                            T.C. Summary Opinion 2016-68



                           UNITED STATES TAX COURT



             DENNIS K. HICKS AND SHERRY L. HICKS, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 26484-13S.                           Filed October 17, 2016.



      Dennis K. Hicks and Sherry L. Hicks, pro sese.

      Alexander D. DeVitis, for respondent.



                                SUMMARY OPINION


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

provisions of section 7463 of the Internal Revenue Code in effect when the

petition was filed.1 Pursuant to section 7463(b), the decision to be entered is not


      1
          Unless otherwise indicated, subsequent section references are to the
                                                                        (continued...)
                                         -2-

reviewable by any other court, and this opinion shall not be treated as precedent

for any other case.

      In notices of deficiency dated August 9 and September 24, 2013 (notices),

respondent determined deficiencies in petitioners’ Federal income tax and

imposed accuracy-related penalties as follows:

                                                          Penalty
                  Year            Deficiency             sec. 6662(a)

                  2009              $7,364                 $1,473
                  2010              10,240                  2,048
                  2011               8,883                  1,777

The issues for decision for each year are whether petitioners are: (1) entitled to

various trade or business expense deductions claimed on a Schedule C, Profit or

Loss From Business, in excess of the amounts that respondent allowed and (2)

liable for a section 6662(a) accuracy-related penalty.

                                     Background

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

the petition was filed, and at all other times relevant here, petitioners resided in

California.

      1
       (...continued)
Internal Revenue Code in effect for the years in issue, and Rule references are to
the Tax Court Rules of Practice and Procedure. Monetary amounts are rounded to
the nearest dollar.
                                         -3-

       During the years in issue Dennis K. Hicks (petitioner) was employed as a

sales engineer for Freescale Semiconductor, Inc., and Sherry L. Hicks was

employed as an office manager for Innovative Stamping Co. Petitioners have

three children, Kyle, Stacey, and Sarah. At least two of petitioners’ children were

students during one or more of the years at issue, and all were older than 18 as of

the date of trial.

       A Schedule C for a business identified as SC Management is included with

petitioners’ Federal income tax return for each year in issue. Depending upon the

year, one or the other of petitioners is shown to be the sole proprietor of the

business. The relevant detail of the items shown on each of the Schedules C will

be set forth later in this opinion.

SC Management

       Petitioners, or at least one of them, established SC Management in 2005.

According to petitioner, its stated purpose was to manage the careers of the Hicks

family. Although the exact services that the business was intended to provide with

respect to the career(s) of each family member are less than clear, it appears that

each family member agreed to contribute a portion of income earned from outside

sources to SC Management in return for whatever services the family member
                                        -4-

received. During the years in issue the income shown on the Schedules C is

attributable to amounts petitioner and one of his children earned.

Education Expenses

      During 2009 Kyle was a candidate for a bachelor of music in performance

degree at Musicians Institute in Los Angeles. His tuition and related expenses

totaled $7,700 for that year. Sarah attended the Marinello Schools of Beauty

during 2009. She studied esthetics, cosmetology, and beauty techniques. Her

tuition and related expenses, paid with student loans, totaled $10,175.

Use of Vehicles

      During the years in issue petitioner, Kyle, Stacy, and Sarah used the

family’s cars--a 2007 Honda CRV, a 2006 Mini Cooper, and a 2005 Nissan

Altima--for a mix of business and personal travel. Petitioners maintained a

mileage log for each vehicle for each year in issue. According to the logs, most of

petitioner’s travel was related to an electronic device that he was developing as an

independent contractor.2 According to the logs, Kyle’s and Sarah’s travel was

largely related to commuting from home to their respective schools.




      2
        All of the trade or business expense deductions at issue, including those
relating to travel, were reported on petitioners’ Schedules C for SC Management.
                                         -5-

Petitioners’ Indiana House

      In 2008 petitioners moved from their residence in Indiana (former

residence) to a house that they rented in California. The former residence was

briefly rented to a coworker of petitioner; otherwise petitioners’ attempts to rent it

out or sell it were not successful. While it was otherwise vacant, petitioner stored

some work-related equipment there. Apparently, petitioners defaulted on the

mortgage loan on the former residence, and foreclosure proceedings were

commenced in or around May 2010. In connection with the foreclosure

proceedings, the mortgagee charged petitioners $2,121 for various expenses,

including inspection, photos, and title fees.

