T.C. Memo. 2010-15
UNITED STATES TAX COURT
SIVATHARAN NATKUNANATHAN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 17291-07. Filed February 1, 2010.
R determined a deficiency and an addition
to tax under sec. 6651(a)(1), I.R.C., for failure
to file on time. In response, P claimed a
qualified business stock exclusion under sec.
1202, I.R.C., deductions for uncollected software
development invoices under sec. 165, I.R.C., as
business losses or, alternatively, under sec. 166,
I.R.C., as bad debt losses, and deductions for
meals and entertainment, advertisement, rent, and
utilities expenses under sec. 162, I.R.C.
Held: P may not claim a sec. 1202, I.R.C.,
qualified business stock exclusion to shield from
tax any part of the proceeds from the sale of
stock acquired upon exercise of employee stock
options where P has not established that either
the options or the stock constituted qualified
small business stock within the meaning of sec.
1202, I.R.C.
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Held, further, P may not deduct billed and
unreceived amounts that have not been previously
included in income.
Held, further, P may not deduct as business
expenses meals and entertainment, advertisement,
rent, and utilities expenditures that are
substantiated solely by a log of such expenditures
and in the absence of any primary evidence of
having made such expenditures.
Held, further, P is liable for the late
filing addition to tax where he has admitted to
having filed his return late and has failed to
provide any reasons for the delay.
Sivatharan Natkunanathan, pro se.
Robert H. Berman, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WHERRY, Judge: This case is before the Court on a petition
for redetermination of deficiency, an addition to tax under
section 6651(a)(1)1 for a failure to file on time, and an
accuracy-related penalty under section 6662(a) that respondent
determined for petitioner’s 2003 tax year. After mutual
concessions,2 the issues for decision are:
1
All section references are to the Internal Revenue Code
(Code) of 1986, as amended and in effect for the tax year at
issue. All Rule references are to the Tax Court Rules of
Practice and Procedure.
2
Petitioner conceded the following amounts of previously
unreported income items: $90 (interest), $460 (dividend), and
$25,182 (State refunds, credits, or offsets). Respondent
(continued...)
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(1) Whether petitioner is entitled to the qualified small
business stock exclusion of section 1202;
(2) whether petitioner is entitled to business loss or bad
debt deductions for contracted payment amounts for software
development that he was unable to collect;
(3) whether petitioner is entitled to business expense
deductions for meals and entertainment, advertisement, rent, and
utilities expenditures in excess of those respondent allowed or
conceded; and
(4) whether petitioner is liable for an addition to tax
under section 6651(a)(1).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
2
(...continued)
conceded various losses and deductions that were previously
disallowed. These included an S corporation loss of $7,706
claimed on Schedule E, Supplemental Income and Loss, a $26,919
deduction for unreimbursed employee expenses claimed on Schedule
A, Itemized Deductions, and the following deductions claimed on
Schedule C, Profit or Loss From Business: $7,787 (car and truck
expenses), $2,106 (travel expenses), $3,257 (legal and
professional services expenses), $5,250 (depreciation and section
179 expenses), $2,559 (office expense), $500 (repairs and
maintenance expenses), $1,200 (taxes and license expenses),
$1,849 (telephone expenses) $90 (bank charges), $593 (dry
cleaning expenses) and $455 (DSL expenses). In a posttrial
brief, respondent also conceded the accuracy-related penalty
under sec. 6662(a). Finally, petitioner and respondent have
agreed upon a Schedule A itemized deduction of $8,523 for cash
charitable contributions instead of the previously claimed
$17,374, with petitioner conceding the remainder.
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incorporated herein by this reference. Petitioner resided in
California at the time he filed the petition.
Petitioner became an employee of Cognet Microsystems
(Cognet), a domestic C corporation, before 2001. Some time
during his employment at Cognet, petitioner received options to
purchase Cognet stock as compensation for services rendered to
that corporation. Petitioner retained these options until after
Cognet merged with Intel Corp. (Intel), another domestic C
corporation, in 2001. As part of the merger agreement,
petitioner’s options to purchase Cognet stock converted into
options to purchase Intel stock. Petitioner exercised his
options to purchase Intel stock sometime in the fourth quarter of
2003 and on the same day sold the Intel stock that he had
received upon exercise for a gain of $295,285. This amount was
reported on a Form W-2, Wage and Tax Statement, that petitioner
received from Intel for 2003.
