TAX COURT OPINION

Case: John Patrick Cronin
Docket Number: 16979-11S
Judge: Holmes
Opinion Type: bench
Filed: 06/18/2013
Pages: 9

UNITED STATES TAX COURT WASHINGTON, DC 20217 SEC JOHN PATRICK CRONIN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent ) ) ) ) ) ) ) ) ) O R D E R Docket No. 16979-11S. 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 transcript of Holmes at St. Paul, Minnesota, containing his oral fact and opinion rendered at was heard. the trial in the above case before Judge Mark V. findings of the trial session at which the case the pages of the 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 18, 2013 SERVED Jun 20 2013 Capital Reporting Company 3 1 2 3 4 5 6 7 8 9 10 11 12 13 Bench Opinion by Judge Mark V. Holmes May 8, 2013 John Patrick Cronin v. Commissioner Docket No. 16979-11S THE COURT: THE COURT HAS DECIDED IN THE CASE OF JOHN PATRICK CRONIN V. COMMISSIONER, DOCKET NUMBER 16979-11S TO RENDER A BENCH OPINION, AND THE FOLLOWING IS THE COURT'S BENCH OPINION. This Bench Opinion is made pursuant to the authority granted in section 7459(b) of the Internal Revenue Code of 1986, as amended, and Rule 152 of the Tax Court Rules of Practice and Procedure. The taxpayer involved, Dr. Cronin, was a 14 Minnesota resident when he filed his petition, and 15 16 17 18 19 20 21 22 23 this case concerns his '07 to '09 tax years. A little bit of background would help. Dr. Cronin is a recognized, licensed psychologist and a small business owner. He has a thriving practice that produces incredibly complicated tax returns and has invested in a couple of partnerships and other business opportunities that render his tax returns even more complicated. In addition to investing, he also spends 24 money on some nice vehicles and a boat, but as he 25 also invests a lot of money in his business, and it 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 2 3 4 5 6 7 8 9 is the interlocking nature of these business investments and personal expenses that has created this case. He files exceptionally complicated returns, and he has turned to a CPA to prepare them for each of the years at issue. However, despite the complicated returns, which go to dozens of pages, each of the three years at issue, there were only three substantive items at issue. 10 For the 2007 year, there was a home 11 mortgage interest disallowance of $18,635; a home 12 mortgage interest disallowance for 2008 of $35,508; 13 14 15 16 17 18 19 20 21 22 23 24 25 and a business interest deduction that the Commissioner disallowed of $35,.823 for 2009. On a couple of these substantive matters, the answer is perfectly clear. Let me take the home mortgage interest first. Clearly in 2007 and 2008, these deductions were overstated. Home mortgage interest payees generate forms to the IRS, and the amounts on those forms by the IRS were, of course, allowed. The extra interest just doesn't make sense as a home mortgage interest deduction, and Dr. Cronin had no real explanation for any of that. However, the amounts are kind of 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 5 1 2 3 4 5 6 7 8 interesting, because in 2007, the disallowed portion, about $18,000, ties reasonably well to the outstanding working capital loan that Dr. Cronin had on his Sub-Chapter Corporation, which, during that year, was approximately $210,000 at an interest rate of 8 and 3/4%, and since it was partially amortizing, it ties in pretty well with the interest that he was paying through his business to a small state bank in 9 Vermillion, Minnesota. 10 11 Similarly, the overstated home mortgage interest amount of about $35,000 ties reasonably well 12 with the increased loan business on that Sub-Chapter 13 14 15 16 17 18 19 S Corporation and the somewhat reduced interest rate of about 8 and a half percent he was paying in 2008. So it looks like some of the interest from the business was leaking into the home, it was leaking onto the home mortgage; nevertheless, it's disallowed because it wasn't home mortgage interest. And this raises a more interesting question of 20 whether it should be allowed as a business interest 21 22 23 24 25 deduction, a question raised squarely in the 2009 tax year with the disallowance of a $35,823 item for business interest in 2009. Again, that disallowed business interest corresponds reasonably closely to the approximately $350,000 of the loan balance that 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 6 1 2 3 was outstanding, more or less, on average throughout 2009, albeit with a sharply-reduced interest rate. Most of these deductions stem from Dr. 4 Cronin's belief that if a loan has to be paid by a 5 6 7 8 9 10 11 12 13 14 15 corporation, whether because the corporation has borrowed the money or because the corporation would be on the hook for the money when it guarantees loan, is just wrong as a matter of law. It's somewhat understandable because, after all, the corporation is paying the interest, but the law -- or is on the hook to pay the interest because it's in a guaranteeg( position . The law here is very clear. A representative case is Enoch v. Commissioner from my own Court. That is 57 T.C. 781., dated 1972, in 16 which we held that payments have to proximately 17 18 19 20 21 22 23 24 25 result from the business and not personal obligation of