T.C. Memo. 1999-390
UNITED STATES TAX COURT
DANÉ MARIE SMILEY AND RICHARD DEAN SMILEY, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13712-98. Filed December 1, 1999.
Dané Marie Smiley and Richard Dean Smiley, pro se.
Reid M. Huey, for respondent.
MEMORANDUM OPINION
POWELL, Special Trial Judge: Respondent determined
deficiencies in petitioners' 1995 and 1996 Federal income taxes
and accuracy-related penalties under section 6662(a)1 as follows:
Penalty
Year Deficiency Section 6662(a)
1995 $3,875 $771
1996 2,505 501
1
Unless otherwise indicated, section references are to
the Internal Revenue Code in effect for the years in issue.
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The issues are whether petitioners are entitled to
deductions for alleged expenses incurred in the construction of a
home for the mother of petitioner Richard Dean Smiley
(petitioner) and whether petitioners are liable for the section
6662(a) penalties.
The facts may be summarized as follows. Petitioners resided
in Blaine, Minnesota, at the time the petition was filed. Before
1984 petitioner had manufactured bedroom furniture. In 1984,
petitioner sold the business and began constructing single unit
houses. In 1991, petitioner quit that business and became a
"house husband". In 1994, petitioner entered into an agreement
with his mother whereby he agreed to construct a house for her in
Detroit Lakes, Minnesota. According to petitioner, his mother
owned a lot in Detroit Lakes that she quit-claimed to him. On
August 3, 1994, petitioner and his mother entered into a written
contract whereby petitioner sold the lot and a "house built new"
to her for $200,000. The closing date specified was February 1,
1995.
Petitioner commenced construction on the house in August
1994. Sometime in November 1994, the partially built house was
severely damaged in a storm. Petitioner allegedly had insurance
on the house; the insurance company, however, has not paid for
the storm damage. Apparently, petitioner continued to work on
the house. On April 28, 1995, petitioner and his mother executed
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another document called a "bid", whereby petitioner estimated
that the storm damage would cost $64,900 to repair. Petitioner
has no workups either of the original cost of constructing the
house or of the estimated repair expenses. Petitioner did not
have any documentation for the subcontracting work. According to
petitioner, he estimated the following expenses: Materials
($120,000), employee wages ($50,000), and travel, meals, and
lodging ($10,000). Petitioner is not licensed as a contractor,
plumber, or electrician.
It is unclear when the house was completed or, if in fact
the property had been conveyed to him, when petitioner reconveyed
the property to his mother. Petitioner testified that over the
years 1994 to 1997 his mother paid him $200,000, but he did not
know how much or when the payments were made. Petitioners did
not report any of these payments on their Federal income tax
returns for the years in issue. On January 5, 1998, petitioner
filed a mechanic's lien against the property in the amount of
$64,900.
Petitioner allegedly drove from his home to Detroit Lakes
each week. On Schedules C filed with the 1995 and 1996 returns,
petitioners reported no income and claimed the following
expenses:
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1995 1996
Car & truck expenses $11,625 $7,007
Legal expenses 1,956 3,000
Office expenses 235 235
Repairs & maintenance -0- 1,000
Travel 4,200 2,450
Meals & entertainment1 3,250 1,896
Utilities -0- 400
Other expenses 2,023 700
23,289 16,688
1
For 1995 and 1996, petitioner claimed total meal expenses
of $6,500 and $3,792, respectively, and reduced those figures by
50 percent. See sec. 274(n).
With regard to the car and truck expenses, petitioner
allegedly drove a 1985 Chrysler automobile to and from the
construction site. He computed the mileage between his home and
Detroit Lakes and multiplied that figure by the number of trips
he made each year. He then added the mileage he estimated was
incurred while working in Detroit Lakes. Petitioner did not
maintain contemporaneous logs or records of his mileage. The
meal expenses were also estimated, and petitioner has no records
of these expenses. The travel expenses were presumably for
lodging while in Detroit Lakes. Petitioner has no receipts,
canceled checks, or other documentation of these expenses.
The legal expenses allegedly were incurred in seeking advice
concerning petitioner's suit against the insurance company to
recover damages from the November 1994 storm. Petitioner has no
documentation of these expenses and claims that the attorneys
with whom he consulted would not provide corroborating evidence.
