T.C. Summary Opinion 2008-63
UNITED STATES TAX COURT
JONELLE MARIE BROADY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14675-06S. Filed June 5, 2008.
Jonelle M. Broady, pro se.
Veena Luthra, for respondent.
GOLDBERG, Special Trial Judge: This case was heard pursuant
to the provisions of section 7463 of the Internal Revenue Code in
effect at the time the petition was filed. 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. Unless otherwise indicated, subsequent
section references are to the Internal Revenue Code in effect for
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the year in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
Respondent determined a $3,579 deficiency in petitioner’s
income tax for 2003. The issues for decision are: (1) Whether
petitioner operated a daycare business out of her home during the
year in issue, and if so, whether she is entitled to claim
certain business-related expenses, and (2) whether petitioner is
entitled to claim certain tax credits (a child tax credit, an
additional child tax credit, and the earned income credit (EIC))
for the year in issue.
Background
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. Petitioner resided in
Maryland when she filed her petition.
In 1992 petitioner and her boyfriend (the couple) moved into
a rented home in Bowie, Maryland. The house was a Cape Cod-style
house situated on approximately one-third acre. The house had
five bedrooms, 2-1/2 bathrooms, a large living room, and a large
backyard. Petitioner has four children. The couple never
married.
Petitioner did not work outside of the couple’s home.
Petitioner’s sister and her boyfriend’s sister asked petitioner
to provide daycare services for their children in the couple’s
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home. Although petitioner did not envision starting a daycare
business per se, she soon found herself the recipient of multiple
inquiries for her services from neighboring parents, parents at
her children’s daycare and school, and parents she met while
shopping in the supermarket. On the basis of this response, and
her desire to make money, petitioner decided to operate a daycare
business in the couple’s home.
In 2003 petitioner had at least eight children enrolled in
her daycare, not including her own four children, two of whom
stayed home with her during the day. Three of the children
belonged to her neighbors. Four of the children belonged to
either her sister or her boyfriend’s sister. At least one other
child belonged to a parent she met while shopping.
Petitioner’s daycare service operated 5 days per week, from
early morning through the early evening. Petitioner provided
breakfast, lunch, and two snacks to the children in her care.
The daycare activity occupied the family room, dining room, and
kitchen of the couple’s home. Petitioner would sometimes take
the children in her care on field trips to places such as the
National Zoo in Washington, D.C. When making such field trips,
petitioner would use her vehicle, a 1985 Chevrolet Cavalier
station wagon, to transport herself and the children.
Petitioner charged for her services according to the length
of time that the child was in her care each day. If the child
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was in petitioner’s care for the full day, the charge was $80 per
week. If the child was in petitioner’s care only after school,
then the charge was $60 per week. On occasion, petitioner would
negotiate a lower fee for parents whom she knew to be single
parents with one income. Petitioner accepted only cash. The
parents would pay either at the end of the week or at the end of
every other week, pursuant to their pay cycle. At the end of
each calendar year, including the year in issue, petitioner would
provide the parents with a dated receipt showing the total number
of weeks of childcare she provided for their child(ren) and the
total cost. Petitioner included her name and full address of the
child(ren) on the receipt, as well as her “Tax ID” number. The
“Tax ID” number provided on these receipts was actually
petitioner’s Social Security number.
Although she had taken a childcare course years before she
started her service, petitioner did not have a daycare license
and did not have either a business phone line or a business
checking account. When petitioner was paid in cash, she usually
used the bulk of the money to purchase items for the daycare, her
household, or for herself and her children. Petitioner would
deposit whatever cash was remaining after these purchases into
her personal checking account.
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Petitioner had a set of business cards made which advertised
her daycare service, and she placed advertisements for her
service in the local “Pennysaver” gazette.
Petitioner ceased her daycare service in November of 2003.
Petitioner moved out of the couple’s home sometime in 2004.
Petitioner prepared her timely filed 2003 Federal income tax
return using TurboTax. Petitioner reported $22,070 of wage
income and $7 interest and claimed the following tax credits:
(1) A $593 child tax credit; (2) an additional $1,157 child tax
credit; and (3) a $2,422 earned income credit.
On May 2, 2006, respondent sent petitioner a notice of
deficiency wherein respondent determined a deficiency of $3,579,
resulting from the disallowance of the additional child tax
credit and the earned income credit on the ground that petitioner
did not have income for 2003 that would entitle her to claim
those credits.1 Respondent also determined that petitioner had
nonemployee compensation of $325 for 2003. Petitioner concedes
that she did receive this income but failed to report it on her
return.
