John E. Rogers & Frances L. Rogers v. Commissioner , 2019 T.C. Memo. 90 ( 2019 )

T.C. Memo. 2019-90UNITED STATES TAX COURT
JOHN E. ROGERS AND FRANCES L. ROGERS, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 29356-14, 15112-16, Filed July 17, 2019.
2564-18.
John E. Rogers, for petitioners.
Maya Solh-Cade, Mayer Y. Silber, Jay D. Adams, and Briseyda
Villalpando, for respondent.
1
Cases of the following petitioners are consolidated herewith: John E.
Rogers and Frances L. Rogers, docket No. 15112-16, and Frances L. Rogers,
docket No. 2564-18.
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[*2] MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: Respondent issued notices of deficiency to petitioners
determining income tax deficiencies for 2010 and 2012 of $940,747 and $243,913,
respectively, and accuracy-related penalties under section 6662(a) for 2010 and
2012 of $188,149 and $48,783, respectively.2 Petitioner Frances L. Rogers seeks
relief from joint and several liability under section 6015 for 2010, 2011, and 2012.
The Court severed the section 6015 issue in order for Mrs. Rogers to obtain new
counsel. Therefore, we do not address the issues under section 6015 in this
opinion.3
Petitioners are no strangers to this Court. They litigated their income tax
liability for 2003 in Rogers v. Commissioner, T.C. Memo. 2011-277, aff’d, 728
F.3d 673 (7th Cir. 2013). The Court determined that petitioners had unreported
2
Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) as amended and in effect at all relevant times, and all Rule
references are to the Tax Court Rules of Practice and Procedure. All amounts are
rounded to the nearest dollar.
3
In the case at docket No. 2564-18 Mrs. Rogers requests relief from joint
and several liability under sec. 6015 for tax year 2011. That case was consolidated
with the other two. Petitioners received a timely notice of deficiency for their
2011 tax liability but failed to timely petition this Court with respect to the
deficiency determined for that year. As the only issue for 2011 is relief from joint
and several liability under sec. 6015, we do not address that year in this opinion.
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[*3] income from petitioner John Rogers’ business activities and disallowed
certain business expense deductions related to both petitioners’ business activities.
Petitioners were also assessed income tax and a penalty for 2003 as a result of our
decision in Superior Trading, LLC v. Commissioner, 137 T.C. 70 (2011),
supplemented by T.C. Memo. 2012-110, aff’d, 728 F.3d 676 (7th Cir. 2013).
Petitioners litigated their 2004 tax liability in Rogers v. Commissioner, T.C.
Memo. 2014-141, and their 2005, 2006, 2007, and 2009 tax liabilities in Rogers v.
Commissioner (Rogers 2005-09), T.C. Memo. 2018-53. In both cases we
determined that petitioners had unreported income and disallowed business
expense deductions related to their business entities.4 Petitioners were also
assessed income tax for 2005 as a result of our decision in Kenna Trading, LLC v.
Commissioner, 143 T.C. 322 (2014), aff’d sub nom. Sugarloaf Fund, LLC v.
Commissioner, 911 F.3d 854 (7th Cir. 2018), and for 2006, 2007, and 2008 as a
result of our decision in Sugarloaf Fund, LLC v. Commissioner, T.C. Memo.
2018-181.
After concessions, the issues remaining for consideration are: (1) whether
petitioners are entitled to the following deductions: a casualty loss deduction for
4
Petitioners were subsequently subject to penalties related to their 2005,
2006, 2007, and 2009 liabilities as a result of Rogers v. Commissioner, T.C.
Memo. 2019-61.
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[*4] 2010, certain business expense deductions for 2010 and 2012, a worthless
debt or stock deduction relating to Portfolio Technologies, Inc. (PTI), for 2010,
and a net operating loss carryforward deduction for 2010 or 2012; we hold that
they are not except to the extent stated herein; (2) whether Sterling Ridge, Inc.
(SRI), an S corporation wholly owned by Mrs. Rogers, was entitled to include
certain costs in costs of goods sold (COGS) and deduct certain business expenses
for 2010 and 2012; we hold that it was not except to the extent stated herein;
(3) whether Portfolio Properties, Inc. (PPI), an S corporation wholly owned by Mr.
Rogers, was entitled to include certain costs in COGS and deduct certain business
expenses for 2010; we hold that it was not except to the extent stated herein; and
(4) whether petitioners are liable for accuracy-related penalties under section
6662(a) for 2010 and 2012; we hold that they are.
FINDINGS OF FACT
Petitioners resided in Illinois when the petitions were timely filed with this
Court. The stipulations of facts and the accompanying exhibits are incorporated
herein by this reference. In addition, the parties have settled a number of issues
originally in dispute in these cases.
Petitioners were married during the years at issue and remained married at
the time of trial. They filed a joint tax return prepared by Mr. Rogers for each of
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[*5] the years at issue. Mr. Rogers is a tax attorney licensed in the State of Illinois
with decades of experience. He earned a juris doctor degree (J.D.) from Harvard
University and a master of business administration degree (M.B.A.) in
international finance from the University of Chicago. In 1992 Mr. Rogers joined
FMC Corp., a multinational conglomerate with operations in over 100 countries,
and served as its tax director and assistant treasurer through 1997. In 1998 he
joined the law firm Altheimer & Gray where he worked as a partner until 2003.
From July 2003 to May 2008 he worked as a corporate and tax attorney, and
partner, at the law firm Seyfarth Shaw, LLP (Seyfarth), in downtown Chicago,
Illinois. In 2008 Mr. Rogers left Seyfarth to open his own law firm, Rogers &
Associates. He is also a licensed certified public accountant in the State of
Illinois.
Mrs. Rogers has a bachelor of science degree in chemistry from the College
of St. Francis and a master of science degree in biochemistry from Purdue
University. She also holds an M.B.A. and a doctorate in educational
administration from Northern Illinois University, and a J.D. from Villanova
University School of Law. Mrs. Rogers has been a licensed attorney in the State
of Illinois since 1991 and has held a real estate broker’s license since 1967. She
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[*6] worked as a high school teacher and associate principal from 1973 until
retiring from the education field in 2005.
I. Deductions
A. Casualty Loss
Petitioners claimed no casualty loss deduction on their 2010 joint Form
1040, U.S. Individual Income Tax Return. However, before trial in these cases
petitioners asserted that they had suffered a casualty in 2010 related to a broken
sewer line and sought a deduction for a resulting casualty loss. The break
occurred on the sewer line of petitioners’ neighbor, and the record does not reflect
what caused the break.
Petitioners hired F.J. Kerrigan Plumbing (Kerrigan) to handle repairs as a
result of the sewer line break. Kerrigan provided petitioners with a proposal to
install a new sewer line, which explained that the new sewer “will run from village
right of way to just outside the north face of the house.” Under the proposal
Kerrigan would also replace a broken floor drain in the basement of petitioners’
home.
To facilitate the project petitioners paid a $3,000 deposit to the Village of
Kenilworth (Village) for any damage that might be done to Village property. In
addition, petitioners paid the Village an escrow of $2,247 guaranteeing the work
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[*7] would be completed under the time prescribed in the permit granted by the
Village. Both amounts were fully refunded to petitioners upon completion of the
sewer line repair work. Petitioners paid $18,984 to Kerrigan for its work,
including a $3,000 deposit on April 7, 2010, and a final payment for the balance
on September 1, 2010.
The record reflects that petitioners repaired their neighbors’ sewer line and
items that were on city property. On July 21, 2010, Mrs. Rogers addressed a letter
to Kerrigan explaining her displeasure with the work performed and noting that
“the break occurred on across-the-street neighbor’s sewer line, not mine. It was
not my responsibility to bear the full cost of the giant hole in the parkway to repair
the neighbor’s sewer.”
B. Rogers & Associates Business Expense Deductions
In 2010 and 2012 Mr. Rogers operated the law firm Rogers & Associates,
which was primarily a tax law practice. For both years petitioners filed a Schedule
C, Profit or Loss From Business, for Rogers & Associates to accompany their joint
Form 1040. Petitioners claimed several deductions relating to Rogers &
Associates business activities which respondent disallowed in his notices of
deficiency.
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[*8] 1. Legal Expenses
Petitioners claimed a deduction for legal and professional fees of $681,414
for 2010 on Rogers & Associates’ Schedule C. Respondent disallowed this
deduction entirely in his notice of deficiency. The parties have stipulated that
petitioners are entitled to deduct $7,523; the remaining amount, $673,891, is still
in dispute. Petitioners submitted canceled checks and invoices to substantiate this
amount. The notation “JER” on these invoices refers to John Edwards Rogers, a
petitioner in two of these cases. The notation “SLF” or “SF” refers to Sugarloaf
Fund, LLC (Sugarloaf). Sugarloaf is a TEFRA partnership that has been the
subject of litigation before this Court. See Sugarloaf Fund, LLC v. Commissioner,
T.C. Memo. 2018-181.
