T.C. Summary Opinion 2009-88
UNITED STATES TAX COURT
MICHELLE L. AND DUKE T. HWYNN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19862-07S. Filed June 2, 2009.
Michelle L. Hwynn and Duke T. Hwynn, pro sese.
Michael K. Park, for respondent.
LARO, Judge: This case was heard pursuant to the
provisions of section 7463 of the Internal Revenue Code in effect
when the petition was filed.1 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.
1
Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code, and Rule
references are to the Tax Court Rules of Practice and Procedure.
Some dollar amounts are rounded.
- 2 -
Petitioners petitioned the Court to redetermine respondent’s
determinations relating to their Federal income taxes for 2004
and 2005. For 2004, respondent determined a $4,038 deficiency
and an $807.60 accuracy-related penalty under section 6662(a).
For 2005, respondent determined a $4,890 deficiency and a $987
accuracy-related penalty under section 6662(a).
At trial, respondent amended his answer to assert an
increased deficiency and accuracy-related penalty for 2004 of
$5,013 and $1,002.60, respectively. Following this amendment and
certain concessions, we are left to decide the following issues:
1. Whether petitioners may deduct unreimbursed employee
business expenses in amounts greater than those respondent
allowed. We hold they may not;
2. whether petitioners may deduct passthrough losses from
their wholly owned S corporation, Appworks Consulting, Inc.
(Appworks). We hold they may not except to the extent stated
herein;
3. whether Duke Hwynn (Mr. Hwynn) is an independent
contractor or an employee of Appworks. We hold he is an
employee;
4. whether petitioners are liable for the accuracy-related
penalties. We hold they are not.
Background
I. Preliminaries
The parties have submitted to the Court stipulations of fact
with accompanying exhibits. The stipulated facts and
- 3 -
accompanying exhibits are incorporated herein by this reference.
Petitioners are husband and wife, and they filed joint Forms
1040, U.S. Individual Income Tax Return, for 2004 and 2005. They
resided in California when they petitioned the Court.
II. Appworks
Petitioners formed Appworks, a computer consulting business,
in 1996. Appworks is taxed as an S corporation, and each
petitioner owns one-half of its stock. Mr. Hwynn is Appworks’
president. He is the only person who performs services on its
behalf, and he is Appworks’ sole source of income. Michelle
Hwynn, also known as Hui Lu (Ms. Hywnn), is employed full time as
a registered nurse.
III. Petitioners’ 2004 Federal Income Tax Return
A. Unreported Wages
Appworks paid Mr. Hwynn $6,500 in wages during 2004.
Petitioners failed to report those wages on their 2004 Federal
income tax return. The increase in deficiency asserted in the
amendment to answer is attributable to respondent’s allegation
that the $6,500 is includable in petitioners’ gross income for
2004. Petitioners agree with that allegation. We hold without
further discussion that the $6,500 is includable in petitioners’
gross income for 2004.
B. Unreimbursed Business Expenses
Petitioners claimed on their 2004 return a $6,930 deduction
for unreimbursed employee business expenses of Mr. Hwynn,
reporting that he incurred those expenses while working as an
- 4 -
employee of Appworks. Petitioners now seek to deduct an
additional $16,471 of such expenses. The specifics of these
expenses are as follows:
Reported Expenses Additional Expenses
Vehicle $3,750 $6,978
Parking fees and tolls 150 150
Business 2,780 9,195
Meals and entertainment 250 418
Total 6,930 16,741
Petitioners elected to use the applicable standard mileage rate
of 37.5 cents to report the business expenses of their vehicles
and, accordingly, computed the $3,750 of vehicle expenses
reported on their return by multiplying 37.5 cents by 10,000
business miles reportedly driven by Mr. Hwynn during 2004. The
additional vehicle expenses of $6,978 included petitioners’ claim
of some of the actual expenses of Mr. Hwynn’s vehicle.
Petitioners also claimed on their 2004 return a $3,051
deduction for unreimbursed employee business expenses of Ms.
Hwynn, reporting that she incurred those expenses while working
as a registered nurse. Petitioners now seek to deduct an
additional $4,808 of such expenses. The specifics of these
expenses are as follows:
Reported Expenses Additional Expenses
Vehicle $1,125 $1,232
Travel 35 415
Business 1,516 1,590
Meals and entertainment 375 1,571
Total 3,051 4,808
- 5 -
Petitioners computed the $1,125 of vehicle expenses by
multiplying the applicable standard mileage rate of 37.5 cents by
3,000 business miles reportedly driven by Ms. Hwynn during 2004.
