Court Opinion

ID: 4330923
Source: CourtListenerOpinion
Date Created: 2018-11-13 23:53:34.665771+00
Date Added: 2024-06-11T14:47:04.296380
License: Public Domain

HENRY PETER NOVICK AND CAROLYN S. NOVICK, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentNovick v. CommissionerDocket No. 3478-94United States Tax CourtT.C. Memo 1996-564; 1996 Tax Ct. Memo LEXIS 577; 72 T.C.M. 1615; December 30, 1996, Filed 1996 Tax Ct. Memo LEXIS 577">*577  Decision will be entered under Rule 155.  Gino P. Cecchi, for petitioners. Scott Johnson and Lori M. Mersereau, for respondent.  JACOBSJACOBSMEMORANDUM FINDINGS OF FACT AND OPINION JACOBS, Judge: Respondent determined the following deficiencies and accuracy-related penalties with respect to petitioners' Federal income taxes: Accuracy-Related PenaltyYearDeficiencySec. 6662(a)1989$ 18,167$ 2,933199024,1464,829199139,1627,832The deficiencies result from respondent's determination that petitioners are not entitled to deductions to the extent claimed for Schedule E rental losses, miscellaneous employee business expenses, charitable contributions, and investment interest. The accuracy-related penalty is based on respondent's determination that petitioners were negligent with respect  to the preparation of their tax returns. For the reasons that follow, we sustain respondent's determinations in all respects. All section references are to the Internal Revenue Code in effect for the years under consideration. All Rule references are to the Tax Court Rules of Practice and Procedure. FINDINGS OF FACT 1Petitioners, 1996 Tax Ct. Memo LEXIS 577">*578 husband and wife, resided in Sacramento, California, at all relevant times, including the time they filed their petition. They filed joint Federal income tax returns for each of the 3 years under consideration. Petitioner Henry Novick is a physician, specializing in urology. Dr. Novick conducted his medical practice in corporate form until 1986, at which time the corporation was dissolved. During the years under consideration (1989-91), he was an employee of Sacramento Sierra Medical Group; petitioner Carolyn Novick was a housewife. Schedule E Rental LossesDuring each of the years under consideration, petitioners reported income and expenses attributable to three rental activities on Schedule E of their tax returns: The Texas rental, the Tahoe rental, and the F Street (Sacramento) Duplex rental. Respondent disallowed numerous expenses claimed by petitioners with respect to each of these rental properties and recalculated petitioners' net Schedule E gain/loss after applying the passive activity loss rules. 21996 Tax Ct. Memo LEXIS 577">*581  Petitioners do not dispute the application of the passive activity loss rules to the rental expenses claimed on Schedule E of their tax returns. The following tables show the income/loss 1996 Tax Ct. Memo LEXIS 577">*579 reported by petitioners and the amounts allowed by respondent with respect to each of the three rental properties, before application of the passive activity loss rules (hereafter referred to as Pre-Pals): TEXAS RENTAL198919901991ReportedAllowedReportedAllowedReportedAllowedIncome$ 2,268  $ 2,268 $ 3,767  $ 3,767 $ 2,344  $ 2,344 (Rent & royalty)Advertising220  0 405  0 0  0 Auto/travel2,654  0 0  1,211 2,832  0 Cleaning/210  0 920  0 345  0 maintenanceRepairs244  322 284  0 428  1,170 Supplies141  0 792  0 695  0 Taxes145  145 310  140 164  78 Utilities0  0 156  0 0  0 Association fee0  0 2,889  0 0  0 Paint0  0 255  0 112  0 Gardening &360  360 674  0 420  0 landscapingLicenses108  0 111  0 25  0 Management fees220  0 235  0 320  0 Pest Control82  0 100  0 622  0 Security & safety42  0 223  0 0  0 Telephone190  0 217  0 318  0 Oil prod exp48  0 108  0 1,700  0 Depletion0  0 0  0 269  269 Fence0  0 0  0 478  0 Net Profit(2,396) 1,441 (3,912) 1 2,273 (6,384) 827 Pre-PalsTAHOE RENTAL198919901991ReportedAllowedReportedAllowedReportedAllowedIncome$  1,140 $  1,140$    980 $    980 $    220 $   220 (Rent & royalty)Advertising480 0 695 0 113 0 Auto/travel681 357 1,520 1,372 0 0 Cleaning/204 230 511 130 490 0 maintenanceInsurance484 484 502 493 505 84 Legal and other100 0 2,157 0 859 0 professionalfeesRepairs1,548 1,287 2,168 573 984 298 Supplies1,236 104 1,173 0 1,082 0 Taxes2,123 212 2,344 2,286 855 312 Utilities1,228 741 1,330 1,120 746 636 Security0 312 0 0 0 0 Telephone632 172 541 0 681 67 Gardening &541 0 890 653 2,280 480 landscapingLicenses644 0 610 0 0 0 Management fees0 0 519 0 425 0 Paint2,434 0 841 0 