IN THE OREGON TAX COURT
REGULAR DIVISION
Personal Income Tax
ORMAND H. ORMSBY
and BARBARA J. ORMSBY
)
)
)
)
)
)
)
)
)
)
)
Plaintiffs,
v.
DEPARTMENT OF REVENUE,
State of Oregon,
Defendant.
TC 4637
OPINION
I. INTRODUCTION
This matter is before the court for decision following a trial at which Plaintiffs
(taxpayers) appealed the audit of their 1996 and 1997 personal income tax returns performed by
Defendant Department of Revenue (the department).
II. FACTS
Taxpayers are married and file joint personal income tax returns. During the 1996 and
1997 personal income tax years (the relevant period), Barbara Ormsby worked as a flight
attendant for Delta Air, Inc. (Delta). As a flight attendant, Barbara Ormsby earned income from
the sale of duty free goods. Barbara Ormsby also made certain job related expenditures for
which she was not reimbursed by Delta.
During the relevant period, Ormand Ormsby owned and operated a financial consulting
business, the experience of which was reflected on Schedule C to taxpayers’ federal income tax
OPINION
Page 1.
return. In addition, Ormand Ormsby was the CEO and manager of United Recycling, Inc.,
(United Recycling) a corporation in which he owned all of the voting common shares. Others
owned nonvoting shares in that corporation.
Every two weeks during the relevant period, United Recycling issued to Ormand Ormsby
a payroll check in the amount of $1,200, before any withholdings. As CEO and manager of
United Recycling, Ormand Ormsby knew, at the time he received each check, whether the
corporation had sufficient funds to honor the check. Ormand Ormsby did not cash a number of
checks that he believed United Recycling could not honor. Taxpayers deducted the amount of
those checks from their gross income on their 1996 and 1997 personal income tax returns.
Ormand Ormsby made a number of purchases that he claimed were either for his financial
consulting business or for United Recycling. Taxpayers offered copies of canceled checks that
they contended were issued for those businesses. Taxpayers also indicated that they commingled
business expenditures with personal expenditures. Taxpayers did not provide any receipts or
other evidence that might indicate whether the particular expenditures were attributable to
business or personal purposes.
Taxpayers owned two pieces of real property, one wholly in Clackamas County and one
partially in Clackamas County and partially in Multnomah County. During the relevant period,
taxpayers made a number of payments to those counties and deducted the amount of those
payments as an itemized deduction on their Schedule A to their federal income tax returns.
Taxpayers also paid deductible mortgage interest.
During the 1996 and 1997 personal income tax years, taxpayers took other itemized
deductions on Schedule A of their federal return for personal property tax paid and for charitable
OPINION
Page 2.
contributions.
Taxpayers claimed Schedule C deductions of $119,863 and $61,853 in the 1996 and 1997
personal income tax years, respectively. The auditor disallowed most of those deductions. At
trial, the parties litigated the Schedule C deductions line-by-line. Taxpayers focused their
attention on specific Schedule C deductions for which they believed they had proper legal bases
and for which they believed they had proper substantiation.
Taxpayers also claimed their daughter, Brianna Ormsby, as a dependent in the 1996 and
1997 personal income tax years. In 1997, Brianna Ormsby filed a personal income tax return in
which she claimed a personal exemption deduction for herself.
In the Magistrate Division, the parties litigated the issues presented in this case, along
with other issues that taxpayers subsequently abandoned. The magistrate affirmed most of the
conclusions of the auditor, but modified some of the auditor’s positions related to taxpayers’
claims. Taxpayers appealed to this division with respect to both the conclusions of the auditor
and the decision of the magistrate to this division.
Taxpayers came to trial with a number of boxes of apparently unorganized records. Over
the course of a two-day trial, taxpayers consumed a large amount of their time searching through
their documents in an effort to substantiate their claims.
III. ISSUES
A.
May taxpayers make adjustments to their 1996 and 1997 personal income for
income attributable to the sale of duty free goods and for uncashed payroll
checks?
B.
