NEWHART v. COMMISSIONER

MEMORANDUM FINDINGS OF FACT AND OPINION

CHIECHI, JUDGE: Respondent determined a deficiency in petitioner's Federal income tax (tax) for 1995 in the amount of $ 18,181.

The issues remaining for decision ¹ are: ²

(1) Did petitioner materially participate in a certain business within the meaning of section 469(h)(1)? ³ We hold that he did not.

(2) Is petitioner entitled to deduct under section 212 certain claimed expenses with respect to a rental property *326 that he owned? We hold that he is not.

FINDINGS OF FACT

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

At the time the petition was filed, petitioner resided in Redwood City, California.

Petitioner was a full-time employee of Scimed/Boston Scientific Corporation (Scimed), a medical device corporation, working 10 to 12 hours a day in that company's sales operations. The sales territory of petitioner, who resided in Foster City, California (Foster City), included California, Nevada, and Hawaii. Petitioner's employment with Scimed required him to travel an aggregate of about one week each month.

CHICKEN BAR

During 1991, petitioner, Marc Caplan (Mr. Caplan), a friend of petitioner who lived in Lake Oswego, Oregon (Lake Oswego), ⁴ and three other individuals incorporated Chicken Bar, Inc. (Chicken Bar), under the laws of the State of Oregon. At all relevant times including 1995, Chicken Bar owned and operated a fast food restaurant (Chicken Bar restaurant), located in Beaverton, which is near Portland.

*327 At all relevant times including 1995, petitioner owned 35 percent, Mr. Caplan owned 35 percent, and three other individuals owned the remaining 30 percent of the stock of Chicken Bar. The board of directors of Chicken Bar consisted of five members, two of whom were petitioner and Mr. Caplan. ⁵

Mr. Caplan was the president, and petitioner was the secretary, of Chicken Bar. Mr. Caplan, as president, had primary responsibility for the day-to-day management and operations of Chicken Bar, including the Chicken Bar restaurant. ⁶ Petitioner, as secretary, had no responsibility for the day-to-day management and operations of Chicken Bar, including the Chicken Bar restaurant. ^{7*328 *329}

Sometime during 1994, Chicken Bar hired a general manager (general manager) who was to be directly responsible for planning and implementing its objective of opening three additional restaurants. During 1995, $ 180,000 was made available to the general manager in order to enable him to accomplish that objective. Through the efforts of the general manager, sometime during 1995, a new corporation was organized, ⁸ which opened and operated a fast food restaurant in Beaverton. Because the general manager exhausted the entire $ 180,000 that had been made available to him in order to open only one restaurant in 1995, his services were terminated around March 15, 1995.

Petitioner did not keep a contemporaneous log of any activities that he undertook with respect to the Chicken Bar business. At a time or times not disclosed by credible *330 evidence in the record, petitioner prepared a handwritten document entitled "1995 -- CHICKEN BAR LOG BOOK OF TIME SPENT ON CHICKEN BAR BUSINESS" (1995 document). The 1995 document contains a series of entries ⁹ consisting of (1) very brief summaries of certain activities that petitioner claims he undertook with respect to the Chicken Bar business, (2) the respective dates on which petitioner claims he undertook those activities, and (3) the number of hours that he claims he spent on each such activity. The 1995 document does not indicate where petitioner claims he undertook the various activities listed in that document or whether petitioner was required to travel in order to perform any of those claimed activities.

The following chart shows the total number of hours listed in the 1995 document that petitioner contends he spent on certain types of activities:

    Claimed Types of Activities      Claimed Total Hours

    ___________________________      ___________________

Review of management files and             2

  responsibilities

Review of catering functions with local        2.5

  schools

Review of, and/or planning, new business        3.5

  *331 sites

Review of, and/or recommendations on,         9

  employee hiring criteria and/or employee

  pay scales

Review of, and/or recommendations on, menu      17.5

  items and/or pricing

Review of employee files               18.5

Review of, and/or drafting of, budgets        19.5

Review of prospective purchase proposals       22.5

Internet search for, and/or study of,         25

  licensing information and/or

  opportunities

Review of payroll reports               28

Review of past growth and/or drafting of,       28.5

  or review of, projections relating to

  expansion

Discussions with Mr. Caplan              32.5

  regarding:

   Franchising concepts and

    possibilities             4

   Advertisements, budgets, and payroll   4

   Licensing and franchising        4

   Pro forma                3.5

   Employee issues, wages, and payroll   5

   Budget and menu items          4

   Financial reports            3.5

   Current financial status         4.5

   Budgets for 1995 and 1996         ¹

Review of, and/or recommendations on, budgets 33

Advertisement and media review and/or study 35.5

Internet stock market search and/or comparison analysis to Chicken Bar 41.5

Internet searches for, and/or study of, franchising information *332 and/or opportunities 46.5

Internet searches for, and/or analysis of, restaurant statistics 59.5

Review and analysis of financial reports 98

Total Hours Listed ² 523

The following chart shows the total number of hours listed in the 1995 document that petitioner claims he spent on each day of the week on the activities listed in that document:

  Day of the Week for        Total Hours Shown

  Which Entries Were Made     for Each Day of the Week

  _______________________      ________________________

     Mondays               36.5

     Tuesdays              30.5

     Wednesdays              29

     Thursdays              17

     Fridays              116

     Saturdays              150

     Sundays              144

TACOMA PROPERTY

Petitioner owned certain rental real property (Tacoma property) located in Tacoma, Washington (Tacoma), a city in which various members of his family lived, including his father Jack E. Newhart, his mother Juanita Demas, his brother David Newhart, *333 and his sister Julie Ayala.

Stan Cybaliski (Mr. Cybaliski) managed the Tacoma property on behalf of petitioner. Mr. Cybaliski was a property manager who worked for Clover Creek Realty, a real estate company owned by Roy Burnsides. As the property manager, Mr. Cybaliski was responsible for, inter alia, collecting the rent and soliciting bids when the Tacoma property needed work. Petitioner paid approximately $ 50 a month for the management of the Tacoma property.

Petitioner traveled at various times to Portland and to Tacoma. Petitioner's trips to Portland were usually made in combination with his trips to Tacoma (combination trips). On his combination trips, petitioner usually: Drove from his home in Foster City to the airport in San Francisco, California (San Francisco), flew from that airport to the Portland airport, rented a car, drove to Tacoma, returned the rental car to Portland, flew from the Portland airport to the San Francisco airport, and drove home to Foster City. A one-way trip from petitioner's home in Foster City to Portland took approximately three hours, including ground transportation.

During 1997, at the recommendation of the revenue agent examining petitioner's 1995 *334 tax return (return), petitioner prepared a handwritten document entitled "JACK NEWHART TRAVEL LOG & EXPENSES" (1997 document). The 1997 document contains a series of entries consisting of (1) very brief summaries of certain activities that petitioner claims he undertook with respect to both the Chicken Bar restaurant and the Tacoma property, (2) the respective dates on which petitioner claims he undertook those activities, and (3) the respective locations at which petitioner claims such activities took place. The 1997 document does not indicate the number of hours that petitioner claims he spent on the activities listed in that document.

Petitioner paid the amounts indicated with respect to the following airplane flights from San Francisco:

                          ______

Petitioner paid the amounts indicated with respect to the following car rentals: ^10*335

Petitioner paid the amounts indicated with respect to the following meals:

Petitioner paid the amounts indicated with respect to the following hotel expenses:

            Location Where

Petitioner paid the amounts indicated with respect to the following types of expenses:

         Type of      Location Where

*336 PETITIONER'S RETURN FOR THE YEAR AT ISSUE

Petitioner timely filed Form 1040, U.S. Individual Income Tax Return, for 1995 (1995 return).

The 1995 return included Schedule E, Supplemental Income and Loss (Schedule E). With respect to the Tacoma property, the 1995 Schedule E reported rental income of $ 10,200 and claimed rental expenses of $ 24,505, which included $ 4,896 of claimed "TRAVEL" expenses (petitioner's claimed traveling expenses), and a Schedule E loss of $ 14,305.

