T.C. Summary Opinion 2003-16
UNITED STATES TAX COURT
DANVIS S. AND SHERYL S. SMITH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9210-00S. Filed February 28, 2003.
Danvis S. Smith, pro se.
Sara J. Barkley, for respondent.
DINAN, 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. The decision to be
entered is not reviewable by any other court, and this opinion
should not be cited as authority. Unless otherwise indicated,
subsequent section references are to the Internal Revenue Code in
effect for the years in issue.
- 2 -
Respondent determined deficiencies in petitioners’ Federal
income taxes of $8,993 and $5,053, and accuracy-related penalties
of $1,799 and $1,011, respectively, for the taxable years 1995
and 1996.
The issues for decision are: (1) Whether petitioners are
entitled to charitable contribution deductions in 1995 and 1996;
(2) whether petitioners are entitled to certain miscellaneous
itemized deductions in 1995 and 1996 and business expense
deductions in 1995; and (3) whether petitioners are liable for
accuracy-related penalties under section 6662(a) for 1995 and
1996.1
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
Highlands Ranch, Colorado, on the date the petition was filed in
this case.
Charitable Contribution Deductions
During the years in issue, petitioner husband (petitioner)
was the director of Alpha Ministries. Petitioners provided
nearly all of the funds used by Alpha Ministries, and nearly all
of these funds were in turn used to pay for expenses of
1
Petitioners concede respondent’s determination that they
received $123 in unreported interest income in 1995. Respondent
determined that petitioners were entitled to unclaimed deductions
in 1995 of $463 for investment interest expense and $62 for
business office expense.
- 3 -
petitioners, primarily in the form of a “housing allowance”.2
Petitioner, upon receiving paychecks from unrelated employment,
would sign the back of the paychecks over to Alpha Ministries
prior to depositing them into a checking account bearing the
designation “Alpha Ministries”. The account into which the funds
were deposited was owned and controlled by petitioners, and
petitioners alone had authority to use the funds therein.
Petitioners filed joint Federal income tax returns for the
years in issue. On these returns, petitioners claimed deductions
of $27,150 in 1995 and $30,500 in 1996 for charitable
contributions purportedly made to Alpha Ministries. In the
statutory notice of deficiency, respondent disallowed these
deductions in full.
2
Petitioners, relying on uncorroborated summary documents
entered into evidence, argue that Alpha Ministries had the
following income and expenses for each of the years in issue:
1995 1996
Income
Cash donations by petitioners $31,560 $25,740
Cash donations by other individuals 290 100
Interest on deposits 12 18
31,862 25,858
Disbursements
Petitioner’s housing allowance $22,000 $24,775
Petitioner’s health care allowance 700 -0-
Petitioner’s auto/travel allowance 700 200
Petitioner’s books and materials 94 -0-
Loan to petitioner 8,135 -0-
Supplies, postage, fees, and copies 34 -0-
31,663 24,975
Although we do not accept these figures as actual amounts of
income and expenses of Alpha Ministries, we accept them as an
admission by petitioners that any funds received by, or
designated for use by, Alpha Ministries were used almost
exclusively for the personal benefit of petitioners.
- 4 -
As a general rule, personal, living, and family expenses are
nondeductible. Sec. 262(a). Subject to limitations not relevant
here, section 170(a) allows a deduction for charitable
contributions made during the taxable year to certain types of
organizations. For a contribution to be deductible, it must be
made to an organization “no part of the net earnings of which
inures to the benefit of any private shareholder or individual”.
Sec. 170(c)(2)(C).
The facts in the case before us are substantially similar to
the facts in a prior case before this Court, Miedaner v.
Commissioner, 81 T.C. 272 (1983). In Miedaner, the taxpayers
established and subsequently operated an entity known as the
Church of Physical Theology. They had established a separate
checking account for the church, but used funds from this account
for a variety of personal expenses, primarily for “living
allowances” for each of the taxpayers. In sustaining the
Commissioner’s disallowance of deductions claimed by the
taxpayers for amounts purportedly contributed to the church, this
Court stated:
the church was essentially inseparable from the personal
interests of Terrel and Penelope, and we agree with
respondent’s observation that petitioners literally bathed
themselves in personal benefits. Their “contributions”
funded their living allowances * * * . The church account
was simply a magic wand whereby personal expenses were
converted into tax deductions. Where contributions go to
- 5 -
pay personal expenses, they are neither charitable nor
deductible. * * *
Id. at 281.
