T.C. Memo. 2012-239
UNITED STATES TAX COURT
KERRY MARK KERSTETTER AND SHERRY LEE KERSTETTER, Petitioners
v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10391-10. Filed August 21, 2012.
Kerry Mark Kerstetter and Sherry Lee Kerstetter, pro sese.
Ann Louise Darnold, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined deficiencies, additions to tax, and
penalties in relation to petitioners’ Federal income tax as follows:
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[*2] Penalty Addition to Tax
Year Deficiency Sec. 6662(a) Sec. 6651(a)(1)
2001 $25,541 $5,108.20 $6,385.25
2002 27,554 5,446.20 ---
2003 13,656 2,257.80 3,414.00
2004 8,903 1,316.80 ---
After concessions, the issues for decision are whether petitioners are entitled to
business expense deductions or net operating loss carryovers beyond those
conceded by respondent and whether petitioners are liable for the section 6651(a)(1)
addition to tax for 2003 and for the section 6662(a) penalties. Unless otherwise
indicated, all section references are to the Internal Revenue Code in effect for the
years in issue, and all Rule references are to the Tax Court Rules of Practice and
Procedure.
FINDINGS OF FACT
Petitioners resided in Arkansas at the time they filed their petition. During
the years in issue Kerry Mark Kerstetter (petitioner) conducted an accounting and
tax preparation business operated out of petitioners’ home. Sherry Lee Kerstetter
assisted in petitioner’s business and also conducted some real estate activity out of
petitioners’ home.
Petitioner and Ms. Kerstetter maintained separate offices in the home.
Sixteen percent of the home, or 740 square feet, was used exclusively and
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[*3] regularly for business purposes during the years in issue. The rest of the home
was sometimes used for meeting with clients or with Internal Revenue Service (IRS)
personnel auditing petitioner’s clients’ returns but was also used for personal
purposes.
Petitioners filed a joint Federal income tax return for each of the years in
issue. On Schedule C, Profit or Loss From Business, attached to each of those
returns they claimed depreciation of $6,181, which was based on 100% of the cost
basis of the home with no reduction for personal use. Also on Schedules C they
claimed interest expense deductions of $94,380, $82,954, $27,229, and $22,578 for
2001, 2002, 2003, and 2004, respectively. Some of the interest should have been
allocated to a farm activity reported on Schedule F, Profit or Loss From Farming,
and some should have been allocated to personal mortgage interest and reported on
Schedule A, Itemized Deductions. Other interest that they reported on their returns
was personal and not deductible.
On their Schedules C for the years in issue petitioners deducted as supplies
expenses amounts spent for pet food and pet supplies, but they now concede the
disallowance of those deductions.
On each of the tax returns for the years in issue petitioners claimed a net
operating loss carryover that eliminated any tax liability. The claimed net
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[*4] operating losses allegedly were incurred beginning in 1995, and the amount
claimed on the 2003 return, for example, was $454,694.
Petitioners’ 2001 tax return was due, with extensions, October 15, 2002, but
was not filed until May 31, 2003, the same date on which their 2002 return was
filed. Their 2003 return was due, with extensions, October 15, 2004, but was not
filed until July 9, 2005, two days before their 2004 return was filed. Petitioners did
not have reasonable cause for late filing of their returns.
Examination of petitioners’ returns commenced in 2006, and the notice of
deficiency was sent on February 22, 2010. Disallowance of the net operating loss
carryover was explained in the notice of deficiency as follows:
Due to the disallowance of net operating loss carryovers from prior
years, as set forth in the examination report for the taxable years ended
December 31, 1997 and December 31, 1998, the net operating loss
carryover to the taxable years ended December 31, 2001, December
31, 2002, December 31, 2003, and December 31, 2004 is $0.00.
Accordingly, your taxable income for 2001, 2002, 2003, and 2004 are
[sic] increased $470,362.00, $470,362.00, $454,694.00, and
$413,236.00, respectively.
During the examination, the pretrial processes in this case, and at trial,
petitioners claimed to have boxes of documents substantiating the net operating
loss carryovers. At no time, however, did they present to respondent or to the
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[*5] Court evidence to substantiate any losses or carryovers applicable to the years
in issue.
OPINION
Business Expense Deductions
Petitioners’ arguments in this case have not been supported by evidence or by
authority. Instead petitioners make assertions based only on their generalized
testimony and on petitioner’s claimed years of experience in dealing with the IRS on
behalf of clients. Petitioners have the burden of proof with respect to deductions.
See Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).
We are not required to accept testimony that is improbable or implausible. See
Blodgett v. Commissioner, 394 F.3d 1030, 1035-1036 (8th Cir. 2005), aff’g T.C.
Memo. 2003-212; Shea v. Commissioner, 112 T.C. 183, 189 (1999). Particularly in
view of petitioner’s experience, the absence of corroboration of his testimony by
organized and reliable records leads us to conclude that petitioners have not carried
their burden of proof as to the disputed deductions. See Shea v. Commissioner, 112
T.C. at 188. They have not satisfied the conditions for shifting that burden to
respondent under section 7491(a).
After an extensive examination of petitioners’ records of expenditures during
the years in issue and negotiations before and concessions after trial, respondent
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[*6] has agreed to deductions based on use of 16% of petitioners’ home as their
business offices. Petitioners, however, continue to claim that the percentage should
be increased to reflect storage space, floor space under furniture and equipment
located in combined use areas, and bathrooms connected to their offices.
