                     T.C. Summary Opinion 2011-107



                        UNITED STATES TAX COURT



           JIAN DONG SUN AND MING-YAN SHEN, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 15044-10S.            Filed August 31, 2011.



        Edward M. McElroy, for petitioners.

     Donald D. Priver, for respondent.



     JACOBS, Judge:     This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect

when the petition was filed.    Pursuant to section 7463(b), the

decision to be entered is not reviewable by any other court, and

this opinion shall not be treated as precedent for any other

case.     Unless otherwise indicated, all section references are to
                               - 2 -

the Internal Revenue Code in effect for 2007, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

      Respondent determined a deficiency of $4,757 in petitioners’

2007 Federal income tax and a section 6662(a) accuracy-related

penalty of $951.40.   The issues for decision are:     (1) Whether

respondent’s disallowance of deductions for various alleged

business expenses should be sustained, and if so (2) whether

petitioners are liable for the section 6662(a) accuracy-related

penalty.

                             Background

      Some of the facts have been stipulated, and they are so

found.   We incorporate by reference the parties’ stipulation of

facts and the accompanying exhibits.      At the time they filed

their petition, petitioners resided in northern California.

I.   Petitioners’ Business

      Petitioners, husband and wife, emigrated to the United

States from China in the early 1990s.      Jian Dong Sun (Mr. Sun)

graduated from medical school in China and practiced medicine

there as a surgeon for 15 years.

      During 2007 Mr. Sun was employed part time as a dialysis

technician at Satellite Dialysis Center.      He began working there

in 1994.   He also worked part time in 2007 at El Camino Hospital.

During 2007 Ming Yan Shen (Ms. Shen) worked for Stanford

University Medical School as well as Kaiser Permanente.
                                - 3 -

     Through his employment as a dialysis technician, Mr. Sun

became aware of a number of shortcomings in both the equipment

and techniques used in kidney dialysis.    Mr. Sun devised four

inventions.

     The first of the inventions, a “Roller bed surface”, was a

“medical bed” designed to reduce the likelihood of the patients

developing bedsores as well as to enable the user to move easily

from the bed to a wheelchair and back again.    In 2003 Mr. Sun

attempted to patent this device, but his application was denied

because (1) a similar device already existed and (2) his patent

application was not in the proper form.

     Mr. Sun’s second invention was an “Emergency Disengagement

Device for Patients Undergoing Hemodialysis” or a “cut-and-run”

device.   This device permitted the user to quickly and safely

disconnect himself/herself from the dialysis machine in case of

emergency.    On June 24, 2006, Mr. Sun submitted a patent

application for this device.    On April 23, 2009, the patent

office rejected Mr. Sun’s application request, again on the

grounds that his patent submission was not in proper form and

another party had previously patented a similar device.      In the

rejection letter the patent office noted Mr. Sun’s lack of

familiarity with patent application procedures and remarked

that he should seek the services of a registered patent attorney.

     Mr. Sun’s third invention was an “Apparatus to Assist with

Disconnecting Dialysate Tubing”.    This device was designed to
                              - 4 -

ease the connecting and disconnecting of the dialysis tubes.        The

patent office rejected this patent application.

     Mr. Sun’s fourth invention involved a “Baggage claim

assistance device” designed to assist individuals in wheelchairs

in removing their luggage from airport luggage carousels.      This

device currently is in the development stage.

     Mr Sun organized Sun Pioneer in 2001 to further his interest

in developing devices that could be used in kidney dialysis.        Ms.

Shen worked part time for Sun Pioneer, often acting as Mr. Sun’s

interpreter or speaking with others on his behalf.

     Mr. Sun obtained a business license for Sun Pioneer.      He

opened a checking account for the company and applied for an

employer identification number from the Internal Revenue Service.

However, because of his lack of knowledge of bringing products to

market and his lack of knowledge of good business practices, Mr.

