DocketNumber： Docket No. 29303-11
Judges： WHERRY
Filed Date： 6/30/2015
Status： Non-Precedential
Modified Date： 11/21/2020
Decision will be entered under
P operates two veterinary practices, one through a wholly owned S corporation (S). P donated trilobite fossils to an
WHERRY, After the filing of a stipulation of facts and a stipulation of settled issues, the facts of which are agreed to by the parties and incorporated herein by this reference, as well as a subsequent concession by respondent, the issues remaining for decision are: (1) whether respondent properly disallowed petitioner's (2) whether respondent properly disallowed passthrough deductions for 2006, 2007, and 2008 for certain business expenses of petitioner's wholly owned S corporation, Calabasas Veterinary Center, Inc. (CVC);*131 and (3) whether and to what extent petitioner is liable for Effective August 1, 2000, Dr. Isaacs signed and issued an interoffice policy to delineate responsibilities for and control of his two clinics' management, inventory, and personnel. Pursuant to the interoffice policy, EVC provided management services to CVC through Dr. Isaacs or his delegate and could elect to charge a management fee for its services.*132 The interoffice policy left the frequency and amount of this fee to Dr. Isaacs' discretion. He elected to impose a fee in 2007 but not in 2006 or 2008. The interoffice policy also addressed bulk inventory ordering. Vendors of vaccines, medications, surgical supplies, and other consumables used in veterinary practices commonly offer price concessions to clinics that buy in bulk. To take advantage of these incentives, Dr. Isaacs caused EVC to order supplies for both *125 clinics and then distributed the items between them. A log tracked the movement of supplies inventory between the clinics. Bills for bulk-ordered supplies were directed to EVC, but pursuant to the interoffice policy, the clinics' bookkeeper allocated financial responsibility for each bill between EVC and CVC in accordance with the percentage of goods from the order distributed to each clinic. This allocation, and the only written evidence of CVC's reimbursement of EVC, was made on the clinics' books, through a pair of offsetting adjusting journal entries; CVC never wrote checks to document any transfer of money to EVC to pay for the supplies. For 2007, rather than allocate supplies expenses with adjusted journal entries, EVC*133 instead imposed a $100,000 management fee. CVC paid the fee in nine installments along with an additional, unexplained $3,000 between April 24, 2007, and October 31, 2008. On its 2006, 2007, and 2008 Forms 1120S, U.S. Income Tax Return for an S Corporation, CVC reported that it employed the accrual method of accounting. CVC has reported using the accrual method since its incorporation. Dr. Isaacs intended for CVC to use the accrual method in keeping its books and for EVC to use the cash method. *126 CVC requires its clients to pay the fees charged for its services at the time services are rendered. It generally records its income at the time of receipt because, if its pay-in-advance-at-the-time-of-service rule is strictly followed, it does not have accounts receivable with respect to its customers. CVC did, however, report opening and closing values of, respectively, $6,045 and $10,000, for "Trade notes and accounts receivable" on Schedule L, Balance Sheet per Books, of its 2006 Form 1120S. It reported precisely offsetting opening and closing allowances for bad debts of, respectively, $6,045 and $10,000. For the 2007 tax year CVC reported an opening value*134 for accounts receivable of $10,000 and left the closing value line blank. It reported a precisely offsetting opening allowance for bad debts of $10,000 and, as with the closing value for accounts receivable, left the closing value for allowances for bad debts blank. For 2008 CVC reported no opening or closing values for either accounts receivable or allowances for bad debts. With regard to expenses, Cathy Fogel, who at the time of trial had served as CVC's bookkeeper since July 2008, characterized CVC's method of accounting as "accrual basis". Ms. Fogel had been instructed that, under the accrual method, if an expense is taken upon receipt of a bill, additional expenses cannot be taken for payments against that bill. Nevertheless, Ms. Fogel would record an expense *127 when CVC received a bill and, if the bill was not paid in full in the year of receipt, would also expense payments made on the bill in the following year. CVC's books reflect that, for at least some categories of expenses in some years, CVC expensed bills upon receipt and later expensed payments made against outstanding balances.*135 record suggest that she may have recorded entries in a manner consistent with the cash method of accounting during the latter half of 2008. Before Dr. Isaacs hired Ms. Fogel, Angela Lopez worked as EVC's and CVC's bookkeeper. In that role, Ms. Lopez was responsible for depositing payroll tax for EVC's employees, but she did not do so. At around the same time, she made the same omission at Wexley Medical Clinic, which was operated by Dr. Lilia Wexley and her daughter, Dr. Victoria Wexley, Dr. Isaacs' fiance, who had referred Ms. Lopez to Dr. Isaacs. Contrary to EVC's rules, Ms. Lopez removed two boxes of documents from the clinic and took them to her home. Dr. Isaacs went with the police to Ms. Lopez's home three times in efforts to recover the *128 missing records. When Ms. Lopez finally returned some records to Dr. Isaacs, he discovered that they were for another doctor's clinic. Ms. Lopez left CVC's books in disarray and riddled with inaccuracies. CVC ultimately*136 hired Ms. Fogel on the recommendation of its accountants after Ms. Lopez went missing for two weeks. On or about December 29, 2006, Dr. Isaacs donated four fossil trilobites to the California Academy of Sciences (CAS), a Dr. Isaacs filed Forms 8283, Noncash Charitable Contributions, with his 2006 and 2007 Federal income tax returns. On each form, in Part IV, "Donee Acknowledgment", an individual signed on behalf of CAS to acknowledge that CAS was a qualified organization under Both of*137 Dr. Isaacs' Forms 8283 bear the signature "Jeffrey R. Marshall" in Part III, "Declaration of Appraiser". Dr. Isaacs called Jeffrey Robert Marshall as a witness at trial. The Court accepted Mr. Marshall as an expert in the valuation of fossils over respondent's objection.*138 likewise identified his signature on Dr. Isaacs' 2007 Form 8283 but could not recall signing the form. Mr. Marshall similarly identified his signature on two letters, dated December 31, 2006 and 2007, that purported to be appraisals of the fossils Dr. Isaacs donated to CAS in 2006 and 2007. But Mr. Marshall did not write or even recognize the letters, and as Dr. Isaacs offered no testimony from any other expert *130 as to the letters' author, we did not admit them into evidence.