T.C. Summary Opinion 2009-109
UNITED STATES TAX COURT
DAVID AND TRANG LE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
DAVID LE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 18789-07S, 18791-07S. Filed July 13, 2009.
David and Trang Le, pro sese.
Erin R. Hines, for respondent.
PANUTHOS, Chief Special Trial Judge: These consolidated
cases were heard pursuant to the provisions of section 7463 of
the Internal Revenue Code in effect when the petitions were
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filed.1 Pursuant to section 7463(b), the decision to be entered
in each docket is not reviewable by any other court, and this
opinion shall not be treated as precedent for any other case.
The Internal Revenue Service (IRS) determined a $5,418
deficiency and a $1,083.60 accuracy-related penalty in
petitioner’s 2004 Federal income tax. The IRS determined a
$4,448 deficiency and an $889.60 accuracy-related penalty in
David and Trang Le’s (hereinafter petitioners) 2005 Federal
income tax.
After concessions,2 the issues for decision are: (1)
Whether petitioner is entitled to a trade or business loss
deduction for taxable year 2004; (2) whether petitioners are
entitled to itemized deductions greater than those respondent
allowed for 2004 or 2005; (3) whether petitioners are entitled to
an education credit for 2005; and (4) whether petitioners are
liable for accuracy-related penalties under section 6662(a) and
(b)(1).
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
2
Respondent conceded at trial that petitioners are entitled
to claimed deductions for State and local taxes and for real
estate taxes paid in taxable years 2004 and 2005. Respondent
also conceded that petitioners are entitled to joint filing
status for 2004.
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Background
Some of the facts have been stipulated, and we incorporate
the stipulation and the accompanying exhibits by this reference.
Mrs. Le moved to the United States in 2004 and married Mr. Le in
August 2004. Petitioners remained married throughout the years
in issue. They purchased a home in 2004 and lived in Maryland
when they filed the petitions.3
Petitioner has been an officer in the Metropolitan Police
Department for the District of Columbia (MPDC) since 1999. In
2004 petitioner worked in the bicycle division. During 2004 he
spent approximately $30 every 2 weeks to maintain his uniforms.
He also paid union dues of $16 every 2 weeks.
In 2005 he joined the canine division, and the MPDC issued
him a German Shepherd trained for bomb-sniffing and police work.
Before the MPDC would allow him to keep his dog at home in
connection with his work as a canine officer, the MPDC required
him to construct, at his own expense, a kennel that met certain
specifications.4 Petitioner spent approximately $3,500 in 2005
3
On Oct. 6, 2008, we consolidated these two cases for trial
and opinion.
4
The MPDC kennel requirements included at least 100 square
feet of open space, solid flooring, chain link fence sides, and a
chicken wire fence top.
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to build a kennel in his backyard that met or exceeded each MPDC
specification.5
In 2004 petitioner briefly worked as a security consultant
at a construction site in the District of Columbia in addition to
his work for the MPDC. He terminated this activity after he
learned that the MPDC would not approve his working at that
site.6 The construction company issued petitioner a Form 1099-
MISC, Miscellaneous Income, for 2004.
In 2004 and 2005 petitioner gave money to his parents to
donate at functions raising money for people and projects in
Vietnam, where both petitioners were born. Petitioner also sent
money to individuals in Vietnam to contribute to Buddhist
temples. Petitioner did not obtain any receipts for funds he
contributed, nor did he obtain any documentation about the
organizations that received his donations. He also did not
inform his return preparer that his donations went to
unidentified organizations in a foreign country.
5
For example, petitioner’s kennel provides 144 square feet
of open space and a doghouse.
6
With approval, an MPDC officer may provide security
services in his off-duty hours but not within the part of the
District of Columbia he regularly patrols. Because the
particular construction site was within petitioner’s usual patrol
area, the MPDC would not approve the work.
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In 2004 petitioner paid $1,356 to attend a class in criminal
justice at University of Maryland University College. The record
further reflects that petitioner paid student loan interest of
$69.81 in 2004 and $62.73 in 2005. In the fall semester of 2005
Mrs. Le attended an English as a second language (ESL) class at
Montgomery College. Although the record includes an unofficial
transcript reflecting a grade of A in that 6.8-credit-hour class,
petitioners did not offer any records of the amounts paid for
Mrs. Le’s education in 2005.
Petitioners engaged a paid return preparer to prepare the
2004 and 2005 Federal income tax returns.
