                   T.C. Summary Opinion 2006-93




                     UNITED STATES TAX COURT



  GUNASUNDRAN R. PILLAY AND KALAIVANI GOVENDER, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 5872-04S, 17168-04S.   Filed June 8, 2006.



     Gunasundran R. Pillay and Kalaivani Govender, pro sese.

     Margaret A. Martin, for respondent.



     PANUTHOS, Chief Special Trial Judge:   These cases were heard

pursuant to the provisions of section 7463 of the Internal

Revenue Code in effect at the time the petitions were filed.    The

decisions to be entered are not reviewable by any other court,

and this opinion should not be cited as authority.   Unless

otherwise indicated, subsequent section references are to the

Internal Revenue Code in effect for the years in issue, and all
                               - 2 -

Rule references are to the Tax Court Rules of Practice and

Procedure.

     Respondent determined deficiencies of $4,586 and $3,929 in

petitioners’ 2000 and 2001 Federal income taxes, respectively.

After concessions by petitioners,1 the issue for decision is

whether petitioners are entitled to expense deductions in the

taxable years 2000 and 2001 related to a sole proprietorship.

                            Background

     These two cases were consolidated for purposes of trial,

briefing, and opinion.   Some of the facts have been stipulated,

and they are so found.   The stipulation of facts and the

supplemental stipulation of facts with attached exhibits, as well

as an additional exhibit admitted during trial, are incorporated

herein by this reference.   Petitioners Gunasundran R. Pillay (Mr.

Pillay) and Kalaivani Govender are married and resided in Citrus

Heights, California, when the petition in each docket was filed.

Unless otherwise indicated, all references to petitioner are to

Mr. Pillay.




     1
       Petitioners concede that a $1,175 State income tax refund
they received in 2001 is taxable. Petitioners also concede
certain expense deductions claimed on their Schedule C, Profit or
Loss From Business, which are discussed infra. The remaining
adjustments in the notices of deficiency are computational;
therefore, we do not address them.
                               - 3 -

     During the years at issue, petitioner was a 50-percent owner

of Worldwide Technology Solutions, Inc. (the corporation).2     The

corporation placed consultants with businesses and government

agencies for a fee.   Petitioner also operated a similarly named

sole proprietorship called Worldwide Technology Solutions (WTS).

Petitioner described WTS as a business consulting firm.    He

explained that WTS provided direct consulting services, whereas

the corporation provided consultants.   It is not clear why WTS

and the corporation had nearly identical names.

     In addition to his involvement with the corporation and WTS,

petitioner worked full time for the California State Board of

Equalization (SBOE) as a program manager.   SBOE was also one of

the corporation’s clients in 2000 and 2001.   Petitioner could not

recall whether WTS had any clients in 2000.   WTS had one client

in 2001, a company called “3com”.   WTS performed a feasibility

study for 3com and made a proposal to update 3com’s business

software.   3com did not accept the proposal and instead

contracted with the corporation for a consultant.   WTS was not

paid for the study it performed.

     The corporation was operated from an office in Sacramento.

WTS was operated from petitioners’ home, but it also leased


     2
       The corporation’s tax liability is not at issue. At
trial, however, the parties made frequent reference to the
corporation for purposes of comparing it with the sole
proprietorship. We therefore include information about the
corporation necessary to address the parties’ arguments.
                                 - 4 -

office space from the corporation.       Petitioner explained that

although WTS was a home-based business, he wanted more

professional surroundings when he met WTS clients.       WTS paid one-

half of the rent for the Sacramento office.

         The corporation reported gross receipts of $922,843 in

2001.     WTS had no gross income during the years at issue.    On

their jointly filed 2000 and 2001 Federal income tax returns,

petitioners claimed WTS-related expense deductions totaling

$45,520 and $18,353, respectively.3       Respondent issued a notice

of deficiency for each year disallowing the deductions in full.

