BISHOP v. COMMISSIONER

T.C. Memo. 2001-82

UNITED STATES TAX COURT

RANDALL AND LYNN BISHOP, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14129-98. Filed April 4, 2001.

P husband (H) carried on a financial planning
business on behalf of individual clients. R disallowed
various deductions claimed by H during 1994 on
Schedule C filed with Ps’ 1994 return and also
determined that Ps were subject to the sec. 6662,
I.R.C., accuracy-related penalty.
1. Held: R’s disallowance of various Schedule C
deductions is sustained in substantial part.
2. Held, further, no portion of R’s deduction
disallowance may be treated as a disallowance of
Schedule A itemized deductions rather than of
Schedule C deductions.
3. Held, further, R’s penalty against Ps for the
whole of petitioners’ underpayment of tax for the
taxable year is sustained under sec. 6662, I.R.C.
 - 2 -

Michael G. Moore, for petitioners.

Nancy L. Spitz, for respondent.

MEMORANDUM OPINION

HALPERN, Judge: By notice of deficiency dated May 13, 1998

(the notice), respondent determined a deficiency in petitioners’

Federal income tax for 1994 in the amount of $58,632 and an

accuracy-related penalty in the amount of $11,726.40.

Petitioners have conceded certain of respondent’s adjustments

giving rise to that deficiency. The issues remaining for

decision are (1) certain adjustments by respondent to deductions

claimed by petitioners for depreciation, office expenses, rental

expenses, and expenses for meals and entertainment, (2) certain

ancillary consequences of respondent’s adjustments, and (3)

petitioners’ liability for the accuracy-related penalty.1

Some facts have been stipulated and are so found. The

stipulation of facts, with accompanying exhibits, is incorporated

herein by this reference. We need find few facts in addition to

those stipulated and shall not, therefore, separately set forth

our findings of fact. We shall make additional findings of fact

1
The deficiencies also reflect adjustments to petitioners’
itemized deductions, personal exemptions, the credit for self-
employment taxes, and the sec. 164(f) deduction for one-half of
self-employment taxes, all of which derive from the principal
adjustment and are not directly disputed by petitioners.
 - 3 -

as we proceed. Petitioners bear the burden of proof. See

Rule 142(a).

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year at issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

Background

Hereinafter, petitioners Randall and Lynn Bishop will be

referred to as the Bishops or, individually, as Randall and Lynn.

At the time of the petition, the Bishops resided in Bonita

Springs, Florida.

During 1994, the Bishops resided in Burlingame, California.

Until July 8, 1994, Randall was employed as a financial planner

by Wells Fargo Bank in San Francisco, California, and, during

1994, Lynn was employed as a flight attendant. During 1994,

Randall also carried on a financial planning business (the

financial planning business) separate from his employment by

Wells Fargo Bank. Customers of the financial planning business

came from referrals to Randall or from seminars conducted by

Randall. The Bishops made a joint return of income for 1994,

filing a U.S. Individual Income Tax Return, Form 1040 (the Form

1040), which included, among other schedules, a Schedule A,

Itemized Deductions (the Schedule A), and a Schedule C, Profit or

Loss From Business (Sole Proprietorship) (the Schedule C).
 - 4 -

Petitioners reported the results of the financial planning

business on the Schedule C. Petitioners computed the taxable

income of the financial planning business under the cash receipts

and disbursements method of accounting. The Schedule C reports

gross receipts of $424,497 and net profit of $203,020.

In part, respondent’s determination of a deficiency in tax

results from the following adjustments (disallowances) of

deductions claimed on the Schedule C:

Depreciation $34,726
Meals & entertainment 40,000
Office expenses 24,091
Rental expenses 18,247
Travel 17,584
Seminars 15,260
Presentations 12,675

On brief, petitioners concede the following: (1) the

correctness of respondent’s disallowance of any deduction for

travel, (2) the correctness of a portion of respondent’s

disallowance of a deduction for depreciation, (3) the correctness

of a portion of respondent’s disallowance of a deduction for

office expenses, (4) that the amounts claimed for “seminars” and

“presentations” are amounts paid for meals and entertainment,

which are subject to the 50-percent disallowance rule of section

274(n), and (5) the correctness of a portion of respondent’s

disallowance of a deduction for meals and entertainment

(including the amounts claimed for “seminars” and

“presentations”).
 - 5 -

We accept all of petitioners’ concessions. After

concessions, the deductions still in issue are as follows:

