T.C. Summary Opinion 2001-38
UNITED STATES TAX COURT
JEFFERRY PHUONG VO AND MAI XUAN NGUYEN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3555-99S. Filed March 26, 2001.
Jefferry Phuong Vo and Mai Xuan Nguyen, pro sese.
Robert V. Boeshaar, for respondent.
DEAN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect at the time the petition was filed. Unless otherwise
indicated, subsequent section references are to the Internal
Revenue Code in effect for the year in issue. The decision to be
entered is not reviewable by any other court, and this opinion
should not be cited as authority.
Respondent determined a deficiency of $5,726 in petitioners’
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1995 Federal income tax and an accuracy-related penalty under
section 6662 of $1,145 for taxable year 1995.
The issues for decision are: (1) Whether petitioners were
engaged in a trade or business or an activity for the production
of income during the year in issue; (2) if so, whether
petitioners’ claimed expenses are ordinary and necessary; and (3)
whether petitioners are liable for negligence penalties pursuant
to section 6662.
Background
The stipulation of facts and the accompanying exhibits are
incorporated herein by reference. Petitioners resided in
Portland, Oregon, at the time the petition in this case was
filed.
Petitioners were husband and wife in 1995 and filed a joint
Federal income tax return for the taxable year. Petitioner
Jefferry Phuong Vo (petitioner), along with two friends, formed a
partnership and designed a system in 1992 to use solar energy to
generate electricity to run household appliances. They rented a
three bedroom residential property located at 1770 Caloosa Court,
San Jose, California (San Jose property), in which to develop and
apply the solar-powered electric generator (generator).
Petitioners claim that they needed a large unobstructed yard with
sufficient sunlight to meet their solar needs and that the
residential property was less expensive than a commercial
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property. None of the partners lived in the San Jose property.
All three had their own personal residences.
The partners began marketing the generator in 1993, and they
continued to use the San Jose property for office space and to
demonstrate the generator for potential distributors. They used
a room in the San Jose property as a demonstration area to
display the generator’s capacity to run a television, fan, and
several lights. Petitioner explained that the generator was not
designed to supply sufficient energy to run a typical household
in the United States but that it was designed to meet the more
limited energy needs of households in developing countries.
In 1994 the partners sent a generator to one of the
partner’s relatives in Vietnam who unsuccessfully attempted to
sell the system in Vietnam at a price of $2,000. The relative
decided to keep the generator for himself, and the partners gave
it to him at their cost of $300.
After further unsuccessful attempts at establishing
distributors in Vietnam, petitioner bought out his partners’
interests for $1,000 on May 30, 1994, and began marketing the
generator under the name Solarsys Technology (Solarsys).
Petitioners continued to use the San Jose property and began
looking for distributors in other countries such as Malaysia and
the Philippines. In 1995 approximately 12 people expressed an
interest in establishing distributorships in their countries, and
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five people gave petitioners $1,500 or $2,000 for generators to
take to their countries to determine if there was a market for
the system. All five returned the generators for a refund after
determining that they were too expensive to sell.
Petitioner continued making improvements to the system and
attempting to establish distributors. In 1996 petitioners sold a
generator for $1,500 for the personal use of one of the people
who had agreed to sell the generators in Vietnam.
Petitioners filed a joint Form 1040, U.S. Individual Income
Tax Return, for 1995 and Schedule C, Profit or Loss From
Business, for their activity with respect to Solarsys.
Respondent issued a notice of deficiency for petitioners’ 1995
taxable year disallowing deductions for all the Schedule C
expenses on the grounds that petitioners were not engaged in a
trade or business or activity for profit and determining that if
petitioners were engaged in such activity, the claimed expenses
are not ordinary and necessary. The expenses at issue are as
follows:
Advertising $94
Car & truck expenses 256
Depreciation 1,600
Office expenses 103
Rent 12,600
Travel 1,875
Meals & entertainment 100
Utilities 3,095
Other 724
Total 20,447
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Discussion
Deductions are allowed under section 162 for the ordinary
and necessary expenses of carrying on an activity which
constitutes the taxpayer's trade or business. Deductions are
allowed under section 212 for expenses paid or incurred in
connection with an activity engaged in for the production or
collection of income, or for the management, conservation, or
maintenance of property held for the production of income.
To be engaged in a trade or business within the meaning of
section 162, “the taxpayer must be involved in the activity with
continuity and regularity” and “the taxpayer's primary purpose
for engaging in the activity must be for income or profit.”
Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). In
addition, the taxpayer’s business operations must actually have
commenced. See Thomason v. Commissioner, T.C. Memo. 1997-480;
Scagliotta v. Commissioner, T.C. Memo. 1996-498; McManus v.
Commissioner, T.C. Memo. 1987-457, affd. per curiam without
published opinion 865 F.2d 255 (4th Cir. 1988). An examination
of the facts and circumstances of each case is necessary to
determine whether a taxpayer is carrying on a trade or business.
