T.C. Summary Opinion 2009-124
UNITED STATES TAX COURT
THOMAS A. AND VERNESTER O. JOHNSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 29866-07S. Filed August 5, 2009.
Thomas A. Johnson and Vernester O. Johnson, pro sese.
Matthew D. Carlson, for respondent.
DEAN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect when the petition was filed. Pursuant to section 7463(b),
the decision to be entered is not reviewable by any other court,
and this opinion shall not be treated as precedent for any other
case. Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year in issue,
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and all Rule References are to the Tax Court Rules of Practice
and Procedure.
Respondent determined for 2005 a deficiency in petitioners’
Federal income tax of $8,134 and an accuracy-related penalty
under section 6662(a) of $1,626.80.
The parties agree that $5,000 of petitioner Vernester O.
Johnson’s income reported on Form 1099-MISC, Miscellaneous
Income, from “Red Gum TIC” is properly reportable on Schedule C,
Profit or Loss From Business, rather than as “Wages, salaries,
tips, etc.” on line 7 of petitioners’ return. The issues
remaining for decision1 are whether petitioners are:
(1) Entitled to a home mortgage interest deduction; (2) entitled
to deduct expenses for supplies and legal and professional
services on Schedule C; (3) entitled to charitable contribution
deductions; and (4) liable for the accuracy-related penalty under
section 6662(a).
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the exhibits received in evidence
are incorporated herein by reference. Petitioners resided in
California when the petition was filed.
1
Adjustments to petitioners’ self-employment income and
self-employment income tax deduction are computational and will
be resolved consistent with the Court’s decision. See secs.
1401, 164(f).
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In January 1998 Maury and Pelipa Power, one-third joint
tenants, Trenton and Elvia Shultz, one-third joint tenants, and
Roman Hernandez and Refugio Perez, one-third joint tenants,
granted a deed to property (property) to Diversified Unlimited,
Inc., doing business as United Investments (Diversified).
Diversified purchased the property subject to a “First note and
deed of trust” in favor of Knutson Mortgage Corp. (Knutson)
securing a note of $192,758.62.
In January 1998 petitioners entered into an executory
contract for the purchase of the property from Diversified. In
February 1998 the parties entered into an agreement for the sale
of real property by Diversified. According to the latter
agreement, petitioners agreed to purchase the property subject to
the first note and deed of trust in favor of Knutson.
Petitioners also agreed to pay Diversified $15,000 by June 15,
1998. Attached to the sale contract is an affidavit in which
petitioners acknowledge “their awareness” that: (a) They are
purchasing the property subject to the encumbrance; (b) that
Diversified asks that petitioners assume the loan or refinance
the property after a 6-month period had expired; and (c) they
will be the “owner of title on record” of the property.
Diversified subsequently issued to petitioners a “CORPORATION
GRANT DEED”, and petitioners issued to Diversified a deed of
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trust to secure a promissory note for $10,000 in favor of
Diversified.
The property was used as petitioners’ primary residence.
Petitioners provided as evidence of interest payments copies of
cashier’s checks drawn on Washington Mutual Bank (WaMu) to
“Countrywide” or “Countrywide Home Loans”: (a) For $8,709.23
dated February 3, 2005, bearing the handwritten notation “OCT,
NOV, DEC, JAN, F [illegible]” (the space showing the remitter is
blank); (b) for $2,095.95 dated March 10, 2005, bearing the
handwritten notation “FEB” (the remitter is listed as Thomas A.
Johnson, Jr.); (c) for $13,491.75 dated July 28, 2005, bearing no
notation as to month nor the name of a remitter; and (d) for
$4,361.00 dated November 9, 2005, bearing no notation as to month
nor the name of a remitter. Petitioners also provided a copy of
a FedEx “tracking update” for a FedEx standard overnight envelope
shipped July 28, 2005, by Vanessa Johnson to Countrywide Home
Loans. Petitioners submitted copies of other checks drawn on
WaMu that show that they had made payments in 2003 and 2004 to
“Guaranty Residential Lending” the last of which, for $2,185.77,
was a cashier’s check dated November 22, 2004.
Countrywide Home Loans sent a Form 1098, Mortgage Interest
Statement, to Maury and Pelipa Power, “Care of Vernester
Johnson”, reporting paid mortgage interest of $19,457 for 2005.
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New Century Mortgage sent petitioners a Form 1098 reporting paid
mortgage interest of $2,476.24 for 2005.
Discussion
Generally, the Commissioner’s determinations in a notice of
deficiency are presumed correct, and the taxpayer has the burden
of proving that those determinations are erroneous. See Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). In some
cases the burden of proof with respect to relevant factual issues
may shift to the Commissioner under section 7491(a). Petitioners
did not present evidence or argument that they satisfied the
requirements of section 7491(a). Therefore, the burden of proof
does not shift to respondent.
