Daniel E. Larkin & Christine L. Larkin v. Commissioner ( 2020 )

T.C. Memo. 2020-70
UNITED STATES TAX COURT
DANIEL E. LARKIN AND CHRISTINE L. LARKIN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6345-14. Filed May 28, 2020.
In 2008, 2009, and 2010 Ps, an attorney and a homemaker who
were U.S. nonresident citizens, owned interests in various entities and
real properties in the United States and Europe. Ps’ joint Federal
income tax returns for 2008, 2009, and 2010 claimed Schedule A
deductions, Schedule E losses, self-employed health insurance
deductions, and foreign tax credits.
By notice of deficiency issued in 2013, R disallowed some of
Ps’ deductions and Schedule E losses, and the foreign tax credits. R
also determined that Ps are liable for accuracy-related penalties and
additions to tax.
Held: Ps failed to substantiate their Schedule A deductions
beyond the amounts that R already allowed.
Held, further, Ps do not qualify as real estate professionals and
are therefore prohibited from deducting their Schedule E rental real
estate losses after the passive activity loss limitation.
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[*2] Held, further, Ps are not entitled to the additional self-
employed health insurance deductions beyond the amounts that R
allowed for 2009 and 2010.
Held, further, Ps are not entitled to a foreign tax credit
carryover to 2009.
Held, further, Ps are liable for the I.R.C. sec. 6662(a)
accuracy-related penalties for 2009 and 2010 and are liable for the
addition to tax under I.R.C. sec. 6651(a)(1) for 2008, 2009, and 2010.
Gerald Edward Kubasiak, Steven J. Rotunno, and Daniel F. Cullen, for
petitioners.
Mayah Solh-Cade, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GUSTAFSON, Judge: The Internal Revenue Service (“IRS”) issued to
petitioners, Daniel E. Larkin and Christine L. Larkin, a statutory notice of
deficiency (“SNOD”) pursuant to section 62121 on November 15, 2013, for the
Larkins’ 2008, 2009, and 2010 tax years. This case arises from the Larkins’
1
Unless otherwise indicated, all citations of sections refer to the Internal
Revenue Code of 1986 (26 U.S.C.; “the Code”), as amended as in effect at all
relevant times, and all Rule references are to the Tax Court Rules of Practice and
Procedure. Dollar amounts are rounded to the nearest dollar.
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[*3] timely petition pursuant to section 6213 for redetermination of the
deficiencies, additions to tax, and accuracy-related penalties2 determined by the
IRS. After stipulations and concessions by the parties, the issues for decision are:
(1) whether the Larkins are entitled to additional itemized deductions
claimed on Schedule A, “Itemized Deductions”, for the years at issue (we hold that
they are not);
(2) whether the Larkins are entitled to a rental real estate loss deduction
claimed on Schedule E, “Supplemental Income and Loss”, after passive limitation,
for the years at issue (we hold that they are not);
(3) whether the Larkins are entitled to additional self-employed health
insurance deductions for tax years 2009 and 2010 (we hold that they are not);
(4) whether the Larkins are entitled to a foreign tax credit (“FTC”) (or to an
FTC carryover) for 2009 (we hold that they are not);
(5) whether the Larkins are liable for additions to tax pursuant to
section 6651(a)(1) for the years at issue (we hold that they are); and
2
The SNOD determined the accuracy-related penalties on alternative
grounds; but the Commissioner has conceded all such grounds except negligence
under section 6662(a) and (b)(1), so we do not further discuss the alternative
grounds.
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[*4] (6) whether the Larkins are liable for accuracy-related penalties pursuant to
section 6662(a) for the years at issue (we hold that they are not liable for 2008 but
that they are liable for 2009 and 2010).
FINDINGS OF FACT
At the time they filed their petition, Mr. and Mrs. Larkin resided in Surrey,
England, in the United Kingdom (“U.K.”). The Larkins were married U.S. citizens
and resided in England at all times during the relevant years.
Daniel E. Larkin
Mr. Larkin is a highly educated attorney with more than 20 years’
experience dealing in a variety of complex transactional matters. For all relevant
years, Mr. Larkin was a partner at Squire, Sanders & Dempsey, LLP (“SSD”),
which was based in Cleveland, Ohio. He previously worked for
PricewaterhouseCoopers LLP and at the time of trial was employed by another
multinational law firm. Mr. Larkin testified that he advises institutional clients on
legal and financial matters.
Christine L. Larkin
Mrs. Larkin is a “homemaker”, as the Larkins reported on their income tax
returns. The Larkins claim that Mrs. Larkin is a real estate professional (for the
purposes of qualifying for Schedule E rental real estate deductions), but we find
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[*5] that in the years at issue Mrs. Larkin did not spend as much as 750 hours per
year in real property trades or businesses.
Mr. Larkin’s U.K. income
In each of the years at issue, Mr. Larkin received from SSD guaranteed
payments and a distributive share of ordinary income, which constituted most of
the Larkins’ income. We are unable to find that, as of 2008, Mr. Larkin had paid
U.K. income tax in prior years for which an FTC had not been allowed that might
be carried over into the years at issue.
Home mortgage interest
In 2001 the Larkins purchased a plot of land in the outskirts of London.
They divided it into two lots and built their residence on one of them. (The second
lot is discussed below.) In the years at issue, the Larkins still owned that house in
England and paid interest on a mortgage loan secured by that house, for which the
balance due in 2008 was $2,432,152. In 2008 they paid mortgage interest of
$24,270 (an amount reported by third-party payees and allowed by the IRS as a
Schedule A deduction). On their 2009 return the Larkins reported mortgage
interest of $17,000, which the IRS allowed as a Schedule A deduction along with
an additional $7,223, totaling $24,223 (presumably reported by third-party
payees). Despite the Larkins’ contentions that they could deduct additional
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[*6] mortgage interest paid in 2008, 2009 and 2010, the amounts for 2008 and
2009 are not at issue. We find that they have not substantiated additional
mortgage interest payments in 2010.
Real estate interests
The Larkins assert that during the relevant period, they maintained
ownership interests in four properties as part of a rental real estate activity:
Denton Homes lot. The second of the two lots outside London that the
Larkins acquired in 2001 is referred to as the “Denton Homes lot”. They sold it to
a developer in 2007. We find that in the years at issue they did not retain an
interest in, nor conduct any substantial activity in connection with, the Denton
Homes lot.
Belmont property. In 2007 the Larkins purchased a condominium
apartment in Chicago that they refer to as “the Belmont property”. The Larkins’
daughters lived at the Belmont property during at least some part of the years at
issue. We do not find that any paying tenants lived at the Belmont property during
these years or that the Larkins owned any interest in the Belmont property after
2008.
France property. The Larkins allege that during the years at issue they co-
owned a property in France along with Mrs. Larkin’s sister and brother that they
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[*7] periodically rented to third parties as a large vacation home. In the absence of
proof, we find that they did not establish that they owned such a property.
Lake house. The Larkins consider a house in Wisconsin (“the lake house”)
to be their “second home”. They purchased the lake house along with another
couple, and the two couples own their interests indirectly through Treetops LLC,
an entity that they formed to purchase and hold the lake house, the sole asset of
Treetops LLC. The Larkins owned their share of Treetops LLC through another
entity, Larmodt LLC. During 2009 and 2010, the Larkins each owned 35%--
totaling 70%--of Larmodt LLC,3 and two of the Larkins’ daughters each owned
10% of Larmodt LLC. (The evidence does not show who owned the remaining
10% or whether that owner was an individual.) In 2008 Larmodt LLC owned 50%
of Treetops LLC, but we have no evidence as to the Larkins’ precise equity
3
The evidence of the ownership of Larmodt LLC is its Schedules K-1,
“Partner’s Share of Income, Deductions, Credits, etc.”, for 2009 and 2010, though
the record does not contain Schedules K-1 sufficient to account for 100% of
Larmodt LLC’s ownership for either of these years. No 2008 Schedules K-1 for
Larmodt LLC are in evidence. (In their prior case, “[t]he record does not further
identify Larmodt, L.L.C., or its owners”, Larkin v. Commissioner (“Larkin I”),
T.C. Memo. 2017-54, at *26 n.19, aff’d in part, rev’d in part, Larkin v.
Commissioner (“Larkin II”), No. 17-1252, 2020 WL 2301462 (D.C. Cir. Apr. 21,
2020), but we decide this case on its own evidence.)
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[*8] interest in Larmodt LLC.4 We find that the lake house was not rented out
during any of the years at issue.
Investment interest
In the SNOD the IRS conceded that the Larkins paid deductible investment
interest in the years at issue--$6,310 in 2008, $5,278 in 2009, and $6,150 in 2010--
and the parties have stipulated that “the Schedule A--Investment Interest already
4
The evidence of the ownership of Treetops LLC is the Schedule K-1 for
2008 issued by Treetops LLC to Larmodt LLC reflecting a 50% equity interest.
(In Larkin I we found that in the years 2003-06 the Larkins’ equity interest in
Treetops LLC was 65%, see Larkin I, at *8-*9, but our opinion in this case
involves different years and is based on different evidence.) In Larkin I there was
no evidence about the ownership of Larmodt LLC or the assets it owned, and we
determined that Treetops LLC was a “small partnership” within the meaning of
section 6231(a)(1)(B) because the record established that it had at most two
partners (each married couple treated as a single partner). Therefore items on the
Schedules K-1 for Treetops LLC in Larkin I were subject to redetermination in
that case rather than requiring partnership-level proceedings under the unified
audit and litigation procedures of the Tax Equity and Fiscal Responsibility Act of
1982 (“TEFRA”). See id. at *63. For the years now at issue it appears that
Treetops LLC was not a “small partnership” within the meaning of section
6231(a)(1)(B) because one of its owners, Larmodt LLC, was not “an individual
(other than a nonresident alien), a C corporation, or an estate of a deceased
partner.” The evidence is insufficient to determine whether Larmodt LLC itself
would be subject to TEFRA; it shows that 90% of Larmodt LLC was owned by
individuals in the Larkin family, but for all we know the owner of the remaining
10% was a nonresident alien, a partnership, or an LLC, in which case Larmodt
LLC, too, was not a “small partnership” but was instead subject to TEFRA. We
accept the status and ownership of Larmodt LLC and Treetops LLC as shown by
the Schedules K-1; we assume correct the Larkins’ allegations about ownership of
the LLCs where Schedules K-1 are missing; and we do not attempt to redetermine
any partnership items in this proceeding.
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[*9] allowed on the notice of deficiency, in the amounts of $5,278 and $6,150, for
tax years 2009 and 2010, respectively, was from Larmodt, LLC”. We do not
disturb the IRS’s concessions in the SNOD. We find that the Larkins have not
substantiated additional amounts of investment interest that they allege they paid
to four other entities in 2009 and 2010. (Investment interest is not at issue for
2008. See infra part I.B.1.)
State income tax and personal property tax
Mr. Larkin’s law firm SSD withheld and paid over State and local income
tax for Mr. Larkin in amounts no greater than $7,136 for 2008, $6,015 for 2010,
and $2,305 for 2010. The Larkins also paid $300 in personal property tax in 2009.
