Griggs v. Comm'r

T.C. Summary Opinion 2007-3
UNITED STATES TAX COURT
GERRY M. GRIGGS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 839-04S. Filed January 3, 2007.
Gerry M. Griggs, pro se.
Portia N. Rose, for respondent.
COUVILLION, Special Trial Judge: This case was heard
pursuant to section 7463 in effect when the petition was filed.1
The decision to be entered is not reviewable by any other court,
and this opinion should not be cited as authority.
1
Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year at issue,
and all Rule references are to the Tax Court Rules of Practice
and Procedure.
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Respondent determined a deficiency of $23,709 in
petitioner’s Federal income tax for the year 2000, an addition to
tax under section 6651(a)(1) in the amount of $5,334.53, an
addition to tax under section 6651(a)(2), and an addition to tax
under section 6654 in the amount of $1,275.16. In the answer,
respondent conceded the section 6651(a)(2) addition to tax and,
pursuant to section 6214(a), claimed an increase in the section
6651(a)(1) addition to tax of $592.72. In a trial memorandum,
respondent conceded the section 6654 addition to tax.2
The issues for decision are: (1) Whether petitioner is
entitled to claim a deduction for miscellaneous legal expenses on
Schedule A, Itemized Deductions, in an amount exceeding what was
allowed by respondent; (2) whether petitioner is entitled to
claim deductions for various trade or business expenses
disallowed by respondent for two business activities of
petitioner reported on separate Schedules C, Profit or Loss From
2
At the time the notice of deficiency was issued,
petitioner had not filed his Federal income tax return for the
year at issue. The notice of deficiency is based upon
information returns filed by third-party payers for nonemployee
compensation, wages, and interest paid to petitioner. Petitioner
does not challenge these determinations. After the notice of
deficiency was issued, as stated in respondent’s brief,
“petitioner provided respondent with his individual income tax
return for the 2000 taxable year.” Respondent further stated on
brief: “Petitioner has never provided an explanation as to why
his return was filed late.” That statement appears to indicate
that petitioner’s return was processed as a filed return.
Petitioner does not challenge the income determinations in the
notice of deficiency, and the issues essentially involve two
trade or business activities and itemized deductions.
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Business; (3) whether petitioner is entitled to a Schedule A
deduction for the writeoff of unsold inventory that belonged to a
discontinued trade or business activity; and (4) whether
petitioner is liable for the section 6651(a)(1) addition to tax.
Some of the facts were stipulated, and those facts are so
found. At the time the petition was filed, petitioner was a
legal resident of Houston, Texas.3
Although petitioner was an employee during the year at
issue, the principal issues in this case arise from two self-
employed trade or business activities petitioner was engaged in
that year. Petitioner claimed losses from both of these
activities that respondent challenges.
Petitioner has an M.B.A. degree from Harvard University and
is a certified public accountant. Since 1983, he has been
involved in various business ventures as an investment and
3
Sec. 7491(a) shifts the burden of proof to the
Commissioner with regard to any factual issue relevant to
ascertaining the taxpayer’s liability. Sec. 7491(a)(2) limits
application of this rule to an issue or issues for which the
taxpayer has complied with the requirements for substantiation of
any item, has maintained all records with respect to such items,
and has cooperated with reasonable requests by the Secretary for
witnesses, information, documents, and interviews, etc.,
regarding matters at issue. In this case, the burden of proof
does not shift to respondent because petitioner’s failure to
cooperate with respondent’s counsel in submitting records as to
the matters at issue resulted in the issuance of an order by the
Court on Oct. 6, 2004, ordering the parties to stipulate and
exchange documents with each other to enable this case to proceed
to trial. As to the additions to tax, the burden of production
is on respondent. Sec. 7491(c).
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merchant banker. In 1985, petitioner was employed by Advanced
Energy Technologies (AET) as vice president and chief financial
officer (CFO). He was also on the board of directors of AET
until January 1989. AET terminated petitioner from his position
as CFO in September 1988. In May 1989, petitioner returned to
AET as CFO and was again terminated in January 1990.
The first issue is petitioner’s claim to Schedule A
deductions of $11,981.54 for miscellaneous legal expenses.
Petitioner paid legal fees in connection with litigation against
his former employer, AET, for breach of his employment contract
and for the recovery of retirement benefits. Petitioner also
paid legal fees in connection with litigation against two other
corporations over the purchase of certain film rights and assets.