Before trial, petitioners conceded certain expense deductions but

also claimed additional expense deductions beyond those claimed

on their tax returns.     Petitioners now claim the following

Schedule C expense deductions:4

                                         2000        2001

     Advertising                      $248           ----
     Car and truck                   6,085         $6,085
     Commissions and fees           38,372           ----
     Rent                              852         12,973
     Supplies                        2,236          1,030
     Travel                           ----          2,018
     Meals and entertainment           571          1,926
     Utilities                         897          1,717
      Totals                        49,261         25,749



     3
       The $18,353 figure includes $12,488 that petitioners
originally claimed as unreimbursed employee business expenses on
Schedule A, Itemized Deductions, but which they now claim as
additional Schedule C expense deductions.
     4
         All amounts are rounded to the nearest dollar.
                                - 5 -

                            Discussion

     Deductions are a matter of legislative grace, and the

taxpayer bears the burden of proving that he is entitled to any

deduction claimed.   Rule 142(a); New Colonial Ice Co. v.

Helvering, 292 U.S. 435, 440 (1934).     This includes the burden of

substantiating the amount and purpose of the claimed deduction.

See Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd. per

curiam 540 F.2d 821 (5th Cir. 1976).     The taxpayer is required to

maintain records that are sufficient to enable the Commissioner

to determine his correct tax liability.     See sec. 6001; sec.

1.6001-1(a), Income Tax Regs.

     Pursuant to section 7491(a), the burden of proof as to

factual matters shifts to respondent under certain circumstances.

Petitioners have neither alleged that section 7491(a) applies nor

established their compliance with the requirements of section

7491(a)(2)(A) and (B) to substantiate items, maintain records,

and cooperate fully with respondent’s reasonable requests.

Petitioners therefore bear the burden of proof.

     Section 162(a) generally allows a deduction for ordinary and

necessary business expenses.    To qualify as an allowable

deduction under section 162(a), an item must:    (1) Be paid or

incurred during the taxable year; (2) be for carrying on any

trade or business; (3) be an expense; (4) be a necessary expense;

and (5) be an ordinary expense.    Commissioner v. Lincoln Sav. &
                               - 6 -

Loan Association, 403 U.S. 345, 352 (1971); FMR Corp. & Subs. v.

Commissioner, 110 T.C. 402, 414 (1998).

     Section 274(d) imposes strict substantiation requirements

for listed property as defined in section 280F(d)(4), gifts,

travel, entertainment, and meal expenses.   Sec. 1.274-5T(a),

Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).

Listed property includes passenger automobiles and any other

property used as a means of transportation.   Sec.

280F(d)(4)(A)(i) and (ii).   To obtain a deduction for a listed

property, travel, meal, or entertainment expense, a taxpayer must

substantiate by adequate records or sufficient evidence to

corroborate the taxpayer’s own testimony the amount of the

expense, the time and place of the use, the business purpose of

the use, and, in the case of entertainment, the business

relationship to the taxpayer of each person entertained.   Sec.

274(d); sec. 1.274-5T(b), Temporary Income Tax Regs., 50 Fed.

Reg. 46014 (Nov. 6, 1985).

      According to respondent, petitioners have not demonstrated

that WTS was a separate business activity in the years at issue.

Respondent therefore contends that none of petitioners’ claimed

deductions were paid or incurred in carrying on a trade or

business.   Respondent notes that WTS and the corporation had

similar names and shared office space, that WTS had only one

client, and that WTS had no gross income, whereas the corporation
                                - 7 -

had gross receipts of $922,843 in 2001.    Respondent argues that

to the extent expenses were paid or incurred, they were either

petitioners’ personal expenses or expenses of the corporation.

     Petitioner contends that WTS was an active business that was

distinct from the corporation and that WTS paid or incurred the

expenses in question.   Although WTS had few clients in 2000 and

2001, petitioner contends WTS “was making proposals all over the

country” trying to generate business.

     We agree with respondent that it is unclear whether WTS was

a separate business.    WTS reported no gross receipts in the years

at issue.   It conducted limited activities and had only one

client, which eventually chose to do business with the

corporation.   Although petitioner claims WTS was attempting to

generate business, he did not provide WTS brochures, marketing

materials, or other evidence of WTS’s sales efforts.   Petitioner

introduced a balance sheet and income statement for the

corporation, but petitioner did not produce any accounting

records for WTS.   While petitioner maintains that WTS was

separate from the corporation, he testified that he “made no

distinction between * * * [his] employment and * * * [his] home-

based business because * * * they were one and the same thing.”

It is not entirely clear what petitioner meant by this comment;
                                 - 8 -

however, at the very least his testimony casts doubt on his

assertion that WTS was a separate business.5

        Even if WTS was a separate business, each of the claimed

expense deductions fails to satisfy one or more requirements to

be deductible.     With respect to travel, meals, and entertainment

expenses, petitioner has not met the substantiation requirements

of section 274(d).     Although petitioner introduced a number of

receipts, they do not describe the business purpose of the

expenses or the business relationship to petitioner of the

persons he entertained.     See sec. 274(d); sec. 1.274-5T(b),

Temporary Income Tax Regs., supra.

     Petitioner testified that he purchased a vehicle that he

used exclusively for WTS-related business, even though title to

the vehicle was held in petitioners’ names rather than in WTS’s

name.     Because the vehicle was listed property as defined in

section 280F(d)(4)(A), deductions related to the vehicle are also

subject to the heightened substantiation requirements of section

274(d).     Petitioner did not keep a mileage log, however, or

otherwise corroborate his testimony concerning the business

purpose of the vehicle.     See sec. 274(d); sec. 1.274-5T(c),

Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).



     5
       Petitioner’s belief that WTS was related to his employment
with SBOE may explain why he originally claimed the $12,488 of
additional Schedule C deductions as unreimbursed employee
expenses. See supra note 3.
                               - 9 -

     With respect to advertising and supplies expenses,

petitioner has not established the business purpose of these

expenditures or that they were WTS’s expenses, as opposed to

personal expenses or the corporation’s expenses.   The same is

true for utilities expense.   For example, petitioner introduced a

number of invoices from AT&T Wireless.   The invoices are

addressed to petitioner, however, and do not reference WTS.     In

addition, some of the invoices list petitioners’ home address,

while others list the office in Sacramento that WTS shared with

the corporation.   Petitioner did not introduce evidence linking

the telephone number listed on the invoice to WTS, such as a WTS

business card or WTS letterhead.   Nor did petitioner provide

evidence of his personal utilities expense or the corporation’s

utilities expense, which may have been circumstantial evidence

that WTS used the AT&T Wireless service and incurred the expense

in question.

     WTS paid one-half of the rent for the office space it shared

with the corporation.   While rent generally is an ordinary

business expense, petitioner testified that the office space was

“only a professional front” for WTS; i.e., WTS used it solely to

meet clients.   Given the limited use that WTS made of the office

space, as well as the dearth of clients in the years at issue, it

appears that this expenditure may not have been a necessary

expense.   See Alondra Indus., Ltd. v. Commissioner, T.C. Memo.
                               - 10 -

1996-32 (“Excessive rental payments do not constitute ordinary

and necessary business expenses and are therefore not

deductible.”).   Only the reasonable portion of the rent is

allowed as a deduction.    Hopkins v. Commissioner, T.C. Memo.

2005-49.   There is nothing in the record which indicates that any

portion of the rent paid by WTS was reasonable.

     Finally, petitioner testified that the commissions and fees

expense of $38,372 in 2000 represents the cost of computer

software that he commissioned a company called “R Systems” to

develop.   The software was designed to aid in the electronic

filing of State sales tax returns.      Petitioner had hoped to sell

or lease the software to SBOE but was unable to do so.

     For the same reasons discussed supra, it is not clear that

WTS paid or incurred the cost of acquiring the software.     Even if

WTS did pay or incur this cost, software generally must be

depreciated rather than currently deducted.     See secs. 167(f),

197; sec. 1.167(a)-14(b)(1), Income Tax Regs.     The period for

depreciation of an asset begins when the asset is placed in

service.   Sec. 1.167(a)-10(b), Income Tax Regs.     The record does

not indicate when, if ever, WTS placed the software in service.

Accordingly, petitioners cannot deduct any costs associated with

the software.    See Hahn v. Commissioner, T.C. Memo. 1990-43.

     We conclude that the WTS-related expense deductions that

petitioners claim are not ordinary and necessary business
                               - 11 -

expenses.    Accordingly, respondent’s determinations are

sustained.

     Reviewed and adopted as the report of the Small Tax Case

Division.

     To reflect the foregoing,


                                          Decisions will be entered

                                     for respondent.