Real estate tax
For 2009 and 2010 the Larkins did not prove that they paid--and we find
that they did not pay--any additional amounts of income tax or property tax. (Real
estate tax is not at issue for 2008. See infra part I.B.1.)
Self-employed health insurance
The Larkins purchased health insurance for themselves in 2008 (which is
not in dispute), 2009, and 2010. For their health insurance premiums, the parties
have stipulated that “[p]etitioners are entitled to Self-Employed Health Insurance
deductions limited to the amount of $15,511 for tax year 2008.” For the
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[*10] subsequent years, we find that the Larkins paid no more than $7,178 in 2009
and $2,192 in 2010.
Tax returns
Mr. Larkin himself prepared petitioners’ joint Forms 1040, “U.S. Individual
Income Tax Return”, for the years at issue.
2008 Form 1040
The Larkins requested and were granted an extension to file their 2008 tax
return on or before December 15, 2009, but failed to file the 2008 return by the
extended deadline. The IRS received third-party information regarding the
Larkins’ income for 2008 and filed a substitute for return (“SFR”) on June 14,
2011. (The 2008 SFR is not in the record; however, the Larkins never contested
its existence or validity.) The adjustments in the SNOD for 2008 are based in part
on the SFR.
An FTC was claimed on the Form 1040 that Mr. Larkin prepared (but did
not file) for 2008. (No FTC is at issue for 2008, see infra part I.B.3, but the
Larkins’ 2008 reporting is relevant to their claim of an FTC carryover into 2009.)
The Form 1116, “Foreign Tax Credit”, for 2008 showed that the Larkins’ claim of
an FTC of $16,785, of which $578 was credited against their tax for 2008, was
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[*11] based on a “carryback or carryover”, but a detailed computation of the
carried FTC was not attached to the form.
Mr. Larkin prepared a Form 1040 for 2008 and submitted it to a revenue
agent on August 23, 2012. It appears that the Commissioner considered some of
the information from that Form 1040 in preparing the SNOD. However, we find
(as the Commissioner contends) that the Larkins did not file a return for 2008. See
infra part VII.A.
2009 return
The Larkins requested and were granted an extension to file their 2009 tax
return on or before October 15, 2010. The Larkins filed their 2009 tax return more
than a year late on November 8, 2011.
The Larkins claimed an FTC sufficient to cover their U.S. income tax due
on their return for 2009. Mr. Larkin attached to the Form 1040 a Form 1116,
claiming an FTC “carryback or carryover” of $16,307, of which $4,014 was
applied against their tax for 2009. But a detailed computation of the carried FTC
was not attached.
The IRS found that the Larkins’ self-prepared 2009 return contained
mathematical errors and claims of credits exceeding those allowed by the Code.
The IRS adjusted the totals of income and tax as reported on the returns, resulting
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[*12] in a correct adjusted gross income of $160,869 and taxable income of
$54,471, assessed tax of zero after application of a reported foreign tax credit, and
issued the Larkins a refund of $140 for tax year 2009.
2010 return
The Larkins requested and were granted an extension to file their 2010 tax
return on or before October 15, 2011, which was a Saturday, so that the return
would have been timely if filed Monday, October 17, 2011. The Larkins did not
meet this deadline but filed their 2010 return almost a month late on November 16,
2011.
The IRS found that the Larkins’ self-prepared 2010 return contained
mathematical errors and claims of credits exceeding those allowed by the Code.
The IRS adjusted the totals of income and tax as reported on the return, resulting
in an adjusted gross income of $64,955, taxable income of zero, and an
overpayment of tax of $2,356 for 2010.
The Larkins’ record-keeping
Mr. Larkin took responsibility for the Larkins’ tax return preparation, which
included consulting with tax professionals at his various places of work--in this
case, SSD. His testimony suggested that he could back up the positions taken on
the Larkins’ returns by, inter alia, tracing alleged investment interest to specific
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[*13] eligible investments proffered in his exhibits and pointing to specific items
in the proffered exhibits, such as the Schedules K-1, which would supposedly
explain the figures reported on the returns. However, when pressed, he was
unable to explain reporting positions he had taken on the returns. Many of the
exhibits the Larkins have offered are standard tax forms that are used to prepare
income tax returns (i.e., information returns such as the Schedules K-1 for their
interests in various closely held entities), and yet many of these documents are
incomplete and fail to fully support the extent of the Larkins’ claimed ownership
in a given year or the continuity of ownership over the course of the years at issue.
Records that the Larkins have submitted to substantiate payment of expenses for
which they claim deductions, such as credit card statements, do not segregate
deductible expenses from those that are not deductible. Despite the Larkins’
assertion that they engaged in significant rental real estate activity, they have
submitted not one document evidencing a contract for rental or lease of any of
their properties to a third party. The only lease the Larkins offered into evidence
showed Mr. Larkin as lessee and was admitted in support of their claim for a
housing exclusion. Overall, there is a dearth of records to support the Larkins’
disputed return positions.
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[*14] The Larkins imply nonetheless that such records exist, asserting that “they
were never submitted to the IRS because they were not requested”. This
explanation is not a valid excuse for their failure to substantiate their deductible
expenses at trial, as we explain below in part I.C.2.
SNOD and petition
The IRS conducted an examination for the Larkins’ years 2008, 2009, and
2010. Revenue Agent Sabrina Thorne determined to disallow the deductions
discussed herein. In addition, she initially determined that accuracy-related
penalties should be asserted “under IRC 6662(c)”, i.e., for “negligence”; and her
immediate supervisor approved her penalty determination in writing on
January 15, 2013. Ten months later the IRS issued the SNOD on November 15,
2013, disallowing deductions and determining additions to tax and accuracy-
related penalties for all years at issue.
Mr. and Mrs. Larkin timely filed their petition on March 19, 2014.
Pretrial proceedings
Trial was scheduled for January 5, 2015. At the Larkins’ request the case
was continued, and trial was rescheduled for June 1, 2015. The Larkins again
requested a continuance, their request was granted, and trial was rescheduled for
October 19, 2015--nine months after the originally scheduled trial date in January
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[*15] 2015, 17 months after the Larkins filed their petition in March 2014,
23 months after the issuance of the SNOD in November 2013, and almost four
years after the Larkins’ filing of the return for the latest year at issue (i.e., the 2010
return filed in November 2011).
We issued our standing pretrial order on May 19, 2015. That order required
each of the parties to file a pretrial memorandum. The Larkins did not do so, but
the Commissioner did.
On October 13, 2015, the Court held a telephone conference with
respondent’s counsel and the Larkins (who at that time represented themselves).
During that conference Mr. Larkin requested a third continuance. The Court
pointed out to him that he was making that request less than 30 days before the
trial session, which under Rule 133 is presumptively dilatory. The Court stated
that it saw no grounds warranting a continuance and denied the request.
The Larkins did not appear personally at the calendar call on October 19,
2015, but sent a newly retained attorney (who said he was not available to try the
case that week) to appear for them and move for another continuance. We denied
the continuance and scheduled the case for trial the next day, on October 20, 2015.
At the Larkins’ counsel’s request we recalled the case in the afternoon of
October 19, 2015. The new counsel who had appeared that morning moved to
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[*16] withdraw from the case (a motion we granted), and newer counsel filed an
entry of appearance and again moved for a continuance. We denied the motion
and tried the case as scheduled.
The Larkins’ motions to supplement the record
At the conclusion of trial, petitioners’ counsel requested that the Court leave
the trial record open for 30 to 45 days so that the Larkins could add to the trial
record additional exhibits they hoped to be able to find. The Court stated:
I’m going to deny your very broad motion to leave the record open so
that you can bring in anything that relates to any deduction already at
issue in the case.
However, I am going to do so without prejudice to your
renewing that motion when you have specific documents that you
wish to offer. * * * You are free to file whatever motion you wish.
I will tell you that a motion filed after 45 days [i.e., after December 4,
2015], when Respondent[’s counsel] begins to work on her brief and
invests time in it, and then you would be changing the ground
underneath her, that would not be just.
On December 2, 2015, the Larkins moved to supplement the record with
additional documents, and the Commissioner did not object. The Court deferred
the parties’ filing of post-trial briefs so that they could attempt additional
stipulations, which they filed June 6 and July 27, 2016, and which rendered moot
the Larkins’ motion to supplement the record.
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[*17] The Court directed the parties to propose a briefing schedule as to the
remaining issues, but on August 3, 2016--more than nine months after the
conclusion of the trial--the Larkins filed a second motion to supplement the trial
record, to which the Commissioner objected; but at the Court’s instruction the
parties attempted and were able to file a second supplemental stipulation of facts
that rendered moot the Larkins’ second motion (to the extent they did not concede
the motion). The Court denied as moot or as conceded the two motions to
supplement, and the Court then set a briefing schedule, calling for an opening brief
by the Larkins, an answering brief by the Commissioner, and a reply brief by the
Larkins.
However, when the Larkins filed their reply brief on April 28, 2017, they
also filed on that same date--more than 18 months after the conclusion of trial--a
third motion to supplement the record with proposed exhibits (not admitted at trial
or thereafter) that they cited in their reply brief. The Commissioner objected to the
third motion and moved to strike from the Larkins’ reply brief all references to the
proposed new exhibits. For the reasons explained below in part I.D, we will deny
the Larkins’ third motion to supplement the record and will grant the
Commissioner’s motion to strike.
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[*18] Graev v. Commissioner
On December 20, 2017, after the parties had filed their briefs in this case,
this Court issued its Opinion in Graev v. Commissioner, 149 T.C. 485 (2017),
supplementing and overruling in part 147 T.C. 460 (2016), addressing the effect of
section 6751(b)(1) on penalty liabilities. By order of February 8, 2018, we set in
motion a procedure for addressing the application of Graev to this case, and that
process concluded with the parties’ filing on March 22, 2018, a supplemental
stipulation that sets out the facts stated above concerning supervisory approval of
penalties, and their filing supplemental briefs in April and May 2018.
Related cases
Before filing their petition in this case, the Larkins had commenced two
other cases (docket Nos. 14886-08 and 19940-09) that concern their taxable years
2003 through 2006. On April 3, 2017, during the time when the Larkins were
preparing to file their reply brief in this case, the Court issued its opinion in those
earlier consolidated cases--Larkin v. Commissioner (“Larkin I”), T.C. Memo.
2017-54. On October 31, 2017, the Larkins filed notices of appeal in those cases
in the U.S. Court of Appeals for the District of Columbia Circuit, Docket
No. 17-1252, which issued its unpublished opinion on April 21, 2020, ordering
Larkin I affirmed in part and (as to issues the Commissioner had conceded)
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[*19] vacated and remanded in part. Larkin v. Commissioner (“Larkin II”), No.
17-1252, 2020 WL 2301462 (Apr. 21, 2020).
Some issues for the years 2003 through 2006 in those related cases are
similar to some of the issues in this case for the years 2008 through 2010.
However, neither party has raised the issue of collateral estoppel,5 see
Commissioner v. Sunnen, 333 U.S. 591, 598-599 (1948), which is a “special
matter” that Rule 39 would require to be pleaded; and we decide the disputed
issues in this case on the basis of the evidence admitted in this case.