Another legal action involved a malpractice claim against one of
his former attorneys.
Of the $11,981.54 claimed by petitioner for miscellaneous
legal expenses on Schedule A of his return, respondent concedes
petitioner’s entitlement to a deduction of $5,000 for legal
expenses, leaving at issue $6,981.54.
Based on the evidence presented at trial, the Court is
satisfied that petitioner is entitled to an additional deduction
of $5,501.86 for legal expenses. This consists of $3,000, which
is shown as a credit on a statement presented at trial from one
of the law firms that represented petitioner, and $2,501.86,
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represented by three checks payable to one of the other law firms
that represented petitioner. Therefore, of the $11,981.54 claimed
by petitioner as miscellaneous legal expenses on his return,
petitioner is entitled to a deduction of the $5,000 conceded by
respondent and $5,501.86 based on the evidence presented at
trial. This leaves a balance of $1,479.68, which the Court finds
has not been substantiated and, therefore, holds is not allowable
as a deduction.
As stated earlier, the income tax return submitted by
petitioner at trial included two Schedules C with respect to
trade or business activities engaged in by petitioner. One of
these activities was described as “Media Content and
Entertainment and Songs” with a business name of “Kirshner
Content and related entities”.4 The Schedule C reported gross
income of zero and various expenses. The activity was described
at trial as an activity of petitioner and another individual,
Robert Thurmond (Thurmond), as partners. Petitioner and Thurmond
referred to their affiliated activity as the Equisource Group.5
4
Petitioner’s other Schedule C involves an activity called
“Frexie”. Respondent made adjustments to that activity, and
those adjustments are addressed later in this opinion.
5
Since Kirshner Content was represented to be an activity
of petitioner and Thurmond, the Court assumes that the numbers on
the Schedule C represent petitioner’s allocable portion of the
expenses.
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Sometime in 1993, petitioner and Thurmond were approached by
Don Kirshner (Kirshner), a noted song publisher, entertainment
promoter, and agent, to exploit rights Kirshner had to various
entertainment assets. Kirshner had been the host and creator of
a weekly rock concert program on national television called “Don
Kirshner’s Rock Concert” (Rock Concert) from 1972 to 1983 and
possessed rights to about 185 to 200 hours of programming from
the Rock Concert as well as “Don Kirshner’s Comedy Hour” that had
never been rebroadcast or licensed.
Petitioner, Thurmond, and Kirshner agreed to establish
business entities that would obtain a license from Kirshner to
exploit rights to “Don Kirshner’s Rock Concert”, the name “Don
Kirshner”, and his likeness, together with extensive
entertainment memorabilia. These tangible and intangible
properties were collectively known as the Kirshner properties.
Beginning with the license from Kirshner for the Kirshner
properties as a base, the various Kirshner entities were also
envisioned as a base for acquiring, managing, producing, and
distributing entertainment software in various forms.6
On or about May 12, 1995, Kirshner and the Equisource Group
(petitioner and Thurmond) signed a venture agreement to form
6
According to petitioner, the various Kirshner entities
were known collectively as “Kirshner Content”, which is not to be
confused with the Don Kirshner Content, Inc., one of the
entities. See infra.
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Kirshner Global, Inc. (Kirshner Global). Kirshner and Equisource
were listed as “Founding Partners”. Under the terms of the
venture agreement, Equisource was to obtain interim financing of
$1 million within a 60-day period or Kirshner would have the
option of terminating the agreement. Similar terms were also
provided for permanent financing within a 120-day period. The
interim financing proceeds would have been used, in part, to pay
the “Founding Partners” for out-of-pocket expenses incurred on
Kirshner Global’s behalf prior to the interim financing.7
Under the venture agreement, the execution of other
documentation within a 15-day period subject to interim financing
was also required. The documents included an employment
agreement, a stockholders’ agreement, an Equisource financial
advisory agreement, a licensing agreement, and a subscription
agreement. Once this was accomplished and Kirshner Global was
formed, petitioner and Thurmond would be named as directors on
Kirshner Global’s board of directors.
On or about February 21, 1996, the Don Kirshner Content Co.,
Inc. (Kirshner Content) was formed with the specific intention of
acquiring the Rock Concert license from Kirshner and maintaining
an aggressive plan of strategic acquisitions of other
entertainment assets. As the managing director of the Equisource
7
As noted, petitioner and Thurmond would be entitled to
reimbursement as “Founding Partners”, only through Equisource.
