UNITED STATES TAX COURT
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T.C. Memo. 2001-3
UNITED STATES TAX COURT
NORMAN E. DUQUETTE, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 1933-98.
Filed January 8, 2001.
D, a consultant, carried on his consulting
business as an employee of P, a "C corporation". D and
his wife were the sole shareholders and directors of P.
R disallowed various deductions claimed by P during its
1994 fiscal year and also determined that P was subject
to the sec. 6662, I.R.C., accuracy-related penalty. P
alleged that R’s notice of deficiency was invalid.
1. Held: The notice of deficiency is valid.
2. Held, further, R’s disallowance of various
deductions is sustained in substantial part.
3. Held, further, R’s penalty against P for the
taxable year is sustained, in part, under sec. 6662,
I.R.C.
Norman E. Duquette (an officer), for petitioner.
Alan R. Peregoy, for respondent.
- 2 MEMORANDUM OPINION
HALPERN, Judge:
By notice of deficiency dated November 20,
1997 (the notice), respondent determined a deficiency in
petitioner’s Federal income tax for its taxable year ended
September 30, 1994 (the 1994 tax year), in the amount of $63,232
and an accuracy-related penalty in the amount of $12,646.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
The parties have resolved certain issues, and issues
remaining for decision are (1) the validity of the notice,
(2) petitioner’s entitlement to certain deductions for rent,
depreciation, business meals, travel, supplies, and legal fees,
and (3) the accuracy-related penalty.
Some facts have been stipulated and are so found.
The
stipulation of facts, with accompanying exhibits, is incorporated
herein by this reference.
We need find few facts in addition to
those stipulated and will not, therefore, separately set forth
our findings of fact.
as we proceed.
Rule 142(a).
We will make additional findings of fact
Petitioner bears the burden of proof.
See
- 3 Background
Petitioner is a Maryland corporation, organized on
November 8, 1991.
At the time of the petition, petitioner’s
mailing address was in Rockville, Maryland.
During the period
relevant to this case, petitioner was owned equally by Norman E.
and Aline J. Duquette (together, the Duquettes; individually,
Norman and Aline, respectively).
From 1968 until 1986, Norman was employed as an auditor by
the Defense Contract Audit Agency (DCAA).
In 1986, he left the
employ of DCAA, and he opened a consulting business (the
consulting business), offering advice to Government contractors
in connection with their dealings with DCAA.
Initially, Norman
carried on the consulting business as a sole proprietorship.
Norman’s activities as a proprietor were subject to examination
by respondent in May 1991.
That examination led to a criminal
investigation of Norman for tax crimes committed in connection
with the sole proprietorship (the criminal investigation).
The
criminal investigation was resolved by Norman’s pleading guilty
to two counts of filing a false income tax return, for 1989 and
1990, in violation of section 7206(1).
As a result of his guilty
pleas, Norman paid a fine, but he did not serve a prison
sentence.
In November 1991, Norman organized petitioner to carry on
the consulting business.
Norman testified that petitioner was
- 4 organized in order to encourage him to keep better records, so as
to avoid further difficulties with respondent.
Petitioner
carried on the same business, with the same clients, as had
Norman (as a proprietor).
During the 1994 tax year, Norman and
Aline were the only directors and officers of petitioner.
Petitioner’s Federal income tax return for the 1994 tax year (the
1994 tax return) shows gross receipts of $309,630.35 and taxable
income of $1,178.30.
On the 1994 tax return, petitioner claimed
no deduction for salaries and wages but did claim a deduction for
compensation of officers in the amount of $112,000, which amount
was reported by the Duquettes, $100,000 by Norman and $12,000 by
Aline, on the joint return of income that they made for 1994.
Norman was employed by petitioner to provide consulting services
to customers.
Although Norman testified that petitioner employed
part-time consultants, petitioner has failed to identify those
individuals, and the 1994 tax return does not show any salary or
wage paid to any such part-time consultants.
We conclude,
therefore, that, at least during the 1994 tax year, petitioner’s
sole business activity was offering Norman as a consultant.
The Duquettes were married in Rockville, Maryland, on
February 4, 1988, and they were divorced in Florida in June 1996.
They lived in Montgomery County, Maryland, until December 1991,
when they moved to Dallas, Texas.
In Dallas, they made their
home in a condominium apartment located at 3510 Turtle Creek
- 5 Blvd. (the Dallas apartment or the apartment).
The Dallas
apartment was their home from December 1991 until April 18, 1994.
In April 1994, the Duquettes relocated to Naples, Florida.
Aline made her home there, and Norman visited her there until
September 1994, after which, in substantial part because of
marital difficulties, he did not return to Florida.
In May 1993, Norman began work for a Washington, D.C., law
firm (the law firm) as an accounting consultant.
The law firm
treated Norman as an employee, issuing him a Form W-2, Wage and
Tax Statement, for both 1993 and 1994.
Those Forms W-2 show
compensation of $52,060 and $155,372.50 for 1993 and 1994,
respectively.
During the 1994 tax year, Norman worked in
Washington, D.C., on approximately 177 days.
On those days,
Norman resided in an apartment in Bethesda, Maryland (the
Bethesda apartment).
Discussion
I.
Validity of Notice
A.
Assignments of Error
In the petition, petitioner assigns the following errors to
respondent’s determination of a deficiency:
(a) The Commissioner issued an invalid notice of
deficiency as the notice is not based on an actual
deficiency determination. Further, the notice is
invalid because the IRS did not examine the
petitioner’s tax return for the tax year ended
September 30, 1994.
- 6 (b) The notice of deficiency is arbitrary and
erroneous, and is not based on any ligaments of fact.
Moreover, the notice of deficiency amounts to a naked
assessment without foundation whatsoever.
B.
Facts
Documents in evidence establish the following:
On
October 27, 1997, Pat Grimes, a Revenue Agent employed by
respondent, commenced an examination (the examination) of the
1994 tax return.
On that date, Revenue Agent Grimes sent to
petitioner two letters and a request for documents.
The first
letter informs petitioner that the 1994 tax return has been
assigned to Revenue Agent Grimes for examination.
It also states
that she needs additional information to verify certain items on
that return.
The request for documents (document request)
contains a specific and comprehensive list of documents,
including documents substantiating the following items with
respect to the 1994 tax year:
1.
2.
3.
4.
5.
Year end wages accrued but not paid to shareholder
Supplies
Professional Services
Rent expense
Automobile expenses and depreciation
Travel expenses:
a. Meal expenses
b. Hotel expenses
c. Airplane tickets
The second letter informs petitioner that the limitation period
for the assessing of additional tax for the 1994 tax year will
expire soon, encloses a Form 872, Consent to Extend the Time to
Assess Tax (Form 872), and requests that petitioner sign and
- 7 return the Form 872.
In pertinent part, the Form 872 states:
“The amount of any Federal Income tax due on any return(s) made
by or for the above taxpayer(s) for the period ended
September 30, 1994, may be assessed any time before December 31,
1998.”
Petitioner did not return the Form 872 or respond to the
document request.
Instead, petitioner attempted to negotiate
restrictions to be incorporated into the Form 872.
Revenue Agent
Grimes and her supervisors refused to restrict the Form 872 and,
on November 20, 1997, no Form 872 having been received by
respondent, the notice was issued.
