T.C. Memo. 2009-168
UNITED STATES TAX COURT
LELAND B. AND BRENDA J. BRUNS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6881-07. Filed July 14, 2009.
Kathryn Barnhill, for petitioners.
Catherine S. Tyson, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: Respondent determined a $10,695 deficiency
in and a $2,139 section 6662(a)1 penalty on petitioners’ 2003
Federal income tax. The issues for decision are: (1) Whether
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
- 2 -
petitioners are entitled to deductions claimed; and (2) whether
petitioners are liable for the accuracy-related penalty under
section 6662(a).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts, the supplemental stipulation of facts,
and the attached exhibits are incorporated herein by this
reference. At the time they filed the petition, petitioners
resided in South Dakota.
Petitioner Brenda Bruns (Mrs. Bruns), Joetta Swanhorst (Mrs.
Bruns’s mother), and Heather Mitzel (petitioners’ daughter) are
the partners of ABS Associates (ABS).2 Mrs. Bruns is entitled to
100 percent of the profits and losses of ABS. Petitioner Leland
Bruns (Mr. Bruns) is not a partner of ABS.
ABS is an independent distributor of Shaklee Corp.
(Shaklee), which produces nutritional and cleaning products. The
Shaklee business model allows distributors of products to earn
income in three ways: (1) Distributors earn income from
purchasing Shaklee products at a wholesale price and reselling
them at a higher price; (2) distributors are paid commissions on
2
ABS is not subject to the Tax Equity and Fiscal
Responsibility Act of 1982 (TEFRA) partnership audit and
litigation rules. See sec. 6231(a)(1)(B) (the partnership ABS
had 10 or fewer partners and all partners were natural persons
and U.S. citizens).
- 3 -
the purchases of distributors in their group;3 and (3)
distributors receive bonuses on the purchases of leaders they
develop. Leaders are distributors who generate sales of $2,000
per month or more. ABS is a leader, has developed 12 leaders,
and has approximately 500 to 600 customers, not counting the
customers of other distributors or leaders that ABS trained.
ABS holds customer meetings to look for potential
distributors. In the lower level of petitioners’ personal
residence, petitioners keep a small inventory of Shaklee
products, equipment, and sales aides used in training and
development. Customers and distributors come to the lower level
of petitioners’ home to get products and receive coaching.
During 2003 ABS earned $77,547 from its activities related
to the distribution of Shaklee products.4 On Form 1065, U.S.
Return of Partnership Income, ABS reported gross income of
$78,570 and net income of $60,570 after taking an $18,000
deduction for rent paid. All income from ABS was distributed to
Mrs. Bruns, and she reported this income on petitioners’ 2003
Form 1040, U.S. Individual Income Tax Return.
3
Each distributor has a group of customers. A customer
may get discount buying privileges by paying a fee to become a
member or distributor. Once the customer becomes a distributor,
the customer-distributor is in the group of his original
distributor and starts a group of his own.
4
Respondent does not dispute the income to Mrs. Bruns from
ABS.
- 4 -
Schedule C Expenses
On petitioners’ Schedule C, Profit or Loss From Business,
attached to their 2003 Form 1040, petitioners claimed expenses of
$44,975 paid during 2003, which resulted from Mrs. Bruns’ work
for ABS in the distribution and sale of Shaklee products.
Petitioners were issued a notice of deficiency that disallowed
some of the expenses claimed on that Schedule C. The following
is a table of reported expenses, the amount of each expense
allowed after examination, and the amount disallowed:
Item Amount Claimed Allowed Disallowed
Advertising $4,854 $1,361 $3,493
Car and truck expenses 2,238 798 1,440
Commissions and fees 495 495 –-
Contract labor 1,490 -– 1,490
Depreciation 1,500 1,500 --
Insurance 47 47 --
Other interest 101 101 --
Legal and professional
services 679 679 --
Business (office) expenses 9,545 1,331 8,214
Rent or lease--vehicle,
machinery, and equipment 5,968 3,647 2,321
Taxes and licenses 635 635 --
Travel 4,253 2,526 1,727
Meals and
entertainment 2,582 1,192 1,390
1 2
Other expenses 10,588 8,588 2,000
Total 44,975 22,900 22,075
1
This amount is the total of the following claimed
business expenses: Freight postage expenses of $988, business
phone expenses of $4,684, cleaning expenses of $175, books/
publications subscription expenses of $304, meeting expenses of
$952, sales aids expenses of $1,390, bank charge expenses of $95,
and image expense of $2,000.
2
This disallowed amount is the complete disallowance of
petitioners’ claimed “image” expense of $2,000.
- 5 -
1. Advertising Expenses
Petitioners claimed deductions for advertising expenses of
$4,854; respondent allowed $1,361 and disallowed $3,493. The
$1,361 deduction allowed includes $500 respondent determined
petitioners were entitled to for advertising-related gifts worth
$25 apiece to 20 individuals.
Shaklee leaves advertising up to distributors and does not
advertise or market its products. ABS does not advertise in the
phonebook or on the Internet; instead, Mrs. Bruns goes out and
meets customers’ families and friends to sell Shaklee products.
She then rewards customers who go out and talk up the product,
who have provided consistent business or increased their volume
of products sold, and who have been willing to introduce her to
their families and friends. As a reward Mrs. Bruns will give
books, movies, cards, jewelry, flowers, and food. Mrs. Bruns’
reward criteria are that the person be a good referral source,
love the products, and be a consistent customer. Petitioners
provided photocopies of receipts for gifts purchased by Mrs.
Bruns and substantiated gifts to 26 individuals.
Additionally, ABS paid to have newsletters, flyers, and
pictures printed. Mrs. Bruns took pictures at Shaklee-related
meetings and when she met with different groups of Shaklee
customers, distributors, and leaders. She then sent the photos
over the Internet and used them in presentations to show sales
- 6 -
leaders’ achievements with their group members. Petitioners
submitted photocopies of receipts and invoices from Harold’s
Photo Centers, Office Max, Vista Print, and Express Copy &
Printing for copies, a Nikon camera with accessories, photo
development costs, and shipping labels. The receipts total
$699.13. The camera purchased by ABS is used only for taking
pictures of customers and has never been used by petitioners for
personal purposes.
