Bradley M. McGuigan & Shirley W. McGuigan v. Commissioner

T.C. Summary Opinion 2019-27
UNITED STATES TAX COURT
BRADLEY M. MCGUIGAN AND SHIRLEY W. MCGUIGAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10617-17S. Filed September 30, 2019.
Maris Baltins, for petitioners.
Patsy A. Clarke, Lisa R. Jones, and Melissa D. Lang, for respondent.
SUMMARY OPINION
VASQUEZ, Judge: This case was heard pursuant to the provisions of
section 7463 of the Internal Revenue Code in effect when the petition was filed.1
1
Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect at all relevant times, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
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Pursuant to section 7463(b), the decision to be entered is not reviewable by any
other court, and this opinion shall not be treated as precedent for any other case.
Respondent determined deficiencies of $2,770 and $5,168 in petitioners’
Federal income tax for 2014 and 2015, respectively. Respondent also determined
a section 6662(a) accuracy-related penalty of $1,033.60 for 2015.
The issues for decision are whether: (1) petitioner husband was an
independent contractor or a statutory employee entitled to report expenses on
Schedules C, Profit or Loss From Business, or a common law employee whose
expenses were reportable on Schedules A, Itemized Deductions, (2) petitioners are
entitled to deductions for legal and professional services, insurance (other than
health), and rent for vehicles, machinery, or equipment, and (3) petitioners are
liable for the section 6662(a) accuracy-related penalty for 2015.
Background
Some of the facts have been stipulated and are so found. The stipulation of
facts and the attached exhibits are incorporated herein by this reference.
Petitioners resided in Montana when they timely filed their petition.
During the years at issue petitioner Bradley M. McGuigan worked as a
diesel technology specialist. Before then Mr. McGuigan had worked off and on
for John Knerr for approximately 20 years. In or around 2012 Mr. Knerr partnered
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with Chad Pardee to form Pardee Excavating, LLC, which later became Montana-
Dakota Services, Inc. (MDS).2 Mr. Knerr invited Mr. McGuigan to work for
MDS, and he accepted.
Pursuant to an oral agreement with Mr. Knerr, Mr. McGuigan performed
gas recovery services for MDS at multiple oil well sites across Montana and North
Dakota. His duties included moving gas recovery equipment between oil well
sites, setting up and maintaining the equipment to recapture gas, and training oil
company employees to ensure continued plant operations. Much of the equipment
was leased directly to MDS, which entrusted it to Mr. McGuigan. Whenever Mr.
McGuigan needed assistance on a job, MDS sent additional workers to help him.
Mr. McGuigan worked at the oil sites without direct supervision. He set his
own hours, which varied with the task at hand. Each day Mr. McGuigan filled out
reports entitled “Montana-Dakota Services, Inc. Daily Production Reporting”.
These reports offered proof that Mr. McGuigan was providing quality service.
Additionally Mr. McGuigan submitted equipment logs to MDS secretaries,
who tracked the equipment from site to site. Because he performed gas recovery
2
In 2014 Pardee Excavating, LLC, brought in a new member and merged
with MDS. Mr. Knerr and Mr. Pardee were part owners of both entities, and Mr.
McGuigan kept the same employment agreement following this transition.
Accordingly, references to MDS are to both companies.
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services on site, he sometimes traveled hundreds of miles to do his job.
Accordingly, he worked away from home for approximately 300 days in 2014 and
270 days in 2015.
Under his agreement with MDS, Mr. McGuigan was responsible for work-
related expenses including food, lodging, travel, and insurance. He was also
responsible for any expenses arising from damage to the equipment during
transport. MDS did not reimburse him for these expenses. Additionally, he drove
his own truck to the various worksites and took his tools with him.
In 2014 Mr. McGuigan paid $2,000 to rent a forklift, which he used to move
certain equipment. MDS offered him a rollback truck to perform this task, but he
opted to use the forklift instead because it would make the job easier. MDS did
not reimburse him for the forklift expense.