Issues in dispute
After stipulations and concessions by the parties, the following issues
remain in dispute:6
5
The pendency of the appeal in Larkin I while this case was being briefed
would not have precluded the invocation of collateral estoppel. See Martin v.
Malhoyt, 830 F.2d 237, 264 (D.C. Cir. 1987) (noting that for purposes of applying
the doctrine of collateral estoppel, the pendency of an appeal does not
automatically diminish the preclusive effects of a prior adjudication).
6
Pursuant to Rule 91(a) the parties stipulated the inclusion of $5 of taxable
interest for 2009; however, it is clear to the Court that the parties intended to
stipulate the inclusion of $5 of taxable interest for 2010, the year indicated on the
SNOD for that adjustment.
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[*20] Schedule A itemized deductions
In Schedules A submitted with their 2009 and 2010 tax returns (and with
their untimely Form 1040 for 2008), the Larkins originally claimed deductions of
certain amounts. In the SNOD the IRS allowed Schedule A deductions of lesser
amounts. In their briefs7 the Larkins argue that they are entitled to additional
Schedule A deductions as follows for 2008, 2009, and 2010:
Mortgage Investment
Year interest interest Taxes
2008 $28,667 $4,023 $3,465
2009 -0- 4,882 6,015
2010 6,673 9,311 5,400
For the reasons explained below in part I.B.1, Schedule A deductions for 2008 are
not properly at issue. The Commissioner contends that the Larkins are entitled to
no additional Schedule A deductions.
7
Some of the amounts of deductions claimed in the Larkins’ opening brief
are increased in their reply brief, but there are inconsistencies in the reply brief
where they appear to have copied smaller amounts from their opening brief. We
assume that the Larkins argue for the amounts in the reply brief, except that we
assume they claim for 2008 the larger amount of mortgage interest stated in their
opening brief, though their reply brief argues for “at least” a smaller amount.
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[*21] Schedule E real estate expenses
As to the four property interests described above, the Larkins argue that
they are entitled to deduct Schedule E rental real estate losses, not reduced by the
passive loss limitation of section 469, in the full amounts that they reported on
their Forms 1040 and that were disallowed in the SNOD--i.e., $35,591 for 2008,
$42,810 for 2009, and $28,240 for 2010. For the reasons explained below in
part I.B.2, Schedule E deductions for 2008 are not properly at issue. The
Commissioner contends that the Larkins’ loss deductions are foreclosed by
section 469.
Self-employed health insurance
The Larkins claim they are entitled to deductions for self-employed health
insurance of $15,700 for 2009 and $12,700 for 2010. The Commissioner
conceded that the Larkins substantiated deductions of $7,178 for 2009 and $2,192
for 2010, and the differences between the claimed amounts and the conceded
amounts remain at issue.
Foreign tax credit
In the SNOD the Commissioner disallowed the FTC claimed for 2009. The
Larkins disputed that disallowance in their petition. For the reasons explained
below in part I.B.3, an FTC for 2008 is not properly at issue.
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[*22] Penalties and additions to tax
For each of the years at issue, the Commissioner contends that petitioners
are liable for an accuracy-related penalty under section 6662(a) and for an addition
to tax under section 6651(a)(1) for failure to timely file their return.
OPINION
I. General principles
A. Abandoned issues
The Larkins’ opening brief challenges some (but not all) of the IRS’s
determinations in the SNOD. We consider any issue or argument that the Larkins
did not advance on brief as having been abandoned. See Mendes v.
Commissioner, 121 T.C. 308, 312-313 (2003); Nicklaus v. Commissioner, 117
T.C. 117, 120 n.4 (2001); Rybak v. Commissioner, 91 T.C. 524, 566 n.19 (1988).
We decide only the issues that the Larkins pleaded, addressed on brief, and did not
concede.
B. Issues not pleaded or tried by consent for 2008
A petition for redetermination of a deficiency determined in an SNOD
“shall be complete, so as to enable ascertainment of the issues intended to be
presented.” Rule 34(a)(1). The petition shall, among other things, contain “[c]lear
and concise assignments of each and every error which the petitioner alleges to
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[*23] have been committed by the Commissioner in the determination of the
deficiency * * * . * * * Any issue not raised in the assignments of error shall be
deemed to be conceded.” Rule 34(b)(4); see also Foley Mach. Co. v.
Commissioner, 91 T.C. 434, 441 (1988) (holding that the Court does not consider
issues which are not raised by the pleadings). In certain circumstances, an issue
not raised by the pleadings may be “tried by express or implied consent of the
parties, * * * [and] treated in all respects as if they had been raised in the
pleadings.” Rule 41(b)(1). But we have held that when a party is not aware of an
issue at trial, he cannot be held to have expressly or impliedly consented to the
trial of that issue, as required for application of Rule 41(b). See Markwardt v.
Commissioner, 64 T.C. 989, 998 (1975).
In their reply brief, the Larkins attempt to raise new issues related to 2008,
but we do not entertain them because we find that none of these issues was
properly pleaded or tried by consent.
1. Schedule A deductions for 2008
We hold that Schedule A deductions--mortgage interest, investment interest,
and State and local tax deductions--for 2008 are not at issue. The petition
disputed the disallowance of investment interest and real estate tax deductions for
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[*24] 2009 and 2010 and disputed the disallowance of mortgage interest for 2010
but was silent as to any Schedule A deductions for 2008.
The Commissioner’s pretrial memorandum reflected his understanding that
itemized deductions were in dispute (as issue “8”) “for tax years 2009 and 2010”
and was silent as to 2008. (As we have noted, the Larkins did not file the required
pretrial memorandum.) At the beginning of trial the Court undertook to confirm
explicitly the issues to be decided. The Commissioner gave his list of issues,
which were fewer than the list in his pretrial memorandum but which did include
his issue “8” (i.e., itemized deductions for 2009 and 2010). In response to the
Court’s query, petitioner’s counsel assented to the Commissioner’s list and agreed
that there were “[n]o extra issues raised by either party.” The Larkins gave no
testimony as to deductions for investment interest or mortgage interest for 2008.
The only testimony the Larkins offered regarding real estate taxes for 2008
pertained to their residence in England, and Mr. Larkin’s discussion of those taxes
was to distinguish them from the other items offered in the Exhibit 5 that he
proffered in support of his housing exclusion (an issue later conceded by the
Commissioner). The Larkins’ first contention that they should be allowed
additional Schedule A deductions for 2008 (other than those allowed in the
SNOD) was in their post-trial brief. For substantiation of real estate taxes and
- 25 -
[*25] investment interest, the brief cites only the 2008 Schedule K-1 for
Treetops LLC, but at trial this document was not proffered to substantiate
investment interest or real estate tax deductions. Rather, Mr. Larkin’s only
testimony about this Schedule K-1 was nonspecific. He testified generally about
the process of preparing the Schedules K-1 for Larmodt LLC and Treetops LLC
during the years at issue (e.g., as part of a narrative answer regarding the real
estate activities in which he and his wife participated); about the fact that the
distributive shares of items from Treetops LLC that petitioners claimed were
“rolled up through the Larmodt LLC K-1” before being reported on their
individual tax return; and about the “fact” that “every year * * * [they] would
attach a Treetops [LLC Schedule] K-1 along with a Larmodt [LLC
Schedule] K-1”--an assertion not otherwise supported by the record. The post-trial
contentions as to Schedule A deductions for 2008 were neither pleaded nor tried
by consent, so they are not properly in the case.
2. Schedule E deductions for 2008
We hold that losses allegedly sustained for rental real estate activity that
were reported on the Larkins’ Schedule E for 2008 are not properly at issue. As
we have noted, the Larkins did not file an income tax return for 2008, but they did
submit a Form 1040 (prepared by Mr. Larkin) to a revenue agent during an audit
- 26 -
[*26] and before the issuance of the SNOD, which was evidently prepared using
information considered in audit from that Form 1040. The petition that the
Larkins filed after receiving the SNOD disputed the “proposed reductions to
[Schedule E] losses claimed in 2009 and 2010”, but it raised no issues regarding
and made no reference to Schedule E losses for 2008.
The Commissioner’s pretrial memorandum reflected his understanding that
Schedule E rental real estate losses were in dispute (as issue “9”) “for tax years
2009 and 2010” and was silent as to 2008. Again, the Larkins did not file a
pretrial memorandum; and at trial the Larkins confirmed, through counsel, that
there were no “extra issues raised by either party.”
At trial Mr. Larkin testified (consistent with the Form 1040 he prepared)
that the only property for which he reported rental real estate activity on
Schedule E for 2008 was the Belmont property; and he gave this testimony as part
of his explanation for why he had taken a “capital write-down” for the property on
Schedule D, “Capital Gains and Losses”, after changing the manner in which he
reported his activity on that property from Schedule C, “Profit or Loss From
Business”, of his return for 2007 to Schedule E for 2008. This testimony did not
raise the issue of Schedule E losses for 2008, and the issue was not tried by
- 27 -
[*27] consent. Again, the first time the Larkins raised Schedule E losses for 2008
was in their post-trial brief--too late to try the issue in this case.
3. FTC for 2008
An FTC is properly at issue only for 2009, and not for 2008. The only FTC
adjustment in the SNOD was for 2009. The only FTC contention in the petition--
and thus the only such claim in the pleadings in this case--was: “The Service
proposes to disallow FTC claimed for 2009. This represents carryforward FTC”.
The Commissioner’s pretrial memorandum reflected his understanding that
the only FTC issue in this case (issue “12”) is “[w]hether the Larkins are entitled
to a Foreign Tax Credit in the amount of $16,207 for tax year 2009”; the Larkins
did not file the required pretrial memorandum; and at trial they confirmed, through
counsel, that there were “no extra issues raised by either party.” During
Mr. Larkin’s testimony, the Court asked petitioners’ counsel: “Is the dispute about
foreign tax credit for 2009 only?” Counsel replied: “Yes, Your Honor.” To the
same effect, the Larkins’ first post-trial filing--a motion to supplement the record--
stated: “This issue is whether Petitioners are entitled to a foreign tax credit for the
payment of taxes to the United Kingdom in 2009.”
In their post-trial briefs, however, the Larkins attempted to change course:
Their opening brief purported to add a contention as to an FTC for 2008, but we
- 28 -
[*28] will not entertain this contention since it conflicts with their statements at
trial and the pleadings upon which the case is based.
The Larkins’ opening brief was equivocal about whether their FTC claim
was for U.K. taxes paid in the years at issue (we find that no such taxes were paid)
or arose instead from carryovers from prior years. But the Larkins’ reply brief
stated that “[t]he issue is not if Petitioners had any income or if they paid any
foreign taxes during the years 2008-2010, the issue is whether they properly used a
foreign tax credit carryover from prior years.”
We therefore address the FTC only as to 2009 and only as to carryovers
from pre-petition years--i.e., in the words of the petition, “FTC claimed for 2009”
as “carryforward FTC”--and we treat as conceded any other FTC claims.
C. Burden of proof
1. General rule
The IRS’s determinations are presumed correct, and taxpayers generally
bear the burden to prove their entitlement to any deductions they claim. Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Taxpayers must satisfy the
specific requirements for any deduction claimed. INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992).
