T .C . Memo . 2007-14 5
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T .C . Memo . 2007-14 5
UNITED STATES TAX COUR T
JAMES G . LEBLOCH AND CATHY MICHELSEN LEBLOCH, Petitioners v .
COMMISSIONER OF INTERNAL REVENUE, Responden t
Docket No . 2724-05 .
Filed
June
11,
2007 .
James G . LeBloch , for petitioners .
Michael W . Berwind , for respondent .
MEMORANDUM FINDINGS OF FACT AND OPINIO N
LARO,
Judge :
Petitioners petitioned the Court to
redetermine respondent's determinations with respect to their
1997, 1998, and 1999 Federal income taxes . Respondent determined
SER'' JUN 1+ ZOO1
-2the following deficiencies and sectionl6662(a) accuracy-related
penalties for those years :' Year
Deficiency Accuracy-Related Penalt y
1
1997 $36,478
1998 18,103
1999 29,666
$7,288 .00
3,620 .60
5,933 .2 0
The deficiencies and accuray-related penalties are primarily
attributable to respondent's determination of unreported income
(by way of bank deposits anlyses) and[to respondent's
disallowance of self-employment expenses (for lack o f
I
substanltiation) . Following concessions,' we decide the followin g
issues as to each subject year :
Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code . Rule
references are to the Tax Cburt Rulesjof Practice and Procedure .
z Petitioners' petition contains no allegation of error as
to the accuracy-related penalties included in the notices of
I
deficiency
. Nor does petitioners' posttrial opening brief set
forth any argument as to the accuracy related penalties (or list
that matter as an issue requiring decision) . We consider,
petitioners to have conceded their liability for the accuracyrelated penalties . See Rule 34(b)(4)j Funk v . Commissioner ,
123 T .C . 213, 215 (2004) ; se e also Palahnuk v . Comm issioner ,
127 T . C . 118 , 120 n . 2 (2006 ) ; Harbor Cove Marina Partners Pship .
v . Commissioner , 123 T . C . 64, 66 ( 2004 ) ; cf . Swain v .
Co mm issioner , 118 T .C . 358 ( 2002 ) ( the Co mm issioner ' s burden of
production under sec . 7491 c) does not apply where the taxpayer
concedes liability for an accuracy-related penalty by failing to
assignUerror to the Co mm issioner ' s determination of th e
accuta y-related penalty ) . We also consider petitioners to have
conceded all other determinations set forth in the notices of
deficiency that petitioners did not adequately pursue in their
posttrial opening brief .' See Palahnu !k v . Comm issioner , supra at
120 n . 2 ; Harbor Cove Marina .Partners •Pship . v . Comm issioner ,
- supra at 66 .
-31 . Whether petitioners underreported their income . We hol d
they did in the amounts set forth herein .
2 . Whether petitioners may deduct the disputed expenses .
We hold they may not .
FINDINGS OF FAC T
A.
Prefac e
Some facts were stipulated or contained in the exhibits
submitted therewith . We find the facts accordingly . Petitioners
were husband and wife from December 31, 1997, through the end of
the subject years, and they filed joint Federal income ta x
returns for those years . When their petition was filed, they
resided in a 3-bedroom house (residence) in Laguna Beach,
California . Petitioners purchased the residence for $563,000,
each of them paying half of the downpayment, and the interior of
the residence measured approximately 2,200 square feet . That
square footage does not include a 2-car-garage that measured
approximately 400 square feet .' At the time of trial,
petitioners were divorced, and petitioner Cathy Michelsen LeBloch
(Michelsen) lived in or around Brisbane, Australia .
With respect to their household bills and other finances,
petitioners had an arrangement that they pay equally all common
expenses (e .g ., mortgage, property taxes, utilities) and that th e
3 The record does not establish whether the
attached to the residence .
garage was
4spouse' benefiting from any oither expense pay that expense .
Petitioners maintained separate financial accounts and did not
own anyjfinancia1 account jointly . When one of them paid a
commo n
xpense in full, or paid an expense of the other, th e
other one typically wrote contemporaneously a check to the payee
for half of the expense (in the case of a common expense) or for
the full expense .
B.
LeBloc h
James G . LeBloch (LeBloch) received a law degree from th e
University of Illinois in 1972 and a graduate law degree i n
taxation from New York University in
Motor s
1978 .
He worked for Genera l
orp . from about 1972 through 1980, except fo r
approxilmately 9 months whe n he was earning his graduate la w
degree .
He worked as tax counsel for ; Monsanto Corp . from abou t
1980 through 1988 and as a hief financial officer for Seagate
Technology from 1988 through 1990 . He worked from 1990 through
1999 as a senior attorney in respondent's Office of Chief Counse l
in Los Angeles, California .
He has worked in private practice a s
a tax attorney since 2000 .'
C.
Nature's Touc h
Michelsen formed and operated three retail gift shops known
as Nature's Touch . From January 1 through November 23, 1997, she
operated two of the shops is a sole poprietor ; she operated the
third shop as a sole proprietor from its opening on November 1,
-51997, through November 23, 1997 . After November 23, 1997, she
operated the three shops as an officer and director of her wholly
owned corporation, NT, Inc . (NT) . Michelsen formed NT in
November 1997, and she has always been its sole officer, sole
director, and sole shareholder .
Michelsen opened one of the three Nature's Touch shops in
San Juan Capistrano, California, in June 1993 . Nineteen months
later, she opened the second shop in Palm Desert, California .
The Palm Desert shop did not do well financially, and Michelsen
moved the business of that shop to Palm Springs, California, in
May 1997 . Michelsen's lease of the vacated premises had not yet
expired at the time of the move, and she sublet those premises in
exchange for $3,000 . On November 1, 1997; Michelsen opened the
third Nature's Touch shop in Carlsbad, California . The
approximate sizes of the shops in San Juan Capistrano, Palm
Springs, and Carlsbad were 1,300, 1,700, and 1,500 square feet,
respectively .
The Nature's Touch shops sold mostly 300 to 500 different
gift items (e .g ., fountains, garden supplies, stationery, books) .
Michelsen purchased those items from approximately 130 different
vendors and displayed most of the items throughout the shops in
wooden display cubes built by her and LeBloch, or on wall and
ceiling hangers built by LeBloch . LeBloch helped Michelsen
prepare each shop for its, opening, and he helped her maintain the
6shops by performing a variety of handyman services . LeBloch also
advisedMichelsen (initially in her capacity as a sole proprietor
and later in her capacity as, an officer and director of NT) o n
financial and legal matter s related to ;the shops, as, well as o n
items to purchase as inventory for the shops . LeBloch routinely
paid e xpenses for the shop s out of his,personal finances, and h e
contemporaneously requested and obtained from the shops reimbursement,for those payments through his submission to
Michelson of written reports that listed the specific expense s
that he paid on behalf of the shops, accompanied by any related
receipt . During the subject years, LeBloch did not receive any
compensation for services that he performed for or on behalf of
the shops .
