UNITED STATES TAX COURT

T.C. Memo. 2004-213

UNITED STATES TAX COURT

TIBOR GUENTHER HORWATH and CHRISTEL HORWATH, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 16927-02.

Filed September 21, 2004.

Tibor Guenther Horwath and Christel Horwath, pro sese.

Dustin M. Starbuck, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

CHIECHI, Judge:

Respondent determined the following defi-

ciencies in, and accuracy-related penalties under section 6662(a)

on, petitioners’ Federal income tax (tax):

Year

1997

1998

Deficiency

$58,427.00

45,435.00

Accuracy-Related Penalty

$7,157.80

6,824.40

- 2 The issues remaining for decision are:

(1) Are petitioners entitled for each of the taxable years

at issue to the depreciation deduction that they claim?

We hold

that they are not.

(2) Are petitioners entitled for the taxable year 1998 to a

deduction of $14,686 for travel expenses?

We hold that they are

not.

(3) Are petitioners liable for each of the taxable years at

issue for the accuracy-related penalty under section 6662(a)1?

We hold that they are.

FINDINGS OF FACT

Most of the facts have been stipulated and are so found.

Petitioners resided in Falmouth, Virginia, at the time they

filed the petition in this case.

In 1988, petitioners formed TG&C Associates, Inc. (TGC), an

S corporation, that at all relevant times provided consulting

services to various corporate and government entities.

At all

relevant times, TGC’s principal place of business was located in

petitioners’ residence.

During the taxable years at issue, petitioners were the only

two stockholders of TGC.

For each of the taxable years at issue,

each petitioner had a zero basis in the TGC stock that each

1

All section references are to the Internal Revenue Code

(Code) in effect for the years at issue. All Rule references are

to the Tax Court Rules of Practice and Procedure.

- 3 owned.

During the taxable years at issue, petitioner Tibor Guenther

Horwath (Mr. Horwath) occasionally provided consulting services

as a sole proprietorship known as “Tibor G. Horwath, Consulting”

(Tibor Horwath Consulting).

Claimed Depreciation Deductions

On June 24, 1992, TGC entered into contract DASG60-92-C-0069

(1992 contract) with the United States Army Strategic Defense

Command (SDC).

During the course of the 1992 contract, SDC paid

TGC a total of $1,049,117.

The 1992 contract provided in pertinent part with respect to

the specific tasks to be completed pursuant to that contract:

The following specific tasks will be performed under

the proposed program:

Phase I:

(1)

Design and construct an experimental

SSPG [small spinning projectile guidance] seeker and associated laboratory

setup for open loop performance evaluation of the concept against computer

generated and recorded, single and multiple target and background images.

(2)

Evaluate the performance of the SSPG

seeker for various target and background

conditions, including the presence of

detector noise.

(3)

Determine performance limits for the

SSPG seeker in terms of minimum detectable line of sight motion to the target,

and its ability to extract target feature information.

- 4 (4)

Conduct analysis to determine valid

parameter ranges for follow-on simulation effort, and attempt to define projected hardware implementations.

(5)

Prepare an interim report of the findings and recommendations.

Phase II:

(1)

Adapt the open loop SSPG seeker laboratory experiment for interfacing with a

6-DOF flight dynamics computer code for

a hardware in the loop simulation.

(2)

Design and construct a line of sight

(LOS) processor to extract guidance

information from the SSPG seeker output

signals.

(3)

Modify and update the existing 6-DOF

flight dynamics code to include rapid

spin and nutation, and optimize the code

for interface with the line of sight

processor and other relevant laboratory

hardware.

(4)

Assemble the hardware in the loop simulation model using the above components,

debug and calibrate, and perform simulation runs against simulated single and

multiple target and background images.

(5)

Transfer the hardware and software of

the simulation effort to the KHILS facility, interface with the KHILS equipment and conduct simulation against

typical strategic and theater missile

defense scenarios.

(6)

Conduct a top level projectile design,

defining a basic configuration, essential parameters like mass, moments,

ballistic characteristics, and guidance

and control, for various potential applications.

(7)

Prepare an interim report and material

- 5 for a briefing to the Government.

Phase III:

(1)

Conduct an analysis effort aimed at

determining the optimum selection of

field test conditions, scaling of parameters and target representations, and

prepare a test plan.

