T.C. Memo. 2010-109
UNITED STATES TAX COURT
THEODORE M. AND JACQUELINE GREEN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8247-08. Filed May 17, 2010.
Theodore M. Green and Jacqueline Green, pro sese.
Michael Park, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Theodore M. Green (Mr. Green) and Jacqueline
Green (Ms. Green) petitioned the Court for redetermination of the
following deficiencies in Federal income tax and penalties:
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Penalty
Year Deficiency Sec. 6662
2004 $3,383 $677
2005 7,188 1,438
In his answer, respondent further asserted that petitioners’
underpayments of tax for both 2004 and 2005 were attributable to
fraud under section 6663.1
The issues for decision after concessions2 are: (1) Whether
petitioners may deduct from income for 2004 as a net operating
loss (NOL) carryforward $8,098 relating to a $166,013 damage
award judgment that Ms. Green never received and that has now
been discharged in bankruptcy; (2) whether Social Security
disability benefits Ms. Green received in 2004 should be treated
as nontaxable worker’s compensation benefits; (3) whether
petitioners are entitled to a long-term capital loss carryover of
$3,000 for 2004; (4) whether petitioners failed to report pension
income of $7,978 for 2004; (5) whether petitioners are entitled
to deductions on Schedule A, Itemized Deductions, for medical
expenses of $53,888 and $102,242 for 2004 and 2005, respectively;
(6) whether petitioners are liable for fraud penalties under
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.
2
Respondent concedes that petitioners are entitled to
medical expenses of $355 and $4,347 for 2004 and 2005,
respectively.
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section 6663 for 2004 and 2005; and (7) whether petitioners are
liable for accuracy-related penalties under section 6662(a) for
2004 and 2005. For all purposes hereafter, the term “years at
issue” shall refer to 2004 and 2005.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the supplemental stipulation of
facts, together with the attached exhibits, are incorporated
herein by this reference. At the time petitioners filed their
petition, they resided in California.
Petitioners are husband and wife. From 1985 to September
19, 2005, Mr. Green worked as a tax service representative and as
a tax auditor for respondent.
I. Income From Default Judgment, Social Security Disability
Benefits, and Pensions
A. Net Operating Loss Carryforward and Long-Term Capital
Loss
Before November 1989 Ms. Green worked on a General Motors
Corp. (GM) assembly line. On November 12, 1989, Ms. Green was
injured at a grocery store when she was hit by a shopping cart.
Her injuries were apparently so severe that she was unable to
continue to work on the assembly line. On November 7, 1990, Ms.
Green filed a lawsuit for personal injury damages against the
individual who hit her with the shopping cart, and on November
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12, 1996, Ms. Green obtained a $166,013 default judgment against
that individual.
On March 14, 1997, in a bankruptcy proceeding, the person
who hit Ms. Green with the shopping cart was discharged of
liability to pay the $166,013 default judgment, and petitioners
never collected the damages. Petitioners never included any
portion of the $166,013 judgment in taxable income, and the
record does not establish that petitioners had any tax basis in
the uncollected judgment.
On their 1997 joint individual income tax return petitioners
claimed an $11,068 casualty loss deduction relating to the
$166,013 uncollected judgment discharged in bankruptcy.
Petitioners attached to their 1997 tax return a statement that
they intended to deduct the balance of the $154,946 uncollected
judgment over the course of the next 15 years--$11,068 in each
year--as a loss carryforward under section 172.
On their 2004 joint individual income tax return petitioners
claimed an NOL carryforward of $8,098 related to the uncollected
judgment. Petitioners also claimed a long-term capital loss of
$3,000, which petitioners considered to represent a portion of
the uncollected judgment.3
3
Petitioners did not attach a Schedule D, Capital Gains and
Losses, to their 2004 return. On Aug. 3, 2005, respondent
received petitioners’ Schedule D, on which they claimed a long-
term capital loss of $3,000. Petitioners do not account for why
(continued...)
