TAX COURT OPINION

Case: Marlene D. Morten
Docket Number: 2451-13
Judge: Gustafson
Opinion Type: bench
Filed: 05/18/2016
Pages: 21

58 cuS UNITED STATES TAX COURT WASHINGTON, DC 20217 MARLENE D. MORTEN, Petitioner, v. ) ) ) ) Docket No. 2451-13. COMMISSIONER OF INTERNAL REVENUE, Respondent ) ) ) ORDER Pursuant to the opinion of the Court as set forth in the transcript of the proceeding at Washington, D.C., on May 12, 2016, 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 in the above case before the undersigned judge at Washington, D.C., 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 under Rule 155. (Signed) David Gustafson Judge Dated: Washington, D.C. May 18, 2016 SERVED May 18 2016 Capital Reporting Company 3 1 2 Bench Opinion by Judge David Gustafson May 12, 2016 3 Marlene D. Moreten v. Commissioner 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Docket No. 2451-13 The Court has decided to render the following as its oral Findings of Fact and Opinion in this case. This Bench Opinion is made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code, and Tax Court Rule 152; and it shall not be relied on as precedent in any other case. By a notice of deficiency ("NOD") dated November 7, 2012 (Ex..36-R), the Internal Revenue Service ("IRS") determined deficiencies in the 2003 and 2005 Federal income tax liabilities of petitioner Marlene D. Morten, plus additions to tax. The issues for decision are (1) whether for 2003 the IRS's NOD was untimely (we hold that it was and that we therefore lack jurisdiction over 2003), and (2) whether for 2005 Ms. Morten received unreported income (we hold that she did), is entitled to deductions (we hold that she is, to a limited extent), and is liable for additions to tax (we hold that in large part she is). The case was tried in Washington, D.C., on May 6, 2016. Ms. Morten represented herself, and respondent was represented by William J. Gregg. 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company FINDINGS OF FACT 4 Applying the burden of proof principles set out in the opinion below, we find the following facts: Background Ms. Morten is an attorney. (Stip. 2.) In 1977 her father founded Unfoldment, Inc., a non-profit organization ruled by the IRS to be exempt from tax under section 501(c)(3). (See Ex. 40-P.) Its purposes include rehabilitating criminals and helping at-risk youth. In its heyday it received million- dollar grants from the Federal and D.C. Governments to run programs. When the troubled D.C. foster care system was under Federal receivership and had a new receiver appointed in 1998, Unfoldment's contract was terminated, and it fell on hard times. Ms. Morten represented Unfoldment in litigation challenging that contract termination, and Unfoldment eventually received a settlement of its claims under the contract. One aspect of its claim is still in litigation. Ms. Morten's business activities and bank accounts Ms. Morten had six bank accounts for as many 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 activities and entities. (See Ex. 27-P; Ex. 36-R, 24 25 pp. 11-12.) In the two years at issue Ms. Morten was Executive Director of Unfoldment and also served as 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 5 an attorney for Unfoldment, Inc., which had a bank account (with an account number ending -9141). She established "Unfoldment, LLC", of which she (and not Unfoldment, Inc.) was the owner and sole member (Ex. 42-R), and opened for it two bank accounts (-2768, and -9645). She intended to handle through the LLC and its accounts some of the finances of Unfoldment, Inc., for its benefit, but she accomplished this intention imperfectly. Ms. Morten was also the proprietor of a trucking business (in which her ex-husband was also involved), which she operated through "Integrity Trucking, LLC". By 2005 she was winding up the trucking business. She also owned and operated real estate through "Integrity Real Estate Holding Company, LLC" (Ex. 43-R), which had a separate account (-6155). Ms. Morten also had two personal checking accounts (-8560, and -8803). Her ex-husband was also named on the accounts, but she did not show at trial that he interfered with her complete control over all of these accounts. We find that she had complete dominion and control of all the accounts and used them at her discretion for her personal spending. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Receipt of income 25 Because we lack jurisdiction over 2003 (for the 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 reasons explained below), we hereafter largely confine the discussion to income and expenses in 2005. In 2005 Ms. Morten deposited into the six bank accounts identified above a net amount of $560,890 (after subtracting transfers and re-deposits). The deposits were made with no consistent rules or patterns that we can discern: She deposited rent from Friendship Charter School (totaling $35,000) into Unfoldment Inc.'s account (-9141) and into one of the Unfoldment LLC accounts (-9645). She deposited cash from unidentifiable sources into the Integrity Real Estate Account (-6155), the personal accounts (-8560 and -8803), and one of the Unfoldment LLC accounts (-2768). (Some of those cash deposits into -2768 were quite large in amount--$7,800 in 17 March; $4,800, $4,500, and $14,994 in April; and 18 19 20 21 $14,657 in May--and Ms. Morten had no explanation for them.) She deposited rent from her farm property into her personal account (-8560) and into the Integrity Real Estate account (-6155). She deposited 22 disability insurance benefit checks payable to her 23 24 25 husband into the Integrity Real Estate Holding account (-6155). The most confusing feature of her finances was 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company her use of cashier's checks to deposit, re-deposit, and transfer amounts between accounts. She testified 7 that one purpose of this procedure was to leave a clear paper trail for the use of the money, but it had the opposite effect. She had Unfoldment LLC procure a $110,000 check payable to herself and deposited it into her personal account (-8560; Ex. 44-R, p. 31). The same day she used those funds to purchase a cashier's check for $105,000 payable to herself (evidently pocketing the $5,000 difference) and deposited it several days later it into the same account (id. at 40). Soon thereafter she used those funds to purchase a cashier's check for $100,000 payable to herself (again evidently pocketing the $5,000 difference) and deposited it several days later it into the same account (id. at 41). We cannot tell why. Ms. Morten undertook a significant instance of this procedure when the D.C. Government issued a $275,000 check payable to Unfoldment LLC in settlement of its litigation claims. Ms. Morten deposited the check into one of the LLC's accounts (-2768; see Ex. 44-R); then wrote a check from that account for $250,000.(Ex. 44-R, p. 71); used it to purchase a cashier's check for $250,000 (id. at 69); 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 Capital Reporting Company 8 used that $250,000 cashier's check to purchase another cashier's check for $225,000; and deposited the leftover amount of $25,000 back into the same account (id. at 68)--and then the $225,000 cashier's check did not reappear, as far as our record shows. She testified that one purpose of this arrangement was to enable her, during her extended stays in Zimbabwe to help her ailing father, to have access to funds in a form that foreign banks would honor; and for all we know the $225,000 ended up in a foreign bank. When these puzzling transactions are netted out against each other, the end result is that a net of $560,890 came into the accounts that Ms. Morten controlled. Expenditures for Unfoldment Ms. Morten did show that certain of the expenditures she made from this pool of funds were for the benefit of, and therefore constituted contributions to, Unfoldment, Inc. (deductible on Schedule A): "Business Registration Fees" ($554); "Corporate Filing"($155); Newcomb repair ($4,003.86); "Professional fees" ($2,666.18, plus $1,000 on 3/16/2005 from Ex. 26-P, p. 110); and "Business postage" ($1,428). 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 Capital Reporting Company 9 1 2 3 4 5 Expenditures for Schedule C business Ms. Morten did show that certain of the expenditures she made from this pool of funds were ordinary and necessary expenses of her Schedule C business activities: "Business Administrative 6 Services" ($399); "Business Home Office Maintenance" 7 8 9 10 11 12 13 14 15 16 17 18 ($866); "Business Legal Research" ($126); "Business Postage/Mailing Service" ("1,428); and "Office supplies" ($988.95). In addition, Ms. Morten showed that she had a home office used exclusively for her business, consisting of an office and a storage room for files. Because her testimony about the portion of the house used for business (supposedly 25%) was vague and poorly demonstrated, we resolve doubt against her and conclude that 10% of the house was used for the home office. Therefore, 10% of the following household expenses were home office expenses: "Business Home 19 Office [real estate] Taxes" ($9,034); "Electricity" 20 21 22 23 24 25 ($1,094); "Household Maintenance" ($6,618); homeowners insurance ($1,591); and "Water" ($465). (The remaining 90% of the real estate taxes are deductible on Schedule A.) Tax returns Ms. Morten self-prepared a 2003 tax return, 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 10 using tax preparation software for the year 2000 and changing by hand the year designations on the form. She signed it on October 2, 2004; but rather than signing the correct signature block under the invocation of the penalties of perjury, she inappropriately signed the line for "Preparer's signature". (Ex. 1-P.) She mailed the defective return to the IRS (Stip. 5) in October 2003, but the IRS has no record of having received and processed the return (Ex. 46-R). The parties have stipulated that Ms. Morten