(2)

Design and construct an experimental

guided SSPG test vehicle and launcher to

be used in field tests.

(3)

Repackage and miniaturize the laboratory

SSPG seeker and line of sight processor

and integrate into the test vehicle,

together with thrusters, solenoid valves

and cold propellant reservoir.

(4)

Define specific parameters of the field

experiment by using the hardware in the

loop simulation model adapted for the

characteristics of the experimental test

vehicle.

(5)

Conduct field tests with various targets

and test conditions and document and

analyze test data.

(6)

Prepare a final report for the entire

effort and put together a briefing for

the Government.

The 1992 contract provided in pertinent part with respect to

certain contract data requirements:

CONTRACT DATA REQUIREMENTS LIST

*

*

A001

2)

*

*

1)

*

*

*

*

*

Funds & Man-hour Expenditure Report

*

*

*

*

*

16) First report due 15 calendar days after first full

accounting period. Submissions will include both the

- 6 formatted report and a columned report reflecting the

time-phased expenditure and forecast, on a cumulative

basis by month, through the period of performance. A

formatted report and columned report will be submitted

for the total contract. Graphic plots are not required.

1)

A002

2)

*

*

Contract Funds Status Report

*

*

*

*

*

16) First report due 15 days after first full accounting period. Columns 2-10 of blocks 12, 13, & 14 will

be headed to show a 6-month “Rolling Window” followed

by remaining projections by FY. “Rolling Window” is

defined as a projection for each of the next 6 months

from the reported date. This will be followed by a

projection for remaining month by fiscal year.

1)

A003

2)

*

*

Innovations Report

*

*

*

*

*

16) Submit draft Innovations Report MLT 2 months after

identification to address in BLK 6. Government comments will be provided in 15 days: update and distribute within 15 days.

*

*

A005

2)

*

*

1)

*

*

*

*

*

*

*

Quarterly Progress Report

*

*

*

16) Initial report is to cover period ending first 3

months following contract award. Report is due 15 days

after completion of each quarters effort. When report

is presented orally, provide copies of viewgraphs and

narratives to attendees.

1)

A006

2)

*

*

Scientific & Technical Reports Summary

*

*

*

*

*

16) Submit final draft 60 days prior to end of the

contract. The government comments will be provided

within 30 days. A final version shall be delivered at

- 7 EOC. The contractor shall identify, control, and

document any hazards and control procedures associated

with the process and include this documentation in the

final report. Any design, modeling, and hardware

resulting from this effort shall become government

property.

Pursuant to the 1992 contract, TGC, inter alia, designed and

constructed a computer simulator (computer simulator) that

consisted of a large calibrated star display, various computers,

a precision spin and positioning platform for seeker hardware,

assorted electronic devices, and special software developed for

controlling that equipment.

After TGC completed the testing and

analysis required by the 1992 contract, TGC was to transfer the

computer simulator and associated software to a United States

government facility in Florida for further testing.

On May 14, 1996, TGC entered into contract DASG60-96-C-0042

(1996 contract) with SDC.

Pursuant to the 1996 contract, TGC was

to use the computer simulator, when completed, to study various

technical matters related to strategic intercept with low-cost

precision intercept devices.

Pursuant to that contract, SDC was

to pay TGC a total of $8,169,616.

On or about December 17, 1996, TGC completed the design,

construction, and testing of the computer simulator.

The com-

puter simulator was not transferred at that time or any other

time to the United States government facility in Florida.

On November 6, 1997, petitioner Christel Horwath (Ms.

Horwath) executed on behalf of TGC a document entitled “Contrac-

- 8 tor’s Release and Assignment” (1997 release) with respect to the

1992 contract.

The 1997 release provided in pertinent part:

Pursuant to the terms of Contract No. DASG60-92-C0069 [1992 contract] and in consideration of the sum of

One Million Fourty [sic] Nine Thousand One Hundred

Seventeen Dollars and NO cents ($1,049,117.00) which

has been or is to be paid under said contract with TG&C

Associates, Inc. (hereinafter called “the Contractor”)

or its assignees, if any, the Contractor, upon payment

of said sum by the UNITED STATES OF AMERICA (hereinafter called “the Government”), does hereby:

1.

