T.C. Memo. 1997-275
UNITED STATES TAX COURT
CHARLES A. DENNIS AND ALISON M. DENNIS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 25443-95. Filed June 18, 1997.
Charles A. Dennis, pro se.
Horace Crump, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
KÖRNER, Judge: Respondent determined deficiencies in,
additions to, and penalties on petitioners' Federal income taxes
as follows:
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Additions to Tax Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6653(a)(1) Sec. 6662
1988 $29,348 $6,226 $1,473 --
1989 24,951 4,988 -- $4,990
1990 17,475 3,228 -- 3,495
1991 18,416 3,480 -- 3,683
All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, except as otherwise
noted. A trial was held on October 21, 1996. At trial,
petitioner (references to petitioner in the singular are to
Charles A. Dennis) testified on his own behalf. No other
witnesses were called.
Petitioners conceded that they failed to timely file their
income tax returns for the years in issue. They are accordingly
liable for the additions to tax under section 6651(a)(1) for
those years. There remain six issues to decide. They are as
follows:
(1) Whether petitioners are entitled, for the 1991 taxable
year, to a $48 deduction for bank fees incurred on an account
which produced $45 of interest income.1 Petitioners are not so
entitled.
(2) Whether petitioners must include $3,577 in income for
the 1991 tax year. Petitioners must include that amount in
income for 1991.
1
Petitioner concedes on brief that the $45 interest was
improperly excluded from his income on his 1991 return.
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(3) Whether petitioners overstated their commission expense
on Schedule C of their 1989 return by $403. We hold that they
did.
(4) Whether amounts received by petitioner during the 1988
through 1991 tax years are advance commissions includable in
income in those years, or loan proceeds. We hold that the
amounts received were loan proceeds.
(5) Whether petitioners are liable for additional self-
employment tax due on the increase in petitioners' nonemployee
compensation for tax years 1988 through 1991. We hold that
petitioners are liable for self-employment tax on a $403 increase
of petitioners' nonemployee income for 1989.
(6) Whether petitioners were negligent or intentionally
disregarded the rules or regulations in filing their tax returns
for the years in issue and are liable for the additions to tax
under section 6653(a) for 1988, and penalties under section 6662
for 1989 through 1991. We hold that the additions to tax or
penalties do apply to the deficiencies as determined herein.
Petitioners resided in Prattville, Alabama, at the time they
filed their petition in this case, which was December 6, 1995.
Respondent sent a notice of deficiency for the 1988 through 1991
tax years on September 29, 1995.
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FINDINGS OF FACT
Bank Fees
Petitioners failed to include $45 of interest income, earned
from their bank account, on their 1991 income tax return. There
was no evidence presented as to whether the bank account was
personal or business. At the time of filing of their return,
petitioners reasoned that because they incurred $48 of bank fees
in obtaining such interest, they could net the two and exclude
the income and not claim the deduction. Petitioners conceded
that the interest was properly includable in income for the 1991
tax year, but claim that they are entitled to a $48 deduction as
an ordinary and necessary trade or business expense for the 1991
taxable year.
Unreported Income
During 1991, petitioner purchased from Doug Priester
insurance policies on himself, his wife, and his children. Doug
Priester issued a Form 1099 to the Internal Revenue Service and
(allegedly) to petitioners, indicating that petitioners had
received $3,577 as gross income in the form of a discount on
insurance sold to them. Respondent determined in the notice of
deficiency that petitioners failed to report the $3,577 in gross
income for the 1991 tax year. Petitioner argues that he did not
receive a copy of Form 1099, that he was not in the position to
have performed services for Doug Priester for which payments may
have been made, and that he received no money from Doug Priester.
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While he denies that he received a $3,577 discount, he
acknowledges that he may have received a discount, but he does
not know the size of it. Petitioner did not put into evidence
the insurance policies, evidence as to his basis in such
policies, the cost, or the fair market value of such policies.
Commission Expense
Respondent determined that petitioners overstated the
commission expense shown on Schedule C of their 1989 Federal
income tax return by $403. Petitioner testified that he
presented respondent with substantiation of the $403 deduction.
No such substantiation was introduced into evidence at trial.
Advance Commissions
Petitioner was an insurance sales agent for American Service
Underwriters, Inc. (American), for the years 1988 through 1991.
