TAX COURT OPINION

Case: Miguel & Rebeca Aldaz
Docket Number: 14851-12
Judge: Kroupa
Opinion Type: bench
Filed: 06/25/2013
Pages: 14

UNITED STATES'fAX COURT WASHINGTON, D.C. 20217 MIGUEL & REBECA ALDAZ, Petitioners, V. COMMISSIONER OF INTERNAL REVENUE, Respondent. ) ) ) ) ) ) ) ) ) ORDER Docket No. 14851-12 Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit to petitioners and to respondent a copy of the pages of the transcript of this case before Judge Diane L. Kroupa in San Francisco, California on June 5, 2013, containing her oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fact and opinion, an appropriate decision will be entered for respondent. (Signed) Diane L. Kroupa Judge Date: Washington, D.C. June 25, 2013 SERVED JUN 25 2013 Capital Reporting Company 3 1 2 Bench Opinion by Judge Diane L. Kroupa June 5, 2013 3 Miguel & Rebeca Aldaz v. Commissioner 4 5 6 7 8 9 10 11 12 13 Docket 14851-12 BENCH OPINION THE COURT: THE COURT HAS DECIDED TO RENDER ORAL FINDINGS OF FACT AND OPINION IN THIS CASE, AND THE FOLLOWING REPRESENTS THE COURT'S ORAL FINDINGS OF FACT AND OPINION. THESE ORAL FINDINGS OF FACT AND OPINION SHALL NOT BE RELIED UPON AS PRECEDENT IN ANY OTHER CASE. This bench opinion is made pursuant to the authority granted by section 7459(b) and Rule 152. 14 All section references are to the Internal Revenue 15 Code for 2009 and all rule references are to the Tax 16 Court Rules of Practice & Procedure. 17 18 19 20 21 22 23 24 25 Anthony Diosdi appeared for petitioners, and Sarah Sexton appeared for respondent. FINDINGS OF FACT Certain facts have been stipulated. The parties have filed a stipulation of facts and a supplemental stipulation of facts along with accompanying exhibits. We incorporate the facts and exhibits by this reference. The facts are so found. Petitioners resided in San Jose, 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 4 1 California, at the time they filed the petition. 2 3 4 5 6 7 Petitioners timely filed a return for 2009 that an 81-year old woman named Patty prepared with the tax service known as A Plus. Petitioner husband was a machinist that worked as a General Manager for an outside business. Petitioner husband also operated a sole proprietorship called Innovative 8 Consulting & Manufacturing during 2009. Petitioners 9 reported approximately $225,000 of gross receipts 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 from the sole proprietorship and approximately $241,000 of expenses, for a net loss of approximately $16,000. Respondent examined petitioner's records and determined in the deficiency notice that petitioners failed to report all gross receipts and respondent disallowed most Schedule C expenses. Respondent determined that there was a $44,742 deficiency in petitioners' Federal income tax for 2009 and that petitioners were liable for an $8,948 accuracy-related penalty under section 6662. All future references to petitioner shall be to petitioner husband individually. The parties filed a Stipulation of Settled Issues and a Supplemental Stipulation of Settled Issues. The parties have resolved all issues set 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 5 forth in the deficiency notice except for certain Schedule C expenses and the accuracy-related penalty. The Schedule C expenses still in dispute include $25,200 for rental payments petitioner claimed for his home/business, $1,350 of utility costs for his home/business, $1,800 of gardener fees for his home/business, $2,000 for meals and entertainment, and 4,747 of business miles. The 4,747 miles is half of the miles petitioner claimed for business purposes and is the amount respondent disallowed in the deficiency notice. OPINION This is primarily a substantiation case where we must determine whether petitioner is entitled to the still disputed claimed Schedule C expenses and whether petitioners are liable for the accuracy-related penalty. We begin with two fundamental principles of tax litigation. First, the Commissioner's determinations are generally presumed correct, and the taxpayer bears the burden of proving that those determinations are erroneous. Rule 142(a). 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 Petitioners do not assert that the burden shifts to 24 25 respondent with respect to any factual issue. See sec. 7491(a) (2) (A) and (B) . The burden therefore 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 6 1 2 3 4 5 6 7 8 remains with petitioners. Second, deductions are a matter of legislative grace, and the taxpayer must show that he or she is entitled to any deduction claimed. Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933). This includes the burden of substantiation. Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976). Substantiation 9 means that a taxpayer shall keep such permanent 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 records or books of account as are sufficient to establish the amount of deductions claimed on the return. Sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs. The Court need not accept a taxpayer's self- serving testimony when the taxpayer fails to present other probative evidence. Beam v. Commissioner, T.C. Memo. 1990-304 (citing Tokarksi v. Commissioner, 87 T.C. 74, 77 (1986)). Taxpayers may deduct ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Sec. 162(a). The term "ordinary and necessary business expenses" means only those expenses that are ordinary and necessary and are directly attributable to the trade or business. Sec. 1.162-17(a), Income Tax Regs. The term does not include personal, living, or family 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 