Genecure, L.L.C., Frank Y. Tung, Tax Matters Partner ( 2022 )

United States Tax Court
T.C. Memo. 2022-52GENECURE, L.L.C., FRANK Y. TUNG, TAX MATTERS PARTNER,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 14916-15. Filed May 23, 2022.
—————
Frank Y. Tung, pro se.
John T. Arthur, Rubinder K. Bal, Rebeccah L. Bower, Christopher D.
Bradley, and Shannon E. Craft, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
JONES, Judge: This TEFRA 1 partnership-level case was heard
pursuant to section 6226(a)(1). 2 Petitioner, Frank Y. Tung (Mr. Tung),
seeks review of adjustments made by the Internal Revenue Service (IRS)
in Notices of Final Partnership Administrative Adjustment (FPAA)
issued to Genecure, L.L.C. (Genecure), for taxable years 2009–12.
The outstanding issues for decision are whether Genecure: (1) had
unreported income of $6,000; $21,578; and $7,000 for taxable years
1 Before its repeal, TEFRA (the Tax Equity and Fiscal Responsibility Act of
1982, Pub. L. No. 97-248, §§ 401–407, 96 Stat. 324, 648–71) governed the audit and
litigation procedures for many partnerships.
2 Unless indicated otherwise, all statutory references are to the Internal
Revenue Code (Code), Title 26 U.S.C., in effect at all relevant times, all regulatory
references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all
relevant times, and all Rule references are to the Tax Court Rules of Practice and
Procedure. All monetary amounts are rounded to the nearest dollar.
Served 05/23/22
2
[*2] 2009–11, respectively, 3 (2) had various deductible business
expenses of $180,586; $161,004; 4 $174,229; and $123,963 for taxable
years 2009–12, respectively, (3) is subject to a $230,979 recapture tax
for excess amounts received as a Qualified Therapeutic Discovery
Project (QTDP) grant in taxable year 2010, 5 (4) received a $200,000 loan
from a limited liability company member (LLC), Lilly Tung (Mrs. Tung),
in taxable year 2009, 6 (5) received a $100,000 capital contribution from
Mrs. Tung in taxable year 2011, 7 and (6) is liable for section 6663 civil
fraud penalties for any underpayments of tax attributable to fraud for
taxable years 2009–12. 8
We resolve these issues largely in respondent’s favor.
FINDINGS OF FACT
This case was tried in Atlanta, Georgia. The Stipulations of
Facts, including the jointly stipulated exhibits contained therein, are
incorporated by this reference. At the time Mr. Tung filed the Petition,
Genecure’s principal place of business was located in Norcross, Georgia. 9
3Respondent conceded the determination in the FPAA for taxable year 2012
that Genecure had unreported gross receipts or sales of $388.
4 Respondent conceded $18,000 in purported business expense deductions
(specifically, research and development expenses) previously disallowed in the FPAA
for taxable year 2010.
5Respondent conceded the determination in the FPAA for taxable year 2009
that QTDP grant recapture should be applied to that year.
6 The IRS also determined in the FPAA for taxable year 2009 that the loan
lacked economic substance—a determination that Mr. Tung challenged in the Petition.
However, respondent did not pursue the argument on brief. We therefore deem it
abandoned. See Mendes v. Commissioner, 121 T.C. 308, 312–13 (2003).
7 Respondent conceded the determination in the FPAA for taxable year 2009
that Genecure failed to substantiate any capital contribution received during that
year. Genecure did not report any capital contribution on its return for that year.
Respondent also conceded the determination that Genecure failed to substantiate
capital contributions from LLC members other than Mrs. Tung in taxable year 2011.
8 Respondent conceded his alternative determinations in the FPAAs for each
of the taxable years at issue with respect to the applicability of accuracy-related
penalties under section 6662(a).
9 Absent stipulation to the contrary, this case is appealable to the U.S. Court
of Appeals for the Eleventh Circuit. See § 7482(b)(1)(E).
3
[*3] I. Genecure and Mr. Tung
Genecure is a biotechnology firm and is organized as a
member-managed LLC. It is treated as a partnership for federal income
tax purposes. 10 See Treas. Reg. § 301.7701-3(b)(1). Among other things,
Genecure was involved in the research and development of a therapeutic
vaccine 11 for the disease caused by the human immunodeficiency virus
(HIV) that would eliminate the need for antiviral drug treatment for
those infected. It operated primarily out of a facility located at 3150
Corners North Court, Norcross, Georgia (3150 Corners), at all relevant
times.
Genecure was founded by Mr. Tung in 1999. During the taxable
years at issue, Mr. Tung possessed the largest ownership interest in
Genecure and served as its member manager as well as its tax matters
partner (TMP); he also represented himself to be its chief executive
officer in dealings with outside parties. Prior to founding Genecure, Mr.
Tung was a professor at multiple academic institutions, including the
University of Florida and the University of Pittsburgh. He earned his
bachelor’s and master’s degrees in Taiwan and completed his doctoral
studies in the United States, including postdoctoral research at the
Harvard Medical School.
Throughout the taxable years at issue, Genecure paid for various
expenses in connection with its research and development activity (e.g.,
liquid nitrogen, pipettes, enzymes). Genecure was also engaged in
multiple contractual service and collaborative research relationships
during this period, including with Georgia State University Research
Foundation, Inc. (GSURF), MPI Research, Inc. (MPI), and the
University of Miami (UM). Under an agreement executed in November
2008, Genecure and GSURF entered into a collaborative research
relationship whereby Genecure provided funding for research activities
in exchange for the use of Georgia State University (GSU) facilities and
equipment. One project sponsored by Genecure under this agreement
was SP0000ALW95. Under an agreement executed in September 2009
By extension, members of the LLC are treated analogously to partners in a
10
partnership.
11 Therapeutic vaccines are nonprophylactic and are designed to treat diseases
by eliciting an immune response. See Ctr. for Biologics Evaluation & Rsch., U.S. Food
& Drug Admin., Guidance for Industry: Preclinical Assessment of Investigational
Cellular and Gene Therapy Products 28 (Nov. 2013), https://www.fda.gov/
media/87564/download.
4
[*4] with MPI, Genecure sponsored a toxicity study in rats of an HIV
vaccine it had engineered. Lastly, under an agreement executed in July
2011 with UM, Genecure also sponsored a clinical trial study (in
humans) to evaluate the safety and immunogenicity of its HIV vaccine; 12
this study started in July 2011 and was carried out by Dr. Margaret
Fischl of UM School of Medicine. 13
Genecure was not a profitable entity during any of the years at
issue. Nonetheless, Genecure was not without income. In taxable years
2009–11, respectively, Genecure received $6,000; $20,000; and $7,000
from Washington Biotechnology, Inc. (WBI). These payments were
received pursuant to a settlement agreement and as compensation for
material damages attributable to WBI’s failure to carry out a contracted
toxicology study in compliance with applicable federal regulations. In
taxable year 2010, Genecure also received two checks totaling $1,578
from Hiroshi and Hiromi Yoshida. This sum of money was received for
reagent prepared by Genecure.
II. QTDP Program
In 2010, Congress passed the Patient Protection and Affordable
Care Act (ACA), Pub. L. No. 111-148, 124 Stat. 119 (2010). ACA
§ 9023(a), 114 Stat. at 877, created an incentive program for small
businesses engaged in a QTDP by allowing taxpayers to claim a credit
for certain expenses, which was codified at section 48D. This incentive
program was only in effect for taxable years beginning in 2009 or 2010,
and the credit was computed as 50% of a taxpayer’s “qualified
investment” in such taxable years in a qualifying project. 14 See § 48D(a),
(b)(5). In lieu of a credit, taxpayers were permitted to elect to receive
this benefit in the form of a cash grant. 15 See ACA § 9023(e), 114 Stat.
at 881. The IRS released I.R.S. Notice 2010-45, 2010-23 I.R.B. 734, to
provide taxpayers guidance on the procedures governing application for
the QTDP credit or grant.
We make no finding whether this HIV vaccine was the same as that under
12
study by MPI.
13 Dr. Fischl was the director of the medical school’s AIDS Clinical Research
Unit.
14 Whether Genecure’s HIV vaccine development constituted a qualifying
project is not at issue.
15 This election was particularly beneficial for taxpayers without sufficient
income to make use of the credit.
5
[*5] Genecure applied for the QTDP program in 2010 using Form
8942, Application for Certification of Qualified Investments Eligible for
Credits and Grants Under the Qualifying Therapeutic Discovery Project
Program. Genecure initially applied under the name “GeneCure
Biotechnologies”; however, in an amended Form 8942, it applied under
the name “GeneCure LLC.” Between the initial and amended Forms
8942, there was no difference apart from the variation in applicant
name. On the Forms 8942, Genecure reported that its project concerned
the development of therapeutic HIV vaccines, and it made elections to
receive any credits attributable to qualified investments certified by the
IRS in the form of grants. Moreover, it reported qualified investments
of $600,000 and $1,060,000 in taxable years 2009 and 2010, respectively.
In a Letter 4615 dated October 29, 2010, the IRS informed
Genecure that it had certified $488,958 in qualified investments
Genecure reported and that a grant of $244,479 had been approved. 16
The Letter 4615 does not state whether the certified qualified
investments related to taxable year 2009, 2010, or both; however, the
parties have stipulated that the $244,479 awarded as a grant was
attributable to qualified investments reported for taxable year 2009. On
November 10 and 16, 2010, respectively, Genecure received electronic
transfers of $44,479 and $200,000 to its BB&T Bank account (-1487).
On April 8, 2011, the IRS informed Genecure that as a recipient
of a QTDP grant, it was required to amend its tax return for taxable
year 2009 by reducing its previously reported deductible expenses and
depreciable costs. 17 Genecure responded to the IRS in a letter dated
May 8, 2011, stating that it did not believe an amended return for 2009
was necessary. Genecure did not file an amended return for taxable
year 2009.
III. Genecure’s Returns at Issue
Genecure timely filed Forms 1065, U.S. Return of Partnership
Income, for the taxable years at issue (i.e., 2009–12).
16 The amount certified was far less than the aggregate $1,660,000 reported
qualified investment. Because the QTDP program was oversubscribed and capped at
$1 billion for the years in which it was in effect, see § 48D(d)(1)(B), the IRS was limited
in its ability to certify the full amounts reported by interested taxpayers.
17 Section 48D(e)(2)(B) denies taxpayers who receive a QTDP credit or grant
from also claiming a deduction for the same underlying expenses.
6
[*6] A. 2009 Return
Among other things, Genecure indicated on its 2009 return that
it was a cash method taxpayer and reported (with respect to its trade or
business) no items of income; $100,000 in deductible rent expenses; and
$80,586 in “other” deductible expenses. In Statement 1 included with
the return, Genecure itemized the “other” deductible expenses as
follows: $925 (“Accounting”); $26 (“Bank Charges”); $1,082 (“Dues and
Subscriptions”); $3,400 (“Insurance”); $3,234 (“Legal and
Professional” ); $574 (“Office Supplies”); −$2,027 (“Other Income/
18
(Expenses)”); $56,279 (“Research & Development”); $3,242
(“Telephone/Internet”); $5,424 (“Travel”); and $8,427 (“Utilities”).
Moreover, Genecure reported on Schedule L, Balance Sheets per
Books, that it had $200,000 in “Other liabilities” at taxable yearend. In
Statement 3 attached to the return, it indicated that the $200,000 was
solely attributable to a loan from Mrs. Tung, who was married to Mr.
