TAX COURT OPINION

Case: Khairy E. Aref
Docket Number: 11164-06
Judge: Vasquez
Opinion Type: memo
Filed: 05/27/2009
Pages: 16

T .C . Memo . 2009-11 8 UNITED STATES TAX KHAIRY E . AREF, Petit oner v . COMMISSIONER OF INTERNAL REVE UE, Responden t Docket No . 11164-06 . Filed May 27, 2009 . Khairy'E . Aref, pro se . John D . Faucher ; for respondent . MEMORANDUM FINDINGS OF FAC'T' AND OPINIO N VASQUEZ, Judge : Respondent determ~ned a $41,920 deficiency . in and a $8,384 section 6662(a)' penalt on petitioner's 200 2 1 All section references are to the Internal Revenue Code ; in effect for'the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure . SERVED MAY 2 7 'I f 2 - Federal income taxes . After a concession,2 the issues for decision are : (1) Whether petitioner substantiated deductions claimed on his'Schedule C, Profit or Loss From Business ; (2) whether petitioner had unreported income ; (3) whether petitioner is entitled to claim head-of-household filing status ; and (4) whether petitioner is liable for the section 6662(a) penalty . FINDINGS OF FACT Some of the facts have been stipulated and are so found . The .stpulation of facts and the attached exhibits are -incorporated herein by this reference . At the time he filed the petition, petitioner resided in Egypt . , During 2002 petitioner worked for the California Department F i of Corrections . He was the agency coordinator . Petitione r developed and coordinated new programs for the State of California Department of Corrections--which had 155,000 employees, 165,000 inmates, and a $6 .-7„billion budget . Hi s supervisor was a cabinet secretary, and his second level supervisor was the Governor of California . Petitioner is a licensed hazardous material specialist and a certified instructor in hazardous materials . He also is a registered professional engineer and an environmental specialist . 2 Respondent concedes that petitioner paid $30,000 in deductible alimony during 2002 . 3 - Additionally, during 2002 petitioner operated an international consulting and training .b siness that provided training and technical services on-hand ing hazardous materials and toxic substances'(Mr'. Aref's busine s) . The training an d technical services were provided to-priate entity firefighters military personnel., and peace officers Ind for the operation . o f correctional facilities,-custody of inmates and prisoners, handling and management of toxic'substaices, and emergency response for, spills and medical waste, as the case may be . Mr . Aref's business had over 400 videotapes available for'(cid:127)- training purposes, covering topics .such as correctional' facilities construction and administration, peace officers' training, environmental impact statemen s and reports , 1 1 corrections officers . training,, fire pro health and safety plans . Petitioner ov rsaw the production . . . (including writing the narratves)'and . -eproduction of th e videotapes . Petitioner met with clien t in the United States , including the Prime Minister and the Deputy Prime minister o f Egypt . Mr . Aref's business operated-in a n equipment in Egypt . Mr . Aref's busines that included two leased cars , Toyota L were used to get to training sessions aid for pickups and 4 deliveries related to Mr . Aref's business . Mr . Aref's busines s also had an accountant in Egypt . 1 Petitioner -leased office space win!. Egypt . The offices were C located at 17 Atbara Street and also at 64 Talmaneal Street in Mohandeseen, Giza, Egypt . At 17 Atbara Street a sign outside the building had the name of Mr . Aref's business on it . During the year in issue Mr . Aref's business was marketed and operated in Egypt by Ahmed Fadel .° Petitioner had a written contract with Mr . Fadel . The contract provided that petitione r would-establish training and technical .services and thati,Mr . Fadel would market them in Egypt . Mr . Fadel was responsible for providing logistical support to petitioner necessary to provide the training . ,,For 2002 petitioner deducted the following amounts a s business expenses : Depreciation $1,119 ; interest $8,699 ; rent or lease of vehicles, machinery, and equipment $9,808 ; rent-or lease of other business property $9,755 ; wages $23,000 ; and othe r expenses $6,309 (accounting $3,600 and . telephone $2,709) for a total of $58,690 . Fadel sent petitioner monthly invoices for the expense s of Mr: :~Aref's business . These invoices were delivered .to - petitioner . Petitioner paid the invoices and had the payment delivered directly to Mr . Fadel . The amounts on the invoices ti e .into the amounts claimed on petitioner's Schedule C . During 2002 petitioner received twd separate loans3 o f $60,000 (a total of $120,000) . One lo a was from Jose Fawzia , and the second loan was from the Gawish Medical Center .4 OPINION I . Substantiation of Schedule C Deduct ons - Generally, deductions are a matte r of-legislative grace ; taxpayers have the burden of showing th t they are entitled t o any deduction claimed . Rule 142(a) ; New Colonial Ice Co . v . Helvering, 292 U .S . 