104 T.C. 518 (T.C. 1995), 25076-92, Tippin v. Commissioner of Internal Revenue
|Citation:||104 T.C. 518, 104 T.C. No. 26|
|Opinion Judge:||JACOBS, Judge:|
|Party Name:||James W. Tippin and Billie R. Tippin, Petitioners v. Commissioner of Internal Revenue, Respondent|
|Attorney:||James W. Tippin, pro se. Charles J. Graves, for respondent.|
|Case Date:||April 27, 1995|
|Court:||United States Tax Court|
As Amended April 28, 1995
Decision will be entered under Rule 155.
P is an attorney who operates his law practice as a sole proprietorship. During the years under consideration, he had six employees. The IRS filed Notices of Federal Tax Liens against Ps. The tax liens related to Ps' unpaid Federal income tax liabilities, interest, and penalties for 1983, 1984, 1985, and 1986, totaling approximately $ 67,000. Subsequently, P filed for protection under ch. 11 of the Bankruptcy Code. At that time, receivables due P's law practice totaled approximately $ 20,000. P filed an application to use the receivables of his law practice. The bankruptcy court ordered P to pay $ 850 per month to the IRS as adequate protection with respect to the law practice's receivables. The order did not mandate how the IRS was to apply the $ 850 payments. The IRS applied the $ 850 payments to offset tax, penalties, and interest, in that order, for the earliest period and then for the next succeeding period until the payments were absorbed. Ps deducted the $ 850 payments as business interest on Schedules C attached to their Federal income tax returns for the years under consideration.
1. Held, the adequate protection payments do not constitute business interest.
2. Held, further, the IRS had the authority to allocate the payments as it did.
3. Held, further: No portion of the payments is deductible. The portion applied to interest on Ps' tax deficiencies for prior years is a nondeductible personal interest expense.
Ps reported the income and expenses of P's law practice using the cash receipts and disbursements method. Ps deducted the gross wages paid to the employees of P's law practice. R disallowed a deduction for income tax, FICA, and FUTA taxes that were unpaid in the year in which a deduction for such taxes was claimed. Rather, R allowed a deduction for such taxes in the subsequent year, when such taxes were paid.
1. Held: Ps are entitled to deductions for the gross wages of the employees of P's law practice. The gross wages include each employee's share of the FICA tax as well as each employee's income tax wage withholdings.
2. Held, further, Ps are not entitled to deduct either the FUTA taxes or P's share of FICA taxes until the year in which such taxes are paid.
Respondent determined the following deficiencies in, and additions to, petitioners' Federal income taxes:
Accuracy- related Additions to tax penalty Sec. Sec. Sec. Sec. Year Deficiency 6651(a)(1) 6653(a)(1) 6661 6662(a) 1988 $ 7,879 $ 1,970 $ 1,219 $ 1,970 __ 1989 14,274 714 __ __ $ 2,855 1990 17,079 __ __ __ 3,416
Page 520 After concessions,  the issues for decision are: (1) Whether petitioners are entitled to Schedule C deductions for bankruptcy court-ordered adequate protection payments made during 1988, 1989, and 1990; (2) whether petitioners are entitled to Schedule C deductions for wages paid during 1988, 1989, and 1990 in excess of the amounts allowed in the notice of deficiency; (3) whether petitioners are entitled to Schedule C deductions for unemployment taxes and the employer's portion of employment taxes paid during 1989 and 1990 in excess of the amounts allowed in the notice of deficiency; (4) whether petitioners are liable for section 6651(a)(1) additions to tax for filing delinquent 1988 and 1989 returns; (5) whether petitioners are liable for the addition to tax for negligence or intentional disregard of rules or regulations pursuant to section 6653(a)(1) for 1988, and for the accuracy-related penalty for negligence under section 6662(a) for 1989 and 1990; and (6) whether petitioners are liable for the addition to tax for substantial understatement pursuant to section 6661 for 1988.
