The opinion
T.C. Memo. 2013-222
UNITED STATES TAX COURT
LARRY ZAVADIL AND DIANE ZAVADIL, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 17403-10. Filed September 19, 2013.
Joseph A. Nilan and Joshua A. Dorothy, for petitioners.
Blaine C. Holiday, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MARVEL, Judge: Respondent determined the following deficiencies in
petitioners’ Federal income tax and section 6662(a)1 accuracy-related penalties:
1
Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the years in issue, and all Rule references are to
(continued...)
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[*2] Penalty
Year Deficiency sec. 6662(a)
2004 $163,806 $32,761
2005 130,126 26,025
After concessions, the issues for decision are: (1) whether petitioners are entitled
to charitable contribution deductions in excess of the $218,355 and $202,059 that
respondent allowed for 2004 and 2005, respectively; (2) whether petitioners
substantiated nonpassive, unreimbursed expenses of $185,800 and $75,000 that
they claimed on their Schedules E, Supplemental Income and Loss, attached to
their Forms 1040, U.S. Individual Income Tax Return, for 2004 and 2005,
1
(...continued)
the Tax Court Rules of Practice and Procedure. Monetary amounts have been
rounded to the nearest dollar.
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[*3] respectively;2 and (3) whether petitioners are liable for accuracy-related
penalties under section 6662(a) for 2004 and 2005.
FINDINGS OF FACT
Some of the facts have been stipulated. The stipulation of facts is
incorporated herein by this reference. Petitioners resided in Minnesota when they
petitioned this Court.
I. Background
A. American Solutions for Business
Mr. Zavadil organized American Business Forms, Inc. (ABF), in February
1981. ABF is a subchapter S corporation organized under Minnesota law that did
2
Respondent disallowed unreimbursed expenses of $220,684 and $165,259
that petitioners claimed on Schedules E attached to their Forms 1040 for 2004 and
2005, respectively. The unreimbursed expenses originally at issue were as
follows:
Description 2004 2005
Travel expenses $32,184 $90,259
Payments to Becky DePree 38,500 -0-
Payments to NBD&F 150,000 75,000
Total 220,684 165,259
Petitioners concede that (1) they are unable to substantiate their claimed
travel expenses and (2) Ms. DePree received $35,800 in 2004 and not $38,500 .
Accordingly, the unreimbursed expenses remaining at issue are the $35,800 paid
to Ms. DePree in 2004 and the $150,000 and $75,000 paid to NBD&F in 2004 and
2005, respectively.
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[*4] business during the years in issue as American Solutions for Business (ASB).3
Mr. Zavadil was ASB’s sole shareholder until June 27, 2000. On that date Mr.
Zavadil sold all of the outstanding shares of ASB to ASB’s newly formed
employee stock ownership plan (ESOP). In exchange for his shares of ASB Mr.
Zavadil received a $28,760,000 note from ASB, payable with interest in 20
consecutive annual installments. After the sale of his ASB shares Mr. Zavadil
continued to serve without compensation on ASB’s board of directors and as its
CEO.
In 2000 ASB’s board of directors consisted of Mr. Zavadil, Curt Briggs, and
Joseph A. Nilan (petitioners’ counsel in this case). Mr. Briggs was also the
president of National Business Development & Finance (NBD&F) during the
years in issue. After the formation of the ESOP, and at the request of Wells Fargo,
Jeff Seidel joined ASB’s board of directors.
B. American Diversity Business Solutions
Diane Zavadil organized American Minority Business Forms, Inc. (AMBF)
in June 1992. AMBF is a subchapter S corporation that did business during the
3
Although the corporation’s official name is American Business Forms, Inc.,
the parties and witnesses consistently referred to the corporation by its trade name,
American Solutions for Business, and we do the same.
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[*5] years in issue as American Diversity Business Solutions (ADBS). Mrs.
Zavadil was the sole shareholder of ADBS during the years in issue.
C. Zavadil Development
Mr. Zavadil organized Zavadil Development, Inc., a subchapter S
corporation, in January 2000. Mr. Zavadil was the sole shareholder of Zavadil
Development during the years in issue.
D. Account No. 5458
During 2004 and part of 2005 Mr. Zavadil maintained a checking account
with an account number ending in 5458 (account No. 5458) at Glenwood State
Bank in the name of “Larry Zavadil Expense Account”. Before April 2005 the
checks written on account No. 5458 stated: “Zavadil Sales Company, Larry
Zavadil Expense Account”. At some time in April 2005, the checks written on
account No. 5458 stated: “Larry Zavadil Expense Account”. In November or
December 2005 Mr. Zavadil changed the name on account No. 5458 to “Zavadil
Development, Inc., Expense Account Larry Zavadil”.
II. Mr. Zavadil’s ASB Ledger Account
ASB maintained a ledger account on its books to keep track of Mr.
Zavadil’s non-ASB expenditures. The ledger account was maintained by Marci
Henke, an ASB employee. To generate a ledger entry either Mr. Zavadil would
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[*6] instruct Ms. Henke to ask ASB’s finance department to issue a check for a
non-ASB item or he would charge a non-ASB item to his ASB credit card. Mr.
Zavadil would then instruct Ms. Henke or his executive assistant, Gladys Freese,
to charge the item back to his ASB ledger account.
During the years in issue Ms. Henke and/or Ms. Freese charged various
non-ASB expenses to Mr. Zavadil’s ASB ledger account. Included in those
charges were the following: (1) various charitable contributions; (2) monthly
payments to Becky DePree, the former wife of a longtime ASB employee, the late
Dusty DePree; (3) monthly payments to NBD&F; and (4) advances to account No.
5458.
