T.C. Memo. 1999-3
UNITED STATES TAX COURT
JOEL HILLMAN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3706-96. Filed January 5, 1999.
Joel Hillman, pro se.
Daniel J. Parent, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
FOLEY, Judge: In a notice dated December 7, 1996,
respondent determined a deficiency, a section 6651(a) addition to
tax, and a section 6662(a) penalty relating to Joel Hillman's
1991 Federal income tax. All section references are to the
Internal Revenue Code in effect for the year in issue, and all
Rule references are to the Tax Court Rules of Practice and
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Procedure. Petitioner resided in Lompoc, California, when he
petitioned this Court.
FINDINGS OF FACT
Petitioner was involved in the business of selling antiques.
On September 6, 1991, petitioner borrowed $50,000 from his
mother, Myrtle Hillman. Later that month, petitioner lent these
funds to Peter Scholes. Mr. Scholes used these funds to finance
PM For Export and agreed to repay the loan in September 1992. PM
For Export was an Argentinean business that exported European
antique furniture from Buenos Aires to the United States and
Canada. After making the loan, PM For Export hired petitioner to
find purchasers. During the latter part of 1991 and in 1992, PM
For Export failed to generate any business. As a result, Mr.
Scholes could not repay petitioner.
In 1993, the Drug Enforcement Agency (DEA) investigated
petitioner and seized most of his records. Petitioner was
arrested and charged with conspiracy to possess marijuana. In
1994, petitioner pleaded guilty and was sentenced to 5 years in
Federal prison.
Petitioner typically did not prepare his own Federal income
tax returns. In 1993, while in the Federal Correctional
Institution in Lompoc, California, petitioner had his 1991
Federal income tax return prepared by his accountant, Kenneth
Casey. Petitioner could not provide Mr. Casey with some records
relating to 1991 because the DEA refused to release them. Mr.
Casey's entries on the return were based on the available records
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and information received from petitioner during telephone calls
from prison. The return was filed on October 9, 1994. On his
1991 return, petitioner reported a $50,000 ordinary loss and a
$3,000 capital loss relating to PM For Export.
OPINION
Respondent denied petitioner's deductions for an ordinary
loss, a capital loss, state and local income taxes, unreimbursed
employee expenses, and expenses relating to rental property.
Respondent further determined that petitioner was liable for an
addition to tax for failure to file and an accuracy-related
penalty.
1. Ordinary and Capital Loss Deductions
Petitioner lent Mr. Scholes the $50,000 in mid-September of
1991. Petitioner contends that the loan, which was due in 1992,
became worthless in 1991 and that he is entitled to a $50,000
ordinary loss deduction for a business bad debt. Respondent
contends that petitioner failed to establish that the loan became
worthless in 1991. We agree with respondent. Although a
taxpayer need not wait until a debt becomes due to determine that
it is worthless, section 1.166-1(c), Income Tax Regs., petitioner
did not establish that the loan became worthless in 1991, the
year he deducted it. See Higginbotham-Bailey-Logan, Co. v.
Commissioner, 8 B.T.A. 566 (1927) (holding that the taxpayer must
establish that he ascertained the debt to be worthless in the
taxable year in which he claims it to be deductible). Petitioner
also reported a $3,000 capital loss deduction that allegedly
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related to the $50,000 loan. Petitioner did not contest
respondent's disallowance of the $3,000 capital loss.
Accordingly, we sustain respondent's determinations.
2. Deductions for Rental and Other Expenses
Respondent denied, for lack of substantiation, petitioner's
deductions for state and local income taxes, unreimbursed
employee expenses, and expenses relating to rental property.
Although petitioner's testimony established that he owned rental
property and incurred expenses relating to this property, he
failed to substantiate, or provide any reasonable basis for us to
estimate, these expenses. Petitioner failed to meet his burden
of substantiating the remainder of his deductions. See Hradesky
v. Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam 540 F.2d
821 (5th Cir. 1976). Accordingly, we sustain respondent's
determination.
3. Addition to Tax for Failure To File a Timely Return
Respondent determined, pursuant to section 6651(a), a
$4,875 addition to tax for petitioner's failure to file in a
timely manner a 1991 Federal income tax return. Petitioner's
1991 return was filed on October 9, 1994. Petitioner did not
contest respondent's determination, yet respondent concedes that
he overstated the addition to tax by $1,625 in the notice of
deficiency. Accordingly, petitioner is liable for a $3,250
addition to tax.
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4. Accuracy-Related Penalty
Respondent determined that petitioner is liable for a
section 6662(a) accuracy-related penalty. The penalty applies to
the portion of petitioner's underpayment that is attributable to
a substantial understatement of income tax. Sec. 6662(b)(2). If
petitioner establishes that he acted in good faith and there was
reasonable cause for claiming the deductions, an accuracy-related
penalty will not be imposed on the portion of the underpayment
relating to such deductions. See sec. 1.6664-4(a), Income Tax
Regs. Reliance on an accountant may demonstrate reasonable cause
and good faith. Sec. 1.6664-4(b)(1), Income Tax Regs.
Petitioner contends that he should not be liable for the
accuracy-related penalty on the portion of the underpayment that
relates to the bad debt deductions because he reasonably relied
on the advice of his accountant.
While in prison, petitioner hired Mr. Casey to prepare the
1991 return. Petitioner supplied Mr. Casey with all the
available relevant records and did not withhold any information.
In addition, petitioner used his limited telephone privileges to
consult with Mr. Casey. Mr. Casey proceeded incorrectly to
report petitioner's bad debt loss as a $50,000 ordinary loss on
Form 4797 (Sales of Business Property) and a $3,000 capital loss
on Schedule D (Capital Gains and Losses). Petitioner took
reasonable efforts to assess his proper tax liability and
reasonably relied on Mr. Casey's expertise in reporting, and
determining the deductibility of, the bad debt. Thus, petitioner
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acted in good faith, and there was a reasonable cause for the
portion of the underpayment relating to the ordinary and capital
loss deductions.
Petitioner also established that he acted in good faith and
had reasonable cause for claiming expenses for road dues,
mortgage interest, and professional fees relating to his rental
property. Although petitioner, at trial, was unable to
substantiate these deductions, at the time he filed his return he
took reasonable efforts to determine the deductibility of these
expenses. Petitioner did not, however, present any evidence that
he exercised good faith and had reasonable cause for claiming
deductions for state and local taxes and unreimbursed employee
expenses. Accordingly, the accuracy-related penalty is
applicable to the portion of the underpayment attributable to
those items.
Contentions we have not addressed are either irrelevant,
moot, or meritless.
To reflect the foregoing,
Decision will be entered
under Rule 155.