The Tax Court in Brief
Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.
The Week of August 8 – August 14, 2020
Sham v. Comm’r, T.C. Memo. 2020-119 | August 12, 2020 | Gustafson, J. | Dkt. No. 10531-17
Short Summary: Ms. Sham became unemployed and suffered from medical problems requiring treatment. Later, she became an independent business consultant for a medical doctor. Ms. Sham filed 2010 through 2015 income tax returns late and claimed significant medical expense deductions and other deductions on Schedules A and C.
The IRS issued a notice of deficiency to Ms. Sham. In the notice of deficiency, the IRS determined that she had failed to report all of her income for the years at issue and that some of her claimed deductions should be disallowed. In addition, the IRS imposed accuracy-related penalties for 2010 through 2013 and late-filing, late-payment, and failure-to-pay estimated tax penalties for 2013 through 2015.
Key Issues: Whether Ms. Sham: (1) failed to report all amounts of gross income; (2) is entitled to all deductions she claimed beyond those conceded by the IRS in the notice of deficiency or during the court proceedings; and (3) is liable for the accuracy-related penalties for 2010 through 2013 and additions to tax for the years 2013 through 2015.
- Sham: (1) failed to report all amounts of gross income that should have been reported; (2) failed to substantiate many of her claimed Schedule A and Schedule C expenses; and (3) is liable for the accuracy-related penalties for the years 2010 through 2013 and additions to tax for the years 2013 through 2015.
Key Points of Law:
- The IRS’s determination is presumed correct, and taxpayers generally bear the burden to prove incorrect the adjustments made by the IRS in its statutory notice of deficiency. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). A taxpayer’s statement in brief does not constitute evidence, Rule 143(c), and cannot supplement the record, see Niedringhaus v. Comm’r, 99 T.C. 202, 214 n.7 (1992).
- The IRS may rely on information returns (Forms W-2, “Wage and Tax Statement”, and 1099) from third-party payors when determining a taxpayer’s taxable income. See, e.g., Cabirac v. Comm’r, 120 T.C. 163, 167 (2003), aff’d, 95 A.F.T.R.2d (RIA) 2004-5490 (3d Cir. 2004). But if “[i]n any court proceeding * * * a taxpayer asserts a reasonable dispute with respect to any item of income reported on an information return filed with the Secretary * * * and the taxpayer has fully cooperated with the Secretary * * *, the Secretary shall have the burden of producing reasonable and probative information concerning such deficiency in addition to such information return.” 6201(d).
- The Commissioner bears the burden of proof with respect to “any new matter, increases in deficiency, and affirmative defenses, pleaded in the answer”. Rule 142(a)(1). In Wayne Bolt & Nut Co. v. Comm’r, 93 T.C. 500, 507 (1989), the Tax Court stated: “A new theory that is presented to sustain a deficiency is treated as a new matter when it either alters the original deficiency or requires the presentation of different evidence. * * * A new theory which merely clarifies or develops the original determination is not a new matter in respect of which respondent bears the burden of proof.” See also Shea v. Comm’r, 112 T.C. 183, 191-97 (1999).
- If the taxpayer makes new claims of deductions not addressed in a notice of deficiency, the Commissioner does not bear the burden of disproving the deductions. See Rappaport v. Comm’r, T.C. Memo. 2006-87.
- If the preponderance of the evidence resolves the issues in dispute, it negates the import of which party bears the burden of proof. See Dagres v. Comm’r, 136 T.C. 263, 279 (2011).
- When deductions are in dispute, the taxpayer must satisfy the specific requirements for any deduction claimed. See INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992). Furthermore, taxpayers are required to maintain records sufficient to substantiate items underlying their claimed deductions. See 6001; Treas. Reg. § 1.6001-1(a); see also Treas. Reg. § 1.6001-1(e). The failure to keep and present accurate records counts heavily against a taxpayer’s attempted proof. Rogers v. Comm’r, T.C. Memo. 2014-141.