Petitioner was paid advance insurance sales commissions in the
amounts of $93,413, $17,839.79, $51,161, and $42,529 for the
1988, 1989, 1990, and 1991 tax years, respectively. Under
petitioner's contract with American, he would receive a monthly
draw against his future commission income. Petitioner signed a
note, dated July 14, 1986, which made him personally liable on
the advance commissions, payable on demand. Regarding such
personal liability, the contract with American provided:
7. INDEBTEDNESS: Any and all indebtedness of any
kind or nature owed by [petitioner] to [American] shall
be and serve as a first lien on any commissions due or
to become due said [petitioner]. [American has] the
right and may at any time elect to withhold or offset
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against all accrued commissions, any debt due from
[petitioner] arising from all transactions under this
or any previous contract. Any debit balance that has
not paid itself off within 12 months after the
termination of this contract will be due and payable as
described in 15.b below and no additional bonus
commissions will be due and payable to [petitioner]
under this contract.
* * * * * * *
15.b. Any refunds or indebtedness owed by
[petitioner] arising under this contract, or arising in
any other matter, less accrued commissions due
[petitioner] shall be due and payable within thirty
(30) days after written demand by [American] * * *
Petitioner had complete dominion and control over the
advance commissions (other than an obligation to make repayment)
and did not include in income any amount received as an advance
commission. The advance commissions were recorded in an advance
commissions account. The advance commissions account was offset,
or reduced, by the amount of actual commissions later earned by
petitioner. The advances were charged a 1.3 percent-
administrative fee each month. In the event that there were a
debit balance at the end of 12 months after the termination of
the relationship between petitioner and American, such balance
would be due and payable on demand. Petitioner received a
termination letter from American on December 10, 1992. At that
time, there was a debit balance in the advance commissions
account of approximately $156,000. This balance had been
eliminated by the time of trial, and American never demanded
payment from petitioner. Petitioner alleged that demand was
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never made because his payments on the balance were current. The
debit balance was paid by later commissions earned (year not
shown). Because such later commissions covered the payment due
on the loans, petitioner was never required to make an out-of-
pocket payment on the debit balance.
Self-Employment Tax
Respondent determined that due to the increase in
petitioner's nonemployee compensation for the tax years 1988
through 1991, petitioners were liable for increased self-
employment tax under section 1401. Petitioner asserts that he
did not receive the income in question because the amounts
received constituted loan proceeds, and therefore there is no
self-employment tax due.
Additions to Tax
Petitioners neither requested nor received extensions of
time from the Internal Revenue Service to file their returns.
Petitioners did not timely file their returns for the years at
issue, and they do not deny that such returns were not timely
filed.
OPINION
Generally, petitioners have the burden of proving that the
determinations made by respondent in the notice of deficiency are
erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933).
Bank Fees
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Petitioners have conceded that $45 should have been reported
as interest income in 1991 earned on a bank account. They claim
that they are entitled to a deduction of $48, the amount of bank
fees incurred in maintaining the account either as an ordinary
and necessary trade or business expense, under section 162, or as
an ordinary and necessary expense incurred for the production of
income, deductible under section 212.
The general rule is that bank fees are deductible only if
the bank account on which the fees were incurred was used for
business purposes. Callander v. Commissioner, 75 T.C. 334
(1980). The only evidence that the account was used for business
purposes is petitioners' testimony at trial. Petitioner failed
to offer into evidence any records that would show that this
account was not used for personal purposes. Petitioners are
accordingly not entitled to any deduction for the bank charges.
Unreported Income
Respondent determined that petitioners received income in
the form of discounted insurance premiums from Doug Priester in
1991. Petitioner testified at trial that he performed no
services for Doug Priester and that he did not receive a Form
1099--or cash--from Priester. Petitioner did purchase insurance
from Priester, but offered nothing into evidence on this issue
that would rebut the determination that he received a discount
that constituted income.
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On brief, petitioner asserts that respondent has not carried
the burden of proving the accuracy of the disputed Form 1099.
For support, he cites section 6201(d), which provides:
(d) Required Reasonable Verification of
Information Returns.--In any court proceeding, if a
taxpayer asserts a reasonable dispute with respect to
any item of income reported on an information return
filed with the Secretary * * * by a third party and the
taxpayer has fully cooperated with the Secretary
(including providing, within a reasonable period of
time, access to and inspection of all witnesses,
information, and documents within the control of the
taxpayer as reasonably requested by the Secretary), the
Secretary shall have the burden of producing reasonable
and probative information concerning such deficiency in
addition to such information return.
