Related Penalty Under Sec. 6662(a) DKD 2003 $23,458.61 $2,345.86 2004 47,740.00 4,774.00 2005 42,376.00 Ms. Dursky 2003 17,476.00 2004 16,403.00 2005 12,604.00 -- -- -- -- $9,548.00 8,475.00 3,280.60 2,520.80 The issues remaining for decision for the years at issue are:S (1 Is DKD Enterprises, Inc. (DKD), entitled to deduct under section 162 (a) certain respective amounts relating to its cattery activity that it (a) reimbursed to Debra K. Dursky (Ms. Dursky) and her personal partner, Elizabeth Watkins (Ms. || 2Agl section references are to the Internal Revenue Code in effect for the years at Tax CouÊt Rules of Practice and Procedure. issue All Rule references are to the 3In addition to the issues remaining for decision that are there are: other questions relating to certain listed in the text, determiŠations in the respective notices of deficiency with respect DKD whiòh are computational our resålution of certain of issued to Ms . Dursky and in that their resolution flows from the issues that we address herein. to those years that respondent - 3 - Watkins), (b) paid to Ms. Watkins, (c) paid for certain "taxes and licenses", and (d) paid to Ms. Dursky? We hold that it is not. (2) Is Ms. Dursky required to include in gross income as constructive dividends the. certain respective amounts that we have held with respect to issue (1) DKD is not entitled to deduct? We hold that she is . (3). In the light of our holdings with respect to issues (1) and (2), is Ms. Dursky entitled to deduct under section 162(a) the certain respective amounts that we have held DKD is not entitled to deduct? We hold that she is not. (4) In the light of our holding with respect to issue (1) , is Ms . Dursky entitled to deduct in Schedule E, Supplemental Income and Loss (Schedule E) , certain respective amounts of home mortgage interest and real estate taxes that she paid? We hold that she is not. (5) Is DKD a' qualified personal service corporation, as defined in section 448(d) (2), that is subject to the 35-percent tax rate prescribed in section 11(b) (2)? We hold that it is not. (6) Is DKD entitled to- deduct under section 162 (a) certain amounts that it paid into a certain account that Fidelity Investments maintained for it? We hold that it is not. (7) Is Ms. Dursky.required to include in gross income as a constructive dividends certain amounts that we have held with respect to issue (6) DKD is not entitled to deduct? We hold that - 4 - she is. (8) Is DKD entitled to deduct under section 162 (a) certain amounts of premiums that it paid with respect to a health || 11 insurance policy that Ms. Dursky purchased for herself? We rhold that it is not. (9) Is Ms. Dursky entitled to exclude from gross income the certain amounts, of premiums that that we have held with respect to issue (8) DKD is not entitled to deduct? We hold that she is not. FINDINGS OF FACT Soke of the facts have been stipulated and are so found. At all relevant times, including throughout 2003 through 2005 (the years at issue) and at the times Ms. Dursky filed the respective petitions in the cases at docket Nos. 24404-07 and 10819-08, Ms. Dursky resided in a house that she owned (Ms. Dursky's residence) in West Des Moines, Iowa (West Des Moines) . For an ndisclosed period starting before the years at issue to at least the time of the trial in these cases, Ms. Dursky's persona partner, Ms. Watkins, resided with Ms. Dursky in Ms. Dursky's residence. At all relevant times, including throughout the years at issue a d at the times DKD filed the respective petitions in the - 5 - cases at docket Nos. 24403-07 and 10818-08, DKD maintained its place of operation.at Ms. Dursky's residence. At all relevant times, Ms. Dursky was the sole owner of Ms. Dursky's residence, which had approximately 2,100 square feet of space. During each of the years at issue, the monthly fair rental value of Ms. Dursky's residence was $1,600. Dallas County, Iowa (Dallas County) , - the county in which Ms . Dursky' s residence was located, assessed the following real property tax on that residence for the real property tax year indicated: Real Property Tax Assessed Real Property Tax Year Ended March 31 $3,976 3,966 3, 708 3,630 2003 2004 2005 2006 At all relevant times, Ms. Dursky's residence was subject to a home mortgage loan on which Ms .' Dursky paid an undisclosed amount of interest (home mortgage interest) during each of the years at issue. For an undisclosed pežiod starting before 1997 through at least the years at issue, Ms. Dursky was an information technology (IT) consultant. On May 28, 1997, Ms. Dursky incorporated DKD to provide IT consulting services. - 6 - At all relevant times, including throughout the years at issue, DKD employed Ms. Dursky, who was the sole stockholder and the sole officer of DKD, to perform IT consulting services for it.4 At all relevant times, including throughout the years at- issue, KD provided IT consulting services to a company known as Octagon At those times, Octiagon, in turn, provided IT consult ng services to other acompanies such as Wells Fargo. Octagon paid DKD on an hourly basis for the IT consulting services that DKD performed for it. During the years at issue, Ms . Dur ky was the only persön whom DKD employed to work on matters relating to DKD's IT consulting business. Ms Dursky spent approximately 2, 000 hours during 2003 and approxi ately 2,200 hours during each of the years 2004 and 2005 working for DKD in its IT consulting business . DKD paid Ms . Dursky 80, 400 annually as compensation for the IT consulting work th t she performed for DKD during each of the years 2003, 2004, and 2005.5 || il For each of the years 2003 through 2005, DKD issued to Ms. Dursky Form W-2, Wage and Tax Statement (Form W-2), in which it 'At least during the years at issue, Ms. Dursky did not have a written employment agreement with DKD. 3DKD also paid Ms. Dursky $80,400 annually as compensation for the IT consulting work that she performed for DKD during each of the ears 2001 and 2002. - 7 - reported that it had paid her wages of $80,400. In each of those Forms W-2, DKD also reported certain respective amounts of "Federal income tax withheld", "Social security wages", "Social security tax withheld", "Medicare.wages and tips", "Medicare tax withheld", "State wages, tips, etc.", and "State income tax". DKD did not report any other amounts in.each of those.forms. Throughout the years at issue, Ms. Dursky's personal assets consisted primarily.of Ms. Dursky's residence, certain retirement accounts, certain automobiles, certain stocks, including her 100-- percent stock interest in -DKD, a joint checking account that Ms. Dursky maintained with Ms. Watkins, and certain cats, kittens, and equipment (e.g.,' cat trees, feeding bowls, .litter boxes) relating to a cattery. Cattery Activity of Ms. Dursky and Ms. Watkins Since at least 1989 Ms. Watkins, and since at least 1994 Ms. Dursky, each was engaged in the hobby of operating a cattery from which each derived significant personal pleasure. That cattery operation included breeding, raising, and -offering for sale certain cats and certain kittens, attending certain cat shows, and entering in some of those-shows some of those cats and kittens (cattery activity). At a time not disclohed by the record before the years at issue, Ms. Dursky and Ms. Watkins became engaged in the hobby of jointly operating a cattery (cattery activity of Ms. Dursky and - 8 - Ms. Watkins) from which they continued to derive significant personail. pleasure . Ms . Dursky and Ms . Watkins had at least the following two breeds of cats in the cattery activity of Ms. Dursky ànd Ms . Watkins : The Maine Coon breed (Maine Coons) and the Nor egian Forest breed (Norwegian Forest cats) .' The cattery activity of Ms . Dursky and Ms . Watkins took place in Ms. Dursky's residence, except for attending cat shows and visiting veterinarians. The cattery activity= of Mss. Dursky and Ms. Watkins required them to spend substantial time and substantial money in operating that activity. As part of the catterydactivity of Ms. Dursky and Ms. Watkins, they traveled * extensively to certain cat shows in the United States. The money that Ms Dursky and Ms . Watkins spent in operating that activity was for, inter alia, cat food, cat litter, veterinarians, cat ' show en rance fees, and transportation, meals, and lodging relating to the attendance bys Ms. Dursky and/or Ms. Watkins at certain cat .shows. At a time not disclosed by the record before the years at issue, s. Dursky and Ms. Watkins created a Web site (cattery activit Web site) that they maintained for the cattery activity 'I 1989, a person or persons not identified by the record In 1994, Ms. Dursky was In 1997, Ms. nd Ms. Watkins were jointly operating a cattery for operated a cattery for Maine Coons. operati g a cattery for Norwegian Forest cats. Dursky Norwegi n Forest cats. At a time not disclosed by the record, Ms. Dursky and Ms. Watkins were jointly operating a cattery for Maine CC ons . - 9 - of Ms. Dursky and Ms. Watkins. At the time of the trial in these cases, the general public was able to access that Web site, although it had not been updated since 2002. The cattery activity Web site stated: "We treat our cats as members of our family", and "we have invested too much love in our wonderful kittens to risk exposing them to an uncertain and risky environment." The cattery activity Web site also indicated that kittens were.born in one of the bedrooms in Ms. Dursky's residence, that the kittens stayed in the bedroom for five to eight weeks after birth,- and that after the kittens were older and well socialized "they are then allowed to run the house with the other cats." The cattery activity Web -site stated that "Our goal * * * is to breed healthy, well-socialized Wegies [Norwegian Forest cats] who are at home--whether in the show ring or simply as a beloved member of the family." That Web site further stated that."Our goal is to breed healthy, large, shaggy coated Maine Coons with a gentle, loving personality." As part of the cattery activity of Ms. Dursky and Ms. Watkins, Ms. Dursky and Ms. Watkins participated in certain competitions, clubs, and associations and attended cat shows over much of the United States and developed relationships with cat breeders around the world. In this regard, the cattery activity Web site stated: - 10 - We tinguished Merit. C rrently less than 10 Norwegian the world have been awarded the We currently show exclusively in the Cat , Fancief-s ave shown five of our cats to Ashociation (CFA) . Re ional? Wins and two of our female NFC' s [Norwegian , Fo est cats] have produded such outstanding offspring th t they achieved the oveted title of CFA Di Fo esta Cats throughout ti le of Distinguished lvlerit--it is the highest award th t CFA presents , to a þreeding pedigreed cat and we ar very proud to [be] [D stinguished Merits] ! tw CFA clubs, To cat Club. CFA Norwegian Forest Cat Breed Council and Deh [Ms . Du sky] Fa ciers Association. th United States we ha e developed friendshipsewith breeders and exhibitors 3from around the world. Our sußcess is built, on the trust of those breeders who hage sold us our cats, and to all the Hawkeye Cat Club and the Lucky In addition, we are also members of those breeders who came beforetthem. By attending shows over much of the owners of TWO NFC DM' s We are: currently members of, ermitted us to use their studs * * * is a Breeder Me ber of, the Norwegian Forest *Cat the The cattery activity Web site also indicated -that the Cat Fanciers