TAX COURT OPINION

Case: Ernestine Forrest
Docket Number: 24971-08
Judge: Wherry
Opinion Type: memo
Filed: 01/04/2011
Pages: 14

, T.C. Memo. 2011-4 . . UNITED STATES TAX COURT ERNESTINE FORREST, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 24971-08. Filed January 4, 2011. R determined a deficiency in P's income tax for the 2005 tax year based on P's unreported dividend income and a disallowed deduction for an IRA contribution. In an amended answer, R increased the determined deficiency by disallowing an income tax withholding credit of.$20,060.89 and Schedule C business expense deductions of $29,942.74 for the 2005 tax year. Held: This Court does not have jurisdiction to decide the withholding credit issue. deficiency arising from the disallowed Schedule C business expense deductions. P is liable for the ~ Ernestine Forrest, pro se. Michael K. Park, for respondent. - 2 - MEivlORANDUM FINDI-NGS OF FACT AND OPINION WHERRY, Judge: This case is before the Court on a petition for redetermination of a Federal income tax deficiency that responþent determined for petitioner's 2005 tax year. After concessions by petitioner,l the issues left for decision are: ( ) Whether petitioner is entitled to a Federal income tax withho ding credit of $20,060.89 for the 2005 tax year; (2) whether petitioner is entitled to business expense deductions claimed on Schedulle C, Profit or Loss from Business, of $29 942.74 for the 2005 tax year; and (3) whether petitioner is entitled to a deduction under sectio 1341 for amounts subtracted from her pension distributions during the 2005 tax year. FINDINGS OF FACT S me of the facts have een'stipulated, and the stipulated facts nd the accompanying e hibits are hereby incorporated by this rbference. At the time she filed her petition, petitioner resided in California. ! !I. il Petitioner conceded receiving unreported dividend income of $90 fog the 2005 tax year and that she is not entitled to an IRA contribution deduction of $4;500 for the 2005 tax year, which entirejly disposes of defici'ency. issues in the notice of the oriéinal I! %nless otherwise indicated, all section references are to the Internal Revenue Code, as amended and in effect. for the year at Practice and Procedure. issue, and all Rule referânces are' to the Tax Court Rules of - 3 - Respondent'issued a notice of deficiency on July 7, 2008, determining an income tax deficiencyefor petitioner's 2005 tax year of $459. Petitioner filed a timely petition with the Court on October 14, 2008, alleging a "substantial deduction which will wipe~out the alleged deficiency". By an amendment to the answer, served on-petitioner by respondent on April 29, 2009, respondent disallowed aswithholding tax credit of $20,060.89 and Schedule C deductions of $29,942.74. The State of California withheld $20,060.89 for Federal income tax from a termination of employment lawsuit settlement it made with and paid to petitioner. It,also issued to petitioner a Form W-2, Wage and Tax Statement, for 2005 reflecting the withheld tax of $20,060.89 and the $172,071 settlement payment. Petit-ioner claimed a credit for the $20,060.89 of allegedly withheld tax onaher 2005 Federal income tax return. She did not, however, include any of- the $172 071 payment in her taxable income shown on her 2005 Federal income tax:return. Respondent's examining agent initially sought to tax the $172,071 settlement payment by increasing petitioner's 2005 Federal taxable income by that amount. Although the evidentiary record is sparae, it is apparent from each party's statements in Court and filed documents that petitioner eventually convinced respondent that, notwithstanding the Form W-2, she did not actually receive the, $172,071 until 2006. Therefore: respondent did not, at the conclusion of the examination, seek to- increase i petitióner's 2005 Federal taxable income.by the $172,071.amount of the set-tlement payment . Råspondemt' s decision to exclude the $172, 071 amount of the || settleinent payment from petitioner's 2005 Federal taxable income would eem to have the consequence -of rendering petitioner' s claime $20, 060 .89 withholdirig credit on her .2005 Federal income tax return to be "an overstatement of the credit for income tax withh d at the source" within-the meaning of section 6201(a) (3) . If so then, as we note below, "the amount so overstated which * * * [was] allowed against the tax shown on * * * [petitioner' s 2005] return" could have been summarily assessed by respondent without being -subject to deficiency.procedures pursuant to - sectiàn 6201(a) (3). However, respondent apparently neglected to do this. To address this evident oversight respondent instead sought to amend his answer to challenge the claimed $20,060.89 | withhölding credit for 2005.1 Petitioner started collecting unemployment compensation in 2005. She also considered starting a solo law practice, a li proceás that apparently began as far back as 2003. See Forrest v. Co missioner, T.C. Memo. r2009-228. She claimed, sin connection wixth èf forts to find work