T.C. Memo. 2005-119
UNITED STATES TAX COURT
ROBERT E. CORRIGAN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3588-96. Filed May 23, 2005.
Robert E. Corrigan, pro se.
Margaret S. Rigg, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Chief Judge: Petitioner seeks the redetermination
of respondent’s determinations contained in two separate notices
of deficiency. Unless otherwise indicated, all section
references are to the Internal Revenue Code in effect for the
taxable years at issue. All Rule references are to the Tax Court
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Rules of Practice and Procedure. Respondent determined the
following income tax deficiencies, penalties, and additions to
tax for petitioner’s 1987 through 1991 taxable years:1
Year: 1987 1988 1989 1990 1991
Deficiency: $374,201 $86,517 $105,165 $173,542 $40,337
Additions to tax
and penalties
under secs.:
6651(a)(1) 58,840 11,931 8,710 41,598 5,997
6653(a)(1)(A) 15,607 --- --- --- ---
6653(a)(1) --- 3,755 --- --- ---
6653(a)(1)(B) ---1 --- --- --- ---
6653(b)(1)(A) 78,269 --- --- --- ---
6653(b)(1) --- 10,573 --- --- ---
6663 --- --- 13,786 21,190 10,240
6653(b)(1)(B) ---2 --- --- --- ---
6662(a) --- --- 13,828 30,571 5,337
1
50 percent of interest due on $280,318.
2
50 percent of interest due on $62,059.
After concessions by the parties, the issues remaining for
our consideration are: (1) Whether petitioner’s debt that was
forgiven as part of a settlement agreement is includable in
petitioner’s 1990 income; (2) whether petitioner’s stock and
option trading activity was a trade or business entitling him to
claim ordinary losses and/or business deductions on a Schedule C,
Profit or Loss From Business; (3) whether petitioner’s capital
gains/losses for 1987, 1990, and 1991 were correctly reported;
(4) whether petitioner is entitled to deduct payments or
1
Respondent also determined substantial understatement and
negligence additions to tax under former secs. 6661 and 6653(a)
for 1987 and 1988, respectively, and under sec. 6662(a) for 1989
through 1991 as an alternative position if the fraud penalty were
not sustained under sec. 6653(b) or sec. 6663 as the case may be.
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brokerage commission rebates claimed for 1987 and 1988; (5)
whether petitioner is entitled to defer gain realized from the
1987 sale of a residence under section 1034 and, if not, the
amount of gain to be recognized; (6) whether petitioner is
entitled to deduct losses from a horse breeding activity for 1987
through 1991; (7) whether petitioner has shown that respondent’s
determination that petitioner failed to report certain items of
income was in error; (8) whether petitioner is entitled to
itemized deductions for interest expenses, casualty losses, and
employee expenses in excess of the amounts allowed by respondent;
(9) whether petitioner is entitled to dependency deductions for
his children and/or a personal exemption for his former wife;
(10) whether petitioner is liable for additions to tax and
accuracy-related penalties for negligence for 1987 through 1991;
and (11) whether petitioner is liable for additions to tax and
penalties for substantial understatements.
FINDINGS OF FACT2
Petitioner resided in Newport Beach, California, at the time
his petition was filed. Petitioner’s Federal income tax returns
for 1987, 1988, 1989, 1990, and 1991 were filed on December 20,
1988, October 9, 1990, November 17, 1990, February 26, 1993, and
2
The parties’ stipulation of facts is incorporated by this
reference.
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March 26, 1993, respectively. Petitioner and respondent entered
into timely agreements extending the period for assessment for
each tax year in controversy.
Petitioner married Jo Ann Corrigan (Mrs. Corrigan) during
1965, and they had four children. Petitioner holds a master’s
degree in finance and in business administration and began
working as a stockbroker in southern California during 1970.
Beginning in 1976, petitioner began working as a stockbroker in
San Francisco, California. Although petitioner and Mrs. Corrigan
legally separated during 1973, they moved to Walnut Creek,
California, and lived together in a home with their children.
Petitioner and Mrs. Corrigan jointly purchased the home in Walnut
Creek for $89,000. They remodeled the Walnut Creek home and
added a barn and horse stables to the property at a cost of
approximately $70,000. After the improvements, Mrs. Corrigan
began boarding, breeding, and showing horses.
At the time of their 1973 separation, petitioner and Mrs.
Corrigan entered into a property settlement agreement providing
for child support, custody, and alimony. Mrs. Corrigan was given
physical and legal custody of the four children under the
agreement. On what purported to be joint returns for 1987
through 1991, petitioner claimed dependency exemptions for his
four children and a personal exemption for Mrs. Corrigan.
Respondent conceded that petitioner is entitled to file the
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returns as head of household for 1987 through 1991. Respondent
also conceded that petitioner is entitled to dependency
exemptions for David in 1987 through 1989, Erin in 1987 through
1991, Robert in 1987 and 1991, and Amy in 1991.
After petitioner and Mrs. Corrigan’s divorce became final
during 1977, they continued to cohabit. Petitioner left his
position in San Francisco during 1978 and accepted a new position
as a stockbroker with Smith Barney Harris Upham (Smith Barney) in
southern California. Petitioner flew to the Smith Barney office
in San Francisco for business on Fridays, and spent most weekends
with his family at his Walnut Creek home that he continued to
maintain as his principal residence.
Petitioner and Mrs. Corrigan purchased new residences and
left the Walnut Creek home during 1986. The Walnut Creek home
was sold for $254,000 during 1987. On the 1987 Federal income
tax return, petitioner reported the Walnut Creek home sale and
attempted to defer the gain by attaching a Form 2119, Sale or
Exchange of Principal Residence. The Form 2119 reflected that
gain was realized from the Walnut Creek home sale and that the
recognition of the gain was to be deferred pursuant to former
section 1034.
During 1986, petitioner and Mrs. Corrigan jointly purchased
real property in Chino, California, for $495,000. Mrs. Corrigan
operated the property as a ranch, and her initials were used to
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name the ranch “JAC Ranch”. Although the mortgage on the ranch
was in petitioner’s name alone, the deed to the property
reflected joint ownership by petitioner and Mrs. Corrigan. Mrs.
Corrigan used JAC Ranch as her primary residence beginning in
1986. Petitioner owned a home in Newport Beach, California,
which he used as his primary residence beginning in 1986.
Although petitioner and Mrs. Corrigan maintained separate
residences during the years in issue, they occasionally spent
time together in the same household.