By letter dated December 8,
1997, Stephen P. Taylor, Chief, Exam Branch V (apparently, a
supervisor of Revenue Agent Grimes), explained respondent’s
failure to restrict the Form 872:
“Conditions required under the
Internal Revenue Manual were not met.
We do not restrict
statutes or the scope of an examination prior to initiating the
examination.”
Other documents in evidence establish the following:
On
October 27, 1997 (the date the examination commenced), Revenue
Agent Grimes was examining petitioner’s income tax returns for
the 2 taxable years preceding 1994 (the preceding years’
examination).
She completed the preceding years’ examination on
November 6, 1997.
On that date, petitioner was sent a copy of
the resulting report (the report).
with respect to the following items:
The report shows adjustments
- 8 Accrued wages to related party
Rents
Auto/truck expense
Depreciation
Supplies–office
Legal & professional fees
Meals & entertainment
Hotel expenses
In negotiating with respect to the Form 872, petitioner
attempted to have the Form 872 restricted so that petitioner
would consent to waive the time to assess tax only with respect
to tax attributable to items similar to those giving rise to
adjustments in the report.
As stated, respondent’s agents would
not agree to such restriction.
The notice is addressed to petitioner, references the 1994
tax year, determines the deficiency in income tax and penalty
described above, and, with additional explanations, sets forth
the following adjustments to income giving rise to such
deficiency:
a.
b.
c.
d.
e.
Interest income
Compensation of officers
Rents
Depreciation
Other deductions
The category “Other Deductions” (other deductions) is
particularized as follows:
Business meals
Travel
Supplies
Professional fees
- 9 C.
Discussion
1.
Validity of Notice
Petitioner claims that the notice is invalid because
respondent failed to determine a deficiency in petitioner’s
income tax or examine its return.
Section 6212(a) authorizes the Secretary to send a notice of
deficiency in respect of certain taxes, including the income tax.
We have jurisdiction to redetermine deficiencies determined by
the Secretary.
See sec. 6214(a).
A valid notice of deficiency
has been described as the “ticket to the Tax Court”.
Baron v. Commissioner, 71 T.C. 1028, 1034 (1979).
E.g.,
Petitioner
directs us to Scar v. Commissioner, 814 F.2d 1363 (9th Cir,
1987), revg. 81 T.C. 855 (1983).
In Scar, the Court of Appeals
for the Ninth Circuit considered a notice of deficiency that, on
its face, revealed that no determination of a deficiency had been
made with respect to the taxpayers in question for the year in
question.
See id. at 1370.
The Court of Appeals held that such
a notice was invalid and the petition contesting such notice
should have been dismissed in the taxpayers’ favor for lack of
jurisdiction.
See id.
Commenting on Scar, we have held:
“Where
the notice of deficiency does not reveal on its face that the
Commissioner failed to make a determination, a presumption arises
that there was a deficiency determination.”
Commissioner, 90 T.C. 110, 113 (1988).
Campbell v.
- 10 We have examined the notice and, on its face, it does not
reveal that respondent failed to make a determination:
It is
addressed to petitioner, references the 1994 tax year, states
both that respondent has determined a deficiency in petitioner’s
tax for that year and the amount of that deficiency, and sets
forth the adjustments (and explanations of those adjustments)
giving rise to such determination.
Petitioner has failed to
rebut the resulting presumption that respondent did determine a
deficiency in petitioner’s income tax for the 1994 tax year.
Indeed, the presumption is borne out by evidence in the record.
The adjustments in the notice are similar to the adjustments
resulting from the preceding years’ examination.
No doubt,
Revenue Agent Grimes, being responsible for examination of all
3 years, determined that petitioner was subject to adjustments
for the 1994 tax year similar to those for the preceding 2 years.
The particularity of the document request, to which petitioner
made no response, and the content of the correspondence from
Norman, negotiating on behalf of petitioner with respect to the
Form 872, make clear that, prior to the date of the notice,
Revenue Agent Grimes had examined petitioner’s return for the
1994 tax year and determined that, barring a satisfactory
explanation from petitioner of the items in question, similar
adjustments were called for.
Prior to the notice, respondent
(acting through his agent) had determined a deficiency in
- 11 petitioner’s tax for the 1994 tax year.
Petitioner has failed to
show the invalidity of the notice.
2.
Claim of Arbitrariness
Petitioner claims that the notice is arbitrary and
erroneous, and amounts to nothing more than a naked assessment,
without foundation.
We assume that petitioner wishes to invoke
the rule of Helvering v. Taylor, 293 U.S. 507 (1935).
rule of Helvering v. Taylor, may be simply put:
The
A court is given
sufficient cause to set aside respondent’s determination of a
deficiency if it is shown to the court that such determination
was arbitrarily made.
See id.
discussion of that rule.
We need engage in no extended
The record adequately demonstrates that
respondent’s determination of a deficiency was based on the
similarity of the 1994 tax return to petitioner’s returns for the
preceding 2 years (for which respondent found cause for
adjustments) and petitioner’s failure to comply with the document
request and consent to an extension of time to assess tax.
Simply put, respondent did not act arbitrarily, but with cause.1
1
On brief, petitioner argues that respondent acted
arbitrarily in not agreeing to a restricted Form 872, requiring
petitioner to consent to waive the time to assess tax only with
respect to tax attributable to items similar to those giving rise
to adjustments for the preceding 2 years. Respondent’s
explanation is that it is against policy to agree to restricted
consents until an examination is completed. While we do not find
that policy arbitrary (quite to the contrary), we fail to see how
here, at least, respondent’s refusal to agree to a restricted
consent makes respondent’s determination of a deficiency
(continued...)
- 12 Respondent did not make a naked assessment.
The rule of
Helvering v. Taylor is not properly invoked in this case.
II.
Rental Expenses
A.
Introduction
On the 1994 tax return, petitioner deducted $32,244.12 for
rents paid (the deduction for rents).
By the notice, respondent
disallowed the deduction for rents, explaining that petitioner
had failed to establish that the amount deducted constituted an
ordinary and necessary business expense, was expended, or was
expended for the purpose designated.
The parties have stipulated
that the deduction for rents represents three separate amounts,
as follows:
$7,540 – Rent for space in the Dallas apartment
13,994 – Bethesda apartment expenses
10,710 – Florida expenses
32,244 - Total
B.
Dallas Apartment
1.
Facts
As stated, the Duquettes made their home in the Dallas
apartment from December 1991 until April 1994.
On February 8,
1992, the board of directors of petitioner (sometimes, the board)
resolved that petitioner’s offices be transferred from Maryland
1
(...continued)
arbitrary and erroneous. The adjustments in the notice appear to
reflect in substantial part the scope of the examination of the
1994 tax year communicated by Revenue Agent Grimes to petitioner
and forming the basis of Norman’s request for a restricted
consent.
- 13 to Texas and petitioner’s address be the address of the Dallas
apartment, effective January 1, 1992.
The board also resolved:
The rental expense for the Corporation offices in
Dallas, Texas shall not exceed $1,500.00 per month.
The actual rental shall be the association maintenance
fees charged by the Claridge Association to the
residents of 3510 Turtle Creek Blvd. All additional
charges including the acquisition of the unit, property
taxes, insurance, and telephone expense shall be borne
personally by Norman E. Duquette and shall not be
charged to the Corporation.
