T.C. Memo. 2009-274
UNITED STATES TAX COURT
TIMOTHY P. FOSTER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24411-07. Filed November 25, 2009.
Timothy P. Foster, pro se.
John W. Strate, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined a deficiency of
$265,665 and a section 6662(a) penalty of $53,133 with respect to
petitioner’s Federal income tax for 2005.1 The issues for
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure. Amounts
are rounded to the nearest dollar.
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decision are: (1) Whether petitioner is entitled to business
expense deductions for labor costs and rental payments for 2005;
and (2) whether petitioner is liable for the negligence penalty
under section 6662.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts, together with attached exhibits, is
incorporated herein by this reference. At the time petitioner
filed his petition, he resided in California.
Petitioner is in the commercial relocation business. Since
2004 he has been the sole proprietor of C&C Services, a business
relocation company. Before striking out on his own he was a
salesperson at several other business relocation companies,
including Golden State Services.
Commercial relocation is a labor- and cash-intensive
business. It involves the moving of heavy equipment and
machinery from one site to another and requires large amounts of
storage space. In 2005 petitioner hired two unrelated companies,
Piece of Mind and California State Interiors, to provide contract
laborers for C&C Services to staff specific relocation projects.
Petitioner did not pay these contract laborers directly but
rather paid Piece of Mind and California State Interiors with
checks and in cash for meeting C&C Services’ staffing
requirements. Petitioner sent invoices to clients for services
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C&C Services performed, and in return would receive checks that
he placed in his bank account.
Petitioner hired two project managers, Telemu Jennings and
Navassa Brown, to supervise and coordinate the contract laborers.
Petitioner paid Mr. Jennings and Mr. Brown in cash at least 70
percent of the time.
Petitioner rented part of a large warehouse in San Jose from
California State Interiors in order to store clients’ materials
while their businesses were being relocated by C&C Services.
Petitioner often combined rental and staffing payments in the
checks he made to California State Interiors.
Petitioner did not keep a general ledger, cash expenditure
journal, or computer program to keep track of his income and
expenses. Petitioner had studied business finance at San Jose
State University for 3 years in the 1970s and taken a basic
accounting course.
Petitioner hired an old acquaintance, Bill Miller, to
prepare his 2005 return. Mr. Miller had helped employees of
Golden State Services prepare their taxes while petitioner was a
member of that firm. Petitioner never attempted to ascertain Mr.
Miller’s qualifications to prepare tax returns, and it is unclear
whether Mr. Miller was a licensed accountant. Mr. Miller passed
away in February 2007.
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On April 17, 2006, petitioner filed Form 1040, U.S.
Individual Income Tax Return, for 2005. On his Schedule C,
Profit or Loss From Business, petitioner claimed deductions for
business expenses consisting of wages of $603,662, contract labor
of $8,160, and rental costs of $120,000. Petitioner also filed
multiple Forms 1099-MISC, Miscellaneous Income, reporting that he
paid various independent contractors $645,524 in 2005.2
On July 23, 2007, respondent sent a notice of deficiency to
petitioner disallowing his business expense deductions for wages,
contract labor, and rental costs. Petitioner filed a timely
petition with this Court, and trial was held on November 6, 2008,
in San Francisco, California.
OPINION
I. Burden of Proof
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 certain
circumstances, however, section 7491(a)(1) places the burden of
proof on the Commissioner. Petitioner has not alleged that
section 7491 is applicable, nor has he established compliance
2
Petitioner lost access to the original copies of these
Forms 1099-MISC when Mr. Miller passed away.
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with the requirements of section 7491(a)(2)(A). Therefore, the
burden of proof does not shift to respondent.
II. Claimed Business Expense Deductions
Deductions are strictly a matter of legislative grace, and
taxpayers must satisfy the specific requirements for any
deduction claimed. See INDOPCO, Inc. v. Commissioner, 503 U.S.
79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435,
440 (1934). Taxpayers bear the burden of substantiating the
amount and purpose of any claimed deduction. See Hradesky v.
Commissioner, 65 T.C. 87 (1975), affd. per curiam 540 F.2d 821
(5th Cir. 1976).
