                                  T.C. Memo. 2017-36



                           UNITED STATES TAX COURT



                    JASON M. SCHEURER, Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 25308-14.                             Filed February 21, 2017.



      Jason M. Scheurer, pro se.

      Rachel G. Borden and Warren P. Simonsen, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


      LAUBER, Judge: With respect to petitioner’s Federal income tax for 2009

and 2010, the Internal Revenue Service (IRS or respondent) determined deficien-

cies, an addition to tax, and penalties as follows:1


      1
          All statutory references are to the Internal Revenue Code in effect for the
                                                                         (continued...)
                                         -2-

[*2]                                    Addition to tax             Penalty
       Year          Deficiency         sec. 6651(a)(1)           sec. 6662(a)

       2009            $44,607              $12,343                  $8,921
       2010              3,873                 -0-                      775

After concessions,2 the issues for decision are whether petitioner for 2009 is en-

titled, by virtue of certain alleged advances of funds, to either a business bad debt

deduction or a partnership loss deduction. We hold that he is entitled to neither.

                               FINDINGS OF FACT

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

facts and the attached exhibits are incorporated by this reference. Petitioner resi-

ded in Virginia when he petitioned this Court.


       1
       (...continued)
years in issue, and all Rule references are to the Tax Court Rules of Practice and
Procedure. We round all monetary amounts to the nearest dollar.
       2
        For 2009 petitioner concedes that he: (1) received $55,702 of taxable
wages ($46,431 of which he incorrectly reported on a Schedule C, Profit or Loss
From Business), (2) is not entitled to deductions in the aggregate amount of
$20,552 as claimed on that Schedule C, and (3) is liable for an addition to tax and
(to the extent the deficiency is sustained) an accuracy-related penalty as set forth
in the notice of deficiency. For 2010 petitioner concedes that he: (1) received
$73,342 of taxable wages ($57,134 of which he incorrectly reported on a Schedule
C), (2) is not entitled to deductions in the aggregate amount of $33,339 as claimed
on that Schedule C, and (3) is liable for an accuracy-related penalty as set forth in
the notice of deficiency. For 2009 and 2010 respondent concedes that petitioner is
entitled to miscellaneous deductions of $14,232 and $29,548, respectively, for
“other expenses” on Schedule A, Itemized Deductions. All other adjustments
(apart from those discussed in the text) are computational.
                                        -3-

[*3] During 2009 petitioner worked full time as a financial adviser. For part of

the year he was employed by Wachovia Shared Resources and Raymond James

Financial Services. He subsequently worked for both firms as an independent

contractor.

      The tax deficiency in dispute grows out of petitioner’s involvement with

Continental Financial Services (CFS), a Florida sole proprietorship formed by

Kevin Zinn. Petitioner had known Mr. Zinn for more than 20 years, and they were

good friends. Petitioner was the best man in Mr. Zinn’s wedding.

      CFS originally operated a call center business selling various products and

services. Sometime in 2008 it moved to a new location in Florida and started a

“robocall” operation that employed 30 to 40 workers. Using “robocalling” equip-

ment, CFS contacted consumers with heavy credit card debt that bore high interest

rates. In exchange for an upfront fee, CFS offered to negotiate with the consu-

mer’s bank in an effort to reduce the interest rate. If the consumer accepted this

offer, CFS would charge its fee to the consumer’s credit card.

      In order to charge its fees to consumers’ credit cards, CFS needed to have

“merchant accounts” with one or more banks. Because Mr. Zinn had very poor

credit, neither he nor CFS could secure a merchant account with any bank. Mr.
                                       -4-

[*4] Zinn accordingly sought assistance from petitioner, who agreed to use his

superior credit to help open merchant accounts on behalf of CFS.

      Toward this end, petitioner and Louis Jasikoff in October 2008 formed Jasi-

koff Consulting LLC (JC). The partnership agreement provided that petitioner

would be a 90% partner and Mr. Jasikoff a 10% partner. Petitioner was to be

solely responsible for financing JC, and Mr. Jasikoff was to be responsible for

day-to-day operations, including preparing financial statements and tax returns.

The partnership agreement stated that JC was being formed for the purpose of

“providing merchant processing services primarily for, but not limited to, [CFS].”