      In March 2010 the mortgagee had the locks changed on petitioners’ former

residence. As a result, petitioners did not have routine access to their former

residence or the equipment stored there. During that year petitioners paid an

attorney $1,000 for legal advice in connection with the foreclosure proceedings.

Petitioners maintained some type of insurance on their former residence, but the

record does not disclose the details of the coverage provided by the policy.

      Nothing in the record suggests that petitioners made any attempt to retrieve

any of the equipment from their former residence during 2010 or 2011 or that any

of the equipment that was stored there was used in connection with their business
                                        -6-

during 2010 or 2011. Later, in 2012, petitioners received permission from the

mortgagee to enter the former residence and retrieve the equipment.

Petitioners’ Income Tax Returns

      One or the other of petitioners prepared and timely filed a joint Federal

income tax return for each of the years in issue. As noted, each return includes a

Schedule C for SC Management.3

      On the 2009 Schedule C petitioners reported $500 of gross receipts, claimed

expense deductions that total $55,874, and reported a net loss of $55,374 which is

taken into account in the computation of the $180,694 adjusted gross income

reported on their 2009 return. The deductions claimed on the 2009 Schedule C

include: (1) $25,094 for car and truck expenses and (2) $17,516 for other

expenses. The deduction for other expenses includes Kyle’s tuition at Musicians

Institute and Sarah’s tuition at Marinello Schools of Beauty.

      On the 2010 Schedule C petitioners reported $440 of gross receipts, claimed

expense deductions that total $59,203, and reported a net loss of $58,763 which is

taken into account in the computation of the $213,948 adjusted gross income

reported on their 2010 return. The deductions claimed on the 2010 Schedule C


      3
      Petitioners’ 2011 Federal income tax return includes two Schedules C. We
concern ourselves only with the one for SC Management.
                                         -7-

include: (1) $17,219 for car and truck expenses; (2) $3,377 for insurance (other

than health); (3) $21,432 for interest (other);4 and (4) $4,280 for legal and

professional services.

       On the 2011 Schedule C petitioners reported $1,800 of gross receipts,

claimed expense deductions that total $45,470, and reported a net loss of $43,670

which is taken into account in the computation of the $213,913 adjusted gross

income reported on their 2011 return. The deductions claimed on the 2011

Schedule C include: (1) $21,753 for car and truck expenses and (2) $17,363 for

interest (other).5

       There is no deduction for wages claimed on any of the Schedules C.

Notices of Deficiency

       In the notices and as relevant here respondent: (1) disallowed car and truck

expense deductions of $4,571, $1,473, and $9,513, respectively, claimed on the

2009, 2010, and 2011 Schedules C for SC Management; (2) disallowed the

deduction for other expenses claimed on the 2009 Schedule C for SC


       4
       The 2010 interest (other) expense consists of interest payments on Kyle’s
student loans, and student loan disbursements used to pay Kyle’s tuition at
Musicians Institute.
       5
       The 2011 interest (other) expense consists of interest payments on Kyle’s
student loans, credit card interest, and homeowners insurance expenses on the
former residence.
                                          -8-

Management; (3) disallowed a dependency exemption deduction for Kyle for

2009;6 (4) disallowed the deductions for insurance (other than health), interest

(other), and legal and professional services claimed on the 2010 Schedule C for

SC Management; and (5) disallowed the deduction for interest (other) claimed on

the 2011 Schedule C for SC Management. Respondent also imposed section

6662(a) accuracy-related penalties on several grounds, including “negligence or

disregard of rules or regulations” and “substantial understatement of income tax”,

for each year in issue. Other adjustments made in the notice are computational

and need not be addressed.

                                      Discussion

      As we have observed in countless opinions, deductions are a matter of

legislative grace, and the taxpayer bears the burden of proving entitlement to any

claimed deduction.7 Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

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

burden requires the taxpayer to substantiate expenses underlying deductions

claimed by keeping and producing adequate records that enable the Commissioner


      6
          Petitioners concede this adjustment.
      7
       Petitioners do not claim and the record does not otherwise demonstrate that
the provisions of sec. 7491(a) are applicable here, and we proceed as though they
are not.
                                        -9-

to determine the taxpayer’s correct tax liability. Sec. 6001; Hradesky v.

