T.C. Memo. 2011-4
UNITED STATES TAX COURT
ERNESTINE FORREST, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24971-08. Filed January 4, 2011.
R determined a deficiency in P’s income tax for the
2005 tax year based on P’s unreported dividend income and a
disallowed deduction for an IRA contribution. In an amended
answer, R increased the determined deficiency by disallowing
an income tax withholding credit of $20,060.89 and Schedule
C business expense deductions of $29,942.74 for the 2005 tax
year.
Held: This Court does not have jurisdiction to decide
the withholding credit issue. P is liable for the
deficiency arising from the disallowed Schedule C business
expense deductions.
Ernestine Forrest, pro se.
Michael K. Park, for respondent.
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MEMORANDUM FINDINGS OF FACT AND OPINION
WHERRY, Judge: This case is before the Court on a petition
for redetermination of a Federal income tax deficiency that
respondent determined for petitioner’s 2005 tax year. After
concessions by petitioner,1 the issues left for decision are:
(1) Whether petitioner is entitled to a Federal income tax
withholding credit of $20,060.89 for the 2005 tax year;
(2) whether petitioner is entitled to business expense
deductions claimed on Schedule C, Profit or Loss from Business,
of $29,942.74 for the 2005 tax year;2 and
(3) whether petitioner is entitled to a deduction under
section 1341 for amounts subtracted from her pension
distributions during the 2005 tax year.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts and the accompanying exhibits are hereby incorporated by
this reference. At the time she filed her petition, petitioner
resided in California.
1
Petitioner conceded receiving unreported dividend income of
$90 for the 2005 tax year and that she is not entitled to an IRA
contribution deduction of $4,500 for the 2005 tax year, which
entirely disposes of the original issues in the notice of
deficiency.
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended and in effect for the year
at issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
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Respondent issued a notice of deficiency on July 7, 2008,
determining an income tax deficiency for petitioner’s 2005 tax
year of $459. Petitioner filed a timely petition with the Court
on October 14, 2008, alleging a “substantial deduction which will
wipe out the alleged deficiency”. By an amendment to the answer,
served on petitioner by respondent on April 29, 2009, respondent
disallowed a withholding tax credit of $20,060.89 and Schedule C
deductions of $29,942.74.
The State of California withheld $20,060.89 for Federal
income tax from a termination of employment lawsuit settlement it
made with and paid to petitioner. It also issued to petitioner a
Form W-2, Wage and Tax Statement, for 2005 reflecting the
withheld tax of $20,060.89 and the $172,071 settlement payment.
Petitioner claimed a credit for the $20,060.89 of allegedly
withheld tax on her 2005 Federal income tax return. She did not,
however, include any of the $172,071 payment in her taxable
income shown on her 2005 Federal income tax return.
Respondent’s examining agent initially sought to tax the
$172,071 settlement payment by increasing petitioner’s 2005
Federal taxable income by that amount. Although the evidentiary
record is sparse, it is apparent from each party’s statements in
Court and filed documents that petitioner eventually convinced
respondent that, notwithstanding the Form W-2, she did not
actually receive the $172,071 until 2006. Therefore respondent
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did not, at the conclusion of the examination, seek to increase
petitioner’s 2005 Federal taxable income by the $172,071 amount
of the settlement payment.
Respondemt’s decision to exclude the $172,071 amount of the
settlement payment from petitioner’s 2005 Federal taxable income
would seem to have the consequence of rendering petitioner’s
claimed $20,060.89 withholding credit on her 2005 Federal income
tax return to be “an overstatement of the credit for income tax
withheld at the source” within the meaning of section 6201(a)(3).
If so, then, as we note below, “the amount so overstated which
* * * [was] allowed against the tax shown on * * * [petitioner’s
2005] return” could have been summarily assessed by respondent
without being subject to deficiency procedures pursuant to
section 6201(a)(3). However, respondent apparently neglected to
do this. To address this evident oversight respondent instead
sought to amend his answer to challenge the claimed $20,060.89
withholding credit for 2005.