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B. Social Security Disability Benefits
After sustaining injuries from the shopping cart in November
1989, Ms. Green worked for GM as a decal assembler. On August
27, 1991, Ms. Green was involved in an industrial accident at a
GM plant. Her injuries required surgery and left her unable to
work. On August 6, 1992, Ms. Green filed a claim for Social
Security disability benefits at the order of GM, and on December
17, 1993, Ms. Green began to receive Social Security disability
benefits.
In 2004 Ms. Green received Social Security disability
benefits of $13,495. On their 2004 return petitioners reported
the $13,495 but did not report any amount of the $13,495 as
taxable income, on the grounds that the benefits were excludable
from income under section 104.
C. Pension Income
For 2004 the State of California filed a Form 1099-R,
Distributions from Pensions, Annuities, Retirement or Profit-
Sharing Plans, IRAs, Insurance Contracts, etc., with the IRS that
reported Mr. Green as having received pension income of $1,578.
Petitioners reported Mr. Green’s pension income as taxable income
3
(...continued)
the combined amount of the net operating loss (NOL) carryforward
and the long-term capital loss reported on their 2004 return is
$30 higher than the NOL carryforward of $11,068 reported on their
1997 return or--as discussed below--on each of their 2000, 2001,
and 2003 returns.
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on their 2004 return. Also for 2004, the GM Hourly-Rate Pension
Trust filed a Form 1099-R with the IRS that reported Ms. Green as
having received pension income of $8,778, of which $7,979 was
taxable. Petitioners did not include any amount of Ms. Green’s
pension income as taxable on their 2004 return.
D. Prior Litigation
On their 2000 and 2001 joint individual income tax returns
petitioners claimed an NOL carryforward of $11,068 relating to
the uncollected judgment. Petitioners also reported Social
Security disability benefits received by Ms. Green of $12,258 and
$12,708, for 2000 and 2001, respectively, but did not report any
amount as taxable income.
The Internal Revenue Service (IRS) issued timely notices of
deficiency for 2000 and 2001, and petitioners filed petitions
with this Court.4 In a consolidated Tax Court opinion released
on March 9, 2006, Green v. Commissioner, T.C. Memo. 2006-39
(Green I), affd. 262 Fed. Appx. 790 (9th Cir. 2007), we held that
petitioners were not entitled to deduct the NOL carryforward as a
loss under section 165 and that Ms. Green’s Social Security
disability benefits were taxable for both 2000 and 2001.
Petitioners appealed our decision in Green I to the U.S. Court of
Appeals for the Ninth Circuit. The Court of Appeals affirmed our
4
The cases for 2000 and 2001 became docket Nos. 2475-04 and
4970-05, respectively.
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decision in an unpublished opinion issued on December 28, 2007.
Mr. Green testified at trial that he appealed the decision of the
Court of Appeals to the U.S. Supreme Court. The record does not
indicate whether petitioners filed a writ of certiorari with the
Supreme Court, but it is clear that the Supreme Court did not
grant certiorari in petitioners’ case.
On their 2003 joint individual income tax return petitioners
again claimed an NOL carryforward of $11,068 and failed to report
any of Ms. Green’s Social Security disability benefits as taxable
income. The IRS issued a notice of deficiency, and petitioners
filed a petition.5 In an opinion released on August 7, 2007,
Green v. Commissioner, T.C. Memo. 2007-217 (Green II), we held
that petitioners were not entitled to deduct the NOL carryforward
and that Ms. Green’s Social Security disability benefits were
taxable. Petitioners did not appeal Green II.
II. Schedule A Medical Expenses
Petitioners claimed unreimbursed medical expenses of $1,525
on Schedule A of their 2004 return. Petitioners claimed
unreimbursed medical expenses of $38,367 on Schedule A of their
2005 return. At the time of trial petitioners claimed medical
expenses for 2004 and 2005 of $53,888 and $102,242,
5
The case for 2003 became docket No. 5216-06.
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respectively.6 These sums included expenditures related to
transportation expenses, housekeeping expenses, gas and electric
bills, and accrued but unpaid general medical expenses.
