T.C. Summary Opinion 2011-80
UNITED STATES TAX COURT
THOMAS ALEXANDER PAYAN AND SUSAN LORRAINE PAYAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 1004-10S. Filed July 5, 2011.
Thomas Alexander Payan and Susan Lorraine Payan, pro sese.
Sarah E. Sexton, for respondent.
DEAN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect when the petition was filed. Pursuant to section 7463(b),
the decision to be entered is not reviewable by any other court,
and this opinion shall not be treated as precedent for any other
case. Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year in issue,
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and all Rule references are to the Tax Court Rules of Practice
and Procedure.
Respondent issued a notice of deficiency to petitioners in
which he determined a deficiency of $16,119 in their 2006 Federal
income tax as well as a section 6662(a) accuracy-related penalty
of $2,681.1 After concessions,2 the issues for decision are
whether petitioners: (1) Are entitled to deduct business
expenses reported on Schedules C, Profit or Loss From Business;
(2) had unreported income from rents received; (3) are entitled
to deduct certain Schedule E expenses; and (4) are liable for a
section 6662(a) accuracy-related penalty.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by reference. Petitioners resided in
California when they filed their petition.
In 2006 petitioners were both full-time employees--
petitioner as a loan officer with E Loan and U.S. Bank and
petitioner husband with Pacific Gas & Electric.
1
All figures are rounded to the nearest dollar.
2
Petitioners conceded that petitioner wife (petitioner)
received unreported wages of $32,746 from Popular Financial
Management and that they were not entitled to depreciation of $22
claimed on Schedule E, Supplemental Income and Loss.
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In 2006 petitioners purchased property in Las Vegas, Nevada
(the condo). Petitioners intended to rent the condo and engaged
a property management company to oversee it.
Petitioners timely filed their 2006 Federal income tax
return. Petitioners provided an accountant with tax documents
and information for the preparation of the return. After the
accountant prepared the return, petitioners signed it. Included
with their return was a Schedule C for Mary Kay products
(Schedule C-1) and a Schedule C for the collection and sale of
sports memorabilia by Tappers Collectibles (Schedule C-2). On
Schedule C-1 petitioners deducted business expenses of $15,362.
On Schedule C-2 petitioners deducted business expenses of
$22,476. Petitioners also included a Schedule E with their
return on which they reported no income and deducted expenses of
$14,940.
Respondent disallowed all of the business expense deductions
on Schedule C-1 and all of the business expense deductions on
Schedule C-2. Respondent also included $5,550 of Schedule E
rental income and disallowed $1,209 of Schedule E expenses.
Additionally, respondent determined that petitioners are liable
for a section 6662(a) accuracy-related penalty of $2,681 for a
substantial understatement of income tax.
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Discussion
Generally, the Commissioner’s determinations are presumed
correct, and the taxpayer bears the burden of proving that those
determinations are erroneous. Rule 142(a); see INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); Welch v. Helvering, 290
U.S. 111, 115 (1933). In some cases the burden of proof with
respect to relevant factual issues may shift to the Commissioner
under section 7491(a). Petitioner3 did not argue or present
evidence that she satisfied the requirements of section 7491(a).
Therefore, petitioner bears the burden of proof with respect to
the issues in the notice of deficiency.
Deductions and credits are a matter of legislative grace,
and the taxpayer bears the burden of proving that he or she is
entitled to any deduction or credit claimed. Rule 142(a); Deputy
v. du Pont, 308 U.S. 488, 493 (1940); New Colonial Ice Co. v.
Helvering, 292 U.S. 435, 440 (1934). Additionally, a taxpayer
must substantiate all expenses. Sec. 6001; Hradesky v.
Commissioner, 65 T.C. 87, 89 (1975), affd. per curiam 540 F.2d
821 (5th Cir. 1976).
Petitioner’s return was audited by a tax compliance officer
(TCO) in respondent’s Stockton, California, office. During the
TCO’s “pre-contact analysis” of petitioners’ return, she noted
3
Petitioner husband signed the petition, the stipulation of
facts, the supplemental stipulation of facts, and the stipulation
of settled issues but was not present at trial.
