HUANG v. COMMISSIONER

T.C. Summary Opinion 2003-99

UNITED STATES TAX COURT

BARNEY K. HUANG AND LINDY W. HUANG, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8664-02S. Filed July 23, 2003.

Barney K. Huang and Lindy W. Huang, pro se.

Jeanne Gramling, 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
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effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

Respondent determined deficiencies in petitioners’ Federal

income taxes of $5,132, $3,941, and $2,878 for the taxable years

1995, 1996, and 1997, respectively.

The issues for decision are: (1) Whether petitioners are

entitled to offset capital gain income with a capital loss

carryover in each of the years in issue; (2) whether petitioners

are entitled to a deduction for mortgage interest in an amount

greater than that determined by respondent for 1996; (3) whether

petitioners are entitled to miscellaneous itemized deductions in

amounts greater than those determined by respondent, namely (a)

for investment expense of $29,103 in 1995, and (b) for certain

legal expenses in each of the years in issue; (4) whether and to

what extent petitioners received unreported pension or annuity

income in 1996; and (5) whether petitioners are entitled to

deduct an IRA contribution for petitioner wife in 1996. All

remaining adjustments in the notice of deficiency are in

petitioners’ favor, have been conceded by petitioners, or are

computational and will be resolved by the Court’s holding on the

issues.1

1
In their petition, petitioners state that they made a
payment of $831 for 1997 which was “ignored” by the Internal
Revenue Service. However, the record shows that this payment was
in fact credited to an assessment of the same amount, an
(continued...)
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Some of the facts have been stipulated and are so found.

The stipulations of fact and those attached exhibits which were

admitted into evidence are incorporated herein by this reference.

Petitioners resided in Raleigh, North Carolina, on the date the

petition was filed in this case.

Generally, a taxpayer bears the burden of proving the

Commissioner’s determinations in a statutory notice of deficiency

to be in error. Rule 142(a). Although section 7491(a) shifts

the burden of proof to the Commissioner with respect to certain

factual issues, the burden remains on the taxpayer with respect

to an issue where the taxpayer (1) fails to introduce credible

evidence with respect thereto, or (2) fails to comply with

statutory recordkeeping and substantiation requirements.

A taxpayer must keep records 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

1
(...continued)
assessment of taxes and interest which apparently had been made
by respondent under the authority of sec. 6213(b)(1). The amount
of this assessment (exclusive of the interest portion) is
properly reflected in the notice of deficiency in such a manner
as to reduce the amount of the 1997 deficiency.
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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).

Capital Loss Carryovers

In each of the years in issue, petitioners did not include

in income any capital gains or report any capital losses.2 In

the notice of deficiency, respondent determined that petitioners

must include in income capital gains of $4,122 in 1995, $5,219 in

1996, and $3,853 in 1997. Petitioners concede that they realized

capital gains in these amounts. Petitioners, however, argue that

they are entitled to offset these gains with capital loss

carryovers.

A capital loss is a loss from the sale or exchange of a

capital asset. Sec. 1222. A capital asset is property held by a

taxpayer of a type other than the eight categories of property

2
There were no capital gains or capital losses reflected on
the faces of the returns filed by petitioners in each of the
years in issue. For the 1997 return, there was a Schedule D,
Capital Gains and Losses, attached to the return which showed a
capital gain for the year. Respondent suggests that this
schedule may have been submitted at the request of the IRS after
the rest of the return had been filed. In any event, the amount
of the gain--which is substantially less than that determined in
the notice of deficiency and which does not reflect any capital
loss carryover--was not included in the computation of
petitioners’ 1997 gross income.
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enumerated in section 1221(a). One such category includes

depreciable property and real property used in the taxpayer’s

trade or business. Sec. 1221(a)(2).

In general, a taxpayer’s capital losses are allowed only to

the extent of the taxpayer’s capital gains, plus $3,000, in any

given taxable year. Sec. 1211(b). However, where a taxpayer’s

losses are not allowed in a given taxable year due to

insufficient capital gains, the losses generally may be carried

over from year to year until the entire amount of the losses is

allowed. Sec. 1212(b).

Petitioners argue that they are entitled to capital loss

carryovers with respect to losses they sustained in connection

with a partnership known as Tara of North Hills (Tara). Over the

years, petitioners had invested a large amount of money in this

partnership, which owned an apartment complex. Petitioners were

also involved in the management of the complex. Tara entered

into bankruptcy proceedings in the late 1980s.