See Commissioner v. Groetzinger, supra at 36.
It is unclear on what basis respondent determined that
petitioners’ activity with respect to Solarsys did not constitute
a business in 1995. Upon consideration of all the evidence in
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the record, however, we are satisfied that petitioners were
actively engaged in business in 1995 under the name Solarsys with
the primary purpose of making a profit.
Petitioners’ activity attempting to establish distributors
to sell their generators was conducted with regularity and
continuity. Their activity went beyond the mere startup phase.
In 1995 the generator was available for sale, and five
individuals purchased the generator for resale. The fact that
these individuals eventually returned the generators for a refund
does not undermine a conclusion that petitioners were engaged in
business. Further, nothing in the record suggests that
petitioners’ activity attempting to develop a market for their
generators was not undertaken with the primary purpose of making
a profit. See Golanty v. Commissioner, 72 T.C. 411, 426 (1979),
affd. without published opinion 647 F.2d 170 (9th Cir. 1981);
sec. 1.183-2(a) and (b), Income Tax Regs.
The next consideration is whether the expenses petitioners
claimed on their Schedule C are ordinary and necessary business
expenses. See sec. 162(a); Commissioner v. Lincoln Sav. & Loan
Association, 403 U.S. 345, 352 (1971); Welch v. Helvering, 290
U.S. 111, 113 (1933). “Ordinary” has been defined in the context
of section 162(a) as that which is “normal, usual, or customary”
in the taxpayer's trade or business. Deputy v. du Pont, 308 U.S.
488, 495 (1940). “Necessary” has been construed to mean
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“appropriate” or “helpful” in the development of the taxpayer's
business. Welch v. Helvering, supra. Unless expressly provided
for, section 262 prohibits deductions for personal, living, or
family expenses.
The basis of respondent’s determination that the expenses at
issue are not ordinary and necessary appears to be that the
expenses were personal in nature and not related to petitioner’s
business of selling generators. Based on petitioner’s
explanations at trial, we are satisfied that the following
expenses are ordinary and necessary expenses incurred in
petitioners’ business:
Advertising $94
Car & truck expenses 256
Depreciation 1,600
Office expenses 103
Rent 12,600
Utilities 2,755
Other 724
Total 18,132
We found credible petitioner’s testimony that the San Jose
property was used for business purposes and not as their personal
residence despite the fact that petitioners rented the property
under a residential lease that provides that the property is to
be “used only as a private residence”. With respect to the
expenses related to petitioners’ truck (depreciation, car &
truck, and $524 of “other” expense), petitioner testified that he
and his wife used the truck to transport solar panels, to
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transport the generator system, and to travel to different
locations to distribute brochures about their business.
Respondent did not challenge petitioners’ substantiation of these
expenses, and nothing in the record contradicts petitioner’s
testimony.
We find that petitioners are not entitled to deductions for
$340 of utility expenses. These expenses were incurred for cable
television. Petitioner testified that the cable was necessary
because he liked to watch the news. These expenses are personal
and not attributable to petitioners’ business. We also find that
petitioners are not entitled to deductions for travel and meal
and entertainment expenses as petitioners have provided no
evidence that these expenses were related to their business.
Finally, we address the accuracy-related penalty imposed
pursuant to section 6662(a). Section 6662(a) and (b)(1) imposes
a penalty on any portion of an underpayment that is attributable
to negligence or disregard of rules or regulations. The term
“negligence” includes any failure to make a reasonable attempt to
comply with the statute, and the term “disregard” includes any
careless, reckless, or intentional disregard. Sec. 6662(c). The
penalty does not apply to any portion of an underpayment for
which there was reasonable cause and with respect to which the
taxpayer acted in good faith. See sec. 6664(c).
Petitioners bear the burden of proving that the accuracy-
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related penalty is inapplicable.1 See Rule 142(a); Welch v.
Helvering, supra at 115; Bixby v. Commissioner, 58 T.C. 757, 791-
792 (1972).
With respect to the cable charges, petitioners claimed
business deductions for expenses which were personal in nature.
Petitioners have failed to provide any information about the
business purpose of their claimed travel and meal and
entertainment expenses.
Accordingly, we hold that petitioners are liable for an
accuracy-related penalty pursuant to section 6662(a) with respect
to the understatement of tax attributable to the deductions we
have disallowed.
Reviewed and adopted as the report of the Small Tax Case
Division.
Decision will be entered
under Rule 155.
1
Section 7491(c), applicable to court proceedings arising
in connection with examinations commencing after July 22, 1998,
requires the Secretary to carry the burden of production with
respect to additions to tax. See Internal Revenue Service
Restructuring & Reform Act of 1998, Pub. L. 105-206, sec. 3001,
112 Stat. 726. Petitioners do not contend that their examination
commenced after July 22, 1998, or that sec. 7491 is applicable to
them.