T.C. Memo. 1998-451
UNITED STATES TAX COURT
STEVEN AND JENNIE JACOBS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15664-95. Filed December 23, 1998.
Steven and Jennie Jacobs, pro sese.
Milton B. Blouke, for respondent.
MEMORANDUM OPINION
BEGHE, Judge: Respondent determined a deficiency of $12,930
in petitioners' 1992 Federal income tax. In so doing, respondent
disallowed for lack of substantiation all deductions claimed by
petitioners as expenses of the advertising business carried on by
petitioner Steven Jacobs (petitioner), as sole proprietor, under
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the name of "Jacobs Creative Group". Those deductions claimed by
petitioners, in the amount of $40,612, exceeded the gross income
of $21,876 reported on Schedule C as the income of Jacobs
Creative Group, which respondent did not dispute, and reduced the
taxable income from the salary of petitioner Jennie Jacobs
(Ms. Jacobs) reported on their joint return.
After making some findings of fact of general application,
reciting the procedural history of the case, and providing an
introductory exposition of applicable law, we shall, for
convenience, combine our findings, discussion and holding under a
separate heading for each type of expense in issue.
Petitioners timely filed an electronic joint return for
1992. At the time petitioners filed their petition, they resided
in Reno, Nevada. Petitioners were divorced in 1996.
The case was continued from the Court's May 20, 1996, and
May 4, 1997, Reno, Nevada, general trial sessions on petitioners'
motions on the ground of petitioner's asserted inability to
prepare for trial by reason of “Chronic Fatigue Immune
Dysfunction Syndrome (CFIDS)” and a spinal injury.
In due course, the case was placed on the Court's May 4,
1998, Reno, Nevada, general trial session. During the week
immediately preceding the session, in response to petitioner's
telephone message that he wished to request another continuance,
the Court informed petitioner and respondent that no more
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continuances would be granted. Petitioner and respondent
thereupon entered into a bare bones stipulation of facts,
agreeing only that petitioners resided in Reno, with attached
hard copy of petitioners' return and copy of the statutory notice
of deficiency. The only documentation that was presented by
petitioner and admitted into evidence at trial were examples of
brochures and other printed materials that petitioner produced
for clients of his advertising business during the taxable year.
Petitioner asserted over the years prior to trial and at trial
that he had documentary evidence to support the claimed
deductions. Although a day or two before trial petitioner had
finally obtained from storage the boxes in which--he told
respondent and the Court--his records were located, at trial
petitioner produced no profit and loss statements, no journals or
ledgers reflecting income and expenses, and no invoices,
receipts, or canceled checks documenting payments to vendors of
goods or services received by his business during the taxable
year. Nor did petitioner produce and submit any such documentary
evidence to respondent for inclusion in a supplemental
stipulation of facts during the 30-day period following the trial
that the record was held open to allow him to do so.
The Court set a seriatim briefing schedule, with respondent
to file the first brief. On August 10, 1998, following enactment
of the IRS Restructuring and Reform Act of 1998, Pub. L. 105-206,
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112 Stat. 685, ___, respondent and Ms. Jacobs filed a stipulation
of settled issues, agreeing that Ms. Jacobs "is entitled to
relief from liability under the innocent spouse provisions of
I.R.C. § 6015 for the 1992 taxable year."
On November 16, 1998, following the filing of respondent's
opening brief, petitioner filed a motion to dismiss on the ground
that his ailments were preventing him from preparing and filing a
reply brief, and that "if the Court would see fit to grant a
dismissal it would be an act of mercy for which [petitioner]
would be eternally grateful". The Court denied petitioner's
motion in an order explaining that under the Court's Rule 1231
the granting of petitioner's motion would require entry of a
decision in favor of respondent. The order informed the parties
that the case was fully submitted and excused them from filing
any additional briefs.
Petitioner had an advertising business, creating story
boards for radio and TV advertisements and placing those
advertisements, and creating layouts for print brochures and
folios. On Schedule C, petitioner reported gross income from the
business of $21,876, which was allocated (rounded off) as
follows:
1
Unless otherwise stated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code in effect for the
taxable year in issue.
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Radio & TV ads $15,000
Brochures & folios 3,500
Other print ads 3,000
Total 21,500
The $40,612 of expenses claimed by petitioner on Schedule C
and disallowed by respondent was as follows:
1. Advertising $2,500
2. Bad debt 1,700
3. Car and truck 8,400
4. Legal and professional 3,342
5. Office 6,360
6. Travel 1,829
7. Entertainment 754
($942 - $188 (20 percent) = $754)
8. Publications 427
9. Printing 15,300
Total 40,612
Respondent's determination in the notice of deficiency is
presumed correct, and petitioner bears the burden of proving that
it is incorrect. Rule 142(a).
