T.C. Memo. 2009-133
UNITED STATES TAX COURT
PAUL RUDNICK, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 17500-06. Filed June 9, 2009.
Paul Rudnick, pro se.
Margaret Burow, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MARVEL, Judge: Respondent determined a deficiency of
$103,194 and a section 6662(a)1 accuracy-related penalty of
$20,634 with respect to petitioner’s 2004 Federal income tax.
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
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After concessions,2 the issues for decision are:
(1) Whether, and to what extent, petitioner is entitled to
certain deductions claimed on his Schedule A, Itemized
Deductions;
(2) whether, and to what extent, petitioner is entitled to
business expense deductions claimed with respect to a business
activity known as Eglobal Call Solutions;
(3) whether petitioner is liable for the 10-percent
additional tax under section 72(t) on early distributions from
qualified retirement plans; and
(4) whether petitioner is liable for the section 6662(a)
accuracy-related penalty.
FINDINGS OF FACT
Some of the facts have been stipulated. We incorporate the
stipulation of facts and supplemental stipulation of facts into
our findings by this reference. Petitioner resided in California
when he petitioned this Court.
Before 2004 petitioner was employed as president of a
software development company, Five-by-Five Networks, Inc. (Five-
2
Respondent concedes the $101 dividend income adjustment.
Respondent also concedes that petitioner is entitled to a home
mortgage interest deduction of $32,905, and petitioner concedes
that he is not entitled to the remaining home mortgage interest
deduction of $3,423. Respondent concedes that petitioner is
entitled to $10,998 of deductions claimed on Schedule C, Profit
or Loss From Business, for a business activity known as 4-Play,
and petitioner concedes that he is not entitled to the remainder
of those deductions claimed.
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by-Five Networks). Before and during 2004 petitioner was
involved in various business ventures related to software
development and telephone call centers in Vietnam and the United
States.
Petitioner’s Testimony at Trial
Petitioner testified regarding his involvement with several
business entities during 2003 and 2004. Although we find that
petitioner was engaged in a business activity during 2004 under
the name Eglobal Call Solutions, petitioner did not introduce
documents to establish the relationship, if any, between Eglobal
Call Solutions and other business activities mentioned during his
testimony. We are not willing to make findings of fact regarding
those business activities based solely on petitioner’s
uncorroborated testimony. However, we summarize petitioner’s
testimony to provide a framework for our holdings. That summary
is set forth below.
Five-by-Five Networks3 started a software development center
in Vietnam. Sometime around December 2003 or January 2004, when
Five-by-Five Networks ran out of money, petitioner acquired as
severance from his employment with Five-by-Five Networks4 the
3
The record does not show what kind of entity Five-by-Five
Networks was, nor does the record show who owned it.
4
The record does not show in which year (2003 or 2004) this
occurred or whether petitioner included the value of the software
program in his income.
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rights5 to a software development program that the Vietnam center
was developing. Specifically, petitioner acquired the rights to
two assets--I-Contact, integrated software that assisted with
Internet sales, and Hey-Voice, call center software that provided
an automated list of options over the telephone. However, when
petitioner acquired the rights to the software, it was not ready
for immediate use.
After receiving the rights to the software from Five-by-Five
Networks, petitioner arranged for employees at a Vietnam call
center to integrate the software petitioner had acquired from
Five-by-Five Networks into a software program called Integrated
Agent Desktop. Integrated Agent Desktop was necessary for
petitioner’s business to operate. Development and testing of
Integrated Agent Desktop occurred from early 2004 through August
2004. In March 2004 Integrated Agent Desktop was brought online
in beta version, and in June 2004 it was formally launched.
Around August or September 2004 Integrated Agent Desktop
underwent a major revision.
In approximately December 2003 or January 2004 petitioner
also obtained6 for $250,000 the rights to several assets from
Eglobal Call Networks, Inc. (Eglobal Call Networks), a
5
The record does not disclose how or in what name petitioner
acquired the rights.
6
The record does not disclose how or in what name petitioner
acquired the assets.
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corporation that was in the business of selling calling cards.
Those assets included a Voice Over IP network router in Vietnam,
fiber optic links from San Francisco to Hong Kong and from Hong
Kong to Vietnam, and billing equipment in San Francisco.
Petitioner made a downpayment of $125,000 to Eglobal Call
Networks and paid the balance of the purchase price by giving
Eglobal Call Networks cash to keep its business afloat.7
Petitioner and Eglobal Call Networks did not execute any
agreement or bill of sale formalizing the purchase. After the
purchase, petitioner began operating the assets jointly with
Eglobal Call Networks.
During 2004 petitioner effected several transactions using
the name Eglobal Call Networks. For example, on February 19 and
March 20, 2004, petitioner transacted with Business Wire using
Eglobal Call Networks’s account. Petitioner also placed an order
with Source Voice Data Systems Solutions under the name Eglobal
Call Networks and signed loan documents as president of Eglobal
Call Networks. In addition, petitioner had some control of
Eglobal Call Networks’s checking account and used Eglobal Call
Networks to transfer money to Vietnam.
