Lawson v. Commissioner

• Decision Date: 21 June 1994
• Docket Number: Docket No. 20931-92.
• Citation: 67 T.C.M. 3121
• Parties: Bennie S. Lawson v. Commissioner.
• Court: U.S. Tax Court

67 T.C.M. 3121

T.C. Memo. 1994-286

Bennie S. Lawson v. Commissioner.

Docket No. 20931-92.

United States Tax Court.

Filed June 21, 1994.

Bennie S. Lawson, pro se. Josh Ungerman, for the respondent.

Memorandum Findings of Fact and Opinion

DAWSON, Judge:

Respondent determined deficiencies in the joint Federal income taxes of Bennie S. Lawson (hereinafter petitioner) and her husband Alvin C. Lawson (hereinafter Lawson) of $6,761 and $8,721, for 1987 and 1988, respectively. Respondent also determined that petitioner and Lawson (collectively referred to as the Lawsons) are liable for additions to tax for failure to timely file Federal income tax returns pursuant to section 6651(a)(1)¹ in the amounts of $315 and $1,563 for 1987 and 1988, respectively, and an addition to tax for negligence or intentional disregard of rules or regulations pursuant to section 6653(a)(1) in the amount of $436 for 1988. Petitioner filed a petition with this Court. Lawson did not. The issues for decision are: (1) Whether petitioner is entitled to relief from joint and several liability pursuant to section 6013(e) and (2) whether she is liable for the additions to tax.

Findings of Fact

Some of the facts have been stipulated, and they are so found. Petitioner and Lawson filed joint Federal income tax returns for 1987 and 1988 on October 27, 1989, and on June 21, 1990, respectively. Petitioner resided in Irving, Texas, when she filed her petition in this case.

Petitioner married Lawson in 1962. Although they were separated during the years in issue, petitioner submitted her income tax information to Lawson, who had the joint income tax returns professionally prepared. Petitioner signed those income tax returns without reviewing their contents. During the more than 20 years petitioner was married to Lawson, he always hadtheir joint income tax returns professionally prepared, and petitioner had no reason to question their accuracy. She expressed the same faith in her husband and his tax preparer at the time of trial.

Because petitioner knew very little about Lawson's business activities, did not possess any of his books and records, and did not know his whereabouts at the time respondent selected their 1987 and 1988 joint Federal income tax returns for audit, she was unable to substantiate any of the items that were attributable to Lawson's activities. Consequently, respondent disallowed all of the items specified in the notice of deficiency for lack of substantiation. Among the items disallowed by respondent for 1987 was a $37,400 loss from "H & G" property claimed on Form 4797 (Gains and Losses From Sales or Exchanges of Assets Used in a Trade or Business and Involuntary Conversions). Respondent determined in the notice of deficiency

that the $37,400 shown on your return as a loss from the sale of Lyne & Glass, Inc. stock is not allowed since it has not been established that any loss occurred or, if a loss occurred, that it qualified as an ordinary loss. Accordingly, your taxable income is increased $37,400 for the 1987 tax year.

In addition, respondent disallowed a deduction reported on Schedule A attached to the Lawsons' 1987 Federal income tax return in the amount of $9,558 in unreimbursed employee business expenses. Lawson claimed these expenses in connection with his employment as an outside salesman. Respondent also disallowedthe $2,917 Lawson claimed as a mortgage interest deduction in that year.

On Schedule C attached to the Lawsons' 1988 Federal income tax return, Lawson reported gross receipts from outside sales in the amount of $23,904, and cost of goods sold in the amount of $24,952. He also deducted various business expenses totaling $11,158. In the notice of deficiency, respondent disallowed the cost of goods sold and business expenses.

Petitioner never possessed any information regarding the items reported by Lawson on their joint 1987 and 1988 Federal income tax returns, and she did not live with Lawson during the years in issue.

Opinion

I. Innocent Spouse

Petitioner contends that she should be relieved of joint and several liability for the deficiencies and additions to tax as an "innocent spouse" under section 6013(e). Respondent maintains that petitioner does not qualify as an "innocent spouse" because none of the items disallowed constitute "grossly erroneous items" as required by section 6013(e)(1)(B).

In general, when a husband and wife file a joint Federal income tax return, they are jointly and severally liable for the tax due. Sec. 6013(d)(3). However, to alleviate some of the harsh results of this rule, Congress enacted special provisions to relieve a spouse from such liability, but only if such spouse satisfies certain conditions. Sec. 6013(e). To qualify for section 6013(e) relief, a spouse must show that: (1) A joint return was filed for the years in issue; (2) the return contains a substantial understatement of tax; (3) such understatement is attributable to grossly erroneous items of the other spouse; (4) in signing the return, the spouse did not know, and had no reason to know, that the return contained a substantial understatement of tax; and (5) when considering all the facts and circumstances, it would be inequitable to hold the spouse liable for the deficiency in tax attributable to the substantial understatement. Sec. 6013(e); Purcell v. Commissioner [Dec. 42,894], 86 T.C. 228, 235 (1986), affd. [87-2 USTC ¶ 9479] 826 F.2d 470 (6th Cir. 1987). An understatement is substantial if it exceeds $500. Sec. 6013(e)(3).