Sun did not initially develop a business plan or keep adequate

business records.

     To improve his entrepreneurial skills, Mr. Sun attended

classes taught by the Small Business Administration and the

Silicon Valley Small Business Development Center.    He read

literature and sought the assistance of Adrian Pelkus, the

president of A Squared Technologies, Inc., with respect to

obtaining a U.S. patent for his medical inventions.

Additionally, Mr. Sun sought advice with respect to certain
                                - 5 -

technical aspects of his medical device inventions from Nengli

Zhang of NASA and Dr. Cindy Xin Huang of Tufts Medical Center.

     Mr. Sun sought legal advice from an unnamed U.S. patent

attorney.    He did not engage the services of that attorney for

economic reasons.    Mr. Sun did, however, engage the services of

an attorney to obtain a patent in China.1

     In connection with each of his inventions, Mr. Sun drafted

diagrams and explanatory notes (all in Chinese) with regard to

the device’s design, construction, and functionality.    With

regard to several of his inventions, Mr. Sun had prototypes built

in China, and he partnered with an undisclosed individual to

facilitate arrangements with Chinese contract manufacturers.     Mr.

Sun’s relationships with his Chinese partner and contract

manufacturers were informal; there were no written contracts.

     Mr. Sun conducted market research for each of his

inventions.    He approached medical equipment distributors, such

as Baxter Healthcare, Dialysis Parts and Supplies, and DaVita,

Inc., as well as potential consumers (doctors and hospitals), to

discuss their interest in his inventions.    In 2010 Mr. Sun

stopped working as a dialysis technician in order to focus

exclusively on his inventive interests.

     Mr. Sun’s inventive activities have not as yet generated

gross receipts.    Petitioners reported losses, all of which relate


     1
        The Chinese patent was obtained in Mr. Sun’s brother’s
name.
                                 - 6 -

to Mr. Sun’s inventive activities, on Schedule C, Profit or Loss

From Business, of their Federal income tax returns as follows:

          Year                               Net Loss

          2002                               $14,724
          2003                                18,992
          2004                                14,490
          2005                                14,791
          2006                                13,372
          2007                                16,518
          2008                                11,395

     Petitioners reported wage and salary income as follows:

          Year                                Wages

          2002                              $113,468
          2003                               123,970
          2004                               140,773
          2005                               125,536
          2006                               141,453
          2007                               152,225
          2008                               127,138

     Petitioners reported gross receipts, all of which were from

Mr. Sun’s consulting activities, on Schedules C of their Federal

income tax returns as follows:

          Year                           Gross Receipts

          2002                                 -0-
          2003                                 -0-
          2004                                 -0-
          2005                                 -0-
          2006                               $3,600
          2007                                2,400
          2008                                7,500

     At the conclusion of trial, the Court remarked that on the

totality of the evidence and after observing Mr. Sun’s demeanor

while he was testifying, the Court was satisfied that he had an
                               - 7 -

honest intent to earn a profit from his inventive activities.

The Court found as a fact that during 2007 Mr. Sun engaged in his

inventive activities primarily for profit.

II.   Petitioners’ Expenses

      During 2007 petitioners deducted numerous expenses which

allegedly related to Mr. Sun’s inventive activities.    On

Schedule C, petitioners made the following expense claims:

      Schedule C Expense                           Amount

      Automobile                                   $3,396
      Section 179 property                            323
      Legal & professional services                 4,075
      Office                                          100
      Rent or lease of vehicles,                       60
         machinery, & equipment
      Supplies                                          511
      Taxes & licenses                                  150
      Travel                                          7,208
      Meals & entertainment                           1,324
      Utilities                                       1,367
      Other                                             404

      Petitioners attached a Form 8829, Expenses for Business Use

of Your Home, to their 2007 Federal income tax return.    On Form

8829, petitioners claimed utility expenses of $552.    However, on

line 35, “Allowable expenses for business use of your home”,

petitioners reported zero with respect to expenses for the

business use of their home.

