2000 U.S. Tax Ct. LEXIS 29">*29 Appropriate orders will be issued.
Ps were married in 1989, separated in 1995, and divorced in
1996. In 1994, W operated Medi-Task, a physician's transcription
business. H was employed full time by a large corporation until
September 1994. In the fall of 1994, he moved to a lake and
began to renovate some rental cabins. Ps filed a joint tax
return for 1994 in which they reported that they had self-
employment tax liability for the transcription business and
deducted rental cabin expenses.
R determined a deficiency based in part on adjustments to
Ps' self-employment tax and denial of deductions relating to the
cabins. Ps filed petitions disputing R's determination. Ps also
alleged they each qualified for relief as an innocent spouse.
H contends that he qualifies for relief under
and (c), I.R.C. W contended at trial that she qualifies for
relief under
contends that she qualifies for relief only under
I.R.C. R contends that the Tax Court2000 U.S. Tax Ct. LEXIS 29">*30 lacks jurisdiction to
decide W's claim under
HELD: All transcription-related self-employment income is
allocated to W under
HELD, FURTHER, Ps' rental cabin expenses are not deductible
because they are preoperational startup expenses. See
I.R.C.
HELD, FURTHER, H does not qualify for relief under sec.
under
HELD, FURTHER, We have jurisdiction to review whether
relief is available under
114 T.C. 333">*334 COLVIN, JUDGE: Respondent determined that, for 1994, petitioners were liable for a $ 15,192 deficiency in income tax and a $ 1,731 accuracy-related penalty under
Following2000 U.S. Tax Ct. LEXIS 29">*31 concessions, 1 the issues for decision are:
1. Whether all of petitioners' self-employment income from
Medi-Task is allocated to petitioner Sarah K. Hawthorne
(Hawthorne) for purposes of computing self-employment tax for
1994. We hold that it is.
2. Whether petitioners may deduct expenses relating to
their rental cabins in 1994. We hold that they may not.
3. Whether petitioner Fredie Lynn Charlton (Charlton) is
entitled to relief from joint and several liability under
petitioners' 1994 joint return. We hold that he is not.
4. Whether petitioner Fredie Lynn Charlton qualifies2000 U.S. Tax Ct. LEXIS 29">*32 for
limitation of liability under
deficiency arising from petitioners' 1994 joint return. We hold
that he does to the extent described below.
5. Whether we have jurisdiction to review whether relief is
available to petitioner Sarah K. Hawthorne under section
6015(f). We hold that we do. Thus, we will delay entry of
decision to permit Hawthorne and respondent to report on the
status of Hawthorne's application for relief under section
6015(f), and if relief is denied, to file a motion as part of
this docketed case requesting our review of the Secretary's
denial.
Section references are to the Internal Revenue Code in effect for 1994. Rule references are to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
Petitioner Sarah K. Hawthorne (Hawthorne) lived in Burnet, Texas, when she filed her petition. Petitioner Fredie Lynn Charlton (Charlton) lived in Buchanan Dam, Texas, 114 T.C. 333">*335 when he filed his petition. Petitioners lived in Texas, a community property State, at all times2000 U.S. Tax Ct. LEXIS 29">*33 relevant to this case.
Hawthorne has a college degree in English. She completed an accounting class and a marketing class but she did not do well in them. Hawthorne did not take any income tax courses. Petitioners were married in 1989. Before they were married, Charlton hired Hawthorne to be an office manager for a large manufacturing business.
Charlton was employed full time in Houston, Texas, until September 1994. He moved his residence to Buchanan Dam, Texas, in the fall of 1994.
Medi-Task was a physician's transcription service. Hawthorne managed Medi-Task and performed most of its day-to-day operations. Medi-Task had one employee in 1994. Independent contractors did most of the transcribing for Medi-Task. Charlton did not devote much time to Medi-Task because he was employed full time until September 1994. He was not involved with Medi-Task's hiring or marketing. He did not type any reports for Medi-Task, but he assisted when there were computer problems. Hawthorne kept Medi-Task's business records in petitioners' home in a file cabinet next to Charlton's records. She deposited Medi-Task's gross receipts in Charter Bank of Houston, and Lake Buchanan State Bank.