Each Nature's-Touch shop had a manager and three or four
other' fear round employees . .) The general duties of the managers,
with respect to the shops they managed,•was to monitor the shop's
invent liry and report to Michelsen theneed or desire for any
additional inventory ; to oversee and schedule employees ; to kee p
the shgp clean and orderly ;
and to prepare the shop's receipt s
for weekly deposit in the bank . Michelsen's main role in the
shops was to oversee the work of the managers by speaking to them
telephonically, usually once a day while they were at the shop s
The number of employees at each shop increased
approximately threefold during the seasonal 2-month period
beginning on November 1 .
i
-7and she was at the residence, about the status of the shops
including whether any manager needed or desired any specific
piece (or pieces) of inventory that Michelsen had at the
residence . Michelsen purchased inventory for all of the shops,
usually by calling the vendors and having most (if not all) of
the merchandise shipped directly to the shops .' She aimed to
coordinate a somewhat even distribution of inventory between the
shops, and, when she visited the shops (usually on a weekly
basis), she transported inventory (in her car) from the . residence
to the shops or from one shop to another . Michelsen also
prepared and monitored the budget for the shops, and she
generally deposited the shops' weekly receipts into the bank .
For the most part in 1997, Michelsen also toured a few locations
in Southern California in search of a place to move the second
Nature's Touch store and a place to open the third Nature's Touch
shops .
Inventory was displayed at the shops or, to a lesser extent,
stored at the residence in either the garage or in the guest
bedroom closet (approximately 56 square feet in size), or at th e
' Michelsen also once or twice a year purchased inventory at
retailer-only gift shows . There, petitioners (and sometimes one
or more employees of Nature's Touch) viewed various merchandise
displayed by manufacturers (usually on tables) and ordere d
products for sale at the Nature's Touch stores .
-8shops .'
(The record does not establish the specific pieces o r
amount of inventory that was stored at ; any of these places . .)
Petitioners did not park automobiles in the garage, but they used
the garage to store items of inventory and for personal purpose s
such as storing shovels, rakes, and tools unrelated to the shops .
Michelsen used another bedroom
size )
( approximately 225 square feet i n
in the residence as art office where she performed some o f
her work related to the shops .
This bedroom was set up by
petitioners as an office , and it was not used for any othe r
purpose
(e .g ., it did not have any bedroom furniture) . Th e
officeChad a computer which Michelsen used mainly for budgeting
and accounting purposes related to
the shops ;
Michelsen did no t
record the income and expenses of the Nature's Touch shops on
paper
' e .g ., in a ledger) bet recorded the information solely o n
a program on the computer .
The office also had a facsimil e
machine and a telephone wit h two lines, the second line generall y
.I
devoted to the facsimile machine .
During 1997, the Nature's Touch shops experienced dire
cashfYow problems that required an immediate borrowing of cash .
On four occasions during that year, Michelsen informed LeBloch
that she needed cash to alleviate a cashflow problem of th e
shops ,
6
and she asked LeBlo h to lend her the necessary cash .
Michelsen also kept in the guest bedroom closet "old
tapes" and "old credit card records" .j
On
-9May 29, 1997, as a .result of Michelsen's moving the shop to Palm
Springs, LeBloch lent Michelsen $5,000 to use in the business .
On each of the days October 6 and 17 and November 24, 1997, as a
result of Michelsen's opening of the shop in Carlsbad, LeBloch
lent Michelsen another $10,000 . Each loan in 1997 was informal ;
the parties thereto (at the time living together as significant
others) understood that Michelsen would repay the loans without
interest in the near future when the shops' cashflow allowed her
to do so . Michelsen used all $35,000 of the loan proceeds
($5,000 + $10,000 + $10,000 + $10,000) for the benefit of the
Nature's Touch shops . On December 30, 1997, Michelsen repaid the
entire $35,000 .
The Nature's Touch shops experienced additional cashflow
problems in 1998 that required the borrowing of money .' On five
occasions during that year, Michelsen informed LeBloch that NT
needed cash to alleviate a cashflow problem of the shops, and she
asked LeBloch to lend NT the necessary cash . In or around
December 1997, Michelsen (on .behalf of NT) had purchased a lot of
inventory for the holiday season, and Michelsen realized in
January 1998, when the bills were coming due on these purchases .,
that she would need additional money for the business . Michelsen
(on behalf of NT) was also entering into a permanent lease for
the shop in Carlsbad, and she needed money to pay the first and
last months' rent for those premises as well as an accompanying
-10security deposit .
She also
eeded money to buy inventory for th e
newly ;o'pened shop in Carlsbad, as well as to pay for display
units,ad•fixtures such as Counters, shelving, and specia l
lightin§ . On the respective days January .6 .and 9, 1998, LeBloch
lent Michelsen $20,000 and $10,000 for use in the business of NT . ..
On each of the days January 14 and February 2 and 6, 1998 ,
LeBloch lent $10,000 directly to NT . Each of these five loan s
was informal, the principals thereto (husband and wife)
understanding that Michelsel (with respect to the first two
loans] and NT (with respect to the last three loans) would repay
the loans without interest -n the near future when the shops'
cashflow allowed her or it to do so .
of the $60,000 in loans
made In 1998 ($20,000 + $10,000 + $10,000 + $10,000 + $10,000),
$15,000 was repaid to LeBloch in 1998 ;( .$10,000 on April 8, 1998, .
and $5,1000 on May 8, 1998) and $20,000 was repaid to LeBloch in
1999-($10,000 on January 19, 1999, and $10,000 on May 8, 1999) .
Mlche
ls
en (or NT) used all of the $ .60 ;000 in loan proceeds in the
business of the . Nature's Touch shops,jand as of the time of
trial,1'all of the $60,000 had been repaid :
During 1999, petitioners traveled to Australia and Tahiti .
Petitioners flew from Los Angeles, California, to Sydney,
Australia, on September 16 1999 . They stayed in Sydney for 3
nightsland then rented a car and drove to Brisbane . On October
1, 1999, they flew from Brisbane to Papeete, Tahiti . They stayed
-11in Papeete for 8 nights and returned to Los Angeles on October 8,
1999 . During those travels, Michelsen attended a gift trade fair
in Sydney .where she found a single product that she ended up
selling at the Nature's Touch shops . She also in or around
Brisbane purchased some other items which she displayed for sale
in the Nature's Touch shops . Petitioners incurred $12,847 .26 of
expenses for the trip to Australia and considered $4 ;129 of that
amount to be a business-related travel expense (as discussed
further below) . Petitioners did not consider or report any of
their expenses related to Tahiti as business related .
D.
