                  T.C. Summary Opinion 2002-22



                     UNITED STATES TAX COURT



      DAVID D. BRAYSHAW & NORA D. BRAYSHAW, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3264-00S.                Filed March 22, 2002.



     David D. Brayshaw and Nora D. Brayshaw, pro sese.

     Peter C. Rock, for respondent.



     DINAN, Special Trial Judge:    This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed.   The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority.   Unless otherwise indicated,

subsequent section references are to the Internal Revenue Code in
                              - 2 -

effect for the year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

     Respondent determined a deficiency in petitioners’ Federal

income tax of $21,149 and an accuracy-related penalty of

$4,229.80 for the taxable year 1996.

     The issues for decision are:   (1) Whether petitioners are

entitled to various business expense deductions disallowed by

respondent, or to any itemized deductions in lieu thereof, and

(2) whether petitioners are liable for the accuracy-related

penalty under section 6662(a) for negligence or disregard of

rules or regulations.1

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

The stipulations of fact and the attached exhibits are

incorporated herein by this reference.   Petitioners resided in

Sausalito, California, on the date the petition was filed in this

case.

     Petitioner husband (Mr. Brayshaw) has a background in

mathematics and physics as well as corporate law.   During the

year in issue, he was involved in several business activities.

First, he was engaged in the development of computer software

which would predict water currents in the San Francisco Bay area.

In connection with this activity, he periodically took


     1
      Adjustments to self employment income tax and the deduction
therefor are computational and will be resolved by the Court’s
holding on the issues in this case.
                                 - 3 -

measurements on the bay throughout the year using a yacht

petitioners had owned since approximately 1984.    Mr. Brayshaw

began selling this software in early 1997.

     In addition, Mr. Brayshaw prior to 1996 had formed a

corporation named First Draft Legal System, Inc. (FDLS).      This

corporation was engaged in the sale of a computer software

program which automated the creation of legal documents.      A

separate bank account was maintained in the corporation’s name.

For taxable year 1996, a Federal income tax return was filed for

FDLS.   This return reported $57,553 in income, $825 in cost of

goods sold, and $55,500 in salaries, leaving $1,228 in taxable

income.   Mr. Brayshaw was an employee and/or an independent

contractor of FDLS.    Finally, Mr. Brayshaw was engaged in

“database work” which was unrelated to either of his other

business activities.

     Prior to 1996, petitioner wife (Ms. Brayshaw) conducted a

medical consultation business.    By 1996, however, she had ceased

operating this business.

     Petitioners filed two Schedules C, Profit or Loss from

Business, with their joint Federal income tax return for taxable

year 1996.   The first was filed for an alleged business activity

of Ms. Brayshaw, the second was for the business activities of

Mr. Brayshaw.   In the statutory notice of deficiency, respondent

disallowed all of the expenses claimed on each Schedule C,
                                  - 4 -

including the returns and allowances and the expenses for

business use of the home.      Respondent did not adjust the income

reported on either schedule.

Ms. Brayshaw’s Schedule C

     The first Schedule C listed Ms. Brayshaw as the proprietor

of a business engaged in medical consultation.       This schedule

listed the following amounts:

     Gross receipts                                            $11,400
     Expenses
           Car and truck                              $2,018
           Depreciation and section 179 expense        2,248
           Mortgage interest                           5,100
           Legal and professional services                45
           Office                                        418
           Repairs and maintenance                        80
           Supplies                                      150
           Taxes and licenses                            810
           Total expenses                                      (10,869)
     Net profit                                                    531

Petitioners have conceded that this schedule should not have been

filed because Ms. Brayshaw had ceased conducting the medical

consultation business by 1996.       Allegedly, the gross receipts

listed on the Schedule C are amounts which represented lease

payments made by Mr. Brayshaw to Ms. Brayshaw for use of a

vehicle held by petitioners as community property (a Jeep Grand

Cherokee), and the expenses are related thereto.2

     In light of petitioners’ concession, we sustain respondent’s

disallowance of all the deductions claimed with respect to this

     2
      It is unclear how the mortgage interest, office expenses,
and legal and professional services relate to the rental of a
Jeep Grand Cherokee.
                                  - 5 -

schedule.   However, because the corresponding deduction on Mr.