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Group, petitioner was listed as a member of the support team
responsible for organizing and obtaining financing for Kirshner
Content.
On or about February 22, 1996, State Street Capital Markets
Corp. offered a confidential private placement memorandum for the
purpose of raising capital for Kirshner Content. Investors would
invest a maximum of $1.5 million for 30 units, which would be
convertible into a promissory note, common stock, and common
stock purchase warrants in Kirshner Content. Petitioner was
listed as the executive vice president, chief financial officer,
treasurer, and director of Kirshner Content.
On or about April 17, 1996, in connection with an attempt to
obtain interim financing, Kirshner Content issued a promissory
note in the amount of $279,440 to C&C Partners, LLC, a New York
limited liability company,8 which petitioner and Thurmond
personally guaranteed. Petitioner and Thurmond’s guaranties were
subject to four separate conditions. Another guaranty was made
on April 24, 1996, by Martin Licht, secretary and counsel for
Kirshner Content.9 Under the terms of the promissory note, it
8
The record sometimes refers to “C&C Investments” in
connection with the promissory note. For this purpose, C&C
Investments and C&C Partners, LLC, are treated as one and the
same.
9
Although not specified in the record, Licht apparently was
a business associate of Kirshner.
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was payable together with interest no later than June 17, 1996.
Kirshner Content defaulted on the promissory note.10
In a confidential business plan dated July 1996, Kirshner
Content proposed the issuance of stock in a public offering for
at least $25 million. As the managing director of Equisource,
petitioner was named as a member of the support team
participating in the organization and financing of Kirshner
Content.
On or about March 7, 1997, C&C Partners filed suit in Texas
against petitioner and Thurmond for payment of the $279,440
promissory note due to Kirshner Content’s default. Petitioner
and Thurmond retained the law firm Baker & Botts, L.L.P., in
Houston to represent them in the ensuing litigation.11
As previously stated on the Schedule C that petitioner
submitted with respect to Kirshner Content, petitioner reported
zero gross income for the activity and claimed deductions for
various expenses related to the activity: (1) A bad debt in the
amount of $7,118; (2) legal and professional fees in the amount
10
On or about Sept. 18, 1996, C&C Partners, LLC, filed suit
in New York State court against petitioner, Thurmond, and Licht,
the three guarantors, and, a month later, the case was removed to
Federal District Court. With respect to petitioner and Thurmond,
the case was removed to Texas. The case against Licht in New
York continued. In that court proceeding, judgment was entered
in favor of C&C Partners, LLC, in November 1997.
11
The record is not clear with respect to the ultimate
resolution of the Texas case involving petitioner and Thurmond.
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of $18,508; (3) supplies of $139.50; (4) travel expenses of
$1,050; and (5) deductible meals and entertainment of $347.65.
The Schedule C listed the “Kirshner Content and related entities”
as the business name and the activity was listed as “Media
Content and Entertainment and Songs”. Respondent did not agree
to deductions for these expenses.
Petitioner argues he is entitled to claim the $7,118 as a
bad debt deduction as it relates to various expenses that were
incurred in 1994, 1995, and 1996, in connection with the
attempted financing for the various Kirshner entities. The
expenses were for travel, meals, and entertainment. Although not
explicitly stated, as the Court understands, petitioner believed
he had a contractual right to be reimbursed for these expenses
from Kirshner Global, Kirshner Content, and/or other Kirshner
entities. Since he was never reimbursed for these expenses,
petitioner contends his claim for reimbursement is an
uncollectible bad debt.
Respondent contends the expenses were not created or
incurred in connection with a trade or business and questions
whether petitioner had the right to be reimbursed for such
expenses, and, if so, whether the debts became uncollectible in
2000.
Section 166 allows a taxpayer a deduction for any business
debt which becomes wholly or partially worthless during the
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taxable year. Sec. 166(a), (d)(1)(A). A bona fide debt is one
that arises from a debtor-creditor relationship based upon a
valid and enforceable obligation to pay a fixed or determinable
sum of money. Sec. 1.166-1(c), Income Tax Regs.
