                            T.C. Summary Opinion 2018-32



                            UNITED STATES TAX COURT



               RODRIGO KHO AND LORETA KHO, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 7720-17S.                             Filed June 27, 2018.



      Rodrigo Kho and Loreta Kho, pro sese.

      Christiane C. Sanicola, for respondent.



                                 SUMMARY OPINION


      GUY, 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 reviewable by


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

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

case.

        Respondent determined that petitioners are liable for a Federal income tax

deficiency of $27,032 for the taxable year 2014 (year in issue) and an accuracy-

related penalty of $5,406 under section 6662(a). Petitioners, husband and wife,

filed a timely petition for redetermination pursuant to section 6213(a). At the time

the petition was filed, they resided in California.

        The parties agree that petitioners are (1) not entitled to a dependency

exemption deduction for Mrs. Kho’s mother; (2) entitled to deduct mortgage

interest payments of $75,568;2 (3) entitled to deduct real estate taxes of $8,193;3

(4) entitled to deductions claimed on Schedule C for legal and professional

expenses of $1,151, office expenses of $322, taxes and license fees of $201,

parking fees of $43, and postage expenses of $102; and (5) not entitled to


        1
       (...continued)
Revenue Code, as amended and in effect for 2014, and all Rule references are to
the Tax Court Rules of Practice and Procedure. Monetary amounts are rounded to
the nearest dollar.
        2
       Regarding mortgage interest payments, the parties agree that $63,318 shall
be reported on Schedule A, Itemized Deductions, and $12,250 shall be reported on
Schedule C, Profit or Loss From Business.
        3
      Regarding real estate taxes, the parties agree that $6,865 shall be reported
on Schedule A and $1,328 shall be reported on Schedule C.
                                         -3-

deductions claimed on Schedule C for rent or lease expenses and education

expenses.

      Petitioners offered no evidence that they are entitled to (1) an itemized

deduction for a claimed charitable contribution of $8,000 or (2) a deduction for the

business use of their home in excess of the $15,717 allowed in the notice of

deficiency. Accordingly, those adjustments are deemed conceded.

      The issues remaining for decision are whether petitioners are (1) entitled to

a dependency exemption deduction for Mrs. Kho’s father, (2) entitled to

deductions for certain expenses related to a foster care activity in excess of

amounts allowed by respondent, and (3) liable for an accuracy-related penalty

under section 6662(a).4




      4
       Some adjustments in the notice of deficiency are computational and will
flow from the parties’ concessions and the Court’s disposition of the issues
remaining in dispute.
                                          -4-

                                     Background5

I. Petitioners’ Foster Care Activity

      Petitioners have one child, and they reside in a single-family home where

they provide foster care for two adult men with developmental disabilities.

Petitioners’ foster care clients have separate bedrooms but share a single

bathroom.

      During the year in issue one of petitioners’ clients routinely spent weekends

at his parents’ home. The other client lived with petitioners year round and

required a gluten-free diet. This client accompanied petitioners on all family

outings, including vacations and recreational outings. To accommodate his

dietary needs, petitioners prepared only gluten-free meals in their home, and they

ordered only gluten-free items when they dined out.

II. Mrs. Kho’s Parents

      During the year in issue Mrs. Kho’s parents lived in the Philippines. Her

father is a U.S. citizen but her mother is not.

      Petitioners provided financial support to Mrs. Kho’s parents in 2014,

transferring funds to them through electronic channels and sometimes sending

cash to them when friends from the United States traveled to the Philippines. The

      5
          Some of the facts have been stipulated.
                                           -5-

record shows that petitioners transferred about $3,000 to Mrs. Kho’s parents in

2014.

        Mrs. Kho’s father had been employed for many years in the Philippines as

an accountant but had retired sometime before 2014. Mrs. Kho acknowledged that

her father received social security benefits from the Philippine Government in

2014, although she was uncertain of the amount. She was also uncertain whether

her father received any pension payments in 2014.

III. Petitioners’ Tax Return

        Petitioners filed a joint Form 1040, U.S. Individual Income Tax Return, for

2014. The tax return was prepared by an accounting firm that petitioners had

relied upon in the past. Petitioners claimed five dependency exemption

deductions--including exemptions for themselves, their son, and Mrs. Kho’s

parents.

