T.C. Memo. 2006-159
UNITED STATES TAX COURT
KEVIN L. AND VICTORIA L. HARGROVE, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 16441-04, 16442-04, Filed August 8, 2006.
16443-04, 16444-04,
16448-04.
Richard Edward Preston and Alvin S. Brown, for petitioners.
Paul T. Butler, for respondent.
MEMORANDUM OPINION
KROUPA, Judge: Respondent determined deficiencies in
petitioners’ Federal income taxes for 1999, 2000, 2001, and 2002
1
This case is consolidated for briefing and opinion with the
cases of William C. and Deborah L. Kirkpatrick, Docket No. 16442-
04, David J. and Ann M. Nakagawa, Docket No. 16443-04, Robert C.
and Yvonne R. Anthony, Docket No. 16444-04, and Timothy E. and
Mary L. Breeding, Docket No. 16448-04.
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(the years at issue)2 and accuracy-related penalties under
section 6662(a).3
Respondent determined that petitioners Kevin L. and Victoria
L. Hargrove were liable for a $11,814 deficiency and a $2,362.80
accuracy-related penalty for 2000. For 2001, respondent
determined that petitioners Mr. and Mrs. Hargrove were liable for
a $8,497 deficiency and a $1,699.40 accuracy-related penalty.
Respondent determined that petitioners William C. and
Deborah L. Kirkpatrick were liable for a $1,943 deficiency in
2000 and a $1,843 deficiency in 2001.
Respondent determined that petitioners David J. and Ann M.
Nakagawa were liable for a $1,862 deficiency and a $372 accuracy-
related penalty for 1999. For 2000, respondent determined that
petitioners Mr. and Mrs. Nakagawa were liable for a $1,848
deficiency and a $370 accuracy-related penalty. For 2001,
respondent determined that petitioners Mr. and Mrs. Nakagawa were
liable for a $1,841 deficiency and a $368 accuracy-related
penalty.
Respondent determined that petitioners Robert C. and Yvonne
R. Anthony were liable for a $2,332 deficiency for 2000, a $2,396
deficiency for 2001, and a $2,158 deficiency for 2002.
2
Not all petitioners had a deficiency for each year at
issue. The term “relevant years” will be used to refer to the
years for which respondent determined deficiencies for those
particular petitioners.
3
All section references are to the Internal Revenue Code in
effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
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Respondent determined that petitioners Timothy E. and Mary
L. Breeding were liable for a $13,232 deficiency and a $2,232
accuracy-related penalty for 2000. For 2001, respondent
determined that petitioners Mr. and Mrs. Breeding were liable for
a $13,482 deficiency and a $2,284 accuracy-related penalty.
After concessions,4 there are three issues for decision.
The first issue is whether petitioners may exclude the costs of
lodging provided by their employer from income under section 119.
We hold that they may not. The second issue is whether Mr. and
Mrs. Hargrove and Mr. and Mrs. Breeding are entitled to exclude
certain allowances under section 912. We hold that they are not.
The third issue is whether Mr. and Mrs. Hargrove and Mr. and Mrs.
Breeding are liable for accuracy-related penalties under section
6662(a). We hold that they are.
Background
These cases were submitted fully stipulated pursuant to Rule
122, and the facts are so found. The stipulations of facts and
the accompanying exhibits are incorporated by this reference.
All petitioners resided outside the United States at the times
they filed their petitions.
One or both petitioners in each case were employees of TRW
Overseas Inc. (TRW) during the relevant years. These petitioners
worked for TRW in Pine Gap, Australia, at the Joint Defense Space
Research Facility/Joint Defense Space Communication Station (the
4
Respondent concedes that Mr. and Mrs. Nakagawa are not
liable for accuracy-related penalties under sec. 6662(a).
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defense facility) at the Pine Gap Air Force Base (the base). TRW
was a U.S. Government contractor providing services at the
defense facility.