A business bad debt deduction is allowable if the taxpayer,
among other requirements, establishes: (1) He was engaged in a
trade or business, and (2) the acquisition or worthlessness of
the debt was proximately related to the conduct of such trade or
business. United States v. Generes, 405 U.S. 93 (1972); sec.
1.166-5(b), Income Tax Regs. For a debt to be considered a
business debt, it must have a proximate relation to the
taxpayer’s trade or business. In determining whether a proximate
relationship exists, the proper measure is the taxpayer’s
dominant motivation for incurring the debt. A significant
motivation is not sufficient. United States v. Generes, supra at
103.
Petitioner bears the burden of proving that the amounts in
question constituted business debts and that such debts became
worthless in 2000, the year in which the deduction is claimed.
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
At the outset, respondent disputes that expenses were
incurred in connection with petitioner’s trade or business.
Petitioner argues that he was in the trade or business of
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investment and merchant banking. The facts support petitioner on
that argument.
Petitioner and Thurmond credibly testified that they were in
the trade or business of investment and merchant banking. The
totality of the circumstances shows that they sought to obtain
financing in return for obtaining a percentage interest in
various Kirshner entities. Multiple Kirshner documents show that
petitioner was described as the managing director of Equisource
Group and responsible for obtaining financing as well as pursuing
possible acquisitions.
Petitioner was also slated to be on the board of directors
of Kirshner Global once financing was completed. He was listed
as executive vice president, chief financial officer, treasurer,
and director of Kirshner Content in the February 22, 1996,
confidential private placement memorandum. The Court concludes
that these activities were not merely investment activities or
the management of petitioner’s investment but were part and
parcel of petitioner’s trade or business. Thus, the Court finds
that petitioner was engaged in a trade or business with respect
to these expenses.
With respect to the claimed bad debts, petitioner must
establish that the debts had some value at the beginning of 2000
and became worthless by the end of the year. Milenbach v.
Commissioner, 106 T.C. 184, 204 (1996), affd. in part, revd. in
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part on other grounds, and remanded 318 F.3d 924 (9th Cir.
2003). The issue rests on the particular facts and circumstances
of each case, although, generally, “the year of the worthlessness
is fixed by identifiable events that form the basis of reasonable
grounds for abandoning any hope of recovery.” Id. at 204-205;
see also Estate of Mann v. United States, 731 F.2d 267, 276 (5th
Cir. 1984); Dallmeyer v. Commissioner, 14 T.C. 1282, 1291-1292
(1950).
Petitioner argues that, under the venture agreement for the
formation of Kirshner Global, he was entitled to reimbursement
for out-of-pocket costs. Petitioner testified that the venture
agreement was one of several such agreements that provided for
the formation of Kirshner entities. According to petitioner,
these Kirshner entities received interim financing. In addition,
petitioner contends he submitted a claim for reimbursement, and
it was approved by Kirshner.
Petitioner contends that his business relationship with
Kirshner and the Kirshner-related entities “effectively ended” in
2000, thus entitling him to a bad debt deduction for that year.
Respondent strongly disagrees with that contention and instead
argues the relationship ended in 1995 or 1996. Petitioner
testified:
When Kirshner decided not to do business any more with
us and go on and do business with someone else then
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there was no hope of getting paid. It was over. And
that was in the year 2000.
Petitioner contends that all activity on the Kirshner deal ended
in the year 2000 due to litigation against Kirshner by an outside
investor who had been brought in by petitioner. Up to that
point, petitioner contends, he had continued to try to raise
capital, reform Kirshner Content, and repay the outstanding debt.
Petitioner offered the testimony of his business partner,
Thurmond, with respect to the claimed deduction. However,
Thurmond was uncertain when the business relationship
definitively ended. He admitted that the actual attempt to fund
and operate Kirshner Content ended “a long time ago” but was
unable to fix an exact date, other than it was in the late 1990s.
At trial, Thurmond stated it was either in 1999 or 2000.12 While
Thurmond believed that several Kirshner entities received interim
financing, he could not positively state that Kirshner Global
received any interim financing. Thurmond’s testimony does not
convince the Court that the business relationship ended in the
year 2000.
Moreover, the Court is not satisfied from the evidence that
there even was a bona fide debt, much less a debt that became
wholly worthless in 2000 for the following reasons.
12
Thurmond also stated at one point that it was in 2002 but
immediately corrected himself to provide that it was “either 2000
or before”.
