Scott v. Department of Revenue ( 2013 )

IN THE OREGON TAX COURT
MAGISTRATE DIVISION
Income Tax
LESLIE NEAL SCOTT, )
)
Plaintiff, ) TC-MD 120706N
)
v. )
)
DEPARTMENT OF REVENUE, )
State of Oregon, )
)
Defendant. ) DECISION
Plaintiff appeals Notices of Deficiency Assessment, issued by Defendant for the 2007
and 2008 tax years.1 (Ptf’s Compl at 7-10.) A trial was held in the Oregon Tax Courtroom in
Salem, Oregon on May 1, 2013. Orrin L. Grover, Attorney at Law, appeared on behalf of
Plaintiff. Plaintiff testified on his own behalf. Tyler Wallace (Wallace), Tax Auditor, appeared
and testified on behalf of Defendant. Plaintiff’s Exhibits 1 through 8 were received without
objection. Defendant’s Exhibits A through I and K through M were received without objection.
Plaintiff objected to Defendant’s Exhibit J, a one page excerpt from a Pendente Lite Order that
did not include the date of the Order. Wallace stated that Defendant’s Exhibit J was provided to
him during the audit. The court excluded Defendant’s Exhibit J because Defendant failed to
show that Exhibit J was relevant to the issues presented in this appeal.
I. STATEMENT OF FACTS
For the 2007 and 2008 tax years, Plaintiff claimed certain business deductions for his
adult foster care business, Scott’s Quality Care. (See Ptf’s Exs 1, 4; Def’s Exs C, D.) Plaintiff
testified that he operated the business with his former wife, Debra. Plaintiff testified that he and
1
Plaintiff withdrew his appeal of Defendant’s Notice of Deficiency Assessment for the 2009 tax year.
(Ptf’s Statement of Issues, Nov 8, 2012.)
DECISION TC-MD 120706N 1
Debra lived in Sandy and they operated the business out of a facility in Gresham. He testified
that the facility was a five-bed foster care home that “typically” housed between four and five
residents. Plaintiff testified that the business “usually” had three or four employees, including a
resident care manager and a few substitute care providers. Plaintiff testified that the residents
were provided meals, “Depends,” over-the-counter pharmaceuticals, and beds as part of their
care. Plaintiff testified that Debra left in March 2008 and he ceased operations of the adult care
facility in June 2008.
Plaintiff testified that he maintained a separate checking account and a separate debit
card for Scott’s Quality Care. (See Ptf’s Exs 4, 8). He testified that he did not have any receipts
for the 2007 and 2008 tax years, but he did have bank statements for his business checking
account for the 2007 and 2008 tax years. (Ptf’s Exs 4, 8.) Plaintiff testified that he prepared
proposed amended income tax returns (proposed returns) for 2007 and 2008 based on the bank
statements for his business checking account, but he did not file those returns with Defendant or
the Internal Revenue Service (IRS). (Ptf’s Exs 1-3, 5-7.) On his original 2007 Schedule C,
Plaintiff reported gross income of $34,505 and total expenses of $34,505 with the explanation of
expenses “turned over to Debra.” (Def’s Ex C at 6-7.) On his proposed federal Schedule C for
the 2007 tax year, Plaintiff reported gross income of $80,827.04 and total expenses of
$85,352.39. (Ptf’s Ex 1 at 3.) Plaintiff did not provide a written explanation of his expenses on
his proposed return. (Id.) Plaintiff testified that he did not file a Schedule C for the 2008 tax
year. On his proposed Schedule C for the 2008 tax year, Plaintiff reported gross income of
$41,543.84 and total expenses of $41,165.03. (Ptf’s Ex 5 at 3.) Plaintiff did not provide a
written explanation of his expenses on his proposed return. (Id.)
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DECISION TC-MD 120706N 2
Plaintiff did not provide a written explanation of the expenses claimed on his proposed
Schedule Cs for the 2007 and 2008 tax years, but he testified at trial that the expenses were
business expenses associated with Scott’s Quality Care. His testimony consisted of generalized
explanations for certain payments on the business’ bank statements. For instance, he testified
that a payment to Walmart could have been “anything from food to buying Depends for the
residents.” (See Ptf’s Ex 8 at 8.) When asked by Wallace to be more specific, Plaintiff testified
that Debra did all of the shopping. He testified that, as a result, he did not have any receipts, nor
could he testify with any more specificity regarding business expenses.