2000 U.S. Tax Ct. LEXIS 29">*34 Charlton had access to Medi-Task's records while he prepared petitioners' 1994 return. Hawthorne prepared and gave Charlton lists that included all but $ 22,601 of Medi-Task's income and all but $ 2,050 of Medi-Task's expenses for 1994. She also gave him bank statements for Medi-Task, Forms 1099, Forms W-2, Wages and Tax Statement, and documents showing Medi-Task's expenses.
Charlton received unemployment compensation and VA disability payments in the last quarter of 1994. Medi-Task was Charlton's and Hawthorne's only other source of income during that 3- month period.
Petitioners signed a personal financial statement on April 15, 1995, which stated that Medi-Task was worth $ 110,000. Hawthorne sold Medi-Task in 1995 without Charlton's consent or participation and kept the proceeds.
Petitioners bought real property in the spring of 1993 at Charlton Pointe on Lake Buchanan in Llano County, Texas. There were some rental cabins on the property which were built in the 1950's and were rented until 1988 or 1989.
Petitioners began to rehabilitate the cabins in the fall of 1994. Charlton spent time in 1994 working on the cabins and other aspects of the Charlton Pointe2000 U.S. Tax Ct. LEXIS 29">*35 property. Petitioners incurred expenses for travel to Charlton Pointe and expenses to rehabilitate the cabins. However, petitioners rented no cabins at Charlton Pointe in 1994. Charlton began renting the cabins in 1998.
Charlton used tax return preparation software to prepare returns for petitioners for 5 years, including 1994.
Petitioners filed a joint income tax return for 1994. On it, they reported profits and losses on Schedules C, Profit or Loss From Business, for Medi-Task and the cabins. Charlton used the gross revenue amounts from the lists Hawthorne prepared to prepare the return. He did not review the bank statements. He also used the lists that Hawthorne prepared to report Medi-Task's expenses. He decided how to report the expenses on part II of Schedule C for Medi-Task; e.g., as advertising, legal and professional services, travel and meals, utilities, wages, and other expenses.
Petitioners reported that the Medi-Task income was divided equally between themselves for self-employment tax purposes.
Petitioners reported that Charlton had $ 62,135 in wages for 1994. They reported that Medi-Task had gross receipts and gross income of $ 147,782, 2000 U.S. Tax Ct. LEXIS 29">*36 total expenses of $ 117,588, and net profit of $ 30,194. Petitioners underreported 1994 gross receipts for Medi-Task by $ 22,601 and did not deduct $ 2,050 of Medi-Task expenses. They reported that they had no income from the cabins and $ 27,724 in expenses. Hawthorne examined parts of the 1994 return, such as the children's names and Social Security numbers and child care credits, but otherwise accepted the return that Charlton prepared.
Petitioners separated in 1995, after they filed their 1994 return, and were divorced in 1996. Under the divorce settlement, Charlton received the rental cabin property and Hawthorne received Medi-Task. As required by the divorce settlement, Charlton deposited petitioners' 1994 refund check for $ 4,453 in a joint bank account at Texas Bank in Burnet, Texas, on June 2, 1995. Charlton used some of the 1994 refund to pay his personal expenses.
OPINION
A. WHETHER ALL MEDI-TASK INCOME IS ATTRIBUTABLE TO HAWTHORNE FOR
SELF-EMPLOYMENT TAX PURPOSES
Charlton contends that the Medi-Task income should be divided equally between him and Hawthorne for self-employment tax purposes. Respondent and Hawthorne contend that all of2000 U.S. Tax Ct. LEXIS 29">*37 the Medi-Task income is attributable to Hawthorne and that the self-employment tax reported by petitioners for 1994 should be increased by $ 6,962.
Self-employment tax for a husband and wife filing a joint return is the sum of the taxes computed on the self-employment income of each spouse. See
Charlton contends that he and Hawthorne jointly operated Medi-Task and that Medi-Task was a partnership or should be treated as one. We disagree. Hawthorne managed Medi-Task and performed most of its day-to-day operations. Charlton had a full-time job until September 1994, and he also renovated cabins in 1994. He did not devote much time to Medi-Task. We conclude that all of the Medi-Task income in 1994 is attributable to Hawthorne for self-employment2000 U.S. Tax Ct. LEXIS 29">*38 tax purposes.