Section 162 allows a deduction for ordinary and necessary
business expenses. Whether an expense is deductible under
section 162 is ultimately a question of fact. Commissioner v.
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Heininger, 320 U.S. 467, 475 (1943). An expense is ordinary
under section 162 if it bears a reasonably proximate relationship
to the operation of the taxpayer's business. Deputy v. du Pont,
308 U.S. 488, 495-496 (1940); Gill v. Commissioner, T.C. Memo.
1994-92, affd. without published opinion 76 F.3d 378 (6th Cir.
1996). An expense is necessary if it is helpful and appropriate
in promoting and maintaining the taxpayer's business. Carbine v.
Commissioner, 83 T.C. 356, 363 (1984), affd. 777 F.2d 662 (11th
Cir. 1985).
Taxpayers must substantiate amounts claimed as deductions by
maintaining the records necessary to establish their entitlement
thereto. Sec. 6001; Hradesky v. Commissioner, 65 T.C. 87, 90
(1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976).
Where a taxpayer establishes his entitlement to a deduction,
but does not establish the amount because of the lack of
documentary evidence, the Tax Court should estimate the amount
allowable, Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir.
1930), provided there is enough evidence in the record to provide
a rational basis for an estimate, Williams v. United States, 245
F.2d 559, 560 (5th Cir. 1957); Vanicek v. Commissioner, 85 T.C.
731, 743 (1985).
In Cohan v. Commissioner, supra at 543, the Court of Appeals
for the Second Circuit recognized that the expenses of an
impresario in entertaining actors and crew members were
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legitimate and deductible. The taxpayer, however, did not
produce any of the receipts substantiating such expenses. The
Court of Appeals directed the Board of Tax Appeals to estimate
such expenses "bearing heavily if it chooses upon the taxpayer
whose inexactitude is of his own making". Id. at 544.
Section 274(d) overrides the Cohan doctrine with respect to
expenses of travel away from home (including meals and lodging)
and entertainment. Sanford v. Commissioner, 50 T.C. 823, 827
(1968), affd. per curiam 412 F.2d 201 (2d Cir. 1969); sec. 1.274-
5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6,
1985). Under section 274(d), a taxpayer must substantiate the
amount, time, place, and business purpose of the expenditures and
furnish adequate records or sufficient evidence corroborating his
own statement. Sec. 1.274-5T(c)(1), Temporary Income Tax Regs.,
50 Fed. Reg. 46016 (Nov. 6, 1985). Adequate records are defined
as an account book, diary, log, statement of expense, trip
sheets, or similar records, plus "documentary evidence". Sec.
1.274-5T(c)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46017
(Nov. 6, 1985). Examples of documentary evidence include
receipts, paid bills, or similar evidence to support an
expenditure, except that, with respect to any expenditure of less
than $25 incurred prior to October 1, 1995, or transportation
charges "documentary evidence will not be required if not readily
available, provided, however, that the Commissioner in his
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discretion may prescribe rules waiving such requirements in
circumstances where he determines it is impracticable for such
documentary evidence to be required." Sec. 1.274-5T(c)(2)(iii)
(B), Temporary Income Tax Regs., 62 Fed. Reg. 13990 (Mar. 25,
1997).
"Listed property", the use of which for transportation
purposes must meet the substantiation requirements of section
274(d)(4), includes passenger automobiles and trucks. Sec.
280F(d)(4)(A)(i) and (ii); sec. 1.280F-6T(b)(2)(i), Temporary
Income Tax Regs., 49 Fed. Reg. 42713 (Oct. 24, 1984). However,
section 1.274(d)-1, Income Tax Regs., authorizes the Commissioner
to prescribe rules for mileage allowances for ordinary and
necessary expenses for local transportation, see Dehr v.
Commissioner, T.C. Memo. 1998-441, and such rules were prescribed
for the year 1992. See Rev. Proc. 91-67, 1991-2 C.B. 887.
1. Advertising Expense of $2,500
Petitioner claimed and testified that he paid a total of
$2,500 in cash for advertising his advertising business at the
rate of $100 per ad in two local publications published monthly
by Matson Publications, "Nevada Today" and "Nevada Woman".
