Eugene Villarreal & Soon S. Villarreal v. Commissioner

PURSUANT TO INTERNAL REVENUE CODE
SECTION 7463(b),THIS OPINION MAY NOT
BE TREATED AS PRECEDENT FOR ANY
OTHER CASE.
T.C. Summary Opinion 2014-87UNITED STATES TAX COURT
EUGENE VILLARREAL AND SOON S. VILLARREAL, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 23439-11S. Filed September 3, 2014.
Eugene Villarreal and Soon S. Villarreal, pro sese.
Sze Wan Florence Char, for respondent.
SUMMARY OPINION
CARLUZZO, Special Trial Judge: This case was heard pursuant to the
provisions of section 7463 of the Internal Revenue Code in effect when the
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petition was filed.1 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.
In a notice of deficiency dated July 15, 2011 (notice), respondent
determined a $21,410 deficiency in petitioners’ 2008 Federal income tax and
imposed a $1,070.50 section 6651(a)(1) addition to tax and a $4,282 section
6662(a) accuracy-related penalty. After concessions, the issues for decision are:
(1) whether petitioners are entitled to various trade or business expense deductions
in excess of the amounts now allowed by respondent; (2) whether petitioners are
entitled to mortgage interest deductions in excess of the amounts now allowed by
respondent; (3) whether petitioners are liable for a section 6651(a)(1) addition to
tax; and (4) whether petitioners are liable for a section 6662(a) accuracy-related
penalty.
Background
Petitioners are, and were at all times relevant, married to each other. Their
untimely joint 2008 Federal income tax return (return) was filed on November 6,
2009. When the time the petition was filed, petitioners resided in New Jersey.
1
Unless otherwise indicated, section references are to the Internal Revenue
Code of 1986, as amended, in effect for the year in issue. Rule references are to
the Tax Court Rules of Practice and Procedure.
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Mrs. Villarreal organized Art Florist, LLC (Art Florist), in 2003. During
2008 Art Florist operated out of rented space in a commercial building in New
Jersey. Although it is not entirely clear from the record, it appears that Mrs.
Villarreal ran the day-to-day operations of Art Florist and Mr. Villarreal assisted
her in various, if not fully explained, ways.
Mrs. Villarreal maintained a checking account and a savings account for Art
Florist, each separate from petitioners’ personal banking accounts. In addition to
Art Florist’s bank account records and the registers associated with the accounts,
petitioners retained receipts and invoices for many of the expenses that Art Florist
incurred.
Petitioners requested, and were granted, an extension of time within which
to file their return. The due date for the return was extended to October 15, 2009.
As noted, the return was not filed until November 6, 2009. Apparently, Mr.
Villarreal prepared the return using a commercially available return preparation
software program. Among other things and as relevant here, the return includes:
(1) a Schedule A, Itemized Deductions, on which petitioners claimed a $40,863
home mortgage interest deduction; (2) a Schedule C, Profit or Loss From
Business, showing Mrs. Villarreal as the proprietor of Art Florist; and (3) a
Schedule E, Supplemental Income and Loss, on which, as relevant here,
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petitioners claimed a $32,394 deduction for mortgage interest attributable to two
rental properties.
The Schedule C indicates that the items reported thereon were reported
using the cash basis method of accounting as follows:
Income:
Gross receipts or sales $92,956
Cost of good sold -0-
Returns and allowances 1,008
Gross income 91,948
Expenses:
Advertising 1,993
Car and truck 5,959
Depreciation and section 179 57
Insurance (other than health) 539
Interest (other) 6,647
Legal and professional services 3,258
Office 213
Rent or lease of other business property 15,000
Supplies 43,182
Taxes and licenses 4,779
Utilities 10,172
Other expenses 149
Total 91,948
Net profit/loss -0-
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In the notice respondent disallowed for lack of substantiation: (1)
deductions claimed on the Schedule C for advertising, interest (other), rent or
lease of other business property, supplies, taxes and licenses, and utilities; (2) the
deduction for home mortgage interest claimed on the Schedule A; and (3) the
deduction for mortgage interest claimed on the Schedule E. Respondent also
imposed a section 6651(a)(1) addition to tax on account of petitioners’ failure to
file the return by its due date and a section 6662(a) accuracy-related penalty on
several grounds, including “negligence or disregard of rules or regulations” and
“substantial understatement of income tax”. Other adjustments made in the notice
are computational and need not be addressed.
Discussion
Respondent now agrees that petitioners are entitled to deductions for some
or at least portions of some of the expenses listed above; according to respondent,
however, the deductions remaining in dispute should not be allowed because
petitioners have failed to properly substantiate the expenses underlying those
deductions.
