T.C. Memo. 2006-120
UNITED STATES TAX COURT
HECTOR PROWSE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 16562-03. Filed June 12, 2006.
Hector Prowse, pro se.
Marc L. Caine, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MARVEL, Judge: In a notice of deficiency dated July 31,
2003, respondent determined that petitioner was liable for an
income tax deficiency of $5,797 with respect to his 2001 taxable
year. In a letter to this Court dated September 16, 2003, which
we filed as an imperfect petition on September 23, 2003,
petitioner stated his intention to appeal respondent’s
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determination for 2001 as well as determinations for 1999 and
2000 that petitioner alleged respondent had also made. By order
dated September 29, 2003, we ordered petitioner to file a proper
amended petition and to pay the required filing fee on or before
November 28, 2003. On November 12, 2003, we received and filed
petitioner’s amended petition, which again sought a
redetermination of deficiencies for 1999, 2000, and 2001.
On January 12, 2004, we filed respondent’s motion to dismiss
for lack of jurisdiction and to strike as to petitioner’s 1999
and 2000 taxable years. After receiving an extension of time to
object to the motion, petitioner filed no objection, and we
granted the motion on April 16, 2004.
This case was originally calendared for trial at the New
York, New York, trial session commencing on October 25, 2004.
Following a conference call with the parties, we continued the
case generally.
On April 21, 2005, we filed respondent’s motion for leave to
file amendment to answer to amended petition. In that motion,
respondent acknowledged certain mistakes in the notice of
deficiency and conceded that the correct amount of the income tax
deficiency in the notice of deficiency should have been $5,196.
In addition, respondent alleged that petitioner is liable for an
“increased” deficiency of $5,784.14, for a total deficiency of
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$10,980.14, and for a civil fraud penalty under section 6663(a).1
Respondent alleged in the motion that the reasons for the
increased deficiency and the civil fraud penalty were not evident
when he filed his answer to the amended petition. Respondent
further alleged that petitioner had received fair warning of
respondent’s intention to amend his answer and that petitioner
had ample time to prepare for trial under the circumstances.
By order dated April 26, 2005, we directed petitioner to
file a response to respondent’s motion on or before May 10, 2005.
No response was received by the deadline, so we granted
respondent’s motion and filed respondent’s amendment to answer on
May 19, 2005.
On June 1, 2005, we held a conference call with the parties
to discuss petitioner’s request for a continuance and
respondent’s request for a date and time certain for the trial.
Respondent objected to the continuance on a variety of grounds
including petitioner’s failure to document a compelling medical
reason for the request and his continuing failure to cooperate in
preparing the case for trial. We denied petitioner’s request
without prejudice to petitioner’s right to renew the request if
petitioner could document a compelling reason for another
continuance.
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.
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On June 14, 2005, the case was called for trial. Petitioner
did not appear, although he had been in contact with respondent’s
counsel and with the Court in the days leading up to the trial.
Instead, petitioner submitted a written motion for continuance in
which he claimed that he had had a “heart attack seizure” on June
9, 2005. However, despite repeated warnings from this Court to
petitioner during various pretrial conference calls, he failed to
attach any documentation of the episode or of a current medical
condition sufficient to prevent him from appearing in Court on
June 14. We denied petitioner’s motion.
When the case was called for trial on June 14, 2005,
respondent orally moved under Rule 123(a) for a default judgment
on the underlying deficiency. We granted the motion with respect
to the original deficiency as corrected by respondent but denied
the motion with respect to the additional deficiency and the
civil fraud penalty, matters on which respondent had the burden
of proof. Thereafter, a trial was held on June 14, 2005, to
permit respondent to introduce evidence regarding the additional
deficiency and the civil fraud penalty.
