Interex, Inc. v. C.I.R.

Decision Date28 February 2003
Docket NumberNo. 02-1784.,02-1784.
Citation321 F.3d 55
PartiesINTEREX, INC., Petitioner, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent, Appellee.
CourtU.S. Court of Appeals — First Circuit

Paul J. Dee, Jr. with whom Truelove, Dee, & Chase, LLP was on brief for appellant.

Marion E.M. Erickson, Attorney, Tax Division, with whom Eileen J. O'Connor, Assistant Attorney General, and Richard Farber, Attorney, Tax Division, were on brief for appellee.

Before SELYA, Circuit Judge, STAHL, Senior Circuit Judge, and LYNCH, Circuit Judge.

LYNCH, Circuit Judge.

This case concerns the factual finding by the tax court that a business deduction, supposedly for counsel and accounting services, was improperly reported. The petitioner argues that enough evidence was introduced to support the deduction, and that the tax court judge should have been recused. Finding no factual or legal error, we affirm the holding of the tax court and the denial of the recusal motion.

I.

In September 1993, Tamara Olbres incorporated Interex, Inc. in Massachusetts and was its sole shareholder and president. The company was in the business of designing, storing, and refurbishing trade show exhibits. It used an accrual method of accounting, under which income and liabilities are included in the tax year in which "all events have occurred" to establish the right to receive the income or to establish the fact of liability. See Treas. Reg. § 1.446-1(c)(ii) (2002); see also I.R.C. § 446(c)(2) (2000) (permitting the accrual method).1

When she formed Interex, Olbres asked George Coupounas, of Chestnut Hill, Massachusetts, to act as outside counsel and accountant for Interex. Olbres and Coupounas never discussed the rate at which he would be paid for performing legal and accounting services. In 1993, on its federal tax return, Interex deducted $4,695 in fees paid to Coupounas.

Coupounas prepared Interex's 1994 federal tax return and signed it as the preparer. Olbres signed the return as well, but if she read it at all, she did so cursorily. On this return, Interex deducted $65,000 for accrued professional fees owed to Coupounas. Coupounas never billed Interex for that amount.

In late 1996, the IRS began to examine Interex's 1994 tax return. Coupounas was questioned by IRS agents but refused to provide time sheets to support the corporation's alleged liability. In January 1998, the IRS issued a Proposed Report of Income Tax Changes, which included, among the issues raised, a challenge to the $65,000 deduction for accrued professional fees. The IRS investigation prompted activity. In August 1998, at Coupounas's request, Olbres wrote him a check from Interex postdated December 31, 1998, purportedly in payment of the fees incurred in 1994.

II.

On September 8, 1999, the Commissioner of the IRS issued a Notice of Deficiency under I.R.C. § 6212 which challenged, inter alia, the $65,000 in accrued professional fees. Interex filed a petition with the tax court for redetermination of the deficiency. The other alleged deficiencies were settled; the only issue presented to the tax court was the $65,000 deduction and the accompanying negligence penalty under I.R.C. § 6662.

After trial, but before decision, Interex filed a motion for recusal of the tax court judge under 28 U.S.C. § 455(a). Interex argued that the judge was predisposed to find against Interex on the merits. The tax court denied the recusal motion.

On February 27, 2002, the tax court issued a memorandum opinion in favor of the IRS. It found that Interex had failed to show that economic performance with respect to the $65,000 in professional fees had occurred in 1994; that the amount of fees due to Coupounas "could not have been determined with reasonable accuracy by the end of 1994"; and that the services performed by Coupounas for Interex in 1994 were not "specialized, unique, or otherwise reasonably valued at $65,000." Finally, the court awarded negligence penalties under § 6662(a) because Olbres had not examined the tax return, other than the bottom line, when she signed. Interex, Inc. v. Comm'r, No. 17030-99, 2002 WL 273170, 2002 Tax Ct. Memo LEXIS 59, at *4, *7-*8 (T.C. Feb. 27, 2002).

