Bradford J. Sarvak v. Commissioner , 2018 T.C. Memo. 68 ( 2018 )

T.C. Memo. 2018-68UNITED STATES TAX COURT
BRADFORD J. SARVAK, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 30150-15. Filed May 21, 2018.
Erika E. Peterson and Jerry M. Lobb, for petitioner.
Heather K. McCluskey and Jeffrey L. Heinkel, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined deficiencies in petitioner’s Federal
income tax of $359,668 and $452,461 and accuracy-related penalties of $71,934
and $90,492 for 2011 and 2012, respectively. Unless otherwise indicated, all
section references are to the Internal Revenue Code (Code) in effect for the years
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[*2] in issue, and all Rule references are to the Tax Court Rules of Practice and
Procedure.
The stipulated issues for our consideration are: (1) whether Emery
Financial, Inc. (Emery), an S corporation wholly owned by petitioner, is entitled to
a bad debt deduction of $363,210 for 2011; (2) whether petitioner had unreported
capital gains for the years in issue as a result of distributions that he received from
Emery; and (3) whether petitioner is liable for the accuracy-related penalties under
section 6662(a).
FINDINGS OF FACT
Some facts have been stipulated and are incorporated in our findings by this
reference. Petitioner resided in California when he filed the petition.
Emery
Petitioner has a real estate mortgage broker’s license. He incorporated
Emery in California in 1993, and during the years in issue he was Emery’s sole
shareholder and president. Emery was a mortgage broker business that brokered
home loans for residential buyers. It acted as an intermediary between borrowers
and lenders. It did not hold any loans itself. As of the date of trial Emery was no
longer actively doing business.
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[*3] Emery elected to be treated as an S corporation for Federal income tax
purposes, and for the years in issue it filed Forms 1120S, U.S. Income Tax Return
for an S Corporation. On its return for 2011 Emery claimed a deduction for bad
debts of $363,210. Emery’s general ledger reflects that in 2011 it wrote off four
debts totaling $1,088. The remaining $362,122 of the claimed bad debt deduction
for 2011 was attributable to a write off for advances made to William Boehringer.
Advances to Boehringer
Petitioner first met Boehringer in 2003, when Boehringer was subdividing a
property in Aspen, Colorado. Petitioner purchased one lot in Aspen from
Boehringer, which petitioner developed and later sold. Boehringer engaged in
land development and building projects, and between 2003 and 2006 petitioner
was familiar with some of Boehringer’s projects in Aspen and in California.
In 2011 petitioner authorized Emery to make a series of advances to
Boehringer and to others on Boehringer’s behalf. The 2011 advances were made
by checks, credit card payments, and wire transfers. The balance of these
advances was recorded on Emery’s general ledger as a loan receivable from
Boehringer. The general ledger reflects that between June and December 2011
Emery made 24 advances to or for Boehringer, as follows:
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[*4] Date Debit
June 3 $35,000
June 9 10,000
June 9 11,000
June 29 5,000
June 30 2,984
July 12 1,500
July 22 2,000
July 26 44,607
Aug. 15 3,000
Aug. 18 2,999
Sept. 6 35,245
Sept. 15 5,000
Sept. 19 4,276
Sept. 19 17,000
Sept. 25 28,129
Oct. 3 23,000
Oct. 20 5,000
Oct. 26 53,858
Nov. 16 5,000
Nov. 16 10,000
Nov. 18 5,000
Nov. 25 33,360
Dec. 8 20,000
Dec. 21 20,000
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[*5] Some of the advances were made to Boehringer or on his behalf, and some
were made to or on behalf of Boehringer’s business partner in Switzerland.
Between June and December 2011 Emery’s general ledger reflects one credit to
Boehringer’s loan receivable account of $20,836, described in the memo line as
“Zurich hotel credit”. As of December 21, 2011, the balance of the 2011 advances
was $362,122.
Boehringer did not execute any notes for the 2011 advances. The advances
were unsecured, and neither Emery nor petitioner made a public filing to record a
debt in connection with the advances. Petitioner did not know the business
activities that Boehringer or his partner in Switzerland conducted. He thought that
Boehringer was getting back into the development business.