Assuming arguendo that petitioners made any contributions in
this case, petitioners, by their own admission, used any
contributed funds funneled through Alpha Ministries almost
exclusively for their own housing and for other expenses
benefitting only petitioners. Thus, in accordance with section
170(c)(2)(C) and Miedaner v. Commissioner, supra, petitioners are
not entitled to the claimed charitable contribution deductions.
See also Davis v. Commissioner, 81 T.C. 806, 817 (1983), affd.
without published opinion 767 F.2d 931 (9th Cir. 1985) (no
charitable contributions were made where taxpayer retained
control of the funds and derived personal benefits therefrom).
Itemized and Business Deductions
During 1995 and 1996, petitioner’s primary employment was as
a faculty member of Apollo Group, Inc. of Phoenix, Arizona.
Petitioner’s duties included class preparation, keeping records
of grades and attendance, communicating with the school
administration, conducting tests, and grading papers and tests.
In connection with this employment, petitioners claimed
miscellaneous itemized deductions with respect to the following
unreimbursed employee business expenses, in each respective year:
- 6 -
1995 1996
Vehicle expense $2,949 $2,520
Parking fees, tolls, and transportation 24 32
Other expenses
“Business auto loan interest” 698
“Office rent” 4,800
“Postage and express” 64
“Office supplies” 80
“Grading services” 7,513
Unspecified 3,647
Less reimbursements by employer (653) (168)
Total (adjusted for rounding errors) 15,474 6,031
Respondent disallowed the deductions with respect to expenses of
$13,011 in 1995 and $3,166 in 1996.3
For taxable year 1995, petitioner filed a Schedule C, Profit
or Loss From Business, for a sole proprietorship known as “Smith
Table Pads”. The schedule listed the principal business of the
proprietorship as “distributor of custom fitted table pads and
teaching”. On the schedule, petitioners claimed deductions for,
among others, the following: interest expense of $2,163; rent
expense of $5,800; travel expense of $2,642; and meal and
entertainment expense of $680. Respondent disallowed each of
these deductions in full, except with respect to interest expense
of $731.
During both of the years in issue, petitioners resided in
residences owned by petitioners in their own names.
In 1995, petitioner organized a corporation under Colorado
law known as Smith Corporation. The articles of incorporation
3
Respondent’s additional adjustment to the total of the 1995
miscellaneous itemized deductions, which was based on a change in
petitioners’ adjusted gross income, is computational and will be
resolved by the Court’s holding on the issues in this case.
- 7 -
were stamped received by the Colorado Secretary of State on
December 13, 1995. The corporation never received an employer
identification number from the Internal Revenue Service and never
filed Federal income or employment tax returns. Petitioner, the
sole shareholder, intended to use this corporation for a number
of separate activities: First, the corporation was meant to
establish a vending machine route. Second, petitioner hoped the
corporation would take over his table pad business. Third,
petitioner thought that he could “pay” the corporation to provide
grading services needed for his Apollo Group employment, services
which he in turn would personally provide. Finally, petitioner
thought that he could “pay” the corporation rent for use of his
residence in grading papers and other activities, while
petitioner and his wife personally owned the residence. With
respect to the latter two activities, petitioner claimed
deductions on the 1995 return for alleged payments to the
corporation, which had been incorporated on or about December 13
of that year. Petitioner never transferred any funds to the
corporation or to an account designated for corporate use.
A taxpayer may deduct the ordinary and necessary expenses
paid or incurred during the taxable year in carrying on a trade
or business, including the trade or business of being an
employee. Sec. 162(a); Primuth v. Commissioner, 54 T.C. 374,
377-378 (1970). A taxpayer, however, generally must keep records
- 8 -
sufficient to establish the amounts of the items reported on his
Federal income tax return. Sec. 6001; sec. 1.6001-1(a), (e),
Income Tax Regs. In the event that a taxpayer establishes that a
deductible expense has been paid but is unable to substantiate
the precise amount, we generally may estimate the amount of the
deductible expense bearing heavily against the taxpayer whose
inexactitude in substantiating the amount of the expense is of
his own making. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d
Cir. 1930). We cannot estimate a deductible expense, however,
unless the taxpayer presents evidence sufficient to provide some
basis upon which an estimate may be made. Vanicek v.