2. Car and Truck Expenses
Mrs. Bruns drove a passenger vehicle to and from activities
related to the distribution and sale of Shaklee products.
Petitioners claimed deductions for car-related expenses of
$2,238; respondent allowed $798 and disallowed $1,440.
Petitioners submitted photocopies of gasoline receipts,
carwash receipts, and car repair/maintenance invoices and
receipts. The gasoline receipts total $1,132.49, the carwash
receipts total $115.20, and the car repair/maintenance invoices
and receipts total $102.84.
3. Contract Labor Expenses
Petitioners claimed deductions for contract labor expenses
of $1,490, and respondent disallowed the full amount. At trial
petitioners conceded they are entitled only to a $910 deduction
for contract labor.
- 7 -
To substantiate the expenses for contract labor, petitioners
submitted a Quicken printout that showed payments totaling
$1,489.66 made to Robin Berg on numerous occasions, Cournie
Gunderson on 1/14/03, Michelle Bruns on 2/1/03, Robin Ramsey on
3/21/03, Richie Clary on 4/16/03, and Brandon Carpet Cleaning on
11/15/03. Petitioners hired Robin Berg to clean their office and
living space. No invoices or canceled checks were submitted to
prove payment of contract labor expenses.
4. Business Expenses
Petitioners claimed deductions for business expenses of
$9,545 incurred by Mrs. Bruns in distributing and selling Shaklee
products; respondent allowed $1,331 and disallowed $8,214.
Petitioners submitted photocopies of receipts totaling
$7,619.17 to substantiate their claimed business expenses of
$9,545. Petitioners submitted receipts for furniture, a portable
CD player with speakers, supplies, refreshments, and decorations
used by Mrs. Bruns in her role as a Shaklee salesperson. The
furniture receipts were for display cases, storage and file
cabinets, a table, a rubber floor cover, and a chair. There was
a receipt for a portable CD player with speakers Mrs. Bruns used
for training herself and others about Shaklee products when at
home and when traveling. The supplies receipts were for pens,
paper, tape, printing costs, and various other items.
Petitioners also submitted receipts for refreshments, such as
- 8 -
coffee and candy that Mrs. Bruns offered to customers, and
receipts for seasonal decorations Mrs. Bruns put up in the space
she devoted to meeting with customers and displaying Shaklee
products.
Although Mrs. Bruns often delivers Shaklee products to
customers and meets with Shaklee distributors and leaders at
restaurants, she does have customers, distributors, and leaders
stop by her home. She maintains and displays a small inventory
of Shaklee products in her home, and she receives and stores
Shaklee products ordered by customers. Further, Mrs. Bruns keeps
a desk and file cabinets which store Shaklee distribution and
sales information. In another cabinet she stores Shaklee
training tapes, CDs, and sales aids. Adjacent to that cabinet is
a table used for customer appointments and business planning with
distributors and leaders.
5. Rent or Lease--Vehicle, Machinery, and Equipment
Petitioners claimed and deducted vehicle leasing expenses of
$5,968; respondent allowed $3,647 and disallowed $2,321. As a
result of ABS’ high volume of sales in 2003, ABS qualified for
and participated in a car bonus program where ABS selected a car
from Shaklee’s lease program.
Petitioners submitted monthly statements issued by Shaklee
to ABS from December 2002 through November 2003. On each
statement ABS earned a monthly $400 car bonus credit and incurred
- 9 -
a monthly lease charge of $702.21 and a monthly insurance charge
of $88.20. ABS paid these charges in advance (i.e., in December
2002, ABS made lease payments for January 2003).
ABS’ participation in the Shaklee bonus program resulted in
a monthly car lease and insurance cost of $790.41 to ABS at a
yearly cost of $9,484.92. This amount was subtracted from the
direct deposit to ABS from Shaklee each month after the $400 car
bonus was added as earnings. If ABS had not participated in
Shaklee’s car leasing program, ABS would have received $400 per
month in cash.
Petitioners drove two other vehicles in addition to the ABS
car and reported having occasionally driven the ABS car for
unrelated business matters. The ABS car was driven a total of
23,550 miles in 2003 and the total number of business miles
petitioners claimed the car was driven in 2003 was 18,755. Mrs.
Bruns calculated 79 percent business use for the car.
Petitioners submitted a 2003 mileage log, a 2003 daily
planner, and a list of abbreviations used in the mileage log and
the daily planner. The mileage log lists the destination to
which Mrs. Bruns drove, the person Mrs. Bruns met with, the miles
driven to arrive at the location, and an abbreviation of the
business purpose for the meeting. The business purposes stated
included leaving information (such as literature or CDs),
conducting a demonstration of products, delivering products,
- 10 -
orienting new members, and conducting an overview of business
with distributors and sales leaders. The mileage log reported
18,242 miles traveled for 2003 but failed to list the business
purpose for 1,266 of the reported miles traveled.
6. Travel Expenses
Petitioners claimed deductions for travel expenses of
$4,253; respondent allowed $2,526 and disallowed $1,727.
Petitioners’ Quicken printout reported travel expenses of
$2,770.16. To substantiate the travel expenses, petitioners
provided photocopies of receipts from hotel stays and a receipt
from a travel agency. Because ABS has no territorial
limitations, many of its customers are in States other than South
Dakota. Petitioners wrote on the top of each photocopied receipt
the purpose for the trip. The total of the photocopied receipts
is $2,464.60. However, some of the receipts were missing a date,
and one receipt was in Mr. Bruns’ name.
Respondent disallowed expense deductions for a trip for
petitioners to see Kim and Mike Bruns, relatives and distributors
for ABS. Respondent disallowed expense deductions for a trip to
see Mrs. Bruns’ mother, Joetta Swanhorst, a “bonus earner” for
ABS who lives in a retirement community in Aberdeen, South
Dakota. Petitioners seek to deduct the cost of a three-night
hotel stay in Aberdeen, South Dakota. Respondent disallowed
expense deductions for a trip to meet with Lori Kimball, a “bonus
- 11 -
earner” for ABS who lives in Minnesota. Petitioners stayed in a
hotel near her to spend time with her while they were in
Minneapolis and provided a photocopy of a hotel receipt for
$168.36 for two nights. Respondent disallowed expenses incurred
in petitioners’ overnight stay at the Radisson Encore Hotel on
December 26, 2003. It was an “award bonus weekend” where
petitioners stayed with six other persons, including petitioners’
daughter, and shared with them the possible business
opportunities in distributing Shaklee products. ABS paid for
petitioners’ and their daughter’s rooms. Petitioners provided
photocopies of their receipts for two rooms at the rate of $80.66
per night for staying overnight on December 26, 2003.
