T . C. Memo . 2011-118
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T . C. Memo . 2011-118
UNITED STATES TAX COURT
LIAOSHENG ZHANG, Petitioner v_.
COMMISSIONER OF INTEllNAL REVENUE, Respondent
Docket No. 6042-08.
Filed June 2, 2011.
Liaosheng Zhang, pro se.
Randall E. Heath and Kristin H. Joe, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MORRISON, Judge:
The IRS détermined a $7,614 deficiency in
Ms. Liaosheng Zhang's 2003 incc-me tax, a $7,769 deficiency in her
2004 income tax, and a $1,127 deficiency in her 2005 income tax,
and added a 20-percent section 6662 accuracy-related penalty on
SERVED Jun 02 2011
- 2 the entirety of each of these deficiencies.
hang timely
petitioned for redetermination of the deficiencies.
She contests
the IRS's determinations that medical and living expenses she
paid for her mother in 2003 are not deductible and that losses
she claimed each year for a supposed website a tivity are not
deductible.
She further contends that she is entirely exempt
from federal income tax on her wages for each year under a treaty
provision for visiting researchers, that her son was her
dependent in 2003 and 2004, that the IRS audited her returns to
retaliate against her for reporting violations of immigration law
and allegedly unfair college-tuition rates, an
that it coerced
her to sign an extension of the time for assessment for 2003.
FINDINGS OF FACT
1.
Personal History
Zhang is a citizen of the People's Republic of China
(China).
About 1988, Zhang first came to the United States.
After going back to China for a time, she returned to the United
States in 1990.
Phoenix, Arizona.
For the next several years, she lived in
She studied intermittently 4t Arizona State
University in Phoenix.
While she was at the university, she
served as a teaching assistant.
11
In 1998, she graduated with a
I
lAll section references are to the Internal Revenue Code as
in effect for the years in issue, and all Rule I:references are to
the Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
!!
- 3 -
master's degree in computer sci nce.
Shortly after graduation,
Zhang began working for Honeywell International, Inc., in
Phoenix.
Her duties included c e ting computer programs to
control industrial processes an
performing related research.
April 2005, Zhang stopped worki g for Honeywell.
In
About that
time, as the addresses listed for Zhang on several documents in
the record suggest, Zhang moved in with her son.
attending college in Seattle.
He was then
Because the temporary visa that
permitted Zhang to be in this country was conditioned on her
being employed- by Honeywell, Zhang believed that after her
employment with Honeywell terminated, her presence in the United
States was illegal.
She stayed in the United States anyway.
Zhang's reason for staying, as she explained, was to allow her
son an in-state tuition discount.i
In 2005 or 2006, she was
granted permanent-resident immilgration status.
2.
Living and Medical Expens s of Zhang's Mother
Zhang's mother is a resident of China.
a citizen of China.
We infer that she is
(Zhang did not assert otherwise.)
In 2003,
Zhang paid $12,208 for care and dedical treatment of her mother.
3.
Purported Website Business
For 2003, 2004, and 2005, Zhang claimed various business-
expense deductions for what was supposedly a website-based
business called "Hotweb Design Company".
(The supposed business
was a sole proprietorship with the trade name "Hotweb Design
- 4 -
Company".
We call it "Hotweb" for convenience.)
Zhang claimed
that she originally contemplated for Hotweb to gather U.S.
business news and translate it into Chinese a d that she later
contemplated for Hotweb to operate a used-car brokerage.
But we
do not believe that Zhang seriously pursued these or any other
bona-fide business objectives.
Instead, she tried to create the
appearance of working on a website in order to disguise improper
deductions for personal and family expenditures.
In 2000, Zhang registered the trade name "Hotweb Design
Company" with the State of Arizona.
her do this.
She paid a lawyer to help
She obtained an employer identification number from
the IRS under the trade name.
Under the trade name and employer
identification number, she filed Federal employment tax returns
(IRS Forms 941, Employer's Quarterly Federal Tax Return), federal
wage information returns (IRS Forms W-2, Wage ánd Tax Statement),
Washington State tax returns for workers' compènsation
insurance,
||
and Washington State tax returns for unemployment insurance.
Il
Zhang reported on the returns that she was empÍoying her son to
work on Hotweb and that she owed a few hundred dollars in federal
and state employment taxes per year.
The amou ts that she
reported on these returns to have paid her son|are consistent
wi.th the amounts she claimed on her federal indome tax returns to
have paid her son.
Zhang testified that she registered the
- 5 -
Internet domain name hotwebexpress.com and paid for websitehosting service.
Zhang made large payments to her son and for his benefit,
including payment of her son's college-tuition bills.
She
deducted them either as "wages" or, in the case of the payments
of college expenses, as "employee benefits".
In 2003, Zhang
claimed deductions for $5,200 in wages and $9,045 in "employee
benefits"; in 2004, $4,134 in pages and $22,000 in employee
benefits; and in 2005, $460 in wages and no employee benefits on
the tax-return Schedules C, Prcfit or Loss from Business (Sole
Proprietorship), that she completed for Hotweb.
Zhang's son filed federal income tax returns for 2003, 2004
and 2005.
He reported as incore the amounts that his mother had
reported that she paid him as tw ges".
He did not report, as
income or otherwise, the amounts that his mother had reported
that she paid him as "employee benefits".
