T.C. Memo. 1997-132
UNITED STATES TAX COURT
MARK D. AND SHELDON C. MORGAN, Petitioners
v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15590-94. Filed March 13, 1997.
Lewis R. Wiener, for petitioners.
Daniel J. Parent, for respondent.
MEMORANDUM OPINION
JACOBS, Judge: By separate notices of deficiency, both dated
May 27, 1994, respondent determined the following deficiencies and
accuracy-related penalties with respect to petitioners' Federal
income taxes:
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Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)
1988 $ 1,351 ---
1989 19,046 $3,809
1990 16,430 3,286
1991 16,436 3,287
Pursuant to an amended answer, filed October 10, 1995, respondent
seeks a $9,864 increase in the deficiency for 1988, so that the
total amended amount of the proposed deficiency for that year is
$11,215.
Following concessions by petitioners, the issues for decision
are:
(1) The proper characterization (loans, as contended by
petitioners, or wages, as contended by respondent) of monthly
payments received by petitioner Mark D. Morgan from Robert Randall
Co. We hold that such payments are wages, includable in
petitioners' income.
(2) Whether petitioners are entitled to claimed employee
business expense deductions (for 1989, 1990, and 1991) for
automobile expenses. Because of petitioners' failure to provide
sufficient substantiation, we hold they are not.
(3) Whether the increased deficiency asserted by respondent
for 1988 is time-barred. We hold that it is not.
(4) Whether petitioners are liable for the accuracy-related
penalty under section 6662(a) for 1989, 1990, and 1991. We hold
they are.
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All section references are to the Internal Revenue Code for
the years under consideration. All Rule references are to the Tax
Court Rules of Practice and Procedure. All dollar amounts are
rounded.
Some of the facts have been stipulated and are so found. The
stipulation of facts and the attached exhibits are incorporated
herein by this reference.
General Findings
Petitioners, husband and wife, resided in Carmichael,
California, at the time they filed their petition challenging
respondent's determinations. Petitioners timely filed joint
Federal income tax returns for each of the years under
consideration. On June 1, 1992, petitioners were issued a refund
of $1,351 for tax year 1988. The refund resulted from
petitioners' request for a tentative refund based upon a claimed
net operating loss carryback from 1991.
For convenience and clarity, we have combined additional
findings of fact and opinion with respect to each issue.
Issue 1. Characterization of Advances From Robert Randall Co.
Petitioner husband Mark D. Morgan (hereinafter referred to as
petitioner) has been involved for many years in real estate
activities, particularly the construction of real estate. In June
1988, he began working for Robert Randall Co. which is in the
business of developing and managing apartment complexes.
Previously, petitioner had been employed by Gibraltar Community
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Builders, Inc. (Gibraltar). During 1987, petitioner received wages
from Gibraltar totaling $123,671; for the first 5 months of 1988,
petitioner received wages from Gibraltar totaling $66,382.
On June 21, 1988, petitioner and Robert Randall, the president
and apparently the sole or at least the majority shareholder1 of
Robert Randall Co., entered into an agreement (called and
hereinafter referred to as the Sunbelt Project Working Agreement),
pursuant to which petitioner agreed to be the regional manager
responsible for locating, acquiring, and developing properties in
the Sacramento area for multifamily housing on behalf of
partnerships or other entities to be controlled by Robert Randall
or his affiliate. In accordance with the provisions of the Sunbelt
Project Working Agreement, beginning in June 1988, and throughout
all years under consideration, Robert Randall Co. made monthly
payments, labeled "advances", to finance petitioner's living
expenses. In addition to these advances2, Robert Randall Co. paid
wages to petitioner. FICA (Social Security tax) was withheld on
these wages, but Federal income taxes were not.
The amount of wages and advances paid to petitioner were as
follows:
1
The record is not clear on this point. Robert Randall
testified that he was "the chief executive officer, the
president, the chairman, and the owner" of Robert Randall Co.
2
The use of the word "advances" is not meant to give a
legal characterization of the monthly payments.
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Amount of Amount of
Year Wages Advances
1988 $11,008 $40,950
1989 18,000 75,600
1990 18,000 84,600
1991 18,000 87,600
The advances include the following amounts designated as an
automobile allowance:
1988 $1,300
1989 2,400
1990 5,550
1991 6,600
The advances were paid on a monthly basis as follows:
June 1988 $3,150
July 1988-Mar. 1990 6,300
Apr. 1990-Dec. 1991 7,300
Robert Randall Co. did not withhold for income tax or FICA tax
on the advances.