Brayshaw’s Schedule C has also been disallowed, respondent’s

determination must be adjusted to reflect the fact that Ms.

Brayshaw never received the income reported on her Schedule C.

Mr. Brayshaw’s Schedule C

     The second Schedule C listed Mr. Brayshaw as the proprietor

of a business engaged in software development.           This schedule

listed the following amounts:

     Gross receipts                                                $63,050
     Returns and allowances                                         (4,928)
     Expenses
           Advertising                                    $1,639
           Car and truck                                   1,170
           Mortgage interest                               1,771
           Legal and professional services                   225
           Office                                          2,522
           Rent/lease - vehicles, machinery, equipment    13,450
           Rent/lease - other business property              195
           Repairs and maintenance                         2,055
           Supplies                                       11,722
           Taxes and licenses                                478
           Travel                                          2,697
           Utilities                                       3,043
           Total expenses                                          (40,967)
     Expenses for business use of home                             (16,196)
     Net profit                                                        959

At trial, petitioners effectively abandoned the amounts listed on

this schedule, instead relying on stipulations and evidence to

establish the proper amounts of their deductions.           This one

Schedule C is purported to represent the income and expenses of

all three business activities of Mr. Brayshaw.

     Mr. Brayshaw’s business activities are rather complex.             He

has organized a corporation to conduct one business activity, and

he is involved in three other separate and distinct businesses,
                               - 6 -

one as an employee and/or independent contractor for the above-

mentioned corporation, one as an independent software developer,

and one as a “database consultant”.    Despite this, petitioners

have basically come to this Court with a pile of receipts and

stipulated amounts, arguing that the various expenses should be

deductible.   They made little effort to prepare this case with

respondent prior to the calendar call.    There are no

contemporaneous records, such as accounting ledgers, which

differentiate the expenses among the various business activities,

and the corporate checking account was used for purposes of the

other business activities as well as for the corporation.

Nonetheless, despite the disarray of the record, because we are

convinced that Mr. Brayshaw was engaged in the business

activities and that he incurred expenses in connection therewith,

we address each of the broad categories of expenses in turn.

     “Returns and allowances” and advertising expenses

     In conducting the business of FDLS, Mr. Brayshaw was

assisted by another individual, Seth G. Rowland.    The

corporation’s bank account was used to pay Mr. Rowland $518 on

October 24, 1996, and $4,410.02 on February 6, 1997.      Petitioners

argue that these amounts are deductible.    On petitioners’ return,

the amounts were listed as “returns and allowances” because

petitioners did not know how else to classify them.      After Mr.

Brayshaw’s testimony, it remains unclear exactly what portion of
                               - 7 -

these amounts was for reimbursement for expenses incurred by Mr.

Rowland and what portion was for compensation for services

rendered.

     Mr. Brayshaw, with the assistance of Mr. Rowland, produced

several advertisements for the corporation.    The corporation’s

bank account was used to pay $1,031.92 for the production of a

brochure and $625 for a magazine advertisement.    Petitioners

argue that these amounts are deductible as advertising expenses.

     A corporation formed for legitimate business purposes is an

entity separate from its shareholders.     Moline Properties, Inc.

v. Commissioner, 319 U.S. 436 (1943).    Furthermore, the business

of a corporation is separate and distinct from the business of

its shareholders.   Id.; Deputy v. du Pont, 308 U.S. 488, 494

(1940); Crook v. Commissioner, 80 T.C. 27, 33 (1983), affd.

without published opinion 747 F.2d 1463 (5th Cir. 1984).

Consequently, a shareholder is not entitled to a deduction for

the payment of corporate expenses.     Deputy v. du Pont, supra;

Hewett v. Commissioner, 47 T.C. 483 (1967).

