T.C. Memo. 1999-261
UNITED STATES TAX COURT
TAE M. KIM AND YOUNG J. KIM, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15447-97. Filed August 4, 1999.
Tae M. Kim and Young J. Kim, pro sese, and Jee H. Kim
(specially recognized), for petitioners.
Cheryl M.D. Rees and Timothy B. Heavner, for respondent.
MEMORANDUM OPINION
DINAN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7443A(b)(3) and Rules 180, 181, and
182.1
1
Unless otherwise indicated, all section references are
to the Internal Revenue Code in effect for the taxable years in
(continued...)
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Respondent determined deficiencies in petitioners' Federal
income taxes for 1993 and 1994 in the amounts of $4,972 and
$5,465, respectively, and accuracy-related penalties pursuant to
section 6662(a) in the amounts of $873 and $1,093, respectively.
The issues for decision are: (1) Whether petitioners are
entitled to trade or business expense deductions for 1993 and
1994 in excess of the amounts allowed and conceded by respondent;
(2) whether petitioners are entitled to a medical expense
deduction for 1993 in excess of the amounts allowed and conceded
by respondent; and (3) whether petitioners are liable for the
section 6662(a) accuracy-related penalties for 1993 and 1994.
Some of the facts have been stipulated and are so found.
The stipulations of fact and the attached exhibits are
incorporated herein by this reference. Petitioners resided in
Bowie, Maryland, on the date the petition was filed in this case.
All references to petitioner in the singular are to Tae M. Kim.
Petitioner is licensed to practice professional engineering
by the State of Maryland, Department of Licensing and Regulation,
Board for Professional Engineers. During 1993 and 1994,
petitioner operated an engineering business under the business
name of Advance Design Engineering (ADE). He kept an office in
petitioners' condominium unit for which respondent has allowed
1
(...continued)
issue. All Rule references are to the Tax Court Rules of
Practice and Procedure.
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certain deductions. Petitioner wife was employed by the Federal
National Mortgage Association as an analyst during 1993 and 1994.
The first issue for decision is whether petitioners are
entitled to trade or business expense deductions for 1993 and
1994 in excess of the amounts allowed and conceded by respondent.
On a Schedule C attached to petitioners' 1993 return,
petitioner reported gross income in the amount of $900 and
claimed expenses in the total amount of $21,642.46 with respect
to ADE. In the statutory notice of deficiency, respondent
disallowed any deductions for the claimed expenses. After
concessions by respondent, the following amounts remain in issue:
Expense Claimed Concessions In Issue
Advertising $420.00 - 0 - $420.00
Car & truck 9,504.00 - 0 - 9,504.00
Depreciation - 0 - 521.85 - 0 -
Insurance 829.40 - 0 - 829.40
Interest - 0 - 528.09 - 0 -
Legal services 295.00 - 0 - 295.00
Office expense 1,487.22 100.01 1,387.21
Rent or lease of
business property 936.00 383.13 552.87
Repairs 3,200.00 - 0 - 3,200.00
Supplies 490.84 32.15 458.69
Taxes & licenses 280.00 976.89 - 0 -
Travel 1,560.00 - 0 - 1,560.00
Meals & entertainment 960.00 - 0 - 960.00
Utilities 1,680.00 351.67 1,328.33
In addition to the amounts claimed on the 1993 Schedule C,
petitioners claimed Schedule A employee business expenses for
1993 in the total amount of $3,324, listed as follows:
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Vehicle expenses $2,408
Parking fees & tolls 382
Lodging 120
Other business expenses 70
Meals & entertainment 344
In the statutory notice of deficiency, respondent disallowed
any deduction for these expenses. Petitioners allege that these
expenses were paid for petitioner wife's activities on behalf of
ADE during 1993.