Petitioner provided no invoices, no copies of the ads, and no
other witness who established that the ads were placed.
Subsequent to trial, he failed to produce copies of the ads,
either from his retained boxes of records, or from the Reno
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Public Library's copies of the publications in which the ads
appeared. Nevertheless, the Court is satisfied from petitioner's
testimony that he incurred advertising expenses of this type.
Applying Cohan v. Commissioner, supra, and "bearing heavily" on
petitioner, we allow an advertising expense deduction of $1,200.
2. Bad Debt of $1,700
Under section 166, a deduction is allowed for a debt which
becomes worthless during the taxable year. Petitioner claimed a
bad debt deduction of $1,700 by reason of the failure of Roger
Wright, for whom he prepared brochures detailing Mr. Wright's
expertise in tracing horse bloodlines, to pay petitioner’s
agreed-upon fee of $1,700 for preparing the brochures. The
unpaid fee for preparing the brochures, like wages or salary,
would have been ordinary income to petitioner upon payment;
petitioner did not report as income, for 1992 or any prior year,
any of the fee alleged to be owed.
Under applicable law, the unpaid fee is not deductible as a
bad debt. Sec. 1.166-1(e), Income Tax Regs. provides:
Worthless debts arising from unpaid wages, salaries,
fees, rents, and similar items of taxable income shall
not be allowed as a deduction under section 166 unless
the income such items represent has been included in
the return of income for the year for which the
deduction as a bad debt is claimed or for a prior
taxable year.
Inasmuch as petitioner did not report the fee income, he is not
entitled to a bad debt deduction for the unpaid fee for 1992.
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Koenig v. Commissioner, T.C. Memo. 1998-215; sec. 1.166-1(e),
Income Tax Regs.
Even if we had determined that petitioner had included the
unpaid fee in income, he has failed to establish that the debt
was worthless at the end of the taxable year in issue.
Petitioner testified that in 1998 he was still attempting to
collect the debt.
3. Car and Truck Expenses of $8,400
Petitioner claimed car and truck expenses of $8,400, which
respondent disallowed in full in the statutory notice. However,
respondent conceded on brief that "petitioner * * * should be
allowed a mileage expense deduction for his trips to Virginia
City."
Petitioner testified that he traveled to meet his production
assistant, who was located in Virginia City, about 40 miles away
from Reno, and that he did this on an average of three or four
times a week. Petitioner also testified that he had records of
his other expenses that made up the total of $8,400, but he
failed to produce them at trial or subsequently, while the record
was held open. Respondent has made no concession with respect to
any other claimed expenses in this category.
Relying on respondent's concession as a waiver under sec.
1.274-5T(c)(2)(iii)(B), Temporary Income Tax Regs., 62 Fed. Reg.
13990 (Mar. 25, 1997) and Rev. Proc. 91-67, 1991-2 C.B. 887,
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we find that petitioner made trips to Virginia City on an average
of three times per week during 20 weeks during the year, for a
total of 4,800 miles. At the standard business mileage rate of
28 cents per mile in effect for 1992 under Rev. Proc. 91-67,
supra, petitioner is entitled to a mileage allowance deduction
for local travel of $22.40 per day, or a total of $1,344. We
sustain the balance of respondent's disallowance of petitioner's
claimed car and truck expense deduction.
4. Legal and Professional Expenses of $3,342
Petitioner testified that "primarily" the $3,342 was paid
for production costs and that a "small amount" was for legal
expenses. Petitioner testified that the production costs
included both amounts paid to the production assistant in
Virginia City and amounts paid to sound engineers. Petitioner
testified that he worked with the production assistant to
determine a budget and how much of the fee petitioner would keep
and how much the production assistant would keep. However,
petitioner presented no invoices or other documentation showing
how the services of the production assistant were billed and paid
for. Although petitioner testified that he reported the gross
amounts paid under the contracts, it is not clear--indeed it
seems unlikely--that the production assistant's share was part of
the gross income reported by petitioner. We do not believe that
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petitioner included the amounts paid to the production assistant
in the $21,876 of income reported on Schedule C.
Nor are we inclined to give petitioner the benefit of the
doubt--much less consider that he has carried his burden of
proof--that any part of the amount claimed was paid for services
provided by sound engineers. Petitioner admitted that he usually
paid for such services in cash because he was thereby able to
obtain discounts from market rates charged by service providers
who were moonlighting after hours from their regular jobs. We
are sufficiently familiar with the operations of the underground
economy to say that a taxpayer who makes payments in cash to
facilitate income tax underreporting and unauthorized use of
employer facilities by employee service providers does not
thereby convince us, without documentation, that he has incurred
and paid deductible expenses.
