T.C. Summary Opinion 2010-3
UNITED STATES TAX COURT
RONALD STEWART ARMSTRONG, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 28922-07S. Filed January 11, 2010.
Ronald Stewart Armstrong, pro se.
Christina E. Ciu, for respondent.
LARO, Judge: This case was heard pursuant to the provisions
of section 7463 of the Internal Revenue Code in effect when the
petition was filed.1 Pursuant to section 7463(b), the decision
1
Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year in issue,
and Rule references are to the Tax Court Rules of Practice and
Procedure.
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to be entered is not reviewable by any other court, and this
opinion shall not be treated as precedent for any other case.
Respondent determined a deficiency of $7,445 in petitioner’s
2004 Federal income tax. The issues for decision are whether:
(1) Petitioner may deduct $31,570 in business expenses reported
on his Schedule C, Profit or Loss From Business; (2) petitioner’s
itemized deduction for medical and dental expenses is limited to
the amount in excess of 7.5 percent of his adjusted gross income;
and (3) petitioner is entitled to an ordinary deduction for
worthless stock under section 1244.
Background
I. Petitioner
Petitioner is a lifelong musician and an entrepreneur who
has combined his passions for music and business in a variety of
business ventures. A consultant by trade, petitioner filed his
2004 Federal income tax return in April 2005. That return
included a Schedule C that listed petitioner’s business or
profession as “consultant” and claimed the following expense
deductions:
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Expenses Amount
Multi-Labs, Inc. $3,000
Research International 3,000
Diverse Investments, Inc. 3,000
Peterson Controls 3,000
Opsafe 3,000
X-Factor Technologies 3,000
Wizard Guitars 3,000
Bartolini, Inc. 10,570
Total 31,570
On September 19, 2007, respondent issued a notice of
deficiency (notice) disallowing petitioner’s deduction for
Schedule C expenses. Because the disallowance increased
petitioner’s adjusted gross income, respondent also disallowed
petitioner’s deduction of $1,709 in medical and dental expenses
in excess of 7.5 percent of his adjusted gross income.
Petitioner requested redetermination of the deficiency by filing
a petition with this Court on December 14, 2007. Petitioner
resided in California when the petition was filed.
II. Bartolini
A. Petitioner’s Affiliation with Bartolini
Petitioner was employed by Bartolini, Inc. (Bartolini), a
Nevada corporation formed in June 2004 to manufacture and sell
“electronic musical pickups”. Petitioner was also a shareholder
of Bartolini.
B. Formation of Bartolini
Bartolini was formed to acquire Bartolini Guitars, a sole
proprietorship owned by Bill Bartolini (Mr. Bartolini).
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Bartolini was formed under a resolution of its board of directors
that provided in relevant part:
the Board of Directors of * * * [Bartolini] have
determined that the Corporation shall be organized and
managed so that it is a “Small Business Corporation” as
defined in IRC Sec. 1244(1), as amended, and so that
the shares issued by the Corporation are “section 1244
stock” as defined in IRC Sec. 1244(c)(1), as amended.
* * * * * * *
BE IT THEREFORE RESOLVED:
1. Effective June 12, 2004 the proper officers of the
Corporation are authorized to sell and issue
common shares in an aggregate amount of money and
other property (as contribution to capital and as
paid in surplus), which together with the
aggregate amount of common shares outstanding at
the time of issuance, does not exceed $1,000,000.
2. That the sale and issuance of shares shall be
conducted in compliance with IRC Sec. 1244, so
that the Corporation and its shareholders may
obtain the benefits of IRC Sec. 1244.
Petitioner received 999 shares of Bartolini common stock
upon its formation in exchange for $13,250. On July 1, 2004,
petitioner contributed another $4,000 to Bartolini in exchange
for 300 additional shares of Bartolini common stock.
C. Petitioner’s Employment With Bartolini
During 2004 petitioner entered into an employment agreement
with Bartolini to serve as its president and chief executive
officer (CEO) from July 1, 2004 until 2009. In exchange for his
services, petitioner was to receive the following remuneration:
(i) A guaranteed annual salary of $150,000; (ii) a guaranteed
annual bonus of $10,000; (iii) 1,000 shares of Bartolini stock;
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and (iv) warrants each year for 2,000 shares of stock.
Petitioner worked as president and CEO of Bartolini from July
2004 until March 2005 when Bartolini was dissolved.
III. October 5, 2009, Trial
A. Overview
On October 5, 2009, the Court held a trial in San Francisco,
California. Petitioner was the only witness called by either
party. The only evidence which petitioner presented to support
his reported 2004 Schedule C expenses was receipts related to
Bartolini.