*139 Dr. Isaacs did not offer any other purported appraisals of the donated fossils. CVC timely filed Forms 1120S for tax years 2006, 2007 and 2008, claiming deductions for, inter alia, the following business expenses: CVC reported net ordinary business losses of $72,858 for 2006, $53,359 for 2007, and $275 for 2008. *131 Dr. Isaacs timely filed Forms 1040, U.S. Individual Income Tax Return, for tax years 2006, 2007, and 2008. He claimed deductions for passthrough losses from CVC of $53,677 for 2006 and $47,532 for 2007 but did not report any passthrough gain or loss from CVC for 2008.*140 $85,894 deduction on the basis of a $136,500 noncash contribution and an $11,719 carryover from a prior year. For 2007 he claimed a $52,361 deduction on the basis of a $109,800 noncash contribution and a $62,575 carryover from a prior year. For 2008 he claimed a $14,548 deduction on the basis of cash contributions totaling $500 and a $120,309 carryover from a prior year. On September 22, 2011, respondent mailed a notice of deficiency to Dr. Isaacs determining adjustments to his income for tax years 2006, 2007, and 2008. These adjustments included, among other things, disallowance of Dr. Isaacs' 2006 and 2007 charitable contribution deductions, disallowance of a carryover noncash charitable contribution deduction for 2008, and disallowance of certain passthrough deductions for CVC's expenses for 2006, 2007, and 2008. Dr. Isaacs *132 timely petitioned this Court on December 22, 2011, with respect to all three tax years. Revenue Agent Maria Rodriguez (RA Rodriguez), who holds a bachelor of science degree in accounting and a master's degree in taxation, examined CVC's expenses at the request of respondent's counsel after this case was filed. She reviewed numerous documents*141 that Dr. Isaacs provided, including Quickbooks summary pages, invoices, and canceled checks. Dr. Isaacs did not provide RA Rodriguez with a complete set of books or a general ledger for CVC. Some of the invoices he did provide were directed to EVC, not CVC, and some of the checks bore notations on their memo lines indicating that they represented expenses of EVC. Dr. Isaacs also provided some Quickbooks journal entries for EVC, but he did not provide a complete set of books with which RA Rodriguez could reconcile the journal entries. When RA Rodriguez reviewed CVC's Quickbooks summary pages, she noted that there were payments reflected on summaries of CVC's expenses which were in her opinion inconsistent with CVC's representation on its tax return that it followed the accrual method of accounting. For some categories of expenses, most of the items on the Quickbooks summary pages were payments, with only a *133 single, large expense accrued at yearend. Without a full set of books, RA Rodriguez could not reconcile CVC's payables with its tax returns or determine the year-to-year changes in its payables. Because she concluded she could not verify the accuracy of entries on the Quickbooks summary*142 pages or journal entries and because she did not have a complete copy of CVC's books, RA Rodriguez concluded that she would not rely upon the Quickbooks excerpts that Dr. Isaacs had provided. She further concluded that the cash receipts and disbursements method of accounting would clearly reflect CVC's income. Relying solely on source documents such as invoices and canceled checks, RA Rodriguez recomputed CVC's expenses on a cash basis for each tax year at issue. She disallowed expenses for which Dr. Isaacs provided only journal entries but no source documents. She likewise disallowed accrued expenses for which Dr. Isaacs could not provide proof of payment during that taxable year. Since returns for 2009 or other taxable years were not under audit, she apparently did not make any correlative adjustments for other taxable years. CVC's books and source documents indicated that it regularly transacted with the payees on two of these disallowed accrued expenses, Antech and Miller & Co., but payments to them did not follow any regular pattern in terms of either frequency or amount. In a stipulation of settled issues*144 and on the basis of evidence adduced at *135 trial,*145 the parties*143 each conceded portions of the deductions for CVC's expenses that respondent disallowed in the notice of deficiency. The amounts of deductions for CVC's expenses remaining in dispute after these concessions (disputed expenses), which are the only amounts addressed in this opinion, are as follows: As a general matter, the Commissioner's determination of a taxpayer's liability for an income tax deficiency is presumed correct, and the taxpayer bears the burden of proving that the determination is improper. A taxpayer*146 may deduct any charitable contribution made during the taxable year, but only if the contribution is "verified under regulations prescribed by the Secretary." First, for all contributions of $250 or more, a taxpayer generally must obtain a contemporaneous written acknowledgment from the donee. Second, for non-cash contributions in excess of $500, a taxpayer must maintain reliable written records with respect to each donated item. Third, for non-cash contributions of property with a claimed value of $5,000 or more, a taxpayer must--in addition*148 to satisfying both sets of requirements described above--obtain a "qualified appraisal" of the donated item(s) and attach to his tax return a fully completed appraisal summary on Form 8283. Because the values Dr. Isaacs claimed for the fossils donated to CAS on his 2006 and 2007 tax returns--$136,500 and $109,800, respectively--exceeded $5,000, he was obliged to meet all three sets of requirements outlined above. He satisfied none of them. *139 Beginning with the highest applicable value threshold, Dr. Isaacs failed to establish that he obtained qualified appraisals of the donated fossils as required by Even if Dr. Isaacs had obtained qualified appraisals of the fossils donated in 2006 and 2007, however, he would still be precluded from deducting the donations because he failed to satisfy the substantiation requirements for non-cash contributions exceeding $500. Finally, even had Dr. Isaacs satisfied the substantiation requirements for contributions in excess of both $5,000 and $500, we would still sustain respondent's disallowance of his claimed deductions because he failed to obtain a satisfactory contemporaneous written acknowledgment, as required for a contribution exceeding $250.See Because Dr. Isaacs failed to obtain a qualified appraisal and satisfy the relevant substantiation requirements, respondent properly disallowed his claimed charitable contribution deductions for 2006 and 2007, as well as his claimed carryover deduction for 2008.