T.C. Memo. 2004-175
UNITED STATES TAX COURT
KENNETH J. BARELA, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3873-02. Filed July 28, 2004.
Kenneth J. Barela, pro se.
Frederick J. Lockhart, Jr., for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Chief Judge: Respondent, for petitioner’s 1999
taxable year, determined a $49,703 income tax deficiency and
additions to tax under sections 6651(a)(1)1 and 6654 in the
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable year at
issue. All Rule references are to the Tax Court Rules of
Practice and Procedure.
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amounts of $9,201.60 and $1,916.96, respectively. The issues for
our consideration are: (1) Whether petitioner is entitled to
itemized and Schedule C deductions in excess of those allowed or
conceded by respondent; and (2) whether petitioner and
respondent, as part of the settlement of petitioner’s 1998 tax
controversy, had agreed to allow for 1999 a $5,433 loss that had
been claimed and disallowed for 1998.
FINDINGS OF FACT2
Petitioner resided in Littleton, Colorado, when he filed his
petition with this Court. Petitioner’s 1999 joint Federal income
tax return was filed on April 4, 2003.3 During 1999, petitioner
was a sales manager and employee of Cochlear Corporation and
received a $137,604 salary. Petitioner also received interest
income of $401 in 1999.
Respondent determined a $49,703 income tax deficiency for
petitioner’s 1999 taxable year, and petitioner contested the
entire amount. Prior to trial, respondent allowed the following
itemized deductions: $7,326 for medical and dental; $1,935 for
State and local taxes; $3,119 for real estate taxes; $1,783 for
other taxes; $22,481 for home mortgage interest; $15,900 for
charitable contributions; and $13,765 for miscellaneous
2
The parties’ Stipulation of Facts is incorporated by this
reference.
3
Although a joint return was filed, Mrs. Barela is not a
party to this action.
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deductions subject to the 2-percent AGI limitation. Petitioner
was unable to substantiate any of the above-described itemized
deductions in excess of the amounts allowed by respondent.
Petitioner originally claimed $3,915 for employee business
vehicle expense and $2,194 for his wife’s car and truck expenses.
Petitioner has shown entitlement to $5,498 for his employee
business vehicle expense and to $6,951 for his wife’s car and
truck expenses.
Respondent determined that for petitioner’s 1999 taxable
year, he was liable for additions to tax under sections
6651(a)(1) and 6654. Petitioner concedes that he is liable for
both additions to tax.
In a prior case, petitioner petitioned this Court seeking a
redetermination of a 1998 income tax deficiency determined by
respondent. The 1998 case was resolved by means of a settlement
entered into by petitioner and respondent on May 1, 2002. This
Court entered the parties’ stipulated decision on May 3, 2002.
The decision entered for petitioner’s 1998 taxable year resulted
in a $48,767 income tax deficiency and a $5,601 section
6651(a)(1) addition to the tax.
One of the items resolved by the 1998 decision was
respondent’s disallowance of a $5,4334 loss claimed on Schedule C
4
Petitioner originally claimed $5,779. Respondent allowed
$346 which reduced the disallowed loss to $5,433.
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regarding petitioner’s wife’s furniture business. During 1998,
petitioner’s wife attempted to begin a business that would sell
fabric covered stools. A large portion of the $5,433 was spent
on stools and the craft materials needed for covering the stools.
She also claimed travel expenses for promoting her product.
Respondent disallowed the $5,433 amount claimed on the ground
that the activity was not yet a business; i.e., it was in a
startup phase and the expenditures were capital in nature.
In negotiating the 1998 settlement, the parties came to an
agreement as to which deductions would be allowed and disallowed.
Among other items, the parties agreed to the disallowance of the
$5,433 deduction in exchange for the allowance of certain other
losses claimed by petitioner. Petitioner and his accountant, Mr.
Koll, were under the impression that the terms of the agreement
included respondent’s agreement to allow the $5,433 deduction for
1999.
During the negotiations, Mr. Koll suggested that petitioners
be allowed to deduct the $5,433 for the 1999 tax year.
Respondent’s counsel and Appeals officer did not make a response
or expressly agree to Mr. Koll’s proposal. Because respondent’s
counsel and the Appeals officer were silent, petitioner and Mr.
Koll had the impression that an agreement had been reached.
Later in the negotiations, respondent’s counsel and the Appeals
officer informed petitioner and Mr. Koll that the $5,433 loss
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might be allowable for a subsequent year, but not necessarily for
1999.
When the parties concluded their negotiations, respondent’s
counsel prepared a decision document incorporating the parties’
agreement. The decision document did not contain any reference
to the $5,433 loss's being allowed for 1999. Both parties read
and signed this document in settlement of petitioner’s 1998
taxable year.
Mr. Koll later thought it would be wise to have a written
record of the agreement that he believed existed. Mr. Koll
addressed a letter to respondent’s counsel wherein he listed the
settlement issues that he believed were resolved under the
settlement. In particular, Mr. Koll stated: “The Schedule C
losses of Katy’s Furniture of $5,433 will be disallowed in 1998
but this amount will be allowed in 1999 as a deduction”. Mr.