On a date not disclosed by the record, Chicken Bar, an S corporation, issued petitioner Schedule K-1, Shareholder's Share of Income, Credits, Deductions, etc., for 1995. That schedule indicated, inter alia, that petitioner's pro rata share of Chicken Bar's ordinary loss from trade or business activities (Schedule K-1 loss) was $ 19,412.

On a date not disclosed by the record, petitioner filed Form 1040X, Amended U.S. Individual Income Tax Return (Form 1040X), for 1995. In Form 1040X for 1995, petitioner claimed, inter alia, the Schedule K-1 loss of $ 19,412 attributable to Chicken Bar and a refund of $ 5,937. On February 3, 1997, the Internal Revenue Service sent petitioner a refund of $ 5,937 with respect to his 1995 *337 tax year.

NOTICE OF DEFICIENCY

In the notice of deficiency (notice) issued to petitioner for 1995, respondent determined, inter alia, to disallow $ 19,212 of the $ 19,412 Schedule K-1 loss that petitioner claimed in the 1995 Form 1040X on the ground that petitioner did not materially participate in the Chicken Bar business within the meaning of section 469(h)(1). Respondent further determined to disallow petitioner's claimed traveling expenses of $ 4,896 on the ground that petitioner "did not prove that the amount shown [$ 4,896] was (a) rental expense, and (b) paid".

OPINION

Petitioner bears the burden of showing error in the determinations in the notice that remain at issue. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115, 78 L. Ed. 212, 54 S. Ct. 8 (1933). Deductions are strictly a matter of legislative grace, and petitioner bears the burden of proving that he is entitled to any deductions claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84, 117 L. Ed. 2d 226, 112 S. Ct. 1039, 1992 U.S. LEXIS 1374 (1992).

Petitioner attempted to satisfy his burden of proof through his own testimony and certain documentary evidence, including the 1995 document, the 1997 document, and certain *338 alleged receipts for a claimed car rental expense, ¹¹ taxi expense, and meal expenses. ¹² We found petitioner's testimony to be questionable and not credible in certain material respects. We also found the 1995 document, ^13*340 the 1997 document, and the alleged car rental receipt, taxi receipt, and meal receipts to be questionable and not credible. In this connection, virtually all of that documentary evidence was prepared by petitioner whose testimony we found to be questionable and not credible in certain material respects; we found certain inconsistencies and/or discrepancies between the 1995 document and the 1997 document; ^{14*341 *342} and we found certain of the entries (1) in the 1995 document and the 1997 document with respect to the activities that petitioner claims he undertook and (2) on the claimed meal receipts with respect to the purposes for which petitioner claims he incurred the meal expenses at issue to be vague and ambiguous. ¹⁵ Based on our evaluation of petitioner's testimony and the documentary evidence on which he relies, we are not required to, and we shall not, rely on that evidence in determining whether petitioner has carried his burden of establishing error in respondent's *339 determinations with respect to the two issues that remain in this case.

CHICKEN BAR

Respondent *343 determined to disallow $ 19,212 of the $ 19,412 loss that petitioner claimed with respect to Chicken Bar on the ground that respondent determined that petitioner did not materially participate in the Chicken Bar business within the meaning of section 469(h)(1). Petitioner disagrees with respondent's determination. Before turning to the specific contentions of the parties in support of their respective positions, we shall set forth the general framework of section 469 and the regulations thereunder.

Pursuant to section 469(a), a passive activity loss of an individual for the taxable year is generally not allowed as a deduction for such year. ¹⁶ For this purpose, the passive activity loss for the taxable year is generally the amount, if any, by which the passive activity deductions for the taxable year exceed the passive activity gross income for such year. Sec. 469(d)(1).

As pertinent here, section 469(c) defines the term "passive activity" to include any activity which involves the conduct of any trade or business and in which the *344 taxpayer does not materially participate. Sec. 469(c)(1). For purposes of section 469(c)(1), the term "trade or business" is defined in section 469(c)(6) to include any activity in connection with a trade or business or any activity with respect to which expenses are allowable as a deduction under section 212.

Section 469(h)(1) provides that generally an individual is to be treated as materially participating in an activity only if such individual is involved in the operations of the activity on a basis that is regular, continuous, and substantial. Congress expressly authorized the Secretary of the Treasury to prescribe such regulations as may be necessary or appropriate to carry out the provisions of section 469, including regulations that specify "what constitutes * * * material participation". Sec. 469(l)(1).