Wallace testified regarding his review of Plaintiff’s proposed returns. He testified that
Plaintiff, in essence, claimed all bank debits from the business checking account as business
expenses and claimed all checks written on the business checking account as payroll. Wallace
testified that Plaintiff provided no receipts, cancelled checks, or other substantiation of the
business purpose of each claimed expense. Wallace testified that, without substantiation of the
business purpose of each claimed expense, Plaintiff cannot claim the expenses as business
deductions.
Wallace testified that Plaintiff received Form 1099s from LR Property Management
reporting rental income to him in the 2007 and 2008 tax years. (See Def’s Exs G at 28, H at 43-
45.)2 Plaintiff testified that he did, in fact, receive those payments in 2007 and 2008. According
to the 2007 IRS transcript provided by Wallace, Plaintiff received rents of $14,418. (Def’s Ex G
at 28.) Plaintiff filed a Schedule E in 2007 reporting rental income of $14,418 and expenses of
$14,418 with the explanation of expenses “turned over to Debra.” (Def’s Ex C at 8.) According
to the 2008 IRS transcript provided by Wallace, Plaintiff received rents of $15,920. (Def’s Ex H
2
Defendant’s Exhibit H contained two pages labeled as “41,” the court’s references are to the corrected
page numbers.
DECISION TC-MD 120706N 3
at 43-45.) Plaintiff testified that he did not file a Schedule E in 2008 reporting any rental
income. Wallace testified that because Plaintiff received the rent payments of $14,418 in 2007
and $15,920 in 2008, those amounts should be included in Plaintiff’s gross income. (See Def’s
Exs G at 28, H at 43-45.)
Plaintiff also sold Wachovia securities in 2008. (See Def’s Ex K at 2-3.) According to
the 2008 “Form 1099-B Reportable Capital Transactions” provided by Defendant, Plaintiff
received gross proceeds of $194,938.23 and a capital gain of $14,306 from the sale of Wachovia
securities. (Id. at 3-5.) Plaintiff testified that the Wachovia account was liquidated within a few
months after Plaintiff and Debra separated. He testified that they divided the funds equally, so
his realized gain should only be half of that reported on the Form 1099B.
II. ANALYSIS
The issues before the court are: Plaintiff’s allowable deductions for his business, Scott’s
Quality Care; Plaintiff’s rental income and allowable rental expenses for the 2007 and 2008 tax
years; and the amount of Plaintiff’s capital gain for the 2008 tax year.
“The Oregon Legislature intended to make Oregon personal income tax law identical to
the Internal Revenue Code (IRC) for purposes of determining Oregon taxable income, subject to
adjustments and modifications specified in Oregon law. ORS 316.007.” Ellison v. Dept. of Rev.,
TC-MD No 041142D, WL 2414746 at *6 (Sept 23, 2005).3 “In all proceedings before the judge
or a magistrate of the tax court and upon appeal therefrom, a preponderance of the evidence shall
suffice to sustain the burden of proof. The burden of proof shall fall upon the party seeking
affirmative relief * * *.” ORS 305.427. This court has previously stated that a “[p]reponderance
of the evidence means the greater weight of evidence, the more convincing evidence.” Feves v.
3
All references to the Oregon Revised Statutes (ORS) are to 2007. The 2005 ORS, which are applicable to
the 2007 tax year, do not differ materially from the 2007 ORS with respect to provisions cited in this Decision.
DECISION TC-MD 120706N 4
Dept. of Rev., 4 OTR 302, 312 (1971). In an income tax appeal, this court has the statutory
authority to determine the correct amount of the deficiency (e.g., tax), “even if the amount so
determined is greater or less than the amount of the assessment determined by the Department of
Revenue[.]” ORS 305.575.
