                              T.C. Memo. 2015-204



                         UNITED STATES TAX COURT



                    WSK & SONS, INC., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

          WILLIAM S. KARRAS AND SHANA KARRAS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 27370-12, 27429-12.           Filed October 15, 2015.



      J. David Horspool, for petitioners.

      Jenny R. Casey, Miles D. Friedman, Eric M. Heller, Mindy S. Meigs, and

Kim-Khanh Thi Nguyen, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      COHEN, Judge: In these consolidated cases, respondent determined

deficiencies and penalties as follows:
                                        -2-

[*2] WSK & Sons, Inc., Docket No. 27370-12

                                                             Penalty
          Year                   Deficiency                sec. 6662(a)

          2008                    $48,528                    $9,705.60

William S. & Shana Karras, Docket No. 27429-12

                                                             Penalty
          Year                   Deficiency                sec. 6662(a)

          2008                    $9,993                    $1,998.60

          2009                     5,511                      1,102.20

      Any reference to the tax year 2008 for WSK & Sons, Inc. (petitioner), is to

its applicable fiscal year ended February 28, 2009. Unless otherwise indicated, all

section references are to the Internal Revenue Code (Code) in effect for the years

in issue, and all Rule references are to the Tax Court Rules of Practice and

Procedure.

      After concessions, the issues remaining for decision are whether petitioner

is entitled to a $39,321 deduction for advertising expenses for 2008; whether

petitioner is entitled to a deduction for depreciation in excess of the amount that

respondent allowed for 2008; and whether petitioners are liable for section

6662(a) penalties (petitioner for 2008 and William S. Karras and Shana Karras

(Karrases) for 2008 and 2009).
                                         -3-

[*3]                            FINDINGS OF FACT

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

incorporated in our findings by this reference. At the time their petitions were

filed, the Karrases resided in California, and petitioner had its principal place of

business in California.

       Petitioner is a California corporation that constructs and installs gas station

fuel delivery systems, and its primary customer is Costco Wholesale Corp.

(Costco). It operates on a fiscal tax year ending on February 28 and uses the cash

method of accounting. For the disputed years, the Karrases were the shareholders

of petitioner, whose office was at the Karrases’ home. William S. Karras (WSK)

ran the day-to-day field operations of petitioner as its president. The Karrases’

two adult sons, Robert J. Karras and William B. Karras (WBK), also worked for

petitioner at that time.

       WSK entered into a rental agreement with Estate Properties International,

Inc., to rent a beachfront home at Monarch Beach, California, from December 26,

2008, through January 2, 2009. The rent was $22,950, which included a $5,000

fully refundable security deposit. Guest names were written as “William & Shana

Karras Family”, and the agreement indicated that there would be 10 adults.

“William & Shana Karras/W.S.K. & Sons Inc.” was written in the “Tenant Print
                                        -4-

[*4] Name(s)” field beneath the Karrases’ signatures. WSK provided his personal

credit card information for the requested credit card authorization in the

agreement.

      WBK participated in the weeklong rental at the beachfront home. His

fiance, some of her family, and a few of his friends were also at the rental home

during the week. On January 3, 2009, the day after the rental ended, he and his

fiance were married.

      Petitioners’ tax returns for the years in issue were prepared by Horspool &

Co., Inc. The Karrases timely filed their joint Forms 1040, U.S. Individual Income

Tax Return, for 2008 and 2009, and petitioner timely filed Form 1120, U.S.

Corporation Income Tax Return, for its tax year ended February 28, 2009. On its

return, petitioner claimed a deduction of $39,321 for advertising. The advertising

deduction included payments that petitioner made for, inter alia, expenses related

to WBK’s wedding and purchases at Bass Pro Shops.

      Petitioner’s return also reported a claimed depreciation deduction of

$76,006. Listed property related to this deduction included a 2003 GMC Sierra

truck and a 2005 Hummer vehicle, the title owner of both being Shana Karras, and

a 2008 GMC Sierra truck (2008 truck), the title owner being WSK (collectively,

three vehicles). On an attached Form 4562, Depreciation and Amortization,
                                                             -5-

[*5] petitioner made a section 179 election to fully deduct the claimed $54,559

acquisition cost of the 2008 truck for 2008.