Depreciation $13,232
Office expenses 8,762
Rental expenses 23,170
Meals and entertainment 8,719

Discussion

I. Deductions

A. Introduction

We must determine petitioners’ entitlement to the deductions

still in issue for depreciation, office expenses, rental

expenses, and meals and entertainment. Because petitioners’

principal challenge is substantiating their entitlement to those

deductions, we first set forth the pertinent parts of section

274(d), which sets forth requirements for substantiating certain

deductions:

SEC. 274(d) Substantiation Required.–-No deduction
or credit shall be allowed--

(1) under section 162 or 212 for any traveling
expense (including meals and lodging while away
from home),

(2) for any item with respect to an activity
which is of a type generally considered to
constitute entertainment, amusement, or
recreation, or with respect to a facility used in
connection with such an activity,

* * * * * * *

(4) with respect to any listed property (as
defined in section 280F(d)(4)),
 - 6 -

unless the taxpayer substantiates by adequate records
or by sufficient evidence corroborating the taxpayer’s
own statement (A) the amount of such expense or other
item, (B) the time and place of the travel,
entertainment, amusement, recreation, or use of the
facility or property, or the date and description of
the gift, (C) the business purpose of the expense or
other item, and (D) the business relationship to the
taxpayer of persons entertained, using the facility or
property, or receiving the gift. * * *

Section 280F(d)(4) includes, among the definitions of

“listed property”, “any computer or peripheral equipment”.

At the conclusion of the trial in this case, the Court,

recognizing that substantiation was petitioners’ principal

challenge, ordered the parties to develop a form of schedule, to

be filled in by petitioners, which would set forth each item

still in issue, with appropriate references to evidence in the

record for each element necessary to sustain a deduction. The

parties have complied with that order, and the Court relies on

that schedule (petitioners’ substantiation schedule) for

direction to evidence in support of petitioners’ claims.

B. Depreciation

The depreciation deductions here in question are, in

actuality, deductions under section 179, which allows certain

taxpayers to treat as an expense that is not chargeable to

capital account the cost of certain depreciable property. The

deduction under section 179 is allowed for the taxable year in

which the depreciable property is placed in service. The

property here in question consists of a computer, certain
 - 7 -

elements of computer memory for that computer and for other

computers, and a flatbed computer scanner (the computer

equipment) described by petitioners on a Form 4562, Depreciation

and Amortization (Including Information on Listed Property),

appurtenant to the Schedule C. The computer equipment is listed

property, within the meaning of section 274(d)(4). See, e.g.,

Dugan v. Commissioner, T.C. Memo. 1996-155.2 Therefore,

petitioners must satisfy the substantiation requirements of

section 274(d). The elements to be proved with respect to listed

property are set forth in sec. 1.274-5T(b)(6), Temporary Income

Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985). Those elements

include the amount of “business/investment” use based on an

allocation of the time the computer equipment is used.

Petitioners have failed to offer either adequate records or any

evidence substantiating Randall’s own statements with respect to

such use. See sec. 1.274-5T(c), Temporary Income Tax Regs., 50

Fed. Reg. 46016 (Nov. 6, 1985). Petitioners have, therefore,

failed to satisfy section 274(d) and, as a result, may claim no

deduction under section 179 for the computer equipment. See

2
Petitioners offered no evidence that the computer
equipment is excepted from the definition of listed property
because it was used exclusively at a regular business
establishment owned or leased by Randall, which, with certain
exceptions not here relevant, is not, also, a dwelling unit. See
sec. 280F(d)(4)(B). Indeed, confirmation documents with respect
to the purchase of the computer equipment show that it was
shipped to the address appearing on the Form 1040, which we
assume to be petitioners’ residence.
 - 8 -

Dugan v. Commissioner, supra (“Given that petitioner has failed

to demonstrate the business purpose for the computer expense in

accordance with section 274(d), the [section 179] deduction is

disallowed.”).

C. Office Expenses

Petitioners claim a deduction for office expenses in the

amount of $8,762.

