The opinion
United States Tax Court
T.C. Summary Opinion 2024-18
JONATHAN CHANG AND WEI-LIN CHANG,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 6161-22S. Filed September 16, 2024.
—————
Jonathan Chang and Wei-Lin Chang, pro sese.
Matthew P. Crouch, for respondent.
SUMMARY OPINION
PANUTHOS, Special Trial Judge: This case was heard pursuant
to the provisions of section 7463 1 of the Internal Revenue Code in effect
when the Petition was filed. Pursuant to section 7463(b), the decision
to be entered is not reviewable by any other court, and this Opinion shall
not be treated as precedent for any other case.
In a Notice of Deficiency dated December 8, 2021, respondent
determined a deficiency in federal income tax of $11,380 and a section
6662(a) accuracy-related penalty of $2,256 for taxable year 2019 (year
in issue).
1 Unless otherwise indicated, statutory references are to the Internal Revenue
Code, Title 26 U.S.C., in effect at all relevant times, regulation references are to the
Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and
Rule references are to the Tax Court Rules of Practice and Procedure.
Served 09/16/24
2
After concessions, 2 the issues for decision are:
(1) whether petitioners are entitled to deduct legal and
professional expenses on Schedule C, Profit or Loss From
Business; and
(2) whether petitioners failed to report income of $410 for the year
in issue.
Background
Some of the facts have been stipulated and are so found. We
incorporate the Stipulation of Facts as supplemented and the attached
Exhibits by this reference. The record consists of the Stipulation of
Facts as supplemented with attached Exhibits and the testimony of
Jonathan Chang and Wei-Lin (Grace) Chang.
Petitioners resided in California when the Petition was timely
filed.
I. Petitioners’ Activities
Petitioners were members of Home of Christ 4 Church (HOC4) in
Saratoga, California. Beginning in or around 2001 petitioner Jonathan
Chang became an elder at HOC4 and took on financial responsibilities
which included managing donations and donors. At the time, Mr. Chang
worked at VIA Technologies, Inc., and served as a board director at S3
Graphics, Inc. (S3 Graphics). Both companies were under the same
ownership group. Mr. Chang was a close friend of the owner of the
companies.
Around 2004 Mr. Chang helped set up two entities. HOC
Associates, Inc. (HOCA Inc.), was incorporated in 2004, for the purpose
of “Christ-centered ministries, church purposes, [to] administer and
support religious activities, seminary activities, evangelical missions
and Christian services.” Petitioners were appointed directors of HOCA
Inc. on January 19, 2005. HOCA Inc. was granted tax-exempt status
under section 501(c)(3).
HOC Associates, LLC (HOCA LLC), was formed in 2004 as a for-
profit limited liability company and engaged in the business of “strategic
2 Respondent concedes that petitioners are not liable for the section 6662(a)
accuracy-related penalty for the year in issue.
3
planning and development,” which included the acquisition of rental
property and the receipt of rental income. Mr. Chang was the sole
member of HOCA LLC. S3 Graphics lent HOCA LLC $3 million. HOCA
LLC’s offices were at Mr. Chang’s home. Mr. Chang maintained the
records of the business. Mr. Chang did not have a real estate license.
In 2006 HOCA LLC acquired a residential property at 2091
Clematis Court in Fremont, California. HOCA LLC collected rental
income from the property for subsequent years.
At some time during the year in issue, “MFR REMEDIAION”
(MFR) issued to petitioner and filed with the Internal Revenue Service
(IRS) a Form 1099–MISC, Miscellaneous Income, reporting $410 in
other income for the year in issue.
II. Criminal Case
On February 4, 2016, Mr. Chang was indicted and charged with
multiple counts including conspiracy to commit wire fraud, wire fraud,
conspiracy to commit money laundering, and money laundering. 3 The
charges involved transactions to and from HOCA Inc., HOCA LLC, and
Mr. Chang’s personal account. 4 Upon the conclusion of trial in
September 2019, the jury found Mr. Chang guilty of four counts of wire
fraud and three counts of money laundering.
Beginning in 2016, Mr. Chang retained legal representation to
assist him in the criminal case. During the year in issue petitioners
incurred legal expenses of $365,735. This included attorney fees, expert
witness fees, translator fees, and other miscellaneous expenses. The
fees were paid from petitioners’ personal account, not from the HOCA
Inc. account or HOCA LLC account.