When he was working on site at a refinery plant, the oil company trained
Mr. McGuigan to use its privately owned technology. Some of this information
was confidential. After speaking with an oil company representative about the
issue of privacy laws, Mr. McGuigan sought legal advice on avoiding trade secret
infringement disputes. Accordingly, he paid $1,500 and $2,500 for attorney’s fees
in 2014 and 2015, respectively. MDS did not reimburse him for these expenses.
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Petitioners timely filed joint Forms 1040, U.S. Individual Income Tax
Return, for both tax years at issue. Mr. McGuigan reported on the Forms 1040
that MDS paid him wages of $93,360 and $96,615 in 2014 and 2015, respectively.
Likewise, MDS issued Mr. McGuigan Forms W-2, Wage and Tax Statement, and
withheld Federal income tax.3 Petitioners used a computer program to prepare
their returns and file them electronically. They did not hire a tax preparer or an
accountant.
On the returns Mr. McGuigan declared himself a “mechanic” and petitioner
Shirley W. McGuigan declared herself “retired”. Mrs. McGuigan also listed
herself as a proprietor of “Jaws Northwest Corp.” on petitioners’ Schedules C for
2014 and 2015. Petitioners used these Schedules C to report the expenses related
to Mr. McGuigan’s employment with MDS under the premise that he was a
statutory employee.
On February 17, 2017, respondent mailed petitioners a notice of deficiency
with respect to tax years 2014 and 2015, disallowing their Schedule C deductions
for legal and professional fees, insurance (other than health), and rent expenses.
Respondent also recharacterized petitioners’ remaining Schedule C deductions as
3
The record includes a copy of Mr. McGuigan’s 2015 Form W-2, which
does not indicate in box 13 that Mr. McGuigan was a “Statutory Employee”. The
record does not include a Form W-2 for tax year 2014.
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unreimbursed employee expenses and moved them to Schedule A for each year at
issue.4
For 2015 respondent determined a penalty under section 6662(a) and (b)(2)
for an underpayment due to a substantial understatement of income tax. The
record includes Form 300, Civil Penalty Approval Form, signed by Revenue
Agent (RA) Kyle Crider’s group manager, who approved the RA’s initial
determination to impose the penalty for tax year 2015. The group manager’s
signature is dated January 6, 2017.
Discussion
I. Burden of Proof
Generally, the Commissioner’s determination of a deficiency is presumed
correct, and the taxpayer has the burden of proving it incorrect. Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933). However, under section 7491(a),
the burden of proof may shift to the Commissioner as to any factual issue relevant
to a taxpayer’s liability for tax if the taxpayer meets certain preliminary
conditions. See Higbee v. Commissioner, 116 T.C. 438, 442-443 (2001).
Petitioners have not claimed or shown that they meet the requirements of section
4
Other adjustments made in the notice of deficiency are computational and
need not be addressed in this opinion.
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7491(a) to shift the burden of proof to respondent as to any relevant factual issue.
Accordingly, the burden of proof remains on petitioners.
II. Employment Classification
A. General Rules
An individual performing services as an employee may deduct expenses
incurred in the performance of services as an employee as miscellaneous itemized
deductions on Schedule A to the extent the expenses exceed 2% of the taxpayer’s
adjusted gross income. See secs. 62(a), 63(a), (d), 67(a) and (b), 162(a). Itemized
deductions may be limited under section 68 and may have alternative minimum
tax implications under section 56(b)(1)(A)(i).
“An individual who performs services as an independent contractor is
entitled to deduct expenses incurred in the performance of services on Schedule C
and is not subject to limitations imposed on miscellaneous itemized deductions.”
Feaster v. Commissioner, T.C. Memo. 2010-157, slip op. at 5. A statutory
employee under section 3121(d)(3) is not an employee for purposes of section 62
and may deduct business expenses on Schedule C. See Rosemann v.
Commissioner, T.C. Memo. 2009-185, slip op. at 6-7 & n.3; see also Rev. Rul. 90-
93, 1990-2 C.B. 33.
