T.C. Memo. 2011-236



                     UNITED STATES TAX COURT



         DANIEL E. AND MARILYN J. FUHRMAN, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 21786-08.             Filed September 29, 2011.



     Nicholas I. Andersen and Michael J. Zaino, for petitioners.

     Edward Lee Walter, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     THORNTON, Judge:   Respondent determined deficiencies of

$27,917 and $25,534 in petitioners’ 2004 and 2005 Federal income

taxes, respectively, and section 6662(a) accuracy-related

penalties of $5,583 and $5,107 for 2004 and 2005, respectively.1


     1
      All section references are to the Internal Revenue Code in
                                                   (continued...)
                               - 2 -

After concessions by petitioners, the issues for decision are:

(1) Whether petitioners may deduct, in amounts greater than

respondent has allowed, purported management fees that petitioner

Daniel Fuhrman’s (petitioner) single-member LLC paid to his

wholly owned C corporation, and (2) whether petitioners are

liable for the section 6662(a) accuracy-related penalty for each

year at issue.

                         FINDINGS OF FACT

     The parties have stipulated some facts.     When they filed

their petition, petitioners resided in Ohio.

     During the years at issue petitioner owned a trucking

business.   For liability and other business reasons, he had

organized this business into five wholly owned corporations,

including Top Line Express, Inc. (Top Line), and Top Leasing,

Inc. (Top Leasing), as well as a limited liability company,

Grasshopper Leasing, L.L.C. (Grasshopper), of which he was the

sole member.

     Grasshopper owned about 30 trucks.     Its sole business was

leasing these trucks to affiliated entities, mainly Top Line.

Top Line used the trucks in its business of hauling goods,

primarily auto parts.



     1
      (...continued)
effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure. Dollar amounts have
been rounded to the nearest dollar.
                                - 3 -

     Top Line employed all the business office personnel for

petitioner’s trucking business.    During the years at issue Top

Line had 18 to 20 employees, including petitioner.      Top Leasing

employed all the truck drivers in petitioner’s trucking business.

     Grasshopper had no employees.      Top Line’s employees

performed management and administrative services for Grasshopper.

But there was no written contract with respect to these services.

Moreover, Top Line maintained no contemporaneous time records for

the services its employees provided Grasshopper.      During 2004 and

2005 Top Line billed Grasshopper, generally a flat $9,000 per

month, for management services that it allegedly performed for

Grasshopper.2   In 2004 and 2005 Grasshopper paid Top Line

$101,382 and $108,000, respectively, with respect to these

invoices.3

     On their joint Federal income tax returns, petitioners

reported income tax liabilities of $69,196 for 2004 and $114,869

for 2005.    On Schedules C, Profit or Loss From Business (Sole

Proprietorship), in reporting their passthrough net business

income from Grasshopper, petitioners claimed      “Other expenses” of

$103,645 for 2004 and $115,168 for 2005.      These “Other expenses”




     2
      For January and February 2004, the combined management fee
was $17,000.
     3
      It is unclear from the record why Grasshopper’s payments in
2004 fell short of the total $107,000 that Top Line had invoiced.
                               - 4 -

reflected primarily the purported management fees that

Grasshopper paid Top Line.4

      In the notice of deficiency respondent disallowed $57,052 of

these Schedule C “Other expenses” for 2004 and disallowed $63,660

for 2005.5   The notice of deficiency explains that these amounts

were disallowed because petitioners had not established that

these amounts were paid for ordinary and necessary business

expenses.

                              OPINION

I.   Ordinary and Necessary Business Expenses

      The principal issue is whether in computing Grasshopper’s

net business income petitioners are entitled to deduct, in

amounts greater than respondent has allowed, purported management

fees that Grasshopper paid to Top Line.

      The taxpayer generally bears the burden of proving the

Commissioner’s determinations erroneous.   Rule 142(a).   In

particular, the taxpayer bears the burden of substantiating the



      4
      These “Other expenses” also included relatively small
amounts for general supplies, professional fees, and
miscellaneous expenses.
      5
      The notice of deficiency does not indicate which portion of
the disallowed “Other expenses” relates to management fees as
opposed to other items. On brief petitioners represent that the
entire amount of disallowed “Other expenses” relates to the
claimed management fees, and they do not make any argument with
respect to other items of “Other expenses”. We deem petitioners
to have waived or conceded any argument with respect to these
other amounts.
                              - 5 -

amount and purpose of each item claimed as a deduction.    See

Higbee v. Commissioner, 

, 440 (2001); Hradesky v.

Commissioner, 

, 90 (1975), affd. per curiam 

(5th Cir. 1976).