- 29 -
[*29] The taxpayer must carry his burden of proof with evidence offered at trial,
to which his brief should refer.8 Where the evidence presented at trial is
insufficient to support a finding that a particular expense is deductible, we must
sustain the IRS’s determinations and disallow the deduction.
2. Record-keeping
Section 6001 requires that “[e]very person liable for any tax imposed by this
title, or for the collection thereof, shall keep such records, render such statements,
make such returns, and comply with such rules and regulations as the Secretary
may from time to time prescribe.” (Emphasis added.) A taxpayer is thus required
to keep sufficient records to substantiate his gross income, deductions, credits, and
other tax attributes. See also 26 C.F.R. sec. 1.6001-1(a), Income Tax Regs.9
8
See Rule 151(e)(3) (“All briefs * * * shall contain * * * [p]roposed
findings of fact * * * based on the evidence * * *. * * * [T]here shall be inserted
references to the pages of the transcript or the exhibits or other sources relied upon
to support the statement.”); Adeyemo v. Commissioner, T.C. Memo. 2014-1, at
*28; D’Errico v. Commissioner, T.C. Memo. 2012-149, slip op. at 19 (“We need
not (and will not) undertake the work of sorting through every piece of evidence
petitioners have provided in an attempt to find support for petitioners’ ultimate
legal positions taken in this case”).
9
See also 26 C.F.R. sec. 1.446-1(a)(4), Income Tax Regs. (“Each taxpayer is
required to make a return of his taxable income for each taxable year and must
maintain such accounting records as will enable him to file a correct return. See
section 6001 and the regulations thereunder. Accounting records include the
taxpayer’s regular books of account and such other records and data as may be
(continued...)
- 30 -
[*30] The regulations implementing that statute include 26 C.F.R. section
1.6001-1(a), Income Tax Regs., which provides: “[A]ny person required to file a
return of information with respect to income, shall keep such permanent books of
account or records * * * as are sufficient to establish the amount of gross income,
deductions, credits, or other matters required to be shown by such person in any
return of such tax”.
Taxpayers are required to retain their books and records as long as they may
become material:
Retention of records.--The books or records required by this section
shall be kept at all times available for inspection by authorized
internal revenue officers or employees, and shall be retained so long
as the contents thereof may become material in the administration of
any internal revenue law. [26 C.F.R. sec. 1.6001-1(e), Income Tax
Regs.]
3. The Cohan rule
The Code’s substantiation rules are subject to some flexibility. When a
taxpayer adequately establishes that a deductible expense was paid or incurred but
does not establish the precise amount, the Court may in some instances estimate
the allowable deduction, bearing heavily against the taxpayer whose inexactitude
9
(...continued)
necessary to support the entries on his books of account and on his return, as for
example, a reconciliation of any differences between such books and his return”).
- 31 -
[*31] is of his own making. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d
Cir. 1930). There must, however, be sufficient evidence in the record to provide a
basis upon which an estimate may be made and to permit the Court to conclude
that a deductible expense, rather than a nondeductible personal expense, was
incurred in at least the amount allowed. Vanicek v. Commissioner, 85 T.C. 731,
743 (1985). We must have some basis on which such an estimate may be made.
Id. (citing Williams v. United States, 245 F.2d 559 (5th Cir. 1957)).
4. Witness credibility
At trial Mr. Larkin was the sole witness for petitioners. We observe the
candor, sincerity, and demeanor of a witness in order to evaluate his testimony.
The mere fact that Mr. Larkin’s testimony was unopposed does not mean that we
will make findings consistent with it. We will not accept the testimony of a
witness at face value to the extent it is implausible or not credible in view of the
totality of the surrounding circumstances. Neonatology Assocs., P.A. v.
Commissioner, 115 T.C. 43, 84 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).
In general, Mr. Larkin’s testimony on contested matters was not convincing.
Accordingly, we generally do not rely on his testimony to support the Larkins’
positions, except to the extent his testimony is corroborated by reliable
documentary evidence.
- 32 -
[*32] 5. Shifting the burden of proof
Section 7491(a) provides an exception that shifts the burden of proof to the
Commissioner as to any factual issue relevant to a taxpayer’s liability for income
tax if: (1) the taxpayer introduces credible evidence with respect to the issue and
(2) the taxpayer has satisfied certain other conditions, including that he has
complied with the substantiation requirements for any item set forth in the Code
and has maintained all records required by the Code. See sec. 7491(a)(1) and (2).
A taxpayer bears the burden of proving that he has met the requirements of
section 7491(a). Rolfs v. Commissioner, 135 T.C. 471, 483 (2010), aff’d, 668
F.3d 888 (7th Cir. 2012).
Such “credible evidence” is evidence of a quality that, after critical analysis,
a court would find sufficient upon which to base a decision on the issue if no
contrary evidence were submitted. A taxpayer who provides only self-serving10
10
As we recently observed in Keels v. Commissioner, T.C. Memo. 2020-25,
at *15-*16:
Witness testimony could almost always be said to be “self-serving”,
but that factor alone is not a reason to automatically reject the
evidence as unreliable. * * * We decide whether a witness’ testimony
is credible by relying on objective facts, the reasonableness of the
testimony, the consistency of the witness’ statements, and the
witness’ demeanor. * * * We may discount testimony which we find
to be unworthy of belief, * * * but we may not arbitrarily disregard
(continued...)
- 33 -
[*33] testimony and inconclusive documentation fails to provide credible
evidence. See Higbee v. Commissioner, 116 T.C. 438, 442-446 (2001); see also
Blodgett v. Commissioner, 394 F.3d 1030, 1035-1039 (8th Cir. 2005) (holding the
same), aff’g T.C. Memo. 2003-212.
The Larkins argue that the documentary evidence they submitted, combined
with Mr. Larkin’s testimony at trial, is sufficient to shift the burden of proof. We
disagree. As we show below, the Larkins’ documentary evidence is lacking on
almost every issue, and their testimonial evidence--consisting solely of
Mr. Larkin’s testimony--was not convincing enough to prove any facts without
significant corroborating evidence (which is largely absent). The Larkins have not
persuaded us that section 7491(a) applies to shift the burden of proof to the
Commissioner. We conclude that the Larkins bear the burden of proof as to the
deficiencies determined.
10
(...continued)
testimony that is competent, relevant, and uncontradicted * * *.
- 34 -
[*34] D. Evidence submitted after trial
1. The Larkins’ motion to supplement the record
The documents we must address in connection with the Larkins’ third
motion to supplement the record11 all pertain to their claimed foreign tax credit
carryover. The documents are: (1) a letter from the IRS to the Larkins dated
December 15, 2015, regarding their Form 1040 for 2007 and enclosing a Form
4549, “Income Tax Examination Changes”, reflecting that the IRS “will fully
reduce the tax shown above, along with any related penalties and interest”; (2) the
SNODs issued to the Larkins in April 2008 and March 2009, covering their tax
years 2003 through 2006; and (3) the Larkins’ answering brief before us in
Larkin I.
The Larkins argue that the IRS’s letter and Form 4549 support their position
“that the tax returns filed in 2008 (and 2009 and 2010) were filed in good faith and
to the best of Petitioners’ ability given the fact that they did not have the ‘final’
return for 2007.” They assert with respect to the SNODs and answering brief that
“one cannot say or argue that Petitioners were negligent in preparing their 2008
11
Two of the documents the Larkins offered--a form from HM Revenue &
Customs and a letter from PriceWaterhouseCoopers LLC--pertain to an issue that
the Commissioner has conceded. As for these documents, the motion to reopen
the record is now moot and we do not address them further.
- 35 -
[*35] tax returns when they did not know the precise amount of Foreign Tax
Credits that were available when their 2008 tax return was filed * * * [and that
these documents] put[] in context Petitioners [sic] belief as to the Foreign Tax
Credit that was available to them for 2008.” The Larkins acknowledge that they
filed a 2007 tax return that “sought a Foreign Tax Credit, and the Credit was
allowed.” As reflected in the Form 4549, the amount of FTC allowed was
$135,411, an amount that corresponded exactly with the amount of the Larkins’
reduced tax liability. The recomputation of the Larkins’ tax liability for 2007
detailed in the form does not show the reasons for the adjustments, the
computation of the FTC applied to their tax liability for 2007, or whether any FTC
remains to carry forward.
Whether to reopen the record to receive additional evidence is a matter
within the discretion of the trial court. Zenith Radio Corp. v. Hazeltine Research,
Inc., 401 U.S. 321, 331 (1971); Butler v. Commissioner, 114 T.C. 276 (2000),
abrogated on other grounds by Porter v. Commissioner, 132 T.C. 203, 206-208
(2009). A motion to reopen the record will not be granted unless, among other
requirements, the evidence relied on: is not merely cumulative or impeaching, is
material to the issues involved, and probably would change the outcome of the
case. Butler. v. Commissioner, 114 T.C. 287. We also take into account other
- 36 -
[*36] factors, such as “the character of the additional * * * [evidence] and the
effect of granting the motion”. See Purvis v. Commissioner, T.C. Memo. 2020-13,
at *30 (quoting SEC v. Rogers, 790 F.2d 1450, 1460 (9th Cir. 1986)). For the
following reasons, we will deny the Larkins’ motion.
2. Delay
The Larkins were granted two continuances of their trial. After trial they
moved to reopen the record, and the Court directed the Commissioner to cooperate
with the Larkins, resulting in the filing of a supplemental stipulation. They filed a
second motion to reopen the record, with an equivalent result. The Larkins’ third
motion to supplement the record was filed simultaneously with their reply brief--
when the Commissioner’s opportunity to respond to such evidence under the
existing briefing schedule was foreclosed. The Larkins have been given
remarkable latitude for preparing and presenting their case. This final additional
request is well past the breaking point.
In their motion the Larkins seem to argue, in effect, that they were surprised
by a new contention made by the Commissioner in his post-trial answering brief
(and that they ought therefore to be allowed to put on evidence to counter that
contention). The new contention supposedly raised by the Commissioner was that
the absence in this case of evidence regarding the Larkins’ earlier tax years
- 37 -
[*37] (involved in Larkin I) results in the Larkins’ having failed to substantiate the
foreign tax credit carryover calculated for those earlier years and therefore having
failed to demonstrate the carryover available for 2009. The Larkins argue that the
Commissioner changed course and “is essentially taking the position that the
information about the prior tax years is relevant” to the foreign tax credit issue
with respect to the deficiency for each year as well as the applicable penalties.
In fact, the Commissioner’s pretrial memorandum, filed more than two
weeks before trial, had stated succinctly: “[T]he materials that have been provided
by the petitioners to the respondent are incomplete and unclear in showing the
payment history of claimed foreign tax payments.” (Emphasis added.) And even
if the Commissioner had not so stated, it remains true (as we explain below in
part V) that a taxpayer claiming a carryover of a foreign tax credit must establish
both the existence of the credit and the amount of any credit that remains (after
application to previous years) to be carried over to the year at issue. Inherent in
the Larkins’ own claim of a credit carryforward--whatever the Commissioner may
or may not have stated before trial--is the Larkins’ obligation to prove that the
credit arose in past years and was not entirely applied in past years. They cannot
have been surprised or prejudiced when the Commissioner argued that they had
failed to do so.
