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.
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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.
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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
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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.
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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.
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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.
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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
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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:
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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.
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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.