114 T.C. 333">*338 B. WHETHER PETITIONERS' 1994 EXPENSES FOR THE CABINS WERE
PREOPERATIONAL STARTUP EXPENSES
Charlton contends that petitioners may deduct $ 27,724 for supplies, taxes, travel, utilities, legal and professional services, and car and truck expenses for their cabin rental activity for 1994 under section 162. We disagree.
Generally, a taxpayer may not deduct startup expenses. See
(A) paid or incurred in connection with --
(i) investigating the creation or acquisition of an active
trade or business, or
(ii) creating an active trade or business, or
(iii) any activity engaged in for profit and for the
production of income before the day on which the active
trade or business begins, in anticipation of such activity
becoming an active trade or business, and
(B) which, if paid or incurred in connection with the operation
of an existing active trade or business (in the same field as
the trade or business referred to in subparagraph (A)), would be
allowable2000 U.S. Tax Ct. LEXIS 29">*39 as a deduction for the taxable year in which paid or
incurred.
Petitioners incurred these expenses before the cabin rental activity became an active trade or business. Charlton renovated the cabins in 1994 but did not rent them or offer them for rent until 1998. The cabin rental activity was not an active trade or business in 1994. Thus, we conclude that the claimed expenses were nondeductible startup expenses.
1. PROCEDURAL STATUS OF INNOCENT SPOUSE ISSUES
Petitioners each asserted in their petitions that they qualify for relief as an innocent spouse. The statutory provision providing relief for innocent spouses in effect when the petitions were filed,
At trial, the parties consented to treating the petitions as elections by Charlton and Hawthorne for relief under
Respondent contends that we lack jurisdiction to decide whether Hawthorne is entitled to equitable relief under
2. WHETHER CHARLTON IS ENTITLED TO RELIEF FROM JOINT AND SEVERAL
LIABILITY FOR INCOME TAX FOR 1994 UNDER
Charlton contends that he is entitled to relief from joint and several liability for income tax for 1994 under
(A) a joint2000 U.S. Tax Ct. LEXIS 29">*41 return has been made for a taxable year;
(B) on such return there is an understatement of tax
attributable to erroneous items of one individual filing
the joint return;
(C) the other individual filing the joint return
establishes that in signing the return he or she did not
know, and had no reason to know, that there was such
understatement;
(D) taking into account all the facts and circumstances, it
is inequitable to hold the other individual liable for the
deficiency in tax for such taxable year attributable to
such understatement; and
(E) the other individual elects (in such form as the
Secretary may prescribe) the benefits of this subsection
not later than the date which is 2 years after the date the
Secretary has begun collection activities with respect to
the individual making the election,
then the other individual shall be relieved of liability for tax
(including interest, penalties, and2000 U.S. Tax Ct. LEXIS 29">*42 other amounts) for such
taxable year to the extent such liability is attributable to
such understatement.
Respondent concedes that Charlton qualifies under
Under prior law (former
Charlton was generally familiar with Medi-Task. Hawthorne gave him the bank statements respondent later used in determining Medi-Task's income for 1994, Forms 1099 and W-2, and a computer- generated expense list. Charlton had unfettered access to Medi-Task's financial records. We conclude that Charlton had reason to know of Medi-Task's understatement of income. Thus, Charlton does not qualify for relief as an innocent spouse under
D. WHETHER CHARLTON QUALIFIES FOR LIMITATION OF HIS LIABILITY FOR
PETITIONERS' 1994 INCOME TAX UNDER
Charlton contends that he qualifies for limitation of liability for petitioners' 1994 income tax under
2000 U.S. Tax Ct. LEXIS 29">*44
To be eligible for relief under
An electing spouse bears the burden of proving how much of any deficiency is allocable to him or her. See
We have concluded that Charlton should have known of the omitted income because he knew of and had access to correct information about Medi-Task. See par. C-2, above. However, that does not mean that he actually knew of the Medi-Task omitted income. Charlton did not check Medi-Task's bank records against the lists of Medi-Task revenue that Hawthorne prepared and gave him. 2000 U.S. Tax Ct. LEXIS 29">*45 The lists Hawthorne gave Charlton are not in the record. Charlton testified that he did not know of the omitted income. We have no reason not to believe him. We conclude that respondent has not shown that Charlton had actual knowledge of the item causing the deficiency, and that Charlton qualifies for relief under
2000 U.S. Tax Ct. LEXIS 29">*46
For purposes of
Respondent contends that the parties should perform the computations under
E. WHETHER THE TAX COURT HAS JURISDICTION TO REVIEW A TAXPAYER'S
REQUEST FOR EQUITABLE RELIEF UNDER
Respondent contends that we lack jurisdiction to decide whether the Commissioner properly denied relief to a taxpayer under
Hawthorne and respondent have apparently suspended any activity relating to Hawthorne's claim under
To reflect the foregoing,
Appropriate orders will be issued.