Petitioners were required to accept assigned housing as a
condition of their employment at the defense facility. The
assigned housing was in Alice Springs, Australia, about 22 miles
from petitioners’ workplace at the defense facility, not within
the physical boundaries of the base. Alice Springs was a town of
approximately 28,000 people and included residents who did not
work at the base as well as those who did. The housing in Alice
Springs where petitioners resided was not in a gated community or
an area open only to TRW employees. The housing was scattered
throughout the city on publicly accessible roads adjacent to
homes available to the general public and not within any separate
enclave or area.
Petitioners did not pay any rent or utility expenses for
their homes in Alice Springs during the years at issue. Local
Alice Springs companies provided services such as trash
collection and law enforcement. Petitioners never conducted any
TRW or defense facility business at their homes in Alice Springs.
Petitioners were required to sign closing agreements as a
condition of their employment. In the closing agreements,
petitioners identified TRW as their employer and waived any right
to elect a foreign earned income exclusion under section 911(a)
for the relevant years with respect to the services they would
provide for the defense facility in Australia. They also agreed
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to attach copies of the closing agreements to their respective
returns. No petitioner attached a copy of his or her closing
agreement to the return for any of the relevant years.
Mr. and Mrs. Hargrove did not retain the services of a
preparer to assist them in filing their returns for 2000 and
2001. Mr. and Mrs. Hargrove did not seek advice from any
accountant, attorney, or other tax professional with respect to
their exclusions of income under sections 912 and 119. Mr. and
Mrs. Hargrove reported they owed tax of $4,719 for 2000 and
$4,123 for 2001.5
Mr. and Mrs. Breeding filed their original returns for 1998
and 1999 without the assistance of a preparer. They then
retained Bob Ross, a certified public accountant located in
California, on the advice of coworkers at the defense facility.
Mr. Ross filed amended returns for 1998 and 1999 on behalf of Mr.
and Mrs. Breeding excluding income under sections 119 and 912.
Mr. and Mrs. Breeding’s original returns for 2000 and 2001,
prepared with the assistance of Mr. Ross, also excluded income
under sections 119 and 912. Mr. and Mrs. Breeding reported they
owed tax of $22,235 for 2000 and $23,169 for 2001.6
Respondent disallowed certain deductions and determined that
petitioners are not entitled to certain exclusions they claimed
5
This is the sum stated in the deficiency notice. We note
that the parties stipulated that Mr. and Mrs. Hargrove reported
amounts slightly different.
6
This is the sum stated in the deficiency notice. We note
that the parties stipulated that Mr. and Mrs. Breeding reported
amounts slightly different.
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on their returns for the relevant years in the deficiency
notices.7 Respondent determined that Mr. and Mrs. Hargrove are
not entitled to an exclusion under section 911 of $44,850 in 2000
and $31,861 in 2001, determined that the correct amount of tax is
$16,533 for 2000 and $12,620 for 2001, and determined that Mr.
and Mrs. Hargrove are also liable for the accuracy-related
penalty.8 Respondent determined that Mr. and Mrs. Kirkpatrick
are not entitled to an exclusion under section 119 of $6,606 in
2000 and $6,698 in 2001. Respondent determined that Mr. and Mrs.
Nakagawa are not entitled to an exclusion under section 119 of
$6,607 in 1999, $6,606 in 2000, and $6,698 in 2001 and that Mr.
and Mrs. Nakagawa are liable for the accuracy-related penalty.
Respondent has since conceded that Mr. and Mrs. Nakagawa are not
liable for the accuracy-related penalty. Respondent determined
that Mr. and Mrs. Anthony are not entitled to an exclusion under
section 119 of $7,056 in 2000 and $7,154 in 2001. Finally,
respondent determined that Mr. and Mrs. Breeding are not entitled
to exclusions under section 119 of $7,056 in 2000 and $7,154 in
2001, and their exclusions under section 912 of $34,285 in 2000
and $36,357 in 2001. Respondent determined that the correct
amount of tax Mr. and Mrs. Breeding owe is $35,467 for 2000 and
7
None of petitioners’ returns was introduced as evidence in
any of these cases.