An adjusting entry in Emery’s general ledger for December 31, 2011,
reflects that petitioner instructed that the loan receivable for the 2011 advances be
written off. Emery’s trial balance for 2012 reflects that it made another loan to
Boehringer in 2012. Petitioner did not know the purpose for the 2012 advance.
Emery’s Distributions
As Emery’s president and shareholder, petitioner authorized distributions to
himself during the years in issue. At the time of the distributions he had access to
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[*6] all of Emery’s financial information. In 2011 petitioner received total
distributions of $1,651,455. In 2012 he received distributions of $2,007,699.
Tax Reporting
For the years in issue Emery reported ordinary business losses of $258,370
and $453,441, respectively. Petitioner claimed Emery’s losses on Schedules E,
Supplemental Income and Loss, Part II, Income or Loss From Partnerships and S
Corporations, attached to his Forms 1040, U.S. Individual Income Tax Return. He
engaged the same firm of certified public accountants (CPA firm) to prepare
Emery’s returns and his individual returns for the years in issue. Emery’s in-house
bookkeeper provided the information that the CPA firm used to prepare Emery’s
returns, and she reviewed the returns that the CPA firm prepared for Emery.
Petitioner looked at Emery’s returns, but he did not meet with anyone at the CPA
firm to go over the returns or their contents.
For the years in issue Emery reported on its returns the distributions to
petitioner. It issued Schedules K-1, Shareholder’s Share of Income, Deductions,
Credits, etc., for petitioner that reflected the distributions and reported them as
“[i]tems affecting shareholder basis”.
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[*7] Petitioner did not report any amounts of the distributions that he received
from Emery for the years in issue on his individual returns. On those returns he
reported income tax liabilities of $41,735 and $1,991, respectively.
Examination
Respondent’s revenue agent Shelly S. Gordon conducted an examination of
petitioner’s income tax returns for the years in issue. In the course of the
examination Gordon proposed accuracy-related penalties under section 6662(a)
for petitioner. She prepared a Civil Penalty Approval Form (penalty approval
form) that she forwarded to a group manager, who was her immediate supervisor.
The group manager signed and dated the penalty approval form and approved the
proposed penalties for petitioner on March 27, 2015. On September 4, 2015,
respondent sent to petitioner the notice of deficiency upon which this case is
based.
Respondent determined adjustments to Emery’s income for the years in
issue. The adjustments determined for Emery flowed through to petitioner and
were reflected in the notice of deficiency as increases to income reported on
Schedules E. Respondent disallowed the full amount of Emery’s claimed bad debt
deduction for 2011. Respondent disallowed for both years in issue deductions that
Emery had claimed for commissions, automobile expenses, and travel, meals, and
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[*8] entertainment. The parties have stipulated Emery’s allowable deductions for
those expenses. In addition to adjustments determined for Emery, respondent
determined in the notice of deficiency that petitioner had unreported long-term
capital gains for the years in issue.
OPINION
I. Bad Debt Deduction
Generally the taxpayer bears the burden of proving that the Commissioner’s
determinations set forth in the notice of deficiency are incorrect. Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioner bears the burden of
establishing that Emery is entitled to any deductions, including the claimed bad
debt deduction for 2011. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84
(1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); see also
Winter v. Commissioner, 135 T.C. 238 (2010) (where a notice of deficiency
includes adjustments for S corporation items with other items, we have jurisdiction
to determine the correctness of all adjustments). He has neither claimed nor
shown that he meets the requirements of section 7491(a) to shift the burden of
proof to respondent as to any relevant factual issue.
Section 166(a)(1) allows a deduction for any debt that becomes wholly
worthless within the taxable year. To deduct a business bad debt, the taxpayer
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[*9] must establish the existence of a valid debtor-creditor relationship, that the
debt was created or acquired in connection with a trade or business, the amount of
the debt, the worthlessness of the debt, and the year that the debt became
worthless. Davis v. Commissioner, 88 T.C. 122, 142 (1987), aff’d, 866 F.2d 852(6th Cir. 1989). Respondent contends that petitioner has failed to establish any of
these elements as they relate to the 2011 advances.