filed an income return for 2004. (Stip. 39.) The return is not in our record, but the IRS's computation of section 6654 addition to tax for 2005 shows that her tax liability for 2004 was zero. (Ex. 36-R, p. 20, line 6.) Ms. Morten did not submit a Federal income tax return for 2005. She has made no payments toward her 2005 income tax liability. (Ex. 47-R.) IRS action The IRS determined to examine Ms. Morten's tax liability for a series of years including 2003 through 2006. The agent asked her representative for, among other things, a copy of her 2003 return. (Stip. 6; Ex. 17-P.) She provided a copy to her 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 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 representative, who noted that she had signed on the wrong line, and evidently observed that she had used the 2000 software to prepare the return and as a result had understated the exemption amount (which was greater in 2003) and corrected it by hand. (Ex. 28-P.) Ms. Morten signed a copy of the return on the correct line. On October 17, 2008, the representative gave the IRS agent the 2003 return (Stip. 10), signed on the correct line. Thereafter the agent stopped requesting the 2003 return (Stip. ll; Ex. 18-P at 62, line 2); and for the next 3-1/2 years the IRS took no action as to Ms. Morten's 2003 income tax liability (Stip. 22) until it commenced an audit in April 2012 that covered 2003 and subsequent years (Stip. 26). On November 5, 2012, the IRS prepared a "substitute for return" ("SFR") pursuant to section 6020(b) (Ex. 49-R), showing its calculation of her 2005 income tax liability, as well as her liability for additions to tax for failure to file her return, failure to pay her tax, and failure to pay estimated tax. On November 7, 2012, the IRS issued to Ms. 23 Morten an NOD for 2003 and 2005. 24 25 Tax Court proceedings On January 28, 2013, Ms. Morten timely filed a 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 12 1 2 3 4 petition in this Court. At that time she resided in Zimbabwe. (Stip. 1.) The case was continued three times for Ms. Morten's benefit. By our order of September 30, 2015, we granted the IRS's motion for 5 partial summary judgment on the issue of whether the 6 7 8 9 10 11 12 13 NOD had been properly mailed to Ms. Morten's last- known address. By order of January 8, 2016, we set this case for trial. I. Tax year 2003 OPINION We have found that Ms. Morten submitted her 2003 return on October 17, 2008, when a re-signed a copy of the Form 1040 that had first been submitted in 14 October 2004 was given to the IRS agent at his 15 16 17 18 19 20 21 22 23 24 25 request. "Filing" is to be prescribed by regulations, sec. 6901(a), and the regulations provide that a return that is hand-carried (as was Ms. Morten's 2003 Form 1040) "shall be filed with any person assigned the responsibility to receive hand- carried returns in the local Internal Revenue Service office". 26 C.F.R. sec. 1.6091-2(d) (1). The Internal Revenue Manual makes it clear that the responsibility of examination agents includes "secur[ing]" delinquent returns. I.R.M. pts. 4.12.1.6(1), 4.12.1.9(1). Thus, when the agent 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 13 secured Ms. Morten's return by having it delivered to him by hand, the return was filed. The NOD was issued four years later, in November 2012. However, the general rule of section 6501(a) is that "the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed". Section 6503(a) (1) does provide an exception--i.e., that "the running of the period of limitations provided in section 6501 * * * shall (after the mailing of a notice [of deficiency] under section 6212(a)) be suspended for the [90-day] period during which the Secretary is prohibited from making the assessment * * * (and in any event, if a proceeding in respect of the deficiency is placed on the docket of the Tax Court, until the decision of the Tax Court becomes final), and for 60 days thereafter." That is, the issuance of the NOD suspends the 3-year limitations period of section 6501, but only (as section 6503(a) (1) states) "after the mailing of a notice". If the period has already expired before the issuance of the notice, then the notice does not revive the closed statute. Though the IRS disputed Ms. Morten's contention that she filed a return, it does not dispute the operation of the limitations period as described above. 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 t c é Capital Reporting Company 14 1 2 3 4 5 6 7 8 9 10 11 We hold that the NOD was untimely as to 2003, that the statute of limitations would bar assessment for 2003, that the NOD was therefore invalid as to 2003, and that we lack jurisdiction for that year. II. Tax year 2005 A. General evidentiary principles The IRS's determination in the NOD is presumed correct, and the taxpayer generally bears the burden to prove any adjustment to the income the IRS determined and to prove her entitlement to any deductions she claims. Rule 142(a); Welch v. 12 Helvering, 290 U.S. 111, 115 (1933). The taxpayer 13 14 15 bears the responsibility to maintain books and records that are sufficient to establish her income. See sec. 6001; 26 C.F.R. sec. 1.446-1(a)(4). 