Association (CFA) , the largests association - for" owner of cats in the United States,7 had designated, the cattery activity Áf Ms . Dursky and Ms . Watkins as a "CFA Approved Cattery of Excellence" . The cattery activity Web site adverti-sed for sale a at for $75, a cat for $150, a kitten for $200,3 and a kitten or $400. CatterviActivity During the ears at Issue During each of the- years at issue, DKD had two activities:e A consu ting activity. and a catteryractivity (DKD's cattery 'CF imposed ethical standards and practices for catteries. i t - 11 - activity)." Ms. Dursky and Ms. Watkins operated DKD's cattery activity. DKD's cattery activity was the cattery activity in which Ms. Dursky and Ms. Watkins had engaged before the years at issue. While operating DKD's cattery activity during each of the years at issue, Ms. Dursky and Ms. Watkins continued to breed, raise, and offer for sale certain cats and certain kittens at Ms. Dursky's residence" and to attend certain cat shows in some of which they entered some of those cats and kittens." As was true while they were operating the cattery activity of Ms. Dursky and Ms. Watkins before dhe years at issue, Ms. Dursky and Ms. Watkins continued to derive significant personal pleasure while operating DKD's cattery activity during the years at issue. During each of the years at issue, DKD used, without purchasing, in DKD's cattery'activity the assets (e.g., cats, kittens, cat trees, feeding bowls, litter boxes) that Ms. Dursky 9By referring to the cattery.activity of DKD as "DKD's cattery activity", we are in no way implying or suggesting that during any of constituted a trade or business of DKD within the meaning of sec. 162(a). issue DKD's cattery activity the years at "Of the approximately 2,100 square feet of space at Ms. Dursky's residence, Ms. Dursky and Ms. Watkins used approximately 474 square feet of the years at in operating DKD's cattery activity during each issue. "During each of the years at issue, Ms. Dursky and Ms. Watkins did not attend all of certain cats and/or kittens while operating DKD's cattery activity. the cat shows in which they entered - 12 - and Ms . Watkins had used before those years in the cattery ac t ivity of Ms . Dursky and Ms . Watkins . During each of the years at issue, Ms. Dursky spent approximately 800 hours in ošerating DKD's cattery activity. As discussed above, during each of those years, DKD continued to pay to Ms. Dursky the same amount of wages (i.e., $80,400) that it had paid to her in 2001 and 2002. The wages that DKD paid to Ms. Dursky also remained unchanged in 2006, the year in which DKD- discontinued DKD' s cattery activity. During each of the years: at issue, Ms. 'Watkins spent more hours than Ms. Dursky in operating DKD's cattery activity. During each of those years, DKD made payments to Ms. Watkins || totalin $7,700. (We shall refer to any, -some, or all of those payments as DKD' s payments to.- Ms . Watkins . ) For each of the years at issue, DKD withheld Social Security tax and Medicare tax f rom DKp' s 'payments to Ms . Watkins . For each of the years at issue, DKD issued Form W-2 to Ms. Watkins in which it reported that it had paid her wages of $7,700. For each of those years, Ms. Watkins filed a tax return in whic she included in gross income the $7, 700 that she had received from DKD during each such year, It For each of the taxable years at issue, DKD filed Form 940, Employer' s Annual Federal Unemployment (FUTA) Tax Return, and for each quàrter during each of those years, DKD filed Form 941', - 13 - Employer's,Quarterly Federal Tax Return. tIn each of those forms, DKD reported DKD's payments to Ms. Watkins and paid any Federal tax shown due in each such form. During the years at issue, while operating DKD' s cattery activity Ms . Dursky and Ms . Watkins desired to expand on the national reputation of the cattery activity of Ms. Dursky and Ms. Watkins that they had developed before those years. In order to do so, Ms . Dursky and Ms . Watkins- relied on their respective years of cattery activity experience and their respective reputations in the so-called cattery world. While operating DKD's cattery activity during the years at issue, Ms. Dursky and Ms. Watkins bred, raised and offered for sale Norwegian Forest cats and entered-certain of those cats in certain cat shows.9 Starting at an undisclosed time in 2004, they bred, raised,. and offered for sale -Abyssinian cats and entered certain of those cats in certain cat shows. While operating DKD's cattery "activity during 2003, Ms. Dursky and Ms. Watkins produced approximately seven to nine kittens from approximately five to seven litters. While operating DKD' s cattery activity during each of the years 2004 "The number of breeders that bred Norwegian Forest cats in the Midwest region of approximately three at to 15 by 2005. the United States increased from the beginning of 2003 to approximately 10 14 - and 200 5, Ms. Dursky and Ms. Watkins produced approximá.tely nine kittens from approximately tliree litters. Wh Lle operating DKD' s c ttery activity during the years at issue, s. Dursky and Ms. Wat kins entered at least 62 cats 49 cats and 45. cats, respectively, in various cat shous that were ty ically held on the east coast or the west coast of the United åtates . In order to enter a cat in any 'such "show, the owner o the cat, was require¶ to prepay a nonrefundable entrance fee. Me. Dursky, and Ms. Watkins did not attend all the cat shows in which they entered cats. During the years at issue,- Ms - Watkins typically attended.cat- shows without Ma.»Dursky, although Ms. Dur ky attended some cat shows with Ms. Watkins. yhile operating DKD' s cattery activity duning 2003, 2004, and 2005 Ms. Watkins attended 30,cat shows; 31 cat ishows, and 28 cat ho s, respectively, and Ms . Dursky attended a relativel small n mber of those shows with Ms. Watkins. When one or both of them attended:a cat show, one or -both made .arrangements for travel &nd" lodging. If Ms. Dursky and/or Ms. Watkins attended a cat sho that was'not within driving di-stance of West - Des Moines it took approximately 40 hours in order to travel to and from, and par icipate in, the show. If Ms. Dursky and/or Ms. Watkins attended a cat show that was within driving distance of West Des "The record does not establish how many cat shows during each of the years at and without Ms . Dur sky . issue Ms . Watkins attended" with Ms . Dursky - 15 - Moines, it took approximately -32 hours in order to travel to and from,- and participate in, the show. As was true of the cattery áctivity of Ms. Dursky and Ms. Watkins before the years at issue, DKD's cattery activity was designated by the CFA during -the years at issue as a "Cattery of Excellence" As was true of their beliefs while operating the cattery activity of Ms. Dursky and Ms. Watkins before the years at issue, while Ms. Dursky and Ms. Watkins were operating DKD's cattery activity during the years at issue they believed that the price of any cat or kitten offered for sale would increase if the cats and kittens that they bred won national cat shows. While operating DKD's cattery activity during the years at issue, Ms. Dursky and Ms. Watkins produced a total óf four cats that won national championships." During each of the years at issue, the monthly fair rental value of Ms. Dursky's residence was $1,600. .During none of those "National championship winners were- determined on the basis the number of the total number of points earned by a cat during cat show of season. Cats earned points by winning cat shows; points earned depended on the number of cats competing in a show. The number of cats competing in a cat show typically was not determined until shortly before the show. Ms. Dursky and Ms. Watkins often waited until show was determined before deciding whether to attend the show. Because they waited until shortly before a cat show was scheduled to take place to decide whether to attend it, Ms. Dursky and Ms. Watkins paid a premium for any air transportation costs incurred to attend the show. the number of cats competing in a cat - 16 - years As there a written - rerital agreement between Ms . Dursky and DKD with respect to Ms . Dursky' s residence . Nonetheless , during each of the years at issue, DKD paid Ms. Dursky $1, 000 monthly, or $12, 000 annually (DKD' s purported rent) , for its claimed partial use of Ms. Dursky's esidence for DKD's cattery activity. In arriying at that amount, neither Ms. Dursky nor DKD obtained an appraisal to determine the fair rental value of (1) Ms. Dursky' residence or (2) the portion of that residence used in a cattery activity during each of the- years at issue. Instead, Ms. Dursky, DKD, and Howard Musin (Mr. Musin) , the tax return preparer of Ms . Dursky and DKD for at least each of the years 2003 an 2004,14 agreed that DKD should pay each month to Ms. Dursky 1,000 for the use of¿Ms. Dursky's residence for a cattery activity. Ms. Dursky, DKD, a,nd Mr. Musin also agreed that DKD should pay to Ms; Dursky 10 percent of certain expenses (e.g., utilities, repairs) relating sto Ms. Dursky's residence as allocable to a cattery activity.15 4Mr . Mus in' s colleague , Jill Schwart z the tax ret rn preparer of DKD fcr the year 2001, also advised Ms. Dursky .nd DKD regarding the amount that DKD should pay Ms . Dursky for the use of Ms. Dursky's residence for a cattery activit (Ms . Schwart z) , . isMs . Schwart z also advi ed Ms . Dursky and DKD regarding DKD' s p ying Ms . Dursky 10 percent of certain expenses (e . g . utiliti s, allocable to a cattery activity. repairs) relating to Ms . Dursky' s residence as , The record does not establish whether DKD paid to Ms. Dursky ) (continued. . . - 17 -- As was true while they were operating the cattery activity of Ms. Dursky and Ms. Watkins before the years at issue, while Ms . Dursky and Ms . Watkins were operating DKD' s cattery activity during the years åt issue they continued to incur and pay substantial expenses . As discussed below, at least during each of the years at issue, DKD reimbursed Ms . Dursky and Ms . Watkins for those expenses" and also paid directly a very small amount of expenses relating to the operation of DKD's cattery activity. During each of the years at issue, Ms. Watkins used certain computer software in order to record for each of those years the substantial amounts expended and the insubstantial amounts received while Ms. Dursky and Ms. Watkins were operating DKD's cattery activity during each of those years. During 2003, DKD reimbursed Ms. Dursky and Ms. Watkins $60, 968 for the following amounts (2003 reimbursed cattery expenses) that they had paid: is ( , . . continued) 10 percent of any such expenses. "During each of the years at issue, DKD reimbursed Ms. Dursky and Ms. Watkins for certain amounts that they had expended as shown on certain receipts by issuing checks drawn on DKD' s bank account over which only Ms. Dursky had signature authority. ! - 18 - Type of Expense Mileage to cat shows Motels Meals (50 p rcent) Entry f ees Airfares Pet sitters Rental cars Cattery cleaning Veterinarian bills Postage Litter and food Grooming products Advertising Total Amount $4,277 5, 669 1,151 6 , 78 6 13, 953 - 2,566 2,107 - 1,761 13,576 150 5,993 1,212 1 , 767 60,968 Du ing 20 0 3 , in addition to DKD' s payments to Ms . Wat]iins of $7,700 end DKD's purported rent of $12, 000 that DKD' paid to Ms . Dursky, DKD paid directly $588 of unidentified "taxes and licenses" . Du ing 2004, DKD reimbursed Ms . Dursky and Ms . Watkins $66, 734 for the following amounts (2004 reimbursed cattery expenses) that they had paid: - 19 - Type of Expense Mileage to cat shows Motels Meals (50 percent) Entry fees Airfares Pet sitters Rental cars Cattery cleaning Veterinarian bills Postage Litter and food Photos Grooming and misc. supplies Advertising Long-distance telephone Misc. travel Total Amount $4,643 8,385 1,814 .6,338 7, 652 2,095 1,994 5,080 14,759 167 7, 029 817 3,004 1,580 1,327 50 66,734 During 2004, in"addition to DKD's payments to Ms. Watkins of $7,700 and DKD's purported rent of $12,000 that DKD paid to Ms. Dursky, DKD paid directly $588 of unidentified "taxes and licenses" . During 2005, DKD reimbursed Ms. Dursky and Ms. Watkins $68,329 for the following amounts (2005 reimbursed cattery expenses) that they had paid: - 20 - Type of Expense I Mileage to at shows Motels Meals (50 percent ) Entry fees Airfares Rental cars Veterinarian bills Postage Litter Cat f ood Photos Grooming and mis c . supplies Advertising Total Amount $6, 350 8 , 121 1, 659 2,848 16, 885 2;618 13, 8 60 42 1, 664 8 , 613 78 4, 190 1 401 68 , 329 During 2005, in additiorè to DKD's payments 'to Ms. Watkins of $7,700 ånd DKD's purported reht of $12,000 t-hat DKD paid to Ms. Dursky, DKD paid directly $58ß of unidentified "taxes and li- censes" In addition to reimbursing Ms. Dursky and Ms. Watkins for the amotnts described above that they paid during each of the years a issue, DKD reimburse them (1) $297.84 in 2003 for lodging and food that they ha paid ir that year for the mother of Ms . atkins who had attend d a banquet honoring them «for winning a national cat show, (2) $88 . 