435, 440 (1934) . -maintain .records that are sufficient tojenable the Commissioner to determine their correct tax liability . s See sec . 6001 ; sec . i 1 .6001-1( a), Income Tax Regs . Taxpayers are allowed a deduction expenses paid or incurred in carryin g Sec . 162(a) . Whether an expenditure i s generally a question of fact . Commissioner . v . Heininger , 32 0 U .S . 467, 475 (1943) . Generally,-for a expenditure to be an ordinary and .necessary business expense the taxpayer must show, a bona fide business purpose-for the expe diture ; there must be proximate relationship between the expe diture and the busines s 3 The characterization of the amounts as loans is not in dispute . 4 The testimony was somewhat unclear on whether this loan was from the Gawish Medical Center or from Dr . Hassan Gawish . Either way, it was a separate loan for 60,000 . I of the taxpayer . Challenge Manufacturing Co . v . Commissioner , 37 T .C . 650 (1962) ; Henry v . Commissioner , 36 T .C . 879 (1961) . To be "necessary" within the meaning of section 162, an expense needs to be "appropriate and helpful" to the taxpayer's business . Welch v . Helvering , 290 U .S . 111, 113 (1933) ., The requirement that an expense be "ordinary" connotes that "the transaction which gives rise to it must be of common or frequen t occurrence in the type of business involved ." Deputy v . . du Pont , 308 U .S . 488 , 495 (1940 ) ( citing Welch v . Helvering, supra at 114) When taxpayers establish that they have incurred deductible expenses but are unable to substantiate the exact amounts, we can estimate the deductible amount in some circumstances, but only if the taxpayers present sufficient evidence to establish a'rational basis for making the estimate . See Cohan v . Commissioner , 3 9 F .2d 540, 543-544 (2d Cir . 1930) ; Vanicek v . Commissioner , 85 T .C . 731, 742-743 (1985) . In estimating the amount allowable, we bear heavily upon taxpayers whose inexactitude is of their-,own making .' See Cohan v . Commissioner , supra at 54'4 . There must be sufficient evidence in the record, however, to permit us to conclude that a deductible expense was paid or incurred . Williams v . United States , 245 F .2d 559,560 (5th Cir .. 1957) . In addition to satisfying the criteria for deductibility under IIsection 162, certain categories'of expenses must also - 7 - satisfy the strict substantiation requirements of section 274( d in order for a deduction to be allowed . section 274(d) applies include, among other things, those for listed property, e .g ., automobile expenses .- Secs . 274(d)(4 ) 280F(d)(4)(A)(i) and (ii) . We may .not use the Cohan doctrine estimate expenses covered by section 274(d) . . See Sanford v. . Commissioner , 50 T .C . 823, 827 (19.68), ffd . 412 F .2d ;.201 (2 d Cir . 1969) ; sec . 1 .274-5T(a), Temporary Income Tax Regs ., 50 Fed . i Reg . 46014 (Nov . 6, 1985) . To substantiate a deductio n attributable to listed property, a taxp yer must maintai n adequate records or present corroborative, evidence to show th e following : (1) The amount of the expense ; (2) the time and place of use of the listed . property ; and (3) he business purpose ofd the use . . Sec . 1 .274-5T(b)(6), Temporar Income Tax Regs ., 5 0 Fed . Reg . 46016 (Nov . 6, 1985 ) Our resolution of the substantiatin-issue turns on the applicable law and our determination of the credibility of the evidence presented . . A . Depreciatio n There is allowed as .a depreciation deduction a reasonable I allowance for the exhaustion, wear and tear (including . obsolescence ) of property used in a trade or business . Sec : 167(a) . The basis on which exhaustion, wear and tear, and ii - 8 - (cid:127) I obsolescence are to be allowed in respect of any property is the adjusted basis as provided in section 1011 . Sec . 167(c) : The record does not establish what office furniture and/or equipment was depreciated, . what amount was paid for it, when .it , Was-put in service, or who owned it . Accordingly, petitioner ha s not substantiated the deduction for depreciation . B Interest . ,'i'Petitioner testified that he. gave:~his records regarding interest to his accountant, the accountant arrived at the figure on the return, and he trusted .his accountant . There is r insufficient credible evidence to establish a rational basis for making an estimate of the deductible amount of interes t petitioner paid during 2002 . See Cohan v . Commissioner , supra a t 543-544 ; Vanicek v . Commissioner , supra at 742 -743 . Accordingly , r.; we shall not allow petitioner a deduction for interest . e C . . Rent or Lease of Vehicles, Machinery, and Equipment Petitioner testified that he paid $818 per month to ;Mr . Fadel to lease the two cars . This amount is corroborated by, invoices petitioner submitted . Automobile expenses must also satisfy the strict substantiation requirements of section ;,274(d) in order for a deduction to be allowed because an automobile is listed property . Secs . 274(d)(4), 280F(d) (4) (A) (i) and (ii) . IV - 9 - Petitioner did not keep a diary, 1 record regarding the use of the cars , time and place of . use of the cars (othe than that the vehicle s were used in Egypt) . See secs . 