                  T.C. Summary Opinion 2004-156



                     UNITED STATES TAX COURT



     HOORA RAHIMI AND ISAAC WILLIAM HAMMOND, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9218-03S.             Filed November 10, 2004.



     Hoora Rahimi and Isaac William Hammond, pro sese.

     Jack T. Anagnostis, for respondent.



      DEAN, Special Trial Judge:   This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time that the petition was filed.   Unless otherwise

indicated, subsequent section references are to the Internal

Revenue Code in effect for the year in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

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

and this opinion should not be cited as authority.
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       Respondent determined for 1999 a deficiency in petitioners'

Federal income tax of $16,420 and an accuracy-related penalty

under section 6662(a) of $3,167.

       In the petition, petitioners did not challenge respondent's

adjustments to their Schedule A, Itemized Deductions, totaling

$43,204.     Pursuant to Rule 34(b)(4), Schedule A deductions in

excess of those stipulated by the parties are deemed conceded by

petitioners.

       The issues remaining for decision are whether petitioners

are:    (1) Entitled to deductions on Schedule C, Profit or Loss

From Business; (2) entitled to offset a rental real estate loss

against wage income; and (3) liable for an accuracy-related

penalty under section 6662(a).

       The stipulated facts and the exhibits received into evidence

are incorporated herein by reference.       At the time the petition

in this case was filed, petitioners resided in Chadds Ford,

Pennsylvania.

                               Background

A.   Petitioner's Employment During 1999

       1.   Eli Lilly & Co.

       Dr. Isaac William Hammond (petitioner) worked full time

throughout 1999 for Eli Lilly & Co. (Eli Lilly) conducting

pharmaceutical research.      He received $149,615.82 as employee

wages from Eli Lilly in 1999.
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     2.     Indiana University

     In addition to his full-time employment, petitioner taught a

graduate-level class at Indiana University (the university) two

afternoons per week from January through May 1999.

     The university paid petitioner employee wages of $5,000 for

teaching for that period.     Petitioner was given an office in

which to meet students and to perform administrative duties as

well as office equipment and supplies to prepare course

materials.     Petitioner spent an additional 3 to 4 hours at home

each of the other week nights preparing for class and grading

student assignments.

     Petitioner estimates that he traveled 60 miles from Eli

Lilly to the university to teach each class.     Following class,

petitioner traveled about 90 miles from the university to his

home.     On Form 2106, Employee Business Expenses, petitioner did

not claim a deduction for vehicle expenses.

     On nights when he taught, petitioner bought dinner.     On Form

2106, petitioner claimed a deduction of $1,500 for meals.

     3.     Illinois/Indiana Emergency Medical

     On weekends throughout 1999, petitioner treated patients and

reviewed patient charts for Illinois/Indiana Emergency Medical

(IIEM) at various locations.     Most often, however, he performed

these services at Howard Community Hospital in Greensburg,

Indiana.
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      Petitioner received employee wages of $6,272.50 from IIEM

for his services.      Petitioner traveled 120 miles round trip from

his residence when he treated patients at Howard Community

Hospital.    He bought his meals when he worked there.

      4.   American Research Associates, Inc.

      As a result of his work at IIEM, petitioner became

interested in conducting medical research into the treatment of

hypertension.    He incorporated American Research Associates, Inc.

(ARA), as a nonprofit medical research corporation in Indiana on

June 15, 1999.

      To obtain funding for this medical research, petitioner

prepared and submitted several grant proposals to the National

Institutes of Health (NIH) in 1999.       He did not, however, receive

any grants from NIH during 1999.

B.   Petitioners' 1999 Federal Individual Income Tax Return

      On April 17, 2000, petitioners filed a joint Form 1040, U.S.

Individual Income Tax Return, for 1999.      Among the forms attached

to the return were Schedule A; two Schedules C; Schedule E,

Supplemental Income and Loss; Form 2106; and Form 8829, Expenses

for Business Use of Your Home.

      1.   Petitioners' Schedules C

            a.   ARA

      The first Schedule C petitioners attached to their 1999 Form

1040 was for ARA, which petitioners characterized as a medical
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research business.    Petitioners included the IIEM wages of

$6,272.50 in the $6,610 reported as gross income on the ARA

Schedule C.

     Petitioners deducted various business expenses totaling

$38,557.   They claimed car expenses of $26,075 based on the

number of miles petitioner traveled in 1999 using the same car

for commuting from his residence to Eli Lilly and traveling to

IIEM and to the university.    According to the service book for

petitioner's car, petitioner traveled a total of 25,657 miles.