He claimed a deduction
for a personal exemption for himself for each of 2003 and 2004,
but not for 2005.
On each yead'9 return, he reported very little
income tax liability.
return.
Zhang wts tthe preparer of her son's 2003
Her continued practice of segregating college expenses
as "employee benefits" and her son's continued practice of not
reporting them suggest that she had a hand in the preparation of
his 2004 return.
- 6 For 2003, though not 2004 or 2005, Zhang claimed a large
"office expense" deduction for Hotweb.
Most
f this $6,190
deduction was for the cost of renting an apartment in Seattle in
|
which her son lived.
Zhang's son began college, at the
University of Washington in Seattle, about September 29, 2003.
He continued to study full time until he gradu ted with a degree
in architecture.
She explained that her son's move to Seattle
would both help him and help her business because the city is a
technology-industry hub.
(We infer Zhang's son had lived with
her in Phoenix, whence she brought him to college.)
She also
claimed that part of the deduction was the renbal fee for a
parking space in Seattle.
She claimed that she rented the space
because her son was in Seattle and because the
car to buy things and for something".
needed a "travel
We infer that she deducted
the entire cost of the apartment and parking sgace even though it
is obvious that the apartment was used at least in part for
personal or family purposes.
Zhang claimed on her return deductions for thousands of
dollars in vehicle expenses for each of 2003, 2004, and 2005.
She explained that these vehicle expenses larg ly related to
traveling to Seattle, where her son was in col ege, but said
little about the purpose of these trips.
!
- 7 4.
Zhang's Returns
Zhang timely filed her 2003, 2004, and 2005 returns.
entries most relevant to this case follow.
Her
We present excerpts
first from the main parts of her Forms 1040, U.S. Individual
Income Tax Return, then from her Schedules A, Itemized
Deductions, and Schedules C, Profit or Loss from Business (Sole
Proprietorship).
Description
Dependents
2004
2005
-0-
-O-
Income from wages, etc.2
$57,1L8
$62,062
$22,083
Business (loss)
($30,9L8)
($32,501)
($7,045)
Moving expenses
-0-
-0-
($4,240)
Itemized deductions
($16,052)
($11,275)
N/A
Standard deduction
N/A
N/A
($7,300)
[herself]
($3,050)
[herself]
($3,100)
[herself and
her son]
Deduction for personal
exemptions3 *
11
($6, 400)
Taxable income
$5,4 3
$12,654
5-0-
Tax (before credits)
$548
$1,391
-0-
Education credits
(nonrefundable)'
$1,500
$2,000
-0-
-0-
0-
-0-
Total tax
IZhang claimed her son as her dependent for 2005.
2Zhang did not report substantial income other than wages for 2003,
2004, or 2005.
3Zhang did not have large addi:ional deductions beyond those listed
for 2003, 2004, and 2005.
She, reported large capital losses from short-term
stock trading but, in accordance with sec. 1211(b) (1), claimed only $3,000
per year as deductions against her crdinary income (mostly wages).
*Sec. 151(b) grants an individ2al taxpayer one deduction of the
exemption amount (roughly $3,000 for each of the years at issue) for himself
or herself, and sec. 151(c) grants cne deduction of the exemption amount for
each dependent .
|
l
II
- 8 -
sZhang's deductions for 2005 exceeded her reported gross income by
just $403.
'Zhang's education credits are not at issue. We list Zhang's
deductions and credits which are not .in dispute to shonr that the business
deductions purportedly eliminated what otherwise would) have been substantial
tax liabilities for 2003, 2004, and 2005.
The following items constituted Zhang's itemized deductions,
reported on Schedules A, for 2003 and 2004.
Zhang claimed the
standard deduction instead of itemizing deductions for 2005.
Il
Description
Medical and dental
2003
2004
($572)
1($11,040)
7.5% of adjusted gross
income (sec. 213(a)
threshold)
(1,845)
(2,02 )
Medical and dental
Expenses (over
threshold)
-0-
(9,013)
State, local and other
(3,754)
(1,702)
(90)
(560)
Expenses (total)
deductible taxes
Gifts to charity
Job expenses and most
other miscellaneous
deductions
(collectively subject
2-0-
-0-
3(12,208)
-0-
(16,052)
(11,275)
to 2%-of-AGI
threshold)
Other miscellaneous
deductions (list type
and amount)
Total
Zhang attached a statement to her return which d scribed these
claimed expenses as including $2, 000 for "Medicines and Drugs", $560 for
"Med Miles 4000 at .14/Mile", $7,910 for "Air ambulance', $170 for "road
ambulance", and $400 for "taxi to/back hospital".
Il
2Zhang stated on her 2003 Schedule A that she paid $300 in taxpreparation fees, but that 2 percent of her AGI was $492.
aZhang described the entry for "Other Miscellaneous Deductions" on her
2003 return as being for "Mother(Living cost, Medical bill, nanny)".
||
11
I
- 9 All of the business losses Zhang claimed were listed on
Schedules C for Hotweb, whose relevant parts follow:
Description
K0_3j
2004
2005
Gross receipts
-0-
-0-
-0-
Cost of goods sold
($400)
($200)
-0-
Advertising
(480)
(200)
($100)
Car expensesi
(2,5 0)
(2,500)
(4,860)
Employee benefits
(9, 0 5)
(22,000)
. -0-
(1 0)
(775)
(1,000)
Office expense
(6,130)
(200)
-0-
Repairs , etc .