- 38 -
[*38] Before any audit or litigation, the Larkins had a duty to maintain records to
substantiate their return positions. See 26 C.F.R. sec. 1.6001-1(e), Income Tax
Regs. (“books or records * * * shall be retained so long as the contents thereof
may become material in the administration of any internal revenue law”); see also
Bailey v. Commissioner, T.C. Memo. 2012-96, 2012 WL 1082928, at *17 (“There
is no provision in section 6001 or the regulations thereunder that excuses
taxpayers from retaining their records if the IRS fails to notify them of an
imminent challenge”), aff’d, No. 13-1455, 2014 WL 1422580 (1st Cir. 2014). The
presence of the FTC carryforward issue in this case from its onset belies the
Larkins’ assertion that the presence or absence of documentation to substantiate
the carryforward (or an alleged excuse for the lack thereof) is somehow newly
relevant. They present no valid justification for their delay in offering evidence.
To allow the Larkins to supplement the record with these documents at this
juncture would not serve the interests of justice. Cf. Fiedziuszko v.
Commissioner, T.C. Memo. 2018-75, at *26 (finding justice by reopening the
record to address a section 6751(b) issue when the state of the law on that issue
had changed after the record closed and neither party had notice of or raised the
issue during the proceedings), aff’d, 796 F. App’x 947 (9th Cir. 2020). The effect
of granting the motion would be unfair to the Commissioner, since it would allow
- 39 -
[*39] these documents to come into the record after he litigated an entire case
through trial and post-trial briefing. See Purvis v. Commissioner, T.C. Memo.
2020-13, at *30-*31.
3. Materiality
Even if the Larkins could show that their need for evidence related to the
FTC carryforward was not apparent before trial, we would deny their motion. We
should reopen the record only where the proffered evidence is material rather than
cumulative or impeaching, see Butler v. Commissioner, 114 T.C. 287;
reopening the record is generally not warranted unless the evidence offered will
have a probable impact on the outcome of the case. Relevancy alone is not
enough to meet the materiality standard to reopen the record; rather, the Court
“will not grant a motion to reopen the record unless * * * the evidence probably
would change the outcome of the case.” Id. at 286-287. The Larkins have not
shown the materiality that is required before we could grant their request to reopen
the record.
The documents the Larkins now ask us to admit do not add anything
material to whether they are entitled to an FTC carryover or should be liable for
any penalty arising from claiming an FTC carryover. The SNODs are simply
cumulative of Mr. Larkin’s testimony that the earlier years were under
- 40 -
[*40] examination, which (he says) left him in an uncertain position in the
preparation of his returns for the years at issue. We address this argument below
in part VII and show that, as a matter of law, it is unavailing. Moreover, as a
matter of fact the contention that when the return was due Mr. Larkin could not
compute his FTC carryover is self-contradicted, because he unequivocally took the
position at trial that the FTC carryover to 2009 could be calculated using the
information from his 2007 and 2008 returns and Schedules K-1 from SSD for the
years at issue. Therefore the Larkins cannot persuasively argue that uncertainty in
their allowable foreign tax credit for years before 2007 prevented them from
making a claim, on the basis of the information available to them at the time they
prepared their returns for the years at issue, for an FTC carryover to 2009--
particularly when they did in fact make such a claim.
The IRS Form 4549 showing that $135,411 of FTC was used and allowed in
2007 likewise has little bearing on this case; it shows that the Larkins apparently
had sufficient information to claim an FTC for 2007 that was ultimately allowed.
They now argue that to claim the FTC for a later year was impossible and yet that
they are entitled to it. Because the Form 4549 contains no information about the
computation of the FTC or whether any remains to carry forward, see 26 C.F.R.
- 41 -
[*41] sec. 1.905-2(a)(2), Income Tax Regs., this document cannot serve the
purpose of substantiating the credit.
The information offered does not justify reopening the record under the
considerations set forth in Butler v. Commissioner, 114 T.C. 286-287. For these
reasons we will deny the Larkins’ third motion to supplement the record and will
grant the Commissioner’s motion to strike any references in the Larkins’ reply
brief to the material that was the subject of the motion.
II. Schedule A deductions
Taxpayers who itemize their deductions are allowed to deduct interest paid
during the taxable year with respect to certain types of indebtedness. Sec. 163.
A. Mortgage interest12
1. General principles
Section 163(h)(3) provides that interest on a qualified residence is
deductible by non-corporate taxpayers. Qualified residence interest encompasses
interest payments on two types of debt: acquisition indebtedness and home equity
indebtedness. Sec. 163(h)(3)(A). “Acquisition indebtedness” generally means
debt incurred in, or that results from the refinancing of debt incurred in,
12
Cf. Larkin I, at *62-*64 (holding that home mortgage interest deducted for
the years 2003-06 was not substantiated); Larkin II, 2020 WL 2301462, at *1
(affirming).
- 42 -
[*42] “acquiring, constructing, or substantially improving” a qualified residence.
Sec. 163(h)(3)(B)(i). “Home equity indebtedness” generally means indebtedness,
other than acquisition indebtedness, that is secured by a qualified residence and
that does not exceed the difference between the home’s fair market value and the
amount of acquisition indebtedness. Sec. 163(h)(3)(C)(i).
The deduction for interest on a qualified residence is subject to a $1 million
limit for “[t]he aggregate amount treated as acquisition indebtedness for any
period” and a $100,000 limit for “[t]he aggregate amount treated as home equity
indebtedness for any period”. Secs. 163(h)(3)(B)(ii), (C)(ii).
2. Analysis
The Larkins contend that they are entitled to additional mortgage interest
deductions for 2008 and 2010.
a. 2008
For 2008 the SNOD allowed interest payment deductions for $24,270, an
amount reported by third parties. The Larkins argue they are entitled to an
- 43 -
[*43] additional mortgage interest deduction in the amount of $28,667.13 The
mortgage interest deduction for 2008 is not properly at issue. See supra part I.B.1.
b. 2010
The Larkins claim they are entitled to deduct $6,673 of mortgage interest for
2010. However, the account statements lack sufficient details to prove the interest
paid was for acquisition indebtedness or home equity on a qualified residence, and
therefore the Larkins are not entitled to a deduction.
B. Investment interest14
Personal interest is nondeductible unless it falls under one of the exceptions
enumerated in section 163(h)(2), which allows for the deduction of “investment
13
The Larkins attempt to substantiate their position by documentary
evidence consisting of a letter with an interest payment schedule and several bank
statements from Bank Leumi. Though the letter refers to the loan as a “mortgage
loan”, there is no evidence to indicate whether the underlying debt is the type of
debt allowed--i.e., acquisition indebtedness or home equity indebtedness. The
evidence the Larkins provided also fails to establish that the loan is for a qualified
residence within the meaning of section 163. (Contrary to their argument, the
bank’s action of addressing the letter to their “home address” does not substantiate
this point.) Moreover, the Larkins improperly attempt to deduct 100% of the
interest payments from the loan even though the amount of indebtedness--i.e.,
$2.43 million, after applying the stipulated exchange rate--is over the $1 million
limit provided by section 163(h)(3). See sec. 163(h)(3)(B)(ii), (C)(ii); sec.
1.163-10T, Temporary Income Tax Regs., 52 Fed. Reg. 48410 (Dec. 22, 1987).
14
Cf. Larkin I, at *56 (holding that investment interest claimed for each of
the years 2003-06 was not substantiated); Larkin II, 2020 WL 2301462, at *1
(affirming).
- 44 -
[*44] interest”. Investment interest is defined as interest which is paid or accrued
on indebtedness properly allocable to property held for investment. See sec.
163(d)(3). An individual’s deduction for investment interest expenses cannot
exceed his net investment income. Sec. 163(d)(1).
1. The Larkins’ brief vs. the Larkins’ “Table 1”
After conceding some of what they reported on their returns, the Larkins
contend in their post-trial brief “that the entities to whom they did make payments
of investment interest are Bank of America, Blackhorse, Coutts and Fidelity
(IRA). These amounts total $15,760, $25,730 and $24,875 for the years 2008,
2009 and 2010 respectively.” However, the Larkins’ own chart setting out their
alleged investment interest (in “Table 1” attached to the same brief) says radically
otherwise. The chart does list amounts of interest allegedly attributable to those
four named entities (and to Larmodt LLC and Treetops LLC); however, the yearly
totals are not as the Larkins state in their briefs but instead are much lower--i.e.,
$10,333, $10,160, and $15,461. The larger amounts in the brief are unexplained
and unsubstantiated, and we consider further only the smaller amounts in Table 1--
and only the amounts for 2009 and 2010, since investment interest for 2008 is not
properly at issue. See supra part I.B.1.
- 45 -
[*45] 2. Interest paid via Larmodt LLC and Treetops LLC
The Larkins’ chart of investment interest on Table 1 includes their shares of
the interest payments by Larmodt LLC, which account for $5,278 for 2009 and
$6,150 for 2010. These are the amounts that were allowed in the SNOD and that
the parties have stipulated are attributable to the Larkins’ ownership interests in
Larmodt LLC. Accordingly, regarding these items there is no dispute that we are
called upon to resolve.
3. Four other entities
As we noted above, the Larkins’ chart of investment interest on Table 1
includes alleged payments to four other entities (although some of the amounts are
described on that chart as interest “charged”, not “paid”). The substantiation that
the Larkins proffer for the investment interest claimed as paid to the other four
entities consists of monthly statements from those entities. While the Court
accepts that the Larkins may have made payments to these financial institutions,
the Larkins did not prove that the payments were within the exception set forth in
section 163(h)(2)(B), i.e., “investment interest (within the meaning of
subsection (d))”. The Larkins admit in their post-trial reply brief that “Petitioners
did not provide a detailed tracking of the borrowed money to a particular
investment” and instead rely on Mr. Larkin’s testimony to substantiate their
- 46 -
[*46] deduction. His testimony was not convincing; and accordingly, the Larkins
failed to substantiate any investment interest deductions claimed in excess of the
amounts respondent already allowed for 2009 and 2010.
C. Taxes15
Section 164(a)(1) allows a deduction for “State and local, and foreign, real
property taxes” paid within the taxable year; and section 164(a)(3) allows a
deduction for “State and local, and foreign, income * * * taxes.” The Larkins
claim they are entitled to additional itemized deductions for taxes paid in the
amounts of $3,465 for 2008, $2,508 for 2009, and $2,060 for 2010. The tax
deduction for 2008 is not properly at issue. See supra part I.B.1.16 For the reasons
discussed here, we hold the Larkins are not entitled to additional deductions for
taxes for 2009 and 2010:
15
Cf. Larkin I, at *64-*65 (holding that local real estate taxes reported for
2003 and 2004 were substantiated); Larkin II, 2020 WL 2301462, at *3
(affirming).
16
Documentation generated by SSD (an entity in which Mr. Larkin was a
partner but which we do not assume he controlled) showing tax payments it made
for 2008 supports the Larkins’ position that they paid State and local taxes of
$7,136, and we find that they did pay this amount as withheld and paid over by
SSD. However, this amount is less than the $8,876 deduction for taxes that was
allowed in the SNOD.
