holding that section 6751(b)(1) “requires written supervisory approval before the assessment of the penalty or, if earlier, before the relevant supervisor loses discretion whether to approve the penalty assessment”
How later courts described this case
- holding that section 6751(b)(1) “requires written supervisory approval before the assessment of the penalty or, if earlier, before the relevant supervisor loses discretion whether to approve the penalty assessment”
Written by the judges who cited it.
The opinion
United States Tax Court
T.C. Memo. 2023-4
KYLE D. SIMPSON AND CHRISTEN SIMPSON,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 16923-16. Filed January 9, 2023.
—————
Bryan W. Caddell and Rain L. Minns, for petitioners.
Ann L. Darnold and Vassiliki Economides Farrior, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
JONES, Judge: Pursuant to section 6213(a), Kyle Simpson (Mr.
Simpson) and his wife, Christen Simpson (Mrs. Simpson), seek
redetermination of deficiencies in federal income tax determined by the
Internal Revenue Service (IRS) totaling $12,874, $18,866, and $18,359
for taxable years 2011, 2012, and 2013, respectively. 1 After concessions,
the issues for decision are (1) whether certain deductions claimed by
petitioners’ wholly owned S corporation, Getify Solutions, Inc. (Getify),
are properly deductible at the corporate level or, alternatively, as
expenses incurred by Mr. Simpson in his capacity as Getify’s employee;
(2) whether items underlying petitioners’ claimed deductions have been
substantiated; (3) whether petitioners substantiated Getify’s basis in
1 Unless otherwise indicated, all statutory references are to the Internal
Revenue Code (Code), Title 26 U.S.C., in effect at all relevant times, all regulatory
references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all
relevant times, and all Rule references are to the Tax Court Rules of Practice and
Procedure. All monetary amounts are rounded to the nearest dollar unless indicated
otherwise.
Served 01/09/23
2
[*2] South Austin Co-Working, LLC (Co-Working), so as to justify their
purported loss deductions associated with that entity for taxable years
2011 and 2012; (4) whether petitioners are liable for accuracy-related
penalties under section 6662(a) with respect to taxable years 2011, 2012,
and 2013; and (5) whether petitioners are liable for additions to tax
associated with their failure to timely file tax returns under section
6651(a)(1) with respect to taxable years 2012 and 2013.
We hold that (1) the deductions at issue are properly deductible
by petitioners as unreimbursed employee expenses, reportable on
Schedules A, Itemized Deductions, of their Forms 1040, U.S. Individual
Income Tax Return, and subject to the two-percent limitation of section
67(a); (2) with the exception of petitioners’ business use of the home
expenses for taxable year 2012, petitioners have failed to substantiate
the expenses underlying their claimed deductions beyond what
respondent has allowed; (3) petitioners did not substantiate their basis
in Co-Working and are, therefore, limited to the loss deductions
respondent allowed; (4) petitioners are liable for accuracy-related
penalties under section 6662(a) for taxable years 2011, 2012, and 2013;
and (5) petitioners are liable for additions to tax associated with their
failure to timely file tax returns under section 6651(a)(1) with respect to
taxable years 2012 and 2013.
FINDINGS OF FACT
This case was tried on October 1, 2021, during the San Antonio,
Texas, remote trial session (via Zoomgov). 2 The Stipulations of Facts,
including the jointly stipulated Exhibits contained therein, are
2 This case was originally tried before Judge Carolyn P. Chiechi in September
2017. On October 19, 2018, Judge Chiechi retired from the Tax Court. On October 25,
2018, the Court issued an order informing the parties of Judge Chiechi’s retirement
and proposing to reassign this case to another judicial officer of the Court for purposes
of preparing the opinion and entering a decision based on the record of trial or,
alternatively, allowing the parties to request either a new trial or to supplement the
record. On November 9, 2018, respondent filed a response consenting to the
reassignment of the case and requested that a decision be entered based on the record
of trial. On December 4, 2018, petitioners filed a Motion for a New Trial objecting to
the reassignment of the case and requesting a new trial. On February 8, 2019, the
Court ordered that the case was no longer submitted to Judge Chiechi and granted
petitioners’ Motion for a New Trial. The new trial was scheduled for the Court’s San
Antonio session slated to begin on May 4, 2020, but because of concerns about COVID-
19, the trial session was canceled and the case was restored to the general docket.
3
[*3] incorporated by this reference. When Mr. and Mrs. Simpson timely
filed the Petition, they resided in Texas.
I. Background
Mr. and Mrs. Simpson are equal shareholders in Getify, a wholly
owned S corporation. Through Getify, Mr. Simpson developed open-
source software and sought “to help other developers be better in [his]
industry” by gathering “useful information” and making it available to
them. In the early stages of developing Getify, Mr. Simpson was
employed by three different software development companies: Oasis,
Mozilla, and Zynga. However, in 2011, as Getify grew more successful,
Mr. Simpson started phasing out his other work. The company’s
newfound success also provided Mr. Simpson with the opportunity to
speak at conferences, teach classes, and write books. Getify maintained
a corporate checking account, a corporate savings account, and two
corporate credit cards.
Mr. Simpson also participated in the formation of Co-Working, a
business that rented office space to be communally shared by people
working in the Austin area. Mr. Simpson, acting as Getify’s agent,
caused Getify to join with two other entities to form Co-Working; each
member contributed $2,500 in cash to Co-Working’s business bank
account at the company’s outset in July 2011. Getify served as Co-
Working’s operating manager and as the company’s registered agent
with the Texas Secretary of State. Unlike Getify, however, Co-Working
did not achieve success; the business was not able to cover its expenses
and it ultimately failed.
II. Years at Issue
A. Tax Year 2011
Mr. and Mrs. Simpson timely filed a joint Form 1040 for their
taxable year 2011. The return included Schedule E, Supplemental
Income and Loss, with respect to petitioners’ involvement in Getify and
Co-Working. Mr. and Mrs. Simpson reported losses of $47,950 from
Getify and $12,541 from Co-Working, for a total loss of $60,491, as
reflected on their respective Schedules K–1, Shareholder’s Share of
Income, Deductions, Credits, etc.
On its Form 1120–S, U.S. Income Tax Return for an
S Corporation, for taxable year 2011, Getify reported $6,450 in gross
receipts (line 1b); $297 in interest expenses (line 13); $15,510 in
4
[*4] depreciation expenses (line 14); $3,343 in advertising expenses (line
16); and $35,250 in “other deductions” (line 19). The “other deductions”
reported on line 19 were itemized as follows:
Expense Amount
Auto and Truck $5,140
Bank Charges 372
Gifts 2,800
Meals 4,200
Office Expense 252
Postage 100
Supplies 1,713
Telephone 3 6,904
Travel 2,090
Home Office Rent 4 5,630
Professional Education 161
Domain 288
Medical Expenses 5,600
B. Tax Year 2012
Mr. and Mrs. Simpson filed a joint Form 1040 for their taxable
year 2012 on August 12, 2014. 5 It included a Schedule E with respect to
petitioners’ involvement in Getify. Mr. and Mrs. Simpson reported
income of $57,910 from Getify, as reflected on their respective Schedules
K–1.
On its 2012 Form 1120–S, Getify reported $114,576 in gross
receipts (line 1a); $5,210 in cost of goods sold (line 2); $6,359 in other
ordinary loss (line 5); $4,210 in interest expenses (line 13); and $40,887
in “other deductions” (line 19). The “other deductions” reported on line
19 were itemized as follows:
3 Petitioners included their home internet expenses within the “Telephone”
expense item for each of the taxable years at issue.
4 In the Stipulations of Facts, the parties have chosen to recharacterize this
item as a “business use of the home” expense for each of the taxable years at issue.
5 There is conflicting evidence in the record regarding the filing date, but the
parties stipulated a filing date of August 12, 2014. As discussed infra note 24, we will
hold the parties to the stipulation.
5
[*5] Expense Amount
Accounting $600
Auto and Truck 4,242
Bank Charges 369
Dues and Subscriptions 797
Miscellaneous 825
Office Expense 180
Outside Service 12,052
Postage 189
Supplies 385
Telephone 6,808
Travel 9,125
Home Office Rent 5,315
For taxable year 2012, Getify also reported an ordinary loss of
$6,360 and a section 1231 loss of $19,701, both of which were associated
with its alleged partnership interest in Co-Working.
C. Tax Year 2013
Mr. and Mrs. Simpson filed a joint Form 1040 for their taxable
year 2013. The return was filed on April 28, 2015. 6 The return included
a Schedule E with respect to petitioners’ involvement in Getify. Mr. and
Mrs. Simpson reported income of $114,162 from Getify, as reflected on
their respective Schedules K–1.