Section 162(a) allows as a deduction “all the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business”. Office expenses of the type

claimed by petitioner, e.g., postage, if paid or incurred during

the taxable year in carrying on any trade or business, can

qualify as deductible section 162(a) expenses. See sec. 1.162-

1(a), Income Tax Regs. The adequate-records-or-sufficient-

corroborating-evidence standard of section 274(d) is not

specifically applicable to such expenses. Nevertheless, a

taxpayer is required by section 6001 to keep records and to

substantiate the amounts giving rise to claimed deductions, and,

if he does not, respondent cannot be considered arbitrary or

unreasonable in denying the deductions. Roberts v. Commissioner,

62 T.C. 834, 836-837 (1974); Cook v. Commissioner, T.C. Memo.

1991-590 (citing Hradesky v. Commissioner, 65 T.C. 87, 90 (1975),

affd. per curiam 540 F.2d 821 (5th Cir. 1976)); see sec. 1.6001-

1(a), Income Tax Regs.
 - 9 -

Randall did not keep a regular set of books reflecting the

income and expenses associated with his financial planning

business. To substantiate the office expenses and meals and

entertainment here in issue, petitioners refer us to (1) various

entries in a diary, Randall’s “daily planner”, (2) his

NationsBank VISA card summary statement for 1994, and (3) various

receipts relating to meals and entertainment expenses and office

expenses. We must decide whether and to what extent that

evidence is adequate to substantiate the business expense

deductions that remain in issue.

With respect to the items of office expense set out on

petitioners’ substantiation schedule, with four exceptions,

petitioners’ evidence fails to satisfy one or more of the

elements necessary to establish deductibility as ordinary and

necessary business expenses under section 162. For example, a

number of items are listed in Randall’s daily planner, indicating

a business purpose, but do not appear in the NationsBank VISA

card summary or relate to one of the receipts in evidence. In

other words, there is no proof of payment. For other items,

there is proof of payment, but the items are not listed in the

daily planner resulting in a failure to establish a relationship

to Randall’s business.
 - 10 -

Based on petitioners’ substantiation schedule, we find that

petitioners are entitled to a deduction for office expenses in

the sum of $2,429.05.

D. Rental Expenses

Section 162(a)(3) allows a deduction for rentals paid for

the use of property in a trade or business.

On the Schedule C, petitioners claimed a deduction for

rentals in the amount of $18,247. In the petition, they assigned

error to respondent’s disallowance of that amount. On brief,

petitioners claim a deduction for rentals in the amount of

$23,170. Petitioners have not moved to amend the petition to

assert an overpayment in tax. Nonetheless, since respondent has

not objected to the increased claim for a rental deduction on the

ground that petitioners failed to plead an overpayment, we assume

that such overpayment issue was tried by consent of the parties.

See Rule 41(b)(1). In any event, we allow no deduction for

rental payments. The rental expense in question is claimed by

petitioners to represent the rental costs of rooms in which

Randall held financial planning seminars to educate and attract

new clients.

Petitioners’ substantiation schedule directs us to entries

in Randall’s daily planner as substantiation for the entire

$23,170 of alleged rental expense. Randall testified that he

conducted seminars as a way of attracting new clients.
 - 11 -

Typically, the daily planner entry includes a dollar amount

allegedly representing the cost of renting the room in which the

seminar was held. Petitioners have furnished no evidence that

any of those alleged rental costs were in fact incurred: No

canceled checks, no receipts, no inclusion in the NationsBank

VISA card summary. We find that, having offered no evidence of

actual payment, petitioners have failed to sustain their burden

of establishing that they are entitled to a rental expense

deduction. See Hyde v. Commissioner, T.C. Memo. 1992-419 ("This

Court is not bound to accept the unverified, undocumented

testimony of petitioner”), affd. without published opinion 9 F.3d

112 (7th Cir. 1993). By not offering independent evidence that

the seminars even took place (e.g., brochures, attendance lists,

or the testimony of one or more attendees), petitioners have

failed even to furnish a basis for the Court to estimate, under

the authority of Cohan v. Commissioner, 39 F.2d 540 (2d Cir.

1930), the amount allowable as rental expense. As we stated in

Hyde v. Commissioner, supra:

However, in order to make an estimation, ‘there [must]
be sufficient evidence to satisfy the trier that at
least the amount allowed in the estimate was in fact
spent or incurred for the stated purpose’. Williams v.
United States, 245 F.2d 559, 560 (5th Cir. 1957).
Until the trier has that assurance from the record,
relief to the taxpayer would be “unguided largesse”.
Id.