390 0 Pest control255 0 983 0 239 0 Plumbing223 0 409 0 289 0 Security647 0 0 0 513 0 Move0 0 0 0 0 969 Snow removal0 0 0 0 0 25 Depreciation13,354 13,354 13,354 13,354 0 0 Net Profit(25,674)(18,025)(30,049)(19,001)(10,231)(1,548)Pre-Pals1111996 Tax Ct. Memo LEXIS 577">*580 F STREET (SACRAMENTO) DUPLEX RENTAL198919901991ReportedAllowedReportedAllowedReportedAllowedIncome$ 12,614 $ 12,614$ 14,604 $ 14,604$ 15,000 $ 15,000(Rent & royalty)Advertising124 0418 0214 0Auto/travel780 51820 00 0Cleaning/896 270672 150620 0maintenanceInsurance351 352356 356375 363Mortgage interest3,448 03,553 00 0paid to bks.Legal & other0 0690 0582 0professionalfeesRepairs5,068 1,3084,127 01,844 338Supplies635 2411,029 02,342 123Taxes2,390 1,2552,592 02,690 2,660Utilities1,711 8391,520 1,1061,619 1,374Gardening/658 0743 536781 480landscapingLicense/tax630 541521 0280 0Management fees1,241 3601,091 40820 0Paint2,146 3181,682 0417 0Pest control209 1201,120 0212 0Plumbing/repair756 0296 0180 0Security510 39723 0611 0Telephone0 0210 0298 Maintenance0 00 1500 0Glass0 00 560 0Other0 00 2640 0Garage0 00 1,0350 0Fence0 00 0192 0Accounting0 01,035 01,100 0Depreciation4,429 4,6224,429 4,7604,430 4,667Net Profit(13,368)2,298(13,023)6,150(4,607)4,995Pre-Pals1Respondent's auditor reduced/disallowed the amounts claimed by petitioners primarily on the basis of failure to substantiate. In some instances, the amount was reduced/disallowed on the basis that either the expenditures involved were personal in nature or petitioners failed to indicate the reason the expenditures were claimed. Miscellaneous Employee Business ExpensesFor each of the years under consideration, petitioners claimed a deduction for miscellaneous employee business expenses on Schedule A of their tax returns. The following table shows the items of expenses claimed by petitioners, and the amounts allowed by respondent, for each of the years under consideration: 198919901991ReportedAllowedReportedAllowedReportedAllowedAuto$  7,0200$  7,0200$  7,0200Other asset--119$  7756,015$  1,63243$  1,459depreciationOffice expenses8,252018,922000Promotion1,96200000Storage and rent18,400018,340018,3400Equipment8,00000000Conferences13,764010,349000Legal &16,61019,9162,6654,08039,28127,980accountingAdvertising6,7506,7500000pamphletTax return prep.689639000685Dues & pubs.002,56708400Maintenance003,66804,0261,461Education00006,2570Leasehold impr.0012,50019,61612,50019,287Moving00002,2120Total81,56628,08082,04625,32890,51950,872The 1996 Tax Ct. Memo LEXIS 577">*582 office and storage expenses relate to Dr. Novick's use of petitioners' residence to store medical records and equipment from Dr. Novick's previously dissolved professional corporation. (During the years under consideration, Dr. Novick did not conduct his medical practice, nor did he see patients, in his home.) The stored medical records were those of so-called inactive patients -- patients that Dr. Novick had not seen within 3 years. The medical equipment stored in petitioners' residence was equipment that Dr. Novick had used in his prior medical practice and was not needed by Sacramento Sierra Medical Group, Dr. Novick's employer during all years under consideration. Petitioners determined that 30 percent of their home was used for storage of Dr. Novick's medical records and equipment. They calculated the office/storage expenses by taking 30 percent of their home mortgage payments, interest, taxes, insurance, maintenance, and utilities. Petitioners also claimed a deduction for home mortgage interest and real estate taxes on Schedule A of their tax returns, thereby double counting these items. The parties stipulated that petitioners' home office/storage was not for the convenience 1996 Tax Ct. Memo LEXIS 577">*583 of Sacramento Sierra Medical Group. The automobile expenses relate to an automobile that Mrs. Novick purportedly used to transport medical files, charts, and x rays from petitioners' home to Dr. Novick's medical office. Petitioners allocated 90 percent of the automobile for business use and 10 percent for personal use. Dr. Novick received reimbursement from his employer for claimed employee business expenses. Petitioners presented no documentation at trial to substantiate any of the disallowed miscellaneous employee business expenses. Charitable ContributionsFor each of the years under consideration, petitioners claimed a deduction for charitable contributions. The following table shows the amounts of charitable contributions claimed by petitioners, and