TAX COURT OPINION

Case: Marc A. Jacobi & Monica R. Jacobi
Docket Number: 17490-17
Judge: Buch
Opinion Type: bench
Filed: 11/07/2019
Pages: 12

JRB UNITED STATES TAX COURT WASHINGTON, DC 20217 MARC A. JACOBI & MONICA R. JACOBI, Petitioners, v. ) ) ) ) Docket No. 17490-17. 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 Dallas, Texas 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) Ronald L. Buch Judge Dated: Washington, D.C. November 7, 2019 SERVED Nov 07 2019 3 1 2 3 4 5 6 7 8 9 10 11 12 13 Bench Opinion by Judge Ronald L. Buch October 17, 2019 Marc A. Jacobi & Monica R. Jacobi v. Commissioner Docket No. 17490-17 THE COURT: The following represents the Court's oral findings of fact and opinion. The 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 years at issue, and all Rule references are to the Tax Court Rules 14 of Practice and Procedure. 15 Background 16 17 18 This is a substantiation case involving items reported on an original joint return prepared by Marc Jacobi for himself and his wife, Monica. The Commissioner 19 made adjustments to the original return. In response, Mr. 20 Jacobi prepared an amended return claiming additional 21 deductions or losses that offset the Commissioner's 22 adjustments. The parties have agreed as to some issues, 23 and the only issues remaining for trial are a cost of 24 goods sold adjustment made by the Commissioner, the 25 disallowance of startup costs by the Commissioner, an accuracy-related penalty determined by the Commissioner 4 for the original return, and myriad adjustments claimed by Mr. Jacobi on the amended return. We will address the items reported on the original return before turning to the amended returns. Mr. Jacobi is a certified public accountant and has been since 1993. He started his own CPA firm in 2002. In 2013, the year in issue, he had approximately four employees and over $300,000 of revenue. In 1995, Mr. Jacobi won a lottery. He received annual payments of $475,500 from 1995 until 2014. Until 2013, he reported his lottery winnings as ordinary income. For 2013, on the basis of a conversation he had with a fellow, now deceased, CPA, he reported his lottery 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 winnings as capital gains. He looked for authority for 16 that return position but could not find any. He claimed 17 18 19 it anyhow. His return did not include a disclosure of his return position, such as on a Form 8275. Mr. Jacobi's CPA business is a sole 20 proprietorship reported on a Schedule C, Profit or Loss 21 from Business. On the Schedule C included with his 22 original return, Mr. Jacobi claimed $59,253 of cost of 23 goods sold. That amount included $40,000 Mr. Jacobi paid 24 in settlement of a dispute with another CPA firm. The 25 Commissioner disallowed the remaining $19,253. Mr. Jacobi's QuickBooks statement and accompanying records establish that he incurred the $19,253 of business expenses (although perhaps not best characterized as cost 5 of goods sold). Mr. Jacobi attempted to establish an olive orchard in 2013. During that year, he incurred various expenses, which he reported on a Schedule F, Profit or Loss From Farming. These expenses included car and truck expenses of $93 and depreciation of $12,739. The 1 2 3 4 5 6 7 8 9 10 Commissioner disallowed these amounts as startup costs. 11 12 13 14 In response to the Commissioner's various adjustments, Mr. Jacobi prepared an amended return. The adjustments shown on that amended return relate to: Mr. Jacobi's CPA practice reported on a Schedule C, a bed & 15 breakfast operation reported on a separate Schedule C, a 16 cattle business reported on Schedule F, and an olive 17 business reported on Schedule F. In addition, the amended 18 19 return showed computational changes to Schedule A, Itemized Deductions. The effect of these various 20 adjustments was to more than offset the adjustments made 21 by the Commissioner's notice of deficiency. We note that, 22 during trial, it was discovered that the Schedule A 23 included with the original return failed to add $3,800 of 24 charitable contributions into the total itemized 25 deductions. We now turn to the specific adjustments 6 1 2 3 4 5 6 7 8 9 reported on the amended return. The amended Schedule C for the CPA business made the following adjustments to what was reported on the original return: increased cost of goods sold by $8,098, increased depreciation by $34,466, increased legal fees by $44,725, increased travel, meals, and entertainment by $9,699, and increased bad debts by $7,862. Mr. Jacobi Provided no meaningful substantiation of these additional items, and his testimony tended to lack credibility. The 10 additional legal fees appear to be an effort to deduct the 11 same $40,000 that the Commissioner already allowed as part 12 of cost of goods sold. Mr. Jacobi conceded that he lacked 13 any evidence for the travel, meals, and entertainment. 