A. Income and expenses from Scott’s Quality Care
1. Ordinary and necessary business expenses
The legislature adopted, by reference, the federal definition for deductions, including
those allowed under IRC section 162.4 IRC section 162(a) allows a deduction for “all the
ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade
or business[.]” To be “ordinary,” the “transaction which gives rise to [the expense] must be of
common or frequent occurrence in the type of business involved.” Deputy v. du Pont, 308 US
488, 495, 60 S Ct 363, 84 L Ed 416 (1940) (citations omitted). A “necessary” expense is one
that is “appropriate and helpful” to the taxpayer’s business. Welch v. Helvering, 290 US 111,
113, 54 S Ct 8, 78 L Ed 212 (1933). As a general rule, IRC section 262(a) prohibits the
deduction of most personal and family expenditures. Allowable deductions from taxable income
are a “matter of legislative grace” and the burden of proof (substantiation) is placed on the
individual claiming the deduction. INDOPCO, Inc. v. Comm’r, 503 US 79, 84, 112 S Ct 1039,
117 L Ed 2d 226 (1992).
Generally, if a claimed business expense is deductible, but the taxpayer is unable to
substantiate it fully, the court is permitted to make an approximation of the allowable amount.
Cohan v. Comm’r (Cohan), 39 F 2d 540, 543-44 (2d Cir 1930). Yet such an approximation is
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4
All references to the Internal Revenue Code and accompanying regulations are to the 1986 code, and
include updates applicable to 2007 and 2008.
DECISION TC-MD 120706N 5
only possible where there is evidence upon which the court may make a reasonable estimate.
Vanicek v. Comm’r, 85 TC 731, 742-43 (1985) (citation omitted).
Plaintiff provided checking account statements from “Scott’s Quality Care” checking
account from the 2007 and 2008 tax years. Plaintiff argued that those statements substantiate the
claimed expenses on his proposed schedule C’s. (See Ptf’s Exs 4, 8.) Under Revenue Procedure
92-71:
“An account statement prepared by a financial institution showing an electronic
funds transfer (i.e. a decrease to the account holder’s balance) will be accepted as
proof of payment if the statement shows: 1. the amount of the transfer, 2. the date
of transfer posted to the account by the financial institution, and 3. the name of
the payee.”
Rev. Proc. 92-71, 1992-2 CB 437. The Revenue Procedure further states:
“Proof of payment of an amount alone does not establish that a person is entitled
to a tax deduction. A taxpayer should also keep any other documents that may
help prove entitlement to a tax deduction (for example, receipts, sales slips,
charge slips, payment acknowledgements, check registers, and carbon copies of
checks).”
Id. Plaintiff’s checking account statements establish proof of payment, but they do not
necessarily establish the business purpose of claimed expenses. Although Plaintiff testified
regarding some debits listed on the bank statements, he lacks personal knowledge about many of
the claimed expenses because he did not make the purchases; he testified that Debra shopped for
their business. Keeping that limitation in mind, the court considers those expenses for which
Plaintiff has provided some substantiation and for which the business purpose can be discerned.
On Plaintiff’s proposed returns he claimed $85,352.39 in business expenses for the 2007
tax year and $41,165.03 in business expenses for the 2008 tax year. (See Ptf’s Exs 1, 5.) The
only evidence Plaintiff offered in support of his claimed business expenses was the checking
account statements and Plaintiff’s testimony. At trial Plaintiff was asked to identify the business
DECISION TC-MD 120706N 6
purpose of certain electronic payments on his checking account statements. He testified that
monthly payments to NW Natural Gas and PGE were payments for gas and electricity at the
adult care facility. Plaintiff testified that payments to AOL and T-Mobile were payments for
internet and cellular phones that he, Debra, and the staff used for Scott’s Quality Care. He could
not provide a bill from AOL listing the address where service was provided. Plaintiff testified
that payments made to “Farnsworth Trust” were rent payments for the building he used for
Scott’s Quality Care. He testified that payments to “IRS USA” were payments the IRS took
monthly after Plaintiff submitted a Form 941.
Plaintiff was asked by Wallace to identify the business purpose of multiple general debit
card purchases. Plaintiff could not identify the specific business purpose of any of those
payments or purchases, nor could he produce receipts or identify any specific items that may
have been included in any of those purchases. For instance, Wallace asked Plaintiff to identify
the business purpose behind a $104 charge at Walmart. Plaintiff responded that it could have
been anything from food to “Depends” for the residents. When Wallace asked why Plaintiff
could not identify any of the items more specifically, Plaintiff responded that he only had the
bank statements and that Debra had done all of the shopping for the residents. Wallace testified
that, without receipts, cancelled checks, or other substantiation of the business purpose of each
expense, Plaintiff cannot be allowed to claim them as deductions.