7
Petitioner did not introduce any bank records to document
his investment, nor did he explain the relationship between
Eglobal Call Solutions (the business he operated) and Eglobal
Call Networks.
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Petitioner also formed a company called Eglobal Vietnam,
Ltd. (Eglobal Vietnam). Petitioner needed Eglobal Vietnam in
order to conduct business in Vietnam. Eglobal Vietnam operated
the call center in Vietnam. Although petitioner provided funding
to Eglobal Vietnam, he held no ownership interest.8
In 2004 Eglobal Vietnam entered into a lease agreement with
Quang Trung Software City Development Co. for a facility in
Vietnam. Eglobal Vietnam also contracted with Quang Trung
Software City Development Co. to construct a call center facility
in Vietnam. In July 2004 Eglobal Vietnam moved into the newly
constructed call center facility, and in September 2004 the call
center started generating customer traffic.
In October 2004 Eglobal Call Solutions began to generate
revenue. During 2004 Eglobal Call Solutions’s revenue came from
two customers, Tata Consulting and H & R Block. Eglobal Call
Solutions earned income when employees of the two customers
contacted the call center in Vietnam for technical support
involving software operation.9
Petitioner employed a bookkeeper in Vietnam to help keep his
business records. The bookkeeper used Quickbooks to keep
8
Petitioner did not introduce any documentation regarding
the formation and ownership of Eglobal Vietnam.
9
Petitioner did not explain the relationship between Eglobal
Call Solutions, Eglobal Call Networks, and Eglobal Vietnam, but
his testimony implied that Eglobal Call Solutions income was
generated by the business activity in Vietnam.
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records, and petitioner reviewed the records when he visited
Vietnam. The bookkeeper provided petitioner information from the
Quickbooks records to complete his tax returns.
In 2005 Vietnamese authorities raided the Vietnam facility
because, unbeknownst to petitioner, a manager of Eglobal Vietnam
was operating without a required license. During the raid the
authorities seized various business records.
Petitioner’s 2004 Return
Petitioner, a cash basis taxpayer, prepared his 2004 Form
1040, U.S. Individual Income Tax Return (2004 return).
Petitioner’s Schedule A attached to his 2004 return showed the
following:
Schedule A Expenses Amount
Medical and dental expenses1 $41,000
Taxes
State and local income taxes 2,621
Real estate taxes 10,144
Personal property taxes 3,450
Home mortgage interest and points 36,328
Gifts to charity
Gifts by cash or check 1,360
Other than cash or check 112
Job expenses and most other
miscellaneous deductions2
Unreimbursed employee expenses 118,052
Attorney’s and accountant’s fees 26,575
1
After the application of the 7.5-percent floor under sec.
213(a).
2
Amounts reflect deductions as reported before application
of the 2-percent limitation under sec. 67(a).
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On the Schedule C, Profit or Loss From Business, for Eglobal
Call Solutions attached to his 2004 return, petitioner reported
gross receipts of $45,060 and the following Schedule C expenses:
Schedule C Expenses Amount
Advertising $34,090
Commissions and fees 1,222
Contract labor 4,534
Employee benefit programs 4,532
Insurance 12,389
Legal and professional services 1,459
Office expenses 8,123
Rent or lease
Other business property 88,045
Supplies 2,333
Taxes and licenses 3,123
Travel 6,123
1
Meals and entertainment 6,745
Utilities 13,455
Wages 96,050
1
Amount reflects the deductions for meals and entertainment
expenses as reported before application of the 50-percent
limitation under sec. 274(n).
Petitioner, who was not yet 59-1/2, reported $208,226 of
taxable pension and annuity income on his 2004 return.
Petitioner attached to his 2004 return Form 5329, Additional
Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored
Accounts. On Form 5329 petitioner reported early distributions
of $2,895 that were subject to the section 72(t) additional tax
and early distributions of $28,900 that were not subject to
section 72(t) additional tax.10
10
It appears that there is a mistake on petitioner’s Form
5329. He was supposed to report on line 1 all early
(continued...)
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In a notice of deficiency dated June 1, 2006, respondent
disallowed the medical and dental expenses, unreimbursed employee
expenses, attorney’s and accountant’s fees, and part of the home
mortgage interest and points reported on petitioner’s Schedule A.
Respondent also disallowed all deductions relating to Eglobal
Call Solutions claimed on petitioner’s Schedule C.11 Respondent
also determined that petitioner was liable for section 72(t)
additional tax of $20,823 and a section 6662(a) accuracy-related
penalty of $20,634.
Petitioner timely petitioned this Court, and a trial was
held. After trial we kept the record open to allow petitioner to
introduce additional evidence to substantiate his Schedule A and
Schedule C deductions. Specifically, we instructed petitioner
(1) to arrange for respondent to conduct a telephone interview of
the bookkeeper in Vietnam, (2) to obtain health insurance records
to substantiate his medical expenses, and (3) to provide 2004 and
2005 bank statements with respect to the Eglobal Call Solutions
account and his personal account. Petitioner did not provide any
10
(...continued)
distributions included in income and then, of those distributions
reported on line 1, report on line 2 the distributions that are
not subject to the additional tax.