ASB’s creditors required ASB to ensure that all salesperson ledger accounts
were paid off each month, and Mr. Zavadil accordingly wrote checks drawn on
account No. 5458 to pay off his ledger at the end of each month.4 However, at the
end of several months during the years in issue Mr. Zavadil had insufficient funds
in account No. 5458 to clear the checks drawn on that account. In those months
Mr. Zavadil caused ASB to (1) transfer sufficient funds from ASB to account No.
5458 to cover the check (or checks) drawn on account No. 5458; (2) record the
4
On several occasions Mr. Zavadil also wrote checks drawn on account No.
5458 to pay off part of his ASB ledger account balance in the middle of the month.
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[*7] charge on his ASB ledger account; and (3) then cash the check (or checks)
drawn on account No. 5458.
The following table shows (1) the balance of Mr. Zavadil’s ASB ledger
account before the check (or checks) drawn on account No. 5458 was (or were)
credited to it at the end of the month; (2) the amount of the check (or checks)
drawn on account No. 5458; and (3) the amount that ASB advanced to account
No. 5458 and recorded on Mr. Zavadil’s ASB ledger account after the payment
amount was credited to Mr. Zavadil’s ASB ledger account and on or before the
date that the check (or checks) drawn on account No. 5458 cleared:
Amount of Amount
Ending balance of check(s) drawn on advanced before
Month ASB ledger account account No. 5458 check(s) cleared
2004
January $194,146 $170,000 -0-
February 319,051 319,051 $150,000
March 736,253 736,253 -0-
April 431,943 431,343 400,000
May 1,244,386 1,244,386 -0-
June 500,994 500,994 -0-
July 709,507 709,507 -0-
August 384,676 384,676 87,000
September 438,756 437,406 -0-
October 928,756 927,084 -0-
November 162,131 162,131 142,000
December 621,137 621,137 -0-
-8-
[*8] 2005
January 883,810 883,810 -0-
February 758,089 758,089 500,000
March 391,678 391,678 -0-
April 909,035 909,035 373,000
May 1,139,012 1,139,012 180,000
June 1,134,978 1,134,978 -0-
July 1,429,372 1,429,372 587,000
August 1,428,517 1,428,517 62,000
September 1,258,723 1,258,723 1,371,000
October 1,579,358 1,579,358 1,302,000
November 1,813,757 1,813,757 1,800,000
December 1,508,316 1,508,316 Unknown1
1
The record does not contain a copy of Mr. Zavadil’s ledger
account for any month after December 2005. However, the bank
statements for account No. 5458 show a deposit of $1,610,000 on Jan.
3, 2006.
III. Petitioners’ Tax Reporting
Petitioners reported adjusted gross income of $3,613,063 and $3,074,750 on
their Forms 1040 for 2004 and 2005, respectively. They claimed charitable
contribution deductions of $576,827 and $535,731 on the Schedules A, Itemized
Deductions, attached to their Forms 1040 for 2004 and 2005, respectively.
On statements attached to their 2004 and 2005 Forms 1040 petitioners listed
their Schedule A charitable contribution deductions as follows:
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[*9] Description Amount
2004
Church of the Sacred Heart $53,000
St. Mary’s 11,667
Various--ledger 494,562
Diocese of St. Cloud 12,000
Various 1,487
From K-1--AMBF 4,111
Total for 2004 576,827
2005
Church of the Sacred Heart 29,000
Church of the Sacred Heart 21,000
St. Mary’s 30,100
Habitat for Humanity 5,000
Various--ledger 411,934
Miscellaneous 418
Public TV 249
Guthrie Theatre 9,792
Ellis Island 21,500
MPLS Inst. of Arts 3,000
NIAF 2,000
From K-1--AMBF 1,738
Total for 2005 535,731
Petitioners also attached Schedules E to their 2004 and 2005 Forms 1040.
On a statement attached to their 2004 Form 1040 petitioners reported nonpassive
losses of $220,684 for “unreimbursed expenses” relating to AMBF. On a
statement attached to their 2005 Form 1040 petitioners reported nonpassive losses
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[*10] of $75,000 and $90,259 for “unreimbursed expenses” relating to AMBF and
Zavadil Development, respectively.
OPINION
I. Burden of Proof
Generally, the taxpayer bears the burden of proving that he is entitled to any
claimed deduction. See Rule 142(a)(1); INDOPCO, Inc. v. Commissioner, 503
U.S. 79, 84 (1992). This includes the burden of substantiation. Sec. 6001;
Hradesky v. Commissioner, 65 T.C. 87, 89 (1975), aff’d per curiam, 540 F.2d 821
(5th Cir. 1976); sec. 1.6001-1(a), (e), Income Tax Regs. If, however, a taxpayer
produces credible evidence5 with respect to any factual issue relevant to
ascertaining the taxpayer’s tax liability for any tax imposed by subtitle A or B of
the Code and satisfies the requirements of section 7491(a)(2), the burden of proof
on any such issue shifts to the Commissioner. Sec. 7491(a)(1). Section
7491(a)(2) requires a taxpayer to demonstrate that he or she (1) complied with
requirements under the Code to substantiate any item, (2) maintained all records
required under the Code, and (3) cooperated with reasonable requests by the
5
“‘Credible evidence is the quality of evidence which, after critical analysis,
the court would find sufficient upon which to base a decision on the issue if no
contrary evidence were submitted (without regard to the judicial presumption of
IRS correctness).’” Higbee v. Commissioner, 116 T.C. 438, 442 (2001) (quoting
H.R. Conf. Rept. No. 105-599, at 240-241 (1998), 1998-3 C.B. 747, 994-995).
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[*11] Secretary6 for witnesses, information, documents, meetings, and interviews.
See also Higbee v. Commissioner, 116 T.C. 438, 440-441 (2001).