On its 2013 Form 1120–S, Getify reported $192,849 in gross
receipts (line 1a); $200 in advertising expenses (line 16); and $78,488 in
“other deductions” (line 19). The “other deductions” reported on line 19
were itemized as follows:
6 There is conflicting evidence in the record regarding the filing date, but the
parties stipulated a filing date of April 28, 2015. As discussed infra Opinion Part VI,
we will hold the parties to their stipulation.
6
[*6] Expense Amount
Accounting $500
Auto and Truck 5,415
Bank Charges 3,450
Dues and Subscriptions 4,403
Insurance 144
Legal and Professional Fees 96
Meals 1,446
Miscellaneous 637
Office 1,364
Postage 367
Supplies 12,083
Telephone 236
Travel 35,627
Home Office Rent 5,271
Mobile Phone 4,418
“Multi Media” 3,031
III. Examination and Notices of Deficiency
In 2012, the IRS began an investigation of Spectrum Financial
(Spectrum), the provider of tax services that prepared Getify’s corporate
returns and petitioners’ personal returns. The IRS’ investigation of
Spectrum encompassed examinations of Spectrum’s clients’ returns,
including Getify’s corporate returns and petitioners’ personal returns.
Co-Working’s returns were not selected for audit. Upon conclusion of the
examinations, the IRS issued to petitioners two notices of deficiency,
both dated May 3, 2016.
The first notice of deficiency, regarding taxable years 2011 and
2012, showed that respondent determined deficiencies in federal income
tax of $12,874 and $18,866, respectively. Respondent also determined
accuracy-related penalties under section 6662(a) of $2,575 and $3,773
for taxable years 2011 and 2012, respectively, as well as a failure-to-
timely-file addition to tax under section 6651(a)(1) of $4,967 for taxable
year 2012.
The second notice of deficiency, regarding taxable year 2013,
showed that respondent determined a deficiency in federal income tax
of $18,539. Respondent also determined an accuracy-related penalty
under section 6662(a) of $3,672 and a failure-to-timely-file addition to
tax under section 6651(a)(1) of $4,590.
7
[*7] IV. Amounts Still in Dispute
The parties have settled many of the originally disputed items.
After concessions, the parties now primarily dispute whether
petitioners’ claimed deductions are properly reportable on Getify’s
Forms 1120–S or on petitioners’ Schedules A of Forms 1040. 7
Consequently, the following items are still in dispute for the 2011, 2012,
and 2013 taxable years:
2011
Expenses (and Per Per Notice of Respondent’s Petitioners’
Losses) Return Deficiency Position at Trial Position at
Trial
Auto & Truck – $5,140 -0- -0- $5,001
Getify 1120S
(Schedule E)
Auto & Truck -0- -0- $5,001 -0-
(Schedule A)
Telephone & 6,904 -0- 1,648 4,968
Internet – Getify
1120S (Schedule E)
Telephone & -0- -0- 2,786 -0-
Internet (Schedule
A)
Travel – Getify 2,090 $2,090 4,456 5,954
1120S (Schedule E)
Travel (Schedule A) -0- -0- 1,034 -0-
Business Use of the 5,630 -0- -0- 2,586
Home
Co-Working (12,541) -0- (2,642) (12,541)
(Ordinary Loss)
§ 6662(a) Accuracy- N/A 2,575 2,575 -0-
Related Penalty
7 The parties also disagree as to (1) whether some of petitioners’ reported
expenses have been adequately substantiated, see infra Opinion Part III.C, (2) whether
Getify had a sufficient basis in Co-Working to justify petitioners’ reported ordinary and
section 1231 losses from that business, see infra Opinion Part IV, and (3) whether
petitioners are liable for penalties imposed under section 6662(a) and additions to tax
imposed under section 6651(a)(1), see infra Opinion Parts V and VI.
8
[*8] 2012
Expenses (and Per Per Notice of Respondent’s Petitioners’
Losses) Return Deficiency Position at Trial Position at
Trial
Accounting $600 -0- -0- $600
Telephone & 6,808 -0- $886 3,714
Internet – Getify
1120S (Schedule E)
Telephone & -0- -0- 2,524 -0-
Internet (Schedule
A)
Business Use of the 5,315 -0- -0- 2,500
Home – Getify
1120S (Schedule E)
Business Use of the -0- -0- 1,875 -0-
Home (Schedule A)
Co-Working (Section (19,701) -0- -0- (19,701)
1231 Loss)
§ 6662(a) Accuracy- N/A $3,773 3,773 -0-
Related Penalty
§ 6651(a)(1) Failure- N/A 4,967 4,967 -0-
to-Timely-File
Addition to Tax
2013
Expenses (and Per Per Notice of Respondent’s Petitioners’
Losses) Return Deficiency Position at Trial Position at
Trial
Accounting $500 -0- -0- $600
Meals – Getify 1,446 -0- -0- 231
1120S (Schedule E)
Meals (Schedule A) -0- -0- $231 -0-
Telephone & 4,418 -0- -0- 3,649
Internet – Getify
1120S (Schedule E)
Telephone & -0- -0- 2,971 -0-
Internet (Schedule
A)
Business Use of the 5,271 -0- -0- 2,620
Home – Getify
1120S (Schedule E)
Business Use of the -0- -0- 2,620 -0-
Home (Schedule A)
§ 6662(a) Accuracy- N/A $3,672 3,672 -0-
Related Penalty
§ 6651(a)(1) Failure- N/A 4,590 4,590 -0-
to-Timely-File
Addition to Tax
9
[*9] OPINION
I. Burden of Proof
The determinations in a notice of deficiency bear a presumption
of correctness, see, e.g., Welch v. Helvering, 290 U.S. 111, 115 (1933), and
the taxpayer generally bears the burden of proving them erroneous in
proceedings in this Court, see Rule 142(a)(1). While section 7491(a)(1)
provides that, in general, when “a taxpayer introduces credible evidence
with respect to any factual issue relevant to ascertaining the liability of
the taxpayer for any tax imposed by subtitle A or B, the [Commissioner]
shall have the burden of proof with respect to such issue,” petitioners
did not argue that the burden of proof should be shifted to respondent
and failed to introduce sufficient evidence to shift the burden to
respondent. Accordingly, section 7491(a) does not apply.
II. Deductions, Generally
Section 162(a) permits a deduction for ordinary and necessary
expenses paid to carry on a trade or business during the taxable year.
An “ordinary” expense is one that is common and acceptable in the
particular business. Welch v. Helvering, 290 U.S. at 113–14. Moreover,
the main function of the word “ordinary” in section 162(a) is to clarify
the distinction between currently deductible and capital expenses.
Commissioner v. Tellier, 383 U.S. 687, 689–90 (1966). A “necessary”
expense under section 162(a) is an expense that is appropriate and
helpful in carrying on the trade or business. Heineman v. Commissioner,
82 T.C. 538, 543 (1984).
Deductions are a matter of legislative grace, and the taxpayer
bears the burden of clearly showing entitlement to any deduction
claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Under
that burden, the taxpayer must substantiate the amount and the
purpose of the expense underlying the deduction. Higbee v.
Commissioner, 116 T.C. 438, 440 (2001). A taxpayer must also maintain
adequate records to demonstrate the propriety of any deduction claimed.
Id.; see also § 6001.
Certain expenses otherwise deductible under section 162(a) are
subject to heightened substantiation requirements under section 274(d);
these include expenses for traveling and expenses with respect to any
listed property under section 280F(d)(4). See § 274(d)(1), (4). No
deduction is permitted for personal, living, or family expenses unless
expressly permitted under the Code. See § 262(a).
10
[*10] If a taxpayer is unable to substantiate the amount of a deduction,
the Court may nonetheless allow it (or a portion thereof) if there is an
evidentiary basis for doing so. See Cohan v. Commissioner, 39 F.2d 540,
543–44 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742–43
(1985). In estimating the amount of an allowable expense under the
Cohan rule, the Court bears heavily against the taxpayer whose
inexactitude is of his own making. Cohan v. Commissioner, 39 F.2d
at 544. The Cohan rule cannot be applied to deductions subject to the
strict substantiation requirements of section 274(d). See Sanford v.
Commissioner, 50 T.C. 823, 828 (1968), aff’d per curiam, 412 F.2d 201
(2d Cir. 1969); Temp. Treas. Reg. § 1.274-5T(a) (flush language).
With these general principles in mind, we will address the
correctness of petitioners’ claimed deductions associated with Getify and
their purported losses associated with Co-Working.
III. Expenses Associated with Getify
A. Character of Expenses
A corporation is treated as a separate entity from its shareholders
for tax purposes. Moline Props., Inc. v. Commissioner, 319 U.S. 436,
438–39 (1943). While a shareholder may identify his interest and
business with those of the corporation, they are legally distinct and,
ordinarily, if he voluntarily pays or guarantees the corporation’s
obligations, his expense may not be deducted on his personal return.