Interex appeals both the decision of the tax court and the denial of the motion for recusal.

III.

We review decisions of the tax court "in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury." I.R.C. § 7482(a)(1); see MedChem, Inc. v. Comm'r, 295 F.3d 118, 122 (1st Cir.2002). The tax court's legal interpretations are reviewed de novo. Alexander v. IRS, 72 F.3d 938, 941 (1st Cir.1995). We will overturn its factual findings only if they are clearly erroneous. Capital Video Corp. v. Comm'r, 311 F.3d 458, 463 (1st Cir.2002). A finding is clearly erroneous when, "although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed." Comm'r v. Duberstein, 363 U.S. 278, 291, 80 S.Ct. 1190, 4 L.Ed.2d 1218 (1960) (quoting United States v. United States Gypsum Co., 333 U.S. 364, 395, 68 S.Ct. 525, 92 L.Ed. 746 (1948)). We review a trial court's denial of a recusal motion for abuse of discretion. In re Boston's Children First, 244 F.3d 164, 167 (1st Cir.2001).

The burden of proof is generally on the taxpayer to demonstrate that the IRS's nondeductibility determination is in error. U.S. Tax Ct. R. 142(a); United States v. Janis, 428 U.S. 433, 440, 96 S.Ct. 3021, 49 L.Ed.2d 1046 (1976). Once "a taxpayer introduces credible evidence with respect to any factual issue," the burden shifts to the IRS on that issue. I.R.C. § 7491(a)(1).

IV.
A. Deduction of Professional Fees

I.R.C. § 162 permits deductions from income for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." Accrual method taxpayers may deduct expenses when they are incurred even if they have not yet been paid, as long as three factors are met: 1) all of the events that establish the fact of the liability must have occurred; 2) the amount must be able to be determined "with reasonable accuracy"; and 3) economic performance must have occurred. Treas. Reg. § 1.461-1(a)(2)(i); see also id. § 1.461-4 (explaining economic performance). Whether a taxpayer has satisfied the "all events" test is a question of law we review de novo. Gold Coast Hotel & Casino v. United States, 158 F.3d 484, 487 (9th Cir.1998).

At trial, the only person who testified on Interex's behalf was Olbres. She testified that she did not ask for nor did she ever see a bill for Coupounas's professional services. She did not ask what services Coupounas performed to be valued at $65,000, nor did she ask for or receive any time sheets or other supporting records. Furthermore, Olbres admitted that she did not carefully review the 1994 tax return. She was not even aware of the $65,000 debt until August 1998.

According to Olbres, Coupounas performed the following services: preparing tax returns; setting up the company's record-keeping system; preparing financial statements; reviewing letters and documents; advising Olbres with respect to the conversion of Interex from a subchapter C corporation to a subchapter S corporation; and answering legal questions.

1994 was not the only year in which Interex deducted sums for Coupounas's services. Deductions were taken for his services in the years from 1993 to 1997; Coupounas never issued a bill to Olbres detailing his services from 1994 to 1997. Moreover, after 1993, Coupounas was not paid at all by Interex until the $65,000 check was written in 1998, only after the IRS began to investigate that deduction. Finally, there is no evidence that Coupounas was ever paid for the debts allegedly incurred after 1994, including $36,000 in fees deducted in the 1995 return.

Coupounas did not testify at trial, refused to provide documents to the IRS, and did not cooperate with the IRS. At the close of trial, the Tax Court instructed the parties that the court would entertain a motion to reopen the record within thirty days if Coupounas became available to testify in court or to be deposed. Interex later notified the court that no testimony or statement from Coupounas would be added to the record. Coupounas was under an apparent obligation to provide documents to Interex, his client, arising out of his charges for any services to the company. See Mass. R. Prof. C. 1.4(a). Nonetheless, Interex provided no bills from Coupounas or documentation of $65,000 worth of...

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