The issues for decision are:
(1) Whether respondent has satisfied his burden of proving
by a preponderance of the evidence that petitioner is liable for
an increased deficiency as alleged by respondent; and
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(2) whether respondent has satisfied his burden of proving
by clear and convincing evidence that petitioner is liable for
the civil fraud penalty under section 6663(a).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. We
incorporate the stipulated facts into our findings by this
reference. Petitioner resided in Flushing, New York, when his
petition in this case was filed.
Petitioner’s 2001 Return
During 2001, petitioner was employed by Keyspan Engineering
Associates and by Cosentini Associates.
Petitioner filed a timely Federal income tax return for 2001
on which he reported the income he had earned from his employment
during 2001. On Schedule A, Itemized Deductions, of his 2001
return, petitioner claimed itemized deductions of $31,449.06, and
on Schedule C, Profit or Loss From Business, petitioner claimed a
bad debt deduction of $20,000 and a deduction for legal expenses
of $1,300. The Schedule A itemized deductions that petitioner
claimed on his 2001 return consisted of the following:
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Medical and dental expenses $8,805.87
Less: adjustment 3,428.96
Net deduction $5,376.91
State and local income taxes 4,097.60
Charitable gifts 1,510.00
Job expenses 16,293.00
Tax preparation fees 202.16
Other expenses 3,055.00
Less: adjustment 914.39
20,464.55
1
Total itemized deductions 31,449.06
1
Instead of subtracting the $914.39 adjustment, petitioner
added the adjustment in calculating his total itemized
deductions. The mathematically correct total should have been
$29,620.28.
Petitioner attached a statement to his 2001 return
identifying the medical and dental expenses of $8,805.87 as
follows: Dr. Jayesh Patel ($350), emergency room treatment for
left knee pain ($203.97), an operation ($5,900), Dr. Harvey S.
Pallen ($900), and expenses for eyeglasses, medications, and
transportation ($1,451.90). Petitioner also attached to his 2001
return the following documentation of his medical expenses: A
receipt No. 07060 from Mount Sinai Elmhurst Faculty Practice
dated March 9, 2001, for emergency care on 3/3/01, a receipt No.
308431 dated 4/28/01 for $130, a receipt No. 308434 dated 5/1/01
for $40, a bill from Xeron Clinical Laboratories dated 6/16/01
reflecting a handwritten entry by “Mary Patel” reading “Paid
fully 6/20/01”, a letter dated December 28, 2001 bearing the
signature of “Mary S. Posner” and purporting to confirm that the
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$5,900 cost for surgery performed at St. Luke’s/Roosevelt
Hospital on March 13, 2001, had been paid, and a receipt dated
May 25, 2001, from Harvey S. Pallen, DDS, confirming treatment of
petitioner on various dates in May 2001 for a total cost of $900.
Each of the above-described documents was falsified, and some, if
not all, of the signatures shown on the documents were forged.
None of the documents substantiated any of petitioner’s claimed
medical expenses for 2001.
The charitable gifts claimed on the Schedule A consisted of
an alleged cash gift to a church and a noncash contribution. The
noncash contribution consisted of claimed donations of property
to the Salvation Army during 2001. To document the contribution,
petitioner attached receipt No. 414, dated December 13, 2001,
purportedly from the Salvation Army, that listed 12 categories of
property, assigned a value to each category, and listed the total
contribution as $1,640. The receipt showed that the contribution
was received by “Juanita Rusell” on December 13, 2001. The
receipt was falsified and does not substantiate petitioner’s
claimed noncash contribution for 2001. Petitioner did not attach
to his 2001 return any substantiation of his alleged cash gift to
the church, and he did not substantiate the gift during the
examination of his return.