(2 , O 1.4 )
Legal and professional
services
Taxes and licenses
Travel
- 0.-
(130)
(350)
(2,450)
Meals and entertainment
(after 50% reduction
under sec. 274(n))
-0 (550)
-0-
-0-
-O-
-0-
(550)
Utilities
(1,135)
(300)
Wages
(5,200)
(4,134)
(460)
Other
(259)
(1,220)
(75)
(32,501)
(7,045)
Total
(30,918)
'
-0-
IZhang indicated on her returns that the car-expense deductions
related to business driving of 5,00C miles for 2003, 10,000 miles for 2004,
and 6,000 miles for 2005. She checked boxes on the returns to indicate that
she had written evidence to support the deductions .
(The return forms do
not ask for the specific business purposes of car-expense deductions, only
whether one has evidence to corroborate them.) .But, at trial, Zhang
presented very little to show that the driving occurred or that it served a
business purpose.
5.
Alleged IRS Misconduct
a.
Retaliation
Early in 2004, 2005, and 2006, respectively, Zhang timely
filed 2003, 2004, and 2005 ret r s repeatedly showing substantial
wage income from her Honeywell job and a business with
- 10 -
comparatively large deductions and no gross receipts for any
year.
By the end of 2005, the IRS had begun
n audit of Zhang
which ultimately led to the adjustments at issue in this case.
Later, presumably, the audit was expanded to cover all three tax
years.
In 2005, apparently, Zhang wrote to officþs of the United
States Senate to ask for help with a dispute about her son's
college tuition rate.
alleged,
In 2006, Zhang sued Hon ywell for, as she
(1) firing her on the basis of gender
race, national
origin, disability, and age and (2) refusing to re-hire her on
this basis and "because of her opposition to [its] unlawful
employment practices."
In June 2007, Zhang su d Honeywell and
Internet technology company China Gate, Inc. for, as she alleged,
underpaying her.
As a part of the same proceeding, she sued
several major technology companies for, as she alleged, later
hiring H-1B visa holders instead of her when she was a permanent
resident.
Her lawsuit alleged that these comp nies were
II
|
wrongfully using the H-1B temporary visa program to avoid hiring
American workers, in part to discriminate on tŠe basis of age and
in part to undercut wage rates.
It also alleged that she had
sent a letter to the U.S. Senate about H-1B program abuse around
March 2007.
On December 28, 2007, the IRS issded the deficiency
notice setting forth its determinations for th
years at issue.
Zhang presented to the Court documents showing that the U.S.
- 11 -
Department of Labor took action in 2008 on immigrant-laborrelated complaints she had made to the Department of Labor at
times not known to us.
Zhang also showed that in 2008 she had
made a complaint to the Department of Labor other than those upon
which she showed it took action in 2008.
b.
Coercion
As previously noted, Zhang believed her continued presence
in the United States after she stopped working for Honeywell in
2005 was illegal.
Someone from the IRS, she says,
her "immigration status".
"asked for"
She said she understood this to be a
threat to have her deported if she did not comply with the IRS's
request to extend the statutory limitation on the period for tax
assessment.
On June 1, 2006, she signed an IRS Form 872, Consent
to Extend the Time to Assess Tax, to extend the time for the IRS
to assess her 2003 tax until June 30, 2008.
6.
Procedural History
On December 28, 2007, the IRS issued Zhang a deficiency
notice for her 2003, 2004, and 2005 tax years.
The IRS
determined deficiencies of $7,614, $7,769, and $1,127 for the
respective years.
It also determined that Zhang is liable for an
accuracy-related penalty equal to 20 percent of each deficiency,
on grounds including substantial understatement of income tax and
negligence or disregard of rules and regulations.
The penalties
- 12 -
amount to $1,522.80, $1,553.80, and $225.40 fo
the respective
years.
The bulk of the deficiencies results from the deductions
that Zhang had claimed for Hotweb.
The IRS di allowed all the
Hotweb deductions on the ground that the activity was not
||
conducted for profit.
Another significant portion of the 2003
deficiency stemmed from the deduction Zhang had claimed for her
mother's medical and living expenses.
The IRS disallowed that
deduction on the ground that such expenses are "personal" .
The
notice of deficiency did not disallow the 2004 deduction Zhang
claimed for her own medical expenses on Schedu e A.
Zhang filed a petition to contest the def ciency notice.
Zhang was a resident of Oregon when she filed
he petition.
Zhang contests the income-tax deficiency determinations for her
2003, 2004, and 2005 taxable years and the accuracy-related
penalty for each year.
She further contends tl at the wages she
received from Honeywell during 2003, 2004, and 2005 are exempt
from tax under a treaty rule for visiting teachers and
I
researchers, that the IRS audited her returns do retaliate
against her for reporting violations of immigration law and
allegedly unfair college-tuition rates, and that the IRS coerced
her to sign the period-of-limitations consent form, which is
necessary to the timeliness of notice of the 2003 deficiency, by
I
hinting at having her deported.
- 13 -
7.
Attempt To Deceive Court
At trial, Zhang altered a receipt in an attempt to deceive
us.
