T.C. Memo. 1997-61
UNITED STATES TAX COURT
DAVID E. AND MARY R. PRICE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7902-95. Filed February 3, 1997.
David E. Price and Mary R. Price, for petitioners.
Jennifer H. Decker, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
FOLEY, Judge: By notice of deficiency dated February 15,
1995, respondent determined deficiencies in and an addition to
petitioners' Federal income taxes as follows:
Addition to Tax
Year Deficiency Sec. 6651(a)(1)
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1990 $8,085 --
1991 12,289 $863
1992 10,239 --
Respondent has conceded that petitioners are not liable for
the section 6651(a)(1) addition to tax. In an amendment to her
answer, respondent asserted for the first time that petitioners,
pursuant to section 6662(a), are liable for negligence penalties
of $1,617, $2,458, and $2,048 for years 1990, 1991, and 1992,
respectively.
Unless otherwise indicated, all section references are to
the Internal Revenue Code for the years in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
The issues for decision are as follows:
1. Whether petitioners are entitled to claimed bad debt
deductions. We hold they are not.
2. Whether petitioners are entitled to claimed deductions
for unreimbursed partnership expenses. We hold they are not.
3. Whether petitioners, pursuant to section 6662(a), are
liable for an accuracy-related penalty for negligence. We hold
they are.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. At
the time the petition was filed, petitioners resided in Santa
Claus, Indiana.
David E. Price (petitioner) has been an attorney since 1970.
Between 1970 and 1977, he served as an attorney for the Internal
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Revenue Service in District Counsel's offices in Virginia and
Indiana. In 1978, he opened a private law practice in Dale,
Indiana. Since 1978 and during all relevant years, petitioner's
practice was conducted as a partnership known as Price & Bradley,
in which petitioner held a 51-percent interest.
In the early years of petitioner's practice, Walter Scott
Taylor, Sr., Walter Scott Taylor, Jr., and Brenda Fant Taylor
were petitioner's primary clients. The Taylors were successful
Indiana coal mine owners, and petitioner handled all of their
legal affairs.
In 1979, the Taylors acquired an interest in Speedmart, Inc.
(Speedmart), an Indiana corporation. Speedmart operated a
convenience store located in Cannelton, Indiana. The Cannelton
store had lost money every year since it opened. The Taylors
owned a majority of Speedmart's outstanding shares. Petitioner
owned 20 percent of Speedmart's shares, which he acquired as
compensation for legal services rendered.
In 1982 or 1983, the Taylors moved their residence and coal
mining activities to Alabama, and petitioner took over the day-
to-day management of Speedmart. Petitioner served as president
and a director of Speedmart. In addition, he was the manager of
the Cannelton store. Speedmart was authorized to pay petitioner
an annual salary of $18,000, but Speedmart never made any salary
payments to petitioner.
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In an attempt to make Speedmart profitable, petitioner, in
1982 and 1983, expanded Speedmart's operations from one
convenience store to five, installed gas pumps and food
concessions at each location, opened the stores 24 hours a day, 7
days per week, and hired a general manager. Even after these
changes, Speedmart continued to lose money. On June 24, 1985,
Speedmart filed for protection from creditors under chapter 11 of
the United States Bankruptcy Code. A plan of reorganization was
confirmed on June 8, 1988. Petitioner closed and sold
Speedmart's four unprofitable stores and tried to make the
remaining store profitable.
In 1990, 1991, and 1992, petitioner made several advances of
funds to Speedmart and creditors of Speedmart. Petitioner was
advised by a bankruptcy attorney that his advances to Speedmart
must be in the form of a loan. In December of 1991, petitioner
executed, on behalf of Speedmart, a one-page document entitled
"continuation of 1985 promissory note" (the 1991 Note). In it,
Speedmart promised to repay "All sums advanced in cash and
inventory". The terms called for 8-percent interest and
repayment of principal 30 days following demand.
Petitioner's effort to revive Speedmart was unsuccessful,
and the remaining store continued to lose increasing amounts of
money. In 1992, Speedmart sold the store to a competitor, and
the proceeds were used to partially repay Speedmart's priority
creditors. Unsecured creditors received no repayments.
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Petitioner claimed on his 1990, 1991, and 1992 returns
deductions relating to his 1990, 1991, and 1992 advances to
Speedmart. He reported bad debt expenses of $24,000, $34,103,
and $28,000 on his Schedules C (Profit or Loss From Business
(Sole Proprietorship)) for 1990, 1991, and 1992, respectively.
