United States Tax Court

United States Tax Court

T.C. Memo. 2024-76

GREGORY R. SCHNACKEL AND LAURA B. SCHNACKEL,

Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

__________

Docket No. 5560-18.

Filed July 29, 2024.

__________

John M. Lingelbach, for petitioner Gregory Schnackel.

Edward D. Hotz and Howard N. Kaplan, for petitioner Laura Schnackel.

Britton G. Wilson, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

KERRIGAN, Chief Judge: With respect to petitioners’ federal

income tax for 2012, 2013, and 2014 (years at issue), respondent

determined deficiencies of $244,965, $100,550, and $98,002,

respectively, and accuracy-related penalties under section 6662 of

$44,993, $20,110, and $19,600, respectively.

Unless otherwise

indicated, statutory references are to the Internal Revenue Code, Title

26 U.S.C. (Code), in effect at all relevant times, regulation references

are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect

at all relevant times, and Rule references are to the Tax Court Rules of

Practice and Procedure.

Petitioners timely filed a joint Petition seeking redetermination

of the deficiencies for the years at issue. Before trial the Court granted

petitioner wife’s Motion for Leave to File a Separate Amended Petition.

Petitioner husband opposed this Motion. In her Amended Petition,

petitioner wife raised innocent spouse relief pursuant to section 6015 as

Served 07/29/24

2

[*2] an affirmative defense. Petitioner wife did not specify under which

subsection of section 6015 she seeks relief. Respondent did not issue a

notice of determination regarding innocent spouse relief. At the start of

the trial, respondent conceded that petitioner wife was eligible for

innocent spouse relief. Petitioner husband continued his objection to

petitioner wife’s receiving this relief.

After concessions, 1 we consider whether (1) Schnackel Engineers,

Inc. (SEI), is entitled to deduct rental expenses relating to a New York

condominium as a business expense; (2) SEI is entitled to depreciation

deductions under section 167 or 179 for personal property placed in the

condominium and a Range Rover automobile; (3) petitioners’ net

operating loss (NOL) deduction for 2011 carried over from 2010 must be

reduced by $399,179; (4) petitioners are entitled to an NOL carryforward

from 2011 for 2012; (5) petitioners are liable for accuracy-related

penalties for the years at issue; and (6) petitioner wife is entitled to

innocent spouse relief for the years at issue. Underlying the first four

issues is whether petitioners accurately reported petitioner husband’s

distributive share of income, gain, and loss from SEI from 2011 through

2014.

FINDINGS OF FACT

Some of the facts are stipulated and so found. The Stipulation of

Facts and the attached Exhibits are incorporated herein by this

reference. Petitioners resided in Nebraska when they timely filed their

Petition.

Petitioners were married on May 25, 1985, and filed joint federal

income tax returns for the years at issue. On July 27, 2016, petitioner

wife filed a complaint for dissolution of marriage with the district court

1 Pursuant to the Stipulation of Settled Issues, the parties agree that

(1) petitioner wife failed to report $4,076 in long-term capital gain income for 2011,

(2) petitioners failed to report $215 in long-term capital gain income, $450 of ordinary

dividends, and $539 of qualified dividends for 2012, (3) petitioners failed to report

$2,266 of short-term capital gain income, $402 of long-term capital gain income, $934

of ordinary dividends, and $818 of qualified dividends for 2013, (4) petitioners failed to

report $1,099 of long-term capital gain income, $1,178 of ordinary dividends, and

$1,213 of qualified dividends for 2014, (5) SEI is allowed a deduction of $90,320 for

“officer’s compensation” and petitioners shall increase their wage income by $90,320

for 2013, and (6) SEI is allowed a deduction of $166,264 for “officer’s compensation”

and petitioners shall increase their wage income by $166,624 for 2014.

3

[*3] of Douglas County, Nebraska. That court issued an amended

decree of dissolution of marriage on March 30, 2018. 2

Since January 1, 2000, petitioner husband has been the sole

owner of SEI, a subchapter S corporation for all years at issue. SEI

provides engineering and design services for commercial and residential

construction projects. These services include but are not limited to

plumbing systems, electrical systems, and fire sprinklers.

Approximately 75% of SEI’s business is commercial.

SEI is

headquartered in Omaha, Nebraska, and has offices in various locations

throughout the United States. During the years at issue SEI had offices

in California and New York, New York.

Petitioner wife earned a bachelor’s degree in human nutrition and

food service management and was employed as a nutritionist before

assuming bookkeeping responsibilities for SEI in March 2000. She took

an introductory accounting course in college but otherwise received only

job-specific training from her mother-in-law.

Petitioner wife’s

responsibilities were limited to handling payroll and payroll taxes as

well as invoices and accounts receivable. She used a program called

Peachtree to handle payroll and invoices.

