Diller v. Comm'r

T.C. Summary Opinion 2007-146

UNITED STATES TAX COURT

KENNETH FRANK DILLER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2668-06S. Filed August 22, 2007.

Kenneth Frank Diller, pro se.

Matthew A. Houtsma, for respondent.

DEAN, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code.

Unless otherwise indicated, all section references are to the

Internal Revenue Code in effect for the year at issue, and all

Rule references are to the Tax Court Rules of Practice and

Procedure. Pursuant to section 7463(b), the decision to be

entered is not reviewable by any other court, and this opinion

shall not be treated as precedent for any other case.
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Respondent determined for 2002 a deficiency in petitioner’s

Federal income tax of $8,877, an addition to tax under section

6651(a)(1) of $1,650, an addition to tax under section 6651(a)(2)

of $1,063, and an addition to tax under section 6654(a) of $239.

The issues for decision are whether petitioner: (1) May exclude

under section 104(a)(2) certain damages received, (2) paid

unreported business expenses, (3) is liable for the failure to

timely file addition to tax under section 6651(a)(1), (4) is

liable for the failure to pay timely addition to tax under

section 6651(a)(2), and (5) is liable under section 6654(a) for

the addition to tax for failure to pay estimated tax.

Background

The stipulation of facts and the exhibits received into

evidence are incorporated herein by reference. At the time the

petition in this case was filed, petitioner resided in Greeley,

Colorado.

For several years, until his independent sales contract was

terminated in 1999, petitioner worked for Cronatron Welding

Systems, Inc. (Welding). Petitioner then began working with Gard

Specialists Co. (Gard). Gard was and is in the business of

selling nuts, bolts, screws, traps, drills, grinding discs, and

chemicals for maintenance operations. Petitioner continues to

work for Gard.
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Petitioner filed a claim of age discrimination against

Welding. In 2002, he received $53,000 to settle his

discrimination claim of which $19,055.58 was paid directly to his

attorney. The parties agree that no part of the settlement paid

to petitioner by Welding was compensation for physical injury or

physical sickness, and petitioner made no allegation that the

damages were paid for medical care attributable to emotional

distress.

The parties also agree that petitioner received in 2002:

(1) At least $481 in self-employment income, (2) at least $155 in

taxable interest, of which $19 was withheld, (3) $202 of

dividends, of which $23 was withheld, (4) a gain of $23 from the

sale of stocks and bonds, and (5) rental income of $5,744.23 and

rental expenses of $4,518.46.

The parties agree that petitioner filed a request for an

extension to file his 2002 Federal income tax return along with a

remittance of $1,500 on or before April 15, 2003. But the

parties also agree that petitioner has never filed a Federal

income tax return for 2002. The Internal Revenue Service (IRS)

made a return for him under section 6020(b) for 2002. The IRS

has no record of petitioner’s having filed a Federal income tax

return for 2001.

During preparation for trial, petitioner informed respondent

that he had a business for which he paid significant business
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expenses during 2002. Petitioner submitted to respondent’s

counsel on the morning of trial a Form 1040, U.S. Individual

Income Tax Return, for 2002, with an attached Schedule C, Profit

or Loss From Business, under the name KD Fabricating. The

Schedule C reported gross receipts of $53,826, total expenses of

$49,418 and a net profit of $4,408. Petitioner included in the

gross income reported on Schedule C the recovery from his lawsuit

against Welding, the proceeds from the sale of a vehicle, and

other items. Similarly, the expenses reported on Schedule C

include items from various sources.

Discussion

The Commissioner’s deficiency determinations are presumed

correct, and taxpayers generally have the burden of proving that

the determinations are incorrect. Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933). Under certain

circumstances, however, section 7491(a) may shift the burden to

the Commissioner with respect to a factual issue affecting

liability for tax. Petitioner did not present evidence or

argument that he satisfied the requirements of section 7491(a),

and therefore, the burden of proof does not shift to respondent.

Taxpayers are required, under section 61(a), to include in

gross income “all income from whatever source derived” unless

such income has been specifically excepted from inclusion. See

Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430 (1955)
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(Congress’s intent under section 61(a) was to tax income unless

specifically excluded). Exclusions to section 61(a) must be

narrowly construed. Commissioner v. Schleier, 515 U.S. 323, 328

(1995) (citing United States v. Burke, 504 U.S. 229, 233 (1992)).

The parties have agreed on the amounts of various income

items received by petitioner in 2002 but not to the taxability of

petitioner’s recovery of damages for discrimination or to the

treatment of his payment of attorney’s fees associated with the

recovery.