Commissioner, 85 T.C. 731, 743 (1985).
Furthermore, section 274(d) supersedes the Cohan doctrine
and prohibits estimating certain expenses. Sanford v.
Commissioner, 50 T.C. 823, 827 (1968), affd. 412 F.2d 201 (2d
Cir. 1969). That section provides that, unless the taxpayer
complies with certain strict substantiation rules, no deduction
is allowable (1) for traveling expenses, (2) for entertainment
expenses, (3) for expenses for gifts, or (4) with respect to
listed property. Listed property includes passenger automobiles
and other property used as a means of transportation. Sec.
280F(d)(4). To meet the strict substantiation requirements, the
taxpayer must substantiate the amount, time, place, and business
- 9 -
purpose of the expenses. Sec. 274(d); sec. 1.274-5T, Temporary
Income Tax Regs., 50 Fed. Reg. 46006 (Nov. 6, 1985).
Petitioners have failed to substantiate any of the Schedule
C deductions or the employee business expense deductions
disallowed by respondent.4 Petitioners have failed to provide
evidence that the expenses were incurred, such as receipts, and
they have failed to sufficiently explain the underlying business
purposes. For example, petitioners claim to have traveled to
Hawaii in connection with the business of the sole
proprietorship. However, overlooking whether petitioners in fact
traveled to Hawaii primarily to sell table pads, they provided no
receipts for the travel, and their daily planner indicates that
their primary business-related activity was making phone calls--
calls which presumably could have been made from Colorado.
Petitioners assert that a flood destroyed many of the records
which would have provided substantiation. Even if this were the
case, however, petitioners have not adequately attempted to
reconstruct any destroyed records, by such means as obtaining
copies of bank or credit card records. Finally, petitioners have
not provided the Court with any basis upon which to estimate
expenses (with respect to those for which estimates may be made).
4
Sec. 7491(a) does not shift the burden of proof to
respondent here because petitioners have failed to produce any
credible evidence with respect to the disallowed deductions.
- 10 -
We sustain respondent’s disallowance of each of the deductions at
issue.5
Accuracy-Related Penalties
Respondent determined that petitioners are liable for
accuracy-related penalties under section 6662(a) for both years
in issue with respect to the underpayments resulting from the
total amounts of the deficiencies. Respondent has the burden of
production with respect to the penalties but the burden of proof
remains on petitioners. Sec. 7491(c); Higbee v. Commissioner,
116 T.C. 438 (2001).
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.
Sec. 6662(b)(1). “Negligence” includes any failure to make a
reasonable attempt to comply with the provisions of the Internal
Revenue Code, including any failure to keep adequate books and
records or to substantiate items properly. Sec. 6662(c); sec.
1.6662-3(b)(1), Income Tax Regs. Section 6664(c)(1) provides
that the penalty under section 6662(a) shall not apply to any
portion of an underpayment if it is shown that there was
5
The rent expense claimed by petitioners as both employee
business expense and Schedule C business expense was connected to
petitioner’s use of his own residence. Although petitioners do
not directly address the “home office” provisions of sec. 280A we
note that petitioners have not shown that any portion of their
residence was “exclusively used on a regular basis” for business
purposes. Sec. 280A(c)(1).
- 11 -
reasonable cause for the taxpayer’s position 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 circumstances. 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. Id.
Petitioners claimed deductions for payments which were never
made, and they failed to properly substantiate various other
deductions claimed on their returns. Furthermore, petitioners
used Alpha Ministries and Smith Corporation--entities which were
essentially alter egos of petitioner--to eliminate nearly all
Federal tax liability on their wage and salary income in each of
the years in issue. The use of these entities in this manner is
not evidence of a reasonable attempt to comply with Federal tax
law and does not reflect reasonable cause and good faith for
petitioners’ actions.
We find that petitioners were negligent and hold that they
are liable for the accuracy-related penalties determined by
respondent.
Reviewed and adopted as the report of the Small Tax Case
Division.
- 12 -
To reflect the foregoing,
Decision will be entered
for respondent.