Petitioner’s original Federal income tax return for 2003 was
prepared and signed on October 15, 2004, and received by
respondent on October 21, 2004, more than 6 months after its due
date of April 15, 2004. This return showed a tax liability of
$50,850, taxes withheld of $26,437, and, after adding a self-
reported estimated tax penalty of $554, a balance due of $24,967.
Petitioner has subsequently sought to amend this return on at
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least three separate occasions.3 Working from petitioner’s
original 2003 return, respondent determined a deficiency of
$126,089. Respondent also imposed an addition to tax of
$19,279.55 for late filing. On May 3, 2007, respondent sent
petitioner, who resided in California at that time, a statutory
notice of deficiency.4 Petitioner, who continued to be a
California resident, filed a timely mailed petition with this
Court on August 2, 2007, requesting a trial in Los Angeles,
California. The trial was held on October 23, 2008.
OPINION
At the trial and in his posttrial briefs and other filings,
petitioner claims that he is not liable for the deficiency but
is, in fact, owed a refund of at least $26,437, the entire amount
of Federal income tax withheld for 2003. In support of this
claim, petitioner advances three broad arguments. First, he
contends that the qualified small business stock exclusion of
section 1202 applies to his sale of Intel stock and, therefore,
he is entitled to exclude 50 percent of the resulting gain.
3
Amended income tax returns on Forms 1040X, Amended U.S.
Individual Income Tax Return, for 2003 for petitioner were
received by respondent on Nov. 10, 2005, and Apr. 22, 2008,
respectively. Subsequently, after the record in this case was
closed upon the filing of reply briefs, petitioner sought to file
another amended return on Form 1040X for 2003 dated Apr. 15,
2009.
4
In this notice of deficiency, respondent also determined an
accuracy-related penalty under sec. 6662(a) of $12,998.80 that he
subsequently conceded. See supra note 2.
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Second, petitioner argues that his failure to collect on invoiced
amounts under software design and development contracts
constitute business losses or bad debt losses. Therefore, he is
entitled to deduct such amounts. And third, petitioner claims
that a “business purpose log” listing expenditures for meals and
entertainment, advertisement, rent, and utilities, that “contains
generic points of discussion relating to business * * * should
satisfy the substantiation requirements” of section 162 and,
where applicable, section 274. Consequently, he is entitled to
deduct the expense amounts shown on the log. For the reasons
discussed below, we reject each of these arguments.
We note initially that petitioner has neither argued nor
established that section 7491(a) applies to shift the burden of
proof to respondent on any of the three arguments that he makes.
Consequently, petitioner bears the burden of proof for each of
these arguments. See Rule 142(a).
I. Section 1202 Qualified Small Business Stock Exclusion
Section 1202(a)(1) provides that “In the case of a taxpayer
other than a corporation, gross income shall not include 50
percent of any gain from the sale or exchange of qualified small
business stock held for more than 5 years.” Section 1202(d)(1)
defines “qualified small business” as “any domestic corporation
which is a C corporation if * * * the aggregate gross assets of
such corporation immediately after the issuance (determined by
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taking into account amounts received in the issuance) do not
exceed $50,000,000”. To qualify for the exclusion under section
1202, the C corporation that issued the stock must have satisfied
the gross assets test and constituted a qualified small business
“as of the date of issuance” of such stock. Sec. 1202(c)(1)(A).
Stock in such a C corporation, which “is acquired by the taxpayer
at its original issue * * * as compensation for services provided
to such corporation”, constitutes “qualified small business
stock” for purposes of section 1202. Sec. 1202(c)(1)(B).
Petitioner seeks to invoke section 1202 to exclude from his
gross income 50 percent of the gain he realized on the sale of
Intel stock that he had received by exercising his Intel options.
