T.C. Memo. 2010-266
UNITED STATES TAX COURT
TAX PRACTICE MANAGEMENT, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
JOSEPH ANTHONY D’ERRICO, Petitioner v. COMMISSIONER OF
INTERNAL REVENUE, Respondent
Docket Nos. 1477-09, 1483-09. Filed December 7, 2010.
Adam L. Karp, for petitioners.
Jeremy L. McPherson, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: These cases are before the Court
consolidated for purposes of trial, briefing, and opinion. Tax
Practice Management, Inc. (TPM), and Joseph D’Errico (D’Errico)
separately petitioned the Court for redetermination of the
following deficiencies in Federal income tax:
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Tax Practice Management, Inc., docket No. 1477-09
Penalty
TYE Deficiency Sec. 6662
4/30/2005 $40,736 $8,147
Joseph Anthony D’Errico, docket No. 1483-09
Penalty
TYE Deficiency Sec. 6662
12/31/2004 $229,836 $45,967
The issues for decision after concessions1 are: (1) Whether
TPM is entitled to deductions of $166,421 for its year ending
April 30, 2005; (2) whether D’Errico must increase his 2004 pass-
through income from three wholly owned S corporations by $44,317;
(3) whether D’Errico received constructive dividend income of
$30,000 from TPM as a result of TPM’s paying $30,000 in rent to
D’Errico’s father for the use of the father’s property at 318
1
Petitioners concede that TPM’s gross receipts for its
fiscal year ending Apr. 30, 2005, are understated by $3,000.
Petitioners further concede that the statute of limitations does
not bar pass-through adjustments to D’Errico from his three S
corporations.
Before trial respondent conceded that TPM’s purchase of a
2001 Cessna 172S airplane in December 2004 is not a constructive
dividend to D’Errico. On brief respondent concedes that D’Errico
did not understate his 2004 income by $43,071. Respondent
further concedes that two of D’Errico’s S corporations, D’Errico
& Wedge, Inc., and D’Errico & McCollor, Inc., are entitled to
claim deductions of management fees of $150,000 and $250,000,
respectively.
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Barton Drive in Stateline, Nevada; and (4) whether petitioners
are liable for the accuracy-related penalty.2
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 TPM filed its
petition, its principal place of business was Nevada. At the
time D’Errico filed his petition, he resided in Nevada.
I. Background
On October 9, 2008, respondent sent a notice of deficiency
for the fiscal year ending April 30, 2005, to TPM. On October
15, 2008, respondent sent a notice of deficiency for 2004 to
D’Errico. Petitioners filed timely petitions with this Court.
In 2002 D’Errico operated a tax preparation business through
three wholly owned calendar year S corporations: (1) Joseph A.
D’Errico & Associates, Inc. (J&A), in Lake Tahoe, Nevada; (2)
D’Errico & Wedge, Inc. (D&W), in Mission Hills, California; and
(3) D’Errico & McCollor, Inc. (D&M), in Santa Barbara,
California. Further, in 2002 D’Errico organized TPM, a wholly
owned C corporation with a fiscal year and taxable year ending
April 30. TPM was organized to provide training and management
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1986, 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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services to D’Errico’s tax preparation businesses. In 2003
D’Errico closed J&A’s operations. Further, on January 1, 2005,
D’Errico sold 100 percent of the shares of both D&W and D&M to an
unrelated third party.
II. TPM
In his notice of deficiency, respondent denied TPM the
following deductions:
Expense Amount
Sec. 179 expense $102,000
Depreciation 7,130
Airplane expenses 11,287
Auto expenses 5,143
Meals & entertainment 1,257
Travel 4,581
Repairs & maintenance 1,790
Supplies 3,233
Rent 30,000
Total 166,421
In December 2004 TPM purchased a 2001 Cessna 172S airplane
(the airplane) for $137,500. The airplane was delivered to TPM
on December 23, 2004, at Minden Airport in Nevada. On December
24, 2004, D’Errico received the airplane on behalf of TPM and
flew it to several destinations in California and Nevada on a
test flight before returning to Minden Airport the next day to
finalize the transaction. D’Errico testified that he met with
clients to discuss TPM’s fees during this trip. The test flight
was the only time the airplane was used in 2004.