the amounts allowed and disallowed by respondent, for each of the years under consideration: 198919901991Claimed$ 15,145$ 21,111$ 25,443Allowed13,42115,45018,931Disallowed (at issue)1,7245,6616,502Petitioners presented no documentation at trial to substantiate their claims for charitable contributions in excess of those allowed by respondent. Investment InterestPetitioners claimed a $ 15,000 investment interest deduction on their 1996 Tax Ct. Memo LEXIS 577">*584 1990 tax return which was disallowed by respondent. As best we can glean from the record (which with respect to this item is inadequate), the deduction relates to interest on a $ 50,000 loan secured by a life insurance policy with General Services Life Insurance Co. Respondent allowed petitioners a deduction for $ 7,500 (as a personal interest expense) of the $ 15,000 claimed. Petitioners presented no documentation at trial to substantiate their claim for the investment interest expense deduction. Preparation of Tax ReturnsPetitioners' tax returns for each of the years under consideration were prepared by their accountant, Donald Fenton. Mr. Fenton prepared the returns by entering the information provided to him by petitioners. Mr. Fenton did not receive documentation to verify or substantiate the deductions claimed by petitioners; he took the list of expenses they provided to him at face value. Mr. Fenton was not aware that some of the employee business expenses claimed by petitioners were, in actuality, reimbursed by Dr. Novick's employer. OPINION Deductions are a matter of legislative grace. New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 292 U.S. 435">440 (1934). Taxpayers bear the burden 1996 Tax Ct. Memo LEXIS 577">*585 of establishing that they are entitled to the claimed deductions. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 290 U.S. 111">114 (1933). This includes the burden of substantiating the amount and purpose of the item claimed. Sec. 6001; Hradesky v. Commissioner, 65 T.C. 87">65 T.C. 87, 65 T.C. 87">90 (1979), affd. per curiam 540 F.2d 821">540 F.2d 821 (5th Cir. 1976); sec. 1.6001-1(a), Income Tax Regs.Petitioners claim that respondent's notice of deficiency is "uninformative", and "therefore respondent has the burden of producing evidence from which the petitioners' tax liability can be determined". Petitioners' claim is without merit. While respondent's notice of deficiency to petitioners is not a model of clarity, nonetheless, it is not uninformative. Moreover, Rule 142 places the burden of proof on petitioners, except in situations not relevant herein. "This burden is a burden of persuasion; it requires * * *[petitioners] to show the merits of [their] claim by at least a preponderance of the evidence." Rockwell v. Commissioner, 512 F.2d 882">512 F.2d 882, 512 F.2d 882">885 (9th Cir. 1975), affg. T.C. Memo. 1972-133. Where the Commissioner has made a deficiency determination denying the taxpayer's entitlement to a claimed deduction (such as here), "the taxpayer 1996 Tax Ct. Memo LEXIS 577">*586 has 'the burden of producing enough evidence to rebut the deficiency determination and the burden of persuasion in substantiating a claimed deduction'." Goldberg v. United States, 789 F.2d 1341">789 F.2d 1341, 789 F.2d 1341">1343 (9th Cir. 1986) (quoting Valley Title Co. v. Commissioner, 559 F.2d 1139">559 F.2d 1139, 559 F.2d 1139">1141 (9th Cir. 1977), revg. and remanding T.C. Memo. 1975-48). Schedule E Rental LossesSection 212 provides a deduction for all ordinary and necessary expenses paid or incurred during the taxable year with respect to the management, conservation, or maintenance of property held for the production of income. However, the taxpayer must be able to provide verification or substantiation for any deduction claimed with respect to such expenses. In the case before us, no documentation was introduced to substantiate any of the disallowed rental expenses. Indeed, Dr. Novick and Mr. Fenton admitted that they did not have any documents to substantiate the disallowed rental deductions.  