A substantial amount of petitioners’ 2010 legal fees was paid to the law firm
Kozacky & Weitzel (K&W), which represented petitioners in several professional
and personal legal matters. K&W represented Mr. Rogers in arbitration with the
Attorneys’ Liability Assurance Society (ALAS) and in a suit against Seyfarth to
recover a portion of his capital account. JAMS Arbitration (JAMS) handled the
arbitration between ALAS and Mr. Rogers. K&W also represented Sugarloaf in
litigation to recover an $800,000 loan Sugarloaf made to Marvin Redenius in
2008. Some of the K&W “Redenius” invoices were paid in 2010.
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[*9] Mr. Rogers and his former firm Seyfarth were involved in malpractice
litigation brought by Brian Mills (Mills litigation). Seyfarth paid 75% of the legal
fees in the Mills litigation, and Mr. Rogers paid the remaining 25%. K&W
represented Mr. Rogers in the Mills litigation.5 Some of these invoices were paid
in 2010. In addition, the law firm Craig & Macauley (C&M) represented Mr.
Rogers in the Mills litigation. Nutter McClennan served as a discovery master in
the Mills litigation.
In 2010 Rogers & Associates also incurred nonlegal professional fees for
accounting services to prepare client tax returns, gather data for various legal
matters, and assist with petitioners’ personal returns.
2. Meals, Entertainment, and Travel
For 2010 petitioners claimed deductions for meals and entertainment of
$778 and for travel of $16,327 on Rogers & Associates’ Schedule C. Respondent
disallowed these deductions in their entirety in his notice of deficiency.
Petitioners provided receipts to attempt to substantiate the claimed deduction for
meals and entertainment. Mr. Rogers lost his diary of travel activities for 2010 but
created a log after the fact to document some of his travel. Petitioners provided
5
Mr. Rogers also explained that his dispute with ALAS was to make it
perform on a malpractice contract in connection with the Mills litigation, but he
offered no further context for the dispute.
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[*10] this log, documents, and QuickBooks reports to substantiate the claimed
travel expense deduction.
3. Other Deductions
For 2010 petitioners claimed returns and allowances of $200,000 on their
Schedule C for Rogers & Associates, for uncollectible client account receivables.
Respondent disallowed the entire amount.
For 2012 petitioners claimed a deduction of $20,473 for “insurance other
than health” on Schedule C for Rogers & Associates. Respondent disallowed
$8,759 of this deduction. Mr. Rogers paid Paul Revere Life Insurance Co. $2,473
for disability insurance in 2011. Petitioners received a bill from Paul Revere Life
Insurance Co. for $2,473 due August 1, 2012, and have QuickBooks records
indicating this amount was paid in 2012.
C. Rogers 2005-09 Litigation
Petitioners raise issues that stem from our opinion in Rogers 2005-09. The
parties in these cases are the same involved in the Rogers 2005-09 litigation. In
that case petitioners sought worthless debt or worthless stock deductions with
respect to their activities with Reddy Lab and PTI.6 Specifically, petitioners
6
Reddy Lab was a holding company structure created by Mr. Rogers in 1991
to hold the patent on a medical device and manufacture and distribute the device
(continued...)
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[*11] argued for: (1) a $1.3 million worthless debt deduction for amounts owed
by Reddy Lab; (2) an $808,000 worthless debt deduction for amounts owed by
PTI; (3) a worthless stock deduction for Mr. Rogers’ PTI stock; and (4) an
approximately $2 million worthless debt deduction for Lucas & Rogers’--a real
estate brokerage company wholly owned by Mr. Rogers--claims against Reddy
Lab or a worthless stock deduction for its PTI stock.
In Rogers 2005-09, at *55-*61, we found each of petitioners’ claims to be
without merit. Specifically, as it relates to petitioners’ claim for a $1.3 million
worthless debt deduction for amounts owed by Reddy Lab, we found that
petitioners failed to establish a debt in excess of amounts previously deducted. Id.
at *57. In addition, we did not allow an $808,000 worthless debt deduction for
amounts owed by PTI because we found petitioners failed to establish that a valid
debtor-creditor relationship had existed between PTI and Mr. Rogers. Id. at *59.
We also found that the issues relating to a worthless stock deduction for Mr.
Rogers’ PTI stock was not properly before the Court. Id. at *55-*56. Similarly,
we found the issues relating to deductions for PTI stock owned by Lucas & Rogers
6
(...continued)
as part of Mr. Rogers’ work as the president and chief operating officer for a
medical device company. PTI was organized by Mr. Rogers as its president and
purchased the patent rights to the medical device from Reddy Lab in 1995.
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[*12] were not properly before the Court. Id. Finally, we did not allow a
$2 million worthless debt deduction for Lucas & Rogers’ claims against PTI
because Lucas & Rogers assigned its $2 million claim to PTI in 1998. Id. at *55.
In Rogers 2005-09, petitioners also asserted that they had a net operating
loss carryforward from 2008 available for their 2009 tax year. That issue is
computational, and the amounts will be determined in decision documents entered
in accordance with our opinion in Rogers 2005-09. Following entry of decisions
in those cases, respondent will compute whether petitioners have any remaining
net operating loss to carry forward to the years at issue in these cases--i.e., 2010
and 2012.
II. SRI’s Deductions and COGS
During 2010 and 2012 Mrs. Rogers wholly owned SRI, which was engaged
in the development of a residential real estate subdivision (Sterling Ridge
subdivision). Mr. Rogers was president of SRI and prepared its S corporation
returns for 2010 and 2012. Petitioners reported Mrs. Rogers’ share (100%) of
SRI’s income or loss on their 2010 and 2012 Schedules E, Supplemental Income
and Loss. In his notices of deficiency respondent disallowed COGS and certain
deductions SRI claimed for 2010 and 2012. As a result of these disallowances
respondent increased petitioners’ income from SRI for 2010 and 2012.
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[*13] On January 1, 2010, SRI owned 24 lots. During the 2010 tax year SRI sold
three lots--lots 41, 61, and 77. Lots 41 and 77 had homes erected on them; lot 61
remained vacant. Lot 41 sold for $610,000, lot 61 for $127,500, and lot 77 for
$520,000. On January 1, 2011, SRI held 21 lots. During the 2011 tax year SRI
sold four vacant lots for $150,000 each. On January 1, 2012, SRI owned 17 lots.
During 2012 SRI sold three vacant lots for $150,000 each and otherwise disposed
of another three lots. On December 31, 2012, SRI held 11 lots in the Sterling
Ridge subdivision.
SRI was an accrual method taxpayer for 2010 and 2012. For 2010 SRI
reported COGS of $775,173. In calculating this number SRI reported other costs
of $388,015, itemized as follows: $209,901 for property taxes, $55,000 for
commissions, $32,997 for maintenance, $25,000 for PPI payroll, $15,075 for legal
fees, $4,475 for tile work, $4,400 for deck work, $895 for liability insurance, $820
for fireplace work, $904 in unspecified repairs, $210 in electric work, and an
additional $38,338 in unspecified miscellaneous and other expenses.
Petitioners’ other costs of $388,015 were expenses incurred for the
construction of homes on lots 41 and 77, which sold in 2010. Construction on
both lots began in 2007. Petitioners introduced spreadsheets of costs incurred in
the construction of homes on lots 41 and 77 and a limited number of canceled
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[*14] checks, invoices, and other proof of payment for these amounts. Many of
petitioners’ reported costs did not include proof of payment, and their documents
were riddled with duplicates. The costs petitioners deducted for lots 41 and 77
were incurred primarily in years before 2010.
For 2012 SRI reported COGS of $412,963. In calculating this number SRI
reported additional section 263A costs of $12,963. These costs were for general
expenses incurred at the Sterling Ridge subdivision and include payment for
landscaping work and water bills on indeterminate lots in the subdivision. The
Beverly Ridge Realty Corp. (Beverly Ridge) shared ownership of the subdivision
with SRI. Beverly Ridge would pay expenses incurred for development of the
Sterling Ridge subdivision, and SRI would reimburse it for the costs on the basis
of its share of ownership, 72%. Petitioners substantiated payment of $12,963 for
landscaping work in 2012.
For 2010 SRI claimed an office expense deduction of $60,000, which
respondent disallowed entirely. To substantiate this deduction petitioners
introduced a check for $25,000 made out to PPI as a transfer of funds. No other
substantiation related to this deduction exists in the record. For 2012 SRI claimed
a deduction for commission fees of $221,500 for transfers of funds to Rogers &
Associates, PPI, and petitioners’ son. Respondent disallowed this deduction in its
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[*15] entirety. Petitioners presented QuickBooks records and canceled checks to
substantiate this deduction. No Forms 1099-MISC, Miscellaneous Income, related
to these payments were introduced in the record.
