                         T.C. Summary Opinion 2013-54


                         UNITED STATES TAX COURT



 JEAN MARIE FONTAYNE AND YVES RAYMOND FONTAYNE, Petitioners
       v. COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 5492-12S.                            Filed July 3, 2013.



      Jean Marie Fontayne and Yves Raymond Fontayne, pro sese.

      Vivian Bodey, for respondent.



                              SUMMARY OPINION


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

of section 7463 of the Internal Revenue Code in effect when the petition was filed.

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
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case. 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.

      Respondent issued a notice of deficiency to petitioners in which he

determined a deficiency of $10,414 as well as a section 6662(a) accuracy-related

penalty of $2,082.80 for 2008. Respondent allowed a deduction of $200 for trade

publication expenses but disallowed the remainder of petitioners’ employee

business expense deductions.1 Petitioners conceded at trial that they are not

entitled to the employee business expense deductions adjusted by respondent. The

issues remaining for decision are whether petitioners are: (1) entitled to

deductions claimed for business expenses reported on Schedule C, Profit or Loss

From Business;2 and (2) liable for a section 6662(a) accuracy-related penalty.




      1
       It appears from the notice of deficiency and the income tax return that
respondent also allowed as an itemized deduction a $500 tax preparation fee. The
original return and the amended return both state that they are “self-prepared”.
Respondent, however, failed to adjust the amount and did not request an increased
deficiency.
      2
      Other adjustments made to petitioners’ self-employment tax are
computational and will not be discussed.
                                         -3-

                                    Background

      Some of the facts have been stipulated and are so found. The stipulation of

facts and the attached exhibits are incorporated herein by reference. Petitioners

resided in California when they filed their petition.

      Throughout 2008 both petitioners worked for Vitesse Semiconductor Sales

Corp. (Vitesse). Petitioner Yves Raymond Fontayne (Mr. Fontayne) was an

employee of Vitesse the entire year. Petitioner Jeane Marie Fontayne (petitioner)

worked part time as an independent contractor from her home from January to July

2008. Working from home enabled petitioner to care for her and Mr. Fontayne’s

three-year-old child. At some point in 2008 petitioner’s supervisor retired and his

replacement told her to come to work as a full-time employee or he would end her

contract and find another person to be a full-time employee. In July 2008,

petitioner became a full-time employee of Vitesse.

      Pursuant to her agreement with Vitesse, petitioner was required to work

from the Vitesse office at least two days a week; because of her desire to work

from home and her proven ability to complete her assignments from her home, she

was allowed to work from home up to three days per week.

      Petitioners had moved into their home in January 2008. Petitioner

designated in her house a room with a closet and a bathroom as her office space.
                                          -4-

Petitioner did not see clients in her home office, nor did she receive anyone from

Vitesse in her home office. At some point in 2008 petitioners decided to make

changes to the home office area.

        Petitioners’ contractor, at their instruction, removed the wall separating the

office area from the living room and replaced it with one 14 inches further into the

living room, increasing the size of the office while decreasing the size of the living

room. Petitioners also improved the home office area by replacing all the

carpeting, retiling the bathroom, and by installing an under-the-floor heating

system, a programmable thermostat, a central vacuum system, and a fireproof safe

in the closet of the home office area. The receipts for the supplies used for the

improvements are dated November and December 2008, and the $10,500 check

paying the contractor for his work was both dated, and negotiated, in December

2008.

        Petitioners timely filed their 2008 Federal income tax return. On their

Schedule C petitioners reported a tentative profit of $24,728 with respect to

petitioner’s consulting work for Vitesse. Also on the Schedule C, petitioners

reported expenses of $24,728 for business use of their home relating to her

consulting work.
                                         -5-

      Respondent selected petitioners’ 2008 Federal income tax return for

examination. On December 20, 2011, respondent issued a notice of deficiency to

petitioners disallowing some claimed employee business expenses as personal

expenses, reducing the business use of home percentage, and prorating other

claimed home office expenses to reflect petitioner’s change in employment status

from part-time contractor to full-time employee.