Both temporary and final regulations relating to the meaning of the terms "participation" and "material participation" have been promulgated under section 469. With respect to the term "participation", final regulations issued under section 469 provide that generally

   any work done by an individual (without regard to the capacity

   in which the individual does the work) in connection *345 with an

   activity in which the individual owns an interest at the time

   the work is done shall be treated for purposes of this section

   as participation of the individual in the activity. [Sec. 1.469-5 (f) (1), Income Tax Regs.]

Temporary regulations issued under section 469 provide certain exceptions to that definition of participation. As pertinent here, section 1.469-5T(f)(2)(ii)(A), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), provides that work done by an individual in such individual's capacity as an investor in an activity is not to be treated as participation by the individual in the activity unless the individual is involved in the day-to-day management or operations of the activity. For this purpose, work done by an individual in such individual's capacity as an investor in an activity includes:

     (1) Studying and reviewing financial statements or reports

   on operations of the activity;



     (2) Preparing or compiling summaries or analyses of the



   finances or operations of the activity for the individual's own



   use; and



     (3) Monitoring the finances or operations of the activity

   in a non-managerial capacity. [Sec. 1.469-5T(f)(2)(ii)(B),

   Temporary *346 Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988).]

Temporary regulations relating to the meaning of the term "material participation" in section 469(h)(1) provide that, in general,

   an individual shall be treated, for purposes of section 469 and

   the regulations thereunder, as materially participating in an



   activity for the taxable year if and only if --



     (1) The individual participates in the activity for more



   than 500 hours during such year;



     (2) The individual's participation in the activity for the



   taxable year constitutes substantially all of the participation



   in such activity of all individuals (including individuals who



   are not owners of interests in the activity) for such year;



     (3) The individual participates in the activity for more



   than 100 hours during the taxable year, and such individual's



   participation in the activity for the taxable year is not less



   than the participation in the activity of any other individual



   (including individuals who are not owners of interests in the



   activity) for such year;



     (4) The activity is a significant participation activity



   (within the meaning of paragraph (c) of this section) for the

   taxable year, *347 and the individual's aggregate participation in

   all significant participation activities during such year



   exceeds 500 hours;



     (5) The individual materially participated in the activity



   (determined without regard to this paragraph (a)(5)) for any



   five taxable years (whether or not consecutive) during the ten



   taxable years that immediately precede the taxable year;



     (6) The activity is a personal service activity (within the



   meaning of paragraph (d) of this section), and the individual



   materially participated in the activity for any three taxable



   years (whether or not consecutive) preceding the taxable year;



   or



     (7) Based on all of the facts and circumstances (taking



   into account the rules in paragraph (b) of this section), the



   individual participates in the activity on a regular,

   continuous, and substantial basis during such year. [Sec. 1.469- 5T(a), Temporary Income Tax Regs., 53 Fed. Reg. 5725-5726 (Feb.

   25, 1988).]

According to petitioner, he is to be treated as having materially participated in the Chicken Bar business within the meaning of section 469(h)(1) because he satisfies both section 1.469- 5T(a)(1) and (7), Temporary Income Tax Regs., 53 Fed. Reg. 5725-5726*348 (Feb. 25, 1988). ¹⁷ Respondent counters that petitioner does not comply with either of those provisions of the temporary regulations and that consequently he is not to be treated as having materially participated in the Chicken Bar business within the meaning of section 469(h)(1).