It is unclear whether petitioners ever recognized a loss

from the sale or exchange of a capital asset in connection with

Tara. See secs. 1221 and 1222. While petitioners introduced

into evidence numerous documents purporting to show their

investment in the partnership and the result of the bankruptcy

proceedings, petitioners have failed to substantiate the amount

of any loss sustained with respect thereto, and whether any such
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loss carried over into the years in issue, surviving petitioners’

own personal bankruptcy. The documents that petitioners have

submitted to the Court as evidence of their entitlement to

carryovers are haphazard at best, and no apparent attempt was

made to calculate for the Court the actual amount of the capital

loss carryovers, other than to state that the losses offset the

gains in full in the years in issue. Finally, petitioners’

argument with respect to this issue is suspect because

petitioners failed to report any of the alleged capital losses on

their returns in the years in issue.

We hold that petitioners have not substantiated the

existence of a capital loss carryover that would offset the

capital gain income determined by respondent in any of the years

in issue. Sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs.

Mortgage Interest Expense

Petitioners claimed an itemized deduction for mortgage

interest expense of $8,732 in 1996. Respondent decreased this

deduction, allowing a deduction of only $3,732.

Mortgage interest expense generally is deductible by

individual taxpayers, subject to various limitations not relevant

here. Sec. 163(a), (h).

Petitioners have not substantiated that they paid mortgage

interest expense of any amount in 1996. We therefore sustain
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respondent’s determination on this issue. Sec. 6001; sec.

1.6001-1(a), (e), Income Tax Regs.

Miscellaneous Itemized Deductions

Petitioners claimed miscellaneous itemized deductions for

the following expenses in the respective taxable years:

1995 1996 1997

Unreimbursed employee expenses $4,331 $5,035 $7,087
Legal expenses 3,738 16,274 34,026
Investment 29,103 -- --
Other 860 -- --
38,032 21,309 41,113

Respondent decreased petitioners’ deductions in 1995 and 1996 and

increased their deduction in 1997, allowing deductions for

expenses totaling $10,319 in 1995, $17,940 in 1996, and $42,013

in 1997.

In 1988, petitioner husband (Mr. Huang) was charged with

attempted second degree rape and assault on a female, Grace Wang.

Petitioners were close friends with the Wang family. Mr. Huang

had known Ms. Wang’s father from 30 years earlier; he had known

Ms. Wang since she was about 5 years old, and Ms. Wang was

married to one of Mr. Huang’s coworkers at North Carolina State

University (NCSU). The alleged rape and assault occurred on a

day when Ms. Wang had brought her child to petitioners’ home so

that her child could play with petitioners’ child.

After a jury trial, Mr. Huang was acquitted of the rape

charge but convicted on the assault charge. The conviction

subsequently was reversed by an appellate court, which found that
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the trial court had made an error in the admission of certain

evidence. After the reversal, the State of North Carolina

dismissed the charge against Mr. Huang due to the age of the case

and the potential impact of a retrial on the alleged victim.

These events led to petitioners’ involvement in a number of

additional legal matters, including a malicious prosecution suit

against Ms. Wang. In the malicious prosecution suit, in order to

overcome a presumption of probable cause for initiation of the

prosecution which arose from the jury’s finding of guilt on the

assault charge, Mr. Huang alleged that “members of the faculty

and administration of N.C. State University * * * paid Wang to

falsely accuse Huang of sexually assaulting her” as part of a

conspiracy to deprive Mr. Huang of his employment at NCSU. Mr.

Huang did not prevail in this suit, in part due to the State

court’s finding that Mr. Huang was unable to produce any evidence

of such a payment or conspiracy.

NCSU eventually terminated Mr. Huang’s employment, stating

that the basis for his dismissal was, in part, the alleged attack

on Ms. Wang. In response to the termination of Mr. Huang’s

employment, petitioners filed further lawsuits on various

grounds.

During the years in issue, petitioners hired an attorney,

Kirk Osborn, who represented them in various matters, primarily

related to the criminal and malicious prosecution matters.
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Petitioners also paid another attorney, Janet Brown, and two

reporting services, Bryant Court Reporting Services, Inc., and

Associated Reporting & Transcription, for services rendered in

connection with the malicious prosecution suit.

Prior to the years in issue, petitioners were involved in

various bankruptcy proceedings, both in their individual

capacities and with respect to their status as partners in Tara,

the investment discussed above. Prior to and during 1995,

petitioners employed an attorney, Robert Willis, to bring a

malpractice suit against a law firm which had represented

petitioners with respect to their investment in Tara, the

bankruptcy of Tara, and petitioners’ own personal bankruptcy. In

1995 and 1996, petitioners hired another attorney, Brian

Upchurch, to bring another legal malpractice suit, this time

against Robert Willis.

Investment Expense

While a deduction generally is allowed for interest expense,

an individual’s deduction of investment interest is subject to

certain limitations, and it generally may not exceed the

individual’s “net investment income” for the taxable year. Sec.

163(a), (d)(1); see also sec. 163(h) (disallowing any deduction

for “personal interest”).

