                              T.C. Memo. 2012-286


                        UNITED STATES TAX COURT



       ISIDORO RODRIGUEZ AND IRENE RODRIGUEZ, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 10691-09.                         Filed October 9, 2012.



      Isidoro Rodriguez and Irene Rodriguez, pro se.

      Melissa E. Avrutine, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      THORNTON, Chief Judge: Respondent determined a $13,675 deficiency in

petitioners’ 2006 Federal income tax and a $2,735 accuracy-related penalty
                                          -2-

[*2] pursuant to section 6662(a).1 The issues for decision are: (1) whether during

2006 petitioner Isidoro Rodriguez was an employee or an independent contractor

with respect to legal services he provided to law firms that were clients of two legal

staffing agencies; (2) whether petitioners are entitled to deduct certain alleged

business expenses; and (3) whether petitioners are liable for an accuracy-related

penalty pursuant to section 6662(a).2

                                FINDINGS OF FACT

      The parties have stipulated some facts which are incorporated by this

reference.

      Isidoro and Irene Rodriguez, husband and wife, are U.S. citizens. They

resided in Virginia when they filed their petition.




      1
       Unless otherwise indicated, all section references are to the Internal Revenue
Code (Code) in effect for the year at issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure. All monetary amounts are rounded to the
nearest dollar.
      2
      As a result of respondent’s determinations with respect to petitioners’
income, modified adjusted gross income, and tax, respondent also made
computational adjustments to petitioners’ claimed education and child tax credits.
We expect these computational adjustments to be revised in the Rule 155
computation in accordance with this opinion.
                                         -3-

[*3] I. The Law Offices of Mr. Rodriguez

      A. Background

      Since 1987 Mr. Rodriguez has maintained and operated, as a sole

proprietorship, a law office in Barranquilla, Republic of Colombia (Colombia).

Upon her marriage to Mr. Rodriguez in 2000 and after becoming a licensed attorney

in Colombia, Mrs. Rodriguez became a coequal proprietor of the law office. This

law office provides legal services to nonresident U.S. citizens and non-U.S. citizens

before U.S. Federal courts. In 2006 Mrs. Rodriguez managed the law office’s four

employees, controlled its finances, and provided legal services to its clients.

      Petitioners have a second law office and law library in Santa Veronica,

Colombia, providing legal services to clients residing in the city of Cartagena,

Colombia, and the Republic of Panama. The property on which this law office is

situated includes gardens, a swimming pool, and living quarters in a separate

building.

      In 2000, because of increasing violence in Colombia and the threat of

kidnapping of U.S. citizens, petitioners moved to Virginia. They continued to

maintain and operate their law offices in Colombia. In 2006 they established a

home law office in Annandale, Virginia, to represent clients. This home office
                                         -4-

[*4] occupied a 3,060-square-foot space within their 9,180-square-foot home.

Petitioners’ lease on their Annandale home commenced on May 13, 2006, and ran

through May 31, 2007. During 2006, before May 13, petitioners also resided in

Alexandria, Virginia, but did not have a home office there.

      In 2006 Mrs. Rodriguez worked as a full-time paralegal with the law firm of

Kennedy & Dolan in Silver Spring, Maryland.

      B. Mr. Rodriguez’s Disbarment

      In November 2006 the Virginia State Bar Disciplinary Board (board) revoked

Mr. Rodriguez’s license to practice law in Virginia. On December 16, 2006, Mr.

Rodriguez began civil litigation to pursue judicial review of the board’s order. In

November 2007 the Supreme Court of Virginia affirmed the board’s order, and the

Supreme Court of the United States subsequently denied certiorari.3

II. Temporary Legal Staffing Agencies

      From 2000 to 2006 Mr. Rodriguez intermittently provided temporary legal

services to law firms. As described in more detail below, in 2006 LegalSource


      3
       We take judicial notice that after being disbarred in Virginia Mr. Rodriguez
was also disbarred by this Court. He unsuccessfully appealed his disbarment by this
Court to the U.S. Court of Appeals for the D.C. Circuit. Rodriguez v. United States
Tax Court, 398 Fed. Appx. 614 (D.C. Cir. 2010). We also take judicial notice that
in 2010 Mr. Rodriguez was disbarred by the Supreme Court of the United States. In
re Disbarment of Rodriguez, 130 S. Ct. 3352 (2010).
                                          -5-

[*5] Corp. (LegalSource) and Update Legal (Update) engaged Mr. Rodriguez as a

temporary contract attorney to work on short-term projects for their clients.

      LegalSource and Update (collectively, agencies) are temporary staffing

agencies that provide attorneys, paralegals, and litigation support staff to law firms

and corporate legal departments.4 To obtain work through either of the agencies, an

attorney is required to submit an application and participate in an interview with the

agency. The agencies either assign their temporary contract attorneys to specific

client projects or else allow their clients to choose specific attorneys from lists the

agencies provide. Both agencies consider their temporary contract attorneys to be

at-will employees, dischargeable at the agencies’ discretion.

      A. LegalSource

      In 2000 Mr. Rodriguez began working on short-term legal projects through

LegalSource. In 2006 LegalSource assigned Mr. Rodriguez to perform temporary

legal services for one of its clients, the law firm of Howrey LLP (Howrey), in

Howrey’s Virginia office. This assignment lasted from about January 2 to October

27, 2006; i.e., shortly before Mr. Rodriguez’s disbarment in Virginia. Mr.

Rodriguez worked on temporary litigation projects at Howrey, such as electronic


      4
       LegalSource is in Washington, D.C. Update is headquartered in New York,
N.Y., and has offices in various cities, including Washington, D.C.
                                         -6-

[*6] discovery document review. LegalSource considered Mr. Rodriguez to be its

employee.

      Mr. Rodriguez was compensated by LegalSource for his services at Howrey

on an hourly basis, including overtime pay. LegalSource determined Mr.

Rodriguez’s rate of pay. Neither LegalSource nor Howrey authorized bonuses,

vacation pay, or personal leave, nor did they provide Mr. Rodriguez with health

insurance or other benefits such as the opportunity to participate in a section 401(k)

plan. Neither LegalSource nor Howrey reimbursed Mr. Rodriguez for his expenses

of bar admission, legal education, cell phones, law office books or equipment, or

any other items.

      Mr. Rodriguez entered into a conflicts and confidentiality agreement with

Howrey and was under the control of their staff while working there. Howrey’s

staff coordinated Mr. Rodriguez’s work schedule; they were aware that he

maintained his own law offices and required time to provide legal services for other

clients and to conduct his own litigation.

      Mr. Rodriguez performed his assignments for Howrey at its Virginia

offices. Howrey hired, supervised, and paid all persons who assisted Mr.

Rodriguez in performing his work there. Howrey also provided all computer

equipment, software, and other office supplies necessary for Mr. Rodriguez to
                                         -7-

[*7] fulfill his duties there. Howrey’s full-time supervising attorneys assigned,

reviewed, and approved Mr. Rodriguez’s work product and signed his “Temporary

Agency Time Sheet”, indicating the hours he worked and reflecting the projects

accomplished in those hours. Howrey forwarded the timesheets to LegalSource to

pay his wages.

       LegalSource issued Mr. Rodriguez’s paycheck for his services at Howrey.

The pay stubs list Mr. Rodriguez as “Employee” and designate Howrey as the

“Earning Company” for the particular “Assignment” for which the wages were paid.

       For 2006 LegalSource issued Mr. Rodriguez a Form W-2, Wage and Tax

Statement, identifying itself as “Employer” and Mr. Rodriguez as “Employee”. The

Form W-2 shows “Wages, tips, other comp.” of $59,220, representing amounts

LegalSource paid Mr. Rodriguez for services he performed at Howrey in 2006. The

Form W-2 shows amounts withheld for Federal and State income taxes, employment

taxes, and Medicare taxes. Box 13, “Statutory employee”, is left blank on the Form

W-2.