Deputy v. du Pont, 308 U.S. 488, 494 (1940); Noland v. Commissioner,
269 F.2d 108, 111 (4th Cir. 1959), aff’g T.C. Memo. 1958-60. Such
payments, absent any fixed obligation for repayment, are generally
regarded as a contribution to the capital of a corporation and are
deductible, if at all, by the corporation. Rink v. Commissioner, 51 T.C.
746, 751 (1969). However, a corporate resolution or policy requiring a
corporate officer to assume certain expenses indicates that those
expenses are his rather than the corporation’s. Noyce v. Commissioner,
97 T.C. 670, 683–84 (1991).
It is common in cases such as this for a taxpayer to improperly
claim deductions on his individual return with respect to expenses that
are properly classified as corporate. See, e.g., Noland v. Commissioner,
269 F.2d at 110; Rink, 51 T.C. at 748–50. But petitioners argue that
their reported expenses are properly deductible by their wholly owned
S corporation, Getify, rather than by them. Respondent argues that the
expenses are properly classified as unreimbursed employee expenses
11
[*11] and should be treated as itemized deductions that are reportable
on Schedules A of petitioners’ Forms 1040.
Indeed, this Court has frequently held that being an employee
constitutes a trade or business in and of itself, see Primuth v.
Commissioner, 54 T.C. 374, 377 (1970), and that shareholders of a
corporation may also be engaged in the trade or business of being an
employee, see, e.g., Winslow v. Commissioner, T.C. Memo. 1983-158, 45
T.C.M. (CCH) 1064, 1067 (stating that the Commissioner’s argument
that a taxpayer “cannot be in the trade or business of being the employee
of a corporation that he also owns is obviously without merit” since, for
instance, the Court “must from time to time determine whether a bad
debt is related to a taxpayer’s trade or business of being an employee
where he is also a shareholder of the corporation”). Expenses of
employment, if incurred under a reimbursement arrangement, are
deductible in computing the employee’s gross income. See § 62(a)(2)(A).
Employees that have unreimbursed expenses associated with their
employment may deduct those expenses only as miscellaneous itemized
deductions subject to the two-percent limitation of section 67(a). See
§ 67(b). However, to the extent that any expenses are incurred to protect
a shareholder-employee’s equity interest, those expenses are to be
capitalized and are not deductible to the taxpayer in his capacity as an
employee. Craft v. Commissioner, T.C. Memo. 2005-197, 2005 WL
2078513, at *3. The character of such expenses—that is, whether they
were incurred to protect the shareholder-employee’s equity interest or
incurred as ordinary and necessary expenses associated with the
shareholder’s employment with the entity—depends on the facts and
circumstances of a given case. See Deputy v. du Pont, 308 U.S. at 496;
see also United States v. Generes, 405 U.S. 93, 99 (1972).
Once again, the primary purpose of the word “ordinary” in section
162(a) is to clarify the distinction between expenses that are currently
deductible and those that are capital. Commissioner v. Tellier, 383 U.S.
at 689–90. An expenditure must be capitalized when it (1) creates or
enhances a separate and distinct asset, (2) produces a significant future
benefit, or (3) is incurred “in connection with” the acquisition of a capital
asset such that it is directly related to the acquisition. Lychuk v.
Commissioner, 116 T.C. 374, 385–86 (2001).
12
[*12] In this case, without regard to any specific tax year, the following
categories of expenses are at issue: 8 (1) auto and truck; (2) travel;
(3) meals; (4) accounting; (5) telephone and internet; and (6) business
use of the home. 9 While it is arguable that these expenses were incurred
in connection with the advancement of Getify generally, petitioners have
not proven (nor have they attempted to prove) that the expenses were
incurred specifically for the purpose of acquiring or creating a capital
asset or to produce a significant future benefit; 10 instead, the expenses
seem merely incidental to the nature of the business itself. See id.;
see also INDOPCO, Inc. v. Commissioner, 503 U.S. at 87. To the extent
that any benefit was created by virtue of petitioners’ incursion of the
expenses, it appears to us that such benefit had a more immediate effect.
See D’Angelo v. Commissioner, T.C. Memo. 2003-295, 2003 WL
22413231, at *8. For example, petitioners appear to have incurred their
telephone expenses for the purpose of effectuating instant
communication between themselves and others, irrespective of the
purpose of the communication. Similarly, petitioners’ accounting
expenses were incurred for the purpose of filing their tax returns rather
than for the purpose of procuring advice associated with the acquisition
of a capital asset. Accordingly, all the expenses at issue are properly
8 These categories of expense are at issue with respect to the party that is
rightfully entitled to the deduction (i.e., petitioners in their individual capacity or
Getify, petitioners’ wholly owned S corporation). As laid out further infra note 17, the
parties have stipulated that petitioners have adequately substantiated $5,001 for their
auto and truck expenses for taxable year 2011, $231 for their meals expenses for
taxable year 2013, and $2,620 for their “business use of the home” expenses for taxable
year 2013.
9 Each of the expense categories is at issue for at least one of the years at issue
(i.e., 2011, 2012, or 2013), but they are not all at issue for each year.
10 Petitioners cite Cox v. Commissioner, T.C. Memo. 2001-196, 2001 WL
848658, for the proposition that a taxpayer may increase his basis in an S corporation
if he makes an economic outlay to or for the benefit of the S corporation. However,
petitioners fail to acknowledge, in pertinent part, that an “economic outlay for this
purpose is an actual contribution of cash or property by the shareholder to the
S corporation or a transaction that leaves the S corporation indebted to the
shareholder.” Id. at *4 (emphasis added). With respect to the expenses at issue,
petitioners did not make an actual contribution of cash or property to Getify. Moreover,
there is nothing in the record to indicate that Mr. Simpson and Getify entered into any
loan agreement, nor does any distribution by Getify to petitioners during the taxable
years at issue directly reflect the existence of such an agreement. Accordingly,
petitioners’ basis in Getify was not increased by voluntarily undertaking these
expenses.
13
[*13] characterized as ordinary expenses rather than capital
expenditures. 11
Further, it is evident that the expenses at issue, given their
ordinary nature, were not incurred for the purpose of protecting Mr.
Simpson’s shareholder interest in Getify. See du Pont, 308 U.S. at 496;
Craft v. Commissioner, 2005 WL 2078513, at *3. Instead, it appears they
were incurred to help 12 Mr. Simpson in carrying on his trade or business
as an employee of Getify. See O’Malley, 91 T.C. at 363–64. Consequently,
all of the expenses at issue should be properly characterized as ordinary
and necessary employee expenses. 13 Since they are employee expenses,
11 While we acknowledge that the disjunctive test used to determine whether
an expenditure must be capitalized (delineated in Lychuk, 116 T.C. at 385–86) is not
absolute, the test is nevertheless a helpful tool in assessing the distinctions between
the types of expenditures that are capital and those that are currently deductible. See,
e.g., Shiekh v. Commissioner, T.C. Memo. 2010-126 (holding that travel expenses
incurred by a taxpayer who was investigating potential properties for acquisition must
be capitalized, even though the taxpayer did not acquire the properties); D’Angelo v.
Commissioner, 2003 WL 22413231 (holding that legal fees incurred in defense of a
taxpayer’s business practices rather than to create a separate or distinct asset, produce
a significant future benefit, or acquire a capital asset, were ordinary expenses and
currently deductible); Winter v. Commissioner, T.C. Memo. 2002-173 (holding that
legal and appraisal fees arising from the acquisition of a hotel are not currently
deductible and should have been capitalized). Through this lens, we find that the
relevant expenditures in the instant case are ordinary rather than capital in nature.
But see Koree v. Commissioner, 40 T.C. 961, 965–66 (1963) (holding that a taxpayer
who, as majority shareholder, paid rent obligations on behalf of a corporation, was not
carrying on a trade or business and only made the rent payments to enhance his
interest in a different, related entity that directly benefited from the success of the
corporation; because the payments were made to enhance his interest in the related
entity, the expenditures were required to be capitalized). The context of the taxpayer’s
expenditures in Koree is not analogous to the instant case; Mr. Simpson did not incur
the expenses at issue to enhance his interest in Getify, but rather to make providing
services to Getify more convenient. Therefore, Koree is distinguishable.
12 For an expense to be deductible under section 162(a), it must also be
“necessary.” Once again, a “necessary” expense is one that is appropriate and helpful
in carrying on a trade or business. Heineman, 82 T.C. at 543. The record clearly
indicates that the expenses incurred by Mr. Simpson that are at issue were appropriate
and helpful in carrying out his duties as an employee of Getify. See id.; see also
O’Malley v. Commissioner, 91 T.C. 352, 363–64 (1988); Craft v. Commissioner, 2005
WL 2078513, at *3.
