BLAKE v. COMMISSIONER

T.C. Summary Opinion 2004-69

UNITED STATES TAX COURT

LORIANNE BLAKE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 3583-03S. Filed May 20, 2004.

Lorianne Blake, pro se.

Jeremy L. McPherson, for respondent.

DEAN, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time that the petition was filed. Unless otherwise

indicated, subsequent 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.

The decision to be entered is not reviewable by any other court,

and this opinion should not be cited as authority.
 - 2 -

Respondent determined deficiencies in petitioner's Federal

income taxes of $4,191 for 1998 and $3,073 for 1999. After

concessions,1 the issue remaining for decision2 is whether

petitioner is entitled to costs of goods sold and deductions on

Schedule C, Profit or Loss From Business, in excess of those

allowed by respondent.

Background

The stipulation of facts and exhibits received into evidence

are incorporated herein by reference. Petitioner resided in

Chico, California, at the time the petition was filed.

During 1998 and 1999, petitioner did sales work for Norfield

Industries in Chico, California. During those years, petitioner

was also engaged as a distributor of "Herbalife" products. On

her 1998 and 1999 Forms 1040, U.S. Individual Income Tax Return,

petitioner reported income and expenses from her Herbalife

activities on Schedules C. Petitioner described her activity as

"Nutrition Consultant."

1
In the notice of deficiency, respondent disallowed auto
expenses of $1,863 for 1998 and $3,495 for 1999, and other
interest expenses of $731 for 1998 and $83 for 1999.
Additionally, respondent determined that petitioner received
advance earned income credit payments during 1998 and 1999 in the
amounts of $1,173 and $1,126, respectively. Petitioner did not
report the 1998 advance earned income credit payment on her tax
return. Petitioner has conceded these issues.
2
The amounts of any liabilities for and deductions of self-
employment taxes depend on the resolution of the other issues in
this case.
 - 3 -

1. Product-Related Expenses

Petitioner claimed deductions for "advertising" on line 8 of

her 1998 and 1999 Schedules C in the amounts of $4,964 and

$5,160, respectively. Approximately $1,000 of her claimed

advertising expense for 1998 and $1,500 for 1999 was for samples

which she gave away. The remaining $3,964 for 1998 and $3,660

for 1999 of petitioner's advertising expenses was for Herbalife

products which petitioner used personally. Petitioner did not

maintain any records of the products that she gave away or for

the products she used herself.

The amounts petitioner deducted as advertising expenses were

based upon the retail value of the items, not on the amount which

petitioner had actually paid for the products. Petitioner's

actual merchandise costs were $3,276 in 1998, and $3,406 in 1999.

Respondent disallowed all of petitioner's claimed advertising

expenses.

Petitioner also reported costs of goods sold on her 1998 and

1999 Schedules C in the amounts of $6,240 and $5,913,

respectively. In calculating costs of goods sold, line 36 of

Schedule C reports "Purchases less cost of items withdrawn for

personal use". Petitioner entered the total amounts she paid for

Herbalife products for each year. Those amounts were $6,009 and

$6,128 for 1998 and 1999, respectively. Petitioner did not

subtract from these amounts the value of products which she used
 - 4 -

personally or gave away and for which she had simultaneously

claimed a deduction for advertising expenses. Respondent

disallowed $4,964 and $5,160 for 1998 and 1999, respectively, of

the total amounts which petitioner had claimed as costs of goods

sold.

2. Mortgage Interest

In 1984, petitioner and her then husband, John Little (Mr.

Little), borrowed $25,000 from Tri-Counties Bank, to pay expenses

incurred in their children's apparel business. Petitioner's

father, Vernon Blake (Mr. Blake), cosigned the note. Petitioner

and Mr. Little signed a "Security Agreement" with Mr. Blake and

signed quitclaim deeds on three properties as security for Mr.

Blake. Mr. Blake did not record his security interests in any of

the three properties.

In 1987, petitioner and Mr. Little filed a voluntary Chapter

7 Bankruptcy Petition. Mr. Blake never attempted to foreclose

upon his security interests in any of the properties.