Though petitioner concedes that he “sold the Intel Options [sic]
on the same day he exercised them”, he argues “that the Intel
Options he exercised are in fact Qualified Small Business Stock
* * * since they were received by converting the Cognet Options,
during the M&A of Cognet with Intel.” In support, petitioner
cites section 1202(f), which provides:
If any stock in a corporation is acquired solely through the
conversion of other stock in such corporation which is
qualified small business stock in the hands of the
taxpayer–-
(1) the stock so acquired shall be treated as qualified
small business stock in the hands of the taxpayer, and
(2) the stock so acquired shall be treated as having
been held during the period during which the converted stock
was held.
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Notwithstanding his citation of the provisions of section
1202(f) that allow for carryover treatment and tacking on of a
holding period upon conversion of small business stock into other
stock, petitioner does not assert that he ever held Cognet stock
that he subsequently converted into Intel stock. Instead,
petitioner seems to be arguing that references to the term
“stock” in section 1202 should be read to include options to
acquire stock. As we explain later, we do not believe that the
term “stock” in section 1202 includes options to acquire stock.
Even if it did, however, petitioner has failed to establish that
Cognet constituted a qualified small business on the day or days
that he received his options and that he held such options for
more than 5 years.
There are no balance sheets or other financial statements of
Cognet in the record that establish the amounts of total assets,
total liabilities, or owner’s equity of Cognet at any time, and
petitioner made no attempt to introduce any such evidence at
trial.5 In the absence of any such evidence, we cannot determine
5
After the trial petitioner attached to his reply brief a
document purporting to be a statement by the chief executive
officer of Cognet at the time of its acquisition by and merger
with Intel declaring that “To the best of my recollection, the
company’s assets, including physical assets and total value of
outstanding shares did not exceed $50,000,000 before the
acquisition.” [Emphasis added.] Subsequently, after the record
had closed upon the filing of reply briefs, petitioner filed a
motion for leave to reopen the record in order to introduce a
notarized version of this and other documents. A notarized
(continued...)
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the value of Cognet’s gross assets at the time that it issued
options to petitioner and, therefore, cannot conclude that Cognet
constituted a qualified small business within the meaning of
section 1202(d)(1) at that time.
The record is similarly devoid of facts that would establish
petitioner’s 5-year holding period for purposes of section
1202(a)(1). The only fact that can be ascertained in this
respect is that petitioner held Intel options from the time of
Cognet’s merger with Intel sometime in 2001 until he exercised
these options sometime in the fourth quarter of 2003, a period
that could not have exceeded 3 years. There is no mention in the
record of the date or dates when petitioner received Cognet
options or how long he had held these options before Cognet
merged with Intel. We are, therefore, unable to conclude that
petitioner satisfied the 5-year holding period requirement of
section 1202(a)(1).
Tax deductions are a matter of legislative grace, and a
taxpayer has the burden of proving that he is entitled to the
5
(...continued)
written statement from Cognet’s chief executive officer, even if
it were introduced at trial, could have been subject to a hearsay
objection and, absent concessions or stipulation by respondent,
would probably not have been admitted into evidence. But here,
where the purported statement constitutes an affidavit attached
to a brief, Rule 143(b) explicitly bars us from considering it as
evidence. We have previously issued an order denying
petitioner’s motion to reopen the record as inappropriate because
petitioner has not shown good cause for his failure to introduce
such evidence at trial.
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deductions claimed. Rule 142(a)(1); INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v.
Helvering, 292 U.S. 435, 440 (1934). Petitioner has failed to
establish that Cognet was a qualified small business as specified
in section 1202(d)(1). Further, even assuming arguendo that
options are stock for purposes of section 1202(f), petitioner has
not shown that he held his Cognet and Intel options for a
combined duration of more than 5 years. Therefore, we hold that
petitioner may not avail himself of the qualified small business
stock exclusion of section 1202.
Even if Cognet was a qualified small business within the
meaning of section 1202(d)(1) and petitioner had held his options
for more than 5 years, on the facts we would remain unpersuaded
that petitioner is entitled to the benefits of section 1202.
Section 1202 refers to the “gain from the sale or exchange of
qualified small business stock”. Petitioner with his facts has
failed to establish that the term “qualified small business
stock”, as used in section 1202, should be read to include his
options to acquire such stock.
