T.C. Summary Opinion 2012-94



                         UNITED STATES TAX COURT



   STEPHEN A. WALLACH AND KIMBERLY K. WALLACH, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 11051-11S.                         Filed September 18, 2012.



      Stephen A. Wallach and Kimberly K. Wallach, pro se.

      Matthew D. Carlson and Kimberly A. Kazda, for respondent.



                              SUMMARY OPINION


      PANUTHOS, Chief Special Trial Judge: This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect when the petition

was filed. Pursuant to section 7463(b), the decision to be entered is not
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reviewable by any other court, and this opinion shall not be treated as precedent for

any other case. Unless otherwise indicated, subsequent section references are to the

Internal Revenue Code (Code), and all Rule references are to the Tax Court Rules

of Practice and Procedure.

      Respondent determined a deficiency of $5,418 in petitioners’ 2007

Federal income tax as well as a section 6662(a) accuracy-related penalty of $1,083.

The issues for decision are: (1) whether petitioners are entitled to business expense

deductions claimed on a Schedule C, Profit or Loss From Business, for expenses

related to petitioner Stephen A. Wallach’s real estate brokerage business and (2)

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

                                      Background

      Some of the facts have been stipulated and are so found. The stipulation of

facts and the attached exhibits are incorporated herein by this reference. Petitioners

resided in California at the time the petition was filed.

      During 2007 Stephen A. Wallach (petitioner) was employed as a pilot for

United Airlines and also worked as a real estate broker. Petitioner Kimberly K.

Wallach was a homemaker. Petitioner became a licensed California real estate

broker in 1981, and he operated a brokerage business as a sole proprietorship.
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Petitioner held himself out to deal primarily in commercial real estate sales and

related property management. Petitioner researched properties on the Internet,

talked with listing brokers, and traveled to geographic locations he believed were

promising or met a client’s needs.

      In 2007 petitioner made approximately 12 offers to purchase properties on

behalf of clients. None of the offers resulted in a purchase or sale. Petitioner also

advised his parents with respect to properties. Petitioner received $9,000 from his

parents in 2007 relating to the advice provided and reported this as income on the

Schedule C. Petitioner received similar fees from his parents in other years. The

amount received from his parents represent the only income petitioner reported as a

broker in 2007. On the 2007 joint Federal income tax return petitioners reported a

$31,762 business loss, $23,124 of which related to the real estate brokerage

business.1

      Respondent issued a notice of deficiency disallowing (1) certain business

expense deductions relating to petitioner’s brokerage business and (2) itemized




      1
       Petitioners included two Schedules C with their 2007 return. One Schedule
C relates to petitioner’s real estate brokerage activity; the other relates to a business
named Floatical. None of the adjustments in the notice of deficiency relate to
Floatical.
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deductions relating to petitioner’s employment as an airline pilot.2 Respondent

allowed some of petitioners’ claimed business expense deductions but disallowed all

of the claimed business expense deductions for travel of $10,533, meals and

entertainment of $3,834, and office expenses of $5,512.

                                      Discussion

      The Commissioner’s determination is generally presumed correct, and the

taxpayer bears the burden of proving the determination is in error. Rule 142(a).

The taxpayer bears the burden of proving that he or she is entitled to the deduction

claimed, and this includes the burden of substantiation. Id.; Hradesky v.

Commissioner, 

, 89-90 (1975), aff’d per curiam, 

(5th Cir.

1976). 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. In order

to qualify as a 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.”

      2
        Respondent disallowed a cellular telephone expense deduction claimed on
Schedule A, Itemized Deductions. Although petitioners disputed this adjustment in
the petition, they did not address this issue at trial nor did they provide any evidence
to support the claimed deduction. As a result, this issue is deemed conceded. See
Rule 149(b).
                                         -5-

Commissioner v. Lincoln Sav. & Loan Ass’n, 

, 352 (1971); Deputy v.

du Pont, 

, 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, 

, 113-114 (1933). Respondent did

not determine that petitioner’s activity was not an activity engaged in for profit. See

sec. 183.