1997, 1998, and 1999 Schedules C
1 . 199 7
For 1997 Federal income tax purposes, Michelsen reported the
income and expenses of the Nature's Touch shops on a 1997
Schedule C, Profit or Loss From Business, filed as part of their
return . The schedule reported on the basis of an accrual method
of accounting that the shops, for 1997, had gross receipts of
$501,574, costs of goods sold of $289,647, and total expenses of
$239,745, resulting in a net loss of $27,818 .' The schedule . was
accompanied by a 1997 Form 8829, Expenses For Business Use of
Your Home, reporting home operating expenses of $2,367 and hom e
' According to the 1997 Schedule C, the inventory of the
shops was $98 ;107 at the beginning of the year and $289,647 at
the end of the year .
-12 deprec i ation of $2,388 . Th e Form 88 2 9' .itemized the hom e
operati ng expenses as follow s :
Direct expenses :
Repairs and maintenance
Utilities
Indirect expenses :
Insurance
Repairs and maintenance
Utilities
Total
Business-use . percentage
Total
$1 1
98 9
.
:68 3
1,99 9
2',79 3
5 ;92 5
1 .252 1,36 7
2,36 7
Petitioners did not deduct for 1997 any of either the reported
home operating expenses or he reporte'd home depreciation bu t
deducted all of those amou n s for 1998 as a carryover to tha t
year . : Petitioners claimed on the 1997 Form 8829 that 25 . 2
percent of the residence was used exclusively for business
purposes ; they stated on the form that they ascertained that
percentage by dividing the "Area usedjregularly and exclusively,
for business * * * or for storage of inventory" (reported'as 63 0
squarelfeet) by the "Totallarea of home" (reported as 2,50 0
square feet) .' The 1997 Schedule C itemized the total expenses
{
r
of $239,745 as follows :
Advertising
$2,339
Car and truck- 4,161
Depreciation
1,675
Insurance (other than health)' 5,843
,Legal and profes ional services 475
Rent or lease : ,
Other business property 76,89 8
I
B The record does not reveal how petitioners ascertained
either square footage .
-13 Supplies
17,56 0
Travel
12,36 5
Meals and entertainmen t
(after 50-percent reduction)
Utilities
Wages
Other expenses'
Total
1,58 8
.10,92 1
87,20 1
18,71 9
239,74 5
' The 1997 Schedule C did not identify any of
these "other expenses" .
2 . 199 8
For 1998 Federal income tax purposes, petitioners did not
report the income and expenses of the Nature's Touch shops on
their personal income tax return . Their 1998 personal return
included a 1998 Schedule C that reported the income and expenses
of Michelsen as "Board Chairman of NT" . The schedule reported on .
the basis of .the cash receipts and disbursements method of
accounting that the reported business had a net profit of $23,193
for 1998, resulting from gross receipts of $36,808, total
expenses of $4,137, and home business expenses of $9,478 . The
schedule was accompanied by a 1998 .Form 8829 reporting that 25 .2
percent of the residence (630/2500) was used exclusively for
business purposes and that the $9,478 of home business expenses
consisted of operating expenses of $4,702 (inclusive of the
$2,367 carryover from 1997) and depreciation of $4,776 (inclusive
of the $2,388 carryover from 1997) . The Form 8829 itemized the
home business expenses as follows :
-14Operating expenses :
Direct expenses :!
Utilities
$95 1
Indirect expenses :
insurance .
844
Repairs and maintenance [1,802
Utilities
2, .84 6
Total
5,492
Business-use percentage
.252
1,382
Carryover from 1997
2,36 7
Total
1
14,70 2
Depreciation :
Current depreciation
2,38 8
Depreciation carryove r
from 1997
2,388
Total
4,77 6
Total
9,47 8
We note petitioners' $2 adding mistake .
The 19 9 8 Schedule C itemized the total ' expenses of $4,137 a s
I
follows :
Supplies
$83 5
Meals and entertainmen t
(after 50-percent reduction)
3,302
Total
4,13 7
3 . 199 9
'For 1999 Federal income tax purposes, petitioners did no t
report the income and expenses of the'Nature's Touch shops o n
their personal income tax return .
Their 1999 personal return
included a 1999 Schedule C that reported the income and expense s
t
of Michelsen as "Corporat e
he
reported on the basis of an accrual method of accounting that the
9~Although the 1999 Schedule C .lsts the " Name o f
proprietor " . as "James and Cathy LeBloch " ; the return clarifies on
Schedule SE, Self-Employment Tax, that the income reported on the
Schedule C is that of Michielsen only .
I
3
I
I
-15reported business had a net profit of $14,029 for 1999, resulting
from gross receipts of $37,677, total expenses of $18,206, and
home business expenses of $5,442 . The schedule was accompanied
by a 1999 Form 8829 reporting that 25 .2 percent of the residence
(630/2500) was used exclusively for business purposes and that
the $5,442 of home business expenses consisted of operating
expenses of $3,054 and depreciation of $2,388 . The Form 8829
itemized the home business expenses as follows :
Operating expenses :
Direct expenses :
Utilities
Other expenses
Indirect expenses :
Insurance
Repairs and maintenance
Utilities
Total
Business-use percentage
Total
Current depreciation
Total
$1,35 9
26 4
. 69 2
2,13 2
2,84 0
5, 66 4
.252
1,42 7
'3,05 4
2,38 8
5 ;44 2
'We note petitioners' $4 adding mistake .
The 1999 Schedule C itemized the total expenses of $18,206 as
follows :
Depreciation
Legal and professional services
Office expense
Rent or lease :
Vehicles, machinery, and equipment
Travel
Meals and entertainmen t
(after 50-percent reduction)
Other expenses'
Total
$1,17 5
55 6
24 6
7,47 6
4,12 9
1,37 4
3,25 0
18,206
-161 The 1999 Schedul'le C did not identify any of
these "other expenses" .
E .
Amen ded Return s
On their 1998 Federal income tax return, petitioner s
reported adjusted gross inc ome of $73,361 . The`$73,361 consiste d
of the following reported items and amounts :
LeBloch' s .wages from IR S
$71,091
Interest
1, 00 4
Schedule C net profi t
23,19 3
IRA deduction (2,000)
One-half of self-Imploymentltax (1,639 )
Alimony pai d
( 18, 288)
Adjusted gross income
73,36 1
On their 1999 Federal income tax retun, petitioners reporte d
adjusted gross income of $104,971 . The $104,971 consisted of th e
following reported items and amounts :
LeBloch's wages from IRS
Michelsen's wages from NT
Interest and ordinary dividends
Taxable refund s
Schedule C net profit
f
Capital gain
One-half of self- employment ;tax
{
Alimony pai d
Adjusted gros s income
,Oj or about April 14,
$72, 130
31,00 0
84
- 90
14,02 9
53 .
(991)
(11,424 )
104, 97 1
2002, after the Commissioner had begun
1, i
his audit of the subject years and had proposed his adjustment s
{
increasing petitioners' taxable income to reflect the unreporte d
.
income ascertained under the bank ac c ount analyses, petitioner s
J
filed Ian amended 1998 Federal income tax return claiming without
further explanation that $11,554 reported as compensatio n
1
received from NT during 1998 was really a loan repayment . At th e
-17same time, petitioners also filed an amended 1999 Federal income
tax return claiming without further explanation that
$ 13,038
reported as compensation received from NT during 1999 was really
a loan repayment .