The employee business expenses of $16,293 consisted of
vehicle expenses ($12,948), parking fees, tolls, and
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transportation ($720), classes ($2,300), and one-half of meals
and entertainment expenses totaling $650 ($325). Petitioner
attached to his 2001 return a copy of a letter from the New York
City Public Schools confirming that petitioner had paid $2,300
for classes in asbestos and paint lead abatement. The letter
purported to be signed by Robert Pardi and was dated July 1,
2001. Unfortunately, Mr. Pardi died on December 23, 1999, and
could not possibly have written the July 1, 2001, letter. In
addition, no such classes were offered by the New York City
Public Schools during 2001.2 With respect to the balance of the
employee business expenses, petitioner was not required by either
of his employers to incur travel or client entertainment expenses
during 2001. Even if petitioner had incurred such expenses, each
of his 2001 employers had reimbursement policies that entitled
their employees to obtain reimbursement for any required business
expenses.
To document the Schedule C legal expenses of $1,300 that he
claimed on his 2001 return, petitioner attached to his 2001
return a letter dated May 15, 2001, from Michael E. Greenblatt,
an attorney allegedly employed by Nixon, Hargrave, Devans & Doyle
LLP. However, Mr. Greenblatt never worked for Nixon Hargrave,
2
Similar documents were submitted to substantiate charitable
contributions, medical expenses, and employee business expenses
claimed on petitioner’s 2000 return. At least some of those
documents also appear to have been falsified.
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and petitioner was never a client of the firm. To compound the
problem, petitioner submitted to respondent’s counsel, on October
14, 2004, yet another letter to substantiate the $1,300 legal
expense. This letter, dated May 15, 2001, was purportedly
prepared and signed by Paul Rubenfeld and purports to confirm
that Mr. Rubenfeld represented petitioner before the United
States Bankruptcy Court for the Southern District of New York for
a fee of $1,300. The Rubenfeld letter was falsified, and Mr.
Rubenfeld’s signature on the letter was forged. Mr. Rubenfeld
did not represent petitioner before the Bankruptcy Court at any
time during 2001.
On a date that does not appear in the record, the Internal
Revenue Service selected petitioner’s 2002 and 2003 tax returns
for examination. On December 15, 2004, petitioner met with
Revenue Agent Winslow, the agent who was assigned to conduct the
2002 and 2003 examination, and respondent’s counsel to discuss
petitioner’s claim that he was entitled to deductions for 2001
and to review the documentation needed for the examination of
petitioner’s 2002 and 2003 returns. During that meeting,
petitioner admitted that he personally had prepared some of the
third-party documentation that he had attached to his 2001
return.
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Notice of Deficiency
In the notice of deficiency, respondent disallowed
petitioner’s Schedule C bad debt deduction of $20,000 and his
Schedule C legal expense deduction of $1,300. As a result of
these adjustments, respondent made a computational adjustment
reducing petitioner’s itemized deductions by $2,195 but did not
otherwise disallow the itemized deductions petitioner had claimed
on Schedule A. Respondent did not assert that petitioner was
liable for any addition to tax or penalty.
Amendment to Answer
After respondent uncovered evidence that petitioner had
overstated his Schedule A itemized deductions and had falsified
documentation to substantiate his Schedules A and C deductions,
respondent amended his answer to the amended petition to assert
an additional deficiency of $5,784.14 (thereby increasing the
total claimed deficiency for 2001 to $10,980.143) resulting from
the complete disallowance of petitioner’s itemized deductions for
lack of substantiation. Respondent also asserted for the first
time that petitioner was liable for the fraud penalty pursuant to
section 6663(a).
3
In his motion, respondent conceded a computational mistake
in calculating the original deficiency. The corrected original
deficiency is $5,196.
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OPINION
I. Burden of Proof
Normally, in a case before this Court, the taxpayer bears
the burden of proof.4 Rule 142(a)(1). However, if the
Commissioner raises a new issue or seeks an increase in a
deficiency, the Commissioner has the burden of proof as to the
new issue or increased deficiency. Id. In addition, in any case
involving the issue of fraud with intent to evade tax, the burden
of proof in respect of that issue is on the Commissioner. Sec.
7454(a); Rule 142(b).