- 47 -
[*47] 1. 2009
In their opening post-trial brief the Larkins claimed a total of $8,927 in
deductible taxes for 2009. On audit respondent had allowed a deduction of only
$6,419 for taxes paid by the Larkins--consisting of $6,119 in State and local taxes
(which we find substantiated by an SSD document reporting $6,015, which the
Larkins describe as “Squire Sanders 2009 Tax Return Schedule 4 State and
Municipal Non-Resident Taxes Withheld on behalf of D. Larkin” (emphasis
added)) and $300 in personal property tax. The Larkins claimed they were entitled
to an additional deduction for the difference, i.e., an additional $2,508 for taxes
paid. Their Table 1 listed this additional amount as “Squire Sanders 2009 Tax
Return Schedule 6 Municipal Tax paid and charged to D. Larkin.” (Emphasis
added.) As the Commissioner points out in his answering brief, the documentation
on which the Larkins rely explicitly states that the amount was “to be used for city
resident tax credit purposes only and do[es] not represent federal income tax
deductions.” In their reply brief, the Larkins attempt a different approach:
Petitioners have put forth support for an additional “income tax”
deduction of $6,015, not additional real estate taxes. (Ex. 7-P #263).
Petitioners concede the nondeductibility of the additional $2,912 of
income taxes previously claimed. As a result, this Court should allow
the additional $6,015 of income taxes, plus the amount of $6,119 in
real estate taxes previously allowed for a total of $12,134.
- 48 -
[*48] But their proof for this supposed “additional ‘income tax’ deduction” is the
only visible proof that supported the IRS’s allowance in the SNOD.17 The Larkins
have no additional proof of any further income tax deduction, and we allow
nothing more than the SNOD allowed.
2. 2010
On Schedule A of their Form 1040 for 2010, the Larkins claimed a
deduction for State and local taxes of $2,305, which the SNOD did not disallow,
and which the Commissioner concedes. Table 1 in their opening brief shows that,
as for 2009, this deductible amount corresponds to “Squire Sanders 2010 Tax
Return Schedule 4 State and Municipal Non-Resident Taxes withheld on behalf of
D. Larkin”. (Emphasis added.) However, the Larkins also claimed on their 2010
return a real estate tax deduction of $5,400, which was disallowed in the SNOD
and as to which “Petitioners concede that they have no additional documentation
to support the $5,400 of real estate taxes claimed.”
Instead, the Larkins now attempt to claim an additional $2,060 deduction
for income tax by referring (as they originally did for 2009, before conceding it) to
17
The Larkins’ current attempted characterization of the $6,119 deduction is
contradicted by their own Schedule A. The $6,119 deduction that the IRS allowed
is clearly placed beside “state and local taxes” on Schedule A, rather than “real
estate taxes” (a section filled in with the amount of $5,400, which was
disallowed), as the Larkins now claim.
- 49 -
[*49] a “Squire Sanders 2010 Tax Return Schedule 6 Total Allocable Taxes paid
by firm and charged to D. Larkin.” (Emphasis added.) The Commissioner’s
answering brief demonstrated (as it did for 2009) that the 2010 documentation on
which the Larkins relied for that argument explicitly states that the amount was “to
be used for city resident tax credit purposes only and do[es] not represent federal
income tax deductions. See Schedule 4 for state and municipal taxes that are
deductible for federal income tax purposes.”
In their reply brief, the Larkins fall silent as to reliance on the SSD
“Schedule 6” for an additional income tax deduction and seem to attempt to revive
a deduction for real estate tax of $5,400--acknowledging again that they lack
documentation for that amount but stating simply that they “believe that it is
consistent with real estate taxes for prior years.” They do not actually point to any
such amounts claimed for prior years; but even if they could do so, they would not
thereby substantiate a claim of real estate taxes paid in 2010.
The Larkins did not show entitlement to any deduction for income taxes or
real estate taxes beyond what the IRS allowed in the SNOD.
- 50 -
[*50] III. Schedule E rental real estate expenses18
A. Lack of substantiation
Sections 162 and 212 generally permit taxpayers to deduct ordinary and
necessary expenses paid or incurred in carrying on a trade or business or for the
production of income. The Larkins engaged in rental real estate activities, though
the quantum of those activities was extremely modest. They did not offer into
evidence documentation in the form of leases, rental agreements, receipts,
communications with tenants, depreciation calculations, or any type of records
substantiating expenses incurred in rental real estate activity for any of their
properties (the Belmont condominium in Chicago,19 the lake house in Wisconsin,20
18
Cf. Larkin I, at *61 (holding that rental expenses reported for 2003 were
not substantiated because no evidence showed such expenses were incurred and
paid or were attributable to property held for the production of income); Larkin II,
2020 WL 2301462, at *1-*2 (affirming). In Larkin I no issue was raised with
respect to the applicability of section 469.
19
The only residents of the Belmont property whom the Larkins identified
were their daughters. Moreover, on their untimely 2008 Form 1040 submitted to
the IRS, they reported a loss of $75,000 on the supposed sale of the Belmont
property, though they now assert that they did not sell the property in 2008.
20
The Larkins admit that they personally used the lake house--their “second
home”--for at least four to six weeks during each of the years at issue and that they
do not like to rent it out. They offered no evidence identifying any tenant; and
they allege only that they rented out the lake house for, “at most”, three weeks a
year.
- 51 -
[*51] a property in France, and a financial interest in the Denton Homes lot in
England21).
The Larkins did offer 2009 and 2010 Schedules K-1 for Larmodt LLC
issued to both Mr. and Mrs. Larkin, showing deductible expenses totaling $9,078
for 2009 and $11,116 for 2010. The parties have stipulated that the amounts of
“interest expense” reported by Larmodt LLC on these Schedules K-1 were the
amounts that the Commissioner did not disallow as investment interest for 2009
and 2010. We assume that the remainder of these amounts on the Schedules K-1
for Larmodt LLC was expended for the rental activities and was properly
reportable on Schedule E.22
21
The Larkins claim that after selling the Denton Homes lot in 2007 they
nonetheless retained an interest in the property and that they still hold a note on
the lot, which (they contend) “was part of Petitioners’ ‘real property, trades or
businesses’ pursuant to Internal Revenue Code Section * * * 469(c)(7)(C).”
However, on the untimely 2008 Form 1040 that they submitted to the IRS, they
reported a loss of $235,000 on the supposed sale of a “note from Denton Homes.”
22
The reporting of an item on a return does not substantiate that item. See
Lawinger v. Commissioner, 103 T.C. 428, 438 (1994) (“Tax returns do not
establish the truth of the facts stated therein”). However, because the evidence
does not show the identity or nature of the fifth unnamed partner of Larmodt LLC,
we cannot tell definitively whether it was a “small partnership” under section
6231(a)(1)(B), see supra note 4, or whether instead it might have been a TEFRA
partnership whose items we could not adjust in this deficiency case. Neither party
has made any contention nor put on any evidence as to whether TEFRA would bar
our disallowance of the deductions reported on the Schedules K-1 and claimed by
(continued...)
- 52 -
[*52] B. Section 469
However, even assuming that the Schedules K-1 substantiated expenses
related to those rental real estate activities, the Larkins’ claim of deductible losses
from those activities would founder on section 469: In the case of an individual or
entity listed in section 469(a)(2), section 469 disallows any current deduction for a
passive activity loss. Sec. 469(a)(1), (b). A passive activity loss is equal to the
aggregate losses from all of the taxpayer’s passive activities minus the aggregate
income from all passive activities. Sec. 469(d)(1). Generally, a passive activity is
any trade or business in which the taxpayer does not materially participate, see sec.
469(a)(1), (c)(1); and rental activity (i.e., any activity where payments are
22
(...continued)
the Larkins at trial. One approach we might take is simply to impose on the
Larkins--who are the proponents of the Schedules K-1--the burden of showing the
facts that, under TEFRA, would require us to honor Larmodt LLC’s apparent
reporting of these items. Since they failed to do so, we could find that TEFRA
does not apply and could simply disallow the deductions as unsubstantiated. Cf.
Larkin II, 2020 WL 2301462, at *1 (“The Larkins also assert various conclusory
legal positions without citing any source of law, as when they claim, without
support, that * * * their rental cost deduction is ‘a large partnership item entitled to
deference’”). However, we instead effectively assume (in part III.A) that
Larmodt LLC was a TEFRA partnership, and that these amounts constitute
partnership items, the reporting of which we cannot adjust in this deficiency case;
but we find (infra part III.B) that even if we honor Larmodt LLC’s reporting on its
Schedules K-1, the items when passed through to the Larkins are not deductible
for them at the individual partner level.
- 53 -
[*53] principally for the use of tangible property, sec. 469(j)(8)) is generally a per
se passive activity, see sec. 469(c)(2).
An exception to that general rule is found in section 469(c)(7), which
exempts the rental activity of the taxpayer from the definition of passive activity
under section 469(c)(2) but continues to treat rental real estate activity as a trade
or business subject to the material participation requirements of section 469(c)(1).
The taxpayer will qualify for this exception (as a “real estate professional”, in the
non-statutory lingo of the caselaw) if: (1) more than one-half of the personal
services performed in trades or businesses by the taxpayer during the taxable year
is performed in real property trades or businesses in which she materially
participates and (2) the taxpayer performs more than 750 hours of services during
the taxable year in real property trades or businesses in which the taxpayer
materially participates. Sec. 469(c)(7)(B). A taxpayer materially participates in an
activity “only if the taxpayer is involved in the operations of the activity on a basis
which is--(A) regular, (B) continuous, and (C) substantial.” Sec. 469(h)(1).
With respect to the evidence that may be used to establish hours of
participation, 26 C.F.R. section 1.469-5T(f)(4), Temporary Income Tax Regs., 53
Fed. Reg. 5727 (Feb. 25, 1988), provides:
- 54 -
[*54] The extent of an individual’s participation in an activity may be
established by any reasonable means. Contemporaneous daily time
reports, logs, or similar documents are not required if the extent of
such participation may be established by other reasonable means.
Reasonable means for purposes of this paragraph may include but are
not limited to the identification of services performed over a period of
time and the approximate number of hours spent performing such
services during such period, based on appointment books, calendars,
or narrative summaries.
The regulation quoted above does not allow a party to rely on a post-event
“ballpark guesstimate” or unverified, undocumented testimony. See Moss v.
Commissioner, 135 T.C. 365, 369 (2010); Lum v. Commissioner, T.C. Memo.
2012-103, 2012 WL 1193182, at *4.
Petitioners argue that Mrs. Larkin is a “real estate professional” who
qualifies for the material participation exception applicable to the passive activity
loss limitation for rental real estate activity as defined in section 469(c)(7)(B).
Although she identified herself as a “homemaker” on their tax return for each of
the years at issue, petitioners contend that Mrs. Larkin devoted a substantial
amount of time to managing the aforementioned properties, that this time
constituted more than half of her professional services, that she materially
participated in the management of the property, and that the time devoted to the
real estate activity exceeded 750 hours--nearly 15 hours per week--for each of the
years at issue. Remarkably, Mrs. Larkin did not testify about her supposed
- 55 -
[*55] engagement in this activity. Rather, to support their claim, petitioners rely
on Mr. Larkin’s testimony and a non-contemporaneous summary time log23
prepared for purposes of trial.