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On December 29, 2004, TPM entered into an airplane leasing
agreement with Flying Start Aero, an airplane operator. Pursuant
to the airplane leasing agreement, Flying Start Aero leased the
airplane from TPM for purposes of making the airplane available
to the public for rent. The airplane leasing agreement states
that the airplane was leased to Flying Street Aero to generate
revenue for the purpose of offsetting TPM’s airplane operating
costs. In 2005 the only use of the airplane was for rental and
training purposes. TPM paid expenses of $11,287 with respect to
the airplane during the fiscal year ending April 30, 2005.
Additionally, respondent denied TPM’s claimed $30,000
deduction for rent paid to Anthony D’Errico, D’Errico’s father,
pursuant to a lease agreement for use of the father’s property at
318 Barton Drive in Stateline, Nevada (the Barton Drive
property). The Barton Drive property is a three-bedroom home.
D’Errico testified that he used the top-level bedroom and top-
level common areas for his personal use and that the two bottom
bedrooms and common areas were converted into offices for TPM.
Accordingly, TPM entered into a sublease agreement with D’Errico
at an annual rate of $9,000 in exchange for use of the Barton
Drive property.
Respondent denied additional deductions TPM claimed for
automobile expenses, meals and entertainment, travel, repairs and
maintenance, and supplies. D’Errico testified that TPM
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established an expense reimbursement program whereby D’Errico
could incur expenses on behalf of TPM and submit them to TPM for
reimbursement. TPM produced D’Errico’s hand-written notes
documenting expense reimbursements, as well as D’Errico’s
personal credit card statements reflecting each of TPM’s claimed
expenses. D’Errico testified that he kept a log describing the
nature of these expenses as they relate to TPM’s business;
however, he did not produce this log at trial.
III. D’Errico
In 2004 J&A filed Form 1120S, U.S. Income Tax Return for an
S Corporation, reporting an interest expense of $22,034. J&A was
inactive in 2004; however, D’Errico testified that the interest
expense accrued on accounts payable due from J&A to TPM for TPM’s
management fee. D’Errico provided hand-written notes of TPM’s
accounts receivable to evidence this amount due. These notes do
not attribute TPM’s accounts receivable to an amount due from J&A
and do not describe the source of the amounts due.
As the sole shareholder of J&A, D’Errico included the
interest expense deduction claimed by J&A on Schedule E,
Supplemental Income and Loss, of his Form 1040, U.S. Individual
Income Tax Return. In his notice of deficiency, respondent
denied D’Errico the $22,034 interest deduction.
Respondent further denied deductions D’Errico claimed on
Schedule E attributable to his ownership interest in D&M for
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auto/truck expenses and travel expenses of $4,650 and $2,024,
respectively. Similarly, respondent denied deductions D’Errico
claimed on Schedule E attributable to his ownership interest in
D&W for auto/truck expenses and travel expenses of $4,650 and
$10,959, respectively. D’Errico provided hand-written notes
listing the above-referenced expenses as well as personal credit
card statements to substantiate the claimed deductions.
D’Errico’s hand-written notes do not include any description of,
or reasons for, the expenses incurred.
Finally, as discussed above, TPM paid D’Errico’s father
$30,000 in rent for use of the Barton Drive property. D’Errico
testified that he used the top-level bedroom and top-level common
areas of the Barton Drive property for his personal use and that
the two bottom bedrooms and common areas were converted into
offices for TPM. In his notice of deficiency, respondent
determined TPM’s $30,000 rent payment to be a constructive
dividend to D’Errico.
