McCoy v. Commissioner

MEMORANDUM OPINION

NAMEROFF, Special Trial Judge: This case was heard pursuant to the provisions of section 7443A(b) (3) ¹ and Rules 180, 181, and 182. Respondent determined a deficiency in petitioners' 1991 Federal income tax in the amount of $ 4,200 and an accuracy-related penalty under *201 section 6662(a) in the amount of $ 840.

The issues for decision are: (1) Whether petitioners*202 are entitled to a section 162 deduction for accrued expenses of $ 15,000; and (2) whether petitioners are liable for the section 6662(a) accuracy-related penalty.

Background

Some of the facts have been stipulated, and they are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time they filed their petition, petitioners resided in Thousand Oaks, California. References to petitioner are to Mack L. McCoy.

Petitioner is an architect by trade. In 1991, petitioner managed an interior design firm that built model homes for homebuilders. He worked 30 hours per week as a W-2 wage earner.

Petitioner also acted as a consultant to various individuals under his proprietorship named Mack McCoy. As Mack McCoy's proprietor, petitioner provided his clients with management services, such as marketing and overall management advice and internal work scheduling. Petitioner indicated that his consulting business had been ongoing for about 20 years. In 1991, petitioner had one main client, a structural engineer, who paid petitioner $ 2,000 per month for about 5 months of services. The 1991 Schedule C for Mack McCoy reflects gross income*203 of $ 10,913.64. Petitioner used the cash method of accounting to report Mack McCoy's income and expenses.

Petitioner allegedly formed another proprietorship in 1991 named The Real McCoy (Real McCoy). Petitioner's testimony surrounding the existence and operation of Real McCoy was sketchy. We surmise, however, that petitioner had a plan to build industrialized (i.e., prefabricated) housing, and Real McCoy was conceptualized to engage in the actual manufacture of the industrialized homes.

Petitioner took no formal steps to set up Real McCoy, and he stated it was formed just in his mind. Petitioner also indicated that he intended someday to create a formal structure, but that in 1991 it was just an idea. Real McCoy did not generate any revenue for petitioner and, ultimately, never manufactured anything. Since 1991, petitioner said he took no steps to establish Real McCoy as an ongoing business because "the market totally went dead". Petitioner intended to use the accrual method of accounting to report Real McCoy's income and expenses.

Petitioner did not invest money into Real McCoy. He stated, however, that, while wearing his Mack McCoy hat, he drafted architectural plans (the plans) *204 and "sold" them to Real McCoy for $ 15,000. Petitioner indicated that the plans were a useful tool to solicit potential investors because they allowed him to demonstrate his product on paper. Petitioner valued these plans at $ 15,000. Petitioner testified that he arrived at the above figure using prevailing rates for similar types of architectural drawings.

According to petitioner, as proprietor of both businesses, he took the following actions with respect to the plans: (1) Mack McCoy drew up the architectural plans; (2) Real McCoy agreed to purchase the plans from Mack McCoy for $ 15,000; (3) Mack McCoy delivered the plans to Real McCoy; and (4) Mack McCoy issued a $ 15,000 bill to Real McCoy. Petitioner did not have any written documentation supporting the purported transaction. Real McCoy never paid Mack McCoy for the plans, and Mack McCoy did not institute legal action against Real McCoy for nonpayment. Petitioner stated that Real McCoy did not pay Mack McCoy because "the entity never got going" and that Mack McCoy did not sue Real McCoy because "there was nothing to gain."

On petitioners' 1991 Schedule C for Real McCoy, petitioner claimed a $ 15,000 deduction for the accrued*205 cost of the plans. He did not, however, include $ 15,000 of income on the Schedule C for Mack McCoy. In the notice of deficiency, the Commissioner determined that petitioners were not entitled to the $ 15,000 deduction because they failed to establish that they incurred an ordinary and necessary business expense and because their method of accounting for this deduction did not clearly reflect income.

Discussion

We begin our discussion by stating that respondent's determination is presumed correct, and petitioner bears the burden of proving otherwise. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Moreover, petitioner must prove entitlement to any deduction claimed. New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

The issue before us is whether petitioner is entitled to accrue $ 15,000 as a deduction for 1991. We hold that he is not because he failed to prove that he incurred that expense.

Section 162(a) permits the deduction of ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. The question of whether a taxpayer is engaged in the active*206 conduct of a trade or business requires an examination of all relevant facts and circumstances. Commissioner v. Groetzinger, 480 U.S. 23, 36 (1987). To be deductible under section 162, expenses must relate to a trade or business functioning at the time the expenses are incurred. Hardy v. Commissioner, 93 T.C. 684, 687 (1989), affd. on this point in an unpublished order of the Court of Appeals for the Tenth Circuit filed October 29, 1990. Further, the expense must have been incurred after the taxpayer's trade or business actually commenced; expenses incurred prior to that time are nondeductible pre-opening expenses. Jackson v. Commissioner, 86 T.C. 492, 514 (1986), affd. 864 F.2d 1521 (10th Cir. 1989); Goodwin v. Commissioner, 75 T.C. 424, 433 (1980), affd. without published opinion 691 F.2d 490 (3d Cir. 1982); McManus v. Commissioner, T.C. Memo. 1987-457, affd. without published opinion 865 F.2d 255 (4th Cir. 1988).

Real McCoy was not a functioning*207 business in 1991. By petitioner's own admission, it was just an idea in his mind that never materialized. Petitioner took no formal actions to establish Real McCoy as a going concern, and he has yet to commence any sort of manufacturing activity. Moreover, Real McCoy did not generate any revenue for petitioner and, ultimately, never manufactured anything. In sum, even though petitioner intended to someday build industrialized housing, he failed to demonstrate that he actually carried on that activity during 1991.

