T.C. Summary Opinion 2003-28
UNITED STATES TAX COURT
FREDERICK SMITH, JR. AND VANESSA SMITH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12110-01S. Filed March 26, 2003.
Frederick Smith, Jr., pro se.
Donna Pahl, for respondent.
PANUTHOS, Chief 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
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Revenue Code in effect for the year in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
Respondent determined a deficiency in petitioners’ Federal
income tax of $6,276 for 1997, an addition to tax under section
6651(a)(1) of $113, and an accuracy-related penalty under section
6662(a) of $1,255. After concessions by petitioners,1 the issues
for decision are: (1) Whether petitioners received $27,330 of
unreported income; (2) whether petitioners are liable for an
addition to tax under section 6651(a)(1); and (3) whether
petitioners are liable for an accuracy-related penalty under
section 6662(a).
Respondent also determined that petitioners are not entitled
to certain miscellaneous itemized deductions claimed on Schedule
A, Itemized Deductions. These adjustments are computational, and
petitioners have not disputed them; therefore, we need not
separately address them. Respondent also determined that
petitioners are entitled to an additional deduction of $289 for
one-half of the self-employment tax determined in the
adjustments.
1
Petitioners concede that they failed to report $2,610 of
income received by petitioner Vanessa Smith (Mrs. Smith) from
“Off The Field Productions” in 1997, and that they filed their
1997 return on May 14, 1998, and, therefore, did not timely file.
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Petitioners resided in Carson, California, at the time they
filed the petition. Some of the facts have been stipulated and
are so found.
Discussion
Petitioner Frederick Smith, Jr. (petitioner) worked as a
television engineer for approximately 25 years. In 1997, he also
maintained a television production and web design sole
proprietorship doing business under the name of “Off The Field
Productions” (OTFP). Petitioners claimed a loss of $23,236 on
Schedule C, Profit or Loss From Business, attached to their
Federal income tax return for 1997, from the OTFP activity.
Mrs. Smith worked part-time for OTFP in 1997 performing
office work, such as bookkeeping. She was also employed full-
time as an analyst for the University of California, Los Angeles,
Medical Center.
OTFP produced a television show pilot in 1997 for Jill
Johnson (Ms. Johnson) called “The Fantasy Sports Zone” (FSZ).
Petitioner customarily prepared a proposed budget for a client as
an estimate of the cost of a project. The budget for the FSZ
show was $65,000.
Petitioners maintained an “Itemized Category Report” of
income and expenses for OTFP. The Report reflects the following
three payments in 1997 relating to the FSZ show:
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Fantasy Sports 25% D... Fantasy Payment 16,250
Fantasy 50% payment Fantasy Payment 32,500
Fantasy Fee Final/VSS Fantasy Payment 20,170
68,920
On the 1997 Schedule C, petitioners reported gross receipts of
$60,245, total expenses of $83,481, and a loss of $23,236.
Respondent determined in the notice of deficiency dated July
12, 2001,2 that petitioners failed to report income of $27,330.
Respondent determined petitioners’ unreported income by an
examination of petitioners’ records, including the business bank
account of OTFP. The unreported income was determined as
follows:
Deposits $87,765
Less returned checks 190
Net deposits 87,575
Gross receipts reported 60,245
Unreported income 27,330
Respondent also determined that petitioners are liable for an
addition to tax under section 6651(a)(1) because the 1997 return
was not timely filed. Further, respondent determined that
petitioners are liable for an accuracy-related penalty under
2
Petitioners have not argued that the period of
limitations for assessment under sec. 6501(a) expired though
respondent issued the notice of deficiency more than 3 years
after petitioners filed the 1997 return. The 1997 return was
filed May 14, 1998, and the notice of deficiency was issued on
July 12, 2001. In any event, since we conclude that petitioners
omitted from gross income an amount properly includable therein
which is greater than 25 percent of the amount of gross income
reported in the return, the 6-year period of limitations for
assessment is applicable. Sec. 6501(e)(1)(A).
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section 6662(a) because of negligence or disregard of the rules
or regulations.
As a defense to respondent’s determination of omitted
income, petitioners seek to characterize the $32,500 check issued
to OTFP by Ms. Johnson as a loan. Petitioner and Ms. Johnson did
not execute a loan agreement with respect to the $32,500 payment.
Petitioner testified about the payment from Ms. Johnson. He
indicated that it “was a personal loan made from Ms. Jill Johnson
to myself” and because it “was sealed with a hug and a handshake
outside of her –- outside of our Summer League offices in West
L.A., and if that was good enough for her, that was good enough
for me.” According to petitioner, Ms. Johnson, a personal
friend, lent petitioner the money because he agreed to produce
the FSZ show. OTFP used the $32,500 payment to: (1) Produce the
FSZ show; (2) to pay expenses on other projects; and (3) for
general office expenses. Petitioner deposited the check into the
business bank account of OTFP.
Petitioner testified that he did not have the funds
available to produce the FSZ show and required funds from Ms.
Johnson because he was in bankruptcy at the time. Petitioner
produced a letter dated December 21, 1999, from Ms. Johnson which
indicated that she lent petitioner funds to assist in the
operations of OTFP.
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Analysis
Generally, the burden of proof is on the taxpayer. Rule
142(a)(1). The burden of proof may shift to the Commissioner
under section 7491 if the taxpayer establishes compliance with
the requirements of section 7491(a)(2)(A) and (B) by
substantiating items, maintaining required records, and fully
cooperating with the Secretary’s reasonable requests. Section
7491 is effective with respect to Court proceedings arising in
connection with examinations by the Commissioner commencing after
July 22, 1998, the date of its enactment by section 3001(a) of
the Internal Revenue Service Restructuring and Reform Act of
1998, Pub. L. 105-206, 112 Stat. 685, 726. The burden of
production remains with the Commissioner with respect to the
taxpayer’s liability for any penalty or addition to tax. Sec.