We infer from the facts in the.record, which we describe
next, that she bought a laptop computer, received a cash-register
receipt for it, and photocopied the receipt.
Later the same day,
we conclude, she returned the computer to the store for a refund,
whereupon a store clerk circled the price of the computer and
wrote a note on the receipt to indicate that the computer had
-
been returned.
Zhang introduced the photccopy of the receipt into evidence.
The Court commented that the pl otocopy was hard to read.
Zhang
offered to provide the original, and the Court asked for it.
Before handing the original to the clerk, Zhang obscured part of
it with a black marker.
We conclude from a credit-card statement
showing a purchase and refund dorresponding to the receipt, and
from the store clerk's note that' Zhang had obscured but failed to
obliterate entirely, that what Zhang obscured was the writing
added after the photocopy was made which showed that the laptop
computer had been returned the same day.
Zhang claimed that what she obscured was a mark made by the
store for security purposes as she left the store.
We disagree.
We believe that the faint x-mark that appears on the orig-inal and
the copy was such a mark.
I
- 14 OPINION
1.
Treaty Exemption
Zhang argues that her Honeywell wages wer
exempted from
income tax by the income-tax treaty between the United States and
China, the formal title of which is the Agreem nt Between the
Government of the United States of America and the Government of
the People's Republic of China for the Avoidance of Double
Taxation and the Prevention of Tax Evasion wit
Respect to Taxes
on Income, Apr. 30,
Article 19 of the
1984, T.I.A.S. No. 12,065.
treaty, entitled "Teachers, Professors, and Researchers",
provides:
||
An individual who is, or immediately befoYe visiting a
Contracting State was, a resident of the other
Contracting State and is temporarily presënt in the
first-mentioned Contracting State for the (primary
purpose of teaching, giving lectures, or ðonducting
research at a university, college, school:|or other
accredited educational institution or scientific
research institution in the first mentioned Contracting
State shall be exempt from tax in the first mentioned
Contracting State for a period not exceeddng three
years in the aggregate in respect of remuderation for
such teaching, lectures or research.
By its terms, the exemption in article 19 is available only
for persons who are "temporarily present" in the United States.
After visiting around 1988, Zhang moved to the United States in
1990 and has resided here ever since.
She completed her studies
in 1998, worked for Honeywell from 1998 to 2005, and moved from
Phoenix to Seattle in 2005.
Nothing before us suggests she or
the company intended her employment to last only a short time,
1
- 15 and Zhang did not claim to have had any plans to move out of the
United States.
By 2003, 2004, and 2005, Zhang's presence in the
United States could no longer b) considered temporary.
We
therefore conclude that Zhang is hot-entitled to an exemption
from tax on her Honeywell wages under article 19 of the treaty.
Consequently, we need not address¡the IRS's additional argument
that Zhang's Honeywell wages were not remuneration for teaching,
lecture, or research activities within the meaning of that
article.
2.
Living and Medical Expenses of Zhang's Mother
Section 262 generally denies a deduction for "personal,
living, or family expenses".
Section 213(a) provides for a
deduction for
expenses * * * for medical care of the taxpayer, his
spouse, or a dependent (a I defined in section 152,
determined without regard to subsections (b) (1),
(b) (2) , and (d) (1) (B)
the eof)..
Section 152(b) (3) (A) provides
h t
The term "dependent" does not include an individual who
is not a citizen or natioral of the United States
unless such individual is a iresident of the United
States or a country conticuous to the United States.
Zhang's mother can be a dependent of Zhang only if Zhang's mother
is either (1) a citizen of the Udited States,
the United States,
(2) a national of
(3) a reside:nt of the United States, or (4) a
resident of a country contiguo s to the United States.
The
Internal Revenue Code does not define the term "national of the
- 16 United States".
To define it, we turn to title 8 of the United
States Code, which defines a national of the United States as
either a citizen of the United States or a person who owes
permanent allegiance to the United States.
sec. 1101(a) (22)
Memo. 1984-288
8
.S.C.
(2006); see Pike-Biequnski v. Commissioner, T.C.
(relying on this definition).
Zhang's mother is not a U.S. citizen, a U.S. national, a
U.S. resident, or a resident of a country bord ring the United
States.
We conclude, therefore, that Zhang is not entitled to a
deduction for the $12,208 of expenses she paid for care and
medical treatment of her mother.
3.
Purported Website Business
We conclude that the items Zhang claimed as business
expenses of Hotweb are not deductible even if
he did pay them
because she has not shown that they relate to a business or other
activity conducted for profit.2
2For 2004, Zhang deducted on her Schedule C $22,000 in
"employee benefit programs". At trial Zhang claimed that a
portion of this $22,000 consisted of a benefit program for
herself in the form of payment of her own medi al expenses. The
portion of the $22,000 that consisted of Zhang's own medical
expenses is not deductible.
In addition to the lack of a profit
motive for the activity to which this and the óther Schedule C
expenses allegedly relate, Zhang cannot deduct temployee benefits
provided to herself. A sole proprietorship and its proprietor
are the same entity. See Osborne v. Commissioder, T.C. Memo.
2002-11. Moreover, although medical expenses åre deductible
under sec. 213 even if they are expenses not rülated to a
business, Zhang has not demonstrated that the portion of the
$22,000 consisting of her own medical expenses, if any, was not
(continued...)