Tung at all relevant times. According to the Schedule L, this $200,000
loan was Genecure’s only new liability during the taxable year and its
only liability as of taxable yearend.
Genecure also attached completed Schedules K–1, Partner’s
Share of Income, Deductions, Credits, etc., for 28 partners stating their
individual tax-basis capital account balances at the beginning of taxable
year 2009. 19 Notwithstanding the reported $200,000 liability at taxable
yearend, no portion of the purported loan was allocated among the 28
partners on the respective Schedules K–1.
As stated previously, Genecure did not file an amended return for
taxable year 2009 to reduce the deductible expenses it had initially
reported and for which it received the QTDP grant. See supra note 17.
B. 2010 Return
Among other things, Genecure indicated on its 2010 return that
it was a cash method taxpayer and reported (with respect to its trade or
business) no items of income; $100,000 in deductible rent expenses; and
$79,004 in “other” deductible expenses. In a statement included with
18 These were all legal expenses.
19 Relatedly, Genecure reported on Schedule L that the aggregate capital
account balance of the 28 partners (for financial accounting purposes) at the beginning
of the taxable year totaled $433,113.
7
[*7] the return, Genecure itemized the “other” deductible expenses as
follows: $576 (“Travel”); $480 (“Dues and subscriptions”); $2,343
(“Insurance”); $1,265 (“Legal and professional fees” 20); $643
(“Supplies” 21); $3,284 (“Telephone & Internet”); $6,679 (“Utilities”);
$58,062 (“Research & Development”); and $5,672 (“Other Expenses”).
C. 2011 Return
Among other things, Genecure reported on its 2011 return that it
was a cash method taxpayer and reported (with respect to its trade or
business) no items of income; $100,000 in deductible rent expenses; and
$74,229 in “other” deductible expenses. In a statement included with
the return, Genecure itemized the “other” deductible expenses as
follows: $1,845 (“Travel”); $960 (“Dues and subscriptions”); $2,429
(“Insurance”); $970 (“Legal and professional fees”); $1,867
(“Supplies” 22); $2,949 (“Telephone”); $6,702 (“Utilities”); $44,179
(“Research & Development”); and $12,328 (“Tax”).
Moreover, Genecure reported on the Schedule K–1 for Mrs. Tung
that she had made a capital contribution of $100,000 to the partnership
during the taxable year. On a separate Schedule K–1 for Hsiang-Fen
Yin Lin (Hsiang-Fen), Genecure also reported a $100,000 capital
contribution to the partnership during the taxable year from that
individual.
D. 2012 Return
Among other things, Genecure reported on its 2012 return (with
respect to its trade or business) no items of income and $123,963 in
“other” deductible expenses. In Statement 1 included with the return,
Genecure itemized the “other” deductible expenses as follows: $480
(“Dues and Subscriptions”); $2,487 (“Insurance”); $712 (“Office Supply”);
$7,000 (“Auto”); $98,477 (“Research & Development”); $2,486
(“Telephone & Internet”); $6,560 (“Travel”); and $5,761 (“Utility”).
IV. Examination of Genecure’s Returns and Issuance of FPAAs
Genecure’s returns for taxable years 2009–12 were selected for
audit. In May 2012, the IRS assigned Revenue Agent Thomas White
20 These were all legal expenses.
21 We construe this to mean office supplies.
22 We construe this to mean office supplies.
8
[*8] (RA White) as the examining agent of the Genecure examination.
RA White worked on the Genecure examination for over two years, after
which Revenue Agent Christopher Kittrell (RA Kittrell) took over and
closed the case.
While he was still assigned to the Genecure examination, RA
White prepared Form 11661, Fraud Development Recommendation –
Examination, which was signed by Acting Group Manager Elga
Fontanes (Ms. Fontanes) on August 7, 2012. By the time RA Kittrell
took over the examination, RA White had already completed the bulk of
the exam work. Nonetheless, the Civil Penalty Approval Form in the
record was prepared by RA Kittrell. In addition to his own narrative
entry explaining the reasoning for the assertion of penalties, RA Kittrell
also included a narrative adopted from a lead sheet completed by RA
White. On March 19, 2015, Group Manager Sharonne Smith (Ms.
Smith) signed the Civil Penalty Approval Form.
On February 20, 2015, RA Kitrell issued to Genecure a Letter
1807 inviting Mr. Tung, in his capacity as TMP, to a closing conference
to discuss the IRS’s proposed adjustments concerning Genecure’s
returns for taxable years 2009–12. The proposed adjustments, including
imposition of the section 6663 penalties, were detailed in Forms 4605–A,
Examination Changes – Partnerships, Fiduciaries, S Corporations, and
Interest Charge Domestic International Sales Corporations (Unagreed
and Excepted Agreed), and Form 886–A, Explanation of Items. The
Letter 1807 collectively referred to these forms as the “summary report”
and stated that “[a]ll proposed adjustments [therein] . . . w[ould] be
discussed at the closing conference.” A closing conference was not
ultimately held. 23
On April 9, 2015, the IRS issued to Mr. Tung (in his capacity as
Genecure’s TMP) a separate FPAA for each of the taxable years at issue.
In pertinent part, the IRS determined that Genecure (1) failed to report
income of $6,000; $21,578; and $7,000 for taxable years 2009–11,
respectively, (2) was not entitled to deduct purported business expenses
23 Mr. Tung argues that the IRS erroneously denied Genecure a closing
conference; however, his allegation is inconsequential as we review this case de novo.
See Prod. House Ltd. P’ship C–23 v. Commissioner, T.C. Memo. 1992-304, 1992 Tax Ct.
Memo LEXIS 327, at *14. Moreover, absent substantial evidence of unconstitutional
conduct (which Mr. Tung has not produced), this Court does not look behind the FPAA
to examine the propriety of the IRS’s motive, administrative policy, or procedure
involved in making the adjustments at issue. See Greenberg’s Express, Inc. v.
Commissioner, 62 T.C. 324, 327–28 (1974).
9
[*9] of $180,586; $179,004, see supra note 4; $174,229; and $123,963 for
taxable years 2009–12, respectively, (3) was subject to $230,979 in
QTDP recapture tax with respect to taxable year 2010, see supra note 5,
(4) failed to establish receipt of a $200,000 loan from Mrs. Tung in
taxable year 2009, 24 (5) failed to establish receipt of a $100,000 capital
contribution from Mrs. Tung in taxable year 2011, 25 and (6) was liable
for a section 6663 civil fraud penalty for any underpayment of tax for
each of the taxable years at issue. On June 8, 2015, Mr. Tung filed a
Petition in his capacity as TMP, see § 6226(a)(1), challenging the
aforementioned determinations, which remain outstanding for our
review. 26
OPINION
I. Evidentiary Matters
As a preliminary matter, the Court must address the
admissibility of documentary evidence introduced at trial by Mr. Tung
but for which we reserved ruling. The admissibility of Exhibits 76–P,
78–P, 79–P, 83–P, and 89–P remains at issue. 27 Our evidentiary rulings
are determined under the Federal Rules of Evidence. See § 7453; Rule
143(a).
24 The FPAA for taxable year 2009 does not specifically identify Mrs. Tung or
the amount of the loan (i.e., $200,000); it only refers to Genecure’s failure to
substantiate a loan transaction with a “Dr. Tung.” However, on the Form 1065 for that
year, Genecure reported that it received a $200,000 loan from Mrs. Tung and that the
loan was its only new liability during the taxable year.
25 The FPAA for taxable year 2011 does not specifically identify Mrs. Tung or
the amount of the capital contribution (i.e., $100,000); it only refers to Genecure’s
failure to substantiate capital contributions from its partners generally. However, the
Schedules K–1 included with the Form 1065 for that year indicate that Genecure
reported a $100,000 capital contribution from Mrs. Tung.
26 We note that in the Petition, Mr. Tung did not challenge adjustments made
in the FPAA for each of the taxable years at issue for (1) salaries and wages and
(2) guaranteed payments to partners. These adjustments either had no net effect on
Genecure’s ordinary income (taxable years 2009–11) or reduced it (taxable year 2012).
Notwithstanding certain statements by the parties in their respective pretrial
memoranda suggesting that these adjustments were in dispute, they were not pleaded,
tried, or addressed on posttrial brief. Consequently, we do not consider them to be at
issue.
27 Following trial, respondent withdrew his objection to the admission of
Exhibit 82–P into evidence. The exhibit is therefore admitted into evidence.
10
[*10] Under the Federal Rules of Evidence, irrelevant evidence is not
admissible. See Fed. R. Evid. 402. An item of evidence is relevant to the
extent it tends to make a fact more or less probable and such fact is
consequential to determining the action. See Fed. R. Evid. 401. The
Federal Rules of Evidence also prohibit the admission of hearsay
evidence unless another provision of the rules therein, federal statute,
or other rule prescribed by the Supreme Court provides otherwise. See
Fed. R. Evid. 802; see also Fed. R. Evid. 803 and 804. Hearsay is an
out-of-court statement offered to prove the truth of the matter asserted.
See Fed. R. Evid. 801(c).
With these general principles in mind, we will address the
outstanding evidentiary determinations. We sustain respondent’s
objections with respect to each of the exhibits at issue.
A. Exhibit 76–P
Exhibit 76–P is a purported email exchange that occurred in
November 2017 between Mr. Tung and an individual associated with
H&R Block. It discusses (hypothetically) the deductibility of rent
expense for which a promissory note was issued. Respondent objects to
the admission of this document on the basis of relevance and hearsay.
We sustain the objection on both grounds. Mr. Tung’s question to and
the responsive opinion of the individual associated with H&R Block is of
no consequence to determining whether the purported rent expenses at
issue are in fact deductible. 28 See Fed. R. Evid. 401. Moreover, the
statements made by the individual associated with H&R Block
constitute hearsay, see Fed. R. Evid. 801(c), with respect to which Mr.
Tung fails to demonstrate the applicability of any exception to the rule
against hearsay, see Fed. R. Evid. 802; Brunsting v. Lutsen Mountains
Corp., 601 F.3d 813, 818 (8th Cir. 2010) (holding that the party opposing
a hearsay objection bears the burden of demonstrating the applicability
of a hearsay exception).
28 To the extent this document speaks to Mr. Tung’s section 6664(c)(1)
reasonable cause defense raised in the Petition, this defense was pleaded only with
respect to the alternatively asserted section 6662(a) accuracy-related penalties, which
respondent conceded prior to trial. See supra note 8. Nonetheless, we note that the
exchange reflected in this exhibit took place in 2017. As the taxable years at issue
predate this exchange by several years, it would have no tendency to prove that
Genecure relied on the advice of a professional tax preparer for the returns at issue
from which the asserted section 6663 civil fraud penalties stem. Consequently, it
would be irrelevant for purposes of a section 6664(c)(1) reasonable cause defense to
such penalties. See Fed. R. Evid. 401.
11
[*11] B. Exhibit 78–P
Exhibit 78–P is a collection of purported correspondence between
the IRS and Genecure. Mr. Tung offers this material to illustrate
alleged mistreatment by the IRS (including its denial of a closing
conference) and claims that the material demonstrates Genecure’s
cooperation with the IRS during the examination. Respondent objects
to the admission of this material on the basis of relevance. We sustain
the objection on this ground. Even assuming arguendo the veracity of
Mr. Tung’s claims as to these documents, they have no bearing on the
issues tried and for which we must render a decision. See supra note 23.