On a Schedule C attached to petitioners' 1994 return,
petitioner reported gross income in the amount of $4,750 and
claimed expenses in the total amount of $33,748.65 with respect
to ADE. In the statutory notice of deficiency, respondent
allowed deductions for $5,550 of the claimed expenses. After
concessions by the parties, the following amounts remain in
issue:
Expense Claimed Allowed Concessions In Issue
Advertising $208.40 $208.40 - 0 - - 0 -
Car & truck 7,420.80 - 0 - - 0 - 7,420.80
Depreciation 6,135.18 - 0 - 3,782.62 2,352.56
Insurance 854.30 - 0 - - 0 - 854.30
Interest 4,763.73 - 0 - 4,529.46 234.27
Office expense 1,265.45 845.47 - 0 - 419.98
Rent or lease of
business property 2,818.46 2,814.84 3.62 - 0 -
Repairs & maintenance 1,240.30 - 0 - - 0 - 1,240.30
Supplies 250.18 - 0 - - 0 - 250.18
Taxes & licenses 1,690.88 1,680.88 10.00 - 0 -
Travel 4,980.40 - 0 - - 0 - 4,980.40
Meals & entertainment 1,640.12 - 0 - - 0 - 1,640.12
Utilities 480.45 - 0 - 480.45 - 0 -
Section 162(a) allows a deduction for the ordinary and
necessary expenses paid or incurred during the taxable year in
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carrying on a trade or business. An "ordinary" expense is one
that relates to a transaction of "common or frequent occurrence
in the type of business involved", Deputy v. du Pont, 308 U.S.
488, 495 (1940), and a "necessary" expense is one that is
"appropriate and helpful for the development of the petitioner's
business", Welch v. Helvering, 290 U.S. 111, 113 (1933). Whether
an expenditure is ordinary and necessary is a question of fact.
See Commissioner v. Heininger, 320 U.S. 467, 475 (1943).
We are convinced that petitioner carried on an engineering
business under the business name of ADE during the taxable years
in issue. We are left to decide whether petitioners have
substantiated what petitioner claims to have paid for ordinary
and necessary trade or business expenses during 1993 and 1994 in
excess of the amounts allowed and conceded by respondent.
Taxpayers must generally keep sufficient records to
establish the amounts of claimed deductions. See sec. 6001;
Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965). To be
entitled to a deduction under section 162(a), a taxpayer is
required to substantiate his expenses through the maintenance of
books and records. With certain exceptions, in the event that a
taxpayer establishes that a deductible expense has been paid but
is unable to substantiate the precise amount, we may estimate the
amount of the deductible expense, bearing heavily against the
taxpayer whose inexactitude in substantiating the amounts of the
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expenses is of his own making. See Cohan v. Commissioner, 39
F.2d 540, 543-544 (2d Cir. 1930). We cannot estimate deductible
expenses, however, unless the taxpayer presents evidence
sufficient to provide some rational basis upon which estimates
may be made. See Vanicek v. Commissioner, 85 T.C. 731, 743
(1985). Furthermore, section 274(d) provides that no deduction
is allowable under section 162 for any traveling expenses,
including meals and lodging while away from home, or for any
entertainment expenses, or with respect to any listed property,
defined in section 280F(d)(4) to include passenger automobiles,
unless the taxpayer complies with strict substantiation rules.
See sec. 274(d)(1), (2), (4). The taxpayer must substantiate the
amount, time, place, and business purpose of these expenses by
adequate records or by sufficient evidence corroborating his own
statement. See sec. 274(d); sec. 1.274-5T(b) and (c), Temporary
Income Tax Regs., 50 Fed. Reg. 46014, 46016 (Nov. 6, 1985).
These substantiation rules of section 274(d) supersede the Cohan
doctrine. See 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).
Petitioners submitted various records and documents to
substantiate the claimed business expenses.2 We will separately
2
After the trial, respondent requested that his Exhibit
D in evidence be stricken from the record, and the Court informed
(continued...)
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address this evidence, infra, as it relates to each of the
claimed expenses.
Advertising for 1993 and 1994
We find that petitioners have established that petitioner
paid $403.67 for flyers, cards, envelopes, and stamps during 1993
to promote ADE. Respondent allowed the claimed advertising
expense deduction for 1994. We hold that petitioners are
entitled to deductions for advertising expenses for 1993 and 1994
in the amounts of $404 and $208, respectively.
