DocketNumber: Docket Nos. 18797-03, 16806-08
Citation Numbers: 103 T.C.M. 1206, 2012 Tax Ct. Memo LEXIS 35, 2012 T.C. Memo. 38
Judges: HOLMES
Filed Date: 2/7/2012
Status: Non-Precedential
Modified Date: 11/20/2020
Decisions will be entered under
HOLMES,
Steven and Lori Esrig earned much of their income from real-estate sales and investments in securities. Lori was licensed as a real-estate broker, 2 and had her own business buying and selling real estate for others. Steven was an entrepreneur.
Sometime before 1998, the Esrigs decided to go into business together, starting SEC Financial Services, Inc.—a company Steven said rented, renovated, and repaired properties owned by the Esrigs, and even some owned by others. Steven explained that Lori bought, sold, and rented out the real estate, 2012 Tax Ct. Memo LEXIS 35">*37 but he himself handled the day-to-day maintenance and repair work. He also claimed that SEC produced income from the rent they received and the repair work SEC's crew performed for other property owners.
Steven testified that SEC had one full-time employee who helped out, and from time to time he would also "hire either college students or other part-time renovation tradesmen, electricians, carpenters, plumbers, [and] that type of thing." He claimed that SEC didn't actually pay the student workers, but that they did cleanup work in exchange for a discount on their rent. SEC did pay its subcontractors, however, and Steven said that he kept records of how much he paid and to whom. He also said that he and his wife kept calendar records of the time they spent doing work for SEC. But even though he said all this, he actually introduced no supporting documents or other proof of SEC's expenses.
By early 2002 the Esrigs were out of the real-estate rental and repair business and had sold off all their rental properties. Lori still had her real-estate sales business, but Steven started a new company called Stelor Productions, Inc. (He chose the name "Stelor" because it was a portmanteau of Steven 2012 Tax Ct. Memo LEXIS 35">*38 and Lori.)
Steven told us at trial that he got the idea for the company after an incident involving one of his children. Apparently, his then-five-year-old child asked to look at the Power Rangers website. Steven logged on but inadvertently mistyped a character in the web address. Instead of getting the Power Rangers website, up popped a seriously pornographic one. This, he told us, was the reason he started Stelor, a company he claims invented a technology that protects children from predators and pornography and "shuts down identity theft." We find, however, that much of Steven's trial testimony was not credible, and this particular tale we believe to be nothing more than a pourquoi story.
What we do find is that Stelor operated out of the Esrigs' home in Darnestown, Maryland, and even paid some rent: $3,600 in 2002, and $68,400 in 2003. Steven was the president and CEO of the company; and Stelor did have a board of directors and several other investors.
Stelor, however, never made any money and lost most (if not all) of what the investors put in. Steven told us that the company failed because it "ran into some litigation" after it bought the domain name "googles.com" from someone who 2012 Tax Ct. Memo LEXIS 35">*39 had it before Google. This, he said, led to five or six years of litigation with Google and ultimately bankrupted his company. 32012 Tax Ct. Memo LEXIS 35">*40
The Commissioner noticed that the Esrigs hadn't filed their tax returns for 1998, 1999, and 2000, and sent Steven notices of deficiency for those three years in August 2003. The notices asserted that Steven had more than $1.5 million in total unreported taxable income and that he was also liable for various penalties.
The Esrigs finally filed their 1998 and 1999 returns in late October 2003, and their 2000 tax return a week later. Steven quickly filed his petition for all three years. 2012 Tax Ct. Memo LEXIS 35">*41 We set the case for trial in 2005, but the parties then agreed to continue the case to see if they could settle after the Commissioner looked at the late-filed returns.
What happened instead was that the Commissioner got more curious about the Esrigs, and expanded his investigation to later years and related companies. In early 2008, he sent both Esrigs notices of deficiency for 2001, 2002, and 2003. The Esrigs filed another petition for these years, which we consolidated with Steven's earlier one. Settlement talks continued, but in the summer of 2009 the Esrigs' attorney moved to withdraw as counsel: The couple had filed for divorce, and Steven wouldn't waive the resulting conflict of interest.
The case finally staggered to trial in Baltimore in 2010, with the Esrigs representing themselves. They are, and were when they filed their petitions, Maryland residents. After making several concessions, the Commissioner says these are the deficiencies, additions to tax, and penalties still at issue: 42012 Tax Ct. Memo LEXIS 35">*42
Additions to Tax/Penalties | ||||
Year | Deficiency | Sec. 6654 | Sec. 6662 | |
1998 | $124,983 | $31,243.00 | $5,672.01 | — |
1999 | 261,455 | 65,260.25 | 12,534.00 | — |
2000 | 203,841 | 50,965.50 | 10,962.43 | — |
2001 | 22,407 | 4,617.25 | — | $4,481 |
2002 | 40,387 | 10,066.75 | — | 8,077 |
2003 | 52,918 | 19,834.25 | — | 10,584 |
And these are the particular items being disputed: ! net operating loss (NOL) carryovers claimed for 1998-2003; ! SEC's business losses for 1998-2002; ! office expenses deducted for 2002 and 2003; ! ! unreported rental income for 2002 and 2003; ! capital gain and losses for 2001 and 2002; ! additions to tax under ! additions to tax under ! accuracy-related penalties under
We begin by noting that the Esrigs bear the burden of proving the Commissioner's deficiency determinations are incorrect.