Exclusion of Certain “Damages”

Section 104(a)(2) allows taxpayers to exclude from income

“the amount of any damages (other than punitive damages) received

(whether by suit or agreement * * *) on account of personal

physical injuries or physical sickness”. The flush language of

section 104(a) specifies that “emotional distress shall not be

treated as a physical injury or physical sickness.” But the

exclusion from gross income does apply to the amount of damages

received for any medical care attributable to emotional distress.

Sec. 104(a).

Treasury regulations provide that the term “damages” means

amounts received (aside from workmen’s compensation) through

litigation or settlement of an action that is based on “tort or

tort type rights”. Sec. 1.104-1(c), Income Tax Regs.
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The Supreme Court in Commissioner v. Schleier, supra, held

that damages are excludable from income under section 104(a)(2)

if they meet a two-pronged test. First, the taxpayer must

demonstrate that the underlying cause of action giving rise to

the recovery is “based upon tort or tort type rights”, and

second, the taxpayer must show that the damages were received “on

account of personal injuries or sickness.” Commissioner v.

Schleier, supra at 335-337. Both requirements must be satisfied

for the damages to be excluded from income. Id. at 333.

Section 104(a)(2) was amended in 1996 to include the

requirement that damages be received for physical injuries or

sickness. Small Business Job Protection Act of 1996, Pub. L.

104-188, sec. 1605(a), 110 Stat. 1838. However, this does not

alter the analysis of Schleier. See Tamberella v. Commissioner,

T.C. Memo. 2004-47, affd. 139 Fed. Appx. 319, 321 (2d Cir. 2005).

None of the underlying documentation describing the nature

of the settlement is in the record. The parties have agreed,

however, that no part of the settlement paid to petitioner was

compensation for physical injury or physical sickness, and

petitioner has made no allegation that the damages were paid for

medical care attributable to emotional distress.

Therefore, petitioner’s recovery is not exempted from

inclusion in gross income under section 61. Because petitioner’s

recovery constitutes income, his income includes the portion of
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the recovery paid to his attorney for his representation.

Commissioner v. Banks, 543 U.S. 426, 429 (2005). Petitioner,

however, may deduct the attorney’s fees as a miscellaneous

itemized deduction under sections 67 and 162, subject to the

alternative minimum tax computations under sections 55 and 56.

See Commissioner v. Banks, supra at 432.

Petitioner’s Business Deductions

During preparation for trial, petitioner informed respondent

that he had a business for which he paid significant business

expenses during 2002. Respondent contends that petitioner has

not shown that his activity, if any, was actually conducted for

profit or as a business, but if it was, petitioner has not

adequately substantiated his expenses from the activity. Before

examining the issue of substantiation, consideration of

petitioner’s evidence of his carrying on a trade or business is

appropriate.

Deductions are allowed under section 162 for the ordinary

and necessary expenses of carrying on an activity that

constitutes the taxpayer’s trade or business. Deductions are

allowed under section 212(1) and (2) for the ordinary and

necessary expenses paid or incurred in connection with an

activity engaged in for the production or collection of income,

or for the management, conservation, or maintenance of property

held for the production of income.
 - 8 -

With respect to either section, however, the taxpayer must

demonstrate a profit objective for the activity in order to

deduct associated expenses. See Jasionowski v. Commissioner, 66

T.C. 312, 320-322 (1976); sec. 1.183-2(a), Income Tax Regs. The

profit standards applicable for section 212 are the same as those

used for section 162. See Agro Sci. Co. v. Commissioner, 934

F.2d 573, 576 (5th Cir. 1991), affg. T.C. Memo. 1989-687;

Antonides v. Commissioner, 893 F.2d 656, 659 (4th Cir. 1990),

affg. 91 T.C. 686 (1988); Allen v. Commissioner, 72 T.C. 28, 33

(1979); Rand v. Commissioner, 34 T.C. 1146, 1149 (1960).

Section 1.183-2(b), Income Tax Regs., sets forth nine

nonexclusive factors that should be considered in determining

whether a taxpayer is engaged in a venture with a profit

objective.

In order to show that he was engaged in a trade or business,

petitioner must show not only that his primary purpose for

engaging in the activity was for income or profit but also that

he engaged in the activity with “continuity and regularity”.

Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).

