United States Tax Court

United States Tax Court

T.C. Memo. 2025-8

ANA M. FRANKLIN,

Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

__________

Docket Nos. 15054-21, 4970-22.

Filed January 22, 2025.

__________

William P. Gray, Jr., for petitioner.

Donielle A. Holmon, Martha J. Weber, and Christopher D. Bradley, for

respondent in Docket No. 15054-21.

Donielle A. Holmon, for respondent in Docket No. 4970-22.

MEMORANDUM FINDINGS OF FACT AND OPINION

PARIS, Judge: In these consolidated cases respondent

determined, by separate Notices of Deficiency, deficiencies in

petitioner’s federal income tax for 2015 and 2018. By notice dated May

13, 2021 (2015 Notice), respondent determined a deficiency of $46,079

and an addition to tax pursuant to section 6651(a)(1) 1 for failure to

timely file of $11,948.50 for petitioner’s 2015 tax year. By notice dated

January 25, 2022 (2018 Notice), respondent determined a deficiency of

$15,900 and an accuracy-related penalty pursuant to section 6662(a) he

now concedes.

1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C. (Code), in effect at all relevant times, and Rule references are to

the Tax Court Rules of Practice and Procedure.

Served 01/22/25

2

[*2] After respondent’s concession and allegations raised in the

pleadings, see infra Findings of Fact Part VI.C, the following issues

remain for decision:

1.

Whether petitioner received unreported income of

$155,000 for 2015 and, if so, whether the $155,000 should

have been reported as “other income” or as gross receipts

from a trade or business;

2.

Whether petitioner is entitled to a net operating loss (NOL)

carryback of $18,956 for 2015;

3.

Whether petitioner is liable for the section 6651(a)(1)

addition to tax for failure to timely file for 2015;

4.

Whether petitioner was engaged in a trade or business,

other than the trade or business of being an employee,

during 2018;

5.

Whether $44,967, reported as gross receipts on Schedule C,

Profit or Loss From Business, for 2018 should have been

reported as “other income”;

6.

Whether petitioner is entitled to a deduction of $44,967 for

legal and professional services expenses for 2018. 2

FINDINGS OF FACT

I.

Background

Petitioner resided in Alabama when she filed each of the

Petitions.

Petitioner was elected Sheriff of Morgan County, Alabama, in

2010. She assumed the office in January 2011 and, after being re-elected

in 2014, remained in that role until the end of her second term in 2019.

While serving as sheriff, petitioner received wages from the Morgan

County Commission, which reported those wages on Form W–2, Wage

and Tax Statement.

2 Respondent’s adjustments to self-employment tax and the self-employment

tax deduction are computational.

3

[*3] II.

Sheriff of Morgan County

Among her other responsibilities as Sheriff of Morgan County,

petitioner had an obligation to see that the inmates in the county jail

were properly fed. During the years at issue Alabama law mandated

that sheriffs of counties in Alabama had a duty to feed the prisoners held

in their respective county jails. 3 See Ala. Code § 14-6-40 (1995) (amended

2019). By statute, the State of Alabama provided a monthly allowance

of $1.75 per inmate per day, along with additional amounts conditionally

approved, as well as a food services allowance, determined by the

number of prisoners in the county jail, for the sheriff’s services in

preparing and serving food. 4 See Ala. Code §§ 14-6-42, 14-6-43 (1995)

(amended 2019). Historically, unless otherwise directed by the county

commission, the sheriff was permitted to keep and retain any surplus

funds that remained after feeding the prisoners. See Ala. Code § 36-2217 (1995) (amended 2019). The sheriff’s obligation to adequately feed

prisoners remained, however, whether or not the amounts provided by

the state were sufficient, and the sheriff would be responsible to cover

any shortfall in funds.

III.