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Petitioners argue that Mr. McGuigan was an independent contractor or a
statutory employee during the years at issue and was thereby entitled to deduct
business expenses on Schedules C. Respondent contends that Mr. McGuigan was
a common law employee who could deduct his unreimbursed employee expenses
on Schedules A only, subject to the 2% of adjusted gross income limitation.
An individual qualifies as a statutory employee under section 3121(d)(3)
only if the individual is not a common law employee pursuant to section
3121(d)(2). See Ewens & Miller, Inc. v. Commissioner, 117 T.C. 263, 269
(2001); Rosemann v. Commissioner, slip op. at 7. Section 3121(d)(2) provides
that an “employee” is “any individual who, under the usual common law rules
applicable in determining the employer-employee relationship, has the status of an
employee”. Because an individual qualifies as a statutory employee only if the
individual is not a common law employee, we will first decide whether petitioner
was a common law employee of MDS.
B. Common Law Employee
The term “employee” is not defined for purposes of the income tax issue
before us; therefore, common law rules must be applied to determine whether an
individual is an employee. Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318,
322-323 (1992); Matthews v. Commissioner, 92 T.C. 351, 360 (1989), aff’d, 907
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F.2d 1173 (D.C. Cir. 1990); Simpson v. Commissioner, 64 T.C. 974, 984 (1975).
Whether an employer-employee relationship exists is a question of fact. Air
Terminal Cab, Inc. v. United States, 478 F.2d 575, 578 (8th Cir. 1973); Prof’l &
Exec. Leasing, Inc. v. Commissioner, 89 T.C. 225, 232 (1987), aff’d, 862 F.2d 751
(9th Cir. 1988). If an employer-employee relationship exists, its characterization
by the parties as some other relationship, such as principal-independent contractor,
is of no consequence. Sec. 31.3121(d)-1(a)(3), Employment Tax Regs.
This Court has enumerated the following factors in determining whether an
employer-employee relationship exists: (1) the degree of control exercised by the
principal over the details of the work; (2) which party invests in the facilities used
in the work; (3) the opportunity of the taxpayer for profit or loss; (4) whether the
principal has the right to discharge the taxpayer; (5) whether the work is part of
the principal’s regular business; (6) the permanency of the relationship; and (7) the
relationship the parties believe they are creating. Weber v. Commissioner, 103
T.C. 378, 387 (1994), aff’d per curiam, 60 F.3d 1104 (4th Cir. 1995); Prof’l &
Exec. Leasing, Inc. v. Commissioner, 89 T.C. 232; Simpson v. Commissioner,
64 T.C. 984-985. No single factor is dispositive. Simpson v. Commissioner, 64
T.C. 985. All of the facts and circumstances must be studied. Prof’l & Exec.
Leasing, Inc. v. Commissioner, 89 T.C. 232.
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1. Degree of Control
While all of the above factors are important, the “right-to-control” is the
“master test” in determining the nature of a working relationship. Matthews v.
Commissioner, 92 T.C. 361. Both the control exercised by the alleged employer
and the degree to which the alleged employer may intervene to impose control
must be examined. Radio City Music Hall Corp. v. United States, 135 F.2d 715,
717 (2d Cir. 1943); DeTorres v. Commissioner, T.C. Memo. 1993-161. “[N]o
actual control need be exercised, as long as the employer has the right to control.”
Prof’l & Exec. Leasing, Inc. v. Commissioner, 862 F.2d at 753. In order for an
employer to retain the requisite control over the details of an employee’s work, the
employer need not direct each step taken by the employee. Prof’l & Exec.
Leasing, Inc. v. Commissioner, 89 T.C. 234; Gierek v. Commissioner, T.C.
Memo. 1993-642.
The record does not indicate that Mr. McGuigan worked for any entity other
than MDS or hired his own subcontractors to assist him when he serviced MDS’
customers, as an independent contractor might. Rather, he performed gas recovery
services only for oil companies that were under contract with MDS. Whenever he
needed assistance on a job, MDS sent additional workers to help him. MDS
asserted control over Mr. McGuigan by requiring him to monitor the location of
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the gas recovery equipment he used. In addition, Mr. McGuigan submitted daily
reports to the oil companies as proof that MDS was providing the service for
which it was under contract.