Petitioners have failed to establish that they are entitled

to any deduction for rental expense.
 - 12 -

E. Meals and Entertainment

Petitioners claim a deduction under section 162(a) for meals

and entertainment in the amount of $8,719 ($17,438 before taking

into account the 50-percent reduction in the deductibility of

such expenses provided for by section 274(n)(1)).3

The substantiation requirements of section 274(d) apply to

entertainment activities. Section 274(a)(1)(A) places additional

restrictions on the deduction of expenses with respect to

entertainment activities. Section 1.274-5T, Temporary Income Tax

Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985), contains the

substantiation requirements for deductible, business-related

entertainment, including meals with customers or clients.4 The

applicable requirements, contained in paragraph (b) of section

1.274-5T, Temporary Income Tax Regs. (substantiation of amount,

time, place, business purpose, and business relationship), are

satisfied by the Exhibit B1 and B2 formats.

Petitioners’ substantiation schedule separately lists

(1) expenditures totaling $13,051.56, for restaurant meals with

clients, potential clients, and persons referring potential

clients (restaurant meal expenses), and (2) expenditures totaling

3
The allegedly deductible expenditures are contained in
Exhibits B1 and B2 accompanying petitioners’ reply brief.
4
Mistakenly, petitioners cite sec. 1.274-2(f)(2)(i),
Income Tax Regs., which provides a quiet-business-meals exception
but which applies to “[b]usiness meals and similar expenditures
paid or incurred before January 1, 1987".
 - 13 -

$4,386.66 for meals and entertainment where, in petitioners’

words, “there may have been ‘major distractions not conducive to

business discussion’, i.e., sporting events, shows, etc.” (other

entertainment expenses).

For most, but not all, of the restaurant meal expenses,

petitioners have set forth the business purpose of the meal, and

they have attempted to substantiate the claimed business purpose

by referring to the appropriate entry in Randall’s daily planner.

In most, but not all, cases, the actual expenditure of funds has

been substantiated by reference either or both to Randall’s

NationsBank VISA card summary for 1994 or his restaurant receipts

for that year. Unless there is (1) a clearly stated business

purpose for a restaurant meal expense, (2) the item is included

in Randall’s daily planner, thereby supporting the claimed

business purpose, and (3) the expenditure is verified by the

NationsBank summary or by a restaurant receipt, an essential

element of substantiation is lacking, and we sustain respondent’s

disallowance of a deduction for that item.

In reviewing petitioners’ substantiation schedule to

determine the adequacy of the alleged substantiation, we note

that “business purpose” is often referred to in cryptic terms,

e.g., “open”, “close”, “partial”, “A.L. T.D.A.”, “LNL”, “RLTY”,

etc. In some cases, we have been able to decipher the meaning of

the term from Randall’s testimony, and, in some cases, we have
 - 14 -

not. We are not required to speculate as to the nature of the

business purpose of any expenditure. See Lingham v.

Commissioner, T.C. Memo. 1977-152. The fact that Randall may

have been dining with a client “is not conclusive of the business

character of the meals, for at least some of these people may

also have been personal friends of * * * [Randall]”. Sanford v.

Commissioner, 50 T.C. 823, 827 (1968), affd. per curiam 412 F.2d

201 (2d Cir. 1969). Therefore, where the business purpose of a

meal with a client is not readily discernable from the record, we

find the expense to be nondeductible.

Applying the foregoing criteria to the restaurant meal

expenses, we find that petitioners have provided adequate

substantiation of restaurant meals costing a total of $6,411.28.

There are six items set forth as other entertainment

expenses. Of the six items, three are not referred to in

Randall’s daily planner. Thus, there is no corroboration of the

stated business purpose. Most importantly, for none of the items

is there any indication that some “business discussion or

activity” was associated with the entertainment. See sec.