11
Respondent also disallowed all expenses claimed on a
separate Schedule C relating to a business called 4-Play.
However, the parties have resolved this issue by agreement.
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additional evidence, nor did he file a posttrial brief with the
Court.
OPINION
I. Exhibits 6-P, 7-P, and 8-P
At trial we reserved ruling on petitioner’s Exhibits 6-P,
7-P, and 8-P. Exhibit 6-P is a computer spreadsheet showing
various expenses for a 12-month period. Respondent objected to
Exhibit 6-P on grounds of authenticity, best evidence, and
hearsay and because it was prepared in anticipation of
litigation. In his brief respondent contends that Exhibit 6-P is
an improper summary, chart, or calculation under rule 1006 of the
Federal Rules of Evidence because the underlying documents used
to prepare the spreadsheet were not made available to respondent
and petitioner provided no testimony regarding the preparation of
the spreadsheet.
Rule 1006 of the Federal Rules of Evidence provides that the
contents of voluminous writings that cannot conveniently be
examined in court may be presented in the form of a chart,
summary, or calculation. It also provides that the originals or
duplicates of the summarized writings must be made available for
examination or copying, or both, by other parties at a reasonable
time and place.
Exhibit 6-P does not show the year to which the spreadsheet
relates or who prepared the spreadsheet. Petitioner did not
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present any credible testimony about the source of the amounts
shown in the spreadsheet or what the expenses represented. In
addition, even though we gave petitioner a posttrial opportunity
to provide to respondent and to the Court documentation
substantiating the expenses he claimed, petitioner did not take
advantage of the opportunity. Because petitioner did not produce
the underlying documentation that Exhibit 6-P purportedly
summarized as required by rule 1006 of the Federal Rules of
Evidence, we conclude that Exhibit 6-P is inadmissible.
At trial respondent also objected to Exhibits 7-P and 8-P on
the basis of relevancy because they related to 2003 and not 2004.
Exhibit 7-P is a credit card statement showing charges for
December 2003. Petitioner argued at trial that Exhibit 7-P is
relevant because he paid the credit card statement in 2004.
However, petitioner did not prove that he paid the credit card
statement in 2004. We conclude that Exhibit 7-P is not relevant
and therefore is inadmissible. Exhibit 8-P consists of copies of
the following receipts: (1) Radioshack receipt dated January 9,
2004, paid in cash, (2) San Francisco International Airport
Parking Receipt dated December 20, 2003, paid in cash, and (3)
Dougherty Shell receipt dated January 29, 2004, paid by credit
card. We conclude that the San Francisco International Airport
Parking Receipt is not relevant because it was paid in 2003.
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However, because the other receipts reflect payments in 2004, we
shall admit Exhibit 8-P.
II. Burden of Proof
In general, the Commissioner’s determination of a deficiency
is presumed correct, and the taxpayer bears the burden of proving
otherwise. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933). Petitioner does not contend that section 7491(a), which
shifts the burden of proof to respondent if its requirements are
met, applies, and petitioner has not produced evidence to show he
meets the requirements of section 7491(a). The burden of proof
with respect to the deficiency in his tax, therefore, remains on
petitioner.
III. Schedule A Deductions
A. Medical Expenses
Expenses paid during the taxable year, not compensated for
by insurance or otherwise, for medical care of the taxpayer shall
be allowed as a deduction to the extent that such expenses exceed
7.5 percent of adjusted gross income. Sec. 213(a). A deduction
is allowed only with respect to medical expenses actually paid
during the taxable year, regardless of when the incident or event
which occasioned the expenses occurred. Sec. 1.213-1(a)(1),
Income Tax Regs.
Petitioner deducted $41,000 of medical expenses on his
Schedule A. In support of this deduction, petitioner introduced
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into evidence several documents evidencing that he underwent
outpatient surgery in December 2004. Those documents included
documents titled “Outpatient Surgery Postoperative
Orders/Discharge Instructions”, “Anesthesia Risk Information”,
and “Consent to Surgery/Special Procedures/Anesthesia”, three
Explanation of Benefit forms from petitioner’s health insurer,12
and a medical invoice for $10.49. Petitioner, however,
introduced no credible evidence to prove that he paid any medical
expenses in 2004. Although we allowed petitioner an opportunity
after trial to offer substantiation of the medical expenses he
allegedly paid in 2004, petitioner failed to do so.
Because petitioner did not prove he paid any medical
expenses in 2004, we sustain respondent’s determination
disallowing petitioner’s medical expense deduction.