*153 Respondent disallowed various deductions for business expenses CVC claimed on its returns and consequently, in the notice of deficiency, reduced Dr. Isaacs' pass-through losses for 2006 and 2007 and increased his pass-through *143 income for 2008. At trial, however, respondent contended that Dr. Isaacs had failed to substantiate the disputed expenses underlying the disallowed deductions and that in any event, for some of the disputed expenses,*154 CVC improperly accrued these expenses at yearend despite otherwise maintaining its books on a cash basis. A taxpayer must keep books or records that substantiate the expenses underlying each deduction claimed on his or her return. Similarly, unless corroborated by other evidence, an entry on a taxpayer's books generally will not suffice to substantiate an expense. Under If a taxpayer's records are lost or destroyed because of circumstances beyond his control, the taxpayer may instead substantiate expenses with other *145 credible evidence. Of CVC's claimed $47,009 lab fees deduction for 2006, $6,504 remains in dispute. Except for Exhibit 35-P, Of CVC's claimed deduction for $156,676 of ancillary expenses for 2006, $104,400 remains in dispute.See The $85,000 balance of the amount in dispute consists of a single expense allegedly incurred on December 30, 2006. CVC's 2006 Quickbooks summary page for ancillary expenses*158 lists, as a debit, an $85,000 expense as "Due to/Due from CVC". A December 30, 2006, adjusting journal entry links this $85,000 expense to the "Retail Pet Food & Supplies" account and reads "To record Transfer T" under the memo heading. This debit item is matched with a credit item in the same amount, with the same memo information, to the "Due to/Due from CVC" account. A corresponding adjusting journal entry for EVC for the same amount on the same date lists a debit to "Due to/from CVC" and a credit to "Retail Pet Food & Supplies" and reads "To charge Encino for..." under the memo heading. Dr. Isaacs testified that these journal entries reflect reimbursement by CVC to EVC for inventory items ordered in bulk and paid for by EVC but distributed to CVC during the year pursuant to the interoffice policy. Respondent stipulated the clinics' receipt of discounts on veterinary supplies ordered in bulk. Dr. Isaacs *148 further testified that EVC had included in income reimbursements it received from CVC. Respondent challenges CVC's deduction of this $85,000 alleged expense on two grounds. Dr. Isaacs testified that CVC never actually paid the $85,000 to EVC; rather, CVC's expense*159 and EVC's income existed only as Quickbooks journal entries. Respondent contends that, although CVC's 2006 tax return indicates that it reported its income according to the accrual method of accounting, CVC was a cash method taxpayer. Therefore, respondent reasons, CVC was not entitled to deduct an $85,000 expense that it had not actually paid. But respondent has not made a determination pursuant to Whatever quantum and form of evidence would ordinarily be required from respondent or petitioner to resolve this determination, we think it does not, in this case, reasonably include evidence sufficient to substantiate expenses underlying claimed deductions under a method of accounting different from the one indicated on CVC's return. Substantiating an expense under CVC's claimed accrual method *150 of accounting would require establishing that "all the events ha[d] occurred that establish the fact of the liability", that the amount could "be determined with reasonable accuracy", and that economic performance had occurred. Rebutting respondent's contention would require Dr. Isaacs to present different evidence. The contention therefore constitutes a "new matter", and respondent bears the burden of proof concerning it.See For four reasons, we conclude that respondent has not carried his burden of proof with respect to the 2006 tax year. First, although mixed, the evidence in the record tends to show that CVC computed its income for We give less deference to labels such as that assigned here by CVC's checking the box for the accrual method on its 2006, 2007, and 2008 Forms 1120S. [W]hether a return is made on the accrual basis, or on that of actual receipts and disbursements, is not determined by the label which the taxpayer chooses to place upon it. The * * * inclusion in the returns of accrual items of receipts and disbursements appearing on petitioner's books, indicate the general and controlling character of the account * * * and support * * * [a] finding * * * that books and returns were on the accrual basis. [ The inclusion in CVC's return of values for "accrual items of receipts*164 and disbursements" indicates that CVC computed its income for tax purposes using the accrual method of accounting, not the cash method, although its books may have contained errors. Second, the record does not establish that for Third, [A] taxpayer who uses the cash method of accounting in computing gross income from his trade or business shall use the cash method in computing expenses of such trade or business. Similarly, a taxpayer who uses an accrual method of accounting in computing business expenses shall use an accrual method in computing items affecting *155 gross income from his trade or business. On the income side, other than Dr. Isaacs' ambiguous testimony, CVC's reporting of opening and closing balances for accounts receivable on*167 its tax return constitutes the only available evidence as to CVC's method of accounting for its 2006 receipts. Because RA Rodriguez examined only CVC's expenses, she could not have recomputed CVC's receipts on the cash method along with its expenses. Respondent has allowed CVC to take accrued receipts into income but would disallow deductions for accrued expenses. Such disparate treatment of receipts and expenses would not clearly reflect CVC's 2006 income. Fourth and finally, it is undisputed that CVC has reported using the accrual method of accounting on its income tax returns since its incorporation. Respondent has apparently left CVC's use of the accrual method undisturbed for tax years preceding 2006. If, for 2006 through 2008, CVC's income were to be instead computed for tax purposes on the cash method, this would represent a change in method of accounting. Under the Code, in general, a change in method of accounting can occur in one of three ways. First,*168 Respondent has not exercised his authority under Rejecting as inadequate the excerpts from CVC's and EVC's Quickbooks entries, respondent further contends that Dr. Isaacs did not substantiate the claimed $85,000 of ancillary expenses. The log that tracked inventory movement between EVC and CVC would perhaps have been the best possible substantiation for this expense, but Dr. Isaacs testified that he could not provide this log because he no longer had it. *158 Yet Dr. Isaacs established that CVC's former bookkeeper, Ms. Lopez, failed