TAX COURT OPINION

Case: Caltech Consulting Services
Docket Number: 22011-16
Judge: Nega
Opinion Type: bench
Filed: 03/20/2018
Pages: 10

CLC UNITED STATES TAX COURT WASHINGTON, DC 20217 CALTECH CONSULTING SERVICES, Petitioner, v. ) ) ) ) Docket No. 22011-16. COMMISSIONER OF INTERNAL REVENUE, Respondent ) ) ) ORDER Pursuant to Rule 152(b) of the Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit to petitioner and to respondent a copy of the pages of the transcript of the proceedings in the above case before Judge Joseph W. Nega at San Francisco, California, on February 16, 2018, containing his oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fact and opinion, decision will be entered under Rule 155. (Signed) Joseph W. Nega Judge Dated: Washington, D.C. March 20, 2018 SERVED Mar 20 2018 Bench Opinion by Judge Joseph W. Nega February 16, 2018 Caltech Consulting Services v. Commissioner of Internal 3 Revenue Docket No. 22011-16 THE COURT: The Court has decided to render oral Findings of Fact and Opinion in this case. The following represents the Court's oral Findings of Fact and Opinion. This bench opinion is made pursuant to section 7459(b) and 1 2 3 4 5 6 7 8 9 10 Rule 152, and shall not be relied on as precedent in any 11 other case. Unless other indicated, all section A 12 references are to the Internal Revenue Code (Code) in 13 effect for the yea at issue, and all Rule references are 14 15 16 to the Tax Court Rules of Practice and Procedure. By a notice of deficiency (notice) dated July 15, 2016, respondent determined deficiencies in the 17 Federal income tax of petitioner Caltech Consulting 18 Services for taxable years 2013 and 2014 (collectively, 19 the years at issue), and additionally determined that 20 petitioner was liable for accuracy-related penalties under 21 22 23 24 section 6662(a) for both those years. After concessions by the parties with respect to the determined deficiencies and penalties, the following issues remain for decision: (1) whether petitioner paid $25,324 for deductible 25 purchase expenses, characterized by petitioner as tester (973)406-2250|operations@escribers net |www.escribers.net 4 rental expenses, for 2013; and (2) whether petitioner paid $93,730 of deductible "other" expenses, characterized by petitioner as equipment rental expenses, for 2014. This case was tried on February 14, 2018, in San Francisco, California. Michael Tran appeared on behalf of petitioner. Cameron W. Carr appeared on behalf of respondent. FINDINGS OF FACT Petitioner's principal place of business when 1 2 3 4 5 6 7 8 9 10 the petition was filed was San Jose, California. 11 Petitioner's shareholder is Michael Tran (Mr. Tran), also 12 a resident of San Jose. Petitioner primarily operated out 13 of the first floor of Mr. Tran's residence at 1919 Garden 14 Bing Circle. 15 16 Petitioner operates in the field of computing equipment design and manufacture. Petitioner's 17 manufacture and design activities often require petitioner 18 19 to engage in certain specific and sophisticated testing routines. The cost of purchasing the equipment required 20 to undertake such testing, however, can often prove 21 prohibitive for smaller firms in the field, such as 22 petitioner. For smaller firms a cost-effective solution 23 to this problem is to use "test houses". Test houses are 24 rental vendors that provide smaller firms the ability to 25 access and utilize the testing equipment necessary for ) cribers (973)406-2250|operations@escribers.net|www.escribers.net their work. In the course of its business during the years at issue, petitioner routinely utilized the services 5 of local test houses. Petitioner filed timely Forms 1120, U.S. Corporation Income Tax Return (Form 1120) for the years at issue. On those returns, petitioner reported no tax due for the years at issue. Petitioner's returns for the years at issue were selected for audit. During the audit, respondent 1 2 3 4 5 6 7 8 9 10 determined that petitioner was not entitled to a number of 11 12 13 14 15 business deductions it had claimed for the years at issue. In particular, during the examination petitioner was unable to substantiate $118,737 of the $308,837 of "purchase" expenses it had claimed on its return for 2013, and $223,617 of its $400,663 "other" expenses it had 16 claimed on its return for 2014. The amounts.remaining for 17 decision are elements of these two categories of 18 petitioner's claimed deductions. Respondent's examiner 19 determined that the deficiencies arising from the 20 disallowance of petitioner's deductions also rendered 21 petitioner liable for an accuracy-related penalty for each 22 of the years at issue. Respondent's examiner sought and 23 received approval from his immediate supervisor to assert 24 that penalty for the years at issue. Accordingly, on July 25 15, 2016, respondent issued petitioner a notice of (973)406-2250|operations@escribers;net|www.escribersnet 6 1 2 3 4 5 6 7 8 9 deficiency disallowing petitioner's deductions and asserting the accuracy-related penalty. At trial, petitioner and respondent traded concessions with respect to several business expenses and depreciation deductions, respectively. These final concessions left for decision only petitioner's claim to test house rental expenses in the amounts of $25,342 and $93,730 for years 2013 and 2014, respectively (remaining disputed amounts). We observe that these remaining 10 disputed amounts represent the excess of specific line- 11 item "purchases" and "other" deductions claimed by 12 petitioner on its original returns ($103,124 for 2013 13 14 15 16 17 "tester rental", and $225,370 for 2014 equipment rentals), over those amounts allowed by respondent in the notice ($77,800 for 2013 "tester rental", and $131,640 for 2014 equipment rentals). In support of these claimed deductions 18 petitioner offered into evidence a series of invoices, and 19 20 testified that it had both paid these amounts and that these expenses were necessary to its business operations. 