A bad debt is deductible only for the year in which it becomes worthless.
Denver & Rio Grande W. R. R. Co. v. Commissioner, 32 T.C. 43, 56 (1959), aff’d,
279 F.2d 368 (10th Cir. 1960); see also Hatcher v. Commissioner, T.C. Memo.
2016-188, at *17-*18, aff’d, __ F. App’x __, 2018 WL 1721752 (5th Cir. Apr. 9,
2018). Worthlessness of the debt is determined by an objective standard and is
usually shown by identifiable events that form the basis of reasonable grounds for
abandoning any hope of recovery. Am. Offshore, Inc. v. Commissioner, 97 T.C.
579, 593 (1991); Dustin v. Commissioner, 53 T.C. 491, 501 (1969), aff’d, 467
F.2d 47 (9th Cir. 1972); Dallmeyer v. Commissioner, 14 T.C. 1282, 1291-1292
(1950). The subjective opinion of the taxpayer that the debt is uncollectible,
without more, is not sufficient evidence that the debt is worthless. Fox v.
Commissioner, 50 T.C. 813, 822-823 (1968), aff’d per order, 70-1 U.S. Tax Cas.
(CCH) para. 9373 (9th Cir. 1970).
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[*10] Petitioner failed to present any evidence that the alleged debt was
objectively worthless in 2011. He testified only as to his subjective belief.
Emery’s general ledger reflects that it advanced funds to Boehringer on December
21, 2011, and petitioner did not identify any events between that date and the end
of the year which showed that the alleged debt was uncollectible. He testified that
Boehringer told him in “[e]arly 2012” that he could not repay the 2011 advances;
he offered no reasoning as to why in that case the alleged debt should be treated as
being worthless on December 31, 2011.
Even accepting petitioner’s uncorroborated testimony, Boehringer’s 2012
statement would not be enough to establish that the alleged debt to Emery was
objectively worthless. Petitioner did not describe any actions taken to try to
collect the alleged debt, and he testified that he did not know whether Boehringer
was actually insolvent in 2012. There is no reasonable explanation for advancing
more funds to Boehringer in 2012, which petitioner also described as a “business
loan”, if the prior advances were deemed totally unrecoverable. See Hatcher v.
Commissioner, at *18.
Petitioner has also failed to establish that the 2011 advances constituted a
bona fide debt and that the parties intended to create a bona fide debtor-creditor
relationship. See sec. 1.166-1(c), Income Tax Regs. (“Only a bona fide debt
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[*11] qualifies for purposes of section 166. A bona fide debt is a debt which
arises from a debtor-creditor relationship based upon a valid and enforceable
obligation to pay a fixed or determinable sum of money.”). Generally a debtor-
creditor relationship exists if the debtor genuinely intends to repay the loan and
the creditor genuinely intends to enforce repayment. Beaver v. Commissioner, 55
T.C. 85, 91 (1970); Fisher v. Commissioner, 54 T.C. 905, 909-910 (1970).
Factors indicative of a bona fide debt include: (1) whether the purported debt is
evidenced by a note or other instrument; (2) whether any security was requested;
(3) whether interest was charged; (4) whether the parties established a fixed
schedule for repayment; (5) whether there was a demand for repayment;
(6) whether any repayments were actually made; and (7) whether the parties’
records and conduct reflected the transaction as a loan. See, e.g., Welch v.
Commissioner, 204 F.3d 1228, 1230 (9th Cir. 2000), aff’g T.C. Memo. 1998-121;
see also Kaider v. Commissioner, T.C. Memo. 2011-174.
Boehringer did not execute any notes, and petitioner did not request any
collateral or other security for the 2011 advances. Petitioner has not provided any
documents reflecting the terms for the purported loan. He testified that “[i]t was
implied that * * * [Boehringer] was going to pay me back 10 percent [interest]”,
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[*12] but he provided no corroborating evidence that the parties understood that
the advances would carry an interest rate.