Petitioner started collecting unemployment compensation in
2005. She also considered starting a solo law practice, a
process that apparently began as far back as 2003. See Forrest
v. Commissioner, T.C. Memo. 2009-228. She claimed, in connection
with efforts to find work as a contract attorney, expenses for
office supplies and other items. The claimed expenses were
initially reported on Schedule A, Itemized Deductions, of her
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2003 Federal income tax return but were subsequently claimed on
Schedule C of her 2005 Federal income tax return as a business
expense.
Petitioner reported no income from work as a contract
attorney in either 2003 or 2005. The 2003 expenses which she had
sought to recast as Schedule C business deductions at trial were
rejected on account of the Court’s finding that her work as a
contract attorney was not an active trade or business. See
Forrest v. Commissioner, supra. On Schedule C of her 2005
return, petitioner reported no income and claimed deductions of
$29,942.74. Petitioner’s planned solo law practice never made it
past the startup phase to fruition. She acknowledged that none
of her referrals in 2005 resulted in paying clients and that she
never purchased malpractice insurance.
During 2005 petitioner was engaged in extensive litigation
in connection with the decision by the California Department of
Corporations to again terminate her employment in February 2004.3
Petitioner explained that the State of California “had active
litigation trying to get money back.” Petitioner has incurred
expenses arising from this litigation. Her claimed $29,942.74
Schedule C business expense deduction for 2005 included a $15,778
3
We note that petitioner had previously been terminated from
the California Department of Corporations in 2000 and was
subsequently reinstated in March 2003 after filing suit against
the State of California in 2003. We take judicial notice of
these facts. See Forrest v. Commissioner, T.C. Memo. 2009-228.
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deduction for “Litigation re: clear name and Establish Self
professionally”.
A trial was held in Los Angeles, California. Following
trial, the Court, with agreement of the parties, set a
simultaneous briefing schedule of September 9, 2009, for opening
briefs, and October 26, 2009, for reply briefs. On September 11,
2009, petitioner filed a motion for an extension of time to file
a brief. The Court granted her motion and gave her until October
20, 2009, to file her opening brief and gave both parties until
December 7, 2009, to file a reply brief.
On October 26, 2009, petitioner filed yet another motion
requesting to extend time to file briefs and stating that she
intended to “submit a Brief by Express Mail over the weekend for
delivery on Monday, October 26, 2009”. The Court had still not
received a brief from petitioner by November 16, 2009, when it
denied her motion. Subsequently, on February 1, 2010, petitioner
filed a status report indicating she would soon complete her Los
Angeles Superior Court trial matters and address her tax matters.
On April 16, 2010, the Court, still having received no opening
brief from petitioner, entered an order that it would no longer
wait for or accept briefs from petitioner in this case.4
4
As she did in her companion Federal income tax case for
2004, Forrest v. Commissioner, docket No. 11513-08, tried
separately at the same trial session, petitioner has followed a
practice of requesting repeated extensions of time and then
failing to file a brief. We caution petitioner against abusing
(continued...)
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OPINION
I. Burden of Proof
As a general rule, the Commissioner’s determination of a
deficiency is presumed correct, and the taxpayer bears the burden
of proving that the determination is improper. See Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933). However, the
withholding credit and Schedule C deduction issues were not
raised in the statutory notice of deficiency and are therefore
new matters within the meaning of Rule 142(a). Thus, as
respondent has conceded, with respect to those issues, the burden
of proof lies with respondent. Because petitioner raised the
issue related to the deductions for her pension repayments, she
carries the burden of proof as to that issue.
II. Whether Petitioner Is Entitled to a Federal Income Tax
Withholding Credit of $20,060.89 for the 2005 Tax Year
Section 6213(a) allows the taxpayer to seek judicial review
of a proposed deficiency before this Court. Under section
6211(b)(1) a deficiency is determined “without regard to payment
on account of estimated tax, without regard to the credit under
4
(...continued)
our processes and remind her that sec. 6673(a)(1) allows us in
our discretion to require the taxpayer to pay to the United
States a penalty not in excess of $25,000 whenever it appears
that “(A) proceedings before it have been instituted or
maintained by the taxpayer primarily for delay, (B) the
taxpayer’s position in such proceeding is frivolous or
groundless, or (C) the taxpayer unreasonably failed to pursue
available administrative remedies”.