During the bankruptcy, petitioner and Mr. Little

relinquished their interests in the properties. The bankruptcy

trustee disposed of the properties, and Mr. Blake did not receive

any of the properties or the proceeds from their sale.

Petitioner does not have any records from the 1987 bankruptcy and

does not know whether her father filed a claim or received any

distributions from the bankruptcy.
 - 5 -

Some time after 1984, the $25,000 loan with Tri-Counties

Bank was converted to a "line of credit" with Bank of America in

Mr. Blake's name. As of 1996, the amount Mr. Blake owed on the

Bank of America line of credit was still unpaid.

In 1996, Mr. Blake took out a mortgage on his home in the

amount of $30,000. Before this mortgage, Mr. Blake had owned the

home free and clear of any debts or encumbrances since he had

purchased it in 1993.

Mr. Blake and Bank of America agreed: (a) That $14,832 of

the $30,000 mortgage would be applied against the line of credit

which Mr. Blake owed to Bank of America; (b) that $6,664 of the

$30,000 mortgage would be applied against a VISA account held by

petitioner and her father with Bank of America; and (c) that Bank

of America would forgive $5,7353 of debt owed by Mr. Blake to

Bank of America.

Petitioner and her father both lived in the home from

January 1998 through August 1998 when Mr. Blake died.

Petitioner inherited the house and has continued to live there

since her father's death.

Petitioner made all of the mortgage payments on the home

during 1998 and 1999, but the mortgage account remained in her

father's name. The interest portions of the mortgage payments

3
Bank of America reported to the I.R.S. that, for the 1996
tax year, Mr. Blake had $5,735 of income from debt cancellation.
 - 6 -

for 1998 and 1999 totaled $2,370 and $2,346, respectively.

Petitioner claimed mortgage interest deductions in these amounts

on her 1998 and 1999 Schedules C. Respondent disallowed these

amounts in full.

Discussion

Deductions are a matter of legislative grace, and the

taxpayer bears the burden of proving the entitlement to any

deductions claimed. See INDOPCO, Inc. v. Commissioner, 503 U.S.

79, 84 (1992). Taxpayers generally bear the burden of proving

that the Commissioner’s determinations are incorrect. Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). The

resolution of the issues in this case does not depend on which

party has the burden of proof. The Court resolves these issues

on the preponderance of evidence in the record. Therefore

section 7491 does not apply here.

1. Product-Related Expenses

Section 162(a) allows a taxpayer deductions for ordinary and

necessary business expenses incurred during the taxable year in

carrying on a trade or business. Generally, a taxpayer must

establish that deductions taken pursuant to section 162 are

ordinary and necessary business expenses and must maintain

records sufficient to substantiate the amounts of the deductions

claimed. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.
 - 7 -

Section 262, however, expressly provides that no deduction

shall be allowed for personal, living, or family expenses. For

each of the years in issue, petitioner claimed a Schedule C

deduction for advertising expenses for Herbalife products she

purchased. However, petitioner personally consumed the majority

of the Herbalife products she purchased. She also gave away an

undocumented portion of the purchases as samples.

Additionally, in computing her costs of goods sold,

petitioner failed to deduct from her purchases the products she

consumed personally or gave away. As a result, petitioner's

costs of goods sold are improperly inflated. As detailed supra,

petitioner deducted these same amounts as advertising expenses.

To allow petitioner not only to report these amounts as

costs of goods sold but also to deduct them as advertising

expenses would allow her "the practical equivalent of double

deduction." United States v. Skelly Oil Co., 394 U.S. 678, 684

(1969); Charles Ilfeld Co. v. Hernandez, 292 U.S. 62, 68 (1934);

United Telecomm., Inc. v. Commissioner, 589 F.2d 1383, 1388 (10th

Cir. 1978), affg. 67 T.C. 760 (1977) and 65 T.C. 278 (1975).