Total NOL | Amount | |
Year | carryovers claimed | allowed by IRS |
1998 | $39,384 (1994) | -0- |
15,800 (1995) | ||
45,989 (1996) | ||
145,148 (1997) | ||
246,321 | ||
1999 | 39,384 (1994) | -0- |
15,800 (1995) | ||
45,989 (1996) | ||
145,148 (1997) | ||
113,892 (1998) | ||
360,213 | ||
2000 | 73,316 (1997) | -0- |
113,892 (1998) | ||
187,208 | ||
2001 | 11,295 (1997) | -0- |
113,892 (1998) | ||
125,187 | ||
2002 | 26,649 (1998) | -0- |
26,649 | ||
2003 | 26,649 (1998) | -0- |
13,777 (2002) | ||
40,426 |
In general, a taxpayer has an NOL when he has more deductions than income in a given tax year.
The parties dispute the NOL carryovers the Esrigs reported on their 1998-2003 returns and that we summarize in the table above. To substantiate their NOL carryovers, the Esrigs had to establish that they incurred NOLs for 1994, 1995, 1996, 1997, 1998, and 2002, and that they were entitled to carry those losses forward to the years at issue. 6 But the only documents they introduced to support their NOLs are the returns they filed for 1998 through 2003, including certain IRS worksheets used to help taxpayers with their NOL computations. Tax returns, however, are not substantiation,
SEC Financial Services | ||
Year | Per return | Per IRS |
1998 | ($79,399) | -0- |
1999 | (54,664) | -0- |
2000 | (42,842) | -0- |
2001 | (9,529) | -0- |
2002 | (22,014) | -0- |
2003 | 4,065 | -0- |
The 2012 Tax Ct. Memo LEXIS 35">*45 Commissioner conceded the losses the Esrigs reported on their Schedule E for their "Real Estate Rental Business" and for "EGG, International" but continues to dispute the losses the Esrigs reported for SEC on their 1998-2002 returns. The Commissioner argues that the Esrigs haven't shown that SEC was engaged in a trade or business, and that they haven't shown that SEC actually incurred the expenses that generated the losses claimed on their returns.
The Commissioner has a point: The only evidence of SEC's business activities—other than the Esrigs' tax returns—that we could find in the record was a Maryland building contractor's license issued in 2003, and of course Steven's own testimony. The documentary evidence isn't enough to prove the SEC losses, and Steven's testimony didn't jibe with what was reported on the Esrigs' returns. We do not find it credible.
The Esrigs reported income, expenses, and losses from their real-estate rental properties separately, and the Commissioner generously left those items unadjusted. SEC, however, didn't report any gross receipts for 1998 through 2002. 7 We therefore aren't sure why the Esrigs claimed additional losses and expenses for SEC on their returns, 2012 Tax Ct. Memo LEXIS 35">*46 and what they were for.
We also can't apply the rule of
Year | Per Return | Per IRS | Office Expense at Issue | ||||
Steven | Lori | Steven | Lori | Steven | Lori | Total | |
2002 | $11,248 | $11,885 | $2,885 | $3,522 | $8,363 | $8,363 | $16,726 |
2003 | 70,361 | 1,928 | 47,890 | 1,928 | 22,471 | — | 22,471 |
The Esrigs both worked out of their 13,000-square-foot home and deducted office expenses during all the years in dispute. The Commissioner, however, challenges many of their office-expense deductions only for 2002 and 2003. He says that the Esrigs haven't shown that they had office expenses in 2012 Tax Ct. Memo LEXIS 35">*47 an amount greater than what he's already allowed them for 2002; he also argues that the Esrigs shouldn't have taken an office-expense deduction on their 2003 return for the costs of painting the exterior of their home and maintaining a fish tank. We agree: The Esrigs offered no credible evidence on these points.
Steven claimed a $17,700 deduction under
The only evidence they offered at trial to substantiate this deduction was Steven's testimony. He told us that both he and his wife used their dining room table primarily for business meetings, and that they put in a fish tank in the foyer of their home where their business contacts would sit and wait for meetings. We did not find Steven's testimony credible, and agree with the Commissioner on this issue as well.