                                     Discussion

      Generally, the Commissioner’s determinations are presumed correct, and the

taxpayer bears the burden of proving that those determinations are erroneous.

Rule 142(a); see INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Welch

v. Helvering, 290 U.S. 111, 115 (1933). In some cases the burden of proof with

respect to relevant factual issues may shift to the Commissioner under section

7491(a). Petitioners did not argue or present evidence that they satisfied the

requirements of section 7491(a). Therefore, petitioners bear the burden of proof

with respect to the issues in the notice of deficiency.

      Deductions and credits are a matter of legislative grace, and the taxpayer

bears the burden of proving that he or she is entitled to any deduction or credit

claimed. Rule 142(a); Deputy v. du Pont, 308 U.S. 488, 493 (1940); New

Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Additionally, a taxpayer
                                        -6-

must substantiate all expenses. Sec. 6001; Hradesky v. Commissioner, 65 T.C. 87,

89 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976).

Schedule C Business Expenses

      Section 162 generally allows a deduction for ordinary and necessary

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

business. Generally, no deduction is allowed for personal, living, or family

expenses. See sec. 262. The taxpayer must show that any claimed business

expenses were incurred primarily for business rather than personal reasons.

See Rule 142(a); Walliser v. Commissioner, 72 T.C. 433, 437 (1979). To show

that the expense was not personal, the taxpayer must show that the expense was

incurred primarily to benefit his or her business, and there must have been a

proximate relationship between the claimed expense and the business. See

Walliser v. Commissioner, 72 T.C. at 437. The performance of services as an

employee is considered a trade or business for section 162 purposes. Primuth v.

Commissioner, 54 T.C. 374, 377 (1970).

      Home Office Expenses

      On Schedule C petitioners reported gross receipts from petitioner’s work at

home of $27,511 and total expenses before business use of their home of $2,783,

for a tentative profit of $24,728. Petitioners claimed on Form 8829, Expenses for
                                        -7-

Business Use of Your Home, allowable expenses for business use of their home of

$24,728. Petitioners claimed that their home is 3,100 square feet and that 554

square feet, or 17.87% of their home, was used regularly and exclusively for

business.3 Petitioners reported the following direct and indirect expenses on Form

8829:

                                       Direct expense     Indirect expense

        Insurance                           ---              $3,708
        Repairs and maintenance           $16,501             6,654
        Utilities                              699           13,164
        Other expenses                      ---               8,276
          Total                            17,200            31,802

Petitioners reported “allowable operating expenses” of $22,883.4 Petitioners

added to that “allowable casualty losses and depreciation” of $1,845 to arrive at

the claimed “allowable expenses for business use of your home” of $24,728.

        In the notice of deficiency respondent allowed only $1,113 as business use

of home expenses, which included $391 of real estate taxes removed from

Schedule A and recharacterized as a business expense due to petitioner’s business



        3
      At trial petitioners conceded their claimed business use of home percentage
was overstated and reduced their claimed percentage to 9.9%.
        4
        This amount was computed by multiplying the business use of home
percentage by the total indirect expenses (17.87% x $31,802 = $5,683) and adding
that to the total of the direct expenses ($5,683 + $17,200 = $22,883).
                                        -8-

use of the home. Although respondent agrees that petitioner had a home office,

respondent asserts that expenses related to the home office should be restricted to

the period during which petitioner was a part-time independent contractor.

Respondent’s adjustments also reflect a change in the percentage of the home used

for business as well as a partial or complete disallowance of business expense

deductions claimed for repairs and maintenance, utilities, and other expenses.

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

of a dwelling unit that the taxpayer uses 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 uses exclusively and regularly as the

principal place of business for a taxpayer’s trade or business. In the case of an

employee, the exception applies only if the use of the home office is for the

convenience of the employer. Id. Any personal use of a room or segregated area

will preclude its use in computing depreciation or other allocable expenditures,

unless some or all of the use of the room was for the storage of inventory. See

Hefti v. Commissioner, T.C. Memo. 1993-128.

