Shea v. Comm'r of Internal Revenue

• Decision Date: 01 April 1999
• Docket Number: 23549–96.,No. 10841–95,10841–95
• Citation: 112 T.C. No. 14,112 T.C. 183
• Parties: John D. SHEA, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

112 T.C. 183
112 T.C. No. 14

John D. SHEA, Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 10841–95

23549–96.

United States Tax Court.

April 1, 1999.

[112 T.C. 183]

P and his wife filed joint returns for 1990 and 1991. P submitted a delinquent return for 1992 that was filed as a joint return. R determined that P underreported business receipts for 1990, 1991, and 1992 based on deposits to P's bank accounts and also disallowed business deductions claimed on P's returns. In the notice of deficiency for 1992, R determined that P's proper filing status for 1992 was married filing separately.Even though P and his wife remained married throughout 1992, R did not allocate one-half of P's income for 1992 to P's wife pursuant to California community property law. Sec. 66(b), I.R.C., authorizes R to disallow the benefits of any community property law to P if P acted as if he were solely entitled to the income in question and failed to notify his wife of the nature and amount of such income. On brief, R relies exclusively on sec. 66(b), I.R.C., as justification for denying the benefits of community property law to P. However, R's

[112 T.C. 184]

notice of deficiency contained no reference to sec. 66(b), I.R.C., nor did it refer to any facts that would support a sec. 66(b), I.R.C., determination. A determination of whether or not sec. 66(b), I.R.C., applies requires the presentation of different evidence than that necessary to decide the matters described in the notice of deficiency.Held: R's determinations of additional gross receipts and disallowance of deductions are, with certain modifications, upheld.Held, further: Sec. 7522, I.R.C., requires that a notice of deficiency contain a description of the basis for the Commissioner's tax determination. Where R relies on a basis that was not described in the notice of deficiency that requires the presentation of different evidence, it is “new matter” within the meaning of Rule 142(a), Tax Court Rules of Practice and Procedure. If the new matter is allowed to be raised, Rule 142(a), Tax Court Rules of Practice and Procedure, requires that R bear the burden of proof. The burden of proof regarding application of sec. 66(b), I.R.C., is on R. R failed to meet this burden; therefore, P is entitled to the benefits of California's community property law for the taxable year 1992.David M. Kirsch, for petitioner.

Dale A. Zusi, for respondent.

OPINION RUWE, J.

Respondent determined deficiencies in petitioner's Federal income taxes, an addition to tax, and accuracy-related penalties as follows:

+-----------------------------------------------------------------------------+
                ¦Year¦Deficiency¦Addition to Tax Sec. 6651 ¦Accuracy-related Penalty Sec. ¦
                ¦ ¦ ¦(a)(1) ¦6662(a) ¦
                +-----------------------------------------------------------------------------¦
                ¦ ¦
                +-----------------------------------------------------------------------------¦
                ¦1990¦$155,096 ¦— ¦$31,019 ¦
                +----+----------+---------------------------+---------------------------------¦
                ¦1991¦165,529 ¦— ¦33,106 ¦
                +----+----------+---------------------------+---------------------------------¦
                ¦1992¦138,529 ¦$34,632 ¦27,706 ¦
                +-----------------------------------------------------------------------------+
                

Respondent determined that petitioner substantially underreported gross receipts during the years in issue based on deposits made to petitioner's bank accounts. After concessions, the issues for decision are whether petitioner has substantiated business deductions claimed on his 1990, 1991, and 1992 Federal income tax returns and whether petitioner is entitled to the benefit of California's community property law in calculating his 1992 income tax liability.¹ In order to decide the second issue, we must determine whether

[112 T.C. 185]

respondent's reliance on section 66(b) ² to disregard the community property law of California raises a “new matter” on which respondent bears the burden of proof and, if so, whether respondent has met that burden.

Some of the facts have been stipulated and are so found. The first, second, third, and fourth stipulations of fact are incorporated herein by this reference. Petitioner's legal residence was in Campbell, California, at the time he filed his petitions. For convenience, we will combine our findings of fact with our opinion.

In each of the years in issue, petitioner was married to Flor Shea. Petitioner and Mrs. Shea were divorced in 1993. Petitioner filed timely joint returns with Mrs. Shea in 1990 and 1991. Petitioner's 1992 return was filed on March 31, 1995, as a joint return. In the notice of deficiency for 1992, respondent determined that petitioner's correct filing status was married filing separately. The notice also contains various consequential adjustments. The parties now agree that married filing separately is the correct 1992 filing status for petitioner.

