T.C. Summary Opinion 2012-13
UNITED STATES TAX COURT
SAMUEL C. AND LINDA P. JOHNSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20072-08S. Filed February 2, 2012.
Kathryn S. Crawford, for petitioners.
Brandon S. Cline, 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 years in
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issue, 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 the following deficiencies, additions to tax,
and penalty:
Additions to Tax and Penalty
Year Deficiency 6651(a)(1) 6662(a)
2003 $11,695 $2,769 $2,339
2004 975 244 -0-
2005 9,972 -0- -0-
After concessions,1 the issues for decision are whether
petitioners are: (1) Entitled to a loss deduction of $1 million
for 2003 and corresponding net operating loss (NOL) carryforwards
for 2004 and 2005; (2) liable for a section 6651(a)(1) addition
to tax for 2003 and 2004; and (3) liable for a section 6662(a)
accuracy-related penalty for 2003.
1
Petitioners and respondent signed a stipulation of settled
issues. For 2003 petitioners concede that they: (1) Failed to
file their Federal income tax return timely; (2) failed to report
taxable rental income of $12,000; (3) failed to report
cancellation of debt income of $2,024; and (4) failed to report
on Schedule C, Profit or Loss From Business, income of $18,179.
For 2004 petitioners concede: (1) That they failed to file their
Federal income tax return timely; (2) that they failed to report
taxable rental income of $13,875; and (3) that they were liable
for a computational adjustment to their claimed medical expense
deduction that was based on an increase in adjusted gross income.
For 2005 petitioners concede: (1) That they failed to report
ordinary income of $46,979; and (2) that they were liable for
computational adjustments to their claimed medical expense
deduction and claimed earned income credit that were based on an
increase in adjusted gross income.
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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 Alabama
when they filed their petition.
Johnson & Associates Mortgage Co., Inc. (Johnson &
Associates), was incorporated in Delaware on December 28, 1990.
It was a full-service mortgage company that originated,
underwrote, closed, and serviced single-family residential
mortgages. Johnson & Associates’ initial capital was 5,000
shares of stock with a par value of $1 per share. On April 6,
1992, Johnson & Associates filed for a certificate of authority
to conduct business in Alabama as a foreign corporation. The
application for the certificate reflects 1,014 issued shares.
Mr. Johnson (petitioner) was the president, chief operating
officer, and chief executive officer of Johnson & Associates. He
was a salaried employee of Johnson & Associates, and upon its
incorporation his compensation included a monthly salary of
$10,000 plus bonuses. Petitioner and his father were Johnson &
Associates’ majority shareholders. Johnson & Associates took out
lines of credit with several banks in Birmingham, Alabama,
including Regions Bank (Regions). The line of credit from
Regions was used for operating capital.
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Johnson & Associates began to experience financial
difficulties in either 2000 or 2001. It did not pay petitioner a
salary at that time because it did not have enough profits to pay
his salary and other employees’ salaries.
In 2001 Regions called for payment of Johnson & Associates’
line of credit after the debt reached over $1 million.
Petitioner and his father negotiated a new promissory note with
Regions on July 13, 2001. Under the new agreement petitioner in
his personal capacity, his father, and petitioner as president of
Johnson & Associates are listed as the borrowers on a Regions
promissory note for $1,023,977.52. The loan called for interest-
only payments until after petitioner’s father’s death. Several
mortgages held by Johnson & Associates and a $500,000 life
insurance policy that petitioner’s father owned and that
petitioner was the beneficiary of were given as collateral for
the loan.
Petitioner’s father died on October 6, 2003. In December
2003 the life insurance company issued a check to Regions for
$510,775.28. In January 2004 petitioner signed another
promissory note for $506,558.90 with Regions. Petitioner signed
the promissory note in his individual capacity, as executor of
his father’s estate, and as president of Johnson & Associates.
This promissory note also called for accrued interest-only
payments and was secured by the same mortgages that served as
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collateral for the first promissory note. The maturity date of
the second promissory note was July 23, 2004, at which time the
unpaid principal balance and accrued interest would be due. On
July 24, 2004, petitioner wrote a personal check to Regions to
pay the balance of the second promissory note. The funds to pay
the second promissory note were obtained from petitioner’s
personal checking account, his inheritance from his father’s
estate, and loans from his children.
Petitioners reported a loss of $960,902 on line 21, Other
income, of their 2003 Form 1040, U.S. Individual Income Tax
Return. “SEE STATEMENT 1” is typed on line 21 of Form 1040.
Statement 1, Form 1040, line 21, Other income, lists petitioners’
other income as the following:
Description Amount
NOL carryover to 2001 ($25,943)
Murphy & Johnson I, LLC 16,000
Bank One--debt cancellation 15,992
Chase--debt cancellation 7,148
MBNA--debt cancellation 29,746
Operating loss Johnson &
Associates (1,000,000)
Less expenses 10,681 miles (3,845)
Total (960,902)
Petitioners reported an NOL carryover of $953,405 on line 21
of their 2004 Form 1040. The statement 1 accompanying the 2004
return is for Schedule E, Supplemental Income and Loss, and does
not include any additional information concerning the NOL. Only
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page 2 of Schedule E is attached to the return. No other
statements accompany the return.