      During 2007 Ms. Shen and Mr. Sun separately traveled to

China.   Ms. Shen visited China from March 4 to March 29, 2007.

Mr. Sun visited China from April 23 to May 23, 2007.    While in
                                 - 8 -

China, Mr. Sun met with his partner and several contract

manufacturers.   He also visited friends and family members.      The

record does not reveal the business purpose for Ms. Shen’s visit.

Mr. Sun candidly admitted that Ms. Shen most likely visited

friends and family members during her trip to China.2

     Petitioners took a 7-day cruise to Hawaii in July 2007.         The

record does not reveal the business purpose for the cruise.

Petitioners also twice traveled to Los Angeles and San Diego

(southern California) in 2007.    Again, the record does not reveal

the business purpose of the trips.       We note, however, that

petitioners’ daughter lived in San Diego.3

     At trial respondent’s counsel conceded that petitioners

expended the dollar amounts claimed with respect to the deducted

expenses.   However, respondent’s counsel stated that respondent

did not concede that the amounts petitioners expended and

deducted were for ordinary and necessary business expenses.

     Respondent disallowed petitioners’ expense deductions on two

alternative theories.   First, respondent avers that Mr. Sun was

not engaged in a “for profit activity” with respect to his

inventive work and therefore he could not deduct his expenses

pursuant to the provisions of section 183(a).       Alternatively,


     2
      Ms. Shen did not testify.
     3
      In their posttrial brief petitioners concede the amount
($3,179.92) for their Hawaiian cruise and two trips to southern
California is not deductible.
                               - 9 -

respondent maintains that petitioners failed to establish that

the deducted expenses were “ordinary and necessary” business

expenses within the purview of section 162(a).

      On the basis of our finding that Mr. Sun was engaged in an

activity for profit, see supra p. 7, the only basis on which

respondent’s deficiency determination can be sustained is that

petitioners’ expenses were not ordinary and necessary business

expenses.

                            Discussion

I.   Petitioners’ Business Expense Deductions

      Section 162(a) allows a deduction for ordinary and necessary

business expenses paid or incurred during the taxable year in

carrying on a trade or business.   For an expense to be “ordinary”

the transaction that gives rise to it 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, 113-114 (1933).

      It is well established that deductions are a matter of

legislative grace and that taxpayers bear the burden of proving

they are entitled to the deductions 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).

Taxpayers must substantiate the amount and purpose of the item
                               - 10 -

deducted.   Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975),

affd. per curiam 540 F.2d 821 (5th Cir. 1976).    Taxpayers are

required to maintain records sufficient to enable the

Commissioner to determine their correct tax liability.    See sec.

6001; Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965);

sec. 1.6001-1(a), Income Tax Regs.

     Automobile, travel, and meals and entertainment expenses are

subject to heightened substantiation requirements.    See secs.

280F(d)(4)(A)(i), 274(d)(1) and (2).    Petitioners failed to meet

these heightened substantiation requirements.    Further, we are

unconvinced that the claimed automobile, travel, and meals and

entertainment expenses constitute ordinary and necessary business

expenses within the purview of section 162(a).    Indeed, Mr. Sun

admitted that his and Ms. Shen’s trips to China were for pleasure

as well as business.    Petitioners failed to demonstrate that the

primary purpose of their trips to China was to further Mr. Sun’s

inventive activities.   Further, they concede the amount for their

Hawaiian cruise and two trips to southern California is not

deductible.   See supra note 3.   Consequently, petitioners’

expenses for travel to and from China, Hawaii, and southern

California are not deductible.    See sec. 1.162-2(b)(1), Income

Tax Regs.

