T.C. Memo. 2006-158
UNITED STATES TAX COURT
SHERIF S. ABDELHAK a.k.a. SAMUEL A. ABEL, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 865-05. Filed August 1, 2006.
Sherif S. Abdelhak, pro se.
Mark D. Eblen, for respondent.
MEMORANDUM OPINION
GOEKE, Judge: Respondent determined income tax deficiencies
against petitioner for 1998, 1999, and 2000 in the amounts of
$172,626, $31,059, and $222,655, respectively. Respondent also
determined additions to tax under section 6651(a)(1) for 1998,
1999, and 2000 in the amounts of $30,602.25, $7,810.50, and
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$55,663.75, respectively.1 Further, respondent determined
accuracy-related penalties against petitioner under section
6662(a) in the amounts of $34,525.20 and $6,211.80 for 1998 and
1999, respectively.
The issues for decision are:
(1) Whether petitioner is entitled to a $435,000 charitable
contribution deduction for tax year 1998. We hold that he is
instead entitled to a charitable deduction of $12,713.28.
(2) whether petitioner is entitled to a theft loss
deduction of $2,221,668 for tax year 2000. We hold that he is
not.
(3) whether petitioner, through Global Trading Group (GTG),
an S corporation of which petitioner is the sole shareholder, is
entitled to travel, meal and entertainment business expense
deductions for tax year 1999 for an amount greater than the $437
allowed by respondent. We hold that he is not.
(4) whether petitioner, through GTG, may deduct travel and
meal expense deductions of $53,245 for the tax year 2000. We
hold he may not.
(5) whether petitioner, through GTG, is entitled to more
than $2,850 in rent deductions for tax year 1999. We hold that
he is not.
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
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(6) whether petitioner is liable for additions to tax under
section 6651(a)(1) for tax years 1998, 1999, and 2000. We hold
that he is.
(7) whether petitioner is liable for accuracy-related
penalties under section 6662(a) for disallowed deductions. We
hold that he is not liable for those penalties in 1998 and 1999.
Background
Petitioner was a resident of Prospect, Kentucky, at the time
he filed his petition. Petitioner was the former president and
chief executive officer (CEO) of the Allegheny Health Education &
Research Foundation (AHERF), a Pennsylvania corporation. AHERF
terminated petitioner in June 1998 and filed chapter 11
bankruptcy proceedings 1 month later in July of that year.
A. 1998 Charitable Deduction
In 1990, petitioner sold his home to a subsidiary of AHERF,
Jellico, Inc. (Jellico). In 1992, petitioner signed a land
installment contract with Jellico to repurchase the home for
$1,280,000 with payment spread over 20 years. The terms of this
contract required petitioner to pay 5 percent of the principal
($64,000) each April 30th and interest payments of 7.5 percent on
the remaining principal each October 30th. The contract also
required petitioner to pay all taxes due on the residence.
Jellico retained title during the contract period and would
transfer title when petitioner paid the full contract price. If
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petitioner defaulted, he could file suit to recover any principal
payments made in excess of 25 percent of the purchase price, less
any damages to Jellico. Thus, his recovery in the event of his
default was limited to the excess of his payments over $320,000
($1,280,000 x .25 = $320,000). The contract assured Jellico an
unencumbered title during such a suit.
In October 1998, petitioner could not make the next interest
payment of slightly over $50,000. Petitioner was also in default
with respect to the property taxes on the residence. By this
time, petitioner had made $384,000 in principal payments.
Petitioner contacted Jellico and offered to donate his equity in
the residence to AHERF and vacate the premises. Jellico accepted
the proposal, and petitioner vacated the residence.
B. 2000 Theft Loss Deduction
On his 2000 return, petitioner claimed a theft loss
deduction in the amount of $2,221,668. This loss related to
three pieces of property, two life insurance policies with cash
surrender values of $1,101,000 and $570,768 and a KEYSOP deferred
compensation account which petitioner valued at $550,000.
