                                T.C. Memo. 2013-220



                          UNITED STATES TAX COURT



                    MICHAEL P. CAHILL, Petitioner v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 6444-12.                       Filed September 18, 2013.



        Michael P. Cahill, pro se.

        Debra Lynn Reale and John Aletta, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


        KERRIGAN, Judge: Respondent determined a deficiency of $131,195, an

addition to tax under section 6651(a)(1) of $30,653, and a penalty under section

6662(a) of $26,239 with respect to petitioner’s Federal income tax for tax year

2008.
                                        -2-

[*2] Respondent later determined a revised deficiency of $120,318, a revised

addition to tax under section 6651(a)(1) of $27,934, and a revised penalty under

section 6662(a) of $24,064 with respect to petitioner’s Federal income tax for tax

year 2008.1

      At trial respondent asserted an increase in petitioner’s deficiency, claiming

that he had received an additional $25,000 of income from American Steamship

Owners, Shipowners Claims Bureau (Shipowners Claims Bureau).

      Unless otherwise indicated, all section references are to the Internal

Revenue Code (Code) in effect for the year in issue, and all Rule references are to

the Tax Court Rules of Practice and Procedure. All monetary amounts are

rounded to the nearest dollar.

      After concessions the issues for consideration are whether petitioner (1)

received taxable income from Friemann Christie, L.L.C. (FC), also known as CFC

Advisors, L.L.C. (CFC); (2) received additional taxable income from the

Shipowners Claims Bureau; (3) received a taxable distribution from his section

401(k) plan (401(k) plan); (4) is entitled to deduct various expenses reported on

his Schedule C, Profit or Loss from Business; (5) is entitled to additional itemized

      1
       After issuing the notice of deficiency respondent reduced the amounts of
the deficiency, addition to tax, and penalty on account of an adjustment to self-
employment tax owed by petitioner.
                                          -3-

[*3] deductions claimed on his Schedule A, Itemized Deductions; (6) is liable for

the revised addition to tax under section 6651(a)(1); and (7) is liable for the

revised penalty under section 6662(a).

                               FINDINGS OF FACT

      Some of the facts are stipulated and are so found. Petitioner resided in

Connecticut when he filed the petition.

      Petitioner is an executive in the insurance and reinsurance business. His

work includes consulting and brokering. Petitioner holds a bachelor’s degree in

accounting and a master’s degree in business administration.

      During tax year 2008 petitioner worked for BMS Intermediaries, Inc.

(BMS), which used Odyssey One Source, Inc. (Odyssey), as its payroll firm.

Petitioner received wages of $356,333 from BMS/Odyssey as well as

compensation of $5,000 directly from BMS. His contract for employment was

with Odyssey.

      During the tax year in issue petitioner also received a hardship distribution

of $14,714 from a 401(k) plan provided by BMS/Odyssey and managed by

Lincoln National Life Insurance Co. Petitioner requested the distribution because

of tuition costs.
                                        -4-

[*4] In April 2008 BMS terminated petitioner’s employment. Later that month

petitioner contacted Peter Christie, a principal at FC. At that time FC’s only

principals were J. Bernard Friemann and Mr. Christie. Soon after, petitioner

began developing business with FC jointly.

      On or about May 1, 2008, FC entered into a services, confidentiality, and

noncompete agreement (Eagle agreement) with Eagle Ocean Agencies, Inc.

(Eagle). The Eagle agreement required petitioner to provide insurance consulting

services for Eagle one day per week; in exchange Eagle would pay FC a flat fee of

$125,000 from May 1 through December 1, 2008. The Eagle agreement provided

that Eagle would reimburse FC for travel costs and related expenses monthly.

Expenses over $5,000 needed prior approval.

      On May 14, 2008, petitioner received compensation income of $25,000

from the Shipowners Claims Bureau, a company affiliated with Eagle. Petitioner

provided consulting services to the Shipowners Claims Bureau.

      On July 14, 2008, petitioner executed a memorandum of agreement with

Mr. Christie. In the memorandum of agreement FC agreed to provide petitioner

with two drawdown facilities which he could use to supplement his income from

FC. Because FC agreed that petitioner should receive an average monthly income

of $50,000, the memorandum of agreement allowed him to draw up to $50,000 per
                                        -5-

[*5] month from the first facility. The amount that petitioner could draw each

month depended on the income FC allocated to him that month. That amount,

however, would not take into account the fees that FC received from Eagle

pursuant to the Eagle agreement. The total first drawdown facility available to

petitioner was $150,000; once he reached that amount, he would be able to draw

from the second drawdown facility.

       Petitioner was required to repay the first drawdown facility out of future

income allocated to him by FC. Any outstanding balances would bear interest.

The memorandum of agreement stated that all draws would be treated as income

earned by petitioner for tax purposes and FC would report any draws on a

Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., or a Form

1099-MISC, Miscellaneous Income. In August 2008 FC changed its name to

CFC.

       On November 24, 2008, petitioner executed a revenue sharing and

allocation agreement (revenue sharing agreement) with Mr. Friemann, Mr.

Christie, and CFC. The revenue sharing agreement formalized the memorandum

of agreement. Its goal was to provide “a means for the balancing of distributions

between and among the Producers”-- i.e., petitioner, Mr. Friemann, and Mr.