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the lack of reported income from petitioners’ Schedule C
activities. Respondent sent petitioners a letter inviting them
to come into the Stockton office to discuss their return.
Petitioners made three appointments, including one by the
accountant who prepared petitioners’ return, but they did not go
to the Stockton office for any of the scheduled appointments.
The accountant did mail information to the TCO, which included a
letter from the property management company and a statement
listing the expenses of the condo that included “Rents received”
of $5,550.
Petitioners’ Schedule C Expenses
Section 162 generally allows a deduction for ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on a trade or business. Generally, no deduction is
allowed for personal, family, or living expenses. See sec. 262.
The taxpayer must show that any deducted business expenses were
incurred primarily for business rather than personal reasons.
See Rule 142(a); Walliser v. Commissioner, 72 T.C. 433, 437
(1979). To show that the expense was not personal, the taxpayer
must show that the expense was incurred primarily to benefit his
or her business, and there must have been a proximate
relationship between the deducted expenses and the business. See
Walliser v. Commissioner, supra at 437.
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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 adequately substantiate 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, bearing heavily against the
taxpayer whose inexactitude in substantiating the amount of the
expense is of his or her own making. Cohan v. Commissioner, 39
F.2d 540 (2d Cir. 1930). 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
to unguided largesse. Williams v. United States, 245 F.2d 559,
560-561 (5th Cir. 1957). However, certain business expenses are
subject to more stringent substantiation requirements and no
estimation may be made. See sec. 274(d).
Petitioner entered into evidence account statements from her
banks, credit cards, and phone carrier to substantiate many of
the expenses deducted on the Schedules C.4 None of the account
statements explained petitioner’s purchases beyond the name of
the business to which payments were made and the amount
petitioner spent. Petitioner offered no details about her
4
Petitioner provided no evidence to substantiate the car and
truck expenses deducted on either Schedule C.
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purchases or how they related to expenses for either of the
Schedule C businesses through her testimony. Although there
might be needles of substantiating documents in the several
exhibits admitted into evidence, for the most part those needles
are effectively obscured by the haystacks of exhibits in which
they are buried.
Petitioner has failed to substantiate any of her deducted
Schedule C expenses and has not provided a basis upon which the
Court could estimate those expenses that can be estimated. See
Cohan v. Commissioner, supra; Vanicek v. Commissioner, supra.
Therefore, respondent’s determination to disallow all of
petitioner’s section 162 expenses deducted on Schedule C-1 and
Schedule C-2 is sustained.
Petitioners’ Unreported Schedule E Income
Gross income includes all income from whatever source
derived. Sec. 61(a). Rents are specifically included as an item
of gross income. Sec. 61(a)(5).
A stipulation shall be treated, to the extent of its terms,
as a conclusive admission by the parties to the stipulation, and
the Court will not permit a party to a stipulation to qualify,
change, or contradict a stipulation in whole or in part. Rule
91(e); cf. Jasionowski v. Commissioner, 66. T.C. 312, 318 (1976)
(stipulated facts are not lightly disregarded, but the Court will
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not be bound by the stipulation where such facts are clearly
contrary to facts disclosed by the record).
Exhibit 29-J, attached to the supplemental stipulation of
facts, is a statement from the property management company that
details expenses for the condo. The statement lists rents
received of $5,550. Petitioner, through her accountant, provided
this information to the TCO. Although petitioner testified that
she did not receive any rent payments from the property
management company, she offered no alternative explanation for
what the $5,550 could be.
Petitioner has not given the Court any reasons it should not
accept as an admitted fact that petitioner received $5,550 from
renting the condo. Respondent’s determination that petitioner
received unreported rental income is sustained.
Petitioners’ Schedule E Expenses
Section 212 allows for the deduction of all ordinary and
necessary expenses paid or incurred during the taxable year for
the management, conservation, or maintenance of property held for
the production of income. Petitioners deducted $14,940 of
expenses on their Schedule E. Respondent allowed $13,731 of the
deducted expenses. Petitioner provided evidence of some of the
expenses paid in relation to the condo. It is unclear from the
record whether the substantiation petitioner provided was for
expenses respondent allowed or expenses respondent disallowed.