8
In Docket No. 16441-04, Mr. and Mrs. Hargrove asserted in
the petition that they were entitled to deductions for housing
expenses under sec. 119 and met the requirements for exclusion of
certain income under sec. 912.
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$36,651 for 2001 and that Mr. and Mrs. Breeding are liable for
accuracy-related penalties. Petitioners timely filed petitions.
Discussion
We are asked to decide whether petitioners may exclude the
value of lodging provided by their employer under section 119 and
whether certain petitioners are entitled to exclusions from
income for certain allowances under section 912. We are also
asked to consider whether certain petitioners are liable for
accuracy-related penalties. We begin with the burden of proof.
I. Burden of Proof
In general, the Commissioner’s determinations in the
deficiency notice are presumed correct, and the taxpayer bears
the burden of proving that the Commissioner’s determinations are
in error. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933). The burden of proof may shift to the Commissioner under
certain circumstances, however, if the taxpayer introduces
credible evidence and establishes that he or she substantiated
items, maintained required records, and fully cooperated with the
Commissioner’s reasonable requests. Sec. 7491(a)(2)(A) and (B).
Petitioners repeatedly failed to cooperate with respondent to
prepare these cases for trial and were admonished by the Court
when the case was called for trial. Petitioners have therefore
not met the requirements of section 7491(a)(2)(B), and the burden
of proof remains with them.
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II. Exclusion of Lodging Costs
We now consider whether petitioners may exclude the value of
lodging provided by their employer from income under section 119.
Gross income generally includes all income from whatever source
derived, including compensation for services. Sec. 61(a)(1).
Compensation for services includes income realized in any form
including money, property, or services. Sec. 1.61-2(d)(3),
Income Tax Regs.
The value of lodging provided to an employee, his or her
spouse, and his or her dependents may be excluded from income if
certain conditions are met. Sec. 119. To exclude the value of
lodging, the employee must accept the lodging as a condition of
his or her employment, the lodging must be furnished for the
convenience of the employer, and the lodging must be on the
business premises of the employer. Sec. 1.119-1(b), Income Tax
Regs. The employee must meet all three of these conditions to
qualify for the exclusion. Dole v. Commissioner, 43 T.C. 697
(1965), affd. per curiam 351 F.2d 308 (1st Cir. 1965).
The parties agree that petitioners were required to accept
the lodging as a condition of their employment and the lodging
was furnished for the convenience of TRW. Accordingly, the first
two conditions are met. See sec. 1.119-1(b), Income Tax Regs.
The parties dispute, however, whether the lodging is on TRW’s
business premises.
The business premises of the employer are generally the
place of employment of the employee. See sec. 1.119-1(c)(1),
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Income Tax Regs. The phrase “on the business premises” has been
construed to mean either (1) living quarters that constitute an
integral part of the business property or (2) premises on which
the employer carries on some of its business activities. See
Dole v. Commissioner, supra at 707.
Living quarters are generally an integral part of business
property if they are physically located on the employer’s
premises. Living quarters are also generally an integral part of
business property if the employee does enough work for the
employer at the living quarters so that the living quarters are
identified with the interests of the business and serve important
business functions. See Adams v. United States, 218 Ct. Cl. 322,
585 F.2d 1060, 1066-1067 (1978); Johnson v. Commissioner, T.C.
Memo. 1983-479.
The home of a high-ranking executive has been considered an
integral part of the employer’s business when the executive held
meetings and business social functions in his home, raising the
status of his company. Adams v. United States, supra.
Similarly, a hotel manager’s residence has been considered an
integral part of the employer’s business when the hotel manager
could observe the hotel from his home, worked from home in the
evenings, and also occasionally entertained important hotel
guests in his home. Lindeman v. Commissioner, 60 T.C. 609
(1973).
