T.C. Memo. 1995-456
UNITED STATES TAX COURT
WORLD OF SERVICE, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
FEELIN' GREAT, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 4338-87, 4341-87. Filed September 26, 1995.
Chris H. Johnson, an officer, for petitioners.
Michael A. Pesavento, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: Respondent determined deficiencies in and
additions to petitioners' corporate income tax as follows:
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World of Service, Inc.--Docket No. 4338-87
Additions to Tax
Sec. Sec. Sec.
Year Deficiency 6653(a)(1) 6653(a)(2) 6661
1
1982 $21,848 $1,092 $5,462
1
1983 79,134 3,957 19,784
1
1984 88,404 4,420 22,101
1
50 percent of the interest due on the deficiency.
Feelin' Great, Inc.--Docket No. 4341-87
Additions to Tax
Sec. Sec. Sec.
FYE Deficiency 6653(a)(1) 6653(a)(2) 6661
1
1983 $160,895 $8,045 $40,224
1
1984 74,039 3,702 18,010
1
50 percent of the interest due on the deficiency.
After the parties' concessions, the issues remaining for our
consideration are: (1) Whether petitioners have shown that they
are entitled to various deductions in excess of the amounts
allowed by respondent; and (2) whether petitioners are liable for
additions to tax under sections 6653(a)(1) and (2) and 6661.1
FINDINGS OF FACT2
Petitioners, World of Service, Inc. (Service), and Feelin'
Great, Inc. (Great), are Florida corporations, and Chris H.
Johnson (Mr. Johnson) was president of each corporation at all
relevant times. At all relevant times, Mr. Johnson and his wife,
1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years in issue. Rule
references are to this Court's Rules of Practice and Procedure.
2
The parties' stipulation of facts and exhibits are
incorporated by this reference.
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Vickie L. Johnson, jointly owned 100 percent of the stock of
Service. Personal Elegance (Elegance) was 100 percent jointly
owned by the Johnsons, and Elegance, in turn, owned 100 percent
of Great. Each petitioner had its principal place of business in
Florida at the time of the filing of the petition. Mr. Johnson
had earned an associate's degree3 in tax and accounting.
Great provided educational services and seminars about
nutrition. Service provided business and computer services to
Great and to a related corporation. Service was on the accrual
method of accounting for Federal tax purposes and filed on a
calendar year basis. Great was also on the accrual method of
accounting for Federal tax purposes, yet filed on the basis of a
fiscal year ending (FYE) July 31.
Mr. Johnson had been associated with Glen Turner (Turner), who,
through seminars, promoted self-improvement. Turner also
promoted and franchised his operations during the 1960s and
1970s. After Turner had legal difficulties, Mr. Johnson
continued on his own in the same field, beginning around 1975.
Mr. Johnson established Elegance, a company that marketed
specialty gifts. That operation developed into the 1980
formation of Great, which held seminars on "self-improvement" and
marketed vitamins, nutritional products, health care products,
exercise programs, and the like.
3
We assume this was a 2-year, rather than a 4-year, college
degree.
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In the early 1980s, Great's business area covered the States of
Florida, Georgia, and Alabama. By 1982, Great was operating
(i.e., holding seminars) in about 26 States. Throughout the
years in controversy, Service's principal place of business was
in the Johnsons' residence. The Johnsons' residence, a three-
bedroom condominium, contained 1,600 square feet of usable space,
of which 320 square feet was used exclusively for Service's
business purposes. In addition, the Johnsons' two-car garage
contained 300 square feet, with an equal amount of attic storage
area above the garage. Of the 600 total square feet of combined
garage area, 400 square feet was used exclusively for business
purposes. The Johnsons' residential telephone was listed in
Service's name. Service's checks contained the Johnsons'
residence address. During this period, Great had a separate
principal place of business and office in a commercial location
outside of the Johnsons' residence.
Service paid the Johnsons' residential mortgage payments of
$5,043 and $5,400 during 1982 and 1983, respectively. Service
deducted $1,443 and $1,800 on its 1982 and 1983 income tax
returns for use of the Johnsons' residence. For those same
years, the Johnsons reported $3,600 in income for Service's use
of the residence, because the mortgage was paid by Service.
