TAX COURT OPINION

Case: Eric M. Kerensky
Docket Number: 1557-14
Judge: Holmes
Opinion Type: bench
Filed: 11/13/2015
Pages: 17

UNITED STATES TAX COURT WASHINGTON, DC 20217 ERIC M. KERENSKY, Petitioner, ) ) ) v. ) Docket No. 1557-14. 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 Los Angeles, California on October 30, 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. November 13, 2015 SERVED NOV 202015 Capital Reporting Company 1 Bench Opinion by Judge Mark V. Holmes 2 October 30, 2015 3 Eric M. Kerensky 4 5 6 7 8 9 10 11 12 13 14 15 1 6 17 18 19 20 21 22 23 24 25 Docket No. 1557-14 v. Commissioner THE COURT: In the case of Eric M. Kerensky v. Commissioner, Docket Number 1557-14, The Court has decided to render oral findings of fact and opinion. And the following is he 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 from 1986 as amendod and Rule 152 of the Tax Court's Rules of Practice and Procedure . Mr. Kerensky was a resident of California when he filed his petition, as he remains today. He i s employed as an insurance salesman d in the tax . year in question was also undergoing a terrible divorce. The parties, however, were able to stipulate to the settlement of two issues. Five remain as does the assertion of an accuracy-related penalty under 6662 for all the issues. The set_tled issues were the amount of alimony paid that Mr. Kerensky is entitled to exclude from his income. This was a cartial concession on 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 4 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 both sides. The second was a concession by Mr. Kerensky that he should have included his state tax refund of $2,447 for which he received a Form 1099 from the Government of California. This leaves as unsettled $38,976 in itemized deductions that had been disallowed by the Commissioner at audit. Mr. Kerensky conceded during trial, however, that the legal fees for his divorce were personal and he's not entitled to a deduction for those. He had been so informed by the Service and the Service, of course, is right about this. It has been true for a very long time that the cost of a divorce is a personal and nondeductible expense. As we said in Hicks Co v. Commissioner, 56 T.C. 982, 1023 (1971), "The law is clear on the point that legal fees incident to a divorce of husband and 17 wife are not deductible, but are personal in nature." 18 19 20 The regulations under Section 262 are likewise. clear. 26 CFR Section 1.262-1(b)(7) also states "Generally, attornev's fees and other costs paid in connection 21 with a divorce, separation, or decree for support are 22 23 24 25 not deductible by either the husband or the wife." So Mr. Kerensky was quite right to concede on this issue. The next issues, I'll group them together, 866.488.DEPO www.CapitaIReportingCompany.com Capital Reporting Company 5 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 are his travel expenses and meals and entertainment expenses. These expenses, of course, are governed by the enhanced substantiation requirements of Section 274, a section of the Code that requires cupétL As{-e?Ioci recordkeeping and evidence before allowing a deduction. The requirements of Section 274 simply were not met with regard to these. His deductions were at least within the realm of possibility. His travel expenses were not made up out of thin air but were for a convention that was related to his trade or business. He did have meals and entertainment. Remember, he was an insurance salesman, and so he did take his customers out to lunch and dinner occasionally. Nevertheless, he was supposed to seek reimbursement from these by his employer. And though employees are entitled to deduct normal business expenses subject to the 2 percent floor for 20 miscellaneous deductions, see Code Section 162 and 21 22 23 24 25 Code Section 67, .when an employee has a right to reimbursement for expenditures related to this employment but fails to claim such reimbursement, the expenses are nondeductible because they are not necessary. That is, it's not necessary for an 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 6 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 employee to remain unreimbursed for expenses to the extent he could have been reimbursed. Putman v. Commissioner, T.C. Memo 1998-285 2d, Orvis v. Commissioner 788 F2d 1406, 1408 (Ninth Circuit 1986), affirming T.C. Memo 1984-533. As Mr. Kerensky admitted in Exhibit 11, "I never once turned in an expense check for meals which it says I'm entitled in the contract. That being said, I have no way of backing up other than telling you I didn't. Shame on me for not doing so." That's entirely honest, but it does mean that I have to disallow his travel and meals and entertainment expenses, and he kind of recognized that during trial. The last category that's somewhat easy to deal with is an unspecified category of additional business expenses. I have no clue what those were about, and they weren't