B. Unreimbursed Employee Expenses
A taxpayer may deduct unreimbursed employee expenses as an
ordinary and necessary business expense under section 162. Lucas
v. Commissioner, 79 T.C. 1, 6 (1982). However, an employee
cannot deduct such expenses to the extent that the employee is
entitled to reimbursement from his or her employer for
expenditures related to his or her status as an employee. Id. at
7. Along with other miscellaneous itemized deductions,
12
Although petitioner provided several forms from his health
insurer, petitioner testified that the cost of his procedure was
disallowed by his insurer because he had not paid the premiums.
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unreimbursed employee expenses are subject to the 2-percent of
adjusted gross income limitation under section 67(a).
Petitioner claimed a $118,052 deduction for unreimbursed
employee expenses. Petitioner testified that some of the
unreimbursed employee expenses related to his employment with
Five-by-Five Networks and were expenses not paid by Five-by-Five
Networks. Petitioner, however, did not introduce any credible
evidence that he actually paid any employee expenses or that he
was not entitled to reimbursement from Five-by-Five Networks for
those expenses. In addition, petitioner did not introduce any
credible evidence regarding that part of his unreimbursed
employee expense deduction that did not relate to his employment
with Five-by-Five Networks.
Because petitioner failed to prove he is entitled to a
deduction for unreimbursed employee expenses, we sustain
respondent’s determination disallowing the deduction.
C. Attorney’s and Accountant’s Fees
Petitioner claimed a $26,575 deduction for attorney’s and
accountant’s fees as other miscellaneous itemized deductions.
Petitioner testified that at least some of those fees related to
two lawsuits involving his neighbor, one dealing with a sprinkler
system and the other involving a dispute over petitioner’s tree.
Petitioner did not introduce documentation of his legal expenses
from the attorney representing him in those matters, nor did he
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introduce any credible evidence establishing that he actually
paid any fees to a professional or that the fees, if paid, were
deductible.13
Because petitioner failed to introduce credible evidence to
prove that he paid attorney’s and accountant’s fees during 2004
and that the fees, if paid, were deductible, we sustain
respondent’s determination disallowing the deduction.
IV. Schedule C Deductions for Eglobal Call Solutions
Section 162(a) permits a taxpayer to deduct the ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on a trade or business. See Commissioner v. Lincoln
Sav. & Loan Association, 403 U.S. 345, 352 (1971). In order for
a taxpayer “to be engaged in a trade or business, the taxpayer
must be involved in the activity with continuity and regularity
and * * * the taxpayer’s primary purpose for engaging in the
activity must be for income or profit.” Commissioner v.
Groetzinger, 480 U.S. 23, 35 (1987). An expense is ordinary if
it is normal, usual, or customary within a particular trade,
business, or industry or arises from a transaction “of common or
frequent occurrence in the type of business involved.” Deputy v.
du Pont, 308 U.S. 488, 495 (1940). An expense is necessary if it
is appropriate and helpful for the development of the business.
13
Legal expenses that are personal are not deductible. Sec.
262(a).
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See Commissioner v. Lincoln Sav. & Loan Association, supra at
353; Commissioner v. Heininger, 320 U.S. 467, 471 (1943).
Section 262(a) disallows deductions for personal, living, or
family expenses. See also sec. 1.162-17(a), Income Tax Regs.
When a taxpayer establishes that he paid or incurred a
deductible expense but does not establish the amount of the
expense, we may estimate the amount allowable in some
circumstances (the Cohan rule). See Cohan v. Commissioner, 39
F.2d 540, 543-544 (2d Cir. 1930). There must be sufficient
evidence in the record, however, to permit us to conclude that
the taxpayer paid or incurred a deductible expense in at least
the amount allowed. See Williams v. United States, 245 F.2d 559,
560 (5th Cir. 1957). In estimating the amount allowable, we bear
heavily upon the taxpayer who failed to maintain required records
and to substantiate deductions as the Code requires. See Cohan
v. Commissioner, supra at 544.
For certain kinds of business expenses, such as travel,
meals, and entertainment expenses, section 274(d) overrides the
Cohan rule. See Sanford v. Commissioner, 50 T.C. 823, 827
(1968), affd. per curiam 412 F.2d 201 (2d Cir. 1969); sec. 1.274-
5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6,
1985). Under section 274(d), a taxpayer must satisfy strict
substantiation requirements before a deduction is allowable. See
also sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs.
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Respondent does not dispute that petitioner had a business
or that he was involved in that business with continuity and
regularity and for profit. Respondent contends, however, that
petitioner has not substantiated the expenses he claimed on his
Schedule C relating to Eglobal Call Solutions and that petitioner
has provided only self-serving testimony that he is entitled to
the deductions. In addition respondent contends that the limited
documentation introduced into evidence appears to reflect the
payment of startup expenditures that are not deductible under
section 195.
Section 195(a) provides that, except as otherwise provided
therein, no deduction is allowed for startup expenditures. See
also Hardy v. Commissioner, 93 T.C. 684, 687-693 (1989), affd. in
part and remanded in part per order (10th Cir., Oct. 29, 1990).