as' a contract attorney, expenses for of f ic supplies and other items . The claimed expenses were initiilly reported on Schedule A, Itemized Deductions, of her ! - 5 - 2003 Federal- income tax returnabut were subsequently claimed on Schedule C of her 2005 Federal income tax return as a business expense. Petitioner reported no income from:work ass a contract, attorney in either 2003'or 2005. The 2003 expenses which she had sought to recast as Schedule C business deductions at trial were rejected on account of the Court's finding that her work as a contract attorney was not an active trade.or business. See Forresttv. Commissioner, supra. On Schedule C of her 2005 return, petitioner reported no income and claimed deductions of $29,942.74. Petitioner's planned solo law practice never made it past the- startup phase to fruition.. She acknowledged that none of her referrals i-n.2005 resulted in paying clients and that she never purchased malpractice insurance. During 2005 petitioner'was engaged in extensive litigation in connection with the, decision by the California Department of Corporations to again terminate her employment -in February -2004.3 Petitioner explained that the State of California "had active litigation trying to get money back." Petitioner has incurred expenses arising from this litigation.. Her claimed $29,942.74 Schedule C business expense. deduction for 2005mincluded a $15,778 3We note that petitioner had previously been terminated -from the California Department of Corporations in 2000 and was subsequently reinstated in March:2003 after filing suit against the State of California in 2003. these facts. See Forrest v. Commissioner, T.C. Memo. 2009-228. We take judicial notice of deduction for "Litigation rei clear name and Establish-Self , 6 - prof essionally" . A trial was held in Los Angeles, California. Following trial, the Court, with agreement of the parties, set a i , simultaneous briefing schedule of September 9, 2009, for opening briefs, and October 26,- 2009i for reply briefs. On-Septembere11, 2009, etitioner filed a motion .for an extension of time to. file a briéf . The Court granted her motion and gave her until October 20, 2d09, to file her opening brief and gave both parties-until Decemder 7, 2009, to file a eply brief . On. October 26, 2009, petitioner filed yet another motion requesting 'to extend time to file briefs and stating that she intencied to "submit a Brief by Express Mail over the weekend for deliv ry on Monday, October 426, 2009" . - The Court had still not recei ed a brief from petitidoner by November 16, 2009, when it deniec her motion. Subseque'ntly, on February 1, 2010, petitioner filed a status report -indicating :she would soon complete her, Los Angel s Superior Court triali matters and address her tax matters. On Ap il 16, 2010,. the Court, still having received no opening brief from petitioner, ente ed an order. that it would no longer wait or or accept briefs f om petitioner in this -case.t As she did in her companion Federal income tax c^aae foî- tried 2004, Forrest v. Commissioner, docket No. 11513-08, separetely at practice of requesting repeated extensions of failing to file a brief . the same trial session, petitioner has foll-owed ca time and then Wè caution petitioner against -abusing (continued... . ) I. Burden of Proof OPINION As a general rule, the Commissioner's determination of a deficiency is presumed correct, and the taxpayer bears the burden of proving that the determination is improper. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). However, the withholding credit and Schedule C deduction issues were not raised in the statutory notice of deficiency.and are therefore new matters within the meaning of Rule 142(a). Thus, as respondent has conceded, with respect to those issues, the burden of proof lies with respondent. Because petitioner raised the issue related to the deductions for her pension repayments, she carries the burden of proof as to that issue. II. Whether Petitioner Is Entitled to a__Eede_ral Incom_e_TM Withholding Credit of $20,060.89 for the 2005 Tax Year Section 6213 (a) allows the taxpayer to seek judicial review of a proposed deficiency before this Court. Under section 6211(b) (1) a deficiency is determined "without regard to payment on account of estimated tax, without regard to the credit under 4(...continued) our processes and remind her that sec. 6673(a) (1) allows us in our discretion to require the taxpayer to pay to the United States a penalty not that "(A) proceedings before it have been instituted.or maintained by the taxpayer primarily for delay, the taxpayer's position in such proceeding is frivolous or groundless, or available administrative remedies". the taxpayer unreasonably failed to pursue (C) in excess of $25,000 whenever it appears (B) section 31" . Section 31 generally allows the taxpayer to claim a credit for Federal income tai withheld from wages for that taxable year." The amount ofe an overstated credit may be. summa ily assessed and is not subject to deficiency