     Petitioners’ legal fees relate to the engagement of the

services of an attorney to obtain a patent in China.    We are
                               - 11 -

mindful that the Chinese patent was obtained in Mr. Sun’s

brother’s name.    Mr. Sun credibly testified as to the reason

therefor; i.e., it was “much cheaper than for a foreigner” to do

so.    Recognizing that Chinese familial customs and business

practices differ from those of the United States, we are

satisfied that all of the benefits of the patent belong to Mr.

Sun.    Consequently, we hold that petitioners’ $4,075 in legal and

professional fee expenses constitute ordinary and necessary

business expenses within the purview of section 162.

       As to each of the other types of expenses deducted,

petitioners provided no documentation or testimony which

demonstrated that these expenses were ordinary and necessary

business expenses.    Under certain circumstances, if a taxpayer

establishes entitlement to a deduction, but not the amount, the

Court may estimate the amount allowable.    Cohan v. Commissioner,

39 F.2d 540, 543-544 (2d Cir. 1930).    We generally will not

estimate a deductible expense unless the taxpayer presents

sufficient evidence to provide some basis upon which an estimate

may be made.    Vanicek v. Commissioner, 85 T.C. 731, 742-743

(1985).    Petitioners have not provided us any basis to estimate

any allocation of expenses to business purposes.

       To conclude this portion of our opinion, except for

petitioners’ legal and professional fee expenses of $4,075, we

sustain respondent’s disallowance of the business expense
                                - 12 -

deductions claimed on the basis that petitioners failed to carry

their burden of proof.

II.     Section 6662(a) Accuracy-Related Penalty

        Section 6662(a) imposes a 20-percent penalty on that portion

of an underpayment of tax attributable to, inter alia, negligence

or disregard of rules or regulations, as provided in section

6662(b)(1), or a substantial understatement of income tax, as

provided in section 6662(b)(2).     Negligence includes any failure

to make a reasonable attempt to comply with the provisions of the

Internal Revenue Code.     Sec. 6662(c); ASAT, Inc. v. Commissioner,

108 T.C. 147, 175 (1997).     Negligence also includes any failure

by the taxpayer to keep adequate books and records or to

substantiate items properly.     Sec. 1.6662-3(b)(1), Income Tax

Regs.     The term “disregard” includes any careless, reckless or

intentional disregard.     Sec. 6662(c).

      The section 6662(a) accuracy-related penalty does not apply

where the taxpayer shows that there was reasonable cause for the

underpayment and that he acted in good faith.      Sec. 6664(c)(1).

Such a showing depends on the facts and circumstances of each

case and includes the knowledge and experience of the taxpayer

and the reliance on the advice of a professional, such as an

accountant.     Sec. 1.6664-4(b)(1), Income Tax Regs.

      Respondent has the burden of production pursuant to section

7491(c).     To satisfy that burden, respondent must produce
                              - 13 -

sufficient evidence showing that it is appropriate to impose the

penalty.   See Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

On the record before us, respondent has satisfied his burden by

producing evidence that petitioners were negligent in failing to

keep books and records and in failing to substantiate their

claimed deductions.

     Petitioners have not demonstrated that there was reasonable

cause for their underpayment of tax or that they acted in good

faith.   Although Mr. Sun sought advice regarding the technical

aspects of establishing a business, the record does not reveal

that he sought advice from a tax professional regarding the

deductibility of his expenses.

     To conclude this portion of our opinion, petitioners have

failed to prove that they are not liable for the section 6662(a)

penalty.   Petitioners have neither argued nor offered evidence

that an exception exists which would excuse them from the

penalty.   We therefore sustain respondent’s determination that

petitioners are liable for the section 6662(a) penalty.   However,

respondent must recompute the amount of the penalty to reflect

the recalculation of petitioners’ 2007 business expenses.   This

can be done in the Rule 155 computation.
                             - 14 -

     We have considered all of petitioners’ contentions, and we

conclude they are without merit, irrelevant, and/or moot.

     To reflect the foregoing,


                                        Decision will be entered

                                   under Rule 155.