13 Notwithstanding this analysis, this Court has previously allowed a taxpayer
to report mileage deductions for the use of a personal vehicle as a business expense of
a wholly owned S corporation on the S corporation’s Form 1120S. Consequently, such
expense flows through to the taxpayer’s Schedule E. See Powell v. Commissioner, T.C.
Memo. 2016-111, aff’d, 689 F. App’x 763 (4th Cir. 2017). The instant case is very
14
[*14] the next query we must answer to assess their deductibility is
whether the expenses were reimbursed under an accountable plan. See
§ 62(a)(2)(A).
B. Lack of an Accountable Plan
Under section 62(a)(2)(A), an employee can deduct certain
expenses incurred in connection with the performance of services for an
employer under a reimbursement or other allowance arrangement. If
these expenses are reimbursed by the employer pursuant to an
“accountable plan,” then the reimbursed amount is excluded from
income and is not considered wages or compensation. Treas. Reg.
§ 1.62-2(c)(4). To qualify as an accountable plan, such a plan must meet
the requirements of Treasury Regulation § 1.62-2(d)-(f), which, in
pertinent part, provides:
(d) Business connection—
(1) In general.— . . . [A]n arrangement meets the
requirements of this paragraph (d) if it provides advances,
allowances . . . , or reimbursements only for business
expenses that are allowable as deductions by part VI
(section 161 and the following), subchapter B, chapter 1 of
the Code, and that are paid or incurred by the employee in
similar but distinguishable. For one, it does not appear that the Commissioner in
Powell raised the issue of which party (i.e., the individual taxpayer or the S
corporation) was entitled to the deduction. Instead, the primary issue in that case was
whether the taxpayer substantiated the items underlying the deductions claimed. In
the instant case, however, both respondent and petitioners agree that petitioners have
substantiated $5,001 associated with the business use of their personal vehicles for
taxable year 2011.
The parties here disagree about who is entitled to the deduction. In assessing
the analogy between Powell and the instant case, we consider the arguments advanced
by the parties in each case. See United States v. Sineneng-Smith, 140 S. Ct. 1575
(2020); Greenlaw v. United States, 554 U.S. 237, 243 (2008) (“In our adversary system,
in both civil and criminal cases, in the first instance and on appeal, we follow the
principle of party presentation. That is, we rely on the parties to frame the issues for
decision and assign to courts the role of neutral arbiter of matters the parties
present.”). Though we have indicated in dicta that the party presentation principle
necessarily gives us wide latitude in the deficiency context, 901 S. Broadway Ltd.
P’ship v. Commissioner, T.C. Memo. 2021-132, it does not appear that the issue argued
before us in the instant case was presented to this Court in Powell. Accordingly, we
find that case distinguishable. Thus, it would be inappropriate to extend the logic from
Powell to the instant case.
15
[*15] connection with the performance of services as an employee
of the employer. . . .
....
(e) Substantiation—
(1) In general. An arrangement meets the
requirements of this paragraph (e) if it requires each
business expense to be substantiated to the payor in
accordance with paragraph (e)(2) or (e)(3) of this section,
whichever is applicable, within a reasonable period of time.
...
(2) Expenses governed by section 274(d). An
arrangement that reimburses travel, entertainment, use of
a passenger automobile or other listed property, or other
business expenses governed by section 274(d) meets the
requirements of this paragraph (e)(2) if information
sufficient to satisfy the substantiation requirements of
section 274(d) and the regulations thereunder is submitted
to the payor. . . .
(3) Expenses not governed by section 274(d). An
arrangement that reimburses business expenses not
governed by section 274(d) meets the requirements of this
paragraph (e)(3) if information is submitted to the payor
sufficient to enable the payor to identify the specific nature
of each expense and to conclude that the expense is
attributable to the payor’s business activities. . . .
(f) Returning Amounts In Excess Of Expenses—
(1) In general. . . . [A]n arrangement meets the
requirements of this paragraph (f) if it requires the
employee to return to the payor within a reasonable period
of time any amount paid under the arrangement in excess
of the expenses substantiated in accordance with
paragraph (e) of this section. The determination of whether
an arrangement requires an employee to return amounts
in excess of substantiated expenses will depend on the facts
and circumstances.
16
[*16] Section 62(c) further clarifies that an arrangement will not be
treated as a reimbursement or other expense allowance arrangement for
purposes of section 62(a)(2)(A) if it (1) does not require the employee to
substantiate the expenses covered by the arrangement to the person
providing reimbursement or (2) provides the employee the right to retain
any amount in excess of the substantiated expenses covered under the
arrangement.
At trial, Ruth Hancock (Ms. Hancock), vice president of Spectrum
and Mr. Simpson’s sister, testified that Getify had an unwritten
accountable plan. Similarly, Mr. Simpson affirmed in his testimony
that, although he may have discussed an accountable plan with his
accountants, Getify “did not have any formal thing.” While an
accountable plan does not necessarily have to be in writing, 14 there must
be, at the very least, some extrinsic evidence that indicates that such a
plan exists. 15 For example, if petitioners engaged in a formal process
whereby they collected all relevant documentation to substantiate the
purported expenses and then reimbursed themselves from the corporate
account with the exact amounts associated with the expenses, such
evidence might be sufficient to corroborate the existence of an unwritten
accountable plan. 16 The record here notably lacks any such occurrence.
14 Under Treasury Regulation § 1.62-2(c), an accountable plan qualifies as a
“reimbursement or other expense allowance arrangement” if it meets the requirements
of paragraphs (d), (e), and (f) of the regulation. None of those paragraphs requires that
such an arrangement be in writing. See Treas. Reg. § 1.62-2(d)-(f). Under the omitted-
case semantic canon, nothing is to be added to what a text states or reasonably implies;
that is, a matter not covered is to be treated as not covered. See Antonin Scalia & Bryan
A. Garner, Reading Law: The Interpretation of Legal Texts 93 (2012). Thus, the absence
of text in Treasury Regulation § 1.62-2(d)–(f) requiring that an accountable plan be
written leads us to conclude that there is no such requirement.
15This Court is not obligated to accept a petitioner’s self-serving testimony. See
Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). Moreover, even when no contradictory
evidence is presented by the Commissioner, we are not required to be convinced by a
taxpayer’s own evidence regarding his subjective intent. Fleischer v. Commissioner,
403 F.2d 403, 406 (2d Cir. 1968), aff’g T.C. Memo. 1967-85.
16 It appears that this Court has never addressed the issue of whether (and
under what circumstances) an unwritten accountable plan qualifies as a
“reimbursement or other expense allowance arrangement” under Treasury Regulation
§ 1.62-2. We have found, however, that other sorts of reimbursement plans may exist,
even if they are not written, when (1) the relevant Treasury Regulation addressing the
qualification of such a plan does not have an in-writing requirement, (2) the parties
involved with such a plan behave in accordance with the existence of the plan, and
(3) the behavior of the parties (or extrinsic evidence) with respect to the plan is in
17
[*17] Aside from Mr. Simpson and his sister’s testimony regarding
their subjective intent to establish an accountable plan, there is no
evidence in the record to suggest that Getify required Mr. Simpson to
substantiate his expenses or return any amounts received that exceeded
those expenses. See Treas. Reg. § 1.62-2(e). In fact, Mr. Simpson testified
that with respect to instances in which he transferred money from Getify
to his personal account, such occurrences could have been for a
reimbursement as well as a distribution. Moreover, of the numerous
documented transfers between Getify’s checking account and
petitioners’ checking account, there are no records that identify the
purpose of any specific transfer. See id. subpara. (3). Thus, there is no
credible evidence in the record to indicate that Getify had an
accountable plan that meets all the requirements of Treasury
Regulation § 1.62-2(d)–(f). Petitioners have failed to meet their burden
of proof.
Because petitioners failed to establish that Getify had an
accountable plan that meets the requirements of Treasury Regulation
§ 1.62-2(d)-(f), all the expenses incurred personally by petitioners in
connection with Mr. Simpson’s employment with Getify, and which the
parties agree have been substantiated, are considered unreimbursed
employee expenses. 17 Unreimbursed employee expenses fall under the
broader category of “miscellaneous itemized deductions,” which are
allowed only to the extent that the aggregate of such deductions exceeds
accordance with the requirements of the relevant Treasury Regulation. See, e.g.,
Giberson v. Commissioner, T.C. Memo. 1982-338 (affirming the existence and
qualification of an accident and health reimbursement plan under section 105, despite
it not being written). It is worth noting that the regulation contemplated by the Court
in Giberson explicitly states that an accident and health reimbursement plan need not
be in writing, see Treas. Reg. § 1.105-5, whereas the regulation in the instant case does
not contain such language. In any event, we do not hold that, as a matter of law, an
accountable plan need not be in writing; rather, we are merely pointing out that
Treasury Regulation § 1.62-2 does not specifically call for accountable plans to be in
writing and that there are examples of qualifying unwritten reimbursement
arrangements (albeit, in a different context) elsewhere in this Court’s caselaw.
