Individual Had Unreported Income; Business Deductions Denied

Julie L. Payne, Alicia H. Eyler, and My V. Vo, for respondent.

Respondent determined Federal income tax deficiencies and accuracy-related penalties as follows:

                                                        Penalty

During the taxable years in issue, petitioner owned and operated a land use consulting business that helped landowners create special evaluations (similar to conservation easements for property taxes) in Washington and conservation easements in Washington and Nebraska. The conservation easements were then donated to petitioner's own section 501(c)(3) tax-exempt organization, Northwest Conservation Stewardship Fund. On September 12, 2012, in a stipulated decision executed by the parties and entered by the Tax Court, it was decided that as of January 1, 2003, Northwest Conservation Stewardship Fund was not qualified as an organization described in section 501(c)(3) and is not exempt from taxation under section 501(a). See Nw. Conservation Stewardship Fund v. Commissioner, T.C. Dkt. No. 6521-11X (Sept. 12, 2012).

Petitioner had had a home office since he started his land use consulting business in the 1980s. In 1981 petitioner set up a private office in Pioneer Square in Seattle, Washington. Sometime in the mid-1980s Northwest Conservation Stewardship Fund started paying some expenses including rent, phone bills, and Internet service at the Pioneer Square office. In either 2003 or 2004 the Pioneer Square office became the principal office of Northwest Conservation Stewardship Fund. Petitioner continued to occasionally use the Pioneer Square, office for his consulting business as well. Petitioner met clients related to his consulting business at the Pioneer Square office and used the Pioneer Square office as his business address for his consulting business for all of the years in issue. Petitioner met the revenue agent at the Pioneer Square office when the revenue agent examined petitioner's 2007, 2008, and 2009 tax returns.

Petitioner used the Pioneer Square office approximately 109 days a year. Petitioner's consulting business generally required him to view the clients' property, so petitioner mainly met his clients at the clients' property locations. Petitioner consulted with clients at his home between 5 and 10 times a year. In each of petitioner's residences for the years in issue, petitioner sometimes used some space to conduct his land use consulting business.

In 2007 and 2008 petitioner used one bedroom in a two-bedroom house as a home office. The bedroom was approximately 300 square feet and contained a desk, a chair, and three or four filing cabinets. The desk in this room was not petitioner's desk; he had another desk in the dining room alcove. There was only about enough space in this room to get at the desk and the filing cabinets. Petitioner's home in 2007 and 2008 was approximately 1,800 square feet.

In 2009 petitioner lived at two different homes. From January through June 2009 petitioner lived on Country Club Road. The Country Club Road house had three bedrooms and a basement. From July through December 2009 petitioner lived in Lynnwood. The Lynnwood house had four bedrooms.

In 2008 and 2009 petitioner began to develop a business in student association development consulting in addition to his existing business in land use consulting. This activity was conducted through an organization that petitioner created called the U.S./Libyan Education Facilitator. In 2008 petitioner went to Libya to help Libyan students come to the United States for postgraduate education. Petitioner created a Web page for this business. Petitioner did not receive any income from this activity.

While in Libya in 2008, petitioner visited some Greek and Italian ruins. Petitioner wrote a paper about these ruins and submitted it to an international conference on conservation in the Middle East.

Petitioner received $20,000 from Northwest Conservation Stewardship Fund in 2009. Respondent determined that $19,308 of these proceeds were additional Schedule C gross receipts not reported as income on petitioner's 2009 tax return.

Petitioner reported multiple expenses on his Schedules C for the years in issue including car and truck expenses, legal and professional expenses, office expenses, travel expenses, other expenses, and expenses for the business use of his home that are in dispute. Petitioner claimed on his 2007, 2008, and 2009 tax returns that he used 25% of his home as a home office. To the extent petitioner presented records of his activities, said records were disorganized. Likewise, petitioner's testimony was quite disorganized.

Petitioner claimed deductions for the following expenses that are still in dispute on his 2007, 2008, and 2009 Schedules C for his consulting business, and respondent allowed the following amounts:

                                 2007

A taxpayer must substantiate amounts claimed as deductions by maintaining the records necessary to establish he or she is entitled to the deductions. Sec. 6001. Section 162(a) provides a deduction for certain business-related expenses. To qualify for the deduction under section 162(a), "an item must (1) be 'paid or incurred during the taxable year,' (2) be for 'carrying on any trade or business,' (3) be an 'expense,' (4) be a 'necessary' expense, and (5) be an 'ordinary' expense." Commissioner v. Lincoln Sav. & Loan Ass'n, 403 U.S. 345, 352 (1971); Deputy v. du Pont, 308 U.S. 488, 495 (1940) (to qualify as "ordinary", the expense must relate to a transaction "of common or frequent occurrence in the type of business involved"). Whether an expense is ordinary is determined by time, place, and circumstance. Welch v. Helvering, 290 U.S. at 113-114.

