TAX COURT OPINION

Case: Erin A. Canning
Docket Number: 2659-15S
Judge: Buch
Opinion Type: bench
Filed: 03/24/2016
Pages: 14

SYM UNITED STATES TAX COURT WASHINGTON, DC 20217 ERIN A. CANNING, Petitioner, v. ) ) ) ) Docket No. 2659-15S. 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 with this order to petitioner and respondent a copy of the pages of the transcript of the trial in this case before Judge Ronald L. Buch at San Diego, California, 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 for respondent. (Signed) Ronald L. Buch Judge Dated: Washington, D.C. March 24, 2016 SERVED Mar 25 2016 Capital Reporting Company 3 1 Bench Opinion by Judge Ronald Buch 2 March 9, 2016 3 Erin A. Canning v. Commissioner 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 Docket No. 2659-15S THE COURT: THE FOLLOWING REPRESENTS THE COURT'S ORAL FINDINGS OF FACT AND OPINION. These oral findings of fact and opinion may not be relied upon as precedent in any other case. This opinion is in conformity with Internal Revenue Code Section 7459(b) and Rule 152(a) of the Tax Court Rules of Practice and Procedure. Any section references refer to the Internal Revenue Code or the Treasury regulations in effect during the year at issue, and Rule references are to the Tax Court Rules of Practice and Procedure. This case was heard pursuant to Section 7463. Under Section 7463(b), the decision to be entered in this case is not reviewable by any other court and this opinion may not be treated as precedent for any other case. BACKGROUND The facts in this case are both clear and contradictory. Ms. Canning claims to have gotten into the 25 business of flipping houses in 2011. The facts show 866.488.DEPO twww.CapitalReportingCompany.com Capital Reporting Company 4 1 2 3 4 5 6 that her boyfriend, Jim Studley, may have gotten into the business of flipping houses in 2012. So what happened in 2011? Ms. Canning paid for Mr. Studley to attend the Armando Montelongo Seminar. She made an initial payment of $1000 in 2010 and paid an additional $4500 in early 2011 for 7 Mr. Studley and a partner to attend the seminar. Ms. 8 9 10 11 12 13 14 15 16 17 19 20 21 22 23 24 25 Canning was the partner. There is some ambiguity as to the usage of the word "partner" in this context, but the facts indicate that Ms. Canning was not a partner in the business sense. And while some exhibits list both Mr. Studley and Ms. Canning as the participants, Exhibit 7, in Ms. Canning's handwriting, only lists Mr. Studley as the participant in the seminar. In 2011, Ms. Canning and Mr. Studley explored the business of flipping houses, looking at properties, making some offers, but never having an offer accepted. Having invested time pwr energy into exploring and flipping houses as a business, but having had no success, Ms. Canning paid an additional $25,000 for "Armando's Master Mentor Program." In exchange for that payment made in October 2011, Ms. Canning and Mr. Studley (jointly identified on a letter from Miranda Hart, the Director of Coaching 866.488.DEPO twww.CapitalReportingCompany.com Capital Reporting Company 5 1 2 3 4 5 and Mentoring for Armando's Success Team) received three days of on-site training, eight telephone coaching sessions, and one year of telephone support. The anticipated business model was to purchase homes in need of repairs and updating. Mr. 6 Studley brought to the relationship some familiarity 7 with construction. And it is clear that Ms. Canning 8 9 10 11 12 13 14 15 16 18 19 20 21 23 24 25 brought an interest in the subject matter. Ms. Canning also brought access to cash, but it cannot be said that she was an investor. To fund the anticipated business Ms. Canning rolled over her pension into an IRA. She then withdrew some funds in 2011. It is unclear from this record what happened to those funds, but the distribution amount is equal to the amount paid for the Master Mentor Program. What activities occurred in 2011 is somewhat questionable. Ms. Canning claims to have explored real estate opportunities in San Antonio, where (not coincidentally) her son moved in 2011. She claimed expenses for traveling to San Antonio as business expenses, but the evidence does not support that she was conducting business in San Antonio. She introduced into evidence property listings for an April trip to San Antonio, but none 866.488.DEPO twww.CapitalReportingCompany.com Capital Reporting Company 6 1 2 3 4 5 6 7 of those properties were listed until after April. When confronted with this fact she suggested that the properties must have been from a September trip, but at least one of those properties was not listed until after her September 2011 trip to San Antonio. In 2012 Ms. Canning caused her self- directed IRA to loan money to Mr. Studley. 8 Specifically, in March 2012, Ms. Canning's IRA loaned 9 $52,000 to Mr. Studley. Also in 2012 Studley 10 11 12 13 14 15 16 17 18 19 20 21 22 Investment Enterprises, LLC was formed for purposes of conducting the real estate flipping business. Ms. Canning was not an investor in the LLC. Instead, Mr. Studley and Ms. Canning's father were the investors. According to Ms. Canning, her father was an owner only because her self-directed IRA would not have been able to loan money to the LLC if she, Ms. Canning, was part owner. The loan. was at an interest rate of 0.00%. According to Ms. Canning she and Mr. Studley eventually purchased and resold some ho.mes at a profit. Those transactions, again, according to Ms. Canning, were reported by Studley Enterprises. If that income was reported, it was reported in a 24 manner that resulted in Ms. Canning claiming expenses 25 for a business in which she did not own an interest 866.488.DEPO twww.CapitalReportingCompany.com Capital Reporting Company i I 1 2 3 4 5 6 7 8 10 11 12 and from which she did not report income. Ms. Canning's testimony that she was in the real estate flipping business is simply not credible. Examples include: - Claiming two Coronas and two Bloody Marys from February 10, 2011, before he.r first seminar, as business expenses. - Claiming the Coronas and Bloody Marys twice, once using the receipt without the tip included and once with the tip included (both receipts carry the same transaction number and table number, and the one with the tip included is time 13 stamped three minutes after the one without the tip). 