97 in 2003 for restaurant food th t Ms . Watkins' mother had paid in that year, and (3) $412 in 5.004 for entry tickets to Walt Disney World that Ms. Dursky and Ms.|Watkins had paid in that year. (We shall refer to the reimbursements described in (1) and (2) as DKD' s 2003 reimburse- - 21 - ments for lodging and food relating to Ms. Watkins' mother. We shall refer to the reimbursements edescribed in (3) as DKD's 2004 reimbursements for entry tickets for Ms. Dursky and Ms. Watkins to Walt Disney World.) During 2003, Ms. Dursky and Ms. Watkins did not sell any cats or kittens while operating DKD's cattery activity. During 2004,. Ms. Dursky and Ms. Watkins did not sell any cats or kittens while operating DKD's cattery activity except for three cats and/or kittens that they sold in December of that year for a total of $250. During 2005, Ms. Dursky and Ms.. Watkins did not sell any cats or kittens while operating DKD's cattery activity except for a total- of eight cats and/or kittens that they sold in June, July, August, October, and November of that year for,a total of $1,525. In 2006, at an undisclosed time in or before August, Mr. Musin and Ms. Schwartz informed petitioners that the Internal Revenue Service (IRS) was investigating Mr. Musin and Ms.i Schwartz and intended to commence an examination of petitioners' respective tax returns for 2003 and 2004. As a result; around August 2006, (1) Ms. Dursky and Ms. Watkins discontinued operat- "During 2005, while operating DKD's cattery activity Ms. three cats and/or two cats (2) a total of Dursky and Ms. Watkins sold (1) a total of kittens in June for a total of $200, and/or kittens in July for a total of $200, in August for $100, (5) one kitten in November for $450. (4) one kitten in October for $575, and (3) one cat or kitten - 22 ing DKD s cat tery ac t ivity, " (2 ) "Ms . Dursky and Ms . - Watkins . | continueå operating that cattery activity as thescatter activity of Ms. ursky and Ms. Watkins and (3) Ms. Dursky and i]KD re tained James R. Monroe (Mr. MÞnroe) . Certain Retirement "Accounts Vanguard In I ecember 1995,- Ms. Dursky executed a document entitled "VANG D PROFIT-SHARING PLAN SIMPLIFIED ADOPTION AGREEMENT (006)" Vanguard plan documen .), that by its terms was effective on Januäry 1, 1995. The Vanghard pl n document stated that Debra K. Dursky was the employer and that the employer was a "Sole Proprie or/Self-Employed Indi idual". That document also stated that .De ra K. Dursky was .the þlan administrator and. that Vanguard Fiduciary Trust Company (Vanggard) was the plan trust~ee . The Vanguard plan document did noþ identify a beneficiary. The Vanguard plan document also stated: the Employer [Debra K. Dþrsky] shall make contributions to the Trust for each Plan Year in an amount determined by the Employer in its sple discretion by resolution du y adopted on or befor the last day foi filing its Efederal income tax return, including extensions, for "A1.though Ms. Dursky arid6Ms. Watkins did not discontinue operati g DKD's cattery activity until around August :i006, as discuss d below, DKD did not claim any deductidns relating to DKD' s c ttery activity in the tax return that it filed for its taxable year 2006. "Mr. Monroe prepared petitioners'" respective tax returns for 200$ and is the lead atto ney representing petitioners in these cÊses. - 23 - the taxable year with or within which such Plan Year ends. Pursuant to the Vanguard plan document, on certain dates in 2003 and 2006 Ms. Dursky sent the following checks to Vanguard that she intended to be contributions under that plan document. On December 30, 2003, Ms. Dursky sent a $10,000 check to Vanguard for her benefit that was drawn on DKD's bank account maintained at Bankers Trust (DKD's bank account). In the so-called memo portion of that check, Ms. Dursky wrote, inter alia, "2003 Keogh". On April 10, 2006, Ms. Dursky sent a $10,000 check to Vanguard for her benefit that was drawn on DKD's bank account. During none of the years 2003 through 2005 did Ms. Dursky make any contributions under the Vanguard plan document for the benefit of Ms. Watkins. Fidelity On December 28, 2001, Ms. Dursky executed on behalf of DKD a document that was entitled "Profit Sharing Plan Application" (Fidelity application document) in order to open an account for a profit-sharing plan at Fidelity (DKD Fidelity profit-sharing plan). Ms. Dursky completed and signed that document on behalf of DKD. The Fidelity application document indicated that the employer was DKD Enterprises, Inc. Nonetheless, Ms. Dursky checked the box in that document marked "Self-Employed" and did not check the box marked "Incorporated". In response to the question in the Fidelity application document "Do you currently - 24 - have or have you ever maintained another qualified plan?" , Ms . Dursky tated: "Vanguard - 15% Fidelity - 85%" . On December 28, 2001, Ms. Dursky also executed on behalf of DKD a d cument that was entitled "Profit Sharing Plan Contrib tion Form" (Fidelity contribution document) . The Fidelit r contribution document indicated that the only participant under the DKD Fidelity profit-sharing plan was Ms. Dursky. On certain dates in 2004, 2005, and 2006 DKD sent the following checks to Fidelity that were intended to be contribùtions under the DKD Fidelity profit-sharing plan. On April 14, 2004, DKD sent a $10, 000 check to Fidelity for the benefit of Ms. Dursky that was drawn on DKD's bank account. In the so-called memo portion of that check, Ms. Dursky wrote, inter alia, "Fidelity Profit Sharing Keogh * * * for 2003" . On December 27, 2004, DKD sent a $10,000 check to Fidelity for the benefit of Ms. Dursky that was drawn on DKD's bank account. In the so-called memo portion of |[ that check, Ms. Dursky wrote, inter alia, "Keogh * * * for 2004" . On April 11, 2005, DKD sent a $10,000 check to Fidelity for the benefit of Ms. Dursky that was drawn on DKD' s bank account . In the so-called memo portion of that check, Ms. Dursky wrote, inter alia, "2004 Keogh". On April 10, 2006, DKD sent a $5, 000 check to Fidelity for the benefit of Ms . Duráky that was drawn on DKD' s bank account . In the so- - 25 - called memo portion of that check, Ms. Dursky wrote, inter alia, "2005". - During none of the years 2003 through 2005-did DKD send any checks to "Fidelity that were intended to be contributions under the DKD Fidelity profit-sharing plan for the benefit of Ms. Watkins. Ms. Dursky's Health Insurance Policy At a time not disclosed by the record, Ñs. Dursky purchased a health insurance policy in her name (Ms. Dursky's health insurance policy) that was in effect at least during each of the years 2003 and 2004 and that required her- to pay certain quarterly premiums to the company'(health insurance provider) that issued that policy to her. During 2003 and 2004, DKD paid to Ms. Dursky's health insurance provider the following premiums on the dates indicated for Ms. Dursky's health insurance policy: 2003 2004 Date Mar. 30 July 14 Sept. 14 Dec. 30 Total 5 Apr. June 16 Oct. Dec. 27 Total 4 Amount $1,687.50 1,687.50 1,687.50 1,887.60 6,950.10 $1,887.60 1,887.60 1,887.60 1,988.70 7,651.50 DKD ' s Tax Re turns 2001 DKD filed Form 1120, U.S. Corporation Income. Tax Return (Form.1i20), for 2001 (DKD's 2001 return) that Ms. Schwartz signed is return preparer and that Ms. Dursky signed as the sole officer of DKD. In Schedule K, Other Information (Schedule K) , of DKD'ä 2001 return, DKD indicated that it was on the cash , method Öf accounting. In DKD' s 2001 return, DKD reported (1) "Gross receipts or sales" of $2,770,20 (2) "returns and allowances" of zero, (3) "Cost of goods sold" of zero, (4) "Other income" of $226, 923, " and (5) "Total income" of $229, 693 . In DKD' s 2001 return, DKD claimed, inter alia, the following deducti ns: (1) "Compensation of officers" of $80,400, (2) "Salaries and wages" of zero, (3) "Rents" of $19,150, (4) "Taxes and licenses" of $6, 307," (5) "Pension, profit- sharing etc., plans" of $30,000, and (6) "Employee benefit program " of $8,852. In that return, DKD also claimed "Other 2oT1 e record does not establish the nature of the "Gross receipt( or sales" that DKD reported in DKD' s 2001 return. "DI ) included a schedulel with DKD' s 2001 return in which DKD indicated that the "Other' income" of $226, 923 reported consist d of State tax refund of $3,127. (1) consulting revenue of $223, 796 and (2) an Iowa "DKD included a statement with DKD' s 2001 return in which it desc ibed the "Taxes and licenses" claimed as "payroll taxes". - 27 - deductions" of $55,210. DKD included a schedule with DKD's 2001 return in which it indicated that the "Other deductions" claimed consisted of the "following types and amounts of-deductions: Claimed Deduction labor Cattery expensesi Show fees Promotional Accounting Postage Insurance Insurance - workman's compensation Licenses and permits Meals Supplies Telephóne Travel Utilities Total Amount $19,391 4,076 1,850 1,100 541 1,966 213 50 1,772 9,034 ,183 12,680 354 55,210 DKD's claimed deductions for "Cattery expenses", "Show fees", and "Travel" were for amounts that Ms. Dursky and Ms. Watkins paid during 2001 in operating the cattery activity of Ms. Dursky and Ms.' Watkins. DKD attached to DKD's 2001 return Schedule L, Balance Sheets per Books (Schedule L), for 2001 (2001 Schedule L). In that schedule, DKD showed the following assets: "Cash", "Trade notes and accounts receivable", and "Buildings and other depreciable assets". DKD did not show any other assets in the 2001 Schedule L, such as cats, kittens, cat trees, feeding bowls, litter boxes, or other assets relating to a cattery activity. 