TAX COURT OPINION

Case: Esther Lynn Wynter & Sherwin Lawson Wynter
Docket Number: 21220-09
Judge: Colvin
Opinion Type: bench
Filed: 12/02/2010
Pages: 16

UNITED STATES TAX COURT WASHINGTON, DC 20217 ESTHER LYNN WYNTER & SHERWIN LAWSON WYNTER, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent . ) ) ) ) ) ) ) ) ) O R D E R Docket No. 21220-09. Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit herewith the pages of the to petitioner and to respondent a copy of transcript of the above case before Judge Mark V. Holmes at Los Angeles, California on Monday, November 1, 2010, containing his oral the conclusion of trial. fact and opinion rendered after the trial of findings of In accordance with the oral findings of fact and opinion, a decision will be entered pursuant,to rule 155. (Signed) Mark V. Holmes Judge Dated: Washington, D.C. December 2, 2010 SERVED DEC - 7 2010 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 3 Bench Opinion by Judge Mark V. Holmes November 4, 2010 Wynter v. Commissioner Docket No. 21220-09 THE COURT: In the case of Esther Lynn Wynter & Sherwin Lawson Wynter v. Commissioner, Docket No. 21220-09, the Court has decided to render oral findings of fact and opinion and the following represents the Court's oral findings of fact and opinion. This bench opinion is made pursuant to the authority granted by § 7459(b) of the Internal Revenue Code of 1986 as amended and Rule 152 of the Tax Court's Rules of Practice and Procedure. The Petitioners were California residents when they filed their petition. There was no stipulation in this case, the parties being unable to reach a stipulation even after extensive negotiations, so let me start by saying that it arises from a notice of deficiency that the Commissioner issued for the tax year 2006 asserting a deficiency of $15,524 plus additions to tax for failure to timely file under § 6651(a) (1) of $3,134.75 and a negligence penalty under 6662(a) of $3,104.80. There were numerous issues almost entirely of substantiation in the case. They were: Heritage Reporting Corporation (202) 628-4888 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 4 1) Whether the Wynters are entitled to Schedule C repairs and maintenance expenses in the amount of $4,571; 2) Whether the Wynters are entitled to Schedule C rent and lease expenses for vehicles, machinery or equipment in the amount of $8,552; 3) Whether the Wynters are entitled to Schedule C office expenses in the amount of $6,910; 4) Whether Petitioners are entitled to Schedule C meals and entertainment expenses in the amount of $2,305; 5) Whether the Wynters are entitled to Schedule C travel expenses in the amount of $7,133; 6) Whether the Wynters are entitled to Schedule C car and truck expenses in the amount of $9,218; 7) Whether the Wynters failed to report interest income in the amount of $5,879; 8) Whether the Wynters are entitled to a claimed home mortgage interest deduction in the amount of $93,109. Plus the question of whether they are liable for an addition to tax for the untimely filing of their 2006 tax return under § 6651(a) (1) and then whether they are liable for an accuracy-related Heritage Reporting Corporation (202) 628-4888 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 5 penalty under § 6662(a). As a general matter in substantiation cases, the Commissioner's determinations are generally presumed correct, and it is the taxpayer who bears the burden of proving that the Commissioner was wrong. In this case, the Wynters did not comply with the normal substantiation and recordkeeping requirements for their claimed expenses and relied on estimates and reconstructions after the fact. This colors my findings of fact on all the contested issues in this case. Under Internal Revenue Code § 162, taxpayers are entitled to a deduction for all the ordinary and necessary expenses they paid during a taxable year in carrying on their trade or business, but in order to be entitled to the deduction the taxpayers have to show that the expenses that they claim were actually paid and that they were ordinary and necessary to their business. With those general statements in mind, I'll go down each of the contested items on their return. The first item was for repairs in the amount of $4,571. Mrs. Wynter -- and here I specifically find that Mr. Wynter was not part of this case except to the extent that he filed a joint return with his wife Heritage Reporting Corporation (202) 628-4888 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 6 -- had a business whose income and expenses were reported on Schedule C. Mr. Wynter was a wage earner and there are no issues relating to him, so all these remarks when they refer to Wynter or the Wynters really refer to Mrs. Wynter's business. As I was saying, the first item was repairs in the amount of $4,571. Mrs. Wynter here allocated expenses incurred between expenses relating to their house and to the office that she maintained within that house for her business. There were numerous home improvements during the 2006 tax year, including the installation of additional space for her home office, and she estimated, according to a schedule she prepared and that we admitted as Exhibit 17-P, that of the $68,245.18 of expenses on that home improvement project, $4,571 were allocable to the home office. The problem here for the Wynters is that on their Schedule 8829, Home Office Expenses, there were already more than $81,000 taken as repairs on the home as a whole, part of which was then allocated as an indirect cost of maintaining the home office and so that I will disallow what amounts to a duplication of expenses on their home office taken on the Schedule C. Heritage Reporting Corporation (202) 628-4888 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 7 Moreover, most of the home repairs that Ms. Wynter testified to were perhaps improvements to the home office that should have been capitalized rather than expensed. Although this was not raised by the parties, that in some ways colors my decision here. Certainly part of the expenses that relate to the construction or substantial rehabilitation of what she referred to as the barn -- adding a rec room and then adding a conference room which she divided simply into two -- is an attempt to expense on what is