Car & Truck for 1993 and 1994
The nature of ADE's business required petitioner to travel
frequently to the offices of real estate agents and to
contracting sites. We find that petitioners have substantiated
28,715 business miles for 1993 and 24,520 business miles for
1994. At the business standard mileage rates of 28 and 29 cents
per mile, petitioners are entitled to business mileage expenses
for 1993 and 1994 of $8,040.20 and $7,110.80, respectively. See
Rev. Proc. 93-51, sec. 5.01, 1993-2 C.B. 593, 594; Rev. Proc. 92-
104, sec. 5.01, 1992-2 C.B. 583, 585. We also find that
petitioners have substantiated petitioner's claimed expenses for
tolls and parking for 1993 and 1994. We hold that petitioners
2
(...continued)
respondent that his request was granted.
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are entitled to deductions for car and truck expenses for 1993
and 1994 in total amounts of $8,650 and $7,421, respectively.
Depreciation for 1993 and 1994
For 1993, the parties stipulated that petitioners are
entitled to a deduction in the amount of $521.85 for depreciation
of their condominium unit. For 1994, the parties stipulated that
petitioners are entitled to a deduction in the amount of
$3,726.60 for depreciation of their condominium unit. Respondent
conceded at trial that petitioners are entitled to an additional
depreciation deduction for 1994 for three chairs in the total
amount of $56.02. Petitioners submitted several depreciation
worksheets on which they recorded the information relevant to the
claimed depreciation deductions for 1994. We find these
worksheets reliable. With respect to the 5-year property, we
allow depreciation deductions for the printer, computer,
facsimile machine, typewriter, calculator, laptop computer, and
monitor in the total amount of $1,226.05. We do not allow
deductions for the fan or the television. With respect to the
7-year property, we allow depreciation deductions for the desk,
computer desk, book cases, drawing desk, and carpeting in the
total amount of $485.65. We do not allow deductions for the
other items of 7-year property listed on the worksheet, other
than for the three chairs as conceded by respondent. We also
allow depreciation deductions for petitioner's library in the
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total amount of $1,315.41. We hold that petitioners are entitled
to depreciation deductions for 1993 and 1994 in the total amounts
of $522 and $6,810, respectively.
Insurance for 1993 and 1994
Petitioners claimed insurance expense deductions for 1993
and 1994 for amounts paid for their automobile insurance
policies. However, petitioners claimed and we have held that
they are entitled to deductions for car and truck expenses based
on the business standard mileage rates for 1993 and 1994, which
are claimed in lieu of operating and fixed costs such as
gasoline, oil, depreciation, maintenance and repairs, insurance,
and registration fees. See Rev. Proc. 93-51, sec. 5.03, 1993-2
C.B. 593, 594; Rev. Proc. 92-104, sec. 5.03, 1992-2 C.B. 583,
585. Accordingly, we hold that petitioners are not entitled to
any insurance expense deductions for 1993 and 1994.
Interest for 1993 and 1994
The parties stipulated that petitioners are entitled to
deductions for interest paid during 1993 and 1994 on amounts
borrowed to purchase the condominium unit. Petitioners presented
no evidence that they paid any deductible business interest
during 1993 and 1994 other than the stipulated amounts. We hold
that petitioners are entitled to interest expense deductions for
1993 and 1994 in the amounts of $528 and $4,529, respectively.
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Legal Services for 1993
The legal services claimed by petitioners for 1993 were part
of the settlement costs of the purchase of their condominium
unit. These legal services constitute a capital expenditure
which is added to petitioners' cost basis in the condominium
unit. To the extent the condominium unit is used for business
purposes, a portion of these legal services is deductible as part
of the depreciation deductions for the condominium unit. We hold
that petitioners are not entitled to any deduction for 1993 for
legal services.
Office Expense for 1993 and 1994
We find petitioners' records of their office expenses for
1993 reliable. For 1994, respondent disallowed only the portion
of the claimed office expense deduction which was claimed for a
computer monitor. This item was also claimed by petitioners on
one of their depreciation worksheets. Based on the record, we
sustain petitioners' claimed deduction for 1993 and respondent's
disallowance for 1994. We hold that petitioners are entitled to
office expense deductions for 1993 and 1994 in the amounts of
$1,487 and $845, respectively.