Respondent determined that only 10 percent of the residence was
used for business purposes and disallowed the mortgage and other
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deducted expenditures related to the condominium in excess of 10
percent.
Service also deducted $2,101, $2,178, and $5,018, and
respondent disallowed $1,284, $1,362, and $3,403 for 1982, 1983,
and 1984, respectively. These deductions were for utilities,
trash removal, pest control, telephone, etc. The largest portion
of these amounts was attributable to telephone expenses.
Service made the following expenditures, which were deducted in
the tax year paid and were disallowed by respondent as being
without a business purpose:
Date Payee Amount
05/19/82 Baby Safety Industries $225
10/03/82 Dicker & Dicker of Beverly Hills 1,915
1
11/08/83 Dicker & Dicker of Beverly Hills 15,020
1
Only $14,154 of this amount was included in Service's cost
of goods sold.
Four different styles of mink coats had been purchased from
Dicker & Dicker of Beverly Hills, a furrier. Some of the fur
coats were used by Great for business purposes; however,
petitioners have failed to show that the coats purchased during
1982 or 1983 were used for business purposes. A "Wanda chair"
had been purchased from Baby Safety Industries to be given, as
a gift, to the owner of a company from which Service was to
obtain technology for its computer operations.
Service leased a Mercedes-Benz automobile, paying $915 per
month. During 1983 and 1984, Service deducted, and respondent
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disallowed for lack of a business purpose, the auto lease
payments in the total amounts of $11,347 and $11,151,
respectively. This automobile was used, in part, for business
and, in part, for personal purposes. For 1982, 1983, and 1984,
Service deducted, and respondent disallowed for lack of
business purpose, $2,631, $2,513, and $8,717 of expenditures in
connection with the maintenance and operation of a 1977
Eldorado. During the period under consideration, three
automobiles were used by the Johnsons in connection with the
businesses: The 1977 Eldorado, the leased Mercedes-Benz, and a
1980 Buick. The automobiles were used for both business and
personal purposes.
During 1983, Service purchased a beach condominium (beach
condo) for about $140,000. Improvements and furnishings of
approximately $20,000 to $22,000 were added. The Johnsons
occasionally used the beach condo for personal use. Service
claimed $1,057 for 1983 as "Mortgage Service Expense", and the
claimed amount consisted of loan prepayments, transfer stamp
tax, and related fees in connection with the purchase of the
beach condo. Respondent disallowed the amount for lack of a
business purpose. Service, in connection with the beach condo,
deducted $7,186 and $410 for 1983 and 1984, respectively, for
decorating. Of the $7,186, $1,904 was allowed by respondent
because it was for decorating corporate offices, and the
remainder of these amounts, which involved the beach condo,
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were disallowed for lack of a business purpose. Service, for
1984, paid and deducted other amounts connected with the beach
condo, which respondent disallowed. For 1984, Service deducted
$1,362 as association fees, part of which was for the beach
condo and part of which was for the Johnsons' residence.
Respondent allowed $57, representing 10 percent business use of
the residence, and the remainder was disallowed for lack of a
business purpose.
For 1982, Service deducted the amount of certain MasterCard
charges that were designated as "Seminar Training Program
Costs" and disallowed by respondent for lack of a business
purpose. For 1982, 1983, and 1984, Service deducted $2,172,
$2,008, and $1,797 for dues, subscriptions, and memberships,
including the annual condominium fee of $720 for the Johnsons'
residence. Respondent, asserting the lack of a business
purpose, disallowed $2,076, $1,903, and $1,732 of the these
amounts (10 percent of the condominium fees were allowed).
Service deducted $6,891, $8,800, and $7,694 for automobile
insurance expenses, and respondent disallowed, for lack of a
business purpose, $6,801, $8,470, and $7,609 (10 percent of the
fees that related to the condominium were allowed).