the business's owner. A corporation cannot pay another's obligation and then claim the expense as a business deduction. Such payments aren't expenses of the corporation, and the Court has to look to the origin of the liability out of which the expense accrues. Here, the IRS has done that, and in Exhibit 6-J, it identified four pieces of property which were 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 7 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 bought, at least in part, with borrowed money that don't qualify as business expenses of Dr. Cronin's corporation. The first were what we called two bare lots -- I assume that's undeveloped real estate -- located in·Franklin County, Florida. Dr. Cronin said these were owned by him in his own name, although again, the corporation was, either directly or as a guarantor, on the hook for paying those. They were, in fact, held by his own name as an investment. Similarly, there were another six undeveloped lots located in Franklin County, Florida. These, too, were titled in Dr. Cronin's name rather than his corporation. And of course, they had nothing to do with the practice of psychology, anyway. There was the 1999 Mercedes-Benz that was 18 partially financed. That, again, was titled to the 19 20 21 22 23 24 25 good doctor, and he admitted as much. Whether or not the corporation paid for that, it's not corporate property. However, and to complicate things, the government also had listed part of this loan as going to a 2007 Lincoln Navigator. And here, the doctor said, "Oh, wait, that's in the corporation's name," 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 8 1 2 3 4 and indeed, if one looks at Exhibit 8-J at page 6, the corporation did, in fact, list it as a business vehicle on its 2007 tax return and said that it was used entirely in the corporation's own business. 5 Given that he had a personal vehicle, this is not 6 7 8 9 10 11 12 13 14 unreasonable, and it was unchallenged by the Commissioner. So I'll allow interest that pertains to this 2007 Navigator. The question, of course, becomes how to allocate this, and what I will do is look at Exhibit 12, page 31, which is a note from approximately the time, in 2007, when the Navigator was purchased by the corporation, and it shows that the corporation was paying about 8 and 3/4% for its 15 money and capital in the middle of 2007. 16 17 Turning, again, back to Exhibit 8 at page 6, one sees that the basis for depreciation of that 18 Navigator -- I'm assuming there was trade-in here 19 20 21 22 23 24 25 since the doctor didn't say, one which or the other, why this $60,000-vehicle should have an initial basis of $34,679. I'll draw the inference against him, but I'll give him 8 and 3/4% on a vehicle with a basis of $34,679, beginning on April 1st of 2007, and with that small allowance, sustain the government's finding on all the substantive items in this case. 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 16 17 18 19 That's a rough approximation, I realize, but this is an S case, and the good doctor has to have some inferences drawn against him on account of he did have the burden of proof, here. That leaves the penalty issue. Of course, Code section 6662(a) provides for an addition to tax equal to 20% when a deficiency is due either to negligence or a substantial understatement of income tax. Negligence, for purposes of this section has been defined as the lack of due care or failure to do what a reasonable or ordinarily prudent person would do under the circumstances, see, Neely v. Commissioner, 85 T.C. 934, 947 (1985). A substantial understatement is defined by the Code 6662(d) as an understatement exceeding the greater of 10% of the correct liability or $5,000. The government has clearly met its burden of proof, a burden of proof of coming forward on these penalties, and so Dr. Cronin had to come up 20 with something to defend himself, and I think he did, 21 22 23 24 25 here. These returns are, as I said, exceptionally complicated and lengthy and involved. They involve lots and lots of numbers, and Dr. Cronin clearly was reasonable in relying on a professional CPA to 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 10 prepare them for each of the years at issue; truly, to a tax professional who can't understand why these numbers ended up on home mortgage interest and why the business interest wasn't subject to the tracing rule by the accountant. But I have to find that I found Dr. Cronin credible in his statements that he turned everything over to the CPA. He gave the CPA authorization to talk to the bank to try to sort things out. I don't see that he limited his CPA's investigation into anything or that he held anything back from the CPA, and I certainly find no reason to think that somebody who uses a CPA isn't competent to prepare even these reasonably complicated professional's tax return. So, no sustaining the penalty. A tiny relief from the otherwise disallowed deductions for interest beginning in 2007 for that vehicle that I do find was owned and used by Dr. Cronin's corporation. And this concludes the Court's Finding of Facts and Opinion in this case. Decision will have to be entered under Rule 155. Thank you very much. (Whereupon, at 3:40 p.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