defended during the trial. But that leaves one very key category, his car expenses of $19,156, for the tax year. Car expenses, like meals and entertainment and travel expenses, are governed by Section 274 of the Code. Section 274(d) says that, "No deduction or credit shall be allowed with respect to any listed property as defined in Section 280F(d)(4)." Someone turns to 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 7 1 2 3 4 5 6 7 8 9 10 11 12 13 14 that other section in the Code and finds there included under Section 280F(d)(4) the term listed property means (i) any passenger automobile. So this means that Mr. Kerensky's use of his car in his business is governed by these special substantiation requirements Section 274. The regulations become even more convoluted and specific in governing what somebody who uses his car in his business has to do. Those regulations 26 CFR Section 1.274-5T(c)(i) require that a taxpayer "substantiate each element of an expenditure or use by adequate records or by sufficient evidence corroborating his own statement." Section 274(d) contemplates that a taxpayer 15 will maintain and produce such substantiation as well 16 17 18 19 20 21 22 23 24 25 as constitute proof of each expenditure or use referred to in Section 274. Written evidence has considerably more probative value than oral evidence alone. In addition, the probative value of written evidence is greater the closer in time it relates to the expenditure or use. A contemporaneous log is not required, but a record of the elements of an expenditure or of a business use of listed property made at or near the time of the expenditure or use supported by sufficient documentary evidence has a 866.488.DEPO www.CapitalReportingCompany.com 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 I Capital Reporting Company 8 high degree of credibility not present with respect to a statement prepared subsequent thereto when generally there is a lack of adequate recall. The regulation goes on to describe in 26 CFR Section 1.274-5TC(2)(i) that, in general, to meet the adequate records requirements of Section 274(d), a taxpayer shall maintain an account book, diary, log, statement of expense, trip sheets, or similar record and documentary evidence sufficient to establish each element of an expenditure or use specified in Paragraph (b) of this section. A couple entries later 26 CFR Section 1.274-5TC(2)(ii) (A) says, for example, "A log contained on a weekly basis, which accounts for use during the week, shall be considered a record made at or near the time of use." The next sub, sub, sub, Subsection 26 CFR Section 1.274-5TC(2)(ii) (B) explains that, "Where the business purpose is evidence from the surrounding facts and circumstances there is an explanation of such business purpose will not be required. For example, in the case of a salesman calling on customers on an established sales route, a written explanation of the business purpose of such travel ordinarily will not be required. 866.488.DEPO www.CapitaIReportingCompany.com Capital Reporting Company 9 1 2 3 4 5 6 7 8 9 10 11 12 13 While all this is preliminary to Mr. Kerensky's production of his travel diary, which was a calendar where he noted which potential sales customers or existing customers he was trying to sell additional or different products to he was visiting each week, this was organized by time and he recorded there the name of the business that he was visiting. And cross-examination didn't shake him from his characterization of these as customers, and they certainly appear to be customers when I asked him questions, as well. The mileage was entirely reasonable for each week and consistent with his testimony that he 14 wasn't taking ddcommuting expenses, but was 15 measuring the time from his home office to these 16 17 18 19 20 21 22 23 24 25 various customers that he would visit a few times each week around the Southern California area. So I found him entirely credible on that account. The one problem that I have here is that when one adds up all· the miles in his diary, which again I found to be a credible and contemporaneous substantiation under Section 274 of his travel expenses, one comes up with only 22,729 miles instead of the 35,964 miles. So some math is going to be required here to revise Line 13 on that Form 2106. I 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 10 1 will leave that to the parties and the IRS computers 2 3 4 5 6 7 8 9 10 11 12 13 to do. There is a serious question here that the Government raised about whether these expenses were, like the meals and entertainment, travel and other business expenses, reimbursable and thus not deductible. Again, as I had said before under the Putnam case and many other cases, if an employee could have sought reimbursement but chose not to do so, he doesn't get the deduction because it's not a necessary business expense. But in the case of Mr. Kerensky's automobile expenses, the situation is a little bit 14 more