During 1984, petitioner accepted a position as an account
executive at Prudential-Bache (Prudential). At Prudential, the
position of account executive was the equivalent of a senior
stockbroker. Petitioner was not a licensed stockbroker or dealer
in securities, and no license was required to act as a senior
stockbroker for Prudential. During 1984, Prudential lent
petitioner $390,000, which was evidenced by petitioner’s
promissory note to Prudential. Under the terms of the loan,
petitioner was required to make six annual $65,000 installments
with the first installment due July 1985. Petitioner made one
$65,000 installment, leaving an unpaid balance of $325,000.
Petitioner resigned his position at Prudential during August
1985 without repaying the outstanding $325,000 loan balance.
Prudential sought to collect the loan balance and submitted its
$325,000 claim to arbitration. Petitioner asserted several
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grounds that related to his employment as counterclaims
against Prudential, including breach of contract, breach of the
covenant of good faith and fair employment, fraud, negligent
misrepresentation in petitioner’s hiring, and punitive damages.
During 1990, the arbitration proceeding was settled. Under the
settlement, Prudential released petitioner from his obligation to
repay the $325,000 loan balance, and petitioner agreed to drop
his employment-related claims. Petitioner’s attorney wrote
petitioner a letter stating that the $325,000 would be
reclassified by Prudential as punitive damages, but the attorney
did not provide any tax advice regarding this item.
Prudential, in connection with the settlement and release of
the loan obligation, issued petitioner a Form 1099 MISC,
Miscellaneous Income, for 1990 reflecting $325,000 as nonemployee
compensation to petitioner. Petitioner did not report the
settlement as income.
During 1987, while petitioner’s dispute with Prudential was
ongoing, he transferred his interests in the JAC Ranch and the
Newport Beach residence to Mrs. Corrigan. Mrs. Corrigan quit-
claimed the deeds for both properties back to petitioner once
the Prudential matter was settled. At all pertinent times,
petitioner was the sole mortgagee and the only person obligated
to make mortgage payments with respect to the mortgage on the JAC
Ranch property.
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Mrs. Corrigan intended to use the JAC Ranch for the
breeding, sale, and showing of horses. She had no source of
income or capital other than what she received from petitioner.
She used these funds to pay the operating expenses and mortgage
payments for JAC Ranch. Mrs. Corrigan generally requested, and
petitioner advanced, approximately $10,000 per month for the
payment of expenses for hay and grain, breeding costs, hired
help, and the purchase, training, and showing of horses. During
the time petitioner made these payments, he and Mrs. Corrigan
were legally divorced.
Petitioner and Mrs. Corrigan did not enter into a joint
venture or profit and loss agreement with respect to the
operation of the JAC Ranch. Petitioner and Mrs. Corrigan were
divorced when they filed what purported to be joint Federal
income tax returns and joint amended returns. The purported
joint returns included claimed losses with respect to the
activities at the JAC Ranch. Petitioner and Mrs. Corrigan were
not entitled to file joint income tax returns for the years under
consideration.
Attached to the purported joint returns were Schedules C
reflecting Mrs. Corrigan as the operator and sole proprietor of
the ranch. On separate Schedules C, petitioner, alone, was shown
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as the operator and sole proprietor of an activity in which he
claimed to be engaged in the trade or business of buying and
selling options and commodities.
Petitioner claimed and respondent disallowed a theft loss of
$21,000 for 1987. Petitioner’s claim was on the basis of a
report he filed with the local police reflecting a $21,000 theft
of cash from his Newport Beach home. There was no evidence of
forced entry, and petitioner’s claimed theft was not solved or
verified by local authorities. Petitioner did not seek
reimbursement of the claimed $21,000 loss from his homeowner’s
insurance company.
During 1987 through 1991, petitioner was employed by Smith
Barney as an account executive in Newport Beach, California. He
earned commissions of $1,081,313, $321,692, $527,900, $361,105,
and $205,064 for 1987, 1988, 1989, 1990, and 1991, respectively.
On his 1987 through 1991 returns, petitioner claimed and
respondent disallowed expenses for work-related travel as
itemized deductions on the Schedules A, Itemized Deductions,
attached to each return.
Smith Barney, as a broker, and petitioner, as a Smith Barney
employee, dealt in syndicated stock offerings during 1987 and
1988, which differed from regular stock transactions in that the
underwriting of the stock involved risk to the broker. Because
of the increased risk, the transaction commissions were
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substantially larger and, on occasion, reductions in the amount
of commissions were negotiated.
During 1987 and 1988, JLB Capital, which was owned by Jack
Bergman (Bergman), was a Smith Barney customer which was serviced
by petitioner. Petitioner was the account executive for three
JLB Capital accounts. JLB Capital was operated by Bergman as a
proprietorship during the years at issue. In 1987 and 1988, JLB
Capital purchased syndicated stock offerings through petitioner,
who negotiated with Bergman to rebate a portion of the commission
petitioner received from Smith Barney for syndicated stock sales
to JLB Capital. On his 1987 and 1988 tax returns, petitioner
claimed reductions in gross income for “rebates” of $289,926 and
$135,000, respectively.3 The rebates were paid out of the
commissions petitioner earned from Smith Barney. Petitioner
issued Forms 1099 to JLB Capital with respect to the above-
described payments.4
Petitioner managed a Smith Barney brokerage account in his
name and a second account held jointly with Mrs. Corrigan during
3
For 1988, petitioner also claimed a reduction in income of
$23,837 for an amount claimed to be paid to an Anitra Kalagian.
Petitioner concedes that this item is not proper to consider in
computing his tax liability.
4
For 1987 and 1988, petitioner was able to show, by means
of canceled checks, that he had paid rebates of $265,699 and
$115,000, respectively, to JLB Capital or Bergman. The Forms
1099 issued to JLB Capital and the canceled checks are the only
support petitioner provided for the rebates reported on his
returns.
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1987 through 1991. A third Smith Barney account was held in Mrs.
Corrigan’s name only during the same period. Petitioner was the
account executive for each of these three accounts.
Petitioner purchased and sold options and commodities
through these accounts that resulted in both gains and losses.
Petitioner used the account in his name (account No. 06K-153400)
to buy and sell options and commodities during the years 1987
through 1989, and 1991. Petitioner incurred the following net
gains and (losses) from trading in the account solely in his
name:
Year Net Income/(Loss)
1987 $116,185
1988 (4,704)
1989 25,845
1991 27,375
Petitioner bought and sold commodities and options through
the joint account (account No. 06K-151106) with Mrs. Corrigan
during 1987 and 1988. Petitioner’s share of gains and (losses)
from the joint account were as follows:
Year Net Income/(Loss)
1987 $7,243
1988 (22,163)
Petitioner was the account executive for the third account
(account No. 06K-127531), which was solely in Mrs. Corrigan’s
name. The transactions in that account and the amount of gains
and losses are not those of petitioner.