Norman prepared a document headed “COMPUTATION OF FAIR RENTAL[,]
OFFICE AT 3510 TURTLE CREEK BLVD.[,] DALLAS, TEXAS” (the
computation document).
Among the entries on the computation
document is the following:
1.
Square Footage Proration
a. Business Use
b. Total Square Footage
c. Percentage Business
625 square feet
2,500 square feet
25 percent
The computation document also has entries entitled “Annual
Expenses”, “Prorated Expenses”, “Unique Business Expenses”, and
“Total Business Expenses”.
Expenses” is $12,919.29.
The amount shown as “Total Business
The computation document states:
“The
corporation will pay the association fees of $11,477.16 as fair
rental for the office in home.
This is less than the $12,919.29
calculated * * * [as “Total Business Expenses”].”
The parties have stipulated that the $7,540 deducted by
petitioner as rent for space in the Dallas apartment (the Dallas
apartment amount) represents condominium fees with respect to the
- 14 Dallas apartment of approximately $1,000 a month from September
1993 until April 1994.
2.
Section 162(a)(3)
In pertinent part, section 162(a)(3) provides:
There shall be allowed as a deduction [in
computing taxable income] all the ordinary and
necessary expenses paid or incurred during the taxable
year in carrying on any trade or business, including-–
*
*
*
*
*
*
*
(3) rentals or other payments required to be
made as a condition to the continued use or
possession, for purposes of the trade or business,
of property to which the taxpayer has not taken or
is not taking title or in which he has no equity.
3.
Arguments of The Parties
Petitioner argues:
“The rental of minimum office space at a
reasonable cost in a major revenue producing location is clearly
an ordinary and necessary expense.”
Respondent argues:
[T]he evidence shows that * * * [petitioner’s] payment
of Norman Duquette’s condominium fees for the Texas
home was merely the payment of the Duquette’s personal
living expenses. * * * [petitioner’s] payment of such
condominium fees is a constructive dividend to Norman
Duquette. It was not an ordinary and necessary
business expense for * * * [petitioner] to pay the
condominium fees for the Duquette’s home. Therefore,
the expense must be disallowed.
4.
Discussion
In Greenspon v. Commissioner, 23 T.C. 138 (1954), we dealt
with a corporation taking deductions for expenditures on the home
of its dominant stockholder and chief executive officer.
We
- 15 said:
“In such circumstances, the proof should be very clear and
very certain that the expenses charged to the corporation were
legitimate business expenses of the corporation.
opportunity for abuse would be great.”
Otherwise, the
Id. at 151.
In Place v.
Commissioner, 17 T.C. 199 (1951), affd. per curiam 199 F.2d 373
(6th Cir. 1952), we dealt with a taxpayer claiming a deduction
for rentals paid his wife for the use of her property in a
manufacturing concern owned and operated by him.
The
Commissioner argued that the rentals were excessive.
We stated:
The basic question is not whether these sums
claimed as a rental deduction were reasonable in amount
but rather whether they were in fact rent instead of
something else paid under the guise of rent. The
inquiry is whether the petitioner was in fact and at
law “required” to pay these sums as rent. See * * *
[predecessor of sec. 162(a)(3)]. When there is a close
relationship between lessor and lessee and in addition
there is no arm’s length dealing between them, an
inquiry into what constitutes reasonable rental is
necessary to determine whether the sum paid is in
excess of what the lessee would have been required to
pay had he dealt at arm’s length with a stranger.
* * *
Id. at 203.
In 1994, there was a close relationship between the
Duquettes and petitioner.
The Duquettes were the sole owners of
petitioner, which was, in effect, Norman’s one-man corporation.
That close relationship gives us reason to question whether their
dealings were at arm’s length, and petitioner has failed to show
- 16 any reason why they would (or did) deal at arm’s length.2
Further, petitioner has failed to prove that the Dallas apartment
amount was a reasonable rental for the use that petitioner
obtained of the apartment.
In short, petitioner has failed to substantiate its claim
that 25 percent of the apartment was for business use.
There is
no plan of the apartment in evidence showing any dedication of a
portion of the apartment to business use, nor did petitioner
testify as to such dedication.
Moreover, the apartment was the
Duquettes’ home, and petitioner has failed to show that the
apartment was any larger than the Duquettes needed for domestic
purposes or that they were in any way discommoded on account of
Norman’s carrying out petitioner’s business on the premises.
Norman testified that a considerable amount of his work for
petitioner is done by telephone and fax, and that, in the
apartment, as in other places, he did research and wrote reports.
2
Congress has expressed skepticism that lease transactions
between employers and employees are negotiated at arm’s length:
Sec. 280A(c)(6) provides that no home office deduction is
allowable to an employee who leases a portion of his home to his
employer. The reports of the tax writing committees that
preceded the addition of sec. 280A(c)(6) to the Code state the
doubt of such committees that lease transactions between an
employer and employee are generally negotiated at arm’s length.
See H. Rept. 99-426 (1985), 1986-3 C.B. (Vol. 2) 1, 133–134; S.
Rept. 99-313 (1986), 1986-3 C.B. (Vol. 3) 1, 83. Both of those
reports accompanied H.R. 3838, 99th Cong., 1st Sess. (1985) (H.R.
3838). H.R. 3838 was enacted as the Tax Reform Act of 1986 (TRA
86), Pub. L. 99-514, 100 Stat. 2404. Sec. 280A(c)(6) constituted
sec. 143(b) of TRA 86.
- 17 There is no evidence that petitioner had to maintain an extensive
library or extensive files for Norman to do his work, or that
Norman required a dedicated area in which actually to write his
reports.
There is no substantiation of Norman’s claim:
“The
Dallas office was used about 10 days a month to deal with
clients”.
Petitioner has failed to convince us that any use of
the apartment by Norman to further petitioner’s business was more
than incidental to the Duquette’s use of the apartment as a home.
Assuming such incidental use, petitioner has failed to show that
there was even a market from which to determine what a reasonable
rental would be for such incidental use.
Petitioner has failed to prove that it was required to pay
the Dallas apartment rental amount as a condition to the
continued use or possession of a portion of the apartment.
Consistent with the lack of evidence that petitioner’s use of the
apartment was anything more than incidental to the Duquettes’ use
of the apartment as their home is the conclusion that, if the
Dallas apartment amount was paid to or for the benefit of the
Duquettes, such payment was not made for business purposes but to
distribute to them, as owners of the corporation, profits or
funds unnecessary for business operations.
Petitioner has failed
to prove that such payment was an ordinary and necessary expense
paid or incurred during the 1994 tax year in carrying on
petitioner’s trade or business.
- 18 5.
Conclusion
We shall sustain respondent’s determination of a deficiency
to the extent it is based on a disallowance of a deduction for
the Dallas apartment rental amount.
C.
Florida Expenses
1.
Facts
The parties have stipulated that, in April 1994, the
Duquettes relocated to Naples, Florida.
A property settlement
agreement entered into by them in connection with their divorce
recites that they “lived and cohabited as Husband and Wife until
on or about April 1994".
The Duquettes were married during all
of calendar year 1994, and they filed a joint Federal income tax
return for that year (the joint return).
The joint return is
signed by Norman and is dated March 13, 1995.