7 expenses. Id; see sec. 262(a). Simply because an expense would not have been incurred but for the taxpayer's engaging in a trade or business is insufficient to allow a deduction. The nature of the expense must not be personal or otherwise nondeductible. Drake v. Commissioner, 52 T.C. 842, 844 (1969). The determination of whether an expense is related primarily to the taxpayer's trade or business or is primarily personal in nature depends on the facts and circumstances. Sec. 1.162-2(b) (2), Income Tax Regs. There are many expenses that are helpful, even essential, to one's business but which are not deductible in our tax system. See Carroll v. Commissioner, 51 T.C. 213, 215 (1968), affd. 418 F.2d 91 (7th Cir. 1969). Expenses of driving to and from work, for example, are not deductible. Sec. 1.162- 2(e), Income Tax Regs. Expenses for clothing worn in a taxpayer's trade or business, and the cost of laundering the clothing, are not deductible if the clothing is adaptable for nonbusiness wear. See, e.g., Hawbaker v. Commissioner, T.C. Memo. 1983-665 (car salesman not entitled to deduct cost of cleaning suits that were easily soiled with grease and dirt). In addition, it is not enough for a machinist 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 8 consultant to claim a business deduction if the supplies are helpful to the taxpayer and appropriate for use in the business of being a machinist consultant. They must also be directly related to the taxpayer's job as a machinist consultant and a necessary expense of being a machinist consultant. See Wheatland v. Commissioner, T.C. Memo. 1964-95. Costs for meals and entertainment and costs associated with certain depreciable business assets (otherwise known as listed property) that are otherwise deductible as a business expense will be disallowed in full unless the taxpayer satisfies the strict substantiation requirements. Secs. 274 (d) (4), 280F(d) (4) (A) (i). Strict substantiation requires the taxpayer to maintain an account book, diary, statement of expense or similar record that is sufficient to show the amount/cost of the expense, the time and place of the meals and entertainment or use of the listed property, the business purpose and the business relationship of the person entertained to the taxpayer or the business use of the listed property. Sec. 1.274-ST, Temporary Income Tax Regs. No deduction is allowable based on any approximation or the taxpayer's unsupported testimony. Sanford v. Commissioner, 50 T.C. 823, 827 (1968), affd. per 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 9 1 2 3 4 5 6 7 8 9 10 11 12 curiam 412 F.2d 201 (2nd Cir. 1969); sec. 1.274- ST(a), Temporary Income Tax Regs.; sec. 1.280F- 6T(b) (2), Temporary Income Tax Regs. In certain other situations, if a taxpayer establishes that he or she paid or incurred a deductible business expense but does not establish the amount of the deduction, this Court may approximate the amount of allowable business deductions, bearing heavily against the taxpayer whose inexactitude is of his or her own making. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2nd Cir. 1930). For the Cohan rule to apply, however, a basis 13 must exist on which theis.Court can make an 14 15 approximation. Vanicek v. Commissioner, 85 T.C. 731, 743 (1985). Without such a basis, any allowance 16 would amount to unguided largesse. Williams v. 17 18 19 20 21 22 23 24 25 Commissioner, 245 F.2d 559, 560 (5th Cir. 1957). We now apply these rules to the facts here. We acknowledge and take petitioner at his word that he wants to pay the correct amount of tax. We found his testimony and the record, however, to be inconsistent and confusing. For example, the Court fails to understand why two leases for the same period of time are part of the record and contain the same language except for the list of tenants. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 Petitioner's explanation makes no sense to the Court 10 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 and the one lease showing petitioner as the only tenant appears to have been prepared in preparation for trial, not as of the date it was signed. Interestingly, both leases were signed on the same day. This we find not to be credible. It also is not clear to the Court how petitioner originally determined he was entitled to deduct all rental payments as business expenses and then asserted at trial that he was entitled to claim only 55% of the rental payments. No floor plan or schematic is part of the record. It is also confusing to the Court why a home would have two living rooms. We are also concerned that petitioner failed to report $70,000 of gross receipts from the business and of the approximate $225,000 of gross receipts he did report he claimed approximately $241,000 of business expenses. If we were to find that petitioner reported all income from the business and that the expenses claimed are accurate, we would have to find that every penny petitioner spent for his business was deductible. This we refuse to do. In addition, we refuse to find that petitioner spent all of his time and incurred all of 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 2 his expenses in the trade or business of being a full-time employee plus being a machinist consultant. 