       B. Update Legal

       In 2006 Update assigned Mr. Rodriguez to perform temporary legal services

for one of its clients, the law firm of Winston & Strawn LLP (Winston & Strawn),
                                         -8-

[*8] in Washington, D.C. This assignment lasted from about November 20 to

December 15, 2006.

      Mr. Rodriguez worked at least 40 hours a week at Winston & Strawn and

was compensated on an hourly basis. Update determined his rate of pay. He

received overtime pay for work over 40 hours per week. Neither Update nor

Winston & Strawn paid Mr. Rodriguez any bonus, vacation pay, or compensation

for personal leave time.5 Nor did they reimburse or pay Mr. Rodriguez for his

expenses of bar admission, legal education, cell phones, law office books or

equipment, or any other items.

      Update considered Mr. Rodriguez to be its employee. The employee

handbook which Update provided him indicated that attorneys providing temporary

services to Update’s clients were Update’s employees. Update offered certain

benefits, including health, dental, and vision insurance to temporary attorneys,

commencing on the first day of the first new month in which the temporary attorney

worked for Update.




      5
       Update provided paid time off to employees with more than 400 hours of
service and the opportunity to participate in a sec. 401(k) plan to employees who
worked for the company longer than one year. Mr. Rodriguez worked too few
hours in 2006 to be eligible for these benefits.
                                         -9-

[*9] Having started with Update in mid-November 2006, Mr. Rodriguez became

eligible for health insurance benefits on December 1, 2006.

      Mr. Rodriguez entered into a confidentiality agreement with Winston &

Strawn and was under the control of their staff while working there. Winston &

Strawn’s staff coordinated his work schedule; they were aware that he maintained

his own law offices and required time to provide legal services for other clients and

to conduct his own litigation.

      Mr. Rodriguez performed his assignments for Winston & Strawn at their law

offices. Winston & Strawn hired, supervised, and paid all persons who assisted Mr.

Rodriguez in performing his temporary legal services there and provided all

necessary office supplies and equipment. Winston & Strawn’s full-time attorneys

assigned Mr. Rodriguez to work on tasks such as reviewing discovery documents

and preparing privilege logs. Winston & Strawn’s full-time attorneys reviewed Mr.

Rodriguez’s work product and signed his timesheets indicating the hours he had

worked and projects he had completed. Winston & Strawn forwarded the

timesheets to Update to pay Mr. Rodriguez’s wages.

      Update issued Mr. Rodriguez’s paychecks for his services at Winston &

Strawn. The pay stubs list Mr. Rodriguez as “Employee” and do not mention

Winston & Strawn.
                                           - 10 -

[*10] For 2006 Update issued Mr. Rodriguez a Form W-2, identifying itself as

“Employer” and Mr. Rodriguez as “Employee”. The Form W-2 shows “Wages,

tips, other comp.” of $9,984, representing amounts Update paid Mr. Rodriguez for

services he performed at Winston & Strawn in 2006. The Form W-2 shows

amounts withheld for Federal and State income taxes, employment taxes, and

Medicare taxes. Box 13, “Statutory employee”, is left blank on the Form W-2.

III. 2006 Tax Return

      For 2006 petitioners jointly filed a Form 1040, U.S. Individual Income Tax

Return. They attached to the return a Schedule C, Profit or Loss From Business

(Sole Proprietorship), labeling the activity the “Law Offices of Isidoro Rodriguez”

with an address in Barranquilla, Colombia. On the Schedule C petitioners

reported gross receipts of $72,848 and total expenses of $66,016.6 Petitioners’


      6
          Petitioners reported the following expenses on their 2006 Schedule C:

                         Expense                      Amount

               Automobile                               $913
               Travel                                  3,021
               Meals & entertainment                     609
               Business use of home                    7,920
               Advertising                               127
               Depreciation and sec. 179               1,350
               Employee benefits                       4,990
                                                                         (continued...)
                                           - 11 -

[*11] Schedule C gross receipts consisted of $3,644 in self-employment income

received by the Law Offices of Isidoro Rodriguez from the law offices’

nonlitigation clients; $59,220 of income as reflected on the Form W-2 from

LegalSource; and $9,984 of income as reflected on the Form W-2 from Update.7


      6
          (...continued)
                 Office administration               2,298
                 Insurance                             814
                 Interest                            3,171
                 Rent or lease--other
                  business property                  6,000
                 Repairs and maintenance             1,299
                 Supplies                              834
                 Taxes & licenses                    1,502
                 Utilities                           3,302
                 Wages & benefits                   10,567
                 Filing fees & transcripts           5,155
                 Copies & litigation supplies        4,942
                 Professional dues & fees            1,301
                 Postage & delivery                  1,124
                 Continuing legal education            682
                 Law book supplements
                  and purchases                       977
                 Employee legal education
                  and data processing
                  education course                   1,426
                 Money transfer fees                 1,692
                  Total                             66,016
      7
        The only wages petitioners reported on line 7 of their Form 1040 was
$42,800 of income reflected on a Form W-2 that Mrs. Rodriguez received from
Kennedy & Dolan for her paralegal services. Petitioners reported no employment-
related expenses on their Schedule A, Itemized Deductions.
                                         - 12 -

[*12] IV. Notice of Deficiency

      In the notice of deficiency respondent reclassified all the amounts that Mr.

Rodriguez received from Update and LegalSource, and which petitioners had

reported on Schedule C, as wage income. Respondent also disallowed all of

petitioners’ reported Schedule C expense deductions. The explanation for

disallowing these deductions stated in full:

      Only statutory employee income can be offset by expenses reported on
      Schedule C, Profit or Loss from Business, or Schedule C-EZ. Since
      your employer did not indicate on Form W-2, Wage and Tax
      Statement, that you were a statutory employee, we can not allow the
      expenses used to offset that income on Schedule C or Schedule C-EZ.

      If this is incorrect, please send us a statement from your employer(s)
      verifying that you are a statutory employee.

      If you are not a statutory employee, you must include the income as
      wages on your tax return. Allowable related expenses on Form 2106,
      Employee Business Expenses, can be claimed as an itemized deduction
      on Schedule A.

On the basis of these determinations, respondent also made computational

adjustments to petitioners’ claimed child tax and education credits.

                                      OPINION

I. Burden of Proof

      As a general rule, the Commissioner’s determination of a taxpayer’s liability

is presumed correct; the taxpayer bears the burden of proving that it is incorrect.
                                        - 13 -

[*13] Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). In certain

circumstances, the burden of proof shifts to the Commissioner if the taxpayer

introduces credible evidence with respect to any factual issue relevant to

ascertaining the taxpayer’s tax liability. Sec. 7491(a)(1). For reasons discussed in

more detail below, insofar as the burden of proof is relevant to our analysis, we

conclude that the burden of proof does not shift to respondent pursuant to section

7491(a).8

      On brief petitioners contend that the burden of proof should shift to

respondent because, they assert, respondent issued the notice of deficiency without

conducting an investigation or audit. As a general rule, this Court does not look

behind a notice of deficiency to “examine the evidence used or the propriety of

respondent’s motives or of the administrative policy or procedure involved in

making his determinations.” Greenberg’s Express, Inc. v. Commissioner, 62 T.C.