Service also deducted for the years 1982, 1983, and 1984
travel, meals, lodging, convention, and entertainment expense
amounts totaling $8,671, $6,276, and $19,443, and respondent
disallowed, for lack of a business purpose, all but $180 for
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the 1984 year. Mr. Johnson did extensive traveling on behalf
of the corporations in connection with the promotional
activity. He would travel, entertain, and incur expenses that
were paid with either a credit card or cash. After 1, 2, or
sometimes 3 months' accumulation of receipts, Mr. Johnson would
go through the receipts and mark their purpose. All of the
Johnsons' bills, both personal and business, were paid by the
corporations. At the end of each year, the amount for a
particular category (e.g., gasoline) would be totaled, and Mr.
Johnson would make a judgment call about the percentage of
business and personal use of that item.
Service deducted and respondent disallowed for lack of a
business purpose $858 and $2,222 for 1982 and 1983 as medical
expenses and insurance for the Johnsons. For 1984, Service
deducted (as a bonus) and respondent disallowed (for lack of a
business purpose) the purchase of 30,000 shares of stock in the
name of the Johnsons' minor child for $4,500. Mr. Johnson
testified that the $4,500 was part of reported compensation
from Service to him, yet no substantiation was provided to
support Mr. Johnson's testimony.
For 1984, Service deducted, as a bad debt, $56,000, which
amount comprised loans to Linda Krabill, Kent Oaks, and Ed
Rector. Some of the loans had been made in 1984 and some in
1985, but all were claimed to have been made in 1984. Linda
Krabill was an interior decorator who worked for the Johnsons
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when they decorated the beach condo. The Johnsons lent her
approximately $45,000 of corporate funds because she was having
financial difficulties. Mr. Johnson's instructor-trainer
(personal trainer), Kent Oaks, was also having financial
difficulties, and Mr. Johnson lent him about $2,500. Finally,
Ed Rector was a person Mr. Johnson had met in connection with
Glen Turner's activities. Mr. Rector, who was then involved in
litigation, borrowed over $10,000 from Mr. Johnson. No efforts
were made to collect these loans during the years under
consideration. Respondent disallowed these items due to Mr.
Johnson's failure to show that they were debts and that they
became worthless.
For 1982, Service deducted $7,190 for fees incurred in
representing the Turner family children's trust, of which Mr.
Johnson was trustee, before the Internal Revenue Service.
Respondent disallowed the deduction for lack of a business
purpose. For 1983, Service deducted $5,194 for fees, of which
$2,777 was disallowed for lack of business purpose because it
represented fees for a partition suit by Mrs. Johnson. For
1984, Service deducted $32,185 of legal fees, and respondent
disallowed $14,988, as representing some personal legal matters
of Mrs. Johnson and Ed Rector.
Service, for 1982, 1983, and 1984, deducted depreciation
totaling $7,130, $11,773, and $25,197, and respondent
disallowed $5,430, $10,073 and $24,397 as attributable to
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nonbusiness property (including a General Motors Corp. (GMC)
truck, 1980 Buick, copper sculpture, and the beach condo). The
GMC truck had been purchased with the intent to use it in the
Service and Great businesses; however, it was not suitable.
Mr. Johnson allowed the GMC truck to be used on a farm by his
father, which was not shown to be for a business purpose of
Service. Mr. Johnson's father purchased gasoline with an AMOCO
gasoline credit card in the general vicinity of his home in
Dunn, North Carolina, for personal use of the GMC truck.
Service, for 1982, 1983, and 1984, claimed net operating loss
carryover deductions from 1981 in the amounts of $143,814,
$134,401, and $30,851, respectively, and respondent disallowed
them because the 1981 tax year, after controversy and
settlement by the parties, resulted in an income tax deficiency
and no amount of carryover loss. Service, for 1984, claimed
investment tax credit carryovers from 1982 and 1983 in the
amounts of $659 and $2,226, respectively, which respondent
disallowed as being attributable to nonbusiness property (a GMC
truck and beach condo furniture).
Great, for its FYE July 31, 1983, treated $5,000 as part of
its cost of goods sold for the purpose of making copies of 24
promotional tapes. The old tapes had become worn from use.