For 2012 SRI also claimed a deduction for legal fees of $92,000, which
respondent disallowed. SRI paid $2,000 to Fed Kan & Co. on behalf of a client of
Mr. Rogers and $90,000 to Rogers & Associates. The record contains no invoices
for these payments. Petitioners’ QuickBooks records and canceled checks list
three of the four 2012 payments to Rogers & Associates as transfers of funds.
III. PPI’s Deductions and COGS
For 2010 Mr. Rogers wholly owned PPI, which operated a general
contractor business that performed work on the houses sold by SRI but did not
own or hold any of the houses itself. Mr. Rogers was its president and maintained
its books and records; he was also PPI’s sole director and managing broker for its
real estate operations. Mr. Rogers prepared its 2010 S corporation return, and
petitioners reported Mr. Rogers’ share (100%) of PPI’s income or loss on their
2010 Schedule E. In his notice of deficiency respondent disallowed COGS and
other deductions claimed by PPI for 2010 and increased petitioners’ share of
income from SRI for 2010.
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[*16] PPI was an accrual method taxpayer for 2010. For 2010 PPI reported
COGS of $810,876. In calculating this number PPI reported additional section
263A costs of $1,791.
For 2010 PPI claimed a rent or lease deduction of $1,081 and a travel
expense deduction of $1,456. Respondent disallowed both deductions. PPI’s rent
or lease deduction is in fact a travel deduction related in part to a car Mr. Rogers
rented at the New Orleans International Airport on September 7-8, 2010. The
record does not establish a purpose for Mr. Rogers’ visit to New Orleans, nor an
explanation for why PPI incurred this expense. Petitioners introduced
QuickBooks records purporting to show PPI’s travel expenses for 2010.
Petitioners introduced no travel log, diary, or other contemporaneous record to
substantiate PPI’s claimed travel deduction.
IV. Section 6662(a) Accuracy-Related Penalties
Revenue Agent Diane Linne examined petitioners’ tax returns for 2010 and
2012. On April 30, 2014, Ms. Linne completed penalty approval forms for 2010
and 2012 and initially determined section 6662(a) accuracy-related penalties
against petitioners for negligence or disregard of rules or regulations.
On July 16, 2014, Supervisory Revenue Agent Louis Olivieri, Ms. Linne’s
immediate supervisor, approved the initial determination to assess a penalty for
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[*17] 2010 by signing the penalty approval form. On September 8, 2015, Mr.
Olivieri also approved the 2012 initial determination to assess a penalty by signing
that penalty approval form. Ms. Linne conducted her audit of petitioners’ 2010
and 2012 returns from February 2014 through September 2015.
Respondent issued petitioners a notice of deficiency for 2010 on October 9,
2014, and for 2012 on June 21, 2016. In his notices of deficiency for both years
respondent determined section 6662(a) penalties against petitioners for negligence
or disregard of rules or regulations or, in the alternative, for substantial
understatements of income tax or substantial valuation misstatements.
Respondent’s agent asserted the initial penalty determination and timely received
written supervisory approval for a section 6662(a) penalty only for negligence or
disregard of the rules or regulations. A 30-day letter was not issued for either
year.
OPINION
Generally, the Commissioner’s determinations in a notice of deficiency are
presumed correct, and the taxpayer has the burden of proving the determinations
are in error. Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioners made
factual assertions in their briefs that are not supported by the record and referenced
exhibits that were not admitted into the record. Statements on brief are not
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[*18] evidence and cannot supplement the record. See Rule 143(c); Niedringhaus
v. Commissioner, 99 T.C. 202, 214 n.7 (1992). Petitioners’ opening brief failed to
propose findings of fact or cite the record to support the facts recited as required
by Rule 151(e). It consisted of nothing more than factual assertions in narrative
form and occasional vague legal arguments. Petitioners’ reply brief was submitted
in the same format without citations of the record to support the factual assertions
laid out. Petitioners have failed to assist the Court in making sense of the record
in these cases. See Beane v. Commissioner, T.C. Memo. 2009-152, 2009 WL
1810731, at *3 (citing Stringer v. Commissioner, 84 T.C. 693, 703-705 (1985),
aff’d without published opinion, 789 F.2d 917 (4th Cir. 1986)). Therefore, we
have largely adopted respondent’s proposed findings of fact, to which petitioners
failed to object, except to the extent respondent failed to point to evidence in the
record supporting a proposed finding or a proposed finding was clearly
inconsistent with the record. See Jonson v. Commissioner, 118 T.C. 106, 108 n.4
(2002), aff’d, 353 F.3d 1181 (10th Cir. 2003).
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[*19] I. Deductions7
Deductions are a matter of legislative grace, and the taxpayer bears the
burden of proving he is entitled to claimed deductions. Rule 142(a); INDOPCO,
Inc. v. Commissioner, 503 U.S. 79, 84 (1992). To be entitled to a deduction a
taxpayer “must be able to point to an applicable statute and show that he comes
within its terms.” New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).
A taxpayer must maintain records sufficient to allow the Commissioner to
determine his correct tax liability. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.
A taxpayer has the burden of substantiating both the amount paid and the purpose
of the expense underlying the claimed deduction. Higbee v. Commissioner, 116
T.C. 438, 440 (2001).
7
Petitioners raise in their brief a number of issues related to purported
deductions that the parties settled before trial. These include: reimbursement
expense deductions claimed on Rogers & Associates’ Schedule C for 2010, which
were settled by the fifth supplemental stipulation of settled issues paragraph 2 in
docket No. 29356-14; taxes and licenses deductions claimed on Rogers &
Associates’ Schedule C for 2010, which were settled by the fifth supplemental
stipulation of settled issues paragraph 1 in docket No. 29356-14; and legal and
professional fee expense deductions claimed on Rogers & Associates’ Schedule C
for 2012, which were settled by the second supplemental stipulation of settled
issues paragraph 3 and the third supplemental stipulation of settled issues
paragraph 2 in docket No. 15112-16. To the extent petitioners are seeking to
advocate a position contrary to these settlements, we hold that their arguments are
not supported by the record and their stipulations with respondent are binding.
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[*20] A. Casualty Loss Deduction
Taxpayers may deduct losses sustained in a taxable year and not
compensated for by insurance or otherwise. Sec. 165(a). For individual taxpayers
the deduction is limited to losses incurred in a trade or business, in any transaction
entered into for profit, or otherwise if the loss arises “from fire, storm, shipwreck,
or other casualty, or from theft.” Sec. 165(c). Petitioners claim to have
experienced a casualty loss not connected with their trade or business or a
transaction entered into for profit. Thus, to be deductible, the loss must result
from physical damage to property and there must be a causal connection between
the casualty and the loss. Pulvers v. Commissioner, 407 F.2d 838, 839 (9th Cir.
1969), aff’g 48 T.C. 245 (1967); Kemper v. Commissioner, 30 T.C. 546, 549-550
(1958), aff’d, 269 F.2d 184 (8th Cir. 1959).
Petitioners’ loss did not arise from fire, storm, or shipwreck; thus, to be
deductible it must be the result of some “other casualty”. Other casualties are
those “caused by a sudden, unexpected, or unusual event”. Maher v.
Commissioner, 680 F.2d 91, 92 (11th Cir. 1982), aff’g 76 T.C. 593 (1981); see
Appleman v. United States, 338 F.2d 729, 730-731 (7th Cir. 1964); Rev. Rul. 72-
592, 1972-2 C.B. 101. We find the list of casualties included by Congress in the
text of section 165 to be especially illustrative of the kinds of losses that are
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[*21] entitled to deductions and considered other casualties. See Appleman, 338
F.2d at 730 (“In the absence of any congressional explanation of the phrase ‘or
other casualty’ as used in the above section, the courts have turned to the
traditional rule of ejusdem generis as an intrinsic guide to the construction and
application of the term.”). Section 165 includes losses arising from fire, storm,
and shipwreck--all occurrences that arise suddenly and unexpectedly and are not
everyday natural occurrences. Id. at 730-731 (“Among characteristics of the
specific casualties enumerated in the section are suddenness and unforesee-ability
of the occurrence. Fire and shipwreck are undesigned, sudden and unexpected
events. While storms are to a degree predictable the factors of their violence and
the particular site of loss or damage are uncertain.”). Conversely, damage caused
by “progressive deterioration of property through a steadily operating cause or
normal depreciation” is not a casualty. Maher v. Commissioner, 680 F.2d at 92
(citing Rosenberg v. Commissioner, 198 F.2d 46, 49 (8th Cir. 1952), rev’g 16 T.C.
1360 (1951), and Fay v. Helvering, 120 F.2d 253 (2d Cir. 1941)).