      If a taxpayer establishes that he or she paid or incurred a deductible business

expense but does not establish the amount of the expense, we may approximate the

amount of the allowable deduction, bearing heavily against the taxpayer whose

inexactitude is of his or her own making. Cohan v. Commissioner, 

,

543-544 (2d Cir. 1930). In order for the Cohan rule to apply, there must be

sufficient evidence in the record to provide a basis for the estimate. Vanicek v.

Commissioner, 

, 743 (1985). Certain expenses may not be estimated

because of the strict substantiation requirements of section 274(d). See sec.

280F(d)(4)(A); Sanford v. Commissioner, 

, 827 (1968), aff’d per

curiam, 

(2d Cir. 1969).

      Section 274(d) applies to certain business expenses including, among other

things, expenses for listed property (e.g., automobile expenses, cellular telephones,
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computer equipment, or any property of a type generally used for purposes of

entertainment, recreation, or amusement) and travel (including meals and lodging

while away from home). Secs. 274(d), 280F(d)(4)(A). To substantiate a deduction

attributable to listed property, a taxpayer must maintain adequate records or present

corroborative evidence to show the following: (1) the amount of the expense; (2)

the time and place of use of the listed property; and (3) the business purpose of the

use. Sec. 1.274-5T(b)(6), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov.

6, 1985).

      It is well established that the Court may permit a taxpayer to attempt to

substantiate deductions through secondary evidence where the underlying

documents have been unintentionally lost or destroyed. Boyd v. Commissioner, 

, 320-321 (2004); Malinowski v. Commissioner, 

, 1125

(1979); Furnish v. Commissioner, T.C. Memo. 2001-286; Joseph v. Commissioner,

T.C. Memo. 1997-447; Watson v. Commissioner, T.C. Memo. 1988-29. Moreover,

even though Congress imposed heightened substantiation requirements for certain

deductions by enacting section 274, the regulations thereunder allow a taxpayer to

substantiate a deduction by reasonable reconstruction of his or her expenditures

when records are lost through no fault of the taxpayer. Sec. 1.274-5T(c)(5),

Temporary Income Tax Regs., 50 Fed. Reg. 46022 (Nov. 6, 1985). Because of
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computer malfunctions, petitioner had to replace two computer hard drives, which

resulted in a loss of some of his records relating to 2007, including an electronic

calendar.3

      Petitioner provided the Court with bank records and photocopies of receipts

for meals, hotels, rental vehicles, and airline tickets to substantiate some of his

expenses. Some of the documents were partially or wholly illegible. Petitioner also

provided the Court with multiple schedules for each type of claimed expense, some

of which included a general description, such as “property search” and the city of

the search. To aid the Court’s analysis and for the purpose of clarity of this opinion,

the Court combined the schedules petitioner provided for the reported meal and

entertainment expenses and the travel expenses into a single chronological list. We

consider the various geographic locations where petitioners claim to have incurred

deductible expenses.

Hawaii

      Petitioner reported hotel, rental car, and meal expenses relating to a trip to

Hawaii in February 2007 which lasted approximately 11 days. Petitioner did not

claim a business expense deduction for the cost of his airline ticket to or from

      3
       It is not clear whether the computer malfunctions and record losses occurred
during 2007, during the examination of petitioners’ return, or during preparation for
trial.
                                         -8-

Hawaii; however, he did claim as a business expense deduction the cost of an airline

ticket for a third party. No explanation was given as to who this person is or what

business purpose was furthered by this expenditure. Petitioner’s records reflect that

he paid for multiple hotel rooms for the same nights and that there were multiple

occupants in the rooms. Some of the expenses were not evidenced by receipts or

reflected in the bank records. Petitioner’s explanation for the travel to Hawaii was

that he was scouting potential properties for an unnamed client. On the basis of the

record, petitioner has not established that these expenditures were ordinary and

necessary business expenses, and we disallow all claimed business expense

deductions relating to this travel.