14 15 The evidence of the additional bad debt deduction consisted of his review of his accounts receivable, which 16 he performed in 2016 when he prepared his amended return. 17 Testimony on those alleged bad debts lacked credibility. 18 He claimed that liabilities that were accrued mere weeks 19 before the 2014 year end were uncollectible as of 2014; he 20 21 22 23 continued to attempt to collect the same liabilities he claimed were uncollectible; and he actually collected liabilities that he claimed were uncollectible. The amended Schedule C for the bed and breakfast 24 business made the following adjustments to what was 25 reported on the original return: increased gross receipts .cnnss by $1,472, added costs of goods sold of $4,960, added 7 advertising of $13,372, increased depreciation by $47,237, increased insurance by $1,200, added office expense of $485, increased repairs and maintenance by $8,962, increased supplies by $38,638, increased taxes and licenses by $4,188, increased travel, meals, and entertainment by $3,619, and increased other expenses by $3,219, representing purported bank fees, dues, and memberships. Mr. Jacobi's testimony and records, such as 1 2 3 4 5 6 7 8 9 10 they were, failed to establish any of these items. 11 Although Mr. Jacobi provided some testimony concerning 12 13 14 15 supplies, the testimony was not based on personal knowledge and not backed up by any meaningful documentation. The amended Schedule F for the cattle business 16 made the following adjustments to what was reported on the 17 original return: increased sales of livestock by $4,605, 18 increased depreciation by $400, increased feed by $1,024, 19 increase veterinary costs by $278, and increased other 20 expenses by $4,924, representing tools, butcher costs, and 21 recharacterizing some of the sale of livestock as capital 22 gain. As with the other adjustments, substantiation was 23 lacking. 24 The amended Schedule F for the olive business, 25 made the following adjustments to what was reported on the c nes original return: eliminated car and truck expenses, increased depreciation by $22,029, and added amortization of $750. But that's not all; Mr. Jacobi prepared a Form 1065, U.S. Return of Partnership Income for "Monarc [sic] 8 Ranch Olive Productions" and reported on his personal Schedule E, Supplemental Income and Loss, a nonpassive loss of $110,894 flowing from that purported entity. That same Schedule E also reported a $93 loss from what is identified as UPE - that $93 amount matches the amount of car and truck expense eliminated from the amended Schedule F for the olive business. The record includes many receipts for the costs relating to the olive business. Those expenses all relate to the acquisition and 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 planting of seedlings and the establishment of an 16 irrigation system. In 2013, the olive business was not 17 Producing olives commercially and generated no income. It 18 produced "a handful" of olives from mature trees that were 19 Planted at the entrance to the ranch, which we find to 20 have been ornamental and not part of production. 21 Burden of Proof 22 As a general matter, the Commissioner's 23 determinations in the notice of deficiency are presumed 24 correct, and the taxpayer bears the burden of proving an 25 error. Rule 142(a); welch v. Helvering, 290 U.S. 111, 115 (1933). 9 Income tax deductions are considered a "matter of legislative grace," and the taxpayer bears the burden of Proving entitlement to any claimed deduction or credit. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). In limited situations, the burden can shift to respondent under section 7491(a), but the record does not establish that the criteria under section 7491 have been established, therefore, the burden of proof remains on the 1 2 3 4 5 6 7 8 9 10 taxpayer. 11 Substantiation 12 13 14 15 Taxpayers are required to maintain sufficient records to "show whether or not such person is liable to tax". Sec. 6001. These records must be retained for as long as the contents may become material and must be kept 16 available for inspection. 