Petitioners have claimed, for the first time in this litigation, that they are
entitled to deduct a casualty loss for 2010 for damage resulting from a broken
sewer line. No such loss was reported on their tax return for 2010. In order to
deduct this loss, petitioners must first establish that a broken sewer line constitutes
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[*22] a casualty. They have failed to do so. There is no indication as to the cause
of the broken sewer line, and it can be assumed that such damage is nothing more
than the eventual result of normal wear and tear. There is nothing to suggest the
loss was sudden or caused by some natural disaster. Additionally, petitioners have
failed to establish the loss was connected to their own property. The sewer line
break occurred on their neighbor’s sewer line, and some of the repair work was
done on city property; but the record does not establish what work was conducted
on petitioners’ property. To be deductible, the loss must arise from damage to
petitioners’ property, not the property of others. See Draper v. Commissioner, 15
T.C. 135 (1950); see also Dosher v. United States, 730 F.2d 375 (5th Cir. 1984)
(holding casualty loss deduction applies only to loss resulting from damage to
taxpayer’s property and does not include money taxpayer paid to reimburse third
parties for damage taxpayer caused to their property); Pulvers v. Commissioner,
407 F.2d at 839 (not allowing a casualty loss for a decline in home value because
of fear of landslides where a landslide caused damage to neighboring properties,
but not to taxpayer’s property). Petitioners have not established entitlement to any
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[*23] casualty loss for 2010; therefore, we will not address the remaining issues
relating to the amount of the loss.8
B. Business Expense Deductions
Generally, taxpayers are allowed a deduction for any ordinary and necessary
expense paid or incurred in the carrying on of a trade or business. Sec. 162(a).
Additionally, a deduction is allowed for all ordinary and necessary expenses paid
or incurred for the production of income. Sec. 212. Generally, no deduction is
allowed for any personal, living, or family expenses. Sec. 262(a). While a
taxpayer has the burden to substantiate expenses underlying all claimed
deductions, heightened substantiation requirements apply for expenses relating to
certain deductions such as those for travel, meals, and entertainment. Sec. 274(d).
In order for the Court to sustain these deductions, a taxpayer must provide
sufficient substantiating evidence that corroborates the amount of the expense, the
8
Even if we found petitioners had established the occurrence of a casualty
which could give rise to a deductible loss, the record fails to establish the fair
market value of petitioners’ residence immediately before or after the sewer line
break. This information is required to determine the proper amount of loss. See
sec. 1.165-7(a)(2), (b)(1), Income Tax Regs. The record also does not reflect
whether petitioners submitted a claim for the payment to Kerrigan to an insurance
company for reimbursement. Accordingly, there is nothing in the record to
establish the amount of the loss to petitioners. See Teitelbaum v. Commissioner,
346 F.2d 266, 270 (7th Cir. 1965), aff’g T.C. Memo. 1964-141.
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[*24] time and place of the travel or entertainment, the business purpose of the
expense, and the business relationship to the person benefited by the expense. Id.
1. Legal and Professional Fees
Petitioners claimed deductions for legal and professional fees for 2010 of
$681,414. The parties have stipulated that petitioners are entitled to deduct $7,523
in legal and professional fees for 2010; the remaining amount has not been
resolved. Petitioners have the burden of substantiating their reported expenses.
See sec. 6001; sec. 1.6001-1(a), Income Tax Regs. Further, deductions for legal
expenses are allowed only if they are related to a business or income-producing
activity and are ordinary and necessary. Sec. 162(a).
The bulk of petitioners’ claimed legal fees was paid to the K&W law firm.
Petitioners attempted to substantiate their expenses by providing canceled checks
and invoices. However, files relating to their claimed legal and professional fee
expenses are disorganized and duplicative. Many of the invoices include no
indication they were paid, and canceled checks corroborate payment for only a
limited number of expenses. Additionally, several invoices indicate that the legal
and professional work was personal in nature. Petitioners have a history of
submitting chaotic records to this Court. See Rogers 2005-09, at *62.
- 25 -
[*25] Nonetheless, we have attempted to discern any substantiated deductible
expenses from petitioners’ jumbled records.
We were able to find both a canceled check and a related invoice to
substantiate the payment of only $122,692 in legal fees to K&W. However,
payment is only half the story. To be deductible, the legal fees must be ordinary
and necessary to Rogers & Associates’ business--a tax law practice. See sec. 162.
Many of petitioners’ K&W invoices were captioned “Personal”, and petitioners
offered little explanation for the business purpose of their various legal expenses.
The records they provided show significant overlap between business and personal
expenses.
Petitioners incurred $13,328 in K&W legal fees for an “IRS and FOIA
project”, but they provided no explanation of the purpose of these expenses. In
addition, $67,268 in K&W legal fees was for “Personal” invoices. Petitioners
admitted that these relate to K&W’s representation of Mr. Rogers in a 2003
personal tax matter. Records petitioners submitted also suggest that personal
invoices were related to arbitration with ALAS over a malpractice contract
connected with the Mills litigation and separate litigation with Seyfarth to recover
a portion of Mr. Rogers’ capital account. However, petitioners did not elaborate
further on these matters and the business purpose for Rogers & Associates.
- 26 -
[*26] Petitioners also provided invoices from K&W’s representation of Sugarloaf
in litigation to recover an $800,000 loan Sugarloaf made to Marvin Redenius in
2008.9
Petitioners have failed to establish what business purpose Rogers &
Associates had for incurring any amount of K&W legal expenses. In particular, as
it relates to the personal expenses, petitioners have not explained why Rogers &
Associates, a law firm that Mr. Rogers himself runs, should be responsible for
incurring the legal fees of Mr. Rogers’ personal litigation--including his 2003
personal tax matter, his dispute with Seyfarth, his arbitration with ALAS, and the
Mills litigation. Even if petitioners had articulated a business purpose for some of
these expenses, which they did not, they failed to parse their documentation in any
meaningful way to show which expenses related to which matter. See Higbee v.
Commissioner, 116 T.C. at 440 (“[T]he taxpayer bears the burden of substantiating
the amount and purpose of the claimed deduction.”). Additionally, although Mr.
Rogers has admitted fault for making a bad loan on behalf of Sugarloaf to Mr.
Redenius, he has not explained why Rogers & Associates should be able to deduct
fees related to the resulting litigation. It appears instead that Mr. Rogers is
9
Petitioners explain that they agreed to pay the legal fees for Sugarloaf to
recover the loan from Mr. Redenius because it was Mr. Rogers’ mistake and he
was responsible for making the bad loan.
- 27 -
[*27] attempting to deduct fees related to his personal litigation disputes under the
guise of business expenses. We find that petitioners have failed to explain the
business purpose of any of the K&W legal expenses and they are therefore not
deductible under section 162.
Petitioners also claim a deduction for legal expenses paid to the law firm
C&M, and they provided canceled checks and invoices to substantiate $69,676
paid to C&M. These expenses relate to the Mills litigation. Petitioners have
failed to establish an ordinary and necessary business purpose, and therefore these
expenses are not deductible under section 162. Additionally, petitioners have
failed to explain the business purpose for reported expenses of $327 paid to Nutter
McClennan for acting as discovery master in the Mills litigation, and they are
therefore not deductible.
The only other legal expense for which we were able to find checks and
invoices sufficient to substantiate payment was $6,512 paid to JAMS in relation to
the arbitration between Mr. Rogers and ALAS. We have already explained that
petitioners failed to explain a business purpose for expenses related to Mr. Rogers’
arbitration with ALAS. Accordingly, petitioners are not entitled to deduct these
expenses.
- 28 -
[*28] Finally, petitioners claim a deduction for nonlegal professional fees totaling
$57,600 for “accounting services to help prepare client tax returns and assist with
data gathering and organization of various legal matters.” Petitioners presented
invoices and checks substantiating the payment of $51,840 for these expenses.
However, the invoices and petitioners’ concession on brief reflect that $25,695
relates to petitioners’ personal returns. While personal expenses are ordinarily not
deductible, some expenses related to personal taxes are deductible subject to the
2% floor on miscellaneous itemized deductions. Secs. 212(3), 67(a). Accordingly
the expenses related to petitioners’ personal tax returns are deductible subject to
the limitation for miscellaneous itemized deductions.
Rogers & Associates was a tax law practice; thus we find it ordinary and
necessary for it to have hired an accountant for various client matters. We find
that expenses of $25,650 relate to Rogers & Associates business and are therefore
deductible under section 162.10 Petitioners have failed to explain the business
10
Some of the $25,650 related to Rogers & Associates business was incurred
for tax returns associated with Sugarloaf. Respondent argues that in Kenna
Trading, LLC v. Commissioner, 143 T.C. 322 (2014), aff’d sub nom. Sugarloaf
Fund, LLC v. Commissioner, 911 F.3d 854 (7th Cir. 2018), we held that expenses
related to Sugarloaf are not deducible. In Kenna Trading we said that
“expenditures made in an attempt to obtain abusive tax shelter benefits are not
ordinary and necessary business expenses or otherwise deductible under section
162(a).” Id. at 365 (quoting Gerdau Macsteel, Inc. v. Commissioner, 139 T.C. 67,
(continued...)
- 29 -
[*29] purpose of the remaining nonlegal professional expenses, and we therefore
find them not deductible. Respondent’s other determinations are sustained except
to the extent stated herein.