20 2 e - 28 - DK filed Form 1120 for 2002 (DKD' s 2002 return) that Mr Musin s gned as return prepa er and t-hat Ms. Dursky signed as the sole of icer of DKD. In Schedule K of DKD' s 2002 return, DKD indicat d that it was on the cash method of accounting. In DKD' s 2002 return, D D reported (1) "Gross receipts or sales" of 800, (2) "returns and allowances" of zero, (3) "Cost of good sold" of zero, (4 ) ' Other income" of $198 , 608 , 24 and (5) "To al income" of $199, 408 . In DKD' s 2002 return, DIe claimed, inter alia the following deducti ns (1) "Compensation of officers" of $80, 400, (2) "Sa aries and wages" of $7,350, (3) "Rents" Of $19,800, (4) "Ta es and licenses" of $7,354,2s (5) "Pension, profit- sharing etc., plans" of $10,000, and (6) "Employee,benefit program " of $6, 931. In that return, DKD also claimed "Other deductions" of $58,424. DKD included a schedule with DKD's 2002 return in which it ,indicated that the "Other deductions" claimed consist d of the following t es and amounts of deductions: T e rècord does not est ablish the nature of the "Gross receipts or sales" that DKD repórted in DKD' s 2002 return. 4DKD included a schedule with DKD's 2002 eturn in which DKD ind cated that the "Other income" of $198, 608 reported consist d of State t x refund of $1,142. (1) consulting devenue of $197, 466 and (2) an Iowa 2sDRD included a statemer t with DKD' s 2002 return in which it described the "Taxes and licenses" claimed as "payroll taxes" - 29 - Claimed Deduction Cattery expensesi Show feest Labor Accounting Automobile Postage Licenses and permits Office Supplies Telephone Travel and entertainmenti Utilities Total . . Amount $26,784 4,485 1,245 550 5,170 261 45 557 1,550 2,805 14,571, 401 58,424 DKD's claimed deductions for "Cattery expenses", "Show fees", and "Travel and entertainment" were for amounts that Ms. Dursky and Ms. Watkins paid during 2002 in operating the cattery activity of Ms. Dursky and Ms. Watkins. DKD attached to DKD's 2002 return Schedule L for 2002. In that schedule, DKD. did not show any assets. 2003 DKD filed late Form 1120 for 2003- (DED's 2003 return), the first year at issue in these cases, that Mr. Musin signed as return preparer and that Ms. Dursky signed as the sole officer of DKD. In Schedule K of DKD's 2003 return, DKD indicated that it was on a "MODIFIED ACCRUAL" method of accounting but did not indicate what that meant. In DKD's 2003 return, DKD reported (1) "Gross receipts or sales" of $197,582. None of that amount was from DKD's cattery activity. In DKD's 2003 return, DKD also reported (1) "returns and allowances" of zero, (2) "Cost of goods sold" of zero, - 30 - (3) "Other income" consisting of an "IOWA TAX REFUND" of $675, and (4) "Total income" of $198,257. In DKD's 2003 return, DKD claimed, inter alia, the following deductions: (1)' "Compensation of officers" of $80,400, (2) "Salaries and wages" of $7,700, (3) "Rents" of $19,400, (4) "Takes and licenses" of $6,861," (5) "Pension, profit- sharing etc., plans" of $20,000, and (6) "Employee benefit programa" of $10,274. In that return, DKD also cl-aimed "Other deductions" of $75, OOO. DKD included a schedule with DKD's 2003 return in which it indicated that the "Other deductions" claimed consisted of the following types and amounts sof deductions: Claimed Deduction Cattery expensesi Accounting Dues and subscriptions Insurance Insurance - workman' s compensation Office Travel and entertainment Total DKD' s claimed deduction for "Cattery Amount $69, 515 2, 025 286 1, 687 363 26 1, 098 75,000 expenses" of $69, 515 included the 2003 reimbursed cattery expenses of $60,968. portion of $386.81) was for DKD's 2003 reimbursements for lodging and food relatinŠ to Ms. Watkins' mother. the claimed deduction for, "Cattery expenses" A (i.e., DKI attached to DKD's 2003 return Schedule L for 2003 (2003 Schedul L) . . In that schedule, DKD showed the following assets: "DKD included a statement with DKD's 2003 return in which it desc ibed the "Taxes and licenses" claimed as "payroll taxes" - 31 - "Cash", "Trade notes and accounts receivable", and "Buildings and other depreciable assets" . DKD did not show any other: assets in the 2003 Schedule L, such-as cats, kittens, cat trees, feeding bowls, litter boxes, or other assets relating to~a cattery activity. 2004 - ' DKD filed late Form 1120 for 2004 (DKD' s 2004 return) .27 In Schedule K of DKD's 2004 return, DKD indicated that it was on a "MODIFIED ACCRUAL" method of accounting but did not indicate what that meant . In DKD's 2004 return, DKD reported (l) "Gross receipts or sales" of $233,556,23 (2) "returns and allowances" of zero, (3) "Cost of goods sold" of zero, (4) "Other ,income" consisting of an "IOWA TAX REFUND" of $1, 000, and (5) "Total income" of $234,556. In DKD's 2004 return, DKD claimed, inter alia, the following deductions: (1) "Compensation of officers" of $80,400, (2) "Salaries and wages" of $7, 700, ' (3) "Rents" of $24, 700, 27The copy of DKD' s 2004 return that is in the record is not signed by a return preparer or by an officer of DKD. 2eThe record does not establish whether the $250 that we have found DKD received in 2004 for the sale of certain cats and/or kittens in December of "Gross receipts or sales" of $233,556 that'DKD reported in DKD's 2004 return. that year was included in the !! - 32 - (4) "Ta es, and licenses" of $6,861," (5) "Pension, profit- sharing etc., plans" of zero, and (6) "Employee benefit programa" of $5,763. In that return, DKD also claimed "Other deductions" of $105,414. DKD included a schedule with DKD's 2004 return in which it indicated athat the "Other deductions" claimed consist d of the following types and amounts of deductions: Claimed Dedúction Cattery expensesi Accounting Bank charges Convent ions and meet ings Disability insu ance Dues and subscriptions Insurance Office Meals Telephone Travel Total Amount $75, O91 1, 750 143 1, 50 0 1,145 20,000 3,373 189 1, 367 697 159 105, 414 DK 's claimed deduction for "Cattery expenses" of $75;091 e included the 2004 reimbursed cattery expenses of $66,734. portion|of the claimed deduction for "Cattery expenses" $412) was for DKD's 2004 reimbursements for entry tickets for Ms. Dursky Ånd Ms. Watkins to Walt Disney World. A - (i.e., DKID attached to DKD's 2004 return Schedule L for 2004 (2004. Scheduld L) . In that schedule, DKD showed the following assets: 1. "Cash", "Trade notes and accounts receivable", and "Buildings and other depreciable assets" . DED did not show any other assets in the 200 Schedule L, such as bats, kittens, cat trees, feeding 29DKD included a statement with DKD' s 2004 return ein which it desc ibed the "Taxes and licenses" claimed as "payroll taxes"s bowls, litter boxes, or other assets relating to a cattery - 33- - activity. 2005 DKD filed Form.1120 for 2005- (DKD's 2005 return) that Mr. Monroe," whom, as discussed above, DKD retained around-August 2006, signed as return preparer and that Ms. Dursky signed as the sole officer of DKD. In Schedule K of DKD's 2005 return, DKD indicated that it was on a "MOD ACC" method of accounting but did not indicate what that meant. In DKD's return, DKD reported (1) "Gross receipts or sales" of $212,970," (2) "returns & allowances" of zero, (3) "Cost of goods sold" of zero, (4) "Other income" consisting of "State tax refunds" of $1,000, and (5) "Total income" of $213,970. In DKD's 2005 return, DKD claimed, inter alia, the following deductions: (1) "Compensation of officers" of $80,400, (2) "Salaries and wages" of $7,700, (3) "Rents" of $22,800, (4) "Taxes and licenses" of $6,740," (5) "Pension, profit- sharing, etc., plans" of zero, (6) "Employee benefit programs" of "See supra note 19. "The record does not establish whether the $1,525 that we have found DKD received in 2005 for.the sale of certain cats and/or kittens, see supra note 17, was included in the "Gross receipts or sales" of $212,970 reported in DKD's 2005 return. "Unlike'DKD's -2001 return, 2002 return, 2003 return, and 2004 return, DKD did not return or otherwise provide a description of "Taxes and licenses" of $6,740 claimed in DKD's 2005 return. include a statement with DKD's 2005 the nature of the - 34 - zero, apd (7) "Advertising" c f $1, 240 . P. In that return, DKD also claimed "Other deductior s" of $62, 942. DKD included a schedule with DKD's 2005 return, in which it indicated that the "Other ieductions" claimed cánsisted of the following types and amounts of deductions:44 ! l' "W have found that during 2005 DKD reimbursed Ms. Dursky and Ms. Watkins $1,401 for adrertising. 34Múst of the "Other deductions" were for the 2005 reimbur ed, cattery expenses c f $68 , 329 . However, DKD did -not claim a deduction for the $8,9121 for, which we have found DKD reimbur ed Ms. Dursky and Ms.d Watkins -in 2005 for motels s 35 - Claimed Deductioni ' ' Automobiles Bank charges Legal and professional Meals and entertainment Miscellaneous Office Postage Telephone Travel Utilities Annual report Entry fees Rental car Veterinarian Litter Cat Photos Stud 'service food Total Amount $6,350 38 1,175 21,878 35,188 52 441 710 515,730 377 50 '5,363 71,214 "13,986 91,923 1°8,014 "53 800 62, 942 The deductions for automobiles, meals, miscellaneous, posttravel, entry fees, age, food, photos, and stud service related to DKD's cattery activity. We shall refer to those deductions as "cattery expenses" . rental cars, veterinarian, litter, cat 2We have found that during 2005 DKD reimbursed Ms. Dursky and Ms. Watkins $1,659 for meals. 3We have found that during 2005 DKD reimbursed Ms. Dursky and Ms. Watkins $4,190 for grooming and miscellaneous supplies. 4We have found that during 2005 DKD reimbursed Ms. Dursky and Ms. Watkins $42 for postage. sWe have found that during 2005 DKD reimbursed Ms. Dursky and Ms . Watkins $16 , 885 for airf ares . 'We have found that during 2005" DKD reimbursed Ms. Dursky and Ms. Watkins $2,848 for entry fees. ?We have found that during 2005 DKD reimbursed Ms. Dursky and Ms. Watkins $2,618 for rental cars. "We have found that during 2005 DKD reimbursed Ms. Dursky and Ms . Watkins $13 , 8 60 f or veterinarian bills . We have found that during 2005 DKD reimbursed Ms. Dursky and Ms. Watkins $1,664 for litter. °We have found that during 2005 DKD reimbursed Ms. Dursky and Ms. Watkins $8,613 for cat food. "We have found that during 2005 DKD reimbursed Ms. Dursky and Ms . Watkins $78 for photos . DKD attached to DKD's 2 05 return Schedule L for 2005. In - 36 -- that schedule, DKD did not si ow any assets. 