The parties do not discuss the applicability of section 7491(a)(1) to this
case, and we cannot determine from the record whether petitioners met the
requirements of section 7491(a)(2). Accordingly, the burden of proof remains on
petitioners.
II. Charitable Contribution Deductions
A. Charitable Contributions Generally
Generally, section 170(a) allows a deduction for any charitable contribution
made by a taxpayer. A charitable contribution may be effected through the efforts
of an agent acting for the donor. See Skripak v. Commissioner, 84 T.C. 285, 318
(1985); Weitz v. Commissioner, T.C. Memo. 1989-99, 56 T.C.M. (CCH) 1422,
1426-1427 (1989). “Agency is the fiduciary relationship that arises when one
person (a ‘principal’) manifests assent to another person (an ‘agent’) that the agent
shall act on the principal’s behalf and subject to the principal’s control, and the
agent manifests assent or otherwise consents so to act.” 1 Restatement, Agency
6
The term “Secretary” means the Secretary of the Treasury or his delegate.
Sec. 7701(a)(11)(B).
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[*12] 3d, sec. 1.01 (2006); see also Senor v. Bangor Mills, Inc., 211 F.2d 685, 688
(3d Cir. 1954); Weitz v. Commissioner, 56 T.C.M. (CCH) at 1427.
Deductions for charitable contributions of money are subject to the
recordkeeping requirements of section 1.170A-13(a), Income Tax Regs. For
contributions of $250 or more, the taxpayer must also substantiate the contribution
with a contemporaneous written acknowledgment from the donee organization.7
Sec. 170(f)(8)(A); sec. 1.170A-13(f)(1), Income Tax Regs.
Section 170(f)(8)(B) provides as follows with respect to the content of the
required contemporaneous written acknowledgment:
(B) Content of acknowledgment.--An acknowledgment meets
the requirements of this subparagraph if it includes the following
information:
(i) The amount of cash and a description (but not value)
of any property other than cash contributed.
(ii) Whether the donee organization provided any goods
or services in consideration, in whole or in part, for any
property described in clause (i).
(iii) A description and good faith estimate of the value of
any goods or services referred to in clause (ii) or, if such goods
7
Separate contributions of less than $250 are not subject to the requirements
of sec. 170(f)(8), regardless of whether the contributions made by a taxpayer to a
donee organization during a taxable year total $250 or more. Sec.
1.170A-13(f)(1), Income Tax Regs.
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[*13] or services consist solely of intangible religious benefits, a statement
to that effect.
B. Charitable Contributions at Issue
Respondent disallowed charitable contribution deductions of $358,472 and
$333,672 for 2004 and 2005, respectively. Petitioners conceded that they are not
entitled to some of the claimed charitable contribution deductions. However, the
parties disagree with respect to (1) whether petitioners are bound by certain
monetary concessions in the petition and (2) whether certain of the claimed
charitable contributions should be disallowed for reasons that are unrelated to the
parties’ primary dispute. The parties contend that the charitable deductions
properly at issue are as follows:
2004 2005
Per petitioners $222,675 $165,219
Per respondent 217,514 150,045
1. Whether Petitioners Are Bound by Amounts They Conceded in
the Petition
Respondent contends that petitioners conceded in their petition that they are
not entitled to $140,958 and $183,627 of the claimed charitable contribution
deductions for 2004 and 2005, respectively.8 Accordingly, respondent contends
8
In their petition, petitioners concede that (1) they received value in
(continued...)
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[*14] that only $217,514 and $150,045 of the claimed charitable contribution
deductions for 2004 and 2005, respectively, are at issue.
Petitioners contend that respondent will not be prejudiced if we disregard
the monetary amounts of the concessions set forth in the petition because they are
challenging respondent’s deficiency determinations only with respect to the
charitable contribution deductions that respondent determined to be the charitable
contributions of ASB.
Respondent did not explain in the notice of deficiency his reasons for
disallowing the charitable contribution deductions. Petitioners in their petition
attempted to quantify the amounts at issue. In doing so petitioners made it clear
that they were contesting respondent’s determinations only with respect to the
charitable contributions that respondent disallowed because he determined that
they were the charitable contributions of ASB. Respondent does not contend that
he previously allowed any of the contributions that petitioners listed in their
summary of contributions at issue or that he in any way relied on petitioners’
concessions in preparing this case for trial. We find that respondent will not be
8
(...continued)
exchange for $32,744 and $36,579 of the disallowed contributions for 2004 and
2005, respectively; and (2) they failed to substantiate $108,215 and $147,048 of
the disallowed contributions for 2004 and 2005, respectively.
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[*15] prejudiced by our consideration of all of the charitable contribution
deductions that were disallowed for the reason identified in the petition, and we
conclude therefore that with the exception of certain contributions discussed
below, see infra part II.B.2, all such contributions are properly at issue.9
2. Whether Additional Disputed Amounts Are at Issue
Petitioners introduced summary exhibits purporting to list charitable
contribution deductions at issue of $237,305 and $171,572 for 2004 and 2005,
respectively. At trial petitioners conceded the following adjustments to their
summary exhibits:10
9
We note, however, that upon realizing that they erroneously conceded
certain amounts in the petition, petitioners should have moved to amend the
petition pursuant to Rule 41(a).
10
Petitioners disavow on brief three additional concessions that they made at
trial: First, petitioners conceded that the second receipt on page 483 of Exhibit
22-J shows that the deductible amount was less than the gift amount. Petitioners
now contend that this receipt was dated December 31, 2003, and was therefore not
included in their summary of charitable contributions at issue for 2004. Second,
petitioners conceded that the second receipt on page 525 of Exhibit 22-J shows
that the deductible amount was less than the gift amount. Petitioners now contend
that they included the deductible amount for this contribution only in their
summary of charitable contributions at issue for 2004. Third, petitioners conceded
that the receipt on page 768 of Exhibit 22-J shows that the deductible amount was
less than the gift amount. Petitioners now contend that they included the
deductible amount for this contribution only in their summary of charitable
contributions at issue for 2005. We agree with petitioners that these concessions
were erroneous and that therefore no adjustments to the amounts at issue are
(continued...)