We turn first to section 1.469-5T(a)(1), Temporary Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988), on which petitioner relies. According to petitioner, the 1995 document and his testimony establish that he spent 523 hours on activities relating to the conduct of the Chicken Bar business and that all of those hours must be taken into account in determining whether he satisfies section 1.469-5T(a)(1), Temporary Income Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988). As we indicated above, we shall not rely on that evidence in determining whether petitioner has carried his burden of establishing that he satisfies that temporary *349 regulation.¹⁸ On the record before us, we find that petitioner has failed to carry his burden of proving that he is to be treated as having materially participated in the Chicken Bar business under section 1.469-5T(a)(1), Temporary Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988). ^19*350

We turn next to section 1.469-5T(a)(7), Temporary Income Tax Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988), on which petitioner relies. Petitioner argues that, in applying that temporary regulation in this case, we should disregard section 1.469-5T(b)(2)(ii), Temporary Income Tax Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988). ^20*351 That is because, according to petitioner, that latter temporary regulation is invalid. In support of that position, petitioner asserts:

   The regulation [section 1.469-5T(b)(2)(ii), Temporary Income Tax

   Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988)] too simplistically

   uses the word management without any attempt to actually look at

   the surrounding facts and circumstances. The regulation provides

   that ONLY one person can materially participate as a manager

   under the facts and circumstances test. The regulation's test is

   two-fold. No person is compensated and no *352 other individual

   invests more hours in management of the activity. This

   emasculates the regular, continuous, and substantial

   requirement.

We need not decide whether petitioner is correct in arguing that section 1.469-5T(b)(2)(ii), Temporary Income Tax Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988), is invalid. That is because, on the record before us, ²¹ we find that, without regard to that temporary regulation, petitioner has failed to carry his burden of showing that he participated in the Chicken Bar business on a regular, continuous, and substantial basis during the year at issue and that he should be treated as having materially participated in the Chicken Bar business under section 1.469-5T(a)(7), Temporary Income Tax Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988). See sec. 469(h)(1).

Based on our examination of the entire record before us, we find that petitioner has failed to carry his burden of establishing that he is to be treated as having materially participated in the Chicken Bar business within the meaning of section 469(h)(1) and the regulations *353 thereunder on which he relies.

TACOMA PROPERTY

Respondent determined that petitioner is not entitled to deduct petitioner's claimed traveling expenses of $ 4,896. Although not altogether clear, petitioner appears to contend that not only is respondent's determination wrong, but he is entitled to deduct an additional $ 760.75 of claimed traveling expenses with respect to the Tacoma property, or a total of $ 5,656.75. ²²

In support of respondent's position that petitioner is not entitled to deduct any of the traveling expenses that petitioner claims with respect to the Tacoma property, respondent contends that petitioner failed to prove (1) that those claimed expenses are ordinary *354 and necessary expenses paid or incurred for the production or collection of income and/or for the management, conservation, or maintenance of property held for the production of income under section 212 and (2) that petitioner complied with the substantiation requirements of section 274(d).

An individual is allowed a deduction for all the ordinary and necessary expenses paid or incurred for the production or collection of income and for the management, conservation, or maintenance of property held for the production of income. Sec. 212(1) and (2). Section 274(d) operates to disallow any deduction otherwise allowable under section 212 for any traveling expense, including meals and lodging while away from home, sec. 274(d)(1), and for any item with respect to an activity that is of a type generally considered to constitute, inter alia, entertainment, such as a meal expense paid by a taxpayer for a guest, sec. 274(d)(2), unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the individual's own statement the amount of such expense, the time and the place of the travel and entertainment, the business purpose of the expense, and the business relationship *355 to the taxpayer of any person entertained. Rules for substantiation of each element of an expenditure for traveling and for entertainment are prescribed by section 1.274-5T, Temporary Income Tax Regs., 50 Fed. Reg. 46014-46018 (Nov. 6, 1985).

According to petitioner, the 1997 document, the claimed car rental receipt, taxi receipt, and meal receipts and his testimony establish that he is entitled under section 212 to deduct the expenses at issue. As we indicated above, we shall not rely on that evidence in determining whether petitioner has carried his burden of establishing that he is entitled under section 212 to deduct those expenses. On the record before us, we find that petitioner has failed to carry his burden of proving that the expenses at issue constitute ordinary and necessary expenses paid or incurred for the production or collection of income and/or for the management, conservation, or maintenance of property held for the production of income under section 212. We further find on that record that petitioner has failed to carry his burden of establishing that he is entitled under section 212 to deduct any of those claimed expenses. ^23*356

We have considered all of the contentions and arguments of petitioner that are not discussed herein, and we find them to be without merit and/or irrelevant.

To reflect the foregoing and the concessions of the parties,

Decision will be entered under Rule 155.