OPINION
I. Burden of Proof
Respondent’s determinations in the notice of deficiency are
presumed correct, and petitioners bear the burden of proving them
incorrect. See Rule 142(a)(1). Petitioners do not argue that
the burden of proof shifts to respondent pursuant to section
7491(a), nor have they shown that the threshold requirements of
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section 7491(a) have been met for any of the determinations at
issue. Accordingly, the burden remains on petitioners to prove
that respondent’s determination of deficiencies in their income
tax is erroneous.
II. TPM
Deductions are a matter of legislative grace, and the
taxpayer must prove he is entitled to the deductions claimed.
Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934). Section 162(a) provides that “There shall be allowed as
a deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business”. Taxpayers are required to maintain records sufficient
to establish the amounts of allowable deductions and to enable
the Commissioner to determine the correct tax liability. Sec.
6001; Shea v. Commissioner, 112 T.C. 183, 186 (1999).
If a factual basis exists to do so, the Court may in some
contexts approximate an allowable expense, bearing heavily
against the taxpayer who failed to maintain adequate records.
Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); see
sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014
(Nov. 6, 1985). 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, 85 T.C. 731,
742-743 (1985). Without such a basis, any allowance would amount
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to unguided largesse. Williams v. United States, 245 F.2d 559,
560-561 (5th Cir. 1957).
Items described in section 274 are subject to strict
substantiation rules. No deduction shall be allowed for, among
other things, traveling expenses, entertainment expenses, gifts,
and expenses with respect to “listed property” defined in section
280F(d)(4) “unless the taxpayer substantiates by adequate records
or by sufficient evidence corroborating the taxpayer’s own
statement”: (1) The amount of the expense or other item; (2) the
time and place of the travel, entertainment or use, or date and
description of the gift; (3) the business purpose of the expense
or other item; and (4) in the case of entertainment or gifts, the
business relationship to the taxpayer of the recipients or
persons entertained. Sec. 274(d). We may not use the Cohan
doctrine to estimate expenses covered by section 274(d). See
Sanford v. Commissioner, 50 T.C. 823, 827 (1968), affd. per
curiam 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary
Income Tax Regs., supra.
A. The Airplane
Subject to certain limitations, taxpayers purchasing
qualifying property may elect under section 179 to deduct the
cost of the property in the year the property is placed in
service. Qualifying section 179 property includes tangible
property that is depreciable under section 168 and is described
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in section 1245(a)(3) or computer software that is depreciable
under section 167 and described in section 1245(a)(3), but only
if the property is acquired for use in the “active conduct of a
trade or business.” Sec. 179(d)(1). As used in section 179 the
term “trade or business” has the same meaning as in section 162
and the regulations thereunder, and therefore property held
merely for the production of income does not qualify as section
179 property. Sec. 1.179-2(c)(6)(i), Income Tax Regs. “[A]ctive
conduct” as used in section 179 means that the taxpayer actively
participates in the management or operations of the trade or
business. Sec. 1.179-2(c)(6)(ii), Income Tax Regs.
TPM received the airplane on December 24, 2004, and D’Errico
subsequently flew it on a test flight to several locations in
California and Nevada. D’Errico testified that he also met with
clients during this trip to discuss TPM’s fees. This test flight
was the only use of the airplane before December 29, 2004, when
TPM entered into the airplane leasing agreement with Flying Start
Aero for purposes of making the airplane available to the public
for rent. During the remainder of TPM’s fiscal year, the only
use of the airplane was for rental and training purposes. We
must first decide whether TPM acquired the airplane for use in
its trade or business.
To determine whether a taxpayer is conducting a trade or
business requires an examination of the facts involved in each
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case. Higgins v. Commissioner, 312 U.S. 212, 217 (1941). For a
taxpayer to be engaged in a trade or business, the primary
purpose for engaging in the activity must be for income or
profit. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).