2. Meals and Entertainment
Petitioners claimed deductions related to meals and entertainment on their
2010 Schedule C for Rogers & Associates of $778. Respondent disallowed these
deductions in their entirety. Deductions for entertainment, including meals, are
subject to heightened substantiation requirements. Sec. 274(d). No such
deduction may be allowed unless the taxpayer can substantiate: (1) the amount of
the expense; (2) the time and place of the expense; (3) the business purpose of the
expense; and (4) the business relationship between the taxpayer and anyone
benefiting from the expense. Sec. 274(d); sec. 1.274-5T(b)(3), Temporary Income
Tax Regs., 50 Fed. Reg. 46015 (Nov. 6, 1985). To substantiate the reported meal
and entertainment expenses, petitioners provided receipts and offered testimony
regarding some expenses.
10
(...continued)
182 (2012)). The accountant expenses incurred by Rogers & Associates are not of
the same nature as those in Kenna Trading. They do not relate to developing the
tax shelter but rather to tax advice to clients provided by a third party; accordingly,
we find they have an ordinary and necessary business purpose and are deductible.
- 30 -
[*30] Mr. Rogers attempted during his trial testimony to articulate a business
purpose for some expenses. However, this testimony alone, without “adequate
records” or “sufficient evidence corroborating” his testimony, fails to meet the
rigorous substantiation requirements of section 274(d). See generally sec.
1.274-5T(c), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985)
(explaining what is required to meet the substantiation requirements under section
274(d)). The record does not reflect who paid for the meals and entertainment,
and many of petitioners’ documents are faded and illegible. In addition, the
records contain duplicate receipts, and some of the duplicates are notated with
different explanations for their purported purpose. We find petitioners have failed
to adequately justify a deduction for any of their reported meal and entertainment
expenses under section 274(d).
Petitioners argue that these expenses were for “local meals for business
meetings and staff meetings and special events.” That does not absolve petitioners
from having to meet the heightened substantiation requirements under section
274(d). Section 274(k) provides additional limitations on allowing deductions for
“business meals”, but nothing in subsection (k) “relieves the taxpayer of
complying with the substantiation requirements of (d)”. See Sanford v.
Commissioner, 50 T.C. 823, 833 (1968) (discussing the relationship between
- 31 -
[*31] section 274(d) and subsection (e), previously the business meals provision),
aff’d per curiam, 412 F.2d 201 (2d Cir. 1969). Thus, we sustain respondent’s
determination to disallow the deduction of petitioners’ meal and entertainment
expenses in their entirety.
3. Travel
Deductions for traveling expenses are also governed by the strict
substantiation requirements of section 274(d). Petitioners claimed a travel
expense deduction on Schedule C for Rogers & Associates of $16,327 for 2010;
respondent disallowed the full amount. Mr. Rogers testified that he lost his diary
for 2010, but created a log of his activities “more or less contemporaneously”. Mr.
Rogers provided the log along with his testimony and other documents in an
attempt to substantiate his travel expenses. However, Mr. Rogers’ trial testimony
was brief and contradicted the travel log and other documentation petitioners
provided. Additionally, several of the documents--i.e., boarding passes, hotel
portfolios, and airline receipts--included trips that did not appear on the travel log;
and like many of petitioners’ records, the documentation was disorganized and
included several of the same receipts petitioners presented to substantiate their
meal and entertainment expenses. Given the problems with petitioners’
documentation and their inability to satisfactorily explain the business purpose for
- 32 -
[*32] their travel, we find that they have failed to satisfy the substantiation
requirements of section 274(d). Therefore, respondent’s determination is
sustained, and petitioners’ travel expense deduction is disallowed.
4. Other Issues
Petitioners claimed $200,000 in returns and allowances for 2010, which
respondent disallowed in his notice of deficiency. Petitioners further claimed
deductions for insurance other than health of $20,473 for 2012, of which
respondent disallowed $8,759. Petitioners failed to address either of these issues
on brief and only briefly referenced them at trial. In addition, the documentation
petitioners introduced into the record relating to each of these deductions is
generally unsupportive. On this record, it is difficult for petitioners to meet their
burden of proof. See Rule 142(a).
a. Returns and Allowances
Gross income includes all income from whatever source derived. Sec. 61.
However, taxpayers with business income are allowed to offset the gross receipts
of their business with COGS and returns and allowances when computing the
business’ gross income. See Smith v. Commissioner, T.C. Memo. 2015-214,
at *11; sec. 1.61-3(a), Income Tax Regs. Although returns and allowances are not
technically deductions, taxpayers must still retain sufficient records to substantiate
- 33 -
[*33] the amount of returns and allowances claimed. Sec. 6001; sec. 1.6001-1(a),
Income Tax Regs.
Mr. Rogers’ trial testimony on this issue was cursory, but it appears that he
is attempting to calculate the amount of returns and allowances from bad debts in
the form of uncollectible accounts receivable. Section 166 allows a deduction for
debts which become worthless during the taxable year. Petitioners’ submitted
QuickBooks records related to their accounts receivable for 2009, 2010, and 2012;
however, these documents do not establish any amount of uncollectible accounts
receivable. There is nothing else in the record to explain how petitioners
calculated their returns and allowances. Petitioners offered incomplete and
confusing testimony on this issue and have failed to explain why they viewed any
uncollected accounts receivable as bad debts or otherwise deductible for 2010.
We find that petitioners have failed to meet their burden of proof to substantiate
either an offset of gross receipts by returns and allowances or a bad debt deduction
under section 166; therefore, respondent’s determination in his notice of
deficiency is sustained.
- 34 -
[*34] b. Disability Insurance
Section 162 generally allows for taxpayers to deduct all ordinary and
necessary business expenses from their calculation of taxable income, and section
212 generally allows a deduction for ordinary and necessary expenses incurred for
the production of income. However, no deduction is allowed for personal, living,
or family expenses absent a Code provision specifically allowing such a
deduction. See sec. 262. Petitioners deducted $2,473 for disability insurance
premiums for 2012 and produced Quickbooks records and invoices to substantiate
this payment.
Although petitioners have substantiated their disability insurance payment
for 2012, they have made no credible attempt to articulate its deductibility under a
provision in the Code. There is nothing in the record indicating that this disability
insurance was tied to petitioners’ business or to the production of income. Mr.
Rogers testified he believed the insurance should be deductible as “insurance
protection * * * deductible under section 162 or 212(3) because it was [his]
personal earnings being insured from disability.” However, neither section 162
nor section 212--offering deductions for business expenses and expenses incurred
for the production of income--provides a deduction for the cost of disability
insurance. Additionally, petitioners have pointed us to no Code section allowing a
- 35 -
[*35] deduction for personal disability insurance costs. Petitioners have failed to
meet their burden to establish the deductibility of this expense. Accordingly,
respondent’s determination to disallow $8,759 of petitioners’ 2012 deductions for
insurance other than health is sustained.11
C. Reddy Lab and PTI Bad Debt Deductions
Petitioners appear to seek worthless debt or worthless stock deductions for
2010 as a result of their activities with Reddy Lab and PTI. Petitioners’ arguments
regarding these deductions are confusing and inconsistent and appear largely
similar to arguments addressed by this Court previously. See Rogers 2005-09,
at *55. Petitioners argue they are entitled to: (1) a $1.3 million worthless debt
deduction for amounts owed by Reddy Lab; (2) an $808,000 worthless debt
deduction for amounts owed by PTI; and (3) a $2 million worthless debt deduction
for Lucas & Rogers’ claims against PTI or a worthless stock deduction for Lucas
11
Petitioners did not address the remaining amount of their disallowed
insurance other than health deduction for 2012. Therefore, they have conceded
the issue, and we sustain respondent’s determination disallowing an $8,759
deduction.
- 36 -
[*36] & Rogers’ PTI stock.12 We have already addressed each of these issues.
See generally id. at *55-*61.
Petitioners are not entitled to a $1.3 million worthless debt deduction for
amounts owed by entities within the Reddy Lab structure. Section 166 allows a
worthless debt deduction if: (1) there was a transfer that created a valid debt and
not an equity contribution, (2) the debt became worthless during the year at issue,
and (3) the debt was incurred in connection with a trade or business. Sensenig v.
Commissioner, T.C. Memo. 2017-1, at *17-*18, aff’d, 720 F. App’x 139 (3d Cir.
2018); sec. 1.166-1(c), Income Tax Regs. A worthless nonbusiness debt is
deductible as a short-term capital loss. Sec. 166(d)(1); sec. 1.166-5(a)(2), Income
Tax Regs. In Rogers 2005-09, at *57-*58, we held petitioners failed to show that
they qualify for a worthless debt deduction under section 166 for amounts owed
by Reddy Lab. Specifically, petitioners failed to establish that there was a debt in
excess of amounts previously deducted. Id. at *57. Petitioners have presented no
new arguments and offered no new documents to sway the Court. Accordingly,
we reaffirm our holding in Rogers 2005-09.