Section 162(a) allows a deduction for all ordinary and
necessary expenses paid or incurred by a taxpayer in carrying on
any trade or business. An expense is considered ordinary if
commonly or frequently incurred in the trade or business of the
taxpayer. Deputy v. du Pont, 308 U.S. 488, 495-496 (1940). An
expense is necessary if it is appropriate or helpful in carrying
on a taxpayer’s trade or business. Commissioner v. Heininger,
320 U.S. 467, 471 (1943); Welch v. Helvering, supra at 113.
A taxpayer must maintain records sufficient to substantiate
the amounts of the deductions claimed. Sec. 1.6001-1(a), Income
Tax Regs. If a taxpayer establishes that an expense is
deductible but is unable to substantiate the precise amount, we
may estimate the amount, bearing heavily against the taxpayer
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whose inexactitude is of his own making. Cohan v. Commissioner,
39 F.2d 540, 543-544 (2d Cir. 1930). The taxpayer must present
sufficient evidence for the Court to form an estimate because
without such a basis, any allowance would amount to unguided
largesse. Williams v. United States, 245 F.2d 559, 560-561 (5th
Cir. 1957); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).
A. Wages and Contract Labor Expenses
Petitioner claims that he is entitled to labor cost
deductions of $617,708 for 2005. Taxpayers operating a trade or
business are entitled to deduct “salaries or other compensation
for personal services” which they can substantiate. Sec.
162(a)(1); sec. 1.162-7(a), Income Tax Regs.
Petitioner submitted four Forms 1099-MISC for 2005 listing
payments he made to his project managers and labor providers in
the following amounts:
Labor Contractor Amount
Telemu Jennings $38,700
Navassa Brown 52,000
Piece of Mind 275,000
Jesse Mausa/
California State
Interiors¹ 252,008
¹Petitioner’s Form 1099-MISC for California State
Interiors also listed Jesse Mausa as a recipient of
petitioner’s payments. Petitioner did not provide a
taxpayer identification number for Mr. Mausa, who
presumably is an officer/owner of California State
Interiors.
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As petitioner lost his original Forms 1099-MISC when Mr. Miller
passed away, these reconstituted forms represent petitioner’s
best recollection of his labor costs for 2005.3
Petitioner also submitted a California State Interiors
“aging” worksheet that states C&C Services’ invoices and payments
for 2005. The document lists accrued charges for California
State Interiors’ labor procurement services as $252,008 and C&C
Services’ payments for both labor procurement and rent as
$161,920.
Petitioner’s testimony and submitted documentation are
inadequate to meet his burden to substantiate any of his claimed
labor expenses. A schedule of expenses is not sufficient to
substantiate claimed deductions. Lofstrom v. Commissioner, 125
T.C. 271, 278 (2005); Cluck v. Commissioner, 105 T.C. 324, 338
(1995); see also Paal v. Commissioner, T.C. Memo. 1969-284
(holding that salary expense for secretary to type manuscript
could be substantiated with introduction of manuscript into
evidence), affd. 450 F.2d 1108 (9th Cir. 1971).
However, petitioner’s testimony, coupled with the labor-
intensive nature of his business, indicates that petitioner
incurred substantial labor costs for 2005. Although petitioner’s
3
Although neither party submitted petitioner’s original
Forms 1099-MISC, respondent’s electronic records indicate that
petitioner reported labor costs of $645,524 for 2005.
Petitioner’s reconstructed Forms 1099-MISC list costs of $617,708
for 2005. Petitioner could not account for this discrepancy.
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testimony was too vague to allow us to estimate his payments to
Piece of Mind and California State Interiors for providing
contract laborers, see Vanicek v. Commissioner, supra at 742-743,
petitioner credibly testified that he paid each of his project
managers, Telemu Jennings and Navassa Brown, a regular weekly
wage throughout the year.4 Accordingly, we find that Mr.
Jennings and Mr. Brown were employees of petitioner for 2005 and
that petitioner paid them wages of $38,700 and $52,000,
respectively. See Cohan v. Commissioner, supra at 544.
B. Rental Costs
Petitioner claims that he paid California State Interiors
$10,000 per month in 2005 in order to rent a portion of a
warehouse.5 Taxpayers are entitled a Schedule C deduction for
expenses for rental property used in a trade or business if they
can substantiate them. Sec. 162(a)(3); sec. 1.162-1(a), Income
Tax Regs.