All other duties relating to finance and accounting were managed

by SEI’s outside accountant, Steven Kenney, or its in-house accountant,

Peggy Hinkle. Petitioner wife signed checks and Ms. Hinkle prepared

the checks for her signature. Throughout the years at issue, however,

petitioner wife served as SEI’s wellness coordinator. During her time as

wellness coordinator petitioner wife continued to sign checks but had no

other accounting responsibilities.

In the early 2000s SEI began engaging the New York, New York,

market. Starting around 2004 petitioner husband made several trips to

New York to market SEI’s services and build a network for project

referrals. Initially, SEI shared office space with an architecture firm.

Around 2005 the architecture firm no longer wanted to share space with

SEI. During this timeframe petitioner husband stayed in hotels when

in New York.

Around 2005 and 2006 SEI had only small projects in New York,

but petitioner husband was spending at least a third of his time there.

2 Despite their divorce, and because they were married throughout the years

at issue, we refer to petitioners as petitioner husband and petitioner wife for the

purpose of this Opinion.

4

[*4] On December 6, 2006, petitioner husband completed the purchase

of a penthouse condominium in New York for $3,250,000. Only

petitioner husband was listed as a purchaser of the condominium.

Petitioner wife toured the condominium before purchase but played no

other part in the decision to purchase it.

The condominium was 2,900 square feet with an outdoor terrace

featuring a view of Manhattan. As part of the purchase agreement,

petitioner husband agreed that he would occupy the New York

condominium as his second home and that he would not rent out the

property. On January 1, 2007, petitioner husband executed a lease

agreement by which he, in his personal capacity, leased the New York

condominium to SEI, for which he signed in his role as president of SEI.

The lease agreement permitted SEI to designate use of the condominium

to any one employee.

SEI agreed to pay $28,000 per month in rent to petitioner

husband for the New York condominium. The rent was calculated to

cover petitioner husband’s cost of ownership of the condominium.

Neither petitioner husband nor petitioner wife consulted a real estate

expert to determine the fair market rent. The initial lease agreement

expired on December 31, 2009, but this arrangement continued under

the terms originally agreed upon throughout the years at issue. The fair

market monthly rental values for the New York condominium during

the relevant periods were as follows: $22,500 for 2011, $21,500 for 2012,

$23,000 for 2013, and $25,000 for 2014. 3

After the New York condominium was acquired, petitioner

husband through SEI purchased various furnishings and made

renovations to it. Petitioners used the SEI credit card to purchase

furniture for the condominium. These purchases occurred over several

years and totaled $326,190. For example SEI claimed depreciation

deductions in various amounts for each year at issue relating to a

Steinway & Sons baby grand piano, nonoffice artwork, luxury sheets

and table linens, furniture, rugs, and other miscellaneous home items.

Petitioners did not use the New York condominium strictly for

business purposes. During the years at issue petitioners and their

3 On January 12, 2021, petitioner husband filed a Motion to Admit Evidence

seeking admission of a fair market rental value analysis report prepared by Michael

Grassi and Jonathan Miller. Respondent made no objection to the Motion and

stipulated the report’s conclusions. We will grant petitioner husband’s Motion to

Admit Evidence and admit the fair rental value analysis report into evidence.

5

[*5] immediate family stayed at the condominium when visiting New

York on Thanksgiving weekends and occasionally took personal trips to

the city during the summer. Petitioners’ daughter lived in the

condominium and used the furnishings for a semester while attending

New York University in 2013. Neither petitioners nor their accountant

tracked the personal and/or business use of the New York condo.

In December 2011 at the request of petitioner husband SEI

purchased a 2012 Range Rover automobile for $94,334. Petitioner

husband prepared a mileage log sometime in 2012 to document his use

of the Range Rover for the purpose of claiming the 2011 deduction. The

information on the mileage log was recalled from his memory of where

he was on certain dates. Petitioner wife did not prepare documents

related to the Range Rover, including a mileage log.

Mr. Kenney, however, did not have the mileage log at the time he

prepared SEI’s 2011 tax return. SEI failed to report any use of the

vehicle, business or otherwise, on its 2011 Form 4562, Depreciation and

Amortization. SEI reported a special depreciation allowance of $94,334

for the purchase price of the Range Rover on its 2011 tax return. At the

end of 2011 SEI still owned another vehicle that petitioner husband

claimed to use for business purposes.

In 2010 petitioner husband met a woman with whom he had an

affair while in New York. He met regularly with her for meals in 2010

to 2013. During this time petitioner husband stayed in hotels because

he did not want to have her in the New York condominium. To further

conceal the affair petitioner husband opened a JPMorgan credit card to

hide spending related to the affair. The Douglas County district court

found that from 2013 to 2017 petitioner husband made $2,967,717 in

payments to the secret credit account and $566,050 in cash support to

the extramarital partner sourced from marital funds.

