Personal Expenses Not Deductible as Business Expenses; Gross Understatement and Frivolous Argument Penalties Proper (Swanson, CA-9)

The Tax Court properly held that a married couple failed to shift the burden of proof regarding their deficiencies to the IRS. The deficiency notices were timely because the couple omitted from their gross income an amount in excess of 25 percent of the gross income shown on the tax return. Further, Code Sec. 7491 did not apply to one tax year at issue because the IRS’s investigation of that year began before July 22, 1998. Moreover, the couple failed to produce credible evidence regarding their disallowed personal and business expenses and failed to cooperate with the IRS by bringing a lawsuit against one revenue officer and refusing to answer question posed by his successor during its investigation of two other tax years.

The Tax Court’s determination that the couple was not credible was not clearly erroneous because the couple made frivolous claims that their personal expenses were deductible as “management expenses” and claimed that they gave up their ownership in their trust for no more that a stranger’s promise of a loan. They also claimed not to have discussed tax avoidance with two individuals convicted of promoting tax evasion schemes.

In addition, the Tax Court properly held that the couple’s trust lacked economic substance. The couple’s relationship with the trust property did not materially differ before and after the trust’s creation, there was no independent trustee, the couple failed to respect the rules and restrictions of the trust and the economic benefits did not inure to other beneficiaries. Therefore, the trust income was properly attributed to the couple. Moreover, continuing education expenses the couple deducted on Schedule C were properly disallowed because the couple failed to demonstrate why those deductions were business expenses.

Finally, the Tax Court properly imposed the Code Sec. 6662 substantial understatement penalty and the Code Sec. 6673 penalty for maintaining frivolous or groundless positions on the couple. The couple substantially understated their tax liability and failed to prove that they acted with reasonable cause and in good faith and continued to pursue litigation despite knowing that the co-trustees of their trust were charged with, and eventually convicted of, criminal tax fraud.

Unpublished opinion affirming the Tax Court, 96 TCM 379, Dec. 57,595(M), TC Memo. 2008-265.

D.W. Swanson, CA-9, 2011-1 USTC ¶50,450

Other References:

Code Sec. 61

CCH Reference – 2011FED ¶2150.84

Code Sec. 162

CCH Reference – 2011FED ¶8520.5179

CCH Reference – 2011FED ¶8520.591

Code Sec. 1401

CCH Reference – 2011FED ¶32,543.29

Code Sec. 6501

CCH Reference – 2011FED ¶38,971.55

Code Sec. 6662

CCH Reference – 2011FED ¶39,652.34

Code Sec. 6673

CCH Reference – 2011FED ¶39,790.22

Code Sec. 7491

CCH Reference – 2011FED ¶42,520.10

Tax Research Consultant

CCH Reference – TRC IRS: 27,212

CCH Reference – TRC PENALTY: 3,252

CCH Reference – TRC PENALTY: 3,260.15

CCH Reference –

TRC LITIG: 6,704


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