     We find that both the advertising expenses and the amounts

paid to Mr. Rowland were expenses of the corporation, not Mr.

Brayshaw’s expenses.3   Not only were the expenses paid with funds


     3
      Furthermore, the bulk of the amount paid to Mr. Rowland was
paid in 1997, after the year in issue. Petitioners argue that
the corporation was using the accrual method of accounting and
had become obligated to make the payment in 1996. The relevance
                                                   (continued...)
                               - 8 -

from the corporate bank account, they were clearly for the

business of the corporation.   Petitioners argue that Mr. Brayshaw

is an independent contractor of the corporation, and that the

expenses paid were all taken into account in the amount of

“salary” the corporation paid him and which he reported on the

Schedule C.   With the record before us, there is no manner in

which we could trace the various funds from the corporation

and/or through its bank account to determine if Mr. Brayshaw did

in fact report as income the amounts he used to pay the

corporation’s expenses.4   In any case, respondent has not

challenged the amount of Mr. Brayshaw’s income from the

corporation and, regardless of the source of the funds, Mr.

Brayshaw is not entitled to deduct expenses of the corporation on

his individual income tax return.   See Deputy v. du Pont, supra;

Hewett v. Commissioner, supra.

     Automobile-related expenses

     Petitioners owned at least three automobiles during the year

in issue:   A 1969 Mercedes, a 1972 Mercedes, and a 1995 Jeep

Grand Cherokee.   Petitioners argue that the Jeep--which was

acquired in October 1994--was used solely for business purposes,


     3
      (...continued)
of this argument is unclear, but petitioners’ assertion of it
supports our finding that these were corporate expenses.
     4
      We note that Mr. Brayshaw was a corporate lawyer for
several years and thus presumably should be familiar with the
concept of the separate legal entity of a corporation.
                                - 9 -

and that numerous expenses related to the Jeep--including

registration, insurance, interest, gas, repairs, maintenance, and

depreciation--are deductible.

     A taxpayer generally must maintain records sufficient to

establish the amounts of the items reported on his Federal income

tax return.   Sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs.

However, in the event that a taxpayer establishes that a

deductible expense has been paid but is unable to substantiate

the precise amount, we generally may estimate the amount of the

deductible expense bearing heavily against the taxpayer whose

inexactitude in substantiating the amount of the expense is of

his own making.    Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d

Cir. 1930).   We cannot estimate a deductible expense, however,

unless the taxpayer presents evidence sufficient to provide some

basis upon which an estimate may be made.    Vanicek v.

Commissioner, 85 T.C. 731, 743 (1985).

     Section 274(d) supersedes the Cohan doctrine.    Sanford v.

Commissioner, 50 T.C. 823, 827 (1968), affd. 412 F.2d 201 (2d

Cir. 1969).   Section 274(d) provides that, unless the taxpayer

complies with certain strict substantiation rules, no deduction

is allowable (1) for traveling expenses, (2) for entertainment

expenses, (3) for expenses for gifts, or (4) with respect to

listed property.   Listed property includes passenger automobiles

and other property used as a means of transportation, and
                                - 10 -

computers and peripheral equipment.       Sec. 280F(d)(4).   To meet

the strict substantiation requirements, the taxpayer must

substantiate the amount, time, place, and business purpose of the

expenses.    Sec. 274(d); sec. 1.274-5T, Temporary Income Tax

Regs., 50 Fed. Reg. 46006 (Nov. 6, 1985).

     In order to substantiate the amount of expenses for listed

property, a taxpayer must establish the amount of business use

and the amount of total use for such property.       Sec. 1.274-

5T(b)(6)(i)(B), Temporary Income Tax Regs., 50 Fed. Reg. 46006

(Nov. 6, 1985).    With respect to the use of automobiles, in order

to establish the amount of an expense the taxpayer must establish

the amount of business mileage and the amount of total mileage

for which the automobile was used.       Sec. 1.274-5T(b)(6)(i)(B),

Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).