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section 31”. Section 31 generally allows the taxpayer to claim a
credit for Federal income tax withheld from wages for that
taxable year. The amount of an overstated credit may be
summarily assessed and is not subject to deficiency procedures.
Sec. 6201(a)(3); Bregin v. Commissioner, 74 T.C. 1097, 1104-1105
(1980) (“[T]here is no indication that section 6214(a) was
intended to provide him with an alternative method for recovering
on such a claim. Furthermore, if the Commissioner is allowed to
raise his claim in this proceeding, he would be allowed to
recover on a claim that would otherwise be barred by the statute
of limitations.”).
Since the withholding credit issue is not a factor in
determining the tax deficiency, we have no jurisdiction to
consider it and therefore may not decide whether petitioner is
entitled to a Federal income tax withholding credit of $20,060.89
for the 2005 tax year. We note that under section 6201
respondent may, if he acts timely, assess any overstated
withholding credit as “a mathematical or clerical error” in the
manner specified by section 6213(b).
III. Whether Petitioner Is Entitled to $29,942.72 of Schedule C
Business Expense Deductions for the 2005 Tax Year
A. General 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 (the
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taxpayer “shall keep such records”); INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); sec. 1.6001-1(a), Income
Tax Regs. Taxpayers must maintain records relating to their
income and expenses and must prove their entitlement to all
claimed deductions, credits, and expenses in controversy. See
sec. 6001; Rule 142(a); INDOPCO, Inc. v. Commissioner, supra at
84; Welch v. Helvering, supra at 115. However, as discussed
above the withholding credit and Schedule C deduction issues were
not raised in the statutory notice of deficiency, and, as
respondent has conceded, with respect to those issues, the burden
of proof lies with respondent.
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
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).
B. Petitioner’s Schedule C Other Expense Deductions
1. Startup Expenditures
On her tax return for 2005, in connection with her alleged
practice of law, petitioner claimed Schedule C other expense
deductions for, among other items: “Business use of Telephone”,
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“Postage”, “Supplies (toner cartridges, paper, clips, etc.)”,
“Copies”, “Publications, seminars, training, travel”, “Fees re:
travel legal conventions and meetings, hotels”, “Business
associations provide networking, equipment use re: travel and
other professional support”. On Schedule C of her 2005 tax
return, petitioner reported no income generated by her law
practice but claimed $29,942.74 of deductible expenses, producing
a loss of the same amount. Petitioner testified at trial that
her solo law practice was a “fledgling effort.” She wanted to
“figure out what kind of work * * * [she] was going to do. A lot
of it was making expenditures, making contacts, doing the
networking”.
On the basis of the record, including petitioner’s
testimony, we find that the expenses reported on Schedule C of
her return for 2005, insofar as related to her legal practice,
were not incurred in “carrying on” a business. The expenses were
incurred before it became (if it ever did) a business or profit-
seeking activity. See sec. 162; Toth v. Commissioner, 128 T.C. 1
(2007). Although “Section 162 generally allows a deduction for
all the ordinary and necessary expenses paid or incurred during
the taxable year in carrying on any trade or business * * * [,]
Such expenses must be directly connected with or pertain to the
taxpayer’s trade or business that is functioning as a business at
the time the expenses were incurred.” Woody v. Commissioner,
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T.C. Memo. 2009-93, affd. without published opinion No. 09-1193
(D.C. Cir., Dec. 16, 2010) (emphasis added).
Consequently, petitioner may not deduct any of those expenditures
for 2005.
2. Legal Fees
It is well established * * * that, even though a
taxpayer’s employee status may be regarded as a trade or
business, legal fees stemming from a taxpayer’s employee
status are not deductible in computing adjusted gross income
but are to be treated only as miscellaneous itemized
deductions, subject to the AMT and to a 2-percent floor.
See sec. 62(a)(1) * * *.
Kenton v. Commissioner, T.C. Memo. 2006-13.