May taxpayers take Schedule A itemized deductions on their 1996 and 1997
personal income tax returns for property tax and mortgage interest payments,
charitable contributions, and job related expenditures?
OPINION
Page 3.
C.
May taxpayers make Schedule C deductions for the 1996 personal income tax
year?
D.
May taxpayers make Schedule C deductions for the 1997 personal income tax
year?
E.
May taxpayers take a personal exemption deduction for their daughter, Brianna
Ormsby, for the 1996 and 1997 personal income tax years?
F.
What amount of self-employment taxes may taxpayers deduct for the 1996 and
1997 personal income tax years?
G.
May taxpayers seek relief from interest and penalties related to their 1996 and
1997 personal income tax returns?
H.
May either party claim reasonable attorney fees and expenses?
I.
May the department claim damages from taxpayers?
IV. ANALYSIS
At issue in this case are taxpayers’ personal income tax returns for 1996 and 1997. The
Oregon legislature intended to make Oregon personal income tax law identical to the Internal
Revenue Code (IRC) for purposes of determining taxable income, subject only to modifications
specified in Oregon law. ORS 316.007.1 As a result, the legislature adopted by reference the
federal definitions and code sections relevant to the various personal income tax issues in this
case. Unless otherwise noted, the parties agree as to the code sections applicable to this dispute.
Most tax items in dispute in this case relate to substantiation. Taxpayers, as the appealing party,
bear the burden of proof. ORS 305.427.
In their second amended complaint, taxpayers allege seven claims for relief. Claims one
through five relate to taxpayers’ personal state income tax returns for the tax years of 1996 and
1
OPINION
All references to the Oregon Revised Statutes (ORS) are to 1995 unless otherwise noted.
Page 4.
1997. In their sixth claim, taxpayers request that the court rule in their favor and that the court
remove any penalties and interest imposed by the department. In their seventh claim for relief
taxpayers request that this court award them reasonable costs, expenses, and professional fees.
In its Answer, the department requests that the court issue an order affirming the
department’s assessments or, in the alternative, issue an order consistent with the magistrate’s
decision. The department also requests attorney fees, costs, and disbursements. Finally, the
department requests that the court award damages to the department pursuant to ORS 305.437.
A.
Taxpayers’ First Claim For Relief: Income Adjustments
Taxpayers request that the court adjust their gross income as follows: (1) a reduction of
$344 for the sale of duty free goods in 1996; and (2) reductions of $5,728.68 and $2,868.59 in
the 1996 and 1997 personal income tax years, respectively, for the amount of uncashed payroll
checks that Ormand Ormsby received from United Recycling.
1.
Duty Free Goods
The record indicates that the state auditor increased Barbara Ormsby’s income for
1996 by $344 “from sale of commissioned items from Delta Airlines in-flight duty-free items.”
(Def’s Ex A). The magistrate found that Delta had reported $493 in commission sales on
Barbara Ormsby’s 1996 federal W-2 wage and tax statement (W-2) and that Barbara Ormsby had
$344 in commissions in the 1997 personal income tax year. At trial, the department agreed to
eliminate the auditor’s $344 assessment for the 1996 personal income tax year because that
amount had been included in Barbara Ormsby’s W-2. On the basis of that concession, therefore,
the court concludes that taxpayers’ income shall be reduced by $344 for the 1996 personal
income tax year.
OPINION
Page 5.
2.
Uncashed Payroll Checks
Taxpayers claimed a reduction in their gross income for the 1996 and 1997
personal income tax years for uncashed payroll checks that United Recycle issued to Ormand
Ormsby. Taxpayers claim that Ormand Ormsby received, but did not cash, checks in the
amounts of $5,728.68 in 1996 and $2,868.59 in 1997. The department contends that taxpayers
constructively received those amounts as income and that no reduction from gross income is
therefore appropriate.