Whether an enterprise is conducted as a business for profit is a
matter of intention and good faith. Am. Props., Inc. v.
Commissioner, 28 T.C. 1100, 1111 (1957), affd. 262 F.2d 150 (9th
Cir. 1958). The reasonableness of the taxpayer’s belief that the
activity will generate a profit is not relevant. Hillcone
Steamship Co. v. Commissioner, T.C. Memo. 1963-220. However, a
mere hope that an activity will generate profits, in the absence
of any specific plan to generate a profit, is inconsistent with
an allegation that the belief is in good faith. See Sutherland
v. Commissioner, T.C. Memo. 1968-20.
Thus, whether TPM is entitled to its claimed deductions with
regard to the airplane turns initially on whether TPM has
demonstrated by virtue of D’Errico’s testimony, the test flight,
and the airplane leasing agreement with Flying Start Aero that it
purchased the airplane with the requisite intent, objective, or
motive of making a profit. Intention is a question of fact to be
determined not only from the direct testimony as to intent but
also from a consideration of all the evidence, including the
conduct of the parties. Id. The statement by an interested
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party of his intention and purpose is not necessarily conclusive.
Id.
Factors to be considered in determining whether an activity
is engaged in for profit include: (1) The manner in which the
taxpayer carries on the activity, (2) the expertise of the
taxpayer or her advisers, (3) the time and effort expended by the
taxpayer in carrying on the activity, (4) the expectation that
assets used in the activity may appreciate in value, (5) the
success of the taxpayer in carrying on other similar or
dissimilar activities, (6) the taxpayer’s history of income or
losses with respect to the activity, (7) the amount of occasional
profits, if any, which are earned, (8) the financial status of
the taxpayer, and (9) the elements of personal pleasure or
recreation. Indep. Elec. Supply, Inc. v. Commissioner, 781 F.2d
724, 726-727 (9th Cir. 1986), affg. Lahr v. Commissioner, T.C.
Memo. 1984-472; Antonides v. Commissioner, 91 T.C. 686, 694 n.4
(1988), affd. 893 F.2d 656 (4th Cir. 1990); Golanty v.
Commissioner, 72 T.C. 411, 426 (1979), affd. without published
opinion 647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(b), Income Tax
Regs. No single factor or group of factors is determinative.
Golanty v. Commissioner, supra at 426; Dunn v. Commissioner, 70
T.C. 715, 720 (1978), affd. 615 F.2d 578 (2d Cir. 1980); sec.
1.183-2(b), Income Tax Regs. A final determination is made only
after considering all facts and circumstances. Indep. Elec.
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Supply, Inc. v. Commissioner, supra at 727; Antonides v.
Commissioner, supra at 694; Golanty v. Commissioner, supra at
426.
TPM contends that the airplane was necessary for its
business because at the time of its purchase TPM managed D&W and
D&M and D’Errico was required to travel between Nevada and
California to fulfill TPM’s duties. Additionally, TPM contends
that the airplane was necessary for traveling throughout
California to meet with clients, to market TPM’s services, and to
present an aura of success. At trial D’Errico testified that TPM
entered into the airplane leasing agreement with Flying Start
Aero because he did not have the time to fly the airplane for
marketing trips and to meet with clients during tax season. He
testified that the airplane leasing agreement allowed the
airplane to start “paying for itself” as another source of income
for TPM.
Respondent contends that the timing of TPM’s purchase of the
airplane defeats the claimed deductions. At the time of the
purchase, D’Errico was in negotiations to sell D&W and D&M. The
airplane was purchased on December 25, 2004, and D’Errico sold
D&W and D&M on January 1, 2005. TPM used the airplane only once
before entering into the airplane leasing agreement on December
29, 2004, and that was for the test flight.