      Respondent agrees that it was proper for petitioners to deduct home office

expenses for the period during which petitioner was an independent contractor.

The record shows, however, that petitioner’s new supervisor needed petitioner to
                                          -9-

take on responsibilities that required additional working hours and a presence at

the Vitesse office. Vitesse provided petitioner with an office and required her to

work out of the Vitesse office at least two days every week. Petitioner’s belief

that she was more productive in her home office is of no legal moment.

Petitioners offered in support of their position a letter from petitioner’s supervisor

stating that the split work location arrangement was “beneficial” for Vitesse. But

petitioners offered no evidence that Vitesse required or directed that petitioner

work from her home. Petitioner was allowed to work from home part-time at her

own request and for her own convenience. As a result, petitioners are not entitled

to a home office expense deduction for the period August through December

2008.5

         Petitioners’ calculation of the business use of their home originally included

square footage for a hallway, an entryway, a room, a bathroom, and a closet. At

trial petitioners agreed that their initial claim of 554 square feet was overstated and

         5
         Petitioners testified that they also used the home office area to have
conference calls and do research into whether to begin a real estate business in
Florida. The documents provided to corroborate that testimony are largely
unsigned and undated, and it is unclear to the Court whether these efforts began, if
at all, in 2008. The one document petitioners provided that was signed includes
only the signatures of petitioners. There is insufficient evidence that the home
office area was used regularly and exclusively as the principal place of business
for the real estate business in 2008. See Tokarski v. Commissioner, 87 T.C. 74, 77
(1986).
                                        - 10 -

in fact the home office was 307.5 square feet. Petitioners initially calculated the

square footage using measurements from the outside of the house and the exterior

wall measurement from the hallway and the living room. Petitioners’ calculation

at trial removes the square footage for the hallway and entryway but is still based

on measurements from the hallway and the living room taken outside the home.

      The Court agrees with respondent that the bathroom was not used

exclusively and on a regular basis for business, nor could it be considered an area

where petitioner conducted substantial administrative or management activities of

a trade or business. See sec. 280A(c)(1). Petitioner received no clients in her

home office, nor did she meet with anyone from Vitesse there. The Court also

agrees that petitioner did not use the closet area exclusively and on a regular basis

for her work with Vitesse. Petitioners installed a fireproof safe in that closet in

November or December 2008, which they used to store personal items. Petitioner

performed financial audits, and Vitesse provided her with a laptop, a laptop

docking station, and the financial information needed for the audits. There is no

evidence that petitioner was required to store any inventory or other items for

Vitesse, nor is there any evidence that she used the closet for any reason related to

her work for Vitesse.
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      Although the Court disagrees with petitioners’ calculations, with respect to

the main office space the Court also finds respondent’s position untenable.

Respondent’s examiner determined that petitioner needed only an area of 9 by 11

feet, or 99 square feet, in order to perform her tasks for Vitesse. It appears to the

Court, however, that the interior office space was exclusively and regularly used

by petitioner when performing her work for Vitesse as a contractor. While the

Court does not agree that petitioners’ method of using exterior wall measurements

is accurate, the Court finds that respondent’s determination of the size of the space

petitioner needed to perform her work is arbitrary. On the basis of the stipulated

exhibits provided, the Court has estimated the interior office space. See Cohan v.