to deposit payroll taxes, generally left the clinics' books in disarray, and--as is crucial here--stole business records and refused to return them. Ms. Lopez's egregious conduct was not reasonably foreseeable. Because some of CVC's business records were lost because of circumstances beyond Dr. Isaacs' control, he was entitled*170 to substantiate expenses with other credible evidence. To that end, Dr. Isaacs described the reason for the claimed $85,000 of ancillary expenses and introduced the interoffice policy to support that explanation. He offered uncontroverted testimony that EVC included the $85,000 in income for 2006, and he provided corresponding offsetting journal entries for CVC and EVC that are consistent with his testimony. These items may not be the best possible evidence for the $85,000 of ancillary expenses but they do constitute some evidence. Although uncorroborated book entries generally will not suffice to substantiate an expense, Of CVC's claimed $22,817 lab fees deduction for 2007, after respondent's pretrial and posttrial concessions, On brief Dr. Isaacs contends that the $1,727 expense represents a fee paid to Antech and that a deduction for the expense should be allowable notwithstanding the absence of any substantiation evidence because: (1) he has provided evidence of numerous other fees CVC paid to Antech throughout the year; and (2) Ms. Lopez stole some of CVC's business records and left its books in general disarray. Both of these premises are incorrect. *160 First, although the Second, CVC's loss of business records due to events beyond its control entitles Dr. Isaacs to substantiate the claimed expense with other credible evidence. Yet no document or testimony in the record supports the amount claimed. Neither Dr. Isaacs nor any other witness testified concerning the date, amount, purpose, or method of payment for this specific claimed expense. Dr. Isaacs has not satisfied his burden of proof with respect to the 2007 lab fees, Respondent disallowed in its entirety CVC's $100,000 deduction for office overhead for 2007. Dr. Isaacs testified that this $100,000 expense consisted of a management fee paid by CVC to EVC for 2007, pursuant to the interoffice policy. *161 He acknowledged that CVC did not pay EVC a management fee in 2006 and did not report an expense for a management fee for 2008. Dr. Isaacs explained that for 2007, rather than use yearend adjusting journal entries to reimburse EVC for bulk-ordered consumables transferred to CVC, he caused EVC to impose the management fee. He further testified*173 that--in contrast with the 2006 consumables reimbursement to EVC, which was accomplished through corresponding journal entries without actual payment--CVC actually paid EVC the $100,000 management fee. He stated that EVC included this amount in income for 2007. As with the consumables reimbursement payment for 2006, Dr. Isaacs introduced corresponding, offsetting journal entries for CVC and EVC that reflect a $100,000 debit to CVC on December 31, 2007, and a $100,000 credit to EVC (for "Misc Income") on the same date. EVC's 2007 profit and loss statement includes a $100,000 line item for "Misc Income - Other". To demonstrate that CVC in fact paid the $100,000 management fee to EVC, Dr. Isaacs produced a Quickbooks "Find Report" that lists checks paid by CVC to EVC from April 24, 2007, through October 31, 2008. The check amounts listed total $103,000 rather than $100,000, with $51,000 paid in 2007 and the remaining $52,000 paid in 2008. Respondent contends that the foregoing evidence is insufficient to substantiate the management fee claimed as a deduction on CVC's 2007 Form 1120S, as detailed on statement 3 itemizing claimed other deductions. He dismisses as "self-serving"*174 Dr. Isaacs' testimony that EVC included the full $100,000 in income for 2007, and he contends that nothing ties the documented payments to the claimed office overhead deduction. We disagree. During his testimony, Dr. Isaacs explained the nature of and basis for the management fee, and he introduced the interoffice policy, which addresses the fee. He further introduced journal entries for CVC and EVC that document an expense and corresponding receipt. Dr. Isaacs testified that EVC included the $100,000 management fee in income for 2007, and EVC's inclusion of that fee as income on its 2007 profit and loss statement supports his testimony. Dr. Isaacs' testimony also linked the payments to EVC recorded on CVC's books to the management fee. Although this evidentiary showing may not represent the best possible evidence to substantiate the management fee, it is credible evidence. Respondent further notes that, although CVC claimed a $100,000 deduction for 2007, its own records show that it paid only $51,000 to EVC during that year. We interpret this observation as alluding to respondent's more general contention that CVC "is really a cash method taxpayer." For the same reasons described supra part II.B.1, we decline to adopt this theory with respect to CVC's 2007 tax year. First, the record reflects that CVC computed its 2007 taxable income on the accrual method. On its 2007 Form 1120S, consistent with Dr. Isaacs' testimony that CVC used the accrual method, CVC reported opening and closing values for *165 accounts receivable and accounts payable.See Second, the record does not establish that CVC computed its income for book purposes on the cash*178 method. The record contains only two relevant excerpts from CVC's 2007 books: the $100,000 journal entry for the management fee on December 31, 2007, and the schedule of payments showing only $51,000 actually paid toward that amount during 2007. That CVC recorded the full $100,000 expense in the year in which the management fee was levied, before it had paid the full amount, suggests that it maintained its books on the accrual method during 2007. Third, CVC's tax return reflects that it computed its 2007 taxable receipts on the accrual method, and RA Rodriguez did not recompute those receipts on the cash method when she recomputed CVC's 2007 expenses. Use of inconsistent methods of computing receipts and expenses would not yield a clear reflection of CVC's income. Fourth, before 2007 CVC was an accrual method taxpayer. As was true*179 for 2006, CVC's method of accounting in 2007 did not change pursuant to For 2008 the amounts of CVC's claimed deductions for lab fees, medical supplies, and professional services expenses remaining in dispute are, respectively, $25,865, $135,431, and $12,955. Respondent contends that CVC was a cash method taxpayer for 2008, that CVC impermissibly accrued these expenses at yearend, and that Dr. Isaacs has not established that CVC incurred or paid these expenses during 2008.Accounting Method Respondent bears the burden of proof with respect to his contention that CVC was a cash