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Respondent further argues that TPM never anticipated that
the rental income derived from the airplane leasing agreement
would defray more than a small part of the operating expenses of
the airplane. Respondent relies on the airplane leasing
agreement, which provides that “* * * [TPM] is leasing said
airplane to * * * [Flying Start Aero] with the intention of
generating some revenue for purpose of offsetting a portion of
the airplane operating costs”. Accordingly, respondent argues
that TPM has not demonstrated that the airplane was purchased for
use in its trade or business.
As discussed above, pursuant to Rule 142(a)(1) respondent’s
determinations in the notice of deficiency are presumed correct,
and petitioners bear the burden of proving them incorrect. We do
not find it necessary to analyze all the factors discussed above.
TPM has not demonstrated that the airplane was acquired with the
requisite intent or motive of making a profit. Other than
D’Errico’s self-serving testimony, TPM has not presented any
evidence that it contemplated using the airplane for purposes of
TPM’s management or marketing operations. Further, the airplane
leasing agreement specifically provides that TPM entered into the
agreement with the intention of generating revenue to offset the
airplane’s operating costs. The Court of Appeals for the Ninth
Circuit has held that a profit motive does not exist where
“activities represented mere attempts to recoup some of * * *
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[the taxpayers’] costs”. Carter v. Commissioner, 645 F.2d 784,
786 (9th Cir. 1981), affg. T.C. Memo. 198-202. The record lacks
evidence providing any clear indication that TPM possessed the
requisite profit motive and intent in purchasing the airplane.
Because TPM did not acquire the airplane for use in its trade or
business, it is unnecessary for us to analyze the other
requirements of section 179. Accordingly, TPM has failed to meet
its burden of proof, and we sustain respondent’s determinations
with regard to the section 179 expense.
As discussed above, section 162(a) allows for the deduction
of ordinary and necessary expenses paid or incurred during the
taxable year in carrying on any trade or business. Further,
section 167(a) allows as a depreciation deduction a reasonable
allowance for the “exhaustion, wear and tear” of property (1)
used in a trade or business or (2) held for the production of
income. Having determined that TPM did not acquire the airplane
for use in its trade or business, we further sustain respondent’s
determinations with regard to the depreciation and airplane
expenses.
B. Rent
Section 162(a)(3) provides for a deduction for ordinary and
necessary rental expenses incurred in carrying on a trade or
business. TPM claimed a deduction of $30,000 for rent paid to
D’Errico’s father for use and possession of the Barton Drive
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property. Respondent argues that TPM did not use the Barton
Drive property in connection with its trade or business. Rather,
respondent contends that D’Errico used the property for his
personal purposes. D’Errico testified that he used the top-level
bedroom and top-level common areas of the Barton Drive property
for his personal use and that the two bottom bedrooms and common
areas were converted into TPM’s offices. TPM argues that this
latter portion of the Barton Drive property was used exclusively
for client meetings, bookkeeping, and marketing. TPM further
argues that D’Errico’s personal use of the Barton Drive property
was limited to the top-level bedroom and top-level common areas.
TPM presented a sublease entered into between TPM and D’Errico as
evidence of this arrangement.
We find TPM’s argument to be unpersuasive. Outside of
D’Errico’s testimony, TPM has failed to produce any records of
business-related activities conducted at the Barton Drive
property or any evidence supporting TPM’s need for offices at the
Barton Drive property. TPM’s two primary clients, D&W and D&M,
were both located in California and conducted their businesses in
California. Further, TPM’s rent payments were not made to an
unrelated third party but rather to D’Errico’s father.
Accordingly, TPM has failed to meet its burden of proof, and we
sustain respondent’s determination with regard to the rent
expenses.
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C. Repairs and Maintenance
TPM claimed a deduction for repairs and maintenance expenses
incurred in connection with its use of the Barton Drive property.
Because we have decided that TPM has failed to establish that it
conducted business-related activities at the Barton Drive
property, any expenses incurred in connection with the Barton
Drive property could not have been incurred in connection with
TPM’s trade or business. Accordingly, we sustain respondent’s
determination with regard to repairs and maintenance expenses.