As a threshold matter, the court is unable to substantiate the amounts that
taxpayers claim are at issue for the 1996 personal income tax year. Taxpayers entered into
evidence photocopies of seven payroll checks issued by United Recycling to Ormand Ormsby in
1996, each with a gross amount of $1,200, for a total of $8,400. (Ptf’s Exs 7-13). The net
amount of those checks totals $6,683.90. Those amounts do not reconcile with taxpayers’
claimed amounts and taxpayers did not explain that discrepancy. As to the 1997 personal income
tax year, taxpayers submitted three checks totaling a gross amount of $3,600 and a net amount of
$2,868.59. (Ptf’s Exs 14-16).
Taxpayers assert that they understood they had three options as to the uncashed
payroll checks: (1) report the uncashed payroll checks to the payroll preparation company and
instruct it to issue revised W-2s; (2) forward copies of the uncashed payroll checks along with a
cover letter to the department explaining the basis for not including the amount of those checks
in gross income; and (3) include the amount of the checks in income as wages and report the
uncollected checks as a bad debt on Schedule A of their income tax returns if such checks were
not collectible. Taxpayers argue that, under any of those approaches, the amount of the uncashed
OPINION
Page 6.
payroll checks should not be included in their gross income. Taxpayers have not offered any
legal support for those propositions.
Although taxpayers allege that they had three available options, taxpayers
apparently elected to pursue only the second option, forwarding a copy of the uncashed payroll
checks along with a cover letter to the department. Both parties submitted tax returns purporting
to be the Ormsby’s personal income tax returns for 1996 and 1997 and neither set of returns
contains such a cover letter and copies of uncashed payroll checks. (See Ptf’s Exs 1, 2 and Def’s
Exs BD, BE). Ormand Ormsby testified that he filed the appropriate letter with his personal
income tax return. Although taxpayers understood that all trial exhibits must be exchanged in
advance of trial, they did not exchange that letter with the department during discovery. The
court sustained the department’s objection to the introduction of any new evidence at trial.
The department contends that taxpayers constructively received as personal
income the amount of all of the checks United Recycling issued to Ormand Ormsby, whether he
did or did not cash those checks. Under IRC section 451(a), the “amount of any item of gross
income shall be included in the gross income for the taxable year in which received by the
taxpayer, unless, under the method of accounting used in computing taxable income, such
amount is to be properly accounted for as of a different period.” Cash method taxpayers, such as
the Ormsbys, must report income in the year it is actually or constructively received. Treas.
Reg § 1.451-1 (2004). In a case involving the receipt of a check, this court agrees with the
position of the Eighth Circuit Court of Appeals, which has stated:
“A check in the hands of a taxpayer ordinarily means that funds are immediately
available. Therefore, the general rule is that a check constitutes taxable income to
a cash-basis taxpayer when received. See Avery v. Comm’r, 292 US 210, 215
(1934); Kahler v. Comm’r, 18 TC 31 (1952). There are some common sense
OPINION
Page 7.
exceptions to this rule, such as when the payor may be insolvent, see Lavery v.
Comm’r, 158 F2d 859, 860 (7th Cir 1946), or has imposed substantial restrictions
or conditions that prevent the taxpayer from receiving funds, see Bright v. United
States, 926 F2s 383, 386-87 (5th Cir 1991).”
Walter v. United States, 148 F3d 1027, 98-2 US Tax Cas (CCH) ¶ 50,546 (8th Cir 1998)
(emphasis in original).
Taxpayers assert, by way of implication, that their situation falls into an
exception, arguing that United Recycling’s alleged precarious financial position throughout 1996
and 1997 “imposed substantial hardships or conditions that prevented taxpayer[s] from receiving
funds.” Id. Ormand Ormsby testified that the payroll checks were prepared and issued by a
payroll company on a scheduled basis. He testified that, as CEO and manager of United
Recycling, he knew whether United Recycling had sufficient funds in its checking account to
honor the checks on the date that he received those checks. Ormand Orsmby further testified that
on the date of receipt of each disputed check United Recycling had insufficient funds and that,
therefore, he did not believe that he could cash those seven checks.