1. Respondent concedes that petitioners are not liable for the accuracy-related penalty under
2. Hawthorne contended at trial that she was entitled to relief under
3.
No Longer Married or Taxpayers Legally Separated or Not Living
Together. --
(1) In general. -- Except as provided in this
subsection, if an individual who has made a joint return
for any taxable year elects the application of this
subsection, the individual's liability for any deficiency
which is assessed with respect to the return shall not
exceed the portion of such deficiency properly allocable to
the individual under subsection (d).
* * * * * * * *
(3) Election. --
(A) Individuals eligible to make election. --
(i) In general. -- An individual shall only
be eligible to elect the application of this
subsection if --
(I) at the time such election is filed,
such individual is no longer married to, or
is legally separated from, the individual
with whom such individual filed the joint
return to which the election relates; or
(II) such individual was not a member
of the same household as the individual with
whom such joint return was filed at any time
during the 12-month period ending on the
date such election is filed.
(ii) Certain taxpayers ineligible to elect.
-- If the Secretary demonstrates that assets were
transferred between individuals filing a joint
return as part of a fraudulent scheme by such
individuals, an election under this subsection by
either individual shall be invalid (and section
6013(d)(3) shall apply to the joint return).
(B) Time for election. -- An election under this
subsection for any taxable year shall be made not
later than 2 years after the date on which the
Secretary has begun collection activities with respect
to the individual making the election.
(C) Election not valid with respect to certain
deficiencies. -- If the Secretary demonstrates that an
individual making an election under this subsection
had actual knowledge, at the time such individual
signed the return, of any item giving rise to a
deficiency (or portion thereof) which is not allocable
to such individual under subjection (d), such election
shall not apply to such deficiency (or portion). This
subparagraph shall not apply where the individual with
actual knowledge establishes that such individual
signed the return under duress.↩
4.
subsection (c) --
(1) In general. -- The portion of any deficiency on a
joint return allocated to an individual shall be the amount
which bears the same ratio to such deficiency as the net
amount of items taken into account in computing the
deficiency and allocable to the individual under paragraph
(3) bears to the net amount of all items taken into account
in computing the deficiency.
(2) Separate treatment of certain items. -- If a
deficiency (or portion thereof) is attributable to --
(A) the disallowance of a credit; or
(B) any tax (other than tax imposed by section 1
or 55) required to be included with the joint return,
and such item is allocated to one individual under paragraph
(3), such deficiency (or portion) shall be allocated to such
individual. Any such item shall not be taken into account under
paragraph (1).
(3) Allocation of items giving rise to the deficiency.
For purposes of this subsection --
(A) In general. Except as provided in paragraphs
(4) and (5), any item giving rise to a deficiency on a
joint return shall be allocated to individuals filing
the return in the same manner as it would have been
allocated if the individuals had filed separate
returns for the taxable year.
(B) Exception where other spouse benefits. Under
rules prescribed by the Secretary, an item otherwise
allocable to an individual under subparagraph (A)
shall be allocated to the other individual filing the
joint return to the extent the item gave rise to a tax
benefit on the joint return to the other individual.
(C) Exception for fraud. The Secretary may
provide for an allocation of any item in a manner not
prescribed by subparagraph (A) if the Secretary
establishes that such allocation is appropriate due to
fraud of one or both individuals.↩