At the time AHERF terminated petitioner, the premiums of
several life insurance policies, including the two claimed as
theft losses, were paid by AHERF. In return for payment of the
premiums, AHERF maintained a right of corporate recovery on these
policies. This right allowed AHERF to recover the funds paid for
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the insurance premiums in the event of the policyholder’s death
or termination. Petitioner assigned his rights under these
policies to AHERF in return for its funding of his Key Employees
Shared Option Plan (KEYSOP) account, a pension/deferred
compensation account. The KEYSOP account itself was recoverable
by AHERF in the event AHERF became insolvent or filed for
bankruptcy.
At the time of his termination by AHERF, petitioner’s
KEYSOP deferred compensation account carried a balance of
$2,062,425. Also at the time of his termination, petitioner had
a loan from PNC Bank, which was cosigned by AHERF, for
approximately $2.2 million. After petitioner was terminated, PNC
Bank called the loan due. AHERF issued a check, payable to PNC
Bank and petitioner jointly, for $1,506,170.97 using funds from
petitioner’s KEYSOP account to repay the loan. One month after
petitioner’s termination, AHERF filed for bankruptcy and
reclaimed the remaining funds in petitioner’s KEYSOP account.
C. Business Deductions
Petitioner is the sole shareholder of GTG, an S corporation.
GTG’s business involves buying and selling raw materials
worldwide. Petitioner’s Forms 1040, U.S. Individual Income Tax
Return, for 1999 and 2000 claimed $78,563 and $53,245,
respectively, in business expense deductions for meals, travel,
and entertainment related to GTG. Petitioner submitted records
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that demonstrated that the expenses were incurred but not that
the expenses had a business purpose. Petitioner’s return also
showed a rent expense deduction for 1999 related to GTG; however
petitioner presented no evidence related to this expense.
D. Penalties
The parties stipulated that petitioner was delinquent in
filing his tax returns for 1998, 1999, and 2000. Petitioner
filed his 1998 tax return on June 21, 2000; his 1999 tax return
on February 28, 2001; and his 2000 tax return no earlier than
April 14, 2002.
Discussion
I. Burden of Proof and Production
Deductions are a matter of legislative grace; taxpayers do
not have an inherent right to claim them. Taxpayers
generally bear the burden of proving that they are entitled
to claimed deductions. See Rule 142(a); INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v.
Helvering, 292 U.S. 435, 440 (1934). The taxpayer is required to
maintain records that are sufficient to enable the Commissioner
to determine his or her correct tax liability. See sec. 6001;
sec. 1.6001-1(a), Income Tax Regs.
The Commissioner’s determinations set forth in a notice of
deficiency are generally presumed correct, and the taxpayer bears
the burden of proving that the determinations are in error. Rule
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142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Pursuant
to section 7491(a), the burden of proof as to factual issues may
shift to the Commissioner where the taxpayer complies with
substantiation requirements, maintains records, and cooperates
fully with reasonable requests for witnesses, documents, and
other information. Petitioner has not met the requirements of
section 7491(a) because he has not met the substantiation
requirements regarding the deductions at issue.
The Commissioner carries the burden of production under
section 7491(c) with respect to an individual’s liability for
additions to tax. Once this burden is met, the taxpayer has the
burden of proving that delinquent filings did not stem from
willful neglect and that the taxpayer had reasonable cause for
late filing. See United States v. Boyle, 469 U.S. 241 (1985);
Higbee v. Commissioner, 116 T.C. 438, 446 (2001). To prove
reasonable cause, a taxpayer must show that he or she exercised
ordinary business care and prudence but nevertheless could not
file the return when it was due. Crocker v. Commissioner, 92
T.C. 899, 913 (1989); sec. 301.6651-1(c)(1), Proced. & Admin.
Regs.
II. Charitable Contribution
Petitioner claimed a charitable contribution deduction of
$435,925 on his 1998 tax return as “real estate forfeiture”.