Mortgage Interest Deduction
Section 163(a) allows a deduction for interest paid or
accrued within the taxable year on indebtedness. The
“indebtedness” for purposes of section 163 must, in general, be
an obligation of the taxpayer and not an obligation of another.
Golder v. Commissioner, 604 F.2d 34, 35 (9th Cir. 1979), affg.
T.C. Memo. 1976-150; Smith v. Commissioner, 84 T.C. 889, 897
(1985), affd. without published opinion 805 F.2d 1073 (D.C. Cir.
1986).
Individuals are allowed a deduction for “qualified residence
interest”. Sec. 163(h)(2)(D), (3). Qualified residence interest
includes interest paid to acquire the principal residence of the
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taxpayer or certain indebtedness secured by a personal residence.
Sec. 163(h)(3). Respondent, however, argues that petitioners
have failed to provide adequate substantiation for their claimed
mortgage interest deduction.
Petitioners have not shown that they were directly liable on
the mortgages for which they claimed a mortgage interest
deduction. In fact, the Form 1098 from Countrywide Home Loans
indicates that the mortgage was in the names of former owners of
an interest in petitioners’ residence, Maury and Pelipa Power.
But section 1.163-1(b), Income Tax Regs., provides in pertinent
part: “Interest paid by the taxpayer on a mortgage upon real
estate of which he is the legal or equitable owner, even though
the taxpayer is not directly liable upon the bond or note secured
by such mortgage, may be deducted as interest on his
indebtedness.”
Respondent did not assert that petitioners were not the
beneficial owners of their personal residence, and the evidence
shows that they were the legal owners of the property. The Court
assumes that the February 3, 2005, cashier’s check to Countrywide
was for the October, November, and December 2004 mortgage
payments and the January 2005 payment, and that about one-fourth
of the total was for January 2005 (likely penalty fees would have
been included in this apparently late payment). If the January
payment is added to the March 10, July 28, and November 9, 2005,
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payments, the total approximates the amount for which Countrywide
issued its Form 1098. The Form 1098 New Century Mortgage issued
reporting $2,476.24 of interest was sent in the name of
petitioner Vernester Johnson.
While the financing arrangements of petitioners’ home
purchase are less than clear, the preponderance of the evidence
leads the Court to conclude that petitioners were the legal and
equitable owners of the property and did make mortgage interest
payments to Countrywide Home Loan and New Century as claimed on
their return for 2005.
Schedule C Expenses
Respondent disallowed petitioners’ deductions of $8,890 for
supplies and $6,500 for legal and professional services because
petitioners neither substantiated the expenses nor showed them to
be ordinary and necessary expenses paid during 2005 in carrying
on a trade or business.
Section 162 generally allows a deduction for ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on a trade or business. Generally, no deduction is
allowed for personal, living, or family expenses. Sec. 262.
Where a taxpayer has established that he has incurred a trade or
business expense, failure to prove the exact amount of the
otherwise deductible item may not always be fatal. Generally,
unless precluded by section 274, the Court may estimate the
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amount of an expense and allow a deduction to that extent. See
Finley v. Commissioner, 255 F.2d 128, 133 (10th Cir. 1958), affg.
27 T.C. 413 (1956); Cohan v. Commissioner, 39 F.2d 540, 543-544
(2d Cir. 1930). In order for the Court to estimate the amount of
an expense, however, there must be some basis upon which an
estimate may be made. Vanicek v. Commissioner, 85 T.C. 731, 742-
743 (1985). Without such a basis, an allowance would amount to
unguided largesse. Williams v. United States, 245 F.2d 559, 560
(5th Cir. 1957).
Petitioners claimed the deductions for supplies and legal and
professional services as expenses that Thomas Johnson paid in
connection with his consulting business. At trial, however,
petitioners offered no evidence to substantiate the deductions.
Since the Court has no basis on which to estimate the expenses,
respondent’s determination is sustained.
Charitable Contributions
Respondent disallowed for lack of substantiation
petitioners’ deduction of $2,800 for cash gifts to charity.
Section 170(a)(1) allows a taxpayer to deduct a charitable
contribution only if verified under regulations prescribed by the
Secretary. The regulations, which require substantiation of the
taxpayer’s contribution, provide that if a taxpayer makes a
charitable contribution of money, the taxpayer shall maintain for
each contribution one of the following:
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(i) A cancelled check.