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[*16] Original Corrected
claimed claimed Net
Date Donee amount amount correction
1
2/12/04 St. Anthony Med. Ctr. $834 $1,834 $1,000
4/13/04 Guthrie 3,500 3,456 (44)
5/21/04 Univ. of Minn. Found. (UMF) 3,900 3,120 (780)
5/21/04 UMF 2,600 2,080 (520)
Net correction for 2004 (344)
5/20/05 Nat’l Ethnic Coal. of Orgs.
Found. 25,000 21,500 (3,500)
11/25/05 Guthrie 10,000 9,792 (208)
Net correction for 2005 (3,708)
1
$1,000 was charged to Mr. Zavadil’s ledger on Feb. 12, 2004,
and $834 was charged to his ledger on Sept. 23, 2004.
In their reply brief petitioners concede that they are not entitled to deduct
additional contributions because either (1) the corresponding receipts lacked the
required section 170(f)(8) statement or (2) the contributions were not charged to
Mr. Zavadil’s ASB ledger account. Petitioners’ concessions are as follows:
10
(...continued)
required on account of these concessions.
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[*17] Date Donee Amount
Receipts missing sec. 170(f)(8) statement
2/12/04 Girl Scout Troop 630 $500
3/10/04 Nat’l Wild Turkey Fed’n 250
3/14/04 First Baptist Church of 500
Glenwood
4/19/04 Terrace Mill Found. 250
5/24/04 Minnewaska Lake Ass’n 500
12/13/04 Armful of Love 12,000
Total for 2004 14,000
1/11/05 United Way of Douglas & Pope 1,200
Cntys.
2/22/05 Pioneer Pub. TV 250
5/5/05 United Way of Douglas & Pope 345
Cntys.
11/25/05 Pioneer Pub. TV 250
Total for 2005 2,045
Contributions not charged to ledger account
1/2/04 Am. Cancer Soc’y (ACS) 225
6/14/04 Nat’l Child Safety Council 61
Total for 2004 286
1
9/20/05 Nw. Minn. Found. 100
12/17/05 Ann & Andy Preschool 500
Total for 2005 600
1
In fact, this contribution was charged to Mr. Zavadil’s
ASB ledger account on the date stated in petitioners’ summary
of contributions at issue.
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[*18] Petitioners’ contentions with respect to the amounts of charitable
contributions at issue for 2004 and 2005, respectively, can be summarized as
follows:
2004 2005
Petitioners’ summary of charitable contributions at issue $237,305 $171,572
Petitioners’ concessions at trial (344) (3,708)
Missing sec. 170(f)(8) statement (14,000) (2,045)
Contributions not charged to ledger account (286) (600)
Petitioners’ final claimed contributions at issue 222,675 165,219
Respondent contends that additional contributions are not properly at issue
because either (1) the receipts for the contributions lacked the required section
170(f)(8) statement or (2) the contributions were not charged to Mr. Zavadil’s
ASB ledger account. The contributions that respondent contends are not properly
at issue but not conceded by petitioners are as follows:
Date Donee Amount
Receipts missing sec. 170(f)(8) statement
5/21/04 Minnewaska High School $166
11/22/04 Norgaard Elementary 145
Total for 2004 311
3/24/05 Hospice 59
3/24/05 Norgaard Elementary 33
4/22/05 Norgaard Elementary 33
Total for 2005 125
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[*19] Contributions not charged to ledger account
3/30/04 UMF 237
1
5/21/04 UMF 406
2
5/21/04 UMF 3,120
3
5/21/04 UMF 2,080
4
6/4/04 ACS 800
5
6/15/04 ACS 250
6/22/04 UMF 52
6
6/24/04 UMF 30,000
6
6/24/04 UMF 40,000
7
8/3/04 ACS 525
8
8/4/04 UMF 1,500
12/13/04 UMF 80
Total for 2004 79,050
9
6/16/05 UMF 2,000
7/20/05 ACS 50
7/20/05 ACS 50
10/18/05 UMF 160
Total for 2005 2,260
1
The receipt that petitioners introduced for this contribution
recognizes a contribution of $106.
2
Petitioners concede that they are not entitled to deduct the full
$3,900 payment to UMF that they claimed on their summary of
contributions at issue. See supra part II.B.2.
3
Petitioners concede that they are not entitled to deduct the full
$2,600 payment to UMF that they claimed on their summary of
contributions at issue. See supra part II.B.2.
4
The receipt that petitioners introduced for this contribution
recognizes a contribution in memory of Helen Hustad, Ida Ronnei,
Dale McLain, Susanne Lauer, Richard Frederick, John Arneson,
Howard Elwood, and Clara Cummins. We find that contributions in
their memory were recorded as having occurred on Mr. Zavadil’s
ASB ledger account on May 17, 2004, each in the amount of $100.
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[*20] 5The receipt that petitioners introduced for this contribution
recognizes a contribution from Zavadil Sales Co. that occurred on
June 15, 2004. Zavadil Sales is not an incorporated entity. See infra
part II.C.2. We find that Mr. Zavadil made this contribution directly
from his own funds.
6
The receipts that petitioners introduced for this contribution
recognize contributions made by credit card. We find that these
contributions were recorded on Mr. Zavadil’s ASB ledger account as
having occurred on July 22, 2004, when ASB paid off the $70,000
credit card bill.