The receipts ranged in date from 2003 to 2005 with the
exception of one receipt that was undated. The 2004 receipts
consisted of: (i) A $95 invoice from the Carson City Treasurer
for “Base License Fee”; (ii) a $91 “consulting fee” paid to Mr.
Bartolini; and (iii) $35 in receipts for “Laughlein” expenses.
The undated receipt was from “McBee Systems Inc. Banking
Materials” in the amount of $56.67. The other receipts are not
relevant to our decision and will not be discussed.
B. Amended Return
Petitioner also introduced into evidence an amended 2004
Form 1040 (amended return) which he intended to file with
respondent. The Court admitted this return into evidence as an
admission of petitioner’s intent relating to this case and not as
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a filed tax return.2 On Schedule C of the amended return,
petitioner claimed $11,764 in expenses consisting of $5,659 in
expenses related to an unnamed “business consulting service” and
$6,105 in expenses related to “Building Design Services.”
Petitioner also attached to his amended return a 2004
Schedule K-1, Partner’s Share of Income, Deductions, Credits,
etc., from Wizard Guitars. The Schedule K-1 lists petitioner as
a 33.33-percent general partner of the entity. The Schedule K-1
reports as to 2004 that petitioner’s beginning capital account
was $6,708 and that his ending capital account was $3,708 on
account of a $3,000 ordinary business loss from that year.3
Discussion
I. Deductibility of Schedule C Expenses
A. Overview
Respondent disallowed petitioner’s 2004 Schedule C expense
deductions because petitioner failed to (i) substantiate that the
expenses were paid or incurred during the taxable year; or (ii)
demonstrate that the expenses were ordinary and necessary to
petitioner’s consulting business. Petitioner argues generally
that the expenses are valid section 162 ordinary and necessary
2
The record does not establish that the amended return was
filed by petitioner or accepted by respondent.
3
We are unaware of the origins of the purported business
loss or whether Wizard Guitars filed a return of partnership
income for 2004.
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business expenses and does not address the substantiation issue.
For the reasons set forth below, we hold for respondent.
An income tax deduction is a matter of legislative grace and
is not an unqualified right. See INDOPCO, Inc. v. Commissioner,
503 U.S. 79, 84 (1992); Deputy v. du Pont, 308 U.S. 488, 493
(1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934). A taxpayer such as petitioner bears the burden of
establishing his right to any amount claimed as a deduction.4
Rule 142(a); White v. United States, 305 U.S. 281, 292 (1938);
Welch v. Helvering, 290 U.S. 111, 115 (1933); Roberts v.
Commissioner, 62 T.C. 834, 835 (1974). Every taxpayer is also
required to maintain supporting records or statements for amounts
claimed as deductions. See sec. 6001.
B. Deduction for Ordinary and Necessary Business Expenses
1. Overview
A taxpayer may deduct ordinary and necessary expenses paid
or incurred during the taxable year in carrying on any trade or
business. Sec. 162(a). An expense is ordinary if it bears a
reasonably proximate relationship to the operation of the
taxpayer’s business. Kornhauser v. United States, 276 U.S. 145,
153 (1928). An expense is necessary if it is appropriate and
4
Sec. 7491 is inapplicable to this case because petitioner
did not produce credible evidence with respect to a factual issue
relevant to determining his tax liability.
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helpful to the functioning of the taxpayer’s business. Welch v.
Helvering, supra at 113.
2. Expenses Related to Bartolini
a. Overview
Petitioner seeks to deduct $10,570 in various expenses
incurred on behalf of his involvement with Bartolini.
b. 2004 Base License Fee
Petitioner presents a $95 invoice from the Carson City
treasurer for licensing fees of Bartolini incurred on December 1,
2004. A corporation and its shareholders are separate taxable
entities, and therefore a shareholder may generally not deduct
expenses that would be corporate expenses even if paid by that
shareholder. See Moline Props., Inc. v. Commissioner, 319 U.S.
436, 438-439 (1943); D’Angelo v. Commissioner, T.C. Memo. 2003-
295. Petitioner may not deduct the licensing fees of Bartolini
because they are the expenses of the corporation--not of
petitioner. See Wofford v. Commissioner, 5 T.C. 1152, 1165
(1945).
c. Additional 2004 Expenses
Petitioner also presents a $35 receipt for a Laughlein
certificate and $91 in receipts for consulting fees to Mr.
Bartolini. There is no indication in the record that these
expenses are ordinary or necessary to petitioner’s consulting
business. We deny petitioner a deduction for these items.