Section 1202 itself does not define the term “stock” or
otherwise specify what securities constitute stock for purposes
of the qualified small business stock exclusion. By comparison,
some provisions of the Code explicitly specify that the term
“stock” includes options to acquire stock. See, e.g., sec.
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305(d)(1) (“For purposes of this section, the term ‘stock’
includes rights to acquire such stock.”); sec. 1091(a) (same).
We are unaware of any authority that has interpreted the term
“stock” for purposes of section 1202. However, we have
previously declined to extend the term “stock” beyond its plain
meaning in a statutory provision and construe it expansively to
include options to acquire stock. See Gantner v. Commissioner,
91 T.C. 713 (1988) (options to purchase stock are not “shares” of
“stock or securities” under the plain language of section 1091,
which was subsequently amended to explicitly provide otherwise),
affd. 905 F.2d 241 (8th Cir. 1990). Moreover, the legislative
history of section 1202 suggests that Congress did not intend
section 1202 to cover options to acquire stock.
Section 1202 was added to the Code by the Omnibus Budget
Reconciliation Act of 1993, Pub. L. 103-66, sec. 13113(a), 107
Stat. 422. The accompanying conference report included the
following statement: “Stock acquired by the taxpayer through the
exercise of options * * * is treated as acquired at original
issue. The determination whether the gross assets test is met is
made at the time of exercise * * * and the holding period of such
stock is treated as beginning at that time.” H. Conf. Rept. 103-
213, at 526 (1993), 1993-3 C.B. 393, 404 (emphasis added). The
second sentence of the excerpt from the conference report quoted
above, in the absence of any countervailing argument by
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petitioner, suggests to us that the original issuance
contemplated by section 1202 in petitioner’s case would be the
issuance of Intel stock to petitioner upon exercise of his
options. This conclusion seems appropriate since both the
application of the gross assets test and the commencement of the
holding period would occur at the time of such exercise.
Reading the term “stock” as used in section 1202 to exclude
petitioner’s options to acquire stock, we hold that petitioner
could not possibly have satisfied the 5-year holding period
requirement of section 1202(a)(1). Petitioner concedes that he
sold the Intel stock received upon exercise of his options on the
same day that he had exercised the options. Therefore, the
period during which petitioner could have held qualified small
business stock would, at most, have lasted 1 day. Moreover, for
the stock underlying petitioner’s options to constitute qualified
small business stock under section 1202(d)(1), the aggregate
gross assets of Intel on the date of exercise would have to have
been less than or equal to $50 million. Petitioner makes no such
claims with respect to Intel’s aggregate gross assets.
Petitioner makes a second argument in an effort to alleviate
the tax burden of the gain he realized from the sale of the Intel
stock. He claims that he was a “partner of ‘Thanikai Partners’,
an unincorporated partnership formed under the laws of the State
of California on September 16, 1996”, that he continued to remain
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a partner of that partnership when he sold the Intel stock, and
that he distributed the resulting “gain of the partnership to its
partners, who wanted the distribution to be made according to
partners’ wishes.”
Petitioner’s argument flies in the face of a fundamental
principle of tax law, that income is taxed to the person who
earns it. Lucas v. Earl, 281 U.S. 111, 114-115 (1930). A
taxpayer entitled to receive income cannot avoid tax on that
income by assigning it to somebody else, even where the
assignment precedes the receipt of income. See also Helvering v.
Horst, 311 U.S. 112 (1940). However, petitioner is actually
seeking to assign his income away after he has, in fact, received
it. As stated above, petitioner’s options to purchase Cognet
stock constituted compensation for services rendered to that
corporation. The Form W-2 petitioner received from Intel for the
year 2003 establishes that petitioner had both earned and
received the income representing the gain realized on the sale of
the Intel stock. Whether petitioner was a partner in a
partnership does not affect the fact that it was petitioner
alone, and no other person or entity, that had earned and
received this income. Petitioner cannot avoid tax on this income
by claiming that the proceeds have been distributed to his
partners.
