TAX COURT OPINION

Case: Jorge Luis Calienes & Tamara S. Calienes
Docket Number: 36116-21
Judge: Nega
Opinion Type: bench
Filed: 10/24/2024
Pages: 13

JORGE LUIS CALIENES & TAMARA S. CALIENES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent United States Tax Court Washington, DC 20217 Docket No. 36116-21. ORDER Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, 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 case before Judge Joseph W. Nega at Cincinnati, Ohio, on September 24, 2024, containing his oral findings of fact and opinion rendered at the conclusion of the trial. In accordance with the oral findings of fact and opinion, decision will be entered for respondent. (Signed) Joseph W. Nega Judge Served 10/24/24 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 Joseph W. Nega September 24, 2024 3 Jorge Luis Calienes & Tamara S. Calienes v. Commissioner of Internal Revenue Docket No. 36116-21 THE COURT: The Court has decided to render oral findings of fact and opinion in this case. And the following represents the Court's oral findings of fact and opinion. The oral findings of fact and opinion shall not be relied upon as precedent in any other case. The oral findings of fact and opinion are made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code and Tax Court Rule 152. Rule references in this opinion are to the Tax Court Rules of Practice and Procedure. Regulation references are to the Code of Federal Regulations, Title 26, in effect at all relevant times and section references are to the Internal Revenue Code, in effect at all relevant times. This case was tried in Cincinnati, Ohio on September 23rd, 2024. Petitioners Jorge Calienes and Tamara Calienes appeared pro se. Monica Ibarra appeared on behalf of respondent. By notice of deficiency dated August 25th, 2021, respondent determined deficiencies of $29,086 and $25,824 in petitioners' federal income tax for tax years 2018 and 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 2019, respectively. In the same notice of deficiency, 4 respondent asserted accuracy-related penalties of $5,817.20 and $5,164.20 under section 6662(a) for tax years 2018 and 2019, respectively. [Petition, R#1, p. 4]. The principal issues in this case are: (1) whether petitioners are entitled to claim more than $25,000 in schedule A itemized deductions for tax year 2018, (2) whether petitioners are entitled to claim $8,905 of employee business expenses for tax year 2018, and (3) whether petitioners are entitled to claim more than $60,000 in schedule C deductions for taxable years 2018 and 2019. We must also decide whether petitioners are liable for penalties under section 6662(a). On the evidence before us, and using the burden- of-proof principles explained below, the Court finds the 16 following facts: 17 18 19 20 21 22 23 24 25 FINDINGS OF FACT/Background Some of the facts and certain exhibits have been stipulated. The parties' stipulated facts are incorporated in this opinion by reference, and are found accordingly. Petitioners resided in California at the time they filed the petition in this case. [R#1, p. 3]. Petitioner Jorge Calienes was employed as a professor by the Los Angeles Community College District during 2018 and 2019. 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 Petitioner Tamara Calienes was employed part- 5 time by Walnut Valley Educational Foundation. Petitioners filed joint tax returns for tax years 2018 and 2019, and attached four Schedules C, Profit or Loss from Business (Sole Proprietorship). Petitioners claim to have operated four businesses other than their work as employees; these purported businesses consisted of selling Isagenix products, coaching, mentoring, and boarding international students. The bulk of the deductions that petitioners attempted to substantiate at trial are related to the boarding of international students. Their 2018 schedule C for that business reported more than $65,000 of expenses, including more than $23,000 of car and truck expenses and more than $29,000 of meal expenses. The total expenses far exceeded the gross receipts related to boarding international students. In 2018, petitioners reported $38,910 gross receipts related to boarding, but reported a net loss of ($42,222). For 2019, petitioners reported gross receipts for boarding of $22,213 and enough expenses to reach a net loss of ($73,316). Petitioners' 2018 schedule C for mentoring reported $0 gross receipts and a ($5,746) net loss. For 2019, the gross receipts for mentoring were $900 and the net loss was ($6,196). 