Great, for 1982, included $39,627 as part of its cost of goods
sold, for convention expenses, and respondent disallowed $158
as not being an ordinary and necessary business expense.
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Great deducted $166,162 and $105,905 for its FYE July 31,
1983 and 1984, for film and video fees. These deductions were
allegedly for inspirational films that had been made by
individuals, such as Vince Lombardi. Great's deduction was
based on an alleged agreement, under which Great was to pay 3
percent of sales for the rental of the films. Because Great
was on the accrual method of accounting, the amounts were
projected, and deductions were taken on Great's tax returns.
Some of the films were otherwise available and were in the
public domain. Rights to the films were allegedly in a company
in Barbados. Great did not make any payments with regard to
the alleged film rentals. Respondent disallowed these amounts
because they were not incurred. Great, for its years ended
July 31, 1983 and 1984, deducted $330,536 and $529,321 for
seminars, and respondent disallowed $10,907 and $17,468,
respectively. Respondent's agent was not provided with any
documentation for the seminar deductions for the years at
issue. The agent concluded that 96.7 percent was allowable in
each year based on prior years' audit experience where
documentation was provided and audited. Petitioners did not
provide documentation at trial that would show that
respondent's determination was in error.
Great, for its FYE July 31, 1983, deducted $170,147 for
travel, meals, and entertainment. Respondent reviewed
$65,298.85 of the claimed amount and disallowed $19,382.46, or
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about 30 percent of the sample reviewed. Respondent overlooked
the travel deduction for the FYE July 31, 1984, and made an
error with respect to the FYE July 31, 1983, travel adjustment.
Respondent's agent sampled or reviewed $65,298.85 of the
$170,147 deducted for travel. The review resulted in a 30-
percent disallowance rate, which the agent mistakenly applied
to the $65,298.85 sample rather than the $170,147 amount
claimed. For its FYE July 31, 1983 and 1984, Great deducted
interest expenses in the amounts of $60,101 and $40,474, and
respondent disallowed $56,516 and $28,800, respectively. The
majority of the disallowance was attributable to a transaction
involving Tipuani Limited Partners (Tipuani). Petitioners did
not show that interest was paid in connection with the Tipuani
transaction. The remainder of the claimed interest was
attributable to payments on debt secured by the company
airplane, which respondent allowed. Great had reported income
in connection with Tipuani, and respondent reduced the $212,000
reported to $125,000. The income was attributable to
forgiveness of indebtedness regarding promissory notes to
Tipuani.
For its FYE July 31, 1983, Great deducted $9,654 as bad
debts, and respondent disallowed $4,800 as already having been
deducted as professional fees, insurance, etc. For its FYE
July 31, 1983 and 1984, Great deducted $126,771 and $227,915
for airplane and pilot fees, and respondent disallowed $812 of
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the 1983 amount for lack of substantiation and business
purpose. For 1982 and 1983, Great deducted $530,667 and
$351,983 in net operating loss carryover deductions from the
FYE July 31, 1982. Respondent disallowed the claimed loss
deductions because Great had been the subject of an audit for
years prior to those now before the Court. In a case involving
the prior years which was pending before this Court, the same
net operating losses were eliminated due to the parties' agreed
settlement. Great had agreed to an income tax deficiency,
rather than a loss, in the earlier case.
ULTIMATE FINDINGS OF FACT
1. Service, for each of its 3 taxable years, is entitled to
deduct 20 percent of the costs and expenses connected with the
business use of the Johnsons' residence (condo) including the
utilities, with the exception of the cost of telephone service,
for which Service is entitled to deduct 75 percent for 1982 and
1983 and 100 percent for 1984. Service is also allowed to
deduct 20 percent of the condominium association fees, rather
than the 10 percent allowed by respondent.
2. Service is not entitled to deduct any expenses,
depreciation, or other claimed amounts connected with the beach
condo, including decorating and furnishing expenditures and
association and condo fees. The $1,057 that Service claimed
for 1983 as "Mortgage Service Expense" for closing costs on the
beach condo is not deductible.