Petitioner claims that he has fully cooperated with respondent by
granting access to all records and information for the tax years
in question and therefore urges that respondent has failed to
carry the burden of proving the accuracy of the disputed Form
1099.
The notice of deficiency in this case is dated September 29,
1995. The petition is dated December 6, 1995. Section 6201(d),
amended by sec. 602, Taxpayer Bill of Rights II, Pub. L. 104-168,
110 Stat. 1452, 1463 (1996), is effective as of July 30, 1996.
The trial was held on October 21, 1996. Assuming arguendo that
section 6201(d) is applicable in this case, it provides that if
the taxpayer, in a court proceeding, asserts a reasonable dispute
with respect to income reported on an information return, and
fully cooperates with respondent, then respondent shall have the
burden of producing reasonable and probative information in
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addition to the information return. See Hardy v. Commissioner,
T.C. Memo. 1997-97.
The income in question in this case was earned from Doug
Priester in the form of a discount.2 Petitioner testified on
cross-examination that his only relationship with Doug Priester
was to buy insurance from him. Petitioner denied that the
discount received from Mr. Priester was $3,577, but then admitted
that he did not know the exact size of the discount, a tacit
admission that there was a discount. Petitioner has not
substantiated the size of the discount, but testified that he
would have done so had he received a Form 1099 from Priester.
Petitioner, as the purchaser of the insurance, presumably
had within his control evidence concerning the insurance
policies, such as the policies themselves, the price paid for
them, and their fair market value. Petitioner failed to
introduce such evidence or offer an explanation as to why he
could not produce it. Cf. Schaeffer v. Commissioner, T.C. Memo.
1994-206, where the taxpayers failed to furnish any records or
other information concerning unreported income in question,
failed to show that the third-party information respondent used
was unreliable or inaccurate, and did not deny that they received
the income in question. This Court held that the taxpayers
failed to show that the notice of deficiency was arbitrary, which
2
Petitioner does not argue, and the record does not
support, that any discount received was a purchase discount.
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would have caused a shift in the burden of going forward with the
evidence.
Section 6201(d) requires petitioner to show that he fully
cooperated with respondent, and to make a reasonable dispute.
Petitioner did not deny that he received the income at issue.
Rather, he stated that he performed no services for and received
no cash from Priester. Even if these statements were true, they
would not disprove receipt of the income in question, such income
being in the form of a discount. Petitioner tacitly admitted to
receiving a discount. This does not constitute a reasonable
dispute. Furthermore, the record contains no evidence other than
petitioner's testimony, which casts doubt on petitioner's
statement on brief that he fully cooperated with respondent. See
Schaeffer v. Commissioner, T.C. Memo. 1994-206. Because
petitioner has failed to show a reasonable dispute as to the
income in question, and has failed to fully cooperate with
respondent, the burden of going forward and producing "reasonable
and probative information" concerning the deficiency beyond the
information return has not shifted to respondent. As to the
ultimate burden of proof, in light of the complete lack of
evidence beyond petitioner's testimony, we conclude that
petitioner also has not met his burden of proving that he failed
to receive the income in question in 1991. See Kluger v.
Commissioner, 91 T.C. 969, 976-977 (1988); Kluger v.
Commissioner, 83 T.C. 309, 310 n.1 (1984); Petersen v.
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Commissioner, T.C. Memo. 1995-212, affd. without published
opinion 85 F.3d 624 (5th Cir. 1996).
Commission Expense
In the notice of deficiency, respondent disallowed $403 of
commission expenses claimed by petitioners on Schedule C of their
1989 returns. Petitioner testified that he presented
substantiation to respondent at some point, yet failed to
introduce any such substantiation for this Court to review.
Generally, petitioners have the burden of proving that the
determinations made by respondent in the notice of deficiency are
erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933).
Petitioners have failed to meet their burden of establishing
their entitlement to the additional $403 of commission expense.
Accordingly, we hold for respondent on this issue.
Advance Commissions
Petitioner received advance commissions of $93,413,
$17,839.79, $51,161, and $42,529 for the 1988, 1989, 1990, and
1991 tax years, respectively. Respondent determined that these
advance commissions were income when received because petitioner
had complete dominion and control over the proceeds, there was no
fixed date for repayment, and petitioner never had to repay his
employer for the excess commissions. Petitioner contends that
these amounts received are loans for which petitioner was
personally liable and which he did in fact fully repay.
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Generally, income is taxable when it is received. Sec. 451.