This evidence is insufficient to satisfy the requirements of section 469. The
time log, created in response to discussions with respondent, was allegedly the
result of Mr. Larkin’s review of emails, notes of board meetings, and other
primary sources. Yet the Larkins did not offer into evidence those underlying
documents. The time log did not qualify as a record of a regularly conducted
activity for purposes of Rule 803(6) of the Federal Rules of Evidence, nor as a
summary of those alleged underlying documents for purposes of Rule 1006.
Rather, the log was admitted into evidence only for demonstrative purposes. We
find that this evidence is exactly the type of post-event “ballpark guesstimate” that
we disapproved in Moss v. Commissioner, 135 T.C. 369 (“the regulations do
not allow a post-event ‘ballpark guesstimate’”).
23
Petitioners’ time log, which was admitted solely as a demonstrative
exhibit, summarizes the hours that the Larkins allegedly spent managing their
investments and indicates that the time Mrs. Larkin spent managing petitioners’
four property interests totaled 764 hours in 2008, 792 hours in 2009, and 772 in
2010. The “log” contains no description of how these hours were spent, allocating
only a certain number of hours per property per month. Its information is bare and
devoid of detail, as was Mr. Larkin’s testimony on this issue.
- 56 -
[*56] Since Mrs. Larkin fails to meet the 750-hour requirement, it is not
necessary to address the “more than one-half of personal services” requirement or
to discuss the subsequent analysis of material participation in the light of the
Larkins’ failure to make the election to treat all of their real estate activities as one
activity. See sec. 469(c)(7)(A); sec. 1.469-9(e)(1), (g), Income Tax Regs. Even if
the Court performed this analysis, we would find the evidence the Larkins
provided deficient for the reasons discussed above.
For all of these reasons, petitioners failed to shift the burden to respondent,
and their rental real estate activities must be treated as passive under
section 469(c)(2). See sec. 469(c)(7)(B)(ii). Therefore, they are not entitled to
deduct the losses for those real estate activities shown on their Schedules E in
2008, 2009, and 2010.
IV. Self-employed health insurance
A self-employed taxpayer may deduct health insurance costs paid for
medical care for himself and his family, subject to the special rules of
section 162(l). Pursuant to section 162(l), the deduction may not exceed the
“taxpayer’s earned income (within the meaning of section 401(c)) derived by the
taxpayer from the trade or business with respect to which the plan providing the
medical care coverage is established.” Sec. 162(1)(2)(A).
- 57 -
[*57] The Larkins claim deductions for health insurance premiums of $15,700 for
2009 and $12,700 for 2010. (Respondent conceded that the Larkins are entitled to
self-employed health insurance deductions for 2008 in the amount they claimed
and, for the other years, in the amounts for which the Larkins proffered receipts
showing payment--i.e., $7,178 for 2009 and $2,192 for 2010.) The Larkins admit
they lack records that reflect the full amounts of their claimed deductions for 2009
and 2010. However, without specifically citing Cohan, they argue that Court
should allow in full the deductions claimed since (the Larkins contend) they
proved that they spent some amounts on health insurance and the deductions they
seek are reasonable.
We find that the Larkins did not prove that they spent the amounts on health
insurance claimed. While Cohan does allow the Court to estimate an otherwise
allowable deduction for self-employed health insurance, the Larkins’ receipts did
not indicate consistent payments and did not show coverage during the entire year,
and the Larkins did not provide a sufficient explanation for how they calculated
the amounts they reported for 2009 and 2010. We hold that, even under the more
flexible standard provided by Cohan, the Larkins failed to present sufficient
evidence to substantiate the amounts reported. See Williams, 245 F.2d at 560.
- 58 -
[*58] V. Foreign tax credit24
Section 901(a) generally allows a taxpayer FTCs for foreign income taxes
paid, subject to the limitation imposed by section 904, which in turn limits the
credit to the amount of U.S. tax on foreign income. See generally secs. 901, 904.
An FTC is allowed only to the extent that the taxpayer can prove it was “paid or
accrued” with respect to income from sources without the United States. Section
905(b)(1) and (2). Even if a taxpayer proves payment of foreign tax, a credit for
the tax for a particular year may be limited by section 904(a); however, a taxpayer
may carry back to the first preceding taxable year or carry forward to any of the
first 10 succeeding taxable years any excess foreign tax paid or accrued for the
year at issue. Sec. 904(c). The Larkins’ only claim in this case as to an FTC is
that for 2009 they are entitled to a carryforward credit of $16,207 arising from an
alleged carryover from prior years. On this issue, the Larkins rely on Mr. Larkin’s
24
In Larkin I, at *71-*73, the Commissioner conceded that the Larkins “paid
income taxes to the U.K. aggregating £218,914 during FYE March 31, 2000,
2001, and 2002.” However, we found in that case that the Larkins failed to
substantiate the existence of a credit that could be carried over to the subsequent
years 2003, 2004, 2005 and 2006. Id. at *72-*73 (“A taxpayer claiming a
carryover of a credit must establish both the existence of the credit and the amount
of any credit that may be carried over to a subsequent year”); cf. Larkin II, 2020
WL 2301462, at *1-*3 (affirming). There, as here, the only substantiation offered
with respect to an FTC carryover was the Larkins’ uncorroborated assertion that
the tax was paid in a past year and they should receive a carryover credit.
- 59 -
[*59] testimony for the proposition that using the 2007 and 2008 returns, along
with the 2008 Schedule K-1 for SSD, the FTC “can be calculated”.
The Larkins suggest that unresolved issues from prior years at the alleged
time of filing, combined with Mr. Larkin’s status as a partner in a business doing
business overseas and the method of SSD’s payment of foreign income taxes,
makes it “reasonable to conclude that [p]etitioners paid foreign income taxes and
that the amount claimed is reasonable.” However, mere “reasonable[ness]” in a
party’s contentions is not the standard for substantiating FTCs (nor the standard
for shifting the burden of proof to the Commissioner). A taxpayer claiming an
FTC carryover must establish both the existence of the credit and the amount of
any credit that remains (after application to previous years) to be carried over to
the year at issue. See Rule 142(a)(1); Segel v. Commissioner, 89 T.C. 816, 842
(1987); cf. Keith v. Commissioner, 115 T.C. 605, 621 (2000). Such credit shall be
allowed “only if the taxpayer establishes to the satisfaction of the Secretary--(1)
the total amount of [non-U.S. sourced] income * * * , (2) the amount of [non-U.S.
sourced] income derived from each country, [and] the tax paid or accrued to which
is claimed as a credit * * * , and (3) all other information necessary for the
verification and computation of such credits.” Sec. 905(b).
- 60 -
[*60] The “[c]onditions [imposed by the Secretary] of allowance of credit”
pursuant to section 905 are, in relevant part:
[T]o claim the benefits of the foreign tax credit, the claim for credit
shall be accompanied by Form 1116 in the case of an individual * * *.
* * * The form must be carefully filled in with all the information
called for and with the calculations of credits indicated. Except
where it is established to the satisfaction of the district director that it
is impossible for the taxpayer to furnish such evidence, the taxpayer
must provide upon request the receipt for each such tax payment if
credit is sought for taxes already paid * * * .
26 C.F.R. sec. 1.905-2(a), Income Tax Regs. (emphasis added). Other than the
Forms 1116 submitted with the Larkins’ tax returns for 2008 and 2009, which are
devoid of any information as to how the FTCs claimed for those years were
calculated, there is no information in our record that might bear on the Larkins’
claim of an FTC carryover for 2009.
We find that the Larkins failed to substantiate the existence and amount of
the FTC with credible evidence. The documents that they advance in support of
their position fail to provide any specific amounts of foreign taxes that were paid
(and, relevant to the application of the limitation at section 904(d), fail to provide
any characterization of the income on which they were paid) in the relevant years.
The Larkins’ 2007 return is not in evidence, so we are unable to ascertain what
amount of credit was allowed for that year or how it was computed (nor is there
- 61 -
[*61] any other evidence to that effect).25 The Larkins’ Form 1040 for 2008,
though purporting to claim a credit of $16,785 and indicating on the attached
Form 1116 a “carryover” of credit, omits the “detailed computation” that the form
requires. Lastly, the Schedules K-1 from SSD for 2008, 2009, and 2010 shed little
light on whether the Larkins paid any amount of foreign tax for which they could
claim a carryover of credit for 2009. Instead, the Schedules K-1 contain the
following statement with respect to foreign taxes:
The Firm deducts foreign taxes in computing DNI, but they are not a
deduction in the computation of Ordinary Income and are required to
be stated separately. Depending on the individual partner’s tax
circumstances you may be able to claim a tax credit for this amount
(Form 1116). Any amount not creditable this year may be carried
back one year and forward for ten years.
Mr. Larkin’s Schedule K-1 for 2009 from SSD contains only a few items in Part II,
“Partner’s Share of Current Year Income, Deductions, Credits and Other Items”:
i.e., guaranteed payments of $372,149; self-employment earnings of $372,149;
distributions of $374,750; and, in the box for “foreign transactions”, the word
“various”. We find no indication as to any amounts that SSD actually paid for
foreign taxes on behalf of Mr. Larkin. (And the paragraph relating to foreign
25
Nor do the documents substantiate the amount(s) of the Larkins’ U.S. tax
liabilities for those years, another element necessary to show that they were
entitled to carry over specific amounts of FTC. See Larkin II, 2020 WL 2301462,
at *3.
- 62 -
[*62] taxes suggests that if Mr. Larkin paid them through SSD, they should appear
as a separately stated item on his Schedule K-1.)
The Larkins’ claim that a previous year’s unresolved issue was to blame for
any unclarity, or that the Court should allow a carryover simply because it was
allowed in a prior year, is unavailing. Each tax year stands on its own and must be
separately considered, and the Commissioner is not bound for any given year to
allow a deduction permitted for a prior year. See United States v. Skelly Oil Co.,
394 U.S. 678, 684 (1969); Pekar v. Commissioner, 113 T.C. 158, 166 (1999).
Petitioners did not provide sufficient documentation, calculations, or
evidence that substantiates the FTC carryover claimed for 2009. Because they
failed to prove they are entitled to an FTC, we will sustain the disallowance of this
credit.
VI. Section 6651(a)(1) additions to tax
Section 6651(a)(1) imposes an addition to tax for failure to file a return by
its due date unless the taxpayer demonstrates that the failure to file was due to
reasonable cause and not due to willful neglect. The addition to tax equals 5% of
the amount of tax required to be shown on the return, less any tax actually paid
(i.e., the amount of the tax that is due and not paid) for each month (or fraction
thereof) that the return is late, but may not exceed 25% in total. See sec.
- 63 -
[*63] 6651(a)(1), (b)(1). Thus, the maximum addition to tax is reached when a
return is five months late. Reasonable cause may exist if a taxpayer exercised
ordinary business care and prudence and was nonetheless unable to file a return
within the time prescribed by law. See 26 C.F.R. sec. 301.6651-1(c)(1), Proced. &
Admin. Regs. Willful neglect connotes “a conscious, intentional failure or
reckless indifference” with respect to timely filing. United States v. Boyle, 469
U.S. 241, 245 (1985). Respondent determined that the Larkins are liable for
additions to tax pursuant to section 6651(a)(1) for 2008, 2009, and 2010 for failure
to file timely.