Petitioners timely filed Form 1040, U.S. Individual Income Tax
Return, for the year in issue. Petitioners reported on HOCA LLC’s
Schedule C, total legal and professional services expenses of $367,429
3 Pursuant to Rule 201 of the Federal Rules of Evidence, we take judicial notice
of certain filings in petitioner Jonathan Chang’s criminal case. See United States v.
Chang, No. 16-CR-00047 (N.D. Cal. filed Feb. 4, 2016). The Court provided the parties
with an opportunity to object to the taking of judicial notice. No objection was filed.
4 The criminal charges against Mr. Chang involve both HOCA Inc. and HOCA
LLC. The issue before us only involves HOCA LLC.
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for the year in issue. The return did not include any amounts reported
on the MFR Form 1099–MISC that was filed with the IRS.
On December 8, 2021, respondent issued a notice of deficiency and
disallowed all of the reported legal and professional expenses for the
year in issue.
Discussion
In general, the Commissioner’s determination set forth in a notice
of deficiency is presumed correct, and the taxpayer bears the burden of
proving that the determination is in error. Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933). 5 Deductions are a matter of
legislative grace, and the taxpayer bears the burden of proving that he
or she is entitled to any deduction claimed. See Rule 142(a); Deputy v.
du Pont, 308 U.S. 488, 493 (1940); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934).
I. Section 162 Generally
Section 162(a) allows a deduction for all ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any
trade or business. An ordinary and necessary expense is one which is
appropriate and helpful to the taxpayer’s business and results from an
activity that is common and accepted practice in the business. Amdahl
Corp. & Consol. Subs. v. Commissioner, 108 T.C. 507, 523 (1997);
Blossom Day Care Ctrs., Inc. v. Commissioner, T.C. Memo. 2021-87,
at *36. “Business expenses deductible from gross income include the
ordinary and necessary expenditures directly connected with or
pertaining to the taxpayer’s trade or business . . . .” Treas. Reg.
§ 1.162-1(a). A taxpayer claiming a deduction must show that a reported
business expense was incurred primarily for business rather than
personal reasons and that there was a proximate relationship between
the expense and the business. Walliser v. Commissioner, 72 T.C. 433,
437 (1979); Rogers v. Commissioner, T.C. Memo. 2014-141, at *18. No
deduction is allowed for personal, living, or family expenses. § 262(a).
Whether a payment qualifies for a deduction under section 162(a) is a
factual issue which must be decided on the basis of all relevant facts and
5 Pursuant to section 7491(a), the burden of proof as to factual matters shifts
to the Commissioner under certain circumstances. Petitioners have neither alleged
that section 7491(a) applies nor established compliance with its requirements.
Petitioners therefore bear the burden of proof.
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circumstances. See Commissioner v. Heininger, 320 U.S. 467, 475
(1943).
There is no question that petitioners incurred $365,735 in legal
expenses during the year in issue. Petitioners produced invoices and
other documents that verify the legal expenses, and respondent does not
dispute that petitioners paid those expenses.
The deductibility of legal fees also depends on the origin and
character of the claim for which the expenses were incurred and whether
the claim bears a sufficient nexus to the taxpayer’s business or income
producing activities. See United States v. Gilmore, 372 U.S. 39, 48–49
(1963). The Supreme Court has stated that “the origin and character of
the claim with respect to which an expense was incurred, rather than
its potential consequences upon the fortunes of the taxpayer, is the
controlling basic test.” Id. at 49. If the claim arises “in connection with
the taxpayer’s profit-seeking activities,” the fees are deductible; if not,
they are not deductible. Id. at 48. Public policy does not prohibit the
deduction of legal fees relating to criminal activity so long as the legal
fees are an ordinary and necessary expense of a trade or business.
Commissioner v. Tellier, 383 U.S. 687, 694–95 (1966).
Petitioners maintain that the legal fees are a deductible business
expense because they were incurred in the defense of a criminal case
involving HOCA Inc. and HOCA LLC and their activities.
Consequentially, petitioners contend that the legal fees were an
ordinary and necessary expense to defend the HOCA entities in
litigation. Mr. Chang testified that the business purpose of HOCA LLC
was “strategic planning and development” which involved purchasing
rental properties and receiving rental income, among other activities.
