                                T.C. Memo. 2017-4



                         UNITED STATES TAX COURT



                  MICHAEL LOMBARDI, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 22245-13.                         Filed January 4, 2017.



      Michael Lombardi, pro se.

      Brian A. Pfeifer, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      VASQUEZ, Judge: Respondent determined deficiencies and penalties with

respect to petitioner’s 2010 and 2011 Federal income tax as follows:1



      1
        Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the years at issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
                                         -2-

[*2]                                                          Penalty
             Year                Deficiency                 sec. 6662(a)

             2010                  $53,676                      $10,735.20
             2011                   10,642                        2,128.40

After concessions,2 the issues for decision are: (1) whether petitioner is entitled to

a deduction for meals and entertainment expenses for 2010 in excess of the

amount respondent allowed, (2) whether petitioner is entitled to a deduction for

legal and professional services expenses for 2010 in excess of the amount

respondent allowed, and (3) whether petitioner is liable for accuracy-related

penalties under section 6662(a).

                               FINDINGS OF FACT

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

facts and the attached exhibits are incorporated by this reference. Petitioner

resided in Miami, Florida, at the time he filed his petition.

I.     Petitioner’s Business

       During the years at issue petitioner was the sole shareholder and manager of

U.S. Opportunities, LLC (USO). USO was involved in recruiting foreign workers


       2
        Petitioner conceded that he must include an additional $209,402 in gross
income for 2010. Petitioner also conceded that he was entitled to a deduction of
only $3,016 for supplies for 2011 and that he could not deduct $14,569 of his total
claimed rent and lease expenses for 2011.
                                         -3-

[*3] for seasonal jobs in the United States. USO’s clients included country clubs,

golf courses, national parks, ski resorts, and other similar organizations.

      USO’s services were comprehensive. As USO’s manager, petitioner would

first find foreign workers willing to move to the United States temporarily.

Petitioner would then hire independent lawyers and other professionals to submit

visa applications on behalf of the workers. Finally, petitioner’s wife would find

housing for the workers near the work locations. Petitioner was successful in

recruiting many individuals during the years at issue, and he had clients that

requested his services every year.

II.   Notice of Deficiency

      Respondent issued a notice of deficiency to petitioner on July 16, 2013. In

the notice, respondent (1) disallowed $6,193 of petitioner’s claimed meals and

entertainment expense deduction for 2010; (2) disallowed $36,600 of petitioner’s

claimed legal and professional services expense deduction for 2010; and

(3) determined section 6662(a) accuracy-related penalties for 2010 and 2011.3

Petitioner timely filed a petition with this Court seeking redetermination.




      3
        Other adjustments in the notice were either conceded or are computational
and need not be addressed.
                                         -4-

[*4]                                  OPINION

I.     Burden of Proof

       As a general rule, the Commissioner’s determinations in a notice of

deficiency are presumed correct, and the taxpayer bears the burden of proving that

those determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933). Section 7491(a) shifts the burden of proof to the Commissioner

as to any factual issue relevant to a taxpayer’s liability for tax if the taxpayer meets

certain preliminary conditions. Higbee v. Commissioner, 116 T.C. 438, 440-441

(2001). This case is decided on the preponderance of the evidence and is not

affected by the burden of proof or section 7491(a).

II.    Deductions Generally

       Section 162(a) permits a taxpayer to deduct ordinary and necessary

expenses paid or incurred in carrying on a trade or business. See Commissioner v.

Lincoln Sav. & Loan Ass’n, 403 U.S. 345, 352 (1971). A trade or business

expense is ordinary if it is normal or customary within a particular trade, business,

or industry, and it is necessary if it is appropriate and helpful for the development

of the business. Commissioner v. Heininger, 320 U.S. 467, 471 (1943); Welch v.

Helvering, 290 U.S. at 113-114.
                                        -5-

[*5] A taxpayer ordinarily must maintain adequate records to substantiate the

amounts of his or her income and entitlement to any deductions or credits claimed.

See sec. 6001; sec. 1.6001-1(a), Income Tax Regs. If, however, a taxpayer with

inadequate or nonexistent business records is able to prove that he or she paid or

incurred a deductible business expense but does not prove the amount of the

expense, we may estimate the amount allowable in some circumstances (Cohan

rule). See Cohan v. Commissioner, 39 F.2d 540, 542-544 (2d Cir. 1930). The

taxpayer must introduce sufficient evidence to permit us to conclude that the

taxpayer paid or incurred a deductible expense in at least the amount allowed. See

Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957); Vanicek v.