method taxpayer. On its 2008 Form 1120S, although CVC checked the box indicating that it had computed its income on the accrual method,*181 CVC reported no opening and closing values for accounts receivable. CVC's 2008 tax reporting was consistent *168 with Dr. Isaacs' testimony that, because its clients paid at the time of service, it did not carry accounts receivable on its books. The available evidence therefore suggests that during 2008, CVC took Turning to CVC's expenses, on its 2008 tax return, it reported opening and closing values for accounts payable. Reporting accounts payable would be inconsistent with the cash method, under which a liability is deductible only when actually paid. Ms. Fogel's testimony sheds some light on this pattern. She served as CVC's*182 bookkeeper from July 2008 through at least the time of trial. She testified that, for bills not paid in full before yearend, it was and is her practice to expense the amount of the bill and to also expense payments toward the underlying obligation made in the following year. Indeed, under incredulous questioning *169 from Dr. Isaacs, she twice confirmed this testimony. If CVC was on the accrual method, Ms. Fogel's professed practice would result in the double deduction of affected expenses. When Dr. Isaacs asked her, in apparent frustration: "But based on [the] accrual method [of] accounting, if you expense the bill when you receive it, can you expense it again when you pay it?", she correctly answered, "No." Dr. Isaacs then stated: "Okay * * * do you follow that rule of accounting principles for Calabasas Veterinary Center when you do the books at Calabasas?" She then answered, "Yes." With respect to the disputed expenses, Ms. Fogel would have been the person to record expenses for bills received at yearend 2008 and, according to her professed practice, would have expensed payments on those bills made in 2009. Illustratively, a Quickbooks "Vendor QuickReport" for Miller & Co. for 2008 and*183 2009 with entries for February 23, 2008, through December 31, 2009, reflects that Ms. Fogel credited a December 31, 2008, statement from Miller & Co. to accounts payable, thereby giving rise to the disputed professional fee expense, and then also booked check payments in early 2009 to accounts payable. From the available evidence, we find that CVC did not follow a consistent method of accounting for its In all years from its incorporation through 2005, CVC computed its income for tax purposes on the accrual method. It reported having done so for 2006 and 2007, and we have concluded that the evidence in the record supports CVC's *171 reporting position. For CVC to be a cash method taxpayer for 2008, it would have had to change its method of accounting,*185 but the evidence does not establish that such a change occurred. First, as we have repeatedly noted, respondent did not exercise his Second, there is no evidence that CVC sought and obtained respondent's consent pursuant to And third, any irregularities in CVC's 2008 bookkeeping would represent, at most, a one-year deviation from its preexisting method of accounting. Our caselaw suggests that, absent the Commissioner's direction under *172 To the extent that CVC's 2008 tax return reflects an erroneous application of or deviation from the accrual method, respondent could have pursued at least two*186 courses of action to rectify the errors. Respondent could have asserted Dr. Isaacs bears the burden of substantiating the 2008 disputed expenses. Of CVC's claimed $64,373 lab fees deduction for 2008, $25,865 remains in dispute. The parties stipulated two relevant exhibits: (1) a collection of source documents including an account receivable aging for CVC reflecting a $25,402.30 *173 balance due as of December 30, 2008 (Antech bill),*187 On brief respondent identifies the disallowed lab fees deduction as comprising the accumulated Antech bill and $463 of wholly unsubstantiated expense. In comparing the stipulated list of substantiated expenses to the Quickbooks summary page, we have identified numerous discrepancies.*188 After reviewing the source documents collected in Exhibit 14-P, we find that these records substantiate not only the amounts of expense on the stipulated list but also an additional $463 payment to Heska Corp. for laboratory services paid by CVC*174 check No. 40345 on December 8, 2008. We therefore redetermine respondent's determination as to that expense and allow this $463 deduction. With regard to the remaining amount, we find the Antech bill and the Quickbooks summary page, coupled with Dr. Isaacs' testimony that CVC regularly used this vendor during this time for laboratory services, sufficient to substantiate the expense under the accrual method of accounting. We will therefore allow a deduction for this expense. Of CVC's claimed $266,258 medical supplies expense deduction for 2008, $135,431 remains in dispute. The parties stipulated portions of CVC's and EVC's books relevant to the claimed 2008 medical supplies expense deduction: (1) a Quickbooks summary page for CVC's 2008 medical supplies expenses showing amounts accrued*189 on December 31, 2008, of $24,751 for drugs, $25,506 for surgical supplies, and $88,304 for other medical supplies, for a total of $138,561;*175 supplies, and medical supplies in the same amounts shown on the Quickbooks summary page. Dr. Isaacs testified that the 2008 medical supplies expense represented reimbursement of EVC for consumables ordered in bulk and paid for by EVC but used by CVC pursuant to the interoffice policy. He further testified that EVC included this amount in income. On the basis of the foregoing, we conclude that Dr. Isaacs has adequately substantiated the 2008 medical supplies expense, and we will consequently allow a $135,431 deduction for it. Of CVC's claimed $74,686 professional services expense deduction for 2008, $12,955 remains in dispute. The parties stipulated a Quickbooks summary page for*190 CVC's 2008 professional fees expenses showing a December 31, 2008, accrued expense of $13,283 to Miller & Co., CVC's accounting firm. Respondent contends that this accrued expense accounts for the still-disputed amount.*176 In his testimony Dr. Isaacs asserted that deductions for two invoices from Miller & Co. had been disallowed and that the amounts had been expensed when the invoices were received. The two invoices to which he referred are dated September 15 and October 15, 2008, and are for, respectively, $7,950 and $4,995, for a total of $12,945.