14 15 16 17 18 20 21 22 23 24 25 - Claiming trips to visit her son as a business e xpense. - Claiming use of a storage facility as a business expense, when she was renting the same two storage units both before and after supposedly entering into the real estate flipping business. 2010. rate. - - - Claiming expenses from receipts dated in Loaning money from her IRA at a 0% interest Structuring an LLC so that she is not an owner to avoid a prohibited transaction with her IRA, 866.488.DEPO twww.capita1ReportingCompany.com Capital Reporting Company 8 1 2 3 4 5 6 7 8 but then claiming to be a partner in the business. - Claiming expenses for a business, but not claiming any revenue from that business once it generated revenue. Ms. Canning may have hoped to profit from flipping houses, either directly or through her relationship with Mr. Studley. The manner in which she conducted her activities calls into question 9 whether she was ever involved in a bona fide 10 11 12 13 14 15 16 17 18 business. But for the year at issue it is clear that she was not. On October 27, 2014, the Commissioner issued Ms. .Canning a Notice of Deficiency for 2011 that determined she was not entitled to the Schedule C business expenses and Schedule A itemized deductions she reported. The notice stated a tax deficiency of $10,379 and a Section 6662(a) accuracy- related penalty of $2,075. While residing in 19 California, Ms. Canning timely filed a petition to 20 21 22 23 24 25 challenge the Commissioner's determinations. After concessions the only issues for the Court to decide are whether Ms. Canning is entitled to the Schedule C expenses and whether accuracy related penalties apply. DISCUSSION 866.488.DEPO twww.CapitalReportingCompany.com Capital Reporting Company 9 1 2 3 4 5 6 7 8 9 10 11 12 13 As a general matter, the Commissioner's determinations in the notice of deficiency are presumed correct and the taxpayer bears the burden of proving an error. Rule 142(a), Welch v. Helvering, 290 U.S. 111, 115 (1933). In limited situations the burden can shift to the Commissioner under Section 749 1(a), but the record does not establish that the criteria under Section 7491 have been met, therefore, the burden of proof remains on Ms. Canning Income tax deductions are a matter of legislative grace, and taxpayers bear the burden of proving that they are entitled to any claimed deductions. Rule 142(a), INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Taxpayers are 15 required to maintain sufficient records to "show 16 whether or not such person is liable to tax". 17 18 19 20 22 23 24 25 Section 6001. I. No Bona Fide Business for 2011 Taxpayers must be involved in a trade or business in order to deduct business expenses, Section 162. The Supreme Court stated that in order "[t]o determine whether the activities of the taxpayer are 'carrying on a business' requires an examination of the facts in each case." Hig.gins v. Commissioner, 312 U.S. 212, 217 (1941). The Court 866.488.DEPO twww.CapitalReportingCompany.com Capital Reporting Company 10 further explained that "the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer's primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement diversion does not qualify." Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). Indeed, we have previously held that the scope of the taxpayer's activities must be "considerable, continuous and regular" for the Court to conclude that the taxpayer was engaged in a trade or business. Lewenhaupt v. Commissioner, 20 T.C. 151 (1953), aff'd 221 F.2d 227 (9th Cir. 1955). Generally, the Code only allows taxpayers to deduct expenses associated with activities that they engage in for profit, Section 183(a). Taxpayers bear the burden of establishing that their endeavor was entered into or conducted with the intention of making a profit. Benz v. Commissioner, 63 T.C. 375, 382 (1974). Ms. Canning claims to have been in the business of flipping houses in 2011, but her actions do not support this assertion. At best, Ms. Canning explored a possible future business of flipping houses, attended the Armando Montelongo Seminar, and 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 20 21 22 23 24 25 866.488.DEPO twww.