CHARLES L. FROST, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 30020-15
United States Tax Court
January 7, 2020
154 T.C. No. 2
P, a self-employed insurance salesman and consultant, traveled between Oregon and Texas to service clients and to address personal issues. During the years in issue P prepared his own tax returns and deducted expenses on his Schedules C, Profit or Loss From Business, related to his travels. He also deducted on his 2011 Schedule E, Supplemental Income and Loss, his distributive share of a loss related to an LLC in which he owned an 80% membership interest. After an administrative appeal, the IRS Office of Appeals issued notices of deficiency to P for 2010, 2011, and 2012 that reduced P’s Schedule C deductions, disallowed his entire 2011 Schedule E deduction, and imposed
Held: R’s adjustments to P’s Schedules C and Schedule E deductions are sustained.
Held, further, R bears the initial burden of production under
Held, further, R has not met his initial burden of producing evidence that his agent complied with
Held, further, R satisfied his initial burden of producing evidence that his agent complied with
Held, further, once R has satisfied his initial burden of production under
Held, further, as to the 2012 accuracy-related penalty, P has not introduced evidence, nor does the record support a conclusion, that R made any formal communication of his initial penalty determination before the date that the examining agent‘s manager signed the Civil Penalty Approval Form.
Held, further, R has shown that P‘s underpayment for 2012 was due to a substantial understatement of income tax and P has not shown that he had reasonable cause for his underpayment for 2012, so P is liable for the 2012 accuracy-related penalty.
Gabriel Nuñez-Lafontaine, for respondent.
PUGH, Judge: In two notices of deficiency, dated September 1, 2015,1 respondent determined the following deficiencies and penalties:2
| Year | Deficiency | Penalty sec. 6662(a) |
|---|---|---|
| 2010 | $19,413 | $3,883 |
| 2011 | 20,907 | 4,181 |
| 2012 | 6,095 | 1,219 |
The issues for decision are whether petitioner is: (1) entitled to deduct expenses reported on his Schedules C, Profit or Loss From Business, for the years in issue, (2) entitled to deduct a $28,187 loss from www.retirewell.org, LLC (Retirewell.org), for 2011, and (3) liable for
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulated facts are incorporated in our findings by this reference.
I. Background
Petitioner resided in New Mexico when he timely filed his petition. During the years in issue he was self-employed as an insurance salesman and consultant with Oregon as his principal place of business. Petitioner moved to Oregon in 2005 to work with his brother-in-law and to expand his business.
During the years in issue petitioner served 224 clients throughout Oregon. He also served a much smaller number of clients in several other States, including 14 clients in Texas. While petitioner traveled between Oregon and Texas to service his Texas clients, he mostly traveled to Texas for
Petitioner also owned an 80% membership interest in Retirewell.org, a limited liability company that he organized in Texas in 2011 and treated as a partnership for Federal income tax purposes. Retirewell.org was an information and advertising company focused on promoting health and fiscal awareness. Two other individuals, Robert and Judy Bigman, each owned a 10% membership interest in the company.
During 2011 and 2012 Retirewell.org did not earn any income or incur any liabilities. While the Bigmans each made a $25,000 capital contribution to the company around 2011, petitioner did not make any capital contribution to the company in 2011 or 2012.
Petitioner also prepared tax returns as an enrolled agent with the Internal Revenue Service (IRS) during the years in issue.3 He has prepared returns for profit as an enrolled agent for about 25 years. Before becoming an enrolled agent, petitioner had performed collections work as an IRS revenue agent. During almost 40 years of work at the IRS and then preparing tax returns, petitioner was aware of and advised his clients about tax compliance issues such as the substantiation requirements for expenses related to business deductions. He continued to prepare returns, including his own and others, during the years in issue, despite his health and personal challenges.