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II. Software Design and Development Losses
Petitioner seeks deductions for losses that he claims to
have suffered in connection with three separate software design
and development agreements. He alleges that after having
delivered the contracted work he was left with unpaid invoices of
$137,106, $3,211, and $168,740. Petitioner argues that he
“sustained losses from the agreements, with the delivery of the
products and the non-payment of Invoices by the Customer”.
Therefore, he should be allowed to deduct these uncollected
amounts “in full under any of the * * * Sections 165, 166, 174(a)
and 1060.”
We consider in reverse order these four Code sections that
petitioner has cited. Section 1060 prescribes statutory
allocation rules to be applied to multiasset sales in computing
the seller’s gains and losses and the buyer’s basis and bears no
relevance to petitioner’s claimed losses.
Section 174(a) and (b) allows a taxpayer, at his election,
to either deduct or defer and amortize over a period of not less
than 60 months certain “research or experimental expenditures”
which are paid or incurred by the taxpayer in connection with the
operation of a trade or business. Expenditures covered by
section 174 include only costs for “research and development
* * * in the experimental or laboratory sense.” Sec.
1.174-2(a)(1), Income Tax Regs. This test is met if the
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activities are “intended to discover information that would
eliminate uncertainty concerning the development or improvement
of a product.” Id. Petitioner acknowledges that amounts
invoiced under the software design and development agreements
were for “unique customized functional software modules”. It is
unlikely, therefore, that expenditures made in connection with
these software development agreements were “intended to discover
information that would eliminate uncertainty concerning the
development or improvement of a product.” Expenditures made to
develop and deliver functional products for use by customers do
not usually constitute “research and development * * * in the
experimental or laboratory sense.” And though petitioner may
very well have engaged in extensive testing of these software
products in order to ensure compliance with customer
specifications, costs of “the ordinary testing or inspection of
materials or products for quality control” are excluded from the
definition of research and experimental expenditures in section
174. See sec. 1.174-2(a)(3)(i), Income Tax Regs.
However, the Internal Revenue Service (IRS) has published
guidance that advises taxpayers that “costs paid or incurred in
developing software for any particular project, either for the
taxpayer’s own use or to be held by the taxpayer for sale or
lease to others” and without regard to “whether or not the
particular software is patented or copyrighted * * * in many
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respects so closely resemble the kind of research and
experimental expenditures that fall within the purview of § 174
as to warrant similar accounting treatment.” Rev. Proc. 2000-50,
sec. 5.01, 2000-2 C.B. 601, 601. Accordingly, the IRS “will not
disturb a taxpayer's treatment” of such costs, where all of them
either
(1) * * * are consistently treated as current expenses
and deducted in full in accordance with rules similar to
those applicable under § 174(a); or
(2) * * * are consistently treated as capital
expenditures that are recoverable through deductions for
ratable amortization, in accordance with rules similar to
those provided by § 174(b) and the regulations thereunder,
over a period of 60 months from the date of completion of
the development * * *
Id.
Pursuant to Rev. Proc. 2000-50, sec. 5.01(1), a cash basis
taxpayer could deduct “All of the costs properly attributable to
the development of software” in the year that the taxpayer makes
payment on such costs. An accrual or mixed basis taxpayer could
either deduct such costs in the year that they are incurred or,
alternatively, treat them as deferred expenses chargeable to
capital account and amortize them over a period of 60 months
after development of the software has been completed. In the
Schedules C filed with petitioner’s original Federal income tax
return for 2003 and its successive amendments, petitioner has
consistently checked the box for “cash” in the line item for the
taxpayer’s method of accounting. However, in a posttrial brief,
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petitioner claims that though he “was primarily a Cash Basis
taxpayer for 2003 * * *, some items which were reported qualify
under both Cash Basis, and Accrual Basis of Accounting.” As a
result, “Petitioner specifically demands to * * * report (deduct)
[such items] under the Accrual Method of Accounting.”