Commissioner, 39 F.2d 540 (2d Cir. 1930). Bearing heavily against petitioners,

whose inexactitude is of their own making, the Court finds that the area of their

home used for business is 180 square feet.6

             Direct Expenses

      Mr. Fontayne removed some bookcases from the home office and testified

that in so doing, he damaged the wall that was subsequently removed and


      6
       The estimate concludes the interior office dimensions to be 15 by 12 feet,
or 180 square feet, which is 5.8% of the home. For the reasons more fully
described below, this estimate does not include the additional square footage
created by petitioners’ moving one office wall 14 inches into the living room.
                                       - 12 -

replaced. At some point in 2008 petitioners decided to make changes to the home

office area. The changes included, among other things, expanding the office space

by moving one wall 14 inches into the living room area, replacing the carpeting,

installing a safe in the closet, and making other major changes to the heating and

cooling systems. The record reflects that petitioners purchased the required

materials in November and December 2008 and paid the contractor in December

2008. Petitioners’ claim that these alterations were necessary for petitioner to be

able to work in the home office is self-serving. An under-the-floor heating system

is hardly an ordinary and necessary business expense. Further, the Court finds that

the alterations were made at the end of 2008, when the home office was no longer

her only office and was not maintained for the convenience of her employer.

      Petitioners characterize the work done on the office wall that was removed

and replaced as a “repair” of damage caused by Mr. Fontayne. It appears to the

Court, however, that the expense incurred to remove and replace the wall was not

a repair or maintenance expense but was instead a capital expenditure.

      No deduction is allowed for expenditures for permanent improvements or

betterments that increase the value of any property. Sec. 263. “To repair is to

restore to a sound state or to mend, while a replacement connotes a substitution.”

Jenkins v. Commissioner, T.C. Memo. 1982-407 (removal and replacement of
                                        - 13 -

ceiling was capital improvement). Generally, an expenditure to acquire an asset

with a useful business life exceeding one year is treated as a capital expenditure

and is not currently deducible as a business expense. Webb v. Commissioner, 55

T.C. 743, 744-745 (1971); Rowell v. Commissioner, T.C. Memo. 1988-410

(improvements to office bathroom were capital expenditures and not currently

deductible), aff’d, 884 F.2d 1085 (8th Cir. 1989); Ross v. Commissioner, T.C.

Memo. 1984-352 (sign advertising business was capital asset), aff’d without

published opinion, 780 F.2d 1028 (9th Cir. 1985). Mr. Fontayne’s testimony that

the carpeting was “gross” and the damaged wall had mold suggests that replacing

these items appreciably prolonged the useful life of the office and added to its

value. Likewise, the new heating system, new central vacuum, and new tile in the

bathroom are items having a useful life of more than a year and add to the value of

the home. As a result, petitioners are not entitled to deduct these expenses as

direct expenses related to the business use of the home and must instead capitalize

the costs.

      Petitioners claimed a direct utilities expense of $699 which was the cost of

the monthly home telephone expense. Under section 262(b) the cost of basic local

telephone service with respect to the first telephone line provided to a residence is
                                       - 14 -

a personal expense and is not deductible. We agree with respondent that none of

this expense is allowable.

            Indirect Expenses

      With respect to the indirect repairs and maintenance expense of $6,654,

petitioners offered no evidence. Petitioners did supply the Court with a summary

of the expenses that included the date of the repairs, the company that performed

the repairs, and the amount of each repair expense. The Court, however, is unable

to determine whether petitioners in fact incurred these expenses or how they may

have related to any repair or maintenance of the home. Therefore, petitioners are

not entitled to a deduction for the claimed indirect repairs and maintenance

expenses.

      Petitioners claimed $3,708 in insurance expenses as an indirect expense on

Form 8829. At trial petitioners reduced their claim to $2,244, which reflected the

removal of the claimed automobile insurance expenses. The examiner agreed that

the remaining insurance expenses were generally allowable but should be reduced

for the period of petitioner’s full-time employment. The home office was no

longer maintained at the convenience of Vitesse once petitioner became a full-time

employee, and thus the Court agrees that expenses for the home office were not

allowable as of August 2008.
                                          - 15 -

         Petitioners claimed indirect utilities expenses of $13,164. At trial

petitioners reduced their claim to $6,026, which reflected the removal of the

claimed housekeeper expenses, gardener expenses, and homeowners association

fees. Respondent allowed $3,743, which included electric, gas, sewer, water, and

trash expenses from January through July.7 The Court agrees that petitioners may

not deduct expenses related to the home office for the period after petitioner

became a full-time employee.