      During 2008 and 2009 JC set up merchant accounts with banks in four

countries, including China and the Philippines. When CFS charged a fee to a con-

sumer’s credit card, the payment would be remitted to one of those banks. The

bank would deduct its usual processing charge; hold 10% of the payment in re-

serve for six months to account for potential refund claims; and send the net

amount to JC. JC would send this net amount to CFS and, after the six-month

hold was released, retain the 10% reserve amount as its profit. JC did not set up

merchant accounts for, or perform merchant processing services for, any entity

other than CFS.
                                        -5-

[*5] CFS began to experience financial problems soon after commencing the

“robocall” operation. Mr. Zinn did not have sufficient capital to fund this opera-

tion, and he sought financial assistance from petitioner. Petitioner contends that

he agreed to provide assistance and that he caused funds to be transferred to CFS

in two ways.

      First, petitioner alleges that his girlfriend at the time, Jennifer Soden, made

wire transfers during 2009 from her personal bank account to CFS in the aggregate

amount of $84,000. But she testified that she did not know whether this money

went to petitioner, JC, or CFS. Her bank account statements evidence these trans-

fers; but neither she nor petitioner could establish that the account numbers to

which the funds were wired belonged to CFS. Ms. Soden clearly advanced these

funds to petitioner or on his behalf, because petitioner’s father eventually provided

Ms. Soden with enough money to make her whole. But there is no evidence, apart

from petitioner’s testimony, that this $84,000 was actually received by CFS.

      Second, petitioner alleges that most of the debits to JC’s bank account dur-

ing 2009 represented loans to CFS. But at least $19,800 of these debits represent-

ed payments to Ms. Soden and at least $22,600 represented payments to petitioner;

many other debits represented payment of Mr. Jasikoff’s expenses. Most of the

other large debits appeared to be amounts that JC remitted to CFS pursuant to its
                                        -6-

[*6] “merchant processing” activity. Mr. Jasikoff credibly testified that on at least

one occasion he withdrew cash from JC’s bank account, hand-carried it to Florida,

and distributed it to CFS employees when Mr. Zinn could not make payroll. The

record includes signed releases from CFS employees evidencing receipt of

$19,842 from Mr. Jasikoff.

      CFS’ financial situation continued to worsen as the financial crisis took its

toll. Petitioner and JC ended their involvement with CFS sometime after 2009.

JC apparently continued to exist, at least in form, through 2013.3

      Petitioner filed a delinquent individual income tax return for 2009 on Aug-

ust 26, 2011. On this return he claimed, on Form 4797, Sale of Business Property,

a business bad debt deduction of $122,856 attributable to funds he had allegedly

advanced (directly or through Ms. Soden) to CFS, which CFS allegedly had not




      3
       Mr. Zinn was incarcerated at the time of trial with an anticipated release
date no earlier than 2019. Petitioner sought to introduce into evidence an affidavit
from Mr. Zinn, notarized by a prison official, that described in general terms the
business relationship between JC and CFS. Respondent objected on hearsay
grounds, and we took this objection under advisement. Petitioner stated that the
sole purpose of the affidavit was to establish the arrangement between JC and CFS
during 2009. We conclude that the terms of that arrangement were established by
the documentary evidence and the testimony of petitioner, Mr. Jasikoff, and a
former CFS employee. Because Mr. Zinn’s affidavit is cumulative of the existing
evidence, we will sustain respondent’s objection to its admissibility.
                                        -7-

[*7] repaid. He did not report on that return any income, expenses, or other pass-

through items from JC.

      The IRS selected for examination petitioner’s delinquent 2009 return and

his timely filed 2010 return. For 2009 the IRS disallowed the business bad debt

deduction in full and determined an addition to tax and an accuracy-related penal-

ty. The IRS issued petitioner a timely notice of deficiency for both years, and on

October 24, 2014, he timely petitioned this Court.

      Four days later, on October 28, 2014, JC filed a delinquent Form 1065, U.S.

Return of Partnership Income, for 2009. On this return it reported a loss of

$219,598, which was attributable in large part to claimed “prepaid expenses” in

excess of $170,000. These “prepaid expenses” corresponded to funds that pe-

titioner allegedly had advanced (directly or indirectly) to CFS to cover its payroll

and other operating expenses, i.e., the same advances that formed the basis for the

bad debt deduction claimed on petitioner’s individual return for 2009.

      Petitioner contends that he is entitled to deduct for 2009 his 90% share of

JC’s supposed partnership loss, or $197,368. The record includes a copy of a

Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., allegedly is-

sued by JC to petitioner for 2009. However, petitioner submitted no evidence to

substantiate the claimed partnership loss apart from the testimony and
                                        -8-

[*8] documentary evidence (discussed above) relating to his alleged advances of

funds to CFS.