Attached to the
joint return is a form reporting the sale of the Dallas
apartment.
That form recites that, on July 25, 1994, Aline had
purchased a replacement residence and that Norman “will do so
within the two year period [permitted for tax free replacement of
a principal residence]”.
From April 1994, until September 30,
1994 (the last day of the 1994 tax year), Norman’s presence in
Florida was sporadic.
He testified:
“When I went down there in
May and June, I helped her [Aline] look for places.”
Aline was staying in temporary lodgings.
Apparently,
Norman testified that
he spent time with Aline in such temporary lodging.
He testified
- 19 that, as of September 1994, primarily because of marital
difficulties, he had no reason to return to Florida.
Petitioner claimed a deduction for rent in the amount of
$10,710 on account of the reimbursement of Norman for expenses
incurred from April 22, 1994, through September 30, 1994, as
follows (the Florida expenses):
$8,732.50
97.12
150.00
513.40
1,202.50
3
10,695.52
2.
rent for April-September and application fee
phone
home inspection
utilities
furniture storage
Total
Arguments of the Parties
Petitioner argues that the Florida expenses relate to the
relocation of its corporate office from the Dallas apartment to
Florida in April 1994 and the continued use of a home in Florida
as a corporate office for the balance of the 1994 tax year.
support of that argument, petitioner states:
In
There were many
large Government contractors within a 200-mile radius of Naples,
Florida; its Texas client base was diminishing; and it was able
to secure a large client (Honeywell Corp.) shortly after the
Duquettes arrived in Florida.
Petitioner points to a resolution
of the board deciding to relocate the corporate headquarters from
Texas to Florida.
3
Respondent asks us to find that the relocation
The sum of the stipulated individual items is $10,695.52.
There is no explanation of the $14.48 difference between this
number and the stipulated total expenses of $10,710.
- 20 to Florida was tied in with the Duquettes’ separation, she to
Florida, he to Washington.
Based upon that proposed finding
respondent argues that the relocation and living expenses
associated with that relocation were personal expenses of the
Duquettes, the reimbursement of which constituted a nondeductible
constructive dividend.
3.
Discussion
We agree with respondent.
Petitioner is not clear on the
grounds for his deduction of the Florida expenses.
To the extent
that petitioner claims a deduction for the Florida expenses under
section 162(a)(3), as rentals, petitioner has failed to
substantiate the business use of any rental property.
We deny
such a deduction for reasons similar to those we set forth with
respect to the Dallas apartment amount.
To the extent that
petitioner otherwise claims a business purpose for the
reimbursement of the Florida expenses, we find that such
reimbursement was made principally to serve the personal needs of
the Duquettes, in connection with the breakup of their marriage,
and only incidentally for any purpose associated with petitioner.
Petitioner has failed to prove that the reimbursement of
the Florida expense was an ordinary and necessary expense paid or
incurred during the 1994 tax year in carrying on petitioner’s
trade or business.
- 21 4.
Conclusion
We shall sustain respondent’s determination of a deficiency
to the extent based on a disallowance of a deduction for
reimbursement of the Florida expenses.
D.
The Bethesda Apartment Expenses
1.
Facts
At the meeting of the board on February 8, 1992, in addition
to resolving that petitioner’s offices be transferred to Texas,
the board resolved:
The corporation will maintain a Corporate apartment in
Maryland to serve as a Resident Agent address as
required by Maryland law. The corporate apartment will
also be used by employees of the Corporation when
traveling to the Washington area on Corporation
business.
On the 1994 tax return, petitioner claimed a deduction with
respect to the Bethesda apartment as follows (the Bethesda
apartment expenses):
$9,540
805
1,300
15
43
19
1,294
897
80
4
13,993
4
monthly rent of $795 paid to owner
maid service
cable TV
parking fee
Pepco
newspaper
telephone
answering service
misc. credit card charge
Total
Here again there is no explanation of the discrepancy (in
this case, $1) between the sum of the individual items and the
stipulated total of $13,994. Presumably, the $1 was lost in
rounding one or more of the items to the nearest dollar.
- 22 2.
Sections 162(a)(2) and 274(d)(1)
In pertinent part, section 162(a)(2) provides:
There shall be allowed as a deduction [in computing
taxable income] all the ordinary and necessary expenses
paid or incurred during the taxable year in carrying on
any trade or business, including-*
*
*
*
*
*
*
(2) traveling expenses (including amounts expended
for meals and lodging other than amounts which are
lavish or extravagant under the circumstances)
while away from home in the pursuit of a trade or
business * * *
Section 274(d)(1) provides that no deduction shall be
allowed pursuant to the provisions of section 162 for traveling
expenses, including meals and lodging, unless the taxpayer
substantiates “by adequate records or by sufficient
evidence corroborating the taxpayer’s own statement” the specific
time, place, and amount of the claimed expenditures, as well as
the business purpose of the expense.
Section 274(d)(1) is
applicable to corporate as well as individual taxpayers.
See
Group Admin. Premium Serv., Inc. v. Commissioner, T.C. Memo.
1996-451; Rosenthal Chiropractic Offices, Inc. v. Commissioner,
T.C. Memo. 1993-331.
3.
Arguments of the Parties
Petitioner argues:
“In FY 94 [the 1994 tax year], the
apartment was used for business for approximately 177 days.”
- 23 “This is an ordinary and necessary expense clearly deductible
under IRC sections 161 and 162.”5
Respondent argues that the Bethesda apartment was Norman’s
tax home for the 1994 tax year and, therefore, when he was there,
he was not "away from home", so as to allow a deduction pursuant
to section 162(a)(2).
Respondent argues that the Bethesda
apartment expenses were personal living expenses provided by
petitioner to Norman and, therefore, additional nondeductible
constructive dividends.
4.
Discussion
A corporation may deduct its costs for the travel of its
employees on the business of the corporation.
See, e.g., Avon
Mills v. Commissioner, 7 B.T.A. 143, 146 (1927).
Among the
conditions that must be satisfied before a deduction for
traveling expenses may be taken under section 162(a)(2) is that
the expense is incurred in pursuit of business.
See Commissioner
v. Flowers, 326 U.S. 465, 470 (1946) (interpreting section
23(a)(1)(A) of the 1939 Code, the precursor to section
162(a)(2)).
In Flowers, the taxpayer, an employee of a railroad,
resided in Jackson, Mississippi.
His principal post of business
was in Mobile, Alabama, and he attempted to deduct as traveling
5
Sec. 161 provides: “In computing taxable income under
section 63, there shall be allowed as deductions the items
specified in this part, subject to the exceptions provided in
part IX (sec. 261 and following, relating to items not
deductible).”
- 24 expenses the costs he incurred in making trips from Jackson to
Mobile and his expenditures for meals and hotel rooms while in
Mobile.
See id. at 468-469.
With respect to the pursuit-of-
business condition, in the context of the facts before it in
Flowers, the Supreme Court said:
This means that there must be a direct connection
between the expenditure and the carrying on of the
trade or business of the taxpayer or his employer.
Moreover, such an expenditure must be necessary or
appropriate to the development and pursuit of the
business or trade.
Id. at 470.
The Supreme Court dismissed almost summarily any
claim that the expenses in question had been incurred in pursuit
of the business of the corporation.
See id. at 473.