Rent or Lease of Business Property for 1993 and 1994
The parties have agreed that the amounts allowed and
conceded by respondent for 1993 and 1994 with respect to the
claimed rental expenses represent petitioners' condominium
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owners' association fees, which are more accurately described and
deducted as commissions and fees. We therefore hold that
petitioners are not entitled to any deductions for 1993 and 1994
for the rental or lease of business property. In accordance with
the parties' stipulations, we hold that petitioners are entitled
to deductions for 1993 and 1994 for commissions and fees in the
amounts of $383 and $2,815, respectively.
Repairs & Maintenance for 1993 and 1994
We find that petitioners paid for a number of repairs to
petitioner's home office during 1993 and 1994. After examining
the records of the costs of such repairs, we hold that
petitioners are entitled to deductions for 1993 and 1994 for
repairs and maintenance in the total amounts of $2,087 and
$1,168, respectively.
Supplies for 1993 and 1994
For 1993 and 1994, petitioners claimed deductions for
supplies in the amounts of $490.84 and $250.18, respectively.
Respondent conceded $32.15 of the amount claimed for 1993. We
find petitioners' records of the supplies purchased during 1993
and 1994 reliable. We hold that petitioners are entitled to
deductions for 1993 and 1994 for supplies in the total amounts of
$491 and $250, respectively.
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Taxes & Licenses for 1993 and 1994
For 1993, the parties stipulated that petitioners are
entitled to a deduction in the amount of $976.89 for taxes paid
on their condominium unit. For 1994, respondent allowed
petitioners a deduction in the amount of $1,680.88 for taxes paid
on their condominium unit. Petitioners did not dispute these
amounts at trial. Petitioner also produced a check which shows
that he paid $20 for his professional engineering license during
1994. We therefore hold that petitioners are entitled to
deductions for 1993 and 1994 for taxes and licenses in the
amounts of $977 and $1,701, respectively.
Travel for 1993 and 1994
Petitioner traveled to Korea for business purposes during
1993 and 1994. We find that petitioners have substantiated only
the costs of petitioner's airfares to and from Korea. We find
that petitioner's testimony and supporting records with respect
to his other claimed travel expenses do not meet the
substantiation requirements of section 274(d). We hold that
petitioners are entitled to deductions for 1993 and 1994 for
travel expenses in the amounts of $1,172 and $820, respectively.
Meals and Entertainment for 1993 and 1994
We find that petitioners have failed to substantiate the
meals and entertainment expenses claimed for 1993 and 1994. We
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hold that petitioners are not entitled to any deductions for
meals and entertainment expenses for 1993 and 1994.
Utilities for 1993 and 1994
For 1993, the parties stipulated that petitioners are
entitled to a utility expense deduction in the amount of $351.67
for telephone expenses. Based on the record, we conclude that
petitioners are entitled to a utility expense deduction for their
other utilities for 1993 in the amount of $500. For 1994, the
parties stipulated that petitioners are entitled to deductions
for telephone expenses in the amount of $225.74 and gas and
electric expenses in the amount of $254.71. We hold that
petitioners are entitled to deductions for 1993 and 1994 for
utility expenses in the total amounts of $852 and $480,
respectively.
Employee Business Expenses for 1993
Petitioners argue that petitioner wife's claimed employee
business expenses should have been claimed as additional Schedule
C trade or business expenses of ADE. Petitioner generally
testified that petitioner wife visited several locations to look
for potential clients and to buy materials for ADE. Petitioner
wife did not testify with respect to her activities on behalf of
ADE. Petitioners' records of these expenses show the names of
towns and cities which petitioner wife visited but not the
business purpose of the listed trips. Based on the record, we
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find that petitioners have failed to substantiate the business
purpose of petitioner wife's claimed expenses. We hold that
petitioners are not entitled to any deductions for 1993 for
petitioner wife's claimed expenses.
The second issue for decision is whether petitioners are
entitled to a medical expense deduction for 1993 in excess of the
amounts allowed and conceded by respondent.