     Section 7491(a)(1) provides that if, in any court

proceeding, a taxpayer introduces credible evidence with respect

to any factual issue relevant to ascertaining the taxpayer’s

proper tax liability, the Commissioner shall have the burden of

proof with respect to that issue.   Credible evidence is evidence

the Court would find sufficient upon which to base a decision on

the issue in the taxpayer’s favor, absent any contrary evidence.

See Higbee v. Commissioner, supra at 442.   Section 7491(a)(1)

applies, however, only if the taxpayer complies with all

substantiation and recordkeeping requirements under the Code.

Sec. 7491(a)(2)(A) and (B).

     On brief petitioners contend that by allowing them to deduct

a substantial portion of the management fees, respondent has

acknowledged that they have met their substantiation burden.      As

discussed below, however, petitioners have failed to introduce

credible evidence to show that the disallowed expenses represent

ordinary and necessary business expenses of Grasshopper.    The

burden of proof as to this issue remains with petitioners.

     Section 162(a) allows as a deduction all the ordinary and

necessary expenses paid or incurred during the taxable year in
                                - 6 -

carrying on any trade or business.      Whether an expenditure is

ordinary and necessary is generally a question of fact.

Commissioner v. Heininger, 

, 475 (1943).      An expense

is ordinary if it is customary or usual within a particular

trade, business, or industry or relates to a transaction “of

common or frequent occurrence in the type of business involved.”

Deputy v. du Pont, 

, 495 (1940).      An expense is

necessary if it is appropriate and helpful for the development of

the business.   See Commissioner v. Heininger, supra at 471.        The

Court of Appeals for the Sixth Circuit, to which any appeal of

this case would lie, has held that for expenses to be deductible

as ordinary and necessary, they must be reasonable, because “the

element of reasonableness is inherent in the phrase ‘ordinary and

necessary’”.    Commissioner v. Lincoln Elec. Co., 

,

817 (6th Cir. 1949), revg. a Memorandum Opinion of this Court.

Only the portion of an expense that is reasonable qualifies for

deduction under section 162(a).    United States v. Haskel Engg. &

Supply Co., 

, 788-789 (9th Cir. 1967).

     The reasonableness concept has particular significance in

determining whether payments between related parties, such as

commonly controlled business entities, represent ordinary and

necessary expenses.   See Bittker & Lokken, Federal Taxation of

Income, Estates, and Gifts, par. 20.1.5, at 20-18 (3d ed. 1999).

For instance, in ASAT, Inc. v. Commissioner, 

, 174-
                              - 7 -

175 (1997), this Court held that the taxpayer was not entitled to

deduct consulting fees it paid to its subsidiary where the

taxpayer did not establish how the fees were determined, there

was no written contract, the invoices provided almost no detail,

and there was no evidence of the service provider’s skills that

might warrant the consulting fees.    See also Weekend Warrior

Trailers, Inc. v. Commissioner, T.C. Memo. 2011-105 (holding that

the taxpayer’s wholly owned S corporation was not entitled to

deduct management fees paid to another of his wholly owned S

corporations where the evidence did not adequately establish the

specific services performed and who performed them).

     Similarly, petitioners have failed to demonstrate how the

management fees in question were determined.    They have presented

no contemporaneous documentation.6    The monthly invoices from Top

Line to Grasshopper generally consist of a single line item

showing a flat $9,000 “Management Fee” with no detail as to the

services provided or the derivation of the invoiced amount.

There was no written contract for the management fees.    We

question whether these amounts were determined at arm’s length,

since petitioner was the sole owner of both Grasshopper Leasing

and Top Line Express.



     6
      Although petitioners’ C.P.A. testified that “the company
continued to have documentation in their files” and that
“Schedules were prepared on an ongoing basis to support those
expenses”, no such documentation appears in the record.
                              - 8 -

     Attempting to substantiate the disallowed expenses,

petitioners rely primarily on petitioner’s testimony.   Petitioner

testified that seven of Top Line’s employees performed services

for Grasshopper, aggregating 100 to 110 hours each month.7

According to petitioner’s testimony, the management fees were

attributable to these four categories of services:

(1) Consulting--8 to 10 hours per month, provided by petitioner;