!i
- 17 -
a.
Zhang's Credibility
Zhang did not testify credibly about work supposedly
performed for Hotweb.
Her testimyny was terse and vague.
It
lacked corroboration, aside from records Zhang herself had
created and the receipt she misrepresented.3
Zhang failed to
call her son, a central figure in| the supposed activity, to
testify.
Zhang claims that the substantial payments she made to or
for the benefit of her son were compensation for services he
provided.
She presented documents that stated he worked for her
30-40 hours per week during the second half of 2003, 20 hours per
week for the second and third cuarters of 2004, and 5-6 hours per
week for the fourth quarter of 2004.
was "laid off" December 6, 2004.
They also stated that he
But what, if anything, Zhang's
son was actually doing is not apparent.
Zhang testified that he
assembled computers, but it is not apparent that a small website
business would have a use for more than a few computers.
And
there is no evidence that Zhanc bought parts for more than a few
computers.
She also testified that her son reviewed her emails
2(...continued)
already deducted on Schedule A
instead to have reflected Zhan '
(The entire $22,000 entry seems
son's college expenses.)
3The fact that the supposed activity centered on creating
documents, some to be displayed on a website and others to
instruct a computer, makes the absence of evidence especially
striking.
- 18 -
and other documents for grammar.
But Zhang di
not corroborate
that her son reviewed any substantial quantity of documents or
||
that the documents related to Hotweb.
One of her
unemployment-insurance-tax returns describes hŠr son's work as
"programming", but the record does not show th t Zhang's son
actually worked on any programs.
Zhang presented no explanation for these striking omissions.
Her copious testimony and documentation on oth r matters suggest
that her memory had not simply faded.
We infe
evidence would not have been favorable.
that fuller
The absence of a
legitimate explanation for Zhang's striking failure to
corroborate an activity that supposedly took a great deal of time
and money indicates to us that she is not credible generally.
See Igberaese v. Commissioner, T.C. Memo. 2010 284..
b.
Profit Motive
Section 183 provides that a deduction forsexpenses of an
activity not conducted for profit cannot, gene(ally, exceed gross
income from the activity.4
Zhang did not repor
any gross income
*Sec. 183(c) defines "activity not engaged in for profit" as
"any activity other than one with respect to which deductions are
allowable for the taxable year under section 1$2 [trade-orbusiness expenses] or under paragraph (1) or (2) of section 212
[expenses for production of income or manageme t, etc., of
property held for production of income]." A "trade or business"
(which we refer to simply as a "business"), like an activity "for
production of income", requires a profit motive. See
Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987); Gaiewski v.
Commissioner,
723 F.2d 1062
(2d Cir.
1983), re g. T.C. Memo.
(continued...)
11
il
i
- 19 -
for Hotweb for any of the years at issue.
The IRS determined
that Hotweb was not operated for profit and that therefore Zhang
was not entitled to deduct any of the expenses of the activity.
Whether an activity is conducted for profit depends on the
taxpayer's state of mind.
Because we cannot observe this
directly, we look to all the facts and circumstances of the
activity.
See Dreicer v. Commissioner,
affd. without opinion 702 F.2d 1205
78 T.C. 642,
(D.C. Cir.
1983).
645
(1982),
As we will
explain, we find that there was a lack of profit motive for the
Hotweb activity (to the extent it was an activity at all).
Section 1.183-2(b), Income Tax Regs., provides that "all
facts and circumstances with respect to the activity are to be
taken into account" in determiring the existence of a profit
motive and provides a nonexclusi e list of factors to consider in
determining whether a profit mctive exists.
Analysis of these
factors satisfies us that Zhanc lacked a profit motive for
Hotweb.
The first factor is described by the regulations as follows:
Manner in which the taxpayer carries on the activity.-The fact that the taxpayer carries on the activity in a
businesslike manner and maintains complete and accurate
books and records may ind cate that the activity is
engaged in for profit. S'milarly, where an activity is
carried on in a manner substantially similar to other
activities of the same na ure which are profitable, a
profit motive may be indi ated. A change of operating
4(...continued)
1983-133.
- 20 -
methods, adoption of new techniques, or abandonment of
unprofitable methods in a manner consiste t with an
intent to improve profitability may also ndicate a
profit motive.
Sec. 1.183-2 (b) (1), Income Tax Regs.
We have
ound an activity
to be conducted in a "businesslike" manner if it involves
I
purposeful attention to making a profit.
Businesslike conduct is
characterized by careful and thorough investigation of the
profitability of a proposed venture, monitoring of a venture in
progress, and attention to problems that arise over time.
Ronnen v. Commissioner,
Commissioner,
90 T.C.
74,
88 T.C. 464, 481-482
Commissioner, T.C. Memo. 1990-376.
93
See
(1988); Taube v.
(1987); Stephens v.
It is not dufficient merely
to record an activity's finances in a manner typical of
sophisticated businesspeople--one must use one's knowledge of the
activity's progress to, where appropriate, attempt to improve
that progress.
See Lowe v. Commissioner, T.C. Memo. 2010-129.
|
Zhang did not establish that she (or anyode) conducted the
purported website activity very much at all.
money from a website, it is generally necessar
In order to make
to actually
create a website, and Zhang has not shown that she tried very
hard to do that.
