DeGroat v. Dept. of Rev. , 23 Or. Tax 254 ( 2019 )

254 February 11, 2019 No. 12
IN THE OREGON TAX COURT
REGULAR DIVISION
Christopher C. DeGROAT
Plaintiff,
v.
DEPARTMENT OF REVENUE,
State of Oregon,
Defendant.
(TC 5322)
Taxpayer claimed a deduction on his federal income tax return for attor-
ney fees related to alimony payments, which the Department of Revenue (the
department) denied. After a trial in the Magistrate Division, taxpayer appealed
to the Regular Division. Taxpayer was unable to prove by a preponderance of
the evidence that he had incurred the attorney fees for a deductible purpose and
that he had “actually paid the money to his attorney in 2013.” The court held that
taxpayer had failed to meet his evidentiary burden and was therefore not entitled
to a deduction for attorney fees.
Trial was held in the courtroom of the Oregon Tax Court
on September 24, 2018.
Plaintiff Christopher C. DeGroat argued the cause pro se.
James C. Strong, Assistant Attorney General, Depart-
ment of Justice, Salem, argued the cause for Defendant
Department of Revenue.
Decision for Defendant rendered February 11, 2019.
ROBERT T. MANICKE, Judge.
I. INTRODUCTION
This personal income tax matter is before the court
after trial. The tax year at issue is 2013. Plaintiff (tax-
payer) asserts that he was entitled to a deduction for cer-
tain attorney fees. Defendant Department of Revenue (the
department) asserts that taxpayer is not entitled to the
deduction.
II. FACTS
Taxpayer reported an expense of $19,775 on his
2013 federal income tax return with the description “Legal
Cite as 23 OTR 254 (2019) 255
Fees Re: Alimony.” Taxpayer chose to claim the expense
as a deduction, listing it as the sole item on Line 23 of his
Schedule A, in the category “Other expenses.” The Internal
Revenue Code (the “Code” or “IRC”) includes such items
as “miscellaneous itemized deductions.” See Knight v.
Comm’r, 552 US 181, 184, 128 S Ct 728, 169 L Ed 2d 652(2008) (explaining “miscellaneous itemized deductions”).
IRC section 67(a), known as the “two-percent floor” rule,
provides that a taxpayer’s miscellaneous itemized deduc-
tions are deductible only to the extent that the aggregate of
the deductions exceeds two percent of the taxpayer’s total
adjusted gross income for the year.1 The two-percent floor
reduced taxpayer’s deduction for the legal fees to $18,871
(the “Attorney Fees”).
The department audited taxpayer’s 2013 Oregon
income tax return and proposed adjustments to taxpayer’s
deduction for the Attorney Fees, as well as his deduction
for certain alimony payments, resulting in a net tax owed
of $2,043,2 and added a “substantial underpayment of tax-
able income” penalty of $408.3 The department explained its
adjustments in the Notice of Deficiency (Deficiency Notice)
sent to taxpayer on September 23, 2016. The Deficiency
Notice stated that the department had adjusted taxpayer’s
alimony deduction because taxpayer had failed to properly
substantiate his allocation between amounts he had paid
in child support (a nondeductible expense for payor spouse),
and money he had paid out in alimony (a deductible expense
for the payor spouse) during 2013. IRC §§ 71(c), 215(a). This
adjustment resulted in a reduction of alimony paid from
1
Unless otherwise stated, the court’s references to the IRC, federal Treasury
Regulations (Treas Reg) and the Oregon Revised Statutes (ORS) are to the 2013
editions.
2
The department’s disallowance of taxpayer’s miscellaneous itemized deduc-
tion resulted in a standard deduction amount lower than the net Oregon itemized
deduction. ORS 316.695(1)(c)(A). Therefore, the department allowed taxpayer to
take the standard deduction appropriate for his filing status.
3
A substantial understatement of taxable income exists if the department
determines that a taxpayer has underreported the taxpayer’s taxable income by
more than $15,000 for any taxable year. ORS 314.402(2)(a). The penalty is equal
to 20 percent of the difference between the amount the taxpayer reported and the
amount the department determines the taxpayer to owe. ORS 314.402(1). The
department is then required to add the penalty amount to the total amount of tax
the taxpayer is required to pay for that year. Id.
256 DeGroat v. Dept. of Rev.
$23,637 to $17,800. The department also disallowed any
deduction for the Attorney Fees. The department asserted
that (1) the Attorney Fees were incurred in connection with
taxpayer’s divorce, a nondeductible personal expense; and
(2) the Attorney Fees were not paid in connection with the
production of income, as required by IRC section 62. IRC
§ 62; Treas Reg § 1.262-1.