In this case, the only open issues are issues as to which
respondent concedes he has the burden of proof. In order to
satisfy that burden of proof, respondent must prove by a
preponderance of the evidence that he properly disallowed
petitioner’s Schedule A deductions, and he must also prove by
clear and convincing evidence that petitioner is liable for the
fraud penalty under section 6663. Rule 142.
II. Substantiation of Schedule A Deductions
A. Medical and Dental Expenses
Section 213(a) authorizes a taxpayer, if he itemizes his
deductions, to deduct expenses paid during the taxable year for
4
Although a taxpayer may contend that the burden of proof
should shift to the Commissioner under sec. 7491, sec. 7491 does
not shift the burden of proof in this case. Respondent concedes
that he has the burden of proof with respect to the only open
issues--the increased deficiency and the fraud penalty.
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the medical care of the taxpayer, the taxpayer’s spouse, or a
dependent to the extent that such expenses exceed 7.5 percent of
adjusted gross income. In this case, petitioner claimed an
itemized deduction for unreimbursed medical and dental expenses
of $8,805.87 on his 2001 return and attached documentation to his
return purporting to substantiate the expenses. When respondent
issued his notice of deficiency, he did not disallow these
expenses, although he did make a computational adjustment to the
amount of the deduction because of adjustments affecting the
calculation of petitioner’s adjusted gross income. However,
after respondent discovered that some of the documentation
attached to petitioner’s 2001 return may have been falsified,
respondent disallowed all of petitioner’s Schedule A expenses,
including his medical and dental expenses, for failure to
substantiate, and he moved to increase the deficiency to reflect
the disallowance.
At trial, respondent convincingly proved that the
documentation attached to petitioner’s 2001 return to document
his medical and dental expenses had been falsified.
Consequently, the record contains no credible evidence
substantiating petitioner’s medical and dental expenses for 2001,
and we sustain respondent’s determination.
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B. Taxes Paid
Petitioner claimed a deduction for State and local taxes
paid of $4,097.60. In his pretrial memorandum, respondent
conceded that, if petitioner’s allowable itemized deductions are
greater than the standard deduction, petitioner is entitled to a
deduction for the taxes paid.
C. Charitable Contributions
Section 170(a)(1) generally authorizes a taxpayer to claim a
deduction for any charitable contribution made during the taxable
year. On Schedule A to his 2001 return, petitioner claimed a
charitable contribution deduction for cash gifts to a church
($690) and for noncash gifts ($820). The only documentation
produced by petitioner was a receipt, purportedly from the
Salvation Army, regarding the noncash contribution. At trial
respondent convincingly proved that the documentation had been
falsified. Consequently, the record contains no credible
evidence substantiating petitioner’s charitable contributions for
2001, and we sustain respondent’s determination.
D. Unreimbursed Employee Business Expenses and Other
Miscellaneous Expense
Section 162(a) authorizes a taxpayer to deduct ordinary and
necessary business expenses paid or incurred during the taxable
year in carrying on a trade or business. An “ordinary” expense
is one incurred in a transaction that commonly or frequently
occurs in the type of business involved. Deputy v. du Pont, 308
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U.S. 488, 495 (1940). A “necessary” expense is one that is
“appropriate and helpful” to the taxpayer’s business. Welch v.
Helvering, 290 U.S. 111, 113 (1933). Expenses allowable under
section 162 must be “directly connected with or pertaining to the
taxpayer’s trade or business”. Sec. 1.162-1(a), Income Tax Regs.
Personal, living, and family expenses are not deductible. Sec.
262(a).
An employee is generally recognized as being in the trade or
business of being an employee, and may deduct employment-related
expenses if the requirements of section 162 are met.
Commissioner v. Flowers, 326 U.S. 465 (1946). However, “A trade
or business expense deduction is not allowable to an employee to
the extent that the employee is entitled to reimbursement from
his or her employer for an expenditure related to his or her
status as an employee.” Lucas v. Commissioner, 79 T.C. 1, 7
(1982). If an employee could have requested reimbursement under
the plan and fails or forgets to do so, he may not claim a
deduction for the expenses under section 162. Id.; see also
Orvis v. Commissioner, 788 F.2d 1406 (9th Cir. 1986), affg. T.C.
