Langer v. Comm'r

MEMORANDUM FINDINGS OF FACT AND OPINION

HAINES, Judge: Respondent determined a deficiency in petitioners' 2001 Federal income tax of $ 56,474 and an accuracy-related penalty under section 6662 of $ 11,295. ¹

After concessions, the issues for decision are whether petitioners are entitled to business expense deductions in an amount greater than respondent allowed, and whether petitioners are liable for an accuracy-related penalty under section 6662.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. Petitioners resided in Minnesota at the time their petition was filed.

In 1984 petitioners purchased their 5,500-square-foot home for $ 501,358, and they have lived there at all times since. Petitioners claim that in 1995 additional work was done to the driveway and exterior *254 lighting of their residence at a total cost of $ 31,641. In 1999 they added a low-voltage outdoor lighting system at a cost of $ 18,945, and the property was landscaped at a cost of $ 9,420.

Mrs. Langer, a piano teacher, has operated a piano teaching business from petitioners' residence since its purchase. See Langer v. Commissioner, T.C. Memo. 1992-46 (discussing the use of the home for piano teaching and finding that 315 square feet of petitioners' home was used as a piano studio), affd. 989 F.2d 294 (8th Cir. 1993). Since June 1996 Mr. Langer, a former Internal Revenue Service agent, has operated a financial investigations business out of petitioners' residence. Mr. Langer used office space in the residence, which from 1984 to 1996 had been used by a greeting card company run by Mrs. Langer and her sisters. See id. (finding that 400 square feet of petitioners' home was used by the greeting card company).

Petitioners prepared their own joint Form 1040, U.S. Individual Income Tax Return, for 2001 and submitted it to respondent on May 8, 2002. The return included two Schedules C, Profit or Loss from Business, one for Mr. Langer's investigations business and one for Mrs. Langer's piano *255 teaching business. Both of the Schedules C reported substantial expenses with respect to the businesses, including home office expenses and related depreciation of the home, lighting, driveway, and landscaping.

On April 21, 2005, respondent issued petitioners a notice of deficiency for 2001. ^2*256 Respondent disallowed most of petitioners' Schedule C expenses. Petitioners timely filed a petition with this Court, and a trial was held in St. Paul, Minnesota.

OPINION

On the basis of documentation petitioners provided, respondent conceded that petitioners are entitled to some of the disallowed business expense deductions, while petitioners conceded they are not entitled to others. As evidence that the remaining expenses should be allowed, petitioners presented only Mr. Langer's testimony and scant documentary evidence. Although Mr. Langer testified with detail as to some of the disallowed deductions, he merely identified others, and others were not mentioned at all. His testimony was largely uncorroborated, and we do not find it credible. Under the circumstances, we are not required to accept Mr. Langer's uncorroborated, self-serving testimony, and we do not. See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).

Deductions are a matter of "legislative grace", and "a taxpayer seeking a deduction must be able to point to an applicable statute and show that he comes within its terms." New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440, 54 S. Ct. 788, 78 L. Ed. 1348, 1934-1 C.B. 194 (1934); *257 see also Rule 142(a). As a general rule, section 162(a) authorizes a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business". An expense is ordinary for purposes of this section if it is normal or customary within a particular trade, business, or industry. Deputy v. du Pont, 308 U.S. 488, 495, 60 S. Ct. 363, 84 L. Ed. 416, 1940-1 C.B. 118 (1940). An expense is necessary if it is appropriate and helpful for the development of the business. Commissioner v. Heininger, 320 U.S. 467, 471, 64 S. Ct. 249, 88 L. Ed. 171, 1944 C.B. 484 (1943). Section 262(a), in contrast, precludes deduction of "personal, living, or family expenses."

The breadth of section 162(a) is limited by the requirement that any amount claimed as a business expense deduction must be substantiated, and taxpayers are required to maintain records sufficient therefor. Sec. 6001; Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), affd. 540 F.2d 821 (5th Cir. 1976); sec.1.6001-1(a), Income Tax Regs. Furthermore, business expenses described in section 274 are subject to strict substantiation rules. Section 274(d) provides that no deduction shall be allowed for, among other things, traveling expenses, entertainment expenses, gifts, and expenses *258 with respect to listed property (including passenger automobiles) "unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer's own statement": (1) The amount of the expenditure or use; (2) the time and place of the expenditure or use, or date and description of the gift; (3) the business purpose of the expenditure or use; and (4) in the case of entertainment or gifts, the business relationship to the taxpayer of the recipients or persons entertained.

In addition to the general business expense deduction rule of section 162, section 167(a) authorizes "as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) -- (1) of property used in the trade or business, or (2) of property held for the production of income." Depreciation deductions are calculated with respect to the adjusted basis of the property determined under section 1011, the applicable depreciation method, the applicable recovery period, and the applicable convention. Secs. 167(c), 168(a); Hosp. Corp. of Am. v. Commissioner, 109 T.C. 21, 45 (1997).