17 Certain expenses require strict substantiation 18 under section 274(d). Such expenses include those related 19 to travel, meals and entertainment, gifts, and listed 20 property under section 280F(d)(4). For the years at 21 issue, listed property included, among other things, 22 Passenger automobiles and other property used as a means 23 of transportation. Sec. 280F(d)(4). Under the strict 24 25 substantiation rules the taxpayer must have adequate records or sufficient evidence to corroborate (1) the n nes amount of the expense, (2) 10 the time and place the expense was incurred, (3) the business purpose of the expense, and (4) the business relationship of the taxpayer to any others benefitted by the expense. Sec. 274(d). To substantiate by adequate records, the taxpayer must 1 2 3 4 5 6 maintain an account book, a log, a diary, or a similar 7 8 9 10 11 12 13 14 15 16 17 record and documentary evidence to establish each element of an expense. Sec. 1.274-5T(c)(2)(I), Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985). While a contemporaneous log is not required, a taxpayer's subsequent reconstruction of his or her expenses requires corroborative evidence to support such a reconstruction. The corroborative evidence, coupled with the reconstruction, can elevate that subsequent reconstruction to the same level of credibility as a contemporaneous record. Sec. 1.274-5T(c)(1). In some instances the Court may approximate the 18 amount if the taxpayer can establish a deductible expense 19 but cannot substantiate the precise amount. Cohan v. 20 Commissioner, 39 F.2d 540, 543-544 (2d. Cir. 1930). 21 However, the taxpayer must provide some basis for that 22 estimate. vanicek v. Commissioner, 85 T.C. 731, 742-743 23 (1985). And, the Court is precluded from making estimates 24 of expenses that are subject to section 274(d) strict 25 substantiation rules. Deely v. Commissioner, 73 T.C. 11 1081, 1101 (1980); sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). Mr. Jacobi established that he is entitled to "cost of goods sold" for his CPA business of $59,253, as reported on his original return, $19,253 more than allowed by the Commissioner. He failed to establish that he is entitled to any greater amount. The Jacobis failed to establish that they are entitled to any adjustments to the bed and breakfast 1 2 3 4 5 6 7 8 9 10 business or the cattle business. 11 12 The Jacobis substantiated many expenses for their olive business, but those expenses are disallowed as 13 startup expenses. For an expense to be deductible, it 14 must in the furtherance of an active trade or business. 1 15 Sec. 162; see also, McKelvey v. Commissioner, T. C. Memo, 16 17 18 2002-63 (relating to planting of trees). Startup expenses are generally not allowed as a current deduction, but must be capitalized. Sec. 195. Moreover, the general rules of 19 capitalization of inventory costs found in section 263A 20 apply to farming business for plants that have a 21 preproductive period in excess of 2 years. Sec. 263A(a) 22 and (d)(1); see also, Wasco Real Properties LLC v. 23 Commissioner, T.C. Memo. 2016-224. Regardless of their 24 25 substantiation, the Jacobis are not entitled to deduct expenses for their olive business because, alternatively, (973)40&2250loperationsøesalbersnetlwwwmoibersnet it was not an active trade or business, 12 they were start up expenses that must be amortized, or they are inventory costs required to be capitalized. The Jacobis are entitled to a charitable contribution deduction of $3,800 that was inadvertently omitted from their original return. Lastly, we turn to the accuracy-related penalty. Mr. Jacobi is a CPA, and he prepared his own return. He provided no credible defense of reasonable basis or 1 2 3 4 5 6 7 8 9 10 substantial authority for any return positions disallowed 11 by the Commissioner. Although he claims to have had a 12 13 14 conversation with a now-deceased CPA on the theory of claiming capital gain treatment for lottery winnings, he concedes that did not find any authority supporting that 15 position after purporting to look for authority. Indeed, 16 even a cursory search (if one occurred) would have 17 revealed that "There is no question that the lottery 18 payments in the first instance were ordinary income." 19 Clopton v. Commissioner, T.C. Memo. 2004-95. If 20 computations reveal a deficiency, the Jacobis are subject 21 to an accuracy-related penalty. 22 In accordance with the oral findings of fact and 23 opinion, decision in this case will be entered under Rule 155. 24 25 (Whereupon, at 9:35 a.m., the above-entitled 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 matter was concluded.) 13 e o ne s