Included in petitioner’s $29,942.74 of claimed business
expense deductions was a Schedule C business expense deduction
for “Litigation re: clear name and Establish Self
professionally”. This litigation arose from the decision by the
California Department of Corporations to terminate petitioner’s
employment. Because petitioner’s litigation relates to her
status as an employee, she is not entitled to a Schedule C
business expense deduction. Instead, petitioner may be entitled
to a Schedule A miscellaneous itemized deduction for such
litigation expenses.5 See Kenton v. Commissioner, supra.
5
We note that under sec. 62(a)(20) as amended, effective
Oct. 22, 2004, “attorney fees and court costs” paid by the
taxpayer in connection with discrimination law suits “paid after
Oct. 22, 2004, with respect to any judgment or settlement
occurring after that date are allowed as a deduction in computing
adjusted gross income, with the result that they are not subject
to the AMT, and are not subject to the 2-percent floor.” Kenton
(continued...)
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IV. Whether Petitioner Is Entitled to a Deduction Under Section
1341 for Amounts Deducted From Her Pension Distributions
During the 2005 Tax Year
Section 1341 provides a deduction for an item of income that
was included in gross income in a prior tax year that was
required to be repaid in a subsequent tax year. The provision
has three basic requirements: (1) The item must have been
included as gross income for a prior taxable year because “it
appeared that the taxpayer had an unrestricted right to” it, (2)
the “deduction is allowable for the taxable year [at issue]
because it was established after the close of” the prior taxable
year that the taxpayer did not have an unrestricted right to it,
and (3) “the amount of such deduction exceeds $3,000”. Sec.
1341(a). If all of these requirements are met, the taxpayer may
deduct the item from the current years’ taxes. Id.
Petitioner reported pension distributions of $17,434.36 as
income for the 2005 tax year. She was required to make
repayments on pension distributions from earlier tax years out of
her current year’s distribution. Because petitioner claims that
she had previously included the pension distribution that she was
required to repay in some prior tax year and at which time it had
5
(...continued)
v. Commissioner, T.C. Memo. 2006-13. However, as petitioner has
not included in her gross income for 2005 any proceeds from a
judgment or settlement of the litigation in which she incurred
the legal expenses, she is not entitled to deduct those fees
under sec. 62(a)(20).
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appeared that she had an unrestricted right to it, she is
entitled to deduct, in 2005, the amounts repaid in 2005.
At trial petitioner proffered only three monthly
distribution statements. These statements do not indicate
whether the amounts listed under “recover overpayment”
highlighted by petitioner were included or excluded from the
gross pension distribution.6 If petitioner’s pension
distributions were gross amounts, she might be entitled to a
section 1341 deduction, provided she met the $3,000 deduction
floor. If, however, amounts to cover repayments were deducted
from or netted against petitioner’s pension payment and also
6
Respondent objected to petitioner’s monthly distribution
statements’ being admitted into evidence on grounds of relevance.
We deferred ruling on the admissibility of those statements to
give petitioner more time to gather additional documentation of
the distributions as well as the statements for the missing
months. Petitioner failed to submit any such additional
documentation.
Fed. R. Evid. 401 defines “Relevant evidence” as “evidence
having any tendency to make the existence of any fact that is of
consequence to the determination of the action more probable or
less probable than it would be without the evidence.” The
distribution statements are relevant to show that petitioner made
repayments on her pension distributions from earlier tax years.
However, we note that these documents constitute hearsay; and
because they are not accompanied by any type of certification or
witness identification, they do not fall within the business
records exception to hearsay under Fed. R. Evid. 803(6) and
902(11). Respondent did not raise a hearsay objection at trial
and thus waived it. See Fed. R. Evid. 103(a)(1). We now
overrule the objection on the basis of relevance; however, we
note that had these documents been denied admission, it would not
have changed the result because petitioner failed to submit
additional documentation to clarify whether the deductions had
been included in gross distributions or had already been
deducted.
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deducted from her total Form 1099 yearend tax statement or other
tax information reporting form, then she was already making the
repayment with pretax income and a section 1341 deduction would
in effect give her a second deduction. Petitioner presented no
evidence that she had included the prior pension distributions in
a prior tax year, nor that the deduction would have met the
$3,000 floor. As discussed above, the burden of proof for this
issue rests on petitioner. She has failed to carry her burden
and is not entitled to a deduction under section 1341.
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.