Remise, release and discharge the

Government, its officers, agents, and employees of or from all liabilities, obligations,

claims, and demands, whatsoever, under or

arising from the Contract * * *

At the time the 1992 contract was terminated, the computer

simulator was the property of TGC.

During the taxable years at

issue and continuing until the time of trial in this case, the

computer simulator was located in the basement of petitioners’

residence.

On February 18, 1998, TGC filed a formal complaint with the

Missile Defense Command concerning improper disclosure of TGC’s

proprietary data.

On May 27, 1998, SDC notified TGC by letter that it was

terminating the 1996 contract pursuant to that contract’s limitation of funds clause.

As of that date, SDC had paid TGC only

$1,015,805 of the original contract amount of $8,169,616.

On March 31, 1999, TGC entered into a contract (1999 contract) with the United States Army Armament Research, Develop-

- 9 ment, and Engineering Center Tank-Automotive and Armaments

Command, Armament Research, Development, and Engineering Center

located at Picatinny Arsenal.

Pursuant to the 1999 contract, TGC

was to modify the computer simulator in order to accommodate

tactical projectiles and perform tests in order to make it

possible to evaluate smart munitions technology.

TGC entered into additional contracts after the 1999 contract that required TGC to use the computer simulator.

Claimed Travel Expense Deduction

During the taxable years at issue, TGC had a contract

(Primex contract) with Primex Technologies, Inc. (Primex) under

which TGC was to provide consulting services to Primex.

TGC

retained Tibor Horwath Consulting (i.e., Mr. Horwath) and Ms.

Jean P. Smith (Ms. Smith) to provide to Primex on TGC’s behalf

the consulting services required by the Primex contract.

The

services that Mr. Horwath and Ms. Smith were to provide to Primex

on TGC’s behalf required Mr. Horwath and Ms. Smith to travel

extensively.

Primex agreed to pay TGC for such travel expenses.

Pursuant to the Primex contract, TGC sent Primex an invoice

every month.

Each such invoice reflected, inter alia, a separate

category labeled “Expenses by Dr. Tibor G. Horwath” and “Expenses

by Jean P. Smith”, which listed the respective travel expenses

paid by Mr. Horwath and Ms. Smith in providing to Primex on TGC’s

behalf the consulting services required by the Primex contract.

- 10 TGC treated as income all payments that it received from Primex

pursuant to the Primex contract, including payments for the

respective travel expenses of Mr. Horwath and Ms. Smith.

During 1998, Mr. Horwath paid $16,812 in travel expenses in

connection with providing to Primex on TGC’s behalf the consulting services required by the Primex contract.

Mr. Horwath was

entitled to a reimbursement by TGC for those travel expenses.

Mr. Horwath chose not to be reimbursed by TGC for the travel

expenses that he paid in 1998.

Petitioners’ Tax Returns

Petitioners filed Form 1040, Individual Income Tax Return

(Form 1040), for each of the taxable years at issue, which Ms.

Horwath prepared.

(We shall refer to Forms 1040 that petitioners

filed for taxable years 1997 and 1998 as petitioners’ 1997 return

and petitioners’ 1998 return, respectively.)

In petitioners’

1997 return, petitioners claimed for the first time a depreciation deduction with respect to the computer simulator when in

Schedule C, Profit and Loss from Business (Schedule C), of that

return (Mr. Horwath’s 1997 Schedule C), they claimed such a

deduction of $75,250.

In Form 4562, Depreciation and Amortiza-

tion (Form 4562), relating to Mr. Horwath’s 1997 Schedule C,

petitioners claimed a basis of $215,000 in the computer simulator.

The $215,000 basis in the computer simulator that petition-

ers claimed in Form 4562 represented their best estimate of the

- 11 replacement cost of that simulator.

In Schedule C of petition-

ers’ 1998 return (Mr. Horwath’s 1998 Schedule C), petitioners

claimed a depreciation deduction of $57,100 with respect to the

computer simulator and a deduction of $16,812 for the travel

expenses that Mr. Horwath paid in 1998.

Notice of Deficiency

On August 1, 2002, respondent issued to petitioners a notice

of deficiency (notice) with respect to their taxable years 1997

and 1998.