Thus, the factual allegation these documents are offered to establish is
inconsequential to the determination of this action and therefore
renders them irrelevant. See Fed. R. Evid. 401.
C. Exhibit 79–P
Exhibit 79–P consists of (1) a purported affidavit executed on
February 26, 2014, concerning a call from RA White on February 21,
2014, and (2) purported minutes prepared by an unidentified individual
from a meeting between associates of “Genecure Alliance LLC” and RA
White on February 19, 2014. Mr. Tung claims that this document
demonstrates IRS misconduct during the examination. Respondent
objects to the admission of this material on the basis of authenticity,
hearsay, and relevance. We decline to opine on the first two grounds but
sustain the objection on the basis of relevance. Similar to Exhibit 78–P,
the affidavit and meeting minutes bear no nexus with any issue tried
and for which we must render a decision. Thus, the factual allegation
these documents are offered to establish is inconsequential to the
determination of this action and therefore renders them irrelevant. See
Fed R. Evid. 401.
D. Exhibit 83–P
Exhibit 83–P is a warning letter issued to WBI by the Food &
Drug Administration regarding a facility inspection that it concluded on
October 3, 2008. The warning letter indicates that WBI violated federal
regulations concerning good laboratory practices with respect to certain
nonclinical studies. 29 Mr. Tung offers this evidence in order to establish
that the payments received from WBI in taxable years 2009–11 were
refunds for studies Genecure had contracted to WBI. Respondent
29 Identifying information regarding these studies is redacted.
12
[*12] objected to the admission of this evidence at trial on the basis of
hearsay. For the first time on brief, respondent also objected to the
admission of this evidence on the basis of relevance.
The warning letter constitutes hearsay. See Fed R. Evid. 801(c).
Moreover, Mr. Tung did not otherwise invoke the applicability of any
exception to the rule against hearsay. See Brunsting, 601 F.3d at 818.
We therefore sustain respondent’s objection on that basis and decline to
further address respondent’s relevance objection.
E. Exhibit 89–P
Exhibit 89–P consists of two pages of correspondence between
Genecure and the IRS. These documents are also constituent pages of
Exhibit 78–P, with respect to which we sustained respondent’s relevance
objection. Mr. Tung offers Exhibit 89–P to establish that the IRS denied
him (as TMP) a closing conference. Respondent objects to the admission
of this material on the basis of relevance, which we sustain. As a factual
matter, the denial of a closing conference is inconsequential to the
determination of the issues pending before the Court. See supra note
23. Consequently, these documents are irrelevant. See Fed. R. Evid.
401.
For the reasons elaborated upon above, Exhibits 76–P, 78–P,
79–P, 83–P, and 89–P are not admitted into evidence.
II. Burden of Proof
The adjustments rendered in an FPAA bear a presumption of
correctness, see, e.g., Welch v. Helvering, 290 U.S. 111, 115 (1933), and
the taxpayer generally bears the burden of proving erroneous the
adjustments at issue in proceedings in this Court, see Rule 142(a)(1).
However, respondent does not bear the burden of production with
respect to penalties in a partnership-level proceeding. See § 7491(c);
Dynamo Holdings Ltd. P’ship v. Commissioner, 150 T.C. 224, 236 (2018).
III. Evaluation of Mr. Tung as a Testifying Witness
As the finder of fact:
We observe the truthfulness, sincerity, and demeanor of
each witness to evaluate his or her testimony. We then
assign weight to that testimony for the primary purpose of
finding disputed facts based on the record as a whole. In
13
[*13] the light of that testimony, we weigh the evidence, make
appropriate inferences, and find what we believe to be the
truth. We are “careful to avoid making the courtroom a
haven for the skillful liar . . . .”
Garavaglia v. Commissioner, T.C. Memo. 2011-228, 2011 Tax Ct. Memo
LEXIS 226, at *41 (citations omitted) (quoting Diaz v. Commissioner, 58
T.C. 560, 564 (1972)), aff’d, 521 F. App’x 476 (6th Cir. 2013).
We generally found Mr. Tung’s testimony self-serving, evasive,
conflicted, and at times, improbable. 30
IV. Unreported Income
Section 61(a) provides that gross income means all income from
whatever source derived unless specifically excluded by another
provision of the Code. It includes gross income derived from business.
§ 61(a)(2). To the extent a given amount does not fall within a statutorily
enumerated category of gross income, gross income is construed broadly.
See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955)
(holding that gross income includes any accession to wealth, clearly
realized, over which the taxpayer has complete dominion).
Furthermore, this Court has previously concluded that settlement
proceeds that do not otherwise satisfy an exclusionary provision of the
Code constitute gross income. See, e.g., George v. Commissioner, T.C.
Memo. 2016-156, at *5–6, *10.
As stated previously, the adjustment(s) reflected in an FPAA bear
a presumption of correctness. See Welch v. Helvering, 290 U.S. at 115.
However, in order for the presumption to apply with respect to
unreported income, the Commissioner must produce some minimal
evidentiary foundation. See Blohm v. Commissioner, 994 F.2d 1542,
1548–49 (11th Cir. 1993) (citing Weimerskirch v. Commissioner, 596
F.2d 358, 362 (9th Cir. 1979), rev’g 67 T.C. 672 (1977)), aff’g T.C. Memo.
1991-636. In the present case, respondent has produced the underlying
checks received by Genecure, and Genecure’s BB&T Bank account
(-1487) statements confirm its receipt of those amounts. Consequently,
the presumption of correctness applies to the unreported income
adjustments in question. See id.; see also Tokarski v. Commissioner, 87
30 We also acknowledge that some of Mr. Tung’s testimony is at odds with
representations he made on brief.
14
[*14] T.C. 74, 77 (1986) (“A bank deposit is prima facie evidence of
income . . . .”).
With respect to the $1,578 received from Hiroshi and Hiromi
Yoshida in taxable year 2010 for the preparation of reagent, the Court
finds that such payments constitute gross income derived from
Genecure’s business activity. As Mr. Tung has not demonstrated the
applicability of any exclusionary provision of the Code, these payments
are taxable. See § 61(a)(2). Mr. Tung disputes that the $1,578 should
be so characterized and argues, without evidence, that the payments
were received as reimbursement for material and shipping costs. To the
contrary, however, the Court notes Mr. Tung’s characterization of the
payments as “service revenue” and “a fee” at trial. Furthermore, the two
checks totaling $1,578 do not suggest in any way that they were for
reimbursement of material or shipping costs; rather, they indicate that
they were in fulfillment of certain order numbers. 31 Thus, the Court
rejects Mr. Tung’s characterization of these payments as
reimbursement. 32
With respect to the $6,000; $20,000; and $7,000 received from
WBI in taxable years 2009–11, respectively, the Court concludes that
these payments also constitute gross income. These amounts were
received as compensation for material damages caused by WBI’s breach
of contract (i.e., its failure to carry out a toxicology study in compliance
with applicable federal regulations), and Mr. Tung did not otherwise
demonstrate the applicability of any exclusionary provision of the Code.
Consequently, they constitute gross income and are taxable. See George,
T.C. Memo. 2016-156, at *10. Although Mr. Tung acknowledges that
these payments were settlement proceeds, he simultaneously argues
that these payments were refunds. Despite the inconsistent positions,
the documentary evidence confirms that these payments are settlement
proceeds intended to compensate for damages attributable to WBI’s
failure to comply with applicable federal regulations. Thus, the Court
rejects Mr. Tung’s characterization of these payments as refunds.
31The “For” lines on the $500 and $1,078 checks reference “order # cv2010-1”
and “order # cv2010-2,” respectively.
32 To the extent Genecure paid deductible expenses in producing the reagent,
such expenses must be properly reported on Form 1065 and duly substantiated.
15
[*15] In sum, the Court sustains the unreported income adjustments
totaling $6,000; $21,578; 33 and $7,000 for taxable years 2009–11,
respectively.
V. Business Expense Deductions
Section 162(a) permits a deduction for ordinary and necessary
expenses paid to carry on a trade or business during the taxable year.
An expense is ordinary if it is normal or customary within the particular
trade, business, or industry of the taxpayer. See Welch v. Helvering, 290
U.S. at 114. An expense is necessary if it is appropriate and helpful. Id.
at 113. Relatedly, section 174(a) permits a taxpayer to deduct research
and experimental expenses paid in connection with his trade or
business.
Deductions are a matter of legislative grace, and the taxpayer
bears the burden of clearly showing his entitlement to any deduction
claimed. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).
Under that burden, the taxpayer must substantiate the amount and the
purpose of the expense underlying the deduction. See Higbee v.
Commissioner, 116 T.C. 438, 440 (2001). A taxpayer must also maintain
adequate records to demonstrate the propriety of any deduction claimed.
See § 6001.
Certain expenses otherwise deductible under section 162(a) are
subject to heightened substantiation requirements under section 274(d);
these include expenses for travel (including meals and lodging) and
expenses with respect to any listed property under section 280F(d)(4).
See § 274(d)(1), (4). No deduction is permitted for personal, living, or
family expenses unless expressly permitted under the Code. See
§ 262(a).
If a taxpayer is unable to substantiate the amount of a deduction,
the Court may nonetheless allow it (or a portion thereof) if there is an
evidentiary basis for doing so. See Cohan v. Commissioner, 39 F.2d 540,
543–44 (2d Cir. 1930). In estimating the amount of an allowable
expense under the Cohan rule, the Court bears heavily against the
taxpayer whose inexactitude is of his own making. Id. at 544. The
Cohan rule cannot be applied to deductions subject to the strict
33 This amount comprises the WBI payments (i.e., $20,000) and the payments
from Hiroshi and Hiromi Yoshida (i.e., $1,578).
16
[*16] substantiation requirements of section 274(d). See Temp. Treas.
Reg. § 1.274-5T(a) (flush language).
With these general principles in mind, we address the
deductibility of the various business expenses reported by Genecure on
its Forms 1065 for the taxable years at issue. For the sake of clarity, we
summarize them in the table below.
2009 2010 2011 2012
Rent $100,000 $100,000 $100,000 -0-
Accounting 925 -0- 600 34 -0-
Legal 3,234 1,265 370 -0-
Banking 26 -0- -0- -0-
Dues 35 1,082 480 960 $480
Insurance 3,400 2,343 2,429 2,487
Office supply 574 643 1,867 712
Telephone and
3,242 3,284 2,949 2,486
internet
Travel 5,424 576 1,845 6,560
Utility 8,427 6,679 6,702 5,761
Tax -0- -0- 12,328 -0-
Automobile -0- -0- -0- 7,000
Other 36 (2,027) 5,672 -0- -0-
Research and
56,279 40,062 37 44,179 98,477
development
Total $180,586 $161,004 $174,229 $123,963
34 On its Form 1065 for taxable year 2011, Genecure reported $970 as “legal
and professional fees.” Upon review of the record, it is readily apparent that $600 was
for accounting expense and $370 for legal expense. We separate these sums to
facilitate our analysis.
35 On each of the returns at issue, Genecure referenced “dues and
subscriptions” with respect to these amounts; however, the record indicates that they
were all for purported dues to Corners North Association.