Christie--by “normaliz[ing] the flow” of petitioner’s earned income with the two
                                       -6-

[*6] drawdown facilities. Like the memorandum of agreement, the revenue

sharing agreement provided petitioner with access to $50,000 per month from the

first drawdown facility less the sum of the amount of his “earned income received

from non-CFC production (‘Outside Income’)”, among other things. The

maximum amount petitioner could receive from the first drawdown facility was

$150,000. Any draws on the facility would bear interest. The revenue sharing

agreement also reiterated that the amounts CFC had received from Eagle with

respect to the Eagle agreement would be excluded from the drawdown

calculations.

      The revenue sharing agreement further provided that CFC would report any

money petitioner received from the drawdown facilities on a Form 1099-MISC or

a Schedule K-1. The revenue sharing agreement provided that it would terminate

on November 30, 2010.

      On November 25, 2008, petitioner executed a guaranty connected with the

revenue sharing agreement. The guaranty provided that if a balance remained in

the second drawdown facility on November 30, 2010, petitioner would authorize

CFC “to reallocate income” from him to Mr. Christie until the balance was

eliminated. Mr. Christie was to fund the drawdown facilities.
                                       -7-

[*7] In tax year 2008 petitioner received the following payments from FC/CFC:

                     Date of payment              Amount
                           7/2/08                 $75,000
                          8/15/08                  25,000
                          9/18/08                  25,000
                         11/25/08                  25,000
                         12/22/08                  25,000
                          Total                   175,000

Of these payments $125,000 represented the payments FC/CFC received from

Eagle for services petitioner had rendered under the Eagle agreement. On

December 22, 2008, Eagle paid petitioner $20,000 directly.

      On its 2008 Form 1065, U.S. Return of Partnership Income, CFC reported

the $175,000 paid to petitioner as a guaranteed payment to a partner. CFC also

issued petitioner a Schedule K-1 reporting a guaranteed payment of $175,000.

      In or around August 2009 the relationship between petitioner and CFC

began to falter. On September 4, 2009, Mr. Christie sent petitioner a draft

operating agreement. This agreement was never executed.

      On April 22, 2010, petitioner and his wife filed their joint Federal income

tax return for tax year 2008. On their Schedule A petitioner and his wife claimed a

deduction for the following miscellaneous itemized expenses:
                                         -8-

                       [*8] Expense             Amount
                  Unreimbursed
                   employee expenses            $31,667
                  Tax preparation fee               750
                  Other (see statement)             500
                   Total                         32,917

On his Schedule C petitioner claimed a deduction for the following business

expenses for his consulting business:2

                     Expense                    Amount
                 Advertising                      $3,035
                 Car and truck                    10,593
                 Depreciation                      1,600
                 Insurance                        14,400
                 Interest                          6,800
                 Legal and
                  professional services            4,796
                 Office                           29,243
                 Rent or lease of
                  vehicles, machinery,
                  and equipment                   14,142
                 Repairs and
                  maintenance                        440


      2
      Petitioner erroneously labeled the business on his Schedule C “Caron Croll
Group”.
                                       -9-

                 [*9] Supplies                      2,854
                 Taxes and licenses                 1,980
                 Travel                            15,095
                 Meals and
                  entertainment                    10,378
                 Utilities                         13,985
                 Other                             15,360
                   Total                          144,701

      During 2008 petitioner’s wife received compensation income of $733 from

the Caron Croll Group, Inc.

      The notice of deficiency disallowed the expense deductions petitioner

claimed on his Schedules A and C. The notice of deficiency also adjusted

petitioner’s income to reflect the payments he received from FC/CFC and the

payment he received from his 401(k) plan.

                                    OPINION

I.    Burden of Proof

      Generally, the Commissioner’s determinations in a notice of deficiency are

presumed correct, and a taxpayer bears the burden of proving those determinations

are erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). In

order to shift the burden the taxpayer must comply with all substantiation and
                                       - 10 -

[*10] recordkeeping requirements and cooperate with all reasonable requests by

the Commissioner for witnesses, information, documents, meetings, and

interviews, pursuant to section 7491(a)(2). See Higbee v. Commissioner, 116 T.C.

438, 441 (2001). Petitioner did not argue that the burden should shift, and he

failed to introduce credible evidence that respondent’s determinations are

incorrect. Accordingly, the burden of proof remains with petitioner except with

respect to the payment from the Shipowners Claims Bureau as explained below.

II.   Unreported Income

      A.    Characterization of Payments Received From FC/CFC

      Respondent contends that petitioner received $175,000 of taxable income

from FC/CFC in the form of a guaranteed payment to a partner during tax year

2008. Respondent claims that petitioner erred when he failed to report the

payment on his 2008 Federal income tax return.

