TAX COURT OPINION

Case: Estate of Strown Martin, Deceased, Fannie L. Martin, Special Representative and Fannie L. Martin
Docket Number: 10686-05
Judge: Cohen
Opinion Type: memo
Filed: 08/28/2008
Pages: 12

UNITED STATES TAX COUR T 'ESTATE OF STROWN MARTIN, DECEASED, FANNIE L . MARTIN, SPECIAL REPRESENTATIVE, ANDFANNIE L . MARTIN, Petitioners . v . COMMISSIONER OF INTERNAL REVENUE, Responden t Docket No . 10686-05 . Filed--August 28, 2008 . Alex J . Llorente , for petitioners (through trial only) . Karen Nicholson Sommers , for-respondent . . MEMORANDUM FINDINGS OF FACT-AND'OPINIO N COHEN, Judge : Respondent determined deficiencies and penalties with respect to the Federal income tax liabilities of Strown Martin (decedent) and Fannie L . Martin (petitioner) as follows : SERVE AUG 2 : 8 2008 1 ,2000 "2001 2002--'' Deficiency $231,305 5,771 2, 824 Penalt y Sec .. 6662(a ) $46,26 1 1,15 4 56 5 Unless: otherwise indicated, all section references are to th e 'Internal Revenue Code in .effect for the years in is°sue, and all Rule .references .are to the Tax Court Rules of Practice o f 'Pr.ocedurer.~-The issues for decision are : (1) Whether an arbitration award of-$616,600 is includable in petitioners' gro"ss income for 2000 and, if so, whether they are entitled to deductsfrom .that income business startup cost s from prior year,s ; , (2) whether petitioners may deduct losses from, farming . activity claimed ' on . Schedules F, Profit or Loss .From Farming,-for the years in issue ; (3) whether petitioners may . deduct losses in excess o f $25,000 from rental real-estate activity .for t e_years in issue ; and (4) whether petitioners fare liable . for the,accuracy-related penalty under section 6662 for the years . in issue . FINDINGS OF FAC T Some of the facts have been stipulated, andthe stipulate d facts are incorporated in our findings by this reference . Decedent and petitioner resided in California at the time thei r petition was filed . 8 3 _ , . Both decedent and petitioner were teachers and-held master's degrees . Petitioner taught accounting at the college level, including courses insprinciples of accounting and payroll accounting courses . In 1976 decedent and petitioner purchased 80 acres of lands" in California with the intention of starting a fruit and vegetable farm after retirement . They retired in,1991 . In 1994 petitioners sought .farm'loans from :the branch of'the U .S . ,Department o.f Agriculture (USDA) that. is now"known .as the Farm Service Agency . Petitioners experienced discriminatory treatment from the USDA with respect to their farm loans because they were African-Americans . Eventually they presented a claim to the USDA for damages suffered'as a result-of the discrimination, and they joined a class action lawsuit' involving' many similarly situated African-American farmers . Pursuant to settlement of the class action lawsuit, an arbitrator appointed"by .a U .S . district court found that petitioners were entitled to $50,000 fortemotional distress ..and $.568,600 for lost net income from April"l, 1996, through December' 31, 1999 . The ..lost .net_income *was calculated by . projecting-net income from farming that petitioners would have received if the loans they requested from the USDA had . been processed . In 2000 petitioners received payment of $616,600=,of the damages' awarded by the arbitrator ..,, (The $2,000 discrepancy,-between : the amount awarded and the amount,paid .is not explained''in the-record . ) Decedent-, .and petitioner . timely filed -their, . joint,. Federal income tax .returns for . 2000, 2001, and 2002 . They used the cash, method accounting system .during, :.these tax years . ~.-Decedent'and petitioner did not4,report any of',the-arbitration award :,received' as income on their 2000,return,--On Schedules F,attached .to .th e returns, they reported the following,losses : Year . Farm Income > Farm Expense s Net .Farm :Profit (Loss ) 2000 2001 2002 -0- -0- $47, 40 6 41,37 4 35, 599=; ($47', 406) . (41, 374) (35, 5 .99 ) Most-of the expenses .claiined consisted of,alleged-, .mortgagee : interest payments<"on decedent and petitioner's :-farm in the annual- . amount .of-,$26,616 .' The claimed ; farm .,,losses,reduced theirs, reported adjusted gross,incomeafor(cid:127) .each,of the,years .,:,, Decedent and petitioner also reported rental : activity losses on afSchedule E, Supplemental Income and Loss,, for each of-the years in issue . The Internal Revenue,,Service, .;(IRS) examined, the returns fo r 2000, . 2001,, and 2002 ;.(cid:127) .During the examination process .petitione r presented"documents-to . substantiatethe farm. exp .enses, .claimed o n the returns The documents included-,'.(l), A large_number o canceled checks from 1994 ;,-°,(2,) a statement,°of,s'tart p expenses- . incurred in,1994 and=1995,with respect to :clearing'and preparing . the land for farming ; and.(3), monthly canceled checks from,.2000 to Sephardic Education Center in Jerusalem (Sephardic Center) in the amount of $1,655 .°44 and'to Rafael and Victoria Sarfatti (the Sarfattis) in the amount of $562 .50 . In the notice of deficiency upon which this"case is based ; the following adjustments were made : (1,) The full- arbitration award was indluded_in petitioners' gross income ' for . 