Petitioners argue that the $29,103 “investment” expense

listed on their 1995 return arose as follows: Prior to being
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placed in bankruptcy in 1990, petitioners had filed various

lawsuits in connection with Mr. Huang’s former employment with

NCSU. During the bankruptcy proceedings, the trustee auctioned

petitioners’ causes of action in these matters as assets of the

bankruptcy estate. Petitioners, who outbid NCSU and paid the

bankruptcy estate $102,000, reacquired their rights to sue NCSU

in 1991. Petitioners were lent the $102,000 by Mr. Huang’s

sister in Taiwan, and the $29,103 investment expense on their

1995 return represents an interest payment on this loan which

petitioners paid in cash.

We need not address the merits of petitioners’ contention

that interest payments on the alleged $102,000 loan would be

deductible as investment interest expense. Although it is clear

that $102,000 was paid to the bankruptcy estate, petitioners have

failed to adequately substantiate the existence of a bona fide

loan, they have failed to substantiate that they were required to

pay interest thereon, and they have failed to substantiate that

they in fact made any interest payment during 1995. Petitioners

therefore are not entitled to the claimed investment expense.

Sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs.

Legal Expenses

Taxpayers generally may deduct expenses which are ordinary

and necessary in carrying on the trade or business of being an

employee. Sec. 162(a). Taxpayers also generally may deduct
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expenses which are ordinary and necessary for (1) the production

or collection of income, or (2) the management, conservation, or

maintenance of property held for the production of income. Sec.

212(1) and (2). Personal, living, and family expenses, on the

other hand, generally may not be deducted to any extent. Sec.

262(a).

Whether a legal expense is deductible under section 162(a)

or section 212, or nondeductible under section 262(a), is

contingent upon the origin and character of the underlying claim,

not on its potential consequences upon the fortunes of the

taxpayer. United States v. Gilmore, 372 U.S. 39 (1963); Peters,

Gamm, West & Vincent, Inc. v. Commissioner, T.C. Memo. 1996-186;

Lussy v. Commissioner, T.C. Memo. 1995-393, affd. without

published opinion 114 F.3d 1201 (11th Cir. 1997). This Court has

stated:

Quite plainly, the “origin-of-the-claim” rule does not
contemplate a mechanical search for the first in the chain
of events which led to the litigation but, rather, requires
an examination of all the facts. The inquiry is directed to
the ascertainment of the “kind of transaction” out of which
the litigation arose. Consideration must be given to the
issues involved, the nature and objectives of the
litigation, the defenses asserted, the purpose for which the
claimed deductions were expended, the background of the
litigation, and all the facts pertaining to the controversy.
[Citations and fn. ref. omitted].

Boagni v. Commissioner, 59 T.C. 708, 713 (1973).

Numerous documents related to petitioners’ legal expenses

were introduced into evidence in this case. The bulk of these
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documents show that petitioners were involved in various

investments, lawsuits, bankruptcies, and other legal matters, but

they do nothing to substantiate specific deductible expenses.

The documents which do show specific expenditures are with

respect to the attorneys and the court reporting services noted

above.

Petitioners first argue that they are entitled to deduct

additional expenses paid to Mark Kirby and Brian Upchurch in

1995, and to Matthew Martin in 1996. We hold that petitioners

are not entitled to these deductions because they have failed to

substantiate the payment of these expenses during the relevant

years. Sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs.

Petitioners next argue that they are entitled to deduct

additional expenses paid to the two court reporting services,

Janet Brown, and Brian Upchurch in 1996, and to Kirk Osborn in

1996 and 1997. A portion of these expenses was incurred in

connection with the secondary malpractice suit brought by

petitioners. The suit underlying the original malpractice claim

by petitioners dealt with several issues, including petitioners’

personal bankruptcy and their investment in Tara. Because the

connection between petitioners’ investment in Tara and the

secondary malpractice suit years after Tara’s existence is too

attenuated to ascertain; we are unable to estimate the portion of

these expenses which may be deductible versus the portion which
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is a nondeductible personal expense under section 262(a). We

therefore find that petitioners have failed to substantiate the

amount of deductible expenses, if any, incurred in connection

with this malpractice suit. Sec. 6001; sec. 1.6001-1(a), (e),

Income Tax Regs.

The remainder of the expenses were incurred in connection

with the malicious prosecution suit. Petitioners argue that this

suit is related to petitioner’s former employment with NCSU.

They assert that the underlying criminal charges against

petitioner were brought as part of an ongoing conspiracy to

deprive petitioner of his job. Petitioners, however, have not

offered any credible evidence in support of this assertion. We

have found that petitioners and the Wang family had been personal

friends, and that Mr. Huang and Ms. Wang were together on the

date of the alleged rape and assault because of this friendship.

We accordingly find that the rape and assault charges arose from

the personal relationship between Mr. Huang and Ms. Wang, and

that the malicious prosecution action is likewise personal in

nature. Thus, these legal expenses are nondeductible personal

expenses. Sec. 262(a); United States v. Gilmore, supra.

