T.C. Memo. 2003-229
UNITED STATES TAX COURT
EVERETT J. DIERS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 619-01. Filed July 31, 2003.
Everett J. Diers, pro se.
Catherine S. Tyson, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: Respondent determined a $13,126 deficiency
in petitioner’s Federal income tax for 1996. The issues for
decision are (1) whether petitioner failed to report on Schedule
C, Profit or Loss From Business, nonemployee compensation of
$26,738; (2) whether petitioner is entitled to claim Schedule C
automobile expenses of $8,910; (3) whether he is entitled to
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claim Schedule C office expenses of $3,600; (4) whether he is
subject to self-employment tax of $6,365; and (5) whether he is
liable for an accuracy-related penalty under section 66621 of
$1,052.2
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 El Paso, Texas.
A. Insurance Business
From approximately 1988 through 1994, petitioner worked as
an insurance agent for American Income Life Insurance Co.
(American). As part of its business practice, American would pay
petitioner the year’s commissions in advance for each insurance
policy petitioner sold during the year. Petitioner also would
receive a renewal commission provided that the insured renewed
the policy. American would also lend petitioner funds to cover
expenses related to his business for American.
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.
2
Respondent issued a notice of deficiency claiming, inter
alia, a negligence penalty of $2,627.20. However, because of
petitioner’s reliance on a letter from the attorney who
represented him during the insurance company settlement,
respondent concedes the penalty on the portion of the
underpayment related to this settlement.
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Because of the advance payment of commissions and loans made
to petitioner, American regularly carried a debt on its books for
petitioner. In 1994, when petitioner left employment with
American, he had an obligation to repay American for commission
advances and loans.
After petitioner resigned from American, he worked for
Capitol American Group of Companies (Capitol) and Life USA
Insurance Co. (Life USA). During the year in issue, petitioner
received income of $175 and $797 from Capitol and Life USA,
respectively.
B. Lawsuit and Settlement Agreement
In 1994, American sued petitioner in the 74th Judicial
District Court of McLennan County, Texas, for allegedly taking
policyholders from American and for advances and loans American
had made to petitioner during his employment. Petitioner
threatened to countersue.
On April 25, 1995, petitioner entered a settlement agreement
with American (settlement agreement). The settlement agreement
provided that American would look exclusively to renewal
commissions due or to become due to petitioner to satisfy the
outstanding loan balance. In exchange, petitioner released all
claims and rights to renewal commissions attributable to past
services rendered for American that were due to petitioner or to
become due in the future.
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C. Automobile Expenses
For his work-related travel, petitioner estimated total
mileage for 1996 at 33,000 miles. Petitioner did not maintain a
log of work-related travel during 1996.
D. Home Office Expenses
Petitioner lived with his girlfriend and maintained a home
office in her house. Petitioner paid her $250 per week in cash.
Neither petitioner nor his girlfriend allocated a specific
portion of the weekly payment to particular expenses. Instead,
petitioner left it to his girlfriend’s discretion how the money
was to be used. Petitioner did not maintain receipts for any
home office expenses.
E. 1996 Tax Return
On April 15, 1997, petitioner timely filed his 1996 Federal
income tax return. On his 1996 return, petitioner claimed income
from insurance and other sales of $5,796 after Schedule C
deductions of $8,910 and $3,600 for automobile and office
expenses, respectively. Because of a move from Albuquerque, New
Mexico, to El Paso, Texas, petitioner never received the Forms
1099 issued for his income from American, Capitol, or Life USA
for his 1996 tax year.
Respondent issued a notice of deficiency to petitioner
regarding his 1996 tax year. In the notice of deficiency,
respondent determined, inter alia, that for the year 1996
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petitioner failed to report Schedule C nonemployee compensation
of $26,738,3 that petitioner is not entitled to claim Schedule C
automobile expenses or office expenses of $8,910 and $3,600,
respectively, and that petitioner is subject to self-employment
tax of $6,365.
OPINION
A. Unreported Income
Section 61(a) provides that “gross income means all income
from whatever source derived” except as otherwise provided. The
definition of gross income is broad, Commissioner v. Glenshaw
Glass Co., 348 U.S. 426, 429-430 (1955), and exclusions from
gross income are narrowly construed, United States v. Burke, 504
U.S. 229, 248 (1992); United States v. Centennial Sav. Bank FSB,
499 U.S. 573, 583 (1991).
Respondent’s determinations in the notice of deficiency are
presumed correct, and petitioner must prove those determinations
wrong in order to prevail.4 Rule 142(a); Welch v. Helvering, 290
U.S. 111, 115 (1933). As relevant to the present case,
petitioner asserts that the settlement agreement provided for
3
This amount comprises Form 1099 income of $25,766 from
American, $175 from Capitol, and $797 from Life USA.
