UNITED STATES TAX COURT

T.C. Memo. 2006-159

UNITED STATES TAX COURT

KEVIN L. AND VICTORIA L. HARGROVE, ET AL.,1 Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 16441-04, 16442-04,

16443-04, 16444-04,

16448-04.

Filed August 8, 2006.

Richard Edward Preston and Alvin S. Brown, for petitioners.

Paul T. Butler, for respondent.

MEMORANDUM OPINION

KROUPA, Judge:

Respondent determined deficiencies in

petitioners’ Federal income taxes for 1999, 2000, 2001, and 2002

1

This case is consolidated for briefing and opinion with the

cases of William C. and Deborah L. Kirkpatrick, Docket No. 1644204, David J. and Ann M. Nakagawa, Docket No. 16443-04, Robert C.

and Yvonne R. Anthony, Docket No. 16444-04, and Timothy E. and

Mary L. Breeding, Docket No. 16448-04.

-2(the years at issue)2 and accuracy-related penalties under

section 6662(a).3

Respondent determined that petitioners Kevin L. and Victoria

L. Hargrove were liable for a $11,814 deficiency and a $2,362.80

accuracy-related penalty for 2000.

For 2001, respondent

determined that petitioners Mr. and Mrs. Hargrove were liable for

a $8,497 deficiency and a $1,699.40 accuracy-related penalty.

Respondent determined that petitioners William C. and

Deborah L. Kirkpatrick were liable for a $1,943 deficiency in

2000 and a $1,843 deficiency in 2001.

Respondent determined that petitioners David J. and Ann M.

Nakagawa were liable for a $1,862 deficiency and a $372 accuracyrelated penalty for 1999.

For 2000, respondent determined that

petitioners Mr. and Mrs. Nakagawa were liable for a $1,848

deficiency and a $370 accuracy-related penalty.

For 2001,

respondent determined that petitioners Mr. and Mrs. Nakagawa were

liable for a $1,841 deficiency and a $368 accuracy-related

penalty.

Respondent determined that petitioners Robert C. and Yvonne

R. Anthony were liable for a $2,332 deficiency for 2000, a $2,396

deficiency for 2001, and a $2,158 deficiency for 2002.

2

Not all petitioners had a deficiency for each year at

issue. The term “relevant years” will be used to refer to the

years for which respondent determined deficiencies for those

particular petitioners.

3

All section references are to the Internal Revenue Code in

effect for the years at issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure, unless otherwise

indicated.

-3Respondent determined that petitioners Timothy E. and Mary

L. Breeding were liable for a $13,232 deficiency and a $2,232

accuracy-related penalty for 2000.

For 2001, respondent

determined that petitioners Mr. and Mrs. Breeding were liable for

a $13,482 deficiency and a $2,284 accuracy-related penalty.

After concessions,4 there are three issues for decision.

The first issue is whether petitioners may exclude the costs of

lodging provided by their employer from income under section 119.

We hold that they may not.

The second issue is whether Mr. and

Mrs. Hargrove and Mr. and Mrs. Breeding are entitled to exclude

certain allowances under section 912.

We hold that they are not.

The third issue is whether Mr. and Mrs. Hargrove and Mr. and Mrs.

Breeding are liable for accuracy-related penalties under section

6662(a).

We hold that they are.

Background

These cases were submitted fully stipulated pursuant to Rule

122, and the facts are so found.

The stipulations of facts and

the accompanying exhibits are incorporated by this reference.

All petitioners resided outside the United States at the times

they filed their petitions.

One or both petitioners in each case were employees of TRW

Overseas Inc. (TRW) during the relevant years.

These petitioners

worked for TRW in Pine Gap, Australia, at the Joint Defense Space

Research Facility/Joint Defense Space Communication Station (the

4

Respondent concedes that Mr. and Mrs. Nakagawa are not

liable for accuracy-related penalties under sec. 6662(a).

-4defense facility) at the Pine Gap Air Force Base (the base).

TRW

was a U.S. Government contractor providing services at the

defense facility.

