                       T.C. Summary Opinion 2009-88



                         UNITED STATES TAX COURT



             MICHELLE L. AND DUKE T. HWYNN, Petitioners v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 19862-07S.              Filed June 2, 2009.



        Michelle L. Hwynn and Duke T. Hwynn, pro sese.

        Michael K. Park, for respondent.



        LARO, Judge:   This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect

when the petition was filed.1      Pursuant to section 7463(b), the

decision to be entered is not reviewable by any other court, and

this opinion shall not be treated as precedent for any other

case.

        1
      Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code, and Rule
references are to the Tax Court Rules of Practice and Procedure.
Some dollar amounts are rounded.
                                - 2 -

      Petitioners petitioned the Court to redetermine respondent’s

determinations relating to their Federal income taxes for 2004

and 2005.    For 2004, respondent determined a $4,038 deficiency

and an $807.60 accuracy-related penalty under section 6662(a).

For 2005, respondent determined a $4,890 deficiency and a $987

accuracy-related penalty under section 6662(a).

      At trial, respondent amended his answer to assert an

increased deficiency and accuracy-related penalty for 2004 of

$5,013 and $1,002.60, respectively.     Following this amendment and

certain concessions, we are left to decide the following issues:

      1.   Whether petitioners may deduct unreimbursed employee

business expenses in amounts greater than those respondent

allowed.    We hold they may not;

      2.   whether petitioners may deduct passthrough losses from

their wholly owned S corporation, Appworks Consulting, Inc.

(Appworks).    We hold they may not except to the extent stated

herein;

      3.   whether Duke Hwynn (Mr. Hwynn) is an independent

contractor or an employee of Appworks.     We hold he is an

employee;

      4.   whether petitioners are liable for the accuracy-related

penalties.    We hold they are not.

                              Background

I.   Preliminaries

      The parties have submitted to the Court stipulations of fact

with accompanying exhibits.    The stipulated facts and
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accompanying exhibits are incorporated herein by this reference.

Petitioners are husband and wife, and they filed joint Forms

1040, U.S. Individual Income Tax Return, for 2004 and 2005.           They

resided in California when they petitioned the Court.

II.    Appworks

       Petitioners formed Appworks, a computer consulting business,

in 1996.       Appworks is taxed as an S corporation, and each

petitioner owns one-half of its stock.         Mr. Hwynn is Appworks’

president.       He is the only person who performs services on its

behalf, and he is Appworks’ sole source of income.         Michelle

Hwynn, also known as Hui Lu (Ms. Hywnn), is employed full time as

a registered nurse.

III.    Petitioners’ 2004 Federal Income Tax Return

       A.     Unreported Wages

       Appworks paid Mr. Hwynn $6,500 in wages during 2004.

Petitioners failed to report those wages on their 2004 Federal

income tax return.       The increase in deficiency asserted in the

amendment to answer is attributable to respondent’s allegation

that the $6,500 is includable in petitioners’ gross income for

2004.       Petitioners agree with that allegation.    We hold without

further discussion that the $6,500 is includable in petitioners’

gross income for 2004.

       B.     Unreimbursed Business Expenses
       Petitioners claimed on their 2004 return a $6,930 deduction

for unreimbursed employee business expenses of Mr. Hwynn,

reporting that he incurred those expenses while working as an
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employee of Appworks.    Petitioners now seek to deduct an

additional $16,471 of such expenses.      The specifics of these

expenses are as follows:

                            Reported Expenses   Additional Expenses

  Vehicle                        $3,750               $6,978
  Parking fees and tolls            150                  150
  Business                        2,780                9,195
  Meals and entertainment           250                  418
    Total                         6,930               16,741

Petitioners elected to use the applicable standard mileage rate

of 37.5 cents to report the business expenses of their vehicles

and, accordingly, computed the $3,750 of vehicle expenses

reported on their return by multiplying 37.5 cents by 10,000

business miles reportedly driven by Mr. Hwynn during 2004.        The

additional vehicle expenses of $6,978 included petitioners’ claim

of some of the actual expenses of Mr. Hwynn’s vehicle.

     Petitioners also claimed on their 2004 return a $3,051

deduction for unreimbursed employee business expenses of Ms.

Hwynn, reporting that she incurred those expenses while working

as a registered nurse.    Petitioners now seek to deduct an

additional $4,808 of such expenses.      The specifics of these

expenses are as follows:

                            Reported Expenses    Additional Expenses

  Vehicle                        $1,125               $1,232
  Travel                             35                  415
  Business                        1,516                1,590
  Meals and entertainment           375                1,571
    Total                         3,051                4,808
                                 - 5 -

Petitioners computed the $1,125 of vehicle expenses by

multiplying the applicable standard mileage rate of 37.5 cents by

3,000 business miles reportedly driven by Ms. Hwynn during 2004.

