                          T.C. Summary Opinion 2015-28



                         UNITED STATES TAX COURT



      BAHRAM M. TARIGHI AND PARVANEH TARIGHI, Petitioners v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 7654-13S.                          Filed April 13, 2015.



      Bahram M. Tarighi and Parvaneh Tarighi, pro sese.

      Elizabeth C. Mourges, for respondent.



                              SUMMARY OPINION


      GERBER, Judge: This case was heard pursuant to the provisions of section

74631 of the Internal Revenue Code in effect when the petition was filed.



      1
      Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
                                          -2-

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.

       Respondent determined deficiencies in petitioners’ Federal income tax and

penalties as follows:

                                         Addition to tax               Penalty
      Year           Deficiency          sec. 6651(a)(1)            sec. 6662(a)

      2009            $10,531                $74.80                   $2,106.20
      2010             19,465                  -0-                     3,893.00
      2011              1,763                  -0-                        -0-

After concessions the issues remaining for our consideration are: (1) whether Mr.

Tarighi was engaged in a trade or business; (2) whether petitioners are entitled to

various itemized deductions; (3) whether petitioners failed to report a State tax

refund received in 2010; (4) whether petitioners are liable for an addition to tax for

the failure to timely file their 2009 return; and (5) whether petitioners are liable for

accuracy-related penalties for 2009 and 2010.

                                      Background

      Petitioners resided in Maryland at the time their petition was filed.

Petitioners’ joint income tax return for 2009 was due on April 15, 2010, and was

filed on April 25, 2010. Petitioners’ joint income tax returns for 2010 and 2011

were timely filed.
                                         -3-

      At the time of trial Mr. Tarighi was a civil engineer with 25 years of

experience as a highway designer and construction engineer. After many years of

being an employee, Mr. Tarighi wanted to start his own company. In 2008, after

encouragement from his family and while still employed, he decided to pursue this

goal. He selected the name Civil Engineering Services (CES), had business cards

printed, designed stationery, and set up a Web site. Mr. Tarighi also purchased a

computer, a desk, and other office supplies and set up an office in the basement of

his home.

      In mid-2008 Mr. Tarighi’s employer dramatically reduced his salary, and he

decided he would devote more of his time to developing CES. From his experience

in the field Mr. Tarighi knew many contractors and project engineers performing

work on the local highways in Maryland. He regularly visited construction sites

after work to distribute business cards and speak with managers and others

performing construction on the local highways. In addition to promoting his

business, Mr. Tarighi would use these trips to stay abreast of developments in the

highway construction engineering industry. He continued these visits throughout

2009, 2010, and 2011 (years at issue).

      During 2009 and the first half of 2010 Mr. Tarighi was employed by Wallace

Montgomery & Associates (Wallace Montgomery). Wallace Montgomery had a
                                       -4-

contract with the Maryland Transit Association (MTA), and Mr. Tarighi worked

exclusively on this contract. Mr. Tarighi worked in the MTA’s office. It has not

been shown how often Mr. Tarighi would drive from his home to Wallace

Montgomery’s office before going to the MTA’s office and how often he would

drive from his home directly to the MTA’s office.

      During the second half of 2010 Mr. Tarighi worked for Progressive

Engineering Services (Progressive). MTA contracted with Progressive to perform

the work that MTA had previously contracted Wallace Montgomery to perform.

While employed by Progressive Mr. Tarighi worked in the MTA’s office and drove

from his home directly to the MTA’s office each day. Progressive’s contract with

the MTA was completed on December 3, 2010. Mr. Tarighi became unemployed

when Progressive’s contract with MTA ended, and he rejected a job offer from

Wallace Montgomery to focus his attention on CES.