Conversely, living quarters physically located off the
worksite are not integral to the employer’s business unless the
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employee does significant work for the employer or the employer
conducts a significant portion of its business at the living
quarters. See Johnson v. Commissioner, supra. For example,
housing located 12 miles from the employee’s worksite on the
trans-Alaska pipeline was not integral to the employer’s business
where the employee only prepared some daily inspection reports at
home. Id. Also, proximity is not the standard. Living quarters
as close as a mile from the worksite are not integral to the
employer’s business even if the employee is periodically on call
to perform work for the employer unless the employee performs
significant work for the employer at the living quarters. See
Dole v. Commissioner, supra.
The homes where petitioners and their families lived in
Alice Springs were 22 miles from the defense facility. The
housing was in a separate town on a public road in the same areas
where nonbase employees lived. No TRW activities occurred at the
housing petitioners occupied in Alice Springs. No petitioner
performed any work for TRW at his or her home in Alice Springs.
Accordingly, the housing in Alice Springs was not an integral
part of TRW’s business and having petitioners occupy those
particular homes served no important TRW business functions.
We conclude that the living quarters TRW provided
petitioners were not integral to TRW’s business. The living
quarters therefore do not qualify for the exclusion under section
119, and petitioners are not entitled to exclude the costs of
their lodging from their income for the relevant years.
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Petitioners attempt to redefine their worksite to include
the lodging units in Alice Springs by a broad reading of the
treaty under which the defense facility was established.9 We
find no merit to their argument. In fact, neither the treaty
under which the defense facility was authorized nor its
amendments and extensions refers to housing units or lodging for
employees.10 There is no mention of contractors’ living quarters
and nothing in the treaty implies that contractors’ living
quarters should be considered part of the defense facility.
III. Exclusion of Living Allowances
We next address the argument of petitioners Mr. and Mrs.
Hargrove and Mr. and Mrs. Breeding that they are entitled to
exclude certain living allowances for the relevant years under
9
The defense facility was authorized under a treaty between
the United States and Australia that became effective on Dec. 9,
1966. Agreement Relating to the Establishment of a Joint Defence
Space Research Facility, U.S.-Austl., Dec. 9, 1966, 17 U.S.T.
2235 (the Treaty). The Treaty has been amended and extended
since 1966. Exchange of Notes Constituting an Agreement to
Further Extend in Force the Agreement Relating to the
Establishment of a Joint Defence Facility at Pine Gap of 9
December 1966, as Amended, U.S.-Austl., Jun. 4, 1998, 2171
U.N.T.S. 89; Agreement Amending and Extending the Agreement of
Dec. 9, 1966, As Amended and Extended, Relating to the
Establishment of a Joint Defence Space Research Facility, U.S.-
Austl., Nov. 16, 1988, State Dept. No. 89-2; Agreement Amending
and Extending the Agreement of Dec. 9, 1966, U.S.-Austl., Oct.
19, 1977, 29 U.S.T. 2759.
10
The treaty generally provides for establishing and
operating a facility for general defense research in the space
field in Australia. Treaty, art. 1. We note that under the
treaty, contractors’ income shall be deemed not to have been
derived in Australia for Australian tax purposes as long as it is
not exempt from and is subject to tax in the United States. Id.,
art. 9(1). If the lodging income were exempt from U.S. tax, this
provision would entitle Australia to tax it instead.
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section 912. Section 912 excludes from income foreign area
allowances and cost of living allowances given to civilian
officers and employees of the U.S. Government. Taxpayers must be
civilian employees or officers of the U.S. Government to be
entitled to the exclusion for the types of allowances under
section 912. Sec. 912; Adair v. Commissioner, T.C. Memo. 1995-
493.