        Petitioners attached to their tax return a Schedule C related to the foster care

activity described above. They reported gross receipts from the activity of

$48,000, operating expenses of $66,416, and expenses attributable to the business

use of their home of $71,956, reported on Form 8829, Expenses for Business Use

of Your Home, resulting in a net loss of $90,372. They reported the latter amount

on line 12 of their tax return. As is relevant here, petitioners deducted vehicle
                                          -6-

expenses of $19,720 (computed using the optional standard mileage rate),6 meals

and entertainment expenses of $8,850, and grocery expenses of $14,516.

                                      Discussion

      As a general rule, the Commissioner’s determination of a taxpayer’s liability

in a notice of deficiency is presumed correct, and the taxpayer bears the burden of

proving that the determination is incorrect. Rule 142(a); Welch v. Helvering, 290

U.S. 111, 115 (1933).7 Deductions and credits are a matter of legislative grace,

and the taxpayer generally bears the burden of proving entitlement to any

deduction or credit claimed. 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).

I. Dependency Exemption Deduction

      Generally, taxpayers may claim dependency exemption deductions for their

dependents (as defined in section 152). Sec. 151(c). The term “dependent”

includes a “qualifying relative.” Sec. 152(a)(2).8 Under section 152(d)(1), a


      6
      See Notice 2013-80, sec. 3, 2013-52 I.R.B. 821, 821, setting the standard
mileage rate at 56 cents per mile for taxable year 2014.
      7
       Petitioners do not contend, and the record does not suggest, that the burden
of proof should shift to respondent pursuant to sec. 7491(a).
      8
        As a general rule, the term “dependent” does not include an individual who
is not a citizen or national of the United States unless the individual is a resident
                                                                          (continued...)
                                         -7-

qualifying relative is an individual: (1) who bears a qualifying relationship to the

taxpayer, e.g., the taxpayer’s parent, sec. 152(d)(2)(C); (2) whose gross income for

the year is less than the section 151(d) exemption amount ($3,950 for 2014);

(3) who receives over one-half of his support from the taxpayer for the taxable

year; and (4) who is not a qualifying child of the taxpayer or of any other taxpayer

for the taxable year.

      Although petitioners demonstrated that they transferred about $3,000 to

Mrs. Kho’s parents in 2014, they were unable to provide objective evidence of

Mrs. Kho’s father’s gross income in 2014 or whether he received over one-half of

his support from petitioners as required under section 152(d)(1). Under the

circumstances, petitioners have failed to show that they are entitled to a

dependency exemption deduction for Mrs. Kho’s father.

II. Schedule C Expenses

      Under section 162(a), a deduction is allowed for ordinary and necessary

expenses paid or incurred during the taxable year in carrying on any trade or

business. A deduction normally is not allowed, however, for personal, living, or

family expenses. Sec. 262(a). Whether an expenditure satisfies the requirements

      8
       (...continued)
of the United States or a country contiguous to the United States. Sec.
152(b)(3)(A).
                                          -8-

for deductibility under section 162 generally is a question of fact. See

Commissioner v. Heininger, 320 U.S. 467, 475 (1943).

       As used in section 162 an “ordinary” expense is defined as one which is

“normal, usual, or customary” in the taxpayer’s trade or business, see Deputy v.

du Pont, 308 U.S. 488, 494-495 (1940), and “necessary” has been defined as

appropriate and helpful, see Welch v. Helvering, 290 U.S. at 113.

       Respondent contends that petitioners are not entitled to a deduction for

meals and entertainment expenses and that the amounts petitioners may deduct for

vehicle expenses and groceries are limited to $1,232 and $7,800, respectively.9 In

short, respondent maintains that expenses in excess of the amounts allowed do not

constitute ordinary and necessary business expenses within the meaning of section

162.

       Petitioners assert that, because one or both of their clients always

accompanied them when they left home, all vehicle expenses and all of their

expenses for meals and entertainment constitute ordinary and necessary business

expenses. Petitioners further assert that, because they adopted a gluten-free diet to

accommodate the needs of one of their clients, and gluten-free food products


       9
       Respondent does not dispute that petitioners’ foster care activity was a
trade or business or that they actually paid the expenses in dispute.
                                         -9-

generally are more expensive than similar products that are not gluten-free, all of

the groceries that they purchased in 2014 qualify as ordinary and necessary

business expenses.

      A taxpayer seeking a business expense deduction for what would ordinarily

be considered a personal living expense for one’s self and one’s dependents must

demonstrate that the expenditures were “different from or in excess of that which

would have been made for the taxpayer’s personal purposes.” Duggan v.

Commissioner, 77 T.C. 911, 914 (1981) (quoting Sutter v. Commissioner, 21 T.C.

