                          T.C. Memo. 2007-33



                        UNITED STATES TAX COURT



           RONALD AND JUDITH FRANCIS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6742-05.               Filed February 8, 2007.



     Frank W. Bastian and Reggie L. Wegner, for petitioners.

     David S. Weiner, for respondent.




                MEMORANDUM FINDINGS OF FACT AND OPINION


     KROUPA, Judge:     Respondent determined a $2,167 deficiency in

petitioners’ Federal income tax for 2001.      There are two issues

for decision.    The first issue is whether petitioners are

entitled to deduct $9,502 of medical expenses under section
                                  -2-

162(a).1   We hold that they are not entitled to deduct the

medical expenses under section 162(a) because the compensation to

which the claimed deduction was attributable was not reasonable

in amount.    The second issue is whether $5,571 of the medical

expenses is 60 percent deductible under section 162(l).     We hold

that it is.

                          FINDINGS OF FACT

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

The stipulation of facts and accompanying exhibits are

incorporated by this reference.    Petitioners resided in

Pipestone, Minnesota, at the time they filed the petition.

     Petitioner Ronald Francis (Mr. Francis) has operated a farm

(the farm) as a sole proprietorship for 40 years.    Petitioner

Judith Francis (Mrs. Francis) assisted Mr. Francis by performing

farm chores, such as milking cows, since Mr. Francis began

operating the farm.

     The farm established an employer-provided accident and

health plan for employees (the plan) through an organization

called AgriPlan/BizPlan in 1991.    Eligible employees under the

plan would be fully reimbursed by the farm for health insurance

costs for themselves and their families and reimbursed up to


     1
      All section references are to the Internal Revenue Code
effective for 2001, and all Rule references are to the Tax Court
Rules of Practice and Procedure, unless otherwise indicated.
Amounts are rounded to the nearest dollar.
                                  -3-

$8,000 for out-of-pocket medical expenses.     To be reimbursed, an

eligible employee was required to submit a transmittal form to

AgriPlan/BizPlan noting the amount the eligible employee paid or

incurred for heath insurance and out-of-pocket medical expenses

during the year.     AgriPlan/BizPlan would then audit the

transmittal form and issue a statement to the farm stating the

amount it should reimburse the eligible employee.

         Mr. Francis, as owner and operator of the farm, and Mrs.

Francis executed a written employment agreement in 1997.      Mrs.

Francis agreed to keep the farm’s books, run business errands,

and answer telephone calls.     The employment agreement also

specified that Mrs. Francis would annually receive $2,004 of

wages and would be an eligible employee under the plan.      The

employment agreement did not, however, specify the number of

hours Mrs. Francis was required to work, nor establish the days

or times she was required to be available to work.

     In 2001, Mrs. Francis performed some services for the farm.

Neither Mr. Francis nor Mrs. Francis recorded how many hours, if

any, Mrs. Francis worked, or otherwise documented the nature and

extent of the services Mrs. Francis may have performed.      Mrs.

Francis received $1,9982 of wages from the farm in 2001.



     2
      The record is unclear why Mrs. Francis received $6 less
than the $2,004 she was specified to receive in 2001 under the
employment agreement.
                                -4-

     Mrs. Francis also ran errands for a farming business

operated by petitioners’ son in 2001.   Petitioners’ son did not

treat Mrs. Francis as an employee of his farming operation.

Petitioners’ son performed services on the farm without being

treated as an employee of the farm.

     Mrs. Francis submitted an employee benefit expense

transmittal form to the plan, claiming that she had paid $9,502

of eligible medical expenses in 2001.   Of this amount, $5,571 was

attributable to premiums paid on a joint Blue Cross/Blue Shield

health insurance policy and a Medicare supplemental policy solely

for Mr. Francis.   The farm reimbursed Mrs. Francis for the $9,502

of eligible expenses.   Adding the $9,502 medical expenses

reimbursement to the $1,998 wages she received, Mrs. Francis

received $11,500 of total compensation for 2001.

     Petitioners filed a joint Federal income tax return for

2001.   Petitioners reported income and expenses from the farm on

Schedule F, Profit or Loss From Farming.   Petitioners deducted

$9,502 as an employee benefit plan expense.   The $9,502 deduction

was attributable to the medical expenses Mrs. Francis paid and

for which the farm reimbursed her.

     Respondent sent petitioners a deficiency notice.   Respondent

determined that petitioners were not allowed to deduct 100

percent of their medical expenses on Schedule F as ordinary and
                                -5-

necessary expenses under section 162(a).3   Respondent determined

that 60 percent of the $5,571 health insurance premium payments

for Mr. Francis was deductible under section 162(l) as the health

insurance costs of a self-employed individual.   Petitioners

timely filed a petition.

                              OPINION

     We are asked to decide whether petitioners are entitled to

deduct medical expenses under section 162(a) and, if not, whether

they are entitled to deduct the health insurance premiums

component of their medical expenses under section 162(l).   The

parties agree that petitioners are entitled to deduct the $1,998

wage component of Mrs. Francis’s compensation for 2001; they

disagree as to whether her total compensation, including the

reimbursement under the plan, was reasonable in amount.

     We look to the general rule that deductions are a matter of

legislative grace, and the taxpayer must show that he or she is

entitled to any deduction claimed.    Rule 142(a); Deputy v. du

Pont, 308 U.S. 488, 493 (1940).   This includes the burden of

substantiation.   Hradesky v. Commissioner, 65 T.C. 87, 89-90

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

     In addition, taxpayers may fully deduct all ordinary and

necessary expenses paid or incurred during the taxable year


     3
      Respondent made no determination in the deficiency notice
regarding the deductibility of the $3,931 out-of-pocket medical
expenses under sec. 213.
                                -6-

carrying on a trade or business.   Sec. 162(a).   Ordinary and

necessary business expenses include the reimbursement of employee

benefit plan expenses for expenses the employee pays or incurs.