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3. The Mercedes-Benz, Buick, and Eldorado automobiles were
used one-half for business and one-half for personal purposes
during the years in controversy. One-half of the amounts
claimed by Service for depreciation, gasoline, and repairs and
maintenance of those automobiles is deductible. It has not
been shown that any portion of disallowed claimed foreign
travel was deductible for business purposes of Service or
Great.
4. The GMC truck was not used for business purposes during
the years in controversy. No depreciation or tax credits are
allowable for the GMC truck. Gasoline purchased with the AMOCO
credit card within North Carolina is not deductible because it
was purchased for the personal use of the GMC truck by Mr.
Johnson's father.
5. Service purchased a Wanda chair from Baby Safety
Industries for $225 as a gift for a business purpose. That
amount is deductible for Service's 1982 tax year.
6. It has not been shown that the fur coats purchased from
Dicker & Dicker of Beverly Hills during 1982 or 1983 were for a
deductible business purpose.
7. Petitioners have not shown that they are entitled to any
of the claimed net operating loss deductions or tax credit
carryovers for the taxable years under consideration.
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8. It has not been shown that the $4,500 that Service
deducted for stock purchased in the name of the Johnsons' minor
child was purchased for a business purpose.
9. The $56,000 that Service paid to Linda Krabill, Kent
Oaks, and Ed Rector, claimed as bad debts for 1984, were all
nonbusiness personal loans. It has not been shown that those
loans were uncollectible as of the end of the taxable year
1984. No part of the $56,000 is deductible for the 1984 tax
year.
10. It has not been shown that the legal fees claimed by
Service are allowable in amounts greater than those allowed by
respondent.
11. Service has not shown that it is entitled to the $1,063
deduction for "Seminar Training Program Costs" during 1982.
12. Service has not shown that it is entitled to the
deductions of $2,172, $2,008, and $1,797 claimed for 1982,
1983, and 1984 for "Dues & Subscriptions and Memberships and
Tuitions".
13. Of the $6,891, $8,800, and $7,694 claimed for
"Automobile and Automobile Insurance" for 1982, 1983, and 1984,
Service is entitled to deduct 20 percent of the homeowner's
insurance on the Johnsons' residence and an additional $1,000
each year for auto insurance.
14. Service has not shown that it is entitled to any portion
of the $8,671, $6,276, and $19,264 of the expenses for "Travel
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Meals & Lodging and Convention and Entertainment" disallowed by
respondent for 1982, 1983, and 1984, respectively.
15. Service has not shown that it is entitled to deduct $858
and $2,222 for 1982 and 1983 for "Medical Benefits Insurance".
16. Great is entitled to deduct the $5,000 incurred in
making copies of promotional tapes.
17. Great is not entitled to deduct the $166,162 and
$105,905 for its FYE July 31, 1983 and 1984, claimed for film
rentals.
18. Great has not shown that it is entitled to deduct
seminar expenses for its FYE July 31, 1983 and 1984, in amounts
greater than $319,629 and $511,853, respectively.
19. Great has not shown that it is entitled to deduct
travel expenses for its FYE July 31, 1983, in excess of the
$150,764.54 allowed by respondent.
20. Great has not shown that it is entitled to deduct, for
its FYE July 31, 1983 and 1984, interest expense in excess of
$3,585 and $11,674, respectively.
21. Great, for its FYE July 31, 1983, is not entitled to
deduct bad debts in excess of the $4,854 allowed by respondent.
22. Great has not shown that it is entitled to deduct in
excess of the $39,469 that it claimed for its FYE July 31,
1983, for "Convention Expenses".
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23. Great has not shown that it did not realize income from
forgiveness of indebtedness due to the cancellation of
promissory notes due to Tipuani.
24. Great has not shown that it is entitled to the $812 of
aircraft and pilot fees disallowed by respondent for the FYE
July 31, 1983.
25. Petitioners failed to keep adequate records of their
deduction items.