Petitioners claimed a deduction of $144.15 for luggage used
to carry Shaklee samples and supplies and submitted as
substantiation a receipt that was missing the date of purchase
and had no description of the item.
Petitioners claimed a deduction of $201.40 for a handbag and
a coin purse used to carry sales cards, name tags, and business
cards. Petitioners provided photocopies of two receipts for
$71.02 and $130.38; neither receipt contained a description of
the items purchased.
- 12 -
7. Meals and Entertainment Expenses
Petitioners claimed a deduction of $2,5825 for meals and
entertainment expenses in 2003; respondent allowed $1,192 and
disallowed $1,390. At trial Mrs. Bruns conceded that petitioners
were entitled to a deduction of only $2,195 because she had
realized her husband was not a partner of ABS and his meals were
not deductible.
To substantiate the meals and entertainment expense
deductions, petitioners submitted photocopies of receipts from
restaurants and grocery stores and a list of abbreviations used
by Mrs. Bruns to reference the purpose of the meal. At the top
of most of the receipts, Mrs. Bruns wrote a specific business
purpose for incurring the expense. The business purposes
included trips into Sioux Falls for Shaklee sales-related
errands, nutrition talks, catalog presentations, leaving
literature, business meetings with other Shaklee groups or
leaders, product delivery or exchanges, bookkeeping, Shaklee
products opportunity meetings (to attract new distributors),
member orientations, appreciation of members, and delivering
voice CDs about Shaklee products and about becoming a Shaklee
distributor.
5
The $2,582 deduction is 50 percent of claimed meals and
entertainment expenses of $5,164.
- 13 -
The receipts petitioners submitted total $3,429.58.
However, many of the receipts did not show proof of payment,
lacked the date, or did not have a specific business purpose
listed for the expense.
Some of the receipts from restaurants were for meals costing
less than $10. Mrs. Bruns admitted one of the receipts for a
meal costing $9.60 was only for her meal although she did have
the meal with a customer.
8. Other Expenses
Petitioners claimed deductions for other expenses of
$10,588. Respondent disallowed an expense of $2,000 that
petitioners incurred for “image”.6 Mrs. Bruns explained that the
expense for product promotion reflected the cost of various
products that she took from the inventory of ABS after it
purchased them from Shaklee and that Mrs. Bruns personally tried,
let others try, or gave away at gatherings. Mrs. Bruns
personally tried new products to see whether she believed in the
product and to figure out a way to promote it. Mrs. Bruns
admitted some of the products were used for her personal care.
In substantiating the claimed product promotion expense,
petitioners submitted two invoices listing the product, the
quantity, and the price of the item used for product promotion.
6
We take “image” to mean product promotion and shall
refer to it as such.
- 14 -
The invoices showed that petitioners had used $6,822.24 in
products. However, Mrs. Bruns asked the Court to disregard
$1,124.76 worth of products listed on the invoice because they
had been used for personal care. Petitioners claimed a deduction
for product promotion after taking certain numbers from the two
invoices and rounding the number to $2,000. In picking which
items were used for personal care and which were used as demo
products, Mrs. Bruns made an educated guess.
Schedule E Expenses
On Schedule E, Supplemental Income and Loss, petitioners
reported $18,000 of alleged rents received from ABS and related
expenses of $3,471. The notice of deficiency disregarded the
alleged rental agreement, decreased rents received by $18,000,
and disallowed expenses claimed of $3,471. The notice of
deficiency increased petitioners’ other income by $18,000 to
reflect the disregarded rental agreement. In disregarding the
alleged rental of petitioners’ home to ABS, the income of the
partnership was increased by $18,000. Since Mrs. Bruns was
entitled to 100 percent of the partnership’s income and expenses,
her income from the partnership was increased by $18,000 in 2003.
ABS allegedly leased premises owned by petitioners for
$1,500 a month. Petitioners and ABS had a month-to-month oral
agreement in 2003, and ABS allegedly had leased space from
petitioners for 13 or 14 years. ABS wrote monthly rent checks to
- 15 -
Mr. Bruns. To substantiate this expense, petitioners submitted
photocopies of checks written to Leland Bruns on or around the
15th of every month for the year 2003.
On the Schedule E for 2003, petitioners claimed expenses of
$3,471 arising from the leasing arrangement. The expenses were
as follows: Insurance $358, taxes $1,092, utilities $1,150, and
depreciation $871. The insurance, taxes, and utilities expenses
were calculated by multiplying the annual amount for the house by
40 percent, the approximate percentage of the lease space ABS
occupied in the house.
Petitioners established the monthly rent charged to ABS by
visiting spaces in the community that were smaller than the space
ABS rented from petitioners. The rents of the smaller spaces
were approximately $9 to $13 per square foot. Petitioners
measured the area ABS leased to be approximately 1,400 square
feet and charged a little over $1 per square foot.
In the space ABS allegedly rented there is a meeting space
and a working area. In the meeting area there is a TV for
presentations, and it is connected to cable. There is no door or
lock which separates the area used by ABS from the other part of
the house. ABS allegedly uses the space for Mrs. Bruns to meet
with clients, hold meetings, and sell products. However, Mr.
Bruns and Mrs. Bruns occasionally watch entertainment shows,
- 16 -
sports, and news on the television in the meeting area. Mr.
Bruns has access to the meeting area.
Schedule A Deductions
On Schedule A, Itemized Deductions, petitioners claimed
itemized deductions totaling $9,793 for taxes paid, gifts to
charity, tax preparation fees, and safe deposit expenses.
Petitioners claimed a deduction of $7,353 for alleged gifts to
charity. The notice of deficiency disallowed $945 of the claimed
gifts to charity. After a concession by petitioners of $51.02,
$893.98 of claimed gifts to charity remains in dispute.