Pension and Annuity Income

On their 1996 return, petitioners reported taxable pension

and annuity income of $32,397. Respondent determined that

petitioners had additional unreported pension and annuity income
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of $5,008. Petitioners dispute this determination in part, as

explained below.

In general, gross income includes all income from whatever

source derived, including income from pensions and annuities.

Sec. 61(a)(9), (11); sec. 72(a). However, portions of certain

annuity payments, representing a ratable recovery of a taxpayer’s

investment therein, may be excludable from income. Sec. 72(b),

(d).

Previously taxed contributions to a section 401(a) qualified

plan which are returned to the contributing taxpayer before the

annuity starting date are not included in income in the year they

are returned. Secs. 72(e)(2)(B)(ii), 402(a). Interest earned on

such contributions, however, is included in gross income unless

it is “rolled over” into another eligible retirement plan such as

an IRA. Secs. 72(e)(2)(B)(i), 402(c)(1).

In 1996, petitioners received pension and annuity payments

from Aetna Life Insurance Company and from the Teachers’ and

State Employees’ Retirement System of North Carolina (TSERS),

which is a section 401(a) qualified plan. The Forms 1099-R,

Distributions From Pensions, Annuities, Retirement or Profit-

Sharing Plans, IRAs, Insurance Contracts, etc., attached to

petitioners’ return listed taxable distributions of $14,716 from

Aetna and $19,855 from TSERS. However, petitioners included in

gross income only $32,397, or $2,174 less than the amounts
 - 15 -

reflected on the Forms 1099-R. Petitioners concede that this

amount is includable in their gross income.

The remainder of respondent’s $5,008 adjustment reflects two

separate payments which petitioner wife (Ms. Huang) received from

TSERS. On January 17, 1996, two checks were issued for Ms.

Huang’s benefit from TSERS in the total amount of $2,835. Of

this amount, $1,913 represented a return of previously taxed

contributions which Ms. Huang had made to TSERS, and $922

represented interest on those contributions. The returned

contribution amount was paid directly to Ms. Huang; the interest

amount was paid to an IRA account for Ms. Huang. Ms. Huang

withdrew the contributions because she was not eligible for

retirement benefits under the plan.

The contributions Ms. Huang made to TSERS, which were taxed

as income as they were earned, are not includable in Ms. Huang’s

gross income when they were distributed from the qualified plan

in 1996. Sec. 72(e)(2)(B)(ii). The remainder of the payment for

Ms. Huang was interest on the contributions; this interest is not

includable in petitioners’ gross income in 1996 because it was

paid directly into an IRA account. Sec. 402(c)(1). We

accordingly hold that in 1996 petitioners received unreported

taxable pension and annuity distributions of $2,174, rather than

$5,008 as determined by respondent.
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IRA Contribution Deduction

On their 1996 return, petitioners claimed a deduction of

$2,000 for an IRA contribution for Ms. Huang. Respondent

disallowed this deduction in full. Respondent argues that

petitioners are not entitled to this deduction because Ms. Huang

did not earn any compensation during 1996. Petitioners argue

that the two payments totaling $2,835 paid to Ms. Huang during

that year, discussed above, were compensation.

In general, a deduction is allowed to an individual for

qualified retirement contributions made by the individual for the

taxable year. Sec. 219(a). Among other limitations, the amount

of the deduction for a taxable year cannot exceed the

“compensation includible in the individual’s gross income for

such taxable year”. Sec. 219(b)(1)(B). “Compensation” is

defined in relevant part as “wages, salaries, professional fees,

or other amounts derived from or received for personal service

actually rendered”. Sec. 1.219-1(c)(1), Income Tax Regs.

Specifically excluded from the definition of “compensation” are

interest payments, pension and annuity payments, deferred

compensation, and any amounts not includable in gross income.

Sec. 219(f)(1); sec. 1.219-1(c)(1), Income Tax Regs. The maximum

deduction for married individuals is computed separately with

respect to each individual. Sec. 219(f)(2).
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As discussed above, the two payments totaling $2,835 which

Ms. Huang received from TSERS during 1996 are not includable in

petitioners’ income for that year. These payments therefore are

not “compensation” within the meaning of section 219(b)(1)(B).

Sec. 1.219-1(c)(1), Income Tax Regs. The only other income

reported by petitioners during 1996 was in the form of interest,

dividends, pension and annuity payments, and Social Security

benefits, none of which are compensation. Sec. 219 (f)(1).

Consequently, petitioners are not entitled to a deduction for an

IRA contribution for Ms. Huang during that year. Sec.

219(b)(1)(B).

Reviewed and adopted as the report of the Small Tax Case

Division.

To reflect the foregoing,

Decision will be entered

under Rule 155.