The United States Tax Court has held that taxpayers/assessees have failed to demonstrate that they were carrying on a trade or business themselves or through Homes by the close of 2016. They are not entitled to the deductions claimed on the Schedule C, and respondent’s disallowance of those deductions is sustained.
The court ruled that Section 162(a) permits a deduction for ordinary and necessary expenses paid or incurred during the taxable year “in carrying on any trade or business.” An expense is deductible under section 162 only if it is paid or incurred while the taxpayer is “carrying on” a trade or business, not before. A taxpayer has not “engaged in carrying on any trade or business’ within the intendment of section 162(a) until such time as the business has begun to function as a going concern and performed those activities for which it was organised.”
The tax department determined that petitioners-assessees are liable for a section 6662(a) accuracy-related penalty. It provides for a penalty if, among other reasons, the underpayment of tax required to be shown on a taxpayer’s return is attributable to a substantial understatement of income tax. See § 6662(b)(2), (d). The record shows that the amount of the underpayment of tax required to be shown on petitioners’ 2016 return is attributable to a substantial understatement of income tax. The record also shows that respondent has satisfied the obligations that allow him to impose the section 6662(a) penalty here in dispute.
The court noted that the petitioner-assessees spent a considerable amount to enroll in Education’s courses during 2016. They had business cards and stationery printed during 2016. But for the failure of Education to honor its contractual obligations to them, they might very well have taken additional actions to allow for a finding that the business started during 2016. We are satisfied that they believed in good faith that it did. They are not liable for a section 6662(a) penalty.
Facts
At the start of 2016 petitioners owned two residential properties. One was held for rent and rented out during that year, and the other was sold on June 28, 2016. Kwaku Eason lost his job shortly before or after the start of 2016. For personal and family reasons petitioners decided to explore various income-generating activities separate and apart from their educational and professional backgrounds.
Around that time Advanced Real Estate Education (Education) offered courses on business opportunities available through real estate ownership and investment. Education’s services came to petitioners’ attention through internet research and television programing. During 2016 petitioners enrolled in two courses offered by Education and paid the company $41,934 to do so.
On July 29, 2016, petitioners formed Ashley & Makai Homes (Homes), a corporation that for 2016 made a valid election to be taxed under subchapter S of the Internal Revenue Code. See § 1362. As of the close of 2016, petitioners owned 100% of the stock of Homes. According to petitioners, Homes was formed to provide advice and guidance to real estate owners and investors, although the specific services that Homes intended to offer and/or provide to customers is unclear. Nothing in the record suggests that petitioners or Homes were required to obtain any federal, state, or local license before the intended business activity could begin.
Petitioners had business cards and business stationery printed, and they attended some of the training sessions in connection with Education’s courses; but it is unclear what else, if anything, they did in connection with Homes’ intended purpose. As it turned out, Education defaulted on many of the services that petitioners expected to receive from the company. By the close of 2018 Education had gone out of business, and petitioners had abandoned whatever business activities they intended to conduct through Homes.
Expenses attributable to Homes, including the cost of the Education courses, are shown as deductions on a 2016 Form 1120S, U.S. Income Tax Return for an S Corporation, as well as on a Schedule C included with petitioners’ return. Neither the Form 1120S nor petitioners’ return shows any income attributable to the real estate services intended to be offered or offered by petitioners or Homes. Both the Form 1120S and petitioners’ Schedule C show a loss resulting from the deductions claimed on each document.
What is Schedule C Deductions under US tax laws?
In the notice respondent disallowed all the deductions claimed on the Schedule C. Because petitioners did not claim a flowthrough loss from Homes, the deductions have not been duplicated. At trial petitioners acknowledged that the deductions should have been taken into account as petitioners’ pro rata shares of the loss incurred by Homes, see § 1366(d)(1), rather than claimed on the Schedule C. To keep things simple, however, we ignore the technicalities that govern the federal income taxation of an S corporation and its shareholders and focus on petitioners’ entitlement to the deductions as though the deductions were properly reportable as trade or business expenses on the Schedule C included with the return.
Respondent advances various reasons why petitioners are not entitled to any of the deductions claimed on the Schedule C; we need to focus on only one. According to respondent, petitioners are not entitled to the deductions because whatever business activity petitioners or Homes intended to carry on had not started by the close of 2016.
Generally, the Commissioner’s determination made in a notice of deficiency is presumed correct, and the taxpayer bears the burden of proving that the determination is erroneous. Rule 142(a).
Conclusion
The court held that the deductions are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to any claimed deduction.
The court concluded that the absence of income coupled with the absence of any activity that shows that services were offered or provided to clients or customers during 2016 supports respondent’s position that the business had not yet started by the close of that year.
Case Details
Case Name: Kwaku Eason And Ashley L. Leisner V/S Commissioner Of Internal Revenue
Citation: T.C. Summary Opinion 2024-17
Judges: Carluzzo
Decision Date: 13/08/2024