      Petitioner does not dispute that he received payments in the amounts

determined by respondent for the tax year in issue. Petitioner, however, claims

that he was not a partner of FC/CFC during the tax year in issue because he never
                                        - 11 -

[*11] signed CFC’s amended and revised operating agreement and that the

payments were loans from the partnership to him rather than guaranteed

payments.3

      1.     Petitioner as a Partner of FC/CFC

      Section 761(b) defines a partner as a member of a partnership.4 Notably,

“the definition of the term ‘partnership’ sheds significant light on the definition of

the related term ‘partner’ * * * . Because a partnership can exist only in the

      3
        Generally, we lack jurisdiction to redetermine the partnership items of a
partnership if the partnership is subject to the provisions of the Tax Equity and
Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97-248, sec. 402(a), 96
Stat. at 648. Blonien v. Commissioner, 118 T.C. 541, 551-552 (2002); see sec.
6221. Partnership items include guaranteed payments, sec. 301.6231(a)(3)-
1(a)(2), Proced. & Admin. Regs., and a taxpayer’s status as a partner, McIntyre v.
Commissioner, T.C. Memo. 2009-305.
       Neither FC nor CFC was a partnership subject to TEFRA because both
qualified for the small partnership exception under sec. 6231(a)(1)(B). FC and
CFC had fewer than 10 partners, and all partners were individuals rather than
“pass-thru partners” as defined by sec. 6231(a)(9). See sec. 6231(a)(1)(B).
Therefore, we retain jurisdiction to determine whether petitioner received
guaranteed payments from FC/CFC and whether he was a partner in FC/CFC.
      4
        Sec. 704(e)(1) defines a partner according to whether he or she “owns a
capital interest in a partnership in which capital is a material income-producing
factor”. The Court of Appeals for the Second Circuit, to which an appeal of this
case would lie, see sec. 7482(b)(1)(A), has held that sec. 704(e) is limited to
family partnerships, TIFD-IIIE, Inc. v. United States, 666 F.3d 836, 844 n.6 (2d
Cir. 2012) (“The limited purpose is reflected in the title given to § 704(e)--‘Family
partnerships’--and to § 704(e)(1)--‘Recognition of interest created by purchase or
gift.’ It is further reflected in the other two subsections of § 704(e), which apply
only to partnership interests created by gift.”).
                                         - 12 -

[*12] context of an economic relationship between one person and others, the

questions as to whether a partnership exists and whether specific persons are

partners are restatements of each other.” 1 William S. McKee et al., Federal

Taxation of Partnerships and Partners, para. 3.01[1], at 3-7 (4th ed. 2007); see also

sec. 1.704-1(e)(1)(iii), Income Tax Regs.

      A partnership generally exists when persons “join together their money,

goods, labor, or skill for the purpose of carrying on a trade, profession, or business

and when there is community of interest in the profits and losses.” Commissioner

v. Tower, 327 U.S. 280, 286 (1946); see also Dickerson v. Commissioner, T.C.

Memo. 2012-60. Generally, “each partner contributes one or both of the

ingredients of income--capital or services.” Commission v. Culbertson, 337 U.S.

733, 740 (1949); see also Dickerson v. Commissioner, T.C. Memo. 2012-60.

      To determine whether a partnership exists, we consider whether, in the light

of all the facts, the parties intended to join together in good faith with a valid

business purpose in the present conduct of an enterprise. Commissioner v.

Culbertson, 337 U.S. at 742; Allum v. Commissioner, T.C. Memo. 2005-177,

aff’d, 231 Fed. Appx. 550 (9th Cir. 2007). We weigh several objective factors in

an attempt to discern their true intent. These factors include the agreement

between the parties; the conduct of the parties in executing its provisions; the
                                         - 13 -

[*13] parties’ statements; the testimony of disinterested persons; the relationship

of the parties; their respective abilities and capital contributions; the actual control

of income; and the purposes for which the income is used. Commissioner v.

Culbertson, 337 U.S. at 742. None of these factors alone is determinative. See

Luna v. Commissioner, 42 T.C. 1067, 1077, 1078 (1964).

      Even though petitioner did not sign CFC’s operating agreement, both he

and FC/CFC acted as though he was a partner of FC/CFC. Petitioner stated at trial

that he contacted FC because he wanted to pool his resources and to develop

business jointly with FC. When FC/CFC received a payment from Eagle pursuant

to the Eagle agreement, FC/CFC would pay over the entire amount to petitioner

immediately.

      Petitioner entered into the memorandum of agreement and the revenue

sharing agreement, both of which provided for the mechanism under which he

would share in the profits of FC/CFC. Moreover, the memorandum of agreement

and the revenue sharing agreement stated that FC/CFC would issue petitioner a

Form 1099-MISC or a Schedule K-1 with respect to any money he received under

either agreement. There is no indication in the record that petitioner objected to

receiving a Schedule K-1 on the grounds that he was not a partner.
                                         - 14 -

[*14] Furthermore, the revenue sharing agreement refers to petitioner, Mr.

Friemann, and Mr. Christie as “producers”, thus placing him on the same footing

with respect to revenue sharing as Messrs. Friemann and Christie. When asked

whether the revenue sharing agreement was between CFC and partners, Mr.

Friemann testified: “It was intended to be. * * * We certainly intended that * * *

[petitioner] would be a partner in the business.” Mr. Friemann also testified that

“in 2008, when we were operating, it was always our intention that * * *

[petitioner] would be a principal of the business.”

         Finally, after petitioner entered into the memorandum of agreement, FC

changed its name from “Friemann Christie” to “CFC Advisors”. Mr. Friemann

testified that they chose the name CFC so that Mr. Christie could tell his clients

that it stood for “Christie Friemann Cahill” and petitioner could tell his clients that

it stood for “Cahill Friemann Christie”. There is no indication that petitioner

objected to the name change on the grounds that he was not a partner.