Lake Tahoe

      Within one day of his return from Hawaii in February 2007, petitioner

apparently traveled to Lake Tahoe. He claimed a business expense deduction for

the cost of a two-bedroom townhome in Tahoe, California, for three days. The

receipt for this expense shows that petitioner Kimberly K. Wallach made the

reservation for two people and was listed as the contact person. Petitioner has

failed to establish that this claimed expenditure constitutes an ordinary and

necessary business expense, and we disallow the claimed deduction for the

townhome rental.
                                          -9-

Phoenix

       In March 2007 petitioner purchased three round-trip airline tickets to

Phoenix, Arizona. Petitioner claimed a business expense deduction for one round-

trip airline ticket as well as a rental car that petitioner Kimberly K. Wallach rented

and paid for with her credit card. Petitioner has failed to establish that these

claimed expenditures are ordinary and necessary business expenses. We disallow

the claimed business expense deductions relating to the airline ticket and the rental

car for this travel.

Dayton and petitioner’s parents

       Petitioner apparently traveled to Dayton, Ohio, in August 2007. Petitioner’s

records reflect that petitioner paid for two hotel rooms and had dinner with his

parents. As indicated, petitioner’s parents were the only source of income reported

by the brokerage business for 2007. The hotel room receipts reflect a stay for two

adults and three children in two rooms over two days. Petitioner has failed to

establish that the meals and lodging were an ordinary and necessary business

expense, and we disallow the claimed business expense deductions for the hotel and

meal expenses related to this travel.

       In addition to his travel to Dayton, petitioner had meals with his parents

throughout 2007 and claimed the costs as business expense deductions. Petitioner
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apparently considered his parents clients of the brokerage business for many years.

Petitioner did not provide any records to corroborate the nature of the advice

provided to his parents or any information regarding properties he researched.

Petitioner acknowledged that during meals with his parents, he talked about

personal matters as well as real estate matters. Petitioner has not established that

these meals were ordinary and necessary business expenses. We therefore disallow

all business expense deductions claimed for meals with petitioner’s parents

throughout 2007.

National park

      Petitioner claimed deductions for hotel and meal expenses relating to travel to

Yosemite National Park on December 23, 2007. Petitioner did not provide the

Court with any evidence as to his real estate brokerage activity in his travel to

Yosemite. As a result, we find these expenses are not ordinary and necessary and

we therefore disallow the claimed business expense deductions relating to the meal

and hotel expenses for this travel.

Hotel stays in San Francisco area

      Petitioner claimed business expense deductions for hotel expenses for a

number of stays near the San Francisco airport. Petitioner’s records describe the

San Francisco airport expenses as incurred in order to report to work as a pilot the
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next day. Since these expenditures appear to relate to petitioner’s employment as a

pilot and not his real estate brokerage activity, it is clear that they are not proper

Schedule C deductions. Petitioner has failed to establish that these expenditures are

ordinary and necessary business expenses related to his brokerage activity.

Additionally, petitioner has failed to established that the claimed deductions are

proper employee business expenses.

      Petitioner’s list of hotel expenses also indicates that he incurred multiple

expenses at hotels 30-45 miles from his home, in downtown San Francisco and

Napa, California. Petitioner failed to explain the purpose of these expenditures.

Petitioner has failed to establish that these expenses were ordinary and necessary,

and we therefore disallow these business expense deductions for hotel expenses.

Meals and entertainment

      Petitioner claimed business expense deductions for meals and entertainment

in addition to the previously mentioned travel. We also disallow any meal and

entertainment expense not evidenced by a receipt or bank record as unsubstantiated.

We have carefully examined the receipts and records petitioner provided, and we

are satisfied that petitioner has substantiated business meal and entertainment

expenses of $3,888.99. Section 274(n) provides that only 50% of meal and

entertainment expenses is allowable as a deduction. See also Fleming v.
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Commissioner, T.C. Memo. 2010-60. As a result, petitioner is entitled to a business

expense deduction for meals and entertainment of $1,944.50, rather than the $3,834

petitioner claimed on the return.