The Court
found that the expenses were no different in kind than the
commuting expenses incurred by employees residing in proximity to
their post of duty.
See id.
Such local commuting expenses the
Court characterized as “living and personal expenses lacking the
necessary direct relation to the prosecution of the [employer’s]
business.”
Id.
The Court found that the taxpayer’s added costs
of a long-distance commute "were as unnecessary and inappropriate
to the development of the railroad’s business”.
Id.
The
railroad, the Court stated, did not require the taxpayer to
travel on business from Jackson to Mobile or to maintain living
quarters in both cities:
“It simply asked him to be at his
principal post in Mobile as business demanded and as his personal
convenience was served”.
Id.
The Court concluded:
- 25 Travel expenses in pursuit of business within the
meaning of * * * [sec. 162(a)(2)] could arise only when
the railroad’s business forced the taxpayer to travel
and to live temporarily at some place other than
Mobile, thereby advancing the interests of the
railroad. Business trips are to be identified in
relation to business demands and the traveler’s
business headquarters. The exigencies of business
rather than the personal conveniences and necessities
of the traveler must be the motivating factors. * * *
Id. at 474.
We must determine whether the exigencies of petitioner’s
business rather than the personal conveniences and necessities of
Norman motivated his travel to the Washington, D.C., area, in
order to determine whether any or all of the Bethesda apartment
expenses are traveling expenses deductible by petitioner.
There
is no doubt that petitioner had business in the Washington area.
That business included providing Norman’s services to the law
firm, which treated Norman as an employee.
Taking together
Norman’s testimony, the fact that the income from the law firm
varied from year to year, and our belief that petitioner reported
that income on its own return, we are prepared to give petitioner
the benefit of the doubt, and we find that Norman was not an
employee of the law firm (but that petitioner did business with
the law firm, selling its consulting services provided by Norman,
petitioner’s employee).
To determine whether the exigencies of
petitioner’s business brought Norman to Washington, we must
determine whether Washington was Norman’s principal post of duty.
- 26 We find that it was not, at least through April 18, 1994; it was,
at least through April 18, 1994, a minor post of duty.
We have considered a list of petitioner’s customers, and the
receipts that each generated, for the 1994 tax year and the
preceding and following years.
Those customers are located all
over the country, and, even though the law firm provided over
one-half of petitioner’s receipts for the 1994 tax year, that was
not true for either the preceding or following year.
We give
credit to Norman’s testimony that, in 1991, when the Duquettes
moved to Dallas, major business opportunities for petitioner
existed there.
We also give credit to his testimony that, by
April 18, 1994, when the Duquettes sold the Dallas apartment,
petitioner’s Texas business was in decline.
We, therefore, find
that Norman’s principal post of duty was in Dallas, Texas, during
the 1994 tax year, until April 18, 1994, when the Duquettes moved
from Dallas.
Petitioner has failed to prove that, from April 18,
1994, until the end of the 1994 tax year, Norman’s major post of
duty was other than in the Washington, D.C., area.
Petitioner has convinced us that rental of the Bethesda
apartment was an economical alternative to the cost of hotels,
when Norman traveled to Washington on petitioner’s business.
Petitioner has also substantiated the fact of the Bethesda
apartment expenses by adequate records, principally canceled
checks.
We are satisfied as to the business purpose associated
- 27 with the rental of the Bethesda apartment by the action of the
board, authorizing the rental of a corporate apartment, and the
use of the Bethesda apartment by Norman on the 177 days during
the 1994 tax year that he worked in Washington.
Therefore, we
find that petitioner incurred, and has adequately substantiated,
traveling expenses on account of the travel of Norman to
Washington, in an amount equal to that portion of the Bethesda
apartment expenses incurred on or before April 18, 1994.
5.
Conclusion
We shall sustain respondent’s determination of a deficiency
to the extent based on a disallowance of a deduction for the
Bethesda apartment expenses only to the extent of such expenses
incurred after April 18, 1994.
III.
Travel Expenses
On the 1994 tax return, under the heading “Other
Deductions”, petitioner deducted $45,937.83 for “Travel”.
Respondent disallowed all "other deductions" on the grounds “that
it has not been established that any amount claimed constitutes
an ordinary and necessary business expense, was expended or was
expended for the purpose designated.”
We may dispose of this item without much discussion.
The
parties have stipulated to a “meal analysis” and a “travel
analysis” prepared by petitioner, which analyses (the analyses)
contain details of the travel expenses (travel expenses) claimed
- 28 by petitioner).
The parties also have stipulated that many of
the travel expenses were reimbursed by payment from petitioner’s
customers directly to Norman.
Respondent argues:
“[Petitioner]
is not entitled to a deduction for the travel expenses because
they were all reimbursed.”
Petitioner agrees that travel
expenses were reimbursed to Norman, but claims that all such
reimbursements were included in petitioner’s gross income.
Petitioner points to a stipulated exhibit, a copy of a cash
receipts journal for petitioner prepared by Norman, which,
petitioner claims, supports its claim that all such reimbursement
were included in gross income.
Petitioner has not, however, tied
the entries in the cash receipts journal to the line one amount,
$309,630.25, “Gross receipts or sales”, on the 1994 return.
Nevertheless, we find that all reimbursements were included in
gross income.
We think that such finding is a fair inference
from the substantial amount of gross receipts or sales reported
on the 1994 tax return, the cash receipts journal, and is
implicit in Norman’s testimony that petitioner reported all
reimbursements.
Respondent offered no proof to rebut that
inference.
Respondent also argues that petitioner has failed to
substantiate the business purpose of the travel expenses, as
required by section 274(d)(1).
See sec. 1.274-5T(c)(2)(ii)(B),
Temporary Income Tax Regs., 50 Fed. Reg. 46018 (Nov. 6, 1985).
- 29 The travel expenses set forth in the analyses are supported
by other stipulated exhibits, including canceled checks, copies
of credit card statements, and a daily diary kept by Norman,
which corroborates the list of miscellaneous expenses for
parking, tolls, taxis, gasoline, tips, etc., set forth in one of
the analyses.
We find that those exhibits, plus the parties’
stipulation and Norman’s testimony (not disputed by respondent)
that virtually all of the travel expenses associated with visits
to business clients that are listed on the analyses were
reimbursed by such clients, constitute adequate substantiation of
the amounts, time and place, and business purpose of such
expenses as required by section 274(d) and the regulations.
Travel expenses incurred in connection with the trips to Florida,
which we have found to be personal trips, and all travel expenses
incurred by Norman in the Washington, D.C., area after April 18,
1994 (not shown to be other than commuting expenses), are not
included within that finding on the ground that such expenses do
not constitute expenses associated with business travel while
away from home as required by section 162(a)(2).
Based upon the foregoing criteria, we find that petitioner
incurred deductible travel expenses for the 1994 tax year in the
amount of $30,958.
- 30 IV.
Business Meals
A.
Introduction
On the 1994 tax return, under the heading other deductions,
petitioner deducted $16,070.60 for “Business Meals” (business
meals).
On brief, petitioner concedes a portion of the
adjustment for business meals, arguing for a deduction of
$14,777, divided as follows:
Per diems - Aline Duquette
Per diems - Norman Duquette
Business meals with clients
Board of directors meetings
Total
$6,440
10,010
1,711
310
18,471
Deductible business meals (80 percent)6 $14,777
We may also dispose of this item without much discussion.
