T.C. Memo. 2007-363
UNITED STATES TAX COURT
JOSEPH M. AND MARJORIE SITA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10068-05. Filed December 10, 2007.
Joseph M. Sita, pro se.
Trent D. Usitalo, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined deficiencies in
petitioners’ Federal income taxes for 2001 and 2002 (years at
issue) of $3,121 and $2,100.1
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and Rule references are to
the Tax Court Rules of Practice and Procedure. Amounts are
(continued...)
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After concessions,2 the issues for decision are: (1)
Whether petitioners are entitled to a depreciation deduction of
$2,143 under section 167 for 2001; (2) whether petitioners are
entitled to a disabled access credit under section 44 for 2001;
and (3) whether petitioners are entitled to a business expense
deduction of $14,000 under section 162 for 2002.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. Petitioners resided in
New Richmond, Wisconsin, when they filed their petition.
A. Procedural History
This case, commenced on June 1, 2005, was previously
continued because of the pendency of related litigation in two
U.S. Courts of Appeals (referred to herein as the Alpha Telcom
cases). See Arevalo v. Commissioner, 469 F.3d 436 (5th Cir.
2006), affg. 124 T.C. 244 (2005); Crooks v. Commissioner, 453
F.3d 653 (6th Cir. 2006). The Alpha Telcom cases are concluded,
and the decisions entered in those cases are final. In each
case, the Tax Court sustained the Commissioner’s deficiency
1
(...continued)
rounded to the nearest dollar.
2
Respondent concedes that petitioners qualify for an
education credit for 2001. However, the amount of the education
credit that they are entitled to depends on their adjusted gross
income.
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determination, and in each case the U.S. Court of Appeals has
affirmed the decision of this Court. See Arevalo v.
Commissioner, supra; Crooks v. Commissioner, supra. In short,
this Court and the Courts of Appeals have consistently held that
a taxpayer’s investment in an arrangement involving pay phones
marketed by Alpha Telcom, Inc. (Alpha Telcom), and its wholly
owned subsidiary American Telecommunications Co., Inc. (ATC), did
not support either: (1) A depreciation deduction under section
167 because the taxpayer did not have the requisite benefits and
burdens of ownership to support a depreciable interest in the pay
phones; or (2) a disabled access credit under section 44, because
the investment was not an eligible access expenditure.
B. Background
Alpha Telcom marketed a pay phone investment program through
ATC to thousands of investors nationwide. Alpha Telcom
represented that the pay phones included modifications such as
longer cords, volume controls, and/or other features that
facilitated their use by persons with disabilities. Alpha Telcom
also represented to investors that the modifications made to the
pay phones complied with the requirements of the Americans with
Disabilities Act of 1990 (ADA), Pub. L. 101-336, 104 Stat. 327.
On June 2, 2001, petitioners entered into separate contracts
with ATC entitled “Telephone Equipment Purchase Agreement” (ATC
pay phone agreements) to purchase a total of seven pay phones at
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a cost of $5,000 per pay phone. Pursuant to the ATC pay phone
agreements, petitioners paid $35,000 to ATC, and ATC purportedly
provided petitioners with legal title to the “telephone
equipment” which was described in an attachment to the ATC pay
phone agreements, entitled “Telephone Equipment List”. However,
the attachment did not identify the pay phones subject to the
agreement, the prices, or the locations. Furthermore,
petitioners were not provided with a list of the modifications
that were made to the pay phones they purchased, and they did not
know the cost of these modifications.
The ATC pay phone agreements also provided a “Buy Back
Election” which was valid for 7 years. Under its terms, Alpha
Telcom had the right of first refusal in the event petitioners
were to sell a pay phone. The buy back election also provided
that if petitioners elected to sell a pay phone back to ATC
within 36 months of the date of delivery, they would be refunded
the entire purchase price minus a 10-percent restocking fee. If
the buy back election was made after 36 months, they would be
refunded the entire purchase price without a restocking fee.