36 On brief, Mr. Tung stated that $2,000 of the reported $2,027 for taxable year
2009 was reported by Genecure in error and provided no explanation as to the
remaining $27. We thus construe the entire amount reported (i.e., −$2,027, see supra
Findings of Fact Part III.A) for 2009 as conceded. See Mendes, 121 T.C. at 312–13.
Mr. Tung similarly did not identify on brief the constituent components of the $5,672
reported for taxable year 2010. Consequently, we also deem this reported amount as
conceded. See id.37 Genecure reported a total of $58,062 on its Form 1065 for taxable year 2010,
which the IRS disallowed in full. On brief, respondent conceded $18,000 in research
and development expenses for two payments to MPI made during that year.
17
[*17] A. Rent Expenses
Section 162(a)(3) explicitly provides that a rental expense paid for
property used in a trade or business is deductible as an ordinary and
necessary business expense. Nonetheless, a cash method taxpayer may
only deduct an expense that is actually paid during the taxable year.
See Saviano v. Commissioner, 80 T.C. 955, 964 (1983) (“It is clear that a
cash basis taxpayer cannot deduct an expense incurred unless it has
been paid during the taxable year.” (citing Treasury Regulation § 1.461-
1(a)(1))), aff’d, 765 F.2d 643 (7th Cir. 1985); see also § 446(a); Treas. Reg.
§ 1.446-1(c)(1)(i) (“Expenditures [by cash method taxpayers] are to be
deducted for the taxable year in which actually made.”). Consequently,
a cash method taxpayer may claim a deduction under section 162(a) for
a rental expense only to the extent it is actually paid during the taxable
year. A rental expense paid with a promissory note executed in lieu of
cash payment may be deducted only when the note is satisfied. See
Helvering v. Price, 309 U.S. 409, 413 (1940).
At issue are Genecure’s reported rental expenses for 3150 Corners
totaling $100,000 for each of taxable years 2009–11. Respondent argues
that any deductions for the reported expenses must be disallowed
because Genecure did not pay any such expenses during those years.
Mr. Tung counters that Genecure paid these sums through a $200,000
“loan.” 38
Upon review of the record, we find no credible evidence to suggest
that Genecure ever received a loan, let alone paid rental expenses with
the funds. 39 Although Mr. Tung produced a document generated on
Genecure letterhead and titled “Loan Agreement” (purportedly executed
on December 1, 2009, and signed only by Mr. Tung on behalf of
Genecure), the substance of that document indicates that it is a
promissory note made to “Tu, Su-Ching” (Tu). An undated handwritten
note on that document states that “[t]he purpose of th[e] loan is to pay
Mr. Tung did not explain the discrepancy between the total reported rental
38
expense of $300,000 and the $200,000 principal amount of the purported loan.
39 The record includes copies of unnegotiated checks totaling $200,000, which
were initially produced by Genecure to substantiate rental expenses for 2009 and 2010
during the IRS examination. Mr. Tung did not allege in this action that these
unnegotiated checks substantiate the rental expenses at issue. He specifically alleged
on brief that “a loan was negotiated in lieu of checks due to unanticipated insufficient
fund[s].” (Emphasis added.)
18
[*18] the rent of year 2009–10. Money was directly transferred to the
landlord.”
The Court does not find this document to be credible evidence of
a loan or of a promissory note to pay rent. The document itself appears
indifferent to the nuance between a loan and a promissory note. 40
Although there is a promise to pay Tu $200,000, nothing in the
document indicates Tu’s lending of money to Genecure, notwithstanding
the document’s title (i.e., “Loan Agreement”) and the handwritten note’s
characterization of the document as a “loan.” Moreover, the document
bears no interest rate, maturity date, or other term or covenant beyond
Genecure’s promise to pay $200,000. Neither is there any testimony or
affidavit from Tu confirming that a loan or a promissory note was
executed to pay rent. Lastly, none of Genecure’s bank statements
(across four accounts) reflects receipt of $200,000 from Tu, which belies
Mr. Tung’s allegation of the existence of a loan. We therefore find that
there was no loan or promissory note to pay rent of $200,000.
Consequently, the Court sustains respondent’s disallowance of
Genecure’s reported rental expenses of $100,000 for each of taxable
years 2009–11.
Even assuming arguendo that the purported loan document
constitutes a legitimate promissory note 41 to pay $200,000 to Tu for rent,
the Court would nonetheless sustain the disallowance of the reported
rental expenses. First, the promise to pay is made to Tu; however, Tu
was not the legal owner of 3150 Corners. At trial, Mr. Tung testified
that legal title to the property was under his and Mrs. Tung’s names. It
is therefore inconceivable that the purported note was executed for
purposes of paying rent. The Court also notes the added layer of
inconsistency between executing a promissory note to Tu and the
identity of the lessor on the purported rental agreement, “Lo, Wan Yu”
(Yu), that was allegedly in effect during the relevant years at issue. 42
40 A loan involves an act of lending (typically money) to a borrower, whereas a
promissory note is merely a promise to pay a sum of money. See Loan, Promissory
note, Black’s Law Dictionary (9th ed. 2009).
41 As stated earlier, the substance of the purported loan agreement indicates
that it is a promissory note, not a loan.
42 The only rental agreement offered by Mr. Tung with respect to 3150 Corners
was executed in 2008 and appears to be a periodic tenancy. Given the incongruity
between the lessor identified therein (Yu) and the legal title holders of 3150 Corners
(Mr. and Mrs. Tung), we do not find this purported rental agreement to be credible
evidence.
19
[*19] Second, as a matter of law, Genecure could not deduct expenses
paid with a promissory note until it satisfied the obligation because it
was a cash method taxpayer during each of taxable years 2009–11. See
Helvering v. Price, 309 U.S. at 413. Mr. Tung produced no evidence that
any portion of the obligation was satisfied in the relevant years, and by
his own admission, Genecure satisfied the note in taxable year 2012. 43
For the reasons elaborated upon above, the Court sustains the
disallowance of the $100,000 claimed rent expense deduction for each of
taxable years 2009–11. Moreover, we will not apply the Cohan rule
given the lack of credible evidence.
B. Accounting Expenses
At issue are $925 and $600 in accounting expenses for the
preparation of Genecure’s tax returns, 44 which it reported for taxable
years 2009 and 2011, respectively. Mr. Tung has satisfied his burden of
substantiating that Genecure paid such costs for accounting services in
taxable years 2009 and 2011. The record includes a copy of a check and
an invoice for the $925 and the $600, respectively. Moreover, Genecure’s
BB&T Bank account (-1487) statements corroborate the payment of
these amounts. The amounts reported have therefore been
substantiated, and the business purpose of each expense is self-evident.
The Court will consequently allow Genecure to deduct these expenses
under section 162(a).
C. Legal Expenses
Under section 263(a), a capital expenditure generally may not be
deducted for the taxable year in which it is paid, notwithstanding the
fact that it may otherwise be an ordinary and necessary expense paid to
carry on a trade or business. See § 161 (providing that the deductions
allowed under part VI, which includes section 162, are subject to the
exceptions provided in part IX, which includes section 263). A capital
43 The Court acknowledges that a $200,000 international wire transfer was
made to Tu from Genecure’s Piedmont Bank account (-2665) on June 11, 2012.
Nonetheless, we decline to find, as a matter of fact, that the transfer was made to
satisfy a promissory note in payment of rent. Just days before the transfer, the IRS
met with Mr. Tung for the first time in his capacity as Genecure’s TMP and questioned
him regarding the reported rental expenses. At that time, Genecure did not allege that
it had executed a $200,000 promissory note on December 1, 2009, to pay rent.
44 The services appear to have been rendered for Genecure’s returns for taxable
years 2008 and 2010.
20
[*20] expense is one that either (1) creates or enhances a separate and
distinct asset or (2) otherwise generates significant benefits beyond the
taxable year. See Mylan, Inc. & Subs. v. Commissioner, 156 T.C. 137,
149 (2021).
In pertinent part, the regulations promulgated under section 263
provide that “[a] taxpayer must capitalize amounts paid to a
governmental agency to obtain, renew, renegotiate, or upgrade its rights
under a trademark, trade name, copyright, . . . or other similar right
granted by that governmental agency.” See Treas. Reg.
§ 1.263(a)-4(d)(5)(i). Although “patent” is not expressly enumerated
under Treasury Regulation § 1.263(a)-4(d)(5)(i), we construe it to be a
“similar right” for purposes of the regulation given its intangible nature
and its conferral of a government sanctioned property right.
In addition to amounts paid to a governmental agency to obtain
or renew a patent, a taxpayer must capitalize any amounts paid to
facilitate the acquisition or creation of such an intangible. See id. paras.
(b)(1)(v), (e)(1)(i). Consequently, fees paid for legal services ancillary to
the renewal of a patent must also be capitalized. Id. However, if such
costs in the aggregate do not exceed $5,000 in a given taxable year, they
are deemed de minimis and are not treated as facilitative costs subject
to capitalization. See id. para. (e)(4)(i), (iii).
At issue are $3,234; $1,265; and $370 in legal expenses paid in
taxable years 2009–11, respectively. These amounts comprise both fees
for renewal 45 of foreign patents and fees for legal services in connection
with a foreign patent renewal. With respect to the portion of legal
expenses Genecure paid to renew its foreign patents, these expenses are
capital expenditures and are not immediately deductible. See id. para.
(d)(5)(i). These expenses totaled $900; $1,265; and $370 in taxable years
2009–11, respectively. The Court therefore sustains the disallowance of
deductions for these amounts.
The remaining $2,334 paid for legal services in taxable year 2009
in connection with the renewal of a foreign patent is de minimis and
therefore does not need to be capitalized. See id. para. (e)(4)(i), (iii).
Moreover, Mr. Tung adequately substantiated Genecure’s payment for
such services by producing underlying invoices, an email exchange with
45 Some of the relevant documentary evidence with respect to these payments
references “annuity” payments. In this context, “annuity” refers to a maintenance or
renewal fee for the patent. See Annuity, Black’s Law Dictionary (9th ed. 2009).
21
[*21] its counsel discussing fees, and corroborating BB&T Bank account
(-1487) statements. Because we also find the business purpose of such
expenses self-evident, the Court holds that the $2,334 paid in taxable
year 2009 for legal services may be deducted under section 162(a).
D. Banking Expense
At issue is a $26 fee Genecure paid to BB&T Bank with respect to
a certain checking account transaction. 46 Mr. Tung offered no
explanation or evidence regarding the nature of the underlying
transaction for which the fee was imposed. Without such an explanation
and supporting evidence, the Court cannot determine whether the $26
is an ordinary and necessary business expense, as it is part and parcel
to the underlying transaction. Consequently, Mr. Tung failed to satisfy
his burden of establishing Genecure’s entitlement to a deduction
therefrom. See INDOPCO, Inc. v. Commissioner, 503 U.S. at 84. The
Court sustains the disallowance of a deduction for this expense.
E. Dues Expenses
At issue are $1,082; $480; $960; and $480 purported payments to
Corners North Association in taxable years 2009–12, respectively. Mr.
Tung characterizes these payments as business park association dues
(presumably for the upkeep and maintenance of communal portions of
the broader development in which 3150 Corners is situated).
Although the reported amounts appear to have been debited to
Genecure’s BB&T Bank account (-1487) pursuant to check numbers
identified by Mr. Tung, the Court nonetheless sustains the disallowance
of deductions for these amounts as we are not persuaded of the
credibility of the underlying invoices.