Mainly she attributed to the activity expenses
that she would have incurred anyway.
a profit motive.
This factor weighs against
- 21 -
The second factor is desc ibed by the regulation as follows:
The expertise of the taxpayer or his advisors.-Preparation for the activilty by extensive study of its
accepted business, econom c |and scientific practices,
or consultation with thos
ho are expert therein, may
indicate that the taxpaye has a profit motive where
the taxpayer carries on t e activity in accordance with
such practices. Where a axpayer has such preparation
or procures such expert a vice, but does not carry on
the activity in accordanc with such practices, a lack
of intent to derive profit may be indicated unless it
appears that the taxpayer is attempting to develop new
or superior techniques which may result in profits from
the activity.
Sec. 1.183-2 (b) (2), Income Tax Regs.
Zhang had significant
expertise in computer programming generally.
But nothing in the
record indicates that she had specific expertise in developing
programs related to news storids, translations, or brokerage or
that she had expertise in admiristering a complex website or a
business.
This factor is neutral.
The third factor is described by the regulation as follows:
The time and effort expended by the taxpayer in
carrying on the activity.3-The fact that the taxpayer
devotes much of his perso all time and effort to
carrying on an activity, -articularly if the activity
does not have substantial personal or recreational
aspects, may indicate an intention to derive a profit.
A taxpayer's withdrawal from another occupation to
devote most of his energie s to the activity may also be
evidence that the activity is engaged in for profit.
The fact that the taxpayer devotes a limited amount of
time to an activity does rot necessarily indicate a
lack of profit motive where the taxpayer employs
competent and qualified persons to carry on such
activity.
Sec. 1.183-2 (b) (3), Income Tax Regs.
We infer from Zhang'-s
striking failure to show anything she or her son accomplished for
- 22 -
Hotweb that little meaningful effort was put i to the activity.
This factor weighs against a profit motive.
The fourth factor is the "expectation that assets used in
[the] activity may appreciate in value."
Income Tax Regs .
Sec. 1.183-2(b) (4) ,
There is no indication that
hang expected any
assets to appreciate, but there is also no indication that
appreciation of assets would be important to the success of the
news service or car brokerage she supposedly e pected to operate.
This factor is neutral.
The fifth factor is the success of the ta payer in carrying
on other activities, whether similar or dissimilar to the one for
which a business deduction is sought.
Sec. 1. 83-2(b) (5), Income
Tax Regs.
Zhang had worked as a computer programmer for a large
company.
She would be better situated than most people to make
il
Hotweb succeed.
We conclude, therefore, that this factor weighs
modestly in favor of the existence of a profit motive.
The sixth factor is "The taxpayer's history of income or
losses with respect to the activity."
Tax Regs.
Sec. 1. 83-2(b) (6), Income
This factor weighs against a profit motive.
Zhang
consistently reported losses, without any gros
income or even
gross receipts, for Hotweb.
factor, the
regulation says:
In describing thi
"A series of losses during the initial or
start-up stage of an- activity may not necessarily be an
indication that the activity is not engaged in for profit."
Id.
- 23 -
But Hotweb' s supposed activities pere not so, much starting up as
never begun.
The seventh factor, "The amount of occasional profits, if
any, which are earned", is likewise negative.
2 (b) (7) , Income Tax Regs..
Sec. 1.183-
The regulation continues:
[A]n opportunity to earn a substantial ultimate profit
in a highly speculative venture is ordinarily
sufficient to indicate that the activity is engaged in
for profit even though losses or only occasional small
profits are actually gene ated.
Id.
But even if Zhang's business concepts had the potential to
produce large profits, she failed to make an effort to turn them
into real opportunities.
The eighth factor is described by the regulation as follows:
The financial status of tNe taxpayer.--The fact that
the taxpayer does not have substantial income or
capital from sources othe than the activity may
indicate that an activity is engaged in for profit.
Substantial income from s urces other than the activity
(particularly if the losses from the activity generate
substantial tax benefits) may indicate that the
activity is not engaged ir for profit especially if
there are personal or recreational elements involved.
Sec. 1.183-2(b) (8), Income Tax Regs.
Zhang had a substantial
amount of wage income during tl e years at issue .
She claimed
that Hotweb's losses resulted in a significant tax savings for
her.5
The "losses" consist-ed of expenses she and her son would
sZhang's own tax savings didi not come at the cost of a
significant increase in the re orted taxes of her son. His
reported tax liabilities were Undffected by Hotweb's small
purported "wages" because they were offset by the standard
(continued. . . )
||
- 24 likely have incurred anyway.
Therefore, this factor suggests
that she did not have a profit motive for the activity.
Engdahl v. Commissioner,
72 T.C. 659,
670
See
(197 ); Harrison v.
Commissioner, T.C. Memo. 1996-509.
The ninth factor is described by the reguiation as follows:
|
Elements of personal pleasure or recreatiön.--The
presence of personal motives in carrying on of an
activity may indicate that the activity iš not engaged
in for profit, especially where there arearecreational
or personal elements involved. On the ot er hand, a
profit motivation may be indicated where an activity
lacks any appeal other than profit. It iŠ not,
however, necessary that an activity be enýaged in with
the exclusive intention of deriving a proÿit or with
the intention of maximizing profits. * * *
||
Sec. 1.183-2(b) (9), Income Tax Regs.
a profit motive.