17 Of the items that are still in dispute, the only items that the parties agree
have been sufficiently substantiated (at least with respect to the amount claimed by
petitioners), incurred in connection with Getify, and that we have determined to be
reportable on petitioners’ Schedules A are (1) the “auto and truck” expenses for taxable
year 2011, (2) the “meals” expenses for taxable year 2013, as well as (3) the “business
use of the home” expenses for taxable year 2013. These deductions are properly
characterized as unreimbursed employee expenses and are reportable on petitioners’
Schedules A. Discussion with respect to the substantiation of the amounts associated
with the remaining expense items still in dispute may be found infra Part III.C.
18
[*18] two percent of adjusted gross income. See § 67; Temp. Treas. Reg.
§ 1.67-1T(a). Notwithstanding any concessions made by respondent (or
any agreements reached by the parties), such expenses are generally
reportable on Schedule A of Form 1040.
C. Substantiation
To determine petitioners’ entitlement to any deductions, we must
also determine whether the underlying expenses have been
substantiated. In essence, petitioners assert that they have
substantiated one amount with respect to an item and respondent
asserts that petitioners have either failed to substantiate any amount
or, at most, substantiated a lesser amount. These items are as follows:
travel expenses (taxable year 2011); accounting expenses (taxable years
2012 and 2013); telephone and internet expenses (taxable years 2011,
2012, and 2013); and business use of the home expenses (taxable years
2011 and 2012). We will take each of these expenses in turn.
1. Travel Expenses (2011)
With respect to petitioners’ travel expenses for taxable year 2011,
petitioners’ position at trial was that Getify was entitled to deduct
$5,954. Respondent’s position at trial was that Getify was entitled to
deduct $4,456, which flows through to petitioners’ Schedule E. Also,
respondent averred that petitioners were entitled to deduct $1,034 as
unreimbursed employee expenses, which falls under the category of
“miscellaneous itemized deductions,” is subject to the two-percent
limitation under section 67(a), and is reportable on petitioners’
Schedule A. By this, respondent signals that petitioners have
sufficiently substantiated $5,490 worth of travel expenses for 2011.
Accordingly, the parties dispute whether the discrepancy of $464 has
been properly substantiated.
Travel expenses are subject to heightened substantiation
requirements under section 274(d). Those requirements permit a
deduction for traveling expenses only to the extent the taxpayer proves
(1) the amount of each expenditure for traveling away from home, (2) the
date of departure and return for each trip and the number of days spent
on business, (3) the destination or locality of travel, and (4) the business
reason for travel or the expected business benefit to be derived. See
Temp. Treas. Reg. § 1.274-5T(b)(2). Each element of a traveling expense
must be substantiated through “adequate records” or by “sufficient
evidence corroborating the taxpayer’s own statement.” See § 274(d)
19
[*19] (flush language); see also Temp. Treas. Reg. § 1.274-5T(c)(1), (2),
and (3).
Petitioners provided a spreadsheet of their 2011 travel expenses.
The disputed expenses involve numerous small amounts associated with
toll tag charges and parking fees. These expenses do not clearly
correspond with the travel destinations on petitioners’ travel logs.
Moreover, when asked about several of these expenses at trial, Mr.
Simpson did not provide testimony that corroborated the assertions
made in petitioners’ travel logs.
We hold that petitioners failed to satisfy their burden of
substantiating the full $5,954 in travel expenses for taxable year 2011
in accordance with section 274 and the regulations promulgated
thereunder. Mr. Simpson’s testimony regarding the disputed
spreadsheet items lacks the specificity and detail required under
Temporary Treasury Regulation § 1.274-5T(c)(3)(i)(A). Accordingly,
petitioners are entitled to deduct only the amounts respondent allowed.
As laid out supra Part III.B, the amounts paid out of petitioners’
personal account(s) and not subject to an accountable plan are properly
characterized as unreimbursed employee expenses. Thus, petitioners
are entitled to deduct only what respondent has allowed: Getify may
deduct $4,456, which flows through to petitioners’ Schedule E, and
petitioners are entitled to deduct $1,034 as unreimbursed employee
expenses, which falls under the category of “miscellaneous itemized
deductions,” is subject to the two-percent limitation, and is reportable
on petitioners’ Schedule A.
2. Accounting Expenses (2012 and 2013)
With respect to petitioners’ reported expenses regarding their
payment of accounting fees to Spectrum, petitioners argue that Getify
should be entitled to a $600 deduction for taxable year 2012, as well as
another $600 deduction for taxable year 2013. Meanwhile, respondent
contends that the evidence presented to the Court regarding those
payments is not credible and that the deductions should be disallowed
completely.
Unlike travel expenses, accounting fees are not subject to the
heightened substantiation requirements of section 274(d). Thus, the
Court may allow a deduction even if the taxpayer is unable to
substantiate the expense, assuming there is a proper evidentiary basis
for doing so. See Cohan v. Commissioner, 39 F.2d at 544.
20
[*20] At trial, both Mr. Simpson and Ms. Hancock testified that the
$600 accounting fee for taxable year 2012 was paid in cash at a family
gathering held in Dallas, Texas, in March 2012. They further testified
that the $600 accounting fee for taxable year 2013 was paid in cash at a
family gathering in January 2013. The parties also stipulated the
introduction of two exhibits, purportedly invoices from Spectrum, which
indicated that the accounting fees had been paid by Mr. Simpson for the
preparation of petitioners’ 2011 and 2012 tax returns. 18 Each invoice
shows two separate charges: $470 for the preparation of Getify’s
corporate return and $130 for the preparation of petitioners’ joint
return. The invoices were stamped “PAID” on April 14, 2012, and March
13, 2013, respectively.
At trial, Ms. Hancock was asked to explain the discrepancy
between the date Mr. Simpson paid the fees in cash and the date marked
as paid on the invoice. Ms. Hancock testified that it “was a clerical
oversight that it was marked paid on that date, but that doesn’t make
the receipt false.” Ms. Hancock also testified that Spectrum uses a
“point-of-sale system . . . through our accounting software that shows
that [the invoice] is marked paid, and we [Spectrum] included that in
the funds that we toted [sic] as taxable income.” Spectrum did not
provide any ledgers or records directly corroborating this testimony.
Mr. Simpson was also asked in the new trial why, at the original
trial heard by Judge Chiechi, he did not mention that he had paid the
accounting fees in cash at each of the family gatherings, to which he
testified that he “didn’t remember that at the time.” Moreover, when
asked whether Getify ever paid any other expenses in cash, Mr. Simpson
testified that he put “significant amounts of cash . . . on behalf of Getify
into [Co-Working]” but he did “not have the records and the bank
statements to support that.”
We find Mr. Simpson and Ms. Hancock’s testimony regarding the
cash payment of accounting expenses to be unpersuasive. The only
documentary evidence petitioners put forth to substantiate the
accounting expenses was two purported invoices, which indicated that
the supposed payments were made at times that are not corroborated by
18 The accounting expenses for the preparation of petitioners’ 2011 and 2012
tax returns were allegedly incurred in taxable years 2012 and 2013, respectively
(which comports with the general notion that a taxpayer’s return is typically prepared
in the calendar year following the taxable year associated with the return).
21
[*21] the testimony. 19 Moreover, petitioners supposedly paid for the
preparation of returns in 2012 that were not filed until 2014. This
evidence is not credible. As such, we hold that petitioners failed to
substantiate the $600 in accounting expenses they reported for taxable
years 2012 and 2013.
3. Telephone and Internet Expenses (2011, 2012, and
2013)
For taxable year 2011, petitioners argue that Getify should be
entitled to deduct $4,968 associated with petitioners’ cell phone and
home internet usage that year. This amount appears to reflect 30% of
petitioners’ cell phone bill and 80% of their home internet bill.
Respondent contends that only $1,648 should be deductible by Getify
and that $2,786 should be deductible by petitioners as unreimbursed
employee expenses, subject to the two-percent limitation. The latter
number reflects 30% of petitioners’ phone bill and 60% of their home
internet bill. In essence, respondent agrees that petitioners have
substantiated at least $4,434 of their reported expenses. Accordingly,
the parties dispute whether the discrepancy of $534 has been properly
substantiated.
