United States Court of Appeals
For the First Circuit
No. 02-1784
INTEREX, INC.,
Petitioner, Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent, Appellee.
APPEAL FROM THE UNITED STATES TAX COURT
[Hon. Mary Ann Cohen, U.S. Tax Court Judge]
Before
Selya, Circuit Judge,
Stahl, Senior Circuit Judge,
and Lynch, Circuit Judge.
Paul J. Dee, Jr. with whom Truelove, Dee, & Chase, LLP was on
brief for appellant.
Marion E.M. Erickson, Attorney, Tax Division, with whom Eileen
J. O'Connor, Assistant Attorney General, and Richard Farber,
Attorney, Tax Division, were on brief for appellee.
February 28, 2003
LYNCH, Circuit Judge. This case concerns the factual
finding by the tax court that a business deduction, supposedly for
counsel and accounting services, was improperly reported. The
petitioner argues that enough evidence was introduced to support
the deduction, and that the tax court judge should have been
recused. Finding no factual or legal error, we affirm the holding
of the tax court and the denial of the recusal motion.
I.
In September 1993, Tamara Olbres incorporated Interex,
Inc. in Massachusetts and was its sole shareholder and president.
The company was in the business of designing, storing, and
refurbishing trade show exhibits. It used an accrual method of
accounting, under which income and liabilities are included in the
tax year in which "all events have occurred" to establish the right
to receive the income or to establish the fact of liability. See
Treas. Reg. § 1.446-1(c)(ii) (2002); see also I.R.C. § 446(c)(2)
(2000) (permitting the accrual method).1
When she formed Interex, Olbres asked George Coupounas,
of Chestnut Hill, Massachusetts, to act as outside counsel and
accountant for Interex. Olbres and Coupounas never discussed the
rate at which he would be paid for performing legal and accounting
1
The other common method is the cash method, by which income
and liabilities are measured when payment is actually received or
made. Id. § 1.446-1(c)(i).
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services. In 1993, on its federal tax return, Interex deducted
$4,695 in fees paid to Coupounas.
Coupounas prepared Interex's 1994 federal tax return and
signed it as the preparer. Olbres signed the return as well, but
if she read it at all, she did so cursorily. On this return,
Interex deducted $65,000 for accrued professional fees owed to
Coupounas. Coupounas never billed Interex for that amount.
In late 1996, the IRS began to examine Interex's 1994 tax
return. Coupounas was questioned by IRS agents but refused to
provide time sheets to support the corporation's alleged liability.
In January 1998, the IRS issued a Proposed Report of Income Tax
Changes, which included, among the issues raised, a challenge to
the $65,000 deduction for accrued professional fees. The IRS
investigation prompted activity. In August 1998, at Coupounas's
request, Olbres wrote him a check from Interex postdated December
31, 1998, purportedly in payment of the fees incurred in 1994.
II.
On September 8, 1999, the Commissioner of the IRS issued
a Notice of Deficiency under I.R.C. § 6212 which challenged, inter
alia, the $65,000 in accrued professional fees. Interex filed a
petition with the tax court for redetermination of the deficiency.
The other alleged deficiencies were settled; the only issue
presented to the tax court was the $65,000 deduction and the
accompanying negligence penalty under I.R.C. § 6662.
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After trial, but before decision, Interex filed a motion
for recusal of the tax court judge under 28 U.S.C. § 455(a).
Interex argued that the judge was predisposed to find against
Interex on the merits. The tax court denied the recusal motion.
On February 27, 2002, the tax court issued a memorandum
opinion in favor of the IRS. It found that Interex had failed to
show that economic performance with respect to the $65,000 in
professional fees had occurred in 1994; that the amount of fees due
to Coupounas "could not have been determined with reasonable
accuracy by the end of 1994"; and that the services performed by
Coupounas for Interex in 1994 were not "specialized, unique, or
otherwise reasonably valued at $65,000." Finally, the court
awarded negligence penalties under § 6662(a) because Olbres had not
examined the tax return, other than the bottom line, when she
signed. Interex, Inc. v. Comm'r, No. 17030-99, 2002 Tax Ct. Memo
LEXIS 59, at *4, *7-*8 (T.C. Feb. 27, 2002).