170, 173 (1953)).

      Petitioners failed to show that they are entitled to any deduction for meals

and entertainment expenses or that they are entitled to deductions for vehicle

expenses or grocery expenses in excess of the amounts allowed by respondent.

We conclude on this record that petitioners’ expenditures for meals and

entertainment were nondeductible personal expenses under section 262(a).

Moreover, any excess cost to petitioners in providing gluten-free meals to their

client is accounted for in the amount that respondent allowed as a deductible

expense for groceries.10 In short, we sustain respondent’s determination that the

      10
        For the sake of completeness we note that petitioners failed to satisfy sec.
274(d), which prescribes more stringent substantiation requirements to be met
                                                                       (continued...)
                                         -10-

expenses in dispute were primarily for petitioners’ and their son’s personal benefit

and any business purpose was distinctly secondary and incidental. See, e.g., Int’l

Artists, Ltd. v. Commissioner, 55 T.C. 94, 104 (1970).

III. Accuracy-Related Penalty

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

equal to 20% of the amount of any underpayment of tax that is due to the

taxpayer’s negligence or disregard of rules or regulations or to any substantial

understatement of income tax. Negligence is a lack of due care or failure to do

what a reasonable and ordinarily prudent person would do under the

circumstances. Neely v. Commissioner, 85 T.C. 934, 947 (1985). A taxpayer is

negligent if he or she fails to maintain sufficient records to substantiate disputed

expenses. Higbee v. Commissioner, 116 T.C. 438, 449 (2001); sec. 1.6662-

3(b)(1), Income Tax Regs. An understatement of income tax is “substantial” if the

understatement exceeds the greater of 10% of the tax required to be shown on the

return or $5,000. Sec. 6662(d)(1)(A).


      10
         (...continued)
before a taxpayer may deduct certain categories of expenses, including travel
expenses, meals and entertainment expenditures, and expenses related to the use of
listed property (such as automobiles) as defined in sec. 280F(d)(4)(A). See
Sanford v. Commissioner, 50 T.C. 823, 827 (1968), aff’d, 412 F.2d 201 (2d Cir.
1969).
                                        -11-

      With respect to a taxpayer’s liability for any penalty, section 7491(c) places

on the Commissioner the burden of production, thereby requiring the

Commissioner to come forward with sufficient evidence indicating that it is

appropriate to impose the penalty. Higbee v. Commissioner, 116 T.C. at 446-447.

Once the Commissioner meets his burden of production, the taxpayer must come

forward with persuasive evidence that the Commissioner’s determination is

incorrect. Id. at 447; see Rule 142(a); Welch v. Helvering, 290 U.S. at 115.11

      Section 6664(c) provides, however, that no penalty shall be imposed with

respect to any portion of an underpayment if it is shown that there was reasonable

cause for such portion and that the taxpayer acted in good faith with respect to

such portion. Swihart v. Commissioner, T.C. Memo. 1998-407. The Court must

consider all the facts and circumstances in determining whether the taxpayer acted

with reasonable cause and in good faith. Sec. 1.6664-4(b)(1), Income Tax Regs.




      11
        Respondent has satisfied his burden of production. Even taking
respondent’s concessions into account, it is likely that the understatement of
income tax exceeds 10% of the tax required to be shown on petitioners’ return,
which is greater than $5,000. Moreover, petitioners conceded a number of
adjustments without explanation and failed to maintain sufficient records. Finally,
the record includes a Civil Penalty Approval Form executed by the Internal
Revenue Service examiner’s group manager approving the sec. 6662(a) penalty
determined in the notice of deficiency. See sec. 6751(b).
                                        -12-

Generally, the most important factor is the extent of the taxpayer’s effort to assess

his or her proper tax liability. Id.

      Considering all the facts and circumstances, including petitioners’ lack of

sophistication regarding tax matters and their good-faith reliance on the assistance

of an accountant in preparing their tax return for the year in issue, we conclude

that petitioners have shown reasonable cause and that they acted in good faith in

respect of the portions of the underpayments that are attributable to the

disallowance of deductions for vehicle expenses, meals and entertainment

expenses, and grocery expenses. No penalty may be imposed under section

6662(a) in respect of those portions of the underpayments. In contrast, we

conclude that petitioners are liable for the penalty imposed under section 6662(a)

with respect to the portions of the underpayments attributable to the remaining

adjustments that were sustained in this case.

      To reflect the foregoing,


                                                Decision will be entered

                                       under Rule 155.