In that notice, respondent determined, inter alia,

that petitioners are not entitled to the depreciation deductions

of $75,250 and $57,100 claimed with respect to the computer

simulator in petitioners’ 1997 return and petitioners’ 1998

return, respectively.

Respondent also determined in the notice,

inter alia, that petitioners are not entitled to $14,686 of the

$16,812

deduction that petitioners claimed for the travel

expenses that Mr. Horwath paid in 1998.2

Respondent further

determined in the notice that petitioners are liable for each of

the taxable years at issue for the accuracy-related penalty under

2

Petitioners claimed a deduction of $16,812 for travel

expenses in petitioners’ 1998 return. Respondent allowed $2,126

of that amount. The record does not disclose why respondent

allowed $2,126 of the claimed $16,812 travel expenses. The

parties stipulated that the entire amount of travel expenses

(i.e., $16,812) was paid by Mr. Horwath in connection with

providing to Primex on TGC’s behalf the consulting services

required by the Primex contract. (We shall refer to the $14,686

in travel expense that respondent disallowed in the notice as Mr.

Horwath’s 1998 travel expenses.)

- 12 section 6662(a).

OPINION

Petitioners bear the burden of proving that the determinations in the notice are erroneous.3

See Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933).

Claimed Depreciation Deductions

Petitioners no longer contend that they are entitled to the

respective depreciation deductions that they claimed in petitioners’ 1997 return and petitioners’ 1998 return.

according to petitioners:

That is because,

(1) SDC transferred the computer

simulator to TGC by gift; (2) SDC’s alleged gift of the computer

simulator to TGC was a gift to petitioners as the stockholders of

TGC for purposes of determining any depreciation deductions

allowable with respect to that simulator; (3) pursuant to section

1015(a), petitioners’ basis in that simulator for such purposes

is SDC’s cost of, and thus its basis in, that simulator; and

(4) SDC’s cost of, and thus its basis in, the computer simulator

3

The parties do not address the application of sec. 7491(a)

or (c) in the instant case. Petitioners filed petitioners’ 1997

return on or about Aug. 15, 1998, and petitioners’ 1998 return on

or about July 16, 1999. We presume that respondent's examination

of those returns began after July 22, 1998, and that sec. 7491(a)

and (c) is applicable in the instant case. However, petitioners

do not argue that the burden of proof shifts to respondent under

sec. 7491(a). Even if petitioners had advanced such an argument,

they have not established that they have complied with the

applicable requirements of sec. 7491(a)(2). Under the circumstances presented here, we conclude that the burden of proof does

not shift to respondent under sec. 7491(a).

- 13 is the amount that SDC paid to TGC pursuant to the 1992 contract,

i.e., $1,049,117, and not the $215,000 that petitioners claimed

in Form 4562 relating to Mr. Horwath’s 1997 Schedule C.

Respondent disagrees with the foregoing contentions of

petitioners.

However, respondent appears to agree with petition-

ers, albeit for reasons different from those advanced by them,

that petitioners, as the stockholders of TGC, would be entitled

to any depreciation deductions for the taxable years at issue

with respect to the computer simulator that the Court were to

allow.

In support of that position, respondent asserts on brief:

during the years at issue, petitioners were the only

shareholders of TG&C; thus, they controlled the computer simulator and the depreciation deduction would

have flowed through to them. Thus, the net effect on

petitioners is the same whether the depreciation deduction is taken on Schedule C or flowed through to them.

* * *

On the record before us, we reject the foregoing position of

respondent as contrary to section 1366(d)(1).

Section 1366(d)(1)

provides:

SEC. 1366.

*

PASS-THRU OF ITEMS TO SHAREHOLDERS

*

*

*

*

*

*

(d) Special Rules for Losses and Deductions.-(1) Cannot exceed shareholder’s basis in

stock and debt.--The aggregate amount of

losses and deductions taken into account by a

shareholder under subsection (a) for any

taxable year shall not exceed the sum of-(A) the adjusted basis of the shareholder’s stock in the S corporation (deter-

- 14 mined with regard to paragraphs (1) and

(2)(A) of section 1367(a) for the taxable

year), and

(B) the shareholder’s adjusted basis of

any indebtedness of the S corporation to the

shareholder (determined without regard to any

adjustment under paragraph (2) of section

1367(b) for the taxable year).