As of the date of trial, petitioner had not repaid any of the
advances. The advances were not evidenced by notes, nor was
collateral given. Nor did Robert Randall Co. inquire into
petitioner's ability to repay the advances. There were no specific
repayment terms or fixed maturity dates. Rather, the advances were
to be charged against petitioner's share of profits of partnerships
to be formed between petitioner and Robert Randall.
Respondent determined that the advances petitioner received
from Robert Randall Co. constitute taxable compensation for
services. Petitioners claim that the advances were nontaxable
loans. Except for 1988, petitioners bear the burden of proving
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their characterization of the advances. Rule 142(a); Welch v.
Helvering, 290 U.S. 111 (1933). If petitioners meet their burden
of proof, then the advances are not includable in their income.
See Falkoff v. Commissioner, 62 T.C. 200, 206 (1974); Arlen v.
Commissioner, 48 T.C. 640, 648 (1967). For 1988 only, respondent
bears the burden of proving the advances constitute taxable income
inasmuch as that is a new matter, first raised in respondent's
amended answer. Rule 142(a).
Whether the advances should be characterized as loans or
payments for services is a factual determination. Beaver v.
Commissioner, 55 T.C. 85 (1970); Haber v. Commissioner, 52 T.C. 255
(1969), affd. 422 F.2d 198 (5th Cir. 1970). For a payment to
constitute a loan, at the time the funds are transferred, the
recipient must intend to repay the advance, and the transferor must
intend to enforce repayment. Haag v. Commissioner, 88 T.C. 604,
615-616 (1987), affd. without published opinion 855 F.2d 855 (8th
Cir. 1988). Further, the obligation to repay must be unconditional
and not contingent upon a future event. United States v.
Henderson, 375 F.2d 36, 39-40 (5th Cir. 1967); Bouchard v.
Commissioner, 229 F.2d 703 (7th Cir. 1956), affg. T.C. Memo. 1954-
243. An intent to repay a purported loan by the performance of
services in the future does not result in the exclusion of the
underlying funds from the recipient's income. Beaver v.
Commissioner, supra at 91. In such a case, the purported loan
proceeds are nothing more than an advance salary or other payment
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for services which are includable in the recipient's income when
received.
Various objective factors are used in deciding whether an
advance payment is a loan or compensation. See Haag v.
Commissioner, 88 T.C. at 616 n.6., for a listing of some of these
factors. In the instant case, the following factors lead us to
conclude that the advances petitioner received from Robert Randall
Co. should be characterized as compensation, rather than loans:
1. The advances were from an employer to an employee.
2. Petitioner's wage compensation from his previous
employment with Gibraltar was significantly higher than the Form W-
2 wages petitioner received from Robert Randall Co.
3. The monthly advances began as soon as petitioner started
working for Robert Randall Co.
4. The amount of the advances was pre-set.
5. The advances were paid in regular monthly intervals.
6. There were no set repayment terms or fixed maturity date
at the time the advances were made.
7. There was no stated interest.
8. Petitioner had not repaid any of the advances as of the
date of trial.
9. There was no indication that petitioner could repay the
advances from his own resources.
10. The transferor did not inquire into petitioner's
financial status before making the advances.
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11. There was no collateral for the advances.
12. Petitioner would not have taken the position with Robert
Randall Co. if the latter had not paid him a substantial amount in
addition to his Form W-2 salary.
13. The value of services petitioner rendered was far in
excess of his Form W-2 salary.
14. Robert Randall Co. could not have hired someone with
petitioner's qualifications for the amount of Form W-2 salary paid
to petitioner.
15. The transferor would have caused the advances to
petitioner to stop if petitioner had stopped providing services.
Based on our determination that the advances were not loans,
but rather represent compensation for services, the advances are
includable in petitioner's income in the year paid.
Issue 2. Automobile Expenses
On petitioners' tax returns for 1989, 1990, and 1991,
petitioners claimed employee business expense deductions with
regard to petitioner's purported business use of an automobile, as
follows:
Year Amount
1989 $4,375
1990 5,200
1991 4,950
Respondent disallowed these deductions.
At trial, petitioner failed to provide any evidence or
substantiation (such as a log or diary) for the claimed expenses
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other than his own testimony that he "feels" that he drove
approximately 20,000 miles a year for business purposes.