Accordingly, we find that petitioner was a partner of CFC during the tax year in

issue.

               2.    Whether the Payments Were Guaranteed Payments

         Payments a partner receives from a partnership generally fall into one of

three categories. First, a partner may receive payments representing distributions
                                        - 15 -

[*15] of his or her distributive share of partnership income. See sec. 731. Second,

a partner may receive payments in circumstances where he or she is not treated as

a partner. Sec. 707(a). And third, a partner may receive guaranteed payments for

services or use of capital that do not represent distributions of partnership income.

Sec. 707(c). Specifically, section 707(c) provides:

      SEC. 707(c). Guaranteed Payments.--To the extent determined
      without regard to the income of the partnership, payments to a partner
      for services or the use of capital shall be considered as made to one
      who is not a member of the partnership, but only for the purposes of
      section 61(a) (relating to gross income) and, subject to section 263,
      for purposes of section 162(a) (relating to trade or business
      expenses).

      Whether a partner is acting in his or her capacity as a partner--rather than in

his or her capacity as one who is not a member of the partnership--while providing

services to his or her partnership is a factual determination. See Falconer v.

Commissioner, 40 T.C. 1011, 1015 (1963). The regulations provide: “In all cases,

the substance of the transaction will govern rather than its form.” Sec. 1.707-1(a),

Income Tax Regs. The inquiry under section 707(c) is whether the payments for

petitioner’s services were determined “‘without regard to the income of the

partnership.’” Falconer v. Commissioner, 40 T.C. at 1015, 1016 (quoting section

707(c)); see also sec. 1.707-1(c), Income Tax Regs.
                                       - 16 -

[*16] We are satisfied that the facts of this case place the $125,000 of payments

made to petitioner in accordance with the Eagle agreement within the ambit of the

term “guaranteed payments” pursuant to section 707(c). The Eagle agreement

provided that petitioner would provide insurance consulting services for Eagle one

day per week, in exchange for which Eagle would pay FC/CFC a flat fee of

$125,000 between May 1 and December 1, 2008. At trial Mr. Friemann testified

that petitioner provided services under the Eagle agreement. Mr. Friemann stated

that FC/CFC had hoped that in the long term he and Mr. Christie would also

provide services to Eagle, but that only petitioner provided services to Eagle.

      Mr. Friemann further testified that FC/CFC paid the $125,000 to petitioner

immediately upon receipt. His testimony is consistent with FC/CFC’s bank

statements, which show that the day after FC/CFC received a payment from Eagle

or one of Eagle’s affiliates, petitioner withdrew an amount equal to the payment

received. Petitioner does not dispute that he received this money.

      Moreover, the memorandum of agreement and the revenue sharing

agreement expressly stated that the payments pursuant to the Eagle agreement

would not be considered draws from either drawdown facility. Mr. Friemann

testified that they “wanted to be clear that this $125,000 would in no way reduce

how much * * * [petitioner] could draw each month on the facility”. Mr.
                                       - 17 -

[*17] Friemann also testified that the $125,000 petitioner received was not subject

to the drawdown facilities.

      Petitioner thus contracted with FC/CFC to provide consulting services for a

fixed fee which was not dependent upon the profits of the partnership. Therefore,

the payments from Eagle were determined “without regard to the income of the

partnership.” Falconer v. Commissioner, 40 T.C. at 1016. Thus, $125,000 of the

$175,000 of payments made to petitioner pursuant to the Eagle agreement was

guaranteed payments. Even if petitioner had not been a partner in FC/CFC, these

payments would be taxable to him as compensation for services rendered. See sec.

61(a)(1).

      Petitioner claims that the remaining $50,000 of payments he received were

not income because they were loans from the partnership to him and were subject

to repayment. CFC classified these payments as guaranteed payments on its Form

1065. Petitioner claims in his pretrial memorandum that the remaining $50,000 of

payments “may have been made under a Revenue Sharing agreement, which is

effectively a draw-down facility, subject repayment and interest.” Respondent

agrees that the $50,000 of payments was made under the first drawdown facility.

      Whether a transaction is a loan for Federal income tax purposes is a

question of fact. The following factors are considered in determining whether a
                                        - 18 -

[*18] loan is bona fide: (1) the existence of a sum certain; (2) the likelihood of

repayment; (3) a definite date of repayment; and (4) the manner of repayment.

Seay v. Commissioner, T.C. Memo. 1992-254; Mangham v. Commissioner, T.C.

Memo. 1980-280. Rev. Rul. 73-301, 1973-2 C.B. 216, states that, for purposes of

section 707(a), a loan by a partnership to a partner is considered to have been

made only where the partner is under an unconditional obligation to repay a sum

certain at a determinable date.

      Petitioner’s argument that the payments represent the repayment of loans is

not supported by the record. Although payments under the first drawdown facility

in theory accrued interest, neither the memorandum of agreement nor the revenue

sharing agreement provided any definite date of repayment or a manner of

repayment other than from future income allocated to petitioner. The revenue

sharing agreement was merely set to terminate on November 30, 2010. Moreover,

petitioner was required to execute a guaranty only with respect to the second

drawdown facility. Therefore, the $50,000 of payments petitioner received

pursuant to the first drawdown facility was not for repayment of loans.