Ormand Ormsby testified on cross examination, however, that, with respect to at
least the $1,200 payroll check dated May 17, 1996, United Recycling had sufficient funds in its
account to honor the check at various times from May 1996 until at least 1999. (Ptf’s Ex 7). In
fact, Ormand Ormsby testified that he cashed many payroll checks after May 17, 1996. When
asked if he could have cashed the May 17th check instead of one of the checks he later cashed,
Ormand Ormsby stated that he could have cashed that check and that nothing was unique about
the May 17th check. Ormand Ormsby also testified that he believed that United Recycling had
sufficient funds available to pay the state and federal withholdings at the time the payroll
company issued each of the uncashed payroll checks. Finally, taxpayers did not offer evidence
OPINION
Page 8.
from United Recycling, such as financial statements or bank statements, that might substantiate
that the corporation was unable to meet its obligations during 1996 and 1997.
On this record, the court finds that taxpayers have not met their burden to
establish that “substantial restrictions or conditions * * * prevented taxpayer[s] from receiving
funds” when Ormand Ormsby received the payroll checks from United Recycling. Id. As cash
method taxpayers, the Ormsbys were in constructive receipt of income as soon as Ormand
Ormsby received the checks from United Recycling. The court also finds that no exception to
that general constructive receipt rule applies here because taxpayers did not prove that United
Recycling could not have honored the checks it issued to Ormand Ormsby.
The court concludes, therefore, that the record does not support taxpayers’
assertion that the amount of the uncashed payroll checks should be excluded from gross income
and that taxpayers may not deduct the amount of the uncashed payroll checks from their gross
income for the 1996 and 1997 personal income tax years.
B.
Taxpayers’ Second Claim For Relief: Schedule A Expenses
Taxpayers request that this court grant Schedule A deductions for property taxes
payments, mortgage interest payments, charitable contributions, and various unreimbursed job
related expenses in the 1996 and 1997 personal income tax years amounts greater than the
department allowed on audit.
1.
1996 Property Tax
In their second amended complaint, taxpayers allege that they paid deductible
property taxes in the amount of $10,651 for the 1996 personal income tax year. In their trial
memorandum and at trial, however, taxpayers asserted that they may only claim $5,078.64.
OPINION
Page 9.
The department contends that taxpayers may claim a deduction in the amount of $3,648.
Taxpayers submitted into evidence two property account financial histories for
two properties they alleged that they own in Clackamas County. (Ptf’s Exs 18, 20). Those
account histories indicate that taxpayers paid a total of $3,364.40 to Clackamas County in 1996
for two property tax accounts. In addition, taxpayers submitted evidence indicating that they
paid $283.19 to Multnomah County in 1996 for one property they allege is located in both
Multnomah and Clackamas counties. (Ptf’s Ex 19). The total of those three account histories
equals $3,647.59, which, with allowable rounding off, is the amount the department concedes
taxpayer may claim as a deduction for real property taxes paid on Schedule A.
Taxpayers have not articulated to the court, either at trial or in their written
submissions, exactly how they are came up with an additional $1,714.24. Taxpayers did allege
that they made two payments to Clackamas County that are not reflected in the account histories
they submitted into evidence. Those checks total $1,810.28. (Ptf’s Exs 21, 21b). Taxpayers did
not explain that discrepancy. Without regard to the discrepancy in amounts, taxpayers’ proof as
to the two alleged additional payments also fails for lack of substantiation for the following
reasons.
First, taxpayers assert that they made a $300 payment to Clackamas County on
May 28, 1996. (Ptf’s Ex 21). That payment, however, is not reflected in the detailed account
histories that taxpayers rely on to prove their other property tax payments to the county.
Taxpayers submitted into evidence a carbon copy of the original check as evidence that they had
made the alleged property tax payment. The court cannot verify from that copy whether
taxpayers ever actually mailed the check to the county or whether the check was cashed.
OPINION
Page 10.
Taxpayers did not submit copies of bank statements or any form of verification that a check in
that amount had cleared from their personal accounts. Barbara Ormsby testified at trial,
however, that the payment may have been for a business tax payment related to United
Recycling. In fact, the record contains many examples of taxpayers having made payments on
behalf of United Recycling from their personal checking accounts throughout 1996 and 1997.
