TAX COURT OPINION

Case: Silvia L. Repetto
Docket Number: 15570-14S
Judge: Holmes
Opinion Type: bench
Filed: 06/29/2015
Pages: 13

UNITED STATES TAX COURT WASHINGTON, DC 20217 SILVIA L. REPETTO, Petitioner, ) ) v. ) Docket No. 15570-14S. COMMISSIONER OF INTERNAL REVENUE, Respondent. ) ORDER Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit herewith to petitioner and to respondent a copy of the pages of the transcript of the trial of the above case before Judge Mark V. Holmes at Birmingham, Alabama, on June 9, 2015 containing his oral findings of fact and opinion rendered after the conclusion of trial. In accordance with the oral findings of fact and opinion, a decision under Rule 155 will be entered. . (Signed) Mark V. Holmes Judge Dated: Washington, D.C. June 29, 2015 SERVED JUL - 6 2015 Capital Reporting Company 3 1 2 Bench Opinion by Judge Mark V. Holmes June 9, 2015 3 Silvia L. Repetto v. Commissioner 4 5 Docket Number 15570-14S In the case of Repetto v. Commissioner, the 6 Court has decided to render oral findings of fact and 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 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 section 7459(b) of the Internal Revenue Code of 1987, as amended, and Rule 152 of the Tax Court's Rules of Practice and Procedure. Ms. Repetto was an Alabama resident when she filed her petition challenging the determination by the Commissioner that she had a deficiency for her 2010 tax year. The parties reached a stipulation, and together with the testimony, that constituted the record of the case. Her background is somewhat unusual; she is an immigrant from Uruguay who was trained in Uruguay as an industrial engineer but could not find work here due to certification requirements in her field. She has nevertheless established herself as a consultant for various businesses in the U.S. and has earned a living mostly as a consultant since 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 4 1 2 3 4 5 6 7 8 then. Specifically in 2010 she had three consultancies but was responsible for her own health insurance and the like, so she was an independent contractor. She was very definitely not an employee of any of the three entities that she had these consulting agreements with, including a Mr. Steve 9 Wolfe, who seems to have been the person in charge of 10 11 12 13 14 15 16 LAN, Incorporated, an oil and natural gas exploration or development company. She very much wanted to turn one of these consultancies into a more normal employment relationship, and she thought that by doing hard work in those consultancies, she might further her goal, so she was in it for a living; she was in it for 17 money. It was her trade or business to be a 18 19 20 21 22 23 24 25 consultant. It was not what she particularly wanted to do, but she was good at it that year, and she made a living at it. Four items were at issue in the case. The first three were $2,347 in meals and entertainment expenses; $5,933 in travel; and $4,726 in car and truck expenses. All such expenses are potentially 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 5 1 2 3 4 5 6 deductible but are limited by sections 274 and 162 of the Code. 274 adds the extra substantiation requirements for certain kinds of listed property and certain kinds of deductible expenses and requires rather detailed records. Showing her background as an engineer, Ms. 7 Repetto apparently had quite detailed and well 8 9 organized records, and the Government was able to stipulate that she incurred the expenses and that she 10 met the substantiation requirements of section 274 if 11 12 13 14 15 16 17 18 19 20 21 22 23 24 in fact she had a trade or business. The requirement imposed by section 274 are, of course, in addition to those imposed by section 162, and she still had the burden of proving that those expenses were ordinary and necessary to her business. So we took testimony on that question, and we needed first to know what her trade or business was. And as I said, consulting was her shorthand description for what she was doing, but it was the only way that she got any money that year to live on. She was working for startups; she was getting them organized. In the case of Mr. Wolfe's LAN, Inc., she was rounding up investors, doing 25 whatever it was she could to further the consultancy, 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 6 1 bill hours; make a living, in other words. 