Sec. 162(a)(1); sec. 1.162-10, Income Tax Regs.    Employee benefit

plan expense reimbursements are deductible if they are paid to a

bona fide employee, they are an ordinary and necessary expense,

the amount deducted is substantiated,4 the amount deducted was

reasonable in amount, and the payment was in fact purely for

services.   Sec. 162; secs. 1.162-7(a), 1.162-10(a), Income Tax

Regs.

     Respondent argues that petitioners are not entitled to a

business expense deduction for the employee benefit plan expense

reimbursement because they failed to prove that the total

compensation paid to Mrs. Francis in 2001 was reasonable in

amount.   We agree.

     The deductibility of employee benefit plan expenses

generally requires proof, in the first instance, of an employer-

employee relationship.   Respondent concedes that Mr. Francis had

the right to control5 Mrs. Francis in her performance of services


     4
      Respondent concedes that the amount deducted was
substantiated.
     5
      Although no single factor is controlling, the “right to
control” the activities of the individual whose status is in
issue is the “fundamental test” of whether an employer-employee
relationship exists. Profl. & Executive Leasing, Inc. v.
Commissioner, 89 T.C. 225, 232 (1987), affd. 862 F.2d 751, 753
                                                   (continued...)
                                -7-

for the farm, but he also points to several factual

inconsistencies that discredit petitioners’ characterization of

Mrs. Francis as an employee of the farm.   Specifically, Mrs.

Francis performed services for the farm for many years before

1997 (the year her employment agreement was executed), Mrs.

Francis performed services for their son’s farming operation

without being treated as an employee of the son’s operation, and

petitioners’ son performed services on the farm without being

treated as an employee.   While these facts are troubling,6 we

need not determine whether Mrs. Francis was a bona fide employee

of the farm to decide this case.   Even assuming arguendo that

Mrs. Francis was a bona fide employee,7 we find that petitioners

failed to prove that any compensation paid to Mrs. Francis in

excess of $1,998 was reasonable in amount given that petitioners

failed to document any hours or times Mrs. Francis may have

performed services for the farm.

     Whether amounts paid to an employee are reasonable

compensation for services rendered is a question of fact to be


     5
      (...continued)
(9th Cir. 1988).
     6
      Equally as troubling is respondent’s argument that no bona
fide employer-employee relationship existed, yet respondent
conceded that petitioners were entitled to deduct $1,998 of
“wages” paid to Mrs. Francis.
     7
      If we were to find Mrs. Francis was a bona fide employee,
respondent would concede that the claimed employee benefit plan
expense would be an ordinary and necessary expense.
                                -8-

decided on the basis of the facts and circumstances of each case.

See Estate of Wallace v. Commissioner, 95 T.C. 525, 553 (1990),

affd. 965 F.2d 1038 (11th Cir. 1992).   Further, there are no

fixed rules or exact standards for determining what constitutes

reasonable compensation, although a number of factors have been

identified as relevant.8   See Golden Constr. Co. v. Commissioner,

228 F.2d 637, 638 (10th Cir. 1955), affg. T.C. Memo. 1954-221.

With these rules in mind, we determine whether the compensation

Mrs. Francis received for business-related services was

reasonable in amount.

     The employment agreement for Mrs. Francis did not set the

number of hours she was required to work to earn her pay and

benefits, nor did Mrs. Francis keep a time log recording the

number of hours she worked for the farm in 2001.   Petitioners did

not establish what Mrs. Francis earned on an hourly basis because

they did not prove how many hours she worked, and they did not

establish what employees doing comparable work on other similarly

sized farms in the vicinity were paid hourly.

     We apply close scrutiny to the facts in a family situation

and find petitioners did not prove that any of the compensation

paid to Mrs. Francis for services she provided the farm was

reasonable in amount to the extent it exceeded the $1,998 that



     8
      See Miller & Sons Drywall, Inc. v. Commissioner, T.C. Memo.
2005-114, for a list of the relevant factors.
                                 -9-

respondent has conceded to be deductible.     See Denman v.

Commissioner, 48 T.C. 439 (1967); Haeder v. Commissioner, T.C.

Memo. 2001-7; Shelley v. Commissioner, T.C. Memo. 1994-432;

Martens v. Commissioner, T.C. Memo. 1990-42, affd. 934 F.2d 319

(9th Cir. 1991).   Accordingly, we hold that petitioners are not

entitled to deduct the $9,502 claimed employee benefit plan

expense under section 162(a).

     Finally, we address whether $5,571 of the claimed employee

benefit plan expenses attributable to health insurance premium

costs for Mr. Francis is deductible under the special rules of

section 162(l).    For 2001, self-employed individuals are allowed

to deduct only an amount equal to 60 percent of the amount paid

during the year for health insurance.     Sec. 162(l)(1)(A) and (B).

     Respondent determined that petitioners’ health insurance

costs are 60 percent deductible under section 162(l).     We agree.

Petitioners paid $5,571 in premiums on two health insurance

policies for Mr. Francis in 2001, and Mr. Francis was self-

employed.   Accordingly, we hold that petitioners are entitled to

deduct $3,343 (60 percent) of the $5,571 health insurance

premiums they paid under section 162(l).

     To reflect the foregoing,


                                            Decision will be entered

                                       for respondent.