      Like the $125,000 of payments from the Eagle agreement, the payments

from the drawdown facility were not dependent upon the profits of the partnership.

The amount available to petitioner did not fluctuate with FC/CFC profits.
                                        - 19 -

[*19] Moreover, the memorandum of agreement and the revenue sharing

agreement expressly stated that any draws would be considered income to

petitioner and would be reported on a Form 1099-MISC or a Schedule K-1. Thus,

the remaining $50,000 of payments was also guaranteed payments.5

      Accordingly, respondent correctly determined that petitioner received

taxable income of $175,000 in the form of guaranteed payments from CFC in tax

year 2008.

      B.     Payment From Shipowners Claims Bureau

      At trial respondent asserted an increase in petitioner’s deficiency to reflect

an additional payment of $25,000 that petitioner had received from the

Shipowners Claims Bureau in tax year 2008. Respondent claims that petitioner

erred when he failed to report this amount on his 2008 Federal income tax return.

The Commissioner bears the burden of proof with respect to any increase of

deficiency. Rule 142(a)(1). Therefore, respondent bears the burden of proof with

respect to this issue.

      5
        For purposes of sec. 731 (the extent of recognition of gain or loss in the
case of a distribution from the partnership to the partner) advances or drawings of
money against a partner’s distributive share of income shall be treated as current
distributions. Sec. 1.731-1(a)(1)(ii), Income Tax Regs. Although the $50,000 of
payments were made under the first drawdown facility, there is no indication in
the record that the payments were made against petitioner’s distributive share of
partnership income.
                                       - 20 -

[*20] Respondent proffers (1) an invoice from petitioner to the Shipowners

Claims Bureau requesting a fee of $25,000 that would be due on May 8, 2008, and

(2) a transaction detail report from Deutsche Bank showing that petitioner

received $25,000 from the Shipowners Claims Bureau on May 14, 2008. The

treasurer of the Shipowners Claims Bureau also testified that the Shipowners

Claims Bureau made the $25,000 payment to petitioner. Finally, petitioner

admitted at trial that he received the $25,000 payment from the Shipowners

Claims Bureau but failed to report it on his 2008 Federal income tax return.

Petitioner has offered no evidence regarding this issue.

      Accordingly, respondent correctly determined that petitioner received an

additional taxable income of $25,000 from the Shipowners Claims Bureau in tax

year 2008.

      C.     Distribution From Petitioner’s 401(k) Plan

      Petitioner stipulated that he received a hardship distribution of $14,714

from his 401(k) plan in tax year 2008. Respondent claims that petitioner erred

when he failed to report this payment on his 2008 Federal income tax return.

      Generally, under section 72 amounts actually distributed from retirement

accounts, such as 401(k) plans, are taxable income to the distributee in the taxable

year in which they are distributed. Secs. 402(a), 72. If the taxpayer obtains a
                                       - 21 -

[*21] distribution from a retirement account before he or she retires, only the

amounts allocable to his or her investment in the contract are excludible from

income. Sec. 72(e)(2)(B), (8)(A). Such amounts generally include contributions

to a taxpayer’s retirement account, but only if such contributions were includible

in the taxpayer’s income. Sec. 72(f). Petitioner has not established that any part

of the distribution he received from his 401(k) plan represents contributions that

were includible in his income or other investments he made in the contract.

       Accordingly, respondent correctly determined that petitioner received

taxable income of $14,714 from his 401(k) plan in tax year 2008.

III.   Expense Deductions

       Section 162(a) allows a taxpayer to deduct all ordinary and necessary

expenses paid or incurred in carrying on a trade or business. An ordinary expense

is one that commonly or frequently occurs in the taxpayer’s business, Deputy v. du

Pont, 308 U.S. 488, 495 (1940), and a necessary expense is one that is appropriate

and helpful in carrying on the taxpayer’s business, Welch v. Helvering, 290 U.S.

at 113. The expense must directly connect with or pertain to the taxpayer’s

business. Sec. 1.162-1(a), Income Tax Regs. A taxpayer may not deduct a

personal, living, or family expense unless the Code expressly provides otherwise.

Sec. 262(a).
                                        - 22 -

[*22] Whether an expenditure is ordinary and necessary is generally a question of

fact. Commissioner v. Heininger, 320 U.S. 467, 475 (1943). A taxpayer must

show a bona fide business purpose for the expenditure; there must also be a

proximate relationship between the expenditure and his or her business.

Challenge Mfg. Co. v. Commissioner, 37 T.C. 650 (1962); see also Heinbockel v.

Commissioner, T.C. Memo. 2013-125. In general, where an expense is primarily

associated with profit-motivated purposes--and personal benefit can be said to be

distinctly secondary and incidental--it may be deducted under section 162(a). Int’l

Artists, Ltd. v. Commissioner, 55 T.C. 94, 104 (1970); see also G.D. Parker, Inc.

v. Commissioner, T.C. Memo. 2012-327. Conversely, if an expense is primarily

motivated by personal considerations, no deduction for it will be allowed under

section 162(a). Henry v. Commissioner, 36 T.C. 879, 884 (1961); see also G.D.