12
Petitioners’ briefs are difficult to decipher, but it appears they no longer
claim a $1.3 million worthless debt deduction for amounts owed by Reddy Lab.
Nonetheless, for the sake of completeness, we address it briefly here only to note
that we have already ruled on the issue.
- 37 -
[*37] Likewise, petitioners have failed to show they are entitled to an $808,000
worthless debt deduction for amounts owed by PTI. In Rogers 2005-09, at *59,
we held that petitioners failed to establish that a valid debtor-creditor relationship
existed between Mr. Rogers and PTI. Petitioners have offered no new arguments
or evidence to persuade us to change our holding. Finally, in Rogers 2005-09,
at *55, we held that Lucas & Rogers assigned its $2 million in claims against
Reddy Lab to PTI in exchange for stock; therefore, no worthless debt deduction
was permitted. We did not address whether petitioners could be allowed a
worthless stock deduction for PTI stock owned by Mr. Rogers and Lucas &
Rogers because those issues were not properly before the Court. Id. at *55-*56.
Although petitioners raise the issue of a worthless stock deduction for PTI stock
held by Mr. Rogers and Lucas & Rogers for the first time in their pretrial
memorandum, the record is completely devoid of any documentation or testimony
to substantiate their claim. Accordingly, we hold petitioners have failed to show
they are entitled to any worthless debt or worthless stock deduction related to
Lucas & Rogers’ claims against PTI or Lucas & Rogers’ PTI stock.
D. Net Operating Loss
Petitioners argue they are entitled to a net operating loss carryforward
deduction from 2008 following computation of their tax liability for 2009.
- 38 -
[*38] Generally, taxpayers may claim a net operating loss deduction for the
amount of allowable deductions over gross income. Sec. 172(c). Net operating
losses may be carried forward to each of the next 20 taxable years following the
tax year of the loss, and carried back to each of the two taxable years preceding the
tax year of the loss. Sec. 172(b)(1)(A). The issue of a net operating loss
carryforward is computational and can be determined under Rule 155 in the
decision documents to be submitted by the parties. Accordingly, our holding does
not address whether petitioners have any net operating loss carryforward from
2008 remaining.
E. PTI Subsidy Payments
Petitioners suggest they are entitled to deductions for “additional subsidy”
and legal fees paid by PPI to PTI in 2004, 2005, and 2006. Petitioners present no
legal argument as to why they are entitled to deductions for the amounts paid, and
the payment of such amounts is not supported by the record in these cases.
Accordingly, we hold petitioners are not entitled for 2010 or 2012 to deductions
related to any subsidy payments or legal fees paid by PPI to PTI in 2004, 2005,
and 2006.
- 39 -
[*39] II. SRI’s Deductions and COGS
Respondent disallowed SRI’s COGS of $775,173 and $412,963 entirely for
2010 and 2012, respectively. In addition, respondent disallowed the following
SRI deductions still in dispute: office expenses of $60,000 for 2010; commission
fees of $221,500 for 2012; and legal expenses of $92,000 for 2012.
A. SRI’s COGS
1. 2010
In Rogers 2005-09, COGS claimed by SRI and PPI were in issue. The
parties have agreed that SRI’s COGS will be determined as flows forward from
our decision in that case and will be bound by our determinations as to the amount
of costs petitioners substantiated, how COGS should be calculated, the proper tax
treatment of property transferred by Mrs. Rogers to SRI, and whether petitioners
sold land to SRI or made a capital contribution. In Rogers 2005-09, at *48, we
held that Mrs. Rogers’ transfer of land to SRI was a capital contribution, not a
sale, and therefore SRI held the land with a carryover basis. We also found that
the land’s carryover basis was $15,000. Id. at *14-*15. The parties shall
recalculate SRI’s COGS for 2010 and 2012 in accordance with our opinion in
Rogers 2005-09.
- 40 -
[*40] However, SRI’s reported other costs for 2010 of $388,015 are still in
dispute. Respondent concedes that certain other costs may be included in
petitioners’ calculation of COGS for 2010 but disputes that petitioners have
substantiated all of the other costs. These other costs are related to lots 41 and 77,
which were both sold in 2010. Petitioners provided voluminous documentation to
substantiate their costs related to these lots. However, like most of petitioners’
records, their documents consisted of large numbers of invoices with no proof of
payment, proof of payment with no indication of what it was for, and duplicates.
Petitioners’ documents also pertained to many costs incurred for years before
2010. SRI should have capitalized its costs relating to lots 41 and 77 in the year
they were incurred. See sec. 1.446-1(c)(1)(ii), Income Tax Regs. Construction
began on lots 41 and 77 in 2007, and petitioners’ documents trace back that far.
Accordingly, we assume that costs incurred before 2010 were already considered
in SRI’s COGS calculations, and we will not count them as other costs listed for
2010.13
13
Mr. Rogers testified: “To the best of my knowledge, none of these items
were deducted prior to 2010. And we just take the aggregate cost over the years;
we capitalize those, and then we deduct it in the year that the house is sold.” Mr.
Rogers’ self-serving testimony offers us little comfort that these expenses were not
capitalized in prior years and already included in SRI’s COGS.
- 41 -
[*41] After reviewing petitioners’ documents--discounting duplicates, records that
failed to establish payment or the purpose of payment, and costs incurred before
2010--we have found petitioners substantiated other costs for 2010 of $13,547,
which includes $12,572 and $975 for lots 41 and 77, respectively.14 Accordingly,
this is the only amount petitioners may include in calculating their other costs for
2010. We note also that petitioners’ documents included confirmation of a
$50,000 payment to their son for the sale of lot 77. This payment appears to be a
commission fee and is clearly not deductible as a cost in calculating petitioners’
COGS. Its inclusion in petitioners’ documents attempting to substantiate COGS is
particularly troubling given petitioners’ apparent attempts to double deduct
commission fees under a number of guises on their returns.
2. 2012
For 2012 SRI claimed COGS of $412,963. After stipulations, remaining at
issue is $12,963 of additional section 263A costs incurred for general maintenance
expenses in 2012. Petitioners believe this amount is includible as COGS and
14
The appendix references the amounts we sustain as other costs with
respect to lots 41 and 77 for 2010. Petitioners also contend that $209,901 of their
reported other costs were for property taxes and therefore are deductible for the
year incurred and should not be capitalized. However, the record is completely
void of any proof of property taxes incurred by SRI in 2010. Accordingly, we do
not address this argument.
- 42 -
[*42] deductible for 2012, the year it was incurred. Respondent argues that the
costs should be capitalized into the remaining lots SRI held at the end of the year.
Generally, no deduction is allowed for any amount paid for new buildings
or permanent improvements to increase the value of property. Sec. 263. Instead,
section 263A(a) provides that for certain property, direct and indirect costs
allocable to such property must be capitalized. See sec. 1.263A-1(a)(3)(I), Income
Tax Regs. Among the kinds of property to which section 263A applies is real
property produced or acquired by the taxpayer for resale. Sec. 263A(b). Section
263A costs which must be capitalized include SRI’s additional section 263A costs,
which were incurred for general maintenance of the Sterling Ridge subdivision.
See sec. 1.263A-1(d)(3) and (4), Income Tax Regs. Thus, under section 263A SRI
is required to capitalize the $12,963 claimed as additional section 263A costs, to
the extent petitioners substantiate such expenses.
Petitioners introduced canceled checks and invoices and provided testimony
to substantiate their additional section 263A costs for 2012. Beverly Ridge paid
the expenses related to general maintenance of the subdivision–such as water bills
and landscaping--and SRI would reimburse it in accordance with its 72%
ownership of the subdivision. Petitioners’ records show invoices, Beverly Ridge’s
canceled checks, and two checks from SRI to Beverly Ridge. On this record, we
- 43 -
[*43] find petitioners substantiated $12,963 in additional section 263A costs for
2012.
SRI’s substantiated section 263A costs having been determined, SRI must
now capitalize them to the 11 lots that remained on hand at the end of the 2012
taxable year. See sec. 1.263A-1(c), Income Tax Regs. Section 263A does not
provide for immediate deduction to recover costs, but rather “[c]osts that are
capitalized under section 263A are recovered through depreciation, amortization,
cost of goods sold, or by an adjustment to basis at the time the property is used,
sold, placed in service, or otherwise disposed of by the taxpayer.” Sec. 1.263A-
1(c)(4), Income Tax Regs. Thus, SRI is not entitled to a deduction for its $12,963
in additional section 263A costs incurred in 2012 but must instead capitalize those
costs to the lots remaining at the end of the taxable year and recover those costs
upon sale or other disposition of the lots.15
15
Sec. 1.263A-1(c)(5), Income Tax Regs., provides: “A cost that is allocated
under this section * * * entirely to property sold must be included in cost of goods
sold and may not be included in determining the cost of goods on hand at the end
of the taxable year.” Petitioners have not shown that any of their claimed
additional sec. 263A costs are allocable “entirely” to property disposed of in 2012.