A. Transportation Expenses
After her accident at the GM plant in 1991 Ms. Green was
unable to drive an automobile. For 2004 and 2005 petitioners
hired Christopher McGrath (Mr. McGrath) to be Ms. Green’s
personal driver. Mr. McGrath drove Ms. Green to her numerous
doctor’s appointments, the grocery store, and to have her hair
and nails done. Mr. McGrath did not possess any medical
training, and he drove a Honda Civic that was not modified in any
way to transport a physically disabled individual. Neither Mr.
McGrath nor petitioners kept a log or records showing the dates
and times Mr. McGrath drove Ms. Green to her medical
appointments.
Ms. Green paid only a portion of Mr. McGrath’s service fees.
The balance of Mr. McGrath’s invoices for transporting Ms. Green
was billed to Sedgwick Management Co. (Sedgwick), a car service
provider. In 2004 and 2005 Ms. Green paid Mr. McGrath $135 and
6
At the time petitioners filed their 2004 and 2005 returns,
they believed that GM would pay many of their accrued medical
expenses. As GM failed to pay, petitioners at trial claimed
medical expenses in addition to those reported on their returns.
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$2,365, respectively, while Mr. McGrath billed Sedgwick $756 and
$13,235, respectively.7
B. Housekeeping Expenses
Ms. Green’s injuries also prevented her from performing
household chores. For 2004 and 2005 petitioners hired two
housekeepers to clean the house, cook the meals, and serve Ms.
Green at petitioners’ home. Petitioners paid these housekeepers
$17,770 and $16,380 in 2004 and 2005, respectively.
C. Gas and Electric Bills
For 2004 petitioners paid $1,566 and $2,179 for their gas
and electric bills, respectively. For 2005 petitioners paid $585
and $1,950 for their gas and electric bills, respectively.
D. Method of Accounting
On their 1985 joint income tax return petitioners reported
that they operated a small tax service business. On their
Schedule C, Profit or Loss From Business, attached to their 1985
return, petitioners elected to report their Schedule C income and
expenses on an accrual basis. For 2004 and 2005 petitioners were
not engaged in a Schedule C business.
7
Sedgwick failed to pay Mr. McGrath’s invoices in full for
the years at issue, and Mr. McGrath currently has liens against
Sedgwick for the unpaid portions of his service fees for
transporting Ms. Green.
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III. Present Litigation
On January 17, 2008, respondent sent petitioners a notice of
deficiency for the years at issue. On April 7, 2008, petitioners
filed a petition with this Court. On June 11, 2008, respondent
filed an answer which alleged that petitioners were subject to
fraud penalties for the years at issue under section 6663. On
September 2, 2008, petitioners filed a reply to respondent’s
answer, which denied the allegations of fraud. On May 14, 2009,
respondent filed an amendment to answer which asserted collateral
estoppel as an affirmative defense to whether petitioners are
entitled to exclude their Social Security disability benefits
from income under section 104 and deduct an NOL carryforward
under section 165 for 2004. A trial was held on May 14, 2009, in
Los Angeles, California. At trial petitioners argued that they
were entitled to deduct medical expenses for 2004 and 2005 in
excess of those listed on their respective returns.
OPINION
I. Burden of Proof
Respondent’s determinations in the notice of deficiency are
presumed correct, and petitioners bear the burden of proving that
respondent’s determinations are incorrect.8 See Rule 142(a)(1).
8
Petitioners do not argue that the burden of proof shifts
to respondent pursuant to sec. 7491(a), nor have they shown that
the threshold requirements of sec. 7491(a) have been met for any
of the determinations at issue.
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Respondent has the burden of proof by clear and convincing
evidence with respect to his determination of fraud. See Rule
142(b).
II. Net Operating Loss Carryforward and Social Security Benefits
Petitioners argue that they are entitled to deduct under
section 165 an NOL carryforward of $8,098 for 2004 related to the
uncollected judgment of $166,013 which Ms. Green was awarded as a
result of her shopping cart accident. Petitioners also argue
that the Social Security disability benefits of $13,495 that Ms.