The standard deduction for petitioners in 2003 was $9,500.
The itemized deductions allowed in the notice of deficiency do
not exceed the standard deduction to which petitioners are
entitled. Accordingly, the notice of deficiency allowed the
standard deduction.
To substantiate the disallowed gifts to charity, petitioners
submitted a letter from their church, Abiding Savior Free
Lutheran Church, stating that they had donated a baking rack in
November of 2003 and an invoice from Furniture Discounters
stating they had paid $423.98 for a new baking rack to be
delivered to their church.
Petitioners also claimed cash gifts of $470 made in 2003.
Petitioners allegedly made these donations in amounts of $20 or
$30 at miscellaneous events that occurred throughout the year to
- 17 -
various organizations that asked Mr. or Mrs. Bruns for a
donation. Petitioners did not provide any substantiation for the
additional $470 cash donations claimed.
OPINION
I. Burden of Proof
In pertinent part, Rule 142(a)(1) provides, as a general
rule: “The burden of proof shall be upon the petitioner”.
However, section 7491(a) places the burden of proof on the
Commissioner with regard to certain factual issues. Petitioners
have alleged section 7491(a) applies, and respondent bears the
burden of proof. However, the burden of proof is inconsequential
to the outcome of this case.
II. Deficiency
The Commissioner’s determinations are generally presumed
correct, and the taxpayer bears the burden of proving the
determinations erroneous. Rule 142(a). The taxpayer bears the
burden of proving that he is entitled to the deduction claimed,
and this includes the burden of substantiation. Id.; Hradesky v.
Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam 540 F.2d
821 (5th Cir. 1976). A taxpayer must substantiate amounts
claimed as deductions by maintaining the records necessary to
establish he or she is entitled to the deductions. Sec. 6001.
Section 162(a) provides a deduction for certain business-
related expenses. In order to qualify for the deduction under
- 18 -
section 162(a), “an item must (1) be ‘paid or incurred during the
taxable year,’ (2) be for ‘carrying on any trade or business,’
(3) be an ‘expense,’ (4) be a ‘necessary’ expense, and (5) be an
‘ordinary’ expense.” Commissioner v. Lincoln Sav. & Loan
Association, 403 U.S. 345, 352 (1971); see also Commissioner v.
Tellier, 383 U.S. 687, 689 (1966) (the term “necessary” imposes
“only the minimal requirement that the expense be ‘appropriate
and helpful’ for ‘the development of the [taxpayer’s] business”
(quoting Welch v. Helvering, 290 U.S. 111, 113 (1933))); Deputy
v. du Pont, 308 U.S. 488, 495 (1940) (to qualify as “ordinary”,
the expense must relate to a transaction “of common or frequent
occurrence in the type of the business involved”). Whether an
expense is ordinary is determined by time, place, and
circumstance. Welch v. Helvering, supra at 113-114. Respondent
has not challenged the existence of ABS’ Shaklee distributorship
as a business and Mrs. Bruns’ related activities in distributing
and selling Shaklee products.
If a taxpayer establishes that he or she paid or incurred a
deductible business expense but does not establish the amount of
the expense, we may approximate the amount of the allowable
deduction, bearing heavily against the taxpayer whose
inexactitude is of his or her own making. Cohan v. Commissioner,
39 F.2d 540, 543-544 (2d Cir. 1930). However, for the Cohan rule
to apply, there must be sufficient evidence in the record to
- 19 -
provide a basis for the estimate. Vanicek v. Commissioner, 85
T.C. 731, 743 (1985). Certain expenses may not be estimated
because of the strict substantiation requirements of section
274(d). See sec. 280F(d)(4)(A); Sanford v. Commissioner, 50 T.C.
823, 827 (1968), affd. per curiam 412 F.2d 201 (2d Cir. 1969).
A. Schedule C Expenses
1. Advertising Expenses
In general, advertising expenses to promote a taxpayer’s
trade or business are deductible pursuant to section 162(a).
Brallier v. Commissioner, T.C. Memo. 1986-42; sec. 1.162-1(a),
Income Tax Regs. Petitioners claimed advertising expenses of
purchasing gifts for selected customers, printing a newsletter,
and the purchase of a camera.
a. Gift Expenses
The cost of gifts may be an ordinary and necessary business
expense if the gifts are connected with the taxpayer’s
opportunity to generate business income. Brown v. Commissioner,
T.C. Memo. 1984-120 (finding similarly gifts not connected with
taxpayer’s opportunity to generate business income where
taxpayer, physician employed by hospital, gave out Parker pens as
promotional gifts because physician did not depend upon referrals
for business); cf. Eder v. Commissioner, a Memorandum Opinion of
this Court dated Feb. 10, 1950 (finding gifts were not connected
with taxpayer’s opportunity to generate business income where
- 20 -
taxpayer gave cosmetic sets to office workers employed by someone
else and to telephone operators employed by someone else and paid
monthly by taxpayer to put through calls and deliver messages).
Mrs. Bruns has the burden of proving to what extent the gift
items contributed to her income. See Sutter v. Commissioner, 21
T.C. 170, 173-174 (1953).
Business gift deductions pursuant to section 162 are
restricted to $25 per donee per taxable year. Sec. 274(b)(1).
Further, section 274(d) requires adequate substantiation. A
taxpayer claiming a deduction for a business gift is required to
substantiate the gift with adequate records or sufficient
evidence corroborating his own testimony as to (1) the cost of
the gift; (2) the date and description of the gift; (3) the
business purpose of the gift; and (4) the business relationship
of the person receiving the gift. Sec. 1.274-5T(b)(5), Temporary
Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985). Respondent
allowed petitioners to deduct $25 per donee for gifts to 20
individuals.
Unlike the gifts in the situations in Eder and Brown, the
gifts given were connected with opportunities for Mrs. Bruns to
generate business. Gifts were given only to customers who were
good referral sources, loved the products, and were consistent
customers. The referrals and introductions Mrs. Bruns received
from the gift recipients were to individuals who were not Shaklee
- 21 -
customers. Because of the dependence Mrs. Bruns placed on
personal connections and interactions in distributing Shaklee
products, these introductions were an important part of building
the Shaklee customer base. Accordingly, the gifts given were an
ordinary and necessary advertising expense of Mrs. Bruns in
selling Shaklee products.