Taxpayer requested and received a formal confer-
ence with the department regarding both adjustments. On
March 10, 2017, the department issued a Conference Decision
Letter informing taxpayer that it had restored taxpayer’s
alimony claim to the original amount claimed but that it
continued to deny taxpayer’s deduction for the Attorney
Fees. The department reduced the substantial understate-
ment penalty to reflect the restoration of taxpayer’s original
alimony deduction. Taxpayer appealed to the Magistrate
Division from the final Notice of Assessment that accom-
panied the Conference Decision Letter. Following trial, the
magistrate issued a decision in favor of the department, and
taxpayer appealed to the Regular Division.
III. ISSUE
The issue is whether taxpayer is entitled to the
deduction he claimed for the Attorney Fees.
IV. ANALYSIS
When the department denies a deduction and a
taxpayer appeals, the taxpayer bears the burden of show-
ing by a preponderance of the evidence that the deduction
is allowable. ORS 305.427; Baisch v. Dept. of Rev., 316 Or
203, 211, 850 P2d 1109 (1993). A “preponderance” of the
evidence means “the greater weight of evidence, the more
convincing evidence.” Feves v. Dept. of Revenue, 4 OTR 302,
312 (1971). Oregon courts have concluded that when the law
places the burden of proof on the taxpayer, as it does in this
case, it is the responsibility of the taxpayer to put forward
“sufficient evidence which will weigh more in the mind of
the trier of fact than the * * * weight of the evidence adduced
by the [department] * * *.” Sproul v. Commission, 1 OTR
31, 65 (1962), rev’d on other grounds by Sproul v. State Tax
Com., 234 Or 567, 382 P2d 99 (1963). The “preponderance
Cite as 23 OTR 254 (2019) 257
of evidence” standard requires (1) a taxpayer to provide the
court with facts supporting the taxpayer’s position; and
(2) that those facts must outweigh the department’s evidence.
See Dept. of Rev. v. Bahr I, 20 OTR 434, 448 (2012) (stating
that when the evidence in the record does not favor either
side, “the court must find against the party bearing the bur-
den of proof”). “[I]f the evidence is inconclusive or unpersua-
sive, the taxpayer will have failed to meet his burden of proof
* * *.” Reed v. Dept. of Rev., 310 Or 260, 265, 798 P2d 235(1990).
In this case, taxpayer must show by a preponder-
ance of the evidence that he is entitled under federal and
state law to deduct the Attorney Fees. See ORS 305.427. To
do this, taxpayer generally must prove two things: first, that
he incurred the Attorney Fees for a deductible purpose under
both federal and state law, and second, that he actually paid
the money to his attorney in 2013. The department asserts
that taxpayer has not proven either of these two things.
When determining whether a taxpayer is entitled
to a deduction under federal law, the court applies federal
and Oregon case law on the subject. Baisch, 316 Or at 209-
10. Federal courts have held that obtaining a divorce is a
personal matter that Congress has not decided to subsidize
through the income tax laws, and Oregon follows this rule.
See, e.g., United States v. Gilmore, 372 US 39, 49, 83 S Ct 623,
9 L Ed 2d 570 (1963) (stating rule); see also Treas Reg § 1.262-
1(7) (“Generally, attorney’s fees * * * paid in connection with
a divorce * * * are not deductible by either the husband or the
wife.” (Emphasis added.)). However, divorce-related legal fees
that are allocable to income-producing activities, tax advice,
or a dispute regarding entitlement to business profits may
be deductible under IRC section 212. See Hill v. Comm’r, 100
TCM (CCH) 513 (2010), 2010 WL 5108761 *8, (as amended
Dec 22, 2010) (citing Wild v. Comm’r, 42 TC 706, 711 (1964))
(legal fees incurred to produce monthly alimony payments,
which were includible in the taxpayer’s gross income, were
deductible under section 212); Seidel v. Comm’r, TCM (RIA)
2005-67 (2005), 2005 WL 730077 *12 (US Tax Ct) (holding
that taxpayer is entitled to deduct attorney fees incurred
in divorce proceedings to extent that such fees were paid in
258 DeGroat v. Dept. of Rev.
order to secure production of income, i.e., distribution from
former husband’s 401(k) plan includible in her income as
alternate payee).
Taxpayer has not claimed that the reason he paid
the Attorney Fees in 2013 was related to income production,
preserving investment assets, or to protect his entitlement
to property. However, taxpayer does claim that he paid the
Attorney Fees for tax advice related to his divorce.4
Congress has declared, in section 212(3) of the Code
(“Section 212(3)”):
“In the case of an individual, there shall be allowed as a
deduction all the ordinary and necessary expenses paid or
incurred during the taxable year—
“* * * * *
“(3) in connection with the determination, collection,
or refund of any tax.”