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Petitioner has failed to prove that respondent’s determination to
disallow Schedule E expenses of $1,209 was in error. Thus,
respondent’s determination is sustained.
Accuracy-Related Penalty
Section 6662(a) and (b)(2) imposes a 20-percent accuracy-
related penalty on the portion of an underpayment that is
attributable to a substantial understatement of income tax.5 An
understatement of income tax is the excess of the amount of
income tax required to be shown on the return for the taxable
year over the amount of income tax that is shown on the return,
reduced by any rebate. See sec. 6662(d)(2)(A). An
understatement is substantial if it exceeds the greater of 10
percent of the tax required to be shown on the return for the
taxable year or, in the case of an individual, $5,000. See sec.
6662(d)(1)(A).
The Commissioner bears the burden of production with respect
to the applicability of an accuracy-related penalty determined in
a notice of deficiency. Sec. 7491(c). In order to meet that
burden, the Commissioner need only make a prima facie case that
imposition of the penalty is appropriate. Higbee v.
Commissioner, 116 T.C. 438, 446 (2001). Once that burden is met,
the taxpayer bears the burden of proving that the accuracy-
5
The Court need not determine whether petitioners are liable
for the accuracy-related penalty due to negligence.
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related penalty does not apply because of reasonable cause,
substantial authority, or the like. Secs. 6662(d)(2)(B),
6664(c); Higbee v. Commissioner, supra at 449. Respondent has
met his burden of production for an accuracy-related penalty
based on a substantial understatement of tax because petitioners’
understatement of tax exceeds $5,000.
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). Section 1.6664-
4(b)(1), Income Tax Regs., incorporates a facts and circumstances
test to determine whether the taxpayer acted with reasonable
cause and in good faith. The most important factor is the extent
of the taxpayer’s effort to assess his or her proper tax
liability. Id.
The taxpayer’s reliance on the advice of a professional,
such as an accountant, is examined to determine reasonable cause
and good faith. Id. To justify reliance the taxpayer must show
that he or she supplied the adviser with accurate information.
Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 99
(2000), affd. 299 F.3d 221 (3d Cir. 2002). “Even if all data is
furnished to the preparer, the taxpayer still has a duty to read
the return and make sure all income items are included.” Magill
v. Commissioner, 70 T.C. 465, 479-480, affd. 651 F.2d 1233 (6th
Cir. 1981); see also Bailey v. Commissioner, 21 T.C. 678 (1954)
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(“The duty of filing accurate returns cannot be avoided by
placing responsibility upon an agent. The fact that petitioner
told the person who made up the partnership return about the sale
of leasehold interests * * * cannot excuse his failure to read
the return and ascertain the inclusion of this item.”). The
taxpayer need not duplicate the work of her return preparer but
must exert a reasonable effort to ensure that all items of income
are included on the return. See Woodsum v. Commissioner, 136
T.C. __, __ (2011) (slip op. at 18).
Petitioner testified that she gave an accountant all of the
documentation necessary to prepare the couple’s joint Federal tax
return and that she did not understand how or why the accountant
neglected to include the $32,746 of wages from Popular Financial
Management. She further testified that after the return was
prepared she and her husband signed it without review.
Petitioner cannot rely upon her accountant to avoid the
accuracy-related penalty when she failed to review the return to
ascertain that all items of income were included. Even if the
accountant had inadvertently omitted the $32,746 of wage income
and the $5,550 of rental income from petitioners’ return, a
cursory review would have alerted petitioners to the absence of
over 30 percent of the total wages that should have been reported
on the return.
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Petitioner has failed to demonstrate that she acted with
reasonable cause and in good faith in failing to report wage and
rental income and in substantiating her Schedule C and Schedule E
expenses. Accordingly, respondent’s determination of the
accuracy-related penalty is sustained.
To reflect the foregoing,
Decision will be entered
for respondent.