The additional vehicle expenses of $1,232 included petitioners’
claim of some of the actual expenses of Ms. Hwynn’s vehicle.
Respondent concedes that petitioners may deduct $1,063 of
the unreimbursed employee business expenses relating to Mr.
Hwynn. The $1,063 relates entirely to Mr. Hwynn’s use of his
vehicle. Respondent also concedes that petitioners may deduct
$1,337 of the unreimbursed employee business expenses relating to
Ms. Hwynn. The $1,337 is attributable to the individual expenses
as follows: $986 for vehicle, $35 for travel, and $316 for
business.
C. Loss From Appworks
Petitioners claimed on their 2004 return a deduction for a
$15,968 loss passed through to them from Appworks. Respondent
determined that petitioners were not entitled to deduct any of
this loss because they failed to establish either of their stock
bases in Appworks.
IV. Petitioners’ 2005 Federal Income Tax Return
A. Mr. Hwynn’s Services for Appworks
During 2005, Appworks paid Mr. Hwynn $5,000 for his
services. Petitioners reported on their 2005 return that Mr.
Hwynn received the $5,000 as a self-employed individual
(independent contractor). Petitioners claimed deductions
- 6 -
totaling $12,378 for Mr. Hwynn’s self-employment expenses
relating to the reported business.
Respondent determined that Mr. Hwynn received the $5,000 as
an employee of Appworks and that petitioners were not entitled to
deduct any of the $12,378 as a self-employment expense.
Respondent also determined that petitioners could not deduct any
of the $12,378 as a different type of expense (e.g., an
unreimbursed employee business expense) because petitioners
lacked substantiation as to the amount.
B. Unreimbursed Employee Business Expenses
Petitioners claimed on their 2005 return a $15,498 deduction
for unreimbursed employee business expenses of Ms. Hwynn,
reporting that she incurred those expenses while working as a
registered nurse. Petitioners now seek to deduct an additional
$37,190 of such expenses. The specifics of these expenses are as
follows:
Reported Expenses Additional Expenses
Vehicle $1,213 $7,984
Parking fees and tolls 415 524
Travel 3,500 3,740
Business 9,370 22,122
Meals and entertainment 1,000 2,820
Total 15,498 37,190
Petitioners computed the $1,213 of vehicle expenses by
multiplying the applicable standard mileage rate of 48.5 cents by
2,500 business miles reportedly driven by Ms. Hwynn during 2005.
The additional vehicle expenses of $7,984 included petitioners’
claim of some of the actual expenses of Ms. Hwynn’s vehicle.
- 7 -
Respondent concedes that petitioners may deduct $3,140 of
the unreimbursed employee business expenses. That amount is
attributable to the individual expenses as follows: $1,213 for
vehicle, $203 for parking, and $1,724 for business.
C. Loss From Appworks
Petitioners also claimed on their 2005 return a deduction
for a $7,309 loss passed through to them from Appworks.
Respondent determined that petitioners were not entitled to
deduct any of this loss because they had failed to establish
either of their stock bases in Appworks.
Discussion
I. Income Tax Deficiencies
A. Burden of Proof
As to the income tax deficiencies, petitioners bear the
burden of proving that respondent’s determinations set forth in
the notice of deficiency are incorrect. See Rule 142(a)(1);
Welch v. Helvering, 290 U.S. 111, 115 (1933). While section
7491(a) sometimes shifts the burden of proof to the Commissioner,
that section is not applicable where, as here, petitioners have
failed to satisfy the recordkeeping and substantiation
requirements of the Code. See sec. 7491(a)(2)(A) and (B).
B. Unreimbursed Employee Business Expenses
Petitioners seek to deduct unreimbursed employee business
expenses in amounts greater than those respondent allowed. They
have not, however, proven that they are entitled to do so.
Petitioners provided the Court with various receipts, credit card
- 8 -
invoices, and other documents in an attempt to meet their burden
of proof. Those documents, however, establish that many of the
deductions petitioners claimed are simply their personal, living,
or family expenses.2 An individual generally may not deduct his
or her personal, living, or family expenses, sec. 262(a), and we
conclude that no exception to this general rule applies to the
facts at hand. Nor have petitioners established their
entitlement to deduct any of the remaining expenses. Among other
things, petitioners have met neither the substantiation nor the
recordkeeping requirements that apply to those expenses.3 See
sec. 6001 (providing that taxpayers must keep sufficient records
to substantiate any deduction that would otherwise be allowed by
the Code); see also sec. 274(d)
(providing that an individual may not deduct a travel,
entertainment, or vehicle expense unless he or she meets the
strict substantiation requirements of that section). We sustain
respondent’s determination as to this issue, as adjusted by his
concessions.