Green received in 2004 constitute worker’s compensation under
section 104 and are thus not includable in gross income.
Respondent contends that petitioners are precluded under the
doctrine of collateral estoppel from relitigating these issues.
We agree with respondent.
Collateral estoppel exists for the “dual purpose of
protecting litigants from the burden of relitigating an identical
issue and of promoting judicial economy by preventing unnecessary
or redundant litigation.” Meier v. Commissioner, 91 T.C. 273,
282 (1988); see also Montana v. United States, 440 U.S. 147, 153-
154 (1979); Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326
(1979). In general, the doctrine of collateral estoppel
forecloses relitigation of issues actually litigated and
necessarily decided in a prior suit. Parklane Hosiery Co. v.
Shore, supra at 326 n.5; Meier v. Commissioner, supra at 282;
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Peck v. Commissioner, 90 T.C. 162, 166 (1988), affd. 904 F.2d 525
(9th Cir. 1990).
This Court, expanding upon three factors identified by the
Supreme Court in Montana v. United States, supra at 155, has set
forth five prerequisites necessary for the application in factual
contexts of collateral estoppel:
(1) The issue in the second suit must be identical
in all respects with the one decided in the first suit.
(2) There must be a final judgment rendered by a
court of competent jurisdiction.
(3) Collateral estoppel may be invoked against
parties and their privies to the prior judgment.
(4) The parties must actually have litigated the
issues and the resolution of these issues must have
been essential to the prior decision.
(5) The controlling facts and applicable legal
rules must remain unchanged from those in the prior
litigation.
[Peck v. Commissioner, supra at 166-167; citations
omitted.]
All five requirements are satisfied in the instant case:
(1) The issues of whether petitioners are entitled to exclude
their Social Security disability benefits from income and deduct
an NOL carryforward are identical to the issues litigated in
Green I and Green II; (2) final judgment was rendered in both
cases; (3) the parties in Green I and Green II are identical to
those in the instant case; (4) the parties litigated the issues
and the resolution of those issues was essential to the decision
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in both Green I and Green II; and (5) the controlling facts and
applicable legal rules concerning the issues in the instant case
are unchanged from those in Green I and Green II.
Accordingly, the doctrine of collateral estoppel applies,
and petitioners are precluded from relitigating the net operating
loss carryforward and Social Security benefits issues raised in
Green I and Green II.
III. Long-Term Capital Loss
Section 1211 provides that in the case of noncorporate
taxpayers, capital losses are deductible only to the extent of
capital gains plus $3,000. When capital losses exceed capital
gains by more than $3,000, the excess may be carried over to
later taxable years to reduce capital gains or a limited amount
of ordinary income. Sec. 1212(b). A long-term capital loss is
the loss from the sale or exchange of a capital asset held for
longer than 1 year. Sec. 1222(4).
Mr. Green testified at trial that the $3,000 capital loss
was not from the sale of a capital asset but rather constituted a
recharacterization of a portion of the $11,068 NOL carryforward
that respondent had previously disallowed. The record does not
indicate that the loss is related to the sale of a capital asset.
Accordingly, we sustain respondent’s determinations regarding the
long-term capital loss.
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IV. Pension Income
Petitioners argue that Ms. Green’s $8,778 of pension income
for 2004 constituted worker’s compensation. Petitioners claim
that GM issued the Form 1099-R out of vindictiveness against
petitioners and that the proceeds had been categorized as
worker’s compensation in prior years.
Petitioners offered no evidence that Ms. Green’s pension
income was payment of worker’s compensation. At trial Mr. Green
testified that GM was either “ignorant or malicious” in issuing
the Form 1099-R but the record is devoid of anything to
corroborate this claim. Accordingly, we sustain respondent’s
determination regarding petitioners’ pension income.
V. Deductions for Medical Expenses
Petitioners argued at trial that they incurred medical
expenses of $54,888 and $102,242 for 2004 and 2005, respectively.