2000 ; (2) all of the farm expenses claimed were disallowed because, of lack of substantiation ; (3) the amount of losses from the rental real estate activity for,each year was reduced to $25,000, the maximum deduction allowed per year for passive activitylosses under section 469(i) ; and (4) section'6662(a) accuracy-related penalties-were- .imposed . The IRS disallowed the farm expens e deductions in full because the 1994 and 1995 startup expenses were not incurred during the years in issue, the monthly checks .' to the-Sephardic Center and to the Sarfattis did not establish that payments were made on a mortgage debt, and petitioners did not present any other evidence of a valid mortgage debt . Arbitration Award as Income OPINION Gross income, for purposes of calculating taxable' income , includes all income from whatever source derived . Sec .'61(a) . Petitioners have not claimed that any exclusion applies to the economic damages included ' in' the .arbitration award, and none would apply . Generally, cash basis taxpayers reportincomein the ;;,~year of receipt . Sec . 451(a) . Because decedent and petitioner were cash, .. basis taxpayers in 2000, the arbitration award of .$616,600 .i s includable in their gross, income . for-2000 : ,Petitioner assert .s,that she :!.filed amended returns,for_199 6 99 allocating portionsof_theiarbitration award as ;income t those . years . .However, petitioner has,,neitherproduced copies :.o f amended-returns nor identified any authori(cid:127)t .y .for'allocating- portions .of the,'arbitration award to prior tax years . In an y event, there is .,no authority for such an allocation . , Petitioners contend that iftithearbitration award is, .included in income, then, startup' costs decedent and petitioner- . incurred-in establishing-the-farming operation .-in 1994 and 1995 . .,.,Petitioners .should be deducted against the amount of the award' bear the .burdenof proving entitlement to, the,,claimed(cid:127)deductions See Rule 142-(a) ;, INDOP-CO, Inc . v . Commissioner , 503 U .S . 79, 84 , ( 1992) . As,substantiation for expense deductions,in,200 .0, petitioner presented canceled checks : and lists .of startup expenses from 1994 and 1995 . However, there, isRno",evidence-as- whether expenses . incurred in 1994 and 1995 were claimed on , k petitioners' returns before 2000 . There is no .. evidence .,that .th e expenses were not,ta.ken into(cid:127) account .by the arbitrator~ . when the projected net income from farming , was calculated and included,in the economic damages portion of the arbitration award . . -7- Petitioners have failed to'sati .sfy their burden of proof .- Under these circumstances and on the record in this case, . none-of the 1994 and 1995 expenses may be, .deducted . Schedule F Losse s Petitioner argues that-the IRS erred by disallowing all Schedule F losses for the years in issue . Petitioner also bears the burden of proof with respect to these deductions, and she has failed to satisfy that burden : The IRS disallowed, for lack of substantiation, the Schedule F farming expenses claimed for the years in issue . The notice,of deficiency explained that decedent and petitioner had,neither (cid:127) shown that the expenses claimed were incurred ; during the year in issue nor that any portion of .the $26,616-in-annual payments deducted on the Schedules F was payment of interest- on a debt . Respondentalso argues that petitioners were : not engaged in farming during 2000, 2001 . and 2002, or at any time after 1995, presumably because of the discrimination that they suffered .. Petitioners did not report any income from farming during the years in issue . During the examination and at . trial: petitioner presented copies of-monthly canceled checks in . the amounts of either $1,655 .44 (made out=to Sephardic Center) or $562 .50 (made out to the Sarfattis) to-substantiate the claimed mortgage interest expenses related to the farm in 2000 . After trial petitioner. - 8 - moved to reopen (cid:127)the record for s, receipt .. ofk. a copy . of a deed,sof . . trust,-dated'March'8, 1991, . conveying property .of',.decedent and ,petitioner to Endowment Sephardic . Educational : Center .,- Maimonides .k- Research and Development Foundation, . and Savings Mortgag e Corporation ; in tru'st,> as securitytfor'a ::promissory note of $176,500 . Respondent did .not .object ; and the document wa s received ; in- evidence : Petitioner, . however, has provided n .o . .details about the .-terms. or subject matter . of . 'any loan : 'agr.eement, i and we- have . no basics : ,for' determining what, ift any, .-portions, of the -payments ., were deductible- interest . Petitioner didr .not :identify ,or substantiate the other expenses claimed, on .Schedule's F..F(cid:127) Thus deductions o f farm expenses for the year s in issue were properly,disallowe d Schedule E Losses In her brief petitioner = argues :that „the IRS' ".complete :' disallowance of,all Schedule E -losses" related ,to decedent-,and petitioner' s rental": real . estate' activity r (passive ,acti-vity losses)<-for. ~2001n and' 2002 is incorrect . . .. Generally, . passive activity losses are not allowed to be deducted from .income form the taxable 'year .in which, they are . incurred . - Sec .. 