T.C. Summary Opinion 2012-94
UNITED STATES TAX COURT
STEPHEN A. WALLACH AND KIMBERLY K. WALLACH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11051-11S. Filed September 18, 2012.
Stephen A. Wallach and Kimberly K. Wallach, pro se.
Matthew D. Carlson and Kimberly A. Kazda, for respondent.
SUMMARY OPINION
PANUTHOS, Chief 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
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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 (Code), and all Rule references are to the Tax Court Rules
of Practice and Procedure.
Respondent determined a deficiency of $5,418 in petitioners’ 2007
Federal income tax as well as a section 6662(a) accuracy-related penalty of $1,083.
The issues for decision are: (1) whether petitioners are entitled to business expense
deductions claimed on a Schedule C, Profit or Loss From Business, for expenses
related to petitioner Stephen A. Wallach’s real estate brokerage business and (2)
whether petitioners are liable for the 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 this reference. Petitioners
resided in California at the time the petition was filed.
During 2007 Stephen A. Wallach (petitioner) was employed as a pilot for
United Airlines and also worked as a real estate broker. Petitioner Kimberly K.
Wallach was a homemaker. Petitioner became a licensed California real estate
broker in 1981, and he operated a brokerage business as a sole proprietorship.
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Petitioner held himself out to deal primarily in commercial real estate sales and
related property management. Petitioner researched properties on the Internet,
talked with listing brokers, and traveled to geographic locations he believed were
promising or met a client’s needs.
In 2007 petitioner made approximately 12 offers to purchase properties on
behalf of clients. None of the offers resulted in a purchase or sale. Petitioner also
advised his parents with respect to properties. Petitioner received $9,000 from his
parents in 2007 relating to the advice provided and reported this as income on the
Schedule C. Petitioner received similar fees from his parents in other years. The
amount received from his parents represent the only income petitioner reported as a
broker in 2007. On the 2007 joint Federal income tax return petitioners reported a
$31,762 business loss, $23,124 of which related to the real estate brokerage
business.1
Respondent issued a notice of deficiency disallowing (1) certain business
expense deductions relating to petitioner’s brokerage business and (2) itemized
1
Petitioners included two Schedules C with their 2007 return. One Schedule
C relates to petitioner’s real estate brokerage activity; the other relates to a business
named Floatical. None of the adjustments in the notice of deficiency relate to
Floatical.
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deductions relating to petitioner’s employment as an airline pilot.2 Respondent
allowed some of petitioners’ claimed business expense deductions but disallowed all
of the claimed business expense deductions for travel of $10,533, meals and
entertainment of $3,834, and office expenses of $5,512.
Discussion
The Commissioner’s determination is generally presumed correct, and the
taxpayer bears the burden of proving the determination is in error. Rule 142(a).
The taxpayer bears the burden of proving that he or she is entitled to the deduction
claimed, and this includes the burden of substantiation. Id.; Hradesky v.
Commissioner, 65 T.C. 87, 89-90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir.
1976). A taxpayer must substantiate amounts claimed as deductions by maintaining
the records necessary to establish he or she is entitled to the deductions. Sec. 6001.
Section 162(a) provides a deduction for certain business-related expenses. In order
to qualify as a deduction under section 162(a), “an item must (1) be ‘paid or
incurred during the taxable year,’ (2) be for ‘carrying on any trade or business,’ (3)
be an ‘expense,’ (4) be a ‘necessary’ expense, and (5) be an ‘ordinary’ expense.”
2
Respondent disallowed a cellular telephone expense deduction claimed on
Schedule A, Itemized Deductions. Although petitioners disputed this adjustment in
the petition, they did not address this issue at trial nor did they provide any evidence
to support the claimed deduction. As a result, this issue is deemed conceded. See
Rule 149(b).
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Commissioner v. Lincoln Sav. & Loan Ass’n, 403 U.S. 345, 352 (1971); Deputy v.
du Pont, 308 U.S. 488, 495 (1940) (to qualify as “ordinary”, the expense must relate
to a transaction “of common or frequent occurrence in the type of business
involved”). Whether an expense is ordinary is determined by time, place, and
circumstance. Welch v. Helvering, 290 U.S. 111, 113-114 (1933). Respondent did
not determine that petitioner’s activity was not an activity engaged in for profit. See
sec. 183.