For each of the taxable years at issue, each petitioner had

a zero basis in the TGC stock that each owned.4

Respondent is

thus wrong in asserting on brief that the “net effect on petitioners is the same whether the depreciation deduction is taken

on Schedule C or flowed through to them [from TGC, an S corporation].”

We turn now to petitioners’ position that for purposes of

determining any depreciation deductions allowable with respect to

the computer simulator “TG&C is an S-corporation, [and] the

simulation equipment, which was a gift for [sic] the company,

represents a gift to its stockholders.”

As support for petition-

ers’ position, petitioners point to section 25.2511-1(c)(1) and

(g)(1), Gift Tax Regs.5

Petitioners’ reliance on those regula-

4

Petitioners do not contend, and the record does not establish, that for each of the taxable years at issue they had any

basis in any indebtedness of TGC to them.

5

Petitioners may have intended to rely on sec. 25.25111(h)(1), Gift Tax Regs., and not sec. 25.2511-1(g)(1), Gift Tax

Regs., for their position that any gift of the computer simulator

that SDC made to TGC was a gift to petitioners as the stockholders of TGC. Our response to any such reliance by petitioners on

sec. 25.2511-1(h)(1), Gift Tax Regs., is the same as our response

(continued...)

- 15 tions is misplaced.

Section 25.2511-1(c)(1) and (g)(1), Gift Tax

Regs., deal only with the Federal gift tax and do not support

petitioners’ position that for Federal income tax purposes they

are entitled to the depreciation deductions that they are claiming with respect to the computer simulator.

Assuming arguendo that any gift of the computer simulator by

SDC to TGC were to be treated as a gift of that simulator to

petitioners for Federal gift tax purposes, it does not follow

that petitioners, as the stockholders of TGC, are entitled to

depreciation deductions for Federal income tax purposes with

respect to that simulator.

A stockholder:

is not usually entitled to a depreciation deduction for

property owned by his corporation because he has no

direct economic interest or investment in the property.

* * * Where the corporation is the owner of the property and uses it in its business, the corporation, not

the stockholders, is entitled to the depreciation

deduction.

Hunter v. Commissioner, 46 T.C. 477, 490 (1966).

On the record before us, we find that, assuming arguendo

that we were to accept petitioners’ arguments that SDC transferred the computer simulator to TGC by gift and that any such

gift to TGC represented a gift for Federal gift tax purposes to

petitioners as the stockholders of TGC, petitioners have failed

to establish that they are entitled for the taxable years at

5

(...continued)

set forth below to their reliance on sec. 25.2511-1(c)(1) and

(g)(1), Gift Tax Regs.

- 16 issue to the respective depreciation deductions that they are

claiming with respect to that simulator.6

For the sake of completeness, we shall address whether,

assuming arguendo (1) that SDC transferred the computer simulator

to TGC by gift and (2) that any such gift is treated as a gift to

petitioners for purposes of determining petitioners’ entitlement

for the taxable years at issue to depreciation deductions with

respect to that simulator, petitioners have established the

amounts of such depreciation deductions to which they are entitled.

Petitioners argue that their basis in the computer simula-

tor under section 1015(a) is SDC’s basis in that simulator, i.e.,

SDC’s cost of that simulator.

According to petitioners, SDC’s

cost of, and thus its basis in, the computer simulator was

$1,049,117, the amount that SDC paid to TGC pursuant to the 1992

contract, and not the $215,000 that petitioners claimed in Form

4562 relating to Mr. Horwath’s 1997 Schedule C.7

On the record before us, we reject petitioners’ argument.

Section 167(c) provides in pertinent part:

“The basis on which

6

The record establishes that at the time the 1992 contract

was terminated around Nov. 6, 1997, the computer simulator was

the property of TGC. Assuming arguendo that SDC transferred the

computer simulator to TGC by gift, the record does not establish

that TGC owned the computer simulator prior to the termination of

the 1992 contract.

7

The $215,000 that petitioners claimed as their basis in the

computer simulator in Form 4562 represented petitioners’ best

estimate of the replacement cost of that simulator.

- 17 exhaustion, wear and tear, and obsolescence are to be allowed in

respect of any property shall be the adjusted basis provided in

section 1011".