Maynor v. Morgan County

In 2001, before petitioner’s election as sheriff, a class of pretrial

detainees confined in the Morgan County Jail filed a class action lawsuit

against Morgan County and various county, state, and jail officials,

alleging inhumane treatment and conditions of confinement. See

Maynor v. Morgan County, No. 01-cv-00851 (N.D. Ala. filed Apr. 5,

2001). The parties settled the dispute and, on September 25, 2001,

agreed to a Consent Decree requiring the defendants in that case to

enact a number of reforms to the county prison system. Id. Among the

reforms agreed to in the Consent Decree, Paragraph 22 required that

“County Defendants shall provide a nutritionally adequate diet to

3 Following the years at issue in these cases, efforts were made to reform the

feeding of prisoners in Alabama. In July 2018 Governor Kay Ivey issued a

memorandum to the Alabama State Comptroller directing that payments related to

the feeding of prisoners no longer be paid directly to the sheriffs personally. See

Memorandum From Gov. Kay Ivey to State Comptroller Kathleen Baxter, Sheriff’s

Food Service Allowance (July 10, 2018). In 2019 the Alabama legislature amended the

statutes relating to feeding prisoners to, among other changes, increase the per capita

allowances, alleviate the sheriffs’ personal responsibility for costs, and restrict the use

of the funds. See Ala. Code §§ 14-6-40 through 14-6-51.

4 The federal government provides a separate allowance for federal inmates

housed in county jails. Petitioner testified that in the years at issue, the allowance was

approximately $5 per prisoner per day.

4

[*4] inmates.” Consent Decree Applicable to the Plaintiff Class and the

County Defendants, Maynor, No. 01-cv-00851 (N.D. Ala. Sept. 25, 2001),

ECF No. 45.

In November 2008 a court-ordered investigation into alleged

violations of Paragraph 22 revealed that petitioner’s predecessor in

office had, among other things, served corn dogs as a diet staple at each

meal for several months running, while profiting substantially from the

jail food allowance. 5 The court found that petitioner’s predecessor had

willfully violated the Consent Decree by consistently failing to provide a

nutritionally adequate diet to inmates and that petitioner’s predecessor

had converted to his personal use and benefit state and federal funds

allocated for the feeding of class members. He was held in contempt and

subsequently jailed.

The contempt charge was eventually purged after petitioner’s

predecessor agreed to amend certain provisions of the Consent Decree,

including Paragraph 22. The terms of Amended Paragraph 22(a)(i)

provided, in relevant part, that the Sheriff of Morgan County

shall immediately establish and implement a procedure

whereby all funds provided by any source for the feeding of

inmates, including funds from the State of Alabama, any

municipality, and the federal government, will be used

exclusively for the feeding of said inmates incarcerated in

the Morgan County Detention Facility.

Order Granting Motion for Modification and Clarification of Consent

Decree, Maynor, No. 01-cv-0851 (N.D. Ala. Jan. 27, 2009), ECF No. 104.

Amended Paragraph 22 further provided: “For any year in which there

is a shortfall in funds to provide meals for inmates in the County Jail,

the Sheriff will not be responsible for the shortfall in funds.” Id. A

footnote to the amendment stipulated that the court makes no

determination as to whether the Morgan County Commission would be

liable for any potential shortfall, leaving determination of that question

for another day. Id.

5 According to court filings, the former sheriff purchased an 18-wheeler truck

full of corn dogs for $500 from a friend who owned a trucking company and had been

unable to sell them. The former sheriff served the corn dogs to inmates at each meal

until they had been depleted.

5

[*5] IV.

A.

Jail Food Money Account

Establishment of Account

Petitioner entered office in January 2011. Upon entering office,

petitioner consulted with the Alabama State Sheriffs Association and

with state attorneys regarding her responsibilities with respect to

feeding the prisoners. On the basis of her discussions, petitioner

concluded that the terms of Amended Paragraph 22 applied specifically

to her predecessor, while the original Consent Agreement, which had

been agreed to by the county, was still effective as to her.

With the understanding that she was personally responsible for

feeding the prisoners detained in the county jail, petitioner undertook to

set up accounts with food vendors and establish a line of credit under

her own name and Social Security number. Petitioner additionally

gained signatory authority over a checking account at People’s Bank

ending x2933 (jail food money account), into which the State of Alabama

and the federal government deposited the monthly jail food funds. The

People’s Bank account ending x2933 was used exclusively for the jail

food money. 6 When petitioner assumed office, the outgoing sheriff left

only “a nominal amount of money” in the jail food money account, but it

was insufficient to cover even the cost of the first month’s food.

B.

Priceville Partners

Throughout petitioner’s first term in office, she and her staff

managed to feed the prisoners with the funds provided by the state and

federal government. Some months, the allowances would exceed the cost

of food, while other months, there would be a deficit. Over time, however,

the balance carried over each month gradually increased, and by

January 2015, the account balance was $224,415.97.