274(d)( 280F(d)1(4) (A) (i) and (ii) ; sec . 1 .274-5T(c)(2), Temporary .In ome Tax Regs ., 50 Fed . Reg . 46017 (Nov . 6, 1985) . Petitioner the claimed automobile expenses in acco and 274 and the regulations thereunder . respondent's determination on this issue . D . Rent or Lease of Other Business Propert y This expense was for the lease of office space in Egypt . I Office expenses may be "'ordinary and-n cessary expenses paid o r incurred during the taxable year in car ying on any trade or ; business'" . Schnell v . Commissioner , T C . Memo . 2006-14 7 (quoting section 162(a)) . We find the invoices, corroborated by petitioner's testimony and the written contract with Mr . Fade l to b e credible evidenc e of the amount that petitioner paid in 2 002 for rent or lease of , office space used in Mr . Aref's business . All of the invoices?:.' bear a "paid" stamp from Mr . Fadel acknowledging that petitione r paid the invoice . Accordingly, we conc Lude that petitioner ha s substantiated this expense . E!. Wage s - 10 - This expense was for salary and wages for the people in Egypt,Mwho provided or administered training and technica l services, for office staff, and for the drivers of the two cars . Wages may be ordinary and necessary business expenses which generally are deductible under section 162(a) . Brown v . Commissioner , T .C . Memo . 1992-40 . .,,We find the invoices, corroborated by petitioner's testimony, to be credible evidence of the amount of the wage expense of Mr .. Aref's business that petitioner paid in 2002 . Al l the invoices bear a paid stamp fromiMr . Fadel acknowledgin g that .petitioner paid the, invoice . Accordingly, we conclude that petitioner has substantiated this expense . F . Accountan t The accountant did the accounting, invoicing, and list of purchases and sales for Mr .. Aref's business . Accounting fees may be ordinary and necessary business expenses which generally are deductible under section 162(a) . Smith v .,Commissioner , T .C . Memo .., 1994-640 . We find the invoices, corroborated by petitioner's testimony and the written-contract with Mr . .Fadel, to be credible evidence Ir y i.~ of the amount of the accountant expense of Mr . Aref's busines s that petitioner paid in 2002 . All of the invoices bear a "paid " stamp from Mr . Fadel acknowledging that petitioner paid the invoice . Accordingly , we conclude that petitioner has - 11 - substantiated this expense . G . Telephon e Telephone expenses may be deductib,e under section 162(a) i f the expenses incurred are ordinary and necessary in carrying on a trade or business .. Weeldreyer v . Commissioner , T .C . Memo . 2003-324 (citing Vanicek V . Commissioned , 85 T .C . at 742 , Sengpiehl v . Commissioner , T .C . Memo . 1 98-23, and- Green v .- Commissioner , T .C . Memo . 1989-599) . Petitioner testified that he did not know the cost of a basic telephone line-in Egypt . According to the invoices, petitioner paid $315 per month for telephone service . When a taxpayer establishes that h has incurred deductible expenses but is unable to substantiate he exact .amounts, we'can estimate the deductible amount, but only if the taxpayer presents sufficient evidence : to establish a rational basis,for making .: the estimate . See Cohan v . Commissioner , 3 F .2d at 543-544 ; Vanicek ' v . Commissioner , 85 T .C . at 742-743 . Iestimating the amounts allowable, we bear heavily upon the taxpayer whose inexactitude is of his own making . See Cohan v . Commissioner , supra at 544 . Upon the basis of the evidence presented, pursuant to Cohan , w e e estimate that petitioner paid $150 per month for telephon expenses and allow him a deduction of,$i1,800 for 2002 . 4 II .' Unreported Income - 1 2 Respondent determined that petitioner had $84,581 i n unreported gross income . At trial respondent conceded $6,000, o f this amount . .Every individual liable for tax pis required to maintai n books and records sufficient to establish the amount of his or her gross income . Sec . 6001 ; DiLeo~-v .. Commissioner , 96 T .C . 858 , 867 (1991), affd . 959 F .2d 16 (2d Cir . 1992) . Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized to compute the taxpayer's taxabl e income by any method that clearly reflects income . Sec . 44.6(b) ; Holland v . United States, 348 U .S . 121 ;(1954) ; Webb v . Commissioner , 3 94 F .2d 366, 371-372 ;>(5th Cir . 1968), affg . T .C . Memo .,1966-81 . The reconstruction of income need only be reasonable in the light of all surrounding facts an d circumstances . Giddio v ., Commissioner , 54 T .C . 1530, 1533 .(1970) . The Commissioner is given latitude in determining which method o f "'At the May 15, 2007, recall of this case before Judg e Cohen, respondent conceded the unreported income issue on the record .' (At that time respondent had also conceded the issue in his pretrial memorandum .) Apparently, respondent revoked or withdrew this' concession before the trial in the case (although when asked in the case at bar whether the unreported income issue was still at issue, respondent's counsel initially answered "No") . income issue or assert that the unreported income was no longer at issue . Petitioner did not object to the trial of the unreported 13 - reconstruction to apply when a taxpayer fails to maintain records . Petzoldt v . Commissioner , 92 C . 