7
The receipt that petitioners introduced for this contribution
recognizes a contribution in memory of Norval Lund, Lyle Anderson,
Mable Evenson, Elvera Neros, Julian Nygaard, Mary Hvezda, James
Berg, Gerald Wold, and Ken Helgeson. We find that contributions in
their memory were recorded on Mr. Zavadil’s ASB ledger account as
having occurred on July 6 or 14, 2004, in the amounts of $50, $100,
$25, $25, $100, $100, $25, and $50, respectively.
8
The receipt that petitioners introduced for this contribution
recognizes a contribution of $1,100 and is dated Aug. 4, 2004. This
contribution was recorded on Mr. Zavadil’s ASB ledger account as
having occurred on May 3, 2004, in the amount of $1,500.
9
Petitioners’ summary of contributions combined the claimed
charitable contribution deduction for this contribution with that of a
second contribution to UMF and claimed a total charitable
contribution deduction for both contributions of $6,843. The receipt
that petitioners introduced for this contribution recognizes a
contribution of $2,000, states that only $1,600 of the contribution is
deductible, and is dated June 16, 2005. The receipt for the second
contribution recognizes a contribution of $10,000, states that $5,243
of the contribution is deductible, and is dated June 15, 2005. We find
that these contributions were recorded on Mr. Zavadil’s ASB ledger
account as having occurred on June 16, 2005, in the amount of
$12,000.
With respect to the contribution receipts that respondent contends lack the
required section 170(f)(8) statement, we note that the contributions covered by
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[*21] those receipts were for less than $250. Accordingly, section 170(f)(8)
statements were not required, see sec. 170(f)(8)(A); sec. 1.170A-13(f)(1), Income
Tax Regs., and these contributions are therefore properly at issue.
With respect to the contributions that respondent contends were not charged
to Mr. Zavadil’s ASB ledger account, we find that only the following
contributions were not charged to the ledger account:
Date Donee Amount
3/30/04 UMF $237
1
5/21/04 UMF 406
6/22/04 UMF 52
12/13/04 UMF 80
Total for 2004 775
10/18/05 UMF 160
Total for 2005 160
1
As noted supra p. 19, the receipt for this contribution
recognizes a contribution of only $106.
Petitioners contend that these contributions were not charged to Mr.
Zavadil’s ASB ledger account because they were paid by ASB in cash, rather than
by check or credit card. Petitioners have not introduced any evidence to support
their contention that Mr. Zavadil bore the economic burden of the cash
contributions. Accordingly, we find that petitioners are not entitled to a deduction
for these contributions. See Rule 142(a)(1).
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[*22] C. Charitable Contributions Charged to Mr. Zavadil’s ASB Ledger
Account
Petitioners contend that they properly deducted the charitable contributions
at issue because Mr. Zavadil bore the economic burden of the charitable
contributions that were charged to his ASB ledger account and therefore ASB paid
the amounts in question as Mr. Zavadil’s agent. Respondent contends that (1)
ASB, and not Mr. Zavadil, bore the economic burden of the charitable
contributions; (2) even if ASB did not bear the economic burden of the charitable
contributions, Zavadil Development, and not Mr. Zavadil, bore that burden; and
(3) petitioners did not show that ASB acted as an agent of Mr. Zavadil.
1. Whether ASB Bore the Economic Burden of the Charitable
Contributions
Respondent contends that ASB bore the economic burden of the charitable
contributions at issue because Mr. Zavadil used a circular flow of funds to ensure
that he did not bear the economic burden of the contributions. In particular,
respondent contends that Mr. Zavadil would regularly (1) issue checks from
account No. 5458 at the end of the month to pay off his ledger; (2) advance
sufficient funds from ASB to account No. 5458 at the beginning of the next month
to cover the check drawn on account No. 5458; and then (3) cause ASB to cash the
check from account No. 5458. For example, Mr. Zavadil’s ASB ledger account
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[*23] shows that an outstanding balance of $1,813,757 was paid with a check from
account No. 5458 on November 30, 2005.11 The ledger account further shows that
ASB advanced $1,800,000 to Mr. Zavadil on December 5, 2005. The bank
statement for account No. 5458 reflects a deposit of $1,800,000 on December 5,
2005. The bank statement for account No. 5458 further shows that $1,813,757
(check No. 16743) was debited from the account on December 5, 2005.
Respondent’s argument is too broad and fails to recognize that Mr. Zavadil
at certain times during the years at issue fully paid his ASB ledger account
balances with his own funds. The record shows that the alleged circular flow of
funds of which respondent complains did not become a regular pattern until the
second half of 2005. Moreover, the record shows that Mr. Zavadil paid his ASB
ledger account balances as of December 31, 2004, and June 30, 2005, without the
benefit of any advances from ASB to cover the payments. Because Mr. Zavadil’s
ASB ledger account balances were fully paid off at the end of December 2004 and
June 2005 without an advance to cover those months’ payments, any previous
advances were necessarily paid off. Accordingly, we conclude that ASB did not
bear the economic burden of the charitable contributions charged to Mr. Zavadil’s
ASB ledger account before July 2005.
11
The ledger entry states “CREDIT PMT. BY PERS. CK#16743”.
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[*24] We reach a different conclusion, however, with respect to the charitable
contributions made from Mr. Zavadil’s ASB ledger account after June 2005. From
July 2005 through at least November 2005 Mr. Zavadil caused ASB to advance
funds to account No. 5458 to cover the checks drawn on that account to pay off his
ASB ledger balance for those months.12 This circular flow of funds resulted in
ASB’s assumption of most, if not all, of the economic burden of the charitable
contributions charged to Mr. Zavadil’s ASB ledger account after June 2005.