The additional vehicle expenses of $1,232 included petitioners’

claim of some of the actual expenses of Ms. Hwynn’s vehicle.

      Respondent concedes that petitioners may deduct $1,063 of

the unreimbursed employee business expenses relating to Mr.

Hwynn.     The $1,063 relates entirely to Mr. Hwynn’s use of his

vehicle.     Respondent also concedes that petitioners may deduct

$1,337 of the unreimbursed employee business expenses relating to

Ms. Hwynn.     The $1,337 is attributable to the individual expenses

as follows:     $986 for vehicle, $35 for travel, and $316 for

business.

      C.    Loss From Appworks

      Petitioners claimed on their 2004 return a deduction for a

$15,968 loss passed through to them from Appworks.     Respondent

determined that petitioners were not entitled to deduct any of

this loss because they failed to establish either of their stock

bases in Appworks.

IV.   Petitioners’ 2005 Federal Income Tax Return
      A.    Mr. Hwynn’s Services for Appworks

      During 2005, Appworks paid Mr. Hwynn $5,000 for his

services.     Petitioners reported on their 2005 return that Mr.

Hwynn received the $5,000 as a self-employed individual

(independent contractor).     Petitioners claimed deductions
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totaling $12,378 for Mr. Hwynn’s self-employment expenses

relating to the reported business.

     Respondent determined that Mr. Hwynn received the $5,000 as

an employee of Appworks and that petitioners were not entitled to

deduct any of the $12,378 as a self-employment expense.

Respondent also determined that petitioners could not deduct any

of the $12,378 as a different type of expense (e.g., an

unreimbursed employee business expense) because petitioners

lacked substantiation as to the amount.

     B.    Unreimbursed Employee Business Expenses

     Petitioners claimed on their 2005 return a $15,498 deduction

for unreimbursed employee business expenses of Ms. Hwynn,

reporting that she incurred those expenses while working as a

registered nurse.    Petitioners now seek to deduct an additional

$37,190 of such expenses.    The specifics of these expenses are as

follows:

                            Reported Expenses   Additional Expenses

  Vehicle                        $1,213              $7,984
  Parking fees and tolls            415                 524
  Travel                          3,500               3,740
  Business                        9,370              22,122
  Meals and entertainment         1,000               2,820
    Total                        15,498              37,190

Petitioners computed the $1,213 of vehicle expenses by

multiplying the applicable standard mileage rate of 48.5 cents by

2,500 business miles reportedly driven by Ms. Hwynn during 2005.

The additional vehicle expenses of $7,984 included petitioners’

claim of some of the actual expenses of Ms. Hwynn’s vehicle.
                                  - 7 -

      Respondent concedes that petitioners may deduct $3,140 of

the unreimbursed employee business expenses.      That amount is

attributable to the individual expenses as follows:      $1,213 for

vehicle, $203 for parking, and $1,724 for business.

      C.   Loss From Appworks

      Petitioners also claimed on their 2005 return a deduction

for a $7,309 loss passed through to them from Appworks.

Respondent determined that petitioners were not entitled to

deduct any of this loss because they had failed to establish

either of their stock bases in Appworks.

                                Discussion

I.   Income Tax Deficiencies

      A.   Burden of Proof

      As to the income tax deficiencies, petitioners bear the

burden of proving that respondent’s determinations set forth in

the notice of deficiency are incorrect.      See Rule 142(a)(1);

Welch v. Helvering, 290 U.S. 111, 115 (1933).      While section

7491(a) sometimes shifts the burden of proof to the Commissioner,

that section is not applicable where, as here, petitioners have

failed to satisfy the recordkeeping and substantiation

requirements of the Code.    See sec. 7491(a)(2)(A) and (B).

      B.   Unreimbursed Employee Business Expenses
      Petitioners seek to deduct unreimbursed employee business

expenses in amounts greater than those respondent allowed.      They

have not, however, proven that they are entitled to do so.

Petitioners provided the Court with various receipts, credit card
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invoices, and other documents in an attempt to meet their burden

of proof.   Those documents, however, establish that many of the

deductions petitioners claimed are simply their personal, living,

or family expenses.2   An individual generally may not deduct his

or her personal, living, or family expenses, sec. 262(a), and we

conclude that no exception to this general rule applies to the

facts at hand.   Nor have petitioners established their

entitlement to deduct any of the remaining expenses.   Among other

things, petitioners have met neither the substantiation nor the

recordkeeping requirements that apply to those expenses.3   See

sec. 6001 (providing that taxpayers must keep sufficient records

to substantiate any deduction that would otherwise be allowed by

the Code); see also sec. 274(d)

(providing that an individual may not deduct a travel,

entertainment, or vehicle expense unless he or she meets the

strict substantiation requirements of that section).   We sustain

respondent’s determination as to this issue, as adjusted by his

concessions.




