T.C. Summary Opinion 2008-146
UNITED STATES TAX COURT
MARIO MARQUETTE AND SHONEISHA MYERS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14323-06S. Filed November 24, 2008.
Mario Marquette and Shoneisha Myers, pro se.
Beth A. Nunnink, for respondent.
WELLS, 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.1 Pursuant to section
7463(b), the decision to be entered is not reviewable by any
1
All section references are to the Internal Revenue Code in
effect for the year in issue.
-2-
other court, and this opinion shall not be treated as precedent
for any other case.
Respondent determined a deficiency of $6,766 and an addition
to tax of $1,353.20 with regard to petitioners’ Federal income
tax for 2004. After concessions, the issues we must decide are:
(1) Whether petitioners are entitled to deduct certain expenses
for petitioner husband’s used car sales business in excess of
those previously allowed by respondent;2 (2) whether petitioners
are entitled to deduct certain expenses for a real estate
business reported on a Schedule C, Profit or Loss From Business,
attached to their return; and (3) whether petitioners are liable
for the accuracy-related penalty under section 6662(a).
Background
Some of the facts and certain exhibits were stipulated by
the parties. We incorporate the parties’ stipulations of fact in
this Summary Opinion and the parties’ stipulations of fact are
found accordingly.
At the time they filed their petition in the instant case,
petitioners resided in Tennessee.
Petitioners timely filed their 2004 tax return. Petitioners
attached to their return a Schedule C for a real estate property
business. On the Schedule C, petitioners failed to include the
2
Petitioners concede that they received gross receipts of
$39,900 in the Schedule C auto sales business.
-3-
gross receipts and expenses for petitioner husband’s used car
sales business.
Petitioners maintained no books or ledgers in regard to
their businesses. Petitioners dealt primarily in cash, debit
card charges, and checks.
In a Form 1040X, Amended U.S. Individual Income Tax Return,
that petitioners gave respondent after the notice of deficiency
was sent to petitioners, petitioners claimed that they are
entitled to certain expenses. Petitioners assert that the Form
1040X should be accepted as the “correct activity”.
In the Form 1040X, petitioners included $39,900 of
gross receipts from the used auto sales business. On the Form
1040X, petitioners also reported the following amounts on a
Schedule C: cost of goods sold of $35,325, advertising expenses
of $644, car and truck expenses of $528, legal and professional
services expenses of $260, telephone expenses of $852, and office
expenses of $1,686.
In the notice of deficiency, respondent disallowed the
claimed deductions for the real estate property business,
included the income of $39,900 for the used car sales business,
allowed $27,400 for cost of goods sold, and allowed deductions of
$1,086 for repairs and maintenance, $582 for commissions and
fees, and $5,175 for cost of labor.
-4-
Discussion
Generally, deductions are a matter of legislative grace, and
the burden of clearly showing the right to claimed deductions is
on the taxpayer. Welch v. Helvering, 290 U.S. 111 (1933).
Section 162(a) allows the deduction of “ordinary and necessary
expenses” incurred while carrying on a trade or business. Cost
of goods sold is an offset to gross receipts in determining gross
income. Sec. 1.61-3(a), Income Tax Regs. Accordingly, cost of
goods sold is not treated as a deduction and is not subject to
requirements for deductions contained in sections 162 and 274.
Metra Chem Corp. v. Commissioner, 88 T.C. 654, 661 (1987).
However, any amount claimed as cost of goods sold must be
substantiated, and section 6001 requires a taxpayer to maintain
adequate books of accounts or records that are sufficient to
establish the amount of gross income, deductions, or other
matters required to be shown by such persons on their tax return.
See Nunn v. Commissioner, T.C. Memo. 2002-250.
If a taxpayer establishes that a deductible expense has been
paid but is unable to substantiate the precise amount, the Court
may estimate the amount of the deductible expense bearing heavily
against the taxpayer whose inexactitude in substantiating the
amount of the expense is of his own making. Cohan v.
Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). An estimate
-5-
is only possible, however, if the taxpayer presents evidence
sufficient to provide some basis upon which an estimate can be
made. Vanicek v. Commissioner, 85 T.C. 731, 743 (1985). We
address below the issues presented by the parties.
I. Cost of Goods Sold and Deductions and Expenses for the Used
Car Sales Business
Petitioners claimed the following cost of goods sold and
expenses in the Form 1040X: cost of goods sold of $35,325,
advertising expenses of $644, car and truck expenses of $528,
legal and professional services expenses of $260, telephone
expenses of $852, and office expenses of $1,686. As petitioners
assert that the Form 1040X furnished to respondent is correct, we
deem conceded any other amounts claimed by petitioners.