Petitioner did not incur a binding and enforceable liability that would have entitled him to a deduction under section 162. Generally, an accrual method taxpayer deducts expenses in the year in which they are incurred, regardless of when they are actually paid. Heitzman v. Commissioner, 859 F.2d 783, 787 (9th Cir. 1988), affg. T.C. Memo. 1987-109. A liability is incurred for income tax purposes in the tax year in which: (1) All events have occurred that establish the fact of the liability; (2) the amount of the liability can be determined with reasonable accuracy; and (3) economic performance has occurred with respect*208 to the liability. Sec. 1.461-1(a) (2), Income Tax Regs.; see also sec. 461(h). In order to be accruable, a liability must be binding and enforceable; the liability must not be contingent on a future event; the amount of liability must be certain; and there must be a reasonable belief on the part of the debtor that the liability will be paid. Putoma Corp. v. Commissioner, 66 T.C. 652, 660 (1976), affd. 601 F.2d 734 (5th Cir. 1979); United Control Corp. v. Commissioner, 38 T.C. 957, 967 (1962). We need not dwell on this matter at length as petitioner failed to demonstrate that Real McCoy incurred a binding and enforceable liability.

During opening argument, respondent likened petitioners' situation to those disallowed by section 267, in support of the the contributor in the entity) is a question of fact which must be answered by reference to all of the evidence, with the burden on the taxpayer to establish that the alleged loans were bona fide debt. Rule 142(a); Dixie Dairies Corp. v. Commissioner, 74 T.C. 476, 493 (1980); Yale Avenue Corp. v. Commissioner, 58 T.C. 1062, 1073-1074 (1972).*209 The taxpayer's assertion that an advance was a loan is not determinative of the issue of characterizing an advance as debt or equity. See In re Uneco, Inc., supra. Advances to a closely held corporation by its shareholders are subject to particular scrutiny, as "The absence of arm's-length dealing provides the opportunity to contrive a fictional debt shielding the real essence of the transaction and obtaining benefits unintended by the statute." Gilboy v. Commissioner, T.C. Memo. 1978-114.

In the instant case, the record consists of only the notice of deficiency and copies of petitioners' 1989 return, 1989 amended return, and 1990 return. Petitioners provided no books, records, or tax returns with respect to their interest in CME/CMA. Additionally, petitioners did not provide promissory notes evidencing the alleged loans to CMA/CME or books and records reflecting petitioners' lending activities. At trial, petitioner testified that he had some books and records in Florence, Montana. Additionally, at trial, petitioners' counsel stated that, after petitioner sold his interest in CME during 1990, the new owner threw away most of the records.

We first*210 examine whether petitioner's advances to CME/CMA were bona fide debt. The parties stipulated that, for petitioner's loans to CME/CMA, notes were prepared establishing interest rates and maturity dates. As to the first bad debt deduction for the worthlessness of advances allegedly made by petitioners to CME/CMA in the amount of $ 633,897, however, petitioners failed to provide the notes or any other documentary evidence and sought to substantiate the loans only through petitioner's testimony. We are not required to accept petitioner's self-serving and uncorroborated testimony, particularly where other and better evidence to prove the point in question should be available. Wood v. Commissioner, 338 F.2d 602, 605 (9th Cir. 1964), affg. 41 T.C. 593 (1964). Under the circumstances of the instant case, we do not credit petitioner's testimony where it is not corroborated by documentary or other reliable evidence. Consequently, we conclude that petitioners did not establish that the advances to CME/CMA in the amount of $ 633,897 were bona fide debt.

As to the second bad debt deduction for the worthlessness of loans made by petitioners*211 to CME/CMA in the amount of $ 4,010, petitioners provided no business records, checks, or receipts to corroborate petitioner's testimony that the amount was actually advanced. It is well established that, in the absence of corroborating evidence, we are not required to accept self-serving testimony. Niedringhaus v. Commissioner, 99 T.C. 202, 212 (1992); Tokarski v. Commissioner, 87 T.C. 74, 77 (1986); see Jackson v. Commissioner, 19 T.C. 133, 145 (1952), affd. 207 F.2d 857 (10th Cir. 1953). Consequently, we conclude that petitioners did not establish that the advances to CME/CMA in the amount of $ 4,010 were bona fide debt.

As to petitioners' remaining arguments, we conclude that petitioners have not carried their burden of proving that they are entitled to the alleged losses. As we stated above, petitioners provided no books, records, or tax returns with respect to their interests in CME or CMA. Additionally, petitioners did not provide promissory notes evidencing the alleged loans to CME/CMA or books and records reflecting petitioners' lending activities.

Taxpayers*212 are required to maintain records that are sufficient to enable the Commissioner to determine their correct tax liability. See sec. 6001; Meneguzzo v. Commissioner, supra; sec. 1.6001-1(a), Income Tax Regs. We conclude that petitioners did not carry their burden of substantiating the amount and purpose of either of the two bad debt deductions. Accordingly, we hold that petitioners are not entitled to the two bad debt deductions in the amounts of $ 633,897 and $ 4,010 for the worthlessness of loans allegedly made by petitioners to CME/CMA. ³

*213 Under the circumstances of the instant case, we are not required to, and we generally do not, rely on petitioner's testimony to sustain petitioners' burden of proving error in respondent's determinations. See Geiger v. Commissioner, 440 F.2d 688, 689-690 (9th Cir. 1971), affg. per curiam T.C. Memo. 1969-159; Wood v. Commissioner, supra; Tokarski v. Commissioner, supra; Hradesky v. Commissioner, 65 T.C. 87 (1975). Accordingly, we sustain respondent's determinations.

To reflect the foregoing,

Decision will be entered under Rule 155.