Each . of these amended returns claimed a refund
resulting from the claimed recharacterization of the originall y
reported compensation as loan repayments . . Respondent did no t
grant either of those claims for refund .
F.
Petitioners' Financial Accounts .
1 .
Overvie w
Throughout the subject years, petitioners had 13 bank or
investment accounts (collectively, financial accounts) . Nine of
the financial accounts were in the name of LeBloch . The
remaining four financial accounts were in the name of Michelsen .
2 .
LeBloch's Account s
LeBloch had three financial accounts at the LAIRE Federal
Credit Union (LAIRE) . The first account, a primary savings .
account (LAIRE 00), was open from January 1, 1997, through
February 12, 1999 . The second account, a checking account (LAIRE
50), was open during all of 1997 and 1998 . The third account, a
secondary savings account (LAIRE 01), was open from June 19
through December 31, 1998 .
LeBloch had three financial accounts at the Postal & Federal
Employees Credit Union (PFE) . Each of these accounts was open
from September 24, 1998, through December 31, 1999 . These
{
accounts were a primary share account (PFE Si), a spbshare
accounct(PFE S2), and a reality checking account (PFE S18) .
L'eBloch's last three financial accounts were brokerag e
accounts . One brokerage account was aLMerrill Lynch investment
account (Merrill Lynch account), whichiwas open throughout the
subject years . Another brokerage account was a Paine Webber
investment account (Paine Webber account), which was open durin g
all of j1997 . The last brokerage account was a second account a t
Paine W ebber ; this account w as open during all of 1999 .
Mchelsen ' s four accoui is were all at Bank of America (BA) .
The
first account, a business checking account
( BA 1225), was
open from January 1 through April 18, 1997 .
The second account,
another business checking account
was open from April
18 through December 31, 1997 .
( BA}9606 ),
These two accounts were the
checking accounts for the Nature ' s Touch shops when operated
through Michelsen ' s sole ploprietorshp ;
afterwards ,
BA 9606 was
the corporate bank account for NT : Tlhe balance in BA 1225 was
transferred to BA 9606 on April 18 , 1`997 .
Michelsen's third accLnt ,
a checking account
open, from January 1 through April 22 ,
anoth e r checking account (BA 9605),
1997 .
( BA 7417), was
Her fourth account,
was open from April 22, 1997 ,
! !
through December 31, 1999 .
.The balance in BA 7417 was
transferred to .BA 9605 on April 22,,1997 .
-19G.
Notices of Deficiency
1.
Overvie w
On November 9, 2004, respondent issued to petitioners a
notice of deficiency for 1997 and a notice of deficiency for 1998
and 1999 . The notices of deficiency determined the following
adjustments to amounts reported on petitioners' Federal incom e
tax returns for 1997, 1998, and 1999 :
199 7
Unreported rental income
$3,00 0
Unreported interest income 2,331
Unreported capital gains income -0Unreported Schedule C income
63,85 2
Total unreported income
69, 183
Self-employment tax deduction
(4, 614)
Disallowed itemized deductions
1,795
Disallowed alimony expense
2,436
Disallowed Schedule C expense s
29,276
Total increases to income
98,076
1998
199 9
-0- -0-0- $115
$155 -036,368 49,368
36,523 49,483
(3,531) (4,676 )
-0- 1,424
1,488 624
13,615 23,648
48,095 70,50 3
The notices of deficiency itemized the disallowed Schedule
C
expenses as follows :
Insurance
Meals and entertainment
Supplie s
Travel
Business use of home
Rent or lease expense
Office expens e
Legal and professional
Depreciation
Other expense s
Total
2.
$1,392 -0- -0'1,588 $3,302 $1,374
1,508 835 -09,737 -0- 4,129
-0- 9,478 5,442
-0- -0- 7,476
-0- -0- 246
-0- -0- 556
-0- -0- 1,17 5
15,051 -0- 3,250
29,276 13,615 23,64 8
Respondent's Bank Deposits Analyse s
Respondent determined the amounts of unreported income
listed in the notices of deficiency by performing bank deposits
-20analyse § . The total deposit s
account )
into petitioners'
LAS RE 00
LAIRE 50
ZAIRE 01
PFE Si
PFE S2
PFE S18
Paine Webber account
Merrill Lynch account
Bk 9605
BA 7417
BA 1225
$A 9606
( Total
( including interest credited t o
financial acc ounts . were a s follows :
1997
1998
199 9
$130,2711
$ 15,906
134 , 724
5, 130 .
$25 4
-0 -0 -
15,038
12,08 6
5,150
34,738
-0-059 , 680
-0-
10,04 8
95,04 3
-0 10,00 0
64,14 5
163,0121
-0-
-00-0- G
.31,111
77,045'
65,970!
25,977,
226,146
367,522
1,087,054
- 0- .
270 , 366,
-0 -0-0 191,57 6
As to those deposits, respondent's bank deposits analyse s
4
characterized the following' amounts as nontaxable : .
1997
Interaccount transfers
Loan receipt s
:VISA advance s
Sales tax remittances
1(Jan . to Sept . 1997)
Returned deposits
:Wedding gift
I
1998'
199 9
$293,008 $129,112 $40,702
22,600 -0- -021,750 4,500 3,20 0
32,255
1,387
-0371,00 0
-0- -0-0- -0.5,000 .
-0138,612 43,90 2
Respondent's bank deposits analyses determined that the following
deposits were reported on
he subject Federal income tax returns :
1997
1998
199 9
wages (less withholdings) $56,6413 $54,305 $79,309
Interest
3,86;6 1,004 .
49 .
Dividends
-01
-0. 35
.Schedule C gross receipts 501,574 36,808 37,677
;Schedule D sales
86,487 -0- -0Total
648 ,570'' 92,117 117,070
-21Respondent's bank deposits analyses concluded that petitioners
had unexplained bank deposits as follows :
1997
Total deposits
$1,087,054
Nontaxable items
(371,000)
Reported amounts
(648,570 )
Unexplained deposits'
67,484
1998
$270,366
(138,612)
(92,117 )
39,637
199 9
$191,57 6
(43,902 )
(117,070 )
30,60 4
' The parties do not explain the difference
between the amounts of unexplained deposits and the
amounts of the total unreported income set forth in the
notices of deficiency . .
OPINIO N
A.
Burden of Proo f
Section 7491(a) was added to the Internal Revenue Code by
the Internal Revenue Service Restructuring and Reform Act of
1998, Pub . L . 105-206, sec . 3001(c), 112 Stat . 727, effective for
court proceedings arising from examinations commencing after
July 22, 1998 . While the burden of proof in this Court is
usually on a petitioning taxpayer, see Rule 142(a)(1), section
7491(a)(1) provides that the burden of proof on certain issues
affecting the liability of a taxpayer for tax shifts to the
Commissioner in specified circumstances . We hold that section
7491(a) does not apply to either issue before us because, we
find, petitioners have not proven that they complied with the
requirements of section 7491(a)(2)(B) to cooperate fully with
respondent's reasonable requests for witnesses, information,
documents, meetings, and interviews . See also Weaver v .