Mr. Chang also testified and produced documents indicating that HOCA
LLC, HOCA Inc., HOC4, and S3 Graphics were involved in various
financial arrangements. These arrangements included purchasing real
estate, collecting rental income, and paying interest on a loan.
Respondent asserts that HOCA LLC did not engage in a trade or
business as demonstrated by the lack of gross receipts for the year in
issue and therefore was not a legitimate business. He argues that
petitioners are not entitled to deduct legal fees under section 162 as the
legal fees did not have a proximate relationship to a trade or business.
See Walliser, 72 T.C. at 437. Instead, respondent argues that the legal
expenses were of a personal rather than a business nature. He asserts
that the criminal charges are distinguishable from the business of
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HOCA LLC as the charges arose from Mr. Chang’s embezzlement of
funds. While the funds acquired by Mr. Chang were deposited and used
by HOCA LLC, respondent contends that HOCA LLC activities did not
give rise to the criminal charges. Rather, respondent believes that Mr.
Chang’s personal activities in his role as an elder of the church
originated the criminal charges.
Respondent also argues that the legal fees were personal because
they were paid from petitioners’ personal account rather than a business
account. In response petitioners testified that their attorneys requested
payment be made from a personal account and produced a retainer
agreement that provides that the payments be made from sources that
have no connection to the criminal charges. We are satisfied with
petitioners’ explanation.
Upon review of the criminal proceedings, there is some doubt as
to whether HOCA LLC was a legitimate business. The criminal
conviction supports allegations that Mr. Chang conspired and
participated in wire fraud and money laundering. Those charges involve
transactions that were made between the HOCA entities and Mr.
Chang. Therefore, from the record, it appears that Mr. Chang’s plans to
commit wire fraud and money laundering in addition to those
transactions between Mr. Chang and the HOCA entities gave rise to the
claim originating the legal fees at issue. We conclude that the origin of
petitioners’ legal fees stem from Mr. Chang’s business activities as the
director of the HOCA entities. While those activities have some
relevance to Mr. Chang’s position as an elder, they were ultimately
profit-seeking activities. See Gilmore, 372 U.S. at 48.
As indicated previously, although seemingly against public policy,
legal fees relating to criminal activity may be deducted as an ordinary
and necessary expense of a trade or business. Commissioner v. Tellier,
383 U.S. at 694–95. The Court concludes that at least part of Mr.
Chang’s business activities in HOCA LLC were to defraud donors and
others for his personal financial benefit. Accordingly, petitioners are
entitled to deduct legal and professional expenses for the year in issue.
II. Unreported Income
In order for the presumption of correctness to attach to the
deficiency determination in unreported income cases in the U.S. Court
of Appeals for the Ninth Circuit, the Commissioner must establish
“some evidentiary foundation” connecting the taxpayer with the income-
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producing activity or demonstrate that the taxpayer received
unreported income. Weimerskirch v. Commissioner, 596 F.2d 358, 361–
62 (9th Cir. 1979), rev’g 67 T.C. 672 (1977). Once the Commissioner
introduces such evidence, the burden shifts to the taxpayer to show by
a preponderance of the evidence that the determination was arbitrary
or erroneous. Klootwyk v. Commissioner, T.C. Memo. 2006-130, slip op.
at 4–5. Respondent provided a sworn Declaration of respondent’s
paralegal specialist assigned to the case. The Declaration attaches an
account transcript indicating a Form 1099–MISC from “MFR
REMEDIAION” reporting income of $410.
Gross income includes “all income from whatever source derived.”
§ 61(a). Payments that are “undeniable accessions to wealth, clearly
realized, and over which the taxpayers have complete dominion” are
taxable as income unless an exclusion applies. Commissioner v.
Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
Petitioners do not deny receiving such income. At trial, Mr.
Chang stated that he was not familiar with the income item but did not
provide any further information. Petitioners have not carried their
burden.
Accordingly, we will sustain respondent’s determination with
respect to petitioners’ failure to report income.
The Court has considered all of the arguments made by the
parties, and to the extent they are not addressed herein, they are
considered moot, irrelevant, or otherwise without merit.
To reflect the foregoing,
Decision will be entered under Rule 155.