For taxable year 2012, petitioners argue that Getify should be
entitled to deduct $3,714 associated with petitioners’ cell phone and
home internet usage that year. This amount appears to reflect 30% of
petitioners’ cell phone bill and 80% of their home internet bill. On the
other hand, respondent contends that only $886 should be deductible by
Getify and that $2,524 should be deductible by petitioners as
unreimbursed employee expenses, subject to the two-percent limitation.
The latter number reflects 30% of petitioners’ phone bill and 60% of their
home internet bill. Thus, respondent agrees that petitioners have
substantiated at least $3,410 of their reported expenses. Accordingly,
19 Moreover, the invoices suggest that only $470 of each $600 charge was
dedicated to preparing Getify’s corporate return. Petitioners contend that each $130
payment dedicated to the preparation of their personal returns should also be deducted
by Getify in its corporate capacity. However, in light of the foregoing conclusion, it is
not necessary for us to decide whether fees paid for the preparation of a taxpayer’s
individual return may be deductible by the taxpayer’s business. In fact, judicial
restraint counsels us not to do so. See PDK Lab’ys Inc. v. DEA, 362 F.3d 786, 799 (D.C.
Cir. 2004) (Roberts, J., concurring in part and concurring in judgment) (“[I]f it is not
necessary to decide more, it is necessary not to decide more . . . .”).
22
[*22] the parties dispute whether the discrepancy of $304 has been
properly substantiated.
Finally, for taxable year 2013, petitioners argue that Getify
should be entitled to deduct $3,649 associated with petitioners’ cell
phone and home internet usage that year. This number appears to
reflect 30% of petitioners’ cell phone bill and 80% of their home internet
bill. Respondent contends that Getify is not entitled to any deduction
associated with those expenses for 2013 and that petitioners may deduct
$2,971 as unreimbursed employee expenses, subject to the two-percent
limitation. This amount reflects 30% of petitioners’ phone bill and 60%
of their home internet bill. Accordingly, the parties dispute whether the
discrepancy of $678 has been substantiated.
As a preliminary matter, these expenses are subject to the
analysis supra Part III.A and B. Therefore, to the extent that we find
that petitioners have substantiated their expenses beyond what
respondent has allowed, any additional expense amounts will be
deductible only as unreimbursed employee expenses (to the extent the
deductions exceed two percent of petitioners’ adjusted gross income). In
this respect, petitioners’ deduction of telephone and internet expenses
at the corporate level is limited to what respondent has conceded.
Moreover, since the parties agree that 30% of petitioners’ cell phone bill
is deductible and disagree only as to the proper placement of that
deduction on petitioners’ tax returns, that issue has already been
resolved in favor of respondent in light of our analysis supra Part III.A
and B. Thus, the issue that remains is whether petitioners are entitled
to deduct either 60% or 80% of their home internet usage as
unreimbursed employee expenses, subject to the 2% limitation of section
67(a).
Internet services do not fall under the definition of listed property
under section 280F(d)(4) and are not subject to the heightened
substantiation requirements of section 274(d). Consequently, the Court
may allow a deduction (or a portion thereof) even if the taxpayer is
unable to substantiate it, so long as there is a sufficient evidentiary basis
for doing so. See Cohan v. Commissioner, 39 F.2d at 544. In estimating
the amount of an allowable expense under Cohan, however, the Court
weighs heavily against the taxpayer whose inexactitude is of his own
making. Id. Furthermore, section 262(a) expressly provides that no
deductions are allowed for personal, living, or family expenses.
23
[*23] In taxable year 2011, Mr. Simpson was not engaged in work for
only Getify but was also employed by other entities and performed
services for Co-Working. Mr. Simpson discontinued his employment
with two of his employers during that year. At the start of taxable year
2012, Mr. Simpson continued his work with Getify, Co-Working, and the
other employer 20 but ultimately discontinued his work for the latter two
at different points in the year. In any event, Mr. Simpson used his home
internet service in his work for the other entities, as he testified that he
would do at least some work for them from petitioners’ home.
Mr. Simpson testified that petitioners’ family would occasionally
watch movies and television shows via the internet on Mrs. Simpson’s
personal laptop but that such occurrences were infrequent. Mr. Simpson
also testified that both he and his wife “definitely had [a] Facebook
account” during the years at issue and that Mrs. Simpson “participated
in Facebook groups with other new parents” following the birth of their
youngest child. Furthermore, Mr. Simpson testified that petitioners’
oldest child would use “personal devices” in the home during the years
at issue with unrestricted access to games and streaming services.
Petitioners did not maintain any records allocating the internet usage
between Mr. Simpson’s work for Getify, the employers, Co-Working, or
the family’s personal use.
Ultimately, there is nothing in the record that explains why
petitioners should be entitled to deduct 80% of their home internet
expense instead of 60%. In fact, it is evident from the record that there
were other uses of the home internet service aside from Mr. Simpson’s
work for Getify. Petitioners’ inexactitude is of their own making, see
Cohan v. Commissioner, 39 F.2d at 544, and they have failed to meet
their burden. Thus, petitioners’ deduction for home internet expenses is
limited to what respondent has allowed.
4. Business Use of the Home (2011 and 2012)
For taxable year 2011, petitioners argue that Getify should be
entitled to deduct $2,586 related to Getify’s business use of the home.
Respondent’s position at trial for taxable year 2011 is that petitioners
are not entitled to any deduction related to the business use of the home.
20 See infra Part III.C.4 regarding discussion of Mr. Simpson’s work for Zynga
in taxable year 2012.
24
[*24] For taxable year 2012, petitioners contend that Getify should be
entitled to deduct $2,500 associated with Getify’s business use of the
home. Respondent’s position at trial was that petitioners are entitled to
deduct only $1,875 as unreimbursed employee expenses. Accordingly,
the parties dispute whether the discrepancy of $625 has been
substantiated.
Once again, as a preliminary matter, these expenses are subject
to the analysis supra Part III.A and B. Therefore, to the extent that we
find that petitioners have substantiated their expenses beyond what
respondent has allowed, any additional expenses will be deductible only
as unreimbursed employee expenses, subject to the two-percent
limitation.
As a general rule, taxpayers are unable to claim deductions with
respect to the business use of a dwelling unit that is used by the taxpayer
as a residence during the taxable year. § 280A(a). However, section
280A(c)(1)(A) provides an exception to the general rule to the extent that
a taxpayer, on a regular basis, uses a portion of the dwelling unit
exclusively as the principal place of business for any trade or business of
the taxpayer. The term “dwelling unit” includes houses. § 280A(f)(1)(A).
Before trial, the parties stipulated that petitioners’ residence is
1,891 square feet and that 198 square feet (10.5%) of the residence was
used as Getify’s principal place of business during the years at issue.
The parties also stipulated that, at most, the business’ portion of the
rent, home insurance, and utilities for the taxable years at issue would
be deductible (stipulated expenses). For taxable year 2011, 10.5% of the
stipulated expenses totals $2,610. For taxable year 2012, 10.5% of the
stipulated expenses totals $2,500.
During taxable year 2011, Mr. Simpson was not working
exclusively for Getify; he also performed services for three other
employers and Co-Working. At trial, Mr. Simpson testified that it was
customary for him to do work associated with two of the other entities
from the couch because he wanted to be around his family and that the
office was used exclusively for his work with Getify. We do not find this
testimony credible. Consequently, we hold that the disputed portion of
the dwelling unit was not used exclusively for Getify. Thus, this expense
does not fall under the exception of section 280A(c)(1), and petitioners
are not entitled to deduct the business use of the home expenses for the
2011 taxable year.
25
[*25] During taxable year 2012, Mr. Simpson was not working
exclusively for Getify, as he also performed services on behalf of
Co-Working and another employer. On posttrial brief, respondent
indicated that the reason for the reduction for the allowable deduction
associated with the stipulated expenses for 2012 from $2,500 to $1,875
was the “months when [Mr. Simpson] worked at home for an employer.”
Although Mr. Simpson also worked for Zynga for part of the 2012
taxable year, he testified that his work for Zynga “was not done at [his]
house at all because Zynga has a physical office,” that he did “virtually
all of [his] work for Zynga at their physical office location,” and
furthermore that he “couldn’t recall any work done for Zynga from
home.” We find this testimony credible.
Given that respondent’s adjustment appears to be based on Mr.
Simpson’s work for Zynga, we will treat this as a partial concession.
Thus, we hold that Mr. Simpson used his home office exclusively in his
work with Getify in taxable year 2012 and that petitioners are entitled
to a $2,500 deduction for their business use of the home. However, this
deduction is still subject to our analysis supra Part III.A and B, and we
therefore hold that this expense is properly classified as an
unreimbursed employee expense, subject to the two-percent limitation,
and reportable only on petitioners’ Schedule A for taxable year 2012.