          The Internal Revenue Service (IRS) selected petitioner’s 2008 tax return

and the Karrases’ 2008 and 2009 tax returns for examination. When an IRS agent

went to petitioners’ residence/place of business to conduct the audit, the three

vehicles were not there. During the audit, petitioner provided a document titled

“2008 Federal Summary Depreciation Schedule” (depreciation schedule) that

showed, in part, the following:

                                                                                  Prior
                                                                          Cur     179/
                            Date           Date     Cost/      Bus.       179/    SDA/                         Current
  No.      Description     Acquired        Sold     Basis      Pct        SDA     Depr.     Method      Life    Depr.

 Form 1120

   Auto / Transport Equipment

   1     Truck - Sierra     3/01/04                   ( 1)         ( 1)    ( 1)     ( 1)    )B HY         5      3,463

   2     Truck - GMC      11/30/04                    ( 1)         ( 1)    ( 1)     ( 1)    )B HY         5      3,850

  12    ‘08 GMC Sierra      6/30/08                   ( 1)         ( 1)    ( 1)     ( 1)    )B HY         5             0

   •    Total Auto / Transport Equipment                                                                         7,313

   1
     If entries were entered in these fields, they were obscured (as partially was the “Method” field) by a note that
read “Missing Invoices for Equip + Furniture Purchases 61872 76006”).


          Petitioner also provided an excerpt from its general ledger titled “Query Y-

T-D Detail” with the header “Advertising & Promotion” (advertising detail sheet)

for the period ended February 28, 2009. Showing a balance of $39,321.41, the

advertising detail sheet listed 17 expenses, including a $5,930.88 item for “AMEX
                                       -6-

[*6] CHARGES STMT 7/24” on July 24, 2008, a $22,950 item for

“PRUDENTIAL PROP RENTAL” on November 28, 2008, and a $976.41 item for

“DC-BASS PRO SHOPS” on December 26, 2008. Petitioner also provided a

$976.41 receipt from Bass Pro Shops dated December 24, 2008.

      As a result of the examination, the IRS disallowed $61,872 of petitioner’s

depreciation expense deduction (the amount attributable to the three vehicles). It

also disallowed petitioner’s entire advertising expense deduction.

      At trial petitioners presented a retail installment contract between WSK and

Hatfield Buick GMC that showed a total sale price of $57,083.27 for the 2008

truck. They also produced a single page of one of petitioner’s Wells Fargo Bank

statements that showed an August 25, 2008, debit made by Shana Karras for a

“GMAC” payment of $948.99.

                                    OPINION

      Personal, living, and family expenses are generally not deductible. Sec.

262. On the other hand, section 162 allows as a deduction “all the ordinary and

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

trade or business”. For an expenditure to be an ordinary and necessary business

expense, generally the taxpayer must show a bona fide business purpose for the

expenditure, and there must be a proximate relationship between the expenditure
                                        -7-

[*7] and the business of the taxpayer. See Challenge Mfg. Co. v. Commissioner,

37 T.C. 650, 660-661 (1962); see also sec. 1.162-1(a), Income Tax Regs.

      Taxpayers are required to maintain sufficient records to establish the

amount and purpose of any deduction. Sec. 6001; Higbee v. Commissioner, 116

T.C. 438, 440 (2001); sec. 1.6001-1(a), (e), Income Tax Regs.; see also Lyseng v.

Commissioner, T.C. Memo. 2011-226, slip op. at 8 (“In general, taxpayers must

substantiate claimed deductions with evidence such as invoices or receipts that

establish that the expenses were actually incurred[.]”). They also have the burden

of proving their entitlement to deductions claimed. Rule 142(a); see New Colonial

Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); Rockwell v. Commissioner, 512

F.2d 882, 886 (9th Cir. 1975), aff’g T.C. Memo. 1972-133. The burden may shift

to respondent under section 7491(a)(1) and (2), but petitioners did not satisfy

conditions for that shift, particularly the substantiation requirements and

maintenance of all required records. The burden of proof therefore remains with

petitioners.