Koll prepared this document on May 1, 2002, and faxed it to
respondent’s counsel during the morning of May 2, 2002.
Respondent’s counsel filed the stipulated decision document
with this Court on the morning of May 2, 2002. At the time
respondent’s counsel presented the stipulated decision to the
Court, he was not aware of Mr. Koll’s faxed letter. After
submitting the stipulated decision, respondent’s counsel learned
of the faxed letter and on May 2, 2002, he composed a response
and faxed it to Mr. Koll. Respondent’s letter, in pertinent
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part, stated:
However, at no time did I agree, or express an opinion,
as to a particular year in which the expenditures at
issue (which I consider to be capital) would be
deductible, since this would be based upon facts and
circumstances that I am not now aware of, or at least
aware of in total. I think that any such conclusion as
to the proper year is premature by any of us since not
all of the Barela tax returns (including, in
particular, the return for calendar year 1999) have yet
been filed, let alone reviewed by Eric or me.
Neither Mr. Koll nor petitioner attempted to respond, or
dispute the contentions in respondent’s letter. Petitioner did
not seek to withdraw or to have vacated the decision entered for
1998.
Petitioner filed his 1999 Federal tax return during April
2003 and claimed in that return the $5,433 loss disallowed for
1998. Petitioner contends that an agreement was reached with
respondent providing that the $5,433 amount would be allowed for
1999. Respondent denies the existence of such an agreement.
Petitioner timely appealed to this Court for review of
respondent’s determination for 1999.
OPINION
The controversy in this case involves two issues. Firstly,
whether petitioner is entitled to itemized deductions in excess
of those allowed or conceded by respondent. The second issue
concerns whether there was an agreement between petitioner and
respondent with respect to the deductibility of the $5,433 for
the 1999 year. As a preliminary matter, we note that petitioner
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conceded that the additions to tax for his 1999 taxable year
under sections 6651(a)(1) and 6654 apply to any underpayment
finally decided by the Court.
Itemized and Schedule C Deductions
In his petition, petitioner contends that respondent’s
adjustments for itemized deductions are incorrect and that
petitioner is entitled to the full amount of deductions claimed.
Prior to trial, respondent allowed the following itemized
deductions:
Itemized Deductions Amount
Medical and dental $7,326
State and local taxes 1,935
Real estate taxes 3,119
Other taxes 1,783
Home mortgage interest 22,481
Charitable contributions 15,900
Miscellaneous deductions subject
to the 2% AGI limitation 13,765
Total $66,309
Petitioner was able to provide substantiation for the above
amounts but did not show entitlement to amounts in excess of the
those allowed by respondent.
Tax deductions are a matter of legislative grace with a
taxpayer bearing the burden of proving entitlement to the
deductions claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79,
84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934); Rule 142(a)(1). A taxpayer bears the burden of
substantiating the amount and purpose of any claimed deduction.
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See Hradesky v. Commissioner, 65 T.C. 87 (1975), affd. per curiam
540 F.2d 821 (5th Cir. 1976).5 A taxpayer is required to
maintain sufficient records to establish the amounts of income
and deductions. Sec. 6001; Higbee v. Commissioner, 116 T.C. 438,
440 (2001); sec. 1.6001-1(a), Income Tax Regs. Therefore,
petitioner must produce evidence that he is entitled to
deductions in excess of what he has thus far been able to
substantiate.
At trial, petitioner did not offer evidence supporting his
claim for the above-described itemized deductions in excess of
those allowed or agreed to by respondent. See Hradesky v.
Commissioner, supra. Because petitioner has failed to provide
any substantiation to support such itemized deductions in excess
of those allowed, we sustain respondent’s position with respect
to those itemized deductions.
Petitioner further contends that he is entitled to increased
deductions with regard to his vehicle expenses claimed as a
business deduction on Schedule C of his 1999 return. At trial,
petitioner substantiated by means of documentary evidence amounts
in excess of those previously claimed for vehicle expenses. On
his 1999 return, petitioner claimed $3,915 for employee business
vehicle expense and $2,194 for his wife’s car and truck expenses.
5
No question has been raised with respect to the burden of
proof or production under sec. 7491(a).
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Petitioner produced records at trial supporting a $5,498
deduction for his employee business vehicle expenses and $6,951
for his wife’s car and truck expenses.
Based on petitioner’s substantiation offered at trial,
respondent conceded that petitioner is entitled to the increased
amounts for his employee business vehicle expenses and for his
wife’s car and truck expenses.
Prior Year Loss per Settlement
Background
Petitioner claimed $5,779 on Schedule C of his 1999 return
described as “prior year loss per settlement”. Of that amount,
$5,433 represented petitioner’s wife’s claimed loss, the
disallowance of which was agreed to in the settlement of
petitioner’s 1998 case. Petitioner claimed the loss for 1999 in
the belief that in the settlement of the 1998 tax liability,
respondent had agreed that petitioner could claim the $5,433 for
1999. Respondent had disallowed petitioner’s wife’s 1998 claimed
loss on the ground that the activity was not yet a business and
the loss, therefore, represented startup costs. Respondent also
disallowed the same $5,433 loss claimed for 1999 on the basis
that it was not allowable for 1999 and because respondent did not
agree in the 1998 settlement that the loss was allowable for
1999.