661, 693 (1989) . Respondent used the source and app ication of funds method (also known as the cash expenditures in excess of reported incom e method)-to-reconstruct petitioner's income . Respondent,faile d t o include in his calculation the $120,000 in loans petitioner received during 2002 .6-' When these loan are included in the : : . source and application of funds calculation , petitioner does .not have any unreported .. income for 2002 ( th $120,0,00 of loans that were not included as income exceeds th e $78,581 ($84,581 minu s the $6,000 respondent conceded) determi d to be unreporte d income) . Accordingly, we find for petitioneron this issue . III . Head of Househol d An individual qualifies as a head of household if the individual is not married at the close f the taxable year arnd maintains as his home a household that onstitutes for more than one-half-of .the taxable year the princi al place of abode of .an individual who qualifies as the taxpaye's dependent within th e meaning of section 151 . Sec . 2(b) (1) ( A Respondent did not raise the issue of head-of-household filing status in the notice of deficien y . Respondent raised .it . 6 See supra note 3 . Respondent d : received the loans . We found as a fac t the $120,000 in loans . sputed that petitioner!" that petitioner received - 14 - as a new matter-at trial . Accordingly, respondent bears ;;the- burden of proof on this issue . See Rule 142(a) . 'Petitioner was not married .at the close of the taxable year . Respondent has .not established that petitioner did not maintai n as his :home a household that constituted for more than one-hal f of the taxable year the principal place of abode of an-individual who qualified as . petitioner's dependent within the meaning of section .151 . Petitioner,claimed two dependents on his 2002 tax return .' Furthermore respondent's reconstruction of petitioner's income~using the source and application of funds method was base d on petitioner's having a family of three . -Respondent has not established the total cost of maintaining the household in 2002 or that petitioner did not provide over half of the cost . Accordingly, respondent has failed to prove that petitioner is I s not entitled to head-of-household status . IV . Section 6662(a ) Section 7491(c) provides that the','Commissioner will bear the burden of production with respect to the liability of any . individual for additions to tax and penalties . "The Commissioner's burden of production under section 7491(c) is to produce . evidence that it is appropriate to impose the relevan t penalty, addition to tax, or additional amount" . Swain v . Commissioner , 118 T .C . 358 , 363 (2002 ) ; see also Higbee y . Commissioner , 116 T .C . 438 , 446 (2001 ) ayl'eP5 . However, the - 1 5 Commissioner does not have the obligation to introduce evidence regarding reasonable cause or substantial authority . Higbee' ;v . Commissioner ,(cid:127) supra at 446-447 . Respondent determined that petitio er is liabl'e for the,','' section 6662(a) penalty for 2002 . Pursuant to section 6662(a ) and (b)(1) and'(2), a taxpayer may be liable for a penalty of 2 0 percent on the portion of an underpayment of tax due t o negligence or disregard of rules or regulations or a substantial understatement of income tax . "Negligence" includes any failure by the taxpayer to keep adequate books and records or t o substantiate items properly . Sec . 1 .662- 3(b)(1), Income Tax Regs . An "understatement " is the difference between the amoun t of tax required to be shown on the return and the amount of tax actually shown on the return . Sec . 6662(d)(2)(A) . A "substantial understatement" exists if the understatement exceed s the greater of (1) 10 percent of the tax required to be shown o n the return for a taxable year, or (2) $ ,000 . See sec . 6662 (d) (1) (A) . Respondent met his burd n of production. as ther e was a substantial understatement . The accuracy-related penalty is no imposed with respect t o any portion of the underpayment as to w !rich the taxpayer acte d with reasonable cause and-in good faith Sec . 6664 (c) (1) . The decision as to whether the taxpayer acted with reasonable cause - 16 - and in, .,good faith depends upon all the pertinent facts an d circumstances . Sec . 1 .6664-4(b)(1), Income Tax Regs . Petitioner maintained business records to substantiate his expenses . In total the invoices hardly deviated from the expenses claimed by more than a few dollars (with the exceptio n of the telephone costs which were off by approximately $100) . W e conclude that petitioner acted with reasonable cause and in goo d faith with respect to the substantiation of his busines s expenses . To reflect the foregoing, Decision will be entere d under Rule 155 .