The taxpayer may substantiate the amount of mileage by adequate

records or by sufficient evidence corroborating his own

statement.    Sec. 274(d).   A record of the mileage made at or near

the time the automobile was used, supported by documentary

evidence, has a high degree of credibility not present with a

subsequently prepared statement.    Sec. 1.274-5T(c)(1), (2), and

(3), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6,

1985).

     We do not accept Mr. Brayshaw’s testimony that the Jeep was

used exclusively for business purposes.       We find it highly
                               - 11 -

improbable that petitioners, as per the testimony, bought the

Jeep solely for business use and subsequently completely

segregated their personal and business lives such that they never

overlapped in driving it.    In the absence of any

contemporaneously maintained records to show petitioners’ actual

business and personal use of the Jeep, we hold that they are not

entitled to deduct any of the automobile-related expenses.    See

sec. 274(d).

     Boat-related expenses

     During the year in issue, petitioners owned a 34-foot yacht

which they had purchased in approximately 1984, as well as a 26-

foot sail boat.   Mr. Brayshaw used the yacht to take measurements

on the San Francisco Bay for use in the development of the

computer software.   Petitioners argue that numerous expenses

incurred in connection with this yacht are deductible.

     Respondent, in his trial memorandum, argues that “the

development of the * * * boating software is a separate

enterprise from petitioner’s [primary] occupation and as such the

related expenses are currently non-deductible.”

     Ordinary and necessary business expenses generally are

deductible in the taxable year in which they are paid.    Sec.

162(a).   Expenses incurred prior to the commencement of a

business activity, however, are start-up expenditures which

generally must be amortized and are not currently deductible.
                                - 12 -

Sec. 195(a).    An exception to this general rule is made in the

case of research and experimental expenses, which may be

currently deductible under section 174(a) even before the advent

of an active trade or business.     Sec. 195(c); Snow v.

Commissioner, 416 U.S. 500 (1974).

     We find that the majority of the expenses incurred in

connection with the yacht are not deductible expenses, but rather

are nondeductible personal expenses.     See sec. 262(a).   Mr.

Brayshaw’s research essentially entailed using the boat to drift

around the bay while taking measurements using global positioning

equipment.     It is doubtful that the use of a 34-foot yacht was

necessary in making these measurements.     More importantly,

however, we do not accept petitioners’ assertion that they used

the yacht exclusively for business purposes during the entire

year, never deriving any personal use therefrom.     In the absence

of any contemporaneous substantiation of both the research and

personal use of the boat, we hold that the interest paid in

connection with the yacht (presumably for a purchase money loan),

the cost of insuring the yacht, the cost of the yacht’s usual

berth, and the costs of repairing and maintaining the yacht are

not deductible.     See sec. 274(d).   Likewise, without addressing

petitioners’ attempt to establish a basis in the yacht,

petitioners are not entitled to depreciation deductions for the

yacht.   See id.
                                      - 13 -

     Mr. Brayshaw did incur some expenses which we find to be

deductible.        In addition to the yacht’s normal berth, Mr.

Brayshaw paid duplicative expenses in order to berth the yacht at

locations nearer to where he was required to take measurements.

We hold that petitioners are entitled to deduct under section

174(a) the following research and experimental expenses:

     Boat   slip   rental (check no. 1092)         $440
     Boat   slip   key (check no. 1065)              60
     Boat   slip   key (check no. 1096)              20
     Boat   slip   rental (check no. 3031)          340
                                                    860

     Finally, we come to miscellaneous items which petitioners

classified as being boat-related.            First, we hold that a $99.58

wristwatch purchased by Mr. Brayshaw is not a deductible expense:

We find that this was primarily a personal expense, despite the

watch’s occasional use in taking measurements of currents.           We

likewise hold that the “various boat supplies”, “boating

literature”, and sealant for the boat are also personal expenses,

because there is little or no connection between the expenses and

Mr. Brayshaw’s research.          Furthermore, many of these expenses

could have been incurred in connection with petitioners’ sail

boat, rather than the yacht.