Over the years, federal regulations, federal case law and pro-
nouncements by the Internal Revenue Service have inter-
preted Section 212(3). Treasury Regulation 1.212-1(l) states
that expenses paid for “tax counsel” in connection with any
“proceedings involved in determining the extent of [a tax-
payer’s] tax liability” can be deductible. In 1972, the IRS
released a Revenue Ruling on the meaning of the deduction,
stating, “[i]n order for an expense to be deductible under
Section 212(3) of the Code it must relate solely to tax coun-
sel.” Rev Rul 72-545, 1972-2 CB 179 (citing United States
v. Davis, et al., 370 US 65, 66, 82 S Ct 1190, 8 L Ed 2d 335(1962) (citations omitted)). That same Revenue Ruling also
states, “[w]hen a taxpayer pays the same lawyer for both
tax advice and advice on other matters, the taxpayer must
substantiate what portion of the legal fees was for tax advice
in order to receive the deduction.” Rev Rul 72-545, 1972-2
CB 179 (citing Fleischman v. Comm’r, 45 TC 439 (1966)). The
court agrees with these interpretations.
4
At trial, taxpayer explained that he sought “tax advice” incidental to
his divorce “because there was a business involved, there was personal wages
involved, so I needed to also get tax assistance for that.” Taxpayer stated “[t]hat
bill was related to not all of my divorce fees, as the Department of Revenue keeps
suggesting but related specifically to tax advice.”
Cite as 23 OTR 254 (2019) 259
To “substantiate” means “to establish the existence
or truth; to verify.” Webster’s Third New Int’l Dictionary
2280 (unabridged ed 2002); see also Gorokhovsky v. Comm’r,
104 TCM (CCH) 87, & 549, 527 (7th Cir 2013) (finding that
taxpayer’s submission of self-generated, handwritten notes
was not credible evidence of claimed deductions for legal ser-
vices, and thus was insufficient to meet the taxpayer’s bur-
den of proof). Therefore, in this case, in order to substantiate
the Attorney Fees as required by federal case law, taxpayer
must provide the court with credible evidence verifying that
the Attorney Fees were paid in exchange for legal advice
relating to tax counsel and not legal advice related to his
divorce.
All the evidence in the record was introduced by
the department at trial. Taxpayer reviewed the evidence
and agreed it was authentic. Taxpayer did not introduce any
other documents, witness testimony, or other evidence.
The court has examined the record in detail to
determine whether taxpayer’s deduction for Attorney Fees
is properly substantiated. Defendant’s Exhibits A through
N in the record contain court documents from taxpayer’s
dissolution of marriage proceeding in Clackamas County.
Defendant’s Exhibit O is taxpayer’s 2013 Tax Return.
Defendant’s Exhibit P is the Deficiency Notice. Defendant’s
Exhibit Q is the Conference Decision Letter mailed by the
department to the taxpayer on March 10, 2017. Defendant’s
Exhibit R is the Notice of Assessment mailed by the depart-
ment to the taxpayer on May 5, 2017.
The only evidence describing the purpose of the
legal advice consists of attorney billing narratives for some
periods in 2012-13, which describe various activities by a
lawyer. However, the narratives say nothing about tax
advice. This evidence alone is insufficient to verify that
taxpayer incurred the Attorney Fees in exchange for legal
advice relating to tax counsel, as opposed to legal advice
related to taxpayer’s divorce.
The court next considers whether taxpayer has
produced sufficient evidence to prove that he actually paid
money to an attorney in 2013. The sections of the Code gov-
erning whether a deduction is allowable are based, in part,
260 DeGroat v. Dept. of Rev.
on the taxpayer’s method of accounting for the taxable year
for which the taxpayer seeks the deduction. See IRC § 461(a)
(“The amount of any deduction * * * shall be taken for the
taxable year which is the proper taxable year under the
method of accounting used in computing taxable income.”).
IRC section 446(c) allows a taxpayer to compute taxable
income under a cash receipts and disbursements method of
accounting (the “Cash Method”).
