TAX COURT OPINION

Case: John A. Donovan & Laurie J. Bangart-Smith a.k.a. Laurie J. Donovan
Docket Number: 15325-15
Judge: Gustafson
Opinion Type: bench
Filed: 05/18/2016
Pages: 15

UNITED STATES TAX COURT WASHINGTON, DC 20217 DRC JOHN A. DONOVAN & LAURIE J. BANGART-SMITH A.K.A. LAURIE J. DONOVAN, ET AL., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent ) ) ) ) ) ) ) Docket No. 15325-15, ) ) ) ) 15327-15. ORDER Pursuant to the opinion of the Court as set forth in the transcript of the proceeding at Washington, D.C., on May 5, 2016, it is ORDERED that the Clerk of the Court shall transmit herewith to petitioners and to respondent a copy of the pages of the transcript of the trial in the above consolidated cases before the undersigned judge at Washington, D.C., containing his oral fmdings of fact and opinion rendered at the trial session at which these cases were 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 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 David Gustafson May 5, 2016 John A. Donovan and Laurie J. Bangart-Smith, a.k.a. Laurie J. Donovan, et al v. Commissioner Docket No. 15325-15, 15327-15 The Court has decided to render the following as its oral Findings of Fact and Opinion in these consolidated cases. 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 two notices of deficiency dated March 12, 2015 (Exs. 7-J and 13-J), the Internal Revenue Service ("IRS") determined deficiencies in the 2011 Federal income tax liability of Laurie Donovan and in the 2012 joint Federal income tax liability of Laurie and John Donovan, plus accuracy-related penalties. The parties have resolved several issues in the cases, and the remaining issues for decision are: (1) whether Laurie is entitled to deduct on Schedule C a transcript charge for 2011, a "Royal Express" fee in 2012, and, in both those years, alleged expenditures for rent, management fees, and consulting fees (we hold that she is not), and (2) 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 4 1 whether penalties are owing on the understatements of 2 3 4 5 income tax on the two returns (we hold that they are). The case was tried in Washington, D.C., on May 4, 2016. The Donovans were represented by Timothy J. 6 Murphy, and respondent was represented by Chelsey 7 8 9 10 11 12 13 14 15 16 17 Pearson. FINDINGS OF FACT Applying the burden of proof principles set out in part I of the opinion below, we find the following facts: Laurie Donovan has been a court reporter for 28 years in several geographic areas, in which her principal work is stenographically transcribing depositions and then "scoping" (i.e., rendering and editing) the stenographic transcript. After multiple unhappy marriages, she moved in late 2005 to the 18 Washington, D.C, area where she began to work. She 19 20 21 22 23 24 25 was able to make much greater revenue than she had before; but because she is poor at handling money and because she suffers from depression and anxiety, she accumulated substantial debt, became delinquent in her taxes, and had to declare bankruptcy. However, in her business she used Royal Express ("Royal") as her courier, and in that connection she 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 5 1 2 3 4 became friends with its manager and co-owner John Donovan. Increasingly over the following years, John helped Laurie in her business and with her personal life and finances. They dated in 2011 and were 5 married in 2012. John paid her bills, cooked for 6 7 8 9 10 11 12 13 14 15 her, did her banking, balanced her checkbook, picked up her laundry, and handled much of her personal and office business. As he explained, she was (and still is) a "high maintenance" person, and her depression and anxiety made it expedient for him to do these chores so that the energy she did have could be used for her business. Laurie had been a poor manager of her spending, and John took over the control of that aspect of her life, in order to keep her from building up credit card debt. Laurie credits John 16 with keeping her from another bankruptcy. 17 18 19 20 21 22 23 24 In both 2011 and 2012, Laurie lived in a home in Fort Washington, Maryland, from which she traveled to conduct depositions for various court reporting agencies who hired her to fulfill their contracts. (Ex. 20-R.) After taking a deposition, she returned home to scope the transcript. To other scopists whom she contracted, she gave her Fort Washington address as her office address. (Ex. 19-R.) Laurie had no 25 written contracts with anyone (i.e., neither 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 6 1 2 3 4 5 6 7 8 9 10 11 12 13 14 scopists, nor John, nor Royal, nor her father) for the performance of any services for her business. (Stip. 19-21.) Royal dispatched messengers (from among a group of as many as 400) to pick up and deliver packages for a clientele that included a number of court reporters. In both 2011 and 2012 Royal leased office space in Rockville. That space constituted the regular daily working space for John and a dispatcher and, less frequently, an office manager. Petitioners did not introduce any diagram of that rented space nor prove its size or configuration, and they put on no evidence as to the rent that Royal paid for the space. We do not find that Laurie used a portion of 15 Royal's leased space for her business. 