Interex appeals both the decision of the tax court and
the denial of the motion for recusal.
III.
We review decisions of the tax court "in the same manner
and to the same extent as decisions of the district courts in civil
actions tried without a jury." I.R.C. § 7482(a)(1); see Medchem,
Inc. v. Comm'r, 295 F.3d 118, 122 (1st Cir. 2002). The tax
court's legal interpretations are reviewed de novo. Alexander v.
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IRS, 72 F.3d 938, 941 (1st Cir. 1995). We will overturn its
factual findings only if they are clearly erroneous. Capital Video
Corp. v. Comm'r, 311 F.3d 458, 463 (1st Cir. 2002). A finding is
clearly erroneous when, "although there is evidence to support it,
the reviewing court on the entire evidence is left with the
definite and firm conviction that a mistake has been committed."
Comm'r v. Duberstein, 363 U.S. 278, 291 (1960) (quoting United
States v. United States Gypsum Co., 333 U.S. 364, 395 (1948)). We
review a trial court's denial of a recusal motion for abuse of
discretion. In re Boston's Children First, 244 F.3d 164, 167 (1st
Cir. 2001).
The burden of proof is generally on the taxpayer to
demonstrate that the IRS's nondeductibility determination is in
error. U.S. Tax Ct. R. 142(a); United States v. Janis, 428 U.S.
433, 440 (1976). Once "a taxpayer introduces credible evidence
with respect to any factual issue," the burden shifts to the IRS on
that issue. I.R.C. § 7491(a)(1).
IV.
A. Deduction of Professional Fees
I.R.C. § 162 permits deductions from income for "all the
ordinary and necessary expenses paid or incurred during the taxable
year in carrying on any trade or business." Accrual method
taxpayers may deduct expenses when they are incurred even if they
have not yet been paid, as long as three factors are met: 1) all of
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the events that establish the fact of the liability must have
occurred; 2) the amount must be able to be determined "with
reasonable accuracy"; and 3) economic performance must have
occurred. Treas. Reg. § 1.461-1(a)(2)(i); see also id. § 1.461-4
(explaining economic performance). Whether a taxpayer has
satisfied the "all events" test is a question of law we review de
novo. Gold Coast Hotel & Casino v. United States, 158 F.3d 484,
487 (9th Cir. 1998).
At trial, the only person who testified on Interex's
behalf was Olbres. She testified that she did not ask for nor did
she ever see a bill for Coupounas's professional services. She did
not ask what services Coupounas performed to be valued at $65,000,
nor did she ask for or receive any time sheets or other supporting
records. Furthermore, Olbres admitted that she did not carefully
review the 1994 tax return. She was not even aware of the $65,000
debt until August 1998.
According to Olbres, Coupounas performed the following
services: preparing tax returns; setting up the company's record-
keeping system; preparing financial statements; reviewing letters
and documents; advising Olbres with respect to the conversion of
Interex from a subchapter C corporation to a subchapter S
corporation; and answering legal questions.
1994 was not the only year in which Interex deducted sums
for Coupounas's services. Deductions were taken for his services
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in the years from 1993 to 1997; Coupounas never issued a bill to
Olbres detailing his services from 1994 to 1997. Moreover, after
1993, Coupounas was not paid at all by Interex until the $65,000
check was written in 1998, only after the IRS began to investigate
that deduction. Finally, there is no evidence that Coupounas was
ever paid for the debts allegedly incurred after 1994, including
$36,000 in fees deducted in the 1995 return.
Coupounas did not testify at trial, refused to provide
documents to the IRS, and did not cooperate with the IRS. At the
close of trial, the Tax Court instructed the parties that the court
would entertain a motion to reopen the record within thirty days if
Coupounas became available to testify in court or to be deposed.