D. Summary
In sum, we hold that petitioners’ S corporation, Getify, may
deduct only the specific expenses that respondent has expressly allowed.
Moreover, except for the business use of the home expenses for taxable
year 2012, petitioners are entitled to deduct only their unreimbursed
employee expenses to the extent respondent allowed, subject to the two-
percent limitation contained in section 67(a).
IV. Basis in Co-Working and Associated Losses
We must also determine whether petitioners have established
that Getify, as a partner in Co-Working, had a sufficient basis to justify
the share of Co-Working’s ordinary and section 1231 losses it deducted,
as reflected on petitioners’ tax returns for taxable years 2011 and 2012.
Petitioners argue that (1) they, on Getify’s behalf, made capital
contributions to Co-Working beyond those respondent agrees have been
substantiated and (2) the other members of the Co-Working venture
intended to make gifts of portions of their interests in Co-Working to
Getify and that their intentions are reflected in the equal distribution of
26
[*26] partnership loss reflected on Co-Working’s tax returns and the
partners’ Schedules K–1 for 2011 and 2012.
Co-Working is a limited liability company (LLC) organized under
the laws of Texas and is treated as a partnership for federal tax
purposes. See Treas. Reg. § 301.7701-3(b). Generally, a partner’s
distributive share of income, gain, loss, deduction, or credit shall be
determined by the partnership agreement. § 704(a). However, a
partner’s distributive share of partnership loss (including capital loss)
is allowed only to the extent of the adjusted basis of the partner’s
interest in the partnership at the end of the year in which such loss
occurred, and any excess of such loss over the partner’s adjusted basis
shall be allowed as a deduction at the end of the partnership year in
which such excess is repaid to the partnership. § 704(d).
A partner’s adjusted basis in a partnership is generally
determined under section 705(a)(1), which provides that the partner’s
basis shall be the basis determined under section 722 or section 742 and
shall be increased by the sum of the partner’s distributive share of
“(A) taxable income of the partnership as determined under section
703(a), (B) income of the partnership exempt from tax under this title,
and (C) the excess of the deductions for depletion over the basis of the
property subject to depletion.” Moreover, the partner’s adjusted basis
shall be decreased by distributions by the partnership as well as the
partner’s distributive share for the taxable years and prior taxable years
of “(A) losses of the partnership, and (B) expenditures of the partnership
not deductible in computing its taxable income and not properly
chargeable to capital account.” § 705(a)(2).
Section 722 provides:
The basis of an interest in a partnership acquired by
a contribution of property, including money, to the
partnership shall be the amount of such money and the
adjusted basis of such property to the contributing partner
at the time of the contribution increased by the amount (if
any) of gain recognized under section 721(b) to the
contributing partner at such time.
To be clear, a partner’s adjusted basis is not determined solely by his
initial contribution; subsequent contributions of property also increase
a partner’s adjusted basis. See id.; see also Nwabasili v. Commissioner,
T.C. Memo. 2016-220, at *16; Haff v. Commissioner, T.C. Memo.
27
[*27] 2015-138, at *5; Webster v. Commissioner, T.C. Memo. 1982-427,
1982 WL 10720.
Alternatively, section 742 provides that the “basis of an interest
in a partnership acquired other than by contribution shall be
determined under part II of subchapter O (sec. 1011 and following).”
Under section 1015, the basis of property acquired by gift is the same in
the hands of the donee as it would be in the hands of the donor, unless
the donor’s basis is “greater than the fair market value of the property
at the time of the gift,” in which case the donee’s basis shall be the fair
market value of the property for the purpose of determining loss. See
§ 1015(a). Thus, if a partner receives a portion of his partnership
interest via gift, he is a donee, and his adjusted basis with respect to
that portion of his interest would be the same as the donor’s basis,
assuming the donor’s basis did not exceed the fair market value of the
interest at the time of the gift.
Furthermore, it should be noted that the value of services
performed is not included in basis unless and until the value of those
services performed has been subjected to tax. See Hutcheson v.
Commissioner, 17 T.C. 14, 19 (1951); see also Tonn v. Commissioner,
T.C. Memo. 2001-123, aff’d, 40 F. App’x 337 (8th Cir. 2002).
On June 9, 2011, Mr. Simpson, acting in his role as president of
Getify, caused the certificate of formation for Co-Working to be filed in
Texas. Getify served as Co-Working’s operating manager and registered
agent. An “Initial Investment Agreement” was entered into between
Getify, Niyolab, LLC, and Casey Software, LLC, whereby each entity
pledged $2,500 to be “co-equal partners” in the venture and that the
funds could be used towards reasonable business startup costs. The
agreement was entered into on July 22, 2011, and was binding until
October 31, 2011.
At trial, Mr. Simpson testified that the other two partners made
more financial contributions to Co-Working while he, acting as Getify’s
agent, provided more sweat equity. He also testified that, at some point
after the Initial Investment Agreement was signed, emails were sent
between Co-Working’s partners that corroborated their supposed
agreement concerning the other two partners’ intentions to gift portions
of their interests in Co-Working to Getify. No emails or any other
documentary evidence of this arrangement was entered into evidence
nor was there testimony from a representative of either of the other two
partners.
28
[*28] Moreover, under Texas law, an LLC is required to keep (1) a
current list that includes the percentage or other interest in the LLC
owned by each member and (2) a written statement of the amount of a
cash contribution and a description and statement of the agreed value
of any other contribution made or agreed to be made by each member as
well as the dates any contribution is made by each member (unless that
information is contained within the company agreement). 21 See Tex.
Bus. Orgs. Code Ann. § 101.501(a)(1), (7) (West 2011). Petitioners
provided neither the list of ownership percentages nor the written
statement, and that information is not otherwise contained within
Co-Working’s articles of organization.
Additionally, petitioners assert that, during taxable year 2011,
they, on Getify’s behalf, made capital contributions to Co-Working of
$2,250 beyond what respondent agrees has been substantiated. As
evidence of $550 of these contributions, petitioners point to their own
bank records, which indicate that checks were drawn on the account but
do not make note of the checks’ recipient(s). The remaining $1,700 was
supposedly a cash contribution made by petitioners, documentary
evidence of which is limited to a bank statement showing a $1,700 cash
withdrawal from petitioners’ checking account. Mr. Simpson testified
that he was unable to provide additional documentary evidence to
substantiate these contributions because he did not have permission to
provide, among other things, Co-Working’s bank records.
This testimony is not reliable. Under Texas law, all entities are
required to keep books and records of accounts. Tex. Bus. Orgs. Code
Ann. § 3.151 (West 2011). Moreover, a member of an LLC or an assignee
of a membership interest in an LLC, on written request and for a proper
purpose, may examine and copy such records at any reasonable time. Id.
§ 101.502. Getify, and by association, Mr. Simpson, was Co-Working’s
registered agent and manager. Consequently, Mr. Simpson did not need
permission from the other partners or his accountant to access and use
those records; under Texas law, he had the right to review and copy
them at any reasonable time.
Where a party fails to introduce evidence within his possession
which, if true, would be favorable to him, there arises a presumption
that if the evidence was produced, it would be unfavorable. Wichita
21 A “company agreement” means any agreement, written or oral, of the
members concerning the affairs or the conduct of the business of an LLC. Tex. Bus.
Orgs. Code Ann. § 101.001(1) (West 2011).
29
[*29] Terminal Elevator Co. v. Commissioner, 6 T.C. 1158 (1946).
Although the necessary evidence to substantiate the alleged
contributions and gifted interest arrangement may not have been in
petitioners’ personal possession, it should have been readily accessible
to Mr. Simpson as Getify’s agent. His failure to offer such records as
evidence creates a presumption that such evidence would be unfavorable
to petitioners.
The documentary evidence that petitioners have put forth
regarding both the gifted interest arrangement and the additional
contributions is not enough for petitioners to meet their burden of proof
or to warrant a finding that they had a sufficient basis in Co-Working to
justify a share of the partnership’s losses beyond what respondent has
already allowed. Even if the parties agreed to take an equal distributive
share of profits and losses, as indicated in Co-Working’s “Initial
Investment Agreement,” a partner’s distributive share of partnership
loss is allowed only to the extent of the adjusted basis of the partner’s
interest in the partnership at the end of the year in which the loss
occurred. See § 704(d). As such, we hold that petitioners did not
substantiate that Getify had a sufficient basis in Co-Working to justify
their purported losses and that their losses related to Co-Working are
limited to what respondent has allowed.
V. Accuracy-Related Penalties Under Section 6662(a)
Respondent determined section 6662(a) accuracy-related
penalties against petitioners for taxable years 2011, 2012, and 2013.