In 2014 respondent opened an examination of SEI’s corporate and

petitioners’ individual tax returns for tax year 2011, which later

expanded to the years at issue. The returns in question are complex,

and their contents relate mostly to the business activities of petitioner

husband. Petitioner wife served no role in tracking the mileage or

business use of any SEI property nor in the preparation of SEI’s or

petitioners’ returns. Respondent’s remaining disallowances are items

related only to SEI.

6

[*6] The determined accuracy-related penalties for years 2012 and

2014 were approved on December 17, 2015, when the examining revenue

agent’s supervisor signed a Civil Penalty Approval Form. The 2013

penalty received supervisory approval on December 19, 2017.

Respondent issued the notice of deficiency on December 21, 2017.

OPINION

Generally, the Commissioner’s determinations set forth in a

notice of deficiency are presumed correct, and taxpayers bear the burden

of showing the determinations are erroneous. Rule 142(a); Welch

v. Helvering, 290 U.S. 111, 115 (1933). Petitioners do not contend that

the burden of proof should shift to respondent under section 7491(a).

Deductions are a matter of legislative grace, and a taxpayer must

prove his or her entitlement to a deduction.

INDOPCO, Inc.

v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co.

v. Helvering, 292 U.S. 435, 440 (1934). A taxpayer claiming a deduction

on a federal income tax return must demonstrate that the deduction is

allowable pursuant to a statutory provision and must further

substantiate that the expense to which the deduction relates has been

paid or incurred. § 6001; Hradesky v. Commissioner, 65 T.C. 87, 89–90

(1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976). Generally, an

S corporation shareholder determines his or her tax liability by taking

into account a pro rata share of the S corporation’s income, losses,

deductions, and credits. § 1366(a)(1). 4

Section 172 permits a deduction for the full amount of allowable

NOL carrybacks from subsequent years and carryovers from previous

years, as long as taxable income for the current year is not less than

zero. § 172(a), (b)(2). Petitioners bear the burden of establishing both

the existence of the NOL and the amount of any NOL that may be

carried forward. See Rule 142(a)(1); United States v. Olympic Radio &

Television, Inc., 349 U.S. 232, 235 (1955); Keith v. Commissioner, 115

T.C. 605, 621 (2000). Petitioners reported losses in 2010 and 2011, and

corresponding NOL carryforward deductions for 2011 and 2012,

4 On their 2013 return petitioners reported a long-term capital gain of $424,640

resulting from a distribution to petitioner husband in excess of his basis in SEI. In the

event respondent’s determinations are sustained and SEI’s income is increased for

2013, a corresponding adjustment to petitioner husband’s basis must be made. This

basis increase would reduce the amount of long-term capital gain petitioners realized

for that year.

7

[*7] respectively. 5 To the extent that our conclusions below affect

petitioners’ taxable income for 2010 and 2011, the corresponding NOL

carryforwards must be recomputed.

I.

Rental Expense Deductions

Section 162 permits taxpayers to deduct all ordinary and

necessary business expenses paid or incurred during the taxable year.

An ordinary expense is one that commonly or frequently occurs in the

taxpayer’s business, Deputy v. du Pont, 308 U.S. 488, 495 (1940), and a

necessary expense is one that is appropriate and helpful in carrying on

the taxpayer’s business, Commissioner v. Heininger, 320 U.S. 467, 471

(1943); Treas. Reg. § 1.162-1(a). Whether an expenditure is ordinary

and necessary is generally a question of fact. Commissioner v.

Heininger, 320 U.S. at 475. A taxpayer must show a bona fide business

purpose for the expenditure and there must also be a proximate

relationship between the expenditure and his or her business. Challenge

Mfg. Co. v. Commissioner, 37 T.C. 650, 660 (1962). A taxpayer’s general

statement that his or her expenses were incurred in pursuit of a trade

or business is not sufficient to establish that the expenses had a

reasonably direct relationship to any such trade or business. Ferrer

v. Commissioner, 50 T.C. 177, 185 (1968), aff’d per curiam, 409 F.2d

1359 (2d Cir. 1969).

Where an expense is primarily associated with profit-motivated

purposes and personal benefit can be said to be distinctly secondary and

incidental, it may be deducted under section 162(a). Int’l Artists, Ltd.

v. Commissioner, 55 T.C. 94, 104 (1970). If an expense is primarily

motivated by personal or social considerations, however, no deduction

for it will be allowed under section 162(a). Henry v. Commissioner, 36

T.C. 879, 884 (1961); see also G.D. Parker, Inc. v. Commissioner, T.C.