Section 195(c)(1) defines startup expenditures to mean any amount
paid or incurred in connection with (i) investigating the
creation or acquisition of an active trade or business, or (ii)
creating an active trade or business, or (iii) any activity
engaged in for profit and for the production of income before the
day on which the active trade or business begins, in anticipation
of becoming an active trade or business, which if paid or
incurred in connection with the operation of an existing active
trade or business would be allowed as a deduction for the taxable
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year in which paid or incurred.14 Under section 195(c)(2)(B), an
acquired trade or business is treated as beginning when the
taxpayer acquires it.15
Although petitioner testified he acquired various assets
during 2004, he also testified that the software assets he
acquired were still under development until approximately
September 2004 when a revision of the integrated software was
completed. According to petitioner, the Vietnam call center did
not begin to service customers until September 2004 and did not
generate any revenue until October 2004. Even if we accept
petitioner’s general and very vague testimony as credible and
assume that the Vietnam call center’s business activity was a
part of petitioner’s Schedule C business, Eglobal Call Solutions,
the testimony reveals that call center did not begin to function
until September 2004 at the earliest and did not generate revenue
until October 2004. Consequently, we conclude on the record
14
Sec. 195(b)(1) was amended by the American Jobs Creation
Act of 2004, Pub. L. 108-357, sec. 902(a)(1), 118 Stat. 1651,
effective for amounts paid or incurred after Oct. 22, 2004.
Under sec. 195(b)(1), as in effect both before and after the 2004
amendment, a taxpayer may elect to treat startup expenditures as
deferred expenses that may be amortized as provided therein, and
the amortization period cannot begin any earlier than the month
in which the active trade or business begins. It does not appear
that petitioner elected to amortize any startup expenditures with
respect to Eglobal Call Solutions, and petitioner does not argue
that he made the election.
15
Petitioner testified that he acquired various assets. We
infer from this testimony that he did not acquire an active trade
or business during or before 2004.
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before us that any expenses paid before September 2004 were
nondeductible startup expenditures under section 195(a).
We turn now to specific expenses petitioner deducted on the
Schedule C for Eglobal Call Solutions.
A. Advertising
Petitioner claimed a $34,090 deduction for advertising
expenses on his Schedule C. To substantiate the advertising
expenses, petitioner introduced into evidence several documents
including: (1) An invoice dated February 19, 2004, from Business
Wire addressed to Eglobal Call Networks showing a paid membership
fee of $120, (2) a confirmation dated March 25, 2004, of a $74.93
payment with petitioner’s credit card for promoting an Internet
Web site address described as “www.eglobalcallsolutions.com”
showing the company name as “eglobalcall networks, inc”, (3) an
invoice dated March 31, 2004, from Business Wire for $440, (4) a
confirmation dated April 28, 2004, of a $49.95 payment with
petitioner’s credit card for promoting the Internet Web site
“www.eglobalcallsolutions.com”, and (5) an invoice for $1,081.42
dated April 30, 2004, from Focus Print n Copy primarily for “700
Brochures ‘eGlobalCall Solutions’” that was stamped paid.
Because the Business Wire invoices show that the amounts
were paid on behalf of Eglobal Call Networks and not Eglobal Call
Solutions or petitioner himself, we cannot determine whether they
were paid by petitioner or whether they related to Eglobal Call
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Solutions. And although the payment for promoting Eglobal Call
Solutions’s Internet Web site and the payment for the Focus Print
n Copy invoice appear to relate to Eglobal Call Solutions, all of
the expenses were paid before September 2004.
In addition to the expenses discussed above, petitioner
testified that most of the advertising expenses related to the
purchase of four customer lists at $5,000 each. Petitioner
testified that he paid for the customer lists by wire transfers
from his personal checking account;16 but even after we gave
petitioner a second opportunity to substantiate the payments
after trial, petitioner never introduced evidence of the wire
transfers that he claims he made, nor did he submit any other
documentation to establish he paid for the customer lists.17
All of the documentation of advertising expenses in the
record relates to expenses paid before petitioner’s business
became operational. See, e.g., Feerick v. Commissioner, T.C.
Memo. 1991-330. We conclude, therefore, that petitioner has
failed to prove he paid deductible advertising expenses during
16
Petitioner testified that in the beginning he used his
personal checking account to pay expenses, but then he started
using one of Eglobal Call Networks’s checking accounts.
17
Even if petitioner were able to substantiate that he paid
for four customer lists, it appears that petitioner would not be
entitled a full deduction in 2004 for those payments. Customer
lists are generally considered sec. 197 intangibles that must be
amortized over a 15-year period. Sec. 197(a), (d)(1)(C)(ii);
sec. 1.197-2(b)(4), Income Tax Regs.
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2004, and we sustain respondent’s determination disallowing the
deduction.
B. Commissions and Fees
Petitioner claimed a $1,222 deduction for commissions and
fees on his Schedule C. Petitioner testified that this deduction
represented payments made by check to two people who helped him
generate deals. Petitioner, however, testified that he did not
have copies of the checks or any other evidence to show whether
or when he paid any commissions or fees. Petitioner’s testimony
about the commissions and fees he supposedly paid is insufficient
for the Court to make an estimate of this expense under the Cohan
rule. See Norgaard v. Commissioner, 939 F.2d 874, 879 (9th Cir.