When petitioner entered office in 2011, the average daily

population of the county jail was approximately 250 inmates, 40 of

whom were federal inmates (and thus received the $5 per day food

allowance). In the years that followed, however, the county jail

population increased, driven by a variety of factors, including an

increase in methamphetamine arrests, changes to Alabama sentencing

laws, and the closure of municipal jails within Morgan County and the

6 Petitioner’s salary and the food services allowance, which was paid to

petitioner personally, were deposited into a separate account. Petitioner reported these

amounts on her returns for the years at issue, and respondent has not challenged them.

6

[*6] rehousing of those inmates in the county jail. By 2015 the Morgan

County Jail housed between 450 and 500 inmates per day, and the

number was projected to continue rising. At the same time, the

population of federal inmates remained relatively consistent.

From January 1 to June 1, 2015, petitioner’s office ran deficits in

the jail food money account in three of the five preceding months. 7

During that time, petitioner had begun to investigate avenues to

subsidize the jail food money account. On June 5, 2015, petitioner

withdrew $160,000 from the jail food money account using two cashier’s

checks. The cashier’s checks were for $150,000 and $10,000, and both

were made payable to petitioner.

Petitioner opened a checking account at Traditions Bank in the

name Ana Franklin, Food Money, and deposited $5,000 of the $10,000

cashier’s check into the Traditions Bank account. She cashed the

remaining $5,000 and kept the money in the office safe as petty cash.

Petitioner had been approached with a short-term investment

proposal. On the recommendation of Steve Ziaja, a Morgan County

police officer and petitioner’s boyfriend at the time, petitioner would

lend the $150,000 to Priceville Partners, LLC, a local used car

dealership and title-pawn lending service, with the expectation of a 17%

interest rate and a promise that the funds would be returned in 30 days.

Mr. Ziaja had also invested in Priceville Partners and convinced

petitioner that it would be a good opportunity to recoup some of the

losses on the jail food money account. Mr. Ziaja offered to serve as

guarantor for the loan. Petitioner endorsed and delivered the $150,000

cashier’s check directly to Priceville Partners.

Priceville Partners did not immediately provide petitioner with a

promissory note for the loan, and petitioner’s efforts to obtain one were

met with excuses and evasion. After the prescribed 30 days had passed,

petitioner received neither her principal nor the promised interest. The

owner of Priceville Partners stopped answering petitioner’s phone calls,

and petitioner soon learned that the company had been operating what

7 Petitioner testified that monthly deficits began to be more common in the

latter half of 2014, but the parties did not introduce bank statements or other records

to corroborate or dispute this assertion.

7

[*7] was essentially a Ponzi scheme. The business closed in November

2015, and Priceville Partners filed for bankruptcy in March 2016. 8

Petitioner never received any funds from Priceville Partners or

the bankruptcy estate. In December 2016 Mr. Ziaja, having served as

personal guarantor for the loan to Priceville Partners, repaid the

$150,000 to petitioner on behalf of Priceville Partners. Petitioner

deposited the funds in the Traditions Bank account on December 30,

2016.

V.

Violation of Consent Decree

In January 2017 representatives of the class members in the

Maynor suit learned that the $160,000 had been removed from the jail

food money account and subsequently filed a motion seeking to hold

petitioner in contempt for violating the Amended Paragraph 22 of the

Consent Decree. On June 15, 2017, the court found that, by removing

the $160,000 from the jail food money account, petitioner violated the

terms of the Consent Decree. The court held petitioner in civil contempt

but, because the funds had been returned before the plaintiffs’ motion,

determined that a coercive sanction was unnecessary and imposed a

nominal fine of $1,000. In addition the Court found that Amended

Paragraph 22(a)(i), the provision which specifically restricted the

Morgan County Sheriff’s use of the funds in the jail food money account,

was no longer required and granted petitioner’s motion to terminate

that provision.

VI.

Tax Returns and Notices of Deficiency

A.

2015 Tax Return

On December 18, 2017, petitioner filed Form 1040, U.S.

Individual Income Tax Return, for tax year 2015. On that return

petitioner reported wages of $63,930; taxable interest of $15; and other

income totaling $4,832, which comprised $4,106 in payments from the

State of Alabama and $726 total canceled debt. Petitioner claimed

itemized deductions totaling $7,010 and a personal exemption, resulting

in taxable income of $57,477 and total tax of $10,743. Petitioner did not

8 The parties stipulated that Priceville Partners filed for bankruptcy on March

25, 2015. The bankruptcy petition, however, shows a filing date of March 25, 2016. The

Court may disregard the parties’ stipulation to remedy obvious error. See, e.g., Joseph

v. Commissioner, T.C. Memo. 2020-65, at *30.