Memo. 2012-327, at *44. We scrutinize closely transactions in which

dominant shareholders and executives receive corporate funds under

the label of business expenses. Greenspon v. Commissioner, 23 T.C. 138,

151 (1954), aff’d in part, rev’d in part, 229 F.2d 947 (8th Cir. 1956);

Wysong v. Commissioner, T.C. Memo. 1998-128, slip op. at 8 (“[T]o the

5 We have jurisdiction to consider facts related to closed years that are not

directly in issue to the extent that those facts may be relevant to our redetermination

of tax liabilities for the years that are before the Court. § 6214(b); Cluck v.

Commissioner, 105 T.C. 324 (1995). To redetermine the NOL deduction petitioners

claimed for 2012 we must examine the loss petitioners claimed they incurred in 2011.

8

[*8] extent that rent paid by a lessee to a related lessor is excessive, a

rental deduction will be disallowed.”).

Respondent disallowed deductions SEI claimed for the expenses

of renting the New York condominium from petitioner husband.

Petitioner husband testified that the purpose of the condominium was

to cause SEI to be perceived as a successful business in the New York

City market and to lodge SEI employees travelling there for business

matters. Heightened substantiation requirements apply to deductions

claimed under section 162 for expenses for lodging while away from

home.

§ 274(d)(1).

Section 274(d) requires that the taxpayer

substantiate either by adequate records or by sufficient evidence

corroborating the taxpayer’s own statement (1) the amount of the

expense, (2) the time and place the expense was incurred, (3) the

business purpose of the expense, and (4) in the case of an entertainment

or gift expense, the business relationship to the taxpayer of each expense

incurred. § 274(d) (flush language); see also Temp. Treas. Reg. § 1.2745T(b)(2).

To substantiate by adequate records, the taxpayer must provide

(1) an account book, a log, or a similar record, and (2) documentary

evidence, which together are sufficient to establish each element of an

expenditure. Temp. Treas. Reg. § 1.274-5T(c)(2)(i). Documentary

evidence includes receipts, paid bills, or similar evidence. Treas. Reg.

§ 1.274-5(c)(2)(iii). Although a contemporaneous log is not required, “the

probative value of written evidence is greater the closer in time it relates

to the expenditure or use.” Temp. Treas. Reg. § 1.274-5T(c)(1); see also

Larson v. Commissioner, T.C. Memo. 2008-187. In the absence of

adequate records to establish each element of an expense under section

274(d), a taxpayer may alternatively establish an element “(A) [b]y his

own statement, whether written or oral, containing specific information

in detail as to each element; and (B) [b]y other corroborative evidence

sufficient to establish such element.” Temp. Treas. Reg. § 1.2745T(c)(3)(i).

To substantiate the trade or business purpose of the rental

expenses, petitioners provided only credit card statements, calendars for

those years with dates circled purporting to be when petitioner husband

was in New York for business, and their testimony. Petitioner husband

testified that the calendars were prepared contemporaneously with his

New York visits to track days spent there for tax residency purposes.

9

[*9] Petitioners have failed to carry their burden of substantiating the

business purpose and the amounts of New York condominium rental

expenses for 2011 through 2014. The calendars, credit card statements,

and petitioner husband’s generalized testimony fail to do so because “a

written statement of business purpose generally is required.” See id.

subpara. (2)(ii)(B). The credit card statements and calendar prove

where petitioner husband was at the time of a transaction and the

amount of the transaction, but they do not provide the reason for the

expense or explain why petitioner husband was in New York at the time.

See Chico v. Commissioner, T.C. Memo. 2019-123, at *26, aff’d, 128

A.F.T.R.2d (RIA) 2021-6266 (9th Cir. 2021). Further, petitioner

husband’s testimony fails to substantiate business purpose by “other

sufficient evidence” because his generalized, self-serving statements

were unconvincing. He declined to provide examples of employees or

potential clients other than himself and his immediate family using the

New York condominium.

In addition to the lack of substantiation of a business purpose,

petitioner husband’s testimony detailed personal use of the New York

condominium, including family trips for the Thanksgiving holiday each

year, occasional trips in the summer, and petitioners’ daughter’s living

in the condominium while attending New York University for a

semester. See G.D. Parker, T.C. Memo. 2012-327, at *46–47 (finding

that use of property on personal trips and lodging for children to attend

school supported disallowance).

Petitioner husband began a

relationship with a woman in 2010, creating additional personal

motivations to be in New York throughout the years at issue. Lastly,

the fact that petitioner husband agreed at its closing to occupy the

condominium as his second home further indicates his intent to make

personal use of the property. For the foregoing reasons we sustain

respondent’s disallowance of the rental expense deductions claimed by

SEI for 2011–14.