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The number and frequency of the purchases and sales of
commodities and options in the above-described accounts are as
follows:
Petitioner’s Joint Mrs. Corrigan’s Total Sales
Year Account Account Account or Purchases
1987 23 5 51 79
1988 39 37 4 80
1989 19 0 22 41
1990 0 0 3 3
1991 11 0 21 32
Petitioner claimed that his dealing in options and
commodities constituted a trade or business.
OPINION5
Petitioner challenged numerous adjustments determined by
respondent for 1987 through 1991. After trial, petitioner
requested and was permitted several extensions of time for the
filing of his factual and/or legal arguments with the Court.
Ultimately, petitioner did not file a posttrial brief to assist
the Court in better understanding his position regarding the
errors that he alleged exist with respect to respondent’s
determinations.
I. Settlement and Release of $325,000 Debt
During 1984 petitioner borrowed $390,000 from Prudential.
Petitioner repaid $65,000 and continued to owe $325,000 as of
1985, when he resigned his position with Prudential. Prudential
5
Sec. 7491 does not apply because the audits for 1987
through 1991 occurred before 1998.
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sought to collect petitioner’s $325,000 obligation and petitioner
asserted counterclaims for breach of contract, breach of the
covenant of good faith and fair employment, fraud, negligent
misrepresentation in petitioner’s hiring, and punitive damages.
During 1990, petitioner and Prudential agreed to a mutual
release of all claims between them. According to the terms of
the release, in exchange for petitioner’s release of all claims,
Prudential in turn released petitioner from all claims,
“including without limitation as to any and all promissory notes
by or [indebtedness] of Corrigan to Prudential-Bache.”
Correspondingly, petitioner released Prudential from all of the
asserted counterclaims.
Petitioner contends that the settlement is to be excluded
from income under section 104(a)(2) because it was for a tortlike
personal injury and/or that it was to settle a claim for punitive
damages. Respondent counters that petitioner has not shown that
the settlement was for tortlike injuries, and, even if the
settlement were for punitive damages, it would not be excludable
under section 104(a)(2).
Section 61(a) provides that “all income from whatever source
derived” is gross income unless otherwise excluded by statute.
The definition of gross income includes income from the discharge
of indebtedness. Sec. 61(a)(12); sec. 1.61-12(a), Income Tax
Regs. Accordingly, receipt of funds by a taxpayer is presumed to
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be gross income unless it can be demonstrated that the accession
to wealth is specifically excluded by law. See Commissioner v.
Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
Petitioner was relieved of his obligation to pay the
remaining $325,000 due on his promissory note to Prudential and,
therefore, realized income from the forgiveness of debt, unless
petitioner can show that the income may be excluded.6 Petitioner
contends that section 104(a)(2) should apply to exclude the
$325,000 from his income. Section 104(a)(2) provides:
SEC. 104(a). In General.-–Except in the case of
amounts attributable to (and not in excess of)
deductions allowed under section 213 (relating to
medical, etc., expenses) for any prior taxable year,
gross income does not include–-
* * * * * * *
(2) the amount of any damages received
(whether by suit or agreement and whether as lump
sums or as periodic payments) on account of
personal injuries or sickness;
* * * * * * *
* * * Paragraph (2) shall not apply to any punitive
damages in connection with a case not involving
physical injury or physical sickness.
The term “damages received”, as used in section 104(a)(2),
is defined as an amount received “through prosecution of a legal
suit or action based upon tort or tort type rights, or through a
settlement agreement entered into in lieu of such prosecution.”
6
The exclusions from gross income set forth in sec.
108(a)(1) are not applicable in this case.
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Sec. 1.104-1(c), Income Tax Regs. In the context of a settlement
agreement, the nature of the claim that was the basis for a
settlement controls as to the question of whether damages are
excludable under section 104(a)(2). United States v. Burke, 504
U.S. 229, 237 (1992).
The determination of the nature of a claim is a question of
fact. Robinson v. Commissioner, 102 T.C. 116, 126 (1994), affd.
in part, revd. in part, and remanded on another issue 70 F.3d 34
(5th Cir. 1995). When a settlement agreement explicitly
allocates settlement proceeds between damages for tort type
personal injuries and other types of damages, that allocation may
be respected if a Court finds that it was the product of arm’s-
length, adversarial, and good faith negotiations. Id. at 127.
However, where a taxpayer settles contract claims and tort
claims for a lump-sum amount and neither the agreement nor other
evidence provides a basis to allocate any portion to tort claims
for personal injuries, the courts have decided that they are not
in a position to be able to make allocations on the parties’
behalf. See Taggi v. United States, 35 F.3d 93, 96 (2d Cir.
1994); Reisman v. Commissioner, T.C. Memo. 2000-173, affd. 3 Fed.
Appx. 374 (6th Cir. 2001). Under those circumstances, the
settlement proceeds have been held to be includable in a
recipient’s income. See, e.g., Morabito v. Commissioner, T.C.
Memo. 1997-315.
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Petitioner relies upon a letter received from his attorney
stating that Prudential was willing to “reclassify the $390,000
dollars [sic] given to you in 1984 as a loan to a punitive damage
settlement award in your lawsuit.” The release, however, states
that the settlement is for all claims that petitioner had
asserted in connection with his employment and his termination.
The release is silent with respect to any allocation to a
particular claim and/or punitive damages.
For the $325,000 to be excluded under section 104(a)(2),
petitioner must meet a two-prong test and demonstrate: (1) That
the underlying cause of action giving rise to recovery is based
upon tort or tort type rights, and (2) that the damages were
received on account of personal injuries. Commissioner v.
Schleier, 515 U.S. 323, 336-337 (1995). Unless both prongs are
met, the payment is not excludable from gross income under
section 104(a)(2). Id.
In that regard, petitioner has not shown that the underlying
cause of action that gave rise to recovery was based upon tort or
tort type rights. Most of petitioner’s claims appear to be on
the basis of contractual rights. A tort is defined as a “‘civil
wrong, other than breach of contract, for which the court will
provide a remedy in the form of an action for damages.’” United
States v. Burke, supra at 234 (quoting Keeton et al., Prosser &
Keeton on the Law of Torts 2 (5th ed. 1984)). In the absence of
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a general Federal common law of torts or controlling definitions
in the Internal Revenue Code, we look to State law to determine
the nature of the claim litigated. United States v. Mitchell,
403 U.S. 190, 197 (1971); Erie R.R. v. Tompkins, 304 U.S. 64, 78
(1938).