Commissioner, 65 T.C. 87, 89 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir.

1976); Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965). A taxpayer

claiming a deduction on a Federal income tax return must demonstrate that the

deduction is allowable pursuant to some statutory provision and must further

substantiate that the expense to which the deduction relates has been paid or

incurred. See sec. 6001; Hradesky v. Commissioner, 65 T.C. at 89-90; sec.

1.6001-1(a), Income Tax Regs. On the other hand, a taxpayer is not entitled to a

deduction for personal, living, or family expenses. Sec. 262.

I. Schedule C Deductions

      Taxpayers may deduct ordinary and necessary expenses paid in connection

with operating a trade or business. Sec. 162(a); Boyd v. Commissioner, 122 T.C.

305, 313 (2004). To be ordinary the expense must be of a common or frequent

occurrence in the type of business involved. Deputy v. du Pont, 308 U.S. 488, 495

(1940). To be necessary an expense must be appropriate and helpful to the

taxpayer’s business. Welch v. Helvering, 290 U.S. 111, 113 (1933). The

expenditure must be directly connected with or pertaining to the taxpayer’s trade

or business. Sec. 1.162-1(a), Income Tax Regs. The determination of whether an
                                        - 10 -

expenditure satisfied the requirements for deductibility under section 162 is a

question of fact. See Commissioner v. Heininger, 320 U.S. 467, 475 (1943).

      Section 274(d) imposes strict substantiation requirements for travel,

entertainment, gift, and listed property (including passenger automobiles)

expenses. Sanford v. Commissioner, 50 T.C. 823, 827 (1968), aff’d per curiam,

412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary Income Tax Regs., 50

Fed. Reg. 46014 (Nov. 6, 1985). Under section 274(d), the taxpayer generally

must substantiate either by adequate records or by sufficient evidence

corroborating the taxpayer’s own statement: (1) the amount of the expense; (2) the

time and place the expense was incurred; (3) the business purpose of the expense;

and (4) in the case of an entertainment or gift expense, the business relationship to

the taxpayer of each expense incurred. For listed property expenses, the taxpayer

must establish the amount of business use and the amount of total use for such

property. See sec. 1.274-5T(b)(6)(i)(B), Temporary Income Tax Regs., 50 Fed.

Reg. 46016 (Nov. 6, 1985). Substantiation by adequate records requires the

taxpayer to maintain an account book, a diary, a log, a statement of expense, trip

sheets, or a similar record prepared contemporaneously with the expenditure and

documentary evidence (e.g., receipts or bills) of certain expenditures. Sec. 1.274-

5(c)(2)(iii), Income Tax Regs.; sec. 1.274-5T(c)(2), Temporary Income Tax Regs.,
                                        - 11 -

50 Fed. Reg. 46017 (Nov. 6, 1985). Substantiation by other sufficient evidence

requires the production of corroborative evidence in support of the taxpayer’s

statement specifically detailing the required elements. Sec. 1.274-5T(c)(3),

Temporary Income Tax Regs., 50 Fed. Reg. 46020 (Nov. 6, 1985).

      Informed by these fundamental principles of Federal income taxation, we

turn our attention to the issues remaining in dispute.

      A. Car and Truck Expenses

      For each year in issue petitioners claimed a deduction for car and truck

expenses on the Schedule C for SC Management related to the use of their 2007

Honda CRV, 2006 Mini Cooper, and 2005 Nissan Altima. They deducted

$25,094, $17,219, and $21,753 of car and truck expenses for 2009, 2010, and

2011, respectively, on the basis of miles driven. As noted, in the notices of

deficiency respondent disallowed deductions of $4,571, $1,473, and $9,513 for

2009, 2010, and 2011, respectively.8

      According to petitioners’ 2009-11 mileage logs, petitioner drove one or the

other of the vehicles between petitioners’ residence and various locations in

connection with the work he was then doing as an independent contractor. Most

      8
       We note that with respect to 2011, it appears that respondent allowed a
deduction for all of the miles that petitioners identified as having a business
purpose.
                                          - 12 -

of the miles logged for Kyle and Sarah represent driving between the family’s

residence and their respective schools.