324, 327 (1974); see Riland v. Commissioner, 79 T.C. 185, 201 (1982). “[W]hat

goes on during audits is immaterial to the de novo record on which we decide

deficiency cases.” Kovacevich v. Commissioner, T.C. Memo. 2009-160, 2009

WL 1916351, at *11 n.6. The rationale for this rule is that a trial before the Tax


      8
       Respondent bears the burden of production with respect to penalties. See
sec. 7491(c). We discuss this matter infra.
                                        - 14 -

[*14] Court is a de novo proceeding, and our decision is based on the merits of the

record before us and not on the merits of the administrative record. Jackson v.

Commissioner, 73 T.C. 394, 400 (1979); Greenberg’s Express, Inc. v.

Commissioner, 62 T.C. at 328.

      Petitioners contend that in this case we should recognize an exception to

these well-settled principles because, they assert, respondent’s officers and agents

engaged in criminal conduct by issuing the notice of deficiency in retaliation for

litigation that Mr. Rodriguez had instituted with respect to his disbarment. The

record does not support petitioners’ allegations. The record convinces us that

respondent issued the notice of deficiency because of discrepancies between the

2006 tax return that petitioners filed and the Forms W-2 that LegalSource and

Update issued to Mr. Rodriguez. In any event, this Court has no jurisdiction to

redress alleged criminal violations.

II. Employment Classification

      The principal issue for decision is whether petitioners correctly reported Mr.

Rodriguez’s business expenses on Schedule C as those of a self-employed

individual rather than on Schedule A as itemized expenses, as respondent contends

they should have. The distinction matters because Schedule A itemized
                                        - 15 -

[*15] deductions are subject to various limitations that do not apply to Schedule C

deductions.

      More particularly, an individual performing services as an employee generally

may deduct expenses incurred in the performance of such services as miscellaneous

itemized deductions on Schedule A only to the extent the expenses exceed 2% of

the taxpayer’s adjusted gross income. Secs. 62(a)(2), 63(a), (d), 67(a) and (b),

162(a). Itemized deductions may be limited under section 68 and may have

alternative minimum tax implications under section 56(b)(1)(A)(i).

      Independent contractors and self-employed persons may report their

compensation less related expenses as business income on Schedule C, thereby

avoiding limitations on the deductibility of employee business expenses and other

itemized deductions reportable on Schedule A. See Weber v. Commissioner, 103

T.C. 378, 386 (1994), aff’d, 60 F.3d 1104 (4th Cir. 1995); Feaster v.

Commissioner, T.C. Memo. 2010-157. To be properly reported on Schedule C, a

taxpayer’s expenses must come from a trade or business of his or her own, other

than that of being an employee. See Rosato v. Commissioner, T.C. Memo. 2010-

39. For this purpose, a statutory employee under section 3121(d)(3)(D) is not an

employee and may deduct business expenses on Schedule C. See Cole v.
                                       - 16 -

[*16] Commissioner, T.C. Memo. 2006-44. Petitioners do not claim that Mr.

Rodriguez was a statutory employee.

      Petitioners argue that Mr. Rodriguez was an independent contractor or was

self-employed in 2006 and is thereby entitled to deduct business expenses on

Schedule C. Respondent contends that in 2006 Mr. Rodriguez was the common law

employee of the agencies and that his unreimbursed employee expenses with respect

to these employers are thus properly reportable on Schedule A.9 As discussed

below, we decide this issue by reference to the preponderance of the evidence and

not by reference to the placement of the burden of proof. Consequently, we need

not decide whether pursuant to section 7491(a) the burden of proof should shift to

respondent as to this issue.

      Even though the income tax treatment of a taxpayer’s trade or business

expense deductions depends on whether the taxpayer is performing services as an

employee, subtitle A of the Code does not define “employee”. Rosato v.

Commissioner, T.C. Memo. 2010-39. We apply common law rules to determine

whether the taxpayer is an employee. Weber v. Commissioner, 103 T.C. at 386.




      9
      On brief respondent concedes that petitioners are entitled to certain Schedule
C deductions with respect to their $3,644 in self-employment gross receipts.
                                          - 17 -

[*17] Whether a common law employer-employee relationship exists in a particular

situation is a question of fact. Id.

       In determining whether a worker is a common law employee or an

independent contractor, relevant factors include: (1) the degree of control the

principal exercises over the details of the work; (2) which party invests in work

facilities used by the individual; (3) the opportunity of the individual for profit or

loss; (4) whether the principal can discharge the individual; (5) whether the work is

part of the principal’s regular business; (6) the permanency of the relationship; (7)

the relationship the parties believed they were creating; and (8) whether the

principal provides employee benefits. See id. at 387; Schramm v. Commissioner,

T.C. Memo. 2011-212. No one factor is determinative; all the facts and

circumstances of the relationship must be considered and weighed according to their

significance in the particular case. Ewens & Miller, Inc. v. Commissioner, 117 T.C.

263, 270 (2001); Del Monico v. Commissioner, T.C. Memo. 2004-92. In making

the determination, a realistic interpretation of the term “employee” should be

adopted, and doubtful questions should be resolved in favor of employment. Breaux

& Daigle, Inc. v. United States, 900 F.2d 49, 52 (5th Cir. 1990); see Donald G.

Cave A Profl. Law Corp. v. Commissioner, T.C. Memo. 2011-48, aff’d, 109

A.F.T.R. 2d (RIA) 2012-1504 (5th Cir. 2012).
                                         - 18 -

[*18] 1. Degree of Control

      The degree of control that the principal exercises over the worker is the most

important consideration in determining the nature of a working relationship. See

Clackamas Gastroenterology Assocs., P.C. v. Wells, 538 U.S. 440, 448 (2003);

Cilecek v. Inova Health Sys. Servs., 115 F.3d 256, 260 (4th Cir. 1997); Hawkins v.

Commissioner, T.C. Memo. 1993-350. Because a supervisor’s control over a

professional employee is generally more tenuous and general than the control over

nonprofessional employees, a lesser degree of control may result in a finding of

employee-employer status. See Weber v. Commissioner, 103 T.C. at 389-390;

Gamal-Eldin v. Commissioner, T.C. Memo. 1988-150, aff’d without published

opinion, 876 F.2d 896 (9th Cir. 1989). To possess a degree of control over a

worker indicative of employment, the principal need not direct the worker’s every

move; it is sufficient that the principal has the right to do so. See Weber v.

Commissioner, 103 T.C. at 388; sec. 31.3401(c)-1(b), Employment Tax Regs.

Similarly, the principal need not set the worker’s hours or supervise every detail of

the work environment to control the worker. Gen. Inv. Corp. v. United States, 823

F.2d 337, 342 (9th Cir. 1987). Setting their own hours does not necessarily make

workers independent contractors. See United States v. Silk, 331 U.S. 704, 716-
                                         - 19 -

[*19] 718 (1947); Gen. Inv. Corp. v. United States, 823 F.2d at 342; Ewens &

Miller, Inc. v. Commissioner, 117 T.C. at 270.

      The agencies provided Mr. Rodriguez temporary job placements and directed

him where to work. Mr. Rodriguez turned in time sheets to the agencies, which

paid him on the basis of the hours he worked for the agencies’ clients and at a rate

that the agencies determined. The agencies directed Mr. Rodriguez to perform

services required by their clients, in the manner dictated by their clients, who

controlled the details of Mr. Rodriguez’s work for them. These considerations are

indicative of employment relationships between the agencies and Mr. Rodriguez.

See Cole v. Commissioner, T.C. Memo. 2006-44 (citing similar considerations in

finding that a temporary employment agency exercised a considerable degree of

control over the taxpayer, who worked as a temporary employee for the agency).

      2. Investment in Facilities

      Mr. Rodriguez provided services to the agencies’ clients in the clients’

offices. Nothing in the record suggests that Mr. Rodriguez had any investment in

these facilities or that he supplied the equipment he used while working there. This

factor weighs in favor of common law employee status.
                                         - 20 -

[*20] 3. Opportunity for Profit or Risk of Loss

       The agencies paid Mr. Rodriguez at an hourly rate for the services he

performed for their clients. He was not paid a bonus, and there is no evidence that

he otherwise had any opportunity for profit or risk of loss in the services he

provided. This factor weighs in favor of common law employee status.