Although petitioner’s claims for fraud and negligent
misrepresentation may sound in tort, such claims generally
involve economic loss rather than personal injury.7 In that
regard, petitioner testified that his claim against Prudential
arose from lost commissions. He did not offer any alternate
reasons for his dispute and counterclaims with Prudential.
Finally, concerning petitioner’s claim that the settlement
was for punitive damages, section 104(a) as in effect for the
year in issue specifically states that amounts received on
account of personal injuries or sickness “shall not apply to any
punitive damages in connection with a case not involving physical
injury or physical sickness.”8 There is no indication that
petitioner’s settlement was based on physical injury or physical
7
See Prosser, Law of Torts 5, at 683-684 (4th ed. 1971).
8
The 1989 amendment adding this provision is effective for
amounts received after July 10, 1989, unless received (A) under a
written agreement, court decree, or mediation award in effect, or
issued on or before, July 10, 1989, or (B) pursuant to any suit
filed on or before July 10, 1989. Omnibus Budget Reconciliation
Act of 1989, Pub. L. 101-239, sec. 7641, 103 Stat. 2379. Because
the discharge of indebtedness occurred after July 10, 1989, and
was pursuant to an arbitration claim rather than the filing of a
suit, the amendment applies to the discharge of indebtedness.
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sickness, even if it were for punitive damages. Accordingly, we
hold that petitioner has not shown that he is entitled to exclude
the $325,000 settlement from his gross income.
II. Commodity and Option Trading Activity
During the years under consideration, petitioner was a
successful stockbroker earning annual commissions ranging from
$200,000 to in excess of $1 million. In addition, during the
years under consideration, petitioner claimed to be in the trade
or business of trading options and commodities. Substantially
all of the transactions reported from this activity consisted of
option trading in three separate stock brokerage trading
accounts. The three accounts included one in petitioner’s name,
one held jointly with Mrs. Corrigan, and one in Mrs. Corrigan’s
name. Likewise, the cost of goods sold reflected on the
Schedules C was, in substantial part, the purchase price of the
options that had been sold. In addition to the cost of goods
sold, petitioner claimed deductions for various expenses. The
activity was reported on the Schedules C under the name “Corrigan
Enterprises”, and losses were claimed for 1987, 1988, 1989, and
1991 of $96,098, $25,774, $124,073, and $34,907, respectively.
Respondent determined that this activity produced capital
rather than ordinary gains and losses. In addition, respondent
allocated the gains and losses between petitioner and Mrs.
Corrigan in accord with their ownership of the accounts,
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allocating to petitioner all the gains and losses from the
account in his name only and one-half of the gains and losses
from the joint account held with Mrs. Corrigan. Respondent also
determined that the gains and losses were short-term. Finally,
respondent determined that petitioner had not substantiated the
deductions claimed on the Schedules C.
A. Substantiation of Schedule C Deductions
Even if petitioner shows that he was engaged in a trade or
business, he is obligated to show that deductions of expenses in
controversy are ordinary and necessary and were paid during the
year of deduction.
Petitioner did not introduce evidence showing that the
expenses deducted were ordinary and necessary and/or were paid
during the year of deduction. Therefore, petitioner is not
entitled to the deductions for expenses claimed on the Schedules
C for Corrigan Enterprises.
B. Dealer, Trader, or Investor
Generally, for Federal tax purposes, individuals who
purchase and sell securities have been characterized into one of
three categories: Dealers, traders, and investors. See Estate
of Yaeger v. Commissioner, T.C. Memo. 1988-264, affd. on this
issue 889 F.2d 29 (2d Cir. 1989). Petitioner concedes that he is
not a dealer, so any gains and losses would be capital in nature,
not ordinary. See sec. 1221(a)(6). The parties dispute whether
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petitioner is a trader or investor only because the expenses
petitioner claimed for Corrigan Enterprises would not be trade or
business expenses if petitioner were an investor. Having found
that petitioner is not entitled to the deductions he claimed for
Corrigan Enterprises, we need not determine whether petitioner is
a trader or investor.
III. Capital Gains and Losses
Although petitioner attempted to file joint Federal income
tax returns, he was not entitled to do so because he and Mrs.
Corrigan were divorced at the time he attempted to file. Had
petitioner and Mrs. Corrigan been entitled to file joint returns,
it would not matter that the gains and losses from the joint
account and Mrs. Corrigan’s account were netted with the gains
and losses in petitioner’s account. Because petitioner and Mrs.
Corrigan were not entitled to file joint returns, we must decide
whether petitioner was entitled to report the gains or losses
from each of the three accounts.
When transacted through a brokerage account, gains and
losses from the sale of stock and options are reportable by the
owner of the account in the absence of any evidence demonstrating
that another person is the true or equitable owner. See Ruth v.
Commissioner, 962 F.2d 14 (9th Cir. 1992), affg. without
published opinion T.C. Memo. 1991-30.
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The gains and losses in the three brokerage accounts were
allocated by respondent according to which person owned the
account. At trial, petitioner testified that he was the sole
owner of all three accounts and was entitled to all the claimed
losses. His testimony, however, was inconsistent with the
allegations in his petition alleging a joint venture with Mrs.
Corrigan on the accounts. To some extent, petitioner’s testimony
on this point was inconsistent. For example, he contradicted
himself as to whether the proceeds of sales in the account in
Mrs. Corrigan’s name were remitted to her. Petitioner did not
provide any corroborating testimony or evidence supporting his
claim that the account ownership, in substance, differed from the
form.
Accordingly, we sustain respondent’s allocations of the
capital gains and/or losses from the three accounts.
IV. Deduction of Payments Claimed as Brokerage Commission
Rebates
While employed as a stockbroker during 1987 and 1988,
petitioner was responsible for servicing Smith Barney customers,
including JLB Capital, a sole proprietorship owned by Bergman.
Petitioner earned $1,081,313 and $321,692 in commissions from
that activity during 1987 and 1988, respectively. Also for 1987
and 1988, petitioner claimed reductions in income for “rebates”
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to JLB Capital of $289,926 and $135,000, respectively.9
Petitioner contends that he rebated the amounts to JLB Capital to
induce the purchases of certain syndicated stock offerings during
1987 and 1988.
It was not unusual for brokerage firms that offered
syndicated stock to accept reduced commissions. That is on the
basis of the fact that commissions for syndicated stock
transactions were generally larger than those for other stock
transactions. Petitioner reported the gross commission income
received from Smith Barney for his sales of syndicated stock to
JLB Capital. He reduced the amount reported as income by the
rebates or payments made to JLB Capital as an inducement to trade
with him.