- Section 274(d) establishes higher substantiation requirements for expenses related to travel, meals, and lodging while away from home, entertainment, gifts, and “listed property,” defined in Section 280F(d)(4) to include passenger automobiles and computers—e., many of the reported expenses at issue here. For expenses associated with “listed property,” a taxpayer must prove: (1) the amount of each separate expenditure with respect to such property; (2) the amount of each business use; and (3) the business purpose for an expenditure or use with respect to such property. Temp. Treas. Reg. § 1.274-5T(b)(6) (Nov. 6, 1985). Section 274(d) provides that no deduction or credit under section 162 or 212 shall be allowed for these expenses unless the taxpayer substantiates these expenses by adequate records or sufficient evidence corroborating his own statements.
- For travel expenses, not only must a taxpayer substantiate the “[a]mount of each separate [travel] expenditure” and time and place of the travel, but also she must substantiate the “[b]usiness reason for travel or nature of the business benefit derived * * * as a result of travel.” Treas. Reg. § 1.274-5T(b)(2). A deduction for business gifts requires the taxpayer to describe the gift, to substantiate the amount, time, and “business reason for the gift or nature of business derived or expected to be derived as a result of the gift”, and to provide information sufficient to establish the business relationship of the gift recipient, such as “name, title, or other designation.” Temp. Treas. Reg. § 1.274-5T(b)(5).
- Under the Cohan rule, if a taxpayer adequately establishes that she paid or incurred a deductible expense but does not establish the precise amount, then the Court may in some instances estimate the allowable deduction, bearing heavily against the taxpayer whose inexactitude is of her own making. However, Section 274(d) sets stricter substantiation rules that, when they apply, supersede the Cohan doctrine. See Sanford v. Comm’r, 50 T.C. 823, 827-28 (1968), aff’d per curiam, 412 F.2d 201 (2d Cir. 1969); Temp. Treas. Reg. § 1.274-5T(a).
- A bank deposit is prima facie evidence of income. Tokarski v. Comm’r, 87 T.C. 74, 77 (1986).
- A refund of State tax is taxable to the recipient taxpayer only to the extent of any Federal tax benefit realized as a result of the deduction claimed for the State tax in a prior year. 111(a).
- For 2010 a taxpayer may claim an unreimbursed employee business expense as a miscellaneous deduction on Schedule A, pursuant to section 162(a). An employee is considered to be in the business of being an employee and may deduct expenses that are: (a) nonreimbursable; (b) related to the employee’s trade or business of rendering services to the employer; and (c) ordinary and necessary expenses of such a trade or business. See Lucas v. Comm’r, 79 T.C. 1, 6-7 (1982). Expenses are “ordinary” when they are “normal, usual, or customary” in the taxpayer’s trade or business. Deputy v. DuPont, 308 U.S. 488, 495 (1940). Expenses are “necessary” when they are “appropriate” or “helpful,” even if not “indispensable” or “required.” Ford v. Comm’r, 56 T.C. 1300, 1306 (1971), aff’d per curiam, 487 F.2d 1025 (9th 1973). Unreimbursed employee expenses are subject to the itemized deduction limitation of section 67(a)—i.e., the 2% floor.
- Personal expenses are not deductible. 262; Hamacher v. Comm’r, 94 T.C. 348, 359 (1990).
- Medical expenses which are “not compensated for by insurance or otherwise” are deductible, subject to computational limitations. 213(a) (for tax years 2010 through 2012, such expenses are deductible to the extent they exceed 7.5% of a taxpayer’s adjusted gross income; for tax years 2013 through 2015, such expenses are deductible to the extent that they exceed 10% of the taxpayer’s adjusted gross income). The taxpayer bears the burden to prove that he or she paid any expense and that it was not reimbursed. See Weaver v. Comm’r, T.C. Memo. 1984-634.