Memo. 1984-533; Kennelly v. Commissioner, 56 T.C. 936, 943
(1971), affd. without published opinion 456 F.2d 1335 (2d Cir.
1972).
In this case, petitioner claimed a deduction for
unreimbursed employee business expenses totaling $16,293.
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Although petitioner attached some documentation of these expenses
to his 2001 return, respondent has convincingly demonstrated that
the documentation was falsified and that several of the
signatures thereon were forged. In addition, respondent
introduced evidence at trial that petitioner admitted creating
some of the documentation attached to his 2001 return, and he
also convincingly established at trial that both of petitioner’s
employers had reimbursement plans to cover legitimate employee
business expenses during 2001. The record made by respondent and
the complete lack of credible evidence to substantiate
petitioner’s claimed employee business expenses convince us that
respondent has met his burden of proving by a preponderance of
the evidence that these expenses were properly disallowed.
With respect to the remaining miscellaneous expenses claimed
on Schedule A, respondent has adequately demonstrated that
petitioner has failed to substantiate the expenses as required by
section 6001 and related regulations. See sec. 6001; sec.
1.6001-1(a), (e), Income Tax Regs. Consequently, we sustain
respondent’s determination disallowing the expenses.
III. Disallowance of Schedule C Deductions
A. In General
In his notice of deficiency, respondent disallowed
petitioner’s 2001 Schedule C expense deductions and computed the
resulting income tax deficiency. When petitioner failed to
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appear for trial, respondent moved for a default judgment, and we
granted the motion with respect to the original deficiency as
corrected. However, even if we had denied respondent’s motion,
we would still have concluded that respondent’s determination
disallowing petitioner’s Schedule C expenses must be sustained.
Our reasons are summarized below.
B. Bad Debt Deduction
Section 166(a)(1) authorizes a taxpayer to deduct a business
bad debt that becomes worthless during the year. To be entitled
to the deduction, the taxpayer must prove (1) that a bona fide
debt was created obligating the debtor to pay a fixed or
determinable sum of money, (2) that the debt was created or
acquired in proximate relation to a trade or business, and (3)
that the debt became worthless in the year claimed. See United
States v. Generes, 405 U.S. 93, 96 (1972); Calumet Indus., Inc.
v. Commissioner, 95 T.C. 257, 284 (1990). A debt is bona fide if
it arose “from a debtor-creditor relationship based upon a valid
and enforceable obligation to pay a fixed or determinable sum of
money.” Sec. 1.166-1(c), Income Tax Regs.
In this case, petitioner claimed a bad debt deduction for
compensation that he claimed he was entitled to but did not
receive in connection with his participation in a joint venture
with Thacker Engineering, Inc. (Thacker), beginning in
approximately 1995. Petitioner, a cash basis taxpayer, did not
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report any income from the joint venture on his Federal income
tax returns for 1995-2000. On February 2, 1996, Thacker filed a
voluntary petition for bankruptcy under chapter 11 with the
United States Bankruptcy Court for the Southern District of New
York. Petitioner filed a proof of claim with respect to the
unpaid compensation he claimed was owed to him under the joint
venture agreement with Thacker. Petitioner’s claim was
eventually discharged.
Worthless debts arising from claims of unpaid compensation
are not deductible under section 166 unless the income in
question was reported on the taxpayer’s income tax return for the
year for which the bad debt deduction is claimed or for a prior
taxable year. See sec. 1.166-1(e), Income Tax Regs.; see also
Gertz v. Commissioner, 64 T.C. 598, 600 (1975). In this case,
petitioner did not report the income that is the subject of his
bad debt claim on his 2001 return or on the return of any prior
taxable year. Consequently, respondent properly disallowed
petitioner’s bad debt deduction.