Section 280A establishes the general rule that no deduction is allowed with
respect to business use of a taxpayer’s personal residence. Section 280A(c)(1)(A),
however, provides that section 280A shall not apply if a portion of the taxpayer’s
personal residence is exclusively used on a regular basis as the principal place of
business for any trade or business of the taxpayer. See Sam Goldberger, Inc. v.
Commissioner, 88 T.C. 1532, 1556-1557 (1987).
Petitioners’ testimony fails to persuade us that they used more than 16%
of the residence exclusively for business purposes. From their testimony it appears
that personal records were also kept on computers and in the closet areas that they
claim as business related. A table, a computer, or a copy machine located in a
room that is used both for business and personal purposes may be occasionally used
for business, but dual use of pieces of furniture or equipment does not satisfy the
exclusive use test. Nor does occasional business use of a room, such as a
bathroom which is also used for personal purposes, satisfy this test. See, e.g.,
Sam Goldberger, Inc. v. Commissioner, 88 T.C. at 1556-1557; Sengpiehl v.
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[*7] Commissioner, T.C. Memo. 1998-23. We do not accept petitioners’ claims
that the items remaining in dispute were used exclusively for business or their
allocation of fractional portions of rooms. Depreciation on the portion of the
residence used exclusively for business purposes is thus limited to the 16%
conceded by respondent.
Petitioners contend that interest paid on credit card debt reflects borrowing to
pay business expenses. Their generalized assertions cannot be verified or traced in
the documentary evidence. The IRS determined that 15% of the credit card charges
were for business and allocated a proportionate amount of deductible interest to
Schedules C and F. Petitioners’ contention that all of the credit card interest was
incurred for business purposes is improbable, and they have not established that
they are entitled to deduct any amount greater than that allowed by respondent.
Petitioners also attempt to use self-serving and conclusory assertions rather
than evidence with respect to the net operating loss carryover, demanding that
respondent’s representatives identify “specific documents” needed to substantiate
their carryovers. Petitioners have the burden of proving the amounts of the losses
and that they have not been absorbed in other years. See, e.g., Keith v.
Commissioner, 115 T.C. 605, 621 (2000); Sandoval v. Commissioner, T.C. Memo.
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[*8] 2001-310, aff’d without published opinion, 67 Fed. Appx. 252 (5th Cir. 2003).
They have not shown either, and none of the claimed carryovers may be allowed.
Penalties and Additions to Tax
Respondent has the burden of coming forward with evidence that the
imposition of penalties or additions to tax is appropriate. See sec. 7491(c).
Respondent has conceded the section 6651(a) addition to tax for 2001. The
stipulation establishes that the tax return for 2003 was filed late, so petitioners must
show reasonable cause to avoid the section 6651(a)(1) addition to tax. See sec.
6651(a)(1); Higbee v. Commissioner, 116 T.C. 438, 447 (2001). They have not
done so.
Petitioners contend that they did not expect to owe any tax and thus late
filing was a “moot point”. However, a mistaken belief that the section 6651(a)(1)
addition to tax would not apply because the taxpayers do not expect to owe any tax
does not constitute reasonable cause. See Ruggeri v. Commissioner, T.C. Memo.
2008-300; Morgan v. Commissioner, T.C. Memo. 1984-384, aff’d, 807 F.2d 81
(6th Cir. 1986). They also contend that they requested consecutive extensions of
more than six months for filing their 2003 return. The parties’ stipulation of facts
and section 1.6081-1, Income Tax Regs., refute this contention. Petitioners have
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[*9] neither identified nor established reasonable cause to avoid the section
6651(a)(1) addition to tax for 2003.
Section 6662(a) and (b)(1) and (2) provides a penalty of 20% on the portion
of an underpayment of tax (1) due to negligence or disregard of rules or regulations
or (2) attributable to a substantial understatement of income tax. Section 6662(c)
defines “negligence” as any failure to make a reasonable attempt to comply with the
provisions of the Internal Revenue Code, and “disregard” means any careless,
reckless, or intentional disregard. The evidence of erroneous deductions and
improper allocation of depreciation and interest claimed by petitioners is sufficient
to prove negligence and satisfies respondent’s burden of production.
Whether applied because of a substantial understatement of income tax or
negligence or disregard of rules or regulations, the accuracy-related penalty is not
imposed with respect to any portion of the underpayment as to which the taxpayer
acted with reasonable cause and in good faith. See sec. 6664(c)(1). The decision
as to whether the taxpayer acted with reasonable cause and in good faith depends
upon all the pertinent facts and circumstances. See sec. 1.6664-4(b)(1), Income
Tax Regs. Relevant factors include the taxpayer’s effort to assess his or her proper
tax liability, including the taxpayer’s reasonable and good faith reliance on the
advice of a professional such as an accountant. See id. Petitioners have the burden
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[*10] of proving reasonable cause and good faith. See Higbee v. Commissioner,
116 T.C. at 449. They have not done so here.
In relation to the section 6662 penalties, petitioners claim to have records
with respect to their net operating loss carryovers going back to the 1980s, but they
decline to organize or produce records substantiating their claims. They have not
attempted to justify the excess depreciation claimed, the misallocation of interest
deductions, or the disallowed supplies expenses. Petitioners have failed to identify
or provide support for any exception to application of the penalty, and it will be
applied to the recomputed underpayment amounts.
To reflect concessions and our holdings,
Decision will be entered
under Rule 155.