D. Meals and Entertainment
The heightened substantiation requirements of section 274
apply to meal and entertainment expenses. The only evidence TPM
produced to substantiate meal and entertainment expenses was
D’Errico’s personal credit card statements and D’Errico’s
testimony that TPM reimbursed him for such costs. Accordingly,
TPM has failed to document such expenses with the specificity
required by section 274, and we sustain respondent’s
determination with regard to meals and entertainment.
E. Travel
The heightened substantiation requirements of section 274
also apply to travel expenses. Sec. 274(d)(1). TPM produced
receipts and D’Errico’s personal credit card statements to
substantiate travel expenses. D’Errico testified that he kept a
log describing the nature of these expenses, but he failed to
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produce this log at trial. Other than D’Errico’s testimony, TPM
has not produced any evidence describing the business purpose of
the claimed travel expenses. Accordingly, we sustain
respondent’s determination with regard to the travel expenses.
F. Auto Expenses
Passenger automobiles and any other property used as a means
of transportation are generally “listed property” as defined by
section 280F(d)(4). Secs. 274(d)(4), 280F(d)(4)(A)(i) and (ii).
Accordingly, with certain exceptions, taxpayer’s deducting car
and truck expenses must satisfy the strict substantiation
requirements of section 274. TPM has produced D’Errico’s hand-
written notes and D’Errico’s personal credit card statements
documenting auto expenses of $5,143. However, these documents do
not provide sufficient evidence that such expenses were actually
incurred as part of TPM’s trade or business. Accordingly, TPM
has failed to meet the substantiation requirements of section
274, and we sustain respondent’s determination with regard to the
auto expenses.
G. Supplies
TPM has produced nothing more than receipts, D’Errico’s
personal credit card statements, and D’Errico’s testimony to
substantiate the claimed deduction for supplies. TPM has failed
to establish that such costs were incurred with a business
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purpose. Accordingly, we sustain respondent’s determination with
regard to the supplies.
III. D’Errico
A. S Corporation Pass-Through Deductions
1. Interest Expense
Section 163(a) allows a deduction for interest expenses
incurred by a taxpayer within the taxable year on indebtedness.
In 2004 J&A claimed an interest expense of $22,034 attributable
to accounts payable due from J&A to TPM for TPM’s management fee.
D’Errico provided hand-written notes of TPM’s accounts receivable
to evidence this amount due. As the sole shareholder of J&A,
D’Errico included the interest expense claimed by J&A on his
individual income tax return.
D’Errico has provided little more than his own testimony in
support of the interest expense claimed by J&A. His hand-written
notes do not attribute TPM’s accounts receivable to J&A and do
not describe the source of the amounts due. Further, even if the
hand-written notes provided evidence that the interest expense
due from J&A to TPM had accrued, they do not provide any proof
that the expense was paid. Accordingly, we sustain respondent’s
determination with regard to the interest expense.
D’Errico contends that the interest expense should be
sustained because TPM included that amount as interest income on
its Form 1120, U.S. Corporation Income Tax Return. Having
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determined that D’Errico has failed to establish that J&A was
entitled to its claimed interest expense deduction, D’Errico is
correct in that this item must receive consistent treatment in
determining TPM’s tax liability. Accordingly, an adjustment must
be made to remove $22,034 of interest income attributable to
TPM’s accounts receivable from J&A in the relevant tax years.
2. Auto/Truck and Travel
As the sole shareholder of D&M, D’Errico claimed flow-
through deductions on his individual tax return for auto/truck
expenses and travel expenses attributable to D&M of $4,650 and
$2,024, respectively. Similarly, as the sole shareholder of D&W,
D’Errico claimed flow-through deductions on his individual tax
return for auto/truck expenses and travel expenses attributable
to D&W of $4,650 and $10,959, respectively. As discussed above,
auto/truck expenses and travel expenses are subject to the strict
substantiation requirements of section 274. D’Errico has failed
to sufficiently document the nature and purpose of these
expenses. Further, D’Errico did not testify about any specific
facts regarding these expenses. Accordingly, we sustain
respondent’s determination with regard to the auto/truck expenses
and travel expenses.