As pertinent here, section 1011(a) defines the

term "adjusted basis" as the basis determined under section 1012,

adjusted as provided under section 1016, and section 1012 provides that the basis of property is its cost.

Section 1016(a)(2)

provides in pertinent part that adjustments in respect of property shall be made, inter alia, to the extent of the amount of

depreciation deductions allowed for that property.

Section

1015(a) provides in pertinent part that if “property was acquired

by gift after December 31, 1920, the basis shall be the same as

it would be in the hands of the donor”.

Assuming arguendo (1) that SDC transferred the computer

simulator to TGC by gift, (2) that any such gift is treated as a

gift to petitioners for purposes of determining petitioners’

entitlement for the taxable years at issue to depreciation

deductions with respect to that simulator, and (3) that petitioners’ basis in the computer simulator under section 1015(a) is

SDC’s cost of, and thus its basis in, that simulator, we must

determine SDC’s cost of that simulator.

Petitioners contend that SDC’s cost of the computer simulator is the amount that SDC paid to TGC pursuant to the 1992

contract (i.e., $1,049,117).

that contention.

On the record before us, we reject

SDC paid $1,049,117 to TGC pursuant to the 1992

contract for all of the work that TGC performed under that

- 18 contract.

The work that TGC was to perform under the 1992

contract included 18 discrete tasks, only one of which was to

design and construct the computer simulator.

Other tasks re-

quired TGC, inter alia, to perform tests, to analyze the results

from those tests, to design and construct a test vehicle and

launcher, and to prepare various reports for SDC.

On the record before us, we find that, assuming arguendo

(1) that SDC transferred the computer simulator to TGC by gift,

(2) that any such gift is treated as a gift to petitioners for

purposes of determining petitioners’ entitlement for the taxable

years at issue to depreciation deductions with respect to that

simulator, and (3) that petitioners’ basis in the computer

simulator under section 1015(a) is SDC’s cost of, and thus its

basis in, that simulator, petitioners have failed to establish

that the amount that SDC paid to TGC pursuant to the 1992 contract (i.e., $1,049,117) is SDC’s cost of, and thus its basis in,

the computer simulator.

See secs. 1011(a) and 1012.

On that

record, and making those assumptions arguendo, we further find

that petitioners have failed to carry their burden of establishing (1) how much of the amount (i.e., $1,049,117) that SDC paid

to TGC pursuant to the 1992 contract was paid for the design and

construction of the computer simulator8 and therefore was SDC’s

8

The record contains a so-called funds and man-hour expenditure summary (expenditure summary) which detailed the amounts

(continued...)

- 19 cost of, and basis in, that simulator, see secs. 1011(a) and

1012, or (2) any other basis in that simulator, see sec. 1.10151(a)(3), Income Tax Regs.

On the record before us, we find that, assuming arguendo

(1) that SDC transferred the computer simulator to TGC by gift,

(2) that any such gift is treated as a gift to petitioners for

purposes of determining petitioners’ entitlement for the taxable

years at issue to depreciation deductions with respect to that

simulator, and (3) that petitioners’ basis in the computer

simulator under section 1015(a) is SDC’s cost of, and thus its

basis in, that simulator, petitioners have failed to carry their

burden of establishing that they are entitled for the taxable

years at issue to the depreciation deductions that they are

claiming with respect to that simulator.

8

(...continued)

that TGC expended as of September 1996 pursuant to the 1992

contract. The amounts detailed in the expenditure summary were

for categories such as “DIRECT LABOR” (e.g., costs for 4880

Senior Technologist man-hours, costs for 2475 Mathematician manhours) and “CONSULTANTS”. The expenditure summary did not show

how much of those amounts TGC expended for the design and construction of the computer simulator and how much of those amounts

TGC expended to complete the other tasks that it was obligated to

perform under the 1992 contract. In addition, the expenditure

summary indicated that as of September 1996 TGC spent a total of

$9,925 on “MATERIALS”. The expenditure summary did not indicate

how much of that amount TGC expended on materials for the computer simulator and how much TGC expended on materials that it

needed to complete the other tasks that it was obligated to

perform under the 1992 contract.

- 20 Claimed Travel Expense Deduction

Petitioners argue that Mr. Horwath’s 1998 travel expenses

are deductible under section 162(a) as ordinary and necessary

business expenses because Mr. Horwath paid those travel expenses

while performing consulting services for TGC.