When a person receives amounts without an obligation to repay
such amounts, and without restriction as to the disposition or
use of the amounts received, such amounts are income to the
person. James v. United States, 366 U.S. 213 (1961). The
proceeds of a loan are generally not taxable as income because
the benefit of the income is offset by an obligation to repay.
United States v. Rochelle, 384 F.2d 748 (5th Cir. 1967);
Milenbach v. Commissioner, 106 T.C. 184, 195 (1996). The
determination of whether or not moneys received are the proceeds
of a loan or income is to be determined upon consideration of all
of the facts. Fisher v. Commissioner, 54 T.C. 905, 909 (1970).
In the context of insurance agents who receive advances
based on future commission income, whether or not such advances
constitute income depends on whether, at the time of the making
of the payment, the recipient had unfettered use of the funds and
whether there was a bona fide obligation on the part of the agent
to make repayment. If the funds advanced are merely deposits, of
which the taxpayers do not have free and unrestricted use, they
will not be treated as income. Cf. Van Wagoner v. United States,
368 F.2d 95 (5th Cir. 1966). In many instances, repayment is
simply made out of future earned commissions. Where the
repayments will be taken only from future commissions earned, and
the agent would not become personally liable in the event that
the future income does not cover the repayment schedule, the
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payments will constitute income to the recipient. Moorman v.
Commissioner, 26 T.C. 666, 674 (1956). These payments are
nothing more than disguised salary. Beaver v. Commissioner, 55
T.C. 85, 90 (1970). In the situation where the advances are
actually loans, when the repayments are offset directly by the
future earned commissions, then the recipient will have either
commission income or cancellation of indebtedness income at the
time of such offsets. Cox v. Commissioner, T.C. Memo. 1996-241;
cf. Warden v. Commissioner, T.C. Memo. 1988-165.
The advance insurance sales commissions here were received
during the 1988, 1989, 1990, and 1991 tax years. At the time
petitioner's contract with American was terminated, petitioner
had a debit balance in his advance commissions account of
approximately $156,000. This balance had been paid by the time
of trial in this case. Petitioner testified that he never
defaulted on repayments of the advance commissions, so there was
never any need for demand to be made. Although demand was not
made, under the contract and note, had petitioner defaulted,
American had the right to demand payment under the contract and
loan agreement. Thus, petitioner was personally liable on the
loans. This is the distinguishing feature between this case and
other advance commission cases, where no personal liability
existed in the event of a termination. Beaver v. Commissioner,
55 T.C. 85 (1970); Moorman v. Commissioner, supra; George Blood
Enterprises, Inc. v. Commissioner, T.C. Memo. 1976-102. In
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Beaver v. Commissioner, supra, advance commissions were not loans
because personal liability did not attach until after the years
in question, while at the time the advances were made there was
no personal liability, and the payor treated the advances as
salary advances.
Additionally, there was an administration fee of 1.3 percent
per month charged against the advance commissions balance.
Although it was not referred to as interest, petitioner testified
that the parties referred to and treated the fee as interest. In
light of the facts and circumstances in the record, this
testimony is logical and is accepted as fact. Given these facts,
we find that the advance commissions were loans and need not be
included in income where the income was earned as commissions on
sales or renewals perhaps in a later year. Respondent did not
determine the amount of income earned when petitioner sold
insurance.
Self-Employment Tax
Having decided that petitioner's receipt of the advance
commissions constituted loan proceeds and not income, it follows
that they are not liable for self-employment tax in the years in
question on those amounts received. However, a deduction of $403
on Schedule C has been disallowed due to a lack of
substantiation. Petitioners' nonemployee income is therefore
increased by $403, necessitating an increase in the self-
employment tax on that amount. Sec. 1401. Respondent concedes
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that any increase in the self-employment tax causes a
corresponding increase in the deduction for taxes paid on self-
employment income. Sec. 164(f).
Additions to Tax
Respondent determined that petitioners were negligent or
intentionally disregarded the rules or regulations in filing
their 1988 Federal income tax return under section 6653(a) and
their 1989 through 1991 Federal income tax returns under section
6662. Petitioners do not deny that they were negligent or
intentionally disregarded the rules or regulations, but instead
insist that there was no deficiency. Petitioners offered no
evidence which would disprove respondent's determination to the
extent we have sustained respondent herein. To the extent of the
deficiencies decided by this opinion, the additions to tax and
penalties for the tax years will apply.
Decision will be entered
under Rule 155.