Parker, Inc. v. Commissioner, T.C. Memo. 2012-327. A taxpayer’s general

statement that his or her expenses were incurred in pursuit of a trade or business is

not sufficient to establish that the expenses had a reasonably direct relationship to

any such trade or business. Ferrer v. Commissioner, 50 T.C. 177, 185 (1968),

aff’d per curiam, 409 F.2d 1359 (2d Cir. 1969); see also Adams v. Commissioner,

T.C. Memo. 2013-92.
                                        - 23 -

[*23] Deductions are a matter of legislative grace, and a taxpayer must prove his

or her entitlement to a deduction. INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). To that

end, taxpayers are required to substantiate each claimed deduction by maintaining

records sufficient to establish the amount of the deduction and to enable the

Commissioner to determine the correct tax liability. Sec. 6001; Higbee v.

Commissioner, 116 T.C. at 440.

      Certain expenses specified in section 274 are subject to strict substantiation

rules. To meet these strict substantiation rules, a taxpayer must substantiate by

adequate records or by sufficient evidence corroborating the taxpayer’s own

statement (1) the amount, (2) the time and place of the travel or use, and (3) the

business purpose. Sec. 274(d). To substantiate by adequate records, the taxpayer

must provide (1) an account book, log, or similar record and (2) documentary

evidence, which together are sufficient to establish each element of an

expenditure. Sec. 1.274-5T(c)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg.

46017 (Nov. 6, 1985). Documentary evidence includes receipts, paid bills, or

similar evidence. Sec. 1.274-5(c)(2)(iii), Income Tax Regs. To substantiate by

sufficient evidence corroborating the taxpayer’s own statement, the taxpayer must

establish each element by his or her own statement and by documentary evidence
                                      - 24 -

[*24] or other direct evidence. Sec. 1.274-5T(c)(3)(i), Temporary Income Tax

Regs., 50 Fed. Reg. 46020 (Nov. 6, 1985). To establish the business purpose of an

expenditure, however, a taxpayer may corroborate his or her own statement with

circumstantial evidence. Id.

      A.      Petitioner’s Schedule C Expenses

      On his 2008 Federal income tax return petitioner reported the following

expenses on his Schedule C, some of which respondent has conceded:

       Schedule C         Amount          Amount          Amount
        expenses          claimed        conceded        disallowed
     Travel               $15,095         $13,112          $1,983
     Meals and
      entertainment        10,378              8,202        2,176
     Car and truck         10,593              7,624        2,969
     Utilities             13,985              6,866        7,119
     Office                29,243          17,495          11,748
     Depreciation           1,600              2,350         (750)
     Taxes and
      licenses              1,980              2,807         (827)
     Legal                  4,796              5,425         (629)
     Advertising            3,035              3,035          -0-
     Other                 15,360              1,796       13,564
     Interest               6,800              5,998          802
     Insurance             14,400              3,718       10,682
                                         - 25 -

         [*25] Supplies       2,854               -0-            2,854
         Maintenance
          and repairs           440               -0-               440
         Vehicle lease        14,142          14,086                 56
          Total              144,701          92,514            52,187

         Respondent also has conceded that petitioner is entitled to an education

credit of $1,600 for educational expenses incurred by his wife for the tax year in

issue.

         Petitioner claims he should be able to deduct the remaining expenses

relating to: (1) travel, (2) meals and entertainment, (3) car and truck, (4) utilities,

(5) office expenses, (6) other expenses, (7) interest, (8) insurance, (9) supplies,

(10) maintenance and repairs, and (11) vehicle lease. Travel expenses, meals and

entertainment expenses, car and truck expenses, and vehicle lease expenses are all

subject to the strict substantiation rules of section 274(d). Secs. 274(d)(1), (2), (4),

280F(d)(4)(A)(i) and (ii).

         To substantiate his expenses, petitioner offers American Express bank

statements, which show his travel, restaurant, merchandise, super market, auto,

fees and adjustments, and insurance expenses. Petitioner also offers typed or

handwritten lists for each type of expense, which provide the month, name of

vendor, amount, and a very general explanation for each item listed. These lists
                                        - 26 -

[*26] appear to have been created by petitioner. There is no indication when

petitioner compiled these lists. Petitioner did not testify specifically about any of

the expenses.

      The American Express bank statements and self-compiled lists petitioner

provided for those expenses do not provide enough information for us to

determine what he actually purchased with respect to those expenses and to what

extent these purchases had a business purpose.

      Petitioner has offered no receipts regarding his car and truck expenses,

utility expenses, interest expenses, supply expenses, and maintenance and repair

expenses. The sparse number of receipts and invoices that petitioner does offer

fail to provide enough information for us to determine to what extent these

purchases had a business purpose.

      Petitioner has failed to meet the strict substantiation requirements of section

274(d) with respect to the travel expenses, meals and entertainment expenses, car

and truck expenses, and vehicle lease expenses. Petitioner has also failed to meet

the substantiation requirements with respect to the utility expenses, office

expenses, other expenses, interest expenses, insurance expenses, supply expenses,

and maintenance and repair expenses. Petitioner is not entitled to deduct any of
                                       - 27 -

[*27] these expenses in excess of the amounts respondent has already conceded, if

at all, for tax year 2008.