16 Additional evidentiary principles applicable to 17 18 19 20 21 22 23 24 25 income and certain categories of expenses are discussed below. B. Income When a taxpayer fails to keep adequate books and records, the Commissioner is authorized by section 446 to determine the existence and amount of the taxpayer's income by any method that clearly reflects income. See Holland v. United States, 348 U.S. 121, 130-132 (1954). A bank deposit is prima facie 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 15 1 evidence of income, and a bank deposits analysis is a 2 method of income reconstruction that this Court has 3 4 5 6 7 8 long accepted. Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). Ms. Morten in effect urges another method--i.e., that income be attributed to her only when her bank records show an affirmative personal expenditure on her behalf. Her theory seems to be that the money 9 all belonged to Unfoldment when received and 10 11 12 13 14 deposited in whatever account and became compensation to Ms. Morten when Unfoldment (acting through her) determined to make an expenditure for the benefit of Ms. Morten. Her theory is at odds with the actual rule. But even if it were theoretically possible, it 15 would be unworkable in this case, where she deems 16 17 18 19 20 21 22 23 24 25 unexplained cash expenditures not to be income to herself, and where a $225,000 cashier's check disappeared (into Zimbabwe?) but is supposedly not income unless and until the IRS can show an expenditure. We reject this method and look instead to the bank deposit analysis. The IRS's bank deposit analysis (Ex. 27-P) gives a total of $565,053 for net deposits received in. 2005. This total appears to be slightly excessive because it fails to exclude a 6/10/2005 check of 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 16 1 2 3 4 5 6 7 $4,163 that merely transferred funds from -9645 to -8560. Ms. Morten gives a different amount of supposed total deposits--$477,565.73 (i.e., her total of $479,860.22, minus an opening balance of $2,294.49; Ex. 26-P)--but our review revealed several errors: Her tally omits a 10/25/2005 check for $24,476, apparently because its deposit was delayed 8 until 2006 (Ex. 44-R at 6). Of an 11/25/2005 check 9 for $6,753, her tally counts only the net deposit of 10 11 12 13 14 15 16 17 18 19 $1,800, overlooking the cash received (id. at 18). And her tally simply excludes the 6/17/2005 deposit of the $110,000 cashier's check to Ms. Morten with the stated remitter of "Unfoldment LLC", perhaps assuming--but without showing--that this was a transfer or redeposit of funds from -9645 or -2768. In view of these manifest errors in her presentation, and in view of her failure to give a persuasive critique of the IRS's analysis, we have found that a net of $560,890 came into the accounts that Ms. 20 Morten controlled. 21 22 23 24 25 Ms. Morten's inconsistent use of these accounts, and her intermingling of the moneys in these accounts, show that the separate accounts did not constitute truly distinct funds that she treated separately. Rather, they were all used by her at her 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 17 1 will, and they constitute a single pool of income 2 3 4 that she received. This characterization is consistent with the fact that, when she set out to categorize her expenditures (in Ex. 26-P), she did so 5 without any regard to or indication of the particular 6 7 8 9 account from which an expenditure was made; rather, her own eventual accounting treats the accounts as a single undifferentiated source. We hold that the net of $560,890 that came into the accounts that Ms. 10 Morten controlled was income to her in 2005. The 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 IRS's NOD treats this as Schedule C income, and we do not alter that treatment. C. Deductions To carry her burden of proof, a taxpayer must satisfy the specific requirements for any deduction she claims, see INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). 1. Heightened substantiation requirements For certain deductions, Congress has imposed heightened substantiation requirements. Deductions related to travel expenses, meal expenses, and passenger vehicle expenses are subject to strict substantiation requirements under section 274(d) and section 280F(d)(4). See 26 C.F.R. sec. 1.274-5T(a), -5T(b)(6); Sanford v. Commissioner, 50 T.C. 823, 827 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 18 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 (1968), aff'd per curiam, 412 F.2d 201 (2d Cir. 1969). When section 274(d) applies, a taxpayer must substantiate by adequate records or sufficient evidence corroborating the taxpayer's own statement: (1) the amount of the expense; (2) the time and place the expense was incurred; (3) the business purpose of the expense; and (4) the business relationship of the taxpayer to other persons benefited by the expense or use, if any. Sec. 274(d)(4) (flush language); see also Shea v. Commissioner, 112 T.C. 183, 187 (1999). 