II.

Depreciation Deductions

A depreciation deduction is allowed for reasonable exhaustion

and wear and tear of property used in a trade or business or held for the

production of income. § 167(a); Treas. Reg. § 1.167(a)-1(a). To

substantiate entitlement to a depreciation deduction, a taxpayer must

establish the trade or business use of the property and its depreciable

basis by showing the cost of the property, its useful life, and the

previously allowable depreciation.

Cluck, 105 T.C. at 337.

A

depreciation schedule alone is insufficient to substantiate the

10

[*10] deduction. See Holden v. Commissioner, T.C. Memo. 2015-131,

at *65–66.

Section 179 permits taxpayers to elect to deduct the full cost of

section 179 property for the year it is placed in service. § 179(a). Section

179 property includes tangible property to which section 168 applies.

§ 179(d)(1)(A)(i). To the extent the property is used for nonbusiness

purposes, the deduction is permitted for the portion of the cost of the

property attributable to the trade or business use. Treas. Reg. § 1.1791(d)(1). No deduction is permitted under section 179 where less than

50% of the property’s use is for trade or business purposes. Treas. Reg.

§ 1.179-1(d)(1).

Petitioners claimed depreciation deductions related to the

numerous home furnishings placed in the New York condominium for

the years at issue. Petitioner husband testified that these purchases,

totaling over $300,000, were necessary to show potential clients of SEI

that he had a home in New York City and was successful in and

committed to the market. Respondent disallowed these deductions and

petitioners’ prior year loss carryover claimed in 2011 resulting, in part,

from the disallowance of a $40,384 section 179 depreciation deduction

from a prior year relating to the furniture purchased for the New York

condominium.

As discussed with respect to the rental expenses petitioners failed

to substantiate any instance in which someone other than petitioners or

their immediate family stayed the New York condominium for a

business occasion. Further contradicting the claim that the depreciated

property was used in a trade or business is petitioners’ extensive use of

the condominium for personal reasons as described above. Petitioners

and their close family were the only individuals who enjoyed the use and

benefit of the furnishings. See § 262; Henry, 36 T.C. at 884. We sustain

the disallowance of the deductions claimed for each year at issue

relating to depreciation of such property.

To determine the annual wear and tear of tangible property, the

Code generally requires taxpayers to use the modified accelerated cost

recovery system outlined in section 168. Under section 168(k)(1)(A), the

depreciation deduction provided by section 167 includes a first-year

special allowance for qualified property acquired and placed in service

from September 9, 2010, through December 31, 2011. § 168(k)(5). For

2011 the first-year special allowance deduction was equal to 100% of the

adjusted basis of such qualified property. Id. “Qualified property”

11

[*11] includes any tangible property with a recovery period of 20 years

or less. § 168(k)(2)(A)(i)(I). Automobiles have a recovery period of five

years. § 168(e)(3)(B). Property for which trade or business use does not

exceed 50% of its total use is not “qualified property.” §§ 168(k)(2)(D),

280F(b)(1), (3).

Section 280F(a) limited the bonus depreciation deduction for

automobiles with less than 6,000 pounds of “unloaded gross vehicle

weight,” but no such limitation applies to automobiles with an “unloaded

gross vehicle weight” of more than 6,000 pounds. § 280F(d)(5)(A). For

2010 businesses could either elect to expense the cost of a qualifying new

vehicle under section 179 and depreciate the remaining cost basis, or, if

the property was used entirely for business purposes, depreciate the full

cost in the first year under the 100% bonus depreciation provision.

To substantiate a claimed deduction with respect to any “listed

property (as defined in section 280F(d)(4)),” a category including “any

property used as a means for transportation,” § 280F(d)(4), the taxpayer

must meet the heightened substantiation requirements under section

274(d), described above, § 274(d)(4). Relevant to the deduction claimed

for depreciation of the Range Rover, this includes “the business purpose

of the expense or other item.” § 274(d) (flush language).

Petitioners have not carried their burden of substantiating the

trade or business purpose of the Range Rover. Petitioner husband

provided a mileage log which he alleges shows the vehicle’s use in 2011.

The log indicates that of the miles driven in the Range Rover, 1,463

(95.43%) were for a trade or business purpose and 70 (4.57%) were for

personal use. Petitioner husband testified that he prepared the log

sometime in 2012 in anticipation of preparing his 2011 tax return. The

2011 tax return’s depreciation schedule, however, fails to report any

business use of the Range Rover.

The failure to report any use of the Range Rover on the 2011 tax

return contradicts petitioner husband’s testimony and suggests the

mileage log was prepared sometime after the filing of the 2011 return.

