Griffin v. Comm'r

SUPPLEMENTAL MEMORANDUM OPINION

THORNTON, Judge: This case is before this Court on remand from the U.S. Court of Appeals for the Eighth Circuit for further consideration consistent with its opinion in Griffin v. Comm'r, 315 F.3d 1017 (8th Cir. 2003), vacating and remanding T.C. Memo. 2002-6. The issue for decision on remand is whether respondent has met his burden of proving that petitioners are not entitled to deduct as business expenses certain real property taxes paid by Mr. Griffin with respect to properties owned by two partnerships in which petitioners' wholly owned S corporation was a partner.

In our original opinion, we sustained respondent's determination that petitioners were not entitled to deduct the real property tax payments. In doing so, we held that the burden of proof was not placed on respondent pursuant to section 7491(a)(1), because we found that petitioners failed to introduce credible evidence that they were engaged, in their individual capacities, in a trade or business*65 for which the tax payments would have represented ordinary and necessary expenses. ¹ See, e.g., Lohrke v. Commissioner, 48 T.C. 679 (1967).

On appeal, the Court of Appeals for the Eighth Circuit held that petitioners "did produce sufficient 'credible evidence' to support their personal deductions of the real property tax payments at issue." Griffin v. Comm'r, supra at 1021. Accordingly, the Court of Appeals held that the burden of proof should be placed on respondent pursuant to section 7491(a)(1) and remanded this case for further consideration on the merits as to whether respondent had met his burden of proof. Id. at 1021-1022. The Court of Appeals stated:

     Our application of 26 U.S.C. section 7491(a) in the present

   case does not resolve the merits of the deficiency issues. On

   the record before us, we cannot determine*66 whether the

   Commissioner has met his burden of proof. It is not sufficient

   to summarily conclude that the outcome is the same regardless of

   who bears the burden of proof; if that were the case,

  section 7491(a) would have no meaning. We therefore remand the case to

   the tax court for further proceedings on the merits. On remand,

   the tax court may reconsider all of the evidence properly before

   it or hold a new hearing. In either case, the tax court is

   instructed to make new findings of fact in light of the shifted



   burden of proof. If the same conclusion is reached by the tax



   court without a new hearing, an explanation is warranted as to



   how the existing record justifies the conclusion that the

   Commissioner has met his burden of proof. [Id. at 1022.]

After the remand, we afforded the parties an opportunity for a new hearing. The parties agreed, however, that a new hearing was unnecessary and requested that we reconsider the case on the existing record after further briefing.

             Background

Facts with respect to this case were found in*67 our original opinion in Griffin v. Comm'r T.C. Memo. 2002-6. Those facts, which are not in dispute, are incorporated by this reference.

Petitioners owned all the stock of Griffin California Enterprises, Inc. (Griffin California), an S corporation. In turn, Griffin California held a 60-percent interest in each of two partnerships (Orange Tree Commerce Center Partnerships and Solano Commercial Investors) which owned certain commercial real properties in Vacaville, California.

During 1995 and 1996, Mr. Griffin personally paid delinquent real property taxes that had accrued with respect to the partnerships' Vacaville real properties. These payments (the tax payments) totaled $ 426,566 in 1995 and $ 501,742 in 1996. On Schedules E, Supplemental Income and Loss, attached to petitioners' 1995 and 1996 joint Federal income tax returns, petitioners claimed the tax payments as deductible expenses. Petitioners also attached Schedules C, Profit or Loss From Business, to their 1995 and 1996 joint returns reporting income and loss from certain "construction" activities.

In the notice of deficiency, respondent disallowed petitioners' claimed deductions for the tax payments*68 and instead treated the tax payments as petitioners' capital contributions to Griffin California and as deductible expenses of the partnerships, resulting in a flow-through of 60 percent of the deductions to Griffin California.

             Discussion

Section 162(a) allows a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. An expenditure is "ordinary and necessary" if it is directly connected with, or proximately related to, the taxpayer's trade or business activities. Sutherland Lumber-Southwest, Inc. v. Commissioner, 114 T.C. 197, 200 (2000), affd. 255 F.3d 495 (8th Cir. 2001).

As a general rule, a taxpayer's payment of another person's obligation is not an ordinary and necessary business expense. Deputy v. duPont, 308 U.S. 488, 84 L. Ed. 416, 60 S. Ct. 363 (1940); Welch v. Helvering, 290 U.S. 111, 114, 78 L. Ed. 212, 54 S. Ct. 8 (1933). Under this rule, a shareholder, even a majority or sole shareholder, is not entitled to deduct his payments of his corporation's expenses. Rink v. Commissioner, 51 T.C. 746, 751 (1969). ² An exception (the so-called Lohrke exception) *69 to this general rule may apply if a taxpayer pays someone else's expenses to protect or promote his own separate trade or business. See, e.g., Gould v. Commissioner, 64 T.C. 132, 134-135 (1975); Lohrke v. Commissioner, supra.³ In a recent opinion, the U.S. Court of Appeals for the First Circuit described this exception as involving a twofold test:

*70   First, the tax court must "ascertain the purpose or motive

   which [caused] the taxpayer to pay the obligations of the other



   person." To meet this prong, the expense must have been made



   primarily to benefit the taxpayer's business; any benefit



   conferred on the party whose expenses are being paid must be

   only incidental. Second, the tax court "must then judge

   whether it is an ordinary and necessary expense of the



   [taxpayer's] trade or business; that is, is it an appropriate



   expenditure for the furtherance or promotion of that trade or



   business? If so, the expense is deductible by the individual

   paying it." Lohrke, 48 T.C. at 688.