Apart from the way that the advances were recorded in Emery’s general
ledger, the parties’ conduct does not reflect that the advances were intended as a
bona fide loan. Emery made a series of unsecured advances to or for Boehringer,
and as the balance of the advances rapidly increased Emery did not receive any
offsetting payments or obtain any guaranties of repayment. Petitioner has not
claimed that he and Boehringer agreed to a schedule for repaying the advances or
that he ever demanded repayment. He contends that he determined that the
advances were uncollectible as of December 31, 2011, only 10 days after the last
advance had been made and without making any efforts to collect the amounts
allegedly owed. He testified that by early 2012 he believed Boehringer would not
be able repay the advances, but he continued to direct Emery to advance him more
funds.
Petitioner contends that he had a “good-faith expectation” that Boehringer
would repay him. Boehringer did not testify. Petitioner testified about his prior
business dealings with Boehringer, but the objective evidence and the
preponderance of all evidence suggests that petitioner had no genuine intention of
requiring Boehringer to repay the 2011 advances. The real purpose of the
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[*13] advances remains unexplained, but we are not persuaded that a bona fide
debt was created.
Petitioner has failed to establish whether and when the 2011 advances
became worthless or that the advances should be considered a bona fide debt for
tax purposes. Petitioner provided no evidence to substantiate the existence or the
amounts of the four smaller debts that Emery wrote off and claimed as part of its
bad debt deduction for 2011. Accordingly, we sustain respondent’s determination
to disallow the bad debt deduction in full.
II. Distributions From Emery
Respondent contends that petitioner failed to report capital gains from the
distributions that he received from Emery, because for both years in issue the
distributions were in excess of petitioner’s adjusted basis in Emery’s stock. In
cases of unreported income the Commissioner bears the initial burden of
producing evidence linking the taxpayer to the receipt of funds before the general
presumption of correctness attaches to a determination. Rapp v. Commissioner,
774 F.2d 932, 935 (9th Cir. 1985). The record contains Schedules K-1 issued by
Emery for petitioner that reflect distributions to him for the years in issue.
Petitioner does not dispute that he received the distributions. Respondent has met
the initial burden of production, and petitioner bears the burden of establishing
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[*14] that the unreported distributions should be excluded from income. Gemma
v. Commissioner, 46 T.C. 821, 833 (1966).
Sections 1366 through 1368 govern the tax treatment of S corporation
shareholders such as petitioner. Section 1366(a) provides generally that a
shareholder shall take into account his or her pro rata share of the S corporation’s
items of income, loss, deduction, or credit for the S corporation’s taxable year
ending with or in the shareholder’s taxable year. Section 1367(a) provides that a
shareholder’s basis in stock of the S corporation is increased by items of income
passed through to the shareholder under section 1366(a), and decreased by passed-
through items of loss and deduction. See sec. 1367(a)(1) and (2). A shareholder’s
stock basis is also decreased by distributions received from the S corporation that
are not includible in income pursuant to section 1368. Sec. 1367(a)(2)(A).
A distribution by an S corporation that has no accumulated earnings and
profits is treated in the manner provided in section 1368(b). See sec. 1368(a); sec.
1.1368-1(c), Income Tax Regs. Neither party contends and the record does not
reflect that Emery had accumulated earnings and profits; thus section 1368(b)
applies to determine the treatment of petitioner’s distributions. Section 1368(b)(1)
provides that a distribution “shall not be included in gross income to the extent
that it does not exceed the adjusted basis of the stock.” A distribution or any
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[*15] portion thereof that exceeds the adjusted basis is treated as gain from the
sale or exchange of property. Sec. 1368(b)(2).
Petitioner contends that he did not take distributions in excess of basis. He
contends that he was personally liable to Emery for the distributions that he
received during the years in issue because he received them in violation of the
California Corporations Code. The California Corporations Code provides that a
shareholder who knowingly receives any distribution that exceeds the amount of
the corporation’s retained earnings immediately prior to the distribution is liable to
the corporation for the amount so received. See Cal. Corp. Code secs. 500, 506
(West 2014). For each of the years in issue Emery’s tax return reflected that it had
negative retained earnings. Petitioner contends that his liability to Emery under
California law “increased his debt basis in the corporation”.
