                     T.C. Summary Opinion 2011-97



                        UNITED STATES TAX COURT



         RICHARD MONDELLO AND WIPAPAN KONCHOM, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 9316-10S.             Filed July 25, 2011.



        Richard Mondello and Wipapan Konchom, pro sese.

        Nicholas J. Singer, for respondent.



     DEAN, 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.     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, subsequent section references

are to the Internal Revenue Code in effect for the year at issue,
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and Rule references are to the Tax Court Rules of Practice and

Procedure.

      Respondent determined a deficiency in petitioners’ 2007

Federal income tax of $15,399 and an accuracy-related penalty

under section 6662(a) of $3,079.

      The issues for decision are whether petitioners are entitled

to:   (1) Itemized deductions in excess of those respondent

allowed; (2) a deduction on Schedule C, Profit or Loss From

Business, for an accrued payment to Richard Mondello

(petitioner); and (3) whether petitioners are liable for the

accuracy-related penalty under section 6662(a).

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

The stipulation of facts and the exhibits received in evidence

are incorporated herein by reference.    Petitioners resided in

California when the petition was filed.

                            Background

      In 2007 petitioner was an employee of an employer whose

identity is not part of the record.    He is also the owner of a

Web site business entitled www.uniformoutletonline.com (Web

site).   Petitioners deducted on their Federal income tax return

for 2007 unreimbursed employee business expenses of $20,515 and

on Schedule C of the return a $50,000 accrual for “contract

labor” petitioner performed for his own business.    Respondent

disallowed both deductions, which increased petitioners’ adjusted
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gross income and thereby reduced the amount of petitioners’

allowable deductions for medical expenses for the year.1

     Petitioners provided no document describing the

reimbursement policy of petitioner’s employer.    Petitioners have

no documents substantiating any of the employee business expenses

they deducted on the return.

     Petitioner operated his Web site business using the accrual

method of accounting.    In 2007 petitioner worked 1,000 hours

developing the Web site.    Petitioner charges unrelated parties

between $45 and $55 an hour for performing work similar to that

which he performed on his Web site development.    Petitioner’s

proprietorship, the Web site, did not pay him for any services he

performed for himself.    Petitioner’s proprietorship accrued

$50,000 as a liability for payment to petitioner for his work to

set up his Web site, and the accrued expense was deducted on

Schedule C of the return.

                             Discussion

     Generally, the Commissioner’s determinations in a notice of

deficiency are presumed correct, and the taxpayer has the burden

of proving that those determinations are erroneous.    See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).    In some



     1
      For tax years beginning before Jan. 1, 2013, expenses for
medical care not compensated for by insurance are deductible to
the extent they are in excess of 7.5 percent of adjusted gross
income. See sec. 213(a).
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cases the burden of proof with respect to relevant factual issues

may shift to the Commissioner under section 7491(a).     The Court,

however, finds that petitioners have not met the requirements of

section 7491(a), and the burden of proof does not shift to

respondent.

Petitioners’ Deductions

     As the Court must often state, deductions are strictly a

matter of legislative grace, and a taxpayer bears the burden of

proving entitlement to any deduction claimed.    Rule 142(a); New

Colonial Ice Co. v. Helvering, 292 U.S. 435 (1934); Welch v.

Helvering, supra.     Moreover, taxpayers are required to maintain

records that are sufficient to substantiate their deductions.

Sec. 6001.    As petitioners offered no evidence to substantiate

their unreimbursed business expenses, respondent’s determination

is sustained.

     On the issue of his accrual, petitioner testified that he is

an accountant.    As an accountant petitioner should be familiar

with the concept of imputed or implicit expenses or costs

(imputed expenses).    Imputed expenses are the opportunity costs

of time and capital that the manager of a business has invested

in producing “the given quantity of production and the

opportunity cost of making a particular choice” among

alternatives.    Siegel & Shim, Dictionary of Accounting Terms

(Barron’s Business Guides) 234 (5th ed. 2010).    An imputed
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expense is one that is not actually incurred but is used to

compare with an actual cost.   Oxford Dictionary of Accounting 227

(Gary Owen & Jonathan Law eds., 4th ed. 2010); Tracy, Accounting

for Dummies 237 (3d ed. 2005).    An imputed cost is not recorded

in the books of account and is not accurately measurable but is a

hypothetical cost used in making comparisons; an example is

“salaries of owner-directors of sole proprietorship firms.”