2 3 It was her trade or business, whether viewed from the perspective of did she have a profit 4 motive -- of course, she did; it was her only source 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 of income -- and whether it was systematic and continuous, and I frankly believe her and find her credible that this is what she was doing to earn a living. So I certainly find that she was in the trade or business of consulting and these expenses were incurred and, as the Government said, met the requirements under section 274. So I'll allow all those expenses. Off the record. (Off the record.) THE COURT: See, Ms. Repetto, I was ruling in your favor. So there was certainly no lack of profit- seeking activity here. And it was not only 20 management consulting that she was doing, but she was 21 22 23 24 25 trying to round up investors, particularly for this LAN, Inc. So my conclusion is that all three categories of these first relatively minor schedule C expenses meet the test for deductibility, and I will 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 7 1 2 3 4 5 6 7 allow them under sections 162 and 274. But the item was $52,500 in what was recorded as legal expense. Of this, $2500 was for a personal legal bill. There's no question that that's t no3deductible, as Ms. Repetto agreed before trial. The bigger expense, though, was the $50,000 which represented a 3-percent interest in an oil 8 well. This turned out to be rather extraordinarily 9 complicated to figure out. 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 And it was very unclear exactly what this was. Was it a 3-percent -- when Ms. Repetto says 3- percent interest in a well, does that mean 3 percent of both the costs and income, 3 percent of the income after the costs were recovered, 3-percent interest in some kind of venture -- a joint venture, a partnership, something, who knows -- that itself had the working interest in the well. It was definitely not a loan, which is what the Court and apparently the Respondent thought coming into the case. She said it was definitely not a loan. It was definitely not part of her trade or business of being a consultant. But was clearly for the production of income. She thought that she would not only get the 50,000 back but make money on it as well, and so it 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 8 1 2 3 4 was held for the production of income. It was also very definitely spent. We had a copy of the check which included $50,000 for this. And it was definitely lost. She hasn't recovered any 5 money at all from that, not even a penny. 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 So it's not a trade or business expense. It was an expense of attempted production of income. And it's very unclear as to what kind of interest in a well it represented, oil and gas law being very complex when it runs up against income tax law. One possibility here in oil and gas tax law is that the $50,000 was deductible in the year it was spent. 26 C.F.R. section 1.612-4(a) states that "in accordance with the provisions of section 263(c), intangible drilling and development costs incurred by an operator (one who holds a working or operating interest in any tract or parcel of land, either as a fee owner or under lease or any other form of contract granting working or operating rights) in the development of oil and gas properties may, at his option, be chargeable to capital or to expense. "This option applies to all expenditures made by an operator for wages, fuel, repairs, hauling supples, et cetera incident to and necessary for the 25 drilling of wells and the preparation of wells for 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 9 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 the production of oil or gas." Moreover, the election is extremely informal under this regulation. 26 C.F.R. section 1.612-4(d) says, "The option granted in paragraph (a) of this section to charge intangible drilling and developmental costs to expense may be exercised by claiming intangible drilling and development costs as a deduction on the taxpayer's return for the first taxable year in which the taxpayer pays or incurs such costs. No formal statement is necessary." Well, she didn't put it quite on the right part of her form, but she seems to have been trying to deduct it, and perhaps it represented a claim or election to currently expense the $50,000 in 2010. The problem for her here, though, is the 16 definition of operator. In a case called Hutchinson 17 18 19 20 21 22 v. Commissioner, T.C. Memo 1980-551, 41 T.C.M. 531 (1980), we stated that the option of expensing is available "only to an operator, who is defined as one who holds a working or operating interest in any tract or parcel of land, either as a full owner or under lease or any other form of contract granting 23 working or operating rights".... 