  [Capital Video Corp. v. Comm'r, 311 F.3d 458, 464 (1st Cir. 2002),

   affg. T.C. Memo. 2002-40; some citations omitted.]

The second part of this test requires that the expense arise in connection with the business activities of the taxpayer paying the expense. Id. at 465; see also Lettie Pate Whitehead Found., Inc. v. United States, 606 F.2d 534, 538 (5th Cir. 1979) (observing in*71 the Lohrke line of cases "a direct nexus between the purpose of the payment and the taxpayer's business or income producing activities").

In our original opinion, we held that petitioners failed to introduce "credible evidence", within the meaning of section 7491(a)(1), that they were engaged in their individual capacities in a trade or business for which the tax payments would have represented ordinary and necessary expenses. Griffin v. Comm'r, T.C. Memo. 2002-6. In making this determination, we adopted the following definition of "credible evidence" as found in the legislative history of section 7491:

   "Credible evidence is the quality of evidence which, after

   critical analysis, the court would find sufficient upon which to



   base a decision on the issue if no contrary evidence were



   submitted (without regard to the judicial presumption of IRS



   correctness)." [Id. (quoting H. Conf. Rept. 105-599,

   at 240-241(1998),1998-3 C.B. 747, 994-995)]

Applying this legal standard, we examined all the evidence that petitioners introduced, including the "summary and uncorroborated" testimony of Mr. Griffin, the*72 Schedules C and E attached to petitioners' joint Federal income tax returns for 1995 and 1996, and the testimony of William LaRue, petitioners' accountant and tax return preparer. ⁴ Id. We concluded that the "sparse evidence" introduced by petitioners was insufficient upon which to base a decision that petitioners were "individually engaged in a trade or business, within the meaning of section 162, with respect to which the tax payments would represent ordinary and necessary expenses." ⁵ Id. Accordingly, we concluded that petitioners had failed to carry their burden of proof.

*73 In Griffin v. Comm'r, 315 F.3d at 1021, the Court of Appeals for the Eighth Circuit employed the same definition of credible evidence that this Court had adopted from the relevant legislative history: "'the quality of evidence which, after critical analysis, the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted (without regard to the judicial presumption of IRS correctness).'" Unlike this Court, however, the Court of Appeals found that petitioners had introduced "credible evidence", apparently as to all relevant factual issues, so as to place the burden of proof on respondent with respect to all factual issues. Id. The Court of Appeals stated:

   Viewing Robert Griffin's testimony in the absence of any



   evidence or presumptions to the contrary, we conclude that



   appellants did produce sufficient "credible evidence" to



   support their personal deductions of the real property tax

   payments at issue. [Id.] ⁶

*74 The relevant legislative history provides that once a taxpayer has introduced credible evidence sufficient to place the burden of proof on the Commissioner: "If after evidence from both sides, the court believes that the evidence is equally balanced, the court shall find that the Secretary has not sustained his burden of proof." H. Conf. Rept. 105-599, at 241 (1998),1998-3 C.B. 747, 995. The record before us now is the same as was before us originally and as was before the Court of Appeals. The Court of Appeals has found petitioners' evidence credible. Whatever adverse inferences we might draw from the evidence (assuming that the opinion of the Court of Appeals does not foreclose our drawing such inferences) are insufficient to overcome petitioners' evidence, viewed in the light of the degree of credibility that the Court of Appeals has assigned to it.

For example, on remand, respondent places considerable reliance on the fact that petitioners reported the tax payments in question on Schedules E as S corporation expenses relating to misidentified real properties, rather than on Schedules C as expenses of a business conducted by petitioners in their individual capacity. *75 Ultimately, however, whatever adverse inferences we might draw from such facts appear to be overcome by what the Court of Appeals believed to be credible testimony by Mr. Griffin that the tax payments in question were made with respect to a separate trade or business in which Mr. Griffin was individually engaged.

Likewise, the remaining evidence in the record, consisting largely of the stipulated facts and the joint exhibits, does not directly establish or refute petitioners' allegation that they were individually engaged in a separate trade or business apart from their investments in S corporations and partnerships. Any inferences that we might draw from this evidence (or lack thereof) would not overcome Mr. Griffin's testimony in light of the degree of credibility assigned to it by the Court of Appeals.

Giving effect to the Court of Appeals' conclusion that Mr. Griffin's testimony was credible and sufficient to place the burden of proof on respondent, we conclude that respondent has offered insufficient contrary evidence to overcome petitioners' evidence. ⁷ Accordingly, respondent has failed to sustain his burden of proof.

*76 Decision will be entered for petitioners.