The invoices offered list as Corners North Association’s address
and telephone number the same address and telephone number as those
for Genecure. They also identify Mr. Tung as the association’s point of
contact. We are suspicious of this juxtaposition and find that the
invoices lack credibility. In the absence of other relevant evidence, we
conclude that Mr. Tung failed to substantiate these purported expenses.
Even assuming arguendo that these payments were legitimate
business park association dues, the Court would sustain the
46 The description line on the relevant BB&T Bank account (-1487) statement
references “CHECK CHRG HARLAND CLARKE GENECURE LLC.”
22
[*22] disallowance of the amounts at issue because Mr. Tung has not
established that they constitute ordinary and necessary business
expenses. As stated previously, Mr. and Mrs. Tung, not Genecure,
owned 3150 Corners. It is thus implausible that Genecure would be
liable for these amounts as a tenant. In the absence of any evidence
otherwise establishing an obligation to pay such dues, 47 these payments
would appear to be disguised personal expenses.
For the reasons elaborated upon above, we sustain respondent’s
disallowance of a deduction for each of the purported dues expenses for
taxable years 2009–12. Moreover, we will not apply the Cohan rule
given the lack of credible evidence.
F. Insurance Expenses
At issue are various insurance expenses totaling $3,400; $2,343;
$2,429; and $2,487 reported for taxable years 2009–12, respectively. We
find that Mr. Tung adequately substantiated $1,843; $1,153; and $1,479
in premium payments by Genecure for a State Farm Insurance business
liability policy ending in 020-0 for taxable years 2009, 2010, and 2012,
respectively. These amounts were substantiated with invoices from the
insurer as well as BB&T Bank account (-1487) statements confirming
that such payments were actually made. Moreover, the business
purpose of those expenses is self-evident.
We sustain respondent’s disallowance as to the residual amounts,
which correspond to premium payments by Genecure that Mr. Tung did
not establish were ordinary and necessary business expenses. 48
G. Office Supply Expenses
At issue are $574; $643; $1,867; and $712 in purported office
supply expenses for taxable years 2009–12, respectively. We find that
47 The Court notes that the purported rental agreement (notwithstanding our
earlier finding that it lacks credibility, see supra note 42) makes no mention of
Genecure’s obligation to pay for business park association dues.
48 These include premium payments for insurance policies with TIAA and
Teachers Insurance (which appear to be related, if not the same, entities). Mr. Tung
testified at trial that these payments were for life insurance coverage for himself. We
find that such payments constitute disguised personal expenses rather than Genecure
business expenses and therefore are not deductible. See § 262(a). The disallowed
amounts also include what appear to be premium payments for an auto insurance
policy. There is no evidence in the record indicating the identity of the policy holder,
nor is there any evidence that Genecure owned a vehicle to insure.
23
[*23] Mr. Tung substantiated only an $8 expense for envelopes in 2011
and a $10 expense for stamps in 2012. Consequently, we largely sustain
respondent’s disallowance of Genecure’s reported office supply expense
deductions except with respect to the aforementioned two expenses. 49
H. Telephone and Internet Expenses
At issue are $3,242; $3,284; $2,949; and $2,486 in purported
telephone and internet expenses for taxable years 2009–12, respectively.
The Court will permit as deductible business expenses only $1,327;
$1,318; $1,338; and $1,429 for taxable years 2009–12, respectively.
These amounts correspond to expenses paid for an AT&T account
(ending in -1888) for internet and telecommunication (for a landline)
services. This account was registered under Genecure’s name and
Norcross, Georgia, address. Mr. Tung substantiated the expenses
associated with this account by producing the underlying invoices as
well as BB&T Bank account (-1487) statements confirming payment.
Moreover, we are persuaded that this account served a business
purpose.
The disallowed amounts correspond to payments for
telecommunication services associated with two T-Mobile accounts
(ending in -0373 and -6172) and an additional AT&T account (ending
in -1886). These accounts were registered under either Mr. or Mrs.
Tung’s individual name and their personal address in Georgia.
Notwithstanding Mr. Tung’s testimony that these accounts were used
for business purposes, we do not find such self-serving testimony
credible nor are we obliged to accept it. See Tokarski, 87 T.C. at 77. In
the absence of any credible evidence demonstrating that these accounts
were used in furtherance of Genecure’s business, we find the payments
in connection with these three accounts to be the Tungs’ disguised
personal expenses. Consequently, we will not permit Genecure to
deduct them under section 162(a). 50 See § 262(a).
49 Most of the evidence offered to substantiate the reported office supply
expenses was not in fact for office supplies. It is possible that such expenses are
deductible under some other category of business expense. However, we decline to act
as Genecure’s bookkeeper given the exceedingly voluminous and haphazardly
organized record and will not correct the erroneous categorizations on its behalf. See
also § 6001.
50 The Court also notes that Mr. Tung testified that the two T-Mobile accounts
(ending in -0373 and -6172) were for telecommunication services specifically for
24
[*24] I. Travel Expenses
In pertinent part, section 274(d) provides that no deduction
claimed under section 162 shall be allowed for any traveling expense
(including meals and lodging while away from home) unless the
taxpayer satisfies certain heightened substantiation requirements.
Those requirements permit a deduction for travel expenses only to the
extent the taxpayer proves (1) the amount of each expenditure for
traveling away from home, (2) the date of departure and return for each
trip and the number of days spent on business, (3) the destination or
locality of travel, and (4) the business reason for travel or the expected
benefit to be derived from such travel. See Temp. Treas. Reg. §
1.274-5T(b)(2). This is a conjunctive standard (i.e., all elements must be
met with respect to each trip).
At issue are Genecure’s reported travel-related expenses totaling
$5,424; $576; $1,845; and $6,560 for taxable years 2009–12,
respectively. Although Mr. Tung produced a variety of receipts as well
as credit card and checking account statements in an attempt to
substantiate the amounts of these reported expenses, he failed to prove
with respect to each trip (1) the dates of departure and return and the
number of days spent on business, (2) the destination of travel, and
(3) the business purpose (or the expected benefit). Mr. Tung therefore
failed to satisfy the heightened substantiation requirements of section
274(d). Consequently, we sustain the disallowance of deductions for
these reported travel expenses. Moreover, as these expenses are subject
to section 274(d), the Cohan rule cannot be applied. See Temp. Treas.
Reg. § 1.274-5T(a) (flush language).
cellular telephones and that he used at least one of the cellular phones in part for
personal purposes. For taxable year 2009, cellular telephones constituted “listed
property” under section 280F(d)(4)(A)(v). Consequently, expenses related to cellular
telephones paid during that year were subject to the heightened substantiation
requirements of section 274(d), see § 274(d)(4), which requires a taxpayer to
substantiate with respect to the cellular telephone the amount of the expense, the
amount of business use and total use, the date of each use, and the business purpose
of each use, see Temp. Treas. Reg. § 1.274-5T(b)(6). Mr. Tung did not substantiate the
2009 expenses for the two T-Mobile accounts accordingly, thus providing an alternative
basis for disallowing them. Section 280F was amended such that cellular telephones
no longer constituted “listed property” for taxable years beginning after December 31,
2009. See Small Business Jobs Act of 2010, Pub. L. No. 111-240, § 2043, 124 Stat.
2504, 2560 (2010).
25
[*25] J. Utility Expenses
At issue are Genecure’s reported utility expenses totaling $8,427;
$6,679; $6,702; and $5,761 for taxable years 2009–12, respectively.
These expenses relate to amounts owed for natural gas, electricity, and
water for Genecure’s principal place of business, 3150 Corners.
The Court finds that Mr. Tung substantiated most of the amounts
reported for electricity and natural gas. 51 Consequently, we conclude
that Genecure may deduct as business expenses $5,575; $4,066; $4,390;
and $4,221 for taxable years 2009–12, respectively. Mr. Tung
substantiated such expenses with the associated invoices from Georgia
Power, Gas South, and Georgia Natural Gas, as well as BB&T Bank
account (-1487) statements confirming payment.
The remaining expense amounts relate to purported water
payments for which Mr. Tung produced several quarterly invoices.
However, we do not find these invoices credible for purposes of
substantiating the expenses. First, we note that none of the invoices for
water came directly from a relevant water management authority
(presumably, the Gwinnett County Department of Water Resources).
All of them came from Corners North Association. We also note that the
purported rental agreement makes no reference to the association’s
serving as an intermediary for water billing purposes (notwithstanding
our earlier finding, see supra note 42, that the agreement lacks
credibility).
Second, of the 14 invoices in the record for purported water
expenses, 11 list as Corners North Association’s address and telephone
number the same address and telephone number as those for Genecure.
They also identify Mr. Tung as the association’s point of contact. These
overlapping details cause us to be suspicious of the veracity of these
documents.
Further eroding the credibility of such evidence are blatant
inconsistencies suggesting at best, inaccuracy, and at worst, fabrication.
For example, with respect to taxable year 2012, there are two invoices
for $637 for the period “2/22/2012 thru 6/21/2012” and with a payment
due date of July 20, 2012. One indicates use of 1,618 gallons of water;
however, that figure is crossed out and overwritten with 11,222 gallons.
51 The unsubstantiated amounts total $271 for 2010 for purported electricity
expense and $280 for 2011 for purported natural gas expense.
26
[*26] The second also indicates use of 1,618 gallons but without any
alterations in handwriting. Handwritten notes on both invoices claim
they were paid with check No. 1221. Elsewhere in the record, Mr. Tung
represents that check No. 1221 is only associated with the first invoice
and that the second invoice amount was for $500 and paid with check
No. 1224.
For the reasons elaborated upon above, we find that the
purported water invoices lack credibility. In the absence of other
evidence establishing the amounts Genecure owed and paid for water,
we find that Mr. Tung failed to substantiate its purported water
expenses. Moreover, we will not apply the Cohan rule to estimate
Genecure’s purported water expenses given the lack of credible
evidence.
In sum, Genecure may deduct only $5,575; $4,066; $4,390; and
$4,221 of the reported utility expenses for the respective years at issue.
The Court sustains respondent’s disallowance of any deduction for the
residual amounts.
K. Tax Expenses
Property tax payments may be deducted under section 162(a) to
the extent they are ordinary and necessary business expenditures. See
Bello v. Commissioner, T.C. Memo. 2001-56, 2001 Tax Ct. Memo LEXIS
72, at *17–19. At issue are $12,328 in purported property tax payments
reported by Genecure as business expenses for taxable year 2011.
To substantiate such expenses, Mr. Tung produced (1) a copy of a
check for $11,784 made out to Gwinnett County Tax Commissioner 52
and (2) a BB&T Bank account (-1487) statement for the period ending
March 31, 2011, reflecting a $554 debit associated with check No. 1199
and a handwritten note next to it stating “(Tax).” 53 However, Mr. Tung
did not produce the property tax assessment(s) or invoice(s) from
Gwinnett County underlying these payments, nor did he ever identify
the property to which these payments relate. Consequently, we are
52The “Memo” line of the check is illegible but appears to reference a string of
numerals.
53 We acknowledge that the sum of these amounts is $12,338 (i.e., $10 greater
than the amount for tax expenses reported on the Form 1065 for 2011 and asserted on
brief).