complicated here. When he began his job at the firm he was within tax year 2011, he received not fed reimbursement of expenses, but rather an allowance. See Exhibit 10-J at page 2. "You will receive an automobile allowance of $500.per month to cover all charges, costs, and expenses relating to your automobile, including expenses related to gas, insurance, maintenance, et cetera." In 2011, as the business was having some 15 16 17 18 19 20 21 22 23 difficulties, his employment agreement was changed 24 25 retroactive to the beginning of 2011; in other words, it was congruent with his entire tax year. He no 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 longer got that allowance. Now, his company said that they would "reimburse you for business-related expenses as noted in Frankel's Handbook." When Mr. Kerensky testified, and I believe him entirely, that he was not getting reimbursed for his vehicle expenses, that this was a cutback in the firm that had been giving him $500 a month for his car expenses but now he would have to absorb them himself. He refers in his own communication with the IRS that he never put in for meals, expenses, travel, and the other sort of things for which he would customarily have had receipts that he could then fill out and send in. But he was no longer getting his allowance, which is a little bit different. So I am going to allow him, albeit in the reduced amount of MICS 22,729 his car expenses for the 2011 tax year. So my conclusion is in substantial, but not total agreement with him on this issue I find that his travel diary was credible. But do note that there was a change in the mileage allowance on that Line 13 so that, again, there will be math involved. That leaves only the penalty under Section 6662 that was determined against Mr. Kerensky. Section 6662(a) provides for a penalty in the amount of 20 percent of the portion of the underpayment to 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 1 1 2 3 4 5 6 12 which the penalty applies as defined in Section 6662(b). Section 6662(b) provides in part that the penalty imposed by Section 6662(a) shall apply to the portion of any underpayment which is attributable to negligence or disregard to the rules and regulations. 7 Negligence is defined as lack of due care of failure 8 to do what a reasonable and ordinarily prudent person 9 would do under the circumstances, Neely v. 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Commissioner, 85 T.C. 934, 947 (1985). Section 6662(c) defines negligence to include any failure to make a reasonable attempt to comply with the provisions under the corresponding title of Code. The term disregard means any careless, reckless, or intentional disregard for the rules and regulations. Now, some of this penalty goes away with concessions by the Government or my findings in Mr. Kerensky's favor, but some isn't. In here Mr. Kerensky testified, and, again, I find him credible on this point, that given the disruption of his life in 2011 -- remember he was going through a terrible -- what appeared to be a terrible divorce -- he had had joint custody with his two very small children at the time and he was seeking professional 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 13 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 advice. So he sought out from a friend of his a CPA who prepared his tax returns for him that year. And I believe Mr. Kerensky when he said he just turned over all his records to him. Mr. Kerensky is not skilled in tax law or accounting. He is a salesman whc; a3 cn: coübË -- a salesman with a reasonably good education, but not skilled in tax law, not previously encountering any problems with the IRS. So his education, his training, and experience would have led him -- given the sudden complications in his family life, business life, and tax life -- to seek out a CPA. I found it perfectly reasonable that he said he did and, again, I found him credible that he did so. For this defense to penalties to work, there is a three-part test. First, was the adviser a competent professional who has sufficient expertise to justify reliance. This, again, is reliance from the perspective of Mr. Kerensky, not from the perspective a Tax Court judge or an IRS employee. He got some bum advice from this CPA, but it was a CPA and that is to most ordinary people some guarantee that someone is competent in the field. Second, did the taxpayer provide necessary and accurate information to the adviser? I find that 866.488.DEPO www.CapitaIReportingCompany.com Capital Reporting Company 14 1 2 3 4 5 6 7 8 9 he did based on Mr. Kerensky's own credible testimony. And, third, did the taxpayer actually rely in good faith on the adviser's judgement? I find this to be in general the case for Mr. Kerensky. I do want to go through each of the contested issues here because my findings are slightly different for each one. The reason for this is that under the 10 Regulation 26 CFR 1.6664-4(c)(1)(i), all facts and 