Respondent contends that such payments are not deductible
from petitioner’s gross income and, if allowable would, at very
most, be unreimbursed employee expenses that may or may not be
deductible as itemized deductions. Respondent also contends that
these payments may be in violation of California securities law
and that rebates of commissions may result in disciplinary action
or suspension by the New York Stock Exchange. Respondent did not
9
Even though petitioner could not substantiate the entire
amount reported on his tax returns, petitioner was able to
substantiate 85 percent of the claimed amounts by means of
canceled checks. Petitioner’s proffered evidence is sufficient
to show that the amounts claimed were paid. See Cohan v.
Commissioner, 39 F.2d 540 (2d Cir. 1930).
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argue, however, that such payments would not be deductible as
being illegal. See sec. 162(c)(2). Finally, respondent argued
that the payments are not deductible as a rebate or price
reduction because JLB Capital paid the commissions for its stock
purchases to Smith Barney under their customer-broker business
relationship.
The question we consider focuses upon whether petitioner is
entitled to reduce the gross commission income received from
Smith Barney or whether the payments he made to JLB Capital are
deductible as employee business itemized deductions from adjusted
gross income. We agree with respondent that in these
circumstances petitioner is not entitled to reduce gross income
by the payments made to JLB Capital. See Alex v. Commissioner,
70 T.C. 322 (1978), affd. 628 F.2d 1222 (9th Cir. 1980); see
also Pittsburgh Milk Co. v. Commissioner, 26 T.C. 707 (1956) (in
which such a reduction of income was permitted in a two-party
transaction). Here, petitioner is an agent or employee of Smith
Barney with whom JLB Capital and Bergman have contractual
relationships regarding stock trading and commissions. The
commissions received by petitioner in his role as a Smith Barney
employee and the payments made to JLB Capital are not reductions
or rebates of the customer’s commission payments to Smith Barney.
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Therefore, the payments are “three cornered”, and petitioner is
not entitled to a reduction from gross income. Alex v.
Commissioner, supra at 1224-1225.
Rebates may be allowable under section 162 as business
expenses if they are ordinary and necessary. The payments in
Alex v. Commissioner, supra, were not deductible because of the
prohibition against illegal deduction in section 162(c)(2). The
payments made by petitioner here were not “illegal” within the
meaning of section 162(c) and are ordinary and necessary expenses
incurred in petitioner’s trade or business of being an employee.
As to respondent’s argument that petitioner could have
sought reimbursement for rebate-like payments to Smith Barney
customers, the record does not support a conclusion that the
payments were reimbursable. Respondent’s arguments on this point
are internally inconsistent. Respondent, on one hand, points out
that the payment may have violated California law and/or the
rules of the New York Stock Exchange. On the other, respondent
contends that these payments would be reimbursable. The possible
impropriety of the payments would seem to dictate that such
amount would not be reimbursable. Further, it is obvious from
petitioner’s testimony, and we find on the record before us, that
the payments were not reimbursable.
Petitioner is entitled to deduct the amounts paid to JLB
Capital. The deduction however is not from gross income because
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section 62(a)(1) provides that such deductions, being
attributable to petitioner’s employment, are allowable as
itemized deductions from adjusted gross income. See sec. 63(a).
Accordingly, we find that subject to certain limitations,
petitioner is entitled to deduct itemized employee deductions on
Schedules A of $289,926 for 1987 and $135,000 for 1988.
V. Sale of Residence
Under former section 1034,10 which was in effect for
petitioner’s 1987 tax year, taxpayers were able to defer gain
realized from the sale of their principal residence if they
purchased a replacement residence and met certain other
conditions. Section 1034, in pertinent part, provided:
SEC. 1034(a). Nonrecognition of Gain.–-If
property (in this section called “old residence”) used
by the taxpayer as his principal residence is sold by
him and, within a period beginning 2 years before the
date of such sale and ending 2 years after such date,
property (in this section called “new residence”) is
purchased and used by the taxpayer as his principal
residence, gain (if any) from such sale shall be
recognized only to the extent that the taxpayer’s
adjusted sales price (as defined in subsection (b)) of
the old residence exceeds the taxpayer’s cost of
purchasing the new residence.
Respondent’s sole contention with regard to the sale of
petitioner’s residence is that if petitioner abandoned the Walnut
Creek residence and had a new “principal residence” before the
10
Sec. 1034 was repealed in connection with the Taxpayer
Relief Act of 1997, Pub. L. 105-34, sec. 312(a) and (b), 111
Stat. 836, 839.
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time of the sale, section 1034 does not apply to defer any gain
from sale. Respondent relies on Perry v. Commissioner, 91 F.3d
82 (9th Cir. 1996), affg. T.C. Memo. 1994-247. Accordingly, the
sole question we consider is whether the Walnut Creek residence
was petitioner’s “principal residence” for purposes of section
1034. In the Perry case, the taxpayer had, because of a divorce,
left the home in question approximately 3 years before its sale.
In that case, the Court of Appeals for the Ninth Circuit held
that the home was not the taxpayer’s principal residence because
he had left it several years before it was placed for sale and
sold. In other words, the taxpayer had ceased to “physically
occupy and live in the house” long before it was intended to be
sold. Id. at 85. On the basis of that reasoning in Perry, it
appears that the taxpayer would not have met the 2-year before
and after rule of section 1034.
In this case, petitioner and Mrs. Corrigan used the Walnut
Creek home as their principal residence until some time in 1986
when they decided to sell it and each of them moved to new
residences, one of which was jointly purchased by petitioner and
Mrs. Corrigan. Unlike the taxpayer in Perry, petitioner did not
cease using the Walnut Creek home as his principal residence
several years before and then decide to sell it and reinvest in
another home. Petitioner and Mrs. Corrigan moved to new
residences and sold the Walnut Creek property within a relatively
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short time (well within the 2-year requirement of section 1034).
Thus, petitioner did not have more than one “principal
residence”. Sec. 1.1034-1(c)(3), Income Tax Regs.
Considering the above principles and the record in this
case, the Walnut Creek property was petitioner’s principal
residence. Respondent does not contend that any other
requirement of section 1034 was not satisfied. Accordingly,
petitioner was entitled to defer any gain realized on the 1987
sale of that property.
VI. Deduction of Losses From Horse Breeding Activity
Petitioner claimed losses for 1987 through 1991 of $88,047,
$40,811, $65,647, $116,737, and $27,351, respectively, from the
operation of the JAC Ranch. The losses were claimed on what
purported to be joint returns filed by petitioner and Mrs.
Corrigan. Because the horse breeding activity to which these
claimed losses are attributable was operated by and in the name
of Mrs. Corrigan, and because petitioner was not entitled to file
a joint return, he now contends that he and Mrs. Corrigan
operated the activity as a joint venture, and that he is entitled
to claim all of the losses reflected on the purported joint
returns for 1987 through 1991.