20 6 DKD filed Form 1120 for 2006, the year during which DKD discontinued DKD's cattery activity, that Mr. Monroe signed as return preparer and that Ms. Dursky signed as the sole officer of DKD. In Schedule K of DKD's Form 1120 for 2006 (DKD's 2006 return) DKD indicated that it was on a "MOD ACC" method of account ng but did not indicate what that meant. In DKD's 2006 return, DKD reported (1) "Gross receipts or sales" f $177, 519, 35 (2) "returns & allowances" of zero, (3) "Co t of goods sold" of zero, and (4) "Total income" of $177 , 519 . In DKD''s 2006 return, DKD álaimed, inter alia, tlie followi c deducti pns: (1) "Com'pensatioh of officers" of $80,400, (2) "Sa aries and wages" of zþro, (3), "Rents" of zero (4) "Taxes and lic nses" of $6,740," (5) "P~ension, profit-sharing, etc. plans" of $15, 000, and (6) "E ployee benefit programs" of $13, 458 . In that return, DKD also claimed "Other deductions" of $1,'7/59 DKD included a sched le with DKD's 2006 return in-whi 1 asThe record doesi not establish the nature . of receiptŠ or sales" reported iN DKD' s 2006 return. the "Gross "U like DKD' s 2001 retu n, 2002 return, 2003 return, and 2004 re urn, DKD did not return < r otherwise provide a description of "Taxes nd licenses" of $6,74 incl de a statement with DKD's 2006 claimed in DKD's 2006 return. the nature of the - 37 - it indicated that the "Other deductions" claimed consisted of the following types and amounts of deductions: Claimed Deduction Dues and subscriptions Legal and professional Miscellaneous Annual report Total Amount $35 1,550 124 50 1,759 DKD did not claim any deductions in DKD's 2006 return with respect to DKD's cattery activity.37 DKD attached to DKD's 2006 return Schedule L for 2006. In that schedule, DKD did not show any assets. Summary of DKD's Returns for 2001 Through 2006 The following chart summarizes DKD' s tax return treatment of all income and certain deductions claimed for each of the years 2001 through 2006: 37We have found that Ms . Dursky and Ms . Watkins operated DKD's cattery activity until around August 2006. Income 2001 2002 2003 2004 2005 2006 - 38 - sales" "Other income" Deductions Claimed Deductions claimed relating to DKD' s cattery activity "Cattery expenses" "Salaries and wages" "Taxes and licenses" "Rent" "a5iiipeiisation of officers" "Pension, profit- $2,770 226,923 $800 $197,582 $233,556 $212,970 $177¿519 198, 608 675 1,O00 1,000 -- 55, 210 -- 588 58, 424 7,350 588 69, 515 7,700 588 75, O91 7,700 588 12,000 12,000 12,000 12,000 60 , 540 7,700 588 12,000 - - -- - -- 80,400 80,400 80,400 80,400 80,400 80,400 sharing, etc . , plans" 30, 000 10, 000 20, 000 -- "Employee benefit programs" Income (loss) 8 , 852 42,643 6 , 931 23,715 10 , 274 (2,220) 5 , 763 53,014 - - 52,742 15, 000 13 , 458 68,661 ~ 3 9 - Ms. Dursky's Returns 2003 Ms. Dursky filed Form 1040, U.S. Individual Income Tax Return (Form 1040), for 2003 (Ms. Dursky's 2003 return) that Mr. Musin signed as return preparer and that she- signed. In that return, Ms. Dursky reported "Wages, salaries, tips, etc." of $80,400 that she received during 2003 from DKD as compensation for the IT consulting work that she performed for DKD during that year. In Schedule A--Itemized Deductions (Schedule A) attached to Ms. Dursky's 2003 return, Ms. Dursky deducted "Real estate taxes" of $3,458 and "Home mortgage interest and points" of- $5,204. Ms. Dursky included with Ms. Dursky's 2003 return Schedule E for 2003 (2003 Schedule E) . In the 2003 Schedule E, Ms. Dursky described the "rental real estate property" to which that sched- ule.pertained as "OFFICE SPACE WEST DES MOINE [sic) IA". In that schedule, Ms . Dursky responded in the negative to the following question: For each rental real estate property listed on line 1, did you or your family use it during the tax year for personal purposes for more than the greater of: • 14 days or • 10% of the total days rented at fair rental value? - 40 -- In the 2003 Schedule E, Ms. Dursky reported "Rents received" of $19, i0 0 " and claimed deduc tions for "Mortgage interest paid to bank , etc." of $1,555'and for "Taxes" tof $610. 20 4 Ms Dursky filed Form 1040 for-2004 (Ms. Dursky's 2004 return) that Mr . Musin signed as return preparer and that ,she signed. «In ethat return, Ms. Dursky reported, "Wages, salaries tips, ete." of $80,400 that she, received during 2004 from DKD as compensation for the IT consulting work that she performed for DKD during that year. In Schedule A attached to Ms. Dursky's 2004 return, Ms. Dursky ~ educted "Real estate taxes" of ,$3, 098 and "Home mortgage interest and points" of $4, 302. . Ms' Dursky included with Ms . Dursky' s 2004 return Schedule E for 2004 (2004 Schedule E) . In the 2004 Schedule E, Ms. Dursky 4 described the "rental real estate property" to which that sched ule per ained as "OFFICE SPACE WEST DES MOINE [sic] IA" . In that schedule, Ms . Dursky responded in the negative to the following questioia: each rental real estate property listed on l ne 1 you or your family use it during the tax year for F di personal purposes for more than the greater of : "AÑ discussed above, in DKD' s 2003 return, DKD claimed a deduction for "Rents" of $19, 00. li • 14 days or - 41 - • 10%- of the total days rented at fair rental value? In the 2004 Schedule E, Ms. Dursky reported "Rents -received" of $24, 700" and claimed deductions for "Mortgage interest paid to banks, etc." of $1;555 and for "Taxes" of $610. 2005. Ms. Dursky filed Form 1040 for 2005 (Ms. Dursky's 2005 return) that Mr. Monroe, whom, as discussed above, DKD retained around August 2006, signed as return preparer and that she signed. In that return, Ms. Dursky reported "Wages, salaries, tips, etc." of $80,400 that she received during 2005 from DKD as compensation for the IT consulting work that she performed for DKD during that year. In Schedule A attached to Ms. Dursky's 2006 return, Ms. Dursky deducted "Real estate taxes" of $2,287 and "Home mtg interest and points" of $4,084. Ms. Dursky included with Ms. Dursky's 2005 return Schedule .E for 2005 (2005 Schedule E) . In the 2005 Schedule E, Ms. Dursky described the "rental real estate property" to which that sched- ule pertained as "OFFICE SPACE WEST DES MOINES, IA" . In that schedule, Ms. Dursky responded in the negative to the following question: "As discussed above, DKD claimed a deduction in DKD' s 2004 return for "Rents" of $24,700. 42 - For each rental real est ate property listed on l'ine 1 di you or your family tise it during the tax year for personal purposes for móre than the greater of : • L4 days, or • I 0% of the total days rented at fair rental value? the 2005 Schedule E, Ms. Dursky "reported "Rents received" of $12,0004° and claimed deduåtions for "Mortgage interest paid to banks, etc . " of $2, 398 an for "Taxes" of $1, 343 . Notices of Deficiency DKD On September 26, 2007, espondent issued to,DKD a notice of deficiency (notice) for its taxable year 2003 (DKD's 2003 no- tice) . - On.March.12, 2008, r(spondent issued to DKD a notice for its tax ble years 2004 and 2005 (DKD's 2004.and 2005 notice) IN DKD' s 2003 notice, respondent determined, inter alia, that DKD is not, entitled toothe following deductions claimed for 2003: 1) "Other expenses" of $69,515, (2) "Salaries & wages" of 1 $7,700, (3) "Taxes and licenses" of $588, (4) "Rents" of $19,400 and (5) "Employee benèfit programs" of $10,274. In-that notice, respond nt also determined that DKD is not entitled to a .$20, 000 deductio claimed for 2003 for "Pension, profit sharing, plahš" because Th corporation paid the shareholder' s expenses for the operation of The disallowed the cat breeding business. °A discussed above, DKD claimed a deduction in DKD 2005 return or "Rents" of $22,80d. - 43 - the corporation's business. The business expenses are not ordinary and necessary for the operation of business that the shareholder operated was determined to be a hobby and not operated for profit. The corporation's income increased, by the above amount [$20,000] [sic]. for the tax year ending December 31, 2003 In DKD's 2004 and 2005 notice, respondent determined, inter alia, that DKD is not entitled to the following deductions claimed for 2004: (1) Cattery expenses of $75, 091, (2) "Salaries & Wages" of $7, 700, (3) "Taxes & Licenses" of $588, and (4) "Rents" of $24,700, and (5) "Employee Benefit Programs" of $1,145. In that notice, respondent also determined, inter alia, that DKD is not entitled to the following deductions claimed for 2005: (1) "Meals & Entertainment" of $1,878, (2) "Telephone Expense" of $710, (3) "Advertising" of $1,240, (4) "Auto & Truck Expense" of $6,350, (5) "Travel Expenses" of $15,730, (6) "Miscellaneous Expenses" of $5,188, (7) "Utility Expenses" of $377, (8) "Entry Fees" of $5,363, (9) "Rental Cars" of $1,214, (10) "Veterinarian Bills" of $13,986, (11) "Litter Expense" of $1,923, (12) "Cat Food Expense" of $8,014, (13) "Photo Expenses" of $53, (14) "Stud Service Expense" of $800, (15) "Salaries & Wages" of $7,700, (16) "Taxes & Licenses" of $588, and (17) "Rents" of $22,800. In addition, respondent determined in DKD' s 2004 and 2005 notice that DKD was a qualified personal service corporation, as defined in section 448(d) (2), for each of the years 2004 and 2005. In that notice, respondent also deter- .I : - 44 - mined that DKD is not entitled to the $20, 000 deduction claimed for 200 for "Pension & Profit Sharing"" because rather than $20,000.00 for the taxable It is determined that-pension and profit sharing expense is $0.00, yegr ended December 31, 2004 because it has not been es ablished that more than $0.00 was for an ordinary and necessary business expense, and expended for the pu pose designated. Accordingly, in reased $20, 000 .00 for the taxable year ended December 31, 2004. taxable income is In DKD's 2004 and 2005 niotice, respondent also determined that DKD is liable for its taxable years 2004 and 2005 for accuracy-related penalties under section 6662 (a) in the respec- tive amounts of $9,548 and $8,475. Ms Dursky On September 26, 2007, March 12, 2008, and March 12, 2008, respectively, respondent issued to Ms. Dursky separate notices for her taxable year 2003 (Ms. Dursky's 2003 notice), her taxable year 2004 (.Ms. Dursky's 2004 notice), and her taxable year 2005 (Ms . Dursky' s 200 5 notice) . In Ms. Dursky's 2003 notice, respondent determined that Ms Dursky is required to include in gross income as constructive dividends the following deductions that DKD claimed in DKD' s 003 "As discussed above, DKD did not claim in DKD' s 2004 return DKD claimed in DKD's 2004 return a $20,000 deduction for a deducEion of $20,000 for "Pension, profit-sharing, etc., plans". "Dues ar d subscriptions" . respondent determined that deducti $20,000 deduction for "Pension & Profit Sharing". The record does not explain how the $20, 000 that DKD claimed as a ri for "Dues and subscriptions" in DKD' s 2004 return was a - 45 - return and that respondent disallowed in DKD's 2003 notice! (1) "Cattery expenses" of $69,515, (2) "Salaries and wages" of $7,700, (3) "Taxes and licenses" of $588, (4) "Rents" of $19,400, (5) "Pension, profit-sharing, etc.,. plans".of $20,000, and (6) "Employee benefit programs" of $9,695. In Ms. Dursky's 2003 notice, respondent also- determined to (1) exclude from Ms. Dursky's 2003 Schedule E the rental income of $19,400 that she reported and (2) disallow the deductions of (a) "Mortgage Ex- penses" of $1,555, (b) "Other Expenses" of $2,870, and (c) "Depreciation Expense" of $641 that she claimed in the 2003 Schedule E with respect to Ms. Dursky's residence. In Ms. Dursky's 2004 notice, respondent determined that Ms. Dursky is required to include in gross income as constructive dividends the following deductions that DKD claimed in DKD's 2004 return and that respondent disallowed in DKD's-2004 and 2005 notice: '(1) "Cattery expenses" of $75,091, (2) "Salaries and wages" of $7,700, (3) "Taxes and licenses" of $588, (4) "Rents" of $24,700, (5) "Pension" of'$20,000," and (6) "Employee benefit programs" of $1,145. In Ms. Dursky's 2004 notice, respondent also determined to (1) èxclude from Ms. Dursky's 2004 Schedule E the rental income of $24,700 that she reported and (2) disallow the deductions for (a) "Mortgage Interest" of $1,555, (b) "Taxes" of $610, (c) "Other Expenses" of $730, and (d) "Depreciation" of "See supra note 41. $641 th t .she claimed in the 2004 Schedule E;with respect to Ms Dursky' residence . Int that notice, respondent aalso,determined that Ms Dursky -is liable for her taxable year 2004 for an accuracy-related spenalty under sections 6662 (a) of $3, 280 . 60 In Ms Dursky's 2005 notice, respondent determined that Ms. Durský s required to include in gross income as constructive dividends the following deductions that DKD claimed in DKD's 2005 return and that respondent disallowed in DKD's 2004 and 2005 notice: (1) "Meals and entertainment" -of $1,878 (2) ,"Telephone" o $710 (3) "Advertising" of $1, 240 (4) "Automobiles" of $6,350, (5) "Travel" of $15,730, (6) "Miscellaneous" of $5,188, (7) Uti]ities" of $37.7; -(8) "Cat food" of.