On June 2, 2001, each petitioner also entered into a
separate “Telephone Services Agreement” with Alpha Telcom (Alpha
Telcom service agreements) with a term of 3 years. Under its
terms, Alpha Telcom was responsible for selecting the location of
the pay phones, negotiating site agreements with the owners or
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lessees of the premises where the pay phones were to be
installed, installing the pay phones, obtaining all licenses
needed to operate the pay phones, insuring and maintaining the
pay phones, collecting and accounting for the revenues generated
by the pay phones, and paying vendor commissions and fees.
In return, Alpha Telcom was entitled to 70 percent of the
revenues the pay phones generated, while petitioners were
entitled to the balance. In the event that a pay phone’s
adjusted gross revenue was less than $194.50 for the month, the
Alpha Telcom service agreements provided that Alpha Telcom would
waive or reduce the 70-percent fee and pay petitioners at least
$58.34, so long as the equipment generated at least that amount.
In the event that a pay phone’s adjusted gross revenue was less
than $58.34 for the month, petitioners would receive 100 percent
of the adjusted gross revenue. Notwithstanding this formula,
Alpha Telcom made it a practice to pay its investors $58.34 per
pay phone, regardless of the revenue actually received.
Petitioners’ pay phones were never installed, and they never
received a monthly return because Alpha Telcom filed for
bankruptcy shortly after petitioners entered into the ATC pay
phone agreements. Petitioners never saw or took possession of
the pay phones.
On August 24, 2001, Alpha Telcom filed for bankruptcy under
chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court
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for the Southern District of Florida. The matter was
transferred to the U.S. Bankruptcy Court for the District of
Oregon on September 17, 2001. On March 12, 2002, petitioners
each filed a proof of claim with the bankruptcy court for a total
of $39,492.3 Petitioner did not receive any money from Alpha
Telcom or ATC or the pay phones they purchased.
C. Claimed Deductions and Credits
On April 12, 2002, petitioners jointly filed a Form 1040,
U.S. Individual Income Tax Return, for 2001, to which they
attached a Schedule C, Profit or Loss From Business, claiming a
depreciation deduction of $2,143 with respect to the seven pay
phones. Petitioners also attached to the 2001 return a Form
8826, Disabled Access Credit, claiming a $5,000 tax credit with
respect to the seven pay phones.
On April 12, 2003, petitioners filed a joint Form 1040 for
2002, to which they attached a Schedule C claiming an expense
deduction of $14,000 on line 27 as an “Other” expense. In the
3
The bankruptcy matter was dismissed on Sept. 10, 2003, by
motion of Alpha Telcom. The bankruptcy court held that it was in
the best interest of creditors and the estate to dismiss the
bankruptcy matter so that proceedings could continue in Federal
District Court, where there was a pending receivership involving
debtors.
The Securities and Exchange Commission (SEC) brought a civil
suit against Alpha Telcom in 2001 in the U.S. District Court for
the District of Oregon. On Feb. 7, 2002, the District Court held
that the pay phone scheme was actually a security investment, and
Alpha Telcom had violated Federal law because it did not register
the program with the SEC. SEC v. Alpha Telcom, Inc., 187 F.
Supp. 2d 1250 (D. Or. 2002), affd. 350 F.3d 1084 (9th Cir. 2003).
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explanation section for the “Other” expense, petitioners stated
the $14,000 was for a “payout of phone equipment”.
Thell Prueitt, a representative of Alpha Telcom, helped
petitioners prepare the 2001 and 2002 returns.
Respondent issued a notice of deficiency on March 3, 2005,
disallowing the Schedule C deductions for 2001 and 2002 and the
Form 8826 credit for 2001. Petitioners timely filed their
petition on June 1, 2005.
OPINION
I. Burden of Proof
Under section 7491, the burden of proof shifts from the
taxpayer to the Commissioner if the taxpayer produces credible
evidence with respect to any factual issue relevant to
ascertaining the taxpayer’s tax liability. Sec. 7491(a)(1).
However, section 7491(a)(1) applies with respect to an issue only
if the taxpayer has complied with the requirements to
substantiate any item, has maintained all records, and has
cooperated with reasonable requests by the Commissioner for
witnesses, information, documents, meetings, and interviews. See
sec. 7491(a)(2)(A) and (B).