Respondent disallowed the losses in their entirety, and the
parties’ dispute concerns the question of whether petitioner was
entitled, as a joint venturer, to all of the losses for the horse
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breeding activity at the JAC Ranch. The parties have not
addressed the question of whether the losses are correct in
amount or whether the activity was operated with the intent to
make a profit. Respondent’s position that petitioner was not a
joint venturer is based upon the record and certain other
factors. We agree with respondent that petitioner has failed to
show that the horse breeding activity was a joint venture between
petitioner and Mrs. Corrigan.
Initially, we note that the purported joint returns reflect
that the horse breeding activity was operated by Mrs. Corrigan as
a sole proprietorship. Her name alone was reflected on the
Schedules C. By contrast, petitioner’s name was the only one
reflected with respect to his claimed option trading activity.
This is a potent indication that Mrs. Corrigan was the sole
operator and proprietor of the horse breeding activity.
Respondent also points out that for a partnership or joint
venture to exist there should be (1) an agreement to share profit
and losses, (2) a community of interest in the undertaking, and
(3) a right of control over the activity. See, e.g., Joe
Balestrieri & Co. v. Commissioner, 177 F.2d 867, 871 (9th Cir.
1949) (similar Federal statutory requirements exist), affg. a
Memorandum Opinion of this Court; see also sec. 7701(b).
In that regard, petitioner has not shown that he had a right
to participate in management or to control the activities at the
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JAC Ranch. Although petitioner did provide funding to Mrs.
Corrigan for the operation of the activity, there is no showing
that the character of these advances was debt or equity. Even if
the advances constituted an equity interest, that would not
necessarily entitle petitioner to share in profits and losses.
Petitioner has alleged that there was a written agreement
between him and Mrs. Corrigan regarding the sharing of profits
and losses, etc. No such agreement was produced, and no
corroborating evidence was provided in support of petitioner’s
self-serving allegations.
In view of the foregoing, we hold that petitioner has not
shown that he is entitled to claim losses from the horse breeding
activity.
VII. Unreported Income
Respondent determined that petitioner failed to report
various items of income, including dividends, interest, State
income tax refunds, and royalties during the years in issue.
With the exception of a $1,902 adjustment that respondent now
concedes was in error, petitioner has failed to present any
evidence to show that respondent’s determination was in error.
The net amounts of unreported income for 1987, 1989, 1990, and
1991 are $44, $5,587, $15, and $26, respectively. For 1988,
respondent determined that petitioner overstated the various
items of income by a net amount of $539.
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Generally, petitioner is obligated to show that respondent’s
determination is in error. There are exceptions to that rule,
one of which may concern the determination that there is
unreported income. Under the holdings of the Court of Appeals
for the Ninth Circuit (to which an appeal would normally lie for
petitioner), the Commissioner is required to make a threshold
evidentiary foundation to support a determination of unreported
income. See Weimerskirch v. Commissioner, 596 F.2d 358 (9th Cir.
1979), revg. 67 T.C. 672 (1977). Respondent has made a
sufficient showing to shift to petitioner the obligation to show
that respondent’s determination is in error, which petitioner has
failed to do. Wherefore, respondent’s determination of
unreported or overstated miscellaneous income items is sustained.
VIII. Itemized Deductions
A. Mortgage Interest
Respondent made determinations regarding petitioner’s
itemized deductions for mortgage interest for the years under
consideration. Respondent has conceded that petitioner is
entitled to mortgage interest deductions of $33,799, $21,308.24,
$36,816.24, and $35,558.04 for 1988, 1989, 1990, and 1991,
respectively. Petitioner appears to have contested the 1987
mortgage interest deduction for the Telegraph Avenue property.
In that regard, respondent conceded that petitioner is entitled
to $24,824.63 of mortgage interest attributable to the Telegraph
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Avenue property for 1987. The remaining mortgage interest
deductions for 1987 is not conceded, and petitioner has provided
no evidence or argument to show entitlement to mortgage interest
deductions in excess of those allowed or conceded by respondent.
Accordingly, petitioner is not entitled to mortgage interest
deductions in excess of those allowed by respondent.
B. Casualty Losses
Petitioner claimed casualty losses attributable to theft of
$21,000 and $31,860 for 1987 and 1991, respectively. Section
165(a) permits a deduction for losses not compensated for by
insurance or otherwise. The loss for a casualty, however, is
subject to limitations. The loss may be allowable for 1987 to
the extent that it exceeds $100. Sec. 165(h)(1). In addition,
the loss is deductible only to the extent that it also exceeds 10
percent of a taxpayer’s adjusted gross income. Sec. 165(h)(2).
Applying those rules to petitioner’s $21,000 claimed
casualty loss for 1987, the amount would not exceed the statutory
thresholds or limitations. First, the claim is limited to
$20,900 ($21,000, less the $100 threshold). Second, because
petitioner’s adjusted gross income was approximately $495,000,
the 10-percent limitation would preclude any deduction for a
casualty loss of less than $49,500. Accordingly, petitioner is
not entitled to an itemized casualty loss deduction for 1987.
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With respect to petitioner’s $31,860 casualty loss that he
claimed for 1991, he testified that this was Mrs. Corrigan’s loss
and that there was an insurance recovery. Accordingly,
petitioner is not entitled to any part of the $31,860 casualty
loss that he claimed for 1991.
C. Employee Expenses
Petitioner claimed deductions for each year at issue in
connection with his employment. The deductions concerned travel,
meals, and other employee-type expenses.
A taxpayer may deduct ordinary and necessary business
expenses incurred in conducting a trade or business. Sec.
162(a). The term “trade or business” includes the trade or
business of being an employee. Primuth v. Commissioner, 54 T.C.
374, 377 (1970). Section 274, however, limits deductions for
entertainment and recreation that would otherwise be allowable
unless it is established that the expenditures were directly
related to or preceding a bona fide business discussion and were
associated with the active conduct of a taxpayer’s trade or
business. See sec. 274(a)(1)(A). A deduction is allowed for
meals only if such expenses are not lavish and the taxpayer is
present when such meals are furnished. Sec. 274(k)(1). In
addition, section 274(d) limits such deductions to those that can
be substantiated by adequate records or other evidence
corroborating the amount of the expenditure, the time and place
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of the travel, entertainment, etc., the business purpose, and the
business relationship of persons being entertained.
Petitioner claimed to have logs and other documentary
evidence regarding these claimed expenses, but he did not produce
them or offer them into evidence. Because of the rigorous
requirements for substantiation for expenses of this variety, his
uncorroborated testimony will not suffice, and we accordingly
sustain respondent’s determination disallowing petitioner’s
travel, entertainment, and related expenses.