1991), affg. in part and revg. in part T.C. Memo. 1989-390. We
conclude, therefore, that petitioner failed to substantiate the
deduction he claimed for commissions and fees, and we sustain
respondent’s determination disallowing the deduction.
C. Contract Labor
Petitioner claimed a $4,534 deduction for contract labor on
his Schedule C. Petitioner testified that this deduction
probably represented payments to people he paid by the hour. He
testified that he would have paid those people from the Eglobal
Call Solutions account that he had set up with U.S. Bank.
Petitioner did not have those bank statements because he claimed
that the bank statements were seized by Vietnamese authorities in
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the 2005 raid on his office. Even if we accept as credible
petitioner’s testimony regarding the raid in Vietnam, we are not
convinced that all relevant business records were in Vietnam or
were seized in the raid. Moreover, we gave petitioner an
opportunity after trial to obtain duplicate bank records from
U.S. Bank, but he did not do so. We conclude therefore that
petitioner failed to substantiate that he paid any contract labor
expenses during 2004, and we sustain respondent’s determination
disallowing the deduction.
D. Employee Benefit Programs
Petitioner claimed a $4,532 deduction for employee benefits
on his Schedule C. Petitioner testified that this expense
included cash payments to the Vietnamese Government for health
insurance. However, petitioner did not present any credible
evidence to prove the nature, amount, and purpose of the health
insurance he allegedly paid in 2004. Consequently, we conclude
that petitioner failed to substantiate the deduction he claimed
for employee benefits, and we sustain respondent’s determination.
E. Insurance
Petitioner claimed a $12,389 deduction for insurance on his
Schedule C. Petitioner testified that the insurance expense
mostly represented insurance that he paid on his automobile in
Vietnam. However, petitioner did not introduce any documentation
or other credible evidence to prove that he paid insurance or
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that he even had an insurable interest in a vehicle in Vietnam.
Consequently, we conclude that petitioner has failed to
substantiate the deduction he claimed for an insurance expense,
and we sustain respondent’s determination.
F. Legal and Professional Services
Petitioner claimed a $1,459 deduction for legal and
professional services on his Schedule C. In support of this
deduction, petitioner introduced into evidence an invoice dated
February 26, 2004, from Sedgwick Detert, Moran & Arnold LLP and
Affiliated Entities for professional services through January 31,
2004. Petitioner testified the invoice related to expenses
incurred in establishing the organization and dissolving his
relationship with Five-by-Five Networks. However, petitioner did
not introduce any evidence substantiating that he paid the
invoice in 2004 or showing that the professional services related
to Eglobal Call Solutions. Consequently, we conclude that
petitioner has failed to substantiate the deduction he claimed
for legal and professional services, and we sustain respondent’s
determination.
G. Office Expenses
Petitioner claimed an $8,123 deduction for office expenses
on his Schedule C. Petitioner testified that the office expenses
included payments for utilities in both his Vietnam and U.S.
offices. Petitioner also testified that he made the payments
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from either his personal checking account or the account
established under the name Eglobal Call Solutions, but petitioner
could not produce any canceled checks, bank statements, or other
payment records. As we have already stated several times,
petitioner was given an opportunity to obtain his bank statements
after trial and present them to respondent and the Court, but
petitioner did not do so.
Petitioner also introduced into evidence various receipts,
such as receipts from Staples, Radioshack, CompUSA, Fry’s
Electronics, and the U.S. Postal Service, that may have been
included in office expenses. However, because we have no way of
determining whether those receipts represented business or
personal expenses, we cannot conclude that those receipts
substantiate petitioner’s office expense deduction.18
We conclude that petitioner has failed to substantiate his
deduction for office expenses, and we sustain respondent’s
determination.
H. Rent or Lease for Other Business Property
Petitioner claimed an $88,045 deduction for rent or lease
for other business property. Petitioner testified that the
property in question included land in Vietnam on which petitioner
18
Several of the receipts showed purchases of items that
were personal and not related to Eglobal Call Solutions. For
example, one receipt from Fry’s Electronics included a purchase
of a Euro Pro Shark Professional Iron, and another included a
purchase of a DVD entitled “Matrix Revolutions”.
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constructed a building. Petitioner testified that in 2004 he
paid about $90,000 to Quang Trung Software City Development Co.
for the lease. In support of his testimony, petitioner
introduced into evidence an unsigned copy of a lease that showed
Eglobal Vietnam as the lessor. Petitioner testified that
although the lease showed Eglobal Vietnam as the lessor,
petitioner paid the rent. Petitioner claimed that he had bank
statements that would prove those payments, but he did not
introduce any documentation at trial to substantiate the lease
payments he allegedly made. Although we gave petitioner a
posttrial opportunity to produce the documentation he claimed he
had, petitioner did not do so.