      We are satisfied that petitioners’ mileage logs are sufficiently detailed as

required by section 274(d), but that detail does not, in and of itself, make the

recorded mileage deductible. As best we can tell from what has been submitted,

many of the miles that petitioners reported include nondeductible miles driven for

personal reasons. This is particularly so with respect to the entries attributable to

Kyle and Sarah. Eliminating the miles apparently driven for personal purposes

substantially reduces petitioners’ otherwise allowable deductions. They are not

entitled to deductions for car and truck expenses in excess of those respondent has

already allowed.

      B. Education Expenses

      For each year in issue petitioners claimed a deduction for Kyle’s and

Sarah’s respective school tuition and associated fees, including student loan

interest payments and student loan disbursements. According to petitioners, those

expenses are deductible business expenses because they qualify as ordinary and

necessary training expenses within the meaning of section 162(a). According to

petitioners, business organizations routinely pay for training for their employees.

That might be true, but it does not appear from what has been submitted that Kyle
                                        - 13 -

and/or Sarah were employees of SC Management during any of the years in issue.

But even if they were, we note that parents routinely pay higher education

expenses for their children, and those expenses, routinely, are not deductible. See

sec. 262. We find that petitioners are not entitled to deductions related to the

educational expenses of their children, regardless of how the deduction is

identified or described on the Schedules C, and respondent’s disallowances of

those deductions are sustained.

         C. Homeowners Insurance Expenses for 2010 and 2011

         Petitioners claimed deductions for homeowners insurance expenses on the

SC Management Schedules C attached to their 2010 and 2011 returns.9 According

to petitioners, these expenses are attributable to the cost of homeowners insurance

and utilities for their former residence and are deductible business expenses

because they were no longer living in the former residence during the years in

issue and some items relating to Mr. Hicks’ engineering business were stored

there.


         9
        For 2010 petitioners claimed a $3,377 deduction for insurance (other than
health) which relates entirely to homeowners insurance for the former residence.
Petitioners now claim that they are entitled to a $16,170 homeowners insurance
expense deduction for 2010. For 2011 petitioners claimed a $17,363 deduction for
interest (other), part of which relates to homeowners insurance for the former
residence.
                                       - 14 -

      As stated above, generally, personal, living, or family expenses are

nondeductible. Sec. 262(a); sec. 1.262-1(a), Income Tax Regs.

      Petitioners have not provided a copy of their insurance policy to establish

whether the former residence was insured for personal as well as business

purposes. Cf. Foxworthy, Inc. v. Commissioner, T.C. Memo. 2009-203, 2009 WL

2877850, at *10, aff’d, 494 F. App’x 964 (11th Cir. 2012). Therefore, it is unclear

whether any of the business items stored in the former residence were actually

covered by the homeowners insurance policy. Consequently, petitioners have

failed to establish a business nexus between petitioners’ homeowners insurance

policy on the former residence and the equipment locked inside. Accordingly,

petitioners are not entitled to deduct the homeowners insurance expenses for the

former residence.

      D. Credit Card Interest Expenses for 2011

      Petitioners’ interest (other) expense reported on the SC Management

Schedule C attached to their 2011 return includes $242 of interest expenses

attributable to credit card interest. Petitioners provided a copy of a bank statement

for 2011 showing total interest charged of $242; however, petitioners have not

provided any documentation or testimony regarding the business nature of the

charges giving rise to the interest nor whether such interest was actually paid
                                        - 15 -

during 2011. See sec. 162(a); secs. 1.446-1(c)(1), 1.461-1(a), Income Tax Regs.

Accordingly, petitioners are not entitled to a deduction for credit card interest.

      E. Legal and Professional Service Expenses for 2010

      Petitioners claimed a $4,280 deduction for legal and professional service

expenses on the SC Management Schedule C attached to their 2010 return.

According to petitioners, this deduction includes the legal costs associated with

petitioner’s engineering work as well as the legal fees and bank charges

(inspection, photos, and title fees) incurred during the foreclosure proceedings

with respect to the former residence.