Petitioners were required to accept assigned housing as a

condition of their employment at the defense facility.

The

assigned housing was in Alice Springs, Australia, about 22 miles

from petitioners’ workplace at the defense facility, not within

the physical boundaries of the base.

Alice Springs was a town of

approximately 28,000 people and included residents who did not

work at the base as well as those who did.

The housing in Alice

Springs where petitioners resided was not in a gated community or

an area open only to TRW employees.

The housing was scattered

throughout the city on publicly accessible roads adjacent to

homes available to the general public and not within any separate

enclave or area.

Petitioners did not pay any rent or utility expenses for

their homes in Alice Springs during the years at issue.

Local

Alice Springs companies provided services such as trash

collection and law enforcement.

Petitioners never conducted any

TRW or defense facility business at their homes in Alice Springs.

Petitioners were required to sign closing agreements as a

condition of their employment.

In the closing agreements,

petitioners identified TRW as their employer and waived any right

to elect a foreign earned income exclusion under section 911(a)

for the relevant years with respect to the services they would

provide for the defense facility in Australia.

They also agreed

-5to attach copies of the closing agreements to their respective

returns.

No petitioner attached a copy of his or her closing

agreement to the return for any of the relevant years.

Mr. and Mrs. Hargrove did not retain the services of a

preparer to assist them in filing their returns for 2000 and

2001.

Mr. and Mrs. Hargrove did not seek advice from any

accountant, attorney, or other tax professional with respect to

their exclusions of income under sections 912 and 119.

Mr. and

Mrs. Hargrove reported they owed tax of $4,719 for 2000 and

$4,123 for 2001.5

Mr. and Mrs. Breeding filed their original returns for 1998

and 1999 without the assistance of a preparer.

They then

retained Bob Ross, a certified public accountant located in

California, on the advice of coworkers at the defense facility.

Mr. Ross filed amended returns for 1998 and 1999 on behalf of Mr.

and Mrs. Breeding excluding income under sections 119 and 912.

Mr. and Mrs. Breeding’s original returns for 2000 and 2001,

prepared with the assistance of Mr. Ross, also excluded income

under sections 119 and 912.

Mr. and Mrs. Breeding reported they

owed tax of $22,235 for 2000 and $23,169 for 2001.6

Respondent disallowed certain deductions and determined that

petitioners are not entitled to certain exclusions they claimed

5

This is the sum stated in the deficiency notice. We note

that the parties stipulated that Mr. and Mrs. Hargrove reported

amounts slightly different.

6

This is the sum stated in the deficiency notice. We note

that the parties stipulated that Mr. and Mrs. Breeding reported

amounts slightly different.

-6on their returns for the relevant years in the deficiency

notices.7

Respondent determined that Mr. and Mrs. Hargrove are

not entitled to an exclusion under section 911 of $44,850 in 2000

and $31,861 in 2001, determined that the correct amount of tax is

$16,533 for 2000 and $12,620 for 2001, and determined that Mr.

and Mrs. Hargrove are also liable for the accuracy-related

penalty.8

Respondent determined that Mr. and Mrs. Kirkpatrick

are not entitled to an exclusion under section 119 of $6,606 in

2000 and $6,698 in 2001.

Respondent determined that Mr. and Mrs.

Nakagawa are not entitled to an exclusion under section 119 of

$6,607 in 1999, $6,606 in 2000, and $6,698 in 2001 and that Mr.

and Mrs. Nakagawa are liable for the accuracy-related penalty.

Respondent has since conceded that Mr. and Mrs. Nakagawa are not

liable for the accuracy-related penalty.

Respondent determined

that Mr. and Mrs. Anthony are not entitled to an exclusion under

section 119 of $7,056 in 2000 and $7,154 in 2001.

Finally,

respondent determined that Mr. and Mrs. Breeding are not entitled

to exclusions under section 119 of $7,056 in 2000 and $7,154 in

2001, and their exclusions under section 912 of $34,285 in 2000

and $36,357 in 2001.