                                     OPINION

      The IRS’ determinations in a notice of deficiency are generally presumed

correct, and the taxpayer bears the burden of proving those determinations erro-

neous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). The taxpayer

bears the burden of proving his entitlement to deductions allowed by the Code and

of substantiating the amounts of expenses underlying claimed deductions.

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); sec. 1.6001-1(a), In-

come Tax Regs. Under certain circumstances the burden of proof on factual issues

may shift to respondent. See sec. 7491(a)(1). But petitioner introduced little if

any “credible evidence,” sec. 7491(a)(1), and he did not “maintain[] all records

required” by the Code, sec. 7491(a)(2)(B). He thus bears the burden of proof.

A.    Business Bad Debt Deduction

      Section 166(a)(1) provides that “[t]here shall be allowed as a deduction any

debt which becomes [wholly] worthless within the taxable year.” For a nonbusi-

ness bad debt held by a taxpayer other than a corporation, section 166(a)(1) does

not apply, and the taxpayer is allowed a short-term capital loss for the taxable year
                                         -9-

[*9] in which the debt becomes completely worthless. Sec. 166(d)(1); sec. 1.166-

5(a)(2), Income Tax Regs.

      Section 166(d)(2) defines a business debt as “a debt created or acquired

* * * in connection with a trade or business of the taxpayer” or “a debt the loss

from the worthlessness of which is incurred in the taxpayer’s trade or business.”

To be eligible to deduct a loss as a business bad debt, a taxpayer must show that he

was engaged in a trade or business and that the debt was proximately related to his

trade or business. Putoma Corp. v. Commissioner, 66 T.C. 652, 673 (1976), aff’d,

601 F.2d 734 (5th Cir. 1979); sec. 1.166-5(b), Income Tax Regs. To be engaged

in a trade or business, the taxpayer must participate in the activity with continuity

and regularity, and his primary purpose for engaging in the activity must be for

income or profit. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). The

management of one’s investments, no matter how extensive, is not a “trade or

business.” Whipple v. Commissioner, 373 U.S. 193, 200 (1963).

      For three distinct reasons, we conclude that the IRS correctly disallowed the

$122,856 business bad debt deduction that petitioner claimed on his 2009 return.

First, petitioner failed to substantiate that he advanced $122,856 to CFS. We did

not find petitioner to be a particularly credible witness; and there is no evidence,

apart from his testimony, that CFS actually received any portion of the $84,000
                                        - 10 -

[*10] wired from Ms. Soden’s bank account. Petitioner likewise failed to carry his

burden of proving that the debits to JC’s bank account constituted loans to CFS (as

opposed to “merchant processing” remittances to CFS or payments to Mr. Jasikoff,

Ms. Soden, or petitioner). We find that the maximum amount of advances to CFS

that petitioner has substantiated is $19,842, the sum of the receipts that Mr. Jasi-

koff got from CFS employees for payment of wages.

      Second, petitioner did not carry his burden of proving that his advances to

CFS (such as they were) created bona fide indebtedness. A bona fide debt is a

debt arising from “a debtor-creditor relationship based on a valid and enforceable

obligation to pay a fixed or determinable sum of money.” Kean v. Commissioner,

91 T.C. 575, 594 (1988); sec. 1.166-1(c), Income Tax Regs. Whether an advance

of funds gives rise to a bona fide debt for tax purposes is determined from all the

facts and circumstances. See A.R. Lantz Co. v. United States, 424 F.2d 1330,

1333 (9th Cir. 1970); Road Materials, Inc. v. Commissioner, 407 F.2d 1121, 1126

n.2 (4th Cir. 1969), aff’g in part, vacating in part T.C. Memo. 1967-187; Dixie

Dairies Corp. v. Commissioner, 74 T.C. 476, 493 (1980). “A gift or contribution

to capital shall not be considered a debt for purposes of section 166.” Sec. 1.166-

1(c), Income Tax Regs.; see Wood Preserving Corp. v. United States, 347 F.2d

117, 118 (4th Cir. 1965).
                                        - 11 -

[*11] In determining whether an advance of funds constitutes a bona fide debt,

“economic reality provides the touchstone.” Shaw v. Commissioner, T.C. Memo.