Respondent disallowed *259 petitioners' $ 9,003 Schedule C deduction for "supplies" that comprised numerous separate items. Respondent conceded that petitioners are entitled to $ 7,327 of those expenses. Mr. Langer testified as to two of the disallowed expenses: $ 70 spent at the Georgetown University Medical Bookstore and $ 189 spent at the African Art Museum. Mr. Langer testified that Mrs. Langer intended to give these to her students as awards. However, the purchases are unidentified, and there is no evidence Mrs. Langer actually gave them to her students, or that if given to her students, they were awards and not gifts, which would be subject to strict substantiation requirements. No evidence was presented as to the other deductions not conceded by respondent. Accordingly, petitioners are not entitled to the Schedule C "supplies" expense in an amount greater than respondent allowed.

Mrs. Langer's Schedule C expenses included a $ 24,601 deduction for a category of items labeled "incentive programs". Respondent conceded $ 1,592 of the expenses. Mr. Langer testified as to some of the disputed expenses. The disputed items include expenses for entertainment, gifts/awards to students, business meals, and travel *260 away from home, all subject to the strict substantiation requirements of section 274(d). Petitioners have not substantiated those amounts in accordance with section 274(d).

The awards given to her students present the same problem as the awards from Georgetown's bookstore and the African Art Museum discussed above. The purchases are unidentified, and there is no evidence Mrs. Langer actually gave them to her students, or that if given to her students, they were not gifts.

Other expenses are clearly personal and not business expenses. For example, petitioners claim as expenses: Swimming pool supplies and maintenance, home and holiday decorations, a nativity set, cookbooks, and a television set. Mr. Langer testified and attempted to explain how these items were related to the piano teaching business. His arguments are beyond belief and contrary to all reason. We need not address each of the disputed items, but we give one illuminating and representative example. Petitioners argue that $ 2,446 spent for pool supplies and maintenance are related to Mrs. Langer's piano teaching because the parents of the students would sit by the pool while waiting for their children to finish a lesson. Pool *261 supplies and maintenance are not ordinary and necessary expenses for Mrs. Langer's piano teaching business. Therefore, they are not deductible.

Petitioners also claimed an expense deduction for sweaters Mrs. Langer purchased. Expenses for clothing adaptable for general use are not deductible. Yeomans v. Commissioner, 30 T.C. 757, 767-769 (1958); Wilbert v. Comm'r, T.C. Memo 2007-152. There is no evidence that the sweaters were not adaptable for general purposes, and thus the expense was properly disallowed.

As to the other "incentive programs" expenses, petitioners presented either only Mr. Langer's vague, self-serving, uncorroborated testimony or no evidence at all. Accordingly, we find that petitioners are not entitled to the deductions for "incentive programs" beyond those respondent allowed. ³

Petitioners owned a 2000 Mercedes sport utility vehicle which was driven a total of 15,127 miles during 2001. ⁴ Mr. Langer claims that 65 percent of the use of the *262 Mercedes was for his investigations business. ⁵ Petitioners claimed a $ 4,297 deduction for "car and truck" expenses and a $ 1,918 depreciation deduction with respect to the Mercedes in 2001. Automobile expenses are subject to the strict substantiation requirements of section 274(d). Petitioners presented no evidence substantiating the business use of the automobile or the expenses paid. Accordingly, petitioners are not entitled to these automobile-related deductions.

Petitioners claimed a $ 5,223 deduction for other (nonmortgage) interest accruing on credit cards and other loans, including a loan from their daughter. The record does not contain the origination dates of the loans, the interest rates, the balance *263 and payment histories, or any of the terms of any of the debts on which the alleged interest expense accrued. Nor is there any evidence that if the interest was in fact paid, it related to the investigations business. Accordingly, petitioners are not entitled to these interest deductions for 2001.

Petitioners claimed a $ 28,573 expense deduction for "other expenses". A portion of that deduction relates to depreciation and home-office-related expenses discussed below. The "other expenses" also include a $ 10,901 deduction for "behavior modification" expenses. Mr. Langer testified as to some of the disputed items, most of which are personal and not business expenses. For example, petitioners claimed as expenses the cost of their son's graduation party and flowers given by Mr. Langer to Mrs. Langer and to their daughter for special occasions, such as a birthday and Valentine's Day. Fees paid by Mr. Langer to his college alumni club are rendered nondeductible by section 274(a)(3). The cost of meals allegedly related to Mr. Langer's business was not substantiated as required by section 274(d) and is thus not allowed as a deduction. A crystal vase costing $ 2,635 purchased to cheer Mr. Langer *264 up after the events of September 11, 2001, and because he likes fresh-cut flowers is also not deductible. A vase kept in one's home can be used for any purpose at any time, and there is no evidence that the vase was used primarily in Mr. Langer's office. Petitioners offered no evidence to substantiate any of the remaining "behavior modification" expenses or $ 357 of "miscellaneous expenses" claimed. Accordingly, petitioners are not entitled to these claimed expense deductions.

In addition to the limitations on business expenses discussed above, section 280A(a) provides that a deduction otherwise allowable is not allowed with respect to the use of the taxpayer's residence. However, section 280A(c) provides an exception to the general rule:

SEC. 280A(c). Exceptions for Certain Business or Rental Use; Limitation on Deductions for Such Use. --