In each of the years in issue, petitioner was the owner and operator of an unincorporated consulting business known as Shea Technology Group, hereafter referred to as STG. Petitioner reported income and deductions from this business on Schedule C, Profit or Loss From Business, in each of the years in issue. The parties now agree that petitioner underreported STG's gross business receipts by $216,143 in 1990, $208,134 in 1991, and $272,902 in 1992.³

Petitioner also bought, sold, and traded military memorabilia. Petitioner did not report this activity on his 1990, 1991, or 1992 returns.

A. Schedule C Deductions

In the notices of deficiency for the years 1990, 1991, and 1992, respondent disallowed all petitioner's Schedule C deductions. Respondent now concedes certain of these deductions.⁴

[112 T.C. 186]

We must decide which, if any, of the remaining deductions claimed by petitioner are allowable.

Deductions are a matter of legislative grace, and taxpayers bear the burden of proving that they are entitled to any deductions claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers are required to maintain sufficient records to enable the Commissioner to determine their correct tax liability. Sec. 6001.

Section 162 generally allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Such expenses must be directly connected with or pertain to the taxpayer's trade or business. Sec. 1.162–1(a), Income Tax Regs. The determination of whether an expenditure satisfies the requirements of section 162 is a question of fact. Commissioner v. Heininger, 320 U.S. 467, 475 (1943).

Section 162(a)(2) allows a deduction for all the ordinary and necessary traveling expenses, including meals, paid by a taxpayer during the taxable year while traveling away from home in the pursuit of a trade or business. A travel or entertainment deduction is disallowed if the taxpayer does not satisfy the substantiation requirements of section 274(d) ⁵ through either adequate records or the taxpayer's own

[112 T.C. 187]

detailed statement that is corroborated by sufficient evidence. Section 274(d) also applies to listed property, which includes any passenger automobile. Secs. 274(d)(4), 280F(d)(4)(A)(i). At a minimum, the taxpayer must substantiate: (1) The amount of the expense, (2) the time and place such expense was incurred, (3) the business purpose of the expense, and (4) the business relationship to the taxpayer of persons entertained. Sec. 274(d).

The regulations further clarify the stringent substantiation requirements of section 274. A taxpayer generally must substantiate each expenditure by producing (1) adequate records or (2) sufficient evidence to corroborate his or her own statement. Sec. 1.274–5T(c)(1), Temporary Income Tax Regs., 50 Fed.Reg. 46016–46017 (Nov. 6, 1985). The “adequate records” standard requires that a taxpayer maintain an account book, diary, log, statement of expense, or other similar record in which entries of expenditures are recorded at or near the time of the expenditure. In addition, a taxpayer must supply documentary evidence, such as receipts or paid bills. Sec. 1.274–5T(c)(2)(i) to (iii), Temporary Income Tax Regs., 50 Fed.Reg. 46017–46020 (Nov. 6, 1985). Alternatively, taxpayers who are unable to satisfy the adequate records requirement are still entitled to a deduction for expenses that they can substantiate with other corroborative evidence. Sec. 1.274–5T(c)(3), Temporary Income Tax Regs., 50 Fed.Reg. 46020–46021 (Nov. 6, 1985).

For expenses other than those covered by the provisions of section 274(d), if the taxpayer failed to keep adequate records but the Court is convinced that deductible expenditures were incurred, the Court “should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making.” Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir.1930). However, we must have some rational basis on which an estimate may be made. Vanicek v. Commissioner, 85 T.C. 731, 742–743 (1985).

Petitioner deducted Schedule C business expenses totaling $162,278 in 1990, $192,516 in 1991, and $211,709 in 1992.⁶ These deductions fall into two categories. One category must meet the substantial and stringent requirements of section

[112 T.C. 188]

274(d). The other category consists of all the other claimed deductions.

Regarding the deductions governed by section 274, respondent has conceded some items of expense, and petitioner has conceded that the air travel expenses in all the years in issue cannot be adequately substantiated. Petitioner has put forward no believable explanation for the absence of required records; consequently, the burden of his inexactitude must fall on him. Petitioner did not produce any witnesses to corroborate when and where he traveled on business. Mrs. Shea could testify only to the fact that petitioner was not home and that petitioner said he was traveling on business. While it...