Commissioner, 85 T.C. 731, 743 (1985). In estimating the amount allowable, we

bear heavily upon the taxpayer who failed to maintain required records and to

substantiate expenses underlying deductions as the Code requires. See Cohan v.

Commissioner, 39 F.2d at 544.

      For certain kinds of business expenses, section 274(d) overrides the Cohan

rule. See Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968), aff’d per

curiam, 412 F.2d 201 (2d Cir. 1969). Section 274(d) provides that no deduction is

allowed with respect to travel, entertainment, and listed property (as defined in

section 280F(d)(4)) unless the taxpayer substantiates by adequate records or by
                                        -6-

[*6] sufficient evidence corroborating the taxpayer’s own statement (1) the

amount of the expense or item; (2) the time and place of the travel, entertainment,

or expense; (3) the business purpose of the entertainment or expense; and (4) the

business relationship to the taxpayer of the person or persons entertained.

III.   Meals and Entertainment

       Petitioner argues he is entitled to deduct $24,7744 in meals and

entertainment expenses he incurred in 2010. In support of the deduction petitioner

produced copies of receipts and a schedule summarizing the contents of the

receipts. The receipts include petitioner’s handwritten statements where he

sometimes indicates the business purposes for the expenditures and/or the

identities of the individuals being entertained. Respondent concedes that

petitioner adequately substantiated expenses of $12,388 but argues that petitioner

has failed to substantiate the excess amount claimed.

       The strict substantiation requirements of section 274 apply to “any item with

respect to an activity which is of a type generally considered to constitute

entertainment”. Sec. 274(d)(2). The term “entertainment” is defined to include

“providing food and beverages”. Sec. 1.274-2(b)(1)(i), Income Tax Regs.


       4
        All figures in this section relating to meals and entertainment expenses
have not been reduced by the 50% limitation provided under sec. 274(n).
                                         -7-

[*7] Therefore, meals and entertainment expenses are subject to strict

substantiation requirements, and a taxpayer claiming a deduction for such an

expense must show (1) the amount of the expense, (2) the time and place of the

entertainment or expense, (3) the business purpose of the entertainment or

expense, and (4) the business relationship to the taxpayer of the “person or persons

entertained”. Sec. 1.274-5T(b)(3), Temporary Income Tax Regs., 50 Fed. Reg.

46015 (Nov. 6, 1985); see sec. 274(d).

      We agree with respondent that petitioner adequately substantiated $12,388

in meals and entertainment expenses. However, we have reviewed petitioner’s

remaining receipts and find them to be inadequate to meet the strict substantiation

requirements under section 274(d). First, many of the receipts appear to be for

personal expenses. For example, petitioner included numerous receipts for single

cups of coffee that he consumed by himself. Petitioner also included many

receipts for meals he shared with his wife. These expenses do not generally relate

to any legitimate business purpose. Second, many of the receipts are illegible, and

we are unable to determine the amount, time, and/or place of each expenditure.

Finally, many of petitioner’s handwritten notations on the receipts do not indicate

the business relationship between petitioner and the person being entertained.
                                         -8-

[*8] Under these circumstances, we find that petitioner can deduct only the meals

and entertainment expenses that respondent has conceded.

IV.   Legal and Professional Services

      Next we address whether petitioner is entitled to deduct expenses incurred

for legal and professional services in excess of what respondent has allowed.

Petitioner claimed a deduction of $87,129 on his 2010 return but argued at trial

that he is actually entitled to deduct $123,982.41. Respondent argues that

petitioner is entitled to deduct only $50,529.

      A taxpayer may deduct the costs of legal and professional services if the

costs are ordinary and necessary and directly connected with the taxpayer’s

business. See sec. 162; Levenson & Klein, Inc. v. Commissioner, 67 T.C. 694,

719-721 (1977); sec. 1.162-1, Income Tax Regs. In substantiating his reported

expenses, petitioner provided credit card statements and canceled checks. Several

of the checks are inadequate because they are not related to costs incurred for legal

and professional services. For example, petitioner included several duplicate

checks and two checks labeled “commission” expenses. However, we find that the

remaining checks and credit card statements petitioner provided (as supported by

petitioner’s credible testimony) are ordinary and necessary expenses for USO and

sufficient to substantiate a large portion of the reported legal and professional
                                         -9-

[*9] expenses. Accordingly, we find that petitioner is entitled to deduct $95,923

for legal and professional services expenses for 2010.

