TAX COURT OPINION

Case: Michael B. McCullough
Docket Number: 10636-19
Judge: Kerrigan
Opinion Type: bench
Filed: 06/09/2021
Pages: 11

Docket No.: 10636-19 Page 1 of 1 United States Tax Court Washington, DC 20217 Michael B. McCullough Petitioner v. Commissioner of Internal Revenue Respondent Docket No. 10636-19 ORDER Pursuant to Rule 152(b), Tax Court Rules of Practice of 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 in the above case before Judge Kathleen Kerrigan held remotely at Charleston, West Virginia, containing here 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 shall be entered under Rule 155. (Signed) Kathleen Kerrigan Judge Served 06/09/21 IN THE UNITED STATES TAX COURT 1 1 2 3 In the Matter of: 4 MICHAEL B. MCCULLOUGH, 5 6 v. Petitioner, 7 COMMISSIONER OF INTERNAL REVENUE, Respondent. Docket No. 10636-19 ) ) ) ) ) ) ) ) ) ) ) ) 8 9 10 11 12 13 14 United States Bankruptcy Court Robert C. Byrd Federal Courthouse 300 Virginia Street, East Charleston, WV 25301 (Remote Proceeding) April 21, 2021 The above-entitled matter came on for bench opinion, 15 pursuant to notice at 1:15 p.m. BEFORE: HONORABLE KATHLEEN KERRIGAN Judge APPEARANCES: For the Petitioner: No Appearance For the Respondent: No Appearance 16 17 18 19 20 21 22 23 24 25 P R O C E E D I N G S 2 (1:15 p.m.) THE CLERK: Recalling from the calendar docket number 10636-19, Michael B. McCullough. (Whereupon, a bench opinion was rendered.) 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 Bench Opinion by Judge Kathleen Kerrigan April 21, 2021 Michael B. McCullough v. Commissioner Docket No. 10636-19 3 THE COURT: The Court has decided to render in this case the following as its oral findings of fact and opinion, which shall not be relied upon as precedent in any other case. This Bench Opinion is made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code and Rule 152 of the Tax Court Rules of Practice and Procedure. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar amount. By notice of deficiency dated March 19, 2018, the Internal Revenue Service (IRS or respondent) determined deficiencies of $22,541 and $22,772 and penalties pursuant to section 6662 of $4,508 and $4,554, respectively, for 2016 and 2017. The issues for consideration are whether petitioner is entitled to deduct business expenses of $81,245 and $5,900 for tax years 2016 and 2017, respectively, has cost of goods sold of $68,242 for 2017, and is liable for section 6662 penalties for 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 2016 and 2017. Partial trial of this case was conducted February 9, 2021, during the remote Los Angeles, California trial session. Trial of this case was 4 completed on April 19, 2021, during the remote Charleston, West Virginia trial session. Petitioner represented himself during the first proceeding and was represented by Jennifer R. Schinke during the subsequent trial and Albert B. Brewster represented respondent. Exhibits were admitted into evidence. We find the following facts: FINDINGS OF FACT Petitioner resided in California when he timely filed his petition. For about 40 years petitioner worked as an interior designer. During 2016 and 2017 he had his own interior design business. In 2016 he worked exclusively for one client and in 2017 he worked for the same client and an additional client. Both clients were former clients of petitioner. During 2016 and 2017 petitioner worked 35 to 50 hours a week for his interior design business. He was hired to decorate and furnish multiple rooms. He had no additional 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 businesses. 23 24 25 On his 2016 Form 1040, U.S. Individual Income Tax Return, petitioner listed his occupation as interior design. On his Schedule C-EZ, Net Profit From Business, 1 2 3 4 5 6 7 8 9 10 11 12 13 14 petitioner reported gross receipts of $78,568, total 5 expenses of $81,245, and a net loss of $2,677. The transcript for petitioner's Federal income tax return for 2017 shows gross receipts of $70,294, total expenses of $5,900, and a net profit of $8,285. Respondent disallowed expenses for the years in issue. On September 26, 2018, respondent mailed a 30- day letter to petitioner which was signed by the examining officer's immediate supervisor. OPINION Generally, the Commissioner's determinations in a notice of deficiency are presumed correct, and a taxpayer bears the burden of proving those determinations are incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 15 111, 115 (1933). 16 17 18 Petitioner has neither claimed nor shown that he meets the specifications of section 7491(a) to shift the burden of proof to respondent as to any relevant factual 19 issue. 20 21 22 23 24 25 "Cost of goods sold" is an offset subtracted from gross receipts in determining gross income, sec. 1.61-3(a), 6(a), Income Tax Regs., and is not a "deduction", see Metra Chem Corp. v. Commissioner, 88 T.C. 654, 661 (1987). Any amount claimed as cost of goods sold must be substantiated, and taxpayers are required to 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 maintain records sufficient for this purpose. Sec. 6001; 6 Nunn v. Commissioner, T.C. Memo. 2002-250, slip op. at 16; sec. 1.6001-1(a), Income Tax Regs. Section 162(a) allows a taxpayer to deduct all ordinary and necessary expenses paid or incurred in carrying on a trade or business. An ordinary expense is one that commonly or frequently occurs in the taxpayer's business, Deputy v. du Pont, 308 U.S. 488, 495 (1940), and a necessary expense is one that is appropriate and helpful in carrying on the taxpayer's business, Welch v. Helvering, 290 U.S. at 113; sec. 1.162-1(a), Income Tax Regs. A taxpayer may not deduct a personal, living, or family expense unless the Code expressly provides otherwise. Sec. 262(a). Deductions are a matter of legislative grace, and a taxpayer must prove his or her entitlement to a deduction. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). To that end, taxpayers are required to substantiate each claimed deduction by maintaining records sufficient to establish the amount of the deduction and to enable the Commissioner to determine the correct tax liability. Sec. 6001; see also Higbee v. Commissioner, 116 T.C. 438, 440 (2001). To be engaged in a trade or business within the 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 meaning of section 162(a), an individual taxpayer must be 7 involved in the activity with continuity, regularity, and the primary purpose of deriving a profit. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). Whether the taxpayer is carrying on a trade or business requires an examination of all of the facts in each case. Id. at 36. The pertinent regulations set forth a nonexhaustive list of factors that may be considered in deciding whether a profit objective exists. These factors include: (1) The manner in which the taxpayer carries on the activity, (2) the expertise of the taxpayer or his advisers, (3) the time and effort expended by the taxpayer in carrying on the activity, (4) the expectation that assets used in the activity may appreciate in value, (5) the success of the taxpayer in carrying on other similar or dissimilar activities, (6) the taxpayer's history of income or losses with respect to the activity, (7) the amount of occasional profits, if any, which are earned, (8) the financial status of the taxpayer, and (9) the elements of personal pleasure or recreation. Sec. 1.183- 2(b), Income Tax Regs; Golanty v. Commissioner, 72 T.C. 411, 426 (1979), aff'd. without published opinion 647 F.2d 170 (9th Cir. 1981). No single factor or group of factors is determinative. Golanty v. Commissioner, 72 T.C. at 426. A review of the factors results in a conclusion 1 2 3 4 5 6 7 8 9 that petitioner was engaged in a business for purposes of 8 section 162. Petitioner had four decades of experience in interior design. His business stemmed from his past experiences and prior relationships. He worked at his interior design business full time. Even though he testified that he did not have a written business plan, he had one in his mind which he executed. His plan was to do projects for prior clients and obtain new work based on client recommendations. From his past experiences, he 10 knew that he could have enough business without 11 advertising. 12 13 14 15 16 17 18 19 Normally, the Court may estimate the amount of a deductible expense if a taxpayer establishes that an expense is deductible but is unable to substantiate the precise amount. See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). This principle is often referred to as the Cohan rule. See, e.g., Estate of Reinke v. Commissioner, 46 F.3d 760, 764 (8th Cir. 1995), aff'g T.C. 20 Memo. 1993-197. 21 22 23 24 25 Petitioner produced receipts for items purchased on behalf of his clients and invoices that he sent to his clients. These documents substantiate that the purchases were made on behalf of his clients. Petitioner testified credibly that he never purchased any items for himself and 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 reported his expenses on his Schedules C. Petitioner is 9 allowed to deduct expenses of $78,325 for 2016 and costs of goods sold of $64,876 for 2017. Even though the purchases of items for clients are reported differently for 2016 and 2017 on petitioner's tax returns, the result is the same. Petitioner did not produce evidence in support of the $5,900 of expenses reported for 2017. Therefore, respondent's disallowance of these expenses is sustained. Section 6662(a) Penalty Respondent bears the burden of production with respect to the penalty imposed by section 6662(a). Sec. 7491(c). This burden of production includes producing evidence that respondent has complied with the procedural requirements of section 6751(b). Frost v. Commissioner, 154 T.C. 23, 34 (2020). Once respondent meets this burden, the taxpayer must come forward with contrary evidence. Id. Because we mostly decide for petitioner, we conclude that petitioner is not liable for the section 6662(a) penalty for 2016 and 2017. A decision will be entered under Rule 155. This concludes the Court's oral Findings of Fact and Opinion in 23 this case. (Whereupon, at 1:30 p.m., the above-entitled matter was concluded.) 24 25 CERTIFICATE OF TRANSCRIBER AND PROOFREADER 10 CASE NAME: Michael B. McCullough v. Commissioner DOCKET NO.: 10636-19 We, the undersigned, do hereby certify that the foregoing pages, numbers 1 through 10 inclusive, are the true, accurate and complete transcript prepared from the verbal recording made by electronic recording by Adrian Morris on April 21, 2021 before the United States Tax Court at its remote session in Charleston, WV, in accordance with the applicable provisions of the current verbatim reporting contract of the Court and have verified the accuracy of the transcript by comparing the typewritten transcript against the verbal recording. _______________________________________________ Meribeth Ashley, CET-507 Transcriber 5/4/21 Date _______________________________________________ Lori Rahtes, CDLT-108 Proofreader 5/4/21 Date 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