Thad Marshall Pugh v. Commissioner ( 2019 )

T.C. Summary Opinion 2019-2UNITED STATES TAX COURT
THAD MARSHALL PUGH, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13462-16S. Filed February 28, 2019.
Peter A. Lowy, for petitioner.1
Lewis A. Booth II, for respondent.
SUMMARY OPINION
CARLUZZO, Chief Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in effect when the
petition was filed.2 Pursuant to section 7463(b), the decision to be entered is not
1
Mr. Lowy’s appearance was entered on the day of trial as a result of his
participation in a pro bono program sponsored by the American Bar Association.
2
Unless otherwise indicated, section references are to the Internal Revenue
(continued...)
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reviewable by any other court, and this opinion shall not be treated as precedent
for any other case.
In a notice of deficiency (notice) dated March 7, 2016, respondent
determined deficiencies in petitioner’s 2010 and 2011 Federal income tax and
imposed additions to tax under sections 6651and 6654.
After significant concessions by both parties, the issues for decision for
each year are whether petitioner is entitled to deductions for (1) mortgage interest
and (2) legal fees claimed on Schedules C, Profit or Loss From Business, included
with his untimely (and apparently unprocessed) Federal income tax returns.3
Background
Some of the facts have been stipulated and are so found. When the
petition was filed, petitioner resided in Texas.
During each year in issue petitioner, who holds a bachelor of science degree
in electrical engineering, was the sole proprietor of Pi Integrated Systems (Pi). At
2
(...continued)
Code of 1986 as amended, in effect for the years in issue, and Rule references are
to the Tax Court Rules of Practice and Procedure.
3
All of the adjustments made in the notice have been resolved between the
parties. The issues that remain in dispute arise from deductions claimed on the
untimely Federal income tax returns submitted to respondent, one after the notice
was issued.
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all times relevant, Pi was engaged in the business of software development. Pi had
few employees during the years in issue, and the business was conducted from an
office in petitioner’s house. In earlier years things looked good, and petitioner had
a plan to expand the business.
In business sometimes things do not go as planned.
In 2005 and 2006 petitioner purchased two vacant lots, one adjacent to land
he already owned and the other directly across the street (properties). He had to
borrow money to do so, and he paid interest on those loans during each of the
years in issue. Later he purchased two steel buildings, disassembled them, and
stored some of the components on one of the properties. His plan was to re-
assemble the buildings on the properties as shown on a site plan prepared by an
architect in 2007. Petitioner intended that the reassembled buildings would serve
as Pi’s “headquarters”.
Circumstances, however, did not cooperate. Before petitioner’s plan could
be put into effect, Pi lost a major customer, revenues sharply decreased, and later
some of its employees left to work for other employers. As of the date of trial, the
properties, some of which were sold, remained undeveloped, and some of the
components of the steel buildings were sold as scrap metal.
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Petitioner submitted 2010 and 2011 Federal income tax returns to
respondent long after each was due. Each included a Schedule C for Pi, and each
Schedule C included numerous deductions. We need to focus on only two
deductions for each year: (1) a deduction for mortgage interest and (2) a
deduction for legal fees. Respondent allowed most of the deductions claimed for
legal fees; the deductions for mortgage interest have been disallowed.
Discussion
As we have observed in countless opinions, deductions are a matter of
legislative grace, and the taxpayer bears the burden of proving entitlement to any
claimed deduction.4 Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79,
84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).
A taxpayer claiming entitlement to a deduction must demonstrate that the
deduction is allowable pursuant to some statutory provision and must further
substantiate that the expense to which the deduction relates has been paid or
incurred. See sec. 6001; Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975),
aff’d, 540 F.2d 821 (5th Cir. 1976); sec. 1.6001-1(a), Income Tax Regs.
4
Petitioner does not claim and the record does not show that the provisions
of sec. 7491(a) are applicable, and we proceed as though they are not.
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Mortgage Interest
Section 163(a) provides: “There shall be allowed as a deduction all interest
paid or accrued within the taxable year on indebtedness.” This general rule is
simple and seemingly should resolve the dispute between the parties on the point.
It is undisputed that the interest as shown on the Schedules C was paid on the
indebtedness created by the acquisition of the properties. But the simple general
rule in subsection (a) is followed by no less than 13 other subsections, some
including multiple paragraphs, subparagraphs, clauses, and subclauses, that
establish a variety of limitations and exceptions to the general rule. We need to
concern ourselves with only some of the exceptions.
The first is subsection (d). According to respondent, the interest deductions
here in dispute are limited by section 163(d) that provides that a taxpayer, other
than a corporation, may deduct “investment interest” only to the extent of
investment income. For purposes of section 163(d) and in general, “investment
interest” means interest that is “paid or accrued on indebtedness properly allocable
to property held for investment.” Sec. 163(d)(3)(A). According to respondent,
because the properties were never actually used in petitioner’s trade or business,
the properties must be treated as property held for investment. Because petitioner
does not claim to have enjoyed any investment income during either year in issue,
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respondent argues that petitioner is not entitled to deduct any of the interest paid
in connection with the indebtedness that burdens the properties.
But “property held for investment” is specifically defined in section
163(d)(5), and the properties do not fit within that definition. Consequently, the
interest paid to finance the acquisition of the properties is not treated as
investment interest, and petitioner’s entitlement to deductions for that interest is
not, as respondent argues it is, subject to limitation under section 163(d). That
does not, however, end the matter.
Another exception to the general rule that must be taken into account is
section 163(h) that provides that a taxpayer, other than a corporation, is not
entitled to a deduction for personal interest. For purposes of section 163(h) and as
relevant here, “interest paid or accrued on indebtedness properly allocable to a
trade or business” is excluded from the exception. Sec. 163(h)(2)(A).
As respondent notes, the properties were not actually used in petitioner’s
trade or business during the years in issue. Nevertheless, we are satisfied that the
properties were certainly “allocable” to that business. Consequently, the interest
paid in connection with the indebtedness on the properties is not treated as
personal interest. Respondent does not suggest that any of the other exceptions or
limitations to the general rule set forth in section 163(a) are applicable, and we are
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satisfied that none are. That being so, we find that petitioner is entitled to the
deduction claimed for mortgage interest for each of the years in issue. We further
find that because the deduction for each year is “allocable” to petitioner’s trade or
business, the deduction is properly taken into account in the computation of
petitioner’s adjusted gross income. See sec. 62(a)(1).
Legal Fees
Respondent has already allowed all but small portions of the deductions
claimed for legal fees on the Schedules C included with the untimely returns. No
explanation has been provided that shows why some portions were allowed and
others not. But more significantly, petitioner has not established the nature of the
legal services, how the legal services relate to his trade or business, or the amounts
actually paid or incurred for those legal services. Given the small amounts
involved, we can understand the parties’ failure to address the items; but that small
amounts remain in dispute does not relieve petitioner of his burden to prove
entitlement to all of the deductions claimed.
The parties stipulated the proper deduction for legal fees and expenses for
each year; nevertheless, both proceeded as though the small amount that
respondent has not allowed for each year remains in dispute. We will follow their
lead and ignore the stipulation; however, there is really not much for us to do.
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Because petitioner has failed to establish the nature of the legal services involved,
how those services relate to his trade or business, or the amounts actually paid or
incurred for those services, he is not entitled to a deduction for legal fees in excess
of the amount already allowed by respondent for each year in issue.
To reflect the foregoing and the concessions of the parties,
Decision will be entered under
Rule 155.