       4. Right To Discharge

       The principal’s retention of the right to discharge a worker is indicative of a

common law employer-employee relationship. See Weber v. Commissioner, 103

T.C. at 391. The agencies considered Mr. Rodriguez an at-will employee and

retained the right to discharge him at any time. This factor weighs in favor of

common law employee status. See Kumpel v. Commissioner, T.C. Memo. 2003-

265.

       5. Integral Part of Regular Business

       The work performed by Mr. Rodriguez, as one of many temporary

employees, was within the scope of the agencies’ businesses of providing their

clients temporary employees and was also within the scope of those clients’

businesses. This factor weighs in favor of common law employee status. See

Simpson v. Commissioner, 64 T.C. 974, 985, 989 (1975); Rosemann v.

Commissioner, T.C. Memo. 2009-185.
                                         - 21 -

[*21] 6. Permanency of Relationship

      A continuing relationship indicates an employment relationship, while a

transitory relationship may be indicative of independent contractor status. Ewens &

Miller, Inc. v. Commissioner, 117 T.C. at 273. Further, a relationship established to

accomplish a specified objective is indicative of an independent contractor

relationship. See Ellison v. Commissioner, 55 T.C. 142, 155 (1970).

      In 2006 Mr. Rodriguez worked for about 10 months on a project for

LegalSource’s client, Howrey. He also worked for about four consecutive weeks

for Update’s client, Winston & Strawn. Although the record is somewhat vague in

this regard, it appears that although Mr. Rodriguez may have performed other

services for the agencies in other years, the services were intermittent and the

projects were all short term. We find this factor to weigh in favor of independent

contractor status. We note, however, that this factor alone is not sufficient to

preclude a finding of common law employee status. See Potter v. Commissioner,

T.C. Memo. 1994-356.

      7. Relationship Contemplated by the Parties

      Representatives from both agencies testified that they considered Mr.

Rodriguez to be their employee. The agencies withheld income taxes,
                                        - 22 -

[*22] employment taxes, and Medicare taxes from Mr. Rodriguez’s wages. These

actions are consistent with treating Mr. Rodriguez as a common law employee.

      8. Provision for Employee Benefits

      Provision of benefits such as health insurance, life insurance, paid vacations,

and retirement plans are indicative of an employment relationship. Weber v.

Commissioner, 103 T.C. at 393-394. LegalSource provided no such employee

benefits to Mr. Rodriguez. With respect to LegalSource, this factor weighs in favor

of independent contractor status.

      Update offered its employees health, dental, and vision insurance as well as a

section 401(k) plan. Mr. Rodriguez was eligible to enroll in Update’s insurance

plan and would have been eligible for its section 401(k) plan had he worked for

Update for more than one year. With respect to Update, this factor weighs in favor

of common law employee status.

      9. Conclusion

      On the basis of the preponderance of the evidence, taking into account all the

facts and circumstances, we conclude and hold that Mr. Rodriguez was a common

law employee of both of the agencies. Accordingly, Mr. Rodriguez’s unreimbursed

employee expenses with respect to these employers are properly reportable, if at all,

as itemized deductions on Schedule A.
                                        - 23 -

[*23] III. Business Expense Substantiation

      In the notice of deficiency respondent not only determined that petitioners had

improperly reported alleged business expense deductions on Schedule C but also

disallowed all the claimed deductions. In this proceeding, respondent concedes that

petitioners are entitled to certain of these deductions.10 Respondent does not argue

that petitioners must claim these conceded deductions as itemized deductions on

Schedule A. Respondent having conceded that petitioners had $3,644 of Schedule

C income from the Law Offices of Isidoro Rodriguez, we interpret respondent’s

position to be that allowable expenses with respect to that business are deductible

on Schedule C. The parties disagree as to whether petitioners have adequately

substantiated additional expenses and who bears the burden of proof.

      As previously indicated, the taxpayer generally bears the burden of proving

the Commissioner’s determinations erroneous. Rule 142(a). Deductions are a

matter of legislative grace, and the taxpayer bears the burden of proving that he is



      10
        Respondent concedes that petitioners are entitled to deductions of $384 for
meal and entertainment expenses, $1,316 for home office expenses consisting of
$975 for rent and $341 for home office utilities, $32 for office administrative
expenses, $604 for utilities expenses, $1,252 for filing fees and transcripts, $564 for
copies and litigation supplies, $423 for professional dues and fees, $168 for postage,
$434 for continuing legal education expenses, $360 for law books and supplements,
and $1,161 for money transfer fees.
                                        - 24 -

[*24] entitled to any claimed deductions. INDOPCO v. Commissioner, 503 U.S.

79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). The

taxpayer bears the burden of substantiating the amount and purpose of each expense

claimed as a deduction. See Higbee v. Commissioner, 116 T.C. 438, 440 (2001);

Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), aff’d per curiam, 540 F.2d 821

(5th Cir. 1976). Taxpayers must maintain records relating to their expenses and

must prove their entitlement to all claimed deductions, credits, and expenses. See

sec. 6001; Rule 142(a).

      Section 7491(a)(1) provides that if, in any court proceeding, a taxpayer

introduces credible evidence with respect to any factual issue relevant to

ascertaining the taxpayer’s proper tax liability, the Commissioner shall have the

burden of proof with respect to that issue. Credible evidence is evidence the Court

would find sufficient upon which to base a decision on the issue in the taxpayer’s

favor, absent any contrary evidence. See Higbee v. Commissioner, 116 T.C. at 442.

Section 7491(a)(1) applies, however, only if the taxpayer complies with all

substantiation and recordkeeping requirements under the Code and cooperates with

the Commissioner’s reasonable requests for witnesses, information, documents,

meetings, and interviews. Sec. 7491(a)(2)(A) and (B).
                                         - 25 -

[*25] For reasons discussed in detail infra, we have allowed on the basis of the

preponderance of the evidence, the deduction of certain expenses beyond the

amounts respondent conceded. For all other expenses, we conclude that petitioners

have failed to substantiate, in amounts greater than respondent has conceded, the

amounts and purpose of the disputed expenses claimed as deductions. Accordingly,

section 7491(a) does not operate to shift the burden of proof to respondent, and the

burden of proof remains with petitioners.11

      11
         Although petitioners have not expressly raised this issue, we have also
considered whether respondent’s contention that petitioners have failed to
substantiate the amounts and purpose of certain items claimed as business expense
deductions should be treated as a “new matter” under Rule 142(a)(1), as to which
respondent should bear the burden of proof, since the notice of deficiency does not
expressly describe lack of substantiation as the basis of respondent’s determination
and respondent never amended his answer to expressly raise this ground. It is well
settled that the Commissioner’s determinations may be affirmed for reasons other
than those assigned in the notice of deficiency, provided that the taxpayer has not
been surprised and substantially disadvantaged in the presentation of his or her case
because of the manner in which the statutory notice and pleadings were drawn. See
Considine v. Commissioner, 74 T.C. 955, 964-965 (1980); Estate of Horvath v.
Commissioner, 59 T.C. 551, 555 (1973). We do not believe that petitioners have
been surprised or substantially prejudiced in presenting evidence to substantiate the
disputed deductions. To the contrary, the record shows that well before trial
petitioners presented to respondent large quantities of documents that they rely upon
in attempting to substantiate their claimed deductions. These materials are the
subject of extensive stipulations between the parties, and petitioners adduced
testimony at trial in an effort to substantiate the amounts and business purpose of the
disputed deductions. Moreover, respondent’s disallowance of the claimed
deductions for lack of substantiation is implicitly within the ambit of the
determination, which disallowed all the claimed Schedule C deductions. We
                                                                          (continued...)
                                         - 26 -

[*26] Section 162 generally allows a deduction for all ordinary and necessary

expenses paid or incurred during the taxable year in carrying on a trade or business.