On this record, therefore, the court finds that taxpayers have not met their burden of proof
necessary to deduct the $300 check dated May 28, 1996, as personal property taxes paid.
Second, taxpayers assert that they made a $1,510.28 payment to Clackamas
County on November 8, 1996. (Ptf’s Ex 21b). That payment also is not reflected in the detailed
account histories that taxpayers rely on to prove their other property tax payments to the county.
That payment is also represented by a carbon copy unsupported by anything other than taxpayers’
testimony. Moreover, the carbon copy does not contain the signature of either taxpayer.
Taxpayers could not explain why the check was not signed. On this record, therefore, the court
finds that taxpayers have not met their burden of proof necessary to deduct the $1,510.28 check
dated November 8, 1996, from their Schedule A property taxes paid.
Based on the foregoing, the court concludes that taxpayers may claim $3,648 for
real property taxes paid as a Schedule A itemized deduction for the 1996 personal income tax
year.
2.
1997 Property Tax
In their second amended complaint, taxpayers allege that they paid property taxes
in the amount of $10,865 for the 1997 personal income tax year. In their trial memorandum and
at trial, however, taxpayers conceded that they may only claim $3,268. The department agreed
OPINION
Page 11.
that taxpayers may claim a deduction in the amount of $3,268. At trial, the parties stipulated to
that amount. Based on that agreement, the court concludes that taxpayers may claim $3,268 for
real property taxes paid as a Schedule A itemized deduction for the 1997 personal income tax
year.
3.
Mortgage Interest
In their second amended complaint, taxpayers allege that they paid mortgage
interest in the amount of $16,061 for the 1996 personal income tax year and $23,177 for the 1997
personal income tax year. In their trial memorandum, taxpayers alleged that they made mortgage
interest payments of $18,571.79 and $16,471.44 for the 1996 and 1997 personal income tax
years, respectively. At trial, however, the parties stipulated to figures of $18,914 for 1996 and
$15,449 for 1997. Based on that stipulation, the court concludes that taxpayers may claim
Schedule A itemized deductions for mortgage interest paid in the amounts of $18,914 for the
1996 personal income tax year and $15,449 for the 1996 personal income tax year.
4.
Personal Property Tax
In their second amended complaint, taxpayers allege that they paid $25 for vehicle
registration for a vehicle used in connection with taxpayers’ business. Taxpayers did not prove
in which personal income tax year they made that payment. Taxpayers made no argument and
introduced no evidence at trial as to this item. The court concludes, therefore, that taxpayers may
not deduct $25 for personal property tax paid as a Schedule A itemized deduction for either the
1996 or 1997 personal income tax years.
5.
Charitable Contributions
In their second amended complaint, taxpayers allege that they made charitable
OPINION
Page 12.
contributions in the amounts of $1,928 for the 1996 personal income tax year and $1,991 for the
1997 personal income tax year. In their trial memorandum, taxpayers decreased those amounts
to $1,576 and $1,680 for the 1996 and 1997 personal income tax years, respectively. At trial,
however, the parties stipulated to $1,000 for both the 1996 and 1997 personal income tax years.
Despite stipulating at trial to those amounts, in their summation brief taxpayers reasserted their
right to claim $1,576 for the 1996 personal income tax year and $1,680 for the personal income
tax year.
Taxpayers have not explained why this court should not enforce the stipulation
made at trial. On this record, the court finds that $1,000 per year is a generous concession by the
department. Taxpayers entered into evidence a number of documents related to charitable
contributions, none of which substantiate the amounts taxpayers now seek to deduct as charitable
contributions. Taxpayers submitted a spreadsheet entitled “Tabulation of Charitable
Contributions 1996 and 1997.” (Ptf’s Ex 46). For 1996, that document indicates that taxpayers
made $1,200.83 worth of payments to Riverdale School, Rolling Hills Community Church, and
the Portland Police Association. Of that amount, taxpayers labeled $565 under the heading
“Confirmation Not Available.” (Id.). For 1997, the tabulation indicates that taxpayers made
$1,305 to the school, church, and “One Voice Productions,” $481 of which taxpayers indicated
lacked confirmation.