IX. Dependency and/or Personal Exemptions
On his 1987 through 1991 returns, petitioner claimed
dependency exemptions for his four children and a personal
exemption for Mrs. Corrigan. Respondent conceded that petitioner
was entitled to file his returns as head of household for 1987
through 1991, and that petitioner was entitled to dependency
exemptions for David in 1987 through 1989, Erin in 1987 through
1991, Robert in 1987 and 1991, and Amy in 1991. All other
dependency exemptions and the personal exemptions have not been
conceded and were determined not allowable by respondent.
Section 151(c) provides for a deduction for each dependent
(as defined in section 152). A “dependent”, among others, can be
a son or daughter “over half of whose support, for the calendar
- 34 -
year in which the taxable year of the taxpayer begins, was
received from the taxpayer (or is treated under subsection (c) or
(e) as received from the taxpayer)”. Sec. 152(a).
The circumstances of this case are such that petitioner
provided all the support to his children and Mrs. Corrigan, who
had no source of income and was dependent upon petitioner for the
children’s expenses and those of her horse breeding activity.
During the years in question, petitioner was divorced and Mrs.
Corrigan was awarded custody of the children who had not reached
majority. Petitioner’s son Robert was 19 in 1988, resided with
petitioner, and attended school for at least 5 months during each
of the years in controversy. Amy was a minor and resided with
Mrs. Corrigan.
In addition, Mrs. Corrigan, who had no other source of
income, subscribed to the joint returns in which dependency
exemptions were claimed for all of the children. This act by
Mrs. Corrigan is tantamount to her consent in allowing petitioner
to claim the exemptions. These circumstances conform to the
substance of Form 8332, Release of Claim to Exemption for Child
of Divorced or Separated Parents, and meet the requirements for a
noncustodial parent claiming dependency exemptions under section
1.152-4T(a), Q&A-3, Temporary Income Tax Regs., 49 Fed. Reg.
- 35 -
34459 (Aug. 31, 1984). Cf. Miller v. Commissioner, 114 T.C. 184,
188-189 (2000), affd. on other grounds sub nom. Lovejoy v.
Commissioner, 293 F.3d 1208 (10th Cir. 2002).
Accordingly, petitioner is entitled to claim dependency
exemptions for Amy in 1987 through 1991 and for Robert in all
years including 1988, 1989, and 1990 (the years denied by
respondent).
With respect to Mrs. Corrigan, petitioner is not entitled to
claim a personal or dependency exemption because they were
divorced, and she did not reside in his household. Secs. 151(b),
152(a)(9).
X. Negligence Additions to Tax and Accuracy-Related
Penalties
For 1987 and 1988, respondent determined that petitioner was
liable for an addition to tax for negligence under section
6653(a)(1) equal to 5 percent of the underpayment. For 1987,
respondent also determined that petitioner was liable under
section 6653(a)(1)(B) for an amount equal to 50 percent of the
interest payable on the portion of the underpayment attributable
to negligence. For 1989 through 1991, respondent determined that
petitioner was liable for a 20-percent accuracy-related penalty
under section 6662(a) due to negligence or intentional disregard
of the rules or regulations. The standards and principles
- 36 -
regarding these penalties are substantially similar, and,
accordingly, we combine our discussion of whether respondent’s
determination should be sustained.
Negligence has been defined as “the lack of due care or the
failure to do what a reasonable and prudent person would do under
similar circumstances.” Allen v. Commissioner, 925 F.2d 348, 353
(9th Cir. 1991), affg. 92 T.C. 1 (1989); Zmuda v. Commissioner,
731 F.2d 1417, 1422 (9th Cir. 1984), affg. 79 T.C. 714 (1982).
Negligence includes the “failure to make a reasonable attempt to
comply with the provisions [of the Internal Revenue Code]” and/or
to exercise ordinary and reasonable care in the preparation of a
tax return. Secs. 6653(a)(3), 6662(c); sec. 1.6662-3(b)(1),
Income Tax Regs. “Disregard” includes any careless, reckless, or
intentional disregard. Secs. 6653(a)(3), 6662(c); sec. 1.6662-
3(b)(2), Income Tax Regs.
The accuracy-related penalty under section 6662 does not
apply with respect to any portion of an underpayment for which
there was reasonable cause and the taxpayer acted in good faith.
Sec. 6664(c)(1). Whether a taxpayer acted with reasonable cause
depends on the facts and circumstances. Sec. 1.6664-4(b)(1),
Income Tax Regs. The most important factor to be considered is
the extent of the taxpayer’s efforts to determine the proper
income tax liability. Id. With respect to 1987 and 1988,
section 6653(a)(1) provides that the 5-percent addition to tax
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applies to the entire underpayment if any part of the
underpayment is due to negligence or disregard of rules or
regulations.
Respondent contends that petitioner’s failure to maintain
adequate books and records and to provide them to respondent
supports the determination that petitioner was negligent. See
sec. 1.6662-3(b)(1), Income Tax Regs. We agree with respondent
that petitioner failed to maintain and to provide respondent or
the Court adequate records with respect to the claimed deductions
in connection with his option trading, travel, entertainment, and
meals. In addition, respondent contends that petitioner was
negligent in connection with the exclusion of the amount received
in settlement of his relationship with Prudential. Finally,
negligence has been asserted with respect to petitioner’s
claiming ordinary losses in connection with his option trading.
With respect to the exclusion of the settlement, petitioner
contends that he relied on his attorney’s advice that the
settlement was for punitive damages. The attorney’s letter,
however, merely advised petitioner of the characterization of the
settlement, not of the tax consequences. In addition, the
relevant law for the year in issue provided that punitive damages
were excludable from gross income only if arising from physical
injuries or physical sickness. Accordingly, it was not
- 38 -
reasonable for petitioner to exclude the settlement on the basis
of his attorney’s characterization of the settlement as for
punitive damages.
With respect to the disallowed deductions, the negligence
penalty or addition to tax applies, and petitioner has not shown
reasonable cause. His negligence is on the basis of his failure
to maintain records and failure to comply with rules or
regulations. As to petitioner’s claim of ordinary loss status
for his option trading activity, his business experience as a
stockbroker and educational background placed petitioner in a
position where he knew or should have known that his activity was
not entitled to ordinary loss treatment. See, e.g., Walker v.
Commissioner, T.C. Memo. 1990-609.
XI. Substantial Understatement Liabilities11
Section 6661, as applicable for 1987 and 1988,12 provides
for a 25-percent addition to tax for substantial understatements
of tax liability. See Pallottini v. Commissioner, 90 T.C. 498,
11
Respondent had determined that the fraud penalty applied
for each of the taxable years. As an alternative, respondent
determined that the substantial understatement penalty applied in
each year. Respondent conceded that the fraud penalty does not
apply.