Petitioner’s claims advanced in a posttrial brief do not
constitute evidence, and we disregard them. See Rule 143(b). On
the basis of the method of accounting that petitioner declared on
his 2003 Federal income tax return, we treat him as a cash basis
taxpayer for tax year 2003. Consequently, under Rev. Proc. 2000-
50, supra, petitioner may deduct as software development expenses
only such expenditures attributable to his three software
development agreements that were paid by him in 2003 and that
were not otherwise allowed as deductions. However, petitioner
has failed to introduce any evidence of actual out-of-pocket
expenditures that he made in 2003 and that he has not thus far
deducted in connection with any one of the three software
agreements at issue. Instead, petitioner merely cites Rev. Proc.
2000-50, supra, and insists in self-serving conclusory fashion
that he “incurred losses from the sale of customized software”,
that the amount of such losses “is clearly evidenced in the
purchase orders and invoices”, and that this amount “is entitled
for a full deduction” because “he did not charge his capital
account or other expense accounts” for such losses. But at trial
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he did not call witnesses or introduce evidence that proved any
of these claims.
We further note that petitioner’s arguments for the
deductibility of software development expenses would remain
unavailing even if we were to accede to his demands in his
posttrial brief and treat him as an accrual basis taxpayer for
purposes of these three software development agreements. Under
Rev. Proc. 2000-50, supra, as an accrual or mixed basis taxpayer,
petitioner could deduct previously undeducted costs in connection
with the three software development projects that were incurred
in 2003 regardless of when the payments were made so long as such
costs were incurred or accrued during the 2003 tax year. Costs
incurred in an earlier year and capitalized in that year would be
subject to amortization over either 36 or 60 months, with any
unamortized balance becoming deductible in the year of
disposition or abandonment. However, petitioner provides no
evidence in the form of canceled checks, bank statements, bills
or receipts of having actually made any such payments that have
not been otherwise allowed as deductions. Nor does he show that
such costs were incurred or accrued in 2003 and are, therefore,
properly taken into account in the 2003 tax year.
For similar reasons, we remain unpersuaded by petitioner’s
sincere arguments under sections 165 and 166. These arguments
would have been persuasive to the extent petitioner established
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that he had a tax basis in the receivables or that the claimed
losses on the software agreements represented out-of-pocket
expenditures that he has made but not yet deducted. He has
established neither. For such expenditures, section 165(c)(2)
might have allowed an ordinary deduction for a business loss.
Alternatively, subject to satisfaction of other applicable
conditions, section 166(d) might have permitted a short-term
capital loss deduction for a worthless bad debt. However,
petitioner has failed to introduce any evidence of actual
undeducted cash expenditures that he has made (i.e., costs that
he has incurred) in connection with any one of the three software
agreements at issue here. Instead, petitioner alleges in a
posttrial brief that “he provided to the Commissioner copies of
purchase orders, invoices, agreements, and letters * * * [and]
copies of collection letters that [he] had sent to the
customer[s]” in support of his contention “that the claimed
‘software design and development’ loss * * * should be allowed in
full”.
“It is well settled that a taxpayer is not allowed to reduce
ordinary income actually received by the amount of income he
failed to receive.” Hendricks v. Commissioner, 406 F.2d 269, 272
(5th Cir. 1969), affg. T.C. Memo. 1967-140; see also Escofil v.
Commissioner, 464 F.2d 358, 359 (3d Cir. 1972), affg. T.C. Memo.
1971-131; Hutcheson v. Commissioner, 17 T.C. 14, 19 (1951).
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Indeed, it is axiomatic that a deduction cannot be claimed for
profits that will never be reported as income. Hort v.
Commissioner, 313 U.S. 28, 32-33 (1941); J.G. Boswell Co. v.
Commissioner, 34 T.C. 539, 545 (1960), affd. 302 F.2d 682 (9th
Cir. 1962). Therefore, petitioner may not claim as a business
loss any part of the uncollected amounts on the three software
agreements.
Similarly, petitioner’s claim of a worthless debt under
section 166 cannot be allowed. Section 166(d) allows “a taxpayer
other than a corporation” a deduction for “any nonbusiness debt
[which] becomes worthless within the taxable year.” However,
worthless debts arising from unpaid wages, fees, and similar
items of taxable income are not deductible as bad debts unless
the taxpayer has included the amounts in income for the year for
which the bad debts are deducted or for a prior tax year because
otherwise they have no tax basis.