If a taxpayer establishes that he or she paid or incurred a deductible business
expense but does not establish the amount of the expense, we may approximate the
amount of the allowable deduction, bearing heavily against the taxpayer whose
inexactitude is of his or her own making. Cohan v. Commissioner, 39 F.2d 540,
543-544 (2d Cir. 1930). In order for the Cohan rule to apply, there must be
sufficient evidence in the record to provide a basis for the estimate. Vanicek v.
Commissioner, 85 T.C. 731, 743 (1985). Certain expenses may not be estimated
because of the strict substantiation requirements of section 274(d). See sec.
280F(d)(4)(A); Sanford v. Commissioner, 50 T.C. 823, 827 (1968), aff’d per
curiam, 412 F.2d 201 (2d Cir. 1969).
Section 274(d) applies to certain business expenses including, among other
things, expenses for listed property (e.g., automobile expenses, cellular telephones,
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computer equipment, or any property of a type generally used for purposes of
entertainment, recreation, or amusement) and travel (including meals and lodging
while away from home). Secs. 274(d), 280F(d)(4)(A). To substantiate a deduction
attributable to listed property, a taxpayer must maintain adequate records or present
corroborative evidence to show the following: (1) the amount of the expense; (2)
the time and place of use of the listed property; and (3) the business purpose of the
use. Sec. 1.274-5T(b)(6), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov.
6, 1985).
It is well established that the Court may permit a taxpayer to attempt to
substantiate deductions through secondary evidence where the underlying
documents have been unintentionally lost or destroyed. Boyd v. Commissioner, 122
T.C. 305, 320-321 (2004); Malinowski v. Commissioner, 71 T.C. 1120, 1125
(1979); Furnish v. Commissioner, T.C. Memo. 2001-286; Joseph v. Commissioner,
T.C. Memo. 1997-447; Watson v. Commissioner, T.C. Memo. 1988-29. Moreover,
even though Congress imposed heightened substantiation requirements for certain
deductions by enacting section 274, the regulations thereunder allow a taxpayer to
substantiate a deduction by reasonable reconstruction of his or her expenditures
when records are lost through no fault of the taxpayer. Sec. 1.274-5T(c)(5),
Temporary Income Tax Regs., 50 Fed. Reg. 46022 (Nov. 6, 1985). Because of
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computer malfunctions, petitioner had to replace two computer hard drives, which
resulted in a loss of some of his records relating to 2007, including an electronic
calendar.3
Petitioner provided the Court with bank records and photocopies of receipts
for meals, hotels, rental vehicles, and airline tickets to substantiate some of his
expenses. Some of the documents were partially or wholly illegible. Petitioner also
provided the Court with multiple schedules for each type of claimed expense, some
of which included a general description, such as “property search” and the city of
the search. To aid the Court’s analysis and for the purpose of clarity of this opinion,
the Court combined the schedules petitioner provided for the reported meal and
entertainment expenses and the travel expenses into a single chronological list. We
consider the various geographic locations where petitioners claim to have incurred
deductible expenses.
Hawaii
Petitioner reported hotel, rental car, and meal expenses relating to a trip to
Hawaii in February 2007 which lasted approximately 11 days. Petitioner did not
claim a business expense deduction for the cost of his airline ticket to or from
3
It is not clear whether the computer malfunctions and record losses occurred
during 2007, during the examination of petitioners’ return, or during preparation for
trial.
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Hawaii; however, he did claim as a business expense deduction the cost of an airline
ticket for a third party. No explanation was given as to who this person is or what
business purpose was furthered by this expenditure. Petitioner’s records reflect that
he paid for multiple hotel rooms for the same nights and that there were multiple
occupants in the rooms. Some of the expenses were not evidenced by receipts or
reflected in the bank records. Petitioner’s explanation for the travel to Hawaii was
that he was scouting potential properties for an unnamed client. On the basis of the
record, petitioner has not established that these expenditures were ordinary and
necessary business expenses, and we disallow all claimed business expense
deductions relating to this travel.