Respondent argues lack of substantiation, failure to report
reimbursements, and duplication of certain expenses.
Petitioner
supports the deduction with the analyses and other stipulated
documents.
For the same reason as set forth supra, in
section III, we find that all reimbursements were included in
gross income.
B.
Per Diems – Aline Duquette
We allow no deduction with respect to the $6,440 claimed as
business meals for “Per diems – Aline Duquette”.
Petitioner
argues that it paid Aline per diem of $35 a day for 184 days
6
With exceptions not here pertinent, sec. 274(n)(1)
provides that any deduction for food or beverages shall not
exceed 80 percent of such expense.
- 31 ($6,440), while she was “in a travel status”, related to her
relocation to Florida.
Petitioner’s policy was to pay a per diem
amount for meals rather than reimbursing an employee’s actual
meal expenses, if the employee so elected.
As set forth supra in
section II.D.2, section 162(a)(2) permits a deduction for
traveling expenses (including amounts expended for meals) while
away from home in the pursuit of business.
Aline’s duties for
petitioner are vaguely described at best.
Her marriage to Norman
was in trouble in April 1994, and, we believe, she moved to
Florida for personal reasons.
Petitioner has failed to prove
that the expenses incident to her relocation to Florida were
incurred in pursuit of its business, rather than pursuant to
Aline’s relocation to Florida for personal reasons.
On that
basis, we allow no deduction.
C.
Per Diems – Norman Duquette
We allow a deduction of $3,409 with respect to the $10,010
claimed as business meals for “Per diems – Norman Duquette”.
Petitioner claims that it paid Norman per diem of $35 a day for
286 days ($10,010), while he was “in a travel status”.
We
believe that, to a limited extent, such per diem payments were
legitimate traveling expenses (for meals) incurred by petitioner
with respect to travel by Norman while away from home in pursuit
of the business of petitioner.
During the 1994 tax year, through
April 18, 1994, Norman’s principal post of duty was in Dallas,
- 32 Texas.
See supra sec. II.D.4.
During that period, Norman was in
a travel status with respect to petitioner when he traveled away
from Dallas in pursuit of petitioner’s business.
The analyses
show per diem payments to Norman for various dates (e.g., “11/3 –
11/5; 11/29 – 12/17) through April 18, 1994.
We accept that
Norman was traveling on behalf of petitioner, away from Dallas,
on all dates through April 18, 1994, for which per diem payments
are shown (all as reflected in the analyses and supporting
documents).7
Per diem payments for such travel are deductible by
petitioner.
After April 18, 1994, Dallas no longer was Norman’s
principal post of duty, see section III.D.4., and Norman has
failed to prove that his principal post of duty was other than
Washington, D.C., where he worked for 177 days during the 1994
tax year.
See id.
The analyses show per diem payments to Norman
for every day from April 19, 1994, through the end of the 1994
tax year (the remainder of the year).
Petitioner has failed to
prove that Norman was in a travel status on every day during the
remainder of the year.
Nevertheless, the analyses and certain
supporting documents allow us to determine that petitioner was
outside of the Washington, D.C., area on petitioner’s business on
7
Petitioner’s payment of per diem to Norman and
petitioner’s reimbursement of his miscellaneous travel expenses
is evidenced by copies of canceled checks issued to Norman, which
contain notations that they represent expense reimbursements.
Also, respondent did not object to the amount of the per diem
($35 a day). Therefore, we do not consider the amount to be in
issue.
- 33 some days during the remainder of the tax year and, on those
days, incurred expenses for meals.
Based upon the foregoing discussion, we find that, for the
1994 tax year, petitioner incurred deductible traveling expenses
(for meals), under the heading:
Per diems – Norman Duquette, in
the amount of $3,409 (80% x $4,261).
D.
Business Meals With Clients
We allow no deduction with respect to the $1,711 claimed as
“Business meals with clients” (client meals).
On brief, in its
discussion of client meals, petitioner merely directs us to the
analyses and other stipulated documents.
We have examined those
exhibits and are unable to identify the charges that constitute
the client meals.
Moreover, with respect to the group of charges
that might contain the charges for client meals, petitioner has
failed to comply with the substantiation requirements of section
1.274-5T(b)(3), Temporary Income Tax Regs., governing
entertainment of clients.
Petitioner has presented no evidence
concerning the specific "business reason" for the meals, the
"nature of business derived or expected to be derived as a result
of the [meals]", or (with few exceptions) the "business
relationship" of the person or persons entertained by
Mr. Duquette.
See sec. 1.274-5T(b)(3)(iv) and (v), Temporary
Income Tax Regs.
We, therefore, deny any deduction for the
charges for client meals.
- 34 E.
Board of Director’s Meetings
We allow no deduction with respect to the $310 claimed for
“Board of Directors Meetings” (board meals).
As stated, during
the 1994 tax year, the Duquettes were petitioner’s only
directors.
On January 1 and February 1, 1994, the Duquettes met,
as directors, to discuss corporate matters (the January 1 meeting
and the February 1 meeting, respectively).
The January 1 meeting
took place at a restaurant called “The Mansion at Turtle Creek”,
and the February 1 meeting took place at a restaurant called "The
Riviera”.
The charge for dinner at the first restaurant was $162
and the charge for dinner at the second restaurant was $148.
Petitioner claimed a deduction for both dinners ($310).
The
minutes of the January 1 meeting show that the sole substantive
purpose of that meeting was to approve payment for the Duquettes’
prior trips to Naples, Florida, and the decision "to relocate the
corporation to Naples".
The minutes of the February 1 meeting
show that the purpose of that meeting was to hear Mr. Duquette’s
report of petitioner’s earnings as of December 31, 1993, and to
approve Mr. Duquette’s consultation with an attorney "regarding
some tax issues".
infra.)
(See the discussion of those attorney’s fees,
There is no evidence that these matters actually
required significant discussion or, in light of Norman’s absolute
control of all aspects of petitioner’s business, any action other
than the preparation and signing of the minutes by Norman as
- 35 petitioner’s secretary.
Petitioner has failed to show any
business necessity for it to spend anything (much less $310) for
two meals for two persons so that the Duquettes, who were
married, lived together, and, as petitioner would have it, worked
together, could discuss the affairs of Norman’s one-man
corporation.
See Moss v. Commissioner, 758 F.2d 211, 213 (7th
Cir. 1985), affg. 80 T.C. 1073 (1983); see also Dugan v.
Commissioner, T.C. Memo. 1998-373.
V.
Automobile Depreciation
On the 1994 tax return, petitioner deducted depreciation of
$2,550, which it explained as being with respect to an automobile
placed in service on June 17, 1992, costing $15,884, used
100 percent for business, and driven 12,000 miles on business
during the 1994 tax year (the automobile).
Respondent disallowed
that deduction, explaining that petitioner had failed to
establish the cost of the automobile, that it was depreciable,
and that it was used in a trade or business.
On brief, petitioner claims:
The company car was driven 12,000 business miles in
FY94 which included a househunting trip from Dallas to
Naples [Florida] in December 1993, a one way trip to
Florida in April 1994 incident to the relocation, and a
trip from Dallas to Phoenix in January 1994 for
consulting. * * * These three trips account for 6,100
of the 12,000 business miles in FY 94. The balance of
the business miles (5,900) is an average of 113 miles
per week for travel to business meetings, post office,
banks, and other incidental business activity.