An expense is ordinary if it is customary or usual within a particular trade, business,

or industry or relates to a transaction “of common or frequent occurrence in the type

of business involved.” Deputy v. du Pont, 308 U.S. 488, 495 (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 (1943). A taxpayer’s general

statement that expenses were incurred in pursuit of a trade or business is insufficient

to establish that the expenses had a reasonably direct relationship to any such trade

or business. Ferrer v. Commissioner, 50 T.C. 177, 185 (1968), aff’d per curiam,

409 F.2d 1359 (2d Cir. 1969). Personal expenses are generally not allowed as

deductions. Sec. 262(a).

      When a taxpayer establishes that he or she has incurred deductible business

expenses but is unable to substantiate the exact amounts, we can estimate the

deductible amount, but only if the taxpayer presents sufficient evidence to


      11
        (...continued)
conclude that respondent’s contentions as to lack of substantiation are, at most, a
new reason for disallowing petitioners’ Schedule C deductions rather than a new
matter. Consequently, no amendment to the answer was required, and the burden of
proof remains with petitioners. See Considine v. Commissioner, 74 T.C. at 966
(and cases cited thereat).
                                         - 27 -

[*27] establish a rational basis for making the estimate. See Cohan v.

Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); see also Vanicek v.

Commissioner, 85 T.C. 731, 742-743 (1985).

      Section 274(d) supersedes the general rule of Cohan and precludes us from

estimating the taxpayer’s expenses with regard to certain items. See Sanford v.

Commissioner, 50 T.C. 823, 827-828 (1968), aff’d per curiam, 412 F.2d 201 (2d

Cir. 1969). Section 274(d) imposes strict substantiation requirements for expenses

relating to, among other things, travel, entertainment, and “listed property”,

including automobiles and other property used as a means of transportation. Sec.

280F(d)(4); sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014

(Nov. 6, 1985). To deduct such items, the taxpayer must substantiate “by [either]

adequate records or by sufficient evidence corroborating * * * [his] own statement”

the amount of the expense, the business purpose of the expense, and the business

relationship to the taxpayer of the person using the property. Sec. 274(d)(4);

Beale v. Commissioner, T.C. Memo. 2000-158; sec. 1.274-5A(b)(1), Income

Tax Regs. To meet the “adequate records test”, a taxpayer must maintain an

account book, a diary, a log, a statement of expense, trip sheets, or a similar

record prepared contemporaneously with the expenditure and documentary

evidence of certain expenditures, such as receipts or bills. See sec. 1.274-
                                        - 28 -

[*28] 5T(c)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985).

In combination, these records must be sufficient to establish each element--amount,

time and place, business purpose, and business relationship--of the expenditure for

which a deduction is sought. See sec. 1.274-5T(b), Temporary Income Tax Regs.,

50 Fed. Reg. 46014 (Nov. 6, 1985).

      In the absence of adequate records to establish each element of an expense

under section 274(d), a taxpayer may alternatively establish an element: “(A) By his

own statement, whether written or oral, containing specific information in detail as

to such element; and (B) By other corroborative evidence sufficient to establish such

element.” Sec. 1.274-5T(c)(3)(i), Temporary Income Tax Regs., 50 Fed. Reg.

46020 (Nov. 6, 1985). In the case of listed property, these elements to be

established are the amount of the expenditure; the amount of each business use; the

date of the expenditure; and the business purpose. Sec. 1.274-5T(b)(6)(i)-(iii),

Temporary Income Tax Regs., 50 Fed Reg. 46016 (Nov. 6, 1985).

      1. Automobile Expenses

      Petitioners claimed a deduction for $913 in automobile expenses related to a

1994 Ford Pinto that was in Colombia. The only substantiation petitioners

provided was seven receipts, only three of which were legible and totaled $111.

Petitioners did not provide any other documentary evidence or testimony to
                                        - 29 -

[*29] establish the amounts of expenditures, dates of business use of the vehicle,

business purpose of such use, mileage for business use, or total mileage for all uses

of the automobile. Petitioners have not met the substantiation requirements of

section 274(d) and may not deduct any automobile expenses.

      2. Travel Expenses

      Petitioners claimed a deduction for travel expenses totaling $3,615,

comprising the following:

             Virginia State Bar Hearing,
              Richmond, VA, 10/26-10/27                      $375
             VA Supreme Court, Richmond,
              VA--Rodriguez v. Davis                          291
             Trip to NY--meet possible client                 133
             Trip to NY--meet possible client                 202
             Trip to Barranquilla, Colombia, via NY         1,116
             Trip to Barranquilla, Colombia, via NY         1,149
             Tolls, gas, and bus to and from
              Santa Veronica                                 349
               Total                                       3,615

      Of the $375 petitioners reported with respect to the Virginia State Bar

(VSB) hearing, they provided legible receipts to substantiate $159 for a hotel.12 Of

the $291 petitioners reported with respect to a hearing with the Virginia Supreme

Court, they provided legible receipts to substantiate $177 for a hotel, meals, tolls,

      12
        Of the other receipts petitioners provided with regard to this expense, one is
for a Domino’s Pizza order that indicates that it was delivered to petitioners’ home
address in Annandale, Virginia. The remaining receipts are illegible.
                                           - 30 -

[30 ] and gas.13 Of the $133 and $202 that petitioners reported for trips to New

York, they provided legible receipts to substantiate tolls, gas, and meals of $150.

Petitioners provided handwritten schedules indicating the dates and business

purpose of travel for the above-mentioned business trips and are entitled to deduct a

total of $486 ($159 + $177 + $150) in travel expenses on their Schedule C.

      With respect to the remaining expenses petitioners reported for business

travel to and within Colombia, petitioners provided some receipts but have not

established a business purpose for the trips. The record does not establish that

petitioners’ trips to Colombia were for business purposes. One of the receipts

provided by petitioners is for a $787 plane ticket for Mr. Rodriguez’s son to travel

from Colombia to New York.14 Petitioners assert that the son traveled to New York

to testify in a trial related to his alleged expulsion from the United States by the U.S.

Government. This litigation is not related to petitioners’ trade or business.

Petitioners are not entitled to deduct any travel expenses apart from the $486

mentioned above.




      13
           The remaining receipts submitted were illegible.
      14
           The evidence of this ticket is an email written in Spanish.
                                        - 31 -

[*31] 3. Meals and Entertainment

      Of the $609 in meals and entertainment expenses petitioners reported,

respondent concedes that they are entitled to deduct $384. As to the remaining

$225 of expenses, petitioners provided no documentation or testimony to support

them and thus are not entitled to deduct them.

      4. Expenses Related to Business Use of Home

      As a general rule, section 280A(a) denies deductions with respect to the use

of a dwelling unit that the taxpayer used as a residence during the taxable year.

Section 280A(c)(1)(A), however, permits the deduction of expenses allocable to a

portion of a dwelling unit that the taxpayer used exclusively and on a regular basis

as the principal place of business for a taxpayer’s trade or business.

      Respondent concedes that approximately one-third of petitioners’

Annandale residence qualifies as a home office. On their 2006 Federal income tax

return petitioners claimed home office deductions totaling $7,920, consisting of

$4,533 for rent, $105 for insurance, and $3,282 for utilities. With respect to

petitioners’ claimed rent expense, respondent conceded a total of $975, consisting

of $567 for June 2006 and $408 for September 2006. Petitioners’ 2006 rental

agreement for the Annandale residence calls for monthly rent payments of $1,700.

