T.C. Memo. 2003-215
UNITED STATES TAX COURT
CHRISTOPHER Y. KIMM, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4102-01. Filed July 17, 2003.
Steve Mather and Stephen J. Mihaly, for petitioner.
Jean Song, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: Respondent determined a $9,717 deficiency
in petitioner’s Federal income tax for 1996. The issues for
decision are (1) whether Christopher Y. Kimm (petitioner) is
entitled to deduct a $30,000 payment to his father in 1996 as an
ordinary and necessary business expense under section 162 and (2)
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whether petitioner is liable for an accuracy-related penalty
under section 6662.1
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. At the time he filed the
petition, petitioner resided in Walnut, California.
A. Background
During 1996, petitioner worked as the director of
acquisitions for K Young Homes, Inc. From November 1974 to March
1996, Douglas T. Kimm (petitioner’s father), owned a 7-Eleven
franchise and operated other businesses within Southern
California. During the year in issue, petitioner’s father lived
with his daughter and with petitioner in their respective
apartments. Petitioner’s father would travel back and forth
between the two apartments. For more than half of the year 1996,
petitioner’s father resided with petitioner in his apartment.
B. Proposed Business Arrangement
During the last quarter of 1996, petitioner spoke to his
father about helping petitioner locate U.S. real estate
investment opportunities for the purpose of selling interests to
1
All section references are to the Internal Revenue Code in
effect for the year in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
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Asian investors. At that time, the real estate experience of
petitioner’s father consisted of the ownership of a 7-Eleven
franchise for approximately 22 years and the purchase and sale of
two commercial properties and his personal residence.
The proposed arrangement was for petitioner’s father to
locate potential real estate investments and advise petitioner on
their profitability. Petitioner’s father agreed to drive around
Southern California and assist in locating investment
opportunities. In exchange, petitioner orally agreed to pay2
petitioner’s father $30,000 annually for his services.
C. Maintenance of Records
In December 1996, petitioner opened a checking account with
Bank of America (Bank of America account). The Bank of America
account was petitioner’s personal account. During the same
month, petitioner’s father received a check drawn from
petitioner’s Bank of America account in the amount of $30,000.
At this time, petitioner’s father did not have a checking
account. Therefore, in January 1997, petitioner’s father asked
Mark M. Hathaway (Mr. Hathaway), his tax attorney and C.P.A., to
deposit the check in Mr. Hathaway’s client trust account (trust
account). From the trust account, Mr. Hathaway made payments as
2
We use the words “pay,” “paid,” and “payment” in our
findings of fact for convenience only. We do not intend our use
of these terms to indicate any conclusion about the substance of
the transactions at issue.
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petitioner’s father instructed either to petitioner’s father
directly or to creditors of petitioner’s father.
For the year 1996, petitioner did not provide to the Court
records of any sites visited, dates or hours worked, or mileage
traveled by petitioner’s father. Petitioner and petitioner’s
father never executed a written consulting agreement. Petitioner
did not issue to petitioner’s father a Form 1099-MISC,
Miscellaneous Income, for the $30,000 payment.
D. 1996 Tax Return
Mr. Hathaway prepared U.S. Individual Income Tax Returns for
both petitioner and petitioner’s father for 1996. On his
Schedule C, Profit or Loss From Business, petitioner’s father
claimed a loss of $26,085 from his 7-Eleven business, gross
income of $30,000 for the payment received from petitioner, and
on his Schedule D, Capital Gains and Losses, he claimed a short-
term capital loss of $59,500 from the sale of his 7-Eleven store.
On April 15, 1997, petitioner timely filed his 1996 Federal
income tax return. On his 1996 return, petitioner deducted the
$30,000 paid to petitioner’s father for consulting services.
Respondent issued a notice of deficiency to petitioner
regarding his 1996 tax year. In the notice of deficiency,
respondent determined, inter alia, that petitioner was not
entitled to deduct the $30,000 paid to petitioner’s father in
1996.