II. Tax Returns
A. Petitioner‘s Individual Tax Returns
Petitioner prepared and timely filed Forms 1040, U.S. Individual Income Tax Return, for the years in issue. For 2010
1. 2010 and 2011
On his 2010 and 2011 Forms 1040 petitioner reported $37,764 and $26,335 of business income, respectively. On his 2010 and 2011 Schedules C petitioner reported $118,565 and $77,051 of gross profits, respectively. Petitioner offset these profits in part with business expense deductions, including travel and meal and entertainment expenses related to his trips between Oregon and Texas. These deductions, which respondent adjusted in whole or in part, are listed below:
| Expense | 2010 | 2011 |
|---|---|---|
| Contract labor | $1,700 | $2,266 |
| Other | 31,415 | 9,707 |
| Utilities | 1,440 | 2,009 |
| Meals and entertainment | 1,233 | 2,781 |
| Travel | 11,450 | 11,153 |
| Taxes and licenses | 3,100 | 3,685 |
| Supplies | 7,100 | 1,686 |
| Rent or lease | 4,200 | 2,100 |
| Office | 4,800 | 2,067 |
| Car and truck | 10,447 | 12,133 |
| Advertising | 6,671 | 3,778 |
On his 2011 Form 1040 petitioner also reported a $28,187 loss related to his distributive share of Retirewell.org‘s losses. Family strife in 2012 made access to certain records for 2010 and 2011 difficult.
2. 2012
On his 2012 Form 1040 petitioner reported $56,576 of business income. On his 2012 Schedule C he reported $107,678 of gross profit. Petitioner offset this profit in part with business expense deductions, including travel expenses related to his trips between Oregon and Texas. These deductions, which respondent adjusted in whole or in part, are listed below:
| | Amount |
|---|---|
| Travel | $6,312 |
| Car and truck | 6,755 |
| Advertising | 14,990 |
B. Retirewell.org‘s Tax Return
Petitioner also prepared and timely filed a Form 1065, U.S. Return of Partnership Income, for Retirewell.org for 2011. Petitioner listed the same San Antonio address on the Form 1065 that he listed on his Form 1040, as well as the Schedule K-1, Partner‘s Share of Income, Deductions, Credits, etc., attached to the Form 1065 identifying his interest in the company. The other attached Schedules K-1 each listed an address in Philomath, Oregon, for the Bigmans.
Retirewell.org reported $35,234 of business expenses it had incurred in 2011 without any offsetting income. A list of those business expenses, titled “Supporting Statement #1“, was attached to the Form 1065. The amounts for many of these business expenses (e.g., advertising, office, utilities, travel, postage, and printing) were nearly identical to the amounts for business expenses that petitioner reported on his 2011 Schedule C.
III. Respondent‘s Determinations
Respondent‘s Office of Appeals issued the notices of deficiency to petitioner after an administrative appeal. Respondent reduced petitioner‘s Schedule C deductions by $39,709, $34,678, and $13,204 for 2010, 2011, and 2012, respectively. Respondent also disallowed petitioner‘s entire Schedule E deduction related to the Retirewell.org loss for 2011.
As a result of these adjustments, respondent determined that petitioner owed an additional $19,413, $20,907, and $6,095 of tax for 2010, 2011, and 2012, respectively. Respondent also determined underpayment penalties under
OPINION
I. Burden of Proof
Ordinarily, the burden of proof in cases before the Court is on the taxpayer.
Petitioner makes no argument that the conditions for shifting the burden of proof have been met. He also has not established his compliance with the substantiation requirements governing the deductions in issue as explained below. Petitioner therefore bears the burden of proof.
II. Petitioner‘s Income
A. Schedule C Deductions
A taxpayer must prove his entitlement to any deductions and credits claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers, therefore, are required to maintain sufficient records to establish the amount of the deduction to enable the Commissioner to determine the correct tax liability.
However,
Despite his extensive experience preparing tax returns as an enrolled agent, petitioner submitted no evidence in support of his claimed business expense deductions aside from a list of clients and a calendar he created solely from memory during the examination. Petitioner not only failed to comply with the strict substantiation requirements for expenses covered by
We therefore need not consider respondent‘s second challenge to petitioner‘s travel expenses, namely, whether petitioner‘s tax home was in Oregon or Texas.
B. Schedule E Loss Deduction
Respondent contends that petitioner cannot deduct a $28,187 Schedule E distributive share of partnership losses for 2011 because he has failed to substantiate his basis in Retirewell.org. A deduction for a partner‘s distributive share of partnership losses is allowed only to the extent of the adjusted basis of the partner‘s interest in the partnership at the end of the partnership year in which the losses occurred, and the losses cannot reduce the partner‘s basis below zero.
Petitioner has provided no credible evidence of his adjusted basis. The only evidence he did provide consisted of his and Retirewell.org‘s tax returns. We have held previously that a taxpayer‘s returns do not substantiate deductions or losses because they are nothing more than statements of his claims.