Further, the mileage log merely states where petitioner husband claims

he drove to and from on certain dates and the number of miles driven,

with no explanation of the business purpose of any trip. See Larson,

T.C. Memo. 2008-187, slip op. at 12–13 (finding mileage logs coupled

with highly probative testimony sufficient when, although not prepared

contemporaneously, logs were prepared on the basis of contemporaneous

records and were exhaustively detailed). The lack of business purpose

12

[*12] on the mileage log makes it insufficient to substantiate the

claimed deduction by adequate records, and petitioner husband’s

unconvincing testimony fails to do so by other sufficient evidence.

Accordingly, SEI is not entitled to depreciate the Range Rover under

section 167 or expense it under section 179.

III.

Net Operating Losses

In calculating the NOL amount for an individual taxpayer, only

certain deductions, including passthrough S corporation losses, are

considered. See § 172(c) and (d). Losses from an S corporation are

limited to the shareholder’s basis in his or her stock in the corporation

and any indebtedness of the S corporation to the shareholder.

§ 1366(d)(1). Any part of the loss in excess of the shareholder’s basis

may be carried forward indefinitely until the shareholder has an

adequate basis in the corporation to absorb the loss. § 1366(d)(2).

A taxpayer who claims an NOL deduction bears the burden of

establishing both the existence of the NOL and the amount that may be

carried over to the year involved. See Rule 142(a); Keith, 115 T.C. at 621

(citing Jones v. Commissioner, 25 T.C. 1100, 1104 (1956), rev’d and

remanded on other grounds, 259 F.2d 300 (5th Cir. 1958)). A taxpayer

claiming an NOL deduction must file with his return “a concise

statement setting forth the amount of the [NOL] deduction claimed and

all material and pertinent facts relative thereto, including a detailed

schedule showing the computation of the [NOL] deduction.” Treas. Reg.

§ 1.172-1(c).

Respondent determined that SEI’s 2010 taxable income should be

increased because of a basis adjustment and the disallowance of

deductions petitioners claimed for rental expenses and depreciation

relating to the New York condominium. Petitioners reported a loss in

2010. An increase to SEI’s 2010 taxable income results in a reduced

allowable NOL carryover from 2010 to 2011. Respondent further

determined that SEI’s NOL carryover from 2011 to 2012 should be

reduced because of (1) the reduced NOL carryover from 2010 to 2011,

(2) the disallowance of rental expense and depreciation deductions

relating to the New York condo, and (3) the disallowance of the

depreciation deduction relating to the Range Rover.

Petitioners have not established their incurrence of and

entitlement to deduct losses related to the rental expenses and

depreciation of the New York condominium or depreciation of the Range

13

[*13] Rover.

Petitioners have not met their burden to claim

corresponding NOL deductions. Petitioners’ 2011 and 2012 NOL

deductions must be recomputed accordingly.

IV.

Penalties

Respondent determined an accuracy-related penalty under

section 6662(a) for each year at issue. Section 6662(a) imposes a 20%

accuracy-related penalty on any portion of an underpayment of tax

required to be shown on a return if, as provided by section 6662(b)(1),

the underpayment is attributable to “[n]egligence or disregard of rules

or regulations.” Negligence includes “any failure to make a reasonable

attempt to comply” with the internal revenue laws, and “disregard”

includes “any careless, reckless, or intentional disregard.” § 6662(c).

Negligence also includes any failure by the taxpayer to keep adequate

books and records or to substantiate items properly. Treas. Reg.

§ 1.6662-3(b)(1). The initial determination of such penalties must be

personally approved in writing by the immediate supervisor or other

such official designated by the Secretary to give such approval.

§ 6751(b)(1). Petitioners do not dispute that respondent met the

requirements of section 6751(b).

The accuracy-related penalty does not apply with respect to any

portion of the underpayment for which the taxpayer shows reasonable

cause and good faith. § 6664(c)(1); see Higbee v. Commissioner, 116 T.C.

438, 446–47 (2001). Reasonable reliance on informed, competent

professionals may establish reasonable cause. United States v. Boyle,

469 U.S. 241, 250–51 (1985). A taxpayer claiming reliance on their

advisers must establish by a preponderance of the evidence that (1) the

adviser was competent and possessed sufficient experience to justify

reliance, (2) the taxpayer provided accurately all necessary information

to the adviser, and (3) the taxpayer relied on the adviser’s judgment in

good faith. Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99

(2000), aff’d, 299 F.3d 221 (3d Cir. 2002). Whether a taxpayer relies on

an adviser and whether such reliance is reasonable depends upon all

pertinent facts and circumstances of the case. Treas. Reg. § 1.66644(c)(1).