This facdor weighs against
The primary real activities Šor which Zhang .
Il
claimed business-expense deductions were simply her son's
activities of living in an apartment and going to college--her
expenditures for which would normally just be nondeductible
family expenses.
See sec. 262(a)
("Except as
therwise expressly
provided * * *, no deduction shall be allowablå for personal,
living, or family expenses.").
il
We conclude from the factors in section 1.183-2(b), Income
Tax Regs., that Zhang did not conduct Hotweb, the purported
business to which she claimed her business-expense deductions
s(...continued)
deductions and personal exemptions he claimed. His reported tax
liabilities were unaffected by Hotweb's larger "employee
benefits" because he did not report them as income.
Il
- 26 related, for profit during any of the years at issue.
The most
important reason for this conclusion is that she failed to
conduct much website activity at all.
-c.
Connection of Expenses With Activity
Sections 162 and 212 gene ally allow deductions for expenses
that are "ordinary and necessary" to a business or other profitmotivated activity.
(Expenses of an activity that is not profit
motivated generally are not decuctible.
See sec. 183.) ¡ In order
for Zhang to establish that she is entitled to a deduction she
claimed for an expense of Hotweb (her supposed website-based
business), she must therefore establish (1) that website-related
activity existed,
(2) that the activity was profit motivated, and
(3) that the expense ris necessary to the activity.
As discussed, Zhang failed, to establish that her purported
activity even existed to any significant extent and, relatedly,
failed to establish that she had a profit motive for it.
Additionally, she has failed to show that most of her claimed
expenses have any connection with a website (including, for
instance, by financing or advertising a website).
This last
failure is an independent ground requiring disallowance of her
claimed deductions for "office e pense"
(i.e., rent for"her son's
apartment),
(i.e., -tuition for her
"employee benefit programs"
son's college education), and 'wages"
(i.e., money paid to him).
Zhang has not shown that the apartment was not used entirely as
- 26 -
living space, her explanations of the work her son supposedly
performed in exchange for the employee benefits and wages are
scanty and implausible, and her relationship to him suggests that
the rent, tuition, and money were simply gifts from her to him.
We decline, however, to consider whether every one of the
expenses Zhang claimed for Hotweb lacked a connection with a
website.
4.
Status of Zhang's Son as Dependent
Zhang' s son claimed a personal exemption
or himself for
each of the years 2003 and 2004, but not 2005.
On her 2005
return, but not her 2003 or 2004 return, Zhang claimed that her
son was her dependent and accordingly claimed a personal
exemption for him.
The IRS did not challenge Zhang's entitlement
to claim a personal exemption for her son for 2005.
She now
li
claims that she is also entitled to claim persönal exemptions for
her son for 2003 and for 2004, which the IRS d sputes.
The IRS contends that because Zhang's son claimed exemptions
for himself on his returns, Zhang cannot claim personal
exemptions for him.
But the fact that Zhang' s son claimed
personal exemptions on his own returns is irre evant in
ascertaining Zhang's entitlement to personal e emptions for him.
Section 151(a) provides a personal exemption for the taxpayer,
and section 151(c) provides the taxpayer additional personal
exemptions if he or she has dependents.
The tdrm "dependent"
- 27 -
includes, but is not limited to, a child of the taxpayer over
one-half of whose support the taxpayer provided for the year in
question.
Sec. 152(a).
The taxpayer's additional personal
exemption is not contingent on the dependent's not claiming a
personal-exemption deduction on his or her own return.
In support of its contention, the IRS points us to section
151(d) (2).
Section 151(d) (2) prohibits a taxpayer who is a
dependent of another from claiming a personal-exemption deduction
on his or her own return.
dependent.
But this provision affects only the
Thus, the mere fact that Zhang's son claimed
exemptions for himself for 2003 and 2004 does not mean that Zhang
is not entitled to claim him as a dependent for those two years.
The IRS raises no other challerges- to the personal-exemption
deduction.
On the basis of the record before us, we find that
Zhang is entitled to claim her sdn as her dependent' for 2003 and
2004.'
Consequently, she is entitled to an additional personal-
exemption deduction for each of those years.
'If true, Zhang's allegation that she provided her son money
and covered his college expenses as compensation for working on
Hotweb could weigh against her claim that he is her dependent.
See sec. 152 (a) (taxpayer must have provided more than one-half
of dependent's support); Limpe t v. Commissioner, 37 T.C. 447,
450 (1961) (amounts received at compensation considered support
provided by oneself, rather then support provided by payor). But
the IRS has not questioned whet her Zhang satisfied the support
test.
- 28 -
5.
Alleged IRS Misconduct
Zhang failed to establish a factual basis for her
allegations of misconduct.
a.
Retaliation
Zhang contends that the IRS audited her returns to retaliate
against her because she "reported H1B fraud and abuse, and also
reported unfair tuition for US citizens to thellUS Senate".
We do not find Zhang to have substantiateE her inference
that the audit was retaliatory.
No evidence before us indicates
that Zhang's immigration-law or college-tuitio -related issues
had any bearing on IRS decisions about auditinè her returns.
We also note that Zhang claimed deductions that were
facially dubious, such as thousands of dollars of vehicle
expenses for a small website business.