Although Mr. McGuigan set his own hours and worked without direct
supervision, the record indicates that MDS had the right to control Mr. McGuigan
by dictating his worksite, monitoring the quality of his performance, and tracking
the equipment he needed to do his job. On the basis of the facts presented, this
factor indicates that Mr. McGuigan was an employee.
2. Investment in Facilities
The fact that a worker provides his or her own tools or goods generally
indicates independent contractor status. Ewens & Miller, Inc. v. Commissioner,
117 T.C. 271. Conversely, the fact that a worker has no investment in the
facilities used in the work is indicative of an employer-employee relationship. See
id.
During the tax years at issue Mr. McGuigan supplied his own tools and
transportation to accomplish his job at each oil well site. However, it is not clear
from the record how much he paid for these tools. In addition, Mr. McGuigan did
not invest financially in the transport, setup, or maintenance of the equipment he
used to provide gas recovery services. Rather, MDS and the oil companies paid
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for these essential expenses. Therefore, this factor indicates that Mr. McGuigan
was an employee.
3. Opportunity for Profit or Risk of Loss
An opportunity for profit or the risk of loss on the basis of the worker’s own
efforts and skill indicates independent contractor status. See Simpson v.
Commissioner, 64 T.C. 988; Rosato v. Commissioner, T.C. Memo. 2010-39,
slip op. at 13. In contrast, earning an hourly wage or fixed salary indicates an
employer-employee relationship. See Robinson v. Commissioner, T.C. Memo.
2011-99, slip op. at 17-18 (citing James v. Commissioner, 25 T.C. 1296, 1300
(1956)), aff’d, 487 F. App’x 751 (3d Cir. 2012). For example, in Juliard v.
Commissioner, T.C. Memo. 1991-230, this Court held that, because the taxpayer
earned a salary and was reimbursed for expenses, he was not in a position to
increase his profit by his own actions, and he was not at risk for loss.
For tax years 2014 and 2015, respectively, MDS paid Mr. McGuigan annual
salaries of approximately $93,000 and $96,000. The record indicates that Mr.
McGuigan earned his salary regardless of how well, or poorly, he performed his
duties. Additionally, the record does not show that he received incentive
compensation based on whether MDS increased its profits.
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On the other hand, Mr. McGuigan credibly testified that the requirement
that he pay for repairs on broken equipment could cause him significant losses.
Thus, Mr. McGuigan’s salary could be reduced by the amount he spent on work-
related expenses because MDS did not reimburse these costs. Overall, this factor
is neutral.
4. Right To Discharge
“The principal’s retention of the right to discharge a worker is indicative of
a common law employer-employee relationship.” Rodriguez v. Commissioner,
T.C. Memo. 2012-286, slip op. at 20 (citing Weber v. Commissioner, 103 T.C.
391); see also Ellison v. Commissioner, 55 T.C. 142, 152 (1970). The record is
silent on this factor. At most this factor is neutral.
5. Integral Part of Regular Business
A type of work that is part of the principal’s regular business is indicative of
employee status. See Simpson v. Commissioner, 64 T.C. 989; Rosemann v.
Commissioner, slip op. at 11. During the years at issue, MDS offered oil well
services to oil companies in North Dakota and Montana. MDS assigned Mr.
McGuigan to perform a specific service which the oil companies hired MDS to
provide. Accordingly, Mr. McGuigan provided a service that lies within the scope
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of MDS’ regular business. Therefore, this factor indicates that Mr. McGuigan was
an employee.
6. Permanency of Relationship
A continuing relationship indicates an employment relationship, while a
transitory relationship may be indicative of independent contractor status. See
Ewens & Miller, Inc. v. Commissioner, 117 T.C. 273; Rosemann v.
Commissioner, slip op. at 11.
We believe that the relationship between Mr. McGuigan and MDS was not
transient because Mr. McGuigan worked for MDS from 2012 through the years at
issue. Furthermore, Mr. Knerr, who was a member of MDS, had employed Mr.