- The expense of health insurance for the taxpayer is itself a deductible medical expense, see 213(d)(1)(D), but a taxpayer who is self-employed is permitted, to the extent of her earned income from her trade or business, to claim it as a separate deduction—as an above-the-line adjustment to income, as opposed to an itemized deduction, see Sec. 162(l)(1) and (2)(a). Any amount deducted for health insurance cannot also be taken into account in computing the medical expense deduction under section 213(a). Sec. 162(l)(3).
- Section 170(a) allows as a deduction any charitable contribution made within the taxable year. To qualify as a deduction, the contribution must be made to a donee organization described in section 170(c), including, inter alia, “[a] corporation, trust, or community chest, fund, or foundation * * * organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes.” Deductions for charitable contributions are allowable only if verified under the regulations prescribed by the Secretary. 170(a)(1). The deductibility of a charitable contribution is generally limited to 50% of an individual taxpayer’s “contribution base” for the taxable year; any excess may be carried forward for the succeeding five years. Sec. 170(b)(1). Further, charitable contributions of cash or property of $250 or more must be substantiated by a contemporaneous written acknowledgement (CWA) from the donee. See Sec. 170(f)(8); Treas. Reg. § 1.170A-13(f)(1). A CWA is “contemporaneous” if it is obtained by the taxpayer on or before the earlier of the date the taxpayer files the original return for the taxable year of the contribution or due date (including extensions) for filing the original return for the year. Sec. 170(f)(8)(C); Treas. Reg. § 1.170A-13(f)(3). That acknowledgement, which must be furnished by the donee, must (1) state the amount of cash and describe other property contributed; (2) indicate whether the donee organization provided any goods or services in consideration for the contribution; and (3) provide a description and good faith estimate of the value of any goods or services provided by the donee. Sec. 170(f)(8)(B); Treas. Reg. § 1.170A-13(f)(2).
- The reporting of an item on a return does not substantiate that item. See Lawinger v. Comm’r, 103 T.C. 428, 438 (1994) (“Tax returns do not establish the truth of the facts stated therein.”).
- Section 162(a) allows “as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” To prove entitlement to deduct an expense, the taxpayer must prove not only the fact of the expenditure but also the business purpose. A taxpayer’s general statement that expenses were paid in pursuit of a trade or business is insufficient to establish that the expenses had a reasonably direct relationship to any such trade or business. Ferrer v. Comm’r, 50 T.C. 177, 185 (1968), aff’d per curiam, 409 F.2d 1359 (2d Cir. 1969). Personal expenses are generally not allowed as deductions. 262(a).
- Section 280A(c)(1) requires that, in order for an employee to deduct a portion of the cost of her residence as a “home office” business expense, she must use a portion of the home exclusively and on a regular basis as the principal place of the business she carries on as an employee.
- Passenger automobiles constitute “listed property” and are subject to the heightened substantiation requirements of Section 274(d). See Fernandez v. Comm’r, T.C. Memo. 2011-216. To satisfy these requirements, “ a taxpayer must substantiate each element of an expenditure or use * * * by adequate records or by sufficient evidence corroborating * * * [her] own statement.” Treas. Reg. § 1.274-5T(c)(1). Lacking adequate records, the taxpayer must produce other credible evidence sufficient to corroborate her own statement concerning business use. Temp. Treas. Reg. § 1.274-5T(c)(3).
- The purchase of general circulation newspapers is a non-deductible personal expense. Stemkowski v. Comm’r, 690 F.2d 40, 47 (2d Cir. 1982), aff’g in part, rev’g in part 76 T.C. 252 (1981).
- Because gifts are “listed property,” they are subject to the heightened substantiation requirements of Section 274(d). Additionally, any deduction for a gift under Section 162 is limited to $25 in cumulative value of all gifts to any individual per year. 274(b).