Respondent determined that the correct

amount of tax Mr. and Mrs. Breeding owe is $35,467 for 2000 and

7

None of petitioners’ returns was introduced as evidence in

any of these cases.

8

In Docket No. 16441-04, Mr. and Mrs. Hargrove asserted in

the petition that they were entitled to deductions for housing

expenses under sec. 119 and met the requirements for exclusion of

certain income under sec. 912.

-7$36,651 for 2001 and that Mr. and Mrs. Breeding are liable for

accuracy-related penalties.

Petitioners timely filed petitions.

Discussion

We are asked to decide whether petitioners may exclude the

value of lodging provided by their employer under section 119 and

whether certain petitioners are entitled to exclusions from

income for certain allowances under section 912.

We are also

asked to consider whether certain petitioners are liable for

accuracy-related penalties.

I.

We begin with the burden of proof.

Burden of Proof

In general, the Commissioner’s determinations in the

deficiency notice are presumed correct, and the taxpayer bears

the burden of proving that the Commissioner’s determinations are

in error.

(1933).

See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

The burden of proof may shift to the Commissioner under

certain circumstances, however, if the taxpayer introduces

credible evidence and establishes that he or she substantiated

items, maintained required records, and fully cooperated with the

Commissioner’s reasonable requests.

Sec. 7491(a)(2)(A) and (B).

Petitioners repeatedly failed to cooperate with respondent to

prepare these cases for trial and were admonished by the Court

when the case was called for trial.

Petitioners have therefore

not met the requirements of section 7491(a)(2)(B), and the burden

of proof remains with them.

-8II.

Exclusion of Lodging Costs

We now consider whether petitioners may exclude the value of

lodging provided by their employer from income under section 119.

Gross income generally includes all income from whatever source

derived, including compensation for services.

Sec. 61(a)(1).

Compensation for services includes income realized in any form

including money, property, or services.

Sec. 1.61-2(d)(3),

Income Tax Regs.

The value of lodging provided to an employee, his or her

spouse, and his or her dependents may be excluded from income if

certain conditions are met.

Sec. 119.

To exclude the value of

lodging, the employee must accept the lodging as a condition of

his or her employment, the lodging must be furnished for the

convenience of the employer, and the lodging must be on the

business premises of the employer.

Regs.

Sec. 1.119-1(b), Income Tax

The employee must meet all three of these conditions to

qualify for the exclusion.

Dole v. Commissioner, 43 T.C. 697

(1965), affd. per curiam 351 F.2d 308 (1st Cir. 1965).

The parties agree that petitioners were required to accept

the lodging as a condition of their employment and the lodging

was furnished for the convenience of TRW.

two conditions are met.

Accordingly, the first

See sec. 1.119-1(b), Income Tax Regs.

The parties dispute, however, whether the lodging is on TRW’s

business premises.

The business premises of the employer are generally the

place of employment of the employee.

See sec. 1.119-1(c)(1),

-9Income Tax Regs.

The phrase “on the business premises” has been

construed to mean either (1) living quarters that constitute an

integral part of the business property or (2) premises on which

the employer carries on some of its business activities.

See

Dole v. Commissioner, supra at 707.

Living quarters are generally an integral part of business

property if they are physically located on the employer’s

premises.

Living quarters are also generally an integral part of

business property if the employee does enough work for the

employer at the living quarters so that the living quarters are

identified with the interests of the business and serve important

business functions.

See Adams v. United States, 218 Ct. Cl. 322,

585 F.2d 1060, 1066-1067 (1978); Johnson v. Commissioner, T.C.

Memo. 1983-479.

The home of a high-ranking executive has been considered an

integral part of the employer’s business when the executive held

meetings and business social functions in his home, raising the

status of his company.

Adams v. United States, supra.

Similarly, a hotel manager’s residence has been considered an

integral part of the employer’s business when the hotel manager

could observe the hotel from his home, worked from home in the

evenings, and also occasionally entertained important hotel

guests in his home.