Section 274(d) provides that no deduction shall be allowed
with respect to any listed property (as defined in section
280F(d)(4)) unless the taxpayer substantiates by adequate records
or sufficient evidence corroborating the taxpayer's own statement
the amount of such expense, the time and place of the expense, the
business purpose of the expense, and the business relationship of
the expense. A passenger automobile is considered listed property.
Sec. 280F(d)(4).
Because petitioner failed to satisfy the record keeping or
other substantiation requirements of section 274(d), petitioners
are not entitled to the claimed employee business deductions for
automobile expenses for 1989, 1990, and 1991.
Issue 3. Statute of Limitations Defense
The next issue for consideration is whether respondent is
time-barred from amending her answer to increase the amount of the
deficiency for 1988 by recharacterizing the advances petitioner
received in 1988 as wages.
For 1988, petitioners reported a total gross income of
$82,034, consisting of wages ($77,388), interest ($3,318), and
unemployment compensation ($1,328). In addition, they reported the
sale of their home, but excluded the gain therefrom pursuant to
section 1034. The reported selling price for the home was $180,000;
the excluded gain was $14,050.
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Petitioners did not report in 1988 the $40,950 received in
advances from Robert Randall Co. As previously discussed, the
$40,950 constitutes compensation, which is includable in
petitioner's gross income.
Section 6501(e) provides: "If the taxpayer omits from gross
income an amount properly includable therein which is in excess of
25 percent of the amount of gross income stated in the return, the
tax may be assessed, or a proceeding in court for the collection of
such tax may be begun without assessment, at any time within 6
years after the return was filed." Further, section 6503(a)
provides for the suspension of the running of the period of
limitations if a proceeding is placed on the docket of this Court,
from the issuance of the deficiency notice until a decision of the
Court becomes final.
In the instant case, petitioners filed their 1988 return on
April 15, 1989. The notice of deficiency for 1988 was issued on
May 27, 1994. The petition requesting a redetermination of
respondent's deficiency determination for 1988 was filed on August
30, 1994. Sec. 6503.
The $40,950 which petitioners failed to include in their 1988
income is in excess of 25 percent of the amount of gross income
stated on the return.3 Thus, on the date respondent's notice of
3
Even if the sale of petitioners' home is taken into
account, for sec. 6501(e) purposes, the $14,050 capital gain on
the sale, not the $180,000 gross sales price, is used in
(continued...)
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deficiency for 1988 was issued, the 6-year period of limitations
had not yet expired, and the omitted $40,950 could have properly
been included in respondent's deficiency notice. Accordingly,
respondent is not time-barred from asserting an increased
deficiency in her amended answer with respect to the omitted
$40,950 of wage income.
Issue 4. Accuracy-Related Penalty
Respondent determined an accuracy-related penalty under
section 6662(a) for 1989, 1990, and 1991. Section 6662 imposes a
penalty equal to 20 percent of the portion of an underpayment that,
among other things, is a substantial understatement of income tax.
An understatement of income is substantial if it exceeds the
greater of 10 percent of the tax required to be shown on the return
or $5,000. Sec. 6662(d)(1). The deficiencies here determined are
substantial understatements.
The accuracy-related penalty does not apply with respect to
any portion of the underpayment if it is shown that there was
reasonable cause for such portion and that the taxpayer acted in
good faith with respect to such portion. Sec. 6664(c)(1).
Petitioners claim that they relied on their accountant to correctly
prepare their returns. Reliance by a taxpayer on the advice of a
qualified adviser will constitute reasonable cause and good faith
3
(...continued)
computing the gross income reported on the return. See Burbage
v. Commissioner, 82 T.C. 546, 558 (1984), affd. 774 F.2d 644 (4th
Cir. 1985).
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if, under all of the facts and circumstances, the reliance was
reasonable and the taxpayer acted in good faith. Sec. 1.6664-
4(b)(1), Income Tax Regs. Considering all the facts and
circumstances presented, we do not find persuasive petitioner's
defense that he relied on his accountant to correctly prepare his
returns. The accountant did not testify. And we found
petitioner's self-serving testimony in this regard to be not
credible. In conclusion, we hold that petitioners are liable for
the accuracy-related penalty on the entire underpayment for 1989,
1990, and 1991.
To reflect the foregoing and because of the increased
deficiency for 1988,
Decision will be entered
under Rule 155.