(2) accounting--18 to 22 hours per month provided by two of Top

Line’s accounting personnel;8 (3) sales management--24 to 28

hours per month, provided by one of Top Line’s employees who,

according to petitioner’s testimony, would “sell to the various


     7
      Petitioners also offered into evidence a document (the
noncontemporaneous analysis) that their accountants prepared
during the course of the IRS audit. This document purports to
analyze, in hindsight, the management fees that Grasshopper paid
Top Line and suggests that Top Line’s actual monthly management
costs were somewhat higher than the amounts it charged
Grasshopper. In notable respects, this document varies from
petitioner’s testimony. For instance, the noncontemporaneous
analysis indicates that Top Line employees spent 83.75 hours per
month performing services for Grasshopper, rather than the larger
number indicated by petitioner’s testimony. For a specific
example of this type of discrepancy, see infra note 8. Also, the
makeup of the management costs as accounted for in the
noncontemporaneous analysis differs significantly from that
suggested by petitioner’s testimony. On brief petitioners do not
directly rely on the noncontemporaneous analysis to substantiate
the disputed expenses. Nevertheless, the unexplained
discrepancies between the noncontemporaneous analysis and
petitioner’s testimony call into question the reliability of his
testimony.
     8
      By contrast, the noncontemporaneous analysis indicates that
Top Line employees spent a total of 7.6 hours per month
performing bookkeeping services and financial preparation
management for Grasshopper.
                               - 9 -

customers to make sure that these leased trucks were used and we

were able to pay the lease through Grasshopper”; and (4) safety

and driver relations--about 50 hours per month, provided by three

Top Line employees who performed tasks such as recruiting,

training, testing, tracking, and dispatching truck drivers.

     According to petitioner’s testimony, then, over half the

hours allegedly worked by Top Line employees on behalf of

Grasshopper consisted of services in the categories of sales

management, safety, and driver relations.   Petitioners have not

convinced us that it was necessary for Grasshopper to incur

expenses for such services.   After all, Grasshopper’s business

consisted of leasing trucks to other entities, mainly Top Line,

that petitioner owned.   The sales management services, as

described by petitioner, appear to be services that Top Line

would have performed on its own behalf in maintaining its own

customer base, since Grasshopper had no customers other than Top

Line and other related entities.9   Moreover, the record

establishes no reason why Grasshopper would have had any need to

recruit, train, test, track, or dispatch truck drivers, since it


     9
      Acknowledging that “Grasshopper leases exclusively to
affiliated entities”, the noncontemporaneous analysis indicates
that substantial components of the management fee represent a
“cost assigned to the benefit of not having to market the
equipment for lease to outside parties and to the benefit of
always having 100% of the fleet under lease at all times.” We
are not persuaded that the benefit of not incurring certain types
of expenses is properly assignable as an ordinary and necessary
expense.
                               - 10 -

employed no drivers.   In addition, we are not convinced that

consulting services that petitioner allegedly provided to

Grasshopper were performed in his capacity as an employee of Top

Line rather than in his individual capacity as sole owner of

Grasshopper.   Indeed, because Grasshopper had no other owners and

no employees, it is not apparent with whom at Grasshopper

petitioner might have consulted, other than himself.

      Petitioners have not established that any amounts of

management fees greater than those respondent has allowed

represent ordinary and necessary expenses of Grasshopper.10

II.   Section 6662(a) Accuracy-Related Penalty

      Respondent determined that for each year at issue

petitioners are liable for an accuracy-related penalty pursuant

to section 6662(a) and (b)(2) for a substantial understatement of

income tax.    Section 6662(a) and (b)(2) imposes a 20-percent

accuracy-related penalty on any portion of a tax underpayment

that is attributable to any substantial understatement of income

tax, defined in section 6662(d)(1)(A) as an understatement that

exceeds the greater of 10 percent of the tax required to be shown

on the return or $5,000.




      10
      In the light of this holding, we need not and do not
address respondent’s argument, raised for the first time on
brief, that respondent’s disallowance of portions of the
management fee deductions reflects a proper allocation under sec.
482.
                                 - 11 -

       Respondent bears the burden of production with respect to

this penalty.    Sec. 7491(c).   To meet this burden, respondent

must produce evidence establishing that it is appropriate to

impose this penalty.    Once respondent has done so, the burden of

proof is upon petitioners to show that they acted with reasonable

cause and in good faith.    See Higbee v. Commissioner, 

.

       We have sustained respondent’s determination that

petitioners have deficiencies of $27,917 for 2004 and $25,534 for

2005.    Adding these amounts to the total tax shown on

petitioners’ returns, the tax required to be shown on their

returns was $97,113 for 2004 and $140,403 for 2005.     The

understatements therefore exceed the greater of 10 percent of the

tax required to be shown on the return ($9,711 for 2004 and

$14,040 for 2005) or $5,000 and constitute substantial

understatements of income tax within the meaning of section

6662(d)(1)(A).    Respondent has therefore met his burden of

production.

       The accuracy-related penalty does not apply with respect to

any portion of an underpayment as to which the taxpayer had

reasonable cause and acted in good faith.     Sec. 6664(c)(1).

Petitioners have not established, or even expressly alleged, that

they had reasonable cause or acted in good faith.     Petitioners
                             - 12 -

are liable for the section 6662(a) accuracy-related penalty for

each year at issue as respondent has determined.

     To reflect the foregoing,


                                        Decision will be entered

                                   for respondent.