The debts petitioners claimed are for unpaid fees for
petitioner’s services. Petitioners used the cash method for
reporting income and deductions; therefore, fees for
services that remain unpaid have not been included in
income. Such debts do not constitute “bad debts” within the
meaning of section 166 for which a deduction for
worthlessness may be claimed. * * *
Crosson v. Commissioner, T.C. Memo. 2003-170; see also Gertz v.
Commissioner, 64 T.C. 598, 600 (1975); Prowse v. Commissioner,
T.C. Memo. 2006-120.
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III. Trade or Business Expenses
A. General Deduction Rules
Deductions are a matter of legislative grace, and the
taxpayer must maintain adequate records to substantiate the
amounts of any deductions or credits claimed. Sec. 6001;
INDOPCO, Inc. v. Commissioner, 503 U.S. at 84; sec. 1.6001-1(a),
Income Tax Regs.
Generally, the Court may allow the deduction of a claimed
expense (other than those subjected to the strict substantiation
requirements of section 274) even where the taxpayer is unable to
fully substantiate it, provided the Court has an evidentiary
basis for doing so. Cohan v. Commissioner, 39 F.2d 540, 543-544
(2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743
(1985); sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed.
Reg. 46014 (Nov. 6, 1985). In these instances, the Court is
permitted to approximate the allowable expense, bearing heavily
against the taxpayer whose inexactitude is of his or her own
making. Cohan v. Commissioner, supra at 544.
B. Deductibility of Expenses Relating to Petitioner’s
Schedule C
Section 162(a) authorizes a deduction for “all the ordinary
and necessary expenses paid or incurred during the taxable year
in carrying on any trade or business”. A trade or business
expense is ordinary for purposes of section 162 if it is normal
or customary within a particular trade, business, or industry and
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is necessary if it is appropriate and helpful for the development
of the business. Commissioner v. Heininger, 320 U.S. 467, 471
(1943); Deputy v. du Pont, 308 U.S. 488, 495 (1940). In
contrast, “personal, living, or family expenses” are generally
nondeductible. See sec. 262(a).
Certain business expenses described in section 274(d) are
subject to strict substantiation rules that supersede the Cohan
doctrine. Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968),
affd. 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary
Income Tax Regs., supra. Section 274(d) applies to: (1) Any
traveling expense, including meals and lodging away from home;
(2) entertainment, amusement, and recreational expenses; (3) any
expense for gifts; or (4) the use of “listed property”, as
defined in section 280F(d)(4), including passenger automobiles.
To deduct such expenses, the taxpayer must substantiate by
adequate records or sufficient evidence to corroborate the
taxpayer’s own testimony: (1) The amount of the expenditure or
use, which includes mileage in the case of automobiles; (2) the
time and place of the travel, entertainment, or use; (3) its
business purpose; and in the case of entertainment, (4) the
business relationship to the taxpayer of each expenditure or use.
Sec. 274(d) (flush language).
Petitioner claims as trade or business expense deductions
under section 162 the following amounts: $14,701 for meals and
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entertainment;6 $1,509 for advertising; $1,000 for home office
rent; and $200 for utilities. Petitioner asserts that he
incurred these expenses on behalf of Thanikai Partners, of which
he is a partner. Meals and entertainment expenses claimed as
deductions under section 162 are, with limited exceptions,
subject to the substantiation requirements of section 274(d).
Section 1.274-5T(c), Temporary Income Tax Regs., 50 Fed. Reg.
46016 (Nov. 6, 1985), requires a taxpayer to substantiate each
element of an expenditure by adequate record or by sufficient
evidence corroborating his own statements. Petitioner here has
made no attempt to do so. Instead, at trial, he sought to
introduce a printout of a self-created computer record of meals
and entertainment expenditures, a so-called meals and
entertainment substantiation log. This log was unaccompanied by
any primary evidence of the expenditures in the form of receipts,
paid bills, credit card receipts or cancelled checks. In his
posttrial briefs, petitioner does not argue that his claimed
deductions for meals and entertainment expenses are excepted from
the substantiation requirements of section 274(d). Instead, he
makes detailed and highly involved arguments on why the 50-
6
This was both the total amount of expenses reported and the
total amount of deductions claimed for meals and entertainment.