Section 6662(a) applies to the portion of any underpayment that is
attributable to, among other things, any substantial understatement of
income tax. § 6662(b)(2). A substantial understatement of income tax
exists if the amount of the understatement exceeds the greater of ten
percent of the tax required to be shown on the return or $5,000.
§ 6662(d)(1)(A). For any substantial understatement of income tax,
section 6662(a) provides for the imposition of an accuracy-related
penalty in an amount equal to 20% of the portion of the underpayment
of tax required to be shown on the return.
The Commissioner bears the burden of production with respect to
the liability of an individual for any penalty. § 7491(c). To satisfy his
burden, the Commissioner must present sufficient evidence to show that
it is appropriate to impose the penalty in the absence of available
defenses. See Higbee, 116 T.C. at 446. Once the Commissioner meets his
burden of production on penalties, the taxpayer must come forward with
30
[*30] persuasive evidence that the Commissioner’s showing is incorrect.
Rule 142(a); Higbee, 116 T.C. at 447.
In the instant case, respondent determined deficiencies of
$12,874, $18,866, and $18,359 for taxable years 2011, 2012, and 2013,
respectively. In light of the parties’ concessions and our holdings above,
the deficiencies appear to exceed ten percent of the tax required to be
reported on petitioners’ original returns. Thus, the requirements of a
substantial understatement for each year appear to have been met. 22
Moreover, respondent has established that the managerial approval
requirements of section 6751(b)(1) have been met, as the examiner’s
supervisor signed the relevant Civil Penalty Approval Forms before the
date when petitioners were first notified in writing that respondent
proposed the assessment of the penalties. See Belair Woods, LLC v.
Commissioner, 154 T.C. 1 (2020). 23 Respondent has met his burden of
production, and petitioners have not established any persuasive
evidence showing that the determination is incorrect. See Rule 142(a);
Higbee, 116 T.C. at 447. Consequently, we sustain respondent’s
determinations with respect to the section 6662(a) accuracy-related
penalties for taxable years 2011, 2012, and 2013.
22 A final determination must await the submission of computations under
Rule 155, which we will order. Because the deficiencies respondent determined appear
to represent a substantial understatement of income tax for each year by petitioners,
we find it unnecessary to engage in an analysis with respect to section 6662(b)(1).
23 Appeal of this case would presumably lie in the U.S. Court of Appeals for the
Fifth Circuit. § 7482(b)(1)(G); Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d, 445
F.2d 985 (10th Cir. 1971). Golsen stands for the proposition that this Court will apply
the decision of the Court of Appeals that is “squarely in point where appeal from our
decision lies to that Court of Appeals and to that court alone,” and, as a corollary, that
this Court’s own view(s) will be given effect to the extent the relevant Court of Appeals
has not expressed one. See Golsen, 54 T.C. at 757.
We recognize that there is a split among circuits as to whether written
supervisory approval must be obtained before the IRS issues a formal communication
of the penalty such as a notice of deficiency, Chai v. Commissioner, 851 F.3d 190, 221
(2d Cir. 2017), aff’g in part, rev’g in part T.C. Memo. 2015-42, or merely before the
assessment, Kroner v. Commissioner, 48 F.4th 1272, 1278–79 (11th Cir. 2022), rev’g in
part T.C. Memo. 2020-73; see also Laidlaw’s Harley Davidson Sales, Inc. v.
Commissioner, 29 F.4th 1066, 1074 (9th Cir. 2022) (holding that section 6751(b)(1)
“requires written supervisory approval before the assessment of the penalty or, if
earlier, before the relevant supervisor loses discretion whether to approve the penalty
assessment”), rev’g and remanding 154 T.C. 68 (2020). The Fifth Circuit does not
appear to have taken a clear stance on this issue. See PBBM-Rose Hill, Ltd. v.
Commissioner, 900 F.3d 193, 213 (5th Cir. 2018).
31
[*31] VI. Additions to Tax for Failure to Timely File Under Section
6651(a)(1)
Finally, we address the additions to tax determined against
petitioners for taxable years 2012 and 2013. Under section 6651(a)(1),
when a taxpayer fails to file any required return on the date prescribed
for filing:
[U]nless it is shown that such failure is due to reasonable
cause and not due to willful neglect, there shall be added
to the amount required to be shown as tax on such return
5 percent of the amount of such tax if the failure is for not
more than 1 month, with an additional 5 percent for each
additional month or fraction thereof during which such
failure continues, not exceeding 25 percent in the
aggregate . . . .
Petitioners’ 2012 tax return was, after extension, due on October
15, 2013. There is conflicting evidence in the record as to when the
return was filed. The IRS account transcript suggests the return was
filed on April 23, 2014. Meanwhile, the return itself was stamped as
received on August 12, 2014, and the parties stipulated that filing date.
In either case, the return was delinquent by more than six months. On
posttrial brief, petitioners concede that the late filing of the 2012 return
should be subject to the maximum 25% addition to tax imposed under
section 6651(a).
Petitioners’ 2013 tax return was, after extension, due on October
14, 2014. As with petitioners’ 2012 return, there is conflicting evidence
in the record regarding when the 2013 return was filed. The IRS Account
Transcript suggests the return was filed on December 3, 2014.
Meanwhile, the return itself was stamped as received on April 28, 2015,
and the parties stipulated that filing date. On brief, petitioners allege
that they did not timely file their 2013 return because the examination
that was ongoing with respect to their 2011 return “could subject [them]
to . . . penalties.”
There is nothing in the record to indicate that petitioners sought
to prepare their 2013 return in accordance with respondent’s
determinations from the examination of their 2011 return. In preparing
their return for taxable year 2013, petitioners appear to have taken the
same cavalier approach to deductions as they did when preparing their
returns for the prior taxable years. Moreover, petitioners did not receive
32
[*32] respondent’s examination report concerning the audits until
October 20, 2015, months after they filed the return. Thus, regardless of
whether the 2013 return was filed in December 2014 or April 2015, the
assertion that the return was filed late on account of an effort to adjust
to the results of the 2011 exam is not credible and there is no evidence
in the record to support it. As such, petitioners did not prove that the
tardiness of their filing was due to reasonable cause. See § 6651(a)(1).
While the discrepancy in the record regarding the filing date of
the 2013 return is potentially problematic for the purposes of calculating
how late it was (and thus, what the proper addition to tax should be
under section 6651(a)(1)), the parties stipulated that the Form 1040 for
the 2013 tax year was filed on April 28, 2015, and petitioners asserted
in their posttrial brief that “the 2013 tax year Form 1040 was filed on
April 28, 2015.” For purposes of resolving the timing issue, we will hold
petitioners to the stipulation. 24 Thus, petitioners’ 2013 tax return was
filed more than six months late and should be subject to the addition to
tax respondent determined in the notice of deficiency.
VII. Conclusion
We hold that (1) the deductions at issue are properly deductible
by petitioners as unreimbursed employee expenses subject to the two-
percent limitation of section 67(a), and are reportable on Schedules A of
petitioners’ Forms 1040; (2) with the exception of petitioners’ expenses
for business use of the home for taxable year 2012, the expenses that
petitioners claim beyond what respondent has allowed have not been
substantiated; (3) petitioners did not substantiate their basis in
Co-Working and are limited to the losses respondent allowed;
(4) petitioners are liable for accuracy-related penalties under section
24 Rule 91(e) provides: “A stipulation shall be treated, to the extent of its terms,
as a conclusive admission by the parties to the stipulation, unless otherwise permitted
by the Court or agreed upon by those parties.” Stipulations, like contracts, bind the
parties to their terms. See McGivney v. Commissioner, T.C. Memo. 2000-224, 2000 WL
1036364, at *1 (citing Stamos v. Commissioner, 87 T.C. 1451, 1455 (1986)). Although
we may disregard a stipulation between parties if the evidence contrary to the
stipulation is substantial or the stipulation is clearly contrary to facts disclosed by the
record, see Loftin & Woodard, Inc. v. United States, 577 F.2d 1206, 1232 (5th Cir. 1978);
Jasionowski v. Commissioner, 66 T.C. 312, 317–18 (1976), the parties’ stipulation
regarding the filing date coincides with the date that the return was stamped as being
received. Consequently, the stipulation regarding the filing date is not clearly contrary
to the facts disclosed by the record. Moreover, we do not consider the date on the
account transcript to be substantial evidence. We are therefore not inclined to
disregard the stipulation.
33
[*33] 6662(a) for taxable years 2011, 2012, and 2013; and (5) petitioners
are liable for additions to tax resulting from their failure to timely file
tax returns under section 6651(a)(1) with respect to taxable years 2012
and 2013.
We have considered all of the arguments made by the parties, and
to the extent not mentioned above, we conclude that they are moot,
irrelevant, or without merit. To reflect the foregoing,
Decision will be entered under Rule 155.