27
[*27] unable to ascertain whether the expenses served a business
purpose (as opposed to a personal one of Mr. and Mrs. Tung). 54
The burden is on Mr. Tung to establish Genecure’s entitlement to
deductions, which requires inter alia substantiation as to both amount
and purpose. See INDOPCO, Inc. v. Commissioner, 503 U.S. at 84;
Higbee, 116 T.C. at 440. Mr. Tung failed to produce such substantiation,
and we therefore sustain the disallowance of any deduction for the
property tax expenses reported for taxable year 2011. 55
L. Automobile Expense
At issue is Genecure’s reported automobile expense totaling
$7,000 for taxable year 2012. Mr. Tung did not elaborate on the nature
of this expense other than that it related to an automobile and that it
was effected through a single unidentified check allegedly drawn on
Genecure’s Piedmont Bank account (-2665). Mr. Tung did not produce
any invoice or check for $7,000, nor does a $7,000 debit appear on any of
the Piedmont Bank account (-2665) statements in the record. In the
absence of any substantiating evidence regarding this expense, the
Court sustains the disallowance of any deduction for the $7,000
automobile expense reported for 2012. Moreover, the Cohan rule is
inapplicable as passenger automobiles constitute listed property under
section 280F(d)(4)(A)(i). See Temp. Treas. Reg. § 1.274-5T(a) (flush
language).
54 Although the Court acknowledges a handwritten note on the purported lease
agreement for 3150 Corners stating that the lessor (Genecure) “should” pay the
property tax, the note on its own does not substantiate the purpose of the payments at
issue. Moreover, we previously concluded that this purported agreement is not
credible evidence. See supra note 42.
55 We separately note that Genecure would not be entitled to a deduction under
section 164(a)(1) for the tax payments even assuming that they were with respect to
3150 Corners. Section 164(a), distinct from section 162(a), provides a deduction for
various state and local taxes paid, including real property tax, regardless of whether
paid in connection with the taxpayer’s trade or business. The regulations promulgated
thereunder state that such taxes are generally deductible only by the person upon
whom they are imposed. See Treas. Reg. § 1.164-1(a) (flush language). However, this
Court has previously held “that taxpayers who do not hold legal title to property but
who establish they are equitable owners of the property are entitled to deduct property
tax paid by them for the property.” See, e.g., Abarca v. Commissioner, T.C. Memo.
2012-245, at *16. Genecure did not possess legal title over 3150 Corners, and Mr. Tung
did not allege (or produce evidence) that Genecure paid the property tax as the
equitable owner of the property.
28
[*28] M. Research and Development Expenses
Section 174(a)(1) permits a taxpayer to “treat research or
experimental expenditures which are paid or incurred by him during the
taxable year in connection with his trade or business as expenses which
are not chargeable to capital account.” It further provides that such
expenses may be deducted. 56 “[R]esearch and experimental
expenditures” are research and development costs in the experimental
or laboratory sense and include incidental costs. See Treas. Reg.
§ 1.174-2(a)(1). Amounts which are paid to others for research or
experimentation on the taxpayer’s behalf may also be deducted under
section 174(a)(1). See Treas. Reg. § 1.174-2(a)(8).
At issue are $56,279; $40,062; $44,179; and $98,477 in research
and development expenses reported by Genecure for taxable years
2009–12, respectively. 57 Upon review of the evidence, we find that Mr.
Tung substantiated $18,652; $31,350; $37,830; and $58,190 for taxable
years 2009–12, respectively.
These amounts include expenses for laboratory supplies such as
liquid nitrogen and pipettes, for which Mr. Tung produced numerous
invoices from third parties and proof of payment. 58 They also include
amounts paid for contracted research services rendered by UM 59 as well
as amounts paid to GSU 60 pursuant to the collaborative research
agreement executed in November 2008. Furthermore, we are persuaded
56 Section 174(a)(1) thus enables cash method taxpayers to immediately deduct
research and development expenses (in the taxable year paid) rather than capitalize
them, which would result in depreciation or amortization expense deductions over a
period of multiple taxable years.
57 Respondent conceded $18,000 in payments to MPI for contracted research
services for taxable year 2010. See supra notes 4, 37.
58 Mr. Tung substantiated payment of such expenses largely through the
production of various credit card statements.
59 Mr. Tung substantiated payment of $22,722 and $41,926 to UM in taxable
years 2011 and 2012, respectively, by producing copies of underlying invoices, as well
as credit card statements confirming payment. These payments were for a clinical
trial study to evaluate the safety and immunogenicity of Genecure’s HIV vaccine.
60 Mr. Tung substantiated payment of $10,000; $20,000; $10,000; and $10,000
by Genecure to GSU in taxable years 2009–12, respectively. Mr. Tung produced copies
of the underlying checks each of which referenced “ALW95” (a project sponsored by
Genecure pursuant to the collaborative research agreement), as well as corroborating
BB&T Bank account (-1487) and Piedmont Bank account (-2665) statements
confirming payment.
29
[*29] that these expenses were paid by Genecure in connection with its
HIV vaccine research and development.
In sum, Genecure may deduct only $18,652; $49,350; 61 $37,830;
and $58,190 of the original amounts reported for research and
development expenses under section 174(a)(1) for taxable years
2009–12, respectively. We sustain respondent’s disallowance of the
residual amounts. 62
VI. QTDP Grant Recapture
Section 48D permits taxpayers to claim a credit (or receive a grant
in lieu of a credit) equal to 50% of the qualified investment a taxpayer
makes with respect to a QTDP in a taxable year beginning in 2009 or
2010. Subject to certain limitations and exclusions, “qualified
investment” is defined as “the aggregate amount of the costs paid . . . for
expenses necessary for and directly related to the conduct of a qualifying
therapeutic discovery project.” § 48D(b)(1), (2), and (3).
However, ACA § 9023(e)(5)(B)(i), 124 Stat. at 882, further
provides:
Recapture of excessive grant amounts.—If the amount of a
grant made under this subsection exceeds the amount
allowable as a grant under this subsection, such excess
61This amount comprises the $31,350 substantiated by Mr. Tung and the
$18,000 conceded by respondent (for payments to MPI).
62 A significant portion of the evidence offered by Mr. Tung to substantiate
Genecure’s research and development expenses included amounts paid for meals,
premiums for unidentified insurance policies, and airfare. However, Mr. Tung failed
to establish how such expenses were paid in connection with Genecure’s research and
development activity such that they are deductible under section 174(a)(1) as
incidental costs. See Treas. Reg. § 1.174-2(a)(1) (“The term research or experimental
expenditures, as used in section 174, . . . generally includes all such costs incident to
the development . . . of a product.”).
Moreover, to the extent we sustain the disallowance of deductions for actual
research and development expenses, we note that such expenses are limited to a subset
of those reported for taxable year 2009. These expenses were paid by credit card at
the end of taxable year 2008, but the corresponding credit card statement was paid off
in early taxable year 2009. In such a scenario, the year of deductibility is determined
by the taxable year in which the credit card charge is made regardless of when the
credit card issuer is repaid. See Schroeder v. Commissioner, T.C. Memo. 1986-583,
1986 Tax Ct. Memo LEXIS 23, at *13–14. Consequently, these expenses may be
deducted only for taxable year 2008—a year for which we lack jurisdiction to readjust
partnership items in this proceeding. See § 6226(f).
30
[*30] shall be recaptured under subparagraph (A) as if the
investment to which such excess portion of the grant
relates had ceased to be a qualified investment
immediately after such grant was made.
This provision of the ACA requires recapture of an excess portion of a
QTDP grant in the taxable year the grant was actually disbursed. See
Silver Med., Inc. v. Commissioner, 147 T.C. 547, 554–56 (2016). A
portion of a grant is excess to the extent the qualified investment for
which it was awarded (i.e., the amount certified by the IRS upon its
review of the participating taxpayer’s Form 8942) was not actually
paid. 63 See Wang v. Commissioner, T.C. Memo. 2017-81, at *21–22.
Furthermore, recapture is effected in the form of an increase in federal
income tax equal to the excess portion of the grant. See ACA
§ 9023(e)(5)(A), 124 Stat. at 882; Wang, T.C. Memo. 2017-81, at *21–22.
In this case, Genecure received $244,479 in the form of a QTDP
grant attributable to $488,958 of certified qualified investment expenses
for taxable year 2009. Respondent concedes that Genecure paid for
$27,000 64 worth of qualified investment in taxable year 2009, but he
argues that Mr. Tung has not substantiated any other qualified
investment in excess of that amount. Mr. Tung argues that Genecure
made qualified investments in taxable years 2009 and 2010 totaling
(1) $670,000 in wages; (2) $144,484 in supplies and lab costs; (3) $30,502
in “other costs”; (4) $451,149 in third-party (research) contract costs; and
(5) $240,000 in depreciable property costs. 65 Upon review of the
evidence cited by Mr. Tung, we agree with respondent.
As a preliminary matter, we reiterate that although Genecure
applied for the grant with respect to purported qualified investments for
taxable years 2009 and 2010, the $244,479 QTDP grant it ultimately
63 For IRS certification purposes, qualified investment included not only
expenses actually paid as of the date of application, but also expenses a taxpayer
seeking a QTDP grant expected to pay in the remainder of its taxable year beginning
in 2009 or 2010. See I.R.S. Notice 2010-45, § 5.02(6), 2010-23 I.R.B. at 736. However,
certification of qualified investments by the IRS did not constitute a determination
that the costs reported were or would be in fact paid. See id. § 7.04, 2010-23 I.R.B.
at 737.
64 This amount was a single payment to MPI in taxable year 2009 and relates
to the toxicity study of its HIV vaccine in rats.
65 The aggregate sum of these amounts is $1,536,135, which is significantly
less than the $1,660,000 Genecure reported when it applied for the grant. See supra
Findings of Fact Part II.
31
[*31] received was attributable to amounts reported for taxable year
2009, which the parties stipulated. On brief, Mr. Tung contends that
the grant was attributable to qualified investments reported for both
2009 and 2010. The Court declines to entertain Mr. Tung’s more recent
and inconsistent position as justice does not require the Court to release
him from the binding effect of the stipulation. See Rule 91(e). Mr. Tung
has offered no justification for doing so. Moreover, I.R.S. Notice 2010-45,
§ 5.02(10), 2010-23 I.R.B. at 737, requires that if (1) a taxpayer requests
a grant for both 2009 and 2010 and (2) the aggregate qualified
investment ultimately certified is less than that reported, then the
amount certified must first be attributed to 2009 before 2010. As
$488,958 is less than the $600,000 reported for taxable year 2009, no
amount certified may be attributed to taxable year 2010. Thus, in order
to avoid recapture tax, Mr. Tung must prove that Genecure actually paid
for an additional $461,958 in qualified investment in taxable year
2009. 66
Mr. Tung failed to substantiate payment of any qualified
investment expense in taxable year 2009 beyond the $27,000 respondent
conceded. With respect to the $670,000 purportedly paid for wages, none
of the evidence cited by Mr. Tung for this amount substantiates any
payment for wages. 67 Moreover, Mr. Tung cited no evidence with respect
to the $144,484 in supplies and lab costs nor with respect to the $30,502
in “other costs.”
With respect to the purported $451,149 in third-party contract
expenses, Mr. Tung claims that $406,149 is attributable to payments
associated with the UM contract and that the residual $45,000 is
attributable to payments associated with the MPI contract. As to the
$406,149, none of the evidence cited by Mr. Tung substantiates that
Genecure paid such amounts to UM in taxable year 2009. 68 As to the
66 This sum represents the $488,958 in qualified investment initially certified
by the IRS less the $27,000 conceded by respondent. We note nonetheless that
Genecure reported $600,000 in qualified investment expenses for taxable year 2009
when it applied for the grant.