These consisted of the following amounts: (1) Medical expenses
conceded by respondent of $355 and $4,347 for 2004 and 2005,
respectively; (2) transportation costs of $891 and $15,600 for
2004 and 2005, respectively; (3) housekeeper expenses of $17,770
and $16,380 for 2004 and 2005, respectively; (4) gas and electric
expenses of $3,755 and $2,537 for 2004 and 2005, respectively;
and (5) accrued but unpaid medical expenses of $31,127 and
$63,381 for 2004 and 2005, respectively.
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Section 213(a) allows for the deduction of paid expenses
“not compensated for by insurance or otherwise, for medical care
of the taxpayer, his spouse, or a dependent * * * to the extent
that such expenses exceed 7.5 percent of adjusted gross income.”
We have characterized section 213 as carving out “a limited
exception” to the general rule in section 262 that prohibits the
deduction of personal, living, or family expenses. Jacobs v.
Commissioner, 62 T.C. 813, 818 (1974). The deductibility of the
expenses at issue hinges on whether they were paid for
petitioner’s medical care. If so, they are deductible medical
expenses under section 213. If not, they are nondeductible
personal expenses under section 262.
The term “medical care” includes amounts paid “for the
diagnosis, cure, mitigation, treatment, or prevention of disease,
or for the purpose of affecting any structure or function of the
body”. Sec. 213(d)(1)(A). The regulations provide that
“Deductions for expenditures for medical care allowable under
section 213 will be confined strictly to expenses incurred
primarily for the prevention or alleviation of a physical or
mental defect or illness.” Sec. 1.213-1(e)(1)(ii), Income Tax
Regs. Furthermore, to substantiate medical and dental expenses
under section 213, the taxpayer must furnish the name and address
of each person to whom payment was made and the amount and date
of each payment. See sec. 1.213-1(h), Income Tax Regs.
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As discussed below, petitioners have failed to meet their
burden of substantiating any of their claimed medical expenses.
Therefore, no deductions for medical expenses will be allowed
beyond those respondent has already conceded.
A. Transportation Costs
Petitioners claim that the amounts charged by Mr. McGrath
for transporting Ms. Green in 2004 and 2005 constitute deductible
medical expenses. First, petitioners are not entitled to claim
the amounts billed to Sedgwick as medical expenses.9 Petitioners
have presented no evidence to show that they were in any way
associated with the payments made by Sedgwick to Mr. McGrath, and
Sedgwick has failed to fully pay Mr. McGrath for the amounts
billed.
With regard to petitioners’ out-of-pocket expenses,
transportation costs related to personal errands are
nondeductible personal expenses. Sec. 262; Haines v.
Commissioner, 71 T.C. 644, 646 (1979). Although respondent
concedes that transportation costs associated with driving Ms.
Green to doctor’s appointments may be deductible medical
expenses, petitioners have failed to provide any records to
substantiate the amounts of those expenses or the dates and times
those expenses were incurred. See sec. 1.213-1(h), Income Tax
9
Petitioners paid Mr. McGrath $135 in 2004 and $2,365 in
2005 for his services as a driver. Mr. McGrath billed Sedgwick
$756 in 2004 and $13,235 in 2005 for transporting Ms. Green.
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Regs. The record indicates that a large number, if not the
majority, of Ms. Green’s trips with Mr. McGrath were to run
personal errands.10 Therefore, we find that petitioners have not
met their burden to show that their travel costs constitute
medical expenses.
As a general rule, if the trial record provides sufficient
evidence that the taxpayer has incurred a deductible expense, but
the taxpayer is unable to substantiate adequately the precise
amount of the deduction to which he or she is otherwise entitled,
the Court may estimate the amount of the deductible expense and
allow the deduction to that extent. Cohan v. Commissioner, 39
F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85
T.C. 731, 742-743 (1985); Sanford v. Commissioner, 50 T.C. 823,
827-828 (1968), affd. per curiam 412 F.2d 201 (2d Cir. 1969);
sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014
(Nov. 6, 1985). In these instances, the Court is permitted to
make as close an approximation of the allowable expense as it
can, bearing heavily against the taxpayer whose inexactitude is
of his or her own making. Cohan v. Commissioner, supra at 544.