12
Sec. 6661 was repealed for years with return due dates
after Dec. 31, 1989, and recodified in sec. 6662.
- 39 -
503 (1988). Section 6662(a) provides for a 20-percent addition
to tax for tax years with return due dates after December 31,
1989.13
Petitioner bears the burden of showing that respondent’s
imposition of these additions to tax is erroneous. Rule 142(a);
Tweeddale v. Commissioner, 92 T.C. 501, 506 (1989). Section 7491
is not applicable in this case because the audit of petitioner’s
returns began before July 22, 1998.
An understatement is “substantial” if the amount of the
understatement for the applicable year exceeds the greater of 10
percent of the tax required to be shown on the return or $5,000.
Sec. 6661(b)(1)(A). Under section 6661, an “understatement” is
defined as the excess of the tax required to be shown on the
return over the amount of tax that is shown on the return reduced
by any rebate within the meaning of section 6211(b)(2). Sec.
6661(b)(2)(A).
The amount of the understatement is reduced by the portion
of the understatement attributable to the tax treatment of any
item if there is or was substantial authority for the treatment,
or if there was adequate disclosure of the relevant facts
13
Because the sec. 6662 penalty applies to negligence and
substantial understatements, and we have found that petitioner
was negligent with respect to all improperly reported items, we
need not discuss sec. 6662 any further.
- 40 -
affecting the treatment of the item in the return or a statement
attached to it. See sec. 6661(b)(2)(B); sec. 1.6661-3(a)(1),
Income Tax Regs., T.D. 8017, 1985-1 C.B. 379.
Petitioner did not file a brief or provide at trial any
authority (substantial or otherwise) regarding any of the
adjustments by respondent for the taxable years under
consideration. Accordingly, we consider whether petitioner’s
return contained adequate disclosure with respect to any of the
adjustments by respondent. The adequate disclosure requirement
under the regulations applicable for 1987 and 1988 is that the
disclosure must show, inter alia: “The facts affecting the tax
treatment of the item (or group of similar items) that reasonably
may be expected to apprise the Internal Revenue Service of the
nature of the potential controversy concerning the tax treatment
of the item (or items).” Sec. 1.6661-4(b)(1)(iv), Income Tax
Regs., T.D. 8017, 1985-1 C.B. 382.14
Concerning the claimed ordinary business deductions or
losses from stock trading activity, petitioner reported that he
was in the trade or business of buying and selling options, but
14
We decide these items on an item-by-item basis and,
ultimately, the parties’ Rule 155 computation will be necessary
to finally decide whether the threshold for application of the
substantial understatement addition applies in any of the years
under consideration.
- 41 -
he was not and he failed to disclose that he was a broker or
dealer in options. See, e.g., Little v. Commissioner, T.C. Memo.
1993-281, affd. 106 F.3d 1445 (9th Cir. 1997).
In conjunction with the option trading question, we
allocated between petitioner and Mrs. Corrigan the capital
gains/losses from three separate accounts for 1987, 1990, and
1991. We note that of the three accounts in question, one was in
petitioner’s name, one in Mrs. Corrigan’s, and one was jointly
held between petitioner and Mrs. Corrigan. Petitioner and Mrs.
Corrigan (from whom he was divorced at all pertinent times)
attempted to file joint returns for 1987 through 1991. As a
matter of law, they were not entitled to do so. Accordingly, we
held that petitioner was not entitled to combine the gains and
losses of the three accounts for reporting purposes. There was,
however, no disclosure made on the returns indicating that
petitioner and Mrs. Corrigan were divorced or that they were
otherwise justified in filing a joint return. Likewise, it was
not reasonable to claim joint filing status at a time when
petitioner knew he was divorced. There was therefore no adequate
disclosure or reasonable cause for the position reported by
petitioner. We accordingly hold that the substantial
understatement addition is applicable with respect to this
adjustment for 1987.
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Next, we consider the brokerage commission rebates that
petitioner failed to include in gross income for 1987 and 1988.
The question we consider with respect to those adjustments is
whether there was adequate disclosure of such reductions from
gross income. Petitioner disclosed on his returns that he was
reducing his income by the amount of the rebates reflected on the
Forms 1099 he issued and thus adequately disclosed his position.
Accordingly, petitioner is not subject to the substantial
understatement additions to tax for 1987 and 1988 with respect to
the understatement attributable to the rebate determination.
The adjustment concerning petitioner’s claim that he is
entitled to deduct all of the losses from the horse breeding
activity at JAC Ranch for 1987 through 1991 is one that likewise
was dependent as a threshold matter upon petitioner’s being able
to file a joint return with Mrs. Corrigan. As already explained,
there was no disclosure on the returns that petitioner and Mrs.
Corrigan were divorced and, therefore, not entitled to file a
joint return. Likewise, it was not reasonable to claim joint
filing status at a time when petitioner knew he was divorced.
Accordingly, petitioner may be subject to the substantial
understatement additions to tax for 1987 and 1988 as to the
losses claimed from the JAC Ranch.
- 43 -
We have found that petitioner failed to report certain items
of income, including interest and tax refunds. These amounts
were not disclosed on the return, and it was not reasonable for
petitioner to fail to report these items, especially in light of
the fact that Forms 1099 were issued with respect to them. We
therefore hold that the substantial understatement addition to
tax may be applicable with respect to these income adjustments
for 1987 and 1988.
Petitioner claimed various itemized deductions including
mortgage interest, employee expenses, and casualty losses.
Respondent has agreed that petitioner is entitled to mortgage
interest deductions in each year in amounts that are less than
the amount claimed by petitioner. Respondent also disallowed
casualty losses in 2 years due to failure to exceed the statutory
threshold and failure to substantiate. Finally, respondent
disallowed petitioner’s claimed employee business expenses for
travel, entertainment, and meals. With respect to each category,
petitioner failed to substantiate amounts in excess of those
allowed by respondent or failed to adequately substantiate any
amount with respect to the employee business expenses and the
casualty losses. Petitioner has not shown a reasonable basis or
adequate disclosure for those items, and, accordingly, to the
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extent that a substantial understatement exists, the addition to
tax or penalty applies with respect to these items for 1987 and
1988.
As to whether petitioner adequately disclosed or had a
reasonable basis for claiming Mrs. Corrigan’s personal exemption,
it is clear that he did not and that the substantial
understatement penalty may apply for this item for 1987 and 1988.
To reflect the foregoing,
Decision will be entered
under Rule 155.