Lindeman v. Commissioner, 60 T.C. 609

(1973).

Conversely, living quarters physically located off the

worksite are not integral to the employer’s business unless the

-10employee does significant work for the employer or the employer

conducts a significant portion of its business at the living

quarters.

See Johnson v. Commissioner, supra.

For example,

housing located 12 miles from the employee’s worksite on the

trans-Alaska pipeline was not integral to the employer’s business

where the employee only prepared some daily inspection reports at

home. Id.

Also, proximity is not the standard.

Living quarters

as close as a mile from the worksite are not integral to the

employer’s business even if the employee is periodically on call

to perform work for the employer unless the employee performs

significant work for the employer at the living quarters.

See

Dole v. Commissioner, supra.

The homes where petitioners and their families lived in

Alice Springs were 22 miles from the defense facility.

The

housing was in a separate town on a public road in the same areas

where nonbase employees lived.

No TRW activities occurred at the

housing petitioners occupied in Alice Springs.

No petitioner

performed any work for TRW at his or her home in Alice Springs.

Accordingly, the housing in Alice Springs was not an integral

part of TRW’s business and having petitioners occupy those

particular homes served no important TRW business functions.

We conclude that the living quarters TRW provided

petitioners were not integral to TRW’s business.

The living

quarters therefore do not qualify for the exclusion under section

119, and petitioners are not entitled to exclude the costs of

their lodging from their income for the relevant years.

-11Petitioners attempt to redefine their worksite to include

the lodging units in Alice Springs by a broad reading of the

treaty under which the defense facility was established.9

find no merit to their argument.

We

In fact, neither the treaty

under which the defense facility was authorized nor its

amendments and extensions refers to housing units or lodging for

employees.10

There is no mention of contractors’ living quarters

and nothing in the treaty implies that contractors’ living

quarters should be considered part of the defense facility.

III. Exclusion of Living Allowances

We next address the argument of petitioners Mr. and Mrs.

Hargrove and Mr. and Mrs. Breeding that they are entitled to

exclude certain living allowances for the relevant years under

9

The defense facility was authorized under a treaty between

the United States and Australia that became effective on Dec. 9,

1966. Agreement Relating to the Establishment of a Joint Defence

Space Research Facility, U.S.-Austl., Dec. 9, 1966, 17 U.S.T.

2235 (the Treaty). The Treaty has been amended and extended

since 1966. Exchange of Notes Constituting an Agreement to

Further Extend in Force the Agreement Relating to the

Establishment of a Joint Defence Facility at Pine Gap of 9

December 1966, as Amended, U.S.-Austl., Jun. 4, 1998, 2171

U.N.T.S. 89; Agreement Amending and Extending the Agreement of

Dec. 9, 1966, As Amended and Extended, Relating to the

Establishment of a Joint Defence Space Research Facility, U.S.Austl., Nov. 16, 1988, State Dept. No. 89-2; Agreement Amending

and Extending the Agreement of Dec. 9, 1966, U.S.-Austl., Oct.

19, 1977, 29 U.S.T. 2759.

10

The treaty generally provides for establishing and

operating a facility for general defense research in the space

field in Australia. Treaty, art. 1. We note that under the

treaty, contractors’ income shall be deemed not to have been

derived in Australia for Australian tax purposes as long as it is

not exempt from and is subject to tax in the United States. Id.,

art. 9(1). If the lodging income were exempt from U.S. tax, this

provision would entitle Australia to tax it instead.

-12section 912.

Section 912 excludes from income foreign area

allowances and cost of living allowances given to civilian

officers and employees of the U.S. Government.

Taxpayers must be

civilian employees or officers of the U.S. Government to be

entitled to the exclusion for the types of allowances under

section 912.

Sec. 912; Adair v. Commissioner, T.C. Memo. 1995-

493.

Mr. and Mrs. Hargrove and Mr. and Mrs. Breeding stipulated

that they were employees of TRW, not the U.S. Government, for

each relevant year.

They each also signed closing agreements

identifying TRW as their employer.