1
Form 4549, Income Tax Examination Changes, does not
include the $593 child tax credit taken on petitioner’s income
tax return but rather lists “0.00” for the credit. As the
examination determined that petitioner had adjusted gross income
of $325 for the year in issue, and, accordingly, a corrected tax
liability of zero for 2003, petitioner would not have been
entitled to a child tax credit for that year under sec. 24(b)(3).
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Petitioner timely filed her petition. Subsequently,
petitioner submitted a Form 1040X, Amended U.S. Individual Income
Tax Return, for 2003 to respondent. Petitioner attached a
Schedule C, Profit or Loss From Business, to her amended return
and reported on that schedule gross income of $27,395 for 2003.
Petitioner also reported on that schedule expenses related to
advertising, car and truck expenses, office expenses, repairs and
maintenance, supplies, utilities, and other expenses. These
expenses totaled $12,445.
Petitioner deducted: (1) Advertising expenses of $200,
which included the cost of business cards that she had printed
and advertisements placed in the “Pennysaver” gazette; (2) car
and truck expenses of $1,295 related to mileage, insurance, and
repairs for the 1985 Chevrolet Cavalier; (3) $6,500, which
included the cost of office supplies such as pens and paper which
she used in her daycare service; (4) repairs and maintenance
expenses of $220; (5) supply expenses of $630, which included
expenses related to arts and crafts supplies; (6) utility
expenses of $1,780; and (7) other expenses of $1,820, which
related to food costs associated with her feeding the children in
her care.
Discussion
In general, the Commissioner’s determination as set forth in
a notice of deficiency is presumed correct and the burden of
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proof is on the taxpayer to prove otherwise. Rule 142(a)(1);
Welch v. Helvering, 290 U.S. 111, 115 (1933). Tax deductions are
a matter of legislative grace, and the taxpayer bears the burden
of proving entitlement to deductions claimed on a return. Rule
142(a)(1); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).
Under certain circumstances the burden of proof with respect
to relevant factual issues may shift to the Commissioner under
section 7491(a). The burden of proof may shift to the
Commissioner under section 7491(a) if the taxpayer establishes
compliance with the requirements of section 7491(a)(2)(A) and (B)
by substantiating items, maintaining required records, and fully
cooperating with the Secretary’s reasonable requests. As
discussed below, we find that petitioner has failed to
substantiate her claimed expenses and maintain required records.
The outcome of this case, however, will be based on the
preponderance of the evidence standard and thus is unaffected by
section 7491. See Estate of Bongard v. Commissioner, 124 T.C.
95, 111 (2005).
Although respondent had not accepted petitioner’s amended
tax return as of the date of the trial, respondent’s litigating
position is that petitioner’s daycare was not a business operated
for profit in 2003; and that even if the Court determined that it
was, petitioner has failed to substantiate both her income from
that activity and the aforementioned expenses.
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Section 162(a) allows deductions for all ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business. To be engaged in a trade or
business within the meaning of section 162(a), an individual
taxpayer must be involved in the activity with continuity,
regularity, and with the primary purpose of deriving a profit.
Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). Deciding
whether the taxpayer is carrying on a trade or business requires
an examination of all of the facts in each case. Id. at 36.
Although a reasonable expectation of a profit is not
required, the taxpayer’s profit objective must be actual and
honest. Dreicer v. Commissioner, 78 T.C. 642, 644-645 (1982),
affd. without published opinion 702 F.2d 1205 (D.C. Cir. 1983);
sec. 1.183-2(a), Income Tax Regs. Whether a taxpayer has an
actual and honest profit objective is a question of fact to be
answered from all of the relevant facts and circumstances.
Hastings v. Commissioner, T.C. Memo. 2002-310; sec. 1.183-2(a),
Income Tax Regs.