Advertising Expense Deduction

      Although petitioner contests the disallowance of the entire advertising

expense deduction of $39,321.41, it addresses only two particular items: (1) the

$22,950 expense for a “corporate retreat” allegedly held at the beachfront rental
                                            -8-

[*8] property and (2) the $5,930 expense for a Washington State fishing trip where

the Karrases allegedly hosted Costco executives. Petitioner argues that the retreat

served a legitimate business purpose by enhancing employer-employee

relationships for future productivity and preserving and expanding petitioner’s

client relationship with Costco. Likewise, it asserts that the cost of the fishing trip

was “appropriate and helpful” for the development of its business and its

continuing relationship with Costco, citing Commissioner v. Tellier, 383 U.S. 687,

689 (1966).

      Petitioner provided little documentation of these expenses--primarily a self-

generated advertising detail sheet with no detail about these two items (and refers

to the corporate retreat and fishing trip as “PRUDENTIAL PROP RENTAL” and

“AMEX CHARGES STMT 7/24”, respectively). The only stipulated receipt in the

record is a December 24, 2008, Bass Pro Shops receipt for $976.41, and it does

not seem to be related to the fishing trip in issue, the alleged cost of which would

have been incurred before July 24, 2008. No explanation was given as to how this

receipt related to petitioner’s business.

      The rental agreement between WSK and Estate Properties International,

Inc., presumably negotiated by Prudential California Realty, is also in evidence.

While the agreement shows a total rent of $22,950 ($5,000 of which was a
                                         -9-

[*9] refundable deposit) and a credit card authorization, it does not establish that

this expense was actually paid.

      In an effort to bolster this insufficient documentation, petitioner relies

heavily upon WBK’s testimony. WBK testified that he is a technician, engineer,

and “almost a job superintendent” of petitioner, for which he counsels, programs,

constructs, and does electrical work. He also stated that he was not involved in

petitioner’s banking or accounting. Nevertheless, in reference to the July 24 entry

of $5,930 on the advertising detail sheet, WBK attested that his parents flew to

Washington to meet Costco’s director of operations for gasoline and that they

hosted a fishing trip for Costco executives.

      WBK did not state whether he witnessed third-party records, statements, or

receipts verifying that this expense was paid or why such documents could not be

produced. The record does not reflect his having attended the fishing trip, thus he

has no firsthand knowledge as to whether it actually took place, who attended it,

or how much business-related expense was incurred. See Chagra v.

Commissioner, T.C. Memo. 1991-366, 62 T.C.M. (CCH) 347, 367 (1991)

(determining testimony to be vague and lacking probative value where, in part, the

witness did not personally observe much of the events about which he testified

but, instead, relied on secondhand sources), aff’d without published opinion, 990
                                        - 10 -

[*10] F.2d 1250 (2d Cir. 1993). The Karrases, who actually took the fishing trip,

did not appear at trial and did not testify. Petitioner has not properly substantiated

this expense.

      WBK did, however, attend the event held at the beachfront rental home. He

testified that a large beach house was rented to hold petitioner’s weeklong

company meeting followed by entertainment and that “just the vendors and the

subcontractors * * * [were] invited, along with our employees.” He then testified

that his fiance, some of her family, and a few of his friends showed up at the rental

home because “we ended up sponsoring a--hosting a fishing trip shortly after as

well.” While unsure of the number of employees in attendance (somewhere

between 5 and 10), he stated that more than 30 people attended the meeting.

      WBK also affirmed that his wedding was on January 3, 2009, the day after

the meeting ended. Petitioners had stipulated that the advertising deduction

included payments that petitioner made for the personal expenses of this wedding.

WBK did not clarify what part of the rent expense or the overall advertising

expense was not related to his nondeductible wedding expenses. He did not

disclose whether the $5,000 security deposit had been refunded. He did not

explain any other item on the advertising detail sheet.
                                       - 11 -

[*11] Overall, WBK’s testimony about the advertising expense was vague,

uncorroborated, and led by petitioners’ counsel. We are not required to accept his

testimony and do not do so. See Tokarski v. Commissioner, 87 T.C. 74, 77

(1986); Bennett v. Commissioner, T.C. Memo. 1997-145, slip op. at 22-23, aff’d

without published opinion, 141 F.3d 1149 (1st Cir. 1998). We hold that petitioner

did not properly substantiate any of its advertising expenses and thus is not

entitled to any deduction.