Therefore, the full amount must be capitalized to the lots remaining at the end of
the year.
- 44 -
[*44] B. SRI’s Deductions
1. 2010
SRI claimed an office expense deduction of $60,000 on its 2010 return, all
of which respondent disallowed. Petitioners offered no testimony regarding this
expense at trial. The only documentation in the record relating to this expense is a
check for $25,000 to PPI, which is referenced as “Funds transfer” in petitioners’
records. Petitioners’ brief explains that the $60,000 deduction comprised
“$50,000 reimbursement of PPI payroll; [and a] $10,000 reimbursement of rent at
55 West Monroe Street in downtown Chicago.” Neither of these assertions is
supported by the record. Accordingly, petitioners have failed to substantiate a
$60,000 deduction for office expenses, and respondent’s determination is
sustained.
2. 2012
a. Commission Fees
SRI claimed a deduction of $221,500 for commission fees for 2012, all of
which respondent disallowed. Taxpayers are entitled to deduct all ordinary and
necessary expenses paid or incurred in a trade or business. Sec. 162(a).
Petitioners presented QuickBooks records and canceled checks for $226,500
($5,000 over the amount claimed on their 2012 return) made out to Rogers &
- 45 -
[*45] Associates, petitioners’ son, and PPI. According to Mr. Rogers, SRI paid
$20,000 to Rogers & Associates for assistance with selling the lots in the Sterling
Ridge subdivision and $11,000 to his son for his help with the subdivision and
marketing. Petitioners’ documents support these payments but show that the
amount to Rogers & Associates was a transfer of funds and the amount to
petitioners’ son was for the sale of certain lots in the Sterling Ridge subdivision.
The remaining $195,500 was paid to PPI and included payments for payroll
expenses, a commission on the sale of lot 56, and transfers of funds. Mr. Rogers
explained that he transferred money from SRI to PPI to reimburse PPI for its
expenditures during a downturn in the market, and that he thought those transfers
should be deductible to SRI.
Mr. Rogers testified that he was not sure whether his son included the
amounts in income; and aside from petitioners’ own statements on brief, the record
does not reflect that any of these payments to the three recipients were actually
included in income. In addition, there were no Forms 1099-MISC introduced into
the record relating to these payments.
Petitioners have failed to establish the business purpose of their claimed
commission fees as required under section 162. Other than their own self-serving
testimony, petitioners have offered no evidence to show these payments reflect
- 46 -
[*46] anything more than transfers between their wholly owned entity SRI and
their son, law firm, and other wholly owned entity PPI. We are not required to
accept petitioners’ self-serving testimony and briefs. See Tokarski v.
Commissioner, 87 T.C. 74, 77 (1986). Accordingly, to the extent the
documentation petitioners introduced shows payments by SRI, the expenses are
nevertheless not deductible under section 162. Petitioners have not suggested any
other section of the Code which may give rise to a deduction for these expenses.
Thus, respondent’s determination disallowing all of SRI’s claimed commission
fees deduction is sustained.16
b. Legal Expenses
SRI claimed a deduction for legal and professional fees of $92,000 for
2012, which respondent disallowed entirely. This deduction is for expenses
16
Respondent also suggests that some of the claimed commission fee
expenses may have already been deducted and that petitioners are attempting to
receive a double deduction for them. The commission fees include a $7,000 check
to petitioners’ son for the sale of lot 29 and a $4,000 check for the sale of
unspecified lots in the Sterling Ridge subdivision. PPI also deducted $7,000 as a
“sales bonus” for payment made to petitioners’ son from PPI as a bonus for the
sale of lot 56 of the Sterling Ridge subdivision in 2012. The commission fee
documents further reflect a $10,000 check from SRI to PPI for a commission for
the sale of lot 56, and we have noted that petitioners attempted to claim a $50,000
commission payment to their son as part of their COGS for 2012. In the light of
petitioners’ poor bookkeeping and disorganized recordkeeping we find it likely
that some of these expenses were indeed already deducted by other entities wholly
owned by petitioners or by petitioners themselves.
- 47 -
[*47] allegedly paid by SRI to two law firms: Rogers & Associates and Fred Kan
& Co.17 In 2012 SRI paid $2,000 to Fred Kan & Co. on behalf of one of Mr.
Rogers’ clients.18 It was later reimbursed for this amount. There is no explanation
in the record as to why SRI would pay legal fees on behalf of one of Mr. Rogers’
clients. Additionally, on brief petitioners admit that “[t]he $2,000 is properly
deducted by Rogers & Associates.” It is unclear from this admission whether
petitioners are trying to claim a double deduction for fees that were already
deducted by Rogers & Associates or acknowledging that SRI is not entitled to the
deduction and instead seeking a deduction for Rogers & Associates. In any event,
we find that they have failed to satisfy their burden of showing respondent erred in
disallowing this deduction.
The remaining $90,000 in reported legal fees was paid to Rogers &
Associates. However, petitioners introduced no invoices for the legal work
allegedly performed by Rogers & Associates. Instead, the only documentation
17
Petitioners also introduced documentation for $3,844 in legal fees paid by
SRI to Peabody & Arnold LLP. However, the parties have stipulated that those
documents should be disregarded as that amount was already allowed under
Schedule C as legal and professional fees for 2012.
18
Petitioners also provided a bill from Fred Kan & Co. for $1,200; however,
this amount is unrelated to the $2,000 paid by SRI to Fred Kan & Co. in 2012, and
they introduced no documentation showing this bill was paid by SRI. Therefore,
we will disregard it.
- 48 -
[*48] petitioners introduced to substantiate SRI’s deduction--QuickBooks entries
and canceled checks--lists three of the four payments to Rogers & Associates as
transfers of funds. Petitioners’ failure to substantiate a business purpose for the
$90,000 payment to Rogers & Associates is even more troubling. Petitioners
control SRI and Rogers & Associates; their attempt to deduct money that was
transferred between these two entities appears to be a gross abuse of the Code.
There is nothing in the record to show that Rogers & Associates included this
amount in its income. Mr. Rogers explained that these amounts were paid to
Rogers & Associates for management, administration, closings of transactions,
and other matters in 2012. However, we find his testimony on this matter lacking
credibility. Without more, we are unable to find that these fees were properly
owed to Rogers & Associates, and petitioners have not shown SRI is entitled to a
deduction for them. Therefore, respondent’s determination to disallow the
claimed legal fees deduction in its entirety is sustained.
- 49 -
[*49] III. PPI’s Deductions and Cost of Goods Sold19
For 2010 respondent disallowed PPI’s COGS of $810,876. Petitioners
reported a loss from PPI for 2010 of $1,195,889.20 In addition, respondent
disallowed the following PPI deductions still in dispute for 2010: rent or lease of
$1,081 and travel of $1,456.
A. PPI’s 2010 COGS
For 2010 PPI was operated as a general contractor responsible for the
construction work performed on lots owned by SRI. Petitioners argue that PPI’s
COGS stem from the 2010 sale of lot 77. However, the record shows that lot 77
was held and sold by SRI in 2010, not PPI, and we have already addressed the sale
of lot 77 in discussing SRI’s claimed COGS for 2010 supra pp. 39-41. In fact, the
record shows that PPI held no lots itself at the beginning of 2010 and sold no lots,
19
Petitioners raise on brief whether PPI is entitled to deduct dues and
subscriptions for 2010. This issue was settled by the fifth supplemental stipulation
of settled issues paragraph 3 in docket No. 29356-14. To the extent petitioners are
seeking to advocate a position contrary to the settlement, we hold that their
arguments are not supported by the record.
20
The parties have stipulated that petitioners’ loss from PPI of $1,195,889
was reported in error and that the actual loss petitioners should have reported on
the basis of PPI’s corporate return was $398,875. Nonetheless, deductions related
to calculating PPI’s loss for 2010 remain in dispute, and the actual income or loss
amount attributable to PPI for 2010 and assigned to petitioners must be calculated
in accordance with this opinion.
- 50 -
[*50] homes, or other goods during the year. Nothing in the record substantiates
PPI’s claimed COGS for 2010, and respondent’s determination is sustained.
B. PPI’s 2010 Deductions
1. Rent or Lease
PPI claimed a rent or lease expense deduction of $1,081 for 2010, which
respondent disallowed. The only evidence petitioners introduced to substantiate
this expense was related to a rental car expense incurred in New Orleans on
September 7, 2010. No other evidence in the record purports to substantiate PPI’s
claimed rent or lease expense. Petitioners made no attempt to explain why a rental
car expense would be deductible as rent or lease and provided no documentation
to show the expense was actually paid. At trial Mr. Rogers admitted that the
expense was in fact for travel and entertainment and acknowledged that he rented
the car to attend an American Bar Association meeting in New Orleans. However,
this explanation fails to provide a business justification as to why PPI, which
operates a general contractor business, incurred an expense related to a conference
generally attended by legal professionals. Further, petitioners presented a new
explanation for this expense in their brief: that it was incurred on a trip to Baton
Rouge related to Sugarloaf. Whatever purpose the expense was actually incurred
for, to deduct it as a travel expense petitioners must comply with the heightened
- 51 -
[*51] substantiation requirements under section 274(d). On this record, petitioners
have failed to substantiate the expense, and respondent’s determination is
sustained.