8

[*8] report any income in connection with the withdrawal of funds from

the jail food money account.

On December 18, 2018, following a lengthy investigation, the U.S.

Department of Justice filed an Information against petitioner on

charges of willful failure to file a tax return for tax year 2015, in

violation of section 7203. 9 Information, United States v. Franklin,

No. 18-cr-00605 (N.D. Ala. Dec. 18, 2018), ECF No. 1. That same day,

petitioner pleaded guilty to the charges. Plea Agreement, Franklin,

No. 18-cr-00605 (N.D. Ala. Dec. 18, 2018), ECF No. 2. On October 18,

2019, petitioner was sentenced to probation for a term of 24 months.

Judgment in Criminal Case, Franklin, No. 18-cr-00605 (N.D. Ala. Oct.

18, 2019), ECF No. 31.

B.

2018 Tax Return

Petitioner timely filed her 2018 tax return. On her 2018 return

petitioner reported wages of $67,900; taxable refunds, credits, or offsets

of state and local income taxes of $81; and other income of $2,385.

Petitioner claimed a deduction of $169 for self-employment tax and a

standard deduction of $12,000, resulting in taxable income of $58,197

and total tax of $9,075, including self-employment tax of $337.

Petitioner’s return included Schedule C, on which petitioner

listed her business as “Sheriff’s Jail Food Account.” On the Schedule C,

petitioner reported gross income of $44,967 and a legal and professional

services expense of $44,967, resulting in zero net profit. The $44,967

represented funds that petitioner withdrew from the jail food money

account during 2018 10 and paid to various parties to resolve her ongoing

legal and tax issues.

Petitioner paid $10,867 to the accounting firm Tucker, Scott,

& Wates, LLC, for preparation of her tax returns for 2017 and amended

returns for 2011, 2012, 2014, 2015, and 2016, as well as bookkeeping

related to the jail food money account, meetings with the Alabama

Department of Revenue, and meetings with her attorneys in connection

with the federal investigation. Petitioner paid $16,600 to a law firm for

preindictment representation during her federal investigation and

9 Petitioner filed her 2015 tax return on December 18, 2017, after having

received notice of the investigation.

10 The restriction limiting petitioner’s use of the funds exclusively to feeding

inmates was terminated on June 15, 2017. Order, Maynor, No. 01-cv-851 (N.D. Ala.

June 15, 2017), ECF No. 169.

9

[*9] $17,500 to a different law firm for representation during her

criminal tax investigation. Petitioner reported no other income or

expenses on her Schedule C.

C.

Notices of Deficiency

On May 13, 2021, respondent issued the 2015 Notice, determining

a deficiency of $46,079 and an addition to tax for failure to file pursuant

to section 6651(a)(1) of $11,948.50. Respondent’s deficiency

determination was based on the following adjustments:

Adjustment

Amount

NOL Carryback from tax year 2016

($18,956)

Sch C1 – Gross Receipts (Food Account)

155,000

SE AGI Adjustment

(5,224)

Total Adjustments

130,820

Petitioner timely filed a Petition, docketed at No. 15054-21, on

July 19, 2021, disputing the adjustments to her income.

On July 7, 2022, after a series of jurisdictional motions were

resolved, respondent filed his Answer in the case docketed at

No. 15054-21 (2015 Answer). In the 2015 Answer respondent

substantially modified his position from the 2015 Notice and alleged the

$155,000 adjustment to petitioner’s Schedule C gross receipts set forth

in the 2015 Notice should have been classified as other income under

section 61. Respondent now alleges that petitioner did not operate a

business for feeding prisoners in 2015 and that the $155,000 constituted

proceeds from embezzlement. Accordingly, respondent now contends

that petitioner is not entitled to the NOL carryback allowed in the 2015

Notice. Respondent further contends that the $155,000 adjustment to

petitioner’s income is not subject to self-employment tax. With these

adjustments, respondent now contends that the 2015 proposed

deficiency is slightly reduced in that the 2015 deficiency is $43,562 and

the section 6651(a)(1) addition to tax is $11,319.25.