A. Cost of Goods Sold
For cost of goods sold, petitioners reported inventory at
the beginning of year of $33,825, no inventory at the end of the
year, and cost of labor of $1,500, for cost of goods sold of
$35,325. However, petitioners had previously provided to
respondent cash receipts for cost of labor of $5,175, which
respondent allowed in the notice of deficiency. Respondent
allowed inventory of $27,400 and cost of labor of $5,175, for
total cost of goods sold of $32,575.
Petitioners offered an auto repair order dated July 31,
2004, for a 1994 Audi. The record does not indicate whether the
-6-
amount stated in the auto repair order was actually paid.
Petitioners had previously provided to respondent a “cash
receipt” dated August 18, 2004, for the 1994 Audi for $375, and
respondent allowed the $375 for the 1994 Audi in cost of labor.
In the notice of deficiency, respondent allowed more cost of
labor than petitioners claimed in the Form 1040X.
Petitioners dealt mainly in cash. Petitioners offered no
documents regarding inventory and cost of goods sold.
On the basis of the record, we hold that petitioners have
not shown that they are entitled to any additional cost of labor
beyond the amount allowed by respondent in the notice of
deficiency.
B. Commissions and Fees
In the notice of deficiency, respondent allowed fees of
$582. Petitioners offered 11 receipts from a “Commercial
Appeal”. Of those receipts, respondent allowed as expenses some
of the debit card charges labeled Trade Pub, Shoppers Press, or
Commercial Appeal. Petitioners have failed to offer any invoices
or receipts that show the business purpose of the payments to
Trade Pub, Shoppers Press, or Commercial Appeal. Petitioners
used their checking account for both personal and business
expenses. On the basis of the record, we conclude that
petitioners have failed to show that the remaining debit card
charges for Trade Pub, Shoppers Press, and the Commercial Appeal
-7-
were business expenses. Accordingly, we hold that petitioners
are not entitled to any additional fees beyond the amount allowed
by respondent in the notice of deficiency.
C. Car and Truck Expenses
Petitioners claim they are entitled to a deduction of $528
for car and truck expenses. Petitioners offered one auto fuel
receipt for $12 from Kroger, but the record contains no evidence
as to any car and truck expenses.
Car and truck expenses are subject to the strict
substantiation requirements found in section 274(d). See also
sec. 280F(d)(4)(A)(i) and (ii). The taxpayer must provide
documents that corroborate by adequate records or by sufficient
evidence the amount of the expense, the mileage for each business
use of the automobile and the total mileage for all uses of the
automobile during the taxable period, the date of the business
use, and the business purpose for the use. Sec. 1.274-5T(b)(6),
Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).
The taxpayer must substantiate each element of an expenditure or
use by adequate records or by sufficient evidence. Sec. 1.274-
5T(c), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6,
1985).
Petitioners have failed to meet the strict substantiation
requirements. Consequently, we hold that they are not entitled
to deduct car and truck expenses.
-8-
D. Legal and Professional Services
Petitioners claim they are entitled to deduct expenses of
$260 for legal and professional services. At trial, petitioners
offered an invoice dated August 31, 2004, of $500 for tax
preparation fees. Petitioner husband testified that the invoice
was for the 2004 tax return. However, the document appears to be
the tax preparation fees for petitioners’ individual income
returns for 2001, 2002, and 2003. Petitioners claimed tax
preparation fees of $250 on their Schedule A of Form 1040X. No
checks or cash receipts are in the record to show that the $500
invoice actually was paid. The record contains no other evidence
of any expenses for legal or professional services for the used
car sales business. On the basis of the record, we hold that
petitioners are not entitled to a deduction for legal or
professional services.
E. Telephone Expenses
Petitioners claimed telephone expenses of $852. Cellular
phones are included in the definition of “listed property” for
purposes of section 274(d)(4) and are thus subject to the strict
substantiation requirements of section 274(d). See sec.
280F(d)(4)(A)(v). Gaylord v. Commissioner, T.C. Memo. 2003-273.
A taxpayer must establish the amount of business use and the
amount of total use for the property in order to substantiate the
amount of expenses for listed property. Nitschke v.
-9-
Commissioner, T.C. Memo. 2000-230; sec. l.274-5T(b)(6)(i)(B),
Temporary Income Tax Regs., supra.
Petitioners offered records for Cingular and BellSouth
cellular phone accounts. However, petitioners offered no
evidence that such phones were business phones or, if they were,
the amount of business conducted with such phones. The Cingular
bills appear to be for two phone numbers, which appear to share
minutes. Petitioners offered no evidence as to why two phones
would be necessary for the Schedule C business. Petitioners
offered partial account information for October 28 through
December 28, 2004. While the only payment shown on the Cingular
account is an $80.18 payment on December 15, 2004, the detailed
account information shows a large portion of the calls being made
between the two phones. We conclude that petitioners have not
shown that the cellular phones are used solely for business.
Consequently, we hold that petitioners are not entitled to
deductions for the cellular phone expenses.