     Computer-related expenses

     Petitioners, both in their individual capacities and on

behalf of FDLS, purchased a variety of computer and computer-

related equipment during 1996, including a zip drive, a monitor,

a desktop computer, a facsimile machine, modems, and software.
                              - 14 -

Petitioners argue that the expenses incurred in making these

purchases are deductible under section 179.

     A taxpayer may elect to expense, rather than capitalize,

certain property used in a trade or business.    Sec. 179(a), (c).

The election must be made on the taxpayer’s first income tax

return for the taxable year to which the election applies.   Sec.

179(c)(1)(B); sec. 1.179-5(a), Income Tax Regs.   Petitioners did

not elect to expense the computer equipment on their 1996 return.

Therefore, they are not entitled to a deduction for the equipment

under section 179.   Furthermore, we find that petitioners are not

entitled to any other deduction for the equipment because

petitioners have not substantiated the business versus personal

usage of the computer equipment, as required under section

274(d), discussed supra.   For the same reason, petitioners are

not entitled to deductions for the rental of a scan converter and

other computer equipment, or for their subscription to Compuserve

online service.   See sec. 274(d).

     Travel expenses and professional licenses

     Mr. Brayshaw testified that he incurred numerous deductible

expenses in business-related travel.   He provided receipts as

substantiation.   The receipts, standing alone, do not provide the

level of substantiation which is required under section 274(d).

However, Mr. Brayshaw was able to explain certain of the receipts

at trial in great enough detail to provide adequate
                                  - 15 -

substantiation.    These expenses were incurred in connection with

the business of FDLS.      Because respondent apparently has not

challenged Mr. Brayshaw’s claim that they were incurred in

connection with his role as an independent contractor--rather

than an employee--of FDLS, we hold that petitioners may deduct

the following substantiated travel-related business expenses on

Mr. Brayshaw’s Schedule C:

     United Airlines flight -- March 13          $101.00
     Cab fare -- March 13                          21.00
     Airport restaurant -- March 13                 6.98*
     Southwest Airlines flight -- March 20        161.00
     National car rental -- March 20               41.12
     Gas for rental car -- March 20                 5.55
     Meal - March 20                                5.66*
     National car rental -- March 26               39.59
     United Airlines flight -- May 20             221.00
     Meal -- May 20                                 7.20*
     United Airlines flight -- June 10            126.00
     National car rental -- June 10                29.22
     United Airlines flight -- September 27       131.00
     Magic car rental -- December 4                53.03
     National car rental -- December 16            40.91
     Gas for rental car -- December 16              3.09
                                                  993.85
        *
          Petitioners are entitled to deduct these amounts, after application
     of the 50 percent limitation of section 274(n).

See sec. 162(a).    Petitioners are also entitled to deduct as a

Schedule C business expense the $90 petitioners paid for Mr.

Brayshaw’s American Physical Society dues.          See id.    However, Mr.

Brayshaw’s California State Bar dues are not deductible.             As

discussed supra, because we cannot trace the source or treatment

of these funds, we find that this was not an expense paid by

petitioners which is deductible by them.          See Deputy v. du Pont,

308 U.S. 488, 494 (1940); Hewett v. Commissioner, 47 T.C. 483

(1967).
                               - 16 -

     Miscellaneous expenses

     Petitioners argued at trial that numerous miscellaneous

expenses are deductible.    These expenses include rentals of post

office boxes, postage, shipping expense, copying expense, a New

York Times newspaper subscription, business cards, office

supplies, hardware, telephone lines, and telephone calls.      Some

of these items, in particular the newspaper subscription and

certain of the telephone lines, are personal expenses and are

nondeductible under section 262(a).     With respect to the

remaining items, either no business purpose is evident, the

expenses were paid with corporate funds, or they were hybrid

corporate/non-corporate/personal expenses which we could not

disentangle.   We therefore hold that petitioners are not entitled

to a deduction for any of these expenses.

