T.C. Summary Opinion 2005-11
UNITED STATES TAX COURT
CYNTHIA PAMELA ALDRIDGE DUMOND AND
JEFFREY ALLEN DUMOND, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6692-03S. Filed January 31, 2005.
Jeffrey Allen Dumond, pro se.
J. Anthony Hoefer, for respondent.
GOLDBERG, 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 1999 and 2000 years 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 $1,260 and an accuracy-related penalty of $252 for
the taxable year 1999. Respondent also determined a deficiency
in petitioners’ Federal income tax of $1,260 and an accuracy-
related penalty of $252 for the taxable year 2000.
The issues for decision are: Whether petitioners should be
allowed business expense deductions for amounts paid to their
minor children during 1999 and 2000, and whether petitioners are
liable for the section 6662(a) accuracy-related penalties for
negligence or disregard of rules or regulations in the years in
issue.
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits thereto are
incorporated herein by this reference. Petitioners resided in
Des Moines, Iowa, on the date the petition was filed.
Petitioner-husband Jeffrey Allen Dumond (petitioner) appeared
before the Court and presented petitioners’ case. Petitioner-
wife Cynthia Pamela Aldridge Dumond did not appear.
Background
Petitioners timely filed their Federal income tax returns
for the taxable years 1999 and 2000. Petitioners filed their
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1999 and 2000 income tax returns as married filing jointly using
the cash method of accounting.
During 1999 and 2000, petitioner operated a vending machine
business, State of the Art Vending. Petitioner purchased this
business in 1999, acquiring vending machines and a clientele
list. During 1999 and 2000, State of the Art Vending serviced 10
clients.
On his Schedule C, Profit or Loss From Business, for taxable
years 1999 and 2000, petitioner deducted labor expenses of $8,400
in each year, which consisted of $4,200 paid to each of his two
minor children. In the statutory notice, respondent disallowed
the amounts paid to his children after determining that the
amounts were not ordinary and necessary expenses paid or incurred
in a trade or business.
Discussion
As a general rule, the determinations of the Commissioner in
a notice of deficiency are presumed correct, and the taxpayer
bears the burden of proving the Commissioner’s determinations in
the notice of deficiency to be in error. Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933). Section 7491(a) shifts the
burden of proof to the Commissioner under certain circumstances.
The burden does not shift with respect to any factual issue
relating to petitioners’ liability for the income tax
deficiencies because petitioners neither alleged that section
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7491 was applicable nor established that they complied with the
statutory substantiation requirements of section 7491(a), as
shown below. Sec. 7491(a)(2)(A) and (B).
Business Expenses--Wages Paid to Children
Section 162(a)(1) provides that there shall be allowed as a
deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on a trade or
business, including a reasonable allowance for salaries or other
compensation for personal services actually rendered.
Section 1.162-7(a), Income Tax Regs. provides: “The test of
deductibility in the case of compensation payments is whether
they are reasonable and are in fact payments purely for
services.” See Elec. & Neon, Inc. v. Commissioner, 56 T.C. 1324,
1340 (1971), affd. without published opinion 496 F.2d 876 (5th
Cir. 1974). The question of whether amounts paid represent
reasonable compensation for services is one of fact determined
from all the facts and circumstances of the case. Charles
Schneider & Co. v. Commissioner, 500 F.2d 148, 151 (8th Cir.
1974), affg. T.C. Memo. 1973-130; Home Interiors & Gifts, Inc. v.
Commissioner, 73 T.C. 1142, 1155 (1980).
Deductions are a matter of legislative grace, and the
taxpayer bears the burden of proving that he or she is entitled
to any deduction claimed. Rule 142(a); New Colonial Ice Co. v.
Helvering, 292 U.S. 435, 440 (1934). This includes the burden of
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substantiation. Hradesky v. Commissioner, 65 T.C. 87, 89-90
(1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976).
Petitioner testified that he paid wages of $4,200 a year in
1999 and 2000 to each of his two children. Petitioners’ children
were ages 10 and 5 in 1999. Petitioner testified that the
payments to his children were based on what he believed the “law
allowed for, so that they [his children] would not have to file
taxes.”
