The opinion
T.C. Summary Opinion 2010-79
UNITED STATES TAX COURT
MUHAMMAD AHMED ALVI, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15655-08S. Filed June 21, 2010.
Muhammad Ahmed Alvi, pro se.
Thomas D. Yang, for respondent.
DEAN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 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. Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year in issue,
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and all Rule references are to the Tax Court Rules of Practice
and Procedure.
The issues for decision are whether for 2005: (1)
Petitioner’s activities constituted separate activities; (2)
petitioner’s activities were operating as going concerns, and if
so, whether expenses attributable to the activities are
deductible on Schedule C, Profit or Loss From Business; (3)
petitioner is liable for an addition to tax under section
6651(a)(1); and (4) petitioner is liable for an addition to tax
under section 6654(a).
Background
Some of the facts have been stipulated and are so found.
The stipulations of fact and the attached exhibits are
incorporated herein by this reference. When petitioner filed his
petition, he resided in Illinois.
On a 2005 Federal income tax return provided to the Court on
the date of trial, petitioner reported $4,387 of gross income and
$55,067 of total expenses on Schedule C. For 2005 he also
reported gross receipts of $17,610 for his work as a physician on
Schedule C-EZ, Net Profit From Business.
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I. Petitioner’s “Business” Activities
During 2005 petitioner managed several activities under a
single “business” name, SkillsSoft.1 He hired several employees
to develop the activities, and the employees performed work for
all of the activities using the same tools, software programs,
and resources.
Petitioner’s activities encompassed a variety of interests.
His activities consisted of: (1) Edokan, an online retail sales
Web site; (2) efattofit.com, a weight loss Web site, designed to
assist consumers with determining their body mass index and
calculating their body’s optimal caloric intake; (3) Desi, a
Pakistani language video and music Web site; (4) an individual
weight loss software program; (5) a software program for Urdu to
English and English to Urdu translation and an Internet-based
dictionary; and (6) software for a physician’s desk reference
guide.
Edokan was the only activity to generate income in 2005.
Petitioner did not develop or reduce to writing a business
plan or a written advertising or marketing plan for his
1
Petitioner reported on Schedule C that his activity
operated under the name SkillsSoft/Edokan. He reported his
activities on Schedule C as one activity with two separate names,
SkillsSoft and Edokan, that comprised a total of six activities.
Petitioner described SkillsSoft as a software and Web site
development company and Edokan as an online retail company.
Consistent with our findings, we refer to SkillsSoft and Edokan
as separate activities.
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activities. Although he planned to generate revenue through
advertising sales, he did not maintain or develop a potential
customer list for his activities.
Petitioner incurred considerable expenses developing the
activities, including oil and fuel expenses, legal and
professional fees, Internet and cable expenses, phone bills,
utility expenses, equipment expenses, and other miscellaneous
expenses.
Petitioner believed that because expenses for the activities
exceeded his income, he was not required to file a Federal income
tax return for 2005. He conceded that he earned income of
$17,610 as reported on Form 1099-MISC, Miscellaneous Income, but
thought that the losses from his activities offset his income for
2005.
II. Notice of Deficiency
Respondent prepared for petitioner a substitute for return
for 20052 and on the basis of that return issued to petitioner a
notice of deficiency. In the notice of deficiency respondent
determined a deficiency in petitioner’s Federal income tax of
2
Respondent did not demonstrate that the substitute for
return constituted a sec. 6020(b) return. See Spurlock v.
Commissioner, T.C. Memo. 2003-124.
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$3,349 and additions to tax under sections 6651(a)(1) and (2) and
6654(a) of $753.53, $385.14, and $134.34, respectively.3
Discussion
Generally, the Commissioner’s determinations are presumed
correct, and the taxpayer bears the burden of proving that those
determinations are erroneous.4 Rule 142(a); see INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); Welch v. Helvering, 290
U.S. 111, 115 (1933).
As a preliminary matter, respondent alleged that
petitioner’s activities did not constitute a single activity.
Accordingly, the Court must first address the threshold issue of
whether petitioner’s activities constituted a single activity.
I. Petitioner’s Activities
Multiple undertakings of a taxpayer may be treated as one
activity if the undertakings are sufficiently connected. Sec.
1.183-1(d)(1), Income Tax Regs. The most important factors in
making this determination are the degree of organizational and
economic interrelationship of the undertakings, the business
purpose served by carrying on the undertakings separately or
3
Respondent has conceded the sec. 6651(a)(2) addition to tax
and has requested an increase in the sec. 6651(a)(1) addition to
tax.
4
Petitioner has not claimed or shown that he meets the
requirements under sec. 7491(a) to shift the burden of proof to
respondent as to any factual issue relating to his liability for
tax.
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together, and the similarity of the undertakings. Id. The
Commissioner generally accepts the taxpayer’s characterization of
two or more undertakings as one activity unless the
characterization is artificial or unreasonable. Id.
Factors considered in determining whether the taxpayer’s
characterization is reasonable include: (1) Whether the
undertakings are conducted at the same place; (2) whether the
undertakings were part of the taxpayer’s efforts to find sources
of revenue from his or her land; (3) whether the undertakings
were formed as separate activities; (4) whether one undertaking
benefited from the other; (5) whether the taxpayer used one
undertaking to advertise the other; (6) the degree to which the
undertakings shared management; (7) whether the taxpayer used the
same accountant for the undertakings; and (8) the degree to which
the undertakings shared books and records. Topping v.
Commissioner, T.C. Memo. 2007-92.
Petitioner contends that he operated his activities as a
single activity. His employees, operating from a central
location in Pakistan, developed the activities interactively,
using the same tools, programs, and resources. Petitioner
explained that he did not calculate the expenses and revenue of
his activities separately, but rather as if operating as one
activity. In addition, he maintained that the activities would
depend on one another to promote their business because he
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planned to use each activity as an advertising base for the other
activities.
Although petitioner’s employees developed the activities
from a central location, the activities themselves vary
substantially. Given the unique nature of each activity it is
unlikely that the activities operated interdependently or shared
a common customer base or clientele. There is no common link as
to product or service and there is no indication that the
activities generated goodwill for one another.
The Court is unable to conclude, on the basis of the record,
that the activities were conducted as one activity despite the
central source of operations. They were separate activities
which would each generate a unique customer base and advertising
clientele. Consequently, the Court addresses separately whether
each activity was operating as a going concern during 2005.
Respondent alleges that petitioner’s 2005 expenditures were
startup expenditures and therefore subject to the limitations of
section 195.5 In the alternative, respondent contends that
petitioner failed to conduct his activities with a profit
5
Respondent did not contest that Edokan was operating as a
going concern in 2005. Respondent maintains, however, that
Edokan was not engaged in for profit and that petitioner’s
expenses are nondeductible expenses under sec. 162.
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objective and that he is therefore excluded from claiming expense
deductions except to the extent provided by section 183.6
II. Startup Expenditures
While section 162 generally allows a deduction for ordinary
and necessary expenses paid in connection with carrying on a
trade or business, the trade or business must be functioning as a
business at the time the taxpayer incurred the expenses. Hardy
v. Commissioner, 93 T.C. 684, 687 (1989), affd. in part and
remanded in part per order (10th Cir., Oct. 29, 1990); Woody v.
Commissioner, T.C. Memo. 2009-93; Glotov v. Commissioner, T.C.
Memo. 2007-147; sec. 1.162-1(a), Income Tax Regs. For this
purpose, “A taxpayer is not carrying on a trade or business under
section 162(a) until the business is functioning as a going
concern and performing the activities for which it was
organized.” Glotov v. Commissioner, supra. Until that time,
expenses related to the activity are not ordinary and necessary
expenses deductible under section 162 or section 212 (expenses
incurred for the production of income), but instead are “start-
up” or “pre-opening” expenses. Hardy v. Commissioner, supra at
687-688.
6
Respondent considered the possibility that petitioner’s
software development activities may qualify for sec. 174
treatment. Petitioner has not shown that any of his software
development expenses warranted sec. 174 treatment; accordingly,
the Court deems any argument as to sec. 174 treatment waived.
See Money v. Commissioner, 89 T.C. 46, 48 (1987); Stutsman v.
Commissioner, T.C. Memo. 1961-109.
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Section 195(a) provides that, except as otherwise provided
therein, no deduction is allowed for startup expenditures. See
also Hardy v. Commissioner, supra at 687-693. Section 195(c)(1)
defines startup expenditures to mean any amount paid or incurred
in connection with (i) investigating the creation or acquisition
of an active trade or business, or (ii) creating an active trade
or business, or (iii) any activity engaged in for profit and for
the production of income before the day on which the active trade
or business begins, in anticipation of becoming an active trade
or business, and which if paid or incurred in connection with the
operation of an existing active trade or business would be
allowed as a deduction for the taxable year in which paid or
incurred.
Therefore, the threshold issue is whether petitioner
completed the startup phase and became actively engaged in a
trade or business during 2005. Courts have adopted a facts and
circumstances test focusing on whether the taxpayer has satisfied
all of the following three factors: (1) Whether the taxpayer
undertook the activity intending to earn a profit; (2) whether
the taxpayer was regularly and actively involved in the activity;
and (3) whether the taxpayer’s activity had actually commenced.
See Woody v. Commissioner, supra; McManus v. Commissioner, T.C.
Memo. 1987-457, affd. without published opinion 865 F.2d 255 (4th
Cir. 1988).
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A. SkillsSoft
Petitioner testified that SkillsSoft’s services were
available to the public in 2005. He admitted, however, that
SkillsSoft was focused on demonstrating its expertise as a
software development company. SkillsSoft created the Web sites
for and developed petitioner’s own activities in order to show
potential clients that it was capable of providing efficient and
cost-effective software development services.
In order for a taxpayer to be carrying on a trade or
business, however, the business must function as a going concern
and its services must be held out to the public. Walsh v.
Commissioner, T.C. Memo. 1988-242, affd. without published
opinion 884 F.2d 1393 (6th Cir. 1989). SkillsSoft’s activity
consisted of creating and building petitioner’s own activities.
There is no credible evidence, beyond petitioner’s testimony,
that SkillsSoft’s services were actually being held out to the
general public.
B. Desi, Efattofit.com, Online Dictionary, Software
Development
Petitioner testified that Desi, efattofit.com, the online
dictionary, and the software development associated with his
activities were operating during 2005. Nevertheless, he admitted
that SkillsSoft was still developing these activities during
2005. He presented no further evidence to corroborate his
testimony that these activities were operating in 2005 and the
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Court is unable to conclude that these activities were operating
as a going concern, open to the public during 2005 or that they
commenced business operations in 2005. Consequently, the
expenses associated with these activities are nondeductible
startup expenditures.7
III. Edokan
A. Engaged In for Profit
To be engaged in a trade or business within the meaning of
section 162, petitioner must show not only that his primary
purpose for engaging in the activity was for income or profit but
also that he engaged in the activity with “continuity and
regularity”. Commissioner v. Groetzinger, 480 U.S. 23, 35
(1987). An examination of the facts and circumstances of each
case is necessary to determine whether a taxpayer is carrying on
a trade or business. See id. at 36.
Section 183(a) provides that if an activity is not engaged
in for profit, no deduction attributable to the activity shall be
allowed except as provided in section 183(b). Section 183(b)(1)
authorizes a deduction for any expense that otherwise is
allowable, regardless of profit objective. Section 183(b)(2)
authorizes a deduction for expenses that would be allowable if
7
Because we find that petitioner’s expenses were
nondeductible startup expenditures for 2005, we need not discuss
whether petitioner’s activities were entered into with a profit
objective or whether petitioner substantiated the expenses
associated with those activities.
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the activity were engaged in for profit, but only to the extent
that gross income attributable to the activity exceeds the
deductions permitted by section 183(b)(1). Section 183(c)
defines “activity not engaged in for profit” as “any activity
other than one with respect to which deductions are allowable for
the taxable year under section 162 or under paragraph (1) or (2)
of section 212.”
Section 1.183-2(b), Income Tax Regs., sets forth a
nonexclusive list of factors to be considered in determining
whether a taxpayer has the requisite profit objective. The
factors are: (1) The manner in which the taxpayer carries on the
activity; (2) the expertise of the taxpayer or his advisers; (3)
the time and effort expended by the taxpayer in carrying on the
activity; (4) the expectation that assets used in the activity
may appreciate in value; (5) the success of the taxpayer in
carrying on other similar or dissimilar activities; (6) the
taxpayer’s history of income or loss with respect to the
activity; (7) the amount of occasional profits, if any, which are
earned; (8) the financial status of the taxpayer; and (9)
elements of personal pleasure or recreation. No single factor is
determinative, and not all factors are applicable in every case.
See Allen v. Commissioner, 72 T.C. 28, 34 (1979); sec. 1.183-
2(b), Income Tax Regs.
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Petitioner hired several employees, including a manager who
prepared reports on and managed Edokan operations in Pakistan.
He also maintained a separate bank account for Edokan and kept
extensive business records separate and apart from his personal
records. The Court is satisfied that petitioner has demonstrated
that he operated Edokan with a profit objective during 2005.
B. Edokan Business Expense Deductions
Deductions are strictly a matter of legislative grace, and
taxpayers must satisfy the specific requirements for any
deduction claimed. See INDOPCO, Inc. v. Commissioner, 503 U.S.
at 84; New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934). Taxpayers bear the burden of substantiating the amount
and purpose of any claimed deduction. See Hradesky v.
Commissioner, 65 T.C. 87 (1975), affd. per curiam 540 F.2d 821
(5th Cir. 1976).
Section 162(a) allows a deduction for all ordinary and
necessary expenses paid or incurred by a taxpayer in carrying on
any trade or business. An expense is considered ordinary if
commonly or frequently incurred in the trade or business of the
taxpayer. Deputy v. du Pont, 308 U.S. 488, 495-496 (1940). An
expense is necessary if it is appropriate or helpful in carrying
on a taxpayer’s trade or business. Commissioner v. Heininger,
320 U.S. 467, 471 (1943); Welch v. Helvering, 290 U.S. at 113.
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A taxpayer must maintain records sufficient to substantiate
the amounts of the deductions claimed. Sec. 1.6001-1(a), Income
Tax Regs. If a taxpayer establishes that an expense is
deductible but is unable to substantiate the precise amount, we
may estimate the amount, bearing heavily against the taxpayer
whose inexactitude is of his own making. Cohan v. Commissioner,
39 F.2d 540, 543-544 (2d Cir. 1930). The taxpayer must present
sufficient evidence for the Court to form an estimate because
without such a basis, any allowance would amount to unguided
largesse. Williams v. United States, 245 F.2d 559, 560-561 (5th
Cir. 1957); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).
Petitioner provided extensive records of the expenses
associated with his activities, several of which relate to Edokan
expenses. Expenses related to Edokan’s business during 2005
consisted primarily of expenses for retail items,8 most notably
dresses and similar retail items. During 2005 he used two
currencies for the purchase of retail items, the Pakistani rupee
and the U.S. dollar. The Court is satisfied that petitioner has
8
Sec. 263A provides the rule for inclusion in inventory
costs of certain expenses, specifying that goods purchased for
resale shall be included in inventory costs. Sec. 263A(a)(1),
(b). Under sec. 263A petitioner’s Edokan expenses are properly
allocable as inventory costs. But sec. 263A(b)(2)(B) provides an
exception to the inventory reporting requirements for taxpayers
with gross receipts of $10 million or less. Petitioner’s gross
receipts for 2005 did not exceed $10 million; accordingly, he was
not subject to the inventory reporting requirements of sec. 263A.
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presented sufficient evidence substantiating the following retail
expenses payable in rupees:
Price
Purchase Date Rupees Dollars¹
8/8/05 Rs 13805 $231.12
8/18/05 503 8.42
8/24/05 36825 616.85
11/8/05 7000 117.21
11/22/05 9245 154.26
11/25/05 650 10.88
Total 68,028 1,138.74
¹Rupees were converted to dollars using the exchange rate
for the specified date on www.oanda.com. See http://www.oanda.
com/currency/converter/.
Petitioner further substantiated $2,731 of retail expenses
payable in dollars. The Court finds that petitioner is entitled
to a business expense deduction of $3,869.74.
Petitioner incurred additional expenses during 2005, a
portion of which may be properly allocable to Edokan’s operation.
But petitioner did not provide sufficient evidence to permit an
estimate of the expenses that are properly allocable to Edokan.
Consequently, petitioner is entitled only to those expenses that
are clearly allocable to Edokan, e.g., retail purchases, as
discussed above.
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IV. Additions to Tax
A. Section 6651(a)(1) Addition to Tax9
Section 6651(a)(1) imposes an addition to tax for failure to
file timely a return.10 The addition to tax under section
6651(a)(1) does not apply if the failure to file timely is due to
reasonable cause and not willful neglect. Sec. 6651(a)(1). A
failure to file a timely Federal income tax return is due to
reasonable cause if the taxpayer exercised ordinary business care
and prudence and nevertheless was unable to file the return
within the prescribed time. Barkley v. Commissioner, T.C. Memo.
2004-287; sec. 301.6651-1(c)(1), Proced. & Admin. Regs. Willful
neglect means a conscious, intentional failure or reckless
indifference. United States v. Boyle, 469 U.S. 241, 245 (1985).
Section 7491(c) imposes on the Commissioner the burden of
production in any court proceeding with respect to the liability
of any individual for additions to tax. Higbee v. Commissioner,
116 T.C. 438, 446 (2001); Trowbridge v. Commissioner, T.C. Memo.
2003-164. In order to meet the burden of production, the
Commissioner need only make a prima facie case that imposition of
9
Respondent conceded the sec. 6651(a)(2) addition to tax and
consequently seeks an increased amount under sec. 6651(a)(1).
10
The addition to tax imposed under sec. 6651(a)(1) is equal
to 5 percent of the amount of tax required to be shown on the
return, with an additional 5 percent to be added for each month
or partial month during which the failure to file timely a return
continues, not to exceed 25 percent in the aggregate.
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the addition to tax is appropriate. Higbee v. Commissioner,
supra at 446. Petitioner’s 2005 return was due on April 15,
2006, and was not filed until October 29, 2009. Therefore,
respondent has met his burden of production.11
Petitioner believed, on the basis of his purported business
expenses, that he did not have taxable income for 2005 and
therefore was not under an obligation to file a return for that
year. Petitioner introduced no other legally sufficient reason
for his failure to file a timely return and has not otherwise
demonstrated reasonable cause for his failure to timely file his
return as required by section 6651(a)(1). Accordingly,
respondent’s determination of an addition to tax under section
6651(a)(1) is sustained.
B. Section 6654(a) Addition to Tax
Section 6654(a) imposes an addition to tax on an individual
taxpayer who underpays his estimated tax. The addition to tax is
calculated with reference to four required installment payments
of the taxpayer’s estimated tax liability. Sec. 6654(c)(1).
11
Respondent sought an increase in the sec. 6651(a)(1)
addition to tax and bears the burden of proof with regard to any
increased deficiency. See Rule 142(a). The amount of the sec.
6651(a)(1) addition to tax, however, is a computational matter
and is based on the amount of tax due. To the extent respondent
bears the burden of proving an increased sec. 6651(a)(1) addition
to tax, respondent has met his burden because the record shows
that petitioner is liable for an increased deficiency.
Bhattacharyya v. Commissioner, T.C. Memo. 2007-19 n.19.
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Each required installment of estimated tax is equal to 25 percent
of the required annual payment. Sec. 6654(d)(1)(A). The
required annual payment is equal to the lesser of: (1) 90
percent of the tax shown on the individual’s return for that year
(or, if no return is filed, 90 percent of his or her tax for such
year); or (2) if the individual filed a return for the
immediately preceding taxable year, 100 percent of the tax shown
on that return. Sec. 6654(d)(1)(B).
Respondent bears the burden of production to show that
petitioner had an estimated tax payment obligation, which
includes whether a return was filed for the preceding year. Sec.
7491(c); Wheeler v. Commissioner, 127 T.C. 200, 211-212 (2006),
affd. 521 F.3d 1289 (10th Cir. 2008). Petitioner did not file a
return for 2004; therefore, respondent has satisfied his burden
of production.
Because petitioner failed to file a Federal income tax
return for 2004, his required annual payment for 2005 is equal to
90 percent of the tax for 2005, which was payable in installments
under section 6654. See sec. 6654(d)(1)(B). Petitioner did not
make any estimated income tax payments for 2005 and has failed to
present any evidence or argument that an exception applies.
Consequently, the Court sustains respondent’s determination of
the failure to pay estimated tax addition to tax under section
6654.
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To reflect the foregoing,
Decision will be entered
under Rule 155.