Because Mrs. Le did not receive a taxpayer identification
number or a Social Security number until 2005, petitioner claimed
single filing status for 2004. On his 2004 income tax return
petitioner reported on Schedule C, Profit or Loss From Business,
income of $3,600 from his security work at the construction site,
together with expenses of $5,468. This Schedule C activity
produced a net loss of $1,868, which he deducted as a business
loss on Form 1040, U.S. Individual Income Tax Return. In
addition to deductions for medical expenses and home mortgage
interest which the Internal Revenue Service (IRS) allowed and for
State income taxes and property taxes which respondent concedes,
petitioner claimed itemized deductions for charitable
contributions, unreimbursed employee business expenses, and other
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expenses. On his 2004 income tax return petitioner did not claim
a student loan interest deduction on line 26, but he did claim a
$1,356 tuition and fees deduction on line 27.
Petitioners filed a joint Federal income tax return for
2005. In addition to medical expense and home mortgage interest
deductions which the IRS allowed and State income tax and
property tax deductions which respondent concedes, petitioners
claimed deductions for charitable contributions, unreimbursed
employee business expenses, and tax preparation fees.
Petitioners claimed a $63 student loan interest deduction on line
33 of Form 1040. They did not claim a tuition and fees deduction
on line 34, but they did claim a $1,500 Hope Scholarship
education credit on line 50 for 2005.
In the notice of deficiency for 2004 the IRS disallowed
petitioner’s business loss determining that, because he failed to
substantiate his business expenses, the IRS would not allow
expenses in excess of his Schedule C income. The IRS also
disallowed in full the following itemized deductions petitioner
claimed on Schedule A Itemized Deductions:
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Amount
Description Claimed
Charitable contributions (cash) $6,521
Job expenses & other miscellaneous deductions1
Job expenses (uniform, union dues, edu) 2,656
Other expenses (parking, equip, telephone,
closing cost, legal fee, appr) 6,876
1
These miscellaneous deduction amounts reflect
amounts petitioners reported before application of the
2-percent limitation of sec. 67.
In the notice of deficiency for 2005 the IRS disallowed
petitioners’ claimed education credit because no qualifying
educational institution had issued a Form 1098-T, Tuition
Statement, to petitioners for 2005 and because the IRS had not
received any verification that petitioners made qualified tuition
payments in 2005. The IRS disallowed in full the following
itemized deductions petitioners claimed on Schedule A:
Amount
Description Claimed
Charitable contributions (cash) $7,254
Job expenses & other miscellaneous deductions
Business expense 5,477
Tax preparation fee 350
Discussion
In general, the Commissioner’s determinations set forth in a
notice of deficiency are presumed correct, and the taxpayer bears
the burden of proving that these determinations are in error.
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Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Pursuant to section 7491(a), the burden of proof as to factual
matters shifts to the Commissioner under certain circumstances.
Petitioners have neither alleged that section 7491(a) applies nor
established their compliance with its requirements. Petitioners
therefore bear the burden of proof.
Deductions are a matter of legislative grace, and a taxpayer
bears the burden of proving that he is entitled to any deduction
claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992);
New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). A
taxpayer is required to maintain records sufficient to enable the
Commissioner to determine his correct tax liability. Sec. 6001;
sec. 1.6001-1(a), Income Tax Regs. Such records must
substantiate both the amount and purpose of the claimed
deductions. Higbee v. Commissioner, 116 T.C. 438, 440 (2001).
When a taxpayer establishes that he has incurred a
deductible expense but is unable to substantiate the exact
amount, we are generally permitted to estimate the deductible
amount. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir.
1930). To apply the Cohan rule, however, the Court must have a
reasonable basis upon which to make an estimate. Vanicek v.
Commissioner, 85 T.C. 731, 742-743 (1985).
Congress overrode the Cohan rule with section 274(d), which
requires strict substantiation for certain categories of
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expenses; in the absence of evidence demonstrating the exact
amount of those expenses, deductions for them are to be
disallowed entirely. Sanford v. Commissioner, 50 T.C. 823, 827
(1968), affd. per curiam 412 F.2d 201 (2d Cir. 1969). Expenses
subject to section 274(d) include travel and meal expenses, as
well as expenses for listed property, such as passenger
automobiles, computers, and cellular telephones. Secs. 274(d),
280F(d)(4). The taxpayer must substantiate the amount, time,
place, and business purpose of these expenditures and must
provide adequate records or sufficient evidence to corroborate
his own statement. See sec. 274(d); sec. 1.274-5T(c)(1),
Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).