procedures. Sec. 6201(a) (3) ; Bregin v. Commissioner, 74 T.C. 1097, 1104-1105 (1980) ("[T]here is no indichtion that section 6214(a) was intended to provide him with an -alternative method for recovering on su h a claim. Furthermore, if the Commissioner is allowed to raise his claim in this proceeding, he would be allowed,to recovår on a claim that would otherwise be barred by the statute of lithitations . ") . Since the withholding redit issue is not a factor in II deter ining the tax deficiency, we have no jurisdiction, to consider it and therefore may not decide whether petitioner is entit ed to a Federal incomë tax withholding credit of $20,060.89 for t e 2005 tax year. We note that under section 6201 . IP respohdent may, if he acts timely, assess any overstated withholding credit as "a matjhematical or clerical error" in the manner specified by sectioni6213(b) . III. hether Petitioner Is Entitled to $29, 942.72 of Schedule C Business Expense Deductions for the 2005 Tax Year A. General Rules Deductions are a matte of legislative grace, and the taxp yer must maintain adeq ate records to substantiate the amou ts of any deductions o credits claimed. Sec. 6001 (the taxpayer "shall keep such records"); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); sec. 1.6001-1(a), Income Tax Regs. Taxpayers must maintain records relating to ·their - income and expenses and must prove their'entitlement to all claimed deductions, credits, and expenses in- controversy. See sec. 6001; Rule 142(a); INDOPCO, Inc. 9. Commissioner; supra at 84; 'Welch v. Helvering, supra at 115. However, as discussed above the withholding credit and Schedule C deduction issues were not raised in the statùtory notice of deficiency, and, as respondent has conceded, with respect to those issues, the burden of proof lies with respondent. Section 162 (a) authorizes a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business". A trade or business expense is ordinary for purposes of section 162 if it is normal or customary within a particular trade, business, or industry and is necessary if it is appropriate and helpful for the development of the business. Commissioner v. Heininger, 320 U.S=. 467, 471÷ (1943); Deputy v. du Pont,' 308 U.S. 488, 495 (1940). B. Petitioner's Schedule C Other Expense Deductions 1. Startup Expenditures . On her tax return for 2005, in connection with her alleged practice of law, petitioner claimed Schedule C other expense deductions for, among other items: "Business use of Telephone", - 10 - "Postage", "Supplies (toner cartridges, paper, clips, etc.)", "Copies", "Publications, seminars, training, travel", "Fees re: travel legal conventions and meetings; hotels", "Business associÅtions provide networking, equipment use re: travel and other þrofessional support". On Schedule C of her 2005 tax return, petitioner reported rio income generated by her law practiee but claimed $29, 942 74 of deductible expenses, producing a loss of the same. amount. Petitioner testified at trial that her solo law practice was a "fledgling effort." She wanted to figure out ,what kind of work * * * [she] was going to do. A lot of it was making expenditures, making contacts, doing the H netwo king" . On the basis of the record, including petitioner' s testi ony, we find that the expenses reported on Schedule C of her r turn for 2005, insofars as related to her legal practice, were ot incurred in "carrying on" a business. The expenses were incur ed before,it became (if it ever did) a business og profit- seeki g activity. See sec. 162; Toth v. Commissioner, 128 T.C. 1 (2007 . Although, "Section 162 generally allows a deduction for all the ordinary and necessary expenses paid or incurred during the tixable year in carrying on any trade or business. Such expenses must be directly connected with or pertain to the taxpayer's trade or business that.is functioning as a business at the time the expenses were incurred." Woody v. Commissioner, - 11 - T.C. Memo. 2009-93, affd. without published opinion No. 09-1193 (]D.C. Cir., Dec. 16, 2010) (emphasis added). Consequently, petitioner may not deduct any of those expenditures for 2005. 2. Legal Fees It is well established * * * that, even- though a taxpayer's employee status may be regarded as a trade or business, fees stemming from a taxpayer's employee status are not deductible in computing adjusted gross income but are to be treated only as miscellaneous itemized deductions, subject See sec. 62(a) (1) to the AMT and to a 2-percent floor. legal * * *. Kenton v. Commissioner, T.C. Memo. 2006-13. Included in petitioner's $29,942.74 of claimed business expense deductions was a Schedule C.business expense deduction for "Litigation re: clear name and Establish Self professionally". This litigation arose from the decision by the California Department of Corporat,ions to terminate petitioner's employment. Because petitioner's litigation relates to her status as an employee, she is not entitled to a Schedule C business expense deduction..