One-third of this amount is $567, which coincides with the allocated business use
                                          - 32 -

[*32] of the residence and respondent’s concession for petitioners’ rent payment on

June 1, 2006. Respondent provided no explanation for his calculation of $408 with

respect to petitioners’ September 1, 2006, rent payment, and does not make any

argument on brief with respect to any of petitioners’ other claimed rent deductions.

Petitioners provided the first page of their residential lease as support for their

$1,700 monthly rent payments on their Annandale residence. We find that

petitioners have provided a rational basis for us to estimate the amount of their rent

deduction. See Cohan v. Commissioner, 39 F.2d at 543-544. Petitioners rented the

Annandale residence for approximately 7-1/2 months during 2006. Including the

$975 respondent conceded for June and September, petitioners have substantiated

$567 per month for this period, or $3,810.15

      Petitioners provided an invoice for the $105 home office deduction they

claimed for insurance. Petitioners have not established that this claimed expense

related to their home office in their Annandale residence rather than their Alexandria

residence, which did not have a home office.16 Petitioners are not entitled to deduct

the claimed insurance expense.


      15
       This amount is equal to six payments of $567 for the months of June, July,
August, October, November, and December 2006 and one payment of $408 for
September 2006.
      16
           The invoice is addressed to Mrs. Rodriguez at the Alexandria address.
                                         - 33 -

[*33] On their Federal income tax return, petitioners claimed deductions totaling

$3,282 for home office utilities. In the stipulations and on brief, petitioners

increased this amount to $5,018. In support of these deductions petitioners

provided invoices for home and cellular phones, water, electricity, and gas.

Petitioners also claimed a deduction for Internet service but provided no

documentation in support thereof. Of the $5,018 home office utility expense

deduction petitioners claimed, respondent conceded a total of $341.17

      Several water, electric, and gas invoices petitioners provided as substantiation

relate to their Alexandria residence, which did not have a home office. These

expenses are not deductible. Respondent conceded one-third of most amounts

relating to the water, electricity, and gas invoices petitioners supplied with respect

to their Annandale residence for 2006. Respondent did not, however, concede

amounts for four such invoices totaling $309, one-third of which is $103. All of

these invoices relate to petitioners’ Annandale residence during 2006 and provide a

rational basis for estimating the utility expense deduction relating to the home office

for the months covered by the invoices. See Cohan v. Commissioner, 39 F.2d at

543-544.


      17
        Respondent conceded various amounts paid to Washington Gas, Fairfax
Water, and Dominion Virginia Power.
                                         - 34 -

[*34] On brief and by stipulation petitioners included a total of $3,809 for home and

cellular telephone service in their claimed home office utility expenses. Under

section 262(b) the cost of basic local telephone service with respect to the first

telephone line provided to a residence is a personal expense and is not deductible.

Cellular phones are listed property under section 280F(d)(4) and are subject to the

strict substantiation requirements of section 274(d). Thus, the taxpayer must show

“by [either] adequate records or by sufficient evidence corroborating * * * [his] own

statement” the amount of the expense, the business purpose of the expense, and the

business relationship to the taxpayer of the person using the property. Sec.

274(d)(4).

      For their home telephone service petitioners provided only the first page for

each monthly invoice. This documentation did not provide any detail as to what

portion, if any, of each invoice related to charges in excess of those for the cost of

basic local service for the first line provided to petitioners’ Annandale residence.

Other home telephone service invoices that petitioners provided related to their

Alexandria residence, which did not have a home office.

      Petitioners testified that they had one cellular phone for personal use and

one for business. Both phones were billed on a single invoice each month. As

with their home phone service, petitioners provided only the first page of each
                                         - 35 -

[*35] monthly cellular phone invoice. This documentation does not provide

sufficient detail to distinguish between charges for business and personal use and

does not meet the strict substantiation requirements of section 274(d). Petitioners

are not entitled to deduct any of their claimed expenses for home or cellular phone

service. Petitioners are not entitled to deduct Internet service expenses because they

did not provide adequate substantiation. We conclude that petitioners have

sufficiently substantiated home utility expenses of $103 in addition to the $341

respondent conceded, for a total of $444.

      Part of the expenses that petitioners claimed for repairs and maintenance of

their home office related to the repair of an air conditioner. Petitioners provided a

$475 canceled check dated August 5, 2006, issued to Air Express Appliance Co.

Mrs. Rodriguez testified that the air conditioning repair was for the Annandale

residence, and other evidence supports this testimony. We conclude that petitioners

have adequately substantiated and are entitled to deduct one-third of the $475 air

conditioning repair expense, or $158, as a home office expense.

      In sum, including respondent’s $1,316 in concessions, petitioners have

substantiated $4,412 for their home office, consisting of $3,810 for rent, $444 for

utilities, and $158 for the air conditioning repair. Section 280A(c)(5) limits a

taxpayer’s deductions for business use of a home to the amount by which the
                                        - 36 -

[*36] activity’s gross income from the taxpayer’s business use of the home exceeds

the sum of deductions which are allowable regardless of whether the taxpayer used

the residence for business, such as mortgage interest and property taxes, plus

deductions for expenses of the business which are not allocable to the business use

of the residence. Tobin v. Commissioner, T.C. Memo. 1999-328. In other words, a

taxpayer may not claim a deduction that would give rise to or increase a net loss

from the business to which the deduction relates. Visin v. Commissioner, T.C.

Memo. 2003-246, aff’d, 122 Fed. Appx. 363 (9th Cir. 2005). Additionally, section

280A(c)(5) provides that the taxpayer may carry forward any resulting disallowed

deductions to the next year. See sec. 280A(c)(5) (flush language). Accordingly, the

amount of allowable home office expenses that petitioners may deduct for 2006 or

carry forward to 2007 will be computed under Rule 155.

      5. Advertising, Depreciation, Employee Benefits, and Office
         Administrative Expenses

      Petitioners claimed a deduction of $8,765 for advertising, depreciation,

employee benefits, and office administrative expenses.18 Petitioners did not




      18
        This amount consists of: $127 for advertising, $1,350 for depreciation and
sec. 179 expenses, $4,990 for employee benefits, and $2,298 for office
administrative expenses.
                                         - 37 -

[*37] provide sufficient documentation or testimony to substantiate these claimed

expenses and are not entitled to any deductions with respect to these items apart

from the $32 of office administrative expenses that respondent has conceded.

      6. Insurance Expense

      Petitioners claimed an $814 deduction for insurance expenses. On brief

petitioners argue that they maintained insurance for: (1) one of the Colombian

offices, (2) professional risk insurance for Mrs. Rodriguez, (3) car insurance for a

Ford vehicle, and (4) “Irene Rodriguez Colombian pension”. The substantiation

that petitioners provided in support of these items does not match the descriptions or

amounts of the expenses claimed.19 In addition, petitioners did not provide any

testimony or other evidence to substantiate these expenditures or to establish that

they were not personal. Petitioners are not entitled to any deduction for these

claimed insurance expenses.

      7. Interest Expenses

      Petitioners claimed a deduction of $3,171 for interest expenses, consisting

of $1,434 for interest with respect to a life insurance loan, $571 for interest on a

loan on a Florida condominium, $455 for interest on a car loan, and $711 for

      19
         To support these expenses, petitioners submitted expense reports that are
written in Spanish, as well as a bill from “Suramericana” that is also written in
Spanish.
                                            - 38 -

[*38] interest on office credit cards. On brief petitioners claim that the interest was

paid on loans that they took out for “life insurance and short term credit to conduct

litigation, purchase car to conduct business, and on business rental property of

Rodriguez & Rodriguez”. The documentation that petitioners provided consists of

two insurance loan statements from the Knights of Columbus, one of which relates

partially to 2005, an illegible receipt that petitioners claim is for interest paid on a

loan for a Florida condominium, and a financing statement for a Ford Taurus, the

interest on which does not correspond to the interest amount petitioners claimed.