*191 do not precisely correspond to the amount of the disallowed expense or the date on which the Quickbooks summary page reflects that it was recorded on CVC's books. However, the invoices do not otherwise appear on the Quickbooks summary page, and the parties stipulated no payments corresponding to them. From the evidence before us, we infer that CVC did not pay or expense the September 15 and October 15 invoices upon receipt, and that either (1) Miller & Co. may have sent a yearend statement reflecting these outstanding balances and possibly some additional charges or (2) during the latter part of 2008 Ms. Fogel generally recorded CVC's professional fees expenses when paid, but then she, or the *177 accounting firm to close the books, accrued an expense for the outstanding balances at yearend. Either way, we think the evidence suffices to substantiate the claimed expense. Although generally an uncorroborated entry in a taxpayer's books will not suffice to substantiate*192 an expense, We conclude that the following amounts of the disputed expenses are allowable as deductions: Respondent properly disallowed deductions for the other disputed expenses. For all three tax years at issue, respondent determined accuracy-related penalties under As a general rule, the Commissioner bears the burden of production and "must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty." Whether a substantial understatement exists, and if so, in what amount, will depend upon the recalculation of Dr. Isaacs' tax liabilities on the basis of this opinion. We leave this calculation to the*195 parties under With regard to the negligence penalty, respondent contends that Dr. Isaacs was negligent because he failed to maintain adequate books and records and to substantiate items properly.*196 We agree. *181 Although we consider Dr. Isaacs' failure to obtain a qualified appraisal to be, essentially, a foot fault, he also failed to satisfy several other substantiation requirements applicable to his claimed charitable contribution deductions. For example, he lacked records substantiating his bases in the donated fossils, and the written acknowledgments he received from CAS did not state whether it had supplied goods or services in exchange for Dr. Isaacs' gifts. Dr. Isaacs testified to having consulted a guide published by the IRS to determine which methods of accounting were available to CVC. Yet on the record before us, he did not conduct even basic research concerning the requirements for a charitable contribution*197 deduction.*182 complete and accurate books and records for CVC. From his consistent failure to produce certain items--throughout the audit process, for RA Rodriguez's pretrial examination, or for trial itself--we can only infer these items' nonexistence. Most glaringly, although Dr. Isaacs apparently had access to CVC's Quickbooks files for 2006 through 2008, producing summaries for various expense categories specifically questioned by respondent, he never produced complete books for CVC. Similarly, although three of the*198 disputed expenses consisted of alleged payments to EVC, he did not provide respondent with copies of EVC's yearend financial statements (other than a 2007 profit and loss statement) or portions of its books (other than journal entries) that would corroborate his testimony that EVC included these amounts in income. A reasonably prudent taxpayer would have maintained these records, and in any case, Dr. Isaacs asserts that the reasonable cause and good faith defense shields him from the determined penalties because he relied upon his longtime accounting firm to prepare his and CVC's returns and upon bookkeepers to keep CVC's books.*200 We think it also relevant that Angela Lopez, CVC's bookkeeper prior to *184 July 2008, removed and did not return some of its business records, and we address this issue as well. A taxpayer may establish a section 6664(c) reasonable cause defense by showing that he or she relied reasonably and in good faith on a third party's advice in taking the disputed tax*201 position. Dr. Isaacs presented testimony from a certified public accountant, Paul Cook, who at the time of trial had 33 years of experience and was a partner in Miller & Co., CVC's accounting firm. We need not decide whether Mr. Cook was a competent professional having sufficient expertise to justify reliance, satisfying the first Dr. Isaacs also presented evidence concerning two bookkeepers, Ms. Lopez and Ms. Fogel, who maintained CVC's books during successive portions of the tax years at issue. According to Dr. Isaacs' own witnesses, Ms. Lopez was grossly incompetent and untrustworthy. Ms. Fogel, in turn, testified only that she had been a professional bookkeeper since 1979, and the record contains no other information concerning her credentials or expertise. Dr. Isaacs has not established that either Ms. Lopez or Ms. Fogel was "a competent professional who had sufficient expertise to justify reliance". Deficiency $102,635 $260,615 $68,728 Penalty 20,527 52,123 13,745 Ancillary $152,676 $100,626 — Lab fees 47,009 22,817 $64,373 Medical supplies 73,195 169,094 266,258 Office overhead — 100,000 — Professional services 6,591 13,733 74,686 Ancillary expenses $104,400 — — Lab fees 6,504 $1,727 $25,865 Office overhead — 100,000 — Medical supplies — — 135,431 Professional fees — — 12,955 Ancillary expenses $85,000 — — Lab fees -0- -0- $25,865 Office overhead — $100,000 — Medical supplies — — 135,431 Professional fees — — 12,955
1. Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) of 1986, as amended and in effect for the tax years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. We round all amounts to the nearest dollar.↩
2. At trial petitioner asked to be addressed as "Dr. Isaacs". We refer to him as Dr. Isaacs throughout this opinion.↩
3. The record contains only very limited excerpts from CVC's books. We cannot discern from these documents whether CVC followed the practice of expensing both bills and payments consistently and/or for all categories of expenses.↩
4. Mr. Marshall has collected fossils since his youth. He studied earth science at Santa Barbara City College and has taught earth science classes, mostly to high school students. He has operated 21 different retail stores, including up to 5 at any one time, specializing in fossil sales over the last 40 years. Mr. Marshall's business requires that he set prices for the fossils he sells. Over the years he has sold thousands of fossils at prices ranging from $1 to $2 million. Mr. Marshall and Dr. Isaacs share an enthusiasm for trilobite fossils, and Mr. Marshall has appraised such fossils for Dr. Isaacs at his request. Other than for Dr. Isaacs, Mr. Marshall has never prepared a formal appraisal for tax purposes. Before the trial in this case, he had never testified concerning an appraisal he had made.↩
5. Dr. Isaacs admitted during trial that he had written the letters himself and presented them to Mr. Marshall for signature. He did not, however, make this admission under oath during his testimony but rather after he had been excused as a witness, during a colloquy with the Court. As the admission was not evidence, we make no factual finding concerning it.