Based on the court’s review of Plaintiff’s bank statements and testimony, the court is
persuaded that the payments to NW Natural Gas, PGE, and Farnsworth Trust, for the 2007 and
2008 tax years are substantiated. The court finds that the following expenses should be allowed
for the 2007 tax year: $1,747 for payments to NW Natural Gas; $3,542 for payments to PGE;
and $9,286 for payments to Farnsworth Trust. Plaintiff testified that he ceased operations of
DECISION TC-MD 120706N 7
Scott’s Quality Care in June 2008, so the court will allow the following expenses for January
through June of the 2008 tax year: $1,247 for payments to NW Natural Gas and $2,602 for
payments to PGE.
The court found no substantiation in Plaintiff’s exhibits and testimony for the remaining
business expenses claimed by Plaintiff. (See Ptf’s Ex 4, 8.) Plaintiff did not provide the court
with any evidence that the AOL service was only for Scott’s Quality Care and not his personal
use. Plaintiff did not provide the court with any evidence that the cellular phone service was
used primarily for business purposes and not personal uses, nor did he provide a log or similar
record. Plaintiff’s explanation of the IRS payments was confusing and did not provide the court
with enough evidence to substantiate the purpose of the payments. The court finds that Plaintiff
has failed to meet the burden of proof with respect to the remaining expenses claimed on his
proposed returns for the 2007 and 2008 tax years.
2. Unreported income from Scott’s Quality Care for 2007 and 2008
At trial Plaintiff offered his proposed Schedule Cs for 2007 and 2008. (Ptf’s Exs 1, 5.)
Both proposed Schedule Cs reported income that was not included in his original returns for the
2007 and 2008 tax years. (See Ptf’s Exs 1, 5; Def’s Exs C, D.) Plaintiff testified that he had
prepared his proposed returns for 2007 and 2008 using the bank statements from Scott’s Quality
Care. Plaintiff testified that he reported income of $34,505 on his original 2007 Schedule C and
income of $80,827 on his proposed Schedule C. (Def’s Ex C at 6; Ptf’s Ex 1 at 3.) He testified
that he did not file a Schedule C reporting income from Scott’s Quality Care in 2008, but he
reported income of $41,543 on his proposed Schedule C. (Ptf’s Ex 5 at 3.)
Wallace argued that Plaintiff conceded unreported business income in 2007 and 2008 and
the amounts should be included in his gross income. On his proposed Schedule Cs for 2007 and
DECISION TC-MD 120706N 8
2008, Plaintiff reported additional business income not reported on his original income tax
returns for the 2007 and 2008 tax years. Plaintiff did not offer any explanation why that
additional business income should not be included in his gross income.5 Based on Plaintiff’s
testimony, bank statements, and proposed returns, the court is persuaded that Plaintiff had
unreported business income of $46,322 in 2007 and $41,543 in 2008.
B. Rental Income
Oregon imposes an income tax on the “entire taxable income” of residents.
ORS 316.037(1)(a). ORS 316.022(6) defines taxable income as “the taxable income defined in
* * * section 63 of the Internal Revenue Code.” IRC section 63 provides that “the term ‘taxable
income’ means gross income minus the deductions allowed by this chapter.” Gross income is
“all income from whatever source derived” and includes “[r]ents.” IRC § 61. Expenses that may
be deducted against rental income include all the “ordinary and necessary expenses paid or
incurred during the taxable year * * * for the management, conservation, or maintenance of
property held for the production of income.” IRC § 212(2).
Plaintiff was issued a Form 1099 from LR Property Management reporting rental income
for the 2007 and 2008 tax years. (See Def’s Exs G, H.) Wallace produced IRS transcripts
showing that Plaintiff received rental income of $14,418 for the 2007 tax year and $15,920 for
the 2008 tax year. (Def’s Ex G at 28; H at 44-45.) Plaintiff filed a Schedule E in 2007 reporting
rents received of $14,418 and total expenses of $14,418. (Def’s Ex C at 8.) The only
5
IRC section 131(a) excludes from gross income “amounts received by a foster care provider
* * * as qualified foster care payments.” IRC section 131(b)(1) defines “qualified foster care payment” as
“any payment made pursuant to a foster care program of a State or political subdivision thereof * * * * *
(B) which is -- (i) paid to the foster care provider for caring for a qualified foster individual in the foster
care provider’s home[.]” Plaintiff did not assert or offer evidence that any payments received by Scott’s
Quality Care were “qualified foster care payment[s]” that should be excluded from gross income under
IRC section 131. Absent evidence establishing that payments received by Scott’s Quality Care were
“qualified foster care payment[s]” under IRC section 131, the court concludes that the income is taxable.