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In negotiating the 1998 settlement, petitioner agreed to the
disallowance of the $5,433 loss for 1998. Petitioner, however,
contends that prior to signing the stipulated decision, an
agreement was reached to allow the $5,433 deduction for 1999.
Petitioner contends that respondent has breached the terms of the
parties’ settlement agreement. Petitioner further asserts that
the alleged agreement should be enforced, allowing the deduction
for 1999. Petitioner has advanced no other reason for the
allowance of the $5,433 loss for 1999.
Analysis
At the heart of this controversy is the question of whether
a binding agreement6 was reached between petitioner and
respondent to allow the 1998 loss deduction, in the amount of
$5,433 for 1999. In resolving this question, we apply general
principles of contract law in determining whether a settlement
agreement has been reached. Dorchester Indus., Inc. v.
Commissioner, 108 T.C. 320, 330 (1997), affd. 208 F.3d 205 (3d
Cir. 2000). Formation of a contract requires the mutual assent
of the parties to its essential terms, and mutual assent
generally requires an offer and an acceptance. Id.
6
On brief respondent raises alternative defenses to the
alleged contract. We need not address these arguments as the
general principles of contract law are sufficient to guide us in
our holding on this issue.
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Petitioner alleges that his agreement to the disallowance of
the $5,433 loss for 1998 was bargained for in exchange for
respondent’s agreement to allow the deduction for 1999. For such
a contract to exist and be binding, both parties must have agreed
to the above-stated essential terms. To determine if there was
mutual assent between the parties we must decide whether an offer
and acceptance occurred.
An offer is “'the manifestation of willingness to enter into
a bargain, so made as to justify another person in understanding
that his assent to that bargain is invited and will conclude
it.'” Id. (quoting 1 Restatement, Contracts 2d, sec. 24 (1981)).
Petitioner, through Mr. Koll, made the following proposal:
“Here’s what I’m suggesting. You will allow Barela’s loss,
disallow Mrs. Barela’s loss, but allow it to her in 1999, and
we’ll agree to that $7,000 Schedule A adjustment and two other
minor items”.
Even if we were to find that a valid offer was made, it must
be shown that respondent accepted it by manifesting his assent to
the offer. A prerequisite to the formation of an agreement is an
objective manifestation of mutual assent to its essential terms,
also known as a “meeting of the minds”. Estate of Halder v.
Commissioner, T.C. Memo. 2003-84 (citing various cases).
On that point, respondent’s counsel and the Appeals officer
indicated that the 1998 loss might be allowable in a subsequent
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year, but not necessarily for 1999. Respondent’s statement
reflects that no assent was intended. In these circumstances,
without some affirmative assent by respondent, there could be no
meeting of the minds. A contract was not created, and thus a
settlement agreement was not reached.
The parties agreed to the stipulated decision for 1998.
Conspicuously absent from the decision documents was any express
agreement or closing agreement regarding the allowance of the
$5,433 for 1999. The parties' postnegotiation exchange of
writings also illustrates that a meeting of the minds had not
occurred between the parties. Mr. Koll, on behalf of petitioner,
faxed a letter to respondent’s counsel in an attempt to document
the agreement that he believed existed. Specifically, the letter
stated, in pertinent part, that “The Schedule C losses of Katy’s
Furniture of $5,433 will be disallowed in 1998 but this amount
will be allowed in 1999 as a deduction”. Mr. Koll executed this
document on May 1, 2002, and faxed it to respondent’s counsel the
morning of May 2, 2002, but respondent’s counsel was not aware of
Mr. Koll’s fax when the decision document was filed with the
Court during the morning of May 2, 2002.7
Also on May 2, 2002, after the decision document had been
filed and respondent’s counsel had become aware of Mr. Koll’s
7
The decision document was not entered by this Court until
May 3, 2002.
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fax, respondent faxed the following response to Mr. Koll:
However, at no time did I agree, or express an opinion,
as to a particular year in which the expenditures at
issue (which I consider to be capital) would be
deductible, since this would be based upon facts and
circumstances that I am not now aware of, or at least
aware of in total. I think that any such conclusion as
to the proper year is premature by any of us since not
all of the Barela tax returns (including, in
particular, the return for calendar year 1999) have yet
been filed, let alone reviewed by Eric or me.
Respondent’s letter is consistent with respondent’s response
to petitioner’s proposal during the negotiations. Upon receipt
of respondent’s letter neither Mr. Koll nor petitioner made any
attempt to respond, rebut, or dispute the contentions in
respondent’s letter. Further, petitioner did not move to
withdraw or to vacate the entered decision for 1998.
Accordingly, we hold that the parties did not reach a
binding agreement as to the allowance of the $5,433 loss.
Petitioner has not otherwise shown entitlement to said loss for
1999 and is not entitled to deduct the $5,433 amount on his 1999
return.
We have considered all other arguments advanced by the
parties, and, to the extent that we have not addressed these
arguments, we consider them irrelevant, moot, or without merit.
Decision will be entered
under Rule 155.