Petitioners failed to prove what portion, if any, of the charitable
contributions made after June 2005 Mr. Zavadil effectively paid with his own
funds and not funds advanced by ASB. Petitioners also introduced no credible
evidence that Mr. Zavadil’s ASB ledger account balance at the end of 2005
represented bona fide indebtedness of Mr. Zavadil. We therefore conclude that
petitioners have failed to carry their burden of showing that Mr. Zavadil, and not
ASB, bore the economic burden of the charitable contributions at issue that were
made after June 2005. See Rule 142(a)(1).
12
The record does not show whether ASB advanced funds to account No.
5458 to cover the $1,508,316 check drawn on that account to pay off his ASB
ledger at the end of December 2005. However, the bank statements for account
No. 5458 show that a deposit of $1,610,000 was made to that account on the day
that the check cleared.
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[*25] 2. Whether Zavadil Development Bore the Economic Burden of
the Charitable Contributions
Respondent contends that even if we find that ASB did not bear the
economic burden of the charitable contributions at issue, Zavadil Development,
and not Mr. Zavadil, bore that burden because Mr. Zavadil paid off the balance of
his ASB ledger account from an account of Zavadil Development.
Respondent’s contention is based on his assertion that account No. 5458
was owned by Zavadil Development. However, the parties stipulated that account
No. 5458 was a “Zavadil Sales Company account”, and Mr. Zavadil and Colette
Carlson, a certified public accountant who has prepared petitioners’ tax returns
since the early 1990s, both credibly testified that account No. 5458 was Mr.
Zavadil’s business account for his unincorporated sales activities that he first
started using in 1981, if not earlier.13 Moreover, the name appearing on the bank
statements for account No. 5458 does not include Zavadil Development until at
least November or December 2005. And although Mr. Zavadil testified that he
13
As Mr. Zavadil noted at trial, the check numbers for account No. 5458
corroborate his testimony that the account has been in use for a long time. Check
No. 14113 was drawn on account No. 5458 on January 20, 2004. Check No.
16888 was drawn on account No. 5458 on January 5, 2006. During this roughly
two-year period, Mr. Zavadil wrote 2,775 checks against account No. 5458, or
around 1,387 per year. Mr. Zavadil formed Zavadil Development in January 2000,
and it is unlikely that Mr. Zavadil wrote 14,112 checks during the four years
between January 2000 and January 2004.
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[*26] used some of the funds that he deposited into account No. 5458 to fund
Zavadil Development’s real estate investments, there is nothing in the record that
contradicts the parties’ stipulation and Mr. Zavadil and Ms. Carlson’s testimony
that account No. 5458 was an account of Zavadil Sales. Zavadil Sales is not an
incorporated entity. We therefore find that Mr. Zavadil, and not Zavadil
Development, bore the economic burden of the charitable contributions charged to
his ASB ledger account before July 2005.
3. Whether ASB Was Mr. Zavadil’s Agent
Respondent contends that petitioners have not shown that ASB acted as Mr.
Zavadil’s agent in making the charitable contributions at issue. Respondent notes
that although an agency relationship does not require a written agreement, see
PMH Props. v. Nichols, 263 N.W.2d 799, 803 (Minn. 1978), there still must be
evidence that the agent assented to the undertaking, see id. However, Mr. Zavadil
credibly testified that he directed ASB employees to make the charitable
contributions on his behalf. Moreover, Mr. Zavadil’s testimony was corroborated
by the testimony of Ms. Freese and Ms. Carlson and by the introduction of the
ledger itself into evidence. We infer that, as CEO of ASB, Mr. Zavadil could
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[*27] cause ASB to assent to being his agent in making the charitable
contributions at issue.14
Respondent further contends that this case is distinguishable from cases
such as Skripak v. Commissioner, 84 T.C. at 318, and Weitz v. Commissioner, 56
T.C.M. (CCH) at 1426-1427, where we held that charitable contributions can be
effected through an agent of the taxpayer, because the agents in those cases
contributed the principals’ assets whereas ASB contributed its own money and not
Mr. Zavadil’s money. But by agreeing to act as Mr. Zavadil’s agent in making the
charitable contributions at issue, ASB also agreed to advance the contributed
amounts to Mr. Zavadil. We therefore find that ASB acted as an agent of Mr.
Zavadil when it made the charitable contributions at issue. Accordingly, we (1)
conclude that petitioners are entitled to deduct the charitable contributions at issue
that were charged to Mr. Zavadil’s ASB ledger account before July 2005 and (2)
sustain respondent’s disallowance of the charitable contribution deductions at
14
Respondent points to the fact that ASB was recognized as a 10-year
member of the Minnesota Keystone Program for donating at least 2% of its pretax
earnings to charity. “The Minnesota Keystone Program is a program of the
Minneapolis Regional Chamber of Commerce.”
http://www.minneapolischamber.org/clientuploads/docs/2011/KeystoneInsert_Ov
erview.pdf (last visited July 2, 2013). We do not think that ASB’s participation in
this private program is particularly useful in deciding whether ASB was acting as
an agent of Mr. Zavadil when it made the charitable contributions at issue.
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[*28] issue that were charged to Mr. Zavadil’s ASB ledger account after June
2005.
III. Unreimbursed Expenses
Respondent disallowed the unreimbursed expenses of $220,684 and
$165,259 that petitioners claimed on the Schedules E attached to their Forms 1040
for 2004 and 2005, respectively. After concessions, the unreimbursed expenses
remaining at issue are the $35,800 paid to Ms. DePree in 2004 and the $150,000
and $75,000 paid to NBD&F in 2004 and 2005, respectively.15
A. Section 162(a) Generally
Section 162(a) provides a deduction for ordinary and necessary expenses
that a taxpayer pays or incurs during the taxable year in carrying on a trade or
business. Section 162(a) requires a taxpayer to prove that the expenses deducted
(1) were paid or incurred during the taxable year, (2) were incurred to carry on the
taxpayer’s trade or business, and (3) were ordinary and necessary expenditures of
the business. See also Commissioner v. Lincoln Sav. & Loan Ass’n, 403 U.S.