However, petitioners have failed to adequately substantiate
every gift expense. Petitioners provided photocopies of receipts
for items purchased for the purpose of making gifts, but many of
the receipts were illegible as to the amount spent, the date of
the purchase, or the item purchased. On the receipts which did
contain such information, petitioners consistently failed to note
the person to whom the gift was given, and many of the gifts
exceeded the $25 restriction imposed by section 274(b).
Petitioners have adequately substantiated advertising business
gift expenses to 26 individuals and are entitled to a deduction
of $650. This exceeds the amount allowed by respondent by $150
as we have allowed a deduction for gifts of $25 to 6 recipients
in addition to the 20 recipients previously allowed by
respondent.
b. Newsletter and Camera Expenses
Petitioners have not provided the content of the newsletters
or information as to how the printing of the newsletters is an
- 22 -
ordinary and necessary expense. Accordingly, we cannot allow a
deduction for these printing expenses.
Mrs. Bruns received income (as allocated by ABS) in 2003
from the sales of Shaklee distributors and leaders under ABS.
Mrs. Bruns stated she was constantly looking for new distributors
and coaching distributors on becoming leaders. The photos taken
by Mrs. Bruns of Shaklee sales gatherings and distributed among
distributors and leaders in her group were a part of this
coaching. The camera purchased by Mrs. Bruns was used
exclusively for this business purpose. However, the useful life
of the camera is greater than 1 year. Accordingly, she must
capitalize the cost. See Best Lock Corp. v. Commissioner, 31
T.C. 1217, 1234-1235 (1959) (cost of catalogs with useful life of
more than 1 year must be capitalized); Ala. Coca-Cola Bottling
Co. v. Commissioner, T.C. Memo. 1969-123 (cost of signs, clocks,
and scoreboards with useful lives of more than 1 year must be
capitalized). Petitioners are entitled to a $62.15 deduction for
the substantiated costs of printing photos and an allowable
camera depreciation deduction. These are in addition to the
amount respondent allowed.
2. Car and Truck Expenses
Petitioners claimed a deduction for car and truck expenses
incurred in 2003 for gasoline, car washes, repairs, and
maintenance on the vehicle leased and used for business purposes.
- 23 -
Petitioners claimed $2,238; respondent allowed $798 and
disallowed $1,440.
Section 162(a) allows a deduction for all ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business. Under that provision, an
employee or a self-employed individual may deduct the cost of
operating an automobile to the extent that it is used in a trade
or business. However, under section 262 no portion of the cost
of operating an automobile that is attributable to personal use
is deductible.
A passenger vehicle is listed property under section
280F(d)(4). Section 274(d) disallows any deduction with respect
to listed property unless the taxpayer adequately substantiates:
(1) The amount of the expense, (2) the time and place of the
travel or the use of the property, (3) the business purpose of
the expense, and (4) the business relationship of the persons
using the property.
Mrs. Bruns provided a mileage log that listed the date of
travel, the length of the travel, and the business purpose of the
travel in a majority of the entries. After totaling the miles
recorded for 2003, Mrs. Bruns calculated that she used the car 79
percent of the time for business purposes.7 Upon recalculation
7
Mrs. Bruns arrived at 79 percent by dividing business
miles of 18,755 by total miles of 23,550.
- 24 -
of the business percentage use, we conclude the business
percentage use is 72 percent.8
Petitioners submitted gasoline receipts listing the amount
of gasoline purchased, method of payment, and date. The dates on
the receipts are consistent with the reported travel in the
mileage log; i.e., there are increased gas purchases when the
mileage log reports more miles traveled. The gasoline receipts
total $1,132.49. Petitioners submitted carwash receipts of
$115.20 listing the service provided, the amount, and the date
rendered. The car washes are spaced throughout 2003 and are
reasonable in amount and frequency. Petitioners submitted
receipts of payment totaling $102.84 for repairs and maintenance
on the passenger vehicle. The receipts, which are for oil
changes, specify Mrs. Bruns’ car and are spaced throughout 2003
as the car mileage increased. We conclude petitioners have met
their burden of substantiating these actual expenses of operating
a vehicle for business purposes and are entitled to a deduction
of $972.389 in addition to the amount respondent allowed.
8
Some of the entries in petitioners’ mileage log did not
contain a purpose. The total of the entries containing the miles
traveled, the date, and the purpose of the trip is 16,976 miles.
9
The total of gas expenses of $1,132.49 plus carwash
expenses of $115.20 plus repairs and maintenance expenses of
$102.84 times business use of 72 percent equals $972.38.
- 25 -
3. Contract Labor Expenses
In general, payments made or incurred by a trade or business
for personal services rendered are ordinary and necessary
business expenses and may be deducted under section 162. Sec.
1.162-7(a), Income Tax Regs. Petitioners failed to provide any
proof of payment and did not provide sufficient substantiation to
permit a reasonable estimate of contract labor expenses.
Accordingly, respondent’s complete disallowance of a deduction is
sustained.
4. Office Expenses
The cost of materials and supplies consumed and used in
operations during a taxable year is generally considered an
ordinary and necessary expense of conducting a business or for-
profit activity. Sec. 162; sec. 1.162-3, Income Tax Regs.
Petitioners submitted photocopies of receipts for business
furniture which total $5,106.83 and photocopies of receipts for
business supplies, refreshments, and decorations which total
$2,512.34.
Petitioners introduced into the record photographs showing
the use of the furniture whose costs are claimed as a business
expense. The furniture stored business information and Shaklee
products kept as inventory or orders and displayed Shaklee
products. Although Mrs. Bruns delivered Shaklee products to
customers, customers would also stop by her home to pick up
- 26 -
products. This required her to devote an area to storing a small
inventory of products for sale and those ordered by customers and
to displaying Shaklee products for sales. Because leaders and
distributors would also stop by her home, Mrs. Bruns had to
provide a meeting place and store Shaklee informational tapes,
CDs, and sales aids. An area for Mrs. Bruns to coach
distributors and leaders was frequently used and helpful to
increasing revenue. Further, sales aids and training materials
to refer to was helpful to Mrs. Bruns in selling Shaklee products
and coaching others on how to successfully sell Shaklee products.