The Commissioner bears the burden of production with respect to the
addition to tax under section 6651(a)(1). See sec. 7491(c); Higbee v.
Commissioner, 116 T.C. 446-447. To meet this burden, he must produce
sufficient evidence that it is appropriate to impose the addition to tax. Once the
Commissioner has met his burden, the burden of proof as to reasonable cause or
other mitigating factors shifts to the taxpayer. See Higbee v. Commissioner, 116
T.C. 447.
Even if the Larkins’ 2008 return, due December 2009, was (contrary to our
finding) filed in June 2011 on the date the Larkins allege it was mailed (i.e., about
18 months late), the maximum addition to tax had been reached well before that
- 64 -
[*64] date, at the time it was five months late. The Larkins’ 2009 return, due on
October 15, 2010, was filed on November 8, 2011 (more than 12 months late).
The Larkins’ 2010 return, due on Monday, October 17, 2011, was filed on
November 16, 2011 (one month late). Accordingly, respondent has met his burden
of production with respect to the additions to tax.
The Larkins argue that they are not liable for the additions to tax because
they had reasonable cause--i.e., their returns for previous years were under
examination by the IRS on the respective due dates for their 2008, 2009, and 2010
returns. But as the Larkins acknowledge, this Court has not found that open years
constitute a sufficient reason for finding reasonable cause for late filing. Accord
Denenburg v. United States, 920 F.2d 301, 306 n.10 (5th Cir. 1991) (stating that
an audit of a prior tax year was not sufficient to establish reasonable cause for late
filing of a subsequent affected year); see Estate of Duttenhofer v. Commissioner,
49 T.C. 200 (1967) (holding that taxpayer did not establish reasonable cause to
excuse late filing where there was pending estate litigation that might affect tax
liability at issue), aff’d, 410 F.2d 302 (6th Cir. 1969); Namakian v. Commissioner,
T.C. Memo. 2018-200, at *12 (“the pendency of litigation, even where the
decision for an earlier year may affect the determination of a taxpayer’s liability
for a later year, is not reasonable cause for failure to timely file”).
- 65 -
[*65] We hold that the Larkins did not have reasonable cause for the untimely
filing of their returns, and we sustain respondent’s determination that they are
liable for additions to tax under section 6651(a)(1) for 2008, 2009, and 2010.
VII. Accuracy-related penalty
Section 6662 imposes an “accuracy-related penalty” of 20% of the portion
of an underpayment of tax attributable to (among other things) the taxpayer’s
negligence or disregard of rules or regulations. Sec. 6662(a), (b)(1), (c).
A. 2008
Section 6664(b) provides: “The penalties provided in this part [i.e., title 26,
subtitle F, chapter 68, subchapter A, part II (“Accuracy-Related and Fraud
Penalties”, secs. 6662-6664)] shall apply only in cases where a return of tax is
filed”. The principal penalty for not filing a return is the addition to tax under
section 6651(a)(1) (discussed above). When a taxpayer fails to file a return, the
accuracy-related penalties (such as the negligence penalty at issue here) do not
apply.
Though the evidence is equivocal, we have found--as the Commissioner
contends--that the Larkins did not file a return for 2008. The Larkins contend that
they filed their return for 2008 around the same time they filed their other returns
at issue, “within about two weeks at the end of November, maybe into the first few
- 66 -
[*66] days of December, 2011.” The copy of the 2008 Form 1040 in evidence
reflects a handwritten date of “28 Oct 2011” but no conclusive indication on the
face of the document that it was submitted to or received by the IRS.26 The
Commissioner has submitted in evidence a Form 4340, “Certificate of
Assessments and Payments”, that reflects several entries commencing in
November 2011, that indicate an “amended return filed” for 2008; but the
Commissioner nonetheless repeatedly maintains in his brief that “[p]etitioners
failed to file a tax return (Form 1040) for tax year 2008.” The Commissioner
refers to the Form 4340 as evidence that the Larkins did not file a return for 2008,
and we accept his statement as to the meaning of the entries in his records. The
resolution of this issue bears only on the application of the accuracy-related
penalty determined by the Commissioner, an issue on which he bears the burden of
production under section 7491(c) and for which the non-filing of the 2008 return
is favorable to the Larkins. Having found, as the Commissioner insists, that the
Larkins did not file a return for 2008, we cannot sustain a negligence penalty for
2008.
26
Faded handwriting across the top of the return indicates “delinq. return
* * * [illegible] 8-23-12”.
- 67 -
[*67] B. 2009 and 2010
1. The Commissioner’s burden of production
Under section 7491(c), the Commissioner bears the burden of production
and must produce sufficient evidence that the imposition of the penalty is
appropriate in a given case--in this case, evidence that the underpayment is
attributable to negligence. Once the IRS meets this burden, the taxpayer must
come forward with persuasive evidence that the IRS’s determination is incorrect.
Rule 142(a); Higbee v. Commissioner, 116 T.C. 446-447.
a. Showing of negligence
Negligence can be either the lack of due care or the failure to act reasonably
under the circumstances. See Neely v. Commissioner, 85 T.C. 934, 947 (1985).
Negligence “includes any failure to make a reasonable attempt to comply with
* * * [the internal revenue laws]”, sec. 6662(c), including any failure by the
taxpayer to keep adequate books and records or to substantiate items properly, 26
C.F.R. sec. 1.6662-3(b)(1), Income Tax Regs. We find that the Larkins’
record-keeping was in disarray--to an extent that suggests either that they do not
keep adequate records to substantiate their income tax positions, or that such
records, if available, were not offered. The records that were offered, such as the
“log” of Mrs. Larkin’s time allegedly spent managing the Larkins’ real estate
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[*68] interests, are grossly inadequate to substantiate their contentions. In short,
the Larkins failed to timely report large amounts of income, and they claimed
substantial deductions for which they had either insufficient proof or no proof at
all. We find that they were negligent in the preparation of their returns for the
years for which the section 6662 accuracy-related penalty has been properly
determined--i.e., 2009 and 2010.
b. Supervisory approval
The Commissioner’s burden of production under section 7491(c) also
requires him to show that, in compliance with section 6751(b)(1), the immediate
supervisor of the individual IRS employee who made the “initial determination” of
the penalty approved that penalty in writing. See Graev v Commissioner, 149 T.C.
485. In this case the parties have stipulated that the supervisor gave his approval
10 months before the issuance of the SNOD; and the Larkins made no contention
that anyone in the IRS made any communication to them of an initial
determination before that approval. The Commissioner has therefore carried his
burden of production as to section 6751(b)(1). See Frost v. Commissioner,
154 T.C. ___, ___ (slip op. at 23) (Jan. 7, 2020).
The Larkins contend that the supervisor’s approval did not satisfy
section 6751(b)(1). They argue: “The clear implication under section 6751(b)(1)
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[*69] requiring the ‘immediate supervisor’ to have ‘personally approved (in
writing)’ the initial determination of the assessment of a penalty, is that the
supervisor actually have knowledge of facts to support a basis for the penalty”--
but in this instance (the Larkins maintain) it appears that the supervisor lacked
information and made unwarranted conclusions. That is, they would undermine
the penalty approval by showing that it was granted inappropriately.
However, the question under section 6751(b)(1) is simply whether the
supervisor in fact approved the penalty, not “the propriety of the Commissioner’s
administrative policy or procedure underlying his penalty determinations”,
Raifman v. Commissioner, T.C. Memo. 2018-101, at *61, nor whether the
supervisor “adequately contemplated the * * * [Larkins’] reasonable cause
defense”, id. at *60, nor any other aspect of the merits of the penalty
determination. The Larkins can make such merits challenges as a part of their
case, but not as a means of invalidating the IRS’s compliance with
section 6751(b)(1).
2. Reasonable cause and good faith
a. Standards
The section 6662(a) penalty is not imposed if a taxpayer can demonstrate:
(1) that he had reasonable cause for the underpayment and (2) that he acted in
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[*70] good faith. Sec. 6664(c)(1). Whether a taxpayer acted with reasonable
cause and in good faith is a facts-and-circumstances decision, and the most
important factor is the extent of the taxpayer’s efforts to assess his proper tax
liability. 26 C.F.R. sec. 1.6664-4(b)(1), Income Tax Regs. Also important is the
taxpayer’s knowledge and experience. Id. We find that Mr. Larkin’s professional
experience as an attorney who has spent a significant amount of his time in the
financial sector weighs against him in this regard.
A taxpayer may establish reasonable cause and good faith by demonstrating
reasonable reliance on the advice of an independent, competent professional
adviser as to the tax treatment of an item. See Neonatology Associates, P.A. v.
Commissioner, 115 T.C. 98. To prevail on this defense, a taxpayer must
establish that: (1) the adviser was a competent professional who had sufficient
expertise to justify reliance; (2) the taxpayer provided necessary and accurate
information to the adviser; and (3) the taxpayer actually relied in good faith on the
adviser’s judgment. Id. at 99.
b. The Larkins’ contentions
The Larkins contend that issues from previous years, misunderstandings
about the qualifications for certain deductions, their supposedly good-faith belief
that Mrs. Larkin qualified as a “real estate professional”, and the complexity of the
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[*71] Code combine to create sufficient reason to find reasonable cause for their
underpayments. Finally, the Larkins claim they sought the advice of
professionals.
c. Analysis
The Larkins did not make a plausible showing of reasonable cause and good
faith. Their record-keeping was in disarray; they failed to timely report large
amounts of income; they claimed substantial deductions for which they had no
proof at all and others for which their proof was insufficient.
The Larkins are sophisticated business people. Mr. Larkin is a highly
educated attorney with more than 20 years’ experience dealing in a variety of
complex transactional matters. He was certainly capable of keeping appropriate,
contemporaneous records, preparing detailed notes, and distinguishing personal
from business expenses, yet the evidence he used to substantiate their deductions
shows that he failed to make these efforts. Mr. Larkin disregarded instructions for
properly completing his returns, as evidenced by his failure to attach underlying
documents and the forms and calculations required to claim certain loss
deductions. Such inaccurate and misleading income tax reporting does not reflect
a reasonable attempt to comply with the Code.
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[*72] There is no evidence besides Mr. Larkin’s testimony that the Larkins sought
advice in the preparation of their returns. The evidence shows that Mr. Larkin did
little more than briefly consult with individuals at his place of employ; and he did
not say who those individuals were, what information the Larkins provided to
them, or what specific advice they supposedly gave. Moreover, Mr. Larkin clearly
assumed the ultimate responsibility for the preparation of his returns. Because the
Larkins have not met their burden to establish the relevant facts under
Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 98, we conclude that
their return positions were a product of Mr. Larkin’s decisions rather than those of
informed tax counsel.
We find the Larkins neither had reasonable cause nor acted in good faith
with regard to the positions they maintained on their returns. To the extent we
sustain respondent’s determinations, we also hold that the Larkins are liable for
the accuracy-related penalties for 2009 and 2010.
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[*73] Conclusion
The determinations in the IRS’s SNOD are sustained in part, as explained
above. So that the liabilities for the years at issue can be computed in light of this
opinion and of the parties’ concessions,
An appropriate order will be
issued, and decision will be entered
under Rule 155.