Section 1367(b)(2)(A) provides that if for the taxable year certain items in
section 1367(a)(2) exceed the amount that would reduce a shareholder’s stock
basis to zero, the excess of those items shall be applied to reduce (but not below
zero) the shareholder’s basis in “any indebtedness of the S corporation to the
shareholder.” (Emphasis added.) Petitioner has not argued or shown that he lent
Emery funds or that he assumed direct liability for any debts that Emery owed to
outside creditors. See sec. 1.1366-2(a)(2)(i), Income Tax Regs. (“The term basis
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[*16] of any indebtedness of the S corporation to the shareholder means the
shareholder’s adjusted basis * * * in any bona fide indebtedness of the S
corporation that runs directly to the shareholder.”). He has not established that the
corporation should be indebted to him for anything. Rather, he contends that the
distributions at issue created an indebtedness that he owed to the corporation. A
debt for which he was liable to Emery could not have increased his basis in the
indebtedness of Emery. Petitioner misinterprets the cited Code and regulatory
provisions in arguing that his purported obligation to repay the distributions
created debt basis.
Furthermore, even if petitioner established that he had basis in some bona
fide indebtedness of Emery, it would not affect the taxability of the distributions
that he received for the years in issue. Section 1368(b)(1) provides that a
distribution is not included in gross income only “to the extent that it does not
exceed the adjusted basis of the stock.” Section 1368 does not reference a
shareholder’s basis in indebtedness. Section 1367(b)(2)(A) does not identify
distributions that decrease a shareholder’s stock basis under section 1367(a)(2)(A)
as an item that shall be applied to a shareholder’s debt basis after the stock basis
has been reduced to zero. Under the relevant Code sections distributions are
measured only against the basis of the shareholder’s stock.
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[*17] We agree with respondent that the distributions must be reported as income
and treated as capital gain to the extent that they exceeded petitioner’s basis in
Emery’s stock. “[B]asis is a specific fact which the taxpayer has the burden of
proving.” O’Neill v. Commissioner, 271 F.2d 44, 50 (9th Cir. 1959), aff’g T.C.
Memo. 1957-193. The stipulated exhibits include a copy of a spreadsheet that the
CPA firm prepared to calculate petitioner’s stock basis and copies of other tax and
financial documents that petitioner submitted with the spreadsheet. However,
petitioner failed to address these exhibits at trial and he did not argue at trial or on
brief that he had sufficient stock basis to exclude the distributions from gross
income. He does not dispute respondent’s calculations of his stock basis for the
years in issue.
Respondent’s basis calculations rely in part on audit adjustments determined
for Emery, which should be changed to reflect the parties’ stipulations regarding
Emery’s deductible expenses. In all other respects, because petitioner has failed to
meet his burden of proof, we sustain respondent’s calculations of petitioner’s basis
in Emery’s stock. Allowing for computational adjustments, we sustain
respondent’s determination that petitioner had unreported capital gain for the years
in issue.
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[*18] III. Section 6662(a) Penalties
Section 6662(a) and (b)(1) and (2) imposes a 20% penalty on any portion of
an underpayment of Federal income tax that is attributable to negligence or
disregard of rules or regulations or a substantial understatement of income tax. An
understatement of income tax is substantial if it exceeds the greater of 10% of the
tax required to be shown on the return for the taxable year or $5,000. Sec.
6662(d)(1). Respondent contends that even after concessions made with respect to
Emery’s deductible expenses petitioner substantially understated his income tax
liabilities for both years in issue. Alternatively, respondent contends that
petitioner acted negligently or in disregard of rules and regulations. Only one
accuracy-related penalty may be imposed with respect to any given portion of an
underpayment, even if that portion is attributable to more than one of the types of
conduct listed in section 6662(b). New Phoenix Sunrise Corp. v. Commissioner,
132 T.C. 161, 187 (2009). Under section 7491(c), the Commissioner bears the
burden of production with regard to penalties and must come forward with
sufficient evidence indicating that it is appropriate to impose penalties. Higbee v.