Petitioner argued for an exception to the general rule under sec.
274(n)(1) that only 50 percent of meals and entertainment
expenses be allowed as deduction. As discussed infra, we
consider it irrelevant to examine whether such an exception
applies here.
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percent limitation on meals and entertainment expenses under
section 274(n) does not apply.
In the absence of any showing as to when petitioner created
the record of these expenditures and of any primary evidence that
he had in fact incurred these expenditures, we hold that
petitioner has not met the standard of proof set forth in section
1.274-5T(c), Temporary Income Tax Regs., supra, for
substantiating deductions relating to meals and entertainment.
We, therefore, disallow such claimed expenses in their entirety
and have no reason to address petitioner’s arguments regarding
the inapplicability of the 50-percent limitation on such
deductions.
Petitioner has also failed to substantiate the claimed
deduction for advertising. Petitioner’s substantiation was
limited to a printout of a computer record, a self-styled
“advertisement substantiation log” that purportedly listed
advertising-related expenditures, the majority of which actually
referred to meals. In his posttrial reply brief, petitioner has
sought to explain this reference by arguing that he is reporting
“advertisement related business meals under the Advertisement
substantiation log * * * and all other business meals under [the
separate] meals, and entertainment substantiation log”. The
substantiation requirements of section 274(d) for meals and
entertainment expenses do not allow for an exception merely
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because the expense was related to advertising. Thus, for the
reasons discussed above regarding the substantiation of meals and
entertainment expenses, we disallow the claimed deductions with
respect to business meals that petitioner describes as
advertisement related.
We also disallow deductions for all other claimed
advertising expenses. Petitioner has presented no primary
evidence of having incurred such expenditures or shown how such
expenditures were related to his trade and business. He has,
therefore, failed to meet the adequate records requirement for
claiming these deductions.
Petitioner’s substantiation for rent and utilities is also
limited to a printout of a computer record or log of such
expenditures. In his posttrial briefs, petitioner argues that
the deductions for rent and utilities should be allowed for use
of a rental unit as a home office. For a home office deduction,
section 280A requires a showing that the portion of the dwelling
unit claimed as a home office be exclusively used on a regular
basis as the principal place of business of the taxpayer.
Further, section 280A requires that, in the case of a taxpayer
who is an employee, the use of the dwelling be for the
convenience of the taxpayer’s employer. Petitioner was an
employee of Intel during the year 2003 and is presumably
referring to Intel when he states in a posttrial brief that “Due
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to space constraints at Employer Corporation, the Taxpayer with
verbal assurances from employer used his home office for research
purposes”. Petitioner also claims he used the home office for
administrative and management activities relating to his alleged
trade or business as an “Engineer”. However, other than such
self-serving allegations in his posttrial briefs that do not
constitute evidence under Rule 143(b), petitioner has introduced
no evidence, credible or otherwise, to establish the showing
required under section 280A. We, therefore, deny petitioner’s
claimed deductions for rent and utilities.
IV. Section 6651(a)(1) Addition to Tax
Petitioner filed his 2003 return over 6 months after its due
date. Respondent has, thus, met his burden of production under
section 7491(c), and in order to avoid the section 6651(a)(1)
addition to tax, petitioner has the burden of proving reasonable
cause and the absence of willful neglect for failure to file on
time. Petitioner, however, failed to offer any explanation at
trial for the delay. Instead, in a posttrial brief, petitioner
“admits Respondent’s stated filing dates [sic] for the Original
Tax Return” and goes on to boldly declare that “when the Court
finds that Petitioner does not owe on the Deficiency, the
penalties, and interest calculated as liabilities against the
Petitioner * * * would become zero.” Since the petitioner has
admitted to the late filing and failed to offer any reason, let
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alone an excuse, for the delay, we uphold the addition to tax
under section 6651(a)(1) for late filing.
The Court has considered all of petitioner’s contentions,
arguments, requests, and statements. To the extent not discussed
herein, we conclude that they are meritless, moot, or irrelevant.
To reflect the foregoing,
Decision will be entered
under Rule 155.