Respondent argues that petitioner has not established a valid
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charitable contribution for this amount during 1998. We agree
with respondent. We hold petitioner may claim only $12,713.28 as
a charitable contribution deduction on his 1998 tax return.
Petitioner may donate to AHERF as per section
170(b)(1)(A)(iii). Section 170(c) defines a charitable deduction
as a “contribution or gift to or for the use of * * * (2) a
corporation, trust, or community chest, fund, or foundation”.
Petitioner misunderstands the nature of the installment land
contract. Under this contract, petitioner gained title to the
residence from Jellico only upon completion of all payments.
Therefore, petitioner did not have title at the time of the
donation. Petitioner knew of his lack of title when he offered
the donation, as his donation offered only his equity. Equity is
the amount of principal paid into ownership interests. Schuneman
v. United States, 783 F.2d 694, 701 n.8 (7th Cir. 1986).
We need not decide the complicated issue of whether
improvements to the property constituted payment. Petitioner
merely claimed that he made improvements and then added the
claimed value of these improvements to his deduction. However,
petitioner has offered no proof substantiating these improvements
or their value. Having failed to establish any proof of the
claimed value, we hold petitioner is not entitled to any
deduction for improvements made to the home.
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This leaves petitioner with $384,000 in claimed equity as a
contribution deduction. However, the land installment contract
states that in event of default, petitioner may sue to recover
principal payments only in excess of $320,000. ($1,280,000 x
.25).
Petitioner maintains that he never defaulted on the
contract. He contends that he made the donation before the
October interest due date, fulfilling his obligation without
default. In a contract, however, default occurs when a party to
the agreement fails to fulfill a stated material term. Franconia
Associates v. United States, 536 U.S. 129, 142-143 (2002).
Petitioner failed to pay the real estate taxes as required in the
contract, placing him in default. As petitioner defaulted,
Jellico is entitled to 25 percent of the $1,280,000 purchase
price, or $320,000, per the contract. This leaves petitioner
with $64,000 in remaining equity ($384,000 - $320,000). Of this
sum, Jellico is entitled to deduct the final interest payment and
the unpaid property taxes as damages. This amounts to
$51,286.72. Therefore, petitioner’s remaining equity and actual
charitable contribution is $12,713.28 ($64,000 - $51,286.72).
III. Theft Loss Deductions
Section 165 grants a taxpayer a deduction of any loss
sustained during a taxable year as a result of theft. Sec.
165(c)(3), (e). In order to claim this deduction, a taxpayer
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must prove a theft occurred. Elliott v. Commissioner, 40 T.C.
304, 311 (1963); Davis v. Commissioner, T.C. Memo. 2005-160
(2005). Petitioner claims a theft loss of $2,221,668 on his 2000
tax return relating to the value of employee benefits. This
value stems from (1) a life insurance policy with Pacific Life,
(2) a life insurance policy with Equitable Life, and (3) the
funds in petitioner’s KEYSOP account. Petitioner maintains AHERF
unlawfully converted these funds, resulting in a theft.
We find that petitioner has failed to prove a theft of the
life insurance policies occurred. AHERF was entitled to a right
of corporate recovery on the policies, allowing it to reclaim the
amounts paid in premiums upon the policyholder’s death or
termination. AHERF reclaimed the insurance policy premiums only
after petitioner’s employment was terminated. Further,
petitioner admits that he assigned to AHERF all his rights under
the insurance policies in return for KEYSOP funding.
Essentially, petitioner did not own the policies. Accordingly,
petitioner failed to establish the theft of any value with
respect to the policies.
Petitioner likewise may not claim a theft loss deduction for
his KEYSOP account. At the time of his termination in June 1998,
petitioner’s account had a balance of $2,062,452. Petitioner
also had an outstanding loan from PNC Bank cosigned by AHERF for
approximately $2.2 million. Upon petitioner’s termination, PNC
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Bank immediately demanded full payment of the loan balance. In
response, AHERF issued a check for $1,516,170.97 from
petitioner’s KEYSOP account to repay the balance of the loan (in
addition to using funds from the cashed-out insurance policies).