Section 274(d) applies to certain business expenses including, among other things, expenses for gifts, listed property, and travel (including meals and lodging while away from home). To substantiate travel expenses, a taxpayer must maintain adequate records or present corroborative evidence of his own statement to show the following: (1) the amount of each travel expense; (2) the time and place of travel; and (3) the business purpose for travel. Sec. 1.274-5T(b)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).

Petitioner also provided a list of ferry expenses totaling $4,551. These ferry expenses were not included in the amounts respondent allowed because those amounts were calculated purely on the basis of estimated mileage petitioner traveled. We are satisfied that petitioner has met the strict substantiation requirements of section 274(d) for the ferry expenses by providing a combination of testimony and a list of amounts charged to his credit card by WS Ferries. The Court sustains respondent's disallowance of the deduction for car and truck expenses greater than $10,604 for 2007.⁴

Petitioner did not attempt to substantiate his car and truck expenses for 2008 or 2009 or otherwise provide evidence disputing respondent's determinations for those years. Accordingly, the disallowed amounts for car and truck expenses for 2008 and 2009 are deemed conceded by petitioner. See Rule 149(b).

A. Student Association Development Consulting Business

First we analyze whether the expenses for the travel to Libya are deductible because petitioner was developing a business in student association development consulting. Section 162(a) allows a deduction for ordinary and necessary expenses incurred in "carrying on any trade or business." The phrase "carrying on any trade or business" means that a taxpayer may take advantage of the provision only for an operational existing business. Pino v. Commissioner, T.C. Memo. 1987-28. Generally, preoperational expenses are not deductible under section 162(a). Id. Petitioner did not receive any income from student association development consulting. There are no facts in the record indicating that this activity became operational. Therefore, petitioner was not engaged in an active trade or business of student association development consulting. The expenses for the travel to Libya related to the investigation or development of petitioner's potential student association development consulting business are not deductible under section 162(a).

B. Land Use Consulting Business

Next we analyze whether the expenses related to the travel to Libya are deductible with respect to petitioner's land use consulting business. Petitioner appears to argue that they are ordinary and necessary business expenses since he wrote a paper about Greek and Italian ruins that he visited during the trip. Petitioner has the burden of proving that these travel expenses are ordinary and necessary expenses proximately related to petitioner's trade or business. See Mack v. Commissioner, T.C. Memo. 1976-359. Considering that petitioner's land use consulting business related to special valuations in Washington and conservation easements in Washington and Nebraska, petitioner's trip to Libya to write a paper about Greek and Italian ruins does not appear to be related to petitioner's land use consulting business. Therefore, the expenses for travel to Libya are not deductible because they are not sufficiently related to petitioner's land use consulting business. The Court sustains respondent's disallowance of the deduction for travel expenses greater than $6,422 for 2008.

A. Exclusively Used

Petitioner testified that he used the Pioneer Square office exclusively for Northwest Conservation Stewardship Fund and his home office exclusively for his consulting business. Petitioner's testimony was disorganized and sometimes inconsistent. Petitioner's testimony was also inconsistent with the filed stipulation of facts. In addition, the activities of Northwest Conservation Stewardship Fund and petitioner's land use consulting business are so interrelated and intermingled that it is unlikely that petitioner could have bifurcated the work done for one versus the work done for the other at separate offices. We are not required to find petitioner's self-serving and unsupported testimony to be sufficient to prove that petitioner used his home office exclusively for his consulting business. See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). Because the record lacks any evidence other than petitioner's self-serving testimony, we conclude that petitioner has not met the burden of proving that he used his home office exclusively for his consulting business. Petitioner is therefore not entitled to a home office deduction under either section 280A(c)(1)(A) or (B).

B. Principal Place of Business

As an alternative reason to disallow the home office expenses because petitioner does not meet the requirements of section 280A(c)(1)(A), we analyze whether petitioner met his burden of proving that his home office was the principal place of business of his land use consulting business. In deciding whether a residence is the principal place of business, we compare the business use of the residence to the business use of all of the other places where business is transacted. See Commissioner v. Soliman, 506 U.S. 168, 174 (1993). The Supreme Court laid out a two-part test to determine whether a taxpayer's residence qualifies as a principal place of business: (1) the relative importance of the activities undertaken at each business location and (2) the time spent at each location. Id. at 175. A principal place of business also includes "a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer if there is no other fixed location of such trade or business where the taxpayer conducts substantial administrative or management activities of such trade or business." Sec. 280A(c)(1).