4
Petitioner does not contend that sec. 7491(a) is
applicable to this case. Sec. 7491(a) is in any event
inapplicable because of petitioner’s failure to comply with the
substantiation and recordkeeping requirements of sec. 7491(a)(2)
or to introduce credible evidence within the meaning of sec.
7491(a)(1).
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forgiveness of the debt to American in 1995 in exchange for
American’s right to keep petitioner’s renewal commissions.
Respondent argues that petitioner received income from the
renewal commissions when American credited these commissions
against the outstanding advances and loans in 1996. For the
reasons stated below, we agree with respondent.
Generally, income is taxable when it is received. Sec. 451.
When a person receives amounts without an obligation to repay
them and without restriction as to their disposition or use,
those amounts are income to the person. James v. United States,
366 U.S. 213 (1961). The proceeds of a loan are generally not
taxable as income because the benefit of the income is offset by
an obligation to repay. United States v. Rochelle, 384 F.2d 748
(5th Cir. 1967); Milenbach v. Commissioner, 106 T.C. 184, 195
(1996) affd. in part, revd. in part and remanded 318 F.3d 924
(9th Cir. 2003). The determination of whether moneys received
are the proceeds of a loan or income is to be made upon
consideration of all of the facts. Fisher v. Commissioner, 54
T.C. 905, 909 (1970).
In the context of insurance agents who receive advances
based on future commission income, whether those advances
constitute income depends on whether, at the time of the making
of the payment, the agent had unfettered use of the funds and
whether there was a bona fide obligation on the part of the agent
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to make repayment. Dennis v. Commissioner, T.C. Memo. 1997-275.
In many instances, repayment is simply made out of future earned
commissions. Where the repayments will be taken only from future
commissions earned, and the agent will not become personally
liable in the event that the future income does not cover the
repayment schedule, the payments will constitute income to the
agent for each year to the extent he received them. Moorman v.
Commissioner, 26 T.C. 666, 673-674 (1956). These payments are
nothing more than disguised salary. Beaver v. Commissioner, 55
T.C. 85, 90 (1970). However, in the situation where the advances
are actually loans, when the repayments are offset directly by
the future earned commissions, then the agent will have either
commission income or cancellation of indebtedness income at the
time of the offsets. Cox v. Commissioner, T.C. Memo. 1996-241;
cf. Warden v. Commissioner, T.C. Memo. 1988-165.
Although petitioner’s employment with American terminated in
1994, he continued to earn renewal commissions on policies he had
sold before his departure. As provided in the settlement
agreement, instead of paying these commissions to petitioner,
American credited his account showing outstanding advances in
accordance with his settlement agreement with American. When
American made the advances to petitioner, he was not taxable on
them because they were in effect loans. See Beaver v.
Commissioner, supra at 91. When the commissions he earned after
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his departure from American were credited to his account,
however, petitioner’s obligation to repay the loans was reduced
by those amounts, and the reduction of that obligation
constituted the receipt of taxable income. See Newmark v.
Commissioner, 311 F.2d 913, 915 (2d Cir. 1962), affg. T.C. Memo.
1961-285. On the basis of the foregoing, we find that petitioner
failed to report commission income in the amount determined by
respondent.5
B. Schedule C Expenses
Deductions are a matter of legislative grace, and the
taxpayer has the burden of showing that he is entitled to any
deduction claimed. Rule 142(a); New Colonial Ice Co. v.
Helvering, 292 U.S. 435, 440 (1934). During 1996, petitioner
continued his business as an insurance agent. Petitioner,
however, failed to maintain adequate records to substantiate
claimed deductions for his automobile and home office expenses.
1. Automobile Expenses
Section 162(a) allows a taxpayer to deduct all ordinary and
necessary expenses paid or incurred in carrying on a trade or
business. Under section 274(d), however, automobile expenses are
not deductible as a business expense and will be disallowed in
full unless the taxpayer satisfies strict substantiation
5
Although the amount determined by respondent includes Form
1099 income from Capitol and Life USA, petitioner concedes this
point, and therefore the issue merits no further discussion.
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requirements. These include adequate records or other
corroborating evidence of the amount of the expense, the time and
place of the automobile’s use, and the business purpose of its
use. See Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968),
affd. 412 F.2d 201 (2d Cir. 1969); Maher v. Commissioner, T.C.
Memo. 2003-85. Petitioner claims he is entitled to deduct $8,910
in business expenses related to mileage traveled for work.
Petitioner testified that he recorded annual mileage on December
31 of each year which tended to average approximately 36,000
miles and used that odometer reading as his mileage log to then
take 90 percent as a deduction for work-related travel.
Petitioner, however, submitted no documentation or receipts to
substantiate any of the business expenses he claims he incurred
in 1996. Accordingly, we conclude petitioner is not entitled to
deduct mileage as an automobile expense.