      The deductibility of legal fees depends on the origin and character of the

claim for which the expenses were incurred and whether the claim bears a

sufficient nexus to the taxpayer’s business or income-producing activities. See

United States v. Gilmore, 372 U.S. 39 (1963); see also Test v. Commissioner, T.C.

Memo. 2000-362, 2000 WL 1738858, at *4-*5, aff’d, 49 F. App’x 96 (9th Cir.

2002). Legal expenses are deductible under section 162(a) as ordinary and

necessary business expenses if the expense is directly connected with, or

proximately related to, the taxpayer’s business. Bingham Tr. v. Commissioner,

325 U.S. 365, 373, 374 (1945); Rafter v. Commissioner, 60 T.C. 1, 8 (1973), aff’d

without published opinion, 489 F.2d 752 (2d Cir. 1974).
                                        - 16 -

             1. Legal Expenses Related to the Former Residence

      According to petitioners, the legal and professional expenses relating to the

former residence are deductible business expenses because they were no longer

living there and some business items were stored there during the years in issue.

However, there is nothing in the record to show that any business activity occurred

in or near Indiana during the relevant time. Moreover, the origin of the underlying

claim was not related to the trade or business of SC Management but to

petitioners’ interest in preventing foreclosure on the former residence. Incurring

legal expenses to prevent foreclosure of their former residence is a personal

expense. Therefore, petitioners are not entitled to a deduction for legal and

professional service expenses relating to the former residence for 2010.

             2. Other Legal Expenses

      A portion of the legal expense deduction is attributable to petitioner’s

development of an electronic device. Petitioners paid $225 to an intellectual

property law firm and $923 to the Web site legalzoom.com for services related to

that device and petitioner’s work as an independent contractor. Accordingly,

petitioners are entitled to a $1,148 deduction for legal and professional service

expenses for 2010.
                                       - 17 -

II. Accuracy-Related Penalties

      Lastly, we consider whether petitioners are liable for a section 6662(a)

accuracy-related penalty for any of the years in issue. Relying upon various

grounds, respondent argues that they are. See sec. 6662(a)-(d).

      Section 6662(a) imposes a penalty of 20% of the portion of an

underpayment of tax attributable to a substantial understatement of income tax.

Sec. 6662(b)(2). An understatement of income tax is substantial within the

meaning of section 6662 if, as relevant here, the understatement exceeds $5,000.

See sec. 6662(d); sec. 1.6662-4(b), Income Tax Regs.

      Respondent bears the burden of production with respect to the imposition of

the penalties imposed in the notice and here in dispute, see sec. 7491(c), and that

burden has been satisfied because the understatement of income tax for each year

in issue (here computed in the same manner as the deficiency) exceeds $5,000, see

secs. 6211, 6662(d)(2), 6664(a). That being so, it is petitioners’ burden to

establish that the imposition of the penalty is not appropriate. See Higbee v.

Commissioner, 116 T.C. 438, 447 (2001); see also Rule 142(a); Welch v.

Helvering, 290 U.S. at 115.

      Section 6664(c)(1) provides that the section 6662(a) accuracy-related

penalty does not apply to any portion of an underpayment if the taxpayer
                                       - 18 -

establishes that there was reasonable cause for, and the taxpayer acted in good

faith with respect to, the underpayment. Sec. 1.6664-4(a), Income Tax Regs. The

determination of whether the taxpayer acted with reasonable cause and in good

faith is made on a case-by-case basis, taking into account the pertinent facts and

circumstances. Id. para. (b)(1). “Circumstances that may indicate reasonable

cause and good faith include an honest misunderstanding of fact or law that is

reasonable in light of all of the facts and circumstances, including the experience,

knowledge, and education of the taxpayer.” Id.

      Virtually all of the deductions here in dispute have been disallowed because

they relate to personal rather than business expenses. Petitioners have not shown

reasonable cause, substantial authority, or any other basis for treating any personal

expenses as business expenses. Accordingly, respondent’s imposition of a section

6662(a) accuracy-related penalty for each year in issue is sustained.

      To reflect the foregoing,


                                                     Decision will be entered

                                                under Rule 155.