2
In fact, Mr. Hwynn admitted during his direct testimony
that he caused Appworks to pay most of petitioners’ living
expenses, including their rent, meals, and vehicle expenses.
3
Petitioners also seek to deduct their payment of parking
tickets and similar citations. Such expenses are fines or
penalties that are nondeductible, even if related to Appworks’s
business. See sec. 162(f). We also note that petitioners (as
they conceded at trial) are not entitled to deduct the actual
operating expenses of their vehicles (e.g., gas, repairs) in that
they reported those expenses using the applicable standard
mileage rates.
- 9 -
C. Passthrough Losses
Respondent disallowed petitioners’ deduction of the losses
passed through to them from Appworks because petitioners failed
to establish that either petitioner had any basis in Appworks. A
shareholder may not deduct a loss passed through to him or her
from an S corporation to the extent that the loss exceeds the sum
of the shareholder’s adjusted basis in his or her stock in the S
corporation, plus the shareholder’s adjusted basis of any debt
that the S corporation owes to the shareholder. See sec.
1366(d)(1). Petitioners have not produced any evidence that
would establish the requisite bases. We sustain respondent’s
disallowance of the reported passthrough losses.
D. Status as Employee or Independent Contractor
For 2005, respondent determined that Mr. Hwynn was an
employee of Appworks. Thus, respondent determined, the $5,000
that Mr. Hwynn received from Appworks was taxable to him as wages
and petitioners were not entitled to deduct any expense related
to Mr. Hwynn’s work for Appworks as a self-employment expense.
We agree with these determinations. An officer such as Mr. Hwynn
who performs substantial services for a corporation and who
receives remuneration in any form for those services is
considered to be an employee of that corporation. See sec.
3121(d)(1); Charlotte’s Office Boutique, Inc. v. Commissioner,
121 T.C. 89, 104 (2003), affd. 425 F.3d 1203 (9th Cir. 2005). We
sustain respondent’s determination that Mr. Hwynn was an employee
of Appworks and that petitioners are not entitled to deduct any
- 10 -
of the $12,378 as a self-employment expense. We further hold for
reasons similar to those discussed above as to the unreimbursed
employee business expenses that petitioners are not entitled to
deduct any of the $12,378.
II. Accuracy-Related Penalties
Respondent determined that petitioners are liable for
accuracy-related penalties under section 6662(a) and by way of an
amendment to answer increased the accuracy-related penalty for
2004 by $195. Respondent clarifies in his pretrial memorandum
that the accuracy-related penalty applies to both years because
of a substantial understatement of income tax in each year.
Section 6662(a) and (b)(2) imposes a 20-percent
accuracy-related penalty for any portion of an underpayment that
is attributable to a substantial understatement of income tax.
An understatement of income tax is the excess of the amount of
income tax required to be shown on the return for the taxable
year over the amount of income tax imposed that is shown on the
return, reduced by any rebate. See sec. 6662(d)(2)(A). An
understatement is substantial if it exceeds the greater of 10
percent of the tax required to be shown on the return for the
taxable year or, in the case of an individual, $5,000. See sec.
6662(d)(1)(A).
The Commissioner bears the burden of production with respect
to the applicability of an accuracy-related penalty determined in
a notice of deficiency. See sec. 7491(c). That burden requires
that the Commissioner produce sufficient evidence that it is
- 11 -
appropriate to impose an accuracy-related penalty. Once he has
met his burden, the burden of proof is upon the taxpayer to prove
that the accuracy-related penalty does not apply because of
reasonable cause, substantial authority, or the like. See secs.
6662(d)(2)(B), 6664(c); Higbee v. Commissioner, 116 T.C. 438, 449
(2001). As to respondent’s allegation of a $195 increase in the
accuracy-related penalty for 2004, respondent bears the burden of
proof as to that amount. See Rule 142(a)(1).
Respondent argues that he has met his burdens through the
inclusion in evidence of the notice of deficiency. We disagree.
Petitioners’ understatement for each year may be substantial only
if it exceeds $5,000. See sec. 6662(d)(1)(A). The notice of
deficiency determined the 2004 deficiency as $4,038 and the 2005
deficiency as $4,890. While respondent now asserts that the
deficiency for 2004 is actually $5,013 on account of his
amendment to answer, we do not believe that respondent’s amending
of his answer validates his earlier determination in the notice
of deficiency that the accuracy-related penalty is appropriate.
We do not sustain respondent’s determination as to the accuracy-
related penalty for either year.
Decision will be entered
under Rule 155.