(ii) A receipt from the donee charitable organization
showing the name of the donee, the date of the contribution,
and the amount of the contribution. A letter or other
communication from the donee charitable organization
acknowledging receipt of a contribution and showing the date
and amount of the contribution constitutes a receipt for
purposes of this paragraph (a).
(iii) In the absence of a canceled check or receipt
from the donee charitable organization, other reliable
written records 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 allege that their contribution was in cash, and
they did not provide a canceled check to substantiate their
contribution. Petitioners provided a copy of a letter dated
December 27, 2005, from the “Continentals of Omega Boys and Girls
Club” (Club) that acknowledged a $2,800 donation but failed to
provide a date for petitioners’ contribution. The letter was
signed by Pelton Stewart, executive director.
Respondent called as a witness Richard Wright (Wright),
currently president of the board of directors of the Club.
Wright was also president during 2005. Wright’s duties as
president include reviewing the Club’s financial information and
selecting and hiring the Club’s “chief professional officer”
(executive director). Wright identified petitioner Thomas
Johnson as having provided volunteer accounting services for the
Club and as having known or been a “friend” and possibly a
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fraternity brother of Pelton Stewart,2 the person who signed
petitioners’ donation letter.
Wright testified that the Club maintained a list of donors
on spreadsheets that were updated monthly by a bookkeeper who
then provided them to the board. Wright, who brought the records
with him to court, testified that neither petitioner was listed
as a donor of any amount in 2005. Wright further supplied an
example of what a letter to a donor would have looked like in
2005. Wright testified that the letter petitioners supplied as
substantiation of their alleged donation differs in several
respects from the typical donor letter of 2005 and is not
characteristic of a letter that the Club would have sent to a
donor in 2005.
The Court finds that petitioners’ letter fails to meet the
substantiation requirements of section 1.170A-13(a)(1), Income
Tax Regs. It is not a receipt as defined by section 1.170A-
13(a)(1)(ii), Income Tax Regs., because it does not show the date
of the contribution. The letter does not qualify as “other
reliable written records” either because it lacks a donation
date. In addition, the records of the donee fail to reflect the
fairly sizeable donation petitioners claimed and is at variance
2
Wright testified that upon the removal of Pelton Stewart as
executive director in 2006, petitioner Thomas Johnson notified
Wright by letter that he would no longer serve as a volunteer to
the Club.
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with the form of letters sent to other donors of similar size
donations in 2005. Accordingly, petitioners are not entitled to
the claimed deduction.
Section 6662(a) Accuracy-Related Penalty
Section 7491(c) imposes on the Commissioner the burden of
production in any court proceeding with respect to the liability
of any individual for penalties and additions to tax. Higbee v.
Commissioner, 116 T.C. 438, 446 (2001); Trowbridge v.
Commissioner, T.C. Memo. 2003-164, affd. 378 F.3d 432 (5th Cir.
2004). In order to meet the burden of production under section
7491(c), the Commissioner need only make a prima facie case that
imposition of the penalty or addition to tax is appropriate.
Higbee v. Commissioner, supra at 446.
Respondent determined that petitioners are liable for the
accuracy-related penalty under section 6662(a) for 2005. Section
6662(a) imposes a 20-percent penalty on the portion of an
underpayment attributable to any one of various factors,
including negligence or disregard of rules or regulations and a
substantial understatement of income tax. See sec. 6662(b)(1)
and (2). “Negligence” includes any failure to make a reasonable
attempt to comply with the provisions of the Internal Revenue
Code, including any failure to keep adequate books and records or
to substantiate items properly. See sec. 6662(c); sec.
1.6662-3(b)(1), Income Tax Regs.
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A “substantial understatement” of income tax exceeds the
greater of 10 percent of the tax required to be shown on the
return or $5,000. See sec. 6662(d); sec. 1.6662-4(b), Income Tax
Regs.
Section 6664(c)(1) provides that the penalty under section
6662(a) shall not apply to any portion of an underpayment if it
is shown that there was reasonable cause for the taxpayer’s
position and that the taxpayer acted in good faith with respect
to that portion. The determination of whether a taxpayer acted
with reasonable cause and in good faith is made on a case-by-case
basis, taking into account all the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. The most
important factor is the extent of the taxpayer’s effort to assess
his proper tax liability for the year. Id.
Petitioners failed to substantiate business expense
deductions for supplies and legal and professional services.
Petitioners also failed to properly substantiate their cash
charitable contributions and to properly report self-employment
taxes. They offered no evidence of reasonable cause or good
faith with respect to their treatment of these items. The
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accuracy-related penalty under section 6662(a) is sustained on
account of negligence.
To reflect the foregoing,
Decision will be entered
under Rule 155.