a capital item. Moreover, I have substantial doubt about whether a conference room was an ordinary and necessary expense for a business which, as she testified, had no clients who actually met with her in the home office. So my conclusion for all these reasons is to disallow the repair cost of $4,571. The second item was rent/lease for vehicles of $8,552. This consisted of two parts, a major part of which was an annual expense of $779.51 times 12 for a Lexus that Ms. Wynter said she used in her business plus a $154 one-shot limousine rental. Here the problem is that certain categories of deductions having enhanced substantiation requirements under §§ 274 and 280(F). To deduct any Heritage Reporting Corporation (202) 628-4888 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 8 of these expenses a taxpayer must "substantiate by adequate records or by sufficient evidence" the amount, time and place and business purpose of the expenditure. § 274(d). For the 2006 year, Ms. Wynter offered no evidence to substantiate the amount, time and place or business purpose of these claimed deductions for car and travel. Ms. Wynter used estimates of mileage to calculate the deductions and estimates of business purpose when it came to allocating her vehicle expenses throughout the 2006 year, but she kept no contemporaneous travel log. The strict substantiation requirements of § 274(d) mean that I cannot allow an approximation of expenses or a guess as to the business purpose of each individual use of a vehicle like the Lexus that was used for both business and personal purposes. Moreover, there was no receipt or actual evidence of payment for the $154 for the one-time limousine rental, so this category of expense I am also disallowing. The third category were office expenses of $6,910, or as increased during Ms. Wynter's testimony to $7,583.77. Most of these office expenses were in fact for contract labor work, usually using people Heritage Reporting Corporation (202) 628-4888 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 9 whose presence in the country was not entirely legitimate and paying for cash labor. Some of these expenses called office expenses were also, like the repair expenses, really home improvements, some of which, as I said, were already captured in the indirect expenses of maintaining the home office that the government did not challenge. For example, here there was much electrical work done on the home, including portions of the home that Ms. Wynter used as her home office, during 2006. Now, there were a couple of times that I do find Ms. Wynter presented adequate proof both of payment and of business necessity. Here I specifically find that she's entitled to deduct $240 in actual office supplies and the minor cost of paying a messenger to go get them, and then $107 for replacing the lock on her home office space. Those I find were ordinary and necessary. Moreover, they were direct expenses in maintaining the home office and so I do not think that they were already claimed on the home office deduction form. However, I am disallowing the other expenses for Ms. Wynter's failure to adequately allocate between the cost of home ownership and the cost of her home Heritage Reporting Corporation (202) 628-4888 I 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 10 office. I would specifically note in this regard that she was asserting the right to deduct $236 for the installation of a TV, which with its associated equipment cost an additional $3,078. That's $3,078. These are obviously personal expenses, particularly since she, as I said, testified that she did not meet with clients in her home office. The fourth category of expenses were for meals and entertainment. As disallowed in the notice of deficiency, this was $2,305. It was increased as a result of Ms. Wynter's testimony to a claim for deductions of $2,523. Again, § 274 applies in this situation. The enhanced substantiation requirements of § 274(d) mean that using canceled checks and credit card statements to estimate deductions for meals and entertainment and allocate between personal and business meals and entertainment are inadequate. Even when enhanced with testimony, they failed to provide the sufficient substantiating evidence that that section requires that meal and entertainment expenses have a legitimate business and not just personal purpose. That means that I will disallow all of Ms. Wynter's asserted deductions for Heritage Reporting Corporation (202) 628-4888 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 11 meals and entertainment for the years in question, including in particular tickets to various Las Vegas shows. Ms. Wynter as her counterargument asserted that she did not need to show receipts because most of these amounts were under the threshold. That, however, is not the law for § 274. What I need is a usually contemporaneous but certainly near contemporaneous indication of the business purpose of each of those expenses, and simply saying that underneath a certain dollar threshold § 274 doesn't apply is incorrect. The fifth category were travel expenses of $7,133, which Ms. Wynter reduced on testimony to $2,303. Again, § 274 limits my ability to estimate and to accept testimony and partial records as support for substantiation of such expenses. A schedule prepared after the case has already begun, which is what Ms. Wynter did, is in particular almost always inadequate under the section and the'associated regulations, so again I have to disallow those travel expenses for failure to substantiate enough detail -- the time, the place and especially the business purpose -- of that travel that Ms. Wynter was deducting. Heritage Reporting Corporation (202) 628-4888 1 2/h/ The sixth contested category were car and ac/ travet expenses of $9,218, increased during Ms. 12 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Wynter's testimony to $10,042.07. Again, § 274 applies and limits my ability to estimate or to simply allow a deduction on the basis of her testimony. Again, Ms. Wynter kept no contemporaneous log of these expenses and so again I need to reject her claimed deduction here. Estimates of mileage to calculate the deductions without a travel log mean that I cannot approximate expenses. I have to follow the