      B.      Petitioner’s Schedule A Expenses

      On his 2008 Federal income tax return, petitioner claimed a deduction for

miscellaneous Schedule A expenses totaling $32,917, relating to unreimbursed

employee expenses, tax preparation fees, and other expenses. In the notice of

deficiency respondent disallowed a deduction for $28,823 of petitioner’s Schedule

A expenses. In particular, respondent disallowed a deduction for the following

Schedule A expenses: (1) vehicle expenses; (2) expenses for travel away from

home; (3) business expenses; (4) expenses for meals and entertainment; (5)

expenses relating to tax preparation; and (6) other expenses marked “see

statement”.

      Petitioner claims he should be allowed to deduct these expenses, or, in the

alternative, that he should be able to move these expenses to his Schedule C and

deduct them there.

      For his Schedule A vehicle expenses, travel expenses, and meals and

entertainment expenses petitioner offers no evidence to support these claims

beyond what he offers to substantiate the corresponding Schedule C expenses.

Petitioner’s evidence thus does not sufficiently indicate that the vehicle expenses,
                                       - 28 -

[*28] travel expenses, and meals and entertainment expenses were ordinary and

necessary unreimbursed employee expenses directly related to a trade or business

during the tax year in issue.

      For his Schedule A business expenses petitioner offers: (1) a list titled

“Business Expenses”; (2) American Express bank statements showing his

merchandise expenses; (3) an invoice from T-Mobile; (4) an unidentified

statement showing charges for travel expenses and services; and (5) an American

Express bank statement showing his travel expenses. Other than the T-Mobile

invoice petitioner provided no receipts regarding his reported business expenses.

It is impossible for us to determine what petitioner actually purchased from these

vendors or to what extent the purchases had a business purpose. Likewise, it is

impossible to determine to what extent the items purchased from T-Mobile had a

business purpose.

      For his Schedule A tax preparation expenses petitioner offers a bill from his

accountant, which refers to the preparation of his 2008 Federal and State income

tax returns. The bill, however, is dated October 22, 2008, more than two months

before the close of petitioner’s 2008 taxable year and more than a year before he

filed his 2008 Federal tax return.
                                       - 29 -

[*29] Petitioner offers no evidence to support his Schedule A other expenses

marked “see statement”.

      Petitioner has failed to meet the strict substantiation requirements of section

274(d) with respect to the Schedule A vehicle expenses, travel expenses, and

meals and entertainment expenses. Petitioner has likewise failed to meet the

substantiation requirements with respect to the Schedule A business expenses, tax

preparation expenses, and other expenses. Petitioner is not entitled to deduct any

of these expenses on his Schedule A for tax year 2008 because he has failed to

establish that he incurred these expenses.

      Even if petitioner were to establish that he incurred the expenses reported

on his Schedule A, petitioner would not be entitled to deduct those expenses on

his Schedule C. A taxpayer may deduct unreimbursed employee expenses as an

ordinary and necessary business expense under section 162. Lucas v.

Commissioner, 79 T.C. 1, 7 (1982); see also Farias v. Commissioner, T.C. Memo.

2011-248. A taxpayer may engage in the trade or business of “being an

employee”. O’Malley v. Commissioner, 91 T.C. 352, 363-364 (1988).

Unreimbursed employee expenses are classified as miscellaneous itemized

deductions and are deductible only to the extent they exceed 2% of the taxpayer’s

adjusted gross income. See sec. 67; sec. 1.67-1T(a)(1)(i), (b), Temporary Income
                                       - 30 -

[*30] Tax Regs., 53 Fed. Reg. 9875-9876 (Mar. 28, 1988). An employee may also

deduct miscellaneous itemized deductions on Schedule A for expenses incurred

while looking for a new job in the employee’s current field of employment. See

Primuth v. Commissioner, 54 T.C. 374, 378-379 (1970); see also Hughes v.

Commissioner, T.C. Memo. 2008-249. These expenses likewise are deductible

only to the extent they exceed 2% of the taxpayer’s adjusted gross income. Sec.

1.67-1T(a)(1)(i), (b), Temporary Income Tax Regs., supra. Employee expenses,

however, are not deductible to the extent that a taxpayer obtained or could have

obtained reimbursement from his other employer. Lucas v. Commissioner, 79

T.C. at 7; Stolk v. Commissioner, 40 T.C. 345, 357 (1963), aff’d, 326 F.2d 760 (2d

Cir. 1964).

      Petitioner admitted at trial that the expenses he deducted on Schedule A

were incurred before May 2008. Petitioner was employed by BMS until his

termination in April 2008, and he testified at trial that he had a noncompete

agreement with BMS. He did not begin working with FC/CFC until May 1, 2008.

Therefore, if petitioner incurred any of these expenses, they were incurred before

he began his consulting business with FC/CFC at a time when he was still

employed by BMS, thereby making them employee business expenses which must

be reported as a miscellaneous itemized deduction on Schedule A. Moreover, if
                                        - 31 -

[*31] the expenses were incurred by petitioner for the purpose of finding new

employment in the field of insurance consulting, they would be reportable, if at all,

as miscellaneous expenses on Schedule A. Thus, even if petitioner had

established that he incurred the expenses, they would be reportable as

miscellaneous itemized deductions on Schedule A and would be limited to the

amount exceeding 2% of his adjusted gross income.

      Petitioner is not entitled to deduct any Schedule A amounts as additional

Schedule C expenses for tax year 2008.