      Petitioners claimed deductions for the following expenses related to CES on

Schedules C, Profit or Loss From Business, attached to their 2009 and 2010

Federal income tax returns:

                Expense                      2009             2010
         Taxes and licenses                  $840             $255
         Supplies                             380              110
                                        -5-

          Repairs and maintenance             4,400              -0-
          Office                               770               650
          Interest-mortgage                   6,500            5,090
          Insurance (other than
            health)                           1,200              -0-
          Depreciation and sec. 179           2,947            9,990
          Advertising                          980             1,200
          Car and truck                    10,574              8,133
          Business use of the home            4,588           12,190
          Meals and entertainment             8,800              -0-
          Utilities                           2,200            1,050
          Travel                              2,450            1,500
          Legal and professional
           services                            -0-               180
          Commissions and fees                 -0-               420
          Other                                -0-             4,850
            Total                          46,629             45,618

Respondent disallowed deductions for the Schedule C expenses because of lack of

substantiation.

      During the years at issue CES did not have any clients, was not hired to

perform any services, did not bid on any highway engineering jobs, and had no

income. Mr. Tarighi provided a calendar with cryptic handwritten notes to

substantiate the miles he drove for CES during the years at issue. Petitioners had a
                                         -6-

flood in their basement in 2010 and lost some of the receipts related to CES. Mr.

Tarighi was unable to produce records or receipts for tolls incurred, meals and

entertainment expenses, office supplies, his office furniture, or his office computer.

As substantiation for his home office expenses Mr. Tarighi provided copies of his

household utility bills. The amounts on the bills were inconsistent with the

amounts of his deductions for CES during the years at issue.

      Respondent also disallowed the following deductions on Schedules A,

Itemized Deductions, for lack of substantiation: the 2009 deduction for other taxes,

the 2009 and 2010 medical and dental expense deductions, and deductions for

unreimbursed employee business expenses for the years at issue. Respondent also

adjusted the amount of petitioners’ 2009 Schedule A deduction for real estate taxes

on the basis of the information that petitioner’s lenders provided.

      For 2009 petitioners claimed a $6,945 deduction for State income taxes. In

2010 petitioners received a State income tax refund of $6,945 from the State of

Maryland for the 2009 tax year, and this amount was not reported on their 2010

return.

                                     Discussion

      We must decide whether petitioners have shown that they are entitled to

deduct amounts greater than those respondent allowed for the years at issue and
                                         -7-

whether they failed to include their State income tax refund in income for 2010.2

We also must decide whether petitioners are liable for a failure to timely file

addition to tax for 2009 and whether they are liable for accuracy-related penalties

for 2009 and 2010.

Startup Expenses Reported on Schedules C

      Section 162(a) generally allows taxpayers to deduct ordinary and necessary

expenses paid or incurred in connection with a trade or business. In order for a

taxpayer to deduct expenses, the trade or business must be functioning as a going

concern and performing the activities for which it was organized at the time that

the expenses are incurred. Richmond Television Corp. v. United States, 345 F.2d

901, 907 (4th Cir. 1965), vacated and remanded on other grounds, 382 U.S. 68

(1965); Hardy v. Commissioner, 93 T.C. 684, 687-693 (1989), aff’d in part,

remanded in part, 1990 U.S. App. LEXIS 19670 (10th Cir. Oct. 29, 1990); Woody

v. Commissioner, T.C. Memo. 2009-93, aff’d, 403 Fed. Appx. 519 (D.C. Cir.

2010); Glovtov v. Commissioner, T.C. Memo. 2007-147. Although section 162(a)

       2
        The determinations in the Commissioner’s notice of deficiency are
generally presumed correct, and the taxpayer bears the burden of proving
otherwise. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). No
question was raised by either party regarding shifting the burden of proof or going
forward with the evidence, and petitioners have not shown that the burden should
shift to respondent. Thus, the burden of proof remains on petitioners. See sec.
7491(a).
                                         -8-

does not allow the deduction of startup and preopening expenses, it may be

possible to deduct them over time. Sec. 195; Hardy v. Commissioner, 93 T.C. at

687-693.

      Whether a taxpayer is engaged in a trade or business for purposes of section

162(a) depends on the facts and circumstances of each case. Woody v.