Rajasekaran & Lalitha, Cost Accounting 12 (2011).

     From an accounting standpoint, the time petitioner spent on

his own Web site instead of earning $45 to $55 an hour from

unrelated parties is an opportunity cost, an imputed expense to

petitioner and his business.   It is not an incurred expense, is

not reflected in the financial statements, and is not an actual

cost.

     Section 162 allows deductions for all the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on a trade or business.    Section 212 allows deductions

for all the ordinary and necessary expenses paid or incurred

during the taxable year for the production of income or the

management or maintenance of property held for the production of

income.   Only expenses paid or incurred are deductible as

expenses under sections 162 and 212.

     Respondent cited several cases for petitioners’ and the

Court’s consideration on this issue.     In Maniscalco v.
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Commissioner, T.C. Memo. 1978-274, affd. 632 F.2d 6 (6th Cir.

1980), the Court observed that “Whatever may be said in behalf of

taking into account the value of one’s own services in lieu of

paid labor, such services are not considered an element of the

deduction under section 162(a), just as the flow of satisfaction

from services arising from one’s own labor is not includible in

his gross income.”   In Grant v. Commissioner, 84 T.C. 809, 820

(1985), affd. without published opinion 800 F.2d 260 (4th Cir.

1986), the Court said that the expenditure of a taxpayer’s labor

does not constitute the taxpayer’s payment of a deductible

business expense, and the taxpayer is not allowed a deduction

under section 162(a).   And in Rink v. Commissioner, 51 T.C. 746,

753 (1969), the Court pointed out to the taxpayer that imputed

income as a result of his receipt of the benefit of his own

services is not taxable under our system and neither is an

imputed expense arising from his own exertions a deduction from

income.   “Labor performed by a taxpayer does not constitute an

amount ‘paid or incurred’ by him, and consequently, cannot be

deducted by him under section 162”.    Id.

     Petitioner argues that all these cases involve cash basis

taxpayers, and he agrees that a cash basis taxpayer cannot

deduct a payment to himself in the same year.   However, he argues

inexplicably that because his business was on the accrual method

the cases respondent cites not only are inapposite but also
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support his position.2   Perhaps petitioner did not read Rink or he

failed to read it carefully.   The Court pointed out in that case

that the taxpayer took the position, as petitioner does, that “he

should be permitted to accrue currently, as a liability, amounts

owed by him to himself on account of his labors, but include the

value of such labor in income only when and if such labor gives

rise” to income in the future.    The Court found the argument to

be without any merit; “For one thing, we have found that the

petitioner incurred no liability, in favor of himself or anyone

else, to pay for the value of his services.”       Id. at 753-754

(emphasis added).

     The Supreme Court has held that the standard for determining

when an expense has been “incurred” for Federal income tax

purposes is the “all events” test.       United States v. Hughes

Props., Inc., 476 U.S. 593 (1986); see sec. 1.461-1(a)(2), Income

Tax Regs.   Under the regulations, the all events test has three

requirements, all of which must be satisfied before accrual of an

expense is proper:   (1) All the events must have occurred which

establish the fact of the liability; (2) the amount of the

liability must be determinable with reasonable accuracy; and (3)



     2
      Petitioner cited Remy v. Commissioner, T.C. Memo. 1997-72,
as supporting his position. The Court in that case held that a
cash basis taxpayer could not deduct the value of his labor under
sec. 162 because it was not paid or incurred. Petitioner
interprets the case to mean that an accrual basis taxpayer can
deduct the value of his labor, a logical fallacy.
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economic performance has occurred with respect to the liability.

Sec. 1.461-1(a)(2)(i), Income Tax Regs.    The Court need only

decide the issue of the first requirement, although none of the

requirements has been proved by petitioners.