-22- {
Co mm issioner , 121 T .C . 273,
.
275 (2003) In fact, we find fro m
the record that petitioners did not cooperate with such
reasonable requests by respondent during the course of the audit .
We hold that petitioners bear the burden of proof .
B.
Uhreported .Income
Grioss income includes
derived ,
11 income from whatever sourc e
sec . 61 ( a), and taxpayers are ; required to keep books and
records sufficient to establish their iFederal income tax
liability,
Regs .
see sec .
6001 ;
see also sec .
1 .6001 - 1(b), Income Tax
Where taxpayers have not maintained adequate business .
records to establish such liability ,
the Commissioner may
reconstruct income by any method that the Comm issioner believes
reflects income clearly .
see sec .
94 T .IC1 654, 658
The Co mm issioner ' s method need not be
( 1990 ) .
445(b) ;
exact ; however, it must be reasonable )
States
348 U .S . 121
Parks v . Commissioner ,
See Holland v . United
( 1954) .
The bank deposits method for computing unreported income has
long been sanctioned by the judiciary. See Factor v .
Commissioner , 281 F .2d 100) 116 (9th Cir . 1960), affg . T .C . Memo .
1958-94 ;
DiLeo v . Commissioner , 96 T .I . 858, 867 (1991), affd .
959 P . 2d 16 (2d Cir . 1992)
Bank de posits are prima faci e
evidence of income . See T okarski v . Commissioner , 87 T .C . 74, 77
l
(1986) . Where an individual taxpayer, has .failed to maintain
adequate records as to the-amount and source of his or her income
.l
-23and the Commissioner has determined that the deposits are income,
the burden is on the taxpayer to show .that the Commissioner's
determination is incorrect .
Petitioners argue that respondent's use of the bank deposits
analyses was unjustified because, they state, they kept adequate
records establishing their income . We disagree . Whil e
petitioners may have used a computer program to memorialize their
income and expenses, we are unable to find from credible evidenc e
in the record that petitioners ever gave to respondent ; befor e
issuance of the notices of deficiency, adequate records to
support their reported income for any subject year . On the basis
of the record at hand, we hold that respondent's use of the bank
deposits analyses was proper .
Petitioners argue alternatively that respondent misapplied
the bank deposits analyses in that, .they argue, respondent failed
to recognize that most of the disputed deposits arose from
nontaxable sources . Petitioners argue that . respondent's bank
deposits analyses should be adjusted as follows :
1997
As
Determined
Total deposits (including interest)
$1,087,054
.
Petitioners '
Additiona l
Adjustments
-0-
As
Adjuste d
$1,087,054 .0 0
Less adjustments :
Interaccount transfers
Loan receipts
Loan repayments
VISA advances
Sales tax remittances
Returned deposits
Expense report reimbursement
Total
293,008
22,600
- 021,750
32,255
1,387
$15,599 .29
-035,000 .00
2,500 .00
, 3,800 . 00
-0-
308,607 .2 9
22,600 .0 0
35,000 .0 0
24,250 .0 0
36,055 .0 0
1,387 .0 0
:- 0-
6,414 .04
6 , 414 .0 4
371,000
63,313 .33
434,313 .33
-24Les's reported income :
Wage s
56, 643
3,86 6
501,574
86,487
1
648,570
67,48 4
Interest
Schedule C gross receipts
Schedule D sale s
Total
Unexplained deposits
(2,•927,53 )
{
5,290 .20
1,808 .0 0
-07,098 .20
(70,111 .53 )
61,933 .20
5,674 .0 0
501,574 .00
86,487 .00
655,668 .2 0
199 8
Petitioners'
Total deposits (including int e rest)
Less adjustments :
Interaccount transfers
Loan repayment s
VISA advances
Gift s
Total
Less reported income :
Wage s
'Interest
;Schedule C gross receipt s
Total
nexplained deposits
As
Determine d
Additional
Adjustment s
As
Adjuste d
$270,36 6
-0-
$270,366 .00-
129, 112
04,500
1 5,00 0
138,612
$7,578 .00
15,000 .0 0
136,690 .00
15,000 .00
4,500 .00
5,000 .0 0
161,190 .0 0
59,305
[1, 004
36, 808
8,424 .15
-0-
-0-
62,729 .15
1,004 .00
36, 008 .0 0
92,117
39,63 7
8,424 .15
(31,002 .15 )
100,541 .15
8,634 .8 5
• I Al
Determine d
Petitioners'
Additional
Adjustment s
As
Adjuste d
$191,576
-0-
$191,576 .00
190,70 2
03,200
193, 90 2
$4,002 .50
20 ,
.44, 704 .50
20,000 .00
3,200 .00
67,904 .50
79,309
49
35
8,576 .32
-0-
37, 67 7
-0-
117,070
30, 604
8, 576 .32
(32,578 .82)
-0
22, 5 88 .0 0
1999
.Total deposits (including interest)
'Less adjustments : JInteraccount transfers
Loan repayment s
VISA advances
{ Tota l
Less reported income :
Wage s
Interest
Dividend
Schedule C gross receipt s
k Tota l
nexplained deposits
I
24,002 .5 0
-0-
87,885 .3 2
49 .00
35 .00
37,677 .00
125,646 .3 2
(1,974 .82 )
We agree with petitioner s Ito a large extent . We discuss their
I
requested additional adjus tments seriatim .
1 .
Interaccount Tranlsfer s
Petitioners argue that respondent's bank deposits analyses
for the respective years must be adjusted to reflect $15,599 .29 ,
$7,578, and $4,002 .50 of nontaxable transfer s of funds between
-25their accounts . Following respondent's concession in brief that
the record at hand supports adjusting the amounts shown in the
bank deposits analyses to reflect additional nontaxable transfers
of funds between accounts, the disputed items in this category
are as follows :
199 7
December 18, 1997, deposit of
previously withdrawn fund s
May 23, 1997, check drawn on
LAIRE 50 and payable to
Michelse n
July 3, 1997, check drawn on
LAIRE 50 and payable to
Michelsen
September 17, 1997 , check drawn
on LAIRE 50 and payable to
Michelse n
November 20, 1997, check drawn
on Paine Webber account and
payable to Michelse n
Business deposit mistakenly
deposited into Michelsen's
personal account ;
contemporaneously transferre d
to business account
$1, 900 .0 0
400 .0 0
393 .0 0
240 .0 0
430 .0 0
$5,978 .83
9,341 .8 3
199 8
Check from LeBloch account
at LAIRE to Michelsen for
her payment of his personal
expense s
$745 .00
199 9
Check from NT to Michelsen in
reimbursement, of her payment
of an expense of NT
$660 .50
-26We agree with petitioner that all of these disputed item s
are nontaxable to them and should be reflected as such . The
largest amount , $ 5,978 . 83,
eflects a (business deposit that was
mistakenly deposited into M-chelsen ' s personal account and then
contemporaneously transferred to the business account when
Michelsen discovered the mistake . The next largest amount ,
$1,900, reflects funds that were withdrawn by LeBloch and the n
redeposited into his accoun t . The $660 .50 deposit reflects a
reimbursement that NT mad e to Michelsen . The remaining fiv e
amount are simply transfer s of cash from LeBloch to Michelsen .