1988 Per Per Item return stipulation Total income $ 71,902.00 $ 71,910 Car and truck expense 2,000.00 800 Mortgage interest 10,937.15 9,883 Utilities expense 6,208.73 6,429 Miscellaneous expenses 6,179.76 6,180 1989 Total income 53,554.00 53,565 Car and truck expense 1,500.00 931 Mortgage interest 3,177.52 3,160 Rent 15,014.37 13,200 Client advances 4,231.50 4,420 Miscellaneous expenses 11,402.88 5,246 1990 Car and truck expense 2,500.00 1,277 Utilities expense 8,851.40 8,851 Client advances 17,136.69 14,004 Miscellaneous expenses 24,234.92 18,070
Unless otherwise indicated, all section and chapter references are to the Internal Revenue Code in effect for the years under consideration. All Rule references are to the Tax Court Rules of Practice and Procedure. The facts in this case have been fully stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference. Page 521 Background Petitioners James W. and Billie R. Tippin  resided in Leawood, Kansas, at the time they filed their petition. Petitioners untimely filed Federal income tax returns for 1988 and 1989. Pursuant to extensions, petitioners' 1988 and 1989 Federal income tax returns were due on October 15, 1989, and August 15, 1990, respectively. Both returns were filed on September 4, 1990. Petitioners timely filed their 1990 Federal income tax return. Respondent timely mailed a notice of deficiency to petitioners for the years under consideration. Petitioner is an attorney who operates his law practice as a sole proprietorship. During the years under consideration, he had six employees. Petitioner's areas of expertise are tax and bankruptcy law. The income and deductions relating to petitioner's law practice were deducted on Schedules C attached to petitioners' Federal income tax returns. 1. Bankruptcy Proceedings On November 18, 1987, and April 20, 1988, the Internal Revenue Service (IRS) filed Notices of Federal Tax Liens against petitioners in Johnson County, Kansas. The tax liens related to petitioners' unpaid Federal income tax liabilities, interest, and penalties for 1983, 1984, 1985, and 1986, totaling $ 67,153.74. On June 29, 1988, petitioner filed for protection under chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the District of Kansas (bankruptcy court). At that time, receivables due petitioner's law practice totaled approximately $ 20,000. The IRS had a secured interest in all of these receivables. On July 1, 1988, petitioner filed an " Application to Use Cash Collateral in the Ordinary Course of Business and Motion to Reduce Time for Notice and to Limit Notice" in the bankruptcy court. A hearing with respect to petitioner's application was held on July 11, 1988. At the hearing, petitioner requested that in the event adequate protection payments  Page 522 to the IRS were ordered, the payments be applied to petitioners' back taxes rather than to interest or penalties. On September 10, 1988, the bankruptcy court entered an " Order of Adequate Protection and For Use of Cash Collateral" . Among other things, the bankruptcy court's order provided that petitioner " shall be allowed to use cash collateral of the United States in the form of accounts receivable", and granted the IRS " a continuing interest in the debtor's accounts receivable" . Pursuant to the order, petitioner was required to pay $ 850 per month to the IRS as adequate protection with respect to the law practice's receivables. The order did not mandate how the IRS was to apply the $ 850 payments. In response to a request from the bankruptcy court, the United States/IRS filed a " Proof of Claim for Internal Revenue Taxes" on November 16, 1988 (amending and superseding a prior proof of claim filed on July 18, 1988). The proof of claim asserted that petitioners were liable for the following amounts as of the date of the bankruptcy petition:
Penalty Interest to to Tax Date tax petition petition Notice of period assessed Tax due date date lien filed 12/31/83 4/28/86 $ 1,739.50 $ 3,411.87 $ 5,209.59 11/18/87 12/31/84 7/27/87 12,259.00 6,507.39 5,711.78 11/18/87 12/31/85 2/15/88 11,725.00 5,010.41 3,334.46 4/20/88 12/31/86 2/22/88 12,470.00 4,468.10 1,874.07 4/20/88
On January 5, 1994, the bankruptcy court entered a decree closing the chapter 11 case. Petitioner made the required adequate protection payments to the IRS during the years under consideration. These payments totaled $ 4,250 in 1988, $ 10,200 in 1989, and $ 9,350 in 1990. The IRS applied the payments first to Page 523 petitioners' 1983 and 1984 overdue taxes, then to penalties, and finally to interest, as follows: 
1983 1984 Taxes $ 1,725.00 $ 12,229.00 Penalties 4,237.91 2,099.54 Interest 5,208.55 __
On Schedules C, petitioners deducted as interest all of the adequate protection payments made to the IRS.  Respondent disallowed the claimed interest deductions. 2. Wage Withholdings...
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