We conclude that petitioner has failed to substantiate the
deduction for rent or lease expenses for other business property,
and we sustain respondent’s determination.
I. Supplies
Petitioner claimed a $2,333 deduction for supplies.
Petitioner testified that he deducted amounts spent for generic
office supplies used in his Vietnam and U.S. offices. Although
petitioner introduced into evidence various receipts, we cannot
determine from a review of those receipts whether they reflect
business or personal purchases. Because petitioner did not
introduce any evidence that would allow us to estimate the
supplies petitioner purchased for Eglobal Call Solutions, we will
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not apply the Cohan rule. See Norgaard v. Commissioner, 939 F.2d
at 879.
We conclude that petitioner has failed to substantiate the
deduction for supplies, and we sustain respondent’s
determination.
J. Taxes and Licenses
Petitioner claimed a $3,123 deduction for taxes and licenses
on his Schedule C. Petitioner testified that the taxes and
licenses expense included a license fee that he paid to the
Vietnamese Government. However, because petitioner introduced no
evidence that he actually paid any license fee in 2004 or that a
license fee was required, the Cohan rule is not applicable here.
Consequently, we conclude that petitioner has failed to
substantiate his deduction for taxes and licenses, and we sustain
respondent’s determination.
K. Travel
Petitioner claimed a $6,123 deduction for travel.
Petitioner testified that the travel expense related primarily to
his Vietnam trips and that he also attended a call center
conference in Orlando, Florida.
Petitioner introduced into evidence two credit card
statements showing purchases from China Air that he credibly
testified were for airplane tickets to Vietnam. However, the
first credit card statement shows a China Air purchase on
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December 13, 2003, and the second shows two China Air purchases
on February 2 and February 6, 2004, of $876.50 each. The China
Air purchases occurred before the Vietnam call center became
operational in approximately September 2004. At best, these
travel expenses are nondeductible startup expenditures under
section 195. See supra pp. 17-19.
Petitioner also introduced in evidence a rental car receipt
from Orlando, Florida, where he supposedly attended a call center
conference. Petitioner did not present corroborating evidence
regarding the conference, nor did he show that the car rental was
for business purposes. Consequently, we conclude that petitioner
failed to prove that he is entitled to deduct the rental car
expense. See sec. 274(d).
Petitioner also introduced into evidence numerous receipts
for gasoline purchases. Because petitioner did not produce any
mileage or travel logs to substantiate that the gasoline
purchases related to his activities in Eglobal Call Solutions, we
conclude that he has failed to prove that the gasoline purchases
reflected on the receipts are deductible. See id. We sustain
respondent’s determination.
L. Meals and Entertainment
Petitioner claimed a $6,745 deduction for meals and
entertainment expenses. Petitioner introduced into evidence
restaurant receipts that he claims were for various meetings.
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Although petitioner provided some testimony regarding the meal
receipts, petitioner introduced no documentation to show with
whom he met during these so-called meetings or whether the
meetings were related to his business activities. Petitioner has
not substantiated by adequate records or by sufficient evidence
corroborating his own statement the business purpose of the
expenses as required under section 274(d). Consequently, we
conclude that petitioner has failed to substantiate the deduction
for meals and entertainment expenses, and we sustain respondent’s
determination.
M. Utilities
Petitioner claimed a $13,455 deduction for utilities.
Petitioner testified that the utilities expenses primarily
represented the electricity cost in Vietnam.19 Because
petitioner did not provide any credible evidence that he paid
electricity bills in Vietnam, we conclude that petitioner has
failed to substantiate the deduction for utilities. We sustain
respondent’s determination.
N. Wages
Petitioner claimed a $96,050 deduction for wages.
Petitioner testified that all wages were paid in cash to
employees in Vietnam. Petitioner also testified that the records
19
Petitioner testified that the utility costs for his U.S.
activities were de minimis in comparison to his utility costs in
Vietnam.
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of the wages paid to employees were included in the Quickbooks
accounting records seized by Vietnamese authorities. Petitioner
did not introduce any other evidence to prove that he paid wages
to employees in Vietnam. Petitioner did not testify as to how
many employees he had or the amounts of their wages, and he made
no effort to document this deduction by obtaining duplicate bank
records. We conclude therefore that petitioner has failed to
substantiate the deduction for wages, and we sustain respondent’s
determination.20
O. Other Documents and Receipts
Petitioner introduced in evidence additional documents and
receipts to substantiate his expenses claimed on the Schedule C.
To the extent we did not specifically address the documents or
receipts in this opinion, we conclude that the documents or
receipts do not substantiate that petitioner was entitled to a
business expense deduction for Eglobal Call Solutions.
V. Section 72(t) Additional Tax
Section 72(t)(1) imposes an additional tax of 10 percent on
the portion of a distribution from a qualified retirement plan
that is includable in gross income, unless the distribution falls
under one of the exceptions in section 72(t)(2). Under certain
20
In his testimony petitioner made several references to a
minimum monthly payment of $15,000 to Eglobal Vietnam for various
expenses including wages associated with the Vietnam call center.