An exception allows the taxpayer to substantiate his expenses
through a reasonable reconstruction of his records, but only
where the taxpayer establishes that his records were lost because
of circumstances beyond his control, such as to fire, flood,
earthquake, or other casualty. Sec. 1.274-5T(c)(5), Temporary
Income Tax Regs., 50 Fed. Reg. 46022 (Nov. 6, 1985).
1. Business Loss Deduction
Respondent disallowed petitioner’s claimed business loss
deduction for 2004, limiting petitioner’s allowed deduction for
Schedule C business expenses to the income earned in his security
activity. Petitioner reported the following on Schedule C:
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Description Income (expense)
Gross income $3,600
Car and truck expenses (1,713)
Supplies expenses (650)
Cell phone expenses (985)
Software/computer expenses (2,120)
Net profit or (loss) (1,868)
Section 274(d) imposes strict substantiation requirements
for traveling expenses and expenses related to listed property,
which include petitioner’s claimed car and truck expenses, cell
phone expenses, and computer/software expenses. Petitioner did
not provide any records to substantiate those expenses.7
Because petitioner has been unable to substantiate business
expenses in excess of his business income, we sustain the
disallowance of his claimed business loss.
7
Petitioner thought he needed to retain records for only 3
years, and he discarded records for tax year 2004 in 2007 and for
tax year 2005 in 2008. At trial he acknowledged respondent’s
counsel’s explanation that he should retain records for at least
3 years from the date his return is filed or the date it is due,
whichever is later. Furthermore, his asserted retention
procedure does not explain why he would not have had all of his
records for 2005, at least, at the time the IRS issued the notice
of deficiency on May 21, 2007.
Petitioner prematurely discarded whatever records he had
(which does not constitute a circumstance beyond his control),
and, in any event, his vague testimony is not sufficient either
to reconstruct the records or to satisfy the strict
substantiation requirements of sec. 274.
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2. Itemized Deductions
a. Charitable Contributions
Section 170 allows deductions for charitable contributions
to qualified donee organizations made during a taxable year,
provided the taxpayer verifies the contributions. Taxpayers are
required to substantiate donations made by cash or check via:
(1) Canceled checks, (2) receipts from the donee (showing the
donee’s name and the date and amount of the donation), or (3)
other reliable written records. Sec. 1.170A-13(a)(1), Income Tax
Regs. Taxpayers must substantiate gifts of property via receipts
from the donee (showing the donee’s name, the date and location
of the contribution, and a description of the property
contributed). Sec. 1.170A-13(b)(1), Income Tax Regs. For
charitable contributions over $250, additional substantiation is
required. Sec. 170(f)(8).
Petitioners did not provide support for their contributions.
Furthermore, petitioners were unable to name any organizations to
which they donated funds, nor could they provide specific amounts
of money given. Accordingly, we sustain the disallowance of
their charitable contribution deductions for both 2004 and 2005.
b. Miscellaneous Itemized Deductions
i. 2004
Section 162 allows deductions for all ordinary and necessary
business expenses paid or incurred during the taxable year in
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carrying on a trade or business. Performing services as an
employee constitutes a trade or business. Primuth v.
Commissioner, 54 T.C. 374, 377-378 (1970). Those expenses that
are (1) ordinary and necessary to the taxpayer’s business and (2)
paid or incurred in a given year are deductible that year. Sec.
162(a); see sec. 1.162-17(a), Income Tax Regs. However,
personal, living, or family expenses are not deductible. See
secs. 162(a), 262(a); sec. 1.162-17(a), Income Tax Regs.
Where business clothes are suitable for general wear, their
cost is typically not deductible. Yeomans v. Commissioner, 30
T.C. 757, 767-769 (1958). However, where custom and usage
preclude wearing a uniform when off duty, deduction is allowed.
The cost of maintaining clothes for work is deductible when the
purchase price was deductible. Hynes v. Commissioner, 74 T.C.
1266, 1290 (1980). We will allow petitioner to deduct the $30 he
spent every 2 weeks to clean and maintain his police uniforms.
Petitioner is also entitled to deduct the $16 he paid every
2 weeks in union dues.
Petitioner claimed $2,656 in unreimbursed employee business
expenses for 2004. We have allowed $1,196 for uniform
maintenance and union dues, which leaves a balance of $1,460.
