Badell v. Commissioner ( 2000 )


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  •                          T.C. Memo. 2000-303
    UNITED STATES TAX COURT
    PATRICK C. BADELL AND LILLIAN A. BADELL, Petitioners v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent
    RONALD L. WILSON AND DONNA M. WILSON, Petitioners v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent
    Docket Nos. 14830-98, 14831-98.1     Filed September 26, 2000.
    Ronald L. Wilson, for petitioners.
    Timothy S. Sinnott, for respondent.
    MEMORANDUM FINDINGS OF FACT AND OPINION
    COLVIN, Judge:    Respondent determined deficiencies in
    petitioners’ income tax and determined that petitioners are
    1
    These cases were consolidated for trial, briefing, and
    opinion by order of this Court on Aug. 19, 1999.
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    liable for a penalty as follows:
    Patrick C. Badell and Lillian A. Badell
    Accuracy-related
    penalty
    Year        Deficiency                 sec. 6662(a)
    1994         $10,253                    $2,050.60
    1995          66,815                    13,363.00
    1996          87,210                    17,442.00
    Ronald L. Wilson and Donna M. Wilson
    Accuracy-related
    penalty
    Year        Deficiency                 sec. 6662(a)
    1994          $9,550                    $1,910.00
    1995          59,181                    11,836.20
    1996          87,650                    17,530.00
    Petitioners Patrick Badell (Badell) and Ronald Wilson
    (Wilson) are the sole shareholders of Badell and Wilson, P.C.
    (B&W), an S corporation.      B&W performed legal services for W.R.
    Kelso Co., Inc. (Kelso), and Kelso constructed a roof on the
    Badells’ residence in B&W’s fiscal year 1995.2        Kelso reported
    $49,000 of income on its 1994 return based on the legal services
    it received in lieu of payment of $49,000 it billed to B&W for
    the roof construction.    Kelso credited its accounts payable to
    B&W in the same amount.    B&W did not try to collect from Kelso
    for the legal services B&W had performed in B&W’s 1995 fiscal
    year or report as income the roofing services it received.        After
    concessions, the issues for decision are:
    1.     Whether B&W received barter income of $49,000 from
    2
    Badell & Wilson’s (B&W) fiscal year ended June 30.
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    Kelso in the form of roofing services Kelso provided to Badell in
    B&W’s 1995 fiscal year.     We hold that it did.
    2.      Whether B&W may deduct costs it advanced on behalf of
    its clients of $24,680 for fiscal year 1995 and $37,799 for
    fiscal year 1996.     We hold that it may not.
    3.      Whether petitioners Patrick Badell and Lillian Badell
    (the Badells) and petitioners Ronald Wilson and Donna Wilson (the
    Wilsons) are liable for the accuracy-related penalty for
    negligence under section 6662(a) for 1994, 1995, and 1996.       We
    hold that they are.
    Section references are to the Internal Revenue Code in
    effect during the years in issue.     Rule references are to the Tax
    Court Rules of Practice and Procedure.     References to Badell and
    Wilson are to Patrick Badell and Ronald Wilson, respectively.
    FINDINGS OF FACT
    Some of the facts have been stipulated and are so found.
    A.   Petitioners
    The Badells lived in Indianapolis, Indiana, when they filed
    their petition.     The Wilsons lived in Rushville, Indiana, when
    they filed their petition.
    B.   Badell & Wilson, P.C.
    Badell and Wilson are attorneys.     They each own 50 percent
    of the stock of B&W, an S corporation incorporated on June 3,
    1982.     B&W’s office is located in Rushville.    Badell was B&W’s
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    president, and Wilson was its secretary-treasurer during the
    years in issue.   Badell and Wilson were the only attorneys B&W
    employed during the years in issue.
    B&W is engaged in the general practice of law, and is a
    fiscal year, cash-basis taxpayer.    B&W represents clients in
    minor criminal matters, divorces, bankruptcies, and personal
    injury cases.   B&W also prepares income tax, Federal estate tax,
    and Indiana inheritance tax returns for its clients.    Wilson
    usually prepares those tax returns.
    C.   B&W’s Payment of Client Costs
    B&W paid various expenses for its clients during the years
    in issue such as court fees, fees for court reporter services,
    witness fees, and charges for medical records and inquiries to
    the Indiana Bureau of Motor Vehicles.    B&W recorded these
    expenses on its books as “Costs Advanced.”    B&W also made cash
    advances during the years in issue to clients whom they believed
    were destitute.