- 36 The parties have stipulated a copy of a purchase agreement
for a 1992 Honda, dated June 13, 1992, at a price of $17,184
(“Unpaid balance * * * $15,884")8, and showing co-purchasers:
petitioner and Norman.
Section 167(a)(1) allows a depreciation deduction with
respect to property used in a trade or business.
Section
274(d)(4) requires substantiation of various items with respect
to any deduction for property such as the automobile.
We have already concluded that petitioner failed to prove
that the expenses incident to Aline’s relocation to Florida were
incurred in pursuit of its business.
See supra sec. IV.b.
We
assume that the mileage described by petitioner for house hunting
in, and relocation to, Florida were incident to Aline’s
relocation there.
Any mileage associated with such relocation is
not business mileage.
In addition there is no evidence to
support petitioner’s statement that 5,900 miles were attributable
to incidental business activity.
Petitioner points to an exhibit
headed “Car Mileage”, which Norman testified was an annual
analysis of business usage of petitioner-owned automobiles made
at the end of each of petitioner’s taxable years.
For the 1994
tax year, the entries merely indicate that the automobile was
8
Petitioner has furnished no explanation for its use of
$15,884, rather than the $17,184 purchase price, as the
depreciable cost basis for the automobile.
- 37 driven 12,905 total miles without any breakout of business miles
that would justify a depreciation deduction for that year.
Only the business purpose of the trip to Phoenix is
adequately substantiated by (1) a copy of the expense report
submitted to the law firm, (2) the travel expense analysis
prepared by Norman, which lists the cost of that trip as one of
Norman’s travel expenses for the audit year, and (3) the parties’
stipulation that all travel expenses that pertain to clients of
the law firm were reimbursed in full by that firm (which we
assume that petitioner included in gross income).
The expense
report submitted by Norman to the law firm states that the round
trip covered 2,160 miles, which is 16.7 percent of the total
mileage (12,905 miles) for the 1994 tax year.
Because we find that the percentage of business use of the
auto during the audit year was less than 50 percent, depreciation
for the year is limited to straight line over a 5-year period, as
opposed to declining balance over a 3-year period as shown on the
Form 4562, Depreciation and Amortization, attached to the 1994
return.
See secs. 280F(b)(1), 168(g)(2)(A) and (3)(D).
Depreciation is deductible only to the extent of business use.
D’Angelo Associates, Inc. v. Commissioner, 70 T.C. 121, 138
(1978); L&L Marine Serv. Inc. v. Commissioner, T.C. Memo. 1987428.
Therefore, the correct automobile depreciation deduction
- 38 for the audit year is $531 determined as follows:
16.7% x
$15,884 (the original cost of the auto) x 20%.
VI.
Supplies
On the 1994 tax return, under the heading “Other
Deductions”, petitioner deducted $8,900.50 for “Supplies”
(supplies).
Of that amount, $2,765 remains in dispute.9
The
remaining amount claimed for supplies is as follows:
(1) Safe deposit box
(2) Registry of motor vehicles
(3) Condo application fee
(4) Furniture storage
(5) Office decorations
(6) FOIA request
(7) Entertainment
(8) Auto insurance
(9) Life insurance
(10) Medical bills
Total
$30
498
100
730
300
488
247
149
90
133
2,765
Items (1)-(4) represent costs associated with Aline’s
relocation from Dallas to Florida.
We find that petitioner’s
payment of those costs, like its payment of other costs
associated with Aline’s relocation, was not in connection with
petitioner’s business.
Item (5), office decorations, also represents a personal
benefit to the Duquettes, based upon our finding, supra sec. II.B
9
A portion of this difference is attributable to
petitioner’s concession prior to trial, that many of the
reimbursements for so-called supplies charged to American Express
by Norman related to nondeductible personal items.
- 39 and C., that neither the Dallas apartment nor the Florida
residence qualified as business premises of petitioner’s.
Petitioner’s description of item (6), its request under the
Freedom of Information Act (FOIA) "for tax information", does not
reveal whether the request related to respondent’s examination of
petitioner, of Norman, or to the criminal proceeding instituted
against Norman (discussed infra).
As a result, petitioner has
not shown that that expense provided any business benefit to
petitioner.
Petitioner states that item (7), entertainment, represents
the cost of five "shows" at the Kennedy Center in Washington,
D.C.:
Three attended by Norman and "a part-time consultant to
the petitioner" and two attended by Norman and employees of "a
major client".
Entertainment expenses are deductible to the extent that
they are (1) "directly related to" the "active conduct of the
taxpayer’s trade or business" or
(2) "associated with" the
active conduct of such trade or business, and the entertainment
directly preceded or followed "a substantial and bona fide
business discussion".
Sec. 274(a)(1)(A).
In this case, the
entertainment was not "directly related entertainment" as defined
in section 1.274-2(c), Income Tax Regs.
2(c)(7)(ii)(a), Income Tax Regs.
See sec. 1.274-
Also, it does not qualify as
"associated" entertainment because petitioner has failed to offer
- 40 any evidence as to the existence or nature of any bona fide
business discussion either before or after the entertainment.
See sec. 1.274-2(d)(3), Income Tax Regs., sec. 1.274-5T(b)(3)(iv)
and (b)(4), Temporary Income Tax Regs., 50 Fed. Reg. 46015
(Nov. 6, 1985).
Therefore, the entertainment expense is
nondeductible.
Item (8), the cost of insurance for the automobile, was
incurred on May 28, 1994, more than 4 months after the DallasPhoenix round trip, the only demonstrated business use of the
auto during the audit year.
Because there is no evidence that
the $297 payment of automobile insurance was attributable to
other than periods of personal use of the auto during the 1994
tax year, we find that no portion of this payment constitutes a
deductible expense under section 162(a).
Petitioner argues that item (9), a premium for life
insurance on Norman’s life, was purchased pursuant to a company
plan or policy adopted on February 6, 1992, by Norman acting in
his capacity as petitioner’s president (the plan).
The plan
provided for "[l]ife insurance offered through American Express
on the life of * * * [Norman]", and was limited to life insurance
"covering accidents while traveling".
There is no evidence as to
the amount of the insurance in question.
Apparently, the
proceeds of the policy were payable to petitioner:
“The proceeds
from the policy will be used to effect an orderly business
- 41 transition in the event Mr. Duquette is no longer available to
lead the company.”
Those are just words; they fail to establish
any corporate need for insurance should Norman’s death deprive
his one-man corporation of his services.
Cf. Whipple Chrysler-
Plymouth v. Commissioner, T.C. Memo. 1972-55.
The plan also provided a self-insured medical benefit
consisting of "[p]ayment of Medical Expenses up to a maximum of
$2,000 per year, per employee."
That language is the basis for
item (10), the $133 deduction for "medical bills".
We find that,
even though it covered only the two shareholder employees, the
Duquettes, the plan qualified as a medical benefit plan under
section 105(b), see section 1.105-5(a), Income Tax Regs., and
that petitioner is entitled to deduct any medical expense
payments made under the plan.
Seidel v. Commissioner, T.C. Memo.