On January 25, 2022, respondent issued the 2018 Notice. In the

2018 Notice respondent determined a deficiency of $15,900 and an

accuracy-related penalty pursuant to section 6662(a) of $3,180.

Petitioner timely filed a Petition, docketed at No. 4970-22, on March 15,

2022.

10

[*10] Respondent filed the Answer in Case No. 4970-22 on July 6, 2022.

On October 31, 2022, the Court granted respondent’s Motion for Leave

to File Out of Time First Amendment to Answer. In the First

Amendment to Answer, respondent alleged, in conformity with the

allegations in the 2015 Answer, that petitioner did not operate a

Schedule C business during 2018 and is not subject to self-employment

tax. In so alleging, respondent additionally reclassified petitioner’s

disallowed business expenses as disallowed employee-related expenses.

With these adjustments, respondent now contends that the 2018 Notice

amount is also reduced in that the deficiency for petitioner’s 2018 tax

year is $10,311. 11

These cases were consolidated for trial, briefing, and opinion on

December 12, 2022.

OPINION

I.

2015 Adjustments

A.

Unreported Income

1.

Burden of Proof

The Commissioner’s determination set forth in a notice of

deficiency is generally presumed correct, and the taxpayer bears the

burden of proving that the determination is in error. Rule 142(a)(1);

Welch v. Helvering, 290 U.S. 111, 115 (1933). With respect to any new

matter or increases in deficiency pleaded in an answer, the burden is on

the Commissioner. Rule 142(a)(1). When a case involves unreported

income, the U.S. Court of Appeals for the Eleventh Circuit, to which

appeal in these cases would lie, absent a stipulation to the contrary, see

§ 7482(b)(1)(A), (2), has held that the Commissioner’s determination of

unreported income is entitled to a presumption of correctness only if the

determination is supported by a minimal evidentiary foundation linking

the taxpayer to an income-producing activity, see Blohm v.

Commissioner, 994 F.2d 1542, 1549 (11th Cir. 1993), aff’g T.C. Memo.

1991-636. Once the Commissioner produces evidence linking the

taxpayer to an income-producing activity, the presumption of

correctness applies and the burden of production shifts to the taxpayer

to rebut that presumption by establishing that the Commissioner’s

determination is arbitrary or erroneous. Id.

11 Respondent subsequently conceded the section 6662(a) penalty.

11

[*11] In the 2015 Notice respondent determined that the $155,000 that

petitioner withdrew from the food money account constituted

unreported gross receipts from a trade or business. In the 2015 Answer

respondent now alleges that the funds were income from embezzlement

(and thus not income from a trade or business). 12

The parties agree that petitioner withdrew the $155,000 at issue

from the jail food money account. Respondent has therefore established

the minimal evidentiary foundation, and the burden is on petitioner to

show that respondent’s determination is arbitrary or erroneous.

Whether the funds constitute embezzlement income and not income

from a trade or business, however, is a new matter for which respondent

bears the burden of proof.

2.

Analysis

Section 61(a) defines gross income as “all income from whatever

source derived.” Gross income is construed broadly to include all

“accessions to wealth, clearly realized, and over which the taxpayers

have complete dominion.” Commissioner v. Glenshaw Glass Co., 348

U.S. 426, 431 (1955). It is well established that gross income under

section 61(a) includes income earned from illegal activity, such as

proceeds from embezzlement. James v. United States, 366 U.S. 213, 219

(1961); Howard v. Commissioner, T.C. Memo. 1997-473, 1997 WL

634517, at *3. Loan proceeds, on the other hand, are excluded from gross

income because the benefit of income is offset by a corresponding

obligation to repay. See, e.g., Todd v. Commissioner, T.C. Memo. 2011123, 2011 WL 2183767, at *4, aff’d, 486 F. App’x 423 (5th Cir. 2012).

Respondent argues that, by withdrawing the $155,000 from the

jail food money account, petitioner committed an act of embezzlement,

12 Respondent’s classification of the $155,000 as income from embezzlement

activities, rather than income from a trade or business, carries certain significant

consequences. For instance, section 1401 imposes a tax on self-employment income,

and section 1402(a) defines net earnings from self-employment as the gross income

derived by an individual from the carrying on of any trade or business by such

individual less allowable deductions attributable to such trade or business.