DECISION TC-MD 120706N 9
explanation Plaintiff offered for the expenses was that the income was “turned over to Debra.”
(Id.) Plaintiff did not file a Schedule E for the 2008 tax year. Plaintiff testified that he had
received the rents reported in 2007 and 2008, but he believed Debra was entitled to the rental
income, so he turned the rental income over to her. Plaintiff testified that he did not attempt to
reassign the Form 1099s to Debra or otherwise correct the Form 1099s.
After reviewing the parties’ exhibits and testimony, the court finds that Plaintiff has
failed to provide the court with any evidence of expenses that were paid or incurred for the
management, conservation, or maintenance of his rental property. The court finds that Plaintiff
received rental income of $14,418 in 2007 and rental income of $15,920 in 2008. He failed to
establish any expenses associated with his rental activity in 2007 and 2008.
C. Capital gain
The issue here is how much of the realized capital gain from the sale of securities in 2008
should be attributed to Plaintiff. IRC section 1001(a) states, in part, that “[t]he gain from the sale
or other disposition of property shall be the excess of the amount realized therefrom over the
adjusted basis provided in section 1011 for determining gain * * *.” Under IRC section 1011(a),
“[t]he adjusted basis for determining gain or loss from the sale or other disposition of property,
whenever acquired, shall be the basis” determined under IRC section 1012. IRC section 1012
states that “[t]he basis of property shall be the cost of such property * * *.”
According to the 2008 “Form 1099-B Reportable Capital Transactions” Plaintiff received
gross proceeds of $194,938.23 and $14,306 in capital gain from the sale of Wachovia securities.
(Def’s Ex K at 2-5.) Plaintiff testified that the Wachovia account had been a joint account
owned by him and Debra. He asserted that the distribution from the sale of securities had been
divided equally between him and Debra, so his portion of the realized gain was half of $14,306.
DECISION TC-MD 120706N 10
Plaintiff did not produce any documentation to show that the account was owned jointly by him
and Debra. Plaintiff also did not produce any evidence that he was required to or did in fact
provide half of the proceeds from the sale of securities to Debra. Wallace produced the “Form
1099-B Reportable Capital Transactions” showing only Plaintiff’s name and social security
number on the account and reporting $14,306 of capital gain to him. (Def’s Ex K at 5.)
After reviewing the evidence and testimony presented, the court finds that Plaintiff has
failed to provide any evidence that the Form 1099B reporting Plaintiff’s capital gain of $14,306
in 2008 was in error. The court finds that Plaintiff realized a capital gain of $14,306 in 2008.
III. CONCLUSION
After carefully considering the testimony and evidence presented, the court finds that
Plaintiff has substantiated some of his claimed expenses for the 2007 and 2008 tax years. The
court further finds that Plaintiff received rental income and had unreported income in 2007 and
2008. The court further finds that Plaintiff realized a capital gain in 2008. Now, therefore,
IT IS THE DECISION OF THIS COURT that, for the 2007 tax year, Plaintiff is allowed
business deductions in the amount of $14,575.
IT IS FURTHER DECIDED that, for the 2007 tax year, Plaintiff received $14,418 in
rental income and Plaintiff received $46,322 in unreported business income.
IT IS FURTHER DECIDED that, for the 2008 tax year, Plaintiff is allowed business
deductions in the amount of $3,849.
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DECISION TC-MD 120706N 11
IT IS FURTHER DECIDED that, for the 2008 tax year, Plaintiff received $15,920 in
rental income; Plaintiff failed to report $41,543 in business income; and Plaintiff realized a
capital gain of $14,306.
Dated this day of June 2013.
ALLISON R. BOOMER
MAGISTRATE
If you want to appeal this Decision, file a Complaint in the Regular Division of
the Oregon Tax Court, by mailing to: 1163 State Street, Salem, OR 97301-2563;
or by hand delivery to: Fourth Floor, 1241 State Street, Salem, OR.
Your Complaint must be submitted within 60 days after the date of the Decision
or this Decision becomes final and cannot be changed.
This document was signed by Magistrate Allison R. Boomer on June 24, 2013.
The Court filed and entered this document on June 24, 2013.
DECISION TC-MD 120706N 12