III. Validity of the Notices of Deficiency
Petitioner‘s arguments regarding the validity of the notices of deficiency center on the procedures by which respondent selected his returns for examination. This Court has long held that we generally do not look behind a notice of deficiency to question the procedures the Commissioner followed leading up to the issuance of the notice. See, e.g., Greenberg‘s Express, Inc. v. Commissioner, 62 T.C. 324 (1974). Petitioner has not alleged or shown that respondent‘s conduct was either unconstitutional or sufficiently egregious as to jeopardize the integrity of the judicial process. See id. at 328; see also Green v. Commissioner, 322 F. App‘x 412, 417 (5th Cir. 2009) (citing Portillo v. Commissioner, 932 F.2d 1128, 1133-1134 (5th Cir. 1991) (discussing exception), aff‘g in part, rev‘g in part T.C. Memo. 1990-68), aff‘g T.C. Memo. 2008-130. Accordingly, the Court will not look behind the notices or investigate the motives behind their issuance.
IV. Penalties
The Commissioner bears the burden of production with respect to an individual taxpayer‘s liability for any penalty, addition to tax, or additional amount, requiring the Commissioner to come forward with sufficient evidence indicating that imposition of penalties is appropriate. See
We recently concluded that “the ‘initial determination’ of a penalty assessment--the ‘consequential moment’ of IRS action * * *--is embodied in the document by which the Examination Division formally notifies the taxpayer, in writing, that it has completed its work and made an unequivocal decision to assert penalties.” Belair Woods, LLC v. Commissioner, 154 T.C. ___, ___ (slip op. at 24-25) (Jan. 6, 2020) (quoting Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir. 2017), aff‘g in part, rev‘g in part T.C. Memo. 2015-42). And our recent cases have focused primarily on what constitutes the “consequential moment“. E.g., id. at ___ (slip op. at 23-25); Kestin v. Commissioner, 153 T.C. ___, ___ (slip op. at 27) (Aug. 29, 2019); Clay v. Commissioner, 152 T.C. at 249.
While we have held that the Commissioner‘s initial burden of production under
In Wheeler v. Commissioner, 127 T.C. 200 (2006), aff‘d, 521 F.3d 1289 (10th Cir. 2008), we expanded on our analysis of
We held that the Commissioner‘s burden of production with respect to the
We held that the Commissioner‘s burden of production with respect to the
Finally, we held that the Commissioner‘s burden of production with respect to the
Following our methodology of Higbee and Wheeler we hold that if the taxpayer has challenged the Commissioner‘s penalty determinations, the Commissioner must come forward with evidence of penalty approval as part of his initial burden of production under
Here, respondent produced no evidence of written supervisory approval of the initial determination of
We therefore must decide whether respondent‘s evidence showing that a penalty was approved before a formal communication of the penalty to petitioner (here, the notice of deficiency) is sufficient to satisfy his initial burden of production. If so, then the burden shifts to petitioner to introduce contrary evidence. But if instead respondent must also show as part of his initial burden of production that there were no formal communication(s) to petitioner about the penalty before the penalty was approved, then respondent has failed to meet his burden.
We hold that the Commissioner‘s introduction of evidence of written approval of a penalty before a formal communication of the penalty to the taxpayer is sufficient to carry his initial burden of production under
The burden now shifts to petitioner to offer evidence suggesting that the approval of the substantial understatement penalty was untimely--e.g., that there was a formal communication of the penalty before the proffered approval. If a taxpayer makes that showing, we will weigh the evidence before us to decide whether the Commissioner satisfied the requirements of
Here, petitioner has not claimed, nor does the record support a conclusion, that respondent formally communicated his initial penalty determination to petitioner before the date that the examining agent’s manager signed the Civil Penalty Approval Form approving the substantial understatement penalty. We therefore hold that the substantial understatement penalty for 2012 was approved in writing before the first formal communication to petitioner of the penalty. See Clay v. Commissioner, 152 T.C. at 249.
Because respondent complied with the requirements of
The decision as to whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. See
Petitioner argues that his and his brother-in-law‘s health issues and family strife provide reasonable cause for his underpayment for 2012. But petitioner was an enrolled agent
Any contentions we have not addressed we deem irrelevant, moot, or meritless.
To reflect the foregoing,
An appropriate decision
will be entered.