Petitioner has failed to substantiate he made monthly payments as
alleged.
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circumstances, the section 72(t) additional tax does not apply to
distributions made to cover the costs of medical care or of
higher education expenses. Sec. 72(t)(2)(B), (E).
Section 72(t)(2)(B) provides an exception to the section
72(t) additional tax for distributions made to the employee to
the extent such distributions do not exceed the amount allowable
as a deduction under section 213 to the employee for amounts paid
during the taxable year for medical care. We have already found
that petitioner is not entitled to a deduction for medical
expenses claimed on his Schedule A under section 213 because
petitioner could not substantiate that he paid any medical
expenses in 2004. Thus, petitioner is not eligible for the
section 72(t)(2)(B) exception to the additional tax because his
distribution exceeds the amount allowable as a deduction under
section 213.
Section 72(t)(2)(E) provides an exception to the section
72(t) additional tax for distributions from individual retirement
plans used for qualified higher education expenses of the
taxpayer for the taxable year. This exception applies to
qualified higher education expenses the taxpayer paid for the
taxpayer’s children. Sec. 72(t)(7)(A)(iii). Qualified higher
education expenses generally include expenses for tuition, fees,
books, supplies, and equipment required for the enrollment or
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attendance at an eligible educational institution. Secs.
72(t)(7)(A), 529(e)(3).
Petitioner contends that he paid expenses related to his
children’s college education and therefore he is entitled to the
section 72(t) exception for at least part of his distributions.
However, petitioner did not introduce any evidence other than his
uncorroborated testimony regarding any higher education payments
he allegedly made on behalf of his two children. Without some
documentation to support petitioner’s general testimony, we
cannot conclude that petitioner used the distribution to pay
college education expenses or that the expenses, even if paid,
are qualified higher education expenses within the meaning of
section 529(e)(3). See sec. 72(t)(7)(A).21
Because petitioner failed to prove that he qualifies for any
exception under section 72(t)(2), we sustain respondent’s
21
Even if petitioner were able to substantiate that he used
the distribution from his qualified retirement plan to pay his
children’s qualified higher education expenses, he would likely
not qualify for the sec. 72(t)(2)(E) exception because his
distribution apparently was not a distribution from an individual
retirement plan. See, e.g., Uscinski v. Commissioner, T.C. Memo.
2005-124; see also H. Rept. 105-148, at 288-289 (1997), 1997-4
C.B. (Vol. 1) 319, 610-611. The Internal Revenue Code defines
“individual retirement plan” as an individual retirement account
or annuity described in sec. 408(a) and (b). Sec. 7701(a)(37).
Petitioner attached to his 2004 return two Forms 1099-R,
Distributions From Pensions, Annuities, Retirement or Profit-
Sharing Plans, IRAs, Insurance Contracts, etc., which show that
petitioner’s distribution was not a distribution from an
individual retirement account or annuity. Moreover, on his 2004
return petitioner did not report receiving any distribution from
an individual retirement account or annuity.
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determination that petitioner is liable for the section 72(t)
additional tax on the distribution from his qualified retirement
plan.
VI. Section 6662(a) Accuracy-Related Penalty
Respondent contends that petitioner is liable for the
accuracy-related penalty under section 6662 on the ground that
there was a substantial understatement of income tax in 2004.
Section 6662(a) and (b)(2) authorizes the Commissioner to impose
a 20-percent penalty if there is a substantial understatement of
income tax. A substantial understatement of income tax with
respect to an individual taxpayer exists if, for any taxable
year, the amount of the understatement for the taxable year
exceeds 10 percent of the tax required to be shown on the return
for the taxable year or $5,000, whichever is greater. Sec.
6662(d)(1)(A).
Respondent bears the initial burden of production with
respect to petitioner’s liability for the section 6662 penalty,
in that respondent must first produce sufficient evidence to
establish that the imposition of the section 6662 penalty is
appropriate. Sec. 7491(c). If respondent satisfies his initial
burden of production, the burden of producing evidence to refute
respondent’s evidence and to establish that petitioner is not
liable for the section 6662 penalty shifts to petitioner. See
Higbee v. Commissioner, 116 T.C. 438, 447 (2001).
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Respondent has carried his burden of production by showing
that petitioner substantially understated his 2004 Federal income
tax. Because respondent has met his burden of production,
petitioner must come forth with sufficient evidence to persuade
the Court that respondent’s determination is incorrect. See id.
at 446-447. Petitioner also bears the burden of producing
evidence to demonstrate reasonable cause under section
6664(c)(1). See id.
Petitioner has not introduced any credible evidence that
respondent’s accuracy-related penalty determination is incorrect
or that petitioner had reasonable cause for the substantial
understatement of his 2004 income tax. Therefore, we sustain
respondent’s determination that petitioner is liable for the
section 6662(a) accuracy-related penalty.
To reflect the foregoing,
Decision will be entered
under Rule 155.