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Respondent argues that there was no “debt” that would
qualify for the bad debt deduction. In particular, respondent
contends that petitioner did not show that he was entitled to
reimbursement for the various expenses at issue.
Respondent asserts that a precondition for obtaining out-of-
pocket expenses from Kirshner Global was not fulfilled in that
petitioner failed to show that he obtained interim financing
within the time period specified in the 1995 venture agreement.
At trial, petitioner claimed that his entitlement to
reimbursement for expenses was not contingent on obtaining
interim financing.
The totality of the record satisfies the Court that
respondent is correct. There is no documentation or other
evidence that establishes the existence of a bona fide debt owing
to petitioner by either Kirshner Global or Kirshner Content
(petitioner’s Schedule C activity) that qualified for a bad debt
deduction. Also, there is no evidence to support a finding that
petitioner was contractually entitled to be reimbursed for the
various Kirshner expenses that are characterized as a bad debt on
Schedule C of petitioner’s tax return.
With respect to Kirshner Global, the language of the venture
agreement supports respondent’s position. In a subsection
entitled “Interim Financing”, Kirshner Global was required,
through the Equisource Group, to obtain interim financing that
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would be used to pay, among other things, out-of-pocket costs of
the “Founding partners”; i.e., Equisource and Kirshner. Thus,
obtaining interim financing was a precondition to petitioner’s
entitlement to reimbursement for his out-of-pocket expenses.
Petitioner did not establish that interim financing was
obtained, that Kirshner Global was formed, or that he became a
director on Kirshner Global’s board of directors. While
petitioner claimed that licensing, employment, and financial
advisory agreements were executed in connection with Kirshner
Global, there is no evidence that this came about. Thus, the
Court cannot conclude that petitioner had a right of
reimbursement through Kirshner Global for reimbursement of his
expenses.
The record shows that Kirshner Content had a more tangible
existence because it apparently obtained interim financing from
C&C Partners. However, Kirshner Content, as well as petitioner,
Thurmond, and Licht, all became involved in a lawsuit after
Kirshner Content defaulted on the promissory note. Receipt of
the interim financing and the corporate default both occurred in
1996. Kirshner Content does not appear to have been active after
that year other than to participate in various lawsuits.
Petitioner’s witness, Thurmond, confirmed that the financing for
Kirshner Content had not been completed. Moreover, there is no
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evidence that Kirshner Content contractually agreed to reimburse
petitioner’s expenses.
Petitioner points to the existence of an August 11, 1996,
reimbursement form signed by Kirshner as proof that petitioner
was entitled to reimbursement. The Court disagrees. The
document is indicative, at most, that Kirshner approved
petitioner’s expenses related to “identifying
acquisition/investment opportunities for Kirshner Content et al.”
that were incurred in 1996. Without any corporate identification
on the reimbursement form or an identification of petitioner’s
status as a person requesting reimbursement, the record does not
support a finding that petitioner had the contractual right to
reimbursement with respect to Kirshner Content and/or any other
Kirshner-related entity. Thus, the Court cannot conclude that
there was an actual bona fide debt with respect to the $7,118
claimed as a bad debt on Schedule C of petitioner’s income tax
return.
The Court further notes that petitioner incurred these
expenses over a 3-year period and did not seek reimbursement
during that time. The claimed expenses were still outstanding 4
years later. There is nothing in the record that adequately
explains petitioner’s delay in seeking reimbursement, if, in
fact, petitioner had incurred such expenses and was entitled to
reimbursement.
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Even if petitioner was entitled to reimbursement for
expenses but was, in fact, not reimbursed, he is not allowed a
deduction for such expenses. A taxpayer is not entitled to a
deduction for expenses to the extent that the taxpayer is
entitled to reimbursement where the taxpayer does not claim
reimbursement. Levy v. Commissioner, 212 F.2d 552, 554 (5th Cir.
1954), affg. a Memorandum Opinion of this Court; Universal Oil
Prods. Co. v. Campbell, 181 F.2d 451, 475 (7th Cir. 1950); see
also Lucas v. Commissioner, 79 T.C. 1, 7 (1982); Kennelly v.
Commissioner, 56 T.C. 936, 943 (1971), affd. without published
opinion 456 F.2d 1335 (2d Cir. 1972); Stolk v. Commissioner, 40
T.C. 345, 356 (1963), affd. per curiam 326 F.2d 760 (2d Cir.