$8,014, *(9) "Entry fees", of $5,-363, (10) "Rental car" of $1;214, (11) "Veterinarian" of $13 , 986, (12) "Litter" of $1, 923, (13) "Stud Service" Sof $800 (14) "P otos" sof $53, (15) "Salaries and wages" of $7/700, (16) "Taxes and licenses" of $588; and (17) "Rents" of -$22, 800 . In Ms. IDursky' s 2005 notice, espondent also determined to (1) exclude from Ms. Dursky's 2005 Schedule E the rental income of $12;©00ethat she reported d (2) disallow the deductions for (a) "Mo tgage Interest" of,$2 398, (b) "Taxes" of $1,343, and (c) "Dep eciation" s of -$641 th t she claimed in the 2005 eSchedule E with iresþect to Ms. Dursky's residence.- In thatsnotice, respond t also determined tb t Ms. Dursky is liable for her r taxable year 2005 for an accuracy-related penalty under section - 47 - 6662 (a) of $2, 520 . 80 . OPINION DKD and Ms . Dursky bear the burden of proof with respect to the determinations which remain at issue in the respective notices that respondent - issuedato them.- See Rule 142 (a) ; Welch v. Helvering, 290 U;S. 111, 115 (1933) . Moreover, deductions are strictly a matter of legislative grace, .and DKD and Ms. Dursky bear the burden of proving entitlement to any respective deduc- tions that:they claim. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992) . Respondent bears the burden of proof with respect to any new matter. See Rule 142(a); Achiro v. Commis-- sioner, 77 T.C. 881, 890 (1981) . Before turning to the issues presented, we shall comment on the respective testimonies of Ms. Dursky and Ms. Watkins, who were the only witnesses at the "trial in these cases. We found those testimonies to be in certain material respects question- able, implausible, unpersuasive, uncorroborated, vague, and/or conclusory. We also found (1) the testimony of Ms. Dursky to be in certain material respects self -serving and (2) the testimony of Ms . Watkins to be in certain material respects serving the interests of Ms . Dursky, her personal partner, and DKD, the corporation that Ms. Dursky wholly owned. We shall not rely on the respective testimonies of Ms. Dursky and Ms. Watkins to 48 - establi h the respective positions of DKD and Ms. Dursky with respect to the issues to which those testimonies pertained. See, e.g., T karski v. Commissioner, 87 T.C. 74, 77 (1986). Cattery Activity 1: DKD--Claimed Deductions It is the position of DKD that for the years at issue it is entitled to deduct under section 162(a) the following amounts relating to DKD's cattery activity: (1) Respective reimbursed cattery expenses of $59,817, $64,920, $66,628; (2) purported salary of $7,700 paid- to Ms. Watkins; (3) certain unidentified "taxes and licenses" of $588; and (4) purported rent of $4,333 paid to Ms. Dursky." Se tion 162(a) provides in pertinent part: SE , 162. TRADE OR BUSINESS EXPENSES. (a) In General.--There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * * In order to be entitled for each of the years at issue to the ded ctions that it is claiming with respect to DKD's cattery activity, DKD must show that for each of those years that cattery activity constituted a trade or business of DKD within the || meaning of section 162(a). In order to establish that for each "D D conceded certain additional amounts that it claimed as deducti ns relating to DKD's cattery activity in its respective returns for the years at issue. - 49 - of the years at issue DKD's cattery activity.constituted a trade or business of DKD within the meaning of section 162(a), DKD must show that during each of those years it had"the intent or motive to make a profit from that activity. See Am. Props., Inc. v. Commissioner, 28 T.C: 1100 (1957), affd. per curiam 262 F.2d 150 (9th Cir. 1958). As we explained in Am. Props., Inc., supra at 1111, The determination of whether the activities of a taxpayer constitute the carrying on of a trade or business requires an examination of facts in each case. Hiqqins v. Commissioner, 312 U.S. 212 [(1941)]. held thát whether an enterprise is conducted as la business for profit is a matter of faith, and all considered. the facts in a particular case are to be intention and good It has been * * * Thus, the issues in the final analysis turn upon the question of whether during the years in questiong the petitioner and the corporation had the requisite intent or motive of making a profit. Intention is a question of fact to be determined not only from the direct testimony as to intent, but a consideration of all The statement of an interested party of his intention and purpose is not necessarily conclusive. including the conduct of the evidence, * * the parties. * DKD contends that for each of the years at issue DKD's cattery activity constituted a trade or business within the meaning of section 162(a) because it conducted that activity during each of those years "In order to produce more income and a profit". On the record before us, we reject DKD's contention. Since at least 1989 Ms. Watkins; and since at least 1994 Ms. Dursky, each was engaged in the hobby of operating a cattery from which each derived significant personal pleasure. At a time not - 50 - disclos d.by the record before the years at issue, Ms. Dursky and Ms. Wat ins became engaged in the hobby of jointly operating a cattery from which they continued to derive significant personal pleasure. The cattery activity of Ms. Dursky and Ms. Watkins took place in Ms. Dursky's residence, except for attending cat shows and visiting veterinarians. That cattery activity required them to spend substantial time and substantial money, including substantial time and substantial money spent by one or both of them in participating in certain competitions, clubs, and associ- ations and traveling extensively to attend certain CFA44 cat shows over much of the United States. At least five of the cats of Ms. Dursky and Ms. Watkins won awards during certain competi- li tions, at least two of their Norwegian Forest cats produced such outstanding offspring that they-achieved the coveted title of CFA Disting ished Merit, 45 and the CFA designated the cattery activ- ity of Ms . Dursky and Ms . Watkins as a "CFA Approved Cattery of || Excellence . " At a time not disclosed by the record before the years at issue, Ms. Dursky and Ms. Watkins created a Web site that they "The CFA is the largest association for owners of cats in the UniÃed States. 4sThe title of CFA Distinguished Merit was the highest award the time th CFA presented to a breeding pedigreed cat . At that the CFA awarded the title of CFA Distinguished Merit the two Norwegian Forest cats of Ms. Dursky and Ms. Watkins, fewer than ten Norwegian Forest cats throughout been awŠrded that title. -1 to each of the world had - 51 - maintained for their cattery activity. At the time of the trial in these cases, the general public was able to access that Web site, although it had not been updated since 2002. The cattery activity Web site stated: "We treat our cats as members of our family" and "we have invested too much love in our wonderful kittens to risk exposing them to an uncertain and risky environ- ment." The cattery activity Web site advertised for sale two cats for $75 and $150, respectively, and two kittens for $200 and $400, respectively. During the years at-issue', DKD had a cattery activity, which was the cattery activity in which Ms. Dursky and Ms. Watkins had engaged before those years. While operating DKD's cattery activity during the years at issue, Ms. Dursky and Ms. Watkins continued to engage in the same kinds of activities in which they had engaged before those years while operating the cattery activity of Ms. Dursky and Ms. Watkins." As was true while they were operating the cattery activity of Ms. Dursky and Ms. Watkins before the years at issue, Ms. Dursky and Ms. Watkins each continued to derive significant personal pleasure while operating DKD's cattery activity during the years at issue. "During each of the years at issue, DKD used, without the assets (e.g., cats, kittens, cat trees, feeding litter boxes) that Ms. Dursky and Ms. Watkins had used purchasing, bowls, before those years in the cattery activity of Ms. Dursky and Ms. Watkins. Starting sometime in 2004, while Ms. Dursky and Ms. Watkins were -operating DKD's cattery-activity they began breeding, raising, offering for sale, and showing Abyssinian cats in addition to Norwegian Forest cats. 52 - During the years at issue, while operating DKD' s cattery activity-Ms. Dursky and Ms. Watkins desired to expand on the national reputation that they had developed before those years while operating the cattery activity of Ms. Dursky and Ms. Watkins In order to do so, they- relied on their respective years of cattery activity experience and their respective reputa tions in the so-called cattery world. As I was true of the cattery activity of Ms . Dursky and Ms . Watkins before the years at issue, DKD' s cattery activity was designated by the CFA during the years at issue as a "Cattery of Excellence" . As was true of their beliefs while operating the cattery activity of Ms. Dursky and Ms. Watkins before the years at issue, while M . Dursky and Ms . Watk.ins were operating DKD' s cattery activit during the years at issue they believed that the price of any at or kitten offered for sale would increase if the cats and kit ens that they bred won national cat shows. While operat- ing DKD s activity during the years at issue, Ms . Dursky and Ms . Watkins produced a total of four cats that won national champion- ships . As was true while they were operating the cattery activity of Ms. Dursky and Ms. Watkins- before the years at issue, while Ms . Dursky and Ms . Watkins we{re operat.ing DKD' s cattery activity during he years at issue they continued to incur and pay sub- - 53 - stantial expenses. During the years at issue, DKD reimbursed Ms. Dursky and Ms. Watkins for those substantial expenses and claimed deductions for those reimbursed expenses and for certain other claimed expenses in its respective tax returns for those years." While operating DKD's cattery activity during 2003, Ms. Dursky and Ms. Watkins produced approximately seven to nine kittens from approximately five to seven litters. While operat- ing DKD's activities during each of the years 2004 and 2005, Ms. Dursky and Ms. Watkins produced approximately nine kittens-from approximately three litters. During 2003, Ms. Dursky and Ms. Watkins did not sell any cats or kittens while operating DKD's cattery activity. During 2004, Ms. Dursky and Ms.- Watkins did not sell any cats or kittens while operating DKD's cattery activity except for three cats and/or kittens that,they sold in December of that year ifor a total of $250. During 2005, Ms. Dursky and Ms. Watk.ins did not sell any cats or kittens while operating DKD's cattery activity except for a total of eight cats and/or kittens that they sold in "In DKD's 2003. return, DKD claimed deductions for cattery "Taxes In DKD's 2004 return, DKD claimed expenses of $69,515 and for purported salary of $7,700, and licenses" of $588, and purported rent of $12,000 relating to DKD's cattery activity. deductions.for cattery expenses of $75,091 and for purported salary of $7,700, rent of $12,000 relating to DKD's cattery activity. 