Moreover, the common law

factors defining the employer-employee relationship indicate that

TRW, not the U.S. Government, employed petitioners.

See Matthews

v. Commissioner, 907 F.2d 1173 (D.C. Cir. 1990), affg. 92 T.C.

351 (1989).

Mr. and Mrs. Hargrove and Mr. and Mrs. Breeding have

not shown that the U.S. Government controlled the methods or

manner of their work or had the right to discharge them.

Matthews v. Commissioner, 92 T.C. at 361.

See

Mr. and Mrs. Hargrove

and Mr. and Mrs. Breeding are not civilian officers or employees

of the U.S. Government and have not shown that they received

these types of allowances.

Accordingly, they are not entitled to

any exclusion from income.

Mr. and Mrs. Hargrove and Mr. and Mrs. Breeding also argue

that we should look to the treaty under which the defense

facility was established to define the terms “employer” and

“employee” because those terms are not defined in sections 119

-13and 912.

We disagree.

Article 7 of the treaty defines the term

“United States civilian employee” for purposes of the treaty and

the related Status of Forces Agreement, not for the Internal

Revenue Code.

Moreover, “a civilian employee of the United

States government employed in Australia in connection with the

facility” is not defined in the treaty to include contractors or

their employees.

Contractors and their personnel are

specifically referred to as such in several other parts of the

treaty, such as in paragraph (1) of article 9.

Even if we were to find that petitioners were employees of

the U.S. Government, they would still not be entitled to exclude

income under section 912 because they have not shown that they

meet the other requirements of section 912.

Petitioners

introduced no evidence concerning any allowances they received,

nor have they shown that they received a cost of living

allowance, foreign area allowance under chapter 9 of title I of

the Foreign Service Act of 1980, section 4 of the Central

Intelligence Agency Act of 1949, as amended, or any other

allowance described in section 912.

See sec. 912.

We conclude that Mr. and Mrs. Hargrove and Mr. and Mrs.

Breeding are not entitled to exclude any amounts from income

under section 912.

IV.

Accuracy-Related Penalty

We next consider whether petitioners Mr. and Mrs. Hargrove

and Mr. and Mrs. Breeding are liable for accuracy-related

penalties under section 6662(a) for the relevant years.

-14Respondent has the burden of production under section 7491(c) and

must come forward with sufficient evidence that it is appropriate

to impose the penalties.

See Higbee v. Commissioner, 116 T.C.

438, 446-447 (2001).

A taxpayer is liable for an accuracy-related penalty of 20

percent of any part of an underpayment attributable to, among

other things, a substantial understatement of income tax.11

There is a substantial understatement of income tax under section

6662(b)(2) if the amount of the understatement exceeds the

greater of either 10 percent of the tax required to be shown on

the return, or $5,000.

Sec. 6662(a), (b)(1) and (2), (d)(1)(A);

sec. 1.6662-4(a), Income Tax Regs.

Respondent has met his burden of production with respect to

Mr. and Mrs. Hargrove’s and Mr. and Mrs. Breeding’s substantial

understatements of income tax for the relevant years.

Mr. and

Mrs. Hargrove reported they owed income tax of $4,719 for 2000

and $4,123 for 2001.12

Respondent determined that they owed

$16,533 for 2000 and $12,620 for 2001.

Mr. and Mrs. Hargrove

11

Respondent determined in the alternative that Mr. and Mrs.

Hargrove and Mr. and Mrs. Breeding were liable for the accuracyrelated penalties for negligence or disregard of rules or

regulations under sec. 6662(b)(1) for the relevant years.

Because respondent has proven that petitioners substantially

understated their income tax for the relevant years, we need not

consider whether petitioners were negligent or disregarded rules

or regulations.

12

None of petitioners’ returns for the relevant years was

introduced in evidence. We have used the amounts reflected in

the deficiency notice for the amounts petitioners reported on

their returns. We note there is a slight discrepancy between the

amounts we use and the amounts that petitioners stipulated, but

this difference is immaterial.