McGuigan intermittently for approximately 20 years. On the basis of the facts
presented, this factor indicates that Mr. McGuigan was an employee.
7. Relationship the Parties Thought They Created
The withholding of taxes is consistent with a finding that an individual is a
common law employee. See Packard v. Commissioner, 63 T.C. 621, 632 (1975);
Rosato v. Commissioner, slip op. at 14. MDS provided Mr. McGuigan with
Forms W-2 for the years at issue. In both 2014 and 2015 MDS withheld Federal
income tax from Mr. McGuigan’s income and remitted those amounts to
respondent. MDS did not indicate on Mr. McGuigan’s 2015 Form W-2 that he
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was a statutory employee. On the basis of these facts, this factor indicates that Mr.
McGuigan was an employee.
8. Conclusion
Several of the above factors indicate that Mr. McGuigan was a common law
employee whereas other factors are neutral. After weighing these factors, the
Court concludes that Mr. McGuigan was a common law employee of MDS for the
2014 and 2015 taxable years. Therefore, he is precluded from claiming Schedule
C deductions as a statutory employee under section 3121(d) and the underlying
regulations. See Ewens & Miller, Inc. v. Commissioner, 117 T.C. 269; Colvin
v. Commissioner, T.C. Memo. 2007-157, slip op. at 28, aff’d, 285 F. App’x 157
(5th Cir. 2008); see also sec. 31.3121(d)-1, Employment Tax Regs.
III. Petitioners’ Schedule A Deductions
We next determine whether petitioners are entitled to deductions for
unreimbursed employee business expenses that respondent disallowed for lack of
substantiation.
A. General Rules
Deductions are a matter of legislative grace, and the taxpayer generally
bears the burden of proving entitlement to any deduction claimed. See Rule
142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial
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Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). A taxpayer claiming a deduction
on a Federal income tax return must demonstrate that the deduction is allowable
pursuant to a statutory provision and must further substantiate that the expense to
which the deduction relates has been paid or incurred. See sec. 6001; Hradesky v.
Commissioner, 65 T.C. 87, 89-90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir.
1976).
Section 162 allows a taxpayer to deduct all ordinary and necessary expenses
paid or incurred by the taxpayer in carrying on a trade or business; but personal,
living, or family expenses are not deductible. Secs. 162(a), 262(a). A trade or
business expense is ordinary if it is normal or customary within a particular trade,
business, or industry, and it is necessary if it is appropriate and helpful for the
development of the business. Commissioner v. Heininger, 320 U.S. 467, 471
(1943); Welch v. Helvering, 290 U.S. at 113-114.
A “trade or business” includes the “trade or business” of being an employee.
O’Malley v. Commissioner, 91 T.C. 352, 363-364 (1988); Primuth v.
Commissioner, 54 T.C. 374, 377-378 (1970). The taxpayer bears the burden of
establishing that his employer would not have reimbursed him for such expenses.
See Podems v. Commissioner, 24 T.C. 21, 22-23 (1955); Benson v.
Commissioner, T.C. Memo. 2007-113, slip op. at 9; Putnam v. Commissioner,
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T.C. Memo. 1998-285, slip op. at 8. He can do so by showing that he was
required or expected to bear these costs. See Fountain v. Commissioner, 59 T.C.
696, 708 (1973); see also Dunkelberger v. Commissioner, T.C. Memo. 1992-723
(finding that management team expected taxpayer to bear expense of business
lunches with vendors).
If the taxpayer is able to establish that he paid or incurred a deductible
expense but is unable to substantiate the precise amount, the Court generally may
approximate the deductible amount, but only if the taxpayer presents sufficient
evidence to establish a rational basis for making the estimate (Cohan rule). See
Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); see also Vanicek v.
Commissioner, 85 T.C. 731, 742-743 (1985). For certain kinds of business
expenses, including automobile expenses, section 274(d) overrides the Cohan rule.
See secs. 274(d), 280F(d)(4)(A)(i); Sanford v. Commissioner, 50 T.C. 823, 827-
828 (1968), aff’d per curiam, 412 F.2d 201 (2d Cir. 1969).