345, 352 (1971). An expense is ordinary if it is customary or usual within a
15
Because we sustain respondent’s disallowance of the unreimbursed
expenses at issue for the reasons discussed below, we need not address
respondent’s alternative contention that ASB or Zavadil Development bore the
economic burden of these expenses, and not Mr. Zavadil.
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[*29] particular trade, business, or industry or relates to a transaction “of common
or frequent occurrence in the type of business involved.” Deputy v. du Pont, 308
U.S. 488, 495 (1940). An expense is necessary if it is appropriate and helpful for
the development of the business. See Commissioner v. Heininger, 320 U.S. 467,
471 (1943).
Generally, a taxpayer who pays another taxpayer’s business expenses may
not treat those payments as ordinary and necessary expenses incurred in the
payor’s business. See Columbian Rope Co. v. Commissioner, 42 T.C. 800, 815
(1964); see also Interstate Transit Lines v. Commissioner, 319 U.S. 590, 593-594
(1943); Deputy v. du Pont, 308 U.S. at 494-495; S. Am. Gold & Platinum Co. v.
Commissioner, 8 T.C. 1297, 1301-1302 (1947), aff’d, 168 F.2d 71 (2d Cir. 1948).
However, where a taxpayer pays the ordinary and necessary business expenses of
another taxpayer in order to protect or promote the payor’s own business, the
payment may be deductible. See, e.g., Scruggs--Vandervoort--Barney, Inc. v.
Commissioner, 7 T.C. 779, 787 (1946); Moloney Elec. Co. v. Commissioner, 42
B.T.A. 78, 83 (1940), aff’d in part, rev’d in part on another issue, 120 F.2d 617
(8th Cir. 1941); First Nat’l Bank of Skowhegan, Me. v. Commissioner, 35 B.T.A.
876, 884-885 (1937). In Lohrke v. Commissioner, 48 T.C. 679, 688 (1967), we
articulated a two-part test for determining whether a taxpayer’s payments are
- 30 -
[*30] eligible for this exception: (1) the taxpayer’s primary motive for paying the
expenses was to protect or promote the taxpayer’s business and (2) the
expenditures constituted ordinary and necessary expenses in the furtherance or
promotion of the taxpayer’s business.
B. Payments to Ms. DePree
Petitioners contend that they can deduct $35,800 that Mr. Zavadil charged
to his ASB ledger account in 2004 for payments to Ms. DePree because the
payments satisfied an obligation of ASB that it refused to pay. Additionally,
petitioners contend that ASB would have been allowed to deduct the payments to
Ms. DePree had it made the payments itself because ASB originally agreed to
make the payments on account of Mr. DePree’s long and valuable service to ASB.
The payments to Ms. DePree were recorded on Mr. Zavadil’s ASB ledger
account. Mr. Zavadil testified that, after Mr. DePree died in 1999, he promised to
pay Ms. DePree $250,000 over five years to provide additional compensation for
Mr. DePree’s hard, and often undercompensated, work for ASB during its early
years.16 Mr. Zavadil further testified that, when the ESOP acquired the
16
We note that, in a statement attached to petitioners’ 2004 Form 1040,
petitioners reported that the unreimbursed expenses at issue for 2004, including
the payments to Ms. DePree, were attributable to unreimbursed expenses of
AMBF. To explain this discrepancy, petitioners called their return preparer, Ms.
(continued...)
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[*31] outstanding shares of ASB, the ESOP declined to continue making payments
to Ms. DePree because ASB’s board of directors (board) concluded that (1) the
payments to Ms. DePree were the personal obligations of Mr. Zavadil and (2) it
would be better if the ESOP were not burdened with these payment because the
ESOP already carried significant debt.
Petitioners contend that they disagreed with the board’s decision to
terminate ASB’s payments to Ms. DePree and that, therefore, Mr. Zavadil was
simply paying Ms. DePree what ASB had previously agreed to pay her.
Petitioners further contend that Mr. Zavadil continued paying Ms. DePree to
protect his reputation as a salesperson. However, Mr. Zavadil did not testify that
he continued paying Ms. DePree because he was concerned about his business
reputation, and there is no factual basis in the record to support a finding that Mr.
Zavadil made the payments to protect his reputation.
We conclude that petitioners have failed to satisfy the first part of Lohrke’s
two-part test. See Rule 142(a)(1); Lohrke v. Commissioner, 48 T.C. at 688.
16
(...continued)
Carlson, to testify at trial. Ms. Carlson testified that she originally understood
from her conversations with Mr. Zavadil that the payments were deductible
because Ms. DePree provided consulting services to AMBF. Petitioners did not
call Ms. DePree to testify at trial as to the nature of the payments she received.
- 32 -
[*32] Accordingly, we sustain respondent’s disallowance of the unreimbursed
expense deduction petitioners claimed for the amount paid to Ms. DePree in 2004.
C. Payments to NBD&F
Petitioners contend that they can deduct $150,000 and $75,000 charged to
Mr. Zavadil’s ASB ledger account in 2004 and 2005, respectively, for payments to
NBD&F because the payments were compensation for services actually rendered
to Mr. Zavadil’s various wholly owned business entities.
NBD&F was Mr. Briggs’ consulting company. The payments to NBD&F
were recorded on Mr. Zavadil’s ASB ledger account. Mr. Zavadil testified that
Mr. Briggs mostly provided consulting services for entities belonging to Mr. or
Mrs. Zavadil, and therefore the payments to Mr. Briggs were charged to his ASB
ledger account. Mr. Zavadil further testified that Mr. Briggs was a member of
ASB’s board of directors when the ESOP was formed in 2000.