Petitioner testified that the services provided by his
children included: Riding along on the weekly routes to the
vending machines, putting candy bars into the machines, sorting
the totes full of candy, breaking down the cardboard and sorting
out the recyclable products of waste produced by the business.
The older child also helped with counting money. Petitioner
testified that his children worked approximately 10 hours per
week. Petitioner admitted, however, that he did not know for
sure how often his children worked every week and that he did not
keep any record of their hours.
Petitioner offered into evidence copies of checks and a bank
statement to establish payment of wages to his children.
Petitioner testified that his children were paid once a year at
the end of December. However, the checks made out to his
children were not cashed until at least 2 months later because
there was not enough capital in the business to cash the checks
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when they were issued. Even after the checks were endorsed by
the payee children and petitioner, he retained control of the
proceeds. Petitioner did not set up separate accounts for his
children in which to deposit their alleged wages; instead,
petitioner kept the proceeds and either reinvested the proceeds
into his business or deposited said proceeds into his own
personal account. Petitioner also never established an hourly
rate for his children’s services. His children were paid a set
amount for both years.
Petitioner has failed to carry his burden of proof with
respect to the deductions taken for wages paid to his children,
and thus respondent’s determination must be sustained. See
Romine v. Commissioner, 25 T.C. 859 (1956); Chappell v.
Commissioner, T.C. Memo. 2001-146; Medina v. Commissioner, T.C.
Memo. 1983-253; Snyder v. Commissioner, T.C. Memo. 1975-221.
Accuracy-Related Penalty
Respondent determined that petitioners are liable for the
accuracy-related penalty under section 6662(a) with respect to
the underpayment attributable to the disallowed deductions for
Schedule C wages.
Section 7491(c) provides that the Commissioner shall have
the burden of production in any court proceeding with respect to
the liability of any individual for any penalty, addition to tax,
or additional amount. Specifically, section 7491(c), which was
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enacted by the Internal Revenue Service Restructuring and Reform
Act of 1998 (RRA 1998), Pub. L. 105-206, sec. 3001(a), 112 Stat.
726, provides as follows:
SEC. 7491(c) Penalties.–-Notwithstanding any other
provision of this title, the Secretary shall have the burden
of production in any court proceeding with respect to the
liability of any individual for any penalty, addition to
tax, or additional amount imposed by this title.
Section 7491(c) is effective with respect to court proceedings
arising in connection with examinations commencing after July 22,
1998. RRA 1998 sec. 3001(c)(1), 112 Stat. 727. There is no
dispute that the examination in the present case commenced after
July 22, 1998.
Section 6662(a) imposes a 20-percent penalty on the portion
of an underpayment attributable to any one of various factors,
one of which is negligence or disregard of rules or regulations.
Sec. 6662(b)(1). “Negligence” includes any failure to make a
reasonable attempt to comply with the provisions of the Internal
Revenue Code, including any failure to keep adequate books and
records or to substantiate items properly. Sec. 6662(c); sec.
1.6662-3(b)(1), Income Tax Regs. Section 6664(c)(1) provides
that the penalty under section 6662(a) shall not apply to any
portion of an underpayment if it is shown that there was
reasonable cause for the taxpayer’s position and that the
taxpayer acted in good faith with respect to that portion. The
determination of whether a taxpayer acted with reasonable cause
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and in good faith is made on a case-by-case basis, taking into
account all the pertinent facts and circumstances. Sec. 1.6664-
4(b)(1), Income Tax Regs. The most important factor is the
extent of the taxpayer’s effort to assess his proper tax
liability for the year. Id.
It is clear that petitioner was negligent with respect to
the disallowed deductions for Schedule C wages. Petitioner did
not keep adequate books and records or otherwise substantiate the
deductions reported on Schedule C, as required by the Internal
Revenue Code. Amounts that were allegedly paid to his children
always remained in his control. We sustain respondent’s
determination with respect to the section 6662(a) accuracy-
related penalty.
Reviewed and adopted as the report of the Small Tax Case
Division.
Decision will be entered
for respondent.