469 (a ) However, . section' 469 (i)allows adeduction~ .riot to exceed - .$25, 000 for a portion of passive activity'losses at .tributable't .o renta l real estate activities in .'which,.the' taxpayer:-actively participated_during'the 'taxable . year ... The IRS permittedpetitioners to deduct Schedule E losses . up to the $25,000 limit for each year . For 2000 the IRS allowe d petitioners the full'amountof Schedule E deductions claimed, . which totaled $ 17,435 . The IRS also permitted petitioners to deduct $25 , 000 of their passive .activity,losse,s from their renta l real estate activities for 2001 and 2002 and advised them in the notice of deficiency that they may carry forward the exces s losses into subsequent tax years indefinitely . - .Petitione r presents neither evidence nor argument showing that she is entitled to deduct more than .the amounts allowed in'the statutory notice . Accuracy-Related Penalt y Petitioner contests the imposition of accuracy-related penalties for the tax years in issue . Section 6662 imposes a 20- percent accuracy-related penalty on any underpayment of ;Federal income tax attributable to a taxpayer's negligence or disregard of rules or regulations, or substantial understatement of .income tax . Sec . 6662(a) and (b) (1) and (2) . Section 6662 (d) (1) (A) . defines "substantial understatement of income tax" as an amoun t exceeding the greater of 10 percent of the tax required to be shown on the return or $5,000 . Under section 7491(c), respondent bears the burden of production with regard'to .penalties and .must, come forward-with sufficient evidence' indicating that it is appropriate to impose penalties . See Higbee v . Commissioner , . 116_ _ 1 0 T .C ., ..438 , 44,6 '(2001) . However ., ,once respondent, has, met- the burden of production ,, the,burden of proof ;remains with the . taxpayer.., including the burden of -proving .that,,_ the, penaltie s ar.e . inappropriate because of .reasonable cause or substantia l authority . - See Rule 142 .(.a)' ; Higbee :v . Commissioner , supra at 446-447 . Respondent's-burden,of; production has been met . : .Respondent has shown that, (1) Decedent and petitioner substantially, understated their income . tax-by .failing,to report .any,of the $616 ;'600_arbitration,award .recei'ved in ,2000 ;, (2) decedent_ and ,;_ petitioner's 2001 return contained an understatement of income tax exceeding $5,000 ; (3) decedent and petitioner deducted . ., farming expenses of $47?,406, $41,273,,,and $35,599 for 2000, 2001 and 2002, respectively ; . and ., .they,failed'to maintain . or produce records,to substantiate those deductions ; and (4) .decedent and petitioner were negl.igent,anddisregarded rules by,deducting ~ -passive activity losses ..beyond the~$25,000 .allowe,d .for-their . . 'rental real . estate activity : The accuracy-related.'penalty under section 6 ..662,(a .) will no t be imposed with .:respect to,.any'portion_, .of}the underpayment as to which the taxpayer acted with reasonable,cause_and,in good faith . Sec . 6664(c) (1) .. .. .The decision as to whether a .taxpayer acted . with reasonable ::kcause and~in good,faith is maderby taking intoG . account all .of the pertinent -facts and circumstances . Sec . - 1 1 1 .6664-4(b)(1), Income Tax Regs . The most important factor is the extent of the taxpayer's effortto . assess his or her proper tax liability . Id . An honest misunderstanding of fact . .or .law that is reasonable in light of the experience, knowledge, and education of the taxpayer may indicate reasonable cause and good faith . Higbee v . Commissioner , supra at 449 . Petitioner is a retired accounting teacher and has taught college-level accounting courses . However, she failed to report the $616,600 arbitration award received in 2000 . While she presented evidence of expenses in prior years claiming offsets to income from the years in issue, petitioner does not cite, and w e do not find, any authority that would allow petitioners, as cash basis taxpayers, to recalculate their Federal income tax liability using the accrual method of accounting . Petitioner did not maintain or provide any receipts for the farming expenses claimed on Schedules F for the years in issue . Decedent and petitioner claimed unsupported farm and rental real estate losses . All of these claims, without any reasonable cause given, suggest lack of good faith on the part of decedent and petitioner, especially in light of their education and expertise . Because petitioner presented neither evidence nor argument that the positions taken on the returns . were either reasonable or in good faith, petitioners are liable for accuracy-related penalties under section 6662 for all of the years in issue . - 12 - In reaching our decision, we have considered all arguments . made by the parties L :To the extent not mentionedor addressed , they are irrelevant or .°. .without . merit . To . reflect the ,foregoing, Decision will be entered fo r respondent .