TAX COURT OPINION

Case: Jian-Yun Fang & Xiao-Jing Zhang
Docket Number: 4333-15
Judge: Ashford
Opinion Type: bench
Filed: 05/06/2016
Pages: 14

UNITED STATES TAX COURT WASHINGTON, DC 20217 JIAN-YUN FANG & XIAO-JING ZHANG, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ) ) ) ) ) Docket No. 4333-15 ) ) ) ) ) ) ORDER Pursuant to Rule 152(b) of the Tax Court Rules of Practice and Procedure, it is hereby 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 proceedings in the above case before Judge Tamara W. Ashford at Chicago, Illinois, containing her oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral fmdings of fact and opinion, a decision will be entered for respondent. (Signed) Tamara W. Ashford Judge Dated: Washington, D.C. May 6, 2016 SERVEB MAY 1 0 2016 Capital Reporting Company 3 1 Bench Opinion by Judge Tamara W. Ashford 2 March 18, 2016 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Jian-Yun Fang & Xiao-Jing Zhang v. Commissioner Docket No. 4333-15 THIS 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. This Bench Opinion is made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code of 1986, as amended, and Rule 152 of the Tax Court Rules of Practice and Procedure. Unless otherwise indicated, subsequent section references made in this bench opinion are to the Internal Revenue Code of 1986 as amended and in effect for the year at issue and Rule references are to the Tax 19 Court Rules of Practice and Procedure. 20 21 22 Petitioner Jian-Yun Fang appeared pro se and he also appeared on behalf of his wife, petitioner Xiao-Jing Zhang, who did not appear. 23 Elizabeth Kelly appeared on behalf of respondent. 24 25 When petitioners filed their petition, they resided in St. Charles, Illinois. 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 4 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 On December 12, 2014, respondent mailed to the petitioners a notice of deficiency for 2011, determining a deficiency in income tax of $3,000 and an accuracy-related penalty under section 6662(a) of $600. Petitioners timely filed a petition contesting respondent's determinations. The issues for decision are whether petitioners are entitled to claim the American Opportunity Credit for 2011 and whether petitioners are liable for the accuracy-related penalty under section 6662(a) for 2011. Facts In 2011, petitioners were married and had three children who were ages 10, 8 and 5. In 2011, petitioners worked as traders in securities. Petitioners timely filed a Form 1040, U.S. Individual Income Tax Return, for 2011. Mr. Fang prepared the return without relying on a tax professional. He conducted research and reviewed IRS publications, including Publication 536, Net 20 Operating Losses (NOLs) for Individuals, Estates and 21 22 23 Trusts. On their 2011 Form 1040, petitioners claimed a $3,000 refundable American Opportunity 24 Credit. They listed the names of their three 25 children on the Form 1040, reporting that they 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 5 1 2 3 4 5 6 7 8 9 10 11 12 13 incurred at least $4,000 in qualified expenses for each child. All three children attended private elementary school in Illinois. Mr. Fang believed that attendance at a private school constituted a qualified educational institution as described in the instructions for Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits), and thus they claimed the American Opportunity Credit for their three children. None of petitioners' children attended college or other postsecondary school in 2011. During the examination of their returns for 2010 and 2011, petitioners learned that the American 14 Opportunity Credit was for postsecondary education, 15 16 17 18 19 20 21 22 23 24 25 i.e. college, and that private elementary school was not a qualified educational institution for purposes of the credit. In the Stipulation of Facts and at trial, petitioners conceded that they were not entitled to any part of the credit. Petitioners timely filed a petition with the Court, asserting that they were improperly audited and seeking review of both the 2010 and 2011 taxable years. With respect to 2010, however, no deficiency was asserted by respondent. On June 23, 2015, the Court dismissed petitioners' case as it 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 6 1 2 3 4 5 6 7 8 9 10 11 12 13 related to 2010 for lack of jurisdiction. A trial was held on March 14, 2016. At trial, petitioners' central argument was that respondent's adjustments to their 2010 net operating loss were incorrect. Due to this error, petitioners argue that the audit was improper and violated their Constitutional rights. Petitioners also claim they made an honest mistake in relation to the American Opportunity Credit on their 2011 return. According to Mr. Fang, he learned of the credit in the media, and believed that President Obama spoke about taking the credit for his daughters' private school education. According to Mr. Fang, he and his 14 wife made a concerted effort to properly fill out 15 16 17 their 2011 Form 1040. Respondent disagrees, asserting that petitioners' effort did not constitute a reasonable and good faith effort. 18 Discussion 19 20 21 22 23 24 25 American Opportunity Credit Tax credits are a matter of legislative grace, and a taxpayer bears the burden of proving entitlement to a claimed tax credit. See Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). The American Opportunity Credit is a modified version of the Hope Scholarship Credit. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 7 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Sec. 25A(i). The American opportunity Credit provides for a credit against tax equal to "(A) 100 percent of so much of the qualified tuition and related expenses paid by the taxpayer during the taxable year * * * as does not exceed $2,000, plus (B) 25 percent of such expenses so paid as exceeds $2,000 but does not exceed $4,000." Sec. 25A(i) (1). The credit phases out for taxpayers whose modified adjusted gross income exceeds $80,000, or $160,000 for married taxpayers filing joint returns. Sec. 25A(i)(4). In addition, up to 40 percent of this credit may be refundable. Sec. 25A(i)(5). The American Opportunity Credit is limited to "eligible students" attending an "eligible education institution". An "eligible student" has two criteria: (1) the student is enrolled or accepted for enrollment in a degree, certificate or other program (including a program of study abroad approved for credit by the eligible institution at 20 which such student is enrolled) leading to a 21 22 23 24 25 recognized educational credential at an institution of higher education that is an eligible institution and (2) the student is carrying at least half the normal full-time work load for the course of study the student is pursuing. Sec. 25A(b)(3); see also 20 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 8 U.S.C. 1091(a)(1). An "eligible edu ation institution" means an institution A) which is described in section 481 of the Higher Education Act of 1965 (20 U.S.C. 1088), as in effect on the dates of the enactment of this section [section 25A], and (B) which is eligible to participate in a program under title IV of such Act." Sec. 25A(f)(2). As a general rule, the Commissioner's determinations in a notice of deficiency are presumed correct, and the taxpayers bears the burden of proving that those determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioners did not produce any evidence to show they were eligible for this credit. In fact, petitioners admitted that they erroneously claimed the credit for 2011 because they did not incur any qualifying education expenses and their three children did not attend qualifying institutions in 2011, conceding their entitlement to the credit to respondent prior to trial and in the Stipulation of Facts and instead arguing that respondent's audit of their 2010 and 2011 returns was wrongly conducted. Thus, we sustain respondent's disallowance of the American Opportunity Credit for petitioners' 2011 tax year. 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 Greenberg's Express Argument Nevertheless, petitioners maintain that 9 they are not liable for the deficiency, arguing that the audit was improper and relying on Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324 (1974), to look behind the notice of deficiency. Petitioners distinguish their case from Greenberg's Express in that they are not associated with organized crime. Instead, they contend that respondent needs a reason to conduct an audit. Petitioners repeatedly argue about events that occurred during the audit, and that the audit was based on respondent's mistakes and is therefore invalid. According to petitioners, because of respondent's mistakes and an invalid audit, this 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Court should accept their returns as filed. 16 17 18 19 20 21 22 23 24 25 As a general rule, this Court will not look behind a deficiency notice to examine the evidence used by respondent in making his determination or respondent's motives, administrative policy or procedures. Greenberg's Express, Inc., . . 327. The rationale for this rule is that a trial before the Tax Court is a de novo proceeding, and our decision is based on the merits of the record before us and not on the merits of the administrative record. Jackson v. Commissioner, 73 T.C. 394, 400 866.488.DEPO www.Capita1ReportingCompany.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 (1979) ; Greenberg' s Express, Inc. , 62 T. C. 28. We recognize that there are limited exceptions to this rule. For instance, when there is substantial evidence of unconstitutional conduct by respondent. Suarez v. Commissioner, 58 T. C. 792, 813 (1972). Even in that circumstance, the Court has refused to declare the deficiency notice null and void. See id. at 814. Another exception to this rule is where respondent, in a case involving unreported income, introduces no direct evidence but rests on the presumption of correctness and the taxpayer challenges the deficiency on the grounds that it is arbitrary. Schad v. Commissioner, 87 T. C. 609, 618 (1986), aff'd. without published opinion, 827 F.2d 774 (11th 1987); Llorente V. Commissioner, 74 T. C. 260, 264 (1980) . To the extent that respondent's adjustments are supported not by reason or evidence but only by ill motive, then the taxpayer's burden to prove his actual liability "should be concomitantly easier", cf.Church of Spiritual Tech. v. United States, 20 C1. 22 Ct. 762, 765 (1990), so that respondent's motive for 23 24 25 the adjustments is unimportant. By contrast, in this case, this is not an instance in which the taxpayer alleges that he was 866.488.DEPO www.CapitalReportingCompany.com 1 2 3 4 Express, Inc., 62 T.C. 328. Petitioners merely A Capital Reporting Company selected for audit on the basis of an impermissible criterion, such as ethnicity, see Greenberg's 11 contend that they were audited based on respondent's 5 mistakes and that respondent must establish fair 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 procedures for an audit since they cannot audit everyone. Petitioners' reliance on Greenberg's Express and the argument that respondent needs a justification for an audit is misplaced. As petitioners do not fall within the limited exceptions discussed above, we decline to look behind the notice of deficiency. Penalties Section 6662(a) imposes a penalty on the underpayment of tax in an amount equal to 20 percent of the portion of the underpayment due to negligence or intentional disregard of rules or regulations. Sec. 6662(b)(1). "Negligence" includes a failure to make a reasonable attempt to comply with the provisions of the internal revenue laws, specifically including the failure to maintain adequate books and records. Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. "Disregard" includes any careless, reckless or intentional disregard of the rules or regulations. Sec. 6662(c); sec. 1.6662-3(b)(2), 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 12 Income Tax Regs. With respect to an individual taxpayer's liability for a penalty, section 7491(c) places on respondent the burden of production, thereby requiring respondent to come forward with sufficient evidence indicating that imposition of a penalty is appropriate. Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). Once respondent meets his burden of production, the petitioner bears the burden of proving that respondent's determination is incorrect. Id.; see Rule 142(a); Welch v. Helvering, 290 U.S. at 115. Respondent in the notice of deficiency in this case determined an accuracy-related penalty of $600 for 2011 attributable to petitioners' claim of the American Opportunity Credit that year. As previously noted, petitioners acknowledged prior to trial and in the Stipulation of Facts that they had no basis for claiming the credit. Respondent has therefore discharged his burden of production. See sec. 1.6662-3(b)(1), Income Tax Regs. The accuracy-related penalty does not apply 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 with respect to any portion of an underpayment if it 24 25 is shown that there was reasonable cause for such portion and that the taxpayer acted in good faith 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 1 with respect thereto. Sec. 6664(c)(1). The 13 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 determination of whether a taxpayer acted with reasonable cause and in good faith depends upon the pertinent facts and circumstances of a particular case. Sec. 1.6664-4(b) (1), Income Tax Regs. We consider, among other factors, the experience, education and sophistication of the taxpayer. However, the principal consideration "is the extent of the taxpayer's effort to assess the taxpayer's proper tax liability." Sec. 1.6664-4(b)(1), Income Tax Regs. Furthermore, a taxpayer may establish a section 6664(c) reasonable cause defense by showing that he relied reasonably and in good faith on a third party's advice in taking the disputed tax position. See sec. 1.6664-4(c), Income Tax Regs. In this case, at trial, Mr. Fang testified that he prepared the 2011 return but did not rely on any tax professional within the confines of this exception. Mr. Fang further testified that he learned of the American Opportunity Credit in the news, remarking how he thought President Obama had spoken about the credit in conjunction with his daughters' private school education. However, the 24 media does not constitute third party advice from a 25 competent tax professional. Thus, the reasonable 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 14 1 2 3 4 5 6 7 8 9 reliance on a third party's advice exception does not exculpate petitioners from the accuracy-related penalty here. According to Mr. Fang at trial, petitioners conducted their own research and relied on respondent's instructions and publications; in particular, Mr. Fang continually reiterated his reliance on Publication 536, Net Operating Losses (NOLs) for Individuals, Estates and Trusts. While 10 Publication 536 is of little value for the issue at 11 hand, we acknowledge petitioners' efforts. Mr. Fang 12 diligently prepared their return believing that the 13 14 15 16 17 18 American Opportunity Credit applied to private elementary schools. He candidly admitted that the terms "qualified tuition expenses" and "eligible educational institution" confounded him -- it seemed implausible that it would not apply to the tuition he paid to his childrens' private elementary school. 19 During his testimony, Mr. Fang also attempted to 20 21 22 23 24 25 explain his confusion between state and Federal education credits. We note that a closer examination of the Form 8863 instructions pertaining to this credit would have revealed that the credit related to postsecondary education institutions, i.e. a college or university. Mr. Fang tirelessly researched NOLs, 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 15 1 2 but failed to fully read the instructions on Form 8863, which would have alerted him to his mistake. 3 Petitioners, who are traders in securities, are not 4 5 6 7 8 9 10 11 unsophisticated taxpayers. They may have acted in good faith, but did not have reasonable cause to claim the American Opportunity Credit. We accordingly sustain respondent's imposition of the accuracy-related penalty for 2011. We have considered the remaining arguments made by the parties, and to the extent not discussed above, we conclude those arguments are irrelevant, 12 moot, or without merit. To reflect the foregoing, a decision will be entered for respondent. THIS CONGLUDES THE COURT'S ORAL FINDINGS OF FACT AND OPINION IN THIS CASE. (Whereupon, at 10:36 a.m., the above- entitled matter was concluded.) 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com