Although petitioners claimed that section 7491(a) applies,
they failed to introduce sufficient evidence to shift the burden
to respondent. Nonetheless, our findings in this case are based
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on a preponderance of the evidence. See Arevalo v. Commissioner,
124 T.C. at 250-251.
II. Depreciation Deduction
Section 167(a) allows as a depreciation deduction a
reasonable allowance for the “exhaustion, wear and tear” of
property (1) used in a trade or business or (2) held for the
production of income.
Depreciation deductions are based on investment in and
actual ownership of property rather than on possession of bare
legal title. See Arevalo v. Commissioner, 124 T.C. at 251; Grant
Creek Water Works, Ltd. v. Commissioner, 91 T.C. 322, 326 (1988);
Narver v. Commissioner, 75 T.C. 53, 98 (1980), affd. 670 F.2d 855
(9th Cir. 1982). The transfer of formal legal title does not
shift the incidence of taxation attributable to ownership of
property where the transferor continues to retain significant
control over the property transferred. Arevalo v. Commissioner,
469 F.3d at 439; Crooks v. Commissioner, 453 F.3d at 656; see
also Frank Lyon Co. v. United States, 435 U.S. 561, 572-573
(1978); Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221,
1236 (1981).
If the benefits and burdens reflecting ownership have not
passed from “seller” to “purchaser”, the transfer of formal legal
title is disregarded when determining ownership of an asset for
purposes of depreciation. See Arevalo v. Commissioner, 469 F.3d
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at 439. Whether the benefits and burdens of ownership with
respect to property have passed to the taxpayer is a question of
fact that must be ascertained from the intention of the parties
as established by the written agreements read in the light of the
attending facts and circumstances. See Arevalo v. Commissioner,
124 T.C. at 251-252; Grodt & McKay Realty, Inc. v. Commissioner,
supra at 1237.
The denial of depreciation deductions in the Alpha
Telcom cases has been supported by the examination of six
factors: (1) Whether legal title passes; (2) the manner in
which the parties treat the transaction; (3) whether the
purchaser acquired any equity in the property; (4) whether the
purchaser has any control over the property, and, if so, the
extent of such control; (5) whether the purchaser bears the risk
of loss or damage to the property; and (6) whether the purchaser
will receive any benefit from the operation and disposition of
the property. Arevalo v. Commissioner, 469 F.3d at 439-440;
Crooks v. Commissioner, supra at 656; Arevalo v. Commissioner,
124 T.C. at 252.
If we consider the terms of the ATC pay phone agreements and
the Alpha Telcom service agreements together, Alpha Telcom was
responsible for selecting the locations of the pay phones,
negotiating site agreements with the owners or lessees of the
premises where the pay phones were to be installed, installing
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the pay phones, obtaining all licenses needed to operate the pay
phones, insuring and maintaining the pay phones, collecting and
accounting for the revenues generated by the pay phones, and
paying vendor commissions and fees. Petitioners never saw or
possessed the pay phones or knew where they were to be installed.
Furthermore, Alpha Telcom was entitled to receive most of the
profit, and it bore the risk of loss if the pay phones did not
generate sufficient revenue. Regardless of the revenues actually
generated, petitioners were guaranteed to be paid at least $58.34
per month per pay phone. See Arevalo v. Commissioner, 124 T.C.
at 247, 253. In addition, the ATC pay phone agreements allowed
petitioners to sell the pay phones back to ATC for a fixed
formula price.
For the foregoing reasons, the Court finds that petitioners
did not receive the benefits and burdens of ownership with
respect to the seven pay phones. Therefore, they are not
entitled to a depreciation deduction of $2,143 under section 167
for 2001. See Arevalo v. Commissioner, 124 T.C. at 253.
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III. Disabled Access Credits
For purposes of the general business credit under section
38, section 44(a) provides a disabled access credit for certain
small businesses. The amount of this credit is equal to 50
percent of the “eligible access expenditures” of an “eligible
small business” that exceed $250 but that do not exceed $10,250
for the year. Sec. 44(a).