2005 return, DKD claimed deductions for cattery expenses of $60,540 and for purported salary of $7,700, "Taxes and licenses" of $588, and purported rent of $12,000 relating to DKD's cattery activity. "Taxes and licenses" of $588, and purported In DKD's See supra note 43. - 54 - June, J ly, August, October, and November of that year for a total o $1, 525 . In 2006, at an undisclosed stime" in or before August; Mr. Musin and Ms . Schwartz, the tiax return preparers for DKD and/or Ms. Dursky," informed them that the IRS was investigating Mr. Musin and Ms. Schwartz and intended to commence an examination of Il petitioners' respective tax returns for 2003 and 2004. As a result, around August 2006, (1) Ms. Dursky and Ms. Watkins discontinued operating DKD' s cattery activity, 49 (2) Ms . Dursky and Ms . Watkins continued operating that cattery activity as the cattery activity of Ms. Dursky and Ms. Watkins, and (3) Ms. Dursky and DKD retained Mr. Monroe.5° Ex ept for the respective testimonies of Ms. Dursky and Msg Watkins on which we are unwilling to rely, there is no reliable evidence in -the record to support our finding . that during each of || "See supra note 14 . 49Although Ms . Dursky and Ms . Watkins did not discontinue operatiÅg DKD's cattery activity until around August 2006, DKD did not claim any deductions relating to DKD' s -cattery activity in the tax return that it filed for its taxable year 2006. soSee supra note 19 . -.55 - the years at issue DKD intended to make a profit from DKD's cattery activity. Based upon our examination of the entire record before us,. we find that DKD has failed to carry its burden of establishing that during each of the years at issue it intended to make a profit from DKD's cattery activity. On that record, we find that during each of the years at issue DKD expended substantial amounts in DKD's cattery activity for the personal pleasure of Ms. Dursky, its sole stockholder, and with the -expectation that it would be able to deduct those substantial amounts for each of those years. On the record before us, we further find that during each of the years at issue DKD's cattery activity was incident to the personal hobby of Ms. Dursky,- DKD's- sole stock- holder, who before, during, rand after those years derived signif- i-cant personal pleasure from the cattery activity in which she was involved. Based upon our-examination of the -entire record before us, we find that DKD has failed to carry its ,burden of.establishing that for each of the years at issue DKD's cattery activity constituted a trade or business of DKD within the meaning of "For example, the record does not contain reliable evidence of a business plan for DKD that described specifically what steps intended to Ms. Dursky, DKD's sole stockholder and sole officer, take during the years at to increase significantly revenues and/or to reduce significantly expenses in order to generate a profit for DKD from DKD's cattery activity. issue in an attempt - 56 - section 162(a). On that record, we further find that DKD has failed to carry its burden of establishing that for each of the years a issue it is entitled under section 162(a) to deduct with respect to DKD's cattery: (T)-Amounts reimbursed to Ms. Dursky and Ms. Watkins, (2) amounts paid to Ms. Watkins as purported salary, (3) amounts paid for certain "taxes and licenses", and (4) amounts'paid to Ms. Durs y as purported rent. Ms Dursky--Claimed Constructive Dividends We have found that during each of the years at issue DKD ! expende substantial amounts in DKD's cattery activity for the personal pleasure of Ms. Dursky, its sole stockholder, and that, during each of those years that activity was incident to the personal hobby of Ms. Dursky. On the record before us; we.find that for each of the years at issue Ms. Dursky is required to include in gross income as constructive dividends the amounts of deductions relating to DKD's cattery activity that DKD claimed - for eac of those years and that we havez disallowed." Ms Dursky--Claimed Cattery Activity Deductions Itfis the alternative position of Ms. Dursky.-that - If this Court finds; that the cattery operation was opárated by Debra Dursky and not DKD Enterprises, which is contrary to the stipulation between the parties, th n Debra Dursky should be allowed to deduct the "P titioners do not dispute that for each of the years- at to issue D D had earnings and profits that were at least equal the amoùnt of constructive dividends that we have found Ms. Dursky has for each of those years. - 57 - cattery expenses under I.R.C. § 162, since the cattery was operated for a profit. In holding that DKD is not entitled for each of the years at issue to deduct under section 162(a) the various deductions that it is claiming with respect to DKD's cattery activity, we did not find that "the cattery operation was operated by Debra Dursky and not DKD Enterprises". Instead, we found that DKD failed to carry its burden of establishing (1) that during each of the years at issue DKD intended to make a profit from DKD's cattery activity and (2) that for each of those years DKD's cattery activity constituted a trade or business of DKD within the meaning of section 162(a). Thus, the premise on which Ms. Dursky advances her alternative position is not valid." On the record before us, we find that for each of the years at issue Ms. Dursky is not entitled to deduct under section 162(a) the deductions relating to DKD's cattery activity that DKD is claiming for each of those years and that we have disallowed. Ms. Dursky--Claimed Schedule E Deductions It is the position of Ms. Dursky that she is entitled for each of the years at issue to deduct in Schedule E the respective "Even if the premise on which Ms. Dursky advances her alternative position were validi on the record before us, we would nonetheless reject that position. valid, on the record before us, we would find under sec. 183 and the regulations thereunder that for each of Ms. Dursky is not entitled to deduct claiming as deductions for each of DKD's cattery activity and that we have disallowed. those years with respect the amounts that DKD is to If that premise were the years at issue - 58 - portions of the mortgage interest and real estate tax that she paid wi h respect to Ms. Dursky's residence that are allocable to DKD' s piùrported rental of a portion of that residence for DKD' s cattery activity. We have found that DKD failed to carry its burden of estab- lishing i (1) that for each of the years at issue DKD' s cattery activitë constituted a trade or business of DKD within the meaning of section 162 (a) and (2) that for each of those years DKD is gntitled to deduct under that section any amounts that it claimed as rent for the portion of Ms. Dursky's residence where Ms . Dursky and Ms . Watkins operated DKD' s cattery activity . 54 On the record before us, we find that Ms. Dursky has failed to carry her burden of establishing that for each of the years at issue sl e is entitled to deduct in Schedule E the respective portions of mortgage interest and real estate tax that she paid with respect to Ms. Dursky's kesidence that are allocable to DKD's purported rental of that residence for DKD's cattery activit .55 34Although respondent determined that Ms . Dursky does not income for each of the years at issue attributable to thosé years and that we have disallowed, we have held that for have reÅtal the pur orted rent that DKD is claiming as a deduction for each of each of gross income as constructive dividends that disallowed purported rent . the years at issue Ms. Dursky is required to include in ssRe pondent determined that for each of the years at issue Ms. Dur ky is entitled to deduct in Schedule A the respective (continued. . . )' Qualified Personal Service Corporation - 59 - It is the position of DKD that it is not a qualified per- sonal service corporation, as defined in section 448 (d) (2) , for each of the years 2004 ande2005 that .is subject to the 35-percent tax .rate prescribed in section 11(b) (2) ." Section 448 (d) (2) defines the term "qualified personal service corporation" to mean: SEC. 448 (d) . Def initions and Special Rules . - -For purposes of this section-- * * * * * * (2) Qualified personal service corporation.-- The term "qualified personal service corporation" means any corporation-- (A) substantially all of the activities of which involve the performance of services in the fields of health, architecture, accounting, actuarial science, performing arts, or consulting, and law, engineering, (B) substantially all of the stock of which (by value) rectly through 1 or more partnerships, S corporations, or qualified personal service is held directly (or indi- ss (. . . continued) amounts of mortgage interest and real estate tax that she paid and that she claimed in Schedule E for each of those years and that we have disallowed. s'Respondent determined in DKD' s 2004 and 2005 notice that DKD is a qualified personal service corporation for each of years 2004 and 2005. Respondent did not make any such determination in DKD's 2003 notice. Respondent argues on brief that DKD also is a qualified personal service corporation for 2003. Therefore, a qualified personal service corporation for 2003. respondent has the burden of establishing that DKD is the - 60 - corporations dot described in paragraph (2) or (3) of subsection (a) ) by-- (i) employees performing services for such |corporatiorr in connection with, the activlities involving a field referred to in subparagraph (A) , Se tion 1 . 448 -1T (e ) (3 ) Temporary Income - Tax Regs . , 52 Fed. Reg. 22 68 (June 16, 1987) , provides in pertinent part: (3) Meaning of qualified personal service - coÝporation. "qUalified personal serv!ice corporation" means any cogporation that meets-- For purposes of this section, the term (i), The function telst of paragraph (e) (4) of this seation, and 4 (ii) The ownership test of paragraph - (e)-(5) of th s section. Se tion 1. 448 -1T (e) (4 ) , Temporary Income Tax Regs . , supra, provide in pertinent part thht the function test is met "if 95 percent or more of the time sþent by employees of the corpora ion, serving in their capacity as such, is devoted. to the performance of services" in, inter alia, consulting. Section 1. 448 -1T (e) (5) (i) (A) , Temporaiy Income Tax Regs , , 52 Fed. Reg . 22770 (June 16, 1987) , providgs in pertinent part that a corpora ion "meets the ownership, test, if at all times during the taxable year, " substantially all the corporation' s stock, by value, is held, directly or indirectly, by" employees who perform services for the scorporation n connecti'on with activities involving the performance of åervices in, inter ali consulting. -.61 - We have found- that Ms. Dursky, the only stockholder of DKD and the only employee of DKD who.performed consulting services for it, spent approximately 2-,000 hours during the year-2003 and approximately 2,200 hours during each of the years 2004 and 2005 working.for DKD in its IT consulting business. : We have also found that during each of the years 2003, 2004; and 2005 Ms. Dursky spent approximately 800 hours operating DKD's cattery activity." On the record before us, we find that.during each of the - years 2003, 2004, and 2005 Ms. Dursky did not spend 95 percent or more of her time while working for DKD performing consulting services for it. On that record, we further find that for each of the years at issue DKD is not a qualified personal service corporation, as defined in.section 448(d) (2), that is subject to the 35-percent tax-rate prescribed in section 11(b) (2). DKD Fidelity Profit-Sharing Plan DKD--Claimed Deductions It is the position of DKD that it is entitled to deduct * (1) for 2003 a $10,000 contribution under the 'DKD Fidelity profit-sharing plan that it made on April 14, 2004, by sending a "We have found that during each of the years at issue Ms. Watkins spent more hours than Ms. Dursky operating DKD's cattery found the precise number of hours that Ms. activity. Watkins spent during each of those years operating that-~activity because we are unwilling to rely on her testimony in that respect. We have not - 62 - $10, 000 check to Fidelity; (2) for 2004 a total of $20, 000 of contrib tions that it made under that profit-sharing plan by sending a .