This s ggests that the
IRS simply audited her returns in order to determine whether they
were correct.
b.
Il
Coercion
As previously noted, Zhang signed a conse t form that
extended the time for the IRS to issue notice of the 2003
deficiency.
Zhang did not testify that the IR
specifically
threatened her with deportation or any other adverse immigration-
law consequence to induce her to sign the consdnt form.
She
testified only that an unnamed person at the I S asked about her
li
- 29 -
immigration status, and she presdnted no evidence to corroborate
that the conversation took pla e.
She also testified that ar unknown person called her at home
and told her that he or she knew iZhang was in the country
illegally and asked her for morey.
She said -that not many people
knew her presence in the Unitec States was unlawful and that the
caller therefore must have beer from the IRS.
She said there was
a police record of these incidents but did not introduce the
police record as evidence.
She did not corroborate these alleged
calls or testify about them in de'tail.
Zhang tried to deceive us by altering a receipt in court.
She also tried to deceive us, as she-had for years tried to
deceive the IRSI, by disguising family expenses as expenses of an
essentially fictitious busineSE.
TherefOre, we give her vague,
uncorroborated testimony littlé weight and do not conclude that
the alleged incidents occurred.
Even if the alleged harassing
telephone call did occur, Zhanc's contention that the IRS was
involved is nothing more than speculation.
6.
Penalty
As mentioned earlier, the IRS imposed 20-percent section
6662 accuracy-related penalties upon Zhang for her underpayments
for all three years (which, it determined, were equal to the
deficiencies).
See sec. 6664.
one of the grounds the IRS
-
asserted for the penalty is "stbstantial understatement of income
- 30 -
tax".
Another is "negligence or disregard of rules and
regulations".
It is undisputed that Zhang had underpayments
equal to the correct amounts of her deficiencies (which she has
petitioned the Court to redetermine).
Zhang argued that her tax returns were co¼rect.
explained, they were not.
As we have
The additional personal-exemption
deductions to which Zhang's son's status as het dependent
entitles her for 2003 and 2004 do, however, reduce her
deficiencies, underpayments, and penalties for those years.
11
Under section 7491(c), the IRS must come forward with
sufficient evidence that it is appropriate to impose
penalties.
See Higbee v. Commissioner,
116 T.G. 438, 446
(2001).
However, once the IRS has met this burden of production, the
burden of proof remains with the taxpayer., inciuding the burden
of proving that the penalties are inappropriat
because of
reasonable cause or substantial authority.
Rule 142(a);
Se
Higbee v. Commissioner, supra at 446-447.
Even with the additional personal-exemption deductions,
Zhang's "understatements" of income tax for 2003 and 2004 are
"substantial" because they exceed both (1) 10 percent of the tax
required to be shown on the returns and (2) $5,¡000 for each
year.?
The IRS has met its burden of producing evidence of the
li
||=
?Sec. 6662(d) (2) (B) excludes from the definition of
"understatement" for this purpose a deduction supported by
(continued...)
- 31 deficiency, and the substantia
understatement undisputedly
follows as a computational matter.
Zhang does not have a "substantial understatement" of income
tax for 2005.
But Zhang's contrivance of the supposed Hotweb
activity to claim business-expense deductions for numerous
personal and family expenses not only meets the IRS's burden of
production but persuades us that as to its deductions, the source
of her deficiency for that year, she neglected or disregarded her
tax obligations.
Section 6664(c) provides that no penalty shall be imposed
under section 6662 with respect to any portion of an underpayment
if it is shown that there was a reasonable cause for, and the
taxpayer acted in good faith with respect to, such portion.
Zhang did not specifically argue that we should apply the
reasonable-cause-and-good-faitt exception to any part of any of
her underpayments, and the facts in the record do not establish
that the exception applies.
ZYang used a return-preparation
computer program each year.
She claims that she took a tax
course from a return-preparaticn firm in 2003.
But nothing
7(...continued)
"substantial authority" or a "reasonable basis" and disclosure.
Zhang has not explained what substantial authority or reasonable
bases may have existed for her edroneous deductions. Nor do we
find on our own that her positions had substantial authority or
reasonable bases.
See sec. 1.6662-3(b) (3),
(d) (2),
Income Tax
Regs. (describing the "reasonable basis" and."substantial
authority" standards for support of a tax position which
ultimately proves to be erronedus).
||
i
- 32 before us indicates that any error in Zhang's ½eturn resulted
from an erroneous explanation of tax law provided by a tax
instructor, IRS employee, or computer program, or from an
erroneous computation performed by a program.
She claims that in
the course of preparing one of her returns, shè asked an IRS
employee what address to use for Hotweb (SchedÖle C asks for the
||
"business address") , and the employee suggested she use her son's
apartment address.
'But Zhang did not explain
hy it would be
reasonable for her to think, on the basis of tl is suggestion,
that the apartment was, deductible.
We observe that Zhang's Il
erroneous deduction for her mother's living andt medical expenses
could have followed from" a misunderstanding of .a complex issue:
section 213 does allow a deduction for medical and long-term-care
expenses of a taxpayer and certain dependents.
But Zhang failed
to indïcate specifically what led her to claim this deduction.
To reflect the foregoing,
Decisidn will be entered
under Rule ]55.
.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.