Additionally, section 172(d)(4) limits the availability of NOLs not attributable to a

trade or business to certain listed exceptions, none of which is relevant to the present

cases. The Court has long held that embezzlement activities do not constitute a trade

or business. See, e.g., Yerkie v. Commissioner, 67 T.C. 388 (1976). If the Court were to

find in respondent’s favor, then petitioner would not be liable for the adjustment to her

2015 self-employment tax, but likewise not be entitled to carry back the loss arising

when she returned the funds to the jail food money account in 2016.

12

[*12] misappropriating funds from the jail food money account and

converting those funds for personal use in violation of Alabama law and

the Amended Paragraph 22 of the Consent Decree. Respondent argues

that, upon withdrawing the funds, petitioner had an undeniable

accession to wealth, derived realized economic value, and exercised

completed dominion and control over the funds.

Petitioner maintains that she did not embezzle the funds, but that

they were a loan from the jail food money account, which she withdrew

with the intention of repaying them with interest when she herself was

repaid by Priceville Partners. Petitioner points to the fact that, as

signatory authority on the jail food money account, she always had

dominion and control over the funds in the account, and that she

received no accession to wealth when she withdrew the funds because

she created a corresponding obligation to repay the funds and that she

ultimately did repay them.

While it is true that, under the terms of Amended Paragraph 22

of the Consent Decree, petitioner was not authorized to use the funds in

the manner that she did, the Court has long distinguished between

unauthorized loans and embezzlement. A taxpayer has income when she

“acquires earnings, lawfully or unlawfully, without the consensual

recognition, express or implied, of an obligation to repay and without

restriction as to their disposition.” James, 366 U.S. at 219. In

circumstances where misappropriations do not enrich or benefit the

misappropriator, and there is a consensual recognition of an obligation

to repay the funds, income does not arise. Hobson v. Commissioner, T.C.

Memo. 1992-312, 1992 Tax Ct. Memo LEXIS 334, at *8; see also Beasley

v. Commissioner, T.C. Memo. 1989-173, 1989 Tax Ct. Memo LEXIS 176,

at *49–50.

For genuine indebtedness to be present, there must be a goodfaith intent on the part of the borrower to repay the debt and good-faith

intent by the lender to enforce payment of the debt. Todd v.

Commissioner, 2011 WL 2183767, at *4. Factors considered in finding a

bona fide debt include whether the promise to repay was evidenced by a

note or other instrument; interest was charged; a fixed schedule for

repayment was established; collateral was given to secure payment;

repayment was made; the borrower had a reasonable prospect of

repaying the loan and the lender had sufficient funds to advance the

loan; and the parties conducted themselves as if the transaction was a

loan. Id. Ultimately, the distinguishing characteristic of a loan is the

intention of the lender and borrower that the loan be repaid. Moore v.

13

[*13] United States, 412 F.2d 974 (5th Cir. 1969); Roberts v.

Commissioner, T.C. Memo. 1993-98, 1993 WL 80581, at *8.

On the basis of the evidence, the Court is persuaded that the

withdrawn funds constituted a loan from the jail food money account.

Although petitioner’s withdrawal of the funds failed to adhere to certain

formalities as a written instrument, the lack of such formalities is not

by itself conclusive. See Kean v. Commissioner, 91 T.C. 575, 595–96

(1988). Petitioner credibly testified, and her testimony was corroborated

by that of Mr. Ziaja and others, that she was concerned about the longterm viability of the jail food money account. On the promise of a 17%

return within 30 days, petitioner withdrew the funds from the jail food

money account by cashier’s check and immediately signed the cashier’s

check over to Priceville Partners. Other members of the Morgan County

Sheriff’s staff had access to the jail food money account, yet there is no

indication that petitioner undertook any effort to hide the withdrawal of

the funds from them or otherwise conceal her actions. Petitioner may

have exhibited poor business judgment, both in withdrawing the funds

and in lending them to Priceville Partners, but petitioner’s poor

judgment is not a factor in determining her intent.

The fact that the withdrawal was made in violation of the Consent

Decree does not alter the fact that petitioner intended to (and ultimately

did) return the funds to the jail food money account. Cf. Hobson, 1992

Tax Ct. Memo LEXIS 334, at *12. Petitioner was never charged with,

much less convicted of, embezzlement or theft of the funds. Rather, the

court in Maynor ruled that petitioner was not authorized to use the

funds in the manner she did. Rather, observing that the withdrawn

funds had in fact been restored, the court held petitioner in civil

contempt but ordered only a nominal sanction of $1,000 against her for

her actions. 13

Accordingly, the Court holds that the $155,000 withdrawn from

the jail food money account constituted an unauthorized loan and not

embezzlement income. Because the withdrawal was an unauthorized

loan, petitioner’s restoration of the funds in 2016 constituted a loan

repayment, rather than a repayment of embezzled funds, and petitioner

is not entitled to an NOL carryback for 2015. See, e.g., Porter v.