Respondent coun-

ters that petitioners are not entitled to a deduction for Mr.

Horwath’s 1998 travel expenses because Mr. Horwath was entitled

to a reimbursement by TGC for such expenses, which Mr. Horwath

elected not to request.

On the record before us, we agree with respondent.

A

taxpayer is not entitled to a deduction for expenses to the

extent that such taxpayer is entitled to be reimbursed for such

expenses but does not claim such reimbursement.

See Levy v.

Commissioner, 212 F.2d 552, 554 (5th Cir. 1954), affg. a Memorandum Opinion of this Court dated Mar. 9, 1953; Universal Oil

Prods. Co. v. Campbell, 181 F.2d 451, 475 (7th Cir. 1950); see

also Lucas v. Commissioner, 79 T.C. 1, 7 (1982); Kennelly v.

Commissioner, 56 T.C. 936, 943 (1971), affd. without opinion 456

F.2d 1335 (2d Cir. 1972); Stolk v. Commissioner, 40 T.C. 345, 356

(1963), affd. per curiam 326 F.2d 760 (2d Cir. 1964); Podems v.

Commissioner, 24 T.C. 21, 22-23 (1955); Roach v. Commissioner, 20

B.T.A. 919, 925-926 (1930).

Mr. Horwath was entitled to a

reimbursement by TGC for Mr. Horwath’s 1998 travel expenses.

However, he chose not to be reimbursed for those expenses.

- 21 On the record before us, we find that petitioners have

failed to establish that they are entitled to a deduction for the

taxable year 1998 for Mr. Horwath’s 1998 travel expenses.

Accuracy-Related Penalty

Respondent argues that petitioners are liable for each of

the taxable years at issue for the accuracy-related penalty under

section 6662(a) because of negligence or disregard of rules or

regulations under section 6662(b)(1) or a substantial understatement of income tax under section 6662(b)(2).

Respondent has the burden of production under section

7491(c) with respect to the accuracy-related penalty under

section 6662(a).9

To meet that burden, respondent must come

forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty.

Higbee v. Commissioner, 116

T.C. 438, 446 (2001).

For purposes of section 6662(a), the term "negligence"

includes any failure to make a reasonable attempt to comply with

the Code, and the term "disregard" includes any careless, reckless, or intentional disregard.

Sec. 6662(c).

Negligence has

also been defined as a lack of care or failure to do what a

reasonable person would do under the circumstances.

Leuhsler v.

Commissioner, 963 F.2d 907, 910 (6th Cir. 1992), affg. T.C. Memo.

1991-179; Antonides v. Commissioner, 91 T.C. 686, 699 (1988),

9

See supra note 3.

- 22 affd. 893 F.2d 656 (4th Cir. 1990).

The record establishes that petitioners used the estimated

replacement cost for the computer simulator in determining the

respective depreciation deductions claimed with respect to that

simulator in petitioners’ 1997 return and petitioners’ 1998

return.

The record also establishes that petitioners took a

deduction for Mr. Horwath’s 1998 travel expenses in petitioners’

1998 return even though Mr. Horwath was entitled to a reimbursement by TGC for such expenses, which he chose not to claim.

With respect to the respective depreciation deductions

relating to the computer simulator that petitioners claimed in

petitioners’ 1997 return and petitioners’ 1998 return, assuming

arguendo that petitioners were not negligent in claiming that

they, as the stockholders of TGC, were entitled to such depreciation deductions, the basis that they claimed in Form 4562 relating to Mr. Horwath’s 1997 Schedule C in determining those depreciation deductions, namely, the estimated replacement cost of

that computer simulator, has no support in the Code, the regulations, or the caselaw.

See secs. 167(c), 1011, 1012; secs.

1.167(a)-1(a), 1.1011-1, 1.1012-1(a), Income Tax Regs.; Meredith

Corp. & Subs. v. Commissioner, 102 T.C. 406, 423 (1994); DumontAirplane & Marine Instruments, Inc. v. Commissioner, 28 T.C. 1308

(1957).

With respect to the deduction for Mr. Horwath’s 1998 travel

- 23 expenses that petitioners claimed in petitioners’ 1998 return,

that deduction is not supported by the Code, the regulations, or

the caselaw.