B. Legal and Professional Services
For 2014 and 2015, respectively, petitioners claimed deductions of $1,500
and $2,500 for legal and professional services. Respondent disallowed these
deductions in full for lack of substantiation.
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It is well established that legal fees stemming from a taxpayer’s employee
status are deductible on Schedule A. Test v. Commissioner, T.C. Memo. 2000-
362, slip op. at 14, aff’d, 49 F. App’x 96 (9th Cir. 2002). The deductibility
depends on the “origin and character” of the claim for which the legal fees were
incurred and whether the claim bears a sufficient nexus to the taxpayer’s business
or income-producing activities. See United States v. Gilmore, 372 U.S. 39, 49
(1963); Test v. Commissioner, slip op. at 11.
Mr. McGuigan’s testimony, which the Court found credible and forthright,
establishes that he sought legal advice on avoiding trade secret infringement after
an oil company representative advised him to do so. More specifically, the oil
company was MDS’ client, and MDS expected Mr. McGuigan to bear the cost of
his employment-related expenses. As a result, Mr. McGuigan paid $1,500 and
$2,500 in 2014 and 2015, respectively, to protect his employment as an oil
mechanic. Taking into account the record as a whole, the Court concludes that
these expenses originated in Mr. McGuigan’s conduct as an employee of MDS.
Therefore, petitioners are entitled to Schedule A deductions of $1,500 and $2,500,
respectively, for tax years 2014 and 2015.
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C. Rent of Vehicles, Machinery, or Equipment
For 2014 and 2015, respectively, petitioners claimed deductions of $9,856
and $3,600 for rent of vehicles, machinery, or equipment. Respondent disallowed
these expenses in full for lack of substantiation.
A portion of this reported expense for 2014 arises from Mr. McGuigan’s
renting a forklift. Mr. McGuigan testified at trial that “[he] had a choice to use a
rollback truck that * * * [MDS] would have paid for”, but he opted instead to rent
a forklift for $2,000 “to make * * * [his] job a hundred percent easier and
quicker.” Respondent argues that petitioners are precluded from deducting the
forklift rental expense because MDS offered other equipment for Mr. McGuigan
to use in the course of his employment.
As discussed above Mr. McGuigan must establish that MDS either required
or expected him to pay for the expense of renting vehicles, machinery, or
equipment. See Fountain v. Commissioner, 59 T.C. 708; see also Dunkelberger
v. Commissioner, T.C. Memo. 1992-723, 1992 Tax Ct. Memo LEXIS 763, at *5.
The record, however, shows that MDS neither required nor expected Mr.
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McGuigan to rent the forklift. Accordingly, petitioners are not entitled to deduct
the forklift rental expense.5
Other than the forklift rental expense, the record contains no evidence of
petitioners’ reported rent expenses. We therefore sustain respondent’s
disallowance of these deductions.
D. Insurance (other than health)
We next address respondent’s disallowance of petitioners’ deductions for
insurance (other than health).
1. 2014
On their 2014 return petitioners deducted $987 for insurance. Respondent
argues that petitioners are precluded from deducting this expense for lack of
substantiation. The record is devoid of evidence of this reported expense.
Consequently, respondent’s determination on this issue is sustained.
2. 2015
On their 2015 return petitioners deducted $3,654 for insurance. Respondent
contends that this reported expense was for automobile insurance, and petitioners
have not argued otherwise. Petitioners were allowed a Schedule A deduction for
5
While we do not doubt that the use of the forklift improved his job
performance, Mr. McGuigan’s job performance is not the issue before us.
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car and truck expenses using the standard mileage rate. See sec. 1.274-5(j)(2),
Income Tax Regs.
A taxpayer may deduct vehicle expenses using either actual costs or the
standard mileage rate. See id. Because petitioners cannot claim deductions for
both actual expenses and those calculated using the standard mileage rate, we
sustain respondent’s disallowance. See Tesar v. Commissioner, T.C. Memo.