B. Constructive Dividend
Section 301 requires a taxpayer to include in gross income
amounts received as dividends. Generally, a dividend is a
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distribution of property by a corporation to its shareholders out
of its earnings and profits. Sec. 316(a). A dividend need not
be formally declared or even intended by a corporation. Noble v.
Commissioner, 368 F.2d 439, 442 (9th Cir. 1966), affg. T.C. Memo.
1965-84. When a shareholder’s use of corporate property serves
no legitimate corporate purpose, the value of the use of that
property may be includable in the shareholder’s income as a
constructive dividend to the extent of the corporation’s earnings
and profits. Falsetti v. Commissioner, 85 T.C. 332, 356 (1985).
For the personal use of corporate property to be treated as
a constructive dividend, it must: (1) Be nondeductible by the
corporation; and (2) represent some economic gain or benefit to
the shareholder. Palo Alto Town & Country Vill., Inc. v.
Commissioner, 565 F.2d 1388, 1391 (9th Cir. 1977) (the Tax Court
must find appropriate facts in the record to support a
determination that disallowed expenses constitute constructive
dividends to the taxpayer), affg. in part, revg. in part and
remanding T.C. Memo. 1973-223. A corporation’s inability to
substantiate a deduction, without more, is not grounds for
treating corporate expenditures as constructive dividends to the
individual. Erickson v. Commissioner, 598 F.2d 525, 531 (9th
Cir. 1979), affg. in part and revg. in part T.C. Memo. 1976-147;
Palo Alto Town & Country Vill., Inc. v. Commissioner, supra at
1391; Nicholls, North, Buse Co. v. Commissioner, 56 T.C. 1225,
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1238-1239 (1971); Ashby v. Commissioner, 50 T.C. 409, 417-418
(1968).
As discussed above, TPM has failed to establish a business
purpose for the $30,000 of rent payments to Anthony D’Errico for
use of the Barton Drive property. Further, D’Errico testified
that he derived personal benefit from the Barton Drive property.
Despite testifying that his benefit was limited to the top-level
bedroom and top-level common areas, he has not presented any
additional evidence to support his claim. D’Errico presented two
lease agreements at trial, one between his father and TPM and the
other a sublease between TPM and himself. These agreements
identically describe the Barton Drive property as the leased
property. The sublease therefore fails to support D’Errico’s
testimony. Nowhere does it specify that only a portion of the
Barton Drive property was subject to the sublease, let alone
describe the top-level bedroom and top-level common areas.
D’Errico has therefore failed to establish that he did not derive
a personal benefit from his use of the entire Barton Drive
Property.
TPM’s Form 1120 for 2004 states that TPM had end-of-year
retained earnings of $68,844. Accordingly, TPM had sufficient
earnings and profits, and we sustain respondent’s determination
with regard to the constructive dividend.
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IV. Section 6662(a) 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. An understatement is
“substantial” if it exceeds the greater of: (1) 10 percent of
the tax required to be shown on the return for the taxable year
or (2) $5,000 ($10,000 in the case of a corporation). Sec.
6662(d)(1). 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, including any
failure to maintain adequate books and records or to substantiate
items properly. Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax
Regs. Petitioners’ failure to produce records substantiating
their claimed deductions supports the imposition of the accuracy-
related penalty for negligence for the years at issue.
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
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to show reasonable cause, substantial authority, or any other
basis for reducing the penalties. Accordingly, we find
petitioners liable for the section 6662 penalty for the years at
issue as commensurate with the concessions and our holdings. See
id.
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,
Decisions will be entered
under Rule 155.