As this Court has previously held, "The Code 'should not be

interpreted' to allow double deductions for the same amount

'absent a clear declaration of intent by Congress,' * * * and we

do not think section 162(a) reflects any such intent." Brenner

v. Commissioner, 62 T.C. 878, 885 (1974) (quoting United States
 - 8 -

v. Skelly Oil Co., supra at 684). The Court sustains

respondent's determinations disallowing petitioner's advertising

expense deductions and the improperly claimed amounts for costs

of goods sold.

2. Mortgage Interest

For 1998 and 1999, petitioner claimed deductions for

mortgage interest on her Schedules C. Petitioner alleges she

paid a mortgage in her father's name largely because Mr. Blake

assumed in full and refinanced petitioner's 1984 business loan

which he had originally cosigned. Petitioner has not provided

evidence to show what portion of the mortgage payments, if any,

represents interest on the debt she owed her father. Therefore,

she is not entitled to Schedule C business interest deductions.

Section 163(a) allows a deduction for interest paid or

accrued within the taxable year on indebtedness. The

"indebtedness" for purposes of section 163 must, in general, be

an obligation of the taxpayer and not an obligation of another.

Golder v. Commissioner, 604 F.2d 34, 35 (9th Cir. 1979), affg.

T.C. Memo. 1976-150; Smith v. Commissioner, 84 T.C. 889, 897

(1985), affd. without published opinion 805 F.2d 1073 (D.C. Cir.

1986); Hynes v. Commissioner, 74 T.C. 1266, 1287 (1980).

However, section 1.163-1(b), Income Tax Regs., provides, in

pertinent part:
 - 9 -

Interest paid by the taxpayer on a mortgage upon real
estate of which he is the legal or equitable owner,
even though the taxpayer is not directly liable upon
the bond or note secured by such mortgage, may be
deducted as interest on his indebtedness. * * *

Only interest paid on a mortgage on property for the period after

the taxpayer becomes the legal or equitable owner of the property

is deductible by the taxpayer as interest on her indebtedness.

Zards v. Commissioner, T.C. Memo. 1995-497 (citing Hyde v.

Commissioner, 64 T.C. 300, 306 (1975)).

State law determines the nature of property rights, and

Federal law determines the appropriate tax treatment of those

rights. See United States v. Natl. Bank of Commerce, 472 U.S.

713, 722 (1985); Aquilino v. United States, 363 U.S. 509, 513

(1960). Thus, whatever rights or interests, if any, petitioner

held in the property during the years at issue must be determined

by applying applicable California law.

Under California law, title to the property of a decedent's

estate vests, subject to administration, in his or her heirs or

devisees and legatees immediately on death. Cal. Prob. Code sec.

7000 (West 2004); Olson v. Toy, 54 Cal. Rptr. 2d 29, 33 (Ct. App.

1996) (citing Dorland v. Dorland, 3 Cal. Rptr. 262, 265 (Dist.

Ct. App. 1960)); Raczynski v. Judge, 230 Cal. Rptr. 741, 745 (Ct.

App. 1986). Such vesting is not contingent on any assent,

acceptance, or election by the heirs. Estate of Taylor v.

Crippled Children's Socy., 108 Cal. Rptr. 778, 781 (Ct. App.
 - 10 -

1973) (citing Estate of Meyer v. McGrath, 238 P.2d 597, 605 (Cal.

Dist. Ct. App. 1951)). Thus, here, legal title to the property

passed to petitioner at the time of Mr. Blake's death, in August

1998.

The Court holds that petitioner is entitled only to mortgage

interest deductions on Schedules A, Itemized Deductions, for the

interest portion of mortgage payments she made on the property

from the date of Mr. Blake's death in August 1998 through

December 1999. Petitioner is not entitled to a mortgage interest

deduction on Schedule A for payments she made prior to Mr.

Blake's death because she was not directly liable on the note

securing the mortgage and she has failed to prove that she was

the legal, equitable, or beneficial owner of the property during

that period.

Reviewed and adopted as the report of the Small Tax Case

Division.

Decision will be entered

under Rule 155.