IV.   Addition to Tax and Penalty

      Under section 7491(c) the Commissioner bears the burden of producing

evidence with respect to the liability of the taxpayer for any addition to tax or

penalty. See Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447. Once

the Commissioner meets this burden, the taxpayer must come forward with

persuasive evidence that the Commissioner’s determination is incorrect. Higbee v.

Commissioner, 116 T.C. at 446-447.

      A.     Section 6651(a)(1) Addition to Tax

      Respondent determined that petitioner is liable for an addition to tax

pursuant to section 6651(a)(1) because he did not timely file his 2008 Federal

income tax return. Section 6651(a)(1) provides for an addition to tax for failure to
                                        - 32 -

[*32] timely file a Federal income tax return unless it is shown that such failure

was due to reasonable cause and not willful neglect. See also United States v.

Boyle, 469 U.S. 241, 245 (1985). A failure to file a timely Federal income tax

return is due to reasonable cause if the taxpayer exercised ordinary business care

and prudence but nevertheless was unable to file the return within the prescribed

time. See sec. 301.6651-1(c)(1), Proced. & Admin. Regs.

      Petitioner filed his 2008 Federal income tax return on April 22, 2010.

Respondent has shown that petitioner failed to timely file his Federal income tax

return for 2008. Consequently, we conclude that respondent has satisfied the

burden of production under section 7491(c); petitioner must come forward with

evidence to prove he is not liable for the addition to tax.

      Petitioner failed to introduce any evidence that he is not liable for the

addition to tax or that his failure to timely file was due to reasonable cause and not

willful neglect. Accordingly, petitioner is liable for the addition to tax pursuant to

section 6651(a)(1).

      B.     Section 6662(a) Accuracy-Related Penalty

      Respondent determined that petitioner is also liable for the accuracy-related

penalty pursuant to section 6662(a) for tax year 2008. Section 6662(a) imposes a

20% penalty on any underpayment attributable to, among other things, (1)
                                       - 33 -

[*33] negligence or disregard of rules or regulations within the meaning of section

6662(b)(1), or (2) any substantial understatement of income tax within the

meaning of section 6662(b)(2). Only one accuracy-related penalty may be applied

with respect to any given portion of an underpayment, even if that portion is

subject to the penalty on more than one of the grounds set out in section 6662(b).

Sec. 1.6662-2(c), Income Tax Regs.

      The phrase “substantial understatement of income tax” means an

understatement that exceeds the greater of $5,000 or 10% of the income tax

required to be shown on the tax return for the taxable year. Sec. 6662(d)(1)(A).

Respondent determined that petitioner should have reported an income tax liability

of $125,154 on his 2008 Federal income tax return. Respondent also determined

that petitioner understated his income tax by $120,318 for the tax year in issue.

Respondent has since conceded that petitioner is entitled to $92,514 of deductions

on his Schedule C and a credit of $1,600 for educational expenses. This will result

in a lesser deficiency that may or may not exceed the greater of $5,000 or 10% of

the income tax required to be shown on the tax return.

      Even if petitioner’s understatement is not substantial, respondent claims that

petitioner is liable for the section 6662(a) penalty due to negligence. Negligence

includes any failure to make a reasonable attempt to comply with the provisions of
                                       - 34 -

[*34] the internal revenue laws, to exercise due care, or to do what a reasonable

and prudent person would do under the circumstances. Sec. 6662(c); Neely v.

Commissioner, 85 T.C. 934, 947 (1985); sec. 1.6662-3(b)(1), Income Tax Regs.

Negligence also includes any failure by a taxpayer to keep adequate books and

records or to substantiate items properly. Sec. 1.6662-3(b)(1), Income Tax Regs.

      Respondent has shown that petitioner failed to report as income payments

totaling $175,000 that he received from FC/CFC, for which he received a

Schedule K-1; a payment of $25,000 that he received from the Shipowners Claims

Bureau; and a hardship distribution of $14,714 that he received from his 401(k)

plan. Respondent has further shown that petitioner failed to produce any

documentary evidence showing that the expenses he reported on his Schedules A

and C were ordinary and necessary expenses connected to a trade or business or

his job. Respondent thus has shown that petitioner acted negligently.

      Petitioner therefore is liable for the accuracy-related penalty unless he can

show he had reasonable cause for and acted in good faith regarding part of the

underpayment. See sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. For

purposes of section 6664(c) a taxpayer may establish reasonable cause and good

faith by showing reliance on professional advice. Sec. 1.6664-4(b)(1), Income

Tax Regs. A taxpayer reasonably relied on professional advice if he or she proves
                                       - 35 -

[*35] the following by a preponderance of the evidence: (1) the adviser was a

competent professional who had sufficient expertise to justify reliance, (2) the

taxpayer provided necessary and accurate information to the adviser, and (3) the

taxpayer actually relied in good faith on the adviser’s judgment. See Neonatology

Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d

Cir. 2002); see also Rule 142(a); Welch v. Helvering, 290 U.S. at 115.

      Petitioner failed to introduce any evidence that he relied on professional

advice or otherwise had reasonable cause for and acted in good faith regarding

part of the understatement.

      Accordingly, petitioner is liable for the accuracy-related penalty under

section 6662(a).

      Any contentions we have not addressed are irrelevant, moot, or meritless.

      To reflect the foregoing,


                                                     Decision will be entered

                                                under Rule 155.