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 Petitioners' 2018 schedule C for coaching 6 reported $750 gross receipts and a ($1,516) net loss. For 2019, petitioners reported $0 gross receipts and a ($2,329) net loss attributable to coaching. Petitioners' 2018 schedule C for Isagenix sales reported $0 gross receipts and a ($12,802) net loss. For 2019, petitioners reported that their Isagenix sales activities resulted in $0 gross receipts and a net loss of ($18,037). For each of the net losses described above, petitioners claimed expenses related to travel, meals, depreciation, office supplies, and expenses for the business use of their home. Petitioners are cash basis taxpayers. See Sec 446. There is little doubt that petitioners actually incurred many of the expenses in question--they provided respondent and the Court with a deluge of receipts of all varieties indicating that they spent money on items such as gas, dining, and groceries. However, petitioners failed to meet their burden of proof of showing a business purpose for any of their claimed expenses. Petitioners lacked credibility on the stand. They claimed that any inconsistency pointed out by respondent was an innocent mistake in their hasty preparation of receipts and other substantiating 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 7 documentation. OPINION/Discussion I. Schedule C Deductions and Substantiation Deductions and credits are a matter of legislative grace, and the taxpayer bears the burden of proving that he or she is entitled to any deduction or credit claimed. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). The taxpayer's burden of proof requires that the taxpayer use the evidence to demonstrate that the taxpayer should prevail--it is not enough to deliver a pile of unorganized receipts to the Court. See Hale v. Commissioner, T.C. Memo. 2010-229; Patterson v. Commissioner, T.C. Memo. 1979-362. An individual taxpayer may claim certain deductions attributable to a trade or business carried on by the taxpayer. See Sec. 62(a)(1). Section 162(a) provides one such allowable deduction for ordinary and necessary expenses paid or incurred during the taxable year "in carrying on a trade or business." Individual taxpayers report this deduction on Schedule C. Not all activities that may occupy a taxpayer's time rise to the level of a trade or business within the meaning of section 162(a); "to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and . . . the taxpayer's 1 2 3 4 5 6 7 8 9 primary purpose for engaging in the activity must be for 8 income or profit." Groetzinger v. Commissioner, 480 U.S. 23, 35 (1987). No deduction may be allowed for personal, living, or family expenses unless the Code expressly provides otherwise. Sec. 262(a). Petitioners failed to prove that they were engaged in a trade or business for any of the activities for which they filed a Schedule C. Their testimony failed to convince the court that their boarding, mentoring, 10 coaching, and Isagenix sales activities were primarily 11 motived by profit. 12 13 14 15 16 17 18 19 20 21 22 23 24 25 In addition to failing to prove a qualifying trade or business that could take any of the claimed deductions, petitioners failed to prove that any of the expenses were "ordinary and necessary." The receipts introduced by petitioners included charges for Disney World, iced coffees, personal massages, Hulu, and alcohol. On cross-examination, petitioners claimed that the inclusion of some of these items in their voluminous set of receipts was a mistake, but petitioners failed to offer a satisfying explanation for the number of mistakes. Overall, petitioners failed to meet their burden of proof of showing that any of the expenses that they claimed were "ordinary and necessary." See Sec. 162(a). A. Mileage logs 1 2 3 4 5 6 7 8 9 Section 274(d) prescribes strict substantiation 9 requirements for deductions for business expenses related to travel, entertainment, gifts, and the use of "listed property." As relevant here, the term "listed property" includes passenger automobiles. Sec. 280F(d)(4)(A)(i) and (ii). To satisfy the requirements of section 274(d), petitioners must provide (1) an account book, a log, or similar contemporaneous record and (2) documentary evidence showing business purpose. Treas. Reg. 1.274- 10 5T(c)(2). 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Petitioners claimed extensive mileage for each of their purported businesses in tax years 2018 and 2019. As noted above, they failed to carry their burden of proving that they were engaged in a qualifying trade or business during the relevant tax years. Therefore, petitioners cannot deduct any mileage during the tax years 2018 and 2019. And all of their mileage is a nondeductible personal expense. Even if the mileage expenses were ordinary and necessary to a trade or business, petitioners would fail to meet their burden of complying with the strict substantiation requirement rules of section 274(d) because petitioners failed to produce a contemporaneously compiled mileage log. Petitioners attempted to recreate a mileage log after the fact, but we find petitioners' reconstructed 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 mileage log lacked credibility as to the business purpose 10 and actual use of the vehicles. With respect to all Schedule C deductions taken by petitioners, petitioners failed to carry their burden of proof. Respondent's determination as set out in the notice of deficiency is sustained. II. Schedule A Itemized Deductions and Employee Expense Deductions Petitioners failed to substantiate that they were entitled to any of the deductions which were disallowed by respondent in the notice of deficiency. Petitioners claimed $25,849 of itemized deductions on their 2018 schedule A. Respondent disallowed the itemized deductions and applied the standard deduction of $25,300 to petitioners' 2018 return. Part of this allowance is computational and it is enough to make the standard deduction apply to petitioners. Deductions for medical expenses under section 213 are only permissible to the extent that such expenses exceed 7.5% of the taxpayers' adjusted gross 21 income. 