Commissioner, T.C. Memo. 2009-93. The Court has focused on the following

three factors when making this determination: (1) whether the taxpayer undertook

the activity intending to earn a profit; (2) whether the taxpayer is regularly and

actively involved in the activity; and (3) whether the taxpayer’s activity has

actually commenced. See id.

      On the basis of the evidence presented, we conclude that Mr. Tarighi was not

engaged in a trade or business for purposes of section 162(a) during the years at

issue. CES did not have any income or clients and did not bid on any jobs during

the years at issue. Though Mr. Tarighi frequently visited construction sites to

promote CES, if he had the intention of earning a profit, he would have pursued

contracts and bid on jobs. Mr. Tarighi’s actions exemplify steps taken to set up a

business, not those of a business that has commenced and is presently operating as

a going concern.
                                         -9-

      We hold that the amounts reported on petitioners’ 2009 and 2010 Schedules

C are startup expenses and may not be deducted pursuant to section 162(a).

Consequently, we need not address whether petitioners have provided sufficient

evidence to substantiate the amounts reported on Schedules C.

Adjustments to Itemized Deductions

      Deductions are a matter of legislative grace, and taxpayers bear the burden of

establishing that they are entitled to any claimed deduction. Rule 142(a);

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Taxpayers are required

to maintain sufficient records to allow the Commissioner to determine their correct

tax liability. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.

      Real Estate Taxes

      Taxpayers may deduct State and local real property taxes paid or accrued

within the taxable year. Sec. 164(a). Petitioners claimed a $6,347 deduction for

real estate taxes on their 2009 return. Petitioners’ lender reported to respondent

that petitioners paid $3,834.50 in real estate taxes in 2009. Petitioners have not

provided substantiation to support a deduction greater than the amount reported by

the lender and are not entitled to deduct more than $3,834.50 for 2009.

      On their 2010 return petitioners claimed a $3,015 deduction for real estate

taxes. Petitioners’ lender reported that petitioners paid $4,120.61 in real estate
                                         - 10 -

taxes in 2010. While this discrepancy was not noted in the notice of deficiency, the

lender’s report substantiates that petitioners are entitled to a deduction greater than

what was reported on their 2010 return.

      Other Taxes

      In addition to State, local and foreign real property taxes, section 164(a)

allows a deduction for various other State, local and foreign taxes paid or accrued

during the taxable year. Petitioners claimed a $790 deduction for “other taxes” on

their 2009 return. Petitioners have not provided any support to substantiate this

deduction and are not entitled to a deduction for “other taxes.”

      Medical, Dental and Insurance Premiums

      Section 213(a) generally allows a deduction for expenses paid during the

taxable year for medical care of the taxpayer, his spouse, or a dependent that is not

compensated for by insurance, to the extent the expenses exceed 7.5% of adjusted

gross income. “Medical care” is broadly defined to include amounts paid for “the

diagnosis, cure, mitigation, treatment, or prevention of disease” or for insurance

covering such things. Sec. 213(d)(1)(A), (D).

      In order to deduct expenses for medical care, taxpayers are specifically

required to “furnish the name and address of each person to whom payment for

medical expenses was made and the amount and date of the payment”. Sec. 1.213-
                                         - 11 -

1(h), Income Tax Regs. Further, payments for medical insurance premiums may be

deducted only if the payments were made with money that was included in the

taxpayer’s gross income. Adams v. Commissioner, T.C. Memo. 2013-92; Lenihan

v. Commissioner, T.C. Memo. 2006-259, aff’d, 296 Fed. Appx. 160 (2d Cir. 2008).

      Petitioners claimed deductions of $13,250 for 2009 and $5,995 for 2011,

before the application of the 7.5% adjusted gross income limitation. Mr. Tarighi

submitted a handwritten summary at trial claiming that petitioners’ medical

expenses were $11,098.39 for 2009, $11,066.27 for 2010 and $8,952.12 for 2011.

Petitioners also submitted copies of invoices and statements from various medical

and dental providers, explanations of benefits from multiple insurance companies,

canceled checks, and receipts. Petitioners did not show that their insurance

premiums were paid with after-tax dollars.