However, in order for the Court to estimate the amount of an
expense, the Court must have some basis upon which an estimate
may be made. Vanicek v. Commissioner, supra at 742-743. Without
10
Mr. McGrath testified that he drove Ms. Green to her
doctor’s appointments as well as to run her personal errands such
as grocery shopping, hair styling, and manicures.
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such a basis, any allowance would amount to unguided largesse.
Williams v. United States, 245 F.2d 559, 560-561 (5th Cir. 1957).
The record provides no satisfactory basis for estimating the
amounts of petitioners’ transportation costs that may have been
used for trips to the doctor’s office as opposed to the hair
stylist. Consequently, the Court will not apply the Cohan rule
to estimate the amounts of petitioners’ transportation costs that
may constitute medical expenses.
B. Housekeeper Costs
Petitioners claim that the amounts they paid to their
housekeepers in 2004 and 2005 constitute medical expenses. The
housekeepers did not render medical care but were required
because Ms. Green, according to Mr. Green’s testimony at trial,
“maintains a complete, meticulous, excellent, clean” home, and
“does not like filth in any way, shape or fashion.” Although
petitioners’ zeal for cleanliness may have resulted in a
psychological benefit to Ms. Green, it was not “for the
diagnosis, cure, mitigation, treatment, or prevention of disease,
or for the purpose of affecting any structure or function of the
body”. See sec. 213(d)(1)(A). Expenses incurred which are
merely beneficial to the general health of an individual are not
deductible. Gardner v. Commissioner, T.C. Memo. 1983-541; sec.
1.213-1(e)(1)(ii), Income Tax Regs. Moreover, the salary and
cost of room and board for housekeepers hired on the advice of a
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doctor are not deductible medical expenses. Borgmann v.
Commissioner, 438 F.2d 1211 (9th Cir. 1971), affg. T.C. Memo.
1969-129. Accordingly, petitioners have failed to show that
their payments to their housekeepers constitute medical expenses.
C. Gas and Electric Bills
Petitioners seek to deduct their gas and electric bills for
the years at issue as medical expenses. In general, the cost of
maintaining a household, including amounts paid for utilities,
are personal expenses which are not deductible. Sec. 1.262-
1(b)(3), Income Tax Regs. Petitioners testified at trial that
they paid some of their gas and electric bills in order to power
a heating pool and several devices that were therapeutic for Ms.
Green. Where a living expense is used primarily for the
alleviation of an ailment, a medical deduction is allowable to
the extent of the excess cost attributable to the medical
purpose. Gardner v. Commissioner, supra; see also Randolph v.
Commissioner, 67 T.C. 481 (1976); Harris v. Commissioner, 46 T.C.
672 (1966). Petitioners have failed to demonstrate what portion
of their gas and electric bills was used to power devices
employed primarily for the alleviation of Ms. Green’s medical
problems and whether their utility costs were higher as a result
of the devices. Therefore, we find that their gas and electric
bills do not constitute medical expenses.
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D. Accrued but Unpaid Medical Expenses
At trial petitioners claimed a balance of medical expense
deductions of $31,127 and $63,381 for 2004 and 2005,
respectively. Petitioners argue that these expenses are accrued
medical expenses that have not yet been paid. Petitioners
further argue that they were accrual basis taxpayers for the
years at issue and base this assertion on their election to treat
their Schedule C business on an accrual basis on their 1985
return.
Petitioners’ method of accounting is irrelevant. Medical
expenses may be deducted only in the year of actual payment.
Sec. 1.213-1(a)(1), Income Tax Regs. As far as the record is
concerned, petitioners’ allegedly accrued but unpaid medical
expenses appear to have been conjured out of thin air.
Petitioners have failed to substantiate any of their medical
expenses not otherwise conceded by respondent, and the Court is
left with no basis upon which to estimate them. Accordingly,
other than those respondent has conceded, we allow none of
petitioners’ claimed medical expense deductions for the years at
issue.