As we have observed in countless opinions, deductions are a matter of
legislative grace, and the taxpayer bears the burden of proof to establish
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entitlement to any claimed deduction.2 Rule 142(a); INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934). This burden requires the taxpayer to substantiate expenses
for deductions claimed by keeping and producing adequate records that enable the
Commissioner to determine the taxpayer’s correct tax liability. Sec. 6001;
Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), aff’d per curiam, 540 F.2d
821 (5th Cir. 1976); Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965).
A taxpayer claiming a deduction on a Federal income tax return must demonstrate
that the deduction is allowable pursuant to some statutory provision and must
further substantiate that the expense to which the deduction relates has been paid
or incurred. See sec. 6001; Hradesky v. Commissioner, 65 T.C. at 89-90; sec.
1.6001-1(a), Income Tax Regs.
Taxpayers may deduct ordinary and necessary expenses paid in connection
with operating a trade or business. Sec. 162(a); Boyd v. Commissioner, 122 T.C.
305, 313 (2004). Generally, a cash basis taxpayer may deduct a business expense
for the taxable year in which the expense is paid upon a showing by adequate
substantiation that the expense was actually paid during that year.
2
Petitioners do not claim that the provisions of sec. 7491(a) are applicable,
and we proceed as though they are not.
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Informed by these fundamental principles of Federal income taxation, we
turn our attention to the issues remaining in dispute.
I. Disputed Deductions
A. Schedule C Expenses
1. Advertising
Petitioners claimed a $1,993 deduction for advertising expenses. As best
we can determine from our review of Art Florist’s checking account records and
the related check registers, petitioners paid $259 for advertising expenses in 2008.
Accordingly, petitioners are entitled to a $259 deduction for advertising expenses
for 2008.
2. Interest (Other)
Petitioners claimed a $6,647 deduction for “other” interest expenses;
however, no explanation for the deduction was provided. Petitioners’ business
and personal credit card statements show the accrual of monthly finance charges
on those accounts. For the most part it appears that purchases made on the
business credit card accounts were made on behalf of Art Florist and purchases
made on the personal credit card accounts were personal. To the extent that the
deduction for interest relates to, or includes finance charges incurred on
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petitioners’ personal credit card accounts, that interest is not deductible. See secs.
163(h)(1), 262(a). A review of Art Florist’s monthly credit card statements shows
that balances continued to accrue. Accordingly, with respect to Art Florist, we are
able to determine only the amounts of finance charges incurred during 2008, not
the amounts of finance charges that petitioners actually paid. Nothing else in the
record suggests that petitioners would otherwise be entitled to a deduction for
interest expenses as claimed on their Schedule C. Accordingly, petitioners are not
entitled to any portion of the $6,647 deduction for “other” interest claimed on the
Schedule C.
3. Supplies3
Petitioners claimed a $43,182 deduction for supplies for 2008. Our review
of Art Florist’s checking account records and the related check registers shows
that petitioners paid $41,440.60 for supplies in 2008. Accordingly, petitioners are
entitled to a $41,440.60 deduction for supplies for 2008.
3
As noted, no entry is made on the line for cost of goods sold on the
Schedule C. It would appear that some of the items classified as “supplies” by
petitioners should have been treated as an item includable in cost of goods sold.
Because the distinction makes no difference at this point, we follow petitioners’
lead and for convenience ignore the distinction.
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4. Taxes and Licenses
Petitioners claimed a $4,779 deduction for taxes and licenses attributable to
Art Florist’s sales tax liability for 2008. Our review of Art Florist’s checking
account records and the related check registers, Sales and Use Tax Quarterly
Returns for the New Jersey Division of Taxation, and confirmations of payment of
sales tax from the New Jersey Division of Taxation shows that petitioners paid and
are entitled to a deduction for the amount claimed.
5. Utilities
Petitioners claimed a $10,172 deduction for utilities expenses. Respondent
now concedes that petitioners are entitled to a $5,619.83 deduction for utilities.
Petitioners’ records fail to establish that they are entitled to a deduction in excess
of the amount now allowed by respondent.
B. Schedule A and Schedule E Mortgage Interest Deductions
Petitioners claimed a $40,863 deduction for home mortgage interest on
Schedule A and a $32,394 mortgage interest deduction on the Schedule E.
Subject to certain limitations, section 163(h)(2)(D) allows a deduction for
qualified interest paid on acquisition indebtedness or home equity indebtedness
with respect to a qualified residence. See also sec. 163(h)(3).