-Instead, petitioner may be entitled to a Schedule A miscellaneous.itemized deduction for such litigation expenses." See Kenton v. Commissioner,, supra. "We note that under sec. 62(a) (20) as amended, effective "attorney fees and court costs" paid by the Oct. 22, 2004, taxpayer in connection with discrimination law suits "paid after Oct. 22, 2004, with respect occurring after that date are allowed as a deduction in computing adjusted gross income, with.the result that they are not subject to- the 2-percent floor." Kenton to the AMT, and are not, subject (continued...) .to any judgment or settlement - 12 - IV. Whether Petitioner Is Entitled to a Deduction Under Section 1341 for Amounts Deducted From Her Pension Distributions During the 2005 Tax Year S ction 1341 provides aodeduction for an item of income that was ir cluded in gross income in a prior tax year that was , required to be repaid in a subsequent tax year. The provision has three basic requirementsi (1-) The item must have been I. included as gross income forja prior taxable year because Git appea ed that the taxpayer had 'an unrestricted right to" it, (2) the "deduction is allowable for the taxable year [at issue]. because it was established after the close of" the prior taxable year t hat the taxpayer did nbt have an- unrestricted right- to it, and ( 1341 ( ) ) "the amount of'such deduction exceeds $3, 000" - Sec. . If all of these requirements are met, the taxpayer may deduct the item from the current years' taxes. Id. 10Petitioner reported pension distributions of $17, 434.36 as incom for the 2005 tax year. She was required.to make repayålents on pension distributions from earlier tax years,out of her current year's distribution.- Because petitioner- claims that she had previously included the pension distribution that she was required to repay in some prior tax year and at which time it had . . continued) ( . included in her gross income for 2005 any proceeds from -a v. Commi'ssioner, T.C. Memo. 2006-13. However, as petitioner has not judgåent or settlement of the legal expenses, she is iiot entitled to deduct ethose fees under sec. 62(a) (20). ti1e litigation in which she incurred - 13 - apþeared that she had an unrestricted right to it, she is entitled to deduct, in 2005, the amounts repaid in 2005. At striál petitioner proffered only three monthly distribution statements. These statements do not indicater whether the amounts listed under "recover overpayment" highlighted by'petitioner were included or excluded from the gross pension distribution.' If petitioner's pension distributions were gross amounts, she might be entitled to a section 1341 deductione, provided she met the $3,000 deduction floor. If, however, amounts to cover repayments were deducted from or netted against petitioner's pension payment and also 'Respondent objected to petitioner's monthly distribution statements' being admitted into evidence on grounds of relevance. We deferred ruling on.the admissibility of give petitioner more time to gather additional documentation of the distributi-ons as well as the statements for the missing months. Petitioner failed to submit any such additional documentation. those statements to Fed. R. Evid. 401 defines "Relevant evidence" as "evidence is of The the action more probable or having any tendency to make the existence of any fact that consequence to the determination of less probable than it would be without the evidence." distribution statements are relevant to show that petitioner made repayments on her pension distributions from earlier tax years. However, we note that these documents constitute hearsay; and because they are not accompanied by any type of certification or witness identification, records exception to hearsay under Fed. R. Evid. 803(6) and 902 (11). Respondent did not raise a hearsay objection at trial and thus waived it. overrule the objection on the basis of relevance; however, we note that had these documents been denied admission, it would not have changed the result because petitioner failed to submit additional documentation to clarify whether the deductions had been included in gross distributions or had already been deducted. they do not fall within the business See Fed. R. Evid. 103(a) (1). We now - 14 - deducted from her total Form 1099 yearend tax statement or other tax information reporting form, then she was already making the, 11 repayment with pretax incomes and a section 1341 deduction would in effect give her a second.deduction. Petitioner presented no evidence that she had included the prior pension distributions in a pricr tax year, nor that the deduction would have met the $3,000 floor. As discussed above, the burden of proof sfor this issue rests on petitioner. She has failed to carry her burden and ie not entitled to a deduction under section 1341. The Court has considered all of petitioner' s contentions, argumênts, requests, and statements. To the extent not discussed .I herein, we conclude that they are meritless, moot, or irrelevant. To reflect the foregoi g Decidion will be entered under Rule 155.