         Petitioners claimed other expenses of $8,276. This amount included

expenses for a refrigerator, water filters, a central vacuum, blinds and installation,

home inspection, title fees, and escrow charges. Petitioners conceded this item at

trial.

Accuracy-Related Penalty

         Taxpayers may be liable for a 20% penalty on the portion of an

underpayment of tax attributable to negligence or a substantial understatement of

income tax. Sec. 6662(a) and (b)(1) and (2). 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 that is shown on the return, reduced by


         7
      It appears that these expenses total only $3,636.52; however, respondent
allowed the amount and has not requested an increase in deficiency.
                                       - 16 -

any rebate. See sec. 6662(d)(2)(A). An understatement is substantial if it exceeds

the greater of 10% of the tax required to be shown on the return for the taxable

year or $5,000. See sec. 6662(d)(1)(A).

      The term “negligence” in section 6662(b)(1) includes any failure to make a

reasonable attempt to comply with the Internal Revenue Code, and the term

“disregard” includes any careless, reckless, or intentional disregard. Sec. 6662(c).

Negligence has also been defined as the failure to exercise due care or the failure

to do what a reasonable person would do under the circumstances. See Allen v.

Commissioner, 92 T.C. 1, 12 (1989), aff’d, 925 F.2d 348, 353 (9th Cir. 1991);

Neely v. Commissioner, 85 T.C. 934, 947 (1985). Negligence also includes any

failure by the taxpayer to keep adequate books and records or to substantiate items

properly. Sec. 1.6662-3(b)(1), Income Tax Regs.

      The Commissioner bears the burden of production with respect to the

applicability of an accuracy-related penalty determined in a notice of deficiency.

Sec. 7491(c). In order to meet that burden, the Commissioner need only make a

prima facie case that imposition of the penalty is appropriate. Higbee v.

Commissioner, 116 T.C. 438, 446 (2001). Once that burden is met, the taxpayer

bears the burden of proving that the accuracy-related penalty does not apply

because of reasonable cause, substantial authority, or the like. Secs.
                                       - 17 -

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

has met his burden of production for the accuracy-related penalty on the basis of a

substantial understatement of income tax because petitioners’ understatement of

income tax exceeds $5,000, which is greater than 10% of the tax required to be

shown on the return. It also appears petitioners were negligent in the preparation

of their return, acknowledging that they overstated the percentage of their home

used for business and claimed business expense deductions for personal expenses.

      A taxpayer may avoid the application of an accuracy-related penalty by

proving he acted with reasonable cause and in good faith. See sec. 6664(c)(1); see

also Higbee v. Commissioner, 116 T.C. at 446-447; sec. 1.6664-4(a),

Income Tax Regs. We analyze whether a taxpayer acted with reasonable cause

and in good faith by examining the relevant facts and circumstances and, most

importantly, the extent to which the taxpayer attempted to determine his proper tax

liability. See Neely v. Commissioner, 85 T.C. at 947; Stubblefield v.

Commissioner, T.C. Memo. 1996-537; sec. 1.6664-4(b)(1), Income Tax Regs. In

order for the reasonable cause exception to apply, the taxpayer must prove that he

exercised ordinary business care and prudence as to the disputed items.

Neonatology Assocs. P.A. v. Commissioner, 115 T.C. 43, 98 (2000), aff’d, 299

F.3d 221 (3d Cir. 2002).
                                        - 18 -

      Although petitioner claimed a $500 expense for tax preparation fees and

respondent allowed the deduction, all of the tax return documents in the record

state that they were self-prepared. Petitioners made no statement about their

preparer, if any, and what attempts they made to determine their proper tax

liability. As a result, we conclude that petitioners are liable for the accuracy-

related penalty.

      We have considered all of petitioners’ arguments, and, to the extent not

addressed herein, we conclude that they are moot, irrelevant, or without merit.

      To reflect the foregoing,


                                                      Decision will be entered

                                                 under Rule 155.