    B&W required its personal injury clients to agree to
    reimburse B&W for any costs advanced to them and to pay B&W a
    percentage of any recovery.   B&W’s personal injury clients agreed
    to reimburse B&W for any costs it paid on their behalf,
    regardless of the outcome of their case.    B&W expected its
    clients to reimburse B&W for these advances.    However, B&W’s
    clients did not always do so in the taxable year in which B&W
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    paid the expense.
    B&W deducted expenses for client costs of $24,680 for fiscal
    year 1995 and $37,799 for fiscal year 1996.
    D.   W.R. Kelso Co.
    1.     The Relationship Between Kelso and Badell
    William Kelso (Mr. Kelso) is the president and owner of
    Kelso, an Indianapolis construction company.    Badell has known
    Mr. Kelso since before 1992.
    Kevin Blume (Blume) has been the secretary/treasurer of
    Kelso since September 1993.    Badell has known Blume since about
    1990 when Badell was corporate counsel for another company.
    Badell and Blume also know each other socially.
    2.     Legal Services Performed by B&W for Kelso
    Badell has performed legal services, involving mostly
    contracts and collection matters, for Kelso since 1992 or 1993.
    B&W billed Kelso monthly for legal services rendered.    B&W billed
    Kelso $43,998.86 for legal services provided from June 1994 to
    October 31, 1996.     Kelso made four payments totaling $1,224.50 to
    B&W for legal services provided from October 25, 1994, to October
    14, 1996.
    B&W usually sues clients whose payments are in arrears if it
    believes the bill is collectible.    B&W did not try to collect
    from Kelso from June 30, 1994, to October 31, 1996.
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    3.   Roofing Services Provided by Kelso
    In 1994, Badell hired Kelso to construct a slate roof on the
    Badells’ residence.   Kelso usually gives estimates to customers
    before beginning to work on projects.   However, it did not give
    B&W or the Badells an estimate of the cost of constructing the
    roof on the Badells’ residence.   Kelso began to construct the
    roof in 1994.
    Kelso billed B&W $49,000 on December 31, 1994, for
    constructing the roof on the Badell residence.   B&W made no
    payments to Kelso until September 1997.   Kelso did not try to
    collect that amount for an extended period of time because its
    personnel believed B&W was “working off” B&W’s charges for legal
    services by constructing the roof on the Badell residence.     Kelso
    reported the $49,000 as income on its 1994 return, and on its
    gross profit report for 1994.   Kelso credited its accounts
    payable to B&W for legal services by $49,000 as of December 31,
    1994.
    Kelso worked on the Badell residence from 1994 to 1999, for
    which it billed B&W as follows:
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    Date of bill         Amount billed           Work performed
    12/31/94            $49,000.00          First house billing
    12/31/95              4,668.00          Second year bill
    1/22/97              4,222.86          1996 annual work
    3/9/99              1,640.63          Roof & gutter repairs
    3/17/99                288.75          Replace damaged slate;
    clean gutters
    Kelso performed roofing work on B&W’s office building, for
    which it billed B&W $1,572.18 in 1997 and $765.27 in 1999.    Kelso
    had billed B&W $53,668 as of December 31, 1995, and $62,157.69 as
    of March 17, 1999, for the work performed on the Badell residence
    and the B&W roof from 1994 to 1999.
    E.   Preparation of B&W’s Tax Returns for 1995 and 1996
    B&W used a computer program to prepare its Forms 1120S, U.S.
    Income Tax Return for an S Corporation, for fiscal years 1995 and
    1996.   Wilson gathered the information for the return and
    reviewed the return when it was completed.   Badell signed B&W’s
    returns as B&W’s president.
    F.   Audit of B&W’s Returns
    A revenue agent began examining B&W’s returns in July 1996.
    The revenue agent also examined the returns of B&W’s
    shareholders, Badell and Wilson, and met with them separately in
    July 1996.
    The revenue agent met with Mr. Kelso and Blume on October
    21, 1996, to discuss the roofing job on the Badell residence.
    Mr. Kelso and Blume told the revenue agent that B&W intended to
    “work off” the cost of the roofing job.
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    G.   B&W’s and Kelso’s Payments to Each Other
    Kelso paid B&W $30,000 on October 31, 1996, $20,000 on
    September 11, 1997, $25,000 on August 14, 1998, and $10,000 on
    December 17, 1998.