274(a)(1)(A), (d); and sec. 1.274-5T(b)(3)(iv) and (b)(4)(iii),

Temporary Income Tax Regs., supra. Therefore, we find that

petitioners are entitled to no deduction for any of the other

entertainment expenses.
 - 15 -

II. Schedule A Versus Schedule C Deduction Disallowance

All of respondent’s proposed adjustments decrease expenses

claimed on the Schedule C and, correspondingly, increase

petitioners’ adjusted gross income for 1994. Petitioners claim

that, based upon “guidelines set out in audits of prior years”,

they treated a portion of the expenses listed on the Schedule C

as Schedule A itemized deductions on the premise that the

expenses were associated with Randall’s wages from Wells Fargo

Bank rather than with his own financial planning business. In

fact, an attachment to line 46 of the Schedule C lists “other

expenses”, totaling $76,180, and reduces the total by $39,084

which, instead, is deducted on line 20 of the Schedule A as

unreimbursed employee expenses. Petitioners argue that, because

a portion of the expenses listed on the Schedule C was, in

effect, not taken on the Schedule C but taken, instead, on the

Schedule A, a portion of the disallowance of those deductions

should, likewise, be a disallowance of the itemized deductions

reflected on line 20 of the Schedule A.5 Respondent argues that

5
Although petitioners do not indicate the tax benefit to
be derived from their requested reattribution of a portion of
respondent’s proposed deduction disallowances, we surmise that
one such benefit is the resulting reduction in the loss of
petitioners’ itemized deductions under sec. 68(a)(1) and (b),
which, for 1994, equals 3 percent of petitioners’ adjusted gross
income in excess of $111,800. By restoring deductions to
Schedule C, petitioners reduce adjusted gross income and,
thereby, reduce their loss of itemized deductions under sec.
68(a)(1) and (b). There is also an increase in petitioners’
(continued...)
 - 16 -

there is nothing in the record to support petitioners’ position

and, moreover, there is no authority that supports such

treatment.

We agree with respondent. There is no indication in the

record as to which of the “Other Expenses” listed on the

attachment to line 46 of Schedule C actually relate to Randall’s

wages from Wells Fargo Bank or which expenses petitioners

actually intended to transfer from the Schedule C to the Schedule

A. At a minimum, petitioners must show that the deductions

disallowed by respondent were among the expenses transferred to

the Schedule A, which they have not done. We, therefore, reject

petitioners’ request to treat any portion of respondent’s

deduction disallowance sustained herein as a reduction of

petitioners’ itemized deductions on the Schedule A.

III. Accuracy-Related Penalty

Section 6662 provides for an accuracy-related penalty (the

accuracy-related penalty) in the amount of 20 percent of the

portion of any underpayment attributable to, among other things,

negligence or intentional disregard of rules or regulations

(without distinction, negligence), any substantial understatement

of income tax, or any substantial valuation misstatement.

Respondent determined the accuracy-related penalty against

5
(...continued)
total miscellaneous itemized deductions in excess of 2 percent of
adjusted gross income due to the reduction in that number.
 - 17 -

petitioner. Although the notice states that respondent bases his

imposition of the section 6662(a) accuracy-related penalty upon

“one or more” of the three grounds listed in section 6662(b)(1)-

(3), the issue presented by this case and our resolution thereof

demonstrates that the only possible ground for imposition of the

penalty is section 6662(b)(1), which imposes a penalty in the

amount of 20 percent of the portion of the underpayment that is

attributable to “negligence or disregard of rules or

regulations”. Negligence has been defined as lack of due care or

failure to do what a reasonable and prudent person would do under

like circumstances. See, e.g., Hofstetter v. Commissioner, 98

T.C. 695, 704 (1992). Section 6664(c)(1) provides that the

accuracy-related penalty shall not be imposed with respect to any

portion of an underpayment if it is shown that the taxpayer acted

in good faith and that there was reasonable cause for the

underpayment. The determination of whether a taxpayer acted in

good faith and with reasonable cause is made on a case-by-case

basis, taking into account all pertinent facts and circumstances.

“Circumstances that may indicate reasonable cause and good faith

include an honest misunderstanding of * * * law that is

reasonable in light of all of the facts and circumstances,

including the experience, knowledge, and education of the

taxpayer.” Sec. 1.6664-4(b)(1), Income Tax Regs.
 - 18 -

Petitioners acknowledge their failure to keep adequate

records in support of their claimed deductions for expenditures

subject to the substantiation requirements of section 274(d),

e.g., travel and entertainment expenses (including meals with

clients), and they concede that the accuracy-related penalty

applies to any underpayment attributable to deduction

disallowances with respect to such expenditures. They argue,

however, that they made “a good-faith attempt to maintain proper

documentation in accordance with applicable rules and

regulations” as regards the other section 162 expenses, and that

the penalty should not apply to any underpayment attributable to

the disallowance of deductions attributable to those expenses.

We note that petitioners have conceded all or a portion of

every deduction challenged by respondent, not merely the

deductions subject to section 274(d). Moreover, we have found

that petitioners’ records fail to sustain a large portion of the

deductions remaining in issue. Under those circumstances, we

sustain the negligence penalty for the whole of petitioners’

underpayment of tax.

To reflect the foregoing,

Decision will be entered

under Rule 155.