The “aging” worksheet submitted by petitioner shows that
petitioner paid California State Interiors more than $120,000 in
2005. Petitioner also credibly testified that he paid $120,000
4
Petitioner credibly testified that he paid Mr. Jennings $15
per hour and Mr. Brown $25 per hour.
5
Petitioner’s petition does not dispute respondent’s
disallowance of petitioner’s rental cost deductions. Petitioner
has not moved to amend his petition to assert this issue.
Nonetheless, since the issue was raised at trial and respondent
addressed it on brief, we assume that the rental cost deduction
issue was tried by consent of the parties. See Rule 41(b)(1).
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per year to California State Interiors as part of a joint lease
on the warehouse but often paid late and thus sometimes paid
California State Interiors more or less than $10,000 per month.6
On the basis of the record, we are able to approximate
petitioner’s rental costs considering the aging worksheet and
petitioner’s testimony regarding his warehouse. We find that
petitioner is entitled to deduct $120,000 in rental costs for
2005 as a business expense. See Cohan v. Commissioner, supra at
544.
III. Accuracy-Related Penalty
Respondent determined that petitioner is liable for the
accuracy-related penalty under section 6662(a) for 2005. The
accuracy-related penalty applies to any underpayment of tax
required to be shown on a return that is attributable to
negligence or disregard of rules or regulations under section
6662(b)(1).
Negligence is defined as any failure to make a reasonable
attempt to comply with the provisions of the Internal Revenue
Code. Sec. 6662(c). However, section 6664(c)(1) provides that a
penalty under section 6662 will not be imposed on any portion of
an underpayment if the taxpayer shows reasonable cause for such
portion of the underpayment and that the taxpayer acted in good
6
The aging worksheet indicates that petitioner did not make
any payments to California State Interiors in 2005 until August
of that year.
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faith with respect to such portion. Reliance on the advice of a
professional, such as a certified public accountant, may
constitute a showing of reasonable cause if, under all the facts
and circumstances, such reliance is reasonable and the taxpayer
acted in good faith. Henry v. Commissioner, 170 F.3d 1217, 1219-
1223 (9th Cir. 1999), revg. T.C. Memo. 1997-29; Betson v.
Commissioner, 802 F.2d 365, 372 (9th Cir. 1986), affg. in part
and revg. in part T.C. Memo. 1984-264; sec. 1.6664-4(b)(1), (c),
Income Tax Regs. To prove reasonable cause based on the receipt
of professional advice, a taxpayer must show that he reasonably
relied in good faith upon a qualified adviser after full
disclosure of all necessary and relevant facts. Collins v.
Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988), affg. Dister
v. Commissioner, T.C. Memo. 1987-217; sec. 1.6664-4(b)(1), Income
Tax Regs.
Under section 7491(c) the Commissioner has the burden of
production with respect to the taxpayer’s liability for the
penalty provided by section 6662 and must come forward with
sufficient evidence to impose the penalty. Higbee v.
Commissioner, 116 T.C. 438, 446-447 (2001). But once the
Commissioner meets that burden, the taxpayer has the burden of
proof concerning whether the Commissioner’s determination to
impose the penalty is correct. Allen v. Commissioner, T.C. Memo.
2005-118.
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We conclude that respondent has met his burden of production
under section 6662. Respondent has demonstrated that petitioner
incorrectly claimed Schedule C deductions for 2005 and failed to
maintain records to substantiate his claimed deductions. These
facts indicate that petitioner in general failed to make a
reasonable attempt to comply with the provisions of the Internal
Revenue Code.
Petitioners is otherwise unable to show why respondent’s
determination to impose the penalty is incorrect. Petitioner
demonstrated that he relied on the advice of Mr. Miller to
prepare his 2005 return but failed show that Mr. Miller was a
qualified adviser. Nor has petitioner offered any reasonable
cause for his inability to substantiate his claimed deductions,
particularly given his level of education and experience in the
business relocation industry. Accordingly, with the exception of
the portion of the penalty attributable to adjustments to
petitioner’s business expense deductions for payments to Telemu
Jennings and Navassa Brown and for rental costs, petitioner is
liable for the accuracy-related penalty under section 6662(a).
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In reaching our holdings herein, we have considered all
arguments made, and, to the extent not mentioned above, we find
them to be moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.