,2&
Loan Repayments
. Petitioners argue tha
respondent's bank deposits analyses . .
t
for the respective years and st be adjusted further to reflec t
$35,000, $ 15,000 ,
and $20 , 000 of non taxable loan repayment s
deposited into one of LeBloch's financial accounts . We agree .
Case :]aw establishes a two-part test !fo r, determining whether a
transfer of money qualifies as debt . 'First, repayment of th e
transferred funds cannot be contingent upon a future event .
Secon d, the transfer must b e made with a reasonable expectation,
belief,
and intent that it be repaid . See Zimmerman v . Unite d
States ,
318 F . 2d 611
Commissioner ,
( 9th Cir .
1963 ) ; Estate of Trompeter v .
T .C . Memo . J998-35 .
WhI ether a transfer is mad e
l
with the requisite expectation, belief, and intent is factual
See' John Kelley Co . v . .Co issioner , 326 U .S : 521 (1946) .
-27Our agreement with petitioners that LeBloch's transfers o f
money to Michelsen and NT were loans flows from our findings of
fact that petitioners regularly advanced funds to each other
without formal documentation and without formal terms, that the
transfers in question were made with the expectation, belief, an d
intent that they be repaid, that the transfers in question were
made-incident to the transferee's need for operating funds, and
that the transfers in question were repaid by the transferee
shortly after receipt .10 LeBloch lent $95,000 for use (and that
was used) in the business of . the Nature's Touch shops, and, of
that amount, $35,000 was repaid in 1997, $15,000 was repaid in
1998, $20,000 was repaid in 1999, and $25,000 was repaid after
1999 . In addition, petitioners had an informal understanding
that either of them would advance funds to the other without
formal terms and that the one for whose benefit the funds were
advanced would repay them ., In fact, as to LeBloch, it was not
uncommon for him regularly to pay a common expense in full and
then contemporaneously receive reimbursement from Michelsen for
her share of that expense . Nor was it uncommon for LeBloch
regularly to pay out of his personal funds expenses of a Nature's
Touch shop and then seek and obtain reimbursement from the shop s
10 Because respondent makes no assertion that LeBloch's
transfers were contributions of equity rather than loans, we do
not consider that question . See Metrocorp, Inc . v . Commissioner ,
116 T .C . 211, 217 (2001) .
-28-
1
for that
I
payment . We also
ote that petitioners neve r
interrkii!ngled their funds in a joint account, but kept thei r
'financia l accounts separate
and that petitioners' relationshi p
throughout the subject years was one in which they each
understood that they were responsible ifor the payment of their
share of the expenses . We hold for petitioners on this item . "
VISA advances
F
Petitioners argue that they are entitled for 1997 to an
adjustment of $2,500 for VISA advance . Respondent concedes that
this $2,500 is not taxable income to petitioners, and we so hold .
41
Sales Tax Remittance s
:Petitioners argue that' they are ntitled for 1997 to an
adjustment of $3,800 for sales tax remittances for October an d
November 1997 . . We agree .
Michelsen operated the Nature's Touch
shops as a sole proprietorship from January 1 throug h
November 23, 1997, and she (as a conduit) collected sales tax on*
the ales made at the shops during that time . She deposited the
colle cted sales tax into tie shops' biusiness account and later
remitted that tax to the State of Callifornia . . Respondent's bank
deposits analysis for 1997 made an adjustment for sales ta x
Whereas we understand petitioners to request that we also
hold that other amounts reported as compensation from NT were
actually loan repayments, Iwe declinelto do so . Michelsen was the,
sole ''reported recipient of compensation from NT, and petitioners
make no assertion in this proceeding that Michelsen lent'money to
NT . I
.
-29remittances only through September 1997 ." On the basis of our
review of the record, we find that on November 24, 1997, $3,800
in sales tax was remitted to the State of California on behalf of
the Nature's Touch shops and conclude that petitioners are
entitled to their requested $3,800 adjustment .
5.
Expense Repor t
Petitioners argue that they are :entitled for 1997 to an
adjustment of $6,414 .04 for . expenses report reimbursement . In
support thereof, petitioners point the Court to a December 29,
1997, check drawn on the NT account payable to LeBloch in the
amount of $41,667 . The check states on its face that it is
"Payment for Loan", and LeBloch deposited the check into his
regular savings account at LAIRE . Petitioners point out that
$35,000 of the check was the loan repayment discussed herein and
argue that the balance ($252 .96), after taking into account the
$6,414 .04, was for reimbursement of LeBloch's payment of
Michelsen's share of a personal utility expense . We agree with
petitioners (in that we find) that the $6,414 .04 was paid to
LeBloch as reimbursement of expenses that he paid on behalf of NT
and allow the requested adjustment .
6.
Wage s
Petitioners argue that they are entitled for the respective
years to adjustments of $5,290 .20,$8,424 .15, and $8,576 .32 for
wages . As petitioners see it, their wages for each year should
-30have been calculated by using the amounts shown on
Wage an d'
Tax Statement ;
the Forms W-2,
in other words the amount for each year
that equals their reported cross wages less the sum of th e
reported amounts withheld for Federal income tax ,
Social Security
tax, and Medicare tax . We conclude differently .
The bank'
deposits analyses correctly reflect only the portion of his wages
that wars deposited into his account
( ie ., in addition to the
report ied amounts of tax withheld, LeBloch apparently had other
amounts taken out of his gross wages before those wages were
deposited into his account ) . .
Those amounts are different fro m
the amounts referenced by p etitioners .
C.
Home Office Deduction
for Each Subject Yea r
`Petitioners are generally precluded from deducting expenses
incurred in connection with) the business use of the residence .
See sec . 280A .
Pursuant td section 280A ( c)(1), however ,
petitioners may deduct expenses allocable to a portion of the
residence if that portion 4as exclusively used on a regular basi s
(1) as a principal place of business, (2j as the . .place for
meeting with customers, clients, or patients in the normal course
i
of business, or (3) in the case of aLnattached separate
structure, in connection with the business .12 See als o
12 Sec . 280A(a) also does not apply to items allocable to
space,withing a dwelling unit that is used on a regular basis for
the storage of inventory held for use i'n the taxpayer's trade or
business of selling products at retail provided the dwelling uni t
(continued . . . )
-31Commissioner v . Soliman , 506 U .S . 168 (1993) ;
Browning v .