Commissioner, 116 T.C. 438, 446-447 (2001).
Section 6751(b)(1) provides that “[n]o penalty * * * shall be assessed unless
the initial determination of such assessment is personally approved (in writing) by
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[*19] the immediate supervisor of the individual making such determination or
such higher level official as the Secretary may designate.” A majority of this
Court held in Graev v. Commissioner (Graev II), 147 T.C. 460 (2016), that the
question of whether a penalty was properly approved under section 6751(b) was
premature in a deficiency case, because the penalty was not yet assessed. On
March 20, 2017, the Court of Appeals for the Second Circuit issued its opinion in
Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), aff’g in part, rev’g in part
T.C. Memo. 2015-42, in which it disagreed with the majority’s analysis in Graev
II. The Court of Appeals for the Second Circuit held that section 6751(b)
“requires written approval of the initial penalty determination no later than the
date the IRS issues the notice of deficiency (or files an answer or amended
answer) asserting such penalty.” Chai v. Commissioner, 851 F.3d at 221. When
Chai was issued, a final decision in Graev had not yet been entered.
Trial of this case was held on April 19, 2017, and the final brief ordered at
the time of trial was filed by petitioner on September 18, 2017. As of those dates
this Court’s position regarding compliance with section 6751(b) continued to be
the position held by the majority in Graev II. On December 20, 2017, we issued
Graev v. Commissioner (Graev III), 149 T.C. __ (Dec. 20, 2017), supplementing
and overruling in part 147 T.C. 460 (2016). In Graev III, 149 T.C. at __ (slip op.
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[*20] at 14), we held, consistent with the analysis of the Court of Appeals for the
Second Circuit in Chai, that the Commissioner’s burden of production under
section 7491(c) includes establishing compliance with the supervisory approval
requirement of section 6751(b).
On February 26, 2018, respondent filed a motion to reopen the record so
that respondent could submit evidence of supervisory approval for the determined
penalties. Petitioner objects to respondent’s motion.
Reopening the record for the submission of additional evidence lies within
the Court’s discretion. Nor-Cal Adjusters v. Commissioner, 503 F.2d 359, 363
(9th Cir. 1974), aff’g T.C. Memo. 1971-200; Butler v. Commissioner, 114 T.C.
276, 286-287 (2000). We will grant a motion to reopen the record only if the
evidence relied on is not merely cumulative or impeaching, is material to the
issues involved, and probably would change some aspect of the outcome of the
case. Butler v. Commissioner, 114 T.C. at 287. By the motion respondent seeks
to reopen the record to offer into evidence the declaration of the examining agent,
Gordon, and a penalty approval form signed by Gordon’s immediate supervisor
and dated before the issuance of the notice of deficiency.
The evidence that is the subject of respondent’s motion would not be
cumulative of any evidence in the record, and it would not be impeaching material.
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[*21] Respondent bears the burden of production with respect to penalties and
would offer the evidence as proof that the requirements of section 6751(b)(1) have
been met. The subject evidence is material to the issues involved in the case, and
we conclude that the outcome of the case will be changed if we grant respondent’s
motion.
Petitioner objects to our granting respondent’s motion on the grounds that
the motion is untimely and that granting the motion would result in “inherent
unfairness”. He states in his opposition to the motion that section 6751(b) has
been “on the books since 1998” and that Chai was decided before trial in this case.
He contends that despite having “multiple opportunities” to submit the subject
evidence respondent “saw fit to ignore its burden of production”. However, at the
time of trial and briefing, it was not the position of this Court that respondent’s
burden of production included showing supervisory approval of the penalties. The
applicable precedent after Graev II, and before Graev III, was that compliance
with section 6751(b) was not even properly at issue in a deficiency case.
Petitioner contends that granting respondent’s motion would result in
“dissimilar treatment * * * for similarly situated petitioners”, citing Ford v.
Commissioner, T.C. Memo. 2018-8. In Ford the Commissioner failed to present
evidence of compliance with section 6751(b) and did not move to reopen the
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[*22] record. We did not sustain the determination of the penalties. Ford v.