In addition to petitioner's home office, petitioner used the Pioneer Square office for his consulting business and met his clients at their property locations. Petitioner did not provide any evidence as to the business activities that he performed in his home office or the Pioneer Square office. Petitioner also did not provide any evidence regarding the amount of time that he spent at his home office or at his clients' properties. Therefore, we conclude that petitioner did not meet his burden of proving that his home office was the principal place of business for his consulting business.

C. Used on a Regular Basis for Meeting Clients

As an alternative reason to disallow the home office expenses under section 280(a)(1)(B), we analyze whether petitioner met his burden of proving that he regularly used his home office to meet clients of his land use consulting business. In order for petitioner to prove that he used his home office regularly to meet his clients, he must prove that he met his clients in his home more often than incidentally or occasionally. See Jackson v. Commissioner, 76 T.C. 696, 700 (1981). Petitioner consulted with clients at his home between 5 and 10 times a year. Meeting clients in a home office only 5 or 10 times a year does not rise to the level of regularly using a home office to meet clients. Therefore, we conclude that petitioner used his home only occasionally to meet his clients and did not meet clients at his home regularly.

D. Conclusion Regarding Home Office Expenses

Because we conclude that petitioner failed to establish that (1) he used his home office exclusively for his consulting business, (2) his home office was the principal place of business for his consulting business and (3) he regularly met clients at his home, petitioner is not entitled to a home office deduction for 2007, 2008, or 2009. Respondent's determinations in this regard are sustained.

The section 6662(a) accuracy-related penalty does not apply with respect to any portion of an underpayment if the taxpayer proves that there was reasonable cause for such portion and that he acted in good faith with respect thereto. Sec. 6664(c)(1). The determination of whether a taxpayer acted with reasonable cause and in good faith depends on the pertinent facts and circumstances, including the taxpayer's efforts to assess the proper tax liability; the knowledge and the experience of the taxpayer; and any reliance on the advice of a professional, such as an accountant. Sec. 1.6664-4(b)(1), Income Tax Regs. Generally, the most important factor is the taxpayer's effort to assess the taxpayer's proper tax liability. Id.

The Commissioner has the burden of production under section 7491(c) with respect to the accuracy-related penalty under section 6662. To satisfy that burden, the Commissioner must produce sufficient evidence showing that it is appropriate to impose the penalty. Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Respondent determined the accuracy-related penalty for each year was due to negligence or a substantial understatement of income tax.⁶ Respondent has satisfied his burden by producing evidence that petitioner failed to maintain adequate books and records. Accordingly, because respondent has met his burden of production, petitioner must come forward with persuasive evidence that the accuracy-related penalties should not be imposed with respect to the underpayments because he acted with reasonable cause and in good faith. See sec. 6664(c)(1); Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447.

Petitioner failed to report income and to provide evidence of most of the reported expenses on Schedules C. Petitioner has not demonstrated that he acted with reasonable cause and in good faith with respect to the recordkeeping requirements; therefore, the Court sustains respondent's determinations on this issue.

We have considered all of the parties' arguments, and, to the extent not addressed herein, we conclude that they are moot, irrelevant, or without merit. To reflect the foregoing,

Decision will be entered under Rule 155.

² Even without this admission, respondent's determination in this regard would be sustained. Petitioner claimed that the additional gross receipts were actually loan repayments. To support this position petitioner provided three checks totaling $20,000. The memo section of two of the checks stated that the checks were for repayment of loans. Petitioner also presented an unsigned copy of the Form 990 Return of Organization Exempt From Income Tax, for Northwest Conservation Stewardship Fund for 2009. The Form 990 showed that the loan from petitioner had increased during 2009. In addition, the Form 990 showed that there was a written agreement for this loan. Petitioner did not produce a copy of this loan agreement. By his own admission, petitioner did not report any interest income from a loan to Northwest Conservation Stewardship Fund. We would not conclude on the basis of this record that the payments from Northwest Conservation Stewardship Fund were repayments of a loan.

³ Court makes no conclusion regarding the actual distance between Chelan and Bainbridge Island, Washington.

⁴ $6,053 allowed by respondent + $4,551 of ferry expenses = $10,604.

⁵ The legal and professional expenses related to the settled issue are not deductible on petitioner's Schedule C because petitioner agreed to capitalize them.

⁶ After respondent's concessions and the allowance of the ferry expenses, it is unclear whether any or all of petitioner's understatements exceed the greater of $5,000 and 10% of the tax required to be shown on the return for the applicable year and are thus substantial understatements as defined by sec. 6662(d)(1). In any event, we conclude that the underpayments of tax were due to negligence. See sec. 6662(c).