-15understated their tax by $11,814 for 2000 and $8,497 for 2001.

Accordingly, Mr. and Mrs. Hargrove have understated their tax for

each relevant year by the greater of 10 percent of the tax

required to be shown on the return, or $5,000.

Mr. and Mrs. Breeding reported they owed income tax of

$22,235 for 2000 and $23,169 for 2001.13

Respondent determined

that they owed $35,467 for 2000 and $36,651 for 2001.

Mr. and

Mrs. Breeding understated their tax by $13,232 for 2000 and

$13,482 for 2001.

Accordingly, Mr. and Mrs. Hargrove have

understated their tax for each relevant year by the greater of 10

percent of the tax required to be shown on the return, or $5,000.

The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment, however, if it is shown

that there was reasonable cause for the taxpayer’s position and

that the taxpayer acted in good faith with respect to that

portion.

Sec. 6664(c)(1); sec. 1.6664-4(b), Income Tax Regs.

The determination of whether a taxpayer acted with reasonable

cause and in good faith is made on a case-by-case basis, taking

into account all the pertinent facts and circumstances, including

the taxpayer’s efforts to assess his or her proper tax liability

and the knowledge and experience of the taxpayer.

4(b)(1), Income Tax Regs.

13

Sec. 1.6664-

The taxpayer bears the burden of proof

None of petitioners’ returns for the relevant years was

introduced in evidence. We have used the amounts reflected in

the deficiency notice for the amounts petitioners reported on

their returns. We note there is a slight discrepancy between the

amounts we use and the amounts that petitioners stipulated, but

this difference is immaterial.

-16with respect to reasonable cause.

Higbee v. Commissioner, supra

at 446.

Where a taxpayer chooses a competent tax adviser and

supplies him or her with all relevant information, it is

consistent with ordinary business care and prudence to rely on

the adviser’s professional judgment as to the taxpayer’s tax

obligations.

(1985).

United States v. Boyle, 469 U.S. 241, 250-251

The taxpayer must show that the adviser was a competent

professional with significant expertise to justify reliance.

Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 99

(2000), affd. 299 F.3d 221 (3d Cir. 2002).

Petitioners failed to assert any arguments that the

accuracy-related penalties should not apply.

Petitioners rested

instead on their argument that they were eligible for the

exclusions from income under sections 119 and 912 that respondent

disallowed.

Specifically, petitioners did not argue and did not

introduce any evidence that they acted with reasonable cause or

in good faith with respect to the underpayments for the relevant

years.

Mr. and Mrs. Hargrove did not use a tax return preparer and

did not seek advice from a tax professional concerning their

returns for the relevant years.

While Mr. and Mrs. Breeding used

a tax return preparer to assist with their returns for the

relevant years, they did not introduce evidence regarding the

preparer.

They have not shown, for example, that the preparer

was a competent professional with significant expertise to

-17justify reliance or that Mr. and Mrs. Breeding provided the

preparer all relevant information.

P.A. v. Commissioner, supra.

See Neonatology Associates,

We therefore do not find that Mr.

and Mrs. Breeding have shown that it was reasonable to rely on

this tax return preparer.

After considering all of the facts and circumstances, we

find that Mr. and Mrs. Hargrove and Mr. and Mrs. Breeding have

failed to establish that they had reasonable cause and acted in

good faith with respect to their respective underpayments.

Accordingly, we sustain respondent’s determination as to Mr. and

Mrs. Hargrove and Mr. and Mrs. Breeding for the accuracy-related

penalties for the relevant years.

We have considered all remaining arguments the parties made

and, to the extent not addressed, we conclude they are

irrelevant, moot, or meritless.

To reflect the foregoing and the concessions of the parties,

Decisions will be entered

for respondent in Docket Nos.

16441-04, 16442-04, 16444-04,

and 16448-04.

Decision will

be entered for respondent in

Docket No. 16443-04 with

respect to the deficiencies

and for petitioners with

respect to the section 6662(a)

penalties.