We infer from Mr. Zavadil’s vague testimony that Mr. Briggs provided
some services to ASB during the years in issue. Mr. Zavadil, however, did not call
Mr. Briggs to testify as to the nature of the payments NBD&F received and he did
not otherwise introduce any credible evidence about the nature of the payments.
Petitioners do not contend, and have introduced no credible evidence showing,
that Mr. Zavadil paid ASB’s NBD&F consulting expenses to protect or promote
- 33 -
[*33] his other business activities. See Lohrke v. Commissioner, 48 T.C. at 688.
Because petitioners have failed to introduce any credible evidence regarding the
nature and purpose of the payments at issue, we sustain respondent’s disallowance
of the unreimbursed expenses that petitioners claimed for the amounts paid to
NBD&F in 2004 and 2005, respectively.
IV. Accuracy-Related Penalty Under Section 6662(a)
Section 6662(a) and (b)(1) and (2) authorizes the Commissioner to impose a
20% penalty on an underpayment of tax that is attributable to, among other things,
(1) negligence or disregard of rules or regulations or (2) any substantial
understatement of income tax. Only one section 6662 accuracy-related penalty
may be imposed with respect to any given portion of an underpayment. New
Phoenix Sunrise Corp. v. Commissioner, 132 T.C. 161, 187 (2009), aff’d, 408 Fed.
Appx. 908 (6th Cir. 2010); sec. 1.6662-2(c), Income Tax Regs.
The term “negligence” includes any failure to make a reasonable attempt to
comply with the provisions of the internal revenue laws, and the term “disregard”
includes any careless, reckless, or intentional disregard. Sec. 6662(c); sec. 1.6662-
3(b)(1) and (2), Income Tax Regs. “‘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. Disregard of rules or regulations “is
- 34 -
[*34] ‘careless’ if the taxpayer does not exercise reasonable diligence to determine
the correctness of a return position” and “is ‘reckless’ if the taxpayer makes little
or no effort to determine whether a rule or regulation exists, under circumstances
which demonstrate a substantial deviation from the standard of conduct that a
reasonable person would observe.” Sec. 1.6662-3(b)(2), Income Tax Regs.; see
also Nis Family Trust v. Commissioner, 115 T.C. 523, 542 (2000). An
understatement means the excess of the amount of tax required to be shown on a
return over the amount of the tax imposed which is shown on the return, reduced
by any rebate. Sec. 6662(d)(2)(A). An understatement is substantial in the case of
an individual if the amount of the understatement for the taxable year exceeds the
greater of 10% of the tax required to be shown on the return or $5,000. Sec.
6662(d)(1)(A). An understatement is substantial in the case of a corporation if the
amount of the understatement for the taxable year exceeds the greater of 10% of
the tax required to be shown on the return or $10,000. Sec. 6662(d)(1)(B).
The accuracy-related penalty does not apply with respect to any portion of
the underpayment for which the taxpayer shows that there was reasonable cause
and that he or she acted in good faith. Sec. 6664(c)(1). The decision as to whether
a taxpayer acted with reasonable cause and in good faith is made on a case-by-case
basis, taking into account all of the pertinent facts and circumstances. See sec.
- 35 -
[*35] 1.6664-4(b)(1), Income Tax Regs. “Circumstances that may indicate
reasonable cause and good faith include an honest misunderstanding of fact or law
that is reasonable in light of all of the facts and circumstances, including the
experience, knowledge, and education of the taxpayer.” Id.
The Commissioner bears the burden of production with respect to the
taxpayer’s liability for the section 6662(a) penalty and must produce sufficient
evidence indicating that it is appropriate to impose the penalty. See sec. 7491(c);
Higbee v. Commissioner, 116 T.C. at 446-447. Once the Commissioner meets his
burden of production, the taxpayer must come forward with persuasive evidence
that the Commissioner’s determination is incorrect or that the taxpayer had
reasonable cause or substantial authority for the position. See Higbee v.
Commissioner, 116 T.C. at 447.
We have sustained, or petitioners have conceded, certain of respondent’s
adjustments to petitioners’ claimed charitable contribution and unreimbursed
business expense deductions for 2004 and 2005. The evidence shows that
petitioners did not comply with the rules and regulations under sections 162 and
170 in claiming these deductions. Respondent has therefore met his burden of
producing evidence showing that a section 6662(a) penalty for an underpayment
of tax attributable to negligence or disregard of rules or regulations with respect to
- 36 -
[*36] the disallowed deductions is appropriate. Petitioners have not shown that
such a penalty is inappropriate, and they do not contend that they acted with
reasonable cause and in good faith with respect to the underpayment.
Accordingly, petitioners are liable for a section 6662(a) penalty for an
underpayment of tax attributable to negligence or disregard of rules or regulations.
Alternatively, to the extent that the Rule 155 computations show that the
understatement of tax for 2004 or 2005 exceeds the greater of 10% of the tax
required to be shown on the return or $5,000, see sec. 6662(d)(1)(A), respondent
has met his burden of producing evidence showing that a section 6662(a) penalty
for an underpayment of tax attributable to a substantial understatement of income
tax is appropriate. Petitioners do not contend that they acted with reasonable
cause and in good faith with respect to the underpayments. Accordingly,
petitioners would be liable for a section 6662(a) penalty for an underpayment of
tax attributable to a substantial understatement of tax for such year or years.
However, petitioners will be liable for only one section 6662(a) penalty with
respect to any portion of the underpayment of tax.
- 37 -
[*37] We have considered the parties’ remaining arguments, and to the extent not
discussed above, conclude those arguments are irrelevant, moot, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.