67 The evidence in question is (1) a purported employment agreement between
Genecure and Mr. Tung executed on January 1, 1999, and (2) a purported letter dated
July 1, 1999, from Genecure offering employment to Mrs. Tung.
68 Mr. Tung cites to UM’s response to a subpoena issued by the IRS during the
examination. The documents included in the response indicate that UM did not receive
any payments in 2009 for any invoices issued to Genecure for the clinical trial study,
which totaled $64,648.
32
[*32] remaining $45,000 paid to MPI for the toxicity study in rats,
respondent has already conceded $27,000. 69 The residual $18,000 was
paid in taxable year 2010, not 2009.
Lastly, with respect to the purported $240,000 in depreciable
property expenses (all apparently attributable to construction and
certification of a clean room for vaccine production), none of the evidence
offered by Mr. Tung substantiates payment of that amount by Genecure
in taxable year 2009. 70
In sum, Mr. Tung failed to substantiate qualified investment
expenses in taxable year 2009 in excess of $27,000. Consequently,
Genecure was entitled to a QTDP grant of only $13,500 (i.e., 50% of its
qualified investment), and the excess grant amount, $230,979, 71 is
subject to recapture in taxable year 2010. See ACA § 9023(e)(5)(B)(i),
124 Stat. at 882; Silver Med., Inc., 147 T.C. at 554–56.
VII. Purported Loan and Capital Contribution from Mrs. Tung
At issue are two alleged transactions between Genecure and Mrs.
Tung reflected on Genecure’s Form 1065 for taxable years 2009 and
2011. The first of these transactions concerns a purported $200,000 loan
from Mrs. Tung in 2009, which was Genecure’s only reported liability as
of the taxable yearend. The second of these transactions concerns a
UM also acknowledged having received a $250,000 check dated December 1,
2010, from Genecure on or about July 2, 2012. The check was written from Genecure’s
Piedmont Bank account (-2665). A statement from that account for the period ending
July 31, 2012, indicates that UM deposited the check sometime that month.
Notwithstanding the check date, Genecure’s Piedmont Bank account (-2665) never had
an average balance exceeding $152,000 between December 2010 and August 2011.
Moreover, Mr. Tung offered no credible testimony at trial as to the purpose of this
payment, nor is there an invoice in the record associated with this check. We find
particularly noteworthy that the purported date of the check (i.e., December 2010)
predates the execution of the underlying contract (i.e., July 2011) by over six months.
Regardless of whether this $250,000 transfer constitutes a qualified investment, it did
not occur in taxable year 2009 and is therefore irrelevant for purposes of substantiating
the QTDP grant at issue.
As to the outstanding $91,501 of the $406,149 in alleged payments to UM, Mr.
Tung offered no evidence to substantiate this amount.
69 The record nonetheless confirms that payment of $27,000 to MPI for the
contracted study occurred in taxable year 2009.
70To the extent Mr. Tung produced invoices and corresponding proof of
payment, such expenses were all paid in taxable year 2006.
71 This sum represents the $244,479 received less the $13,500 duly entitled.
33
[*33] purported $100,000 capital contribution to Genecure from Mrs.
Tung in 2011. Mr. Tung did not offer any credible evidence
substantiating these purported transactions.
With respect to the purported $200,000 loan from Mrs. Tung, Mr.
Tung offered as evidence the same purported promissory note he offered
to substantiate purported rent expenses. 72 See supra Opinion Part V.A.
As noted previously, the purported note created an obligation to
someone other than Mrs. Tung. It is therefore incomprehensible how
this note substantiates a purported loan from Mrs. Tung. Furthermore,
it contains no interest rate, maturity date, or other term or covenant
beyond Genecure’s promise to pay. The omission of such critical terms
casts serious doubt as to the credibility of this evidence for purposes of
substantiating any debt obligation whatsoever. In the absence of any
credible evidence of a $200,000 loan from Mrs. Tung, we sustain
respondent’s determination.
With respect to the purported $100,000 capital contribution from
Mrs. Tung, Mr. Tung offered as evidence a copy of Genecure’s BB&T
Bank account (-1487) statement for the period ending August 31, 2011,
and a BB&T Bank wire transfer notice issued to Genecure for the same
account. The statement for the period indicates that a total of $100,000
was credited to Genecure’s BB&T Bank account (-1487), but it does not
identify the source of the credited funds nor whether they came from one
or multiple sources. However, the wire transfer notice establishes that
the $100,000 is attributable to a single source—“Lin Yin, Hsiang-Fen”—
and that it was credited on August 31, 2011. Taken together, this
evidence substantiates only a $100,000 capital contribution from
Hsiang-Fen in taxable year 2011, which is reflected on the Schedule K–1
for Hsiang-Fen included with Genecure’s Form 1065 for that year. In
the absence of any other evidence of a $100,000 capital contribution from
Mrs. Tung, we sustain respondent’s determination.
In sum, we find that Mr. Tung failed to substantiate the
purported $200,000 loan and the purported $100,000 capital
contribution from Mrs. Tung in taxable years 2009 and 2011,
respectively.
72 For purposes of this discussion, we disregard the nuance between a loan and
a promissory note as they are both reported as liabilities on Form 1065.
34
[*34] VIII. Section 6663 Civil Fraud Penalties
At issue are section 6663 civil fraud penalties determined against
Genecure for taxable years 2009–12. 73 Because respondent does not
bear the burden of production with respect to penalties in a
partnership-level proceeding, see Dynamo Holdings Ltd. P’ship, 150 T.C.
at 236, Mr. Tung was required to plead respondent’s noncompliance
with section 6751(b)(1) (requiring written supervisory approval for the
assessment of penalties) as an affirmative defense if he wished to raise
that issue, see Blossom Day Care Ctrs., Inc. v. Commissioner, T.C.
Memo. 2021-87, at *57. Mr. Tung did not do so in the Petition.
We nonetheless deem noncompliance with section 6751(b)(1)
pleaded as an affirmative defense to the section 6663 penalties, as the
issue was actually tried by implied consent of the parties. See Rule
41(b)(1) (“When issues not raised by the pleadings are tried by express
or implied consent of the parties, they shall be treated in all respects as
if they had been raised in the pleadings.”). Respondent called as
witnesses RA White and RA Kittrell, who were each cross-examined by
Mr. Tung. Moreover, both parties introduced documentary evidence
concerning this issue. Consequently, before reaching the merits of the
asserted fraud penalties, the Court must address whether the IRS
complied with section 6751(b)(1).
A. Section 6751(b)
Section 6751(b)(1) provides that no penalty, including the penalty
under section 6663, may “be assessed [against a taxpayer] unless the
initial determination of such assessment is personally approved (in
writing) by the immediate supervisor of the individual making such
determination.”
1. Initial Determination
The Code does not define “initial determination.” See Graev v.
Commissioner, 149 T.C. 485, 500, 503 (2017) (Lauber, J., concurring)
73 Although Genecure is not a taxable entity for federal income tax purposes,
see § 701, TEFRA confers on this Court jurisdiction to determine the applicability of
section 6663 penalties in partnership-level proceedings, see § 6226(f); United States v.
Woods, 571 U.S. 31, 39–42 (2013); see also Omega Forex Grp., LC v. United States, 906
F.3d 1196, 1211–12 (10th Cir. 2018) (sustaining trial court determination that it had
jurisdiction in a TEFRA case to review the applicability of civil fraud penalties in light
of section 6226(f) and Woods).
35
[*35] (Holmes, J., concurring in result), supplementing and overruling
in part 147 T.C. 460 (2016). Nonetheless, in a partnership-level
proceeding under TEFRA, section 6751(b)(1) generally requires that
written supervisory approval of a penalty determination occur no later
than the issuance of the FPAA. See Palmolive Bldg. Inv’rs, LLC v.
Commissioner, 152 T.C. 75, 83 (2019). In Clay v. Commissioner, 152
T.C. 223, 249 (2019), aff’d, 990 F.3d 1296 (11th Cir. 2021), however, this
Court held that written supervisory approval may be required by a date
earlier than the issuance of a notice of deficiency (and analogously, an
FPAA) if there is an earlier formal communication to the taxpayer
advising him of the penalty determination and of his right to appeal.
Regardless, the “initial determination” for purposes of section 6751(b)(1)
must reflect, in a formal writing, that the IRS Examination Division
“completed its work and made an unequivocal decision to assert
penalties.” See Belair Woods, LLC v. Commissioner, 154 T.C. 1, 15
(2020) (rejecting the taxpayer’s argument that a Letter 1807
communicating proposed penalties constituted the initial determination
for purposes of section 6751(b)(1)). Moreover, notwithstanding the
Court’s holding in Clay, conferral of appeal rights is not the sine qua non
of an initial determination, although it may be an indication of it. See
Beland v. Commissioner, 156 T.C. 80, 89 (2021).
Respondent argues that for purposes of section 6751(b)(1), the
FPAAs issued on April 9, 2015, constitute the initial determination.
Conversely, Mr. Tung asserts that the Letter 1807 issued on February
20, 2015, constitutes the initial determination.
We conclude that the initial determination is embodied in the
FPAAs issued on April 9, 2015, as they collectively constitute the first
formal communication advising Genecure of the penalty determinations
at issue and of its right to appeal such determinations. See Beland, 156
T.C. at 89; Clay, 152 T.C. at 249. The Letter 1807 in this case cannot
constitute the “initial determination” for the same reason the Court in
Belair Woods found a similar Letter 1807 insufficient. That is, the
Letter 1807 (dated February 20, 2015) merely communicated proposed
penalties the ultimate imposition of which was subject to further
discussion and consideration (at the closing conference). Consequently,
it did not indicate that the Examination Division had completed its work
and that an unequivocal decision to assert penalties had been made. See
Belair Woods, LLC, 154 T.C. at 11–15. Thus, in order to satisfy section
6751(b)(1), written supervisory approval had to be obtained on or before
April 9, 2015.
36
[*36] 2. Approval in Writing
There is no singular form on which written supervisory approval
must be recorded for purposes of section 6751(b)(1) as long as the writing
manifests the immediate supervisor’s intent to approve the penalty at
issue. See Tribune Media Co. v. Commissioner, T.C. Memo. 2020-2,
at *20–21. This Court has found the written supervisory approval
requirement satisfied by several forms of documentation that were
timely signed by an immediate supervisor, including (1) a Civil Penalty
Approval Form, see, e.g., Belair Woods, LLC, 154 T.C. at 16–17, and (2) a
Form 11661, see Benavides & Co., P.C. v. Commissioner, T.C. Memo.
2019-115, at *45.
In this case, both a Civil Penalty Approval Form and a Form
11661 were signed before the issuance of the FPAAs on April 9, 2015.