Interex later notified the court that no testimony or statement
from Coupounas would be added to the record. Coupounas was under
an apparent obligation to provide documents to Interex, his client,
arising out of his charges for any services to the company. See
Mass. R. Prof. C. 1.4(a). Nonetheless, Interex provided no bills
from Coupounas or documentation of $65,000 worth of services
incurred in 1994.
Given the sparse evidence entered into the record by the
petitioner, the tax court upheld the denial of the deduction
because it failed at least two of the three requirements of the
"all events" test. First, the court was not persuaded that
economic performance had occurred; there was simply not enough
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evidence for the court to conclude that $65,000 in professional
services were provided in 1994. Buttressing this decision was the
fact that none of the services Olbres claimed that Coupounas had
provided were specialized or numerous enough to be valued at
$65,000. Second, because of the lack of an invoice and Olbres's
inability to articulate the basis of the $65,000 fee, the court
found that the amount of the fees owed could not have been
determined with reasonable accuracy when the deduction was taken.
We affirm the Tax Court's holding on both grounds. Since
Coupounas has been so lackadaisical in pursuing payment for these
alleged debts, it is fair to infer that, to put it mildly, their
value was distorted for tax purposes. Moreover, the services
Olbres testified that Coupounas performed could not reasonably have
been valued at $65,000.2
The absence of documentation also makes it unlikely that
the amount owed could have been determined with reasonable
accuracy. There was no evidence as to how many hours Coupounas
worked or to his billing rate for accounting or legal services.
Olbres, the president and sole shareholder of Interex, testified
2
Interex argues that it was error for the tax court not to
allow a deduction for a lesser amount. However, petitioner, who
bore the burden, did not produce any evidence concerning the hours
Coupounas worked, how his time was divided among the various tasks
he performed, or what a reasonable billing rate for these
activities would be. The tax court did not have enough evidence
before it to determine the proper value to attach to any services
Coupounas allegedly performed in 1994.
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she did not even know of the existence of the debt until August
1998. Even if Interex had introduced evidence that Coupounas had
provided services that might possibly be worth $65,000, the accrued
amount could not have met the "all events" test, and been properly
deducted, until there was enough information to determine the value
of those services.
In sum, the petitioner did not present enough credible
evidence to shift the burden to the IRS to prove that the "all
events" test had not been met.
B. Recusal
Interex argues that the tax court judge should have
granted its motion for recusal. "Any justice, judge, or magistrate
judge of the United States shall disqualify himself in any
proceeding in which his impartiality might reasonably be
questioned." 28 U.S.C. § 455(a). We uphold the trial judge's
discretion to hear the case "unless such decision 'cannot be
defended as a rational conclusion supported by a reasonable reading
of the record.'" Cigna Fire Underwriters Co. v. MacDonald &
Johnson, Inc., 86 F.3d 1260, 1271 (1st Cir. 1996) (quoting In re
United States, 666 F.2d 690, 695 (1st Cir. 1981)).
On the day of trial, after testimony had been heard, the
judge commented that "before the trial, before [Olbres's]
testimony, frankly, I thought that the case should be resolved on
the basis of Interex conceding the deduction and Respondent
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conceding the penalty." The judge also noted, after offering to
reopen the record for Coupounas's testimony, that "I don't think it
would change the result in this case." The petitioner argues that
these comments reflect a lack of impartiality. They do not.
These comments were made after the judge had heard
testimony from both parties. The petitioner suggests that the
first comment indicates that the judge had an opinion on this case
before trial, but that is not surprising; this case included
stipulated facts and documents presented to the court before trial.
If they signify anything at all, the comments suggest that the
judge had reached an opinion of the case after consideration of the
facts. And that is, after all, not merely the prerogative but the
duty of a judge. We affirm the denial of the motion for recusal.
The judgment of the tax court is affirmed.
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