1971-238; see sec. 1.162-10(a), Income Tax Regs.
Norman’s
American Express bills covering the 1994 tax year (all of which
were paid by petitioner) show a $25 dentist bill and a $108
charge for prescription drugs.
However, the January 16, 1994,
American Express statement shows both a charge and a credit for
the $108, and Norman’s payment was reduced by the amount of such
credit.
We, therefore, find that petitioner is entitled only to
a $25 deduction for medical expense reimbursements under the
plan.
- 42 VII.
Legal Fees
On the 1994 tax return, under the heading other deductions,
petitioner deducted $57,862.03 for “Professional Fees”.
Remaining in dispute is the amount of $33,842 paid by petitioner
to a law firm in Washington, D.C. (the legal fees), for
representation of Norman in connection with the criminal
investigation.
Petitioner argues that payment of the legal fees
is deductible as an ordinary and necessary expense of
petitioner’s incurred in its business because an unfavorable
result to the criminal investigation “would have destroyed
petitioner’s ability to remain in business by depriving the
Petitioner of its key employee.”
Respondent argues that
petitioner’s payment of Norman’s legal fees was a constructive
dividend to Norman.
The issue presented herein is identical to that recently
considered by this Court in Hood v. Commissioner, 115 T.C. 172
(2000).
Hood concerned the deductibility of legal fees paid by a
corporation on behalf of its sole shareholder and key,
indispensable employee in connection with his indictment for
criminal tax evasion relating to his operation of the same
business prior to incorporation.
In Hood, we held that the
corporation’s payment of legal fees constituted a nondeductible
constructive dividend on the ground that the shareholderemployee, not the corporation, primarily benefited from such
- 43 payment.
We found that, in Hood, the shareholder "had the
wherewithal to pay the legal fees associated with his criminal
defense."
We found that "while the incarceration of Mr. Hood
might have caused * * * [the corporation] to cease operations,
petitioners have not shown that * * * [the corporations’s]
failure to pay the legal fees would have led to Mr. Hood’s
incarceration."
Id. at 181-182.
There is no evidence in this case to contradict that Norman,
like Mr. Hood, was financially capable of paying the legal fees
associated with his criminal defense.
In both cases, the benefit
to the shareholder ("free legal representation for which * * *
[the shareholder] would otherwise have to pay to avoid
incarceration and/or a felony conviction") outweighed any benefit
to the corporation making the payment.
Id. at 181.
We, therefore, find that petitioner’s payment of the legal
fees was primarily for Norman’s, not petitioner’s, benefit and,
therefore, is nondeductible by petitioner.
VIII.
Accuracy-Related Penalty
Respondent determined a 20-percent accuracy-related penalty
under section 6662(a) and (b)(1) on account of negligence or
- 44 intentional disregard of rules or regulations.10
Petitioner
assigns error to respondent’s determination.
In the case of an underpayment of tax required to be shown
on a return, section 6662(a) and (b)(1) imposes a penalty in the
amount of 20 percent of the portion of the underpayment that is
attributable to negligence or intentional disregard of the rules
or regulations (hereafter, simply, negligence).
Negligence has
been defined as lack of due care or failure to do what a
reasonable and prudent person would do under like circumstances.
E.g., Hofstetter v. Commissioner, 98 T.C. 695, 704 (1992).
Negligence includes any failure by the taxpayer to keep adequate
books and records or to substantiate items properly.
1.6662-3(b)(1), Income Tax Regs.
See sec.
Section 6664(c)(1) provides
that the accuracy-related penalty shall not be imposed with
respect to any portion of an underpayment if it is shown that the
taxpayer acted in good faith and that there was reasonable cause
for the underpayment.
The determination of whether a taxpayer
acted in good faith and with reasonable cause is made on a caseby-case basis, taking into account all pertinent facts and
10
In his notice of deficiency, respondent also seeks to
impose the penalty on the ground that there was a substantial
understatement of tax under sec. 6662(b)(2). On brief, however,
respondent has not pursued that argument. We, therefore,
consider him to have abandoned it. See Bernstein v.
Commissioner, 22 T.C. 1146, 1152 (1954), affd. 230 F.2d 603 (2d
Cir. 1956); Lime Cola Co. v. Commissioner, 22 T.C. 593, 606
(1954); Roberts v. Commissioner, T.C. Memo. 1996-225.
- 45 circumstances.
"Circumstances that may indicate reasonable cause
and good faith include an honest misunderstanding of * * * law
that is reasonable in light of all of the facts and
circumstances, including the experience, knowledge, and education
of the taxpayer."
Sec. 1.6664-4(b)(1), Income Tax Regs.
Petitioner bears the burden of proving facts showing good faith
and reasonable cause.
See Rule 142(a).
Petitioner defends against respondent’s determination of a
penalty for negligence by claiming:
“Petitioner has maintained
comprehensive records and had a reasonable basis for all aspects
of the tax return.”
Petitioner concedes that Norman has passed
the examination to be a certified public accountant.
Respondent
argues that "[petitioner] intentionally disregarded rules
prohibiting deductions for personal items and deducted items for
which it had been reimbursed."
Respondent also argues that
petitioner failed to keep adequate records under sections 6001
and 274(d).
To the extent we have sustained respondent’s adjustments, we
have done so principally because petitioner has failed to show
that its deductions represented expenses incurred in carrying on
petitioner’s business, rather than expenses incurred to benefit
the Duquettes, personally.
With respect to such deductions, it
appears to us that Norman believed that, if he produced corporate
resolutions and policies authorizing such expenses, no further
- 46 consideration was necessary as to whether the expense really
benefited petitioner.
questions of law.
judgment.
Respondent’s adjustments raise few
They raise questions of fact; indeed, of
Norman exercised poor judgment.
He had been a
Government auditor, and he had passed his C.P.A. exams.
Undoubtedly, he understood that he wore more than one hat with
respect to his corporation, as shareholder, director, and
employee, and that an expenditure to benefit a shareholder
directly is not a deductible corporate expense.
There is ample
evidence that Norman abused his dual status, exploiting his
director and employee roles in order to shortchange the tax
collector; for example, by deducting dinners at expensive
restaurants to discuss with his wife matters over which he had
complete control or deducting as corporate relocation expenses
personal costs incident to his divorce and his wife’s relocation
to Florida.
See also supra note 8, in which we report Norman’s
concession that he billed petitioner for personal expenditures.
Also, contrary to petitioner’s claim, it did not keep adequate
and full records.
Except as stated in the next paragraph,
petitioner has failed to convince us that it did not act
negligently with respect to any of the adjustments it here
contests.
Petitioner has not argued that the negligence penalty should
not be sustained for adjustments that petitioner conceded.
We
- 47 sustain the negligence penalty for the whole of petitioner’s
underpayment in tax other than that portion of the underpayment
arising from respondent’s disallowance of the legal fees, since
petitioner’s reporting position regarding the deductibility of
legal fees was consistent with our holding in Jack’s Maintenance
Contractor’s, Inc. v. Commissioner, T.C. Memo. 1981-349, revd.
per curiam 703 F.2d 154 (5th Cir. 1983), which we overruled in
Hood v. Commissioner, 115 T.C. 172 (2000).
To reflect the foregoing,
Decision will be entered
under Rule 155.
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.