6. The Schedules K-1, Shareholder's Share of Income, Deductions, Credits, etc., that CVC should have issued to Dr. Isaacs for 2006 and 2007 and that would have included basis information, are not included, nor is other evidence to answer this question included, in the record. The record similarly does not disclose why Dr. Isaacs did not report any passthrough loss for 2008.↩
7. In the stipulation of settled issues (SOSI), by each conceding various amounts the parties entirely resolved respondent's determinations of unreported income and partially resolved respondent's disallowances of deductions. The original SOSI was filed with the Court at the calendar call before trial and bears both parties' signatures. The SOSI is internally inconsistent with respect to the amounts remaining in dispute for 2008; different sets of numbers appear in paragraphs 11 and 12. We resolve that inconsistency on the basis of the stipulation of facts, the amounts stated in which correspond to and corroborate the set of numbers in paragraph 11 of the SOSI.
Making the request for the first time in his reply brief, Dr. Isaacs asks the Court to issue an order modifying the SOSI to reduce the amounts he conceded for each of the three years to $12,141 per year, a total of $36,423. He asks the Court to do this to "accurately reflect[] the actual amounts Petitioner should be conceding versus the amount imposed upon him by the unfortunate circumstance of a person that went crazy doing her bookkeeping job."
Stipulations should be enforced according to their terms "unless manifest injustice would result."
8. Petitioner offered two checks, which we admitted as Exhibits 35-P and 36-P, to substantiate additional expenses for lab fees for 2006 and 2007. Petitioner represented that he had not previously provided these checks to respondent. In his posttrial brief respondent acknowledges that the 2007 check was newly provided and concedes a deduction for the amount of that check, $7,186, reducing the 2007 lab fees in dispute to $1,727. He states, however, that he had already received and conceded a $792 deduction for the amount of the 2006 check before trial. Petitioner does not contest respondent's statement in his reply brief, so we will accept this statement as accurate and refrain from double-counting the 2006 check.
9. A "charitable contribution" is a contribution or gift for the use of a donee identified in
10. This requirement does not apply "if the donee organization files a return, on such form and in accordance with such regulations as the Secretary may prescribe, which includes the information" required to be included in a contemporaneous written acknowledgment.
11. In the course of representing himself, but not while on the witness stand, Dr. Isaacs admitted that he had written the appraisals bearing Mr. Marshall's signature. Dr. Isaacs does not argue that he himself was a qualified appraiser, such that the letters he drafted could be qualified appraisals. We note, however, that the applicable regulation specifically excludes "[t]he donor or the taxpayer who claims or reports a deduction under
12. Although we have held that the requirements of the charitable contribution regulations may be met through substantial, rather than strict, compliance,
13. Because Dr. Isaacs did not satisfy the substantiation requirements for a contribution exceeding $250, we need not assess whether Dr. Isaacs met the requirements for relief under
14.
15. Exhibits 14-P and 17-P consist of copies of invoices and canceled checks related to, respectively, CVC's 2008 lab fees expense and its 2008 professional services expense. Exhibit 24-P consists of miscellaneous bank statements and canceled checks from one of CVC's accounts. The bank statements are from 2007, and the canceled checks and invoices, not all of which are entirely legible, appear to be from 2007 and 2008. No comparable evidence--other than Exhibit 35-P, an October 6, 2006, canceled check for $792, an amount which respondent conceded during the examination and shall be allowed as a sec. 162 deduction--was submitted for 2006, and none of the Quickbooks summary pages or journal entries for 2006 in the record, Exhibits 8-P and 9-P, covers the lab fees expense.
16. On brief petitioner claims that the SOSI incorrectly stated the amount of 2006 ancillary expenses remaining in dispute and that the correct amount is $80,574. Petitioner offers no facts to support this claim, and respondent maintains that the amount in the SOSI is correct. Absent any factual basis on which to question them, we proceed using the dollar amount that the parties stipulated in the SOSI.↩
17. In contrast, respondent's contention that Dr. Isaacs failed to substantiate the disputed deductions is, at most, a new reason for the determinations concerning them in the notice of deficiency.
18.
19. This Court has not so far expressly addressed whether the disputed expenses were "ordinary and necessary" as required for deduction under
Moreover, we think it fairly obvious that lab fees and expenses for consumables such as vaccines, medications, and surgical supplies were "appropriate and helpful" to the business of operating a veterinary clinic,
Management services, however, while certainly necessary to the operation of the business at issue here, are not so plainly an "ordinary" expense when provided by a third party. Indeed, if we analyze the management fee as a payment for the provision of management services, the evidence does not even establish that the expenses were a "common or frequent occurrence" at this particular clinic, let alone among businesses of its kind.