Petitioner husband claims that he is not liable for the determined

penalties because of his reliance on tax advisers concerning the items

respondent disallowed. Mr. Kenney testified that he, a small business

attorney, and petitioner husband had substantial discussions about the

need to maintain a proper business use of the property. Given petitioner

14

[*14] husband’s business experience, financial sophistication, and the

manner in which he used the assets in question, we do not believe that

he was unaware of the need to track business use, or that his claimed

reliance on his advisers was in good faith.

The penalty does not apply to a portion of an understatement

attributable to a taxpayer’s tax treatment of an item “if there is or was

substantial authority for such treatment.” § 6662(d)(2)(B). An authority

that “is materially distinguishable on its facts from the facts of the case

at issue” is “of little relevance.” Antonides v. Commissioner, 91 T.C. 686,

702–03 (1988), aff’d, 893 F.2d 656 (4th Cir. 1990); see Treas. Reg.

§ 1.6662-4(d)(3)(ii).

Petitioners argue that Norman E. Duquette, Inc. v. Commissioner,

T.C. Memo. 2001-3, provided substantial authority for their positions

with respect to the New York condominium. The facts of Norman E.

Duquette, however, are materially distinguishable from those of

petitioners’ case. Petitioners are correct that in Norman E. Duquette a

shareholder of a C corporation used an apartment instead of hotels for

his business travels in order to reduce his expenses. In contrast to the

facts of this case, the shareholder in Norman E. Duquette substantiated

his expenses. Further, petitioners did not show that the condominium

was a cost savings for SEI. They have pointed to no other authority

supporting their positions in this case, and they do not qualify for the

substantial authority exception to the determined penalties.

Accordingly, petitioners are liable for the section 6662(a)

penalties.

V.

Innocent Spouse Relief

Generally, spouses who file a joint tax return are each fully

responsible for the accuracy of that return and the full tax liability under

section 6013(d)(3). Butler v. Commissioner, 114 T.C. 276, 282 (2000). A

spouse may seek relief from this joint and several liability under section

6015(b) or, if eligible, may allocate liability under section 6015(c). If

relief is not available under subsection (b) or (c), a requesting spouse

may seek equitable relief under subsection (f). Petitioner wife seeks

relief pursuant to section 6015(f) for items attributable to the

15

[*15] nonrequesting spouse. 6 See Rev. Proc. 2013-34, 2013-43 I.R.B.

397, modifying and superseding Rev. Proc. 2003-61, 2003-2 C.B. 296.

We apply a de novo standard of review to any determination made

by the Commissioner under section 6015. Porter v. Commissioner, 132

T.C. 203, 210 (2009), superseded in part by statute, Taxpayer First Act,

Pub. L. No. 116-25, § 1203, 133 Stat. 981, 988 (2019). For this case, we

will also employ a de novo scope of review. 7 Petitioner husband contends

petitioner wife is not entitled to relief on the basis that she had

knowledge of the understatements at the time she signed the joint

returns. Respondent has conceded that petitioner wife is entitled to

innocent spouse relief.

Section 6015(f)(1) permits relief from joint and several liability if

it would be inequitable to hold the requesting spouse liable for any

unpaid tax or deficiency. Under section 6015(f), the Secretary may grant

equitable relief to a requesting spouse on the basis of the facts and

circumstances. Petitioner wife bears the burden of proving that she is

entitled to equitable relief under section 6015(f). See Rule 142(a); Porter,

132 T.C. at 210.

The Commissioner has specified in Rev. Proc. 2013-34 the

procedures governing equitable relief. Although we are not bound by

Rev. Proc. 2013-34, and our determination ultimately rests on an

evaluation of all the facts and circumstances, we will analyze petitioner

wife’s request under the guidelines set forth therein to ascertain

whether she satisfies the requirements for relief.

See Pullins

v. Commissioner,

136

T.C.

432,

438–39

(2011);

Johnson

v. Commissioner, T.C. Memo. 2014-240, at *10.

Rev. Proc. 2013-34, § 4.01, 2013-43 I.R.B. at 399–400, sets forth

seven threshold conditions that must be satisfied before the requesting

6 In her posttrial briefs petitioner wife requested innocent spouse relief

pursuant only to section 6015(f). We deem her to have abandoned her request for relief

under section 6015(b) and (c). See Thiessen v. Commissioner, 146 T.C. 100, 106 (2016);

Mendes v. Commissioner, 121 T.C. 308, 312–13 (2003).

7 Section 6015(e)(7) prescribes the scope of review the Tax Court shall employ

in cases such as this one. Paragraph (7) was added to section 6015 by Taxpayer First

Act § 1203, 133 Stat. at 988, and applies to petitions for review of determinations made

under section 6015 filed on or after July 1, 2019, and requests pending with the

Internal Revenue Service on or after July 1, 2019. See Sutherland v. Commissioner,

155 T.C. 95, 104 (2020). Section 6015(e)(7) does not apply because respondent did not

issue a notice of determination. The scope of review in this case is established by

Porter, 132 T.C. at 206–10.