Petitioner explained that unspecified equipment purchases and
education made up this balance. However, equipment is listed
under other expenses on Schedule A, and petitioner could not
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remember what equipment he purchased or how much he spent on
equipment in 2004. Furthermore, petitioner’s education costs for
2004 were also claimed as tuition and fees expenses and may not
be deducted twice. Thus, we conclude that petitioner is entitled
to $1,196 of unreimbursed employee business expenses.
Petitioner also claimed $6,876 in other expenses for 2004.
These expenses included parking fees, equipment purchases for
work, telephone expenses, and various costs associated with the
petitioners’ purchase of a home in 2004. Parking expenses are
subject to the strict substantiation requirements of section 274.
The record provides almost no detail as to the specific
expenditures, beyond petitioner’s vague testimony about paying
for parking for work-related court appearances. Considering
petitioner’s lack of records, we sustain respondent’s
disallowance of the deductions claimed for travel expenses.
Petitioner explained that the MPDC required its officers to have
a “landline” home telephone for emergency contact and
notification purposes. Section 262(b) provides that charges for
basic telephone service on the first telephone line in a
residence are a personal expense of the taxpayer, and section
262(a) provides that a taxpayer’s personal, family, and living
expenses and nondeductible. We sustain the disallowance of the
deductions claimed for telephone expenses.
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As noted, petitioner was unable to identify any specific
equipment he purchased in 2004 or to estimate its cost. His
claimed equipment expense deduction will not be allowed.
Petitioners purchased a home in 2004. Respondent has
allowed or conceded their claimed deductions for property taxes
and home mortgage interest; however, petitioner also claimed
deductions for closing costs, legal fees, and real estate
appraisal expenses related to the home purchase. Petitioner has
neither substantiated any of these expenses nor explained why he
thought these were deductible expenses. His claimed home
purchase expense deduction will not be allowed.
As the 2-percent floor of section 67 exceeds petitioner’s
allowed employee business expenses and all of his claimed
deductions for other miscellaneous itemized expenses have been
disallowed, petitioners are not entitled to any miscellaneous
itemized deductions for 2004.
ii. 2005
Petitioners’ 2005 Schedule A includes a $350 tax preparation
fee and $5,477 in business expenses. Petitioners did not
introduce any evidence to support their payment of any specific
amount for tax return preparation for 2005, other than vague
testimony that they used a paid preparer. Bearing heavily upon
petitioners, whose inexactitude is of their own making, we will
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allow $100 for tax return preparation for 2005. Cf. Cohan v.
Commissioner, 39 F.2d at 544.
Petitioner’s unreimbursed employee business expenses for
uniform maintenance and union dues were similar in 2005 to those
expenses for 2004. Accordingly, we will allow $1,196 for uniform
maintenance and union dues for 2005.
We accept petitioner’s documentary evidence and testimony
that he built the kennel required for his new position as an MPDC
canine officer and that he paid approximately $3,500 in 2005 for
labor and supplies to build the kennel. Respondent argues that
even if petitioner expended the funds in 2005, the expenditure
should be capitalized and not expensed. We are satisfied that
the kennel petitioner had constructed in his backyard for his
police dog was not a building as defined in section 1250 but
rather was depreciable personal property. See, e.g. Moore v.
Commissioner, 58 T.C. 1045 (1972), affd. 489 F.2d 285 (5th Cir.
1973); Estate of Morgan v. Commissioner, 52 T.C. 478, 483-484
(1969), affd. 448 F.2d 1397 (9th Cir. 1971). It was thus section
1245 property. Sec. 1245(a)(3). As such, the kennel qualifies
as section 179 property and is eligible to be expensed under
section 179. Sec. 179(d)(1).
Petitioners have not substantiated other employment or
miscellaneous expenses. Accordingly, we allow them $100 for tax
preparation, $1,196 for uniforms and union dues, and $3,500 for
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building the kennel. The total of the miscellaneous itemized
deductions allowed is $4,796, which is subject to the 2-percent
limitation of section 67.
3. Education Credit
Petitioners claimed a $1,500 education credit in their
electronically filed 2005 return, and their Form 8863, Education
Credits, indicates that they claimed a Hope Scholarship Credit.
A student eligible for the Hope Scholarship Credit must be
pursuing the first 2 years of postsecondary education, sec.
25A(b)(2), and “carrying at least ½ the normal full-time work
load for the course of study the student is pursuing”, sec.