2. Travel
PPI claimed travel expense deductions for 2010 of $1,456, which
respondent disallowed entirely. As we have previously explained, section 274(d)
imposes heightened substantiation requirements to deduct expenses related to
travel. The only documentation petitioners presented were QuickBooks records
purporting to show these expenses. These records alone are not enough to
substantiate that the expenses were actually paid or to explain the business
purpose for each expense. Petitioners presented no log book, diary, or other
contemporaneous documentary evidence that could support their deductions. Mr.
Rogers attempted to explain some of these expenses at trial and on brief, but with
only petitioners’ self-serving statements and unsupported QuickBooks records to
rely on petitioners have failed to meet the heightened substantiation requirements
under section 274(d) for PPI’s claimed travel expense deductions for 2012.
IV. Section 6662(a) Accuracy-Related Penalties
Respondent determined accuracy-related penalties under section 6662(a) of
$188,149 and $48,783 for 2010 and 2012, respectively. Section 6662 applies
- 52 -
[*52] when there is an underpayment of tax that was required to be shown on a
taxpayer’s return, and it imposes an accuracy-related penalty of 20% of the portion
of the underpayment attributable to: (1) negligence or disregard of rules or
regulations, (2) any substantial understatement of income tax, or (3) any
substantial valuation misstatement. Sec. 6662(a) and (b)(1), (2), and (3).
Respondent bears the burden of production and must present sufficient evidence
that the penalty determinations were proper. Sec. 7491(c); Higbee v.
Commissioner, 116 T.C. at 446. Respondent must also demonstrate that he met
the requirements of section 6751(b)(1), i.e., that written supervisory approval of
the initial determination of each penalty was obtained before that penalty was
actually assessed. Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir. 2017), aff’g
in part, rev’g in part T.C. Memo. 2015-42; Graev v. Commissioner, 149 T.C. 485,
493 (2017), supplementing and overruling in part 147 T.C. 460 (2016). In Clay v.
Commissioner, 152 T.C. __, __ (slip op. at 44) (Apr. 24, 2019), we held that the
Commissioner must show that written supervisory approval was obtained before
the proposed penalties were first formally communicated to the taxpayer in a
writing that also advised the taxpayer of his right to appeal the penalties with the
Internal Revenue Service Office of Appeals. Thus, in Clay a 30-day letter with an
attached revenue agent’s report constituted the initial determination to assess the
- 53 -
[*53] penalties proposed therein for purposes of section 6751(b). Id. Once the
Commissioner has satisfied his burden, the taxpayer bears the ultimate burden of
proof to show the penalty determination is incorrect. Rule 142(a); Higbee v.
Commissioner, 116 T.C. at 447.
We will turn first to respondent’s burden to prove the requisite written
supervisory approval was obtained under section 6751(b). Mr. Olivieri approved
the initial penalty determinations for petitioners’ 2010 and 2012 tax returns, and
the parties stipulated the supervisory penalty approval forms for the years at issue.
The initial determination to assess section 6662(a) penalties against petitioners for
2010 and 2012 was made by Ms. Linne over the course of her examination of
petitioners’ 2010 and 2012 tax returns. Ms. Linne completed penalty approval
forms for both years on April 30, 2014, during the audit of petitioners’ returns.
The initial penalty determinations asserted a section 6662(a) penalty for 2010 and
2012 on the basis of negligence or disregard of rules or regulations. The
supervisory penalty approval forms were signed on July 16, 2014, and September
8, 2015, for the taxable years 2010 and 2012, respectively. Approval for the initial
determination of penalties for both years was secured timely during the audit of
petitioners’ returns. There was no 30-day letter or Appeals consideration of this
case.
- 54 -
[*54] The notices of deficiency were mailed October 9, 2014, and June 21, 2016,
for the taxable years 2010 and 2012, respectively. In the notices of deficiency,
respondent determined section 6662(a) penalties against petitioners for 2010 and
2012 on the basis of negligence or disregard of rules or regulations. Respondent
also asserted alternative positions for determining the penalties--i.e., any
substantial understatement of income tax or any substantial valuation
misstatement. However, there was no proper written approval for a section
6662(a) penalty for 2010 or 2012 on these alternative grounds. Therefore,
respondent has met his burden under section 6751(b) to show written supervisory
approval was obtained before communication of the initial determination of
accuracy-related penalties in the notices of deficiency, but only on the basis of
negligence or disregard of rules or regulations.21
We must now turn to respondent’s burden of production to show that the
negligence penalties were appropriate in the absence of available defenses. Graev
v. Commissioner, 149 T.C. at 493. Negligence is defined under section 6662(c) as
“any failure to make a reasonable attempt to comply with the provisions of” the
21
Respondent does not concede the sec. 6662(a) penalties on the alternative
basis of substantial valuation misstatement or substantial understatement of
income tax. However, in the light of our holding on compliance with sec. 6751(b),
we do not address those alternative grounds and focus our analysis on negligence
as a basis for determining the penalties for 2010 and 2012.
- 55 -
[*55] Code, and disregard is defined as “any careless, reckless, or intentional
disregard.” Petitioners are both highly educated attorneys licensed to practice in
Illinois in 2010 and 2012. Mr. Rogers, who prepared petitioners’ tax returns for
2010 and 2012, is a tax attorney who has practiced law since 1969. In 2008 Mr.
Rogers formed his own law practice, Rogers & Associates, which he maintained
operating through the 2010 and 2012 tax years. We have discussed petitioners’
education and employment background in the past as well. See Rogers 2005-09,
at *5-*6. In the light of their education and training, petitioners failed to establish
that they made a reasonable attempt to comply with the rules and regulations
governing Federal tax and that they did not carelessly, recklessly, or intentionally
disregard the provisions of the Code. We have also discussed extensively
petitioners’ sloppy recordkeeping. This further supports a determination that
petitioners exhibited negligence by failing to maintain adequate books and records
to substantiate and reconcile their reported income and expenses. See sec. 1.6662-
3(b), Income Tax Regs. On this record, we find that respondent satisfied his
burden of production to show that petitioners acted with negligence or disregard of
rules or regulations when filing their 2010 and 2012 returns and thus that
imposition of the penalties was appropriate.
- 56 -
[*56] Because we have found that respondent met his burden, petitioners must
now satisfy the burden of proving that the penalties were improper. Accuracy-
related penalties will not apply to any portion of an underpayment with respect to
which the taxpayers can show they acted with reasonable cause and in good faith.
Sec. 6664(c)(1). Petitioners have made no attempt to show that they meet this
exception. Accordingly, respondent’s determination of accuracy-related penalties
for the 2010 and 2012 tax years is sustained.22
In reaching our holding, we have considered all arguments made, and, to the
extent not mentioned above, we conclude they are moot, irrelevant, or without
merit.
To reflect the foregoing,
An appropriate order will be
issued.
22
Our holding does not foreclose Mrs. Rogers’ opportunity to argue her
relief from liability, including penalties, under sec. 6015 in subsequent
proceedings before this Court. We have severed that portion of these cases and
leave for subsequent consideration whether she is liable for penalties and tax
deficiencies in accordance with this opinion.
- 57 -
[*57] APPENDIX
2010 SRI Other Costs From Lots 41 and 77
Amount
Date Lot Contractor Description substantiated
11/28/2010 41 En-Co Replace
Plumbing Inc. plumbing parts $185
7/31/2010 41 Complete Drywall repair
Drywall &
Taping, Inc. 270
7/20/2010 41 GM Trim Replacement
trim work 300
7/20/2010 41 Tri-Star Cabinet Replacement
& Top Co., Inc. shoe & trim 300
7/26/2010 41 Cambridge Painting
Painting & touch-up
Decorating 518
11/1/2010 41 Crawford Bathroom
Supply Co. fixtures 529
10/18/2010 41 DesignTek Final grading
Surveying LLC survey 550
7/2/2010 41 Tri-Star Cabinet Repair doors &
& Top Co., Inc. moulding 634
7/19/2010 41 Southwest Log sets
Fireplace 820
7/28/2010 41 All Secure, Inc. Stereo
installation 1,071
10/17/2010 41 Schaaf Window Shower door &
Co., Inc. custom sliding
door 1,185
10/14/2010 41 Ideal Design Closets
Integration 1,735
- 58 -
[*58]
6/16/2010 41 M.J. O’Neil Replace
Contractors bathroom floor 4,475
6/8/2010 77 Nephin Framing and
Construction installation of
basement door 425
5/10/2010 77 DesignTek Final grading
Surveying LLC survey 550
Total 13,547