    Kelso began trying to collect the amount owed from B&W after
    the audit of B&W (discussed at paragraph F, above) began, and
    after the revenue agent spoke to Mr. Kelso and Blume in October
    1996.     B&W paid Kelso $10,000 on September 10, 1997, and
    $52,157.69 on August 4, 1998, for the work done on the Badells’
    residence and on B&W’s office building.
    OPINION
    A.   Whether B&W Received Barter Income of $49,000 From Kelso in
    Fiscal Year 1995
    1.      The Issue
    We must decide whether, as respondent contends, B&W received
    barter income of $49,000 from Kelso in fiscal year 1995 in the
    form of roofing services Kelso provided for the Badell residence.
    Gross income includes the fair market value of property or
    services received in exchange for other services.     See sec.
    61(a); Baker v. Commissioner, 
    88 T.C. 1282
    , 1288 (1987); sec.
    1.61-2(d)(1), Income Tax Regs.     The fair market value of goods
    and services is normally the amount charged by the providers of
    the goods and services.     See Rooney v. Commissioner, 
    88 T.C. 523
    ,
    527-528 (1987).
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    2.     Petitioners’ Contentions
    Petitioners contend that B&W did not receive barter income
    in fiscal year 1995 because Kelso and B&W paid each other in full
    after B&W’s fiscal year 1995.
    Badell testified that he did not tell Mr. Kelso or Blume
    that he would work off the cost of the roofing services.     Badell
    testified that B&W did not try to collect the debt Kelso owed it
    because B&W expected that Kelso would pay B&W eventually.     Badell
    also testified that he did not know whether the work Kelso did on
    his roof was a large or small project and that he did not
    remember seeing roofing equipment or materials at his home
    because he was not home during the day when the roofers were
    there.    We disagree.   We decide whether a witness is credible
    based on objective facts, the reasonableness of the testimony,
    the consistency of statements made by the witness, and the
    demeanor of the witness.     See Quock Ting v. United States, 
    140 U.S. 417
    , 420-421 (1891); Wood v. Commissioner, 
    338 F.2d 602
    , 605
    (9th Cir. 1964), affg. 
    41 T.C. 593
    (1964); Pinder v. United
    States, 
    330 F.2d 119
    , 124-125 (5th Cir. 1964); Concord Consumers
    Hous. Coop. v. Commissioner, 
    89 T.C. 105
    , 124 n.21 (1987).     We
    may discount testimony which we find to be unworthy of belief,
    see Tokarski v. Commissioner, 
    87 T.C. 74
    , 77 (1986), but we may
    not arbitrarily disregard testimony that is competent, relevant,
    and uncontradicted, see Conti v. Commissioner, 
    39 F.3d 658
    , 664
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    (6th Cir. 1994), affg. 
    99 T.C. 370
    (1992) and T.C. Memo. 1992-
    616.
    We found Badell’s testimony to be unconvincing and
    inconsistent with more convincing evidence in the record.        First,
    Badell’s testimony was implausible and incredible.    He claimed to
    not know what roofing services Kelso had performed at his
    residence and at the B&W office, despite the fact that he
    testified that he did not pay Kelso until the roofing job at his
    residence was completed to his satisfaction.    Badell’s testimony
    that he did not socialize with Blume is contradicted by Blume’s
    testimony that they did occasionally socialize and that they
    sometimes drove to football games together.
    Second, Kelso treated the transaction as a barter.   It
    billed B&W $49,000 for the roof construction on the Badell
    residence in 1994, credited its accounts payable to B&W by
    $49,000, and reported $49,000 as income on its 1994 return even
    though B&W made no cash payment to Kelso that year.    Third,
    although B&W billed Kelso $43,998.86 on October 31, 1996, and
    Kelso billed B&W $53,668 on December 31, 1995, neither Kelso nor
    B&W tried to collect those amounts until after the revenue agent
    began the audit.    Fourth, the parties did not pay each other in
    full until several years after providing the roofing job and
    legal services.    B&W paid Kelso in Kelso’s fiscal years 1998 and
    1999, and Kelso paid B&W in B&W’s fiscal years 1997, 1998, and
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    1999.    Fifth, B&W and Kelso had a longstanding business
    relationship, and Badell and Blume were friends.     Sixth, Mr.
    Kelso and Blume told the revenue agent who conducted the audit of
    B&W and petitioners individually that B&W intended to “work off”
    the cost of the roofing job.     Blume said he did not recall making
    this statement.    We see no reason to doubt the revenue agent’s
    testimony because it was based on the statements of both Mr.