1997-207, slip op. at 17 (“Automobile expense may be computed using actual
costs, such as depreciation, or using the standard mileage method; thus, petitioners
cannot deduct depreciation expense and use the standard mileage rate.”).
IV. Section 6662(a) Accuracy-Related Penalty
We next determine whether petitioners are liable for a section 6662(a)
accuracy-related penalty for tax year 2015.6 Section 6662(a) imposes a penalty
equal to 20% of any underpayment that arises from a substantial understatement of
income tax. See sec. 6662(b)(2). An understatement is substantial if it exceeds
the greater of 10% of the correct tax or $5,000. Sec. 6662(d)(1)(A).
Under section 7491(c) respondent has the burden of production with respect
to the section 6662(a) penalty. To meet this burden, respondent must produce
6
While petitioners did not address their liability for the accuracy-related
penalty in their petition, we find that it was tried by consent. See Rule 41(b).
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sufficient evidence indicating that it is appropriate to impose the penalty against
petitioners. See Higbee v. Commissioner, 116 T.C. 446. Respondent’s burden
of production under section 7491(c) includes establishing compliance with the
supervisory-approval requirement of section 6751(b). See Graev v.
Commissioner, 149 T.C. 485, 493 (2017), supplementing and overruling in part
147 T.C. 460 (2016).
Section 6751(b)(1) provides that, subject to certain exceptions in section
6751(b)(2), no penalty shall be assessed unless the initial determination of the
assessment is personally approved in writing by the immediate supervisor of the
individual making the determination or such higher level official as the
Commissioner may designate. Written approval of the initial penalty
determination under section 6751(b)(1) must be obtained before the proposed
penalty is first formally communicated to the taxpayer in a writing that also
advises the taxpayer of his rights to appeal the penalty with the Internal Revenue
Service Office of Appeals. Clay v. Commissioner, 152 T.C. __, __ (slip op. at 44)
(Apr. 24, 2019).
A reasonable-cause exception to the section 6662(a) penalty is found in
section 6664(c)(1), which provides that no penalty is imposed under section 6662
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“with respect to any portion of an underpayment if it is shown that there was a
reasonable cause for such portion and that the taxpayer acted in good faith with
respect to such portion.” The determination of whether a taxpayer acted with
reasonable cause and in good faith is made on a case-by-case basis, taking into
account all the pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income
Tax Regs. The most important factor is the extent of the taxpayer’s effort to
assess his or her proper tax liability. Id. Similarly, reasonable cause and good
faith is not necessarily indicated by reliance on facts that, unknown to the
taxpayer, are incorrect. Id.
Respondent has complied with the requirements of section 6751(b)7 and
contends that petitioners are liable for a section 6662(a) and (b)(2) penalty for
2015 to the extent that there is a substantial understatement of income tax. Thus,
if the Rule 155 computation indicates that petitioners’ understatement exceeds the
greater of $5,000 or 10% of the amount of tax required to be shown on the return,
respondent has satisfied his burden of production.
7
The RA in this case recommended the assertion of a substantial
understatement penalty under sec. 6662(b)(2). That recommendation was
approved in writing by his immediate supervisor on January 6, 2017, as evidenced
by a Civil Penalty Approval Form included in the record.
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Since respondent has met his burden, petitioners must come forward with
persuasive evidence that the penalty is inappropriate. Petitioners may meet their
burden by proving that they acted with reasonable cause and in good faith with
respect to the underpayment. See sec. 6664(c)(1); see also Higbee v.
Commissioner, 116 T.C. 447; sec. 1.6664-4(b)(1), Income Tax Regs.
Petitioners, however, have not argued or even suggested that they acted with
reasonable cause, arguing only that their returns were correctly based on their
determination that Mr. McGuigan was a statutory employee. As explained supra,
petitioners’ determination was incorrect.
We therefore hold that petitioners are liable for the section 6662(a) and
(b)(2) accuracy-related penalty to the extent the Rule 155 computations show there
is an underpayment attributable to a substantial understatement of income tax.
To reflect the foregoing,
Decision will be entered under
Rule 155.