Mr. and Mrs. Hargrove and Mr. and Mrs. Breeding stipulated
that they were employees of TRW, not the U.S. Government, for
each relevant year. They each also signed closing agreements
identifying TRW as their employer. Moreover, the common law
factors defining the employer-employee relationship indicate that
TRW, not the U.S. Government, employed petitioners. See Matthews
v. Commissioner, 907 F.2d 1173 (D.C. Cir. 1990), affg. 92 T.C.
351 (1989). Mr. and Mrs. Hargrove and Mr. and Mrs. Breeding have
not shown that the U.S. Government controlled the methods or
manner of their work or had the right to discharge them. See
Matthews v. Commissioner, 92 T.C. at 361. Mr. and Mrs. Hargrove
and Mr. and Mrs. Breeding are not civilian officers or employees
of the U.S. Government and have not shown that they received
these types of allowances. Accordingly, they are not entitled to
any exclusion from income.
Mr. and Mrs. Hargrove and Mr. and Mrs. Breeding also argue
that we should look to the treaty under which the defense
facility was established to define the terms “employer” and
“employee” because those terms are not defined in sections 119
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and 912. We disagree. Article 7 of the treaty defines the term
“United States civilian employee” for purposes of the treaty and
the related Status of Forces Agreement, not for the Internal
Revenue Code. Moreover, “a civilian employee of the United
States government employed in Australia in connection with the
facility” is not defined in the treaty to include contractors or
their employees. Contractors and their personnel are
specifically referred to as such in several other parts of the
treaty, such as in paragraph (1) of article 9.
Even if we were to find that petitioners were employees of
the U.S. Government, they would still not be entitled to exclude
income under section 912 because they have not shown that they
meet the other requirements of section 912. Petitioners
introduced no evidence concerning any allowances they received,
nor have they shown that they received a cost of living
allowance, foreign area allowance under chapter 9 of title I of
the Foreign Service Act of 1980, section 4 of the Central
Intelligence Agency Act of 1949, as amended, or any other
allowance described in section 912. See sec. 912.
We conclude that Mr. and Mrs. Hargrove and Mr. and Mrs.
Breeding are not entitled to exclude any amounts from income
under section 912.
IV. Accuracy-Related Penalty
We next consider whether petitioners Mr. and Mrs. Hargrove
and Mr. and Mrs. Breeding are liable for accuracy-related
penalties under section 6662(a) for the relevant years.
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Respondent has the burden of production under section 7491(c) and
must come forward with sufficient evidence that it is appropriate
to impose the penalties. See Higbee v. Commissioner, 116 T.C.
438, 446-447 (2001).
A taxpayer is liable for an accuracy-related penalty of 20
percent of any part of an underpayment attributable to, among
other things, a substantial understatement of income tax.11
There is a substantial understatement of income tax under section
6662(b)(2) if the amount of the understatement exceeds the
greater of either 10 percent of the tax required to be shown on
the return, or $5,000. Sec. 6662(a), (b)(1) and (2), (d)(1)(A);
sec. 1.6662-4(a), Income Tax Regs.
Respondent has met his burden of production with respect to
Mr. and Mrs. Hargrove’s and Mr. and Mrs. Breeding’s substantial
understatements of income tax for the relevant years. Mr. and
Mrs. Hargrove reported they owed income tax of $4,719 for 2000
and $4,123 for 2001.12 Respondent determined that they owed
$16,533 for 2000 and $12,620 for 2001. Mr. and Mrs. Hargrove
11
Respondent determined in the alternative that Mr. and Mrs.
Hargrove and Mr. and Mrs. Breeding were liable for the accuracy-
related penalties for negligence or disregard of rules or
regulations under sec. 6662(b)(1) for the relevant years.
Because respondent has proven that petitioners substantially
understated their income tax for the relevant years, we need not
consider whether petitioners were negligent or disregarded rules
or regulations.
12
None of petitioners’ returns for the relevant years was
introduced in evidence. We have used the amounts reflected in
the deficiency notice for the amounts petitioners reported on
their returns. We note there is a slight discrepancy between the
amounts we use and the amounts that petitioners stipulated, but
this difference is immaterial.