VI. Fraud Penalty
In order to show fraud under section 6663, respondent must
prove: (1) An underpayment exists; and (2) petitioners intended
to evade taxes known to be owing by conduct intended to conceal,
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mislead, or otherwise prevent the collection of taxes. See Parks
v. Commissioner, 94 T.C. 654, 660-661 (1990).
A. Underpayment of Tax
Respondent must first show by clear and convincing evidence
that petitioners had an underpayment of tax in each of the years
at issue. As discussed above, respondent has shown that
petitioners received income from Social Security disability
benefits and pensions on which they failed to pay tax for 2004.
Respondent has also shown that petitioners claimed deductions for
medical expenses, NOL carryforwards, and long-term capital losses
for 2004, and medical expenses for 2005, to which they were not
entitled and which resulted in underpayments of tax. Therefore,
respondent has satisfied his burden of proof on this issue for
both 2004 and 2005.
B. Fraudulent Intent
Because direct evidence of fraud is rarely available, fraud
may be proved by circumstantial evidence and reasonable
inferences from the facts. Petzoldt v. Commissioner, 92 T.C.
661, 699 (1989). Courts have developed a nonexclusive list of
factors, or “badges of fraud”, that demonstrate fraudulent
intent. Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992).
These badges of fraud include: (1) Understating income, (2)
maintaining inadequate records, (3) implausible or inconsistent
explanations of behavior, (4) concealment of income or assets,
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(5) failing to cooperate with tax authorities, (6) engaging in
illegal activities, (7) an intent to mislead which may be
inferred from a pattern of conduct, (8) lack of credibility of
the taxpayer’s testimony, (9) filing false documents, (10)
failing to file tax returns, and (11) dealing in cash. Id.; see
also Spies v. United States, 317 U.S. 492, 499 (1943); Morse v.
Commissioner, 419 F.3d 829, 832 (8th Cir. 2005), affg. T.C. Memo.
2003-332; Recklitis v. Commissioner, 91 T.C. 874, 910 (1988).
Although no single factor is necessarily sufficient to establish
fraud, the combination of a number of factors constitutes
persuasive evidence. Niedringhaus v. Commissioner, supra at 211.
Respondent must prove fraud for each year at issue. See id. at
210; Ferguson v. Commissioner, T.C. Memo. 2004-90. Petitioners’
behavior with respect to their income may be evaluated in the
light of these factors, as follows.
1. Understated Income
Respondent has shown that petitioners understated their
income for 2004. This factor is mitigated by petitioners’
inclusion of their Social Security disability benefits on their
2004 return as proceeds excluded from taxable income by section
104. Respondent argues that petitioners had reason to know at
the time they filed their 2004 return that their position
regarding the benefits was incorrect because respondent had
already issued notices of deficiency determining that the
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benefits were taxable for 2001 and 2002. At the time petitioners
filed their 2004 return, however, no court had issued a decision
regarding the issue.
Petitioners also omitted pension income on their 2004
return. This factor militates in favor of a finding of fraud.
2. Inadequate Records
The record indicates that petitioners did not keep adequate
records for either 2004 or 2005. They failed to substantiate the
bulk of their medical expense deductions for each of the years at
issue.
3. Implausible Behavior
Petitioners believed, at the time they filed their 2004
return, that the taxation of their Social Security disability
benefits and the allowance of their NOL carryforward presented
valid legal disputes to be decided by the courts. Although Mr.
Green, a former IRS agent, placed too much faith in his tax
analytical skills, his behavior with regard to tax reporting has
been consistently plausible: petitioners first notified the IRS
in 1997 of their attempt to claim a casualty loss deduction and
kept the theory alive through petitions and appeals as long as
possible. Less easy to countenance are the large claimed medical
expense deductions. However, both petitioners credibly testified
to the extent of their medical problems and have maintained a
consistent position reflecting their belief that they were
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entitled to medical expense deductions. Petitioners also had a
consistent, if flawed, rationale for not reporting Ms. Green’s GM
pension income and for reporting a long-term capital loss for
2004.