1964); Podems v. Commissioner, 24 T.C. 21, 22-23 (1955); Roach v.
Commissioner, 20 B.T.A. 919, 925-926 (1930).
Moreover, if there was a bona fide debt owing to petitioner,
he provided no evidence that the debt became worthless during the
year at issue. Sec. 1.166-2, Income Tax Regs. Petitioner
offered only his unsupported opinion as to when the debt became
worthless. A taxpayer’s unsupported opinion that a debt became
worthless in a particular year by itself will not normally be
accepted as proof of worthlessness. Dustin v. Commissioner, 53
T.C. 491, 501-502 (1969), affd. 467 F.2d 47 (9th Cir. 1972).
Respondent is sustained on this issue.
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Another deduction claimed on Schedule C of petitioner’s
income tax return for 2000 was $18,508 for legal and professional
services. This amount represented a payment by petitioner on
August 28, 2000, to a Houston, Texas, law firm, Baker & Botts.
The memorandum line on the check issued for payment of these
services indicates that the payment was for “C&C Litigation”.
Respondent does not dispute that petitioner paid the legal
expenses but contends there is no evidence that the payments were
related to petitioner’s trade or business. Respondent argues
that the expenses should, instead, be claimed as an itemized
deduction on Schedule A of petitioner’s return.
The record shows that the litigation expenses related to C&C
Partners arose out of the default on the debt of Kirshner Content
that petitioner had guaranteed. As a result, petitioner,
Thurmond, and Licht were all required to satisfy guarantees that
they had given in connection with the interim financing for
Kirshner Content. Petitioner and Thurmond credibly testified
that the litigation continued until at least 2000 and that they
still owed money to the law firm. Accordingly, the Court finds
that the litigation was proximately related to petitioner’s trade
or business and holds that the fees for legal and professional
services are allowable as a business expense deduction and not as
a Schedule A deduction. Petitioner is sustained on this issue.
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Petitioner testified that, until the first half of 2000, he
was “still trying to raise other funds, get other investors, get
Kirshner back in the fold, deal with this investor that was
having an issue with Kirshner”. According to petitioner, these
expenses, consisting of office supplies, meals, and travel, were
all incurred on behalf of the entire Kirshner enterprise during
the year 2000.
Petitioner’s Schedule C of his 2000 Federal income tax
return included the following other expenses:
Supplies $ 139.50
Travel 1,050.00
Meals and entertainment
(deductible portion) 347.64
Total $1,537.14
As to meals, entertainment, and travel expenses, section
274(d) imposes stringent substantiation requirements for
deductions related thereto. For travel expenses, including meals
and lodging, a taxpayer must substantiate: (1) The amount of
such expense; (2) the time and place such expense was incurred;
and (3) the business purpose for which such expense was incurred.
Sec. 1.274-5T(b)(2), Temporary Income Tax Regs., 50 Fed. Reg.
46014 (Nov. 6, 1985). Section 274(d) specifically bars a
taxpayer from claiming a deduction on the basis of any
approximation or the unsupported testimony of the taxpayer. Sec.
1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov.
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6, 1985). Thus, section 274(d) overrides Cohan v. Commissioner,
39 F.2d 540, 543-544 (2d Cir. 1930), which allows the Court, in
some circumstances, to estimate a deductible expense. See
Sanford v. Commissioner, 50 T.C. 823, 827 (1968), affd. per
curiam 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary
Income Tax Regs., supra.
Although petitioner offered into evidence numerous receipts
in support of his travel, meals, and entertainment expenses, he
did not provide the additional documentation necessary to
substantiate these expenses. In particular, the receipts did not
show the business purpose behind the trips or meals. In short,
there was no documentation or rationale behind such expenses
other than petitioner’s unsupported testimony that the Court
declines to accept. Sec. 1.274-5T(a), Temporary Income Tax
Regs., supra. Respondent is sustained on this issue.