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d. 2003, 2005, and Undated Expenses
Petitioner also presents receipts for expenses incurred in
2003 and 2005 as well as an undated receipt. Again, the record
does not support that these expenses were ordinary or necessary
to petitioner’s consulting business. Even if petitioner did
demonstrate that these expenses satisfied the requirements of
section 162(a), they would still not be deductible. Petitioner
may deduct expenses only for the year paid. See, e.g., Carlisle
v. Commissioner, 37 T.C. 424, 428 (1961) (stating that a cash
method taxpayer’s otherwise deductible expense is not deductible
for any taxable year other than the year in which it is paid).
e. Summary of Expenses Related to Bartolini
In summary, the record contains no evidence that allows us
to permit petitioner a deduction for expenses incurred in
connection with his involvement in Bartolini. Accordingly, we
sustain respondent’s disallowance of the $10,570 deduction.
3. Expenses Related to Wizard Guitars
Petitioner similarly provides no substantiation for expenses
incurred in connection with his affiliation with Wizard Guitars.
In lieu of receipts, petitioner presents a Schedule K-1 from
Wizard Guitars which reports that a $3,000 ordinary business loss
passed through to him in 2004. The limited record before us does
not establish that petitioner is entitled to deduct any of this
$3,000.
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4. Deductibility of Remaining Expenses
We similarly find no evidence in the record that supports
the $18,000 deduction for the claimed expenses related to Multi-
Labs, Inc., Research International, Diverse Investments, Inc.,
Peterson Controls, Opsafe, or X-Factor Technologies. We find it
telling that petitioner’s amended return does not seek a
deduction for any of these claimed expenses. We can only surmise
that petitioner omitted these expenses from the amended return
because he has no means of substantiating them. We deny the
$18,000 in claimed deductions.
II. Impact on Itemized Deductions
Respondent argues that the increase to petitioner’s adjusted
gross income resulting from the disallowance of his Schedule C
deduction causes a computational disallowance of petitioner’s
claimed deduction for medical and dental expenses. We agree.
A taxpayer may deduct medical expenses incurred during the
taxable year provided that the expenses exceed 7.5 percent of the
taxpayer’s adjusted gross income. Sec. 213(a). Petitioner
claims $3,798 in medical and dental expenses for 2004. As
reported on his return, $1,709 of that amount exceeded 7.5
percent of his adjusted gross income. The disallowance of
petitioner’s $31,570 business expense deduction increases
petitioner’s adjusted gross income by a like amount, and thus the
7.5-percent floor imposed by section 213 is increased by
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$2,367.75 ($31,570 x 0.075 = $2,367.75). Petitioner, therefore,
is not entitled to deduct any of the $3,798 in claimed medical
and dental expenses.
III. Section 1244 Stock
Petitioner argues that section 1244 permits him to recognize
an ordinary loss on the worthlessness of his Bartolini stock. We
disagree.
Section 165(g)(1) and (2)(A) provides that a taxpayer
realizes a capital loss when stock that is a capital asset
becomes worthless. A limited exception to this general rule
permits an individual to deduct as an ordinary loss any loss on
“section 1244 stock”. Sec. 1244(a). The term “section 1244
stock” includes common stock issued in exchange for cash when the
issuer is a domestic “small business corporation” (as defined in
section 1244(c)(3)), 50 percent of whose income does not come
from investment activity. Sec. 1244(c)(1). Qualification for
section 1244 status requires strict compliance with the
provisions of the statute and the regulations thereunder. See
Godart v. Commissioner, 51 T.C. 937, 943 (1969), affd. 425 F.2d
633 (2d Cir. 1970); Morgan v. Commissioner, 46 T.C. 878, 889
(1966); Magee v. Commissioner, T.C. Memo. 1993-305.
Petitioner has failed to prove that he meets the
requirements of section 1244. In particular, he has failed to
show that Bartolini meets the definition of a “small business
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corporation” or establish the nature of its receipts. Petitioner
has also failed to demonstrate that his Bartolini stock is
“worthless” within the meaning of section 165. See Klepetko v.
Commissioner, T.C. Memo. 1990-644, affd. without published
opinion 956 F.2d 1159 (2d Cir. 1992). Petitioner is not
permitted a deduction under section 1244 because he failed to
meet his burden of proof on these issues.
IV. Conclusion
Petitioner may not deduct the $31,570 in expenses claimed on
his 2004 Schedule C. Petitioner may not deduct any of the
claimed $3,798 in medical and dental expenses. Petitioner may
not deduct any of his basis in Bartolini. We have considered all
arguments made by the parties and, to the extent not discussed
above, conclude they are without merit.
To reflect the foregoing,
Decision will be entered
for respondent.