     The Supreme Court stated in Hughes Props., Inc., that in

order to satisfy the all events test, the liability must be

final, definite in amount, and unconditional, and all the events

must have occurred that will make it fixed and certain.    Under

the accrual method a taxpayer is not entitled to deduct an

expense “if there is no legal obligation during the taxable year

to make such payment.”     E.H. Sheldon & Co. v. Commissioner, 214

F.2d 655, 656 (6th Cir. 1954), affg. in part and revg. in part 19

T.C. 481 (1952).    The word “liability” means “The quality or

state of being legally obligated or accountable; legal

responsibility to another or to society, enforceable by civil

remedy or criminal punishment”.    Black’s Law Dictionary 997 (9th

ed. 2009).   Should petitioner have “refused” or become unable to

pay himself, there would have been no legal consequence.    He

would not seek forced collection from himself, nor would he be

able to sue himself in a court of law to obtain a judgment

against himself for any amounts he “owed” to himself, even if he

were so inclined.    There was no legal obligation during the

taxable year, or any other year for that matter, for petitioner

to pay himself anything.
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       Neither accounting principles, tax law, nor common sense

supports a deduction by petitioners for contract labor as a

result of an accrual of an amount “owed” by petitioner to himself

for his own labor.

Accuracy-Related Penalty

       Section 7491(c) imposes on the Commissioner the burden of

production in any court proceeding with respect to the liability

of any individual for penalties and additions to tax.    Higbee v.

Commissioner, 116 T.C. 438, 446 (2001); Trowbridge v.

Commissioner, T.C. Memo. 2003-164, affd. 378 F.3d 432 (5th Cir.

2004).    In order to meet the burden of production under section

7491(c), the Commissioner need only make a prima facie case that

imposition of the penalty or the addition to tax is appropriate.

Higbee v. Commissioner, supra at 446.

       Respondent determined that for 2007 petitioners underpaid a

portion of their income tax on account of negligence or disregard

of rules or regulations or a substantial understatement of income

tax.

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

of an underpayment of tax attributable to any one of various

factors, including negligence or disregard of rules or

regulations and a substantial understatement of income tax.    See

sec. 6662(b)(1) and (2).    “Negligence” includes any failure to

make a reasonable attempt to comply with the provisions of the
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Internal Revenue Code, including any failure to keep adequate

books and records or to substantiate items properly.     See sec.

6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.

     A “substantial understatement” includes an understatement of

income tax that exceeds the greater of 10 percent of the tax

required to be shown on the return or $5,000.    See sec. 6662(d);

sec. 1.6662-4(b), Income Tax Regs.

     Section 6664(c)(1) provides that the penalty under section

6662(a) shall not apply to any portion of an underpayment if it

is shown that there was reasonable cause for the taxpayer’s

position and that the taxpayer acted in good faith with respect

to that portion.   The determination of whether a taxpayer acted

with reasonable cause and in good faith is made on a case-by-case

basis, taking into account all the pertinent facts and

circumstances.   Sec. 1.6664-4(b)(1), Income Tax Regs.   The most

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

his proper tax liability for the year.   Id.

     Petitioners have a substantial understatement of income tax

for 2007 since the understatement amount will exceed the greater

of 10 percent of the tax required to be shown on the return or

$5,000.   The Court concludes that respondent has produced

sufficient evidence to show that the accuracy-related penalty

under section 6662(a) is appropriate for 2007.
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     The accuracy-related penalty will apply unless petitioners

demonstrate that there was reasonable cause for the underpayment

and that they acted in good faith with respect to the

underpayment.   See sec. 6664(c).   Section 1.6664-4(b)(1), Income

Tax Regs., specifically provides:   “Circumstances that may

indicate reasonable cause and good faith include an honest

misunderstanding of fact or law that is reasonable in light of

all the facts and circumstances, including the experience,

knowledge, and education of the taxpayer.”

     Petitioners did not show that there was reasonable cause

for, and that they acted in good faith with respect to, the

underpayment.

      Respondent’s determination of the accuracy-related penalty

under section 6662(a) for 2007 is sustained.

     To reflect the foregoing,

                                          Decision will be entered

                                     for respondent.