AHERF’s check required signatures by both petitioner and PNC Bank
in order to be cashed. Although it was perhaps not as petitioner
would have liked, AHERF did issue payment from his KEYSOP account
to discharge petitioner’s debt, conferring a benefit on
petitioner. Thus, AHERF did not make a conversion of
petitioner’s funds, a requirement to claim a theft loss
deduction. See Sperzel v. Commissioner, 52 T.C. 320, 328 (1969)
(“But the word ‘theft’ extends only to the ‘criminal
appropriation of another's property to the use of the taker.’”
quoting Edwards v. Bromburg, 232 F.2d 107, 110 (5th Cir. 1956)).
AHERF also structured employee KEYSOP accounts so that it
had the right to reclaim any funds in the accounts in event of
bankruptcy or insolvency. AHERF filed a petition for bankruptcy
under chapter 11 and reclaimed petitioner’s remaining KEYSOP
funds 1 month after petitioner’s termination. Petitioner
acknowledged and stipulated he knew of AHERF’s rights to reclaim
the funds and may not therefore claim a theft loss on those
funds. We hold that petitioner has failed to prove theft of
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these funds occurred. As such, we hold petitioner is not
entitled to any theft loss deductions from the value of his life
insurance policies or his KEYSOP account.
IV. GTG Business Expense Deductions
Petitioner is the sole shareholder of GTG, an S corporation
that trades in raw materials. Petitioner claimed several
business deductions for expenses related to the payment of rent
in 1999 as well as worldwide travel, meals, and entertainment in
both 1999 and 2000.
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. Section 1.162-1(a),
Income Tax Regs., provides that “Business expenses deductible
from gross income include the ordinary and necessary expenditures
directly connected with or pertaining to the taxpayer's trade or
business”. Deductions are a matter of legislative grace, and
petitioner must prove his entitlement to the deductions claimed.
INDOPCO, Inc. v. Commissioner, 503 U.S. at 84; see also Cohan v.
Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930) (where a
taxpayer claims a business expense but cannot fully substantiate
it, the Court may approximate the allowable amount).
In addition, for any expenses related to travel or
entertainment, section 274(d) provides:
SEC. 274(d). Substantiation Required.--No
deduction or credit shall be allowed–-
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* * * * * * *
unless the taxpayer substantiates by adequate records
or by sufficient evidence corroborating the taxpayer's
own statement (A) the amount of such expense or other
item, (B) the time and place of the travel,
entertainment, amusement, recreation, or use of the
facility or property, * * * (C) the business purpose of
the expense or other item, * * *
The requirements of section 274(d) are designed to ensure
taxpayers maintain records and documentation sufficient to
substantiate each expense claimed as a deduction. See Vanicek v.
Commissioner, 85 T.C. 731, 742-743 (1985). Without business
records or other proof to substantiate that those expenses were
incurred for business purposes, a taxpayer is not entitled to
such deductions. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.
Petitioner has presented no evidence concerning any rent
payments paid by GTG for 1999. Thus, without any evidence to
substantiate the claimed expenses, we find that petitioner is not
entitled to any rent expense deduction in excess of the $2,850
allowed by respondent.
With respect to the travel and entertainment expenses for
both 1999 and 2000, petitioner’s evidence consisted of financial
records in the form of copied receipts, bills, credit card
statements, and a single expense report from a GTG employee.
Petitioner did not offer any testimony as to the business purpose
of any of the expenses noted in the financial records. For
example, while the expense report vaguely listed several costs,
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it provided no details as to the purpose of these costs, other
than that they were incurred in Ghana. Therefore, petitioner’s
documentation did not fulfill the section 274(d) requirements.