16 17 18 19 20 21 22 23 24 John caused at least some of the revenue from Laurie's business to be deposited in Royal's bank account (on which he was a signatory). He also caused various payments to be made to Royal's bank account from Laurie's bank account (which she owned jointly with John). Some portion of these payments were first moved from Royal's account to Laurie's account and were then used to purchase cashier's checks payable to Royal. (See Ex. 21-R.) 25 Petitioners claim that these Laurie-to-Royal payments 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 7 1 2 3 4 5 6 7 8 9 10 11 12 totaled $151,957 in the two years and characterize these payments as "rent", "management fees", "transcript charge", and "Royal Express fee". Respondent contends that the substantiated transfers total only $132,207. We need not resolve the discrepancy, because we do not find that these payments constituted real economic transfers from Laurie to Royal, nor that they were bona fide payments for particular business-related services. (Petitioners argued--but did not make any showing-- that Royal included in its reported income all the amounts that Laurie claimed as deductible payments to 13 Royal. If that were true, then Royal's income might 14 15 16 have been overstated; but that fact would not render the payments deductible for Laurie.) Laurie's elderly father (now deceased) lived in 17 Montana in 2011 and 2012. Petitioners claim that 18 19 20 21 22 23 24 25 Laurie made payments to her father amounting to $12,000 in 2011 and $14,000 in 2012 (totaling $26,000), which she characterized as "consulting fees". Respondent contends that the substantiated payments amount to only $10,683 in 2011 and $12,250 in 2012, totaling only $22,933. We need not resolve the discrepancy, because we do not find that her father performed any substantial services for these 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 8 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 payments. In 2011 Laurie filed her own separate Federal income tax return, and in 2012 Laurie and John filed a joint Federal income tax return. (Stip. 8, 14; Exs. 6-J, 12-J.) Each return included a Schedule C for Laurie's "scoping services" business. For both the 2011 and 2012 returns, John assembled information and took it to an accounting firm that then prepared the returns. For both returns Laurie relied entirely on John to assemble the relevant information and to provide it to the accountant. The supervising accountant admitted at trial that the documents on which the firm relied for some of the entries were not original receipts, invoices, cancelled checks, or the like, but were instead 16 worksheets (some handwritten) that John brought and 17 18 19 20 21 22 23 24 25 that the firm did not verify. The Schedule C deductions reported for Laurie's business included claimed payments to Royal for "rent" ($15,600 in each year), "management fees" ($24,000 in 2011 and $49,000 in 2012), "transcript charge" ($7,757 in 2011), and "Royal Express fee" ($40,000 in 2012)--again, a two- year total of $151,957--which we find were not business expenses. The Schedule C deductions also included claimed "consulting fees" paid to Laurie's 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company '9 father ($12,000 in 2011 and $14,000 in 2012, totaling $26,000), which we find were not paid for business services. The deductions reported on Schedule C also included numerous other claimed expenses that petitioners now concede--including, in 2011, contract labor expense of $36,000, travel expense of $5,095, legal and professional services expense of $7,300, car and truck expense of $10,957, and cell phone expense of $2,418; and including, in 2012, car and truck expense of $21,674, travel expense of $4,001, storage expense of $2,692, cell phone expense of $2,739, and internet expense of $1,984. These now- conceded Schedule C deductions for the two years total $94,860. When the returns had been prepared, Laurie signed them at John's request and did not review them. The returns were both timely filed. The IRS examined the petitioners' 2011 and 2012 returns, disallowed the disputed deductions, and issued notices of deficiency determining the resulting tax and penalties. The Donovans timely filed the petitions in these two cases, and at that time they resided in Maryland. (Stip. 1.) OPINION 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 10 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 I. General evidentiary principles The IRS's determination in the notice of deficiency is presumed correct, and the taxpayer generally bears the burden to prove his entitlement to any deductions he claims, Rule 142(a); and a taxpayer must satisfy the specific requirements for any deduction he claims, see INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). "[T]ransactions between members of a family will be carefully scrutinized." Commissioner v. Culbertson, 337 U.S. 733, 746 (1949). II. 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). Petitioners failed to prove that the disputed deductions correspond to expenditures with actual business purposes. As for Laurie's supposed "rent" of space from 23 Royal, petitioners had no documentation to support 24 25 the supposed rental arrangement but relied only on testimony--and Laurie's testimony about her supposed 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 11 1 2 3 4 5 6 use of the space was perplexing: She testified that she drove 40 miles from her home in Fort Washington to the office in Rockville to wait for calls for her to work, yet her deposition jobs were evidently arranged most times in advance, so that a trip to the office usually would have been a digression. 7 Moreover, that testimony (that she went to the office 8 9 10 11 12 13 14 15 16 at the beginning of the day, and went home in the evening to do her scoping) contradicted the information (Ex. 20-R) that she gave to the IRS (when attempting to justify car expenses), which stated (on a cover sheet) that she used the "office" in the evenings and on weekends and which showed (on the log) that she departed from Fort Washington to go to jobs--unless, as may well be, the "office" she referred to on the log was in fact her Fort 17 Washington home, not the Royal office at all. 18 Petitioners failed to show what Royal paid for its 19 20 21 22 23 24 25 space, how much of the space Laurie supposedly used, and whether her supposed rent would have been a reasonable share of Royal's rent. As for the "transcript charge", petitioners presented no evidence whatsoever--documentary or testimonial--to explain why she would have paid Royal,. a delivery.company, for preparing transcripts. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 12 1 As for the "management fees", that term seems 2 arbitrarily applied to, at best, a mix of personal 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 and business-related services that John provided for Laurie, first as her boyfriend and then as her husband. Cooking for her, doing her laundry, paying her non-business related bills, and managing her personal finances were personal services the payment for which is not deductible. The only testimony about the "Royal Express fee" of $40,000 in 2012 was John's summary, almost terse reference to unspecified tasks that Royal staff other than himself supposedly performed. As for the "consulting fees", petitioners did prove that Laurie made payments to her father; but the only evidence they submitted to prove the supposed business character of those payments was Laurie's testimony that, from Montana, by email correspondence, her father spent a couple hours a week keeping track of the payment of her invoices by the agencies who hired her. Petitioners offered no explanation (and we cannot imagine one) for this surprising division of labor, in which John did her banking but someone else supposedly kept track of payments--someone to whom she would have to redundantly provide information (by scanning and 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 13 1 emailing it) that was already available to John, who 2 managed her finances. Petitioners presented no 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 corroboration of her testimony--no emails or other correspondence from her father, which surely would exist if her account were true. Her testimony did not carry her burden of proof. III. Penalty Section 6662 1mposes an "accuracy-related penalty" of 20 percent of the portion of the underpayment of tax that is attributable to the taxpayer's negligence or disregard of rules or regulations or that is attributable to any substantial understatement of income tax. The precise amount of the 2011 and 2012 understatements that will result from the adjustments that we have sustained is yet to be determined pursuant to Rule 155, but it is clear that it will be "substantial" under section 6662(d)--i.e., that it will exceed both $5,000 and 10 percent of the tax that should have been reported. We therefore need not reach the issue of negligence. Petitioners contend nonetheless that they are not liable for penalty because they showed reasonable cause and good faith for their erroneous reporting. It is true that under section 6664(c)(1), a taxpayer 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 14 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 who is otherwise liable for the accuracy-related penalty may avoid the liability if he can show, first, "that there was a reasonable cause" for the underpayment and, second, that he "acted in good faith with respect to" the underpayment; in that event, no accuracy-related penalty "shall be imposed". Whether the taxpayer acted with reasonable cause and in good faith depends on the pertinent facts and circumstances, including his efforts to assess his proper tax liability, his knowledge and experience, and the extent to which he relied on the advice of a tax professional. 26 C.F.R. sec. 1.6664-4(b)(1). "Reliance on * * * professional advice or other facts, however, constitutes reasonable cause and good faith if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith." Id. Petitioners evidently contend that they meet this standard because of their reliance on their accountant who prepared their returns, and (as to 2011) because of Laurie's reliance on John. This Court's caselaw sets forth the following three requirements in order for a taxpayer to use reliance on a tax professional to avoid liability for a section 6662(a) penalty: "(1) The adviser was a 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 15 competent professional who had sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the adviser, and (3) the taxpayer actually relied in good faith on the adviser's judgment." Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff'd, 299 F.3d 221 (3d Cir. 2002). As for Laurie's reliance on John, it fails the first requirement since John is not a competent professional as to tax matters; and surely Laurie herself, not John, was the source of the false notion that payments to her father were for "consulting services". As for the petitioners' reliance on their return preparer, it fails the second requirement, since petitioners made no showing that they provided "necessary and accurate information". On the contrary, it seems they incorrectly told the accounting firm that some of their personal expenses were business expenses, that circular flows of money were payments, and that Royal provided services that in fact it did not provide. The accounting firm used the bad information that the Donovans gave it, and therefore the Donovans' filing of the returns that the firm prepared does not amount to reasonable cause for the errors on those returns that the Donovans 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 16 themselves induced. Overall, the Donovans failed to show good faith in their filing their returns with the gross errors reflected thereon. John must have known that the information that he gave the accountants was incorrect; and if Laurie did not know it, her ignorance was the result of her knowing failure to review her returns (and her Schedules C in particular) to see what they reported. 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 these cases. (Whereupon, at 2:20 p.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