rules under § 274 and the regulations and disallow all of these expenses as well. The seventh category was unreported interest income of $5,879. Ms. Wynter conceded during her trial testimony that in fact she had received this, but had not received the form from the bank at the end of her tax year due to a move and some disruption in her family life. Because this has been conceded, I won't discuss it further. The eighth issue involved the deductibility of mortgage interest. Here it's mostly a computational problem. The law, as Ms. Wynter and the government both understand, allows deduction of home mortgage interest only up to a principal amount of 25 /3// $1.1 million, and theèer principal imat- of the Heritage Reporting Corporation (202) 628-4888 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 13 mortgage was more than that. The key point of dispute between the parties was whether the Wynters adequately substantiated their attempted deduction of points paid at closing on this mortgage, and during the trial it became clear that in fact they had paid rather than financed these points and so the government conceded that the deductibility of those points paid at closing had been made by the Wynters and so an adjustment needs to be made for that. The computation should of course reflect an allocation between the deductible and nondeductible part of those points, just as for the normal interest payments, because of the $1.1 million limitation on the loan, interest for which can be deducted as home mortgage interest. s The government lawyer clearly understood that, and I count on her to bird dog those computations. The ninth issue was whether the Wynters are liable for an addition to tax under § 6651(a) (1). That section provides for an addition to tax for the failure to file a tax return in a timely manner unless that failure was due to reasonable cause and not willful neglect. The Wynters did file an extension for their Heritage Reporting Corporation (202) 628-4888 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 14 2006 return and should have had until October 15, 2007, to file. They would not have been late if they had filed on or before that date. However, the Wynters did not file their 2006 return until April 27, 2008, and did not show that there was reasonable cause for the delay. Ms. Wynter offered the excuse that she expected a refund. Unfortunately, taxpayers who take that position have to understand that if at the end of the process a refund is not owed they are in the position of having filed late without an adequate excuse, so I find for the government on this issue. The last issue, which circles back and encompasses all the others, is whether the accuracy- related penalty under § 6662 applies. That section provides for the imposition of a penalty when any part of the underpayment is due to negligence or disregard of rules and regulations. The term negligence includes any failure to make a reasonable attempt to comply with the provisions of the Code and the term disregard includes any careless, reckless or intentional disregard. Moreover, the Wynters have perhaps understated their tax for the 2006 year by an amount greater than 10 percent of the tax required to be Heritage Reporting Corporation (202) 628-4888 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 15 shown on their return or $5, 000 . If so, the Wynters are in the position of having made a substantial understatement of income tax for 2006 as that term is defined by § 6662(d) (1). Here again the Wynters would have to show due care in the filing of their return and show that they had reasonable cause for the underpayments and that they acted in good faith. Ms. Wynter listed on • her Form 1040 that she was an accountant, so initially of course taking into account the education, training and experience that an accountant would have the threshold of reasonableness is higher. However, it came out during her testimony that she's not really an accountant, not a CPA, not really even a bookkeeper, but her business consists mostly of tracking and paying bills of various clients who have seemingly quite busy lives. She is therefore something similar to a personal financial assistant. This is a good business for her, but it does mean that she doesn't have the education, training and experience of an actual accountant, and I take that into account in figuring out what part of the understatement should have the accuracy-related penalty assessed against it. In this case I find that I will not assert Heritage Reporting Corporation (202) 628-4888 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 16 or not uphold the penalty for negligence, intentional disregard. I find that she has good cause for most of the understatement here. The requirements of § 274 were clearly unknown to her. They're not intuitively obvious to a person of her education and background. She had, moreover, prepared the family's taxes for many years without running into problems with the IRS. There are a couple of categories where she actually won, and that indicates that her positions were not entirely off the wall in this regard and that she had at least a good faith and under her circumstances reasonable position for what she did. However, I specifically find that the attempted deductions for the giant TV set that cost $3,078 plus an additional $236 to install were, as the regulation says, too good to be true and she should not have attempted a deduction for that almost inherently personal expense. With that exception then, I do not sustain the penalties for negligence or substantial understatement or intentional disregard. A decision will therefore be necessary under Rule 155 of the Tax Court's rules, and I will issue an order calling for that within 90 days of this opinion. The outstanding motion by the government to Heritage Reporting Corporation (202) 628-4888 i 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 17 compel the subpoena is also denied as moot. With that, this bench opinion is concluded and this session is concluded as well. Thank you. THE CLERK: All rise. (Whereupon, at 9:38 a.m., the bench opinion in the above-entitled matter was concluded.) // // // // // // // // // // // // // // // // // // // Heritage Reporting Corporation (202) 628-4888