See sec. 162(a); sec. 1.162-1(a), Income Tax Regs.;

Levy v. Commissioner, supra at 554; Universal Oil Prods. Co. v.

Campbell, supra at 475.

On the record before us, we find that respondent has satisfied respondent’s burden of production under section 7491(c) with

respect to the accuracy-related penalties under section 6662(a)

determined in the notice.

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

apply to any portion of an underpayment if it is shown that there

was reasonable cause for, and that the taxpayer acted in good

faith with respect to, such portion.

Sec. 6664(c)(1).

The

determination of whether the taxpayer acted with reasonable

cause, or in good faith, depends on the pertinent facts and

circumstances, including the taxpayer's efforts to assess such

taxpayer’s proper tax liability, the knowledge and experience of

the taxpayer, and the reliance on the advice of a professional,

such as an accountant.

Sec. 1.6664-4(b)(1), Income Tax Regs.

Petitioners argue that they had reasonable cause for, or

acted in good faith in, claiming the respective depreciation

deductions in petitioners’ 1997 return and petitioners’ 1998

return with respect to the computer simulator because that

simulator was a unique piece of equipment, and petitioners’

- 24 estimate of the replacement cost of the computer simulator was

reasonable.

argument.

On the record before us, we reject petitioners’

Petitioners were in a unique position to know SDC’s

cost of, and thus its basis in, the computer simulator.

That is

because they, acting on behalf of TGC, designed and constructed

that simulator and carried out the other work that TGC performed

for SDC under the 1992 contract.

Assuming arguendo that peti-

tioners were not negligent in claiming that they, as the stockholders of TGC, were entitled to the respective depreciation

deductions in petitioners’ 1997 return and petitioners’ 1998

return, on the record before us, we find, for the reasons set

forth above in our discussion of the basis under section 167(c)

on which a taxpayer may claim a depreciation deduction, that

petitioners did not have reasonable cause for, or act in good

faith in, using the estimated replacement cost of the computer

simulator in calculating such depreciation deductions.

Petitioners advance no argument that they had reasonable

cause for, or acted in good faith in, claiming a deduction for

Mr. Horwath’s 1998 travel expenses in petitioners’ 1998 return.

In any event, petitioners knew that Mr. Horwath was entitled to a

reimbursement by TGC for Mr. Horwath’s 1998 travel expenses and

that Mr. Horwath chose not to be reimbursed by TGC for such

expenses.

On the record before us, we find that petitioners have

failed to establish that they had reasonable cause for, or acted

- 25 in good faith in, claiming a deduction for Mr. Horwath’s 1998

travel expenses in petitioners’ 1998 return.

On the record before us, we find that petitioners have

failed to show that they were not negligent and did not disregard

rules or regulations within the meaning of section 6662(b)(1), or

otherwise did what a reasonable person would do, with respect to

the underpayment for each of the taxable years at issue.

On that

record, we further find that petitioners have failed to show that

they acted with reasonable cause, or in good faith, with respect

to each such underpayment.

See sec. 6664(c)(1).

On the record

before us, we find that petitioners have failed to establish that

they are not liable for the accuracy-related penalty under

section 6662(a) for each of the taxable years at issue.10

We have considered all of the contentions and arguments of

the parties that are not discussed herein, and we find them to be

without merit, irrelevant, and/or moot.11

10

We have found that petitioners are liable for each of the

taxable years at issue for the accuracy-related penalty under

sec. 6662(a) because of negligence or disregard of rules or

regulations under sec. 6662(b)(1). In light of that finding, we

shall not address respondent’s alternative argument that petitioners are liable for each of the taxable years at issue for the

accuracy-related penalty under sec. 6662(a) because of a substantial understatement of income tax under sec. 6662(b)(2).

11

Petitioners advance certain contentions and arguments

relating to the ownership of the computer simulator and SDC’s

alleged transfer by gift of the computer simulator to TGC. We do

not address those contentions and arguments because, even if we

were to accept them, on the instant record we nonetheless reject

(continued...)

- 26 To reflect the foregoing and the concessions of petitioners,

Decision will be entered for

respondent.

11

(...continued)

petitioners’ position that they are entitled to the depreciation

deductions claimed with respect to the computer simulator for the

taxable years 1997 and 1998.