Petitioners reported a loss of $901,623 on line 21 of their
2005 Form 1040. “SEE STATEMENT 1” is typed on line 21.
Statement 1 lists petitioners’ other income as the following:
Description Amount
Debt cancellation--USAA Savings $7,698
Hare, Wynn Newell and Newton 30,838
Prior year NOL (940,159)
Total (901,623)
Respondent issued petitioners a notice of deficiency for
2003, 2004, and 2005 that disallowed their initial loss claim for
2003 and their NOL carryforwards for 2004 and 2005. Respondent
also determined that petitioners were liable for a section
6651(a)(1) addition to tax for 2003 and 2004 and a section
6662(a) accuracy-related penalty for 2003.
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). Petitioners did not argue or present
evidence that they satisfied the requirements of section 7491(a).
Therefore, there is no burden shift under section 7491.
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I. The 2003 Loss Claim and the 2004 and 2005 NOL Carryforwards
Petitioners argue that they should be allowed a deduction
for a bad debt because petitioner had to personally “guarantee”
both of the promissory notes.
Petitioners’ argument that the loan payments constitute a
bad debt is wrong. Petitioner was listed as a separate borrower
on both of the Regions promissory notes. He was not a guarantor
of the loans but instead was primarily liable for each of them in
his personal capacity. “‘Deductions are not permitted on account
of the repayment of loans.’” Brenner v. Commissioner, 62 T.C.
878, 883 (1974) (quoting Crawford v. Commissioner, 11 B.T.A.
1299, 1302 (1928)).
Deductions are allowed under section 162 for the ordinary
and necessary expenses of carrying on an activity that
constitutes the taxpayer’s trade or business. Gantner v.
Commissioner, 91 T.C. 713, 725 (1988), affd. 905 F.2d 241 (8th
Cir. 1990); Hewett v. Commissioner, 47 T.C. 483, 488 (1967). The
performance of services as an employee constitutes a trade or
business. O’Malley v. Commissioner, 91 T.C. 352, 363-364 (1988).
When deciding which taxpayer, an individual or a corporation, is
entitled to deduct certain expenses, it is important to remember
that a corporation is a separate entity from its shareholders for
tax purposes. See Moline Props., Inc. v. Commissioner, 319 U.S.
436 (1943).
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It is well established that officers, employees, or
shareholders may not deduct the payment of corporate expenses on
their individual returns. Craft v. Commissioner, T.C. Memo.
2005-197 (citing Deputy v. du Pont, 308 U.S. 488, 494 (1940),
Noland v. Commissioner, 269 F.2d 108 (4th Cir. 1959), affg. T.C.
Memo. 1958-60, and Rink v. Commissioner, 51 T.C. 746, 751
(1969)). “Such payments constitute either capital contributions
or loans to the corporation and are deductible, if at all, only
by the corporation.” Gantner v. Commissioner, supra at 725
(citing Deputy v. du Pont, supra at 494, and Rink v.
Commissioner, supra at 751).
During his testimony, petitioner often referred to the
“royal we” when discussing whether he, his father, or Johnson &
Associates took certain actions. Petitioner introduced no
evidence that the payment of the loan was an ordinary and
necessary expense related to his trade or business of being an
employee of Johnson & Associates. Petitioner testified that he
“felt a moral obligation, in addition to the legal obligation” to
repay the loan and that he did not want to ruin his name and
reputation in the real estate community. The repayment of the
loan does not morph into a deductible expense just because
petitioner made the payment to protect his reputation. See
Brenner v. Commissioner, supra at 883. Even if petitioner had
paid off the loan to protect his equity interest in Johnson &
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Associates, the payments would be capitalized and not considered
deductible expenses to petitioner. See Craft v. Commissioner,
supra.
Petitioner has failed to prove that the repayment of the
Regions loan was any more than that, the repayment of a loan.
Therefore, respondent’s determination to disallow the 2003 loss
claim and subsequent 2004 and 2005 NOL carryforwards is
sustained.2
II. Additions to Tax and Accuracy-Related Penalty
A. Section 6651(a)(1) Additions to Tax for Failure To File
Tax Return Timely
Petitioners concede that they failed to file their 2003 and
2004 returns timely. A taxpayer will not be responsible for an
addition to tax under section 6651(a)(1) if the taxpayer can show
that the failure to file was due to reasonable cause and not due
to willful neglect. United States v. Boyle, 469 U.S. 241, 245-
246 (1985). Reasonable cause exists when a taxpayer exercises
ordinary business care and prudence and is nonetheless unable to
file his or her return within the date prescribed by law. Sec.
301.6651-1(c)(1), Proced. & Admin. Regs. Willful neglect is
defined as a “conscious, intentional failure or reckless
indifference.” United States v. Boyle, supra at 245.
2
Because the Court finds that petitioners did not incur
losses that might give rise to NOLs, we need not discuss whether
petitioners properly elected to waive their NOL carrybacks before
claiming NOL carryforwards.
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Petitioners did not provide any evidence that their failure
to file their 2003 and 2004 returns timely was due to reasonable
cause and not due to willful neglect. Accordingly, respondent’s
determination of the failure to file additions to tax for 2003
and 2004 is sustained.
B. Section 6662(a) 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.3 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 $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,
3
The Court need not determine whether petitioners are liable
for the accuracy-related penalty due to negligence.
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the taxpayer bears the burden of proving that the accuracy-
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 income tax because
petitioners’ understatement of income 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.
Petitioners provided no evidence that they acted in good
faith and with reasonable cause. Additionally, petitioners
conceded that they failed to report tens of thousands of dollars
of income for the years in issue. Accordingly, respondent’s
determination of the accuracy-related penalty is sustained.
We have considered the parties’ arguments, and, to the
extent not mentioned, we conclude the arguments to be moot,
irrelevant, or without merit.
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To reflect the foregoing,
Decision will be entered
for respondent.