24 25 In the case of Hutchinson, "the source of any working or operating interest in these properties 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 10 1 2 3 4 5 6 was the development concessions granted by the Venezuelan government. "In June 1970, these concessions were held by a joint venture between Talon Petroleum, CA, and Homestake. We are not persuaded that these concession rights or any derivative rights were 7 directly or indirectly transferred in 1970 or to the 8 9 10 11 12 13 14 15 16 17 18 19 1970 program." In other words, as we did in Hutchinson all those years ago, one has to show some connection between the original mineral right and the person who's actually drilling the well here. That was not shown, and indeed we have very informal rules about this, but we have to have some proof that the owner of the mineral rights gave them to Mr. Wolfe or one of his companies and that he then passed them to some form of entity. S,es, fo example, Owen v. Commissioner, T.C. Memo 1990-172, 59 T.C.M. 290 (1990), where we said, "We will look for 20 Petitioners to show that there was at least an 21 22 23 24 25 informal grant of an operating interest before IDCs were paid or incurred." The absence of proof by Ms. Repetto that her $50,000 went to get her an interest in a joint venture or an LLC or a partnership or some other 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 11 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 entity which itself held the right to go onto somebody else's property and drill for oil defeats her claim to say that she was an operator, which means that those potential intangible drilling costs were not deductible in 2010. In addition, she presented no evidence that they were in fact intangible drilling costs. One surmises that that's exactly what was going on here, but there was no proof of that. Nevertheless, section 165 of the Code says that as a general rule, "There shall be allowed as a deduction any loss sustained during the taxable year not compensated for by insurance or otherwise." Section 165(c)(2) then goes on to state that, "In the case of an individual, the deduction under subsection (a) shall be limited to losses incurred in any transaction entered into for profit though not connected with a trade or business." That's exactly what I find happened here. She gave the $50,000 probably because she was looking for more business from Mr. Wolfe, but with the stated intent -- and I believe her on this -- that she hoped to make money by investing in one of his wells. It wasn't a charitable gift to Mr. Wolfe; it wasn't a payment to ensure future consultancy; it 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 was a legitimate interest in a well, however that's defined pursuant to their oral contract. She was in it for the money. That means that her loss is deductible under section 165. However, it's deductible under 165 at the time the well was abandoned as worthless, which occurred only in 2011. So I have to conclude that she's not entitled to this $50,000 deduction in 2010, but she was in 2011. So when the time comes, Ms. Repetto, you should amend your return for 2011 and try to work it out. It's a timing issue rather than a deductibility issue. This leads me to the penalties. The Government asserted without much detail that she was subject to a penalty for the understatement under 6662 either for substantial understatement or for negligence. Since I'm ruling in her favor on the first three items that were challenged -- she clearly owes no negligence penalty on those -- the $2500 deduction of a personal legal expense that Ms. Repetto didn't defend, so I'll sustain the Commissioner if there's any understatement attributable to that $2500 deduction. There was no defense, and I'll apply the 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 6641(A nogligenco penalty to that. However, for the $50,000 deduction, even though I'm not allowing it in 2010, it was definitely not crazy for her to take it in that year. I believe she was operating in entire good faith. It wasn't a legal bill, of course, but she credibly testified that she asked the IRS for its advice; she had never encountered anything like this before in her personal taxes, and oil and gas tax law 1 2 3 4 5 6 7 8 9 10 is famously difficult, even for specialists in the 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 field to understand. The reasonableness of her position namely that she took $50,000 and she lost it all, leading to a loss -- is what would seem to a layperson an entirely justifiable reason for taking it as a loss. The timing issue is one that actually took several hours of clerk and judge time last night to try to figure out, but this seems, on the evidence that I have in front of me, to have been abandoned only in 2011. So I conclude that Ms. Repetto correctly concluded that her $50,000 was a deductible loss, but I have to conclude that it was reported in the wrong year, in light of these rather complicated set of 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 14 precedents and regulations governing abandonment losses in oil and gas. But her efforts to figure it all out before she put it in her 2010 return showed that she was reasonable and she was definitely proceeding in good faith. So this is a mixed decision, and final decision will have to await computations under Rule 155. This concludes the Court's oral findings of fact and opinion in this case. (Whereupon, at 10:24 a.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