V.    Accuracy-Related Penalty

      We next determine whether petitioner is liable for accuracy-related

penalties. Pursuant to section 6662(a) and (b)(1) and (2), a taxpayer may be liable

for a penalty of 20% of the portion of an underpayment of tax attributable to:

(1) negligence or disregard of rules or regulations or (2) a substantial

understatement of income tax. Whether applied because of a substantial

understatement of income tax or negligence or disregard of rules or regulations,

the accuracy-related penalty is not imposed with respect to any portion of the

underpayment as to which the taxpayer acted with reasonable cause and in good

faith. Sec. 6664(c)(1). The decision as to whether the taxpayer acted with

reasonable cause and in good faith depends upon all the pertinent facts and

circumstances. See sec. 1.6664-4(b)(1), Income Tax Regs.

      The term “negligence” in section 6662(b)(1) includes any failure to make a

reasonable attempt to comply with the Code and 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. Negligence has also been defined as the failure

to exercise due care or the failure to do what a reasonable person would do under
                                       - 10 -

[*10] the circumstances. See Allen v. Commissioner, 92 T.C. 1, 12 (1989), aff’d,

925 F.2d 348, 353 (9th Cir. 1991); Neely v. Commissioner, 85 T.C. 934, 947

(1985). The term “disregard” includes any careless, reckless, or intentional

disregard. Sec. 6662(c).

      The term “understatement” means the excess of the amount of tax required

to be shown on a return over the amount of tax imposed which is shown on the

return, reduced by any rebate (within the meaning of section 6211(b)(2)). Sec.

6662(d)(2)(A). Generally, an understatement is a “substantial understatement”

when it exceeds the greater of $5,000 or 10% of the amount of tax required to be

shown on the return. Sec. 6662(d)(1)(A).

      The Commissioner has the burden of production with respect to the

accuracy-related penalty. Sec. 7491(c). To meet this burden, the Commissioner

must produce sufficient evidence indicating that it is appropriate to impose the

penalty. See Higbee v. Commissioner, 116 T.C. at 446. Once the Commissioner

meets this burden of production, the taxpayer must come forward with persuasive

evidence that the Commissioner’s determination is incorrect. Rule 142(a); see

Higbee v. Commissioner, 116 T.C. at 447. The taxpayer may meet this burden by

proving that he or she acted with reasonable cause and in good faith with respect
                                       - 11 -

[*11] to the underpayment. See sec. 6664(c)(1); see also Higbee v. Commissioner,

116 T.C. at 447; sec. 1.6664-4(b)(1), Income Tax Regs.

      Respondent satisfied his burden of production to establish that imposition of

the penalty is appropriate because petitioner acted with negligence and disregard

of rules. Respondent showed that there were underpayments of tax for 2010 and

2011 resulting from petitioner’s failure to properly report income and to

substantiate expenses underlying his claimed deductions. On his 2010 return

petitioner failed to report over $200,000 in gross receipts and claimed numerous

business expense deductions for personal items such as meals with his wife. On

his 2011 return petitioner claimed deductions for supplies and rent that he later

conceded. Petitioner offered no evidence that he acted with reasonable cause and

in good faith. Accordingly, we hold that petitioner is liable for section 6662(a)

accuracy-related penalties, in amounts which the parties shall determine in their

Rule 155 computations for both tax years.5




      5
        In the event the Rule 155 computations demonstrate that petitioner’s
understatement of income tax for either year exceeds the greater of $5,000 or 10%
of the amounts of tax required to be shown on the returns, we conclude that the
underpayment for each year will also be attributable to a substantial
understatement of income tax for which petitioner has not shown reasonable
cause.
                                      - 12 -

[*12] In reaching our holding, we have considered all arguments made, and to the

extent not mentioned, we consider them irrelevant, moot, or without merit.

      To reflect the foregoing,


                                                    Decision will be entered under

                                               Rule 155.