Depreciation Expense Deduction

      Relying on the “benefits and burdens of ownership” test, petitioner next

argues its entitlement to the claimed depreciation and section 179 expensing

deductions. See generally Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C.

1221, 1237-1238 (1981) (using multiple factors from caselaw as guideposts to

determine ownership of property). It contends that these deductions are based

upon its investment in and actual ownership of the three vehicles rather than the

possession of bare legal titles.

      A reasonable depreciation deduction may be allowed for the “exhaustion,

wear and tear” of property used in a trade or business. Secs. 161, 167(a)(1). To

substantiate entitlement to a depreciation deduction, a taxpayer not only has to

show that the property was used in a business but also must establish the
                                        - 12 -

[*12] property’s depreciable basis by showing the cost of the property, its useful

life or recovery period, and its previously allowable depreciation. See, e.g., Cluck

v. Commissioner, 105 T.C. 324, 337 (1995). If a taxpayer has no capital

investment in property, she or he has no right to depreciation deductions with

respect to the capital asset. Miller v. Commissioner, 68 T.C. 767, 775 (1977).

      Alternatively, a taxpayer may elect to treat the cost of certain property used

in an active trade or business as a current expense in the year that property is

placed in service. Sec. 179(a), (d). If the property is used for both business and

other purposes, then the portion of the cost that is attributable to the business use

is eligible for expensing under section 179 but only if more than 50% of the use is

for business purposes (predominant use requirement). See sec. 1.179-1(d), Income

Tax Regs.

      Either way, additional requirements of heightened substantiation must also

be met for proving the business use of certain assets, including “listed property”.

See sec. 274(d); see, e.g., Mears v. Commissioner, T.C. Memo. 2013-52, at *22

(considering section 274(d) requirements with respect to applicable section 167

deductions); Singh v. Commissioner, T.C. Memo. 2009-36, slip op. at 4

(considering section 274(d) requirements with respect to an applicable section 179

deduction). Passenger automobiles and any other property used as a means of
                                       - 13 -

[*13] transportation are listed property. Sec. 280F(d)(4)(A)(i) and (ii). To claim

expenses related to listed property, taxpayers must corroborate their own

statements with additional substantiation that adequately establishes the amount,

time, place, and business purpose of these expenditures. Sec. 274(d)(4) and flush

language; see also sec. 1.274-5T(b)(6), (c)(1) and (2), Temporary Income Tax

Regs., 50 Fed. Reg. 46016-46017 (Nov. 6, 1985).

      Petitioner again relies predominantly on WBK’s testimony to substantiate

these deductions. WBK attested that the 2008 truck is currently used exclusively

by him to pull a job trailer for petitioner’s business. When questioned about how

many other vehicles petitioner owns, he answered: “I believe one more. I’m not

too clear on how many they actually own. We only use the one truck for hauling

the trailer, which I’m responsible for.” When asked, more specifically, what

vehicles petitioner owned in addition to the 2008 truck in 2008, he answered:

“WSK-wise, I’m not very sure on what other vehicles they might have used for the

company.” When asked whether he recalled if his father had a work truck in 2008

that was used in petitioner’s business, WBK stated that he did not recall. He also

stated that petitioner made all payments on the 2008 truck.

      This testimony does not show that petitioner had capital investments in the

2003 GMC Sierra truck and the 2005 Hummer or that they were used in its
                                         - 14 -

[*14] business. Even with the documents petitioner produced at trial, it remains

unclear who owned the 2008 truck or when it was placed in service. Regardless of

capital investment or ownership, petitioner failed to prove entitlement to the

depreciation expense deduction.

      Neither WBK’s testimony nor petitioner’s self-generated depreciation

schedule establishes any cost bases or previously allowable depreciation of the

older two vehicles. (The depreciation schedule actually offers less information

than petitioner’s Form 4562.) Additionally, his testimony did not address whether

the 2008 truck met the predominant use requirement in 2008. His uncorroborated

testimony as to petitioner’s depreciable property for the year in issue is insufficient

to carry petitioner’s burden of proof.