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understated their tax by $11,814 for 2000 and $8,497 for 2001.
Accordingly, Mr. and Mrs. Hargrove have understated their tax for
each relevant year by the greater of 10 percent of the tax
required to be shown on the return, or $5,000.
Mr. and Mrs. Breeding reported they owed income tax of
$22,235 for 2000 and $23,169 for 2001.13 Respondent determined
that they owed $35,467 for 2000 and $36,651 for 2001. Mr. and
Mrs. Breeding understated their tax by $13,232 for 2000 and
$13,482 for 2001. Accordingly, Mr. and Mrs. Hargrove have
understated their tax for each relevant year by the greater of 10
percent of the tax required to be shown on the return, or $5,000.
The accuracy-related penalty under section 6662(a) does not
apply to any portion of an underpayment, however, if it is shown
that there was reasonable cause for the taxpayer’s position and
that the taxpayer acted in good faith with respect to that
portion. Sec. 6664(c)(1); sec. 1.6664-4(b), Income Tax Regs.
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 the pertinent facts and circumstances, including
the taxpayer’s efforts to assess his or her proper tax liability
and the knowledge and experience of the taxpayer. Sec. 1.6664-
4(b)(1), Income Tax Regs. The taxpayer bears the burden of proof
13
None of petitioners’ returns for the relevant years was
introduced in evidence. We have used the amounts reflected in
the deficiency notice for the amounts petitioners reported on
their returns. We note there is a slight discrepancy between the
amounts we use and the amounts that petitioners stipulated, but
this difference is immaterial.
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with respect to reasonable cause. Higbee v. Commissioner, supra
at 446.
Where a taxpayer chooses a competent tax adviser and
supplies him or her with all relevant information, it is
consistent with ordinary business care and prudence to rely on
the adviser’s professional judgment as to the taxpayer’s tax
obligations. United States v. Boyle, 469 U.S. 241, 250-251
(1985). The taxpayer must show that the adviser was a competent
professional with significant expertise to justify reliance.
Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 99
(2000), affd. 299 F.3d 221 (3d Cir. 2002).
Petitioners failed to assert any arguments that the
accuracy-related penalties should not apply. Petitioners rested
instead on their argument that they were eligible for the
exclusions from income under sections 119 and 912 that respondent
disallowed. Specifically, petitioners did not argue and did not
introduce any evidence that they acted with reasonable cause or
in good faith with respect to the underpayments for the relevant
years.
Mr. and Mrs. Hargrove did not use a tax return preparer and
did not seek advice from a tax professional concerning their
returns for the relevant years. While Mr. and Mrs. Breeding used
a tax return preparer to assist with their returns for the
relevant years, they did not introduce evidence regarding the
preparer. They have not shown, for example, that the preparer
was a competent professional with significant expertise to
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justify reliance or that Mr. and Mrs. Breeding provided the
preparer all relevant information. See Neonatology Associates,
P.A. v. Commissioner, supra. We therefore do not find that Mr.
and Mrs. Breeding have shown that it was reasonable to rely on
this tax return preparer.
After considering all of the facts and circumstances, we
find that Mr. and Mrs. Hargrove and Mr. and Mrs. Breeding have
failed to establish that they had reasonable cause and acted in
good faith with respect to their respective underpayments.
Accordingly, we sustain respondent’s determination as to Mr. and
Mrs. Hargrove and Mr. and Mrs. Breeding for the accuracy-related
penalties for the relevant years.
We have considered all remaining arguments the parties made
and, to the extent not addressed, we conclude they are
irrelevant, moot, or meritless.
To reflect the foregoing and the concessions of the parties,
Decisions will be entered
for respondent in Docket Nos.
16441-04, 16442-04, 16444-04,
and 16448-04. Decision will
be entered for respondent in
Docket No. 16443-04 with
respect to the deficiencies
and for petitioners with
respect to the section 6662(a)
penalties.