- Section 6651(a)(1) authorizes the imposition of an addition to tax for failure to file a timely return (unless the taxpayer proves that such failure is due to reasonable cause and is not due to willful neglect). See also U.S. v. Boyle, 469 U.S. 241, 245 (1985). The addition consists of 5% per month (up to a maximum of 25%) of “the amount required to be shown as tax on such return.” 6651(a)(1). Section 6651(a)(2) provides for an addition to tax for failure to timely pay “the amount shown as tax on any return specified in paragraph (1)” unless the taxpayer establishes that the failure was due to reasonable cause and not willful neglect. The addition consists of 0.5% per month (up to a maximum of 25%) of “the amount shown as tax on such return.” Sec. 6651(a)(2). The amount of the addition to tax under Section 6651(a)(2) reduces the addition to tax under Section 6651(a)(1) for any month for which both additions to tax apply. Sec. 6651(c)(1). When a taxpayer has not filed a return, the Section 6651(a)(2) addition to tax may not be imposed unless the Secretary has prepared an SFR that meets the requirements of Section 6020(b). Wheeler v. Comm’r, 127 T.C. 200, 208-209 (2006), aff’d, 521 F.3d 1289 (10th Cir. 2008). Pursuant to Section 6651(g)(2), an SFR prepared by the Commissioner under Section 6020(b) is treated as a taxpayer return for purposes of determining the addition to tax under Section 6651(a)(2).
- To constitute a valid SFR under Section 6020(b), “the return must be subscribed, it must contain sufficient information from which to compute the taxpayer’s tax liability, and the return form and any attachments must purport to be a ‘return.’” Spurlock v. Comm’r, T.C. Memo. 2003-124.
- The Tax Court has held that mistake or ignorance of the law does not excuse a failure to timely file a tax return. See Joyce v. Comm’r, 25 T.C. 13, 15 (1955).
- Section 6654 imposes an addition to tax on an individual taxpayer who underpays her estimated tax. A taxpayer must pay estimated tax for any year in which she has a “required annual payment.” 6654(d). A “required annual payment” is defined in Section 6654(d)(1)(B), in pertinent part, as the “lesser of—(i) 90 percent of the tax shown on the return for the taxable year (or, if no return is filed, 90 percent of the tax for such year)” or (ii) if the individual filed a return for the preceding taxable year, then “100 percent of the tax shown on the return of the individual for the preceding taxable year.” Thus, the IRS’s burden of production under Section 7491(c) requires it to produce, for each year for which the addition is asserted, evidence that the taxpayer had a required annual payment under Section 6654(d).
- Section 6662(a) and (b)(1) and (2) imposes an “accuracy-related penalty” of 20% of the portion of the underpayment of tax that is attributable to the taxpayer’s negligence or disregard of rules or regulations or that is attributable to any substantial understatement of income tax. A Civil Penalty Form, which reflects the signature of the group manager approving the grounds for penalties before the issuance of a statutory notice of deficiency to the taxpayer is sufficient to show that the IRS complied with the requirements of Section 6751(b)(1) for written supervisory approval of the accuracy-related penalties. See Clay v. Comm’r, 152 T.C. 223, 249 (2019).
- Under Section 6664(c)(1), a taxpayer who is otherwise liable for the accuracy-related penalty may avoid the liability if she can show, first, “that there was reasonable cause” for the underpayment and, second, that she “acted in good faith with respect to” the underpayment. Whether the taxpayer acted with reasonable cause and in good faith depends on the pertinent facts and circumstances, including her efforts to assess her proper tax liability, her knowledge and experience, and the extent to which she relied on the advice of a tax professional. Reg. § 1.6664-4(b)(1). “Reliance on * * * professional advice, or other facts, however, constitutes reasonable cause and good faith if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith.” Id.
- Under Neonatology Assocs., P.A. v. Comm’r, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002), the taxpayer must show: (1) the advisor was a competent professional who had sufficient expertise to justify reliance; (2) the taxpayer provided necessary and accurate information to the advisor; and (3) the taxpayer actually relied in good faith on the advisor’s judgment.
Insight: One of the primary functions of the Tax Court is to review evidence (documents, testimony, etc.) and make a determination of the taxpayer’s tax liability for the year in question. The Sham decision shows the perils a taxpayer may undergo if they do not keep good records to substantiate their claimed deductions, particularly those that are subject to heightened substantiation rules under Section 274(d).