The only evidence in the record offered to support the disallowed rental expenses relating to the Texas rental was Dr. Novick's testimony with regard to the automobile and travel expenses. Dr. Novick testified that in 1989, petitioners and their 1996 Tax Ct. Memo LEXIS 577">*587 three children (ages 1, 7, and 14) took a trip to inspect the Texas property and to show petitioners' children the property lines of the property they would one day inherit. The only evidence in the record to support the disallowed rental expenses relating to the Tahoe property was Dr. Novick's testimony that because the Tahoe property was a cedar house, it had to be pressure-sealed with sealant oil each year. No testimony or documentation was offered as to the cost for this treatment. The evidence offered by petitioners with respect to establishing their entitlement to the deduction for rental activity losses was woefully short of that required. Petitioners neither produced enough evidence to rebut respondent's deficiency determination nor produced enough evidence to satisfy their burden of persuasion. Consequently, petitioners are not entitled to any Schedule E rental expenses in excess of those allowed by respondent. Miscellaneous Employee Business ExpensesPetitioners introduced no documentation to substantiate any of the disallowed miscellaneous employee business expenses for any of the years under consideration. Nor was there any meaningful testimony to support petitioners' 1996 Tax Ct. Memo LEXIS 577">*588 entitlement to the claimed employee business expenses. With respect to the claimed office and storage expenses (which relate to Dr. Novick's use of petitioners' residence to store medical records of inactive patients and certain medical equipment), petitioners failed to come within any of the exceptions provided by section 280A(c) to the general rule denying a deduction for home office expenses. 31996 Tax Ct. Memo LEXIS 577">*589  We specifically note that (1) petitioners stipulated that the use of their home as an office/storage was not for the convenience of Dr. Novick's employer (thus, petitioners do not come within the exception under section 280A(c)(1)), and (2) the only items stored at petitioners' home were medical equipment and files (thus, petitioners do not come within the exception under section 280A(c)(2)).  With respect to the claimed depreciation on the automobile that Mrs. Novick purportedly used to transport medical files, charts, and x rays from petitioners' home to Dr. Novick's medical office, we note that Mrs. Novick 1996 Tax Ct. Memo LEXIS 577">*590 was not an employee of either Dr. Novick or Sacramento Sierra Medical Group, nor was the use of the car for that purpose required as a condition of her husband's employment. Thus, even assuming arguendo the automobile was used 90 percent for such purposes, the depreciation would not be deductible. See sec. 280F(d)(3). Moreover, even if Dr. Novick used the automobile for such purposes, that use still would not be deductible, as there was no evidence introduced to show that Sacramento Sierra Medical Group (Dr. Novick's employer) required as a condition of Dr. Novick's employment that Dr. Novick transport the medical files to and from his home. Further, petitioners stipulated that the storage of the medical records at their home was not for the convenience of Dr. Novick's employer. Petitioners claimed employee business expenses other than the home/office and automobile expenses which were disallowed by respondent. Dr. Novick received reimbursement from his employer  for some of these expenses. Mr. Fenton was not aware of the reimbursement when he prepared petitioners' tax returns. Respondent's determination with respect to the disallowed miscellaneous employee business expenses for each 1996 Tax Ct. Memo LEXIS 577">*591 of the years under consideration is sustained. Charitable ContributionsSection 170 allows a deduction for charitable contributions, but only if verified pursuant to regulations. In the case at bar, petitioners had no documentation to verify (substantiate) their claims for charitable contributions in excess of those allowed by respondent. Because the disallowed deductions have not been verified, petitioners are not entitled to them. Investment InterestPetitioners claimed a $ 15,000 deduction for investment interest on their 1990 tax return. Petitioners presented no evidence to substantiate this deduction. Nonetheless, respondent allowed petitioners $ 7,500 of the $ 15,000 claimed. Because petitioners failed to satisfy their burden of proof with respect to the remaining $ 7,500, we sustain respondent's determination in this regard. Accuracy-Related PenaltyRespondent determined that petitioners were negligent with respect to the preparation of their 1989-91 returns and accordingly determined that they are liable for the accuracy-related penalty under section 6662(a) for each of the years under consideration. The