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OPINION
A. Ordinary and Necessary Business Expense
The question we consider is whether petitioner is entitled
to deduct the $30,000 that petitioner paid to petitioner’s father
as an ordinary and necessary business expense under section 162.
Section 162(a) allows a deduction for “all the ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business”.
The question as to whether an expenditure satisfies the
requirements of section 162 is one of fact. Commissioner v.
Heininger, 320 U.S. 467 (1943). “Intrafamily transactions
resulting in the distribution of income within a family unit are
subject to the closest scrutiny.” Van Zandt v. Commissioner, 40
T.C. 824, 830 (1963) (citing Commissioner v. Tower, 327 U.S. 280
(1946)), affd. 341 F.2d 440 (5th Cir. 1965); see Helvering v.
Clifford, 309 U.S. 331 (1940).
Petitioner maintains that the $30,000 was a consulting fee
payment made as part of an oral agreement between petitioner and
his father in 1996. Petitioner argues that he established a
business to sell interests in U.S. real estate investments to
Asian investors. He further argues that the $30,000 check paid
to his father in 1996 was deductible on petitioner’s Schedule C,
Profit or Loss From Business, as an ordinary and necessary
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business expense relating to petitioner’s real estate investment
business.
Respondent argues that petitioner was not involved in any
business activity with petitioner’s father during 1996, and
therefore the $30,000 paid to petitioner’s father was not for the
purpose of carrying on a trade or business under section 162.
Respondent further argues that the $30,000 was in actuality a
redistribution of tax liability. Petitioner’s father already had
a Schedule C loss of $26,085 from his 7-Eleven store to offset
the $30,000 while petitioner was able to gain a tax liability
reduction of $9,717 by claiming a $30,000 expense against his
total wages of $127,039. We agree with respondent.
We note that a “deduction is a matter of legislative grace
and that the burden of clearly showing the right to the claimed
deduction is on the taxpayer.”3 INDOPCO, Inc. v. Commissioner,
503 U.S. 79, 84 (1992); Rule 142(a). Therefore, petitioner must
establish that the $30,000 paid to petitioner’s father was for
the purpose of carrying on petitioner’s trade or business.
Taxpayers are required to keep such permanent records as are
sufficient to substantiate the amount and the purpose of any
deductions. Sec. 6001; Higbee v. Commissioner, 116 T.C. 438, 440
(2001); sec. 1.6001-1(a), Income Tax Regs. Petitioner did not
3
Petitioner does not contend that sec. 7491(a) is
applicable to this case.
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provide the Court with records of any sites visited, dates or
hours worked, or mileage traveled by his father in order to
establish the validity of the $30,000 consulting fee payment and
the corresponding expense to petitioner. The personal check
petitioner issued to his father is the only documentary evidence
provided to substantiate the deduction. The $30,000 check drawn
from petitioner’s Bank of America account fails to substantiate
the purpose of the check. Due to the heightened scrutiny we give
to intrafamily transactions, the testimony of petitioner’s father
coupled with the $30,000 check paid from petitioner’s personal
account are insufficient to establish that petitioner and
petitioner’s father conducted business activities together during
1996. Accordingly, petitioner has failed to substantiate the
purpose of the $30,000 payment.
Petitioner has shown neither that he conducted a real estate
investment business during 1996 nor that he is entitled to an
ordinary and necessary business deduction for the $30,000 related
to efforts petitioner’s father allegedly made in an attempt to
secure potential real estate investment opportunities for Asian
investors. Petitioner did not appear or testify at trial. See
Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165
(1946), affd. 162 F.2d 513 (10th Cir. 1947). As we do not need
to accept testimony of an interested party without corroborating
evidence, the testimony of petitioner’s father, along with the
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$30,000 check, does not establish that petitioner conducted a
real estate investment business during 1996 and that petitioner
was entitled to an ordinary and necessary business deduction
related to site visits that petitioner’s father allegedly made
during the last quarter of 1996. See Wood v. Commissioner, 338
F.2d 602, 605 (9th Cir. 1964), affg. 41 T.C. 593 (1964).