$10, 000 check to Fidelity on December 27, 2004, and a $10, 000 check to Fidelity on April 11, 2005; and (3) for 2005 a $5, 000 contribution that it made under that profit-sharing plan by sending a $5,000 check to Fidelity on April 10, 2006.5" It is the position of respondent that for each of the yeaes at issu DKD is not entitled to the deduction that DKD is claim- ing for DKD's contributions under the DKD Fidelity profit-sharing plan. n support of respondent's position, respondent asserts in pertinent part: If [Ms.] Watkins is determined to have been an the cattery, employee of [Ma.] Watkins in DKD's pension plan is a fatal quÅlified pension plan cannot discriminate in favor of hic hly compensated employees . "H ghly compensated employee" 41 (q) as a [sic] employee who was a 5 percent owner at then the failure to include flaw. . is defined in I.R.C. § 401 (a) (4 ) I . R . C. § A saIn DKD' s 2003 return, D.KD claimed a deduction for the In: DKD's 2004 return, DKD did not $10 , O O O contribut ion under the DKD Fidelity prof it - sharing plan that it is claiming here. claim a deduction of $20, 000 for contributions under that plan. It did, however, claim in that return a $20, 000 deduction for "Dues aüd subscriptions" . Respondent determined that that DKÒ claimed in DKD' s 2004 return for "Dues and subscriptions" was a $20,000 deduction claimed for contributions under the DKD Fidelity profit-sharing plan. explain how respondent made that determination, see supra note 41, but DKD does not dispute it. not "claim a deduction for a $5, 000 contribution under the DKD Fidelit profit-sharing plan. DKD claims for the first, time here a deductiion for 2005 for a $5, 000 contribution that it made under the DKD Fidelity profit-sharing plan by sending a $5, 000 check to Fidelity on Apr. 10, 2006. with reåpect to that claimed deduction for 2005. Thus, DKD has the burden of proof In DKD's 2005 return, DKD did The record does not the $20, 000 - 63 - -any time during the year or preceding year or was in As the sole share- [Ms.] Dursky qualifies as a "highly the top-paid group of employees. holder of DKD, compensated employee." were both employees. Watkins any pension benefits. plan is not, pension contributions should be allowed. [Ms.] Dursky and [Ms.] Watkins [Ms.] DKD did not offer, or pay, The purported pension therefore, a qualified pension plan and no DKD counters that the reason stated in DKD's 2003 notice and in DKD's 2004 and 2005 notice for respondent's determinations that DKD is not entitled for the years 2003 and 2004 to the deductions that it claimed in its respective tax returns for those years for contributions under the DKD Fidelity profit- sharing plan was that those contributions are not "ordinary and necessary" expenses. As a result, DKD argues that respondent has the burden of proving that the DKD Fidelity profit-sharing plan did not include Ms. Watkins as a participant. According to DKD, "Respondent presented no evidence, at trial or otherwise, regard- ing who were the participants in the [DKD] Fidelity pension [sic] plan." We reject DKD's contention about what the record establishes "regarding who were the participants in the [DKD] Fidelity pen- sion [sic] plan." The Fidelity contribution document that Ms. Dursky executed on behalf of DKD on December 28, 2001, indicated that the only participant under the DKD Fidelity profit-sharing plan was Ms. Dursky. Moreover, petitioners have taken the posi- - 64 - tion at trial and on brief that Ms . Dursky was an employee of DKD during each of the years at issue.59 On the record before us, we find that for each of the years at issue the DKD Fidelity profit-sharing plan discriminated in favor of Ms. Dursky, DKD's sole stockholder, who was a "highly compensated employee" as defined in section 414 (q) . On that record, we further find that for each of the years at issue the DKD Fid lity profit-sharing plan did not constitute a qualified profit-sharing plan under section 401(a) . On the record before us, we find that for each of the years at issue DKD is not enti- tied to a deduction for any contributions made under the DKD Fidelit profit-sharing plan.4° Ms Dursky--Claimed Constructive Dividends We have found that for each of the years at issue DKD is not entitled to deduct any contributions made under the DKD Fidelity profit-sharing plan. On the record before us, we find that any respective contributions that DKD made under that plan and ssFor each of the years at issue, DKD issued Form W-2 to Ms. in which it reported that it paid her wages of $7, 700 . Watkins, For eac of she inc uded in gross income the $7, 700 that she had received from DKD during each such year. those years, Ms. Watkins filed Form 1040, in which - '°In the light of our holding, we need not address respon- lternative argument that if the DKD Fidelity profit- dent's sharing plan were to constitute a qualified profit-sharing plan under s c. 401(a) , DKD would be entitled to deduct for each year at during each such year. issu only the contributions that it made under that plan - 65 - claimed as deductions in its respective tax returns for the years at issue and that we have disallowed are required to be included in Ms. Dursky's income as constructive dividends for her respec- tive taxable years at issue in which DKD made those contribu- tions ." Ms . Dursky' s Health Insurance Policy DKD--Claimed Deductions It is DKD's position that for each of the years at issue it is entitled to deduct certain premiums that it paid on a health insurance policy issued in Ms. Dursky's name that she had pur- chased." In support of DKD' s position, DKD asserts: An employer is entitled to deduct, as ordinary and necessary trade or business expense, medical premiums it paid for its employees. . I.R.C. § -162(a) . insurance * * * * * * * Since DKD Enterprises paid medical insurance pre- miums on a medical Debra Dursky, DKD Enterprises is entitled to deduct insurance policy for its employee, the "See supra notes 52 and 58. "In petitioners' opening brief; petitioners state that DKD respectively, and is entitled to deduct paid in 2003 and 2004, for those years the respective premiums of $6, 950 and $7, 651 on Ms. Dursky's health insurance policy. brief, petitioners claim that, respective deductions for 2003 and 2004, it is entitled to deduct for 2005 $7, 651 of health insurance premiums that it paid in that year on Ms. Dursky's health insurance policy. We have found that during 2003 and 2004 DKD paid premiums on Ms. Dursky's health insurance policy totaling $6,950.10 and $7,651.50, We have not during 2005. found that DKD paid any premiums on that policy in addition to those claimed respectively. In petitioners' reply - 66 - me ical business expenses under I.R.C. insurance premiums as ordinary and necessary § 162(a) . It is respondent' s posit ion that DKD is not entitled t of the deductions that it is claiming for the premiums that it paid on Ms. Dursky's health insurance policy." In support of respond nt's position, respondent asserts in respondent's reply brief: insurance premiums paid by DKD [on Ms . to an accident or he lth plan as required by I.R.C. th medical Dursky' s health insurance policy] were not made pursuanj § 106 (a) . ang plan. surer, allegedly>on behalf of DKD never had an accident or health irisur- DKD simply rote checks to a health in- [Ms.] Dursky. Also, I.R.C. § 105 states that amounts received by injuries or sicknéss shall be included in an employee through accident or health insurance for pe sonal gr ss income to the extent such amounts (1) are attributåd -to contributions by the employer which were anot inŠludible in the gross income of (2 include the health insurance premiums as compensat on. are paid by the employer . [Ms . ] Dursky did not the employee or Se tion 162 (a) permità a taxpayer - to deduct all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including -a reasonable In,petitioners' reply brief, petitioners argue that re- conceded in respondent ' s opening brief that DKD is sponden entitled to deduct for the years at, issue any respective premiums that it paid on Ms. Dursky's gealth insurance policy.- We disagree. Although respondent did not offer any reason in respondent's épening brief in support of respondent!s position;that DKD is not ntitled to deduct respond nt did not concede that explained in respondent' s repily brief , which we quote ein perti nent pa t in the text, why re|spondenta believes that DKD is not entitled ,to deduct for each df issue any premiums that it paid on Ms . Dursky' s health insurance policy . those premiums, we conclude that i issue - in that brief . Respondent the years at - 67 - allowance for salaries or other' compensation for personal ser- vices actually rendered. Sec. 162(a) (1). Section 1.162-10, Income Tax Regs., provides in pertinent part with respect to "Certain-employee benefits" as follows: * * * * a sickness, accident, hospitalization, medical Amounts paid or accrued within the taxable year for * expense, under section 162(a) expenses of * or similar benefit plan, are deductible if they are ordinary and necessary the trade or business. a * * In Waterfall Farms, Inc. v. Commissioner, T.C. Memo. 2003- 327, we held: When payments for medical care are properly excludable from an employee's income [under section 105 and/or 106] because they are made under a "plan for employees," they are deductible by the employer as ordinary and necessary business expenses under section 162(a). * * * Based upon our examination of the entire record before us, we find that DKD has failed to carry its burden of establishing that it had in effect during-any of the years at issue a sick- ness, hospitalization, medical expense, or similar benefit plan for employees. On that record, we find that DKD has failed to carry its burden of establishing that for each of the years at issue it is entitled to deduct any premiums that it paid on Ms. Dursky's health insurance policy. Ms. Dursky--Claimed Exclusion from Income It is the position of Ms. Dursky that she is entitled to exclude under section 105 or 106 the premiums that she claims DKD paid during each of the years at issue on Ms. Dursky's health s - .68 - insuran e policy:" We have found that DKD has failed"to carry DKD' s b rden of establishing that during each of thé years at issue- i had in effect a sickness, hospitalization, medical expense or similar plan for employees. On the-record before us, we find that Ms. Dursky is not entitled for any of the years at , issue t exclude from gross ncome under section- 105 or 106 the amount éf any premiums that DKD paid o Ms . Dursky' s health insuran e poliòy. We have considered all c(f the contentions and argüments of the par ies "that are not discussed herein, and weefind them to be without merit, irrelevant, ant1/or moot. To reflect the foregoing(, the concessions of respondent, and the conc essions of petitioners Decisions will be entered under Rule 155 "See supra note 62.