3 Petitioner would have us believe he had no personal 11 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 time or personal expenses. Again, we refuse to so find. Petitioner claimed $1,800 for a gardener to mow his grass and trim his bushes because petitioner was too busy working to do it himself. Petitioner claimed that his employer claims costs for landscapers and window washers and that he should be able to claim similar expenses for his home/business. His employer's situation is different from petitioner's situation. We must focus on the primary purpose of the expense and decide whether the expense is primarily personal or primarily business based upon the facts and circumstances. We find, based upon the facts and circumstances here, that the gardener expenses are primarily personal, nondeductible expenses. As to the utilities, Petitioner at most would be able to deduct only a portion of the expenses--that portion attributable to the business use of the home. We cannot find any documentation in the record as to the amount of utilities paid in 2009 or the property with respect to which the utilities are attributable. Without any basis to make an 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 12 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 approximation, any allowance would be unguided largesse. Petitioner is therefore not entitled to claim any utility expense as a deduction. It is unclear to the Court whether petitioner maintained comtemporaneous logs for the business use of a vehicle or whether he had another vehicle for personal use. The record also fails to show what part of the vehicle's use was for personal, nondeductible use. We refuse to find that he is entitled to any more miles for the business use of a vehicle beyond the 50% respondent already allowed. Accordingly, we sustain respondent's determination in the deficiency notice regarding the deficiency. We turn now to respondent's determination that petitioners are liable for an accuracy-related penalty. A penalty applies to any underpayment of tax that is due, among other things, to a substantial understatement of income tax. See sec. 6662 (a) (b) (2) . A substantial understatement is one that exceeds the greater of ten percent of the tax required to be shown on the return, or $5,000. Sec. 6662 (d) (1) . The Commissioner bears the burden of production under section 7491(c) and the taxpayer bears the burden of proof with respect to reasonable 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 13 cause. Higbee v. Commissioner, 116 T.C. 438 (2001). Respondent has met his burden of production that there was substantial understatement of income tax for 2009 as the amount petitioners reported on the return substantially understated the amount of tax required to be shown on the return. The accuracy-related penalty under section 6662 does not apply, however, to any portion of an underpayment if it is shown that there was reasonable cause for the taxpayer's position and if it is shown that the taxpayer acted in good faith with respect to that portion. Sec. 6664 (c) (1); sec. 1.6664-4 (b), Income Tax Regs. The determination of whether a taxpayer acted with reasonable cause and good faith is made on a case-by-case basis. As stated previously, taxpayers bear the burden of proof as to reasonable cause and willful neglect. Higbee v. Commissioner, 116 T.C. at 447. Petitioners claim that they relied on their 81-year old tax preparer to prepare an accurate return. Petitioners have failed to show reasonable cause for the underpayment on the return, and have not shown that they acted in good faith with respect to any portion of the underpayment. They apparently seek relief from the penalty by casting all 1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 14 1 2 3 4 5 6 responsibility on their tax return preparer. Generally, the duty of filing returns cannot be avoided by placing the responsibility on a return preparer. Loftus v. Commissioner, T.C. Memo. 1992-266. In limited situations, however, reasonable cause for negligence due to a return preparer's 7 mistakes may be established if the taxpayers show 8 9 10 11 12 that they provided the return preparer with complete and accurate information, that an incorrect return was the result of the preparer's mistake and the taxpayers in good faith relied on the advice of a competent return preparer. Id. Even if taxpayers 13 meet these requirements, taxpayers still have a duty 14 15 16 17 18 19 20 21 22 to read and review the return to make sure that all income items are included and the appropriate expenses are claimed. Id. Petitioners have not established the elements for relief from the penalty on account of the return preparer's errors. Moreover, it is clear to the Court that petitioners did not review the returns. By petitioner's own admission, in fact, he stated that he did not review the return. 23 Petitioners are intelligent, gainfully 24 25 employed individuals. They earned wage income in excess of $100,000. Petitioners have the basic 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 15 acumen needed to review the return before they signed it. Petitioners' failure to review their own return reflects that petitioners completely abdicated their duty to file a correct return by closing their eyes to facts that could have been discerned. See id. We cannot excuse taxpayers who make little or no effort to discern whether their tax return is accurate. Accordingly, we find that petitioners did not have reasonable cause for, nor did they act in good faith with respect to, the understatement of income tax. We therefore sustain respondent's determination that petitioners are liable for the section 6662(a),accuracy-related penalty. To reflect the foregoing, decision shall be entered for respondent. THIS CONCLUDES THE COURT'S ORAL FINDINGS OF FACT AND OPINION IN THIS CASE. (Whereupon, at 3:26 p.m., the above- entitled matter was concluded.) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com