Accordingly, the business furniture was an ordinary and necessary
business expense of Mrs. Bruns in selling Shaklee products.
Petitioners also claimed an office expense deduction for the
purchase of a portable CD player with speakers. Because much of
the training Mrs. Bruns received as a Shaklee distributor was
done through CDs that she could listen to on a portable CD player
while at home or while traveling, the CD player was necessary to
sell Shaklee products. However, the receipt petitioners
submitted included the purchase of two radios unrelated to the
business; we disallow a deduction for those radios.
Mrs. Bruns used the supplies in her business of selling
Shaklee products. The total amount spent on business supplies,
decorations, and refreshments is not excessive in consideration
of her business. The cost of pens, paper, and other office
- 27 -
supplies to keep track of products, customer orders, and sales
was an ordinary and necessary business expense she incurred
selling Shaklee products. Further, offering coffee and candy to
customers was helpful to Mrs. Bruns in promoting the sale of
Shaklee products when customers visited her. Putting up seasonal
decorations in the area of her home where Shaklee customers
visited was also helpful to Mrs. Bruns in selling Shaklee
products.
Petitioners’ business expense receipts for purchases of
furniture, supplies, refreshments, and decorations adequately
substantiated those purchases. Each receipt was dated and
provided the amount spent, a description of the item purchased,
and the reason for the purchase. However, because the furniture
and the portable CD player with speakers have an expected useful
life exceeding 1 year, petitioners may not deduct the full
amounts paid as ordinary and necessary business expenses. The
costs of the business furniture and the portable CD player with
speakers are capital expenses, and petitioners must properly
depreciate the property. They are entitled to an allowable
depreciation deduction. See sec. 263(a)(1); sec. 1.263(a)-2(a),
Income Tax Regs. Petitioners are entitled to an ordinary and
necessary business expense deduction of $2,512.3410 for business
10
This is the total of the substantiated business
supplies, decorations, and refreshment purchases in 2003.
- 28 -
supplies, decorations, and refreshments purchased in 2003. The
business supplies deduction and the depreciation deductions for
the furniture and the CD player are allowed in addition to the
amounts respondent already allowed.
5. Rent or Lease--Vehicle, Machinery, and Equipment
Petitioners claimed a deduction of $5,968 for leasing
expenses associated with the business vehicle leased by ABS and
used by Mrs. Bruns in 2003. Respondent allowed a deduction of
$3,647, and $2,321 remains at issue. Car leasing expenses are
subject to the section 274(d) strict substantiation requirements
(explained supra) because a car is listed property. Sec.
280F(d)(4).
We found that Mrs. Bruns used the leased passenger car 72
percent of the time for business purposes in 2003. The direct
deposit reports issued to ABS from Shaklee show a monthly car
charge of $790.41. Petitioners have substantiated ABS’ car
leasing expense of $6,829.14.11 Accordingly, petitioners are
entitled to a deduction for the full amount claimed on their 2003
tax return.
6. Travel Expenses
A deduction is allowed for ordinary and necessary traveling
expenses incurred while away from home in the pursuit of a trade
11
This number results from multiplying $790.41 x 12 months
x 72 percent of business use.
- 29 -
or business. Sec. 162(a)(2). If a taxpayer travels to a
destination at which he engages in both business and personal
activities, the traveling expenses to and from the destination
are deductible only if the trip is related primarily to the
taxpayer’s trade or business. Sec. 1.162-2(b)(1), Income Tax
Regs. If the trip is primarily personal, the traveling expenses
to and from the destination are not deductible; however, expenses
at the location properly allocable to the taxpayer’s trade or
business are deductible. Id.
Whether a trip is related primarily to the taxpayer’s trade
or business depends on the facts and circumstances in each case.
Sec. 1.162-2(b)(2), Income Tax Regs. An important factor is the
amount of time during the trip spent on personal activity
compared to the amount of time spent on activities directly
relating to the taxpayer’s trade or business. Id. If a member
of the taxpayer’s family accompanies him on a business trip,
expenses attributable to the family member are not deductible
unless it can be adequately shown that the presence of the family
member on the trip has a bona fide business purpose. Sec. 1.162-
2(c), Income Tax Regs.
Of the $4,253 petitioners claimed as travel expenses,
respondent allowed $2,526 and disallowed $1,727. Respondent
disallowed deductions for expenses of trips to see relatives, to
visit a friend in Minnesota, and to spend a weekend with
- 30 -
petitioners’ daughter and with others. Respondent also
disallowed deductions for costs of luggage, a handbag, and a coin
purse.
Petitioners submitted photocopies of receipts for travel
expenses incurred in 2003. The disallowed deductions are for
trips having a mixed business and pleasure motivation.
Petitioners saw friends and relatives who were customers and
distributors of ABS and who earned bonuses for ABS in 2003.
Updating these earners about the new Shaklee products and
providing coaching on business leadership was business related.
Visiting with friends and relatives about matters not related to
ABS was for pleasure.
Where a trip has mixed motivations of business and pleasure,
the costs of traveling to and from the location are deductible
only if the primary purpose of the trip is business. Sec. 1.162-
2(b)(1), Income Tax Regs. Petitioners have failed to prove how
much time was spent on each trip for business and for pleasure.
Without this information we cannot conclude that these trips were
primarily for business and must disallow the costs of traveling
to and from these locations. Petitioners would be entitled to a
deduction for expenses incurred at the location properly
allocable to business activities. However, petitioners have
failed to provide sufficient information to allow any of the
- 31 -
disallowed travel expenses. Petitioners have not shown which
expenses are properly allocable to business-related activities.
Petitioners also claimed travel expense deductions for
amounts incurred to purchase business luggage. Petitioners
failed to provide receipts adequately substantiating these
expenses. Accordingly, petitioners are not entitled to a
deduction for travel expenses above that allowed by respondent.
7. Meals and Entertainment Expenses
Section 162 permits the deduction of food and beverage
expenses incurred by a taxpayer if they are ordinary, necessary,
and reasonable expenses incurred by the taxpayer in his business.