F. Office Expenses
Petitioners claimed office expenses of $1,686. Computer or
peripheral equipment is included in the definition of listed
property for purposes of section 274(d)(4) and is thus subject to
the strict substantiation requirements of section 274(d). See
sec. 280F(d)(4)(A)(iv). Petitioners offered a “missing receipt
affidavit” for a computer and accessories that totaled $1,686.
-10-
No additional evidence was offered at trial showing that
petitioners incurred expenses for a computer and accessories.
The receipts, invoices, and other records petitioners offered did
not indicate that petitioners owned a computer. Petitioners
offered no computer generated books, ledgers, or other records
that would indicate a computer was used in petitioners’
businesses. We conclude that petitioners have failed to show any
business usage of a computer. Consequently, we hold that
petitioners are not entitled to deductions for the claimed office
expenses.
II. Expenses for the Real Estate Business
On October 8, 2004, petitioners purchased a single-family
residence located at 1650 Hanauer Street, Memphis, Tennessee (the
Hanauer property) for $16,000. Petitioners converted the Hanauer
property to a six-unit apartment building. On their return,
petitioners deducted expenses related to the Hanauer property.
The costs of starting up a new income producing activity are
“inherently capital because they are expenses of creating or
acquiring a capital asset.” Hardy v. Commissioner, 93 T.C. 684,
690 (1989), affd. in part and remanded in part per order (10th
Cir., Oct. 29, 1990). Expenses must relate to trades or
businesses functioning at the time the expenses are incurred.
Id. at 688. Pursuant to section 263(a), capital expenses include
items that would be currently deductible but for the fact they
-11-
are expended for the acquisition or permanent improvement of a
capital asset. A taxpayer’s pre-opening expenses are not
ordinary expenses, but capital expenditures. Hardy v.
Commissioner, supra at 690.
The receipts, invoices, and contracts offered by petitioners
relating to the Hanauer property appear to relate to the
conversion of the single-family residence into six apartments.
Although petitioners claim an apartment was rented during 2004,
petitioners’ return does not report any rent. Moreover, the
record shows that petitioners never obtained a certificate of
occupancy for the Hanauer property.
Petitioners provided a month-to-month lease agreement dated
December 16, 2004, for apartment #3 of the Hanauer property.
However, as stated above, petitioners did not report any rental
income for taxable year 2004 on either their Form 1040, U.S.
Individual Income Tax Return, or their unfiled Form 1040X
prepared by their accountants. Moreover, the building permit
dated November 11, 2004, specifically states it is for a single-
family residence. The record discloses that a permit was not
requested for a multifamily residence until 2005. Additionally,
the record does not show that any certificate of occupancy has
been issued for the Hanauer property. The single-family permit
issued in 2004 expired on June 9, 2005, without any inspection or
certificate of occupancy. Additionally, it appears that
-12-
significant work remained to be done on the Hanauer property at
the close of 2004. On the basis of the record, we hold that
petitioners have failed to prove that the Hanauer property was
placed in service during 2004. Accordingly, we hold that the
expenses in issue are pre-opening expenses and are capital
expenditures that are not currently deductible. Respondent also
contends that petitioners have failed to substantiate the
expenses. However, on the basis of our holding that the expenses
are all pre-opening expenses, we need not address that issue.
III. The Accuracy-Related Penalty Under Section 6662(a)
Section 6662(a) and (b)(1) and (2) imposes a penalty on the
portion of a taxpayer’s underpayment of tax which is attributable
to a substantial understatement of income tax, negligence, or
disregard of rules or regulations. A “substantial
understatement” of income tax exists for any taxable year when
the amount of the understatement exceeds the greater of $5,000 or
10 percent of the tax required to be shown on the return. Sec.
6662(d)(1). Negligence is any failure to make a reasonable
attempt to comply with the provisions of the Internal Revenue
Code, and disregard is any careless, reckless, or intentional
disregard. Sec. 6662(c). Negligence includes the failure of a
taxpayer to keep proper records or to substantiate his reported
expenses. Sec. 1.6662-3(b)(1), Income Tax Regs. Pursuant to
-13-
section 7491(c), the Commissioner bears the burden of production
with respect to the imposition of any penalty.
Petitioners failed to maintain books, ledgers, and financial
records for the used car sales business and real estate business.
Petitioners failed to report the used car sales business on their
return that they filed. Petitioners dealt mainly in cash and did
not have receipts, invoices, or contracts for many of the claimed
expenses. On the basis of the record, we conclude that
petitioners were negligent. Consequently, we hold that
petitioners are liable for the penalty under section 6662.
We have considered all of the contentions and arguments of
the parties, and to the extent not discussed herein, we conclude
that they are without merit, irrelevant, or moot.
To reflect the foregoing,
Decision will be entered
for respondent.