4. Concealment of Income
Petitioners did not actively conceal income or assets. The
Social Security disability benefits they received were listed on
their 2004 return. Petitioners did not report Ms. Green’s GM
pension income, but they also made no attempt to conceal it when
their return came under audit.
5. Compliance With Tax Officials
Petitioners fully complied with the audit process and all
court proceedings.
6. Illegal Activities
Petitioners never engaged in illegal activities.
7. Pattern of Misconduct With Intent To Mislead
Petitioners did not engage in a pattern of conduct to
mislead tax authorities. As previously stated, petitioners
honestly believed they were entitled to exclude their Social
Security disability benefits and the GM pension from income and
deduct the uncollected judgment resulting from the shopping cart
incident. Petitioners were also under the impression that they
were entitled to additional medical expense deductions for
transportation costs, housekeeping costs, and gas and electric
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bills for the years at issue. The record does not indicate that
petitioners attempted to deduct large and unsubstantiated medical
expenses on their returns for prior years.
8. Credibility of Testimony
Petitioners’ testimony was generally credible with regard to
their intent.
9. False Documents
Petitioners never intentionally filed a false document.
10. Failing to File Tax Returns
Petitioners timely filed their 2004 and 2005 returns.
11. Dealing in Cash
Petitioners did not deal in cash.
As a result of the paucity of badges of fraud, we find that
respondent has failed to show by clear and convincing evidence
that petitioners filed their 2004 and 2005 returns with the
intent to evade tax.
VII. Accuracy-Related Penalty
Section 6662(a) and (b)(2) imposes an accuracy-related
penalty upon any underpayment of tax resulting from a substantial
understatement of income tax. The penalty is equal to 20 percent
of the portion of any underpayment attributable to a substantial
understatement of income tax. Id. The term “substantial
understatement” is defined as exceeding the greater of: (1) 10
percent of the tax required to be shown on the return for the
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taxable year, or (2) $5,000. Sec. 6662(d)(1)(A). Section
6662(a) and (b)(1) also imposes a penalty equal to 20 percent of
the amount of an underpayment attributable to negligence or
disregard of rules or regulations. Negligence includes any
failure to make a reasonable attempt to comply with the
provisions of the Internal Revenue Code. Sec. 6662(c).
We hold that petitioners are liable for the penalty for
negligence in 2004 and substantial understatement of income tax
in 2005. Petitioners’ failure to produce records substantiating
their medical expenses, NOL deductions, and Social Security
disability benefit exclusions supports the imposition of the
accuracy-related penalty for negligence for 2004. Petitioners’
understatement of income tax as reflected in the notice of
deficiency is greater than $5,000 and 10 percent of the tax
required to be shown on the return in 2005. Thus, respondent has
met his burden of production under section 7491(c).
An accuracy-related penalty is not imposed on any portion of
the underpayment as to which the taxpayer acted with reasonable
cause and in good faith. Sec. 6664(c)(1). The taxpayer bears
the burden of proof with regard to those issues. Higbee v.
Commissioner, 116 T.C. 438, 446 (2001). Petitioners have failed
to show reasonable cause, substantial authority, or any other
basis for reducing the penalties. Mr. Green was a tax service
representative with the IRS for over a decade. With this
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background, he had a wider range of knowledge of tax matters than
do members of the general public. See Kendrix v. Commissioner,
T.C. Memo. 2006-9. The Court sympathizes with petitioners for
the injuries that have afflicted them over the years.
Unfortunately, given the dearth of evidence to substantiate
petitioners’ medical expenses, NOL deductions, and Social
Security disability benefit exclusions, we are unable to mitigate
the penalties. Accordingly, we find petitioners liable for the
section 6662 penalty for 2004 and 2005 as commensurate with
respondent’s concessions and our holding. See Higbee v.
Commissioner, supra at 446.
In reaching our holdings herein, we have considered all
arguments made, and, to the extent not mentioned above, we
conclude they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.