21 Petitioner, however, was unable to reconcile all these 22 23 24 claimed expenses with any cancelled checks or other financial records entered into evidence. Petitioner dealt almost exclusively with a limited number of test houses, 25 but yet petitioner did not provide any records from those cribers [973)406-2250|operations@escribers.net|www.escribers.net 7 1 2 3 4 5 6 7 8 9 test houses which may have helped him substantiate the remaining disputed expenses. Similarly, petitioner was unable to credibly explain why these invoiced amounts, totaled, did not correspond with and were in excess of the amounts petitioner had reported paid to its test house vendors on various Forms 1099, as collected into evidence as exhibit 16-R. Moreover, many of the invoices offered by petitioner at trial came from a test house vendor which is operated by the brother-in-law of Mr. Tran, 10 petitioner's sole shareholder. 11 12 13 14 15 16 17 18 Petitioner did not provide the Court with any otherwise persuasive documentary or testimonial evidence to verify its payments for any other purchases or expenses in excess of those previously allowed by respondent. I. Burden of Proof OPINION Generally, the Commissioner's determinations set forth in a notice of deficiency are presumed correct, and 19 the taxpayer bears the burden of persuading the Court that 20 21 respondent's determination is incorrect. Rule 142(a)(1); see Welch v. Helvering, 290 U.S. 111, 115 (1933). 22 Deductions and credits are a matter of legislative grace, 23 24 and the taxpayer bears the burden of proving entitlement to any deduction or credit claimed. Rule 142(a); Deputy 25 v. du Pont, 308 U.S. 488, 493 (1940); New Colonial Ice Co. cribers (973)406-2250|operations@escribers;net|www.escribers.net 8 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers are required to maintain records sufficient to substantiate any claimed deduction or credit, and to maintain records sufficient to substantiate those claims and calculate taxable income. See sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs.; INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). II. Ordinary and Necessary Business Expenses Section 162(a), generally, allows taxpayers a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. A taxpayer's expense is "ordinary" if it is customary or usual within a particular trade, business or industry, and "necessary" if it is appropriate and helpful for the development of the business. Deputy v. du Pont, 308 U.S. 488, 495 (1940); Welch v. Helvering, 290 U.S. at 113. To support the deduction of an expense under section 162, generally, a taxpayer must produce evidence 19 sufficient to establish that an expense was actually paid, 20 21 and that there was an actual connection between that expense and the taxpayer's trade or business. See e.g., 22 Hennessey v. Commissioner, T.C. Memo 2007-131, slip op. at 42. 23 24 Petitioner failed to carry his burden of proving 25 that the remaining disputed amounts constitute deductible ) cribers (973)406-2250|operations@escribers.net|www.escribers.net 9 1 2 3 4 5 6 7 8 9 business expenses. We do not.doubt that, after concessions, the remaining disputed amounts would qualify as an ordinary and necessary business expense within petitioner's industry. That is not the issue. Rather, the evidence offered by petitioner at trial has failed to persuade us that it should be allowed to deduct the remaining disputed amounts in excess of that already allowed or otherwise conceded by respondent, as petitioner failed to sufficiently establish that it actually paid the 10 remaining disputed amounts. 11 Petitioner's invoices are sufficient only to the 12 extent that they establish that petitioner may have 13 incurred an expense or liability. The invoices themselves 14 do not speak to whether petitioner paid or otherwise 15 satisfied its obligations; and in light of the familial 16 17 relationship between Mr. Tran and one of his test house vendors, there is significant doubt as to the reliability 18 of those particular invoices. Additionally, petitioner's 19 testimony with respect to payment of these invoices was 20 uncorroborated, and significantly undermined by its 21 inability to reconcile, or otherwise explain the 22 23 discrepancies between any documentary evidence of payment (i.e., cancelled checks, bank records, and the associated 24 Forms 1099) and the amounts it claims to have paid. 25 Under these circumstances, we sustain cribers (973)406-2250|operations@escribersanet|vmycescribers.net respondent's determination with respect to the remaining 10 disputed amounts. III. Section 6662(a) Penalty Section 6662(a) and 03) (2) imposes an accuracy- related penalty on any portion of an underpayment of Federal income tax that is attributable to, among other things, the taxpayer's "substantial understatement of income tax". An understatement of Federal income tax is substantial if the amount of the understatement for the taxable year exceeds the greater of 10% of the tax required to be shown on the return or $5,000. Sec. 6662(d) (1) (A). . The Commissioner bears the burden of production 1 2 3 4 5 6 7 8 9 10 11 12 13 14 with respect to any accuracy-related penalty under section 15 6662. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 16 at 446. As part of the Commissioner's burden of 17 production, he must offer into the record, as pertinent 18 here, a civil penalty approval form illustrating that an 19 administrative supervisor approved the imposition of 20 penalties, in writing, prior to the issuance of the notice 21 of deficiency. See sec. 675103) (1); Graev v. 22 Commissioner, 149 T.C. , (slip op. at 14) (Dec. 20, Cl¼ibl 2017). 23 24 At trial, respondent entered into evidence the 25 requisite civil penalty approval form. Petitioner has cribers (973)406-2250|operations@escribersmet|www.escribersaet conceded that if, pursuant to its concessions and our holdings, the Rule 155 computations confirm a substantial understatement for the taxable year at issue, then it is responsible for the accuracy-related penalties for the 11 years at issue. IV. Conclusion Accordingly, a decision will be entered under Rule 155. This concludes the Court's oral findings of fact and opinion in this case. In reaching our holdings 1 2 3 4 5 6 7 8 9 10 herein, we have considered all arguments made, and, to the 11 extent not mentioned above, we conclude they are moot, irrelevant, or without merit. (Whereupon, at 11:20 a.m., the above-entitled matter was concluded.) 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cribers (973)406-2250|operationseescribersmet|www.escribersmet