Accordingly, petitioner is not entitled to an ordinary and
necessary business expense deduction for the $30,000 paid to his
father.
B. Accuracy-Related Penalty
As we have found that petitioner is not entitled to the
claimed deduction, we consider next whether petitioner is liable
for a section 6662 accuracy-related penalty for negligence.
Section 6662(a) provides that if any portion of any underpayment
is due to negligence, 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. Negligence is defined as “the lack of due care or
failure to do what a reasonable and ordinary prudent person would
do” under the circumstances. Niedringhaus v. Commissioner, 99
T.C. 202, 221 (1992). “Negligence” includes the failure to keep
adequate books and records or to substantiate items properly.
Id.; sec. 1.6662-3(b)(1), Income Tax Regs.
With respect to the accuracy-related penalty, respondent
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bears the burden of production. Sec. 7491(c); Higbee v.
Commissioner, 116 T.C. at 446. In that regard, respondent “must
come forward with sufficient evidence indicating that it is
appropriate to impose” the accuracy-related penalty. Id.
Respondent contends that he has met that burden.
A taxpayer may avoid the accuracy-related penalty by showing
that (1) there was reasonable cause for the underpayment, and (2)
he acted in good faith with respect to such underpayment. Sec.
6664(c)(1). Whether a taxpayer acted with reasonable cause and
in good faith is determined by the relevant facts and
circumstances, and most importantly, the extent to which he
attempted to assess his proper tax liability. Sec. 1.6664-
4(b)(1), Income Tax Regs. The good faith reliance on the advice
of an independent, competent professional as to the tax treatment
of an item may meet this requirement. United States v. Boyle,
469 U.S. 241 (1985).
In order for reliance on professional advice to excuse a
taxpayer from the negligence additions to tax, the reliance must
be reasonable, in good faith, and based upon full disclosure.
Id.; see Weis v. Commissioner, 94 T.C. 473, 487 (1990). A
taxpayer acts reasonably when he provides his accountant or
attorney with all relevant information necessary to prepare his
tax return, and he relies, in good faith, on the advice of his
attorney or accountant regarding a matter of substantive tax law.
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See Jaques v. Commissioner, T.C. Memo. 1989-673, affd. 935 F.2d
104 (6th Cir. 1991); see also United States v. Boyle, supra at
251. “Ordinary business care and prudence” do not demand that
taxpayers attempt to discern error in the substantive advice of
an accountant or attorney. Id. Taxpayers must be able to show
that the adviser reached his or her decisions independently. See
Leonhart v. Commissioner, 414 F.2d 749, 750 (4th Cir. 1969),
affg. T.C. Memo. 1968-98. In the instant case, Mr. Hathaway is a
C.P.A. and an attorney certified in taxation law by the
California State Bar, Board of Legal Certification.
Additionally, petitioner and petitioner’s father fully disclosed
the facts surrounding the transaction to Mr. Hathaway and
provided him the $30,000 check petitioner had issued to his
father for consulting services. Based on this information, Mr.
Hathaway advised both petitioner and petitioner’s father that the
appropriate income tax reporting was for petitioner’s father to
report the $30,000 payment as compensation income and for
petitioner to claim a $30,000 deduction. Mr. Hathaway prepared
the returns for both petitioner and petitioner’s father
consistent with this advice. Both petitioner and petitioner’s
father reasonably relied on the advice of their tax adviser in
reporting the transaction on their respective returns.
Accordingly, petitioner is not liable for the section 6662(a)
accuracy-related penalty.
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To the extent not herein discussed, we have considered all
other arguments made by the parties, and we find them to be moot
or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.