No deduction is allowed with respect to personal, living, or
family expenses. Sec. 262. However, section 162(a) permits the
deduction of amounts expended for meals (not lavish or
extravagant under the circumstances) when away from home in the
pursuit of a trade or business. In the context of section
162(a)(2), a taxpayer’s home generally refers to the area of a
taxpayer’s principal place of employment, whether or not in the
vicinity of the taxpayer’s personal residence. Daly v.
Commissioner, 72 T.C. 190, 195 (1979), affd. 662 F.2d 253 (4th
Cir. 1981); Kroll v. Commissioner, 49 T.C. 557, 561-562 (1968).
“[I]n the pursuit of a trade or business” has been read to
mean: “The exigencies of business rather than the personal
conveniences and necessities of the traveler must be the
- 32 -
motivating factors.” Commissioner v. Flowers, 326 U.S. 465, 474
(1946).
Section 274(a) further restricts the deduction of business
food and beverage expenses. Such expenditures must be directly
related to the conduct of the taxpayer’s trade or business, or
associated with the active conduct of the taxpayer’s trade or
business, to be deductible. Id.
An expenditure is considered associated with the active
conduct of the taxpayer’s trade or business if the taxpayer
establishes that she had a clear business purpose in making the
expenditure, such as to obtain new business or to encourage the
continuation of an existing business relationship. Sec. 1.274-
2(d)(2), Income Tax Regs.
In order to establish a substantial and bona fide business
discussion, the taxpayer must show that he actively engaged in a
business meeting, negotiation discussion, or other bona fide
business transaction, other than entertainment, for the purpose
of obtaining income or other specific trade or business benefit.
Sec. 1.274-2(d)(3)(i)(A), Income Tax Regs. Additionally, the
taxpayer must establish that this business meeting, negotiation,
discussion, or transaction was substantial in relation to the
entertainment. Id. Entertainment which occurs on the same day
as a substantial and bona fide business discussion will be
- 33 -
considered to directly precede or follow the discussion. Sec.
1.274-2(d)(3)(ii), Income Tax Regs.
Food and beverage expense deductions are further limited by
section 274(k) and (n). No deduction is permitted for food and
beverage expenses unless the expense is not lavish or extravagant
under the circumstances and the taxpayer is present at the
furnishing of such food or beverages. Sec. 274(k). Further, the
amount of the deduction that would otherwise be allowed for food
and beverage expenses is generally reduced by 50 percent. Sec.
274(n)(1).
Finally, in order to deduct food and beverage expenses, a
taxpayer must meet the strict substantiation requirements of
section 274(d). To substantiate these expenditures the taxpayer
must prove: (a) The amount; (b) the time and date; (c) the
place; (d) the business purpose; and (e) the business
relationship. Sec. 1.274-5T(b)(3), Temporary Income Tax Regs.,
50 Fed. Reg. 46015 (Nov. 6, 1985). The majority of the
photocopied receipts and accompanying information petitioners
submitted either did not have a sufficient business purpose, were
for a personal expense, or otherwise failed to meet the strict
substantiation requirements.
Petitioners submitted numerous grocery store receipts as
food and beverage expenses with a notation that they were for
guests. Petitioners failed to specify the time and date of the
- 34 -
entertainment of the guests, the place where they entertained the
guests, the business purpose of buying the groceries for the
guests, and the business relationship of the guests. Because
petitioners have failed to meet the strict substantiation
requirements of section 274(d), we cannot allow a deduction for
these expenses.
Petitioners submitted receipts for personal meals of both
Mr. and Mrs. Bruns. Mr. Bruns was not an employee or partner of
ABS or a participant in Mrs. Bruns’ activities in distributing
Shaklee products. Mrs. Bruns conceded at trial that petitioners
were not entitled to a deduction for these expenses.
Many of the receipts for food and beverage expenses were for
an amount under $10 and for a single serving of food. Mrs. Bruns
admitted a particular receipt for a single serving of food in the
amount of $9.60 was only for her meal, but she said she ate with
a customer. Expenses for meals are personal and as such
nondeductible unless a business purpose can be shown for
incurring the expenses, as in the case of expenses incurred away
from home in the pursuit of business and not lavish or
extravagant under the circumstances. Secs. 262(a), 162(a)(2);
Drill v. Commissioner, 8 T.C. 902, 903 (1947); sec. 1.262-
1(b)(5), Income Tax Regs.
We conclude petitioners’ home, for purposes of section
162(a)(2), was in the Sioux Falls area of South Dakota.
- 35 -
Petitioners claimed multiple deductions under $10 in amount for
meal expenses Mrs. Bruns incurred when she was not away from
home. These are personal expenses and are not deductible. See
Drill v. Commissioner, supra. The meal expenses Mrs. Bruns
incurred while she was away from home were not lavish or
extravagant under the circumstances, were incurred in the pursuit
of business, and are deductible. At the top of each receipt
submitted to substantiate meal expenses incurred while away from
home was a notation explaining Mrs. Bruns’ business purpose in
being away from home. The majority of the notations referenced a
Shaklee convention, and we are persuaded that the exigencies of
business prompted Mrs. Bruns to travel away from home and incur
these expenses.
After eliminating the aforementioned nondeductible food and
beverage expenses petitioners claimed, expenses totaling
$1,409.83 remain. These expenses meet the strict substantiation
requirements of section 274(d) and are for meals where Mrs. Bruns
met with a customer to conduct some form of business for ABS.
A majority of these receipts are for amounts in the range of
$15 to $30. Treating customers, distributors, and leaders to a
meal is a strategy Mrs. Bruns employed to increase the sale of
Shaklee products. Mrs. Bruns used the meals as an opportunity to
deliver products to customers, spend time with customers to
encourage them to buy more Shaklee products, and discuss
- 36 -
potentially starting their own distributorships. She used the
meals with distributors and leaders as opportunities to review
business strategy in their Shaklee distributorships. These
business meals occurred consistently throughout 2003 and were
helpful in promoting the sale of Shaklee products by distributors
and leaders Mrs. Bruns supervised. Accordingly, we conclude the
costs of meals for specific customers, distributors, and leaders
were incurred by Mrs. Bruns to increase the sale of Shaklee
products by Mrs. Bruns, her distributors, and leaders and were
ordinary and necessary business expenses of Mrs. Bruns in selling
Shaklee products.