Respondent’s counsel represented to the Court that he was

not advised by petitioner of the purported business until 10 days

before trial and that petitioner did not provide him with any

evidence of business income and expenses.
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Petitioner responded by offering into evidence a copy of a

simple “letterhead” and a blank “invoice”, each of which appeared

to have been generated by a personal computer. Petitioner also

provided a checking account statement dated January 24, 2002, in

the name of “KD Fabricating Kenneth F. Diller”. Petitioner

testified that KD Fabricating was in the business of selling

welding maintenance and repair products, a business similar to

that of Welding at the time he worked for them.

Petitioner sent copies of the letterhead, invoice, and

checking account statement to respondent. In the cover letter

dated October 15, 2006 (on KD Fabricating, Co. “letterhead”),

transmitting the documents, petitioner stated that the documents

show that KD Fabricating1 is “the name under which I transact

business currently and have for the last ten to twelve years”.

At trial, however, petitioner testified that he started KD

Fabricating in January of 2002. And he testified that his

negative replies to questions about self-employment on his

February 6, 2006, Application For Waiver Of Filing Fee And

Affidavit (waiver), were because he was not conducting business

for KD Fabricating as of that date.2

1
Petitioner offered evidence that he also owned, beginning
in 2000, an interest in and was president of a now defunct
corporate entity named KD Technologies.
2
Question 3 of the waiver asks if you “have * * * received
any money from” self-employment “in the last 12 months”.
(continued...)
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This case was tried on October 23, 2006. On October 20,

2006, petitioner had provided to respondent’s counsel a computer-

generated chart that purports to list for 2002 the “W2 & 1099 &

Miscellaneous” income for Kenneth F. Diller. There is no listing

for KD Fabricating on the chart provided to respondent’s counsel.

At trial, however, petitioner introduced a similar chart that

lists “1099 Income” from KD Fabricating of $2,999.63. Petitioner

explained that the first chart was “incomplete”; he did not

explain why. Petitioner testified that KD Fabricating sent out

invoices in order to receive payment for sales. He kept track of

the invoices, he testified, by copying each invoice and placing

it in a “file folder”. But petitioner produced no copies of any

invoices to actual customers. According to petitioner, customers

paid him by check in 2002. Petitioner, however, produced no bank

statements or check registers to show receipt of payments from

customers. Petitioner did not produce any evidence of any single

amount received in payment from a customer. Petitioner’s

computer-generated record of income did not list customers of KD

Fabricating nor their payments; it merely listed the alleged

total payments for the year.

When questioned by the Court, petitioner testified that he

was indeed aware, before appearing in Court, that respondent was

2
(...continued)
Petitioner indicated “NO” in response.
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challenging the existence of his KD Fabricating business. Yet,

he produced no receipts or any other evidence, other than his own

testimony, of any customer payments to KD Fabricating. The Court

is not required to accept petitioner’s self-serving testimony,

particularly in the absence of corroborating evidence. See

Geiger v. Commissioner, 440 F.2d 688, 689 (9th Cir. 1971), affg.

per curiam T.C. Memo. 1969-159; Urban Redev. Corp. v.

Commissioner, 294 F.2d 328, 332 (4th Cir. 1961), affg. 34 T.C.

845 (1960). The Court concludes that petitioner has not shown

that he was engaged in an activity for profit under the name KD

Fabricating in 2002.

Taxpayers are required to maintain records that are

sufficient to enable the Commissioner to determine the correct

tax liability. See sec. 6001; sec. 1.6001-1(a), Income Tax Regs.

Petitioner’s “substantiation” for claimed business expenses

consists of computer-generated listings of expenses entitled

“cash supplies”, “credit card expenses”, and “check schedule”.

Petitioner produced no original documents or copies of such items

as receipts, credit card records, bank statements, or canceled

checks, on which his computer records were supposedly based.

Petitioner’s cash expenditures as listed on his “cash supplies

document” totaled $31,468.49. Included in both the cash and

check expenses was the purchase of a new Toyota pickup truck for

$23,514.
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Petitioner testified that his listings of expenses contained

some “leftover” expenses from Welding, some fuel expenses related

to KD Technology, and some expenses related to his rental

activity. As he failed to segregate his expenses, he was unable

to identify the expenses attributable to each activity.

Because petitioner has not shown that he was engaged in an

activity for profit under the name of KD Fabricating, has not

shown for what purpose the claimed expenses might otherwise be

deductible, and if deductible, has not provided proper

substantiation, he has not shown that he is entitled to any

deductions other than those agreed to by respondent.3 See Lerch

v. Commissioner, 877 F.2d 624, 629 (7th Cir. 1989), affg. T.C.