Thus, we hold that petitioner is not entitled to any GTG travel,
meal, and entertainment deductions, beyond the $474 allowed by
respondent for 1999, pursuant to section 274(d).
V. Additions to Tax
The parties stipulated that petitioner filed his return for
tax year 1998 on June 21, 2000, his return for tax year 1999 on
February 28, 2001, and his return for tax year 2000 no earlier
than April 14, 2002. Section 6651(a)(1) imposes an addition to
tax for failure to file tax returns on time unless it is shown
that the failure was due to reasonable cause, and not willful
neglect. The stipulation of the parties has met respondent’s
burden of production. Petitioner then bears the burden to show
reasonable cause for late filing. See Marrin v. Commissioner,
147 F.3d 147, 152 (2d Cir. 1998) (“Generally, factors that
constitute ‘reasonable cause’ include unavoidable postal delays,
death or serious illness of the taxpayer or a member of his
immediate family, or reliance on the mistaken legal opinion of a
competent tax adviser, lawyer, or accountant that it was not
necessary to file a return.”), affg. T.C. Memo. 1991-24.
In this case, petitioner offered no testimony or other
evidence that would support his argument that a reasonable cause
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existed for his late filing. Petitioner claims constant transit
and relocations as his reasonable cause for late filing. We are
not convinced by this argument. Thus, with no evidence probative
of reasonable cause, we conclude that petitioner is liable under
section 6651(a)(1) for additions to tax for failure to timely
file his Federal income tax returns for 1998, 1999, and 2000.
VI. Accuracy-Related Penalties
Respondent also determined that petitioner is liable under
section 6662(a) for accuracy-related penalties for tax years 1998
and 1999. Section 6662(a) imposes an accuracy-related penalty
equal to 20 percent of the underpayment to which section 6662
applies. Section 6662 applies to the portion of an underpayment
of tax which is attributable to, among other things, negligence
or intentional disregard of rules or regulations, a substantial
understatement of income tax, or a substantial valuation
misstatement. See sec. 6662(b)(1)-(3). Section 6662(c) defines
“negligence” as “any careless, reckless, or intentional
disregard.” See also Hansen v. Commissioner, 820 F.2d 1464, 1469
(9th Cir. 1987) (“Intentional disregard occurs when a taxpayer
who knows or should know of a rule or regulation chooses to
ignore the requirements.”).
Section 6664(c)(1) provides that the accuracy-related
penalty shall not be imposed with respect to any portion of an
underpayment if it is shown that there was reasonable cause for
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that portion and the taxpayer acted in good faith with respect to
that portion. The determination of whether a taxpayer acted with
reasonable cause and in good faith is made on a case-by-case
basis, taking into account all pertinent facts and circumstances.
Sec. 1.6664-4(b)(1), Income Tax Regs.
In this case, the claimed charitable contribution deduction
in 1998 was aggressive and bears scrutiny, but we believe
petitioner claimed the deduction in good faith based upon his
knowledge of the facts and understanding of the law. This is not
a valuation case where, under section 6664(c)(2), the reasonable
cause exception would not be available unless the taxpayer relied
on a qualified appraisal and made a good faith investigation of
the property’s value. The value of the property has always been
known, $1,280,000. Petitioner merely misunderstood his interest
in the property according to the purchase agreement with Jellico.
We find this misunderstanding to have been in good faith.
With respect to all other 1998 and 1999 items, we find
petitioner’s claims to be reasonable given his difficult
circumstances at the time the tax returns were filed.
Petitioner, once the president and CEO of a health care
organization, had lost his job, his house, and his interest in a
deferred compensation account, and was recently divorced. Thus,
given these difficult circumstances and petitioner’s limited
knowledge of the tax laws, we find that the claimed deductions
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were made with reasonable cause and in good faith. Accordingly,
we do not sustain the imposition of accuracy-related penalties
for the tax years 1998 and 1999.
To reflect the foregoing,
Decision will be entered
under Rule 155.