On Form 4562, Depreciation and Amortization, petitioners claimed

that he used the car 100 percent for business and that he

traveled 60,000 miles in 1999.

     Petitioners deducted $2,100 for insurance premiums

petitioner says he paid for the car he used for travel in 1999.

Petitioner did not provide any records to substantiate these

expenditures.

     Petitioners deducted $450 for fees petitioner says he paid

to an attorney to review his employment contract with IIEM.    He

does not have a bill from the attorney nor any record of the

payment.

     Petitioners deducted $2,800 for office expenses on the 1999

Schedule C for ARA.    Petitioner cannot recall how he calculated

the amount of $2,800 and did not present any records to

substantiate that amount.
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     Petitioners deducted $500 for printer and copier supplies,

repairs, and maintenance.   Petitioner does not have any receipts

to substantiate that amount.

     Petitioners deducted $1,500 for taxes and licenses, which

respondent disallowed.   Respondent allowed petitioner's payments

for licenses as a miscellaneous itemized deduction on Schedule A.

     Petitioners deducted $3,567 on Schedule C for travel in 1999

as part of job-hunting expenses.    Respondent allowed as a

miscellaneous itemized deduction on Schedule A the $3,355 that

petitioner substantiated.

     Petitioners also deducted $1,500 in meal expenses and $5,395

for the business use of their home which respondent disallowed.

     Petitioners' claimed deductions exceeded the wages from IIEM

that were reported as gross income on the ARA Schedule C,

resulting in a reported loss of $37,342.    Petitioners applied the

reported loss against the $149,615.82 of wage income petitioner

received from Eli Lilly for 1999.    Respondent disallowed all the

deductions petitioners claimed on the ARA Schedule C.

          b.   ATE Consulting Services

     The second Schedule C was for ATE Consulting Services

(ATE), which petitioner characterized as a consulting business.

     Petitioners reported the $5,000 of teaching wages

petitioner received from the university as gross income on the

ATE Schedule C.
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      2.   Petitioners' Schedule E

      During 1999, petitioners owned a house in Lithonia, Georgia.

Petitioner received approval from DeKalb County, Georgia, to

participate in its public assistance program.      Petitioner

received rents of $11,405 for his tenants from DeKalb County

under that program.    On their Schedule E for 1999, petitioners

reported a rental real estate loss of $2,635 from the rental of

the house.

      Petitioners offset the rental real estate loss against the

wage income earned from Eli Lilly.      Respondent disallowed

petitioners' rental real estate loss.

C.   Accuracy-Related Penalty

      Respondent also determined that petitioners are liable for

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

                             Discussion

      Under section 7491(a)(1), the burden of proof may shift to

the Commissioner.    Because petitioners failed to meet the

requirements of section 7491(a)(2), the burden of proof does not

shift to respondent in this case.    As to the accuracy-related

penalty, respondent has the burden of production; the burden of

persuasion remains with petitioners.      See sec. 7491(c); Higbee v.

Commissioner, 116 T.C. 438, 446-447 (2001).

      Respondent's determinations are presumed correct, and

petitioners bear the burden of proving otherwise.      Welch v.
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Helvering, 290 U.S. 111, 115 (1933).     Moreover, deductions are a

matter of legislative grace, and petitioners bear the burden of

proving that they are entitled to any deduction claimed.      New

Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); Welch v.

Helvering, supra at 115.    This includes the burden of

substantiation.   Hradesky v. Commissioner, 65 T.C. 87, 90 (1975),

affd. per curiam 540 F.2d 821 (5th Cir. 1976).

A.   Petitioners' Schedule C Expenses

      It is well settled that a corporation is an entity distinct

from its shareholders.     Moline Props., Inc. v. Commissioner, 319

U.S. 436 (1943); Dalton v. Bowers, 287 U.S. 404, 410 (1932).

Furthermore, the business of a corporation is separate and

distinct from the business of its shareholders.      Moline Props.,

Inc. v. Commissioner, supra; Deputy v. DuPont, 308 U.S. 488, 494

(1940); Crook v. Commissioner, 80 T.C. 27, 33 (1983), affd.

without published opinion 747 F.2d 1463 (5th Cir. 1984).

Consequently, a shareholder is not entitled to a deduction for

the payment of corporate expenses.      Deputy v. DuPont, supra at

494; Hewett v. Commissioner, 47 T.C. 483 (1967).     Petitioner

incorporated ARA in Indiana in June 1999 and accordingly would

not be entitled to deduct ARA's expenses.