In fact, the court finds that nearly all of taxpayers’ alleged charitable contributions
lack confirmation. Taxpayers submitted into evidence a single check in the amount of $30 that
had been endorsed and cashed by Rolling Hills Community Church in 1996. (Ptf’s Ex 54). As
with the property taxes, taxpayers provided carbon copies of checks as support for other
OPINION
Page 13.
charitable contributions. Taxpayers submitted carbon copies totaling $795.83 for 1996 and $823
for 1997. (Ptf’s Exs 48-53). The only document offered to confirm that those checks had been
received by any of the entities identified on the checks was a contribution statement from Rolling
Hills Community Church dated January 18, 1998, indicating that the church had received two
payments in 1997 totaling $150. (Ptf’s Ex 47). Taxpayers did not submit any testimonial
evidence as to charitable contributions because they had stipulated to an amount at trial.
Absent the trial stipulation by the parties, the court finds that taxpayers would
only have met their burden of proof for charitable contributions of $30 in 1996 personal income
tax year and $150 in 1997 personal income tax year. Taxpayers’ post-trial argument appears to
have been in bad faith and, given the benefit to them of the stipulation, was ill advised. The
department chose to ignore taxpayers’ claims for increased charitable contribution deductions,
however, and reaffirmed the parties’ trial stipulation. On that basis only, therefore, the court
concludes that taxpayers may deduct $1,000 for charitable contributions for each of the 1996 and
1997 personal income tax years.
6.
Barbara Ormsby’s Job Related Expenses
In their second amended complaint, taxpayers allege that Barbara Ormsby had
unreimbursed job related expenses of $1,988 and $4,110 for the 1996 and 1997 personal income
tax years, respectively. The auditor concluded that Barbara Ormsby could deduct $1,991 in 1996
and $1,225 in 1997. The department did not assert a specific position on Barbara Ormsby’s job
related expenses prior to trial. Despite the auditor’s willingness to increase Barbara Ormsby’s
job related expense deduction from $1,988 to $1,991 for the 1996 personal income tax year, the
parties stipulated at trial to an amount of $1,988. On the basis of that stipulation, the court
OPINION
Page 14.
concludes that taxpayers may deduct $1,988 for Barbara Ormsby’s Schedule A job related
expenses for the 1996 personal income tax year, subject to the applicable limits under federal
law.
At trial, the parties could not reach an agreement as to the deductibility of
Barbara Ormsby’s alleged job related expenses for the 1997 personal income tax year. At trial,
the parties litigated Barbara Ormsby’s job related expenses in three separate categories of
expenses: (1) unreimbursed meal expenses; (2) uniform expenses; and (3) miscellaneous
expenses.
a.
Unreimbursed Meal Expenses
Taxpayers claimed a total of $3,464 for unreimbursed meal expenses for
Barbara Ormsby on their 1997 form 2106-EZ. (Def’s Ex BF, p 12). The department asserted
that, on the basis of one of taxpayers’ own exhibits, a total of $2,649 of that amount had been
reimbursed by Delta. (Ptf’s Exs 62, BF p 54). Taxpayers did not submit any evidence from
which the court could discern how they arrived at an additional $815. The department was
willing, however, to offer to permit taxpayers a deduction for the additional $815. On the basis
of that offer alone, therefore, the court concludes that taxpayers may deduct $815 for
unreimbursed meal expenses as a Schedule A deduction on their 1997 personal income tax
return.
b.
Uniform Expenses
Taxpayers claimed $352 for uniform expenses for Barbara Ormsby on
their 1997 form 2106-EZ. (Def’s Ex BF pp 12-13). In support of their deduction, taxpayers
submitted a copy of Delta’s in-flight service manual, which outlines mandatory attire
OPINION
Page 15.
requirements, and a low-resolution photograph of Barbara Ormsby’s flight attendant gear. (Ptf’s
Exs 55-56). Taxpayers did not produce any evidence, however, that they actually made any
expenditures during 1997 for that gear. In fact, Barbara Ormsby testified that she may have
purchased one item, a topcoat she valued at around $200, in 1996.