Commissioner, T.C. Memo. 2015-122, at *32 (“[A taxpayer] is not

13 In the same order, the court terminated Amended Paragraph 22(a)(i) of the

Consent Decree, which imposed the limitations on the Sheriff’s use of the jail food

funds. Order, Maynor, No. 01-cv-851 (N.D. Ala. June 15, 2017), ECF No. 169.

14

[*14] entitled to deduct repayment of loan principal because loan

proceeds are not income when they are received.”).

B.

Addition to Tax

Section 6651(a)(1) imposes an addition to tax for failure to timely

file a federal income tax return unless it is shown that the failure is due

to reasonable cause and not due to willful neglect. See also Higbee v.

Commissioner, 116 T.C. 438, 447 (2001). The addition to tax is equal to

5% of the amount required to be shown as tax on the delinquent return

for each month or fraction thereof during which the return remains

delinquent, up to a maximum addition of 25% for returns more than four

months delinquent. § 6651(a)(1). Under section 7491(c) the

Commissioner bears the burden of producing evidence with respect to

the liability of the taxpayer for any addition to tax. See Higbee, 116 T.C.

at 446–47. The burden of proving reasonable cause and lack of willful

neglect falls on the taxpayer. See § 6651(a); Higbee, 116 T.C. at 446–47.

Petitioner filed her 2015 income tax return on December 18, 2017,

which was after the due date of April 18, 2016. See §§ 6072, 7503.

Respondent has thus met his burden of production. Petitioner has not

established that her failure to timely file was due to reasonable cause

and, indeed, she pleaded guilty to willful failure to file a tax return for

2015. Accordingly, to the extent that any underpayment remains, the

section 6651(a)(1) addition to tax is sustained for 2015.

II.

2018 Adjustments

A.

Overview

On Schedule C attached to her 2018 tax return, petitioner

reported gross income of $44,967, which she withdrew from the jail food

money account. Petitioner also reported legal and professional services

expenses of $44,967, comprising $10,867 paid to her accountant for the

preparation of her personal tax returns for 2011, 2012, 2014, 2015, 2016,

and 2017, among other services, and the remaining amount paid to

attorneys in connection with her criminal tax case.

In the 2018 Notice respondent disallowed the deductions because

petitioner did not establish that the expenses were paid or incurred

during the taxable year or that she operated a trade or business during

2018. Respondent now argues that petitioner did not carry on a trade or

business during 2018, and that the $44,967 should have been reported

as other income. Under that characterization, petitioner would no longer

15

[*15] be liable for the adjustments to her self-employment tax with

respect to the $44,967.

With respect to the legal and professional services expense,

respondent now agrees that amounts were paid, but that they were

either nondeductible personal expenses or miscellaneous itemized

deductions, deduction of which was suspended for 2018 pursuant to

section 67(g).

B.

Petitioner’s Trade or Business

As a threshold matter, the Court must first determine whether

petitioner’s operation of the jail food money account constituted a

distinct trade or business. Neither the Code nor the regulations provide

a generally applicable definition of a “trade or business.” Commissioner

v. Groetzinger, 480 U.S. 23, 27 (1987). Determining the existence of a

trade or business requires an examination of the facts in each case. Id.

at 36; see also Sestak v. Commissioner, T.C. Memo. 2022-41, at *7. When

examining the facts of each case to determine whether a trade or

business exists, the Court has focused on whether: (1) the taxpayer

undertook the activity intending to earn a profit; (2) the taxpayer is

regularly and actively involved in the activity; and (3) the taxpayer’s

activity has actually commenced. See, e.g., Sestak, T.C. Memo. 2022-41,

at *7; Weaver v. Commissioner, T.C. Memo. 2004-108, 2004 WL 938293,

at *6.