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 circumstances must be taken into account in determining whether a taxpayer has reasonably relied on good faith on advice, including the opinion of a professional tax adviser, as to the treatment of the taxpayer under federal tax law. For example, the taxpayer's education, sophistication, and business expertise will be relevant in determining whether his reliance on tax advice was reasonable and made in good faith. In no event will a taxpayer be considered to have reasonably relied in good faith on advice, includïng an opinion, unless the requirements of this paragraph are satisfied. That fact that these requirements are satisfied, however, will not necessarily establish that the taxpayer reasonably relied on the advice, 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 15 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 including the opinion of a tax adviser, in good faith. I.have to consider all the facts and circumstances. I also take into account the provision in 26 CFR Section 1.6664-4(c)(2), which defines advice as any communication, including the opinion of a professional tax adviser, setting forth the analysis or conclusion of a person other than the taxpayer provided to or for the benefit of the taxpayer and on which the taxpayer relies directly or indirectly with respect to imposition in Section 6662 accuracy-related penalty advice does not have to be in any particular form. In this case, Mr. Kerensky was relying on his CPA to fill out the tax form correctly based on 16 all the information in the returns that Mr. Kerensky 17 18 19 20 21 22 23 24 25 gave him. Again, I find that to be reasonable, and I find the return, itself, to constitute advice under the circumstances of this case. So let me go down each of the items here. On alimony, it's clear to any tax professional that except in extraordinary circumstances, the cost of a lawyer or mediator to handle your divorce is a personal expense. But Mr. Kerensky's situation was complicated by the fact that he was paying third 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 16 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 parties that he had -- was the backup payer for when his wife failed to pay some third parties. A third party, in fact, was garnishing his wages. It's unclear in these situations exactly to what extent alimony is alimony rather than payment of a personal debt. There were complications in his payment schedule. There were even complications in the amount that he had to pay because under the settlement agreement he had with his ex-wife. Part of the increase in his commission schedule, which of course as a salesman is irregular, had to go to pay family support. And, of course, to a layman the family support might be allocated between alimony and child support, one excludable, one not. All this makes reliance on an accountant 16 all the more reasonable, and I find that Mr. Kerensky 17 18 19 20 21 22 23 24 25 did so reasonably n good faith. So that even though legal fees for his divorce and the amount of alimony that he paid are -- or child support that he paid are not deductible or excludable, the computation of those by his professional adviser was reasonable under these circumstances. However, there's something different with regard to his state tax refund. Mr. Kerensky said that he just gave an easy go over to his return. He 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 17 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 didn't look at it with any great degree of care. Now, that' s okay for more complicated items. But in the case of state tax refunds that are sent to a taxpayer and for which there's a little form that anybody can understand who has minimal competence, the regulations under 6662, specifically 26 CFR 1.6662-3(b) (i) say, "Negligence is strongly indicated where a taxpayer fails to include on an income tax return an amount of income shown on an information return." That's what happened here, so I will sustain the negligence penalty as it relates to his failure to include a state income tax refund. His accountant certainly should have caught that, but so should Mr. Kerensky if he had been reasonable in looking over his return after it had been prepared. As to his business expenses, including travel expenses, meals, and entertainment and his 19 mileage, again, I believe that Mr. Kerensky turned 20 all this over to his accountant who made the 21 22 23 24 25 decision. Some of which I'm sustaining, some of which I'm not, but all of which are, from Mr. Kerensky's perspective, reasonably relied upon including especially, of course, these vehicle expenses. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 18 This means the math will be somewhat complicated, and I'll have to enter a decision under Rule 155. This concludes The Court's oral findings of fact and opinion in this case. (Whereupon, at 11:50 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