C. Deduction for Legal Expenses
As explained earlier in this opinion, section 162 authorizes
a taxpayer to claim a deduction for ordinary and necessary
business expenses paid or incurred during the taxable year to
carry on a trade or business. Petitioner claimed a deduction for
legal expenses of $1,300 on his 2001 Schedule C and attached to
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his return a letter purporting to substantiate the deduction.
The letter was falsified. During the pendency of this case,
petitioner submitted another letter from a different lawyer
purporting to substantiate the deduction. That letter was also
falsified. The record contains no other document to substantiate
the expense. Respondent properly disallowed the deduction.
IV. Fraud Penalty
Section 6663 authorizes the Commissioner to impose a 75-
percent penalty on a taxpayer if any part of an underpayment is
due to fraud. The Commissioner must prove a taxpayer’s liability
for the fraud penalty by clear and convincing evidence. Sec.
7454(a); Rule 142(b).
In order for the Commissioner to prove that a taxpayer is
liable for the fraud penalty, he must establish that (1) an
underpayment of tax exists, and (2) some part of the underpayment
is due to fraud. DiLeo v. Commissioner, 96 T.C. 858, 873 (1991),
affd. 959 F.2d 16 (2d Cir. 1992). Fraud is established by
showing that the taxpayer intended “to evade tax believed to be
owing by conduct intended to conceal, mislead, or otherwise
prevent the collection of such tax.” Recklitis v. Commissioner,
91 T.C. 874, 909 (1988).
The existence of fraud is a question of fact to be resolved
upon consideration of the entire record. DiLeo v. Commissioner,
supra at 874. Fraud is never presumed and must be established by
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independent evidence of fraudulent intent. Beaver v.
Commissioner, 55 T.C. 85, 92 (1970). Fraud may be shown by
circumstantial evidence because direct evidence of the taxpayer’s
fraudulent intent is seldom available. Gajewski v. Commissioner,
67 T.C. 181, 200 (1976), affd. without published opinion 578 F.2d
1383 (8th Cir. 1978). The taxpayer’s entire course of conduct
may establish the requisite fraudulent intent. Stone v.
Commissioner, 56 T.C. 213, 223-224 (1971).
Courts have relied upon a number of indicia or badges of
fraud in deciding whether an underpayment of tax is due to fraud.
See, e.g., Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th
Cir. 1986), affg. T.C. Memo. 1984-601; Clayton v. Commissioner,
102 T.C. 632, 647 (1994); Petzoldt v. Commissioner, 92 T.C. 661,
700 (1989). Although no single badge is necessarily sufficient
to establish fraud, the existence of several badges of fraud
constitutes persuasive circumstantial evidence of fraud.
Petzoldt v. Commissioner, supra at 700.
Respondent contends that the following badges of fraud are
present in this case: (1) Inadequate records, (2) providing
implausible or inconsistent explanations of behavior, (3) pattern
of behavior indicating an intent to mislead, and (4) filing false
documents. We agree with respondent.
The record clearly and convincingly establishes that
petitioner maintained inadequate records with respect to the
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deductions claimed on his 2001 returns. Respondent clearly and
convincingly proved that a substantial number of documents
attached by petitioner to his 2001 return in an effort to
convince respondent that his deductions were proper had been
forged and falsified. Respondent also proved that petitioner
submitted at least one other forged document during the pendency
of this case. That document conflicted with another forged
document that petitioner had attached to his 2001 return.
Respondent elicited testimony at trial establishing that
petitioner admitted preparing at least some of the forged
documents. The totality of the evidence clearly and convincingly
establishes that petitioner deliberately overstated his
deductions for 2001 and falsified documents supporting the
overstated and unsubstantiated deductions to mislead respondent
and to evade his proper income tax liability for 2001.
Respondent has met his burden of proving that petitioner is
liable for the fraud penalty, and, consequently, we sustain
respondent’s determination.
Decision will be entered under
Rule 155.