    Kelso and Blume, Blume did not deny making the statement, and Mr.
    Kelso did not testify.3
    Petitioners contend that “work off” means that B&W and Kelso
    agreed to pay the other in money for their services.     We
    disagree.    We construe “work off” to mean that B&W intended to
    trade legal services for Kelso’s roofing services.
    Petitioners contend that respondent’s barter theory would
    improperly convert B&W from a cash basis of accounting to an
    accrual basis.    We disagree.   Respondent’s barter theory
    accelerates into B&W’s 1995 fiscal year income which B&W reported
    in its 1997, 1998, and 1999 fiscal years.     All items of gross
    income, including cash, property, or services, are included in
    the taxable year of the cash basis taxpayer in which the amount
    was actually or constructively received.     See sec. 1.446-
    1(c)(1)(i), Income Tax Regs.     B&W and Kelso entered into a
    3
    The parties agreed that Mr. Kelso was unavailable to
    testify.
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    bartering transaction under which Kelso provided roofing services
    to B&W in B&W’s 1995 fiscal year.
    3.   Conclusion
    We hold that B&W must include the $49,000 of roofing
    services in income in its 1995 fiscal year, the year in which
    Kelso provided the services.
    B.   Whether B&W May Deduct Expenses Advanced on Behalf of
    Clients for Fiscal Years 1995 and 1996
    Petitioners contend that B&W may deduct as ordinary and
    necessary business expenses for fiscal years 1995 and 1996
    amounts it advanced on behalf of its clients for filing and
    recording fees, court costs, and similar expenses in those years.
    We disagree.
    Expenses paid by a taxpayer under an agreement that he or
    she will be reimbursed for those expenses are loans or advances
    and are not deductible business expenses.   See Herrick v.
    Commissioner, 
    63 T.C. 562
    , 569 (1975); Canelo v. Commissioner, 
    53 T.C. 217
    , 224 (1969) (attorney’s reimbursable costs are not
    deductible), affd. per curiam 
    447 F.2d 484
    , 485 (9th Cir. 1971);
    Hearn v. Commissioner, 
    36 T.C. 672
    , 674 (1961), affd. 
    309 F.2d 431
    (9th Cir. 1962); Patchen v. Commissioner, 
    27 T.C. 592
    , 600
    (1956), affd. in part and revd. on other grounds 
    258 F.2d 544
    (5th Cir. 1958).
    Petitioners contend that B&W can deduct the costs advanced
    for its clients because, according to petitioners, repayment of
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    the advanced costs was contingent upon the outcome of the
    underlying litigation (i.e., a gross fee arrangement).   See
    Boccardo v. Commissioner, 
    56 F.3d 1016
    , 1018 (9th Cir. 1995),
    revg. T.C. Memo. 1993-224.   We disagree.   In Boccardo v.
    
    Commissioner, supra
    , the U.S. Court of Appeals for the Ninth
    Circuit held that an attorney’s payment of costs and charges in
    connection with his or her client’s litigation is deductible if
    the client is under no obligation to repay the money spent.
    Unlike the clients in Boccardo, B&W’s clients were obligated to
    reimburse B&W for the costs it paid on their behalf regardless of
    the outcome of the client’s case.   Thus, Boccardo does not help
    petitioners.
    Similarly, B&W may not deduct as business expenses advances
    it made to those clients it believed were destitute.   See Hearn
    v. 
    Commissioner, supra
    (unreimbursed expenses advanced by
    attorney to clients were nondeductible loans in year paid, even
    though attorney believed it “doubtful” he would collect these
    items).
    Petitioners contend that, in the same tax year B&W advanced
    costs, B&W was reimbursed by its clients in an amount greater
    than conceded by respondent.   We agree in part and disagree in
    part.   In fiscal year 1995, B&W’s clients reimbursed B&W $2,311
    for costs paid in fiscal year 1995, over and above those conceded
    by respondent, and B&W may reduce its gross receipts for that
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    year accordingly.   However, petitioners have not shown that B&W
    was reimbursed in an amount greater than that conceded by
    respondent for fiscal year 1996.
    Petitioners contend that respondent’s disallowance of B&W’s
    deduction of those costs would have the effect of improperly
    putting B&W on the accrual method of accounting.   We disagree.
    Although cash-basis taxpayers may deduct business expenses in the
    taxable year paid, the costs advanced by B&W for its clients were
    in the nature of reimbursable loans and were not deductible.