During 2018 petitioner was an employee of the Morgan County

Commission, which paid her wages for her service as sheriff. Among

petitioner’s statutory duties in her position as sheriff was to feed the

prisoners held in the Morgan County Jail in accordance with the

provisions of Alabama law. See Ala. Code § 14-6-40 (1995). Petitioner

did not separately or independently undertake the operation of the jail

food money account with the intent to make a profit, but rather she was

specifically obligated to do so in her position as sheriff. Conversely,

petitioner would have not been able to operate the jail food money

account but for the fact that she was sheriff. The activity was

inextricably connected with her position. Although petitioner could

potentially have profited from the efficient operation of the account, it is

not uncommon for an employee to receive a bonus or other additional

compensation for successful discharge of her duty.

Moreover, petitioner did not treat the operation of the jail food

money account as a separate trade or business. She did not report gross

16

[*16] receipts from the State of Alabama or any other entity and did not

report expenses other than the legal and professional services expense.

She did not hire employees but relied on the work of the inmates or her

own staff in the Morgan County Sheriff’s office.

Accordingly, the Court finds that petitioner was not engaged in

the trade or business of operating the jail food money account during

2018. Rather, she did so in the course of her employment as Sheriff of

Morgan County. Respondent’s characterization of the $44,967 as “other

income” rather than gross receipts from a trade or business is therefore

sustained.

C.

Expense Deductions

On Schedule C, petitioner reported “Legal and professional

services” expenses totaling $44,967. The parties agree that petitioner

paid $10,867 to an accounting firm for the preparation of her personal

federal tax return for tax year 2017, as well as amending certain other

federal and state tax returns, bookkeeping for the jail food account,

handling a teleconference with the Alabama Department of Revenue,

and testimony before a grand jury; and $34,100 to two law firms in

connection with her criminal conviction.

Section 162(a) allows a deduction for ordinary and necessary

expenses paid or incurred during a taxable year in carrying on a trade

or business. Generally, the performance of services as an employee may

constitute a “trade or business.” O’Malley v. Commissioner, 91 T.C. 352,

363–64 (1988); Primuth v. Commissioner, 54 T.C. 374, 377 (1970). No

deduction is allowed for personal, living, or family expenses. § 262.

A deduction under section 162(a), 167(a), or 179 is a

miscellaneous itemized deduction if it is related to the business of

performing services as an employee. §§ 67(b), 63(d), 62(a). A deduction

under section 162(a), 167(a), or 179 is not a miscellaneous itemized

deduction if it is related to a business other than performing services as

an employee. §§ 67(b), 63(d), 62(a)(1).

Section 67(a) provides that miscellaneous itemized deductions are

allowed only to the extent that the total amount of such deductions

exceeds 2% of adjusted gross income. In 2017, however, Congress

enacted section 67(g), suspending miscellaneous itemized deductions for

tax years 2018 through 2025.

17

[*17] The Court has found that petitioner’s operation of the jail food

account during 2018 was not a trade or business but part of her duties

as Sheriff of Morgan County, an employee of the Morgan County

Commission. With respect to the payments to the law firms, as well as

the payments to the accounting firm related to grand jury testimony, the

Court need not decide whether the legal claim was inherently personal

or arose in connection with petitioner’s status as an employee of the

Morgan County Commission, because the expenses would not be

deductible under either circumstance.

Nor is petitioner entitled to a deduction for the tax return

preparation expenses. The tax returns prepared by the accounting firm

were petitioner’s individual income tax returns, and not returns related

to any trade or business. In the case of an individual, section 212(3)

generally allows as a deduction all the ordinary and necessary expenses

paid or incurred during the taxable year in connection with the

determination, collection, or refund of any tax. The deduction allowed

under section 212(3) is a miscellaneous itemized deduction, see, e.g.,

Crouch v. Commissioner, T.C. Memo. 1995-289, and is likewise

suspended for the 2018 tax year pursuant to section 67(g).

III.

Conclusion

For the foregoing reasons, petitioner’s withdrawal of $155,000

from the jail food money account is not included in petitioner’s 2015

gross income, and petitioner is not entitled to an NOL carryback for that

year. To the extent that any underpayment exists for 2015, petitioner is

liable for an addition to tax pursuant to section 6651(a)(1). Petitioner’s

receipt of $44,967 in 2018 is properly characterized as “other income”

and not gross income from a trade or business. Respondent’s

disallowance of the deduction claimed for legal and professional services

expense is sustained.

To reflect the foregoing,

Decisions will be entered under Rule 155.