Further, we conclude these meals were associated with the
active conduct of Mrs. Bruns’ business of distributing Shaklee
products and the meals directly preceded or followed a
substantial and bona fide business discussion. The meals
purchased were associated with the active conduct of Mrs. Bruns
in distributing and selling Shaklee products because there was a
clear business purpose in purchasing the meals for customers,
distributors, and leaders. Mrs. Bruns had an existing business
relationship with these individuals, and meals were used to
facilitate sales of Shaklee products to customers and to
encourage and increase the distribution of Shaklee products by
distributors and leaders. Further, at each meal, substantial and
bona fide business discussions occurred. At the top of each
- 37 -
receipt, petitioners listed what sort of business discussion and
transactions occurred at the meal. Accordingly, petitioners are
entitled to a deduction of $704.9212 for the meals and
entertainment expenses incurred in 2003. This is in addition to
the $1,192 deduction respondent allowed.
8. Other Expenses
The products used by Mrs. Bruns and claimed as a product
promotion expense of petitioners were not specified. Rather Mrs.
Bruns admitted personal use of products and guessed at the amount
of alleged non-personal-use products. Without more specificity
as to which products Mrs. Bruns used for product promotion, we
cannot conclude that any portion of the $2,000 product promotion
expense she claimed as a deduction is allowable as an ordinary
and necessary business expense.
B. Schedule E Expenses
Petitioners assert that ABS rented basement space in
petitioners’ residence during 2003. ABS subtracted $18,000 in
rental expenses from its gross income on its Form 1065. The
alleged rental was month to month, and there was no written
rental agreement. There is lack of proof of a bona fide rental.
The purported rental was not at arm’s length, and we disregard it
12
This is 50 percent of the total expenses of $1,409.83
which met the requirements of secs. 162 and 274(a) and (d). A
50-percent reduction of the allowed deduction is required by sec.
274(n).
- 38 -
for lack of economic substance. Accordingly, we disallow
deductions petitioners claimed on Schedule E of their return for
insurance, taxes, utilities, and depreciation attributed to the
rental.
C. Schedule A Deductions: Charitable Contributions
In general, a taxpayer is entitled to deduct charitable
contributions made during the taxable year to or for the use of
certain types of organizations. Sec. 170(a)(1), (c). A taxpayer
is required to substantiate charitable contributions; records
must be maintained. Sec. 6001; sec. 1.6001-1(a), Income Tax
Regs. Petitioners claim to have made charitable contributions of
$893.98 in 2003: Approximately $470 in cash contributions of $20
to $30 increments to undisclosed charitable organizations and
$423.98 by delivery of a new baking rack to their church.
A contribution of cash in an amount less than $250 made in a
tax year beginning before August 17, 2006, may be substantiated
with a canceled check, a receipt, or other reliable evidence
showing the name of the donee, the date of the contribution, and
the amount of the contribution. Sec. 1.170A-13(a)(1), Income Tax
Regs. Petitioners have provided no substantiation of the cash
contributions, nor have they adequately identified the recipients
of these contributions. Accordingly, petitioners are not
entitled to deduct these claimed cash charitable contributions.
- 39 -
Contributions of cash or property in excess of $250 require
the donor to obtain contemporaneous written acknowledgment of the
donation from the donee. Sec. 170(f)(8). At a minimum, the
contemporaneous written acknowledgment must contain a description
of any property contributed, a statement as to whether any goods
or services were provided in consideration, and a description and
good-faith estimate of the value of any goods or services
referred to. Sec. 170(f)(8)(B). Petitioners claim to have
contributed a baking rack to their church. The receipt they
provided establishes they paid $423.98 for a new baking rack to
be delivered to their church. The invoice establishes the fair
market value of the baking rack as $423.98. Petitioners have
provided a letter of acknowledgment from their church which meets
the statutory requirements of a contemporaneous written
acknowledgment. Accordingly, petitioners are entitled to a
$423.98 charitable contribution deduction.
III. Section 6662(a) Penalty
Section 7491(c) provides that the Commissioner bears the
burden of production with respect to the liability of any
individual for additions to tax and penalties. “The
Commissioner’s burden of production under section 7491(c) is to
produce evidence that it is appropriate to impose the relevant
penalty, addition to tax, or additional amount”. Swain v.
Commissioner, 118 T.C. 358, 363 (2002); see also Higbee v.
- 40 -
Commissioner, 116 T.C. 438, 446 (2001). The Commissioner,
however, does not have the obligation to introduce evidence
regarding reasonable cause or substantial authority. Higbee v.
Commissioner, supra at 446-447.
Respondent determined that petitioners are liable for the
section 6662(a) penalty for 2003. Pursuant to section 6662(a)
and (b)(1) and (2), a taxpayer may be liable for a penalty of 20
percent on the portion of an underpayment of tax due to
negligence or disregard of rules or regulations or a substantial
understatement of income tax. An “understatement” is the
difference between the amount of tax required to be shown on the
return and the amount of tax actually shown on the return. Sec.
6662(d)(2)(A). A “substantial understatement” exists if the
understatement exceeds the greater of (1) 10 percent of the tax
required to be shown on the return for a taxable year or (2)
$5,000. See sec. 6662(d)(1)(A). Respondent met his burden of
production as there was a substantial understatement of income
tax.
The accuracy-related penalty is not imposed with respect to
any portion of the underpayment as to which the taxpayer acted
with reasonable cause and in good faith. Sec. 6664(c)(1). The
decision as to whether the taxpayer acted with reasonable cause
and in good faith depends upon all the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs.
- 41 -
Petitioners deducted as business expenses personal items
such as travel with relatives and personal use of Shaklee
products. At trial petitioners conceded some of these personal
items and claimed inadvertent error. However, petitioners should
have discovered these inadvertent errors well in advance of
trial. Further, petitioners deducted rent when no written rental
agreement existed and the alleged rent was for an area where
petitioners watched TV and relaxed. Petitioners have failed to
show they acted with reasonable care and in good faith.
Accordingly, we sustain the section 6662(a) penalty.
To reflect the foregoing,
Decision will be entered
under Rule 155.