Despite the lack of substantiation, and testimony indicating that a portion
of the expenditures occurred in a different income tax year, taxpayers ask this court to follow the
approach of the court in Douglas v. Commissioner, 38 TCM (CCH) 901 (1979). Douglas,
however, reveals the fatal flaw in taxpayers’ claim for a deduction for uniform expenses. One of
the taxpayer’s alleged expenses in Douglas was for fingernail care. In denying that expense, the
court stated, “the record does not give us any basis for determining the * * * amount (if any) that
Kathleen expended for cosmetics as a consequence of her employer’s requirements. Applying
the analogy of the rules governing deductibility of items constituting work uniforms, we feel that
on the record herein we must sustain respondent’s determination * * *.” Id. at 902-03. The
court, therefore, disallowed the deduction on the basis that the taxpayers lacked substantiation of
those expenditures. Substantiation of the expenditures is where taxpayers fail here as well.
Taxpayers have not placed into evidence sufficient proof of purchase, price, or time of purchase
of the expenditures they wish to deduct.
On this record, the court finds that taxpayers have not met their burden of
proof as to the deductibility of Barbara Ormsby’s uniform expenses. The court concludes,
therefore, that taxpayers may not take a deduction for Barbara Ormsby’s uniform expenses on
their 1997 Schedule A.
c.
OPINION
Miscellaneous Expenses
Page 16.
Taxpayers claimed $294 for miscellaneous expenses for Barbara Ormsby
on their 1997 form 2106-EZ. (Def’s Ex BF pp 12-13). In support of their deduction, taxpayers
asserted that Delta required Barbara Ormsby to communicate via the internet using a program
called “Widget Works.” Taxpayers alleged Widget Works cost about $11 per month and that
they also had to contract with an internet service provider (ISP) for about $20 per month in order
to facilitate the communication. Taxpayers conceded, however, that the ISP could be used for
purposes other than to connect Widget Works to the internet.
Taxpayers did not submit any evidence necessary to prove that they made
those alleged payments. Despite the lack of substantiation, the department was willing to accept
that taxpayers had made the $11 monthly payments for Widget Works, for a total deduction of
$132 for the 1997 personal income tax year. On the basis of that concession only, therefore, the
court concludes that taxpayers may deduct $132 for miscellaneous expenses on their 1997
Schedule A.
7.
Ormand Ormsby’s Job Related Expenses
In their second amended complaint, taxpayers allege that Ormand Ormsby had
unreimbursed job related expenses of $4,800 for the 1997 personal income tax year. Taxpayers
conceded that their 1997 Schedule A indicated that they had improperly taken a $9,600 deduction
for Ormand Ormsby’s unreimbursed job related expenses because of a computational error that
duplicated the actual figure of $4,800. The auditor concluded, and the department contended at
trial, that taxpayers’ reduced amount of $4,800 was actually a duplicate deduction for the $4,800
worth of uncashed payroll checks Ormand Ormsby had already improperly deducted from gross
income for the same tax year. Essentially, therefore, the department argued that taxpayers had
OPINION
Page 17.
improperly taken a $4,800 deduction three times on the same income tax return.
At trial, taxpayers asserted that the $4,800 was not attributable to the uncashed
payroll checks; rather, taxpayers alleged that Ormand Ormsby had unreimbursed expenses related
to United Recycling. As a threshold matter, once again the court is unable to reconcile the
amount alleged by taxpayers with the evidence they offered at trial. Taxpayers submitted
documentary evidence equaling $5,208.96 for expenses they allege were not reimbursed by
United Recycling. Taxpayers broke that amount into three categories. Although the department
alleged that deductions for all of those expenditures should be denied because they were
contributions to capital of United Recycling, the court need not reach that issue.2 Even if the
court were to accept taxpayers’ position on the deductibility of those expenditures, as a matter of
law, the court finds that taