to qualify as "ordinary", the expense must relate to a transaction "of common or frequent occurrence in the type of business involved"
How later courts described this case
- to qualify as "ordinary", the expense must relate to a transaction "of common or frequent occurrence in the type of business involved"
Written by the judges who cited it.
The opinion
T.C. Summary Opinion 2010-109
UNITED STATES TAX COURT
ASIF HAFEEZ, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 17006-09S. Filed August 3, 2010.
Asif Hafeez, pro se.
Steven W. Ianacone, for respondent.
PANUTHOS, Chief 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
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effect for the year in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
Respondent determined a $14,5601 deficiency in petitioner’s
2006 Federal income tax as well as a $4,947.75 addition to tax
under section 6651(a)(1) and a $2,912 accuracy-related penalty
under section 6662(a). The issues for decision are: (1) Whether
petitioner is entitled to certain deductions claimed on Schedule
C, Profit or Loss From Business; (2) whether petitioner is liable
for the addition to tax under section 6651(a)(1); and (3)
whether petitioner is liable for an accuracy-related penalty
under section 6662(a).
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. Petitioner resided in New
Jersey at the time the petition was filed.
Petitioner is a professional driver who worked as an
independent contractor for two different car service companies in
New York City in 2006. Petitioner worked as an independent
contractor for Crestwood Car and Limousine Services, Ltd.
1
Respondent arrived at this amount by subtracting $5,261 as
tax shown on the return from $19,821 as total tax as determined
by respondent after disallowing selected Schedule C expenses. In
fact, the return shows a tax due of $5,231. Respondent has not
sought an increase in the deficiency; thus we will treat it as a
concession.
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(Crestwood), from January through August of 2006 and TriLine
Contracting (Triline) from September through December of 2006.
Potential clients would contact the respective companies and
contract for car services in and around the New York City area.
The car service would contact petitioner by telephone and provide
an assignment. Petitioner was not permitted to pick up
passengers without an assignment. Clients paid the car service a
fare which varied because of distance, duration, waiting time,
stops, and tolls and parking expenses incurred during the trip.
Petitioner was paid each week by the respective car service
company. The amount he received depended upon gross fares
generated.
When petitioner first began working as a professional
driver, he rented or leased a vehicle from the car service
company. On December 29, 2005, petitioner purchased a used
Lincoln Town Car (town car) for $23,590.30. The town car was
white, and Crestwood would permit only black vehicles to be used
to carry passengers for the car service. Petitioner was unable
to place the town car in service until approximately March 2006
after he had it painted black. Petitioner incurred costs for
gasoline, parking, tolls, and parking tickets with respect to the
town car.
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Petitioner was required to wear a suit whenever he drove the
town car for the car service company. The car service company
also required petitioner to clean and wash the vehicle regularly.
Petitioner cleaned and washed his vehicle frequently, as he
understood that a clean vehicle would encourage repeat business
and ultimately increase his income. Petitioner was also required
to have a cellular telephone available so that the company could
reach him to assign him jobs. Occasionally, a client might use
his cell phone.
Petitioner hired an accountant to assist in the preparation
of the return, the Schedule C, and the Schedule SE, Self
Employment Tax. Petitioner filed his 2006 Form 1040, U.S.
Individual Income Tax Return, on September 10, 2007.
Petitioner reported gross income of $86,549 and deducted
expenses on his 2006 Schedule C as follows:
Car and truck expenses $24,923
Insurance 7,603
Rent or lease of vehicles 8,106
Repairs and maintenance 4,528
Supplies 1,809
Taxes and licenses 1,390
Travel 3,315
Other expenses 10,281
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On April 10, 2009, respondent issued a notice of deficiency
to petitioner disallowing the following claimed deductions for
2006: Car and truck expenses of $24,923; rent or lease of
vehicle expenses of $8,106; and other expenses (which included
the cost of car washes, uniforms and dry cleaning, and cellular
telephone services) of $10,281. Respondent also determined a
late-filing addition to tax and an accuracy-related penalty
pursuant to sections 6651(a)(1) and 6662(a) respectively.
Discussion
In general, the Commissioner’s determination set forth in a
notice of deficiency is presumed correct, and the taxpayer bears
the burden of showing that the determination is in error. Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions
are a matter of legislative grace. Deputy v. du Pont, 308 U.S.
488, 493 (1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435,
440 (1934). A taxpayer bears the burden of proving entitlement
to any deduction claimed. Rule 142(a); INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); Welch v. Helvering, supra;
Wilson v. Commissioner, T.C. Memo. 2001-139. A taxpayer is
required to maintain records sufficient to substantiate
deductions claimed on his or her income tax return. Sec. 6001;
sec. 1.6001-1(a), (e), Income Tax Regs. The fact that a taxpayer
reports a deduction on the taxpayer’s income tax return is not
sufficient to substantiate the claimed deduction. Wilkinson v.
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Commissioner, 71 T.C. 633, 639 (1979); Roberts v. Commissioner,
62 T.C. 834, 837 (1974). Rather, an income tax return is merely
a statement of the taxpayer’s claim; it is not presumed to be
correct. Wilkinson v. Commissioner, supra at 639; Roberts v.
Commissioner, supra at 837; see also Seaboard Commercial Corp. v.
Commissioner, 28 T.C. 1034, 1051 (1957) (a taxpayer’s income tax
return is a self-serving declaration that may not be accepted as
proof for the claimed deduction or exclusion); Halle v.
Commissioner, 7 T.C. 245 (1946) (a taxpayer’s income tax return
is not self-proving as to the truth of its contents), affd. 175
F.2d 500 (2d Cir. 1949).
Pursuant to section 7491(a), the burden of proof as to
factual matters shifts to the Commissioner under certain
circumstances. Petitioner has neither alleged that section
7491(a) applies nor established his compliance with the
substantiation and recordkeeping requirements. See sec.
7491(a)(2)(A) and (B). Petitioner therefore bears the burden of
proof. See Rule 142(a).
I. Schedule C Deductions
The taxpayer bears the burden of proving that he is entitled
to the deductions claimed, and this includes the burden of
substantiation. Rule 142(a); Hradesky v. Commissioner, 65 T.C.
87, 90 (1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976). A
taxpayer must substantiate amounts claimed as deductions by
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maintaining the records necessary to establish he or she is
entitled to the deductions. Sec. 6001. Section 162(a) provides
a deduction for certain business-related expenses. In order to
qualify for the deduction under section 162(a), “an item must (1)
be ‘paid or incurred during the taxable year,’ (2) be for
‘carrying on any trade or business,’ (3) be an ‘expense,’ (4) be
a ‘necessary’ expense, and (5) be an ‘ordinary’ expense.”
Commissioner v. Lincoln Sav. & Loan Association, 403 U.S. 345,
352 (1971); Deputy v. du Pont, supra at 495 (to qualify as
“ordinary”, the expense must relate to a transaction “of common
or frequent occurrence in the type of business involved”).
Whether an expense is ordinary is determined by time, place, and
circumstance. Welch v. Helvering, supra at 113-114.
If a taxpayer establishes that he or she paid or incurred a
deductible business expense but does not establish the amount of
the expense, we may approximate the amount of the allowable
deduction, bearing heavily against the taxpayer whose
inexactitude is of his or her own making. Cohan v. Commissioner,
39 F.2d 540, 543-544 (2d Cir. 1930). However, for the Cohan rule
to apply, there must be sufficient evidence in the record to
provide a basis for the estimate. Vanicek v. Commissioner, 85
T.C. 731, 743 (1985). Certain expenses may not be estimated
because of the strict substantiation requirements of section
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274(d). See sec. 280F(d)(4)(A); Sanford v. Commissioner, 50 T.C.
823, 827 (1968), affd. per curiam 412 F.2d 201 (2d Cir. 1969).
The expenses to which section 274(d) applies include, among
other things, expenses for listed property (e.g., automobile
expenses, cellular telephones, computer equipment, or any
property of a type generally used for purposes of entertainment,
recreation, or amusement) and travel expenses (including meals
and lodging while away from home). Secs. 274(d)(4),
280F(d)(4)(A). To substantiate a deduction attributable to
listed property, a taxpayer must maintain adequate records or
present corroborative evidence to show the following: (1) The
amount of the expense; (2) the time and place of use of the
listed property; and (3) the business purpose of the use. Sec.
1.274-5T(b)(6), Temporary Income Tax Regs., 50 Fed. Reg. 46016
(Nov. 6, 1985). Petitioner provided some documentation for the
expenses. We discuss each type of claimed expense in turn.
A. Rent or Lease Expenses
Petitioner claimed $8,196 in rent or lease expenses. This
expense appears to relate to the town car purchased in December
of 2005. Petitioner used the town car in his capacity as a
driver, and petitioner provided the loan agreement and copies of
canceled checks to substantiate that he incurred and paid the
amount. While the return identified the payments as rent or
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lease expenses, the amount claimed represents the repayment of a
loan to finance the purchase of the vehicle, not a lease or rent
of the vehicle. Thus petitioner is not entitled to a deduction
for rental or lease expenses. However, this does not end the
matter. The purchase of the vehicle is properly characterized as
the purchase of a capital asset subject to depreciation under
section 167.
A taxpayer may be entitled to a depreciation deduction for
exhaustion, wear, and tear of property used in a trade or
business. Sec. 167(a)(1); INDOPCO, Inc. v. Commissioner, 503
U.S. 79 (1992). Automobiles are 5-year property under section
168(e)(3)(B)(i) and thus should be depreciated over 5 years.
Sec. 167(b). Petitioner has provided the bill of sale for
purchase of the vehicle which shows petitioner’s cost basis in
the vehicle as $23,590.30. The applicable convention is the
half-year convention, and the applicable method is the 200-
percent declining balance method. Sec. 168(b), (d)(1). We leave
the calculation of the depreciation amount to the parties.2
2
While there may have been an opportunity to expense the
cost of the town car under sec. 179, petitioner did not make such
an election on his Federal income tax return for 2006 and is
therefore not entitled to the benefits of that section. See
Visin v. Commissioner, T.C. Memo. 2003-246, affd. 122 Fed. Appx.
363 (9th Cir. 2005); see also sec. 179(c)(1)(B); sec. 1.179-5(a),
Income Tax Regs.
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B. Car and Truck Expenses
1. In General
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. Under that provision, an
employee or a self-employed individual may deduct the cost of
operating an automobile to the extent that it is used in a trade
or business. However, under section 262, no portion of the cost
of operating an automobile that is attributable to personal use
is deductible. Ordinary commuting expenses are not deductible.
Neal v. Commissioner, 681 F.2d 1157 (9th Cir. 1982), affg. T.C.
Memo. 1981-407.
A passenger vehicle is listed property under section
280F(d)(4) subject to strict substantiation under section 274(d).
The rule in Cohan does not apply to expenses relating to listed
property, which generally includes any passenger automobile.
Secs. 274(d)(4), 280F(d)(4)(A)(i); Sanford v. Commissioner, supra
at 827-828; Seidel v. Commissioner, T.C. Memo. 2005-67. However,
the term “passenger automobile” does not include any vehicle used
by the taxpayer directly in the trade or business of transporting
persons for compensation or hire. Sec. 280F(d)(5)(B)(ii); sec.
1.280F-6(c)(3)(ii), Income Tax Regs. Therefore the town car that
petitioner purchased is not listed property, and the expenses
related thereto are subject to the Cohan rule.
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2. Gasoline
Petitioner claimed $16,245 in gasoline expenses and
submitted bank statements for the entire year with entries
reflecting gasoline purchases. The entries reflect debit and
credit card purchases as well as expenditures made by check.
Petitioner did not provide individual receipts whereby the Court
could verify the cost of gasoline that was purchased separate
from any nondeductible personal items. Petitioner was required
to purchase fuel for his vehicle in order to carry on his trade
or business as a driver; and despite his lack of complete
records, we found petitioner’s testimony to be credible and will
allow him a portion of the amount claimed, correcting for the
inexactitude which is of his own making. See Cohan v.
Commissioner, 39 F.2d at 543-544. We therefore allow 75 percent
of the claimed fuel expenses, for a total gasoline expense of
$12,183.75.
3. Parking and Tolls
Petitioner also claimed a deduction for amounts expended for
parking and tolls. Petitioner did not provide a log and did not
provide receipts. He did provide bank statements which show
numerous charges for tolls. Petitioner claimed a deduction of
$2,920 which represented the cost of tolls to bring his vehicle
into New York City for work each day. While this amount might
otherwise be a nondeductible commuting expense, the nature of
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petitioner’s profession requires further analysis. Petitioner
incurred the additional expense to transport the town car into
New York City in order to carry on his trade or business as a
professional driver. We are satisfied that the daily toll to
bring the town car into New York City is ordinary and necessary
and thus allowable as an expense. See Fryer v. Commissioner,
T.C. Memo. 1974-77; see also Fausner v. Commissioner, 413 U.S.
838 (1973). Petitioner claims he is entitled to a total of
$11,505 for parking and tolls. Petitioner arrived at this number
by adding the following three amounts: (1) The daily toll into
New York City, (2) the tolls he incurred with Triline, and (3)
twice the amount of tolls incurred with Crestwood. Petitioner is
entitled only to expenses incurred and paid and is not entitled
to claim twice that amount to correct a perceived unfairness.
The Court is satisfied that he has shown the actual amount
incurred. We conclude, therefore, that petitioner is entitled to
$7,661.203 for tolls and parking.
4. Town Car Painting
Expenses incurred to maintain property used in a trade or
business in efficient operating condition ordinarily are
deductible. See sec. 162(a); Jacks v. Commissioner, T.C. Memo.
3
This represents $2,920 for tolls to get into New York City
for work every day, $3,843.80 in tolls from January through
August 2006 when petitioner worked for Crestwood, and $897.40 in
tolls from September through December of 2006 when petitioner
worked for Triline.
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1988-237; Gilles Frozen Custard, Inc. v. Commissioner, T.C. Memo.
1970-73. Likewise, the cost of repairs “which neither materially
add to the value of the property nor appreciably prolong its
life, but keep it in an ordinarily efficient operating condition,
may be deducted as an expense”. Sec. 1.162-4, Income Tax Regs.;
see also sec. 1.263(a)-1(b), Income Tax Regs. On the other hand,
a capital expenditure permanently improves property and increases
its value. Sec. 263. The well-established standard that we must
use to evaluate a particular expenditure is as follows:
A repair is an expenditure for the purpose of keeping
the property in an ordinarily efficient operating
condition. It does not add to the value of the
property, nor does it appreciably prolong its life. It
merely keeps the property in an operating condition
over its probable useful life for the uses for which it
was acquired. Expenditures for that purpose are
distinguishable from those for replacements,
alterations, improvements or additions which prolong
the life of the property, increase its value, or make
it adaptable to a different use. * * *
Ill. Merchs. Trust Co. v. Commissioner, 4 B.T.A. 103, 106 (1926);
see also INDOPCO, Inc. v. Commissioner, 503 U.S. at 85-88.
As indicated, petitioner purchased a white town car for use
in his profession. However, Crestwood required that all vehicles
be black. While the expenditure might be both an ordinary and
necessary business expenditure, it would appear that the painting
added to the value of the vehicle and made it adaptable to a
different use. We conclude therefore that the cost of painting
the town car is a capital expenditure.
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In the case of a capital expenditure, the capitalization
rules of section 263 take precedence over the deduction rules of
section 162, thereby preventing capital expenditures from being
deducted currently under section 162. Sec. 161; Commissioner v.
Idaho Power Co., 418 U.S. 1, 17 (1974). Petitioner has not
provided a receipt for the exact amount of the cost of painting
the vehicle but has provided credible testimony as to the
expense. Therefore we allow him one-half of the claimed expense,
or $750, which must be capitalized and depreciated over the life
of the vehicle.
5. Parking Tickets
Petitioner also claimed $690 for parking tickets as a
business expense. Such expenses are fines or penalties that are
nondeductible, even if related to business. See sec. 162(f).
C. Other Expenses
On petitioner’s 2006 Federal income tax return he claimed
$10,281 in “other expenses” comprising car washes, uniforms and
dry cleaning, and cell phone expenses.
Petitioner claimed $2,9034 in expenses for car washes. The
Court is satisfied that the claimed car washes were an ordinary
4
Petitioner claimed $2,903 in car wash expenses on his 2006
Federal income tax return. At trial he claimed the actual
expense was $2,920. Petitioner explained that, on average, he
paid $8 per car wash and that he washed his car at least once a
day. The larger amount represents one car wash per day for 365
days.
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and necessary expense for a professional driver who relied on the
appearance of his vehicle for repeat business. Petitioner
provided bank records which show approximately weekly entries for
car wash charges ranging from $5 to approximately $20. Without
other documentary evidence to substantiate more frequent car
washes, we approximate that petitioner incurred car wash expenses
about once per week at an average cost of $12.50. Therefore,
petitioner is entitled to a car wash business expense of $650.
Section 162 permits a deduction for work clothes or uniforms
required as a condition of employment when the clothing is not
suitable for general or personal wear and is not worn for general
or personal purposes. Yeomans v. Commissioner, 30 T.C. 757,
767-769 (1958). Petitioner provided bank records and handwritten
notations for clothing purchased in 2006. The type of clothing
petitioner purchased for use as a professional driver was
suitable for everyday wear. See Hynes v. Commissioner, 74 T.C.
1266, 1290 (1980). Petitioner’s clothing expenses are
nondeductible personal expenses under section 262, as are the
expenses incurred for laundering and drycleaning his clothing.
See Boltinghouse v. Commissioner, T.C. Memo. 2007-324.
Petitioner claimed $2,961 in expenses for cellular telephone
service. Petitioner claimed to have paid approximately $250 per
month for unlimited calling and text messaging as required by the
car service company. Petitioner did not offer any receipts,
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bills, or other documentary support for these expenses.
Therefore, petitioner has failed to meet the strict
substantiation requirements of sections 274(d) and
280F(d)(4)(A)(v) for cellular telephone expenses. Respondent’s
disallowance of cellular telephone expenses is sustained.
II. Failure To File Addition to Tax
Section 6651(a)(1) imposes an addition to tax of 5 percent
per month of the amount of tax required to be shown on the
return, not to exceed 25 percent, for failure to timely file a
return. The addition to tax under section 6651(a)(1) is imposed
unless the taxpayer establishes that the failure was due to
reasonable cause and not willful neglect.5 The record does not
establish that petitioner’s failure to timely file his 2006
Federal income tax return was due to reasonable cause and not
willful neglect. Thus, petitioner is liable for the section
6651(a)(1) addition to tax.6
5
Sec. 7491(c) provides that the Commissioner has the burden
of production in any Court proceeding with respect to liability
for an addition to tax. Respondent has established that the tax
return for 2006 was not timely filed.
6
Since we have allowed some deductions disallowed by
respondent, the amount of tax required to be shown on
petitioner’s 2006 return will be different from the amount shown
on the notice of deficiency, and the addition to tax, which is 25
percent of that amount, will also differ. We leave the
recalculation to the parties’ Rule 155 computations.
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III. Accuracy-Related Penalty
Section 6662(a) and (b)(1) and (2) imposes an accuracy-
related penalty of 20 percent on the portion of an underpayment
attributable to negligence, disregard of rules or regulations, or
a substantial understatement of income tax. Negligence includes
any failure to keep adequate books and records or to substantiate
items properly. Sec. 1.6662-3(b)(1), Income Tax Regs. An
understatement is substantial if it exceeds the greater of:
(1) 10 percent of the tax required to be shown on the return for
the taxable year, or (2) $5,000. Sec. 6662(d)(1)(A).
A taxpayer may avoid the application of an accuracy-related
penalty by proving that he acted with reasonable cause and in
good faith. See sec. 6664(c)(1); see also Higbee v.
Commissioner, 116 T.C. 438, 446-447 (2001); sec. 1.6664-4(a),
Income Tax Regs. We analyze whether a taxpayer acted with
reasonable cause and in good faith by examining the relevant
facts and circumstances and, most importantly, the extent to
which the taxpayer attempted to assess his proper tax liability.
See Neely v. Commissioner, 85 T.C. 934, 947 (1985); Stubblefield
v. Commissioner, T.C. Memo. 1996-537; sec 1.6664-4(b)(1), Income
Tax Regs. In order for the reasonable cause exception to apply,
the taxpayer must prove that he exercised ordinary business care
and prudence as to the disputed item. See Neonatology
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Associates, P.A. v. Commissioner, 115 T.C. 43, 98 (2000), affd.
299 F.3d 221 (3d Cir. 2002).
Reliance upon the advice of a tax professional may establish
reasonable cause and good faith for the purpose of avoiding
liability for the section 6662(a) penalty. See United States v.
Boyle, 469 U.S. 241, 250 (1985). Reliance on a tax professional
is not an “absolute defense” but merely “a factor to be
considered.” Freytag v. Commissioner, 89 T.C. 849, 888 (1987),
affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991).
As a general rule, a taxpayer cannot shift the responsibility of
filing an accurate return to a return preparer. Metra Chem Corp.
v. Commissioner, 88 T.C. 654, 662 (1987). However, we have held
that under certain circumstances the taxpayer may avoid the
imposition of a penalty if there was good faith reliance by the
taxpayer on the advice of a competent adviser. Jackson v.
Commissioner, 86 T.C. 492, 539-540 (1986), affd. 864 F.2d 1521
(10th Cir. 1989). The taxpayer claiming good faith reliance on a
competent adviser must demonstrate that: “(1) The adviser was a
competent professional who had sufficient expertise to justify
reliance, (2) the taxpayer provided necessary and accurate
information to the adviser, and (3) the taxpayer actually relied
in good faith on the adviser’s judgment.” Neonatology
Associates, P.A. v. Commissioner, supra at 99.
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The record does not provide a sufficient basis for the Court
to permit petitioner to avoid the imposition of the
penalty. Petitioner has not established that he acted with
reasonable cause in attempting to assess his proper tax
liability, nor has he established good faith reliance on his
preparer. Petitioner did not present to the Court required
documentation to substantiate some of the claimed expense
deductions. Petitioner did not assert that he maintained such
records as required by law or that he provided such required
records to his tax preparer. The record is further void of any
advice that the tax adviser provided to petitioner. Also, on the
basis of our findings (e.g. tolls claimed), petitioner clearly
claimed deductions for amounts greater than the amounts actually
expended for such items. Thus, we conclude that petitioner did
not act with reasonable cause, nor has he established that there
was good faith reliance on his tax adviser. Petitioner does not
qualify for the reasonable cause exception of section 6664.
Therefore, petitioner is liable for the accuracy-related penalty
pursuant to section 6662(a) and (b)(1), in an amount to be
recalculated after computation of the deficiency.
To reflect the foregoing,
Decision will be entered under
Rule 155.