2013-170, at *10; see Davis v. Commissioner, 69 T.C. 814, 835 (1978) (“[W]heth-

er the advances * * * are debt or equity depends on the economic substance of the

transactions.”). If a third-party lender would not have lent funds on the same

terms, an inference arises that the advance is not a true loan. See Fin Hay Realty

Co. v. United States, 398 F.2d 694, 697 (3d Cir. 1968). An important factor in de-

ciding the character of an advance is whether the purported creditor expects that

the amount will be repaid. See CMA Consol., Inc. v. Commissioner, T.C. Memo.

2005-16, 89 T.C.M. (CCH) 701, 724. Advances made to an insolvent debtor gen-

erally do not create debts for tax purposes but are characterized as capital contri-

butions or gifts. See Road Materials, Inc., 407 F.2d at 1125 (listing “doubtful

prospects of repayment” as an important factor in deciding whether an uncon-

ditional obligation to repay exists); Dixie Dairies Corp., 74 T.C. at 497; Davis, 69

T.C. at 835-836.

      There is no evidence to support petitioner’s contention that any funds he ad-

vanced to CFS gave rise to a bona fide loan. There was no promissory note, no

fixed or determinable amount due, no specified interest rate, no principal due date,

and no requirement of security. See Bauer v. Commissioner, 748 F.2d 1365,
                                       - 12 -

[*12] 1368-1371 (9th Cir. 1984), rev’g T.C. Memo. 1983-120; Estate of Mixon v.

United States, 464 F.2d 394, 402-405 (5th Cir. 1972); CMA Consol. Inc., 89

T.C.M. (CCH) at 713-715. It seems obvious that no bank would have lent money

to Mr. Zinn or CFS in 2009. Indeed, the reason that Mr. Zinn sought “merchant

processing” assistance from petitioner was that his credit was too poor to enable

him to open merchant accounts himself.

      The only advances to CFS that petitioner substantiated were Mr. Jasikoff’s

payment of wages to its employees when Mr. Zinn could not make payroll. But if

Mr. Zinn could not pay his debts as they became due, he was very likely insolvent.

Because the prospects of repayment from an insolvent person are quite doubtful,

this fact strongly suggests that Mr. Jasikoff’s $19,842 advance did not give rise to

bona fide debt. See Road Materials, Inc., 407 F.2d at 1125. Evaluating all of the

evidence and testimony in light of the relevant factors, we conclude that petition-

er’s advances of funds to CFS, to the extent he substantiated them, did not consti-

tute bona fide debt.

      Third, even if petitioner could prove that his advances to CFS created bona

fide indebtedness, he did not prove that the debt was a “business bad debt” quali-

fying for deduction under section 166(a)(1). A loss is deductible as a business bad

debt only if the taxpayer is in a “business” and the debt in question is proximately
                                        - 13 -

[*13] related to that business. United States v. Generes, 405 U.S. 93, 96 (1972);

Dagres v. Commissioner, 136 T.C. 263, 282 (2011). To determine whether a loss

is proximately related to the taxpayer’s business, we evaluate his dominant motive

for making the loan. Generes, 405 U.S. at 103.

      We conclude that petitioner has failed to show that the advances, to the ex-

tent substantiated, became business bad debts under section 166. Petitioner was

not engaged in the trade or business of lending money during 2009. He worked

full time during that year as a financial adviser, and there is no evidence that he

ever lent money to anyone else. We find no evidentiary support for the propo-

sition that his alleged loan to CFS was “a debt created or acquired * * * in connec-

tion with a trade or business” of lending money in which he was engaged during

2009. See sec. 166(d)(2)(A). Nor was any alleged loan “incurred in the taxpay-

er’s trade or business,” namely, petitioner’s occupation as a financial adviser. See

sec. 166(d)(2)(B).

      We find that petitioner’s dominant motivation for advancing funds to CFS

was personal, stemming from his longtime friendship with Mr. Zinn. He was fully

aware that Mr. Zinn had very poor credit, and it is highly unlikely that he would

have advanced funds under these circumstances unless Mr. Zinn had been a close

personal friend. Because petitioner’s primary motivation for advancing funds was
                                         - 14 -

[*14] personal, we find that the advances, to the extent substantiated, were not

proximately related to any business in which petitioner during 2009 was engaged.