Petitioners provided no documentation or testimony to support the amount they

claimed for interest on office credit cards.

       With respect to petitioners’ loans from the Knights of Columbus, petitioners

have provided no testimony or evidence to establish that the funds borrowed were

used for their business. Petitioners testified that the Florida condominium was used

for personal purposes and have provided no testimony or other evidence to support

a business use.20 With respect to the Ford Taurus, petitioners provided no

documentary evidence or testimony to establish the expense amount they claimed,

the dates of business use of the vehicle, the business purpose of such use, the

mileage for business use, and the total mileage for all uses of the vehicle. See sec.

       20
            Mrs. Rodriguez testified that petitioners did not have an office in Florida.
                                         - 39 -

[*39] 274(d). In addition, petitioners provided no documentation to support their

claimed interest on office credit cards. Petitioners are not entitled to any interest

expense deductions.

      8. Lease of Other Business Property Expense

      Petitioners claimed a deduction of $6,000 in expenses for an alleged special

assessment on their office in Barranquilla, Colombia. To support this deduction,

petitioners provided a self-translated version of a mortgage release document dated

May 31, 2004. In relevant part the document states that “Banco Commercial AV

Villas declares that for office 313 of World Trade Center Building of Barranquilla-

Tower A, it received the amount requested for release of mortgage of $16,473,000.”

Mr. Rodriguez’s testimony with respect to the special assessment did not adequately

explain its purpose or how it related to petitioners’ law practice. Further, Mr.

Rodriguez testified that the special assessment actually occurred in 1997. The

mortgage release that petitioners rely upon to support the assessment indicates that

the bank received the funds in 2004. Nothing in the record supports the amount of

the assessment that petitioners have reported or establishes that the alleged expense

was incurred during the year at issue. Petitioners are not entitled to any deduction

for the alleged special assessment.
                                        - 40 -

[*40] 9. Repairs and Maintenance Expense

      Petitioners claimed a deduction of $1,299 for repairs and maintenance

expenses, consisting of a total of $403 related to their Colombian law offices and

$896 for air conditioning parts and labor. The only support that petitioners provided

for these claimed expenses is a $475 canceled check dated August 5, 2006, made

out to Air Express Appliance Co. We have already allowed a portion of this amount

as a home office expense deduction for the repair of an air conditioner. Petitioners

provided no additional evidence to support the remaining expenses reported and are

not entitled to deduct them.

      10. Supplies Expense

      Petitioners claimed a deduction for $834 in supplies expenses. As support,

petitioners provided two receipts and a credit card statement from Home Depot, a

FedEx Kinkos receipt, and an additional receipt that is illegible. The Home Depot

documentation petitioners provided includes numerous items that appear to be

personal, and the FedEx Kinkos receipt does not include an adequate description of

the purchased items. Petitioners have not shown that the expenses claimed have a

business purpose and are not personal. Accordingly, petitioners are not entitled to

any supplies expense deduction.
                                        - 41 -

[*41] 11. Taxes and Licenses Expense

      Petitioners claimed a deduction of $1,502 for taxes and licenses related to

their Colombian law offices. Most of the supporting documentation that petitioners

provided relates either to their Florida condominium or to vehicles. As previously

mentioned, petitioners have not established a business use for their Florida

condominium. With respect to the vehicles, petitioners provided no documentary

evidence or testimony to establish the dates of business use of the vehicles, the

business purpose of such use, the mileage for business use, or the total mileage for

all uses of the vehicles as required under section 274(d). The remaining

documentation that petitioners provided consists of handwritten notes indicating

amounts allegedly paid for property taxes on the Colombian law offices. These

notes are insufficient to establish the amounts of the property taxes or that they were

actually incurred. Petitioners are not entitled to any deductions for taxes and

licenses.

      12. Utilities Expense for Colombian Offices

      Petitioners claimed a deduction of $3,302 for utilities related to their

Colombian law offices. Petitioners provided sufficient supporting documentation

for Internet service, long distance phone service, and international phone cards
                                        - 42 -

[*42] totaling $620. Respondent concedes $604 of this amount.21 Petitioners

provided no additional support for their remaining reported utility expenses for their

Colombian offices. Accordingly, petitioners are entitled to deduct a total of $620

for utilities, including the $604 that respondent has conceded.

      13. Wages and Benefits

      Petitioners claimed deductions totaling $10,567 for expenses relating to

“Salaries”, “Unemployment Benefits”, “Mid Year/End Year Benefits”, “Paid

Vacation Benefits”, and “Paid Leave”. A reasonable allowance for salaries or

other compensation for personal services actually rendered may be deducted under

section 162(a)(1) as an ordinary and necessary expense paid or incurred during the

taxable year in carrying on a trade or business. Petitioners provided a summary

sheet of their 2006 monthly ledgers as well as a translation of the document from

Spanish into English prepared by Mrs. Rodriguez. In addition, petitioners

provided monthly ledger sheets for January, February, March, April, May, July,


      21
         Respondent conceded several individual expenses and added them together
to arrive at a total of $589. This was a computational mistake by respondent; the
correct sum of all of the individual expenses conceded is $604.

       Respondent conceded 12 months of Internet service at $21.95 per month for a
total of $263. The evidence submitted by petitioners indicates that they paid $21.95
in 11 of the 12 months of 2006 and $23.22 in July 2006, thus entitling them to a
deduction of $265.
                                          - 43 -

[*43] August, and September 2006. The monthly ledger sheets are in Spanish.

Despite the language obstacle, it is clear that the summary sheet does not accurately

summarize the monthly ledgers. The numbers and names of the categories listed on

the summaries and the monthly ledgers do not match. Petitioners are not entitled to

deductions because they have not provided sufficient documentation to establish the

amounts of these claimed expenses or that they were actually incurred.

      14. Filing Fees and Transcripts

      Petitioners claimed a deduction of $5,155 for filing fees and transcript

expenses related to litigation. On brief petitioners increased the amount claimed to

$5,637. Petitioners provided supporting invoices and canceled checks for several of

the reported expenses totaling $1,252, all of which respondent conceded.

Petitioners also submitted receipts for tolls, gas, a rental car, and credit card

statements which include charges for CVS, Shopper’s Food, Toys ‘R’ Us,

Quizno’s, KFC, Walmart, and Amazon.com. Petitioners provided no testimony or

other documentary evidence to establish that any of these expenses related to their

business. To the extent that the receipts are for expenses that may relate to

business travel, petitioners have not met the strict substantiation requirements of

section 274(d). Lastly, petitioners submitted canceled checks made out to the
                                         - 44 -

[*44] Department of Homeland Security. Petitioners did not provide testimony or

documentary evidence establishing that these expenditures related to their business.

Petitioners are therefore entitled to deduct only the $1,252 for filing fees and

transcripts that respondent has conceded.

      15. Copies and Litigation Supplies

      Petitioners claimed a total deduction of $4,942 for copies and litigation

supplies. Respondent conceded a total of $564 of these expenses. Of the total

amount claimed, petitioners apportioned $3,779 to “paper, toner, copies, etc.”