20. No amount was entered on the line for accounts receivable as of yearend; but as the return preparer did not enter zeroes on all lines for items having a zero value, that may simply indicate that the yearend value for accounts receivable was zero.↩
21. We have suggested that a two-year deviation can establish a new method of accounting.
22. We analyze the 2008 disputed expenses in aggregate because respondent makes the same arguments concerning all three expense categories.↩
23. If CVC had accounted for its 2008
24. Respondent reserved a hearsay objection to handwritten notations on the documents collected in Exhibit 14-P, and petitioner offered no rebuttal argument. We conclude these notations are inadmissible hearsay and will not consider them.↩
25. The vendor names, dates, check numbers, and amounts on the stipulated list all correspond to information on the Quickbooks summary page. However, it appears that one entry in the vendor column and one entry in the check number column were skipped on the stipulated list. Many expense amounts on the stipulated list are assigned to dates and vendors different from those delineated on the Quickbooks summary page. For example, the Quickbooks summary page lists a $3,000 check payment to Antech on September 19, 2008. The next listed payment is to Idexx Distribution Corp. (Idexx) on September 25, 2008, for $133. The next listed payment is to Antech. The stipulated list attributes the $3,000 September 19 payment to Idexx rather than to Antech, and it attributes the $133 September 25 payment to Antech rather than to Idexx.
26. We attribute the discrepancy between this amount and the amount remaining in dispute to the parties' debiting two journal entries, for $3,000 and $130, from the total yearend accrued expense.↩
27. We attribute the $328 difference between the accrued expense and the amount remaining in dispute to (1) the parties' stipulation to the existence of two $14 check payments to Bjorn Corp., on March 1 and April 1, 2008, that do not appear on CVC's Quickbooks summary page, and (2) a numerical discrepancy between the Quickbooks summary page and the stipulation of facts. According to the Quickbooks summary page, CVC paid $1,500 by check No. 40078 to Cohen, Miskei & Mowrey on July 21, 2008. The parties stipulated that Dr. Isaacs had substantiated this expense, check No. 40078, but in the amount of $1,800.↩
28. These invoices appear within Exhibit 17-P at pp. 6 and 7. Respondent reserved a hearsay objection to handwritten notations on various documents within the exhibit. We sustain that objection and have not considered the handwritten notations.↩
29. The notice of deficiency also lists a substantial valuation misstatement as an alternative basis for the penalty.
30. Respondent makes two additional arguments that are wholly unsupported by the record. First, respondent asserts that Dr. Isaacs knew that he needed appraisals prepared by a qualified appraiser in order to deduct his charitable contributions to CAS, that he accordingly prepared "false" appraisals and submitted them to respondent and the Court, and that he thereby sought to "circumvent" the applicable regulations. Respondent does not support these allegations with record citations, and the Court can identify no evidence that would. Dr. Isaacs evidently knew that he needed to submit appraisals of the contributed fossils to the IRS, but nothing suggests he was aware of the requirement that they be "qualified" appraisals prepared by a "qualified appraiser".
Moreover, no evidence in the record indicates that Dr. Isaacs acted with any motive to deceive in attempting to secure appraisals in the manner in which he did. Second, respondent contends that Dr. Isaacs followed "a pattern to inflate the expenses of CVC at the end of the year to avoid taxation by manipulating the books of his related corporations." Respondent has identified one expense in each of 2006 and 2007 and three expenses in 2008 that were accrued and deducted at yearend. Of these expenses, only three involved alleged payments to EVC. This hardly constitutes a "pattern". More saliently, there is no direct or circumstantial evidence in the record that Dr. Isaacs acted with any tax avoidance motive.
31. IRS Publication 526, Charitable Contributions, provides detailed guidance on which records a taxpayer claiming a noncash charitable contribution deduction must keep. The current version is available at
32. Whatever the outcome of the
33. Dr. Isaacs further contends that he underwent previous audits in which respondent found no fault with how he had documented prior years' noncash charitable contributions. Dr. Isaacs did not put these facts into evidence. Although he did refer during the trial to a 1997 audit in which an analogous charitable contribution had been reviewed, he did so before being sworn in as a witness, and respondent had no opportunity to cross-examine him on this subject.
A taxpayer's reliance upon the outcome of a prior audit may establish reasonable cause and good faith.
Dr. Isaacs also pointed to a "Veterinary Audit Technique Guide" allegedly published by the IRS as authority for CVC's method of accounting. The Court found this document on the IRS' Web site.
34. While questioning Mr. Cook, Dr. Isaacs stated--outside the context of sworn testimony--that an accountant named Jerry Davis had maintained CVC's books during the years at issue and had since retired. Dr. Isaacs offered no evidence concerning Mr. Davis' credentials. He did not explain what information, if any, he had provided to Mr. Davis. He did not articulate what advice, if any, Mr. Davis provided to him regarding his obligation to substantiate expenses, CVC's accounting methods, and/or the documentation requirements for a noncash charitable contribution deduction. Hence, Dr. Isaacs satisfied none of the three
35. Although "[a]dvice does not have to be in any particular form", it must consist of a "communication * * * setting forth the analysis or conclusion of a person, other than the taxpayer, provided to (or for the benefit of) the taxpayer and on which the taxpayer relies".
36. Dr. Isaacs has not claimed that he reasonably relied upon Mr. Marshall with respect to substantiation of his charitable contributions to CAS. In any event, however, Mr. Marshall testified that he did not recall and had not written the purported appraisals that Dr. Isaacs submitted with his 2006 and 2007 returns. We have no evidence concerning Mr. Marshall's competence to advise on tax-related matters (we accepted him as an expert in fossil valuation), and the record does not support a finding that Mr. Marshall advised Dr. Isaacs concerning his return positions. Accordingly, Dr. Isaacs has not established reasonable reliance on Mr. Marshall under the
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