accuracy-related penalty is equal to 20 percent of any portion of an underpayment 1996 Tax Ct. Memo LEXIS 577">*592 attributable to the taxpayer's negligence or disregard of rules or regulations. Sec. 6662(a) and (b)(1). Negligence is defined as the failure to exercise the due care that a reasonable, prudent person would exercise under similar circumstances. Zmuda v. Commissioner, 731 F.2d 1417">731 F.2d 1417, 731 F.2d 1417">1422 (9th Cir. 1984), affg. 79 T.C. 714">79 T.C. 714 (1982); Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">947 (1985). A taxpayer has the burden of proving that the Commissioner's determination is in error. Rule 142(a); Luman v. Commissioner, 79 T.C. 846">79 T.C. 846, 79 T.C. 846">860-861 (1982). Petitioners claim they were not negligent because the returns for the years under consideration were prepared by an accountant. However, reliance on professional advice, by itself, is not an absolute defense to negligence. A taxpayer must first demonstrate that his reliance was reasonable.  Freytag v. Commissioner, 89 T.C. 849">89 T.C. 849, 89 T.C. 849">888 (1987), affd. 904 F.2d 1011">904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868">501 U.S. 868 (1991). In the case at bar, Mr. Fenton, petitioners' accountant, acted merely as a scrivener; he did not audit or verify the information given him by petitioners. Hence, we do not accept petitioners' reliance on a professional advice defense. Giving consideration to all 1996 Tax Ct. Memo LEXIS 577">*593 the facts before us, we conclude that petitioners were negligent and that they disregarded rules and regulations with respect to the preparation of their 1989-91 tax returns: They double deducted home mortgage interest and real estate taxes; they claimed a $ 15,000 investment interest expense when they had documentation indicating that, at best, they were entitled to a $ 7,500 interest deduction; they claimed miscellaneous employee business expenses for which Dr. Novick had been reimbursed by his employer; they overstated expenses related to their rental activities; and they failed to maintain adequate records. Consequently, we sustain respondent's determination that petitioners are liable for the accuracy-related penalty on  the amount of the underpayment for 1989, 1990, and 1991. To reflect concessions by respondent, Decision will be entered under Rule 155.  Footnotes1. The stipulation of facts and the accompanying exhibits are incorporated by this reference.↩2. Pursuant to sec. 469(a), a passive activity loss is generally not allowed as a deduction for the year sustained. Sec. 469(d)(1) defines a passive activity loss as the amount by which (A) the aggregate losses from all passive activities for the taxable year exceed (B) the aggregate income from all passive activities for that year. Passive activities are those activities that involve the conduct of a trade or business in which the taxpayer does not materially participate. Sec. 469(c)(1). Rental activity ordinarily is treated as a passive activity irrespective of whether there is material participation. Sec. 469(c)(2), (4).1. No explanation was given for the mathematical discrepancy.↩3. Sec. 280A provides generally that no deduction is allowable with respect to the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence. Sec. 280A(c) provides exceptions to this general rule. Pursuant to sec. 280A(c)(1), a taxpayer may deduct an otherwise allowable item of expense allocable to the portion of a taxpayer's personal residence which is used exclusively on a regular basis: (A) [as] the principal place of business for any trade or business of the taxpayer, (B) as a place of business which is used by patients, clients, or customers in meeting with the taxpayer in the normal course of * * * [the taxpayer's] trade or business, or (C) in the case of a separate structure which is not attached to the dwelling unit, in connection with the taxpayer's trade or business.However, where the taxpayer is an employee, the exclusive use requirement set forth above must be for the convenience of the taxpayer's employer. Sec. 280A(c)(2) permits a taxpayer to deduct an otherwise allowable item of expense with respect to the use of a taxpayer's personal residence "which is used on a regular basis as a storage unit for the inventory of the taxpayer held for use in the taxpayer's trade or business of selling products at retail or wholesale, but only if * * * [the personal residence] is the sole fixed location of such trade or business."↩