Nonetheless, Mr. Tung argues that these signed forms fail to satisfy the
written supervisory approval requirement. With respect to the Civil
Penalty Approval Form, he argues that the approval relates to the
assertion of the section 6663 penalties against himself and Mrs. Tung
individually rather than against Genecure. With respect to the Form
11661, he argues that Ms. Fontanes was not the immediate supervisor
of RA White. 74 We address each form in turn.
a. Civil Penalty Approval Form
The Civil Penalty Approval Form consists of two pages and was
signed by Ms. Smith on March 19, 2015. An “x” is marked for a box to
assert the section 6663 fraud penalty. An “x” is also marked next to a
box containing the following text: “Deficiency Case (Explanation
required when adjustments made and penalties are not asserted. The
applicable exceptions to the penalty must be documented.).” On the top
of both pages are identical headers indicating Mr. and Mrs. Tung in the
field for “Taxpayer Name”; a taxpayer identification number (TIN);75
1040 in the field for “Tax Form”; and 2009–12 in the field for “Tax
Year(s).” The form also includes narrative entries by RA White and RA
The Form 11661 at issue references only taxable years 2009–11. Respondent
74
conceded that it does not provide supervisory approval as to taxable year 2012.
75 The TINs disclosed on the headers do not match the Employer Identification
Number (EIN) for Genecure disclosed elsewhere throughout the record; however, they
do match the TINs for Mr. and Mrs. Tung. To the extent the record includes
inadvertent disclosure of sensitive taxpayer information (that the Court is aware of),
we ordered on May 5, 2022, that the parties file redacted versions of certain filings in
accordance with Rule 27(a).
37
[*37] Kittrell which refer to both Genecure and Mr. and Mrs. Tung. In
weighing these various aspects of the document, we cannot conclude
that this form manifests Ms. Smith’s intent to approve the assertion of
the section 6663 penalties against Genecure.
The Civil Penalty Approval Form’s headers establish a clear and
unambiguous context by identifying the Tungs individually by name and
by TIN. The reference to Form 1040 (the IRS form for individual
returns) is consistent with the identification of the Tungs as the subject
of the form rather than Genecure (which filed partnership returns on
Form 1065). The “x” marked for the box referring to “Deficiency Case”
also supports the conclusion that the context for this form is the
examination of individual returns; the examination of partnership
returns does not result in income tax deficiency determinations as
partnerships are not subject to federal income tax. See §§ 701, 6211(a).
To the extent the narrative entries reference Genecure, they do not
explicitly state that the penalties should be asserted against it. When
contextualized against the headers and other details on the Form, they
appear to be surplusage in explaining the applicability of the penalties
as to Mr. and Mrs. Tung. Consequently, we hold that the Civil Penalty
Approval Form does not manifest Ms. Smith’s intent to approve section
6663 penalties against Genecure. See Tribune Media Co., T.C. Memo.
2020-2, at *20–21. It therefore does not satisfy the written approval
requirement. 76 See id.b. Form 11661
The Form 11661 consists of two pages and was signed by Ms.
Fontanes on August 7, 2012. Genecure is listed in the field “Business
Name” within the broader field for “Assigned Taxpayer.” 77 Under the
field for “Taxpayer Identification Number” is a redacted entry within the
subfield “EIN.” 78 The form indicates that the relevant returns under
examination are Forms 1065 for taxable years 2009–11. Within the field
76 We note that the headers provide an essential context not only as to the
identity of the subject taxpayers but also as to the relevant taxable years. There is no
indication of the taxable years to which the penalty assertion is being made other than
the headers. If the Court ignores the context the headers establish as to the identity
of the subject taxpayers, logic would similarly compel us to ignore them as to the
relevant taxable years to which the penalty assertion relates.
77The other subfields within “Assigned Taxpayer” are “Last Name” and “First
Name”; both subfields were left blank.
78 The other subfield within “Taxpayer Identification Number” is “SSN,” which
was left blank.
38
[*38] for “FTA Recommendation,” 79 there is no “x” marked next to the
box “Assert CFP/FFTFP/impose 10-year EITC Ban”; a footnote on the
form indicates that “CFP” stands for civil fraud penalty. The only
reference to penalties on this form is the aforementioned footnote.
Lastly, in the two fields available for narrative entries, there is no
statement reflecting a determination that the section 6663 penalties
should be asserted against Genecure. In weighing these aspects of the
Form 11661, we also cannot conclude that this writing manifests an
intent to approve the imposition of any section 6663 penalty. See
Tribune Media Co., T.C. Memo. 2020-2, at *20–21.
A Form 11661 is used to document the investigation of potential
fraud. See IRM 25.1.2.2 (Oct. 30, 2009). It does not necessarily reflect
a determination that fraud exists or that any fraud-related penalty or
addition to tax should be imposed against the target taxpayer. See id.Although this Court found the written approval requirement
satisfied by Forms 11661 with respect to an individual and corporate
taxpayer in Benavides & Co., P.C., T.C. Memo. 2019-115, at *45, that
consolidated case is distinguishable. 80 The Court determined as a
finding of fact that the Form 11661 for the individual taxpayer evinced
the examining agent’s recommendation that civil fraud penalties should
be asserted, and the Court noted that the “Plan of Action” therein stated
that a 30-day letter would be prepared that included the civil fraud
penalty. Id. at *11, *45–47. The Court found that the Form 11661 for
the corporate taxpayer similarly evinced supervisory approval of the
examining agent’s recommendation to assert civil fraud penalties. Id.
at *46.
The Form 11661 in the present action contains none of the same
characteristics, and to the extent there is any mention of penalties, such
a reference was solely for the purpose of disclosing the meaning of an
abbreviation on the underlying form.
As we find no indication that this form (as completed)
recommended the assertion of the section 6663 penalty against
79 “FTA” stands for fraud technical advisor. See Internal Revenue Manual
(IRM) 25.1.1.1(6) (Dec. 16, 2011).
80 Also at issue was a civil fraud penalty determination against a third
taxpayer; however, the Court did not address whether the IRS complied with section
6751(b)(1) with respect to her because it concluded that the government did not carry
its burden of establishing that she had fraudulent intent. See Benavides & Co., P.C.,
T.C. Memo. 2019-115, at *45–46.
39
[*39] Genecure, we hold that it does not satisfy the written supervisory
approval requirement of section 6751(b)(1). 81
In sum, we hold that neither the Civil Penalty Approval Form nor
the Form 11661 at issue satisfies the written supervisory approval
requirement for purposes of section 6751(b)(1). Consequently, the
section 6663 civil fraud penalties are not applicable against Genecure at
the partnership level. See § 6751(b)(1).
IX. Respondent’s Untimely Opening Capital Account Balance and
Outside Basis Argument
At trial, respondent raised as an issue for the first time
Genecure’s opening tax-basis capital account balances reported for
taxable year 2009. 82 Respondent further articulates on brief that
because Mr. Tung cannot substantiate the opening tax-basis capital
account balances reported on Genecure’s returns, each partner’s outside
basis must be deemed to be zero for purposes of applying the section 704
loss limitation rule. 83
The opening tax-basis capital account balance and outside basis
issue was not raised in the FPAA for taxable year 2009 or in
respondent’s Answer. Similarly, respondent’s Pretrial Memorandum
made no mention of this issue. Consequently, Mr. Tung had no notice
or reason to prepare evidence for trial that would substantiate the
partners’ opening tax-basis capital account balances or outside bases
(the latter of which is not a return item reported on Form 1065 or
associated Schedule(s) K–1). We will not entertain respondent’s
argument as to this issue given the lack of notice and consequent
prejudice. This Court has held on multiple occasions that we will not
consider an issue raised for the first time at trial (or on brief) for this
very reason. See, e.g., Estate of Mandels v. Commissioner, 64 T.C. 61,
73 (1975); Friedman v. Commissioner, T.C. Memo. 1992-588, 1992 Tax
Ct. Memo LEXIS 606, at *10–12, aff’d without published opinion, 48
81 We decline to address Mr. Tung’s argument that Ms. Fontanes was not RA
White’s immediate supervisor for purposes of section 6751(b)(1), as this holding
renders it moot.
82As best we understand respondent’s overall argument, his issue lies with the
opening capital account balances reported on the Schedules K–1, which Genecure
indicated therein were tax-basis figures.
83 Section 704(d) limits the deductibility of a passed-through loss to a partner’s
adjusted basis in his partnership interest (i.e., outside basis) at taxable yearend.
40
[*40] F.3d 535 (11th Cir. 1995); Energy Res. Ltd. P’ship v.
Commissioner, T.C. Memo. 1990-240, 1990 Tax Ct. Memo LEXIS 248,
at *6.
To the extent respondent may claim that Mr. Tung was placed on
notice of this issue by language in the 2009 FPAA stating that Genecure
failed to provide support to verify capital contributions made during
taxable year 2009 that would increase basis, we disagree. 84 A capital
contribution made during a taxable year is distinct from a capital
account balance entering the same year, and substantiating each would
require wholly separate bodies of evidence. Moreover, although the
FPAA language references the word “basis,” the determination itself is
not that the partners’ outside bases should be zero.
Notwithstanding our conclusion that this issue was not timely
raised, respondent’s argument fails on the merits as it is predicated on
his apparent conflation of a partner’s tax-basis capital account with such
partner’s outside basis in a partnership. A partner’s outside basis is
defined under section 705(a), and Treasury Regulation § 1.705-1(a)(1)
explicitly provides that it is determined without regard to any amount
shown in a partnership’s books as the partner’s capital account. While
related concepts, they are not synonymous. 85 See William S. McKee et
al., Federal Taxation of Partnerships and Partners ¶ 6.04 (2022).
Moreover, this Court lacks subject matter jurisdiction to
determine a partner’s outside basis in a partnership-level proceeding.
See Woods, 571 U.S. at 42 (holding that outside basis is not a
partnership item for purposes of section 6226(f)); see also Logan Tr. v.
Commissioner, 616 F. App’x 426, 429 (D.C. Cir. 2015), aff’g in part, rev’g
in part, and remanding Tigers Eye Trading, LLC v. Commissioner, 138
T.C. 67 (2012).
84Respondent conceded this determination at trial stating that “[t]here are no
capital contributions reported on Gene[c]ure’s 2009 Form 1065.” See supra note 7.
85 Although (1) a partner’s outside basis can generally be calculated by adding
his share of partnership liabilities to his tax-basis capital account, see Markell Co. v.
Commissioner, T.C. Memo. 2014-86, at *3 n.3, and (2) we previously concluded that
Mr. Tung failed to substantiate a purported $200,000 loan from Mrs. Tung (the only
liability reported as of taxable yearend 2009) to Genecure, see supra Opinion Part VII,
respondent’s argument also assumes without explanation that there were no
adjustments to the tax-basis capital accounts between the start and end of the taxable
year (such as one attributable to an allocation of partnership income or loss).
41
[*41] X. Conclusion
In conclusion, the Court holds: (1) that Genecure had unreported
income of $6,000; $21,578; and $7,000 in taxable years 2009–11,
respectively, (2) that Mr. Tung largely failed to establish Genecure’s
entitlement to deductions for various business expenses reported for
each of the taxable years at issue, (3) that Genecure is subject to a
$230,979 recapture tax with respect to its taxable year 2010 for excess
amounts received as a QTDP grant, (4) that Mr. Tung failed to
substantiate a $200,000 loan to Genecure from Mrs. Tung in taxable
year 2009, (5) that Mr. Tung failed to substantiate a $100,000 capital
contribution to Genecure from Mrs. Tung in taxable year 2011, and
(6) that Genecure is not liable for section 6663 civil fraud penalties at
the partnership level for any of the taxable years at issue.
We have considered all of the arguments made by the parties, and
to the extent not mentioned above, we conclude that they are moot,
irrelevant, or without merit. To reflect the foregoing,
Decision will be entered under Rule 155.