22 23 24 25 Petitioners claimed $10,577 of medical expenses and of which they claimed $3,672 was actually deductible. After disallowing their schedule C expenses, none of their medical expenses are deductible because 7.5% of their 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 adjusted gross income is more than $11,000. This reduces 11 petitioners' itemized deductions to below the amount of the standard deduction. Respondent's determination relating to schedule A itemized deductions as set out in the notice of deficiency is sustained in full. III. Employee Expense Deduction Prior to the tax year 2018, "expenses are treated as "miscellaneous itemized deductions" under section 67(b), and they are deductible under section 67(a) "only to the extent that the aggregate of such deductions exceeds 2 percent of adjusted gross income." Ayria v. Commissioner, T.C. Memo. 2022-123 at *6. In 2018, Congress enacted section 67(g), suspending miscellaneous itemized deductions for taxable years 2018 through 2025. Petitioners' employee expense deduction would be miscellaneous itemized deductions, and are therefore suspended under section 67(g). Respondent's determination as set out in the notice of deficiency is 20 sustained. 21 22 23 24 25 IV. Cost of Goods Sold Under the Sixteenth Amendment to the Constitution, Congress may tax the gross income of a producer or reseller, not its gross receipts. See Doyle v. Mitchell Bros. Co., 247 U.S. 179, 185 (1918). Gross 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 income is calculated by subtracting the cost of goods sold 12 from gross receipts. Treas. Reg. 1.61-3(a). Unlike deductions for ordinary and necessary expenses, an offset for the cost of goods sold does not require a qualifying trade or business. See Reading v. Commissioner, 70 T.C. 730, 733 (1978). The cost of goods sold should be determined in accordance with the method of accounting consistently used by the taxpayer. Treas. Reg. 1.61-3(a). Petitioners claimed $4,500 and $5,200 in cost of goods sold for their reported Isagenix business in tax years 2018 and 2019 respectively. [R#36, p. 23, p.61] Petitioners do not appear to have reported any sales or receipts from this business during either tax year. Respondent disallowed the entirety of the cost of goods sold for lack of substantiation. Petitioners did not address cost of goods sold at trial. We find that petitioners are not entitled to an offset for cost of goods sold. This makes sense, because petitioners' lack of gross receipts in the Isagenix Schedules C for tax years 2018 and 2019 indicated that their Isagenix business did not sell anything and, as cash-method taxpayers, they are only entitled to an offset of the cost of goods sold when they actually sell 24 something. 25 V. Section 6662(a) Penalty 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 Section 6662(a) and (b)(2) imposes an accuracy- 13 related penalty on any portion of an underpayment of federal income tax that is attributable to, among other things, the taxpayer's "substantial understatement of income tax." An understatement of federal income tax is substantial if the amount of the understatement for the tax year exceeds the greater of 10% of the tax required to be shown on the return or $5,000. Sec. 6662(d)(1)(A). The Commissioner bears the burden of production with respect to any accuracy-related penalty under section 6662. See section 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the burden of production is met, the burden of proof shifts to the taxpayer to show that the penalty should not apply. The section 6662(a) accuracy-related penalty will not apply with respect to any portion of an underpayment if it is shown that there was reasonable cause and that the taxpayer acted in good faith. Sec. 6664(c)(1); Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447. Whether a taxpayer acted in good faith depends upon the facts and circumstances of each case. Treas. Reg. 1.6664-4(b)(1). At trial, petitioners did not raise reasonable cause, and their testimony did not establish it. Because the deficiencies asserted by respondent clearly show a 1 2 3 4 5 6 7 8 9 10 11 12 13 substantial understatement for the taxable years at issue, 14 respondent has met his burden of production; we hold that petitioners are liable for the accuracy-related penalties for a substantial understatement of income tax for tax years 2018 and 2019. VI. Conclusion This concludes the Court's oral findings of fact and opinion in this case. We have considered all arguments made by the parties, and, to the extent not mentioned above, we conclude that they are moot, irrelevant, or without merit. A decision will be entered. This concludes the reading of the bench opinion 14 in Calienes. 15 16 17 18 19 20 21 22 23 24 25 (Whereupon, at 2:01 p.m., the above-entitled matter was concluded.)