     To the extent that the claimed deductions related to

petitioner's employment at the university and IIEM, they were not

substantiated, as petitioners failed to substantiate any of the
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expenses claimed on the ARA Schedule C.       See sec. 6001; sec.

1.6001-1(a), (e), Income Tax Regs.       The Court sustains

respondent's disallowance of the ARA Schedule C deductions.

B.   Schedule E Rental Real Estate Losses

      Petitioners reported a rental real estate loss of $2,635

from the rental of their property in Georgia.       They applied the

loss against petitioner's wages from Eli Lilly.       Respondent

disallowed the loss.

      Section 469 generally prevents a taxpayer from deducting

passive activity losses from income unrelated to a passive

activity, requiring that passive losses be used only to offset

passive income.    Sec. 469; Schwalbach v. Commissioner, 111 T.C.

215, 223 (1998).    A taxpayer's right to make use of passive

activity losses in any year is limited to the amount of the

taxpayer's passive activity income for that year.       Sec. 469(a),

(d)(1).    Amounts disallowed may be carried forward to subsequent

years.    Sec. 469(b).   Subject to exceptions not relevant here, a

passive activity loss includes all losses from passive

activities, and a rental activity is defined by section 469(c)(2)

to be a "passive activity".

      Although petitioners are not entitled to offset the rental

real estate loss against petitioner's wages, section 469(i)

allows a taxpayer to claim up to $25,000 per year in passive

activity losses from rental real estate activities in which the
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taxpayer actively participated, subject to a phaseout once the

taxpayer's adjusted gross income exceeds $100,000.        The $25,000

exemption is phased out by 50 percent of the amount by which the

adjusted gross income of the taxpayer for the taxable year

exceeds $100,000.   Sec. 469(i)(3).       For this purpose, the

taxpayer's adjusted gross income is determined without regard to

any passive activity loss.      Sec. 469(i)(3)(F)(iv).    Respondent

concedes that petitioner actively participated in the rental real

estate activity.

      On their 1999 tax return, petitioners reported $149,616 in

wages, $53 in taxable interest, $3,521 in taxable refunds or

credits, $6,272.50 in wages from IIEM, and $5,000 in wages from

the university for an adjusted gross income (without the passive

activity loss) of $164,462.50.      Petitioners' adjusted gross

income exceeds $100,000 by $64,462.50.        Fifty percent of

$64,462.50 is $32,231.25.    When petitioners' maximum offset

amount of $25,000 is reduced by $32,231.25, it is completely

eliminated.   Thus, the Court sustains respondent's determination

disallowing petitioners' rental real estate loss.

C.   Accuracy-Related Penalty

      Respondent determined that petitioners are liable for the

accuracy-related penalty under section 6662(a).        Section 6662(a)

imposes a 20-percent penalty on the portion of an underpayment

attributable to any one of various factors, including negligence
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or disregard of rules or regulations and a substantial

understatement of income tax.    See sec. 6662(b)(1) and (2).

"Negligence" includes any failure to make a reasonable attempt to

comply with the provisions of the Internal Revenue Code,

including any failure to keep adequate books and records or to

substantiate items properly.    See sec. 6662(c); sec. 1.6662-

3(b)(1), Income Tax Regs.   A "substantial understatement"

includes an understatement of tax of $5,000 or more.     See sec.

6662(d); sec. 1.6662-4(b), Income Tax Regs.

     Section 6664(c)(1) provides that the penalty under section

6662(a) shall not apply to any portion of an underpayment if it

is shown that there was reasonable cause for the taxpayer's

position and that the taxpayer acted in good faith with respect

to that portion.   The determination of whether a taxpayer acted

with reasonable cause and in good faith is made on a case-by-case

basis, taking into account all the pertinent facts and

circumstances.   Sec. 1.6664-4(b)(1), Income Tax Regs.    The most

important factor is the extent of the taxpayer's effort to assess

his proper tax liability for the year.    Id.

     Petitioner failed to keep adequate books and records

reflecting expenses of his ARA activities and to properly

substantiate other items reported on the return.     See sec.

6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.     There is an

understatement of tax greater than $5,000.      The Court concludes
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that respondent has produced sufficient evidence to show that the

section 6662 accuracy-related penalty is appropriate.   Nothing in

the record indicates petitioners acted with reasonable cause and

in good faith.   The Court holds that the record supports

respondent's determination that petitioners are liable for the

accuracy-related penalty.

     Reviewed and adopted as the report of the Small Tax Case

Division.

     To reflect the foregoing,


                                         Decision will be

                                    entered for respondent.
