The opinion
T.C. Memo. 2003-30
UNITED STATES TAX COURT
MICHAEL CHIN AND JULIE HEDRICH CHIN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 599-01. Filed February 6, 2003.
Robert F. Klueger, for petitioners.
Michael W. Berwind, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: Respondent determined deficiencies in
petitioners’ Federal income tax and penalties for the taxable
years 1994 and 1997 as follows:
Penalty
Year Deficiency Sec. 6662(h)
1994 $22,319 $8,928
1997 22,318 8,927
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All 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, unless otherwise
indicated.
After concessions,1 the sole issue for our consideration is
whether petitioners have shown entitlement to a deduction for
rent payments as ordinary and necessary business expenses under
section 162(a).
FINDINGS OF FACT2
Petitioners Michael Chin and Julie Hedrich Chin resided in
Corona, California, at the time their petition was filed in this
case. Michael Chin3 (petitioner) graduated from medical school
in 1984 and became licensed to practice medicine as both a
physician and surgeon in California on December 16, 1985.
Petitioner’s primary medical practice specialty is general
surgery, and his secondary practice specialty is vascular
surgery. During the years at issue, petitioner leased or
subleased two offices in Corona, California, and one office in
1
In the statutory notice of deficiency, respondent
determined accuracy-related penalties due to a gross valuation
misstatement under sec. 6662(h). Respondent conceded the sec.
6662(h) penalties in his posttrial brief.
2
The parties’ stipulations of facts are incorporated by
this reference.
3
Petitioner Julie Hedrich Chin is a party to this case by
reason of the fact that she filed joint Federal income tax
returns with Michael Chin for the years at issue.
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Wildomar, California, to operate his medical practice. All three
offices were within Riverside County limits, and petitioner paid
aggregate rent for the offices of $31,760 in 1994 and $24,039 in
1997.
At all pertinent times petitioner maintained appropriate
State, county, and local licenses to conduct business at all of
his office locations in Riverside County and maintained hospital
privileges at several hospitals in Riverside County. Petitioner
also maintained both general business and surgical telephone
listings in three local Riverside County telephone directories
and was a member of the Riverside County Medical Association.
For the 1994 and 1997 tax years, petitioner reported on his
Schedule C, Profit or Loss From Business, gross receipts of
$1,056,961 and $1,253,902, respectively. All of these gross
receipts were derived from petitioner’s medical practice at the
three Riverside County offices. Further, for 1994 and 1997,
petitioner reported taxable income of $620,115 and $737,341,
respectively, and was in the 39.6-percent tax rate bracket.
In November 1989, petitioner’s mother, Chi Ying Chin,
acquired a commercial building at 13732 Ventura Boulevard,
Sherman Oaks, California (Sherman Oaks Property). Sherman Oaks,
California, is approximately 10 miles northwest of Los Angeles
and approximately 70 miles west of Riverside County.
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On November 18, 1991, the Skin Service Club, Inc. (Skin
Service Club), was incorporated as a C corporation under
California law. Petitioner and his brother, David Sywehong
Chin, each owned 50 percent of the Skin Service Club stock. Two
years later, on November 15, 1993, the Skin Service Club elected
to be taxed as an S corporation.
The Skin Service Club conducted business at the Sherman Oaks
Property in 1992, 1993, and 1994. Petitioner, however, did not
acquire, in his name, any City of Los Angeles permits or licenses
needed to conduct business in the town of Sherman Oaks. In
addition, petitioner never maintained a medical or surgical
listing in any Sherman Oaks telephone directory, and he was not a
member of the Los Angeles County Medical Society.
For both years at issue, the Skin Service Club reported zero
gross receipts. Further, the Skin Service Club did not generate
any revenue from the time of its conversion to an S corporation
through December 30, 1996, when the company was dissolved.
During its entire period of operation, the Skin Service Club did
not claim any rent expense relating to the Sherman Oaks Property.
On November 13, 1991, petitioner executed a 10-year lease on
suite B of the Sherman Oaks Property, with petitioner’s mother as
landlord. Under the terms of the lease, petitioner made rent
payments to his mother of $52,000 in 1994 and $48,000 in 1997.
Petitioner deducted these amounts as business expenses on his
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Schedule C attached to his Forms 1040, U.S. Individual Income Tax
Return, for each tax year. Notwithstanding petitioner’s 1997
rent payments, the Sherman Oaks Property was vacant during this
entire year.
Petitioner’s mother reported the payments received from
petitioner as rental income on her 1994 and 1997 tax returns. In
1994, despite $52,000 in rent receipts from petitioner,
petitioner’s mother had zero taxable income after deductions. In
1997, petitioner’s mother had taxable income of $56,778 and was
in the 28-percent tax rate bracket.
During 1994 and 1995, petitioner’s brother filed three
business name registrations in the State of California, each
designating the Sherman Oaks Property as the place of business.
One of the filings, that of Great Western Kingdom, specifically
designated suite B of the Sherman Oaks Property as the company’s
place of business. In 1994, petitioner paid his brother $36,000
in nonemployee compensation, which petitioner reported using a
Form 1099-MISC, Miscellaneous Income, and petitioner’s brother
reported on his Schedule C as gross receipts from Great Western
Kingdom.
OPINION
The question we consider is whether petitioner is entitled
to deduct the Sherman Oaks Property rent payments (rent payments)
made to his mother as ordinary and necessary business expenses
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under section 162. Section 162(a) allows a deduction for “all
the ordinary and necessary expenses paid or incurred during the
taxable year in carrying on any trade or business”. Section
162(a)(3) specifically includes “rentals or other payments
required to be made as a condition to the continued use or
possession, for purposes of the trade or business, of property to
which the taxpayer has not taken or is not taking title or in
which he has no equity” as deductions that qualify as ordinary
and necessary.
The question as to whether an expenditure satisfies the
requirements of section 162 is one of fact. Commissioner v.
Heininger, 320 U.S. 467 (1943). In addition, “intrafamily
transactions resulting in the distribution of income within a
family unit are subject to the closest scrutiny.” Van Zandt v.
Commissioner 40 T.C. 824, 830 (1963) (citing Commissioner v.
Tower, 327 U.S. 280 (1946); Helvering v. Clifford, 309 U.S. 331
(1940)), affd. 341 F.2d 440 (5th Cir. 1965).
Petitioner maintains that the Sherman Oaks Property rent
payments were made as part of an oral agreement between him and
his brother when incorporating the Skin Service Club in 1991. In
return for the contribution of day-to-day management services to
the corporation by petitioner’s brother, petitioner would be
solely obligated to make rent payments on the Sherman Oaks
Property lease. Petitioner further maintains that the agreement
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called for petitioner’s brother to perform cosmetology services
and to refer his clients to petitioner for sclerotherapy
treatment of varicose veins.
Petitioner argues that he conducted his medical practice at
the Sherman Oaks Property as a part of the business activity of
the Skin Service Club. Petitioner further argues that, despite
the fact that the Skin Service Club is a corporation,
petitioner’s rent payments for the years at issue were deductible
on petitioner’s Schedule C as ordinary and necessary business
expenses relating to petitioner’s personal medical practice. On
the other hand, respondent argues that petitioner was not
involved in any business activity at the Sherman Oaks Property
during the years at issue, and therefore petitioner’s rent
payments were not incurred to carry on a trade or business under
section 162. Respondent further argues that the rent payments
were in actuality a redistribution of income from petitioner, who
was in the highest tax bracket, to his mother, who was in a lower
tax bracket. We agree with respondent.
We note that a “deduction is a matter of legislative grace
and that the burden of clearly showing the right to the claimed
deduction is on the taxpayer.”4 INDOPCO, Inc. v. Commissioner,
503 U.S. 79, 84 (1992); see also Rule 142(a). Therefore,
4
The examination commenced before July 22, 1998.
Accordingly sec. 7491 burden of proof and production standards
are not applicable. See sec. 7491.
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petitioner must establish that his Sherman Oaks Property rent
payments were incurred in carrying on his trade or business.
Petitioner has not shown that he ever conducted his medical
practice at Sherman Oaks Property. The only evidence petitioner
offered was his own self-serving testimony that he had an oral
agreement with his brother and that he saw patients at Sherman
Oaks Property in 1991 and 1992. As we do not need to accept
self-serving testimony without corroborating evidence, this
testimony, by itself, is not enough to establish that petitioner
conducted business activity at the Sherman Oaks Property during
1994 and 1997. Niedringhaus v. Commissioner, 99 T.C. 202 (1992).
Further, even if we accepted petitioner’s testimony, it does not
relate to business activity at the Sherman Oaks Property for the
1994 and 1997 tax years. Petitioner offers no evidence
indicating that he conducted his medical practice at the Sherman
Oaks Property in either 1994 or 1997.
Many facts, however, indicate an absence of business
activity by petitioner at the Sherman Oaks Property during the
years at issue. Petitioner did not take any of the customary
steps of starting up a medical practice at Sherman Oaks Property
that he had taken in Riverside County. Petitioner did not
acquire business permits or licenses, did not maintain any type
of local telephone listing, did not have any local hospital
privileges, and was not a member of the Los Angeles County
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Medical Society. Even if petitioner was to rely on his brother
for patient referrals, these customary business steps were not
taken to attract clients in addition to the referrals.
Most notably, petitioner fails to explain how he could have
conducted his medical practice at the Sherman Oaks Property while
failing to generate any revenue. In 1994, petitioner reported
Schedule C gross receipts of $1,056,961. None of these gross
receipts were shown to be derived from activity at the Sherman
Oaks Property. Further, the Skin Service Club reported zero
gross receipts on its S corporation tax return. If petitioner
had conducted his medical practice at the Sherman Oaks Property
at any time in 1994, such activity would have generated revenue
reportable on either petitioner’s Schedule C or the Skin Service
Club’s corporate return.
Respondent concedes that the Skin Service Club conducted
some business activity at the Sherman Oaks Property during 1994.
However, the business activity was minimal at best, with zero
revenue and minimal expenses. There is no evidence indicating
that petitioner was involved with the Skin Service Club’s
business activity during 1994.
In 1997, none of petitioner’s $1,253,902 Schedule C gross
receipts were derived from activity at the Sherman Oaks Property.
Further, the Skin Service Club was dissolved before 1997, and the
Sherman Oaks Property was completely vacant for the entire year.
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Given these facts, no business activity was conducted by anyone
at the Sherman Oaks Property in 1997.
Although there was little or no business activity during the
years at issue, petitioner had entered into a lease for the
property, paid rent, and had some type of informal understanding
or arrangement with his brother relating to the Skin Service
Club. These facts, at least in form, suggest the expectation of
possible business activity. However, according to the record and
in substance, petitioner’s rent payments merely benefited
petitioner’s brother and mother. Petitioner’s brother was
provided with a place to operate various of his business
ventures, and petitioner’s mother received monthly income
payments. In addition, petitioner has not shown any relationship
between the rent payments and any income-producing activity of
petitioner, including his medical practice. Although
petitioner’s rent payments reflect his generosity to his family,
they fall short of the section 162 standard for deductibility.
Accordingly, we hold that petitioner did not conduct any
business activity at the Sherman Oaks Property during 1994 or
1997. We further hold that petitioner’s relationship to his
brother and/or the Skin Service Club does not provide a basis for
petitioner to claim a deduction for rental expenses on his
personal Schedule C. Any business activity that did occur at the
Sherman Oaks Property during the years at issue could only have
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been that of one of the several ventures entered into by
petitioner’s brother.5 Petitioner’s rent payments were personal
expenditures unrelated to his medical practice and designed to
support his brother’s business interests while shifting income to
his mother, who was in a lower tax bracket.
To the extent not herein discussed, we have considered all
other arguments made by the parties and conclude that they are
moot or without merit.
To reflect the foregoing and concessions of the parties,
Decision will be entered
for respondent.
5
Petitioner did not argue that the rent payments were a
type of investment or contribution of capital in the Skin Service
Club entitling him to deductions for one-half of the rent
payments via the S corporation pass-through rules.