On a separate Schedule C of petitioner’s 2000 income tax
return, petitioner claimed a deduction for expenses relating to
another activity called “Frexie”. This was the name petitioner
ascribed to his purchase of the right to use a luxury suite at
Minute Maid Park in Houston, Texas, the home field for the
Houston Astros major league baseball team, for a 3-year period
for $250,000. The Frexie activity involved the selling or
letting by petitioner of the use of the suite during Houston
Astros baseball games. In exchange for a commitment to purchase
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or use time in the suite, petitioner offered pricing incentives
to two corporations, Nabisco and Chicago Title. The two
companies agreed to the deal with petitioner. The sole expense
at issue in this case is a claimed deduction of $889.52 relating
to the activity.13
It appears that the expense in question was incurred at one
event, which was attended by petitioner and representatives of
Nabisco and Chicago Title. The evidence satisfies the Court that
the representatives of Nabisco and Chicago Title who attended the
game were not there for purposes of entertainment but were there
solely for their evaluation and consideration of how the facility
would be used to further the business interests of Nabisco and
Chicago Title, and petitioner was there to show the facility and
address whatever questions the corporate representatives may have
had. Petitioner paid for the food and beverages consumed at the
event, which amounted to $889.52.
While conceding that petitioner substantiated the expenses
and was entitled to claim the $889.52 paid for food and beverages
on Schedule C of his return as a business expense, respondent
contends that the expense was subject to the 50-percent
limitation of section 274(n). Petitioner argued that section
13
Petitioner claimed the $889.52 item as “Returns and
Allowances” on Schedule C for the trade or business activity
“Frexie”. At trial, petitioner clarified that the item was
mischaracterized and was properly a claimed business expense of
the Schedule C “Frexie” activity.
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274(n) was inapplicable because the expenditure was not incurred
for entertainment. Petitioner claims that the $889.52 was
expended as performance on a contract with Nabisco and Chicago
Title in that he was required to pay for catering services
regardless of whether business was discussed in the luxury suite.
Thus, the Court construes petitioner’s argument to be that the
50-percent limitation for food and beverages found in section
274(n) does not apply to the expense at issue because the $889.52
represented goods and services sold by petitioner in a bona fide
consideration for an adequate and full consideration in money or
money’s worth. Sec. 274(e)(8). Accordingly, petitioner argues
he was not entertaining guests.
Under section 274(n)(1)(A), any amount allowable as a
deduction for “any expense for food or beverages” in connection
with a trade or business activity is generally limited to 50
percent of the amount of the expense that would otherwise be
allowable. However, section 274(e)(8) provides an exception to
the 50-percent limitation of section 274(n)(1) for “Expenses for
goods or services * * * which are sold by the taxpayer in a bona
fide transaction for an adequate and full consideration in money
or money’s worth.” Sec. 274(n)(2).
Section 1.274-2(f)(2)(ix), Income Tax Regs., provides:
Any expenditure by a taxpayer for entertainment (or for
use of a facility in connection therewith) to the
extent the entertainment is sold to customers in a bona
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fide transaction for an adequate and full consideration
in money or money’s worth is not subject to the
limitations on allowability of deductions provided for
in paragraphs (a) through (e) of this section. Thus,
the cost of producing night club entertainment (such as
salaries paid to employees of night clubs and amounts
paid to performers) for sale to customers or the cost
of operating a pleasure cruise ship as a business will
come within * * * [the section 274(e)(8)] exception.
Thus, despite the fact that a facility might meet the definition
of an entertainment facility and be subject to the general rule
of section 274(a)(1)(A), expenses relating to its operation will
not constitute “entertainment” expenses if that facility is
legitimately involved in “selling” entertainment.
Additionally, section 1.274-2(e)(3)(iii), Income Tax Regs.,
provides that expenses (exclusive of operating costs and other
expenses referred to in section 1.274-2(e)(3)(i), Income Tax
Regs.) incurred at the time of an entertainment activity, even
though in connection with the use of a facility for entertainment
purposes, such as expenses for food and beverages, or expenses
for catering, or expenses for gasoline and fishing bait consumed
on a fishing trip, shall not be considered to constitute
expenditures with respect to a facility used in connection with
entertainment.
In Churchill Downs, Inc. v. Commissioner, 115 T.C. 279
(2000), affd. 307 F.3d 423 (6th Cir. 2002), this Court held that
a racetrack operator’s expenses for hosting press parties,
winners’ parties, and other entertainment events did not qualify
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for the section 274(e)(8) exception to the 50-percent limitation
rule of section 274(n) because the expenses were not part of
producing the taxpayer’s entertainment product and the taxpayer
provided the parties free of charge to its guests.