OPINION
Regarding those items on which the parties could not settle,
the trial of this case covered 5 taxable years of the two
corporate petitioners. Numerous deduction items were in
controversy, and we have reviewed the record with respect to
each of them and made specific and ultimate findings for each.
In this portion of the opinion, we express the standards under
which petitioners' controverted items were judged, and we
analyze and make additional ultimate findings regarding the
additions to tax with respect to both petitioners.
Petitioners bear the burden of proving that they are entitled
to the deductions claimed, or of showing that respondent erred
in the determination. Rule 142(a); New Colonial Ice Co. v.
Helvering, 292 U.S. 435, 440 (1934). In addition, petitioners
are required to maintain adequate records to substantiate their
claimed deductions. Sec. 6001. Petitioners were closely held
corporations owned and operated by the Johnsons. The
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businesses marketed and promoted family seminars about "self-
improvement", vitamins, nutritional products, health care, and
exercise programs. There was a substantial amount of travel
involved. Petitioners, for one reason or another, did not have
complete documentation on numerous items. For example, a
receipt that shows the purchase of gasoline might not indicate
whether the expenditure was one for business or personal.
Compounding these problems was the practice of causing
petitioner corporations to pay both their business and the
Johnsons' personal expenditures, which were accumulated and
divided by estimations at yearend.
The trial evidence consisted of two major components: (1)
The documentation used by respondent's agent during the audit,
and (2) Mr. Johnson's testimony (which petitioners offered to
expand on situations where the documents fell short). Mr.
Johnson was, in several instances, unable to distinguish items
in the available documentation without further information;
this information was not forthcoming. In this regard,
testimony of a controlling shareholder involving corporate
activities has been carefully scrutinized. Alterman Foods,
Inc. v. United States, 505 F.2d 873, 877 (5th Cir. 1974).4
4
The U.S. Court of Appeals for the Eleventh Circuit has
adopted, as binding precedent, decisions of the U.S. Court of
Appeals for the Fifth Circuit issued prior to Oct. 1, 1981.
Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11th Cir. 1981).
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Most of the claimed deductions were disallowed by respondent
due to petitioners' lack of business purpose. In that regard,
section 162 governs the deductibility of business expenses. It
allows a deduction for "all the ordinary and necessary expenses
paid or incurred during the taxable year in carrying on a trade
or business". To be "ordinary" the expense must have a
reasonably approximate relationship to the operation of a
taxpayer's trade or business. Challenge Manufacturing Co. v.
Commissioner, 37 T.C. 650, 660 (1962). To be "necessary" the
expense must be appropriate or helpful. Commissioner v.
Heininger, 320 U.S. 467, 471 (1943). A shareholder's personal
expenses are not ordinary and necessary expenses of the
corporation. Pantages Theater Co. v. Welch, 71 F.2d 68 (9th
Cir. 1934); Challenge Manufacturing Co. v. Commissioner, supra
at 650.
It was argued that petitioners' and the Johnsons' expenses
were properly segregated and that the corporations did not
deduct the Johnsons' personal items, which were "backed-out"
and which the Johnsons reported as income. References were
made to worksheets containing the segregations, but none were
offered or received in our record.
Respondent raised the question of whether Service met the
requirements for both section 280A (business use of home) and
the holding of Commissioner v. Soliman, 506 U.S. __, 113 S. Ct.
701 (1993). However, we have found that Service's principal
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place of business was in the Johnsons' residence. Service is
not an S corporation and, accordingly, it is unnecessary to
analyze this matter under the standards of section
280A(c)(1)(A).
With respect to petitioners' claims for bad debts, section
166 permits a deduction for a debt that becomes worthless
during the taxable year. Zimmerman v. United States, 318 F.2d
611, 612 (9th Cir. 1963). Only a bona fide debt, arising from
a "debtor-creditor relationship based upon a valid and
enforceable obligation to pay a fixed or determinable sum of
money", qualifies for a deduction under section 166. Sec.