2. Home Office Expenses
Section 280A(a) generally provides that no deduction
otherwise allowable shall be allowed with respect to the business
use of a taxpayer’s residence. Section 280A(c) provides
exceptions to the general rule of section 280A(a) and requires
that expenses be allocated between the business and personal use
of the dwelling. Thus, as relevant herein, section 280A(a) does
not apply to any item to the extent that the item is allocable to
a portion of the dwelling unit that is exclusively used on a
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regular basis as the principal place of business for any trade or
business of the taxpayer. See sec. 280A(c)(1)(A). Accordingly,
in order to qualify under section 280A(c), a portion of
petitioner’s dwelling must be exclusively used on a regular basis
as the principal place of business for his trade or business.
See Hamacher v. Commissioner, 94 T.C. 348, 353 (1990).
Petitioner has not established that he made expenditures or
that he allocated the expenses between personal and business use.
Petitioner did not provide any evidence of expenditures for the
home office. Petitioner testified that he paid $250 per week to
his friend to reside in her home, and she was entitled to use
these funds for any purpose. However, petitioner failed to
provide any substantiation beyond his testimony that the
expenditures were pursuant to a trade or business. Though
petitioner claims that a portion of this weekly payment included
expenses associated with the home office, he provided neither any
receipts showing the expenditures nor any evidence to indicate
any allocation of expenses. We need not examine the technical
requirements of section 280A(c) regarding the use of a portion of
a residence as a home office, because in any event petitioner has
failed to substantiate any home office expenses. Accordingly,
petitioner is not entitled to a home office deduction under
section 280A.
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C. Self-Employment Tax
Section 1401(a) imposes a tax upon the self-employment
income of every individual. Self-employment income consists of
gross income an individual derives from carrying on any trade or
business. Sec. 1402(a) and (b); Spiegelman v. Commissioner, 102
T.C. 394, 396 (1994).
Petitioner’s self-employment tax has increased because of
the increase in income from the disallowance of claimed Schedule
C business expenses and the inclusion of unreported income.
Petitioner admits that he was self-employed and he earned his
income from his business as an insurance agent. Accordingly, we
sustain respondent’s determination that petitioner is liable for
self-employment tax.6 See Rule 142(a); Simpson v. Commissioner,
64 T.C. 974 (1975).
D. Negligence Penalty
Section 6662 provides for an accuracy-related penalty equal
to 20 percent of the underpayment if the underpayment was due to
a taxpayer’s negligence or disregard of rules or regulations.
See sec. 6662(a) and (b)(1). A taxpayer is negligent when he or
she fails “‘to do what a reasonable and ordinarily prudent person
6
We note that although full-time life insurance salesmen
are statutory employees and not liable for self-employment tax,
the record does not establish that petitioner was a full-time
salesman or a life insurance salesman in 1996. Secs. 1402(b),
(c)(2), and (d), 3121(a), (d)(3)(B).
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would do under the circumstances.’” Korshin v. Commissioner, 91
F.3d 670, 672 (4th Cir. 1996) (quoting Schrum v. Commissioner, 33
F.3d 426, 437 (4th Cir. 1994), affg. in part, vacating and
remanding in part T.C. Memo. 1993-124), affg. T.C. Memo. 1995-46.
As pertinent here, “negligence” includes the failure to make
a reasonable attempt to comply with the provisions of the
Internal Revenue Code and also includes any failure to keep
adequate books and records or to substantiate items properly.
See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. A
taxpayer may, however, avoid the application of the accuracy-
related penalty by proving that he or she acted with reasonable
cause and in good faith. See sec. 6664(c). Whether a taxpayer
acted with reasonable cause and in good faith is measured by
examining the relevant facts and circumstances, and most
importantly, the extent to which he or she attempted to assess
the proper tax liability. See Neely v. Commissioner, 85 T.C. 934
(1985); Stubblefield v. Commissioner, T.C. Memo. 1996-537; sec.
1.6664-4(b)(1), Income Tax Regs.
Petitioner concedes he did not report Form 1099 income from
Capitol and Life USA in 1996. Additionally, we have found that
petitioner failed to maintain adequate records related to claimed
automobile and home office expenses. Therefore, we find the
underpayment due to the omitted Form 1099 income and the
disallowed Schedule C expenses to be attributable to negligence
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or disregard of rules and regulations.
We have found that petitioner did not report an additional
$25,766 of income for 1996. Nevertheless, respondent concedes
that the omission of the Form 1099 income from American was
justified because of petitioner’s reliance on a letter from the
attorney who represented him during his settlement with American.
Accordingly, no penalty will be imposed on this portion of the
underpayment.
We conclude that petitioner is liable for a penalty pursuant
to section 6662 for 1996 in the recalculated amount of $1,052.
In reaching all of our holdings herein, we have considered all
arguments made by the parties, and to the extent not mentioned
above, we find them to be irrelevant or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.