Year | Claimed | Amount determined by IRS |
2002 | 0 | $3,600 |
2003 | 0 | 68,400 |
Steven admitted at trial that the Esrigs received rent from Stelor for the business use of their home. And on the returns signed by Steven on behalf of Stelor, the company deducted rental expenses of $3,600 and $68,400 for 2002 and 2003. The Esrigs, however, didn't report this income on their personal returns for those two years. We therefore sustain the Commissioner's determinations as to the Esrigs' unreported rental income for 2002 and 2003.
Adjustment | |||
Year | Property sold | Gain/loss reported | to income |
1999 | 3254 Q Street | $9,175 | — |
2000 | 3538 S Street | 159,282 | — |
2001 | 3407 R Street NW | 199,741 | $47,306 |
2002 | 2121 Marymount Drive | (130,599) | 130,599 |
Total | 177,905 |
Someone who sells property is taxed on the gain, not the sale price.
The Commissioner argues that the Esrigs had more gain on the sale of their properties in 2001 2012 Tax Ct. Memo LEXIS 35">*49 and 2002 than what they reported because they overstated their bases in both the R Street and Marymount Drive properties. The Esrigs presented no evidence on this issue, so we find for the Commissioner once again.
The final issues are the additions to tax that the Commissioner asserts under
The Esrigs were often very late in filing:
Year | Filing date | Tardiness of the return |
1998 | Oct. 30, 2003 | 4 yrs. 6 mos. 15 days |
1999 | Oct. 30, 2003 | 3 yrs. 6 mos. 13 days |
2000 | Nov. 5, 2003 | 2 yrs. 6 mos. 20 days |
2001 | June 11, 2004 | 2 yrs. 1 mo. 27 days |
2002 | Oct. 12, 2004 | 1 yr. 5 mos. 27 days |
2003 | Dec. 27, 2005 | 1 yr. 8 mos. 12 days |
At trial Steven blamed the couple's return preparer. He said 2012 Tax Ct. Memo LEXIS 35">*50 that he'd asked his accountant to request extensions for all the years at issue, but his accountant missed all the deadlines because she had to serve a very long prison sentence for murdering her husband, and the person in her office who took over their account made a slew of mistakes.
We aren't convinced. The Esrigs had no evidence to corroborate this lurid tale, and we therefore find that they had no reasonable cause for failing to timely file. Accordingly, we find Steven liable for the failure-to-timely-file additions to tax for 1998-2000 and both Esrigs liable for the failure-to-timely-file additions for the later years.
The Commissioner also asserts additions to tax against Steven under
The final issue is whether the Esrigs are liable for the 20% accuracy-related penalty under
"Negligence" includes any failure to make a reasonable attempt to comply with the provisions of the Code, including any failure to keep adequate books and records or to substantiate items properly.
The Commissioner certainly showed that the Esrigs kept generally inadequate books and records for 2001-2003. Given that the Esrigs have not produced any credible evidence to establish why this penalty should not apply for 2001-2003, we sustain the Commissioner's determinations that they are liable for the accuracy-related penalty on the ground of negligence 2012 Tax Ct. Memo LEXIS 35">*52 for the entire amount of the underpayment for each of these years. We also specifically find that the Esrigs were negligent in deducting from their 2003 income the cost of dining room furniture and of feeding and housing their pet fish. We also specifically find them negligent in failing to report the rental income they got from Stelor.
1. When the Commissioner learns that someone has received income—usually from third parties under a duty to report—but has not filed a return,
2. A licensed real-estate broker has to complete more coursework than a licensed real-estate agent. In most states, a real-estate agent must be supervised by a broker. Selling real estate independently often requires a broker's license.↩
3. Some background from the public record: Sometime before August 1997, Steven A. Silvers, a convicted narcotics trafficker and money launderer, wrote a children's book about loveable four-eyed alien creatures called "Googles" who live on the planet Goo.
In 2002, Stelor acquired Silvers's rights to sell Googles products and use the Googles trademarks, intellectual property, and IP address.
4. The Commissioner conceded enough deductions elsewhere in the notices of deficiency and in the prolonged pretrial proceedings that it's possible that the Esrigs did not underpay for some of the years at issue. For any such years, of course, there may not be penalties.
5. Before the Taxpayer Relief Act of 1997,
6. We may determine the amount of a net operating loss for a year—even if an assessment of tax for that year is barred—to determine the correct NOL carryover for the tax year that is at issue.
7. In 2003 SEC reported $4,650 of net income, but we have no idea how it was earned and where it came from. The Commissioner has agreed that this income doesn't exist, and reduced the Esrig's 2003 tax liability by a corresponding amount.↩
8.
Cohan v. Commissioner of Internal Revenue , 39 F.2d 540 ( 1930 )
United States v. Steven A. Silvers, (Two Cases) , 90 F.3d 95 ( 1996 )
United States v. Boyle , 105 S. Ct. 687 ( 1985 )
W. Horace Williams, Sr., and Viola Bloch Williams v. United ... , 245 F.2d 559 ( 1957 )
Indopco, Inc. v. Commissioner , 112 S. Ct. 1039 ( 1992 )