      Respondent determined that the petitioners substantiated medical expenses

of $810 for 2009, $306 for 2010, and $108 for 2011. On the basis of the evidence

submitted at trial, we find that petitioners are not entitled to deduct any of their

medical expenses because their substantiated expenses do not exceed 7.5% of their

adjusted gross income.
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      Unreimbursed Employee Business Expenses

      For 2009, 2010 and 2011 petitioners claimed deductions of $57,820,3

$87,7304 and $10,105,5 respectively, for unreimbursed employee mileage expenses

Mr. Tarighi incurred as an employee. Generally, a taxpayer’s costs of commuting

from home to his or her place of business or employment are personal expenses

that may not be deducted. Sec. 1.262-1(b)(5), Income Tax Regs.; see also sec.

212(a); sec. 1.212-1(f), Income Tax Regs. However, a taxpayer may be able to

deduct expenses incurred in commuting between one or more business locations.

Dehr v. Commissioner, T.C. Memo. 1998-441; Friend v. Commissioner, T.C.

Memo. 1990-144, aff’d without published opinion, 937 F.2d 608 (6th Cir. 1991).

In order for a taxpayer to deduct the business mileage of a passenger vehicle, the



       3
        These amounts were reported on the 2009 return as unreimbursed employee
business expenses. At trial Mr. Tarighi testified that these deductions were
entirely for unreimbursed mileage expenses.
       4
        Petitioners’ 2010 return reported $66,371 as unreimbursed employee
business expenses and $21,359 as other miscellaneous itemized deductions subject
to the 2% adjusted gross income limitation. Petitioners did not provide any
evidence regarding these deductions at trial, and, on the basis of Mr. Tarighi’s
testimony, we find that these amounts should also have been reported as
unreimbursed employee business expenses.
       5
        These amounts were reported on the 2011 return as unreimbursed employee
business expenses. At trial Mr. Tarighi testified that these deductions were
entirely for unreimbursed mileage expenses.
                                        - 13 -

strict substantiation requirements of section 274(d) must be met. Secs. 274(d)(4),

280F(d)(4). Taxpayers must generally establish: (1) the amount of the business

use of each vehicle in terms of mileage; (2) the exact date(s) of the use of the

vehicle; and (3) the business purpose with respect to each expenditure or use.

Robinson v. Commissioner, T.C. Memo. 2014-120; sec. 1.274-5T(b)(6),

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

      During 2009 and the first half of 2010 Mr. Tarighi was employed by Wallace

Montgomery and worked exclusively on Wallace Montgomery’s contract with the

MTA. Wallace Montgomery’s policy was to reimburse employees for each mile

driven in excess of 30 miles. Mr. Tarighi claimed reimbursement for the miles he

drove to the MTA’s office that he was not reimbursed for under Wallace

Montgomery’s policy. Yet, on the basis of the evidence presented, it is not

possible to determine how often Mr. Tarighi drove directly to the MTA’s office

from his home and how often he drove from his home to Wallace Montgomery’s

office and then to the MTA’s office. Further, Mr. Tarighi did not maintain a log of

miles driven for Wallace Montgomery. We accordingly hold that petitioners have

not presented sufficient substantiation to meet the stricter standards for business

travel and to support a deduction for the unreimbursed mileage expenses for 2009

and 2010 incurred while Mr. Tarighi was employed by Wallace Montgomery.
                                        - 14 -

        Mr. Tarighi was employed by Progressive during the second half of 2010

and worked on Progressive’s contract with the MTA. Mr. Tarighi testified that he

drove from his home directly to the MTA’s office every day. The MTA’s office

was Mr. Tarighi’s place of employment while he was employed by Progressive.

Because the cost of commuting is a nondeductible personal expense, petitioners are

not entitled to a deduction for unreimbursed employee expenses for mileage for the

time that Mr. Tarighi was employed by Progressive. See sec. 1.262-1(b)(5),

Income Tax Regs.

        Mr. Tarighi was not employed during 2011. Consequently, as he conceded

at trial, petitioners are not entitled to any unreimbursed employee expenses for

2011.