On our review of the record, we conclude that petitioner
operated a daycare business in the couple’s home during 2003 with
continuity, regularity, and with the primary purpose of making a
profit. Petitioner watched at least eight children each weekday
in her home from January through November of 2003. Although she
did not hold a license or have a separate phone line for her
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business, we are convinced that she operated her daycare service
in a reasonable manner as compared to other similar home-based
daycare services. That is, while we do not condone petitioner’s
lack of a license, we are convinced from her testimony that she
did in fact provide daycare services each weekday for 11 months
of 2003 and that her stated goal (“to make money for [the
couple’s] household”) adequately satisfies the profit motive
requirement. In fact, petitioner’s amended return shows a
$14,950 profit for 2003. Therefore, we are satisfied that
petitioner operated a business within the meaning of section
162(a) for the year in issue.
We are further convinced that petitioner received $17,950 in
income from her business for 2003 as evidenced by an adding
machine tape received into evidence by the Court and her credible
testimony that the tape reflected amounts she received. On the
basis of the entire record, we believe that the figures on the
adding machine tape represent the most accurate record of the
amounts that petitioner actually received for her daycare
services for 2003.
Petitioner did provide copies of receipts akin to those that
she provided to parents at the end of 2003 for daycare services
rendered in that year. These were not, however, actual copies of
those receipts. Petitioner compiled these receipts for trial
from her recollection of records she maintained at the couple’s
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home, which she no longer had access to. Each one of these
receipts notes the name(s) and addresses of the child(ren) during
2003 as well as the addresses of the child(ren) as of the date of
trial. While we view these receipts as support for petitioner’s
testimony that she did, in fact, have at least eight children
enrolled in her daycare for 2003, we are not confident that the
total charges reflected after adding up these receipts ($22,190)
represent petitioner’s income from her daycare for 2003.
Petitioner has failed to substantiate any of the Schedule C
expenses for her daycare for 2003. The scant evidence she
provided consisted only of copies of her checking account
statements for 2003 and canceled checks made payable to Baltimore
Gas & Electric. The only testimony offered was with respect to
petitioner’s advertising costs, car and truck expenses, supplies,
and other expenses. Petitioner testified as to having printed
business cards and placing advertisements in the “Pennysaver”
gazette, using her car for occasional field trips with the
children, buying arts and crafts supplies, and feeding the
children at least two meals and two snacks each day. Petitioner
did not, however, provide any records or receipts to substantiate
any of these expenses, copies of her business cards, or copies of
the advertisements, and she did not introduce any evidence on
which we may estimate the amounts that she paid for such expenses
during 2003. On the record before us, we conclude that it would
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be inappropriate for us to estimate that amount. Cf. Cohan v.
Commissioner, 39 F.2d 540 (2d Cir. 1930).
Finally, and with respect to petitioner’s entitlement to
certain tax credits (a child tax credit, an additional child tax
credit, and the EIC), respondent disallowed these credits on the
basis of his determination that petitioner had adjusted gross
income of $325, and no tax liability, for 2003. An eligible
individual is entitled to an EIC against the individual’s income
tax liability, subject to certain requirements. Sec. 32(a)(1).
Different percentages and amounts are used to calculate the
credit depending on whether the eligible individual has no
qualifying children, one qualifying child, or two or more
qualifying children. Sec. 32(b). To be eligible to claim an EIC
with respect to a “qualifying child”, a taxpayer must establish,
inter alia, that the child bears one of the defined relationships
to the taxpayer specified in section 32(c)(3)(B). Under section
24(a) and (c) a taxpayer may be entitled to a child tax credit
with respect to each qualifying child under the age of 17 as
described in section 32(c)(3)(B).
Respondent does not dispute that petitioner had two
qualifying children for which she would be entitled to an EIC
and/or a child tax credit. Respondent’s disallowance is based
solely on petitioner’s income for 2003. Respondent determined
that petitioner had only $325 in income for the year in issue.
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We have concluded that petitioner had $17,950 in gross receipts
for 2003 from her daycare business, but she is not entitled to
claim expense deductions for any of the amounts reported on
Schedule C of the amended income tax return as they have not been
substantiated. Accordingly, and to whatever extent therefore
allowable under sections 24 and 32, respectively, petitioner is
entitled to an EIC, a child tax credit, and an additional child
tax credit for 2003.
In the light of our conclusion that petitioner had $17,950
in income from her daycare business for 2003 (in addition to the
$325 in nonemployee compensation that she received for that
year), petitioner’s correct tax liability must be computed so as
to determine whether petitioner is entitled to a child tax
credit, an additional child tax credit, and an EIC for the year
in issue.
To take account of the necessary recomputation of
petitioner’s correct tax liability for 2003,
Decision will be entered
under Rule 155.