Petitioners apportioned the remaining $1,163 among expenses related to one

Virginia Court of Appeals case and five U.S. Supreme Court cases. Of the receipts

petitioners provided to substantiate the $3,779 amount, several were for personal

items, including a refrigerator, groceries, tropical fish, fish food, magazines,

photographs, weed killer, and bottled water. Other receipts did not include

sufficient descriptions to identify the items purchased. Apart from the amounts

respondent conceded, petitioners did not sufficiently establish through

documentary evidence or supporting testimony the expense amounts or that the

expenditures related to their business. With respect to the remaining $1,163,

petitioners provided no documentation or supporting testimony to substantiate the
                                         - 45 -

[*45] expenses. Petitioners are therefore entitled to deduct only the $564

respondent conceded for copies and litigation supplies.

      16. Professional Dues and Fees

      Petitioners claimed a $1,301 deduction for expenses related to professional

dues and fees. Of this amount, respondent conceded a total of $423 for bar dues

and professional associations. With respect to the remaining items, petitioners have

either not provided documentation to substantiate that they incurred each particular

expense or have not established a business purpose for expenses that appear to be

personal. Such items include dues for the National Rifle Association, the American

Legion, Costco, and AAA. Petitioners are entitled to deduct only the $423 that

respondent has conceded for professional dues and fees.

      17. Postage & Delivery

      Petitioners claimed a total deduction of $1,124 for expenses relating to

postage and delivery fees. Petitioners provided receipts for several items that

clearly related to their law practice, and respondent conceded most of these items

for a total of $168. Respondent did not concede $69 for a FedEx shipment of legal

documents to petitioners’ law office in Barranquilla, Colombia. The shipment

related to petitioners’ law practice, and we conclude that they are entitled to

deduct this item. The remaining documentation that petitioners have provided
                                        - 46 -

[*46] includes receipts for shipments to Transunion, Virginia Tech University,

Discover Card, and United Healthcare. In addition, several receipts are for

shipments that were made in a year other than 2006 and shipped to unidentified

individuals; the shipments included personal items, such as a guitar. Other than the

items that respondent has conceded and the $69 FedEx shipment expense mentioned

above, petitioners have either not provided documentation to substantiate that they

incurred the particular expense or have not established a business purpose for what

appear to be personal expenses. Including the expenses that respondent has

conceded, petitioners are entitled to deduct $237 for postage and delivery fees.

      18. Continuing Legal Education Expenses

      Petitioners claimed a $682 deduction for continuing legal education (CLE)

expenses. On brief they increased this amount to $690. Of this amount,

respondent conceded $434. Respondent did not concede $226 that petitioners

claimed for a VERSA CLE tape and $32 for what petitioners describe as “CLE

Alien Act”. With respect to the VERSA CLE tape, petitioners provided a credit

card receipt for a payment made to VERSA for the amount claimed. The receipt,

however, does not provide sufficient detail to establish what items were

purchased. Petitioners have not established that the expenditure was related to
                                        - 47 -

[*47] their business and not personal. Petitioners did not provide any

documentation with respect to their expense claim for the “CLE Alien Act”.

Petitioners are entitled to deduct only the $434 that respondent has conceded for

continuing legal education expenses.

      19. Law Book Supplements and Purchases

      Petitioners claimed a $977 deduction for law book expenses. Included in this

amount is $596 which petitioners describe on brief as “Misc. Receipts”. Petitioners

provided no documentation or testimony to support the “Misc. Receipts” they

claimed. Petitioners did, however, provide several receipts for law-related

publications totaling $360, all of which respondent has conceded. The remaining

items petitioners claimed include a geology textbook which Mrs. Rodriguez testified

was for Mr. Rodriguez’s son, a Time magazine subscription, a “To Kill a

Mockingbird” DVD, and a book about military weapons. Petitioners have not

established that any of these items were related to their business and not personal.

Petitioners are entitled to deduct only the $360 that respondent has conceded for

law book expenses.

      20. Employee Legal Education and Data Processing Education
          Course

      Petitioners claimed a $1,426 deduction related to an employee legal and

data processing education course in Colombia. As support, petitioners provided
                                        - 48 -

[*48] two money transfer receipts, one for $50 and another for $40, that Mrs.

Rodriguez sent to an individual in Colombia. Petitioners provided no

documentation or testimony to establish that this money was used to pay for the

legal and data processing education course for any employee. Petitioners are not

entitled to any deduction for this claimed expense.

      21. Money Transfer Fees

      Petitioners claimed a $1,692 deduction for expenses related to money transfer

fees. Of this amount, respondent conceded $1,161. Petitioners provided several

receipts for money transfers to their Colombian law office that included items

specifically designated as “fees”, all of which respondent conceded. Petitioners also

provided similar money transfer receipts that included a total of $44 of “Telex” fees,

which respondent did not concede. These fees, like those items specifically

designated “fees”, were charged to complete the money transfers and are thus

deductible. Petitioners are entitled to deduct, including the $1,161 that respondent

has conceded, $1,205 for expenses related to money transfer fees.

IV. Accuracy-Related Penalties

      Section 6662(a) imposes an accuracy-related penalty of 20% of any

underpayment that is attributable to causes specified in subsection (b). Section

6662(b)(2) applies the penalty to any underpayment attributable to a “substantial
                                        - 49 -

[*49] understatement” of income tax, meaning that the amount of the

understatement exceeds the greater of 10% of the tax required to be shown on the

return for the tax year or $5,000. Sec. 6662(d)(1)(A).

       Generally, the Commissioner bears the burden of production with respect to

any penalty, including the accuracy-related penalty. Sec. 7491(c); Higbee v.

Commissioner, 116 T.C. at 446. To meet that burden, the Commissioner must come

forward with sufficient evidence indicating that it is appropriate to impose the

relevant penalty. Id. Once the Commissioner has met the burden of production, the

taxpayer has the burden of proving that the penalties are inappropriate. See Rule

142(a); Higbee v. Commissioner, 116 T.C. at 446-447.

       Respondent determined that petitioners are liable for a penalty under section

6662(a) because they substantially understated their income tax for the year at issue.

The exact amount of petitioner’s understatement will depend upon the Rule 155

computations, which we order below. To the extent that those computations

establish that petitioner has a substantial understatement of income tax, respondent

has met his burden of production. See Prince v. Commissioner, T.C. Memo. 2003-

247.
                                         - 50 -

[*50] The amount of an understatement on which the penalty is imposed will be

reduced by the portion of the understatement that is attributable to the tax treatment

of an item (1) that was supported by “substantial authority”, or (2) for which the

relevant facts were “adequately disclosed in the return or in a statement attached to

the return”. Sec. 6662(d)(2)(B). Additionally, no penalty will be imposed with

respect to any portion of an underpayment if it is shown that there was reasonable

cause for such portion and the taxpayer acted in good faith with respect to such

portion. See sec. 6664(c)(1).

      Petitioners have failed to show that they made adequate disclosures with

respect to the relevant facts or that they had substantial authority or acted with

reasonable cause and in good faith with respect to any portion of their

underpayment. Accordingly, we hold that they are liable for the section 6662(a)

penalty insofar as the Rule 155 computations show a substantial understatement of

income tax.

      In reaching the foregoing holdings, we have considered all of the parties’

arguments, and, to the extent not addressed herein, we conclude that they are moot,

irrelevant, or without merit.22

      22
        On brief petitioners appear for the first time to request abatement of interest.
In order for this Court to have jurisdiction over such a request, respondent must first
                                                                         (continued...)
                                        - 51 -

[*51] To reflect the foregoing,


                                                           Decision will be entered

                                                    under Rule 155.




      22
          (...continued)
issue a notice of final determination under sec. 6404, and a Tax Court petition for
review of that determination must be filed. Sec. 6404(h)(1); Rule 280; Williams v.
Commissioner, 131 T.C. 54, 55-56 (2008). The record does not establish that
respondent issued a notice of final determination under sec. 6404. Accordingly, we
do not have jurisdiction to determine whether petitioners are entitled to abatement of
interest.