25A(b)(3)(B). There is no evidence that Mrs. Le took any more
than the single ESL course reflected in her transcript, that she
was involved in any postsecondary course of study, or of what the
full-time workload was for students at Montgomery College in
2005. Thus, petitioners have not demonstrated that Mrs. Le was
eligible for the Hope Scholarship Credit.
The Lifetime Learning Credit is less restrictive, providing
credit not only for courses that are part of a postsecondary
course of study but also for courses taken to acquire or improve
an eligible student’s job skills. Sec. 25A(c)(2)(B). The
Lifetime Learning Credit provides a credit equal to 20 percent of
a taxpayer’s first $10,000 in eligible tuition and related
expenses for each tax year after 2002. Sec. 25A(c)(1).
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Petitioners introduced a tuition and fee schedule for the
fall semester of 2008 and offered vague testimony that the
tuition charges did not change much between 2005 and 2008. The
2008 schedule indicates that the total cost of 7 credit hours in
2008 was $929.60. As noted, petitioners claimed a $1,500 credit
and introduced evidence that Mrs. Le took 6.8 credit hours of ESL
classes in 2005, but they did not provide any evidence of amounts
paid in 2005 for tuition or qualified expenses.
We are satisfied that Mrs. Le took the ESL class and earned
an A. Bearing heavily upon petitioners, whose inexactitude is of
their own making, we estimate petitioners’ education expense at
$750 in 2005. Cf. Cohan v. Commissioner, supra at 544. Thus,
petitioners are entitled to a Lifetime Learning Credit for 2005
of 20 percent of $750, or $150.
4. Accuracy-Related Penalty
The IRS determined accuracy-related penalties with respect
to petitioners’ 2004 and 2005 tax underpayments. Section 6662(a)
and (b)(1) provides for a 20-percent penalty on the portion of an
underpayment of tax due to negligence or a disregard of rules and
regulations. Negligence is any failure to make a reasonable
attempt to comply with the provisions of the internal revenue
laws. See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.
Moreover, negligence has been described as the failure to
exercise due care or the failure to do what a reasonable and
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prudent person would do under the circumstances. See Neely v.
Commissioner, 85 T.C. 934, 947 (1985). Disregard includes any
careless, reckless, or intentional disregard of rules or
regulations. See sec. 6662(c); sec. 1.6662-3(b)(2), Income Tax
Regs. Once the Commissioner has determined an accuracy-related
penalty pursuant to section 6662(b)(1), the taxpayer bears the
burden of proof as to this issue. See Bixby v. Commissioner, 58
T.C. 757, 791 (1972).
Pursuant to section 7491(c), respondent has the burden of
production with respect to the accuracy-related penalties.
Petitioners claimed business expenses for 2004 for which they
maintained no records and which they can neither explain,
support, nor recall; made charitable contributions roughly
equivalent to 10 percent of their gross income but without
obtaining any receipts or identifying the organizations to which
they made donations; and claimed deductions for the same
education expenses in two places on their 2004 return.
Respondent has satisfied his burden of producing evidence
indicating that the accuracy-related penalties are appropriate.
The accuracy-related penalty does not apply to any part of
an underpayment of tax as to which the taxpayer shows that he
acted with reasonable cause and in good faith. Sec. 6664(c)(1).
The determination of whether a taxpayer acted in good faith is
made on a case-by-case basis, taking into account all the
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pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income
Tax Regs. A taxpayer bears the burden of proving that he had
reasonable cause and acted in good faith with respect to an
underpayment. See Higbee v. Commissioner, 116 T.C. 438, 449.
Other than vague assertions that they relied upon their
return preparer, petitioners have not demonstrated reasonable
cause for their underpayments. They have not demonstrated that
they acted with good faith in claiming the disallowed deductions
for 2004 or 2005. Accordingly, the accuracy-related penalties
are sustained.8
To reflect our disposition of the issues,
Decisions will be entered
under Rule 155.
8
Because we have allowed some deductions the IRS disallowed
for 2005, and respondent has conceded petitioners’ entitlement to
joint filing status for 2004, the amounts of tax required to be
shown on petitioners’ returns will be different from the amounts
shown on the notices of deficiency, and the accuracy-related
penalties will also differ. We leave the calculation to the
parties’ Rule 155 computations, but we remind the parties of
petitioner’s $69.81 student loan interest expense for 2004, which
apparently was not deducted because of the income phaseout under
sec. 221(b)(2). However, in view of respondent’s concession that
petitioners are entitled to joint filing status for 2004, a
different income limit will now apply.