7491(c); Higbee v. Commissioner, 116 T.C. 438 (2001).
It is not clear from the record when respondent commenced
the examination of petitioners’ return; therefore, we are
uncertain whether section 7491 is applicable. Nevertheless,
petitioners have not established that they complied with its
requirements. Accordingly, even if section 7491 were applicable,
we conclude that the burden of proof remains upon petitioners.
1. Unreported Income
Gross income means all income from whatever source derived.
Sec. 61. When a taxpayer fails to provide adequate records
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substantiating income, the Commissioner is authorized to
reconstruct the taxpayer’s income by using any reasonable method
that clearly reflects income, including the use of bank deposit
records. Sec. 446(b); Clayton v. Commissioner, 102 T.C. 632, 645
(1994). Bank deposits are prima facie evidence of income. Id.
at 645. In calculating the taxpayer’s income, the Commissioner
must take into account any nontaxable source or deductible
expense of which he has knowledge. Id. at 645-646.
Indebtedness means “an unconditional and legally enforceable
obligation for the payment of money.” Autenreith v.
Commissioner, 115 F.2d 856, 858 (3d Cir. 1940), affg. 41 B.T.A.
319 (1940). The traditional indicia of bona fide indebtedness
include the existence of a note, an unconditional promise to
repay the principal, payment of interest, the existence of a
fixed repayment date or a fixed schedule for repayment, whether a
demand for repayment has been made, whether the borrower was
solvent at the time of the loan, and whether the parties’ records
reflect the transaction as a loan. Bergersen v. Commissioner,
109 F.3d 56, 60 (1st Cir. 1997), affg. T.C. Memo. 1995-424;
Noguchi v. Commissioner, 992 F.2d 226 (9th Cir. 1993), affg. T.C.
Memo. 1991-227; Goldstein v. Commissioner, T.C. Memo. 1980-273.
Because of the repayment obligation, loan proceeds do not qualify
as gross income to the taxpayer. Commissioner v. Tufts, 461 U.S.
300, 307 (1983). Interest is the payment for the use or
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forbearance of money. Deputy v. du Pont, 308 U.S. 488, 498
(1940).
Whether a payment constitutes income when received depends
on the parties’ rights and obligations at the time that the
payment was made. Commissioner v. Indianapolis Power & Light
Co., 493 U.S. 203, 211 (1990). Whether a payment is either
includable in the gross income of the recipient or is not taxable
to the recipient (e.g., as a gift) must be reached on
consideration of all factors. See Commissioner v. Duberstein,
363 U.S. 278, 288, 292 (1960) (reversing Court of Appeals and
affirming the Tax Court, finding that a purported gift was a
recompense for past services or an inducement for the taxpayer to
be of further service in the future).
The payment lacks many of the traditional indicia of debt.
See Bergersen v. Commissioner, supra. Petitioner and Ms. Johnson
did not execute a note. As of the time of trial, petitioner had
not paid either principal or interest. Repayment was due upon
demand by Ms. Johnson, but she had not demanded payment of either
principal or interest. Petitioner lost contact with Ms. Johnson,
and petitioner was uncertain even how to locate Ms. Johnson at
the time of trial.
The $32,500 payment is reflected in petitioners’ records as
an income item with two other items of income received from FSZ.
Petitioner failed to provide the Court with a reasonable
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explanation as to why this item should be treated as a loan when
OTFP records reflected the $32,500 as income. We also note that
petitioners’ record of payments from FSZ ($68,920) is
approximately consistent with the budget of $65,000.
Based on the foregoing we conclude that the $32,500 was not
a loan, and respondent’s determination of omitted income is
sustained.
2. Section 6651(a)(1) Addition to Tax
Respondent determined that petitioners are liable for an
addition to file under section 6651(a)(1) for failure to file
their return timely. The parties stipulated that petitioners
filed the return for the 1997 tax year late, on May 14, 1998.
Petitioners have not argued or presented any evidence that
would indicate that their failure to file timely was due to
reasonable cause. Accordingly, respondent’s determination is
sustained.
3. Section 6662(a) Accuracy-Related Penalty
Section 6662 provides that if any portion of any
underpayment required to be shown on a return is due to
negligence or disregard of the rules or regulations, then a
taxpayer will be liable for a penalty equal to 20 percent of the
underpayment of tax required to be shown on the return that is
attributable to the taxpayer’s negligence or disregard of the
rules or regulations. Sec. 6662(a) and (b)(1). “Negligence”
includes any failure to make a reasonable attempt to comply with
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the provisions of the Code. Sec. 6662(c). “Disregard” includes
any careless, reckless, or intentional disregard. Id.
The penalties provided for in section 6662 will not be
imposed with respect to any portion of an underpayment if it is
shown that there was reasonable cause for such portion and that
the taxpayer acted in good faith with respect to such portion.
Sec. 6664(c)(1). Whether the taxpayer has acted with reasonable
cause and in good faith is determined by relevant facts and
circumstances, including the taxpayer’s own efforts to assess his
proper tax liability. Stubblefield v. Commissioner, T.C. Memo.
1996-537; sec. 1.6664-4(b), Income Tax Regs.
There is no support in this record that the payment
petitioners received was a loan. There is nothing in the record
that indicates that the underpayment was due to reasonable cause
or that petitioners acted in good faith. Respondent is sustained
on this issue.
Reviewed and adopted as the report of the Small Tax Case
Division.
To reflect the foregoing,
Decision will be entered
for respondent.