    Respondent’s disallowance of those deductions did not put B&W on
    the accrual method of accounting.
    Petitioners claim that they may deduct as business expenses
    amounts advanced on behalf of clients just as farmers may deduct
    their expenses for fertilizers, chemicals, and fuel.    We
    disagree.   Tax rules for farmers do not make B&W’s payment of
    client costs deductible.
    Petitioners contend that respondent permitted B&W to deduct
    as business expenses advances for client costs in prior years,
    and claim that its identical treatment of client costs during the
    years in issue must similarly be accepted.   We disagree.    First,
    petitioners offered no evidence of a prior examination or audit
    of B&W’s tax returns and thus have not shown that respondent
    allowed B&W to deduct client advances in prior years.    Second,
    respondent is not precluded from raising an issue even if
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    respondent did not raise it in a prior year.   See Hawkins v.
    Commissioner, 
    713 F.2d 347
    , 351-352 (8th Cir. 1983), affg. T.C.
    Memo. 1982-451; Easter v. Commissioner, 
    338 F.2d 968
    , 969 (4th
    Cir. 1964), affg. per curiam T.C. Memo. 1964-58.
    Petitioners point out that the amounts B&W deducted as
    advanced costs were less than 5 percent of its total income for
    fiscal years 1994 and 1995 and argue that no material distortion
    of income or expenses would result from deducting those costs.
    Petitioners’ argument misses the mark.   Respondent did not
    determine that B&W’s income was distorted by its deduction of
    advanced client costs; instead, respondent determined, and we
    agree, that B&W may not deduct advanced client costs because they
    were nondeductible loans to its clients.
    C.   Whether Petitioners Are Liable for the Accuracy-Related
    Penalty for Negligence
    Petitioners contend that they are not liable for the
    accuracy-related penalty for negligence for 1994, 1995, and 1996.
    We disagree.
    Taxpayers are liable for a penalty equal to 20 percent
    of the part of the underpayment attributable to negligence or
    disregard of rules or regulations.    See sec. 6662(a) and (b)(1).
    Negligence includes failure to make a reasonable attempt to
    comply with internal revenue laws or to exercise ordinary and
    reasonable care in preparing a tax return.   See sec. 6662(c).    To
    avoid liability for negligence, the Badells and Wilsons must show
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    that they acted reasonably and exercised due care in preparing
    their 1994, 1995, and 1996 tax returns.   See sec. 6664(c)(1).
    Petitioners concede that B&W should not have deducted as
    office expenses in fiscal years 1995 and 1996 the cost of buying
    PTC Bancorp stock, that the Badells should have included in
    income for 1994, 1995, and 1996 Badell’s fringe benefit income
    from B&W in the form of personal use of corporate-owned
    automobiles and health and life insurance for which B&W paid the
    premiums, and that the Wilsons should have included in income
    Wilson’s fringe benefit income from B&W in the form of personal
    use of corporate-owned automobiles and life insurance for which
    B&W paid the premiums.   They contend that they should not be held
    liable for negligence because they readily conceded these errors.
    We disagree.   Petitioners provided no evidence as to the
    reasonableness of their position regarding these items.     They did
    not explain how they decided to treat these items on their
    returns or claim that they investigated the proper treatment of
    or had authority for their treatment of these items.   The fact
    that they conceded their errors does not show they were not
    negligent.   See McCullen v. Commissioner, T.C. Memo. 1997-280.
    Petitioners argue that B&W’s tax treatment of advanced
    client costs was not negligent because B&W has used the same
    method of accounting for costs since B&W was formed and
    respondent had not previously challenged it.   Finally,
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    petitioners contend that, because (according to petitioners) B&W
    did not receive barter income from Kelso, they are not negligent
    for their failure to report that income.
    In deciding whether Badell and Wilson were negligent, we
    consider their legal education and their years of legal
    experience.   See Tippin v. Commissioner, 
    104 T.C. 518
    , 534
    (1995); Glenn v. Commissioner, T.C. Memo. 1995-399, affd. 
    103 F.3d 129
    (6th Cir. 1996).   Petitioners have not shown that they
    acted with reasonable cause and in good faith with respect to
    these issues.   They did not explain how they prepared their
    individual returns for 1994, 1995, and 1996, or provide any
    authority for the positions they took on those returns.    We
    conclude that petitioners are liable for the accuracy-related
    penalty for negligence for 1994, 1995, and 1996.
    Decisions will be entered
    under Rule 155.