     2
      In fact, Mr. Hwynn admitted during his direct testimony
that he caused Appworks to pay most of petitioners’ living
expenses, including their rent, meals, and vehicle expenses.
     3
      Petitioners also seek to deduct their payment of parking
tickets and similar citations. Such expenses are fines or
penalties that are nondeductible, even if related to Appworks’s
business. See sec. 162(f). We also note that petitioners (as
they conceded at trial) are not entitled to deduct the actual
operating expenses of their vehicles (e.g., gas, repairs) in that
they reported those expenses using the applicable standard
mileage rates.
                               - 9 -

     C.   Passthrough Losses

     Respondent disallowed petitioners’ deduction of the losses

passed through to them from Appworks because petitioners failed

to establish that either petitioner had any basis in Appworks.     A

shareholder may not deduct a loss passed through to him or her

from an S corporation to the extent that the loss exceeds the sum

of the shareholder’s adjusted basis in his or her stock in the S

corporation, plus the shareholder’s adjusted basis of any debt

that the S corporation owes to the shareholder.    See sec.

1366(d)(1).   Petitioners have not produced any evidence that

would establish the requisite bases.   We sustain respondent’s

disallowance of the reported passthrough losses.

     D.   Status as Employee or Independent Contractor

     For 2005, respondent determined that Mr. Hwynn was an

employee of Appworks.   Thus, respondent determined, the $5,000

that Mr. Hwynn received from Appworks was taxable to him as wages

and petitioners were not entitled to deduct any expense related

to Mr. Hwynn’s work for Appworks as a self-employment expense.

We agree with these determinations.    An officer such as Mr. Hwynn

who performs substantial services for a corporation and who

receives remuneration in any form for those services is

considered to be an employee of that corporation.    See sec.

3121(d)(1); Charlotte’s Office Boutique, Inc. v. Commissioner,
121 T.C. 89, 104 (2003), affd. 425 F.3d 1203 (9th Cir. 2005).     We

sustain respondent’s determination that Mr. Hwynn was an employee

of Appworks and that petitioners are not entitled to deduct any
                               - 10 -

of the $12,378 as a self-employment expense.     We further hold for

reasons similar to those discussed above as to the unreimbursed

employee business expenses that petitioners are not entitled to

deduct any of the $12,378.

II.   Accuracy-Related Penalties

      Respondent determined that petitioners are liable for

accuracy-related penalties under section 6662(a) and by way of an

amendment to answer increased the accuracy-related penalty for

2004 by $195.    Respondent clarifies in his pretrial memorandum

that the accuracy-related penalty applies to both years because

of a substantial understatement of income tax in each year.

      Section 6662(a) and (b)(2) imposes a 20-percent

accuracy-related penalty for any portion of an underpayment that

is attributable to a substantial understatement of income tax.

An understatement of income tax is the excess of the amount of

income tax required to be shown on the return for the taxable

year over the amount of income tax imposed that is shown on the

return, reduced by any rebate.     See sec. 6662(d)(2)(A).   An

understatement is substantial if it exceeds the greater of 10

percent of the tax required to be shown on the return for the

taxable year or, in the case of an individual, $5,000.       See sec.

6662(d)(1)(A).

      The Commissioner bears the burden of production with respect

to the applicability of an accuracy-related penalty determined in

a notice of deficiency.    See sec. 7491(c).   That burden requires

that the Commissioner produce sufficient evidence that it is
                              - 11 -

appropriate to impose an accuracy-related penalty.    Once he has

met his burden, the burden of proof is upon the taxpayer to prove

that the accuracy-related penalty does not apply because of

reasonable cause, substantial authority, or the like.    See secs.

6662(d)(2)(B), 6664(c); Higbee v. Commissioner, 116 T.C. 438, 449

(2001).   As to respondent’s allegation of a $195 increase in the

accuracy-related penalty for 2004, respondent bears the burden of

proof as to that amount.   See Rule 142(a)(1).

     Respondent argues that he has met his burdens through the

inclusion in evidence of the notice of deficiency.    We disagree.

Petitioners’ understatement for each year may be substantial only

if it exceeds $5,000.   See sec. 6662(d)(1)(A).   The notice of

deficiency determined the 2004 deficiency as $4,038 and the 2005

deficiency as $4,890.   While respondent now asserts that the

deficiency for 2004 is actually $5,013 on account of his

amendment to answer, we do not believe that respondent’s amending

of his answer validates his earlier determination in the notice

of deficiency that the accuracy-related penalty is appropriate.

We do not sustain respondent’s determination as to the accuracy-

related penalty for either year.


                                         Decision will be entered

                                    under Rule 155.