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With respect to the utility expenses, petitioner produced
telephone bills in the name of his mother (Helen Smiley) for
telephone service at Detroit Lakes from February through July
1995. There is no information as to who paid these expenses or
when they were paid. There is no documentation concerning the
other expenses claimed.
Respondent disallowed the expenses for lack of
substantiation and also contends that the claimed expenses were
not incurred in an activity entered into for profit.
Discussion
Section 162(a) allows deductions for ordinary and necessary
expenses paid or incurred in carrying on a trade or business.
Under section 274(d), however, a taxpayer may not deduct the use
of a passenger vehicle and lodging and meal expenses unless he or
she substantiates the amount of the expense, the time and place
of the travel, and the business purpose of the travel with
adequate records or sufficient evidence corroborating his or her
statement. See Miner v. Commissioner, T.C. Memo. 1999-358.
Generally, "to meet the 'adequate records' requirements of
section 274(d), a taxpayer shall maintain an account book, diary,
log, statement of expense, trip sheets, or similar record". Sec.
1.274-5T(c)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg. 46017
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(Nov. 6, 1985). Petitioner did not maintain any such records2
and he has not otherwise properly substantiated the expenses
claimed for car and truck, travel, and meals.
With regard to the other Schedule C expenses claimed there
is also no substantiation. As far as the explanation that the
attorneys he consulted would not provide receipts, etc., it is
unpersuasive. Similarly there are no substantiating receipts,
canceled checks, etc., with regard to the other expenses claimed.
Respondent's determinations are sustained.
It also should be noted that generally expenses associated
with the building or improvement of a house must be capitalized
if incurred in a profit-seeking activity. See Homes By Ayres v.
Commissioner, 795 F.2d 832, 835 (9th Cir. 1986), affg. T.C. Memo.
1984-475; W.C. & A.N. Miller Dev. Co. v. Commissioner, 81 T.C.
619 (1983); see also sec. 263A. These expenses, if in fact they
were incurred by petitioner, were directly attributable to the
construction of the house. Since the sale of the house to
petitioner's mother did not occur during either of the years
before the Court, even if the claimed expenses had been
substantiated, they would not be allowable as ordinary and
2
Petitioner provided a so-called mileage log that he
constructed just before the trial allegedly based on receipts
that he did not produce. This does not meet the adequate records
requirement.
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necessary expenses of a trade or business during the years in
issue.
In light of the above, we find it unnecessary to explore
whether or not petitioner's home building activity was entered
into for profit. We note, however, that there is a strong
suggestion that petitioner's primary motivation seems to have
been the building of a house for his mother rather than making a
profit.
Respondent also determined that petitioners are liable for
accuracy-related penalties under section 6662(a) for 1995 and
1996 for negligence. Section 6662(a) provides that "there shall
be added to the tax an amount equal to 20 percent of the portion
of the underpayment to which this section applies." Section 6662
applies to "the portion of any underpayment which is attributable
to", inter alia, negligence or disregard of rules or regulations.
Sec. 6662(b)(1). Negligence "includes any failure to make a
reasonable attempt to comply with the provisions of * * * [the
Internal Revenue Code], and the term 'disregard' includes any
careless, reckless, or intentional disregard." Sec. 6662(c).
Petitioners argue that they employed a qualified tax return
preparer and any errors were due to the return preparer. In some
circumstances reliance upon a qualified return preparer may
alleviate a taxpayer's liability for penalties. See Ewing v.
Commissioner, 91 T.C. 396, 423-424 (1988), affd. without
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published opinion 940 F.2d 1534 (9th Cir. 1991); sec. 1.6664-
4(b)(1), Income Tax Regs. The taxpayer must advise the preparer
of all facts that are relevant to the tax treatment of an item.
See sec. 1.6664-4(c)(1)(i), Income Tax Regs.; see also Ellwest
Stereo Theatres, Inc. v. Commissioner, T.C. Memo. 1995-610. The
advice must not be based upon unreasonable factual or legal
assumptions. See sec. 1.6664-4(c)(1)(ii), Income Tax Regs.
There is nothing in this record indicating that petitioners
advised the return preparer of all the facts and circumstances
surrounding the expenses claimed. Moreover, petitioner's
recordkeeping was nonexistent. We sustain respondent's
determinations as to the penalties under section 6662(a).
Decision will be entered
for respondent.