Lake Tahoe
Within one day of his return from Hawaii in February 2007, petitioner
apparently traveled to Lake Tahoe. He claimed a business expense deduction for
the cost of a two-bedroom townhome in Tahoe, California, for three days. The
receipt for this expense shows that petitioner Kimberly K. Wallach made the
reservation for two people and was listed as the contact person. Petitioner has
failed to establish that this claimed expenditure constitutes an ordinary and
necessary business expense, and we disallow the claimed deduction for the
townhome rental.
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Phoenix
In March 2007 petitioner purchased three round-trip airline tickets to
Phoenix, Arizona. Petitioner claimed a business expense deduction for one round-
trip airline ticket as well as a rental car that petitioner Kimberly K. Wallach rented
and paid for with her credit card. Petitioner has failed to establish that these
claimed expenditures are ordinary and necessary business expenses. We disallow
the claimed business expense deductions relating to the airline ticket and the rental
car for this travel.
Dayton and petitioner’s parents
Petitioner apparently traveled to Dayton, Ohio, in August 2007. Petitioner’s
records reflect that petitioner paid for two hotel rooms and had dinner with his
parents. As indicated, petitioner’s parents were the only source of income reported
by the brokerage business for 2007. The hotel room receipts reflect a stay for two
adults and three children in two rooms over two days. Petitioner has failed to
establish that the meals and lodging were an ordinary and necessary business
expense, and we disallow the claimed business expense deductions for the hotel and
meal expenses related to this travel.
In addition to his travel to Dayton, petitioner had meals with his parents
throughout 2007 and claimed the costs as business expense deductions. Petitioner
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apparently considered his parents clients of the brokerage business for many years.
Petitioner did not provide any records to corroborate the nature of the advice
provided to his parents or any information regarding properties he researched.
Petitioner acknowledged that during meals with his parents, he talked about
personal matters as well as real estate matters. Petitioner has not established that
these meals were ordinary and necessary business expenses. We therefore disallow
all business expense deductions claimed for meals with petitioner’s parents
throughout 2007.
National park
Petitioner claimed deductions for hotel and meal expenses relating to travel to
Yosemite National Park on December 23, 2007. Petitioner did not provide the
Court with any evidence as to his real estate brokerage activity in his travel to
Yosemite. As a result, we find these expenses are not ordinary and necessary and
we therefore disallow the claimed business expense deductions relating to the meal
and hotel expenses for this travel.
Hotel stays in San Francisco area
Petitioner claimed business expense deductions for hotel expenses for a
number of stays near the San Francisco airport. Petitioner’s records describe the
San Francisco airport expenses as incurred in order to report to work as a pilot the
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next day. Since these expenditures appear to relate to petitioner’s employment as a
pilot and not his real estate brokerage activity, it is clear that they are not proper
Schedule C deductions. Petitioner has failed to establish that these expenditures are
ordinary and necessary business expenses related to his brokerage activity.
Additionally, petitioner has failed to established that the claimed deductions are
proper employee business expenses.
Petitioner’s list of hotel expenses also indicates that he incurred multiple
expenses at hotels 30-45 miles from his home, in downtown San Francisco and
Napa, California. Petitioner failed to explain the purpose of these expenditures.
Petitioner has failed to establish that these expenses were ordinary and necessary,
and we therefore disallow these business expense deductions for hotel expenses.
Meals and entertainment
Petitioner claimed business expense deductions for meals and entertainment
in addition to the previously mentioned travel. We also disallow any meal and
entertainment expense not evidenced by a receipt or bank record as unsubstantiated.
We have carefully examined the receipts and records petitioner provided, and we
are satisfied that petitioner has substantiated business meal and entertainment
expenses of $3,888.99. Section 274(n) provides that only 50% of meal and
entertainment expenses is allowable as a deduction. See also Fleming v.
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Commissioner, T.C. Memo. 2010-60. As a result, petitioner is entitled to a business
expense deduction for meals and entertainment of $1,944.50, rather than the $3,834
petitioner claimed on the return.