taxpayer used the Cash Method on his 2013
Schedule C. Because taxpayer reported income in 2013 on
the Cash Method, he must also report deductions on the
Cash Method. Comm’r v. South Texas Lumber Co., 333 US
496, 501, 68 S Ct 695, 92 L Ed 831 (1948). A Cash Method
taxpayer may only deduct expenses in the year actual pay-
ment takes place. Treas Reg § 1.446-1(c)(1)(i); e.g., Holmes
v. Comm’r, 93 TCM (CCH) 1137 (2007), 2007 WL 1201571*2 (US Tax Ct). “Generally, delivery of a check will consti-
tute payment.” Reynolds v. Comm’r, 79 TCM (CCH) 1376
(2000), 2000 WL 37730 *10, & 296, 607 (7th Cir 2002); see
Guy v. Comm’r, 105 TCM (CCH) 1626 (2013), 2013 WL
1501524 *3 (because taxpayers lacked evidence as to when
they mailed or delivered a check to their attorney, taxpayers
were not entitled to a Schedule C deduction for legal ser-
vices in 2007 tax year, where check was dated December 29,
2006, and attorney deposited check on January 30, 2007)
(emphasis added); Zarrinnegar v. Comm’r, 113 TCM (CCH)
1148 (2017), 2017 WL 568550 *3 (taxpayers entitled to
Schedule C expense deduction on their 2011 return on the
basis of expenses incurred on their 2011 credit card state-
ment). Thus, in addition to the substantiation requirement
discussed above, taxpayer must also prove by a preponder-
ance of the evidence that he mailed or delivered a check
or cash, or that he incurred a charge on his credit card in
satisfaction of his debt for the Attorney Fees, on or before
December 31, 2013.
Defendant’s Exhibit K is the Declaration of Matthew
D. Lyon, filed on December 10, 2013, in Clackamas County
Circuit Court. This document appears to show that attor-
ney Matthew D. Lyon sought permission from the court to
withdraw as taxpayer’s counsel in his divorce proceedings
Cite as 23 OTR 254 (2019) 261
in Clackamas County during 2013. There is no evidence in
this document, nor in any of other court filings contained in
Defendant’s Exhibits A through N, that suggest taxpayer
actually paid money to an attorney for tax advice related to
this divorce in 2013. Without more, the court concludes that
taxpayer has not proven by a preponderance of the evidence
that he is entitled to the deduction for Attorney Fees actu-
ally paid out in 2013.
Having addressed the merits of taxpayer’s claim,
the court concludes by addressing questions taxpayer raised
at trial. Taxpayer stated that he did not understand what
the “catalyst” was that caused “this deduction suddenly
not to be acceptable.” He stated that he did not understand
when the department first notified him of the assessment.
(“What year did the Department of Revenue first raise this
as a concern?”) Taxpayer also asked when interest began
to accrue on the deficiency amount. (“Being that I wasn’t
notified for three years, at what point did the interest start
accruing?”)
Nothing in the evidence indicates that any partic-
ular catalyst triggered the audit. None is required. Oregon
law generally gives the department three years from the
time a tax return is filed to examine a taxpayer’s return
and provide notice to a taxpayer that it is asserting a defi-
ciency in the amount of tax paid by mailing the notice to
the person’s last known address. ORS 314.410(1), ORS
305.265(11). In this case, the amount of taxpayer’s deduc-
tion for the Attorney Fees was very high in relation to his
total income—about 27 percent. Based on the record, the
court finds nothing unusual in the fact that the department
audited taxpayer’s return or in the procedures the depart-
ment followed, which the court has summarized above.
The department notified taxpayer of the deficiency
by mailing the Deficiency Notice to him on September 23,
2016. Taxpayer does not deny receiving the Deficiency
Notice. The Deficiency Notice gave taxpayer the option of
paying the balance of his assessment at any point during
the appeal process, stating that “[p]ayment doesn’t mean
you agree with this notice, it just stops more interest from
accruing.” The Deficiency Notice also explained that if the
262 DeGroat v. Dept. of Rev.
deficiency is reduced as a result of the taxpayer’s appeal, any
interest that has accrued during the appeal process is also
reduced. ORS 305.270(1). Taxpayer did not pay his assess-
ment at any time during the appeal process. At taxpayer’s
request, the court granted a waiver, based on undue hard-
ship, of the requirement to pay at the time of his appeal to
the Regular Division. Order Regarding Deferral or Waiver
of Filing Fee for Plaintiff, DeGroat v. Dept. of Rev., TC 5322
(Or Tax, Mar 6, 2018). Thus, interest likely began to accrue
on April 15, 2014, the due date of taxpayer’s 2013 return.
OAR 150-314-0165; ORS 305.265(13). Interest continues to
accrue.
V. CONCLUSION
For the foregoing reasons, the court concludes that
taxpayer failed to meet his evidentiary burden to prove by
a preponderance of the evidence that he paid the Attorney
Fees during 2013 for tax advice received incident to his
divorce. Now, therefore,
IT IS THE OPINION OF THIS COURT that
Defendant properly denied Plaintiff’s claim for a deduction
from his Oregon taxable income for the Attorney Fees in
2013. Counsel for Defendant is directed to submit an appro-
priate form of judgment.