Commissioner , 890 F .2d 1084, 1087-1088 (9th Cir . 1989), affg .
T .C . Memo . 1988-293 ;
Cao v . Commissioner , T .C . Memo . 1994-60,
affd . without published opinion 78 F .3d 594 (9th Cir . 1996). .
Petitioners argue that they are entitled to a deduction for
each'subject year attributable to their business use of a portion
of the residence . According to petitioners, the office ,
guest bedroom closet, and garage (collectively, premises) in or
at the residence were used exclusively for business, and the
premises are approximately 25 percent of the residence's square
footage . We understand petitioners to argue that, during each
subject year, Michelsen stored inventory on the premises and used
the premises to work on opening more Nature's Touch stores . We
also understand petitioners to argue that Michelsen also used the
premises after the formation of NT to conduct her business as an
officer of NT .
We do not believe that petitioners meet any of the three
prongs underlying the just-referenced exception of section
280A(c)(1) . As to 1997, when Michelsen operated the Nature's
Touch stores as a sole proprietor, the stores' principal place of
business was not in any part of the residence . Nor are w e
"( . . .continued)
is the sole fixed location of that business . See sec .
280A(c)(2) . That provision is inapplicable here, where the
residence was not the sole fixed location of the Nature's Touch
shops .
-32-
. I
persuaded that Michelsen met there with customers, clients, o r
patients in the normal cour s e of business . Nor does the record
establish that any part of the residence, including the garage,
was in an "unattached separate structure" .
-
i
Wei also are not persuaied that th'le exception was met for
either remaining year in issue . In orader for a taxpayer to
establish
I use on a "regulars' basis, the business use must be mor e
1
than occasional or incidental .
76 T .Cs 696, 700
( 1981 ) .
See Jackson v . Commissioner ,
In order forr a taxpayer to establish
that use of a portion of a dwelling isI "exclusive the portion
must be used only for business purposes .
Inc . v .. Commissioner ,
88 T .C .
See Sam Goldberger,
1532 ,. 1556-1557
( 1987 ) ;
Commissioner , T .C . Memo .
1993-128 ;
see also Irwin v .
Commissioner , T .C . Memo .
1996-490 .
See .generally sec .
Hefti v .
1 .280A12 ( g)(1), Proposed Income Tax Regs ., 45 Fed . Reg . 52404
(Aug . 7, 1980) . The failure of a taxpayer to establish that th e
i
use of a portion of a dwelling is both "regular " and "exclusive"
is fatal to the taxpayer ' s claim thatfsuch use falls within the
exception of section 280A ( i)(1) . Seel Sam Goldberger ,
Commissioner ,
supra at 1556 -1557 ;
Inc . v .
Although the record
establishes that Michelsen performed at the residence a lot of
work for the Nature ' s Touch stores , petitioners . have not offered
suffidient evidence regarding the amount of time and nature o f
i
If
the work conducted anywhere in the premises so as to establish
-33regular use, nor have they established that any portion of the
premises was used exclusively in a business .13 Accord Browning
v . Commissioner ,
supra . We reject petitioners' claim for home
office deductions related to the residence .
D.
Self-Employment Deductions Other Than Home Office Deduction
Section 162(a) lets taxpayers deduct "all the ordinary and
necessary expenses paid or incurred during the taxable year .in
carrying on any trade or business" . Under that section, a n
expenditure is deductible if it is : (1) An expense, (2) an
ordinary expense, (3) a necessary expense, (A) paid (in the cas e
of a cash method taxpayer) or incurred (in .the case of an accrual
method taxpayer) during the taxable year, and (5) made to carry
on a trade or business . See Commissioner'v . Lincoln Sav . & Loan
Association , 403 U .S . .345, 352-353 (1971) ;
Lychuk v .
Commissioner , 116 T .C . 374, 386 (2001) . In the case of personal
travel expenses, a taxpayer also must meet two additional rules .
First, the travel expenses must arise from travel that is relate d
primarily to the taxpayer's business . See sec . 1 .162-2(b)(1),
Income Tax Regs . ; see also Reed v . Commissioner , 35 T .C . 19 9
13 In fact, Michelsen by her own account acknowledged that
the garage was not used exclusively for business purposes and
contended that the only portion of the residence used exclusively
for business was the room with the office . While petitioners ask
the Court to find as to the office that Michelsen spent much time
there working on expanding the Nature's Touch shops through the
opening of additional shops, we decline to find such a fact on
the basis of the record at hand .
-34-
(1960), .
Second, the taxpayer must substantiate, by adequate
records or other sufficient evidence corroborating his or her own
statement, each of the following eleme n ts : (1) The amount of
each expenditure ; (2) the time and place the expenditure was
incurre (3) the business purpose of the expenditure ; and (4) in
the case of entertainment expenses, the business relationship to
the taxpayer of the person entertained(.. See sec . 274(d) ;
Meridian Wood Prods . Co . v . United Stales , 725 F .2d 1183,
188-1191 (9th Cir . 1984) ;
Johnston v . Commissioner , T .C . Memo .
1980-477, affd .•696 F .2d 1003 (9th Cir . 1982) . In the case of
meals incurred while not traveling, substantiation by sufficient
evidence requires that the taxpayer establish the cost, amount ,
time, place, and date of th
expenditure by "direct evidence"
(e .g ., detailed writing) ;
the taxpay e r may establish busines s
purpose or business relationship by "c rcumstantial evidence "
corroborating the taxpayer' own statement . Sec .
1 .274- T(c)(3)(i), Temporary Income Tax Regs ., 49 Fed . Reg . 42704
(Oct . 24, 1984) .
1 , 199 7
Of the Schedule C expenses disalllowed for 1997, petitioners
{
chall'erige only the expenses for travel to the extent of $5,978)
and other ($18,719) .,,
C
-35a.
Trave l
Petitioners argue that they have substantiated $5,978 o f
1"
expenses claimed as travel expenses for 1997 through th e
introduction of Exhibit 112-P . We disagree . Exhibit 112-P was
received into evidence through the parties' stipulation that the
exhibit reflects "documents which Petitioners contend pertain to
business meals, travel and lodging incurred in taxable year
1997" . Exhibit 112-P has approximately 75 pages, and petitioners
have not organized or presented the "documents" included therein
(mainly photocopies of receipts) in a manner that persuades us
that any of the expenses reflected in this exhibit are properly
deductible by petitioners . See Romer v . Commissioner , T .C . Memo .
2001-168 . Nor do petitioners in their posttrial opening brief
make any concerted attempt to persuade us that they have
satisfied the requirements for deductibility ; petitioners' entire
argument on this point is that "These travel expenses are
substantiated in Exhibit 112-P and should be allowed ." We
sustain respondent's determination that petitioners are not
entitled to deduct these claimed expenses . "
" We note that during respondent's audit of the subject
years Michelsen prepared a "travel expense record" for 1997 and
that this expense record was admitted into evidence as part of
Exhibit 135-P . The expense record is an 8-page document that
lists in single spaces each dayin 1997 (i .e ., . .01/01/97,
01/02/97, and so on) . To the right of some of the days is a
brief statement by Michelsen as to the business that she
performed for the Nature's Touch shops on the corresponding day ,
t
(continued . . .