With respect to the legal fee portion of petitioners' claim,
petitioner failed to provide the Court with sufficient
information to determine if the legal expenses claimed were
related to the business or were personal in nature. Petitioner
testified that the legal fees were partly for a bankruptcy that
he had filed in the previous year and for the attorney to review
"contracts".
Respondent's determination on this issue is sustained in
full.
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5. Office Expenses of $6,360
The office expenses listed on the 1992 Schedule C allegedly
consisted of payments to Washoe Association for Retarded
Children, for which petitioner had previously worked as an
employee, of $5,000 for graphics equipment2 and $1,360 for office
supplies. The $5,000 allegedly consisted of a $2,500 lump-sum
payment in cash that petitioner made to the Association and a
$2,500 credit in exchange for his services. Petitioner testified
that he did not include in income the $2,500 credit for services
performed. This was a barter exchange; failing to include the
$2,500 credit in income prevents petitioner from obtaining a tax
basis in the property received and therefore disentitles him to a
deduction for the value of his services or the cost of the
property received. See Barter v. Commissioner, T.C. Memo. 1990-
142; Salon v. Commissioner, T.C. Memo. 1980-77.
We find petitioner's testimony to be generally credible with
respect to his cash payments for the equipment and supplies. We
allow a deduction of $3,860 for the purchase of equipment and
supplies.
6. Travel Expenses of $1,829
Petitioner has completely failed to meet the recordkeeping
and substantiation requirements of section 274(d) for the claimed
2
Respondent did not determine or argue that any payments
that petitioner persuaded the Court he had made should be
capitalized and deducted under sec. 167 or sec. 168.
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deduction of $1,829 for travel expenses. Petitioner provided no
evidence at the trial; he was given additional time after the
trial to provide documentary evidence and he failed to do so.
Respondent's determination on this issue is sustained in full.
7. Meals and Entertainment Expenses of $942, Less the 20
Percent Limitation ($188) for a Deduction of $754
Petitioner has completely failed to meet the recordkeeping
and substantiation requirements of section 274(d) for meals and
entertainment expenses. Petitioner presented no evidence at the
trial; he was given additional time after the trial to provide
documentary evidence and he failed to do so. Respondent's
determination on this issue is sustained in full.
8. Publications Expenses of $427
Petitioner purchased nonbusiness publications (Esquire,
Vanity Fair, Details) without providing any persuasive evidence
of business use. Petitioner failed to provide any substantiation
of his publications expense in the amount of $427, even though he
was given additional time after the trial to provide documentary
evidence. Respondent's determination on this issue is sustained
in full.
9. Printing Expenses of $15,300
Petitioner's total Schedule C reported gross income amounted
to $21,876, of which only $3,500 was attributable to the creative
fees charged for the brochures and folios that he produced for
real estate brokers.
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Petitioner testified that the $15,300 claimed as a deduction
for printing expenses was based upon the following costs of
producing the brochures and folios for the real estate brokers:
Petitioners’ Creative Production Total
Exhibit Fees Costs Cost
5 $1,500 $4,184.77 $5,684.77
6 500 2,201.07 2,701.07
7 500 3,427.10 3,927.10
8 500 3,427.10 3,927.10
9 500 2,201.07 2,701.07
Exhibit totals 3,500 15,441.11 18,941.11
Examples of the brochures and folios, with an attached statement
of the production cost of each, were introduced into evidence.
Attached to Exhibit 5 was an invoice to the client for
photography and printing costs reciting that a partial payment
had already been received.
Petitioner has not persuaded us that he included in his
gross income any amounts corresponding to the $15,300 or more he
allegedly paid to printers and photographers. He claimed to have
the evidence but failed to provide it to the Court. We are
satisfied that the payments were made directly by the clients to
the printers or that, if petitioner acted as a conduit for the
payments, he did not include them in gross income. In either
case, he is not entitled to a deduction for them. It defies
credibility that petitioner would enter arrangements that would
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obligate him to incur and pay production costs more than four
times his $3,500 in fees without reimbursement by the clients.
Respondent's determination on this issue is sustained in
full.
To give effect to our partial allowance of some deductions
claimed by petitioner on his 1992 Schedule C for Jacobs Creative
Group,
Decision will be entered
under Rule 155.