        Professional Engineering Exam Fee

        Petitioners claimed a $275 deduction on their 2009 Schedule C for Mr.

Tarighi’s professional engineering exam fee. At trial Mr. Tarighi testified that he

took the exams in the years at issue. Petitioners provided no records or receipts to

substantiate when these examinations were taken or their cost.

        While we have determined that petitioners are not entitled to any Schedule C

deductions because Mr. Tarighi was not engaged in a trade or business with respect

to CES, taking the professional exam was necessary in order for Mr. Tarighi to
                                         - 15 -

maintain his engineering license. Though it may have been possible for Mr.

Tarighi to deduct his examination fees as an itemized deduction, because of the

unfortunate lack of substantiation, petitioners are not entitled to a deduction.

Failure To Report a Portion of a Taxable State Income Tax Refund

      The tax benefit rule of section 111 provides that if an amount is deducted

from income in one year and a part or all of the amount is recovered in a later year,

the recovered amount is treated as income for the year it is received to the extent

the deduction reduced the amount of tax imposed. Sec. 111(a); Francisco v.

Commissioner, 119 T.C. 317, 333-334 (2002), aff’d, 370 F.3d 1228 (D.C. Cir.

2004); Kadunc v. Commissioner, T.C. Memo. 1997-92; see Hillsboro Nat’l Bank v.

Commissioner, 460 U.S. 370, 377 (1983).

      Petitioners deducted Maryland State income tax of $6,945 on their 2009

Federal return. Their 2010 return indicates that they received a $4,930 State

income tax refund in 2010, but the Form 1099-G, Certain Government Payments,

issued to petitioners by the State of Maryland indicates that they received a refund

of $6,945. We hold that petitioners should have included the entire $6,945 on their

2010 return.
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Failure To Timely File Addition to Tax for 2009

      Section 6651(a)(1) provides for an addition to tax of 5% per month, up to

25%, for late filing. Petitioners’ 2009 income tax return was due on April 15,

2010, but it was not filed until April 25, 2010. Petitioners bear the burden of

showing that there was reasonable cause to excuse the late filing. See Rule 142(a);

Higbee v. Commissioner, 116 T.C. 438 (2001). Petitioners have not shown

reasonable cause for the late filing and therefore are liable for the section

6651(a)(1) addition to tax.

Accuracy-Related Penalties for 2009 and 2010

      Section 6662(a) and (b)(1) and (2) imposes an accuracy-related penalty of

20% on the portion of an underpayment attributable to negligence or a substantial

understatement of income tax. Negligence is defined to include any failure to keep

adequate books and records or to substantiate items properly. Sec. 1.6662-3(b)(1),

Income Tax Regs. An understatement of income tax 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. Sec. 6662(d).

      The Commissioner bears the burden of production for the accuracy-related

penalty. Sec. 7491(c). This requires the Commissioner to come forward with

sufficient evidence indicating that it is appropriate to impose the accuracy-related
                                        - 17 -

penalty. Higbee v. Commissioner, 116 T.C. at 446. Once the Commissioner

satisfies his burden, the burden shifts to the taxpayer to show that the penalty

should not be imposed. Id. at 447; see Rule 142. Respondent has met his burden

of production because petitioners’ understatements of income tax for 2009 and

2010 exceed both 10% of the tax required to be shown on the returns and the

$5,000 threshold for application of the penalty.

      Section 6664(c)(1) provides an exception to the section 6662 penalty if the

taxpayer can establish that there was reasonable cause for the underpayment and

that the taxpayer acted in good faith. Sec. 1.6664-4(a), Income Tax Regs. Whether

a taxpayer acted with reasonable cause and in good faith is determined in each case

by taking into account all relevant facts and circumstances. Petitioners have not

presented any evidence to show that there was reasonable cause for their

underpayments for 2009 and 2010.

      Accordingly, we hold that the section 6662(a) penalties apply to petitioners’

underpayments for 2009 and 2010.

      To reflect the foregoing,


                                                 Decision will be entered under

                                       Rule 155.