On a Schedule A attached to their 1993 return, petitioners
claimed medical expenses in the amount of $10,668.36. After
accounting for the section 213(a) limitation, petitioners claimed
a medical expense deduction for 1993 in the amount of $7,032.51.
In the statutory notice of deficiency, respondent determined that
petitioners did not establish that they paid more than $8,978 for
medical expenses during 1993. Respondent allowed petitioners a
medical expense deduction in the amount of $3,724, after
accounting for his adjustments to their adjusted gross income and
the section 213(a) limitation.3 At trial, respondent conceded
that petitioners are entitled to deduct an additional $20 of
medical expenses. This concession leaves $1,670.36 of the
claimed medical expenses in issue, which approximates the amount
3
Respondent's adjustments to petitioners' medical
expense deductions for 1993 and 1994, to the extent based on his
adjustments to petitioners' adjusted gross income and sec. 213
limitations for 1993 and 1994, are computational and will be
resolved by the Court's holding on the first issue in this case.
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claimed by petitioners and disallowed by respondent for certain
acupuncture treatments.
Section 213(a) allows as a deduction the expenses paid
during the taxable year, not compensated for by insurance or
otherwise, for medical care of the taxpayer, his spouse, or a
dependent, to the extent that such expenses exceed 7.5 percent of
adjusted gross income. Medical care includes amounts paid for
the diagnosis, cure, mitigation, treatment, or prevention of
disease, or for the purpose of affecting any structure or
function of the body. See sec. 213(d)(1)(A). Medical care also
includes amounts paid for transportation primarily for and
essential to medical care listed above. See sec. 213(d)(1)(B).
Petitioner testified that he received acupuncture treatments
to relieve nerve pain in his neck and back while in Korea from
May 27, 1993, to July 2, 1993, Petitioner's 1993 weekly minder,
which he used while in Korea, has 12 entries for acupuncture
treatments in June 1993. Petitioner testified that he paid $120
for each of the 12 acupuncture treatments and approximately $20
for transportation to and from such treatments.
We find petitioner's testimony with respect to his
acupuncture treatments credible. We hold that petitioners are
entitled to a deduction for 1993 for the medical expenses claimed
on their 1993 return to the extent that such expenses exceed the
section 213(a) limitation.
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The third issue for decision is whether petitioners are
liable for the section 6662(a) accuracy-related penalties for
1993 and 1994.
Section 6662(a) imposes a 20-percent penalty on the portion
of an underpayment attributable to any one of various factors,
one of which is negligence or disregard of rules or regulations.
See sec. 6662(b)(1). "Negligence" includes any failure to make a
reasonable attempt to comply with the provisions of the internal
revenue laws or to exercise ordinary and reasonable care in the
preparation of a tax return. See sec. 6662(c); sec.
1.6662-3(b)(1), Income Tax Regs. It also includes any failure to
keep adequate books and records or to substantiate items
properly. See sec. 1.6662-3(b)(1), Income Tax Regs. "Disregard"
includes any careless, reckless, or intentional disregard of
rules or regulations. See sec. 6662(c); sec. 1.6662-3(b)(2),
Income Tax Regs.
Section 6664(c)(1), however, provides that the section
6662(a) penalty shall not apply to any portion of an
underpayment, if it is shown that there was reasonable cause for
the taxpayer's position with respect to that portion of the
underpayment and that the taxpayer acted in good faith with
respect to that portion. The determination of whether a taxpayer
acted with reasonable cause and in good faith is made on a case-
by-case basis, taking into account all the pertinent facts and
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circumstances. See sec. 1.6664-4(b)(1), Income Tax Regs. The
most important factor is the extent of the taxpayer's effort to
assess his proper tax liability for the year. See id.
Based on the record, we find that petitioners have proved
that their underpayments were due to reasonable cause and that
they acted in good faith. Petitioners were able to substantiate
most of the expenses claimed on their returns and disallowed by
respondent. We hold that petitioners are not liable for the
section 6662(a) accuracy-related penalties for 1993 and 1994.
To reflect the foregoing,
Decision will be entered
under Rule 155.