B.    Partnership Loss

      In his post-trial briefs petitioner largely abandoned his claim to a business

bad debt deduction and instead claimed entitlement to deduct his share of a part-

nership loss allegedly incurred by JC. On its delinquent Form 1065 for 2009, filed

in October 2014, JC reported gross receipts of $530,474 (representing its receipts

from the “merchant accounts”) and cost of goods sold of $503,658 (representing

its net payments to CFS). JC reported an overall loss of $219,598, attributable

largely to claimed “prepaid expenses” in excess of $170,000. These “prepaid ex-

penses” corresponded to the funds that petitioner or JC had allegedly advanced to

CFS to cover its payroll and other operating expenses, i.e., the same advances that

formed the basis for the bad debt deduction that petitioner claimed on his individ-

ual return. He contends that he is entitled to deduct his 90% share of JC’s sup-

posed partnership loss, or $197,368.4

       In support of this theory petitioner asserts that JC was in the “robocalling”

trade or business; that JC hired CFS as an “independent contractor” to operate this

      4
        In his post-trial briefs, petitioner contends that the partnership loss deduc-
tion to which he is entitled is $172,163, representing the advances to CFS that he
claimed to have substantiated.
                                        - 15 -

[*15] business; and that JC, in advancing funds to CFS, was defraying “prepaid

expenses” of its own “trade or business.” This argument initially suffers from the

same flaw as petitioner’s bad debt argument, namely, lack of substantiation. As

discussed previously, petitioner substantiated at most $19,842 of advances to CFS,

and he substantiated none of JC’s other expenses.

       More fundamentally, there is no evidentiary support for petitioner’s char-

acterization of the relationship. JC clearly was not in the “robocalling” trade or

business; that business was conducted exclusively by CFS and its 30 to 40 em-

ployees. The partnership agreement between petitioner and Mr. Jasikoff stated

that the partnership was being formed for the purpose of “providing merchant pro-

cessing services primarily for, but not limited to, [CFS].” The agreement recited

no other purpose, and “merchant processing” was the only business that JC ever

conducted. Petitioner thus has the relationship precisely backwards: It was CFS

that hired JC as an independent contractor to act as CFS’ agent in setting up

merchant accounts to facilitate CFS’ “robocalling” business.

       In short, when Mr. Jasikoff expended $19,842 from JC’s bank account to

defray CFS’ payroll costs, JC was not paying its own expenses. Rather, it was

paying CFS’ expenses, and petitioner admitted that JC was under no obligation to

do this. The rule is well established that a taxpayer such as JC generally cannot
                                        - 16 -

[*16] deduct the expenses of a third party such as CFS. See Deputy v. du Pont,

308 U.S. 488, 494 (1940); Reading Co. v. Commissioner, 132 F.2d 306, 311 (3d

Cir. 1942). JC’s voluntary payment is best characterized as a capital contribution

or as a gift to CFS motivated by petitioner’s friendship with Mr. Zinn. JC’s

voluntary payment to CFS is not a valid partnership expense of JC that could give

rise to a net partnership loss that could flow through to petitioner.

      There is a narrow exception to the rule that a taxpayer cannot claim a deduc-

tion for paying a third party’s expenses. That exception applies where: (1) the

taxpayer’s motive for paying the other’s obligation is to protect or promote the

taxpayer’s own business and (2) the expenditure is an “ordinary and necessary ex-

pense” of the taxpayer’s business. Lohrke v. Commissioner, 48 T.C. 679, 688

(1967); Fargo v. Commissioner, T.C. Memo. 2015-96, at *26; Dietrick v. Com-

missioner, T.C. Memo. 1988-180, 55 T.C.M. (CCH) 706, 711-712, aff’d, 881 F.2d

336 (6th Cir. 1989).

      Petitioner did not carry his burden of proving that JC’s motive for defraying

CFS’ payroll expenses was to promote JC’s own business. Petitioner’s strong per-

sonal motivation for helping Mr. Zinn greatly suggests that this advance was a gift

or capital investment, not a business expense. And CFS’ dire financial situation

made it unlikely that JC would have an ongoing “merchant processing” business to
                                       - 17 -

[*17] promote. See Dietrick, 55 T.C.M. (CCH) at 711-712. Because petitioner

has not established that JC’s motive for paying CFS’ expenses was to protect or

promote its own business, we need not address whether the expenses were ordi-

nary and necessary expenses of JC’s business. We conclude that petitioner is not

entitled to any partnership loss deduction for 2009 because he did not prove the

existence or amount of such a loss.5

      To reflect the foregoing and the concessions of the parties,


                                                Decision will be entered under

                                       Rule 155.




      5
       Respondent contends that any partnership loss passed through to petitioner
from JC would be a “passive activity” loss, nondeductible under section 469(a),
because petitioner did not “materially participate” in JC’s trade or business. See
sec. 469(c)(1)(B). In view of our disposition we need not address this alternative
argument.