Respondent does not dispute that petitioner satisfies all of the required criteria except for one; i.e., the items disallowed are not "grossly erroneous items" as defined in section 6013(e)(2).² The term "grossly erroneous items" includes "any item of gross income * * * which is omitted from gross income." Sec 6013(e)(2)(A). Moreover, a claim of a deduction, credit, or basis is considered to be a "grossly erroneous item", only if it lacks a "basis in fact or law". Sec. 6013(e)(2)(B). In order to determine whether respondent's adjustments are with respect to "grossly erroneous items", it is necessary to decide whether the adjustment is with respect to an item of gross income (which is automatically considered grossly erroneous), or an item of deduction, credit, or basis (which must be proven to be without any basis in fact or law). Flynn v. Commissioner [Dec. 46,030], 93 T.C. 355, 360 (1989). Thus, a taxpayer seeking section 6013(e) relief must show that there is no basis in fact or law for an item only if it is an item of deduction, credit, or basis. Moreover, the spouse seeking relief needs to prove only that an item of deduction, credit, or basis lacked either a basis in fact or a basis in law, but need not prove both. See Ness v. Commissioner [Dec. 46,603], 94 T.C. 784 (1990), revd. on other grounds [92-1 USTC ¶ 50,084] 954 F.2d 1495 (9th Cir. 1992); Douglas v. Commissioner [Dec. 43,002], 86 T.C. 758, 762 (1986).³

Although there is no statutory definition, the phrase "no basis in fact or law" has been construed as an item which is frivolous, fraudulent, or phony. Douglas v. Commissioner, supra at 763. A deduction has no basis in fact if the expenditure for which it is claimed was never made. Id. Further, a deduction has no basis in law if the expenditure, even if made, does not-qualify as a deductible expense under well-settled legal principles or when no substantial legal argument can be made in support of its deductibility. Id. However, the fact that a deduction has been disallowed does not, in itself, dictate a finding that the deduction is "grossly erroneous". Russo v. Commissioner [Dec. 47,924], 98 T.C. 28, 32 (1992). For example, deductions disallowed for lack of substantiation are not per se "grossly erroneous". United States v. Shanbaum [94-1 USTC ¶ 50,032], 10 F.3d 305, 314-315 (5th Cir. 1994); Flynn v. Commissioner, supra at 364; Douglas v. Commissioner, supra at 763.

Respondent disallowed all of the losses, cost of goods sold, business expenses and mortgage interest claimed by Lawson because petitioner could not locate Lawson and his substantiating records. However, petitioner testified that she believed Lawson had provided their tax return preparer with the documentation needed to prepare their income tax returns and that the preparer would not have knowingly claimed any deductions to which she and Lawson were not legally entitled. Based on this representation, respondent argues that all of the items in issue have a basis in fact and, therefore, are not "grossly erroneous items" within the meaning of section 6013(e)(2)(B). We disagree with respondent as to two of the items.

Cost of Goods Sold

Respondent first maintains that the cost of goods sold claimed by Lawson on the 1988 Schedule C is not a "grossly erroneous item" because petitioner failed to show that it had no basis in law or fact. However, since the origin of the Federal income tax, cost of goods sold has been taken into account in computing business gross income. Doyle v. Mitchell Bros. Co. [1 USTC ¶ 17], 247 U.S. 179, 184-185 (1918);⁴ Rotolo v. Commissioner [Dec. 43,985], 88 T.C. 1500, 1514 (1987); Metra Chem Corp. v. Commissioner [Dec. 43,787], 88 T.C. 654, 661 (1987); McKenna v. Commissioner [Dec. 127], 1 B.T.A. 326, 332 (1925); secs. 1.61-3(a), 1.162-1(a), Income Tax Regs. In fact, the regulations under section 22, I.R.C. 1939 (the predecessor of sec. 61, I.R.C. 1954), provided that:

In the case of a manufacturing, merchandising, or mining business, "gross income" means the total sales, less the cost of goods sold, plus any income from investments and from incidental income or outside operations or sources. * * * [Sec. 29.22(a)-5, Regs. 111 (1943).]

Currently, section 61(a)(2) includes gross income from business, and the regulations thereunder (section 1.61-3, Income Tax Regs.) still contain the language quoted above from the regulations under the 1939 Code. Moreover, section 1.162-1(a),...