     Home office expenses

     Petitioners argue that various expenses related to their

residence are deductible due to business use of a portion

thereof.   These expenses include depreciation, gas, electricity,

water, sewer, refuse, repairs, property tax, condominium fees,

and mortgage interest.

     Deductions for expenses attributable to a taxpayer’s

business use of his home are disallowed unless they fit within

the exceptions enumerated in section 280A. Sec. 280A(a).      The

exception applicable to the case at hand is the following:      A
                                - 17 -

deduction may be allowed to the extent that the item is allocable

to a portion of the home which is exclusively used on a regular

basis as the principal place of business for the taxpayer’s trade

or business. Sec. 280A(c)(1)(A).

     Petitioners argue that 43 percent of their residence was

used exclusively for business purposes; we find that 12.7 percent

of the residence was so used.    We reject petitioners’ argument

that portions of the middle and bottom floors and the garage were

used exclusively for business:    Certain areas purportedly were

set up for use by Ms. Brayshaw, who was not engaged in her

medical business in the year in issue.    Other areas contained

inherently personal items, such as a fireplace and sofas, or were

for storage which was not necessarily related to Mr. Brayshaw’s

businesses.   Finally, we have found that the Jeep was not used

exclusively for business purposes; consequently, the garage in

which it was stored likewise was not so used.    On the other hand,

we accept Mr. Brayshaw’s testimony–corroborated by photographs--

that portions of the top floor were used exclusively as his

principal place of business with respect to his several

businesses.   We therefore find that 228.75 square feet, of the

total 1,804.32 square feet, were used exclusively and regularly

as Mr. Brayshaw’s principal place of business.    Petitioners are

entitled to deductions for the applicable percentage of the

following substantiated expenses which were paid by petitioners:
                                - 18 -
     Gas and electricity                   $653.63
     Water and sewer                        213.33
     Refuse                                 193.20
     Condominium fee                      3,016.26
     Property taxes                       2,345.42
     Mortgage interest                   19,865.32
                                         26,287.16

We do not accept petitioners’ assertions concerning depreciation

of the residence.    As for the repair expenses (for plumbing and a

broken window), we hold based on the record before us that they

are not sufficiently related to the business use of the property

for any portion to be deductible.

Itemized Deductions

     Finally, petitioners argue that they are entitled to various

itemized deductions in lieu of the disallowed business expense

deductions.   We agree with respect to certain of these expenses:

Petitioners are entitled to deduct the portions of the mortgage

interest and property taxes which they paid and which are not

allocable to Mr. Brayshaw’s business, as discussed supra.    See

secs. 163(a) and (h), 164(a).

Negligence Penalty

     Respondent determined that petitioners are liable for a

penalty under section 6662(a) with respect to the underpayment

resulting from the total amount of the deficiency.

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

of an underpayment attributable to any one of various factors,

one of which is negligence or disregard of rules or regulations.

Sec. 6662(b)(1).    “Negligence” includes any failure to make a
                                - 19 -

reasonable attempt to comply with the provisions of the Internal

Revenue Code, including any failure to keep adequate books and

records or to substantiate items properly.    Sec. 6662(c); sec.

1.6662-3(b)(1), 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 failed to keep adequate books and records

reflecting the income and expenses of Mr. Brayshaw’s businesses

and failed to properly substantiate the majority of the numerous

and varied items reported on their return.    See sec. 6662(c);

sec. 1.6662-3(b)(1), Income Tax Regs.    Furthermore, petitioners’

effort to assess their proper tax liability falls short of what

would be consistent with reasonable cause and good faith.    See

sec. 1.6664-4(b)(1), Income Tax Regs.    We hold that the record

supports respondent’s determination of negligence in this case.
                            - 20 -

    Reviewed and adopted as the report of the Small Tax Case

Division.

    To reflect the foregoing,

                                     Decision will be entered

                                under Rule 155.