      Moreover, petitioner failed to introduce records, mileage logs, receipts, or

other credible evidence that would satisfy the heightened requirements of section

274(d) for any of the three vehicles. Neither taxpayers nor the Court may estimate

permissible deductions for expenses that do not satisfy the strict substantiation

requirements of section 274(d). See Sanford v. Commissioner, 50 T.C. 823,

827-828 (1968), aff’d, 412 F.2d 201 (2d Cir. 1969). Accordingly, we sustain

respondent’s determination that petitioner is not entitled to a depreciation expense

deduction or a section 179 deduction beyond what has already been allowed.
                                        - 15 -

[*15] Section 6662(a) Penalties

      Respondent determined section 6662(a) penalties for petitioner’s 2008 tax

year and the Karrases’ 2008 and 2009 tax years. Section 6662(a) and (b)(1) and

(2) imposes a 20% accuracy-related penalty on any underpayment of Federal

income tax attributable to a taxpayer’s negligence or disregard of rules or

regulations, or a substantial understatement of income tax. Section 6662(c)

defines negligence as including any failure to make a reasonable attempt to

comply with the provisions of the Code and defines disregard as any careless,

reckless, or intentional disregard. See sec. 1.6662-3(b)(1) and (2), Income Tax

Regs. Disregard of rules or regulations is careless if the taxpayer does not

exercise reasonable diligence to determine the correctness of a return position that

is contrary to the rule or regulation. Id. subpara. (2). For a C corporation, an

understatement of income tax is substantial if it exceeds the lesser of 10% of the

tax required to be shown on the return (or, if greater, $10,000) or $10 million.

Sec. 6662(d)(1)(B).

      Under section 7491(c), the Commissioner bears the burden of production

with respect to the liability of an individual for penalties and must come forward

with sufficient evidence indicating that it is appropriate to impose penalties.

Higbee v. Commissioner, 116 T.C. at 446-447; see also NT, Inc. v. Commissioner,
                                        - 16 -

[*16] 126 T.C. 191, 195 (2006) (noting that section 7491(c) applies only to the

liability of an individual for a penalty and thus does not apply to a corporate

taxpayer). Once the Commissioner has met the burden of production, the taxpayer

must come forward with persuasive evidence that the penalty is inappropriate--for

example, by showing that he or she acted with reasonable cause and in good faith.

Sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at 448-449. Respondent

asserts that the Karrases are liable for the penalties because of their negligence.

Contrary to their tax returns, the Karrases stipulated that they received unreported

income in 2008 and 2009 and that they were not entitled to certain rental expense

deductions claimed for those years. The stipulated omission of income and

unwarranted deductions by the Karrases satisfy respondent’s burden of showing

that section 6662(a) penalties are appropriate. Petitioners are thus required to

show that the penalties should not be imposed.

      At trial petitioners called as a witness Brook Horspool of Horspool & Co.,

Inc., the company that prepared their returns for the years in issue. He was asked

inappropriate questions calling for his opinion that the returns were correct. Even

after the Court instructed that it did not need the witness’ opinion of the

correctness of the tax returns but, instead, wanted to know what happened with

regard to the preparing of the returns, Brook Horspool still did not testify about his
                                         - 17 -

[*17] qualifications as a tax professional, what information was provided to him to

prepare the returns, who provided that information, what advice, if any, he gave to

petitioners, or his basis for such advice. (He did not even testify that he prepared

petitioners’ returns for the years in issue.)

      While the witness may have been called to suggest that petitioners

reasonably relied on a tax professional, that argument was never made. See

generally sec. 1.6664-4(b)(1), Income Tax Regs. (providing that the determination

as to whether a taxpayer acted with reasonable cause and good faith depends upon

all the pertinent facts and circumstances). Even if the argument had been

presented, the Karrases did not testify; thus, there is no evidence that petitioners

relied on anyone with regard to their returns. In any event petitioners failed to

show any ground for relief from the penalties for the years in issue.

      We have considered other arguments of the parties, but they are irrelevant,

unsupported by the record or by authority, or otherwise without merit.

      To reflect the foregoing and to give effect to the parties’ concessions,


                                                  Decisions will be entered

                                            under Rule 155.