Travel

      Petitioner claimed business expense deductions for travel in addition to the

previously mentioned travel. We disallow any travel expense not evidenced by a

receipt or bank record as unsubstantiated. We have carefully examined the receipts

and records petitioner provided, and we are satisfied that petitioner has

substantiated business travel expenses of $3,236.17, rather than the $10,533

claimed on the return.

Office expense

      Petitioner claimed an office expense of $5,512 on his 2007 Schedule C for the

real estate brokerage business. At trial petitioner provided an updated schedule in

which he reduced his claim to $4,374. A portion of the reduced claim represents

computer equipment and software which are listed property subject to the

heightened substantiation requirements of section 274(d). Petitioner did not provide

testimony about the office expenses nor any receipts related to the claimed office

expense deduction. Therefore petitioner has failed to substantiate that he incurred

any deductible office expenses. See Diers v. Commissioner, T.C. Memo. 2003-229.
                                         - 13 -

As a result, we disallow the entire business expense deduction related to the office

expenses.

Accuracy-related penalty

      Taxpayers may be liable for a 20% penalty on the portion of an underpayment

of tax attributable to negligence, disregard of rules or regulations, or a substantial

understatement of income tax. Sec. 6662(a) and (b)(1) and (2). The term

“negligence” in section 6662(b)(1) includes any failure to make a reasonable

attempt to comply with the Code, and the term “disregard” includes any careless,

reckless, or intentional disregard. Sec. 6662(c). Negligence has also been defined

as the failure to exercise due care or the failure to do what a reasonable and

ordinarily prudent person would do under the circumstances. See Allen v.

Commissioner, 

, 12 (1989), aff’d, 

, 353 (9th Cir. 1991);

Neely v. Commissioner, 

, 947 (1985). Negligence also includes any

failure by the taxpayer to keep adequate books and records or to substantiate items

properly. Sec. 1.6662-3(b)(1), Income Tax Regs. The section 6662(a) accuracy-

related penalty does not apply where the taxpayer shows that he or she acted in

good faith and with reasonable cause. Sec. 6664(c)(1). The determination of

whether a taxpayer acted in good faith and with reasonable cause depends on the

facts and circumstances of each case and includes the knowledge and experience of
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the taxpayer and the reliance on the advice of a professional, such as an accountant.

Sec. 1.6664-4(b)(1), Income Tax Regs. Most important in this determination is the

extent of the taxpayer’s effort to determine the proper tax liability. Neonatology

Assocs., P.A. v. Commissioner, 

, 99 (2000), aff’d, 

(3d

Cir. 2002).

      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, 

, 446 (2001).

Respondent has satisfied his burden by producing evidence that petitioners failed to

maintain adequate books and records or substantiate the claimed business expense

deductions. Accordingly, because respondent has met his burden of production,

petitioners must come forward with persuasive evidence that the accuracy-related

penalty should not be imposed with respect to the underpayment because they acted

with reasonable cause and in good faith. See sec. 6664(c)(1); Rule 142(a); Higbee

v. Commissioner, 

.

      Petitioners did not offer any argument or other evidence to show that there

was reasonable cause for the portion of the underpayment relating to the deductions

claimed and that they acted in good faith with respect to the claimed deductions.
                                        - 15 -

Respondent’s determination of the accuracy-related penalty under section 6662(a)

for 2007 is sustained.4

                                     Conclusion

      Petitioners are entitled to claim business expense deductions with respect to

petitioner’s real estate brokerage business for 2007 of $1,944.50 for meals and

entertainment and $3,236.17 for travel. Petitioners are also liable for the section

6662(a) accuracy-related penalty for 2007.

      To reflect the foregoing,


                                                 Decision will be entered

                                        under Rule 155.




      4
       Since we have allowed some business expense deductions that respondent
disallowed, the amount of tax required to be shown on petitioners’ 2007 Federal
income tax return will be reduced from the amount determined in the notice of
deficiency.