The Court agrees with petitioner that the $889.52 expense at
issue is excluded from section 274(n)(1) by virtue of section
274(e)(8). The guests entertained by petitioner were
representatives of two corporations that had contracts with
petitioner in a bona fide transaction for adequate and full
consideration for the subsequent business uses of these
corporations.
Petitioner incurred the expenses in question as part of his
business. Respondent agrees that the claimed expenses were
substantiated. Thus, the Court holds that the food and beverages
were sold in a bona fide transaction for adequate and full
consideration in money or money’s worth. Sec. 274(e)(8); see
also secs. 1.274-2(f)(2)(ix), 1.274-2(e)(3)(iii), Income Tax
Regs. Accordingly the Court holds that the $889.52 expense is
not subject to the 50-percent limitation of section 274(n) and is
fully deductible.
At trial, petitioner claimed other expenses in connection
with the Frexie activity. He presented a number of receipts for
ticket purchases, FedEx deliveries, and miscellaneous items such
as programs, scorecards, a baseball cap, and a T-shirt. There
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were also other receipts related to food from Aramark in the
amount of $67, Mission Burritos Carillon for $13.21, and Frankie
B. Mandola’s for $26.26. Some of the receipts had no dollar
figures, and the connection of these expenses, if any, with
Frexie is largely unexplained. The Court holds that these
expenses have not been adequately substantiated and, therefore,
are not deductible.
On Schedule A for the year 2000, petitioner claimed a
deduction of $3,218 for the writeoff of old inventory.
Petitioner testified that he had been in the water filter
business in prior years. After the business was discontinued, he
had on hand an inventory of unsold water filter units.
Petitioner presented at trial a copy of a 1989 Schedule C
relating to the activity that reflected an inventory valuation of
$3,218 in connection with an environmental equipment sales
business. Petitioner testified that he reported his income and
expenses from that activity on Schedule C of his 1989 income tax
return.
Petitioner testified that the business languished for a long
period of time and was discontinued, presumably sometime after
1989. He had inventory remaining from the business that was
never sold. He had received an offer to sell the inventory in
November 1999 for “50 cents on the dollar”, which he declined.
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Petitioner testified that, in the year 2000, the water filters
became inoperable and thus were of no value.
Respondent contends that petitioner provided no
documentation to show that he purchased, utilized, and disposed
of the water filter inventory. Respondent further contends that
petitioner’s Schedule C for petitioner’s 1989 tax year standing
alone is insufficient to demonstrate that petitioner was in a
business activity for the sale of environmental equipment.
Respondent further argues that there is no proof that petitioner
filed a return for 1989.
The record does not show that petitioner either purchased or
held a water filter inventory and, if he did, what was the cost
of that inventory. The Court rejects petitioner’s entitlement to
a deduction on this issue.
The Court next addresses the addition to tax under section
6651(a)(1) for failure to file a timely 2000 income tax return.
Section 6651(a)(1) provides for an addition to tax for
failure to file a timely Federal income tax return unless the
taxpayer shows that such failure was due to reasonable cause and
not willful neglect. United States v. Boyle, 469 U.S. 241, 245
(1985); Baldwin v. Commissioner, 84 T.C. 859, 870 (1985); Davis
v. Commissioner, 81 T.C. 806, 820 (1983), affd. without published
opinion 767 F.2d 931 (9th Cir. 1985).
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The addition to tax under section 6651(a)(1) is based on
respondent’s determination that petitioner failed to file an
income tax return for 2000.
Petitioner’s income tax return was due to be filed on or
before April 15, 2001. He had requested timely and was granted
an extension to file his 2000 tax return by August 15, 2001. He
never filed the return until the statutory notice of deficiency
was issued. At trial, petitioner claimed that he had filed his
2000 tax return timely. No evidence, however, was presented to
support that claim. Respondent is sustained on this issue.
Petitioner’s Federal income tax return for 2000 that was
submitted at trial included a Schedule D, Capital Gains and
Losses, on which petitioner claimed a $5,938.46 short-term
capital loss and a long-term capital loss of $248,643.20. On the
stipulation of facts that was filed by the parties, a basis for
settlement was agreed to with regard to petitioner’s Schedule D.
Reviewed and adopted as the report of the Small Tax Case
Division.
Decision will be entered
under Rule 155.