Memo. 1987-295.

Additions to Tax

Respondent bears the burden of production with respect to

any addition to tax. Sec. 7491(c). In order to meet this

burden, respondent must produce evidence sufficient to establish

that it is appropriate to impose the addition to tax. Higbee v.

Commissioner, 116 T.C. 438, 446-447 (2001).

Addition to Tax Under Section 6651(a)(1)

The parties agree that petitioner did not file a Federal tax

return for 2002. Respondent made a return for petitioner under

3
Petitioner may be entitled to deduct legal fees as
discussed supra.
 - 13 -

section 6020(b). A return prepared under section 6020(b) is to

be disregarded for purposes of determining the amount of the

addition to tax under section 6651(a)(1). Sec. 6651(g)(1).

Respondent has met his burden of production under section 7491(c)

with respect to imposing the addition to tax under section

6651(a)(1).

It is petitioner’s burden to prove that he had reasonable

cause and lacked willful neglect in not filing his return timely.

See United States v. Boyle, 469 U.S. 241, 245 (1985); Higbee v.

Commissioner, supra; sec. 301.6651-1(a)(1), Proced. & Admin.

Regs. Because petitioner failed to offer any evidence of

reasonable cause and lack of willful neglect for his failure to

file timely, respondent’s determination that he is liable for the

addition to tax under section 6651(a)(1) is sustained.

Addition to Tax Under Section 6651(a)(2)

Under section 6651(g)(2), the return made by respondent

under section 6020(b) is to be treated as a return filed by

petitioner for purposes of determining the amount of the addition

to tax under section 6651(a)(2). Because petitioner failed to

offer any evidence of reasonable cause and lack of willful

neglect for his failure to pay timely, respondent’s determination

that he is liable for the addition to tax under section

6651(a)(2) is sustained.
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Addition to Tax Under Section 6654

Section 6654 imposes an addition to tax for failure to make

timely and sufficient payments for estimated taxes. In order for

respondent to satisfy his burden of production under section

7491(c), he must produce evidence necessary to enable the Court

to conclude that petitioner had an obligation to make an

estimated tax payment. Wheeler v. Commissioner, 127 T.C. 200,

211 (2006). Specifically, respondent must produce evidence

showing that petitioner had a “required annual payment” as

defined by section 6654(d)(1)(B) for the year at issue. Id.

The section 6654 addition to tax is calculated with

reference to four required installment payments of the taxpayer’s

estimated tax liability. Sec. 6654(c)(1). Each required

installment of estimated tax is equal to 25 percent of the

“required annual payment”. Sec. 6654(d)(1)(A).

Under section 6654(d)(1)(B), “required annual payment” means

the lesser of--

(i) 90 percent of the tax shown on the return
for the taxable year (or, if no return is
filed, 90 percent of the tax for such year),
or

(ii) 100 percent of the tax shown on the
return of the individual for the preceding
taxable year.

Clause (ii) shall not apply if the preceding taxable
year was not a taxable year of 12 months or if the
individual did not file a return for such preceding
taxable year.
 - 15 -
Respondent produced a Form 4340, Certificate of Assessments,

Payments, and Other Specified Matters, for 2002 establishing that

petitioner filed for an extension of time to file a tax return

for 2002 along with a payment of $1,500. Respondent made a

return for petitioner under section 6020(b) reporting a tax

liability of $8,877. Such a return is “good and sufficient for

all legal purposes.” Sec. 6020(b)(2). The evidence is

sufficient for the Court to make the analysis required by section

6654(d)(1)(B)(i). Respondent introduced evidence in the form of

a Form 4340 for 2001 showing that there is no record that

petitioner filed a return for the preceding taxable year (i.e.

2001). Therefore, under the flush language of section

6654(d)(1)(B), clause (ii) does not apply. The Court concludes

that petitioner had a required annual payment for 2002.

The section 6654 addition to tax is mandatory unless

petitioner can place himself within one of the computational

exceptions provided by section 6654(e). Recklitis v.

Commissioner, 91 T.C. 874, 913 (1988); Grosshandler v.

Commissioner, 75 T.C. 1, 20-21 (1980). Petitioner did not pay

the required estimated tax for 2002 and failed to show that his
 - 16 -

failure to timely pay estimated taxes qualifies for one of the

exceptions under section 6654(e). Accordingly, petitioner is

liable for the addition to tax under section 6654 for 2002.

To reflect the foregoing,

Decision will be

entered for respondent.