Travel
Petitioner claimed business expense deductions for travel in addition to the
previously mentioned travel. We disallow any travel expense not evidenced by a
receipt or bank record as unsubstantiated. We have carefully examined the receipts
and records petitioner provided, and we are satisfied that petitioner has
substantiated business travel expenses of $3,236.17, rather than the $10,533
claimed on the return.
Office expense
Petitioner claimed an office expense of $5,512 on his 2007 Schedule C for the
real estate brokerage business. At trial petitioner provided an updated schedule in
which he reduced his claim to $4,374. A portion of the reduced claim represents
computer equipment and software which are listed property subject to the
heightened substantiation requirements of section 274(d). Petitioner did not provide
testimony about the office expenses nor any receipts related to the claimed office
expense deduction. Therefore petitioner has failed to substantiate that he incurred
any deductible office expenses. See Diers v. Commissioner, T.C. Memo. 2003-229.
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As a result, we disallow the entire business expense deduction related to the office
expenses.
Accuracy-related penalty
Taxpayers may be liable for a 20% penalty on the portion of an underpayment
of tax attributable to negligence, disregard of rules or regulations, or a substantial
understatement of income tax. Sec. 6662(a) and (b)(1) and (2). The term
“negligence” in section 6662(b)(1) includes any failure to make a reasonable
attempt to comply with the Code, and the term “disregard” includes any careless,
reckless, or intentional disregard. Sec. 6662(c). Negligence has also been defined
as the failure to exercise due care or the failure to do what a reasonable and
ordinarily prudent person would do under the circumstances. See Allen v.
Commissioner, 92 T.C. 1, 12 (1989), aff’d, 925 F.2d 348, 353 (9th Cir. 1991);
Neely v. Commissioner, 85 T.C. 934, 947 (1985). Negligence also includes any
failure by the taxpayer to keep adequate books and records or to substantiate items
properly. Sec. 1.6662-3(b)(1), Income Tax Regs. The section 6662(a) accuracy-
related penalty does not apply where the taxpayer shows that he or she acted in
good faith and with reasonable cause. Sec. 6664(c)(1). The determination of
whether a taxpayer acted in good faith and with reasonable cause depends on the
facts and circumstances of each case and includes the knowledge and experience of
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the taxpayer and the reliance on the advice of a professional, such as an accountant.
Sec. 1.6664-4(b)(1), Income Tax Regs. Most important in this determination is the
extent of the taxpayer’s effort to determine the proper tax liability. Neonatology
Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d
Cir. 2002).
The Commissioner has the burden of production under section 7491(c) with
respect to the accuracy-related penalty under section 6662. To satisfy that burden,
the Commissioner must produce sufficient evidence showing that it is appropriate to
impose the penalty. Higbee v. Commissioner, 116 T.C. 438, 446 (2001).
Respondent has satisfied his burden by producing evidence that petitioners failed to
maintain adequate books and records or substantiate the claimed business expense
deductions. Accordingly, because respondent has met his burden of production,
petitioners must come forward with persuasive evidence that the accuracy-related
penalty should not be imposed with respect to the underpayment because they acted
with reasonable cause and in good faith. See sec. 6664(c)(1); Rule 142(a); Higbee
v. Commissioner, 116 T.C. at 446.
Petitioners did not offer any argument or other evidence to show that there
was reasonable cause for the portion of the underpayment relating to the deductions
claimed and that they acted in good faith with respect to the claimed deductions.
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Respondent’s determination of the accuracy-related penalty under section 6662(a)
for 2007 is sustained.4
Conclusion
Petitioners are entitled to claim business expense deductions with respect to
petitioner’s real estate brokerage business for 2007 of $1,944.50 for meals and
entertainment and $3,236.17 for travel. Petitioners are also liable for the section
6662(a) accuracy-related penalty for 2007.
To reflect the foregoing,
Decision will be entered
under Rule 155.
4
Since we have allowed some business expense deductions that respondent
disallowed, the amount of tax required to be shown on petitioners’ 2007 Federal
income tax return will be reduced from the amount determined in the notice of
deficiency.