In order to claim the disabled access credit, a taxpayer
must demonstrate: (1) The taxpayer is an “eligible small
business” for the year in which the credit is claimed and (2)
the taxpayer has made “eligible access expenditures” during that
year. If the taxpayer cannot fulfill both of these requirements,
the taxpayer is not eligible to claim the credit for that year.
For purposes of section 44, the term “eligible small
business” means any person who (1) had gross receipts
of no more than $1 million for the preceding year or not more
than 30 full-time employees during the preceding year and (2)
elects the application of section 44 for the year. Sec. 44(b).
The term “eligible access expenditures” means amounts
paid or incurred by an eligible small business to enable the
eligible small business to comply with the requirements under the
ADA.4 Sec. 44(c)(1).
4
Such expenditures include amounts paid or incurred: (1)
To remove architectural, communication, physical, or
(continued...)
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As relevant here, the requirements set forth in the ADA
apply to: (1) Persons who own, lease, lease to, or operate
certain places of “public accommodation”; and (2) any “common
carrier” of telephone voice transmission services. See 42 U.S.C.
sec. 12182(a) (2000); see also 47 U.S.C. sec. 225(c) (2000). A
person who does not have an obligation to comply with the
requirements set forth in the ADA could never make an eligible
access expenditure. Arevalo v. Commissioner, 124 T.C. at 255.
As in the Alpha Telcom cases, petitioners neither owned,
leased, leased to, or operated a public accommodation during
2001, nor were they a “common carrier” of telephone voice
transmission services during 2001. See Arevalo v. Commissioner,
469 F.3d at 440-441; Crooks v. Commissioner, 453 F.3d at 657;
Arevalo v. Commissioner, 124 T.C. at 255-256. Accordingly, the
Court finds that petitioners were not obligated to comply with
4
(...continued)
transportation barriers that prevent a business from being
accessible to, or usable by, individuals with disabilities; (2)
to provide qualified interpreters or other effective methods of
making aurally delivered materials available to individuals with
hearing impairments; (3) to acquire or modify equipment or
devices for individuals with disabilities; or (4) to provide
other similar services, modifications, materials, or equipment.
See sec. 44(c)(2). Eligible access expenditures do not
include expenditures that are unnecessary to accomplish such
purposes. See sec. 44(c)(3). Additionally, eligible access
expenditures do not include amounts that are paid or incurred to
remove architectural, communication, physical, or transportation
barriers that prevent a business from being accessible to, or
usable by, individuals with disabilities with respect to any
facility first placed in service after Nov. 5, 1990. See sec.
44(c)(4).
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the requirements set forth in the ADA during 2001. See Arevalo
v. Commissioner, 124 T.C. at 255-256. Therefore, petitioners are
not entitled to claim the disabled access credit under section 44
for their investment in the pay phones in 2001. See id. at 257-
258.
IV. Expense Deduction
Respondent contends that petitioners were not entitled to
the $14,000 expense deduction under section 162(a) in 2002
because they failed to establish that they paid or incurred any
expenses with respect to a pay phone trade or business in 2002.
Under section 162(a), a taxpayer may deduct ordinary and
necessary business expenses incurred or paid during the taxable
year. The taxpayer is required to maintain records sufficient to
enable the Commissioner to determine his correct tax liability.
See sec. 6001; sec. 1.6001-1(a), Income Tax Regs. The taxpayer
has the burden to prove the Commissioner’s determination was
incorrect. Rule 142(a).
Petitioners produced no evidence to indicate that they paid
or incurred $14,000 of business expenses with respect to their
pay phone business in 2002. On this record, the Court finds that
petitioners are not entitled to deduct the $14,000 as a business
expense under section 162(a) in 2002.
Petitioners also testified that the $14,000 was not an
expense deduction but a depreciation deduction and they should
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have claimed $24,750, instead of $14,000, which was the remainder
of the cost of the seven pay phones. However, as the Court found
above, petitioners did not receive the benefits and burdens of
ownership with respect to the seven pay phones. Therefore,
petitioners are not entitled to a depreciation deduction for any
amount under section 167 with respect to the seven pay phones in
2002.
In reaching our holdings herein, we have considered all
arguments made, and, to the extent not mentioned above, we find
them to be moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.