Petitioner also claimed, for 1990, 1991, and 1992, unreimbursed
partnership expenses of $500, $500, and $1,000, respectively.
On February 15, 1995, respondent issued a notice of
deficiency disallowing the claimed deductions. By amendment to
her answer, respondent asserted a negligence penalty for each
year.
OPINION
I. Bad Debt Deductions
Section 166(a) allows a deduction for debts that become
worthless during the taxable year. By contrast, capital
contributions are not deductible under section 166(a). See,
e.g., Calumet Indus., Inc. v. Commissioner, 95 T.C. 257, 284
(1990). For purposes of section 166(a), the term "debt" includes
only bona fide debts. Sec. 1.166-1(c), Income Tax Regs.
According to the regulation, "A bona fide debt is a debt which
arises from a debtor-creditor relationship based upon a valid and
enforceable obligation to pay a fixed or determinable sum of
money." Id. Consequently, we must determine whether
petitioner's advances to Speedmart were made in exchange for bona
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fide debt or equity. This is a factual determination, and
petitioner bears the burden of proof. Rule 142(a).
Petitioner has not established that the 1990, 1991, and 1992
advances were made in exchange for Speedmart's bona fide
indebtedness. A bankruptcy attorney advised petitioner that
capital contributions would violate the Bankruptcy Court's
orders. Petitioner contends that he followed this advice and
made the advances "in the form of unsecured notes". We, of
course, are not bound by the form of petitioner's transaction.
See, e.g., Gregory v. Helvering, 293 U.S. 465, 469 (1935).
Petitioner did not produce any notes or other documents
evidencing loans for which he claimed deductions in 1990, 1991,
and 1992. He did introduce the 1991 Note, but it does not
specifically reference any particular advances. Even if we were
to assume that the 1991 Note was meant to evidence transfers made
during the years in issue, petitioner did not establish, or even
assert, that he had demanded repayment and that Speedmart had
refused. In addition, Speedmart did not make interest payments
in accordance with the terms of the 1991 Note. Petitioner has
conceded that his advances were unsecured and that Speedmart was
inadequately capitalized.
After considering the factors relevant to this case, see
Dixie Dairies Corp. v. Commissioner, 74 T.C. 476, 493 (1980), and
cases cited therein, we conclude that petitioner has failed to
carry his burden of proving that he advanced funds in exchange
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for bona fide indebtedness from Speedmart. Accordingly, we
sustain respondent's determination on this issue.
II. Unreimbursed Partnership Expenses
A partner generally cannot directly deduct on his income tax
return the expenses of the partnership. See Cropland Chem. Corp.
v. Commissioner, 75 T.C. 288, 295 (1980). The exception to this
rule is where there is an agreement among the partners that such
partnership expenses shall be borne by particular partners out of
their own funds. Id. Where the exception applies, the partner
is entitled to deduct the amount of the expense from his
individual gross income.
Petitioner claimed on his individual income tax return
deductions for expenses incurred for entertainment and travel
related to partnership business. Petitioner bears the burden of
proving that he is entitled to the claimed deductions. Rule
142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934). In addition, entertainment and travel expenses are
subject to the substantiation requirements of section 274(d).
That section provides that no deduction shall be allowed for
travel and entertainment expenses unless the taxpayer provides
adequate records to corroborate his deductions. Petitioner has
produced no records to substantiate his claimed deductions.
Therefore, we conclude that petitioner has not carried his burden
of proving that he is entitled to claimed deductions for travel
and entertainment expenses.
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III. Negligence Penalty
Section 6662 imposes an accuracy-related penalty equal to 20
percent of any underpayment attributable to negligence. The term
"negligence" is defined as the failure to exercise the due care
that a reasonable and ordinarily prudent person would exercise
under the circumstances. Zmuda v. Commissioner, 731 F.2d 1417,
1422 (9th Cir. 1984), affg. 79 T.C. 714 (1982); Neely v.
Commissioner, 85 T.C. 934, 947 (1985). Where the taxpayer is a
tax attorney, he may be held to a higher standard of
reasonableness than a person lacking in tax expertise. Tippin v.
Commissioner, 104 T.C. 518, 534 (1995). Because respondent
initially raised the penalty in an amendment to her answer,
respondent bears the burden of proof. Rule 142(a).
Petitioner's deductions clearly were not allowable under
relevant statutes and case law. As a result, we conclude that
petitioner, an experienced tax attorney, did not exercise the
care that an ordinarily prudent tax attorney would have exercised
under the circumstances.
We have considered all other arguments made by the parties
and found them to be either irrelevant or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.