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 Capital Reporting Company paid a hefty price for an additional mentoring program. She also claims to have traveled to San Antonio in April and September of 2011 to explore real estate opportunities there, but her testimony 11 1 regarding the business purpose of these trips was not credible. Ms. Canning's activities in the potential business of flipping houses in 2011 were not considerable, continuous and regular, and she did not prove she engaged in the activity for profit. Therefore, she was not engaged in a bona fide business in 2011, and she may not deduct any of the Schedule C business expenses she reported for this reason alone. II. Taxpayers Cannot Deduct Expenses for a Business Section 162(a) provides that taxpayers can deduct ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. The regulations under that section make it clear that deductible expenses under section 162 must be "directly connected with or pertaining to the taxpayer's trade or business", Section 1.162-1(a), Income Tax .Regs. (emphasis added). Even assuming that there was a bona fide business endeavor in 2011, Ms. Canning cannot deduct 866.488.DEPO twww.CapitalReportingCompany.com Capital Reporting Company 12 1 2 3 4 5 6 the business expenses associated with this activity because it was not her business. Her expenses supported a business that Mr. Studley was entering int.o. In 2011 this is evidenced by the documents showing that Mr:. Studley was the student. This is further confirmed by the fact that Studley 7 Enterprises was formed in 2012 for the purposes of 8 9 10 11 conducting the real estate flipping business. Ms. Canning was not an owner of the LLC. Ms. Canning claimed that the endeavor eventually made a profit and thos.e transactions were reported by Studley 12 Enterprises. She cannot report expenses and benefit 13 from the business loss those generate without 14 matching those expenses to the business income she 15 16 claims was generated. It would give her a "have your cake and eat it too" benefit and frustrate the purpose of Section 162. III. Many of the Expenses She Reported Aren't Deductible Even If She Had a Bona Fide Business 20 Venture 21 22 23 24 25 A large portion of the expenses Ms. Canning reported were for things that would not be deductible even if she had started a bona fide house flipping business. Ms. Canning deducted the cost of the seminar 866.488.DEPO twww.CapitalReportingCompany.com Capital Reporting Company 13 1 2 3 4 and mentoring program. These were educational expenses. Educational expenses can be deducted if the education maintains or improves skills required by the taxpayer in his trade or business. 5 Section 1.1 62-5(a), Income Tax Regs. The expense 6 7 8 9 10 11 12 13 14 15 16 is deductible only if the taxpayer is established in the trade or business at the time he pays or incurs the expense. Jungreis v. Commissioner, 55 T.C. 581, 588 (1970). Ms. Canning was employed as teacher at the time she incurred these real estate training expenses, and those expenses were for a completely different trade or business. Ms. Canning deducted her travel costs for trips to san Antonio, her rent for storage units and other ques.tionable expenses. She has the burden to show these expenses were ordinary and necessary business expenses and not personal. She 18 has not done so. Ms. Canning's trips to San 19 Antonio were predominately personal in nature and 20 21 22 24 25 not coincidentally occurred with her son moving to the area. Likewise, the evidence indicates and the Court finds that her rental expenses for her storage units were personal, given that she was renting the same units both before and after she cl.aims she entered the house flipping business. 866.488.DEPO twww.Capita1ReportingCompany.com Capital Reporting Company 14 1 2 3 4 5 6 7 IV. Section 6662(a) Accuracy-Related Penalty Section 6662 imposes a 20 percent accuracy- related penalty on any portion of an underpayment of tax required to be shown on a return if the underpayment is due tó, among other reasons, negligence, disregard of rules or regulations, or any substantial understatement of income tax. The 8 Commissioner bears the burden of production as to 9 the penalties, Section 7491(c). The penalties will 10 not apply to any portion of the underpayment for 11 which a taxpayer establishes that he or she had 12 13 14 15 reasonable cause and acted in good faith, Section 6664(c)(1). As defined in the Code, negligence includes any failure to make a reasonable attempt to comply 16 with the provisions of this title, and the term 17 18 19 20 21 disregard includes any careless, reckless, or intentional disregard, Section 6662(c). Negligence has been further defined as a "lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances." 22 Neely v. Commissioner, 85 T.C. 934, 947 (1985). Additionally, a taxpayer is negligent if he fails to maintain sufficient records to substantiate the 25 items in question. Higbee v. Commissioner, 116 T.C. 866.488.DEPO twww.CapitalReportingCompany.com Capital Reporting Company 438, 449 (2001), Section 1.6662-3(b) (1), Income Tax 15 Regs. Ms. Canning reported expenses for an activity 1 2 3 4 - that was not a bona fide business and an activity in 5 which she did not own an interest. And, quite 6 7 8 9 10 11 12 13 14 15 16 frankly, she was trying to game the system by deducting personal expenses as business expenses. Her testimony attempting to justify these expenses was not credible. Accordingly, Ms. Canning's underpayment of tax was due to negligence and she is liable for the section 6662(a) accuracy-related penalty. Whether the threshold for a substantial understatement is met is a computational matter, and if it is met that penalty would apply. As for defenses to penalties, Ms. Canning presented no evidence of a reasönable basis for her position to overcome negligence, and she certainly does not have 18 substantial authority to overcome a substantial understatement. And she présented no evidénce of a 20 reasonable cause and good faith defense under section 6664. 22 23 24 25 Decision will be entered .for Respondent. (Whereupon, at 9:12 a.m. the above- entitled matter was concluded.) 866.488.DEPO twww.CapitalReportingCompany.com