-36b.
Other Expense d
Petitioners argue that they have substantiated the . $18,71 9
claimed as "other e x p enses" through the introduction of Exhibit s
119-P'a'n
''d 120-P . We disagree . Exhibit 119-P was received into
evidence through the partiel' stipulation that the exhibi t
reflects "documents which Petitioners c ontend pertain to othe r
expensefor taxable years 1997" . Exhibit 120- P was received into
evidence through the parties stipulation that . the exhibit .
f
(
Ilf
reflects "documents which Petitioners contend pertain to the ban k
deposit analysis" . Together, Exhibits
119-P and 120-P hav e
approximately 110 pages, and the "documents" included therein
(mainly canceled checks, bank statements, and receipts)•do not
i
persuade us that the expenses reflected therein are properly
deductible by petitioners . Nor do petitioners .in their po,sttrial
opening' brief persuade us that they have satisfied the
requirements for deductibility ; petitioners' entire argument in
brief as to this point is as follows :
Y The deduction taken of $18,719 has been adequately
substantiated (Exh 119-P . and 110iP) . Natures Touch as
a{sole proprietorship during the first 10 months of
1997 was an accrual taxpayer . Expenses budgeted to
begin the Carlsbad . store location were accrued by the
sole proprietorship` This is an issue that Respondent s
. 14
( . . .continued )
as well as her statement,of any purported business meal that she
purchased on that day alon6 with the identity of the person with
whom she dined . We give little weight to the "expense record" .
We note that the expenses deflected in many of the invoices in
Exhibit 112-P do not appear on Michelisen's expense record .
I
-37[sic] counsel may raise . Petitioners believe they
should prevail .
We sustain respondent's determination that petitioners are not
entitled to deduct these claimed expenses (except for $3,668 that
respondent concedes is deductible) .
2 . 199 8
Of the Schedule C expenses (other than home office
deduction) disallowed for 1998, petitioners do not challenge any
of those expenses .
3 . 199 9
Of the Schedule C expenses (other than home office
deduction) disallowed for 1999, petitioners challenge only the
expenses for lease ($7,476), travel ($4,129), and meals ($9,789) .
a.
Lease Expens e
Petitioners argue that the $7,476 claimed as a lease expense
was actually a legal expense that is deductible as such . We do
not find that any of that amount is deductible . Petitioners'
entire argument in brief as to this point is that "The amount
listed on Schedule C for lease expense was . .misclassified . The
$7,476 amount related to legal fees related to a tax litigation
matter and should be fully deductible (TR2-130 :1-12 ; TR 225 :17227 :14)" . The reference to "TR2-130 :1-12" is to the following
testimony by LeBloch on direct examination :
There is a mistake on the Schedule C attached to
the 1997 [sic] return, and the mistake is a
misclassification . There was listed an amount on th e
r
-38line that called for lease
$711476 .
expens e . Theamount was
In reviewing workpapers , that amount should have
been classified as legal expense . ) It related to the
legal cost that Cathy Michelsen had incurred related to
a (Tax Court proceeding dealing with taxable years 1993
through 1995 and paid to a law firm, the Joseph Mudd
La1W Firm .
Those proceedings related to . Tax Court
Docket 14780-97 .
The reference to "TR 225 :1 7 227 :14" is to Michelsen's direct
testimony that she had a c a e inthi s Court in the "1999 time
frame " and had received a b'ill from an attorney named Joseph Mudd
for $73 632 .75 of legal fees .
We are 4 npersuaded that petitioner s
are entitled to deduct for 1999 the $7,476 claimed for that yea r
as a lase (or, as they claim now, a legal) expense .
I
b . ,. Trave l
Petitioners argue that they have
substantiated the $4,129 of
expenses claimed as a business travel deduction through the
introduction of Exhibit 123-P and th e testimony of Michelsen .
That ;dvidence, petitioners conclude, jproves that they traveled t o
Austr a lia to attend the Sydney gift show, tosearch for a
locat on in Australia to open a foursh Nature ' s Touch store, an d
ii
to identify merchandise tol i mport in4o'the United States . W e
disagree that petitioners
travel expenses for 1999 .
Petitioners have simply not persuaded
1
us that their trip to Australia was 'related primarily to,
Michelsen's reported work for hersole proprietorship during 1999 as a j"Corporate Director/Consultant"J . Nor have petitioners
-39persuaded us as to the specifics .of their day-to-day activities
while in Australia or, more specifically, the amount of time that
they purportedly spent on business versus personal pursuits .
Exhibit 123-P was received into evidence through the parties'
stipulation that the exhibit reflects "documents which
Petitioners contend pertain to business related travel for
taxable year 1999" . Exhibit 123-P has approximately 70 pages,
and petitioners have not organized or presented the "documents"
included therein (mainly photocopies of .receipts) in any manner
that persuades us that any of the expenses reflected in this
exhibit are properly deductible by petitioners . Nor do
petitioners in their posttrial opening brief persuade us that
they have satisfied the requirements for deductibility ;
petitioners' entire argument on this point is :
The trip had a clear business purpose . Ms . Michelsen
was actively pursuing a business expansion . ,
(TR169 :16-171 :1) Substantiated costs total $12,847
(Exhibit 123-P) . Only one-third of this expense was
allocated to business . A deduction of $4,129, which
was taken on the return, should be allowed .
We sustain respondent's determination that petitioners are not
entitled to deduct these claimed expenses .
c .
Meals
.
Petitioners argue that they have substantiated the $9,789 of
expenses claimed as a meals deduction for 1999 through the
introduction of Exhibit 124-P . We disagree . Exhibit 124-P was
-40received into evidence through the parties' stipulation that th e
exhibit reflects "documents, which Petitioners contend . pertain t o
overnight business meal expelnse for taxable year .1999" . Exhibit
112-P has approximately 20 1ages, and petitioners have not
organized or presented the "documents" included therein (mainl y
photocopies of receipts) in any mannerLthat persuades us that an y
of the e xpenses
by petitioners
reflected in this exhibit are properly deductible
as "meals" .
See Romer I .Commissioner ,_ T .C . Memo .
2001-161{8 . Nor do petitioners in their posttrial opening brie f
make any concerted attempt to persuade us that they hav e
satisfied the requirements for such deductibility ; petitioners'
entire argument on this poiit is that "Expenses incurred are
substantiated in Exhibit 124-P . Total expenses are $9,789 ." W e
sustain respondent ' s determination that petitioners are not
entitled to deduct these claimed expenses .
E.
Epi~loau e
We have considered all of the pa r ties' arguments, and al l
arguments not discussed herein have be en rejected as moot ,
irrele1ant, or without merit .
Decision will be entered
under Rule 155 .
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