Commissioner, at *6. We reject petitioner’s contention that he would be subjected
to “dissimilar treatment” if we granted respondent’s motion in this case and
allowed the subject evidence into the record. We will grant the motion to reopen
the record and have included the relevant facts in our findings.
Petitioner has argued that he should not be liable for the accuracy-related
penalties because he had reasonable cause and acted in good faith with respect to
the underpayments of tax. See sec. 6664(c)(1). He contends that he relied on
advice given by the CPA firm that prepared the returns filed for him and for Emery
for the years in issue. To establish reasonable cause through reliance on
professional advice the taxpayer must prove that (1) the adviser was a competent
professional who had sufficient expertise to justify reliance; (2) the taxpayer
provided necessary and accurate information to the adviser; and (3) the taxpayer
actually relied in good faith on the adviser’s judgment. Neonatology Assocs., P.A.
v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).
A partner from the CPA firm testified generally as to the preparation of
petitioner’s and Emery’s returns. He testified that he advised petitioner with
respect to the treatment of the bad debt deduction that Emery claimed for 2011 and
the distributions that petitioner received but did not report as income. Petitioner
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[*23] testified, however, that he does not discuss completed returns or their
contents with the preparers at the CPA firm. He testified that Emery’s bookkeeper
was responsible for providing the financial information that the CPA firm used to
prepare the returns, and he did not know what information or documents the
bookkeeper had provided.
The partner testified on direct examination that he considered the
substantiation requirements for bad debt deductions in connection with the 2011
advances and that he believed petitioner satisfied those requirements. However,
on cross-examination he could not recall any documents that Emery provided
regarding the alleged bad debt or when he was told that the advances were
uncollectible. Petitioner testified that he was not notified that the advances were
uncollectible until 2012. We do not believe that a tax professional familiar with
the requirements for bad debt deductions would advise a client to claim a
deduction for a year before the debt was actually suspected to be worthless, much
less with the knowledge that the client would continue to make advances under
those circumstances.
The partner testified that during the information gathering process Emery’s
bookkeeper told him that petitioner was directly liable to Emery’s creditors and he
therefore determined petitioner had debt basis. However, no documents were
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[*24] introduced in connection with this testimony to show that Emery or
petitioner actually had creditors. The partner did not identify any debts that he
knew about for which petitioner was liable. He testified that the CPA firm kept a
running total of petitioner’s basis, but at no point did he attempt to refute
respondent’s basis calculations or explain why the worksheets that his firm
prepared showed different amounts. When respondent’s counsel asked him how a
distribution could create debt basis, his answers were initially nonresponsive.
Ultimately, the partner acknowledged that “[a] [d]istribution does not create debt
basis.” Petitioner now takes a position that his preparer explicitly rejects,
contending in his brief that his distributions did create basis.
In short, petitioner presented no persuasive evidence that he had reasonable
cause or acted in good faith with respect to any portions of his underpayments for
the years in issue. The record reflects that even after respondent’s concessions
regarding Emery’s expenses petitioner’s understatements of tax are substantial in
the light of our holdings. The available facts also demonstrate that petitioner
disregarded applicable provisions of the Code and regulations in reporting his
taxes for the years in issue. For example, he failed to attach a statement of facts to
Emery’s return for 2011 to substantiate the claimed bad debt deduction, as
required under section 1.166-1(b)(1), Income Tax Regs. He also failed during the
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[*25] years in issue to maintain books or records sufficient to calculate his basis
and to compute his tax liabilities with respect to the distributions that he received
from Emery. See sec. 6001; sec. 1.6001-1, Income Tax Regs.
To the extent that petitioner substantially understated his income tax
liabilities and disregarded applicable rules or regulations, respondent has satisfied
the burden of production by providing sufficient evidence to show that the
penalties are appropriate. Petitioner has not established any reason why the
penalties should not apply. Accordingly, we sustain the determination of the
penalties under section 6662(a).
We have considered all arguments made, and, to the extent not mentioned,
we conclude that they are moot, irrelevant, or without merit. To reflect the
foregoing,
An appropriate order will be
issued and decision will be entered
under Rule 155.