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Respondent now concedes that petitioners are entitled to a $15,947
deduction for home mortgage interest claimed on the Schedule A and the entire
deduction for mortgage interest claimed on the Schedule E.4 Petitioners have
failed to establish that they are entitled to deductions for mortgage interest in
excess of the amounts now allowed by respondent.
II. Section 6651(a)(1) Addition to Tax
Section 6651(a)(1) imposes an addition to tax for failure to file a return by
its due date. The addition equals 5% of the amount required to be shown as tax on
the return for each month or fraction thereof that the return is late, not to exceed
25%. See id. The burden of production with respect to the imposition of the
section 6651(a)(1) addition to tax imposed in the notice rests with respondent. See
sec. 7491(c).
Petitioners requested, and were granted, an extension of time within which
to file their 2008 return. With the extension, the due date for the tax return was
October 15, 2009. There is no dispute that petitioners’ 2008 return was not
received by respondent and filed until November 6, 2009. Respondent’s burden of
production has been satisfied.
4
Respondent’s concession reflects four Forms 1098, Mortgage Interest
Statement, issued by various lenders or loan servicing companies that show that
petitioners paid $48,342.10 of mortgage interest in 2008.
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“A failure to file a tax return on the date prescribed leads to a mandatory
penalty unless the taxpayer shows that such failure was due to reasonable cause
and not due to willful neglect.” McMahan v. Commissioner, 114 F.3d 366, 368
(2d Cir. 1997), aff’g T.C. Memo. 1995-547. A showing of reasonable cause
requires a taxpayer to show that the taxpayer exercised “ordinary business care
and prudence” but was nevertheless unable to file the return within the prescribed
time. United States v. Boyle, 469 U.S. 241, 246 (1985); sec. 301.6651-1(c)(1),
Proced. & Admin. Regs.
Petitioners argue that they are not liable for the section 6651(a)(1) addition
to tax because at the time the return was due, Mr. Villarreal reviewed the return
and concluded that no tax was due with the return. For the foregoing reasons, we
find he was mistaken, and a mistaken belief that no tax is due does not excuse a
taxpayer from the imposition of the addition to tax. See Richardson v.
Commissioner, T.C. Memo. 1991-258. Accordingly, petitioners are liable for a
section 6651(a)(1) addition to tax.
III. Section 6662(a) Accuracy-Related Penalty
Lastly, we consider whether petitioners are liable for a section 6662(a)
accuracy-related penalty. That section imposes an accuracy-related penalty
equal to 20% of the underpayment of tax that is attributable to negligence or
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other specified grounds. A taxpayer’s failure to keep adequate records to
substantiate expenses underlying claimed deductions can support the imposition of
the section 6662(a) accuracy-related penalty on the ground of negligence. See sec.
1.6662-3(b)(1), Income Tax Regs. As with the addition to tax under section
6651(a)(1), the burden of production with respect to the imposition of the section
6662(a) accuracy-related penalty rests with the Commissioner. See sec. 7491(c).
Petitioners failed to maintain adequate substantiating records for some of
the expenses underlying the deductions claimed on their 2008 return. To the
extent that petitioners did maintain records, the records show that some deductions
were overstated, and petitioners failed completely to explain at least one of the
deductions here in dispute. Relying on those reasons, respondent argues that he
has satisfied his burden of production with respect to the imposition of the penalty
based on negligence, see sec. 6662(b)(1), and we agree.
The accuracy-related penalty does not apply to any part of an underpayment
of tax if it is shown that the taxpayer acted with reasonable cause and in good faith
with respect to that portion. Sec. 6664(c)(1). The determination of whether a
taxpayer acted 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.
Petitioners bear the burden of proving that they had reasonable cause and acted in
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good faith with respect to the underpayment. See Higbee v. Commissioner, 116
T.C. 438, 449 (2001). Mr. Villarreal acknowledges that he “did make mistakes on
the tax return”, but according to him, those mistakes are attributable to the tax
preparation software that he used to prepare the return. However, petitioners
failed to introduce any evidence that demonstrates how mistakes on their tax
return were the result of errors in their tax preparation software and not due to
their own misuse of the software.
Petitioners’ explanation for the underpayment of tax required to be shown
on their return, which in this case is computed in the same manner as the
deficiency, see secs. 6211(a), 6664(a), is nonspecific and therefore unavailing.
See, e.g., Bunney v. Commissioner, 114 T.C. 259, 267 (2000). Petitioners are
liable for a section 6662(a) accuracy-related penalty computed on the entire
amount of the redetermined deficiency.
To reflect the foregoing,
Decision will be entered
under Rule 155.