16

[*16] spouse will be eligible for equitable relief under section 6015(f).

The parties do not dispute that the seven threshold requirements are

met.

The second step of the analysis provides three conditions that, if

met, will qualify a requesting spouse for a streamlined determination of

relief under section 6015(f). Rev. Proc. 2013-34, § 4.02, 2013-43 I.R.B.

at 400. Petitioner wife is not eligible for a streamlined determination

because one requirement is that the requesting spouse would suffer

economic hardship if relief were not granted. See id. Petitioner wife did

not contend that she would suffer economic hardship if denied relief.

The third step is available if the requesting spouse satisfies the

threshold conditions but fails to satisfy the conditions for a streamlined

determination. Id. § 4.03, 2013-43 I.R.B. at 400. A requesting spouse

may still be eligible for equitable relief under section 6015(f) if,

considering all the facts and circumstances, it would be inequitable to

hold the requesting spouse liable for the unpaid deficiency. Rev. Proc.

2013-34, § 4.03. Rev. Proc. 2013-34, § 4.03, 2013-43 I.R.B. at 400–03,

lists the following nonexclusive factors: (1) marital status; (2) economic

hardship; (3) knowledge, or reason to know, of the item giving rise to the

deficiency; (4) legal obligation; (5) significant benefit; (6) compliance

with tax laws; and (7) mental or physical health.

We find that most of the factors are neutral. Looking at the facts

and circumstances, the factors with the most relevance to this case are

knowledge or reason to know of the item giving rise to the deficiency and

significant benefit.

Petitioner husband contends that petitioner wife had knowledge

of the items that give rise to the deficiency, including the disallowance

of deductions for rental expenses and depreciation for the New York

condominium, and depreciation deductions relating to the Range Rover.

If the requesting spouse did not have actual knowledge or reason to

know of the understatement at the time of the filing of the joint return,

this factor favors relief. Id. § 4.03(c)(i)(A), 2013-43 I.R.B. at 401. Actual

knowledge of the item will not be weighed more heavily than another

factor. Id. The facts and circumstances considered in determining

whether the requesting spouse has reason to know of an understatement

include, but are not limited to, the requesting spouse’s level of education,

deceit or evasiveness of the nonrequesting spouse, the requesting

spouse’s degree of involvement in the activity generating the income tax

liability, the requesting spouse’s involvement in business or household

17

[*17] financial matters, the requesting spouse’s business or financial

expertise, and lavish or unusual expenditures compared with past

spending levels. Id. § 4.03(c)(iii), 2013-43 I.R.B. at 402.

Petitioner wife attended college and was a trained nutritionist,

but she did work SEI during the years at issue. During this time,

however, she was the wellness coordinator. She signed checks but was

not responsible for any other accounting function. Ms. Hinkle was the

in-house accountant for the years at issue and was responsible for all

regular accounting tasks. Petitioner husband, in consultation with

SEI’s outside accountant, was responsible for the purchase of and

accounting concerning the Range Rover. Petitioner wife was not

involved with keeping the mileage log for the Range Rover nor in the

claim that it was used for business purposes.

Petitioner wife was involved in household financial matters, but

there is no evidence linking her to SEI’s business decision making.

There is also no evidence showing that petitioner wife was aware of her

husband’s lease with SEI regarding the condominium. Petitioner wife

traveled to New York infrequently compared to her husband. She went

to New York for some family holidays. She had no reason to question

that her husband was staying in the condominium because of business

in New York.

Petitioner husband was deceitful in his relationship with his wife.

He hid his affair and opened a secret credit card to hide spending

associated with it. He funded the affair by diverting marital assets

unbeknownst to petitioner wife.

Considering all the facts and

circumstances, petitioner wife did not have reason to know of the

understatements.

The other relevant factor is whether the requesting spouse

significantly benefited from the understatement. A significant benefit

is any benefit in excess of normal support. Id. § 4.03(e), 2013-43 I.R.B.

at 402. Petitioner wife did not benefit at all from the Range Rover, and

she rarely stayed in the New York condominium. She received only a

minimal benefit from the condominium, and she would likely have

received the same benefit when visiting petitioner husband in New York

if he had continued staying in hotels. There is no evidence that

petitioner wife made large expenditures or received lavish benefits.

18

[*18] Taking into consideration these two factors, we conclude that

petitioner wife is eligible for innocent spouse relief pursuant to section

6015(f).

We have considered all of the parties’ arguments and, to the

extent they are not addressed herein, we find them to be moot,

irrelevant, or without merit.

To reflect the foregoing,

Decision will be entered under Rule 155.