2. Business expense deductions Pursuant to section 162(a), a taxpayer may deduct "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business". In contrast, except where specifically enumerated in the Code, no deductions are allowed for personal, living, or family expenses. Sec. 262(a). We have found that Ms. Morten did substantiate certain expenditures as ordinary and necessary business expenses of her Schedule C activity. We hold that those are deductible as such. However, Ms. 23 Morten failed to substantiate the non-personal, 24 25 deductible, business character of the other categories of expenditures she claimed. For example, 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 19 1 2 3 4 5 6 7 8 "Auto" and "Business Meals" would be subject to the heightened standards of section 274, and she attempted no showing of the elements required. Her testimony indicated that "Business Legal Costs" was largely a personal expense for her ex-husband. As for "Phone", pursuant to section 262(b), any charge for the first telephone line to a residence of the taxpayer is treated as a personal expense, and Ms. 9 Morten was unable to show what lines and services the 10 11 12 13 14 15 phone charges were for. 3. Charitable contributions Section 170 allows a deduction for contributions to a charitable organization. We have found that certain of Ms. Morten's expenditures were on behalf of Unfoldment, and we hold that those are deductible. 16 Others are not: 17 18 19 20 21 22 23 24 25 "Meals", "Newcomb - Food for Workers", "Travel and Meetings", and automobile expenses are subject to the special requirements of section 274, with which Ms. Morten did not comply. (Moreover, vehicle expenses incurred on behalf of a charity are deductible only to the extent of "14 cents per mile", sec. 170(i), and she did not show mileage.) Her unexplained "Cash" expenditures and "Miscellaneous" are not substantiated. As we explained above, 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company "Telephone" expenses are personal to the extent of the first line, and the nature of her phone expenses 20 was unexplained. D. Additions to tax 1. Initial showing of liability Section 6651(a)(1) imposes an addition to tax for failure to file a timely return. We have found that petitioner filed no tax return for 2005. The addition is therefore warranted. Section 6651(a)(2) imposes an addition to tax for failure "to pay the amount shown as tax on any return". Her 2005 liability was "shown on a return"--i.e., the SFR prepared by the IRS. See sec. 6651(g)(2). She has made no payments toward her 2005 income tax liability, and she is therefore liable for the (a)(2) addition, albeit in an amount different from what the IRS determined in the NOD. Respondent has shown, as an initial matter, that the determinations of additions to tax under section 6651(a)(1) and (a)(2) are warranted. We hold otherwise as to the section 6654 addition to tax for failure to make estimated tax payments. This addition to tax applies only if the taxpayer had a liability in the preceding year, sec. 6654(e)(2) (B). Thus, respondent's burden of 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 Capital Reporting Company 21 1 2 3 4 production under section 7491(c) requires him to produce evidence that the taxpayer had a liability in the preceding year. See Wheeler v. Commissioner, 127 T.C. 200, 210-12 (2006), aff'd, 521 F.3d 1289 (10th 5 Cir. 2008). Respondent did not make that showing, 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 and we therefore hold that for 2005 Ms. Morten is not liable for the addition to tax under section 6654 for failure to pay estimated tax. 2. Reasonable cause and willful neglect Ms. Morten contends that she should not be held liable for any additions to tax because she had reasonable cause for her failure to file and pay. Section 6651(a)(1) and (a)(2) both include an exception--"unless it is shown that such failure is due to reasonable cause and not due to willful neglect". Ms. Morten did not show "reasonable cause" nor disprove "willful neglect". She stated very generally that her father's failing health and the resulting necessity for her to travel to Zimbabwe interfered with her fulfillment of her tax obligations. However, her financial records show that in that general time period she was handling other business for herself and Unfoldment--i.e., that she decided to handle other business but not taxes. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 22 She failed to show an absence of willful neglect. So that the petitioners' tax liability can be recomputed, decision will be entered under Rule 155. This concludes the Court's oral Findings of Fact and Opinion in this case. (Whereupon, at 11:25 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