1.166-1(c), Income Tax Regs. Whether a bona fide debtor-
creditor relationship exists is a question of fact to be
determined after consideration of all the facts and
circumstances. Fisher v. Commissioner, 54 T.C. 905, 909
(1970).
Although notes were executed in connection with the amounts
given to various individuals, petitioners have not shown that a
genuine debtor-creditor relationship existed between Service
and any of the alleged borrowers. In most instances, the loans
were made through the corporation to friends or acquaintances
of the Johnsons. When the amounts were not repaid, even though
there was "evidence of indebtedness", Mr. Johnson did not want
to pursue collection from friends. Under those circumstances,
where the sole shareholder(s) of a corporation cause a
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corporation to give corporate funds to the shareholder's
friend(s) from whom they would not seek formal collection, it
is difficult to find that there was a true debtor-creditor
relationship. Just as significantly, petitioners have failed
to show that the advances were worthless during the years the
bad debt deductions were claimed.
Respondent determined additions to tax under section
6653(a)(1) and (2) and section 6661 for each taxable year in
issue. Section 6653(a)(1) provides for a 5-percent addition on
the entire underpayment if any part of the underpayment is due
to negligence or intentional disregard of rules or regulations.
Section 6653(a)(2) provides for an additional amount equal to
50 percent of the interest payable with respect to the portion
of the underpayment attributable to negligence.
Negligence is the lack of due care or failure to do what a
reasonable and ordinarily prudent person would do under the
circumstances. Neely v. Commissioner, 85 T.C. 934, 937 (1985).
Petitioners have the burden of showing that their underpayment
was not due to negligence or intentional disregard of rules or
regulations. Rule 142(a); Welch v. Helvering, 290 U.S. 111
(1933); Bixby v. Commissioner, 58 T.C. 757, 791-792 (1972).
Both petitioners failed to maintain adequate records. The
failure to properly segregate personal and business
expenditures and the method of yearend allocation further
exacerbate the inadequacy of petitioners' records. It was the
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Johnsons' and petitioners' choice to mix personal and business
records, and their failure or inability to properly show the
division is of their own making and was clearly negligent.
Stovall v. Commissioner, 762 F.2d 891, 895 (11th Cir. 1985),
affg. T.C. Memo. 1983-450; Crocker v. Commissioner, 92 T.C.
899, 917 (1989).
Further, petitioners claimed, up until the eve of trial,
amounts which had been conceded in prior proceedings. Claiming
hundreds of thousands of dollars in net operating loss
deductions, when those matters had been finally settled in
earlier years' litigation, cannot be considered reasonable or
what an ordinarily prudent person would do. Although
petitioners' returns were prepared by accountants, the Johnsons
made all judgments regarding personal or business decisions,
and they labeled various amounts for inclusion in the corporate
returns. We also note that Mr. Johnson has an associate's
degree in tax and accounting.
Under these circumstances, petitioners have failed to show
that respondent's determination was in error; hence, we find
that petitioners are liable for additions to tax under section
6653(a)(1) and (2).
Respondent determined that petitioners are liable for an
addition to tax under section 6661 for all taxable years in
dispute. Section 6661(a) provides for an addition to tax in
the amount of 25 percent of any underpayment attributable to a
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substantial understatement of income tax. An understatement is
substantial if it exceeds the greater of 10 percent of the
correct tax or, in the case of a corporate taxpayer, $10,000.
If an item is not attributable to a tax shelter, then any
understatement may be reduced by amounts attributable to items
for which a taxpayer had substantial authority or which were
adequately disclosed in the return (e.g., by attaching a
statement thereto). Sec. 6661(b)(2)(B)(i) and (ii).
Petitioners have not shown that there was substantial
authority for their tax treatment of any of the adjustments
determined by respondent. In addition, we find that
petitioners did not adequately disclose any of the adjusted
items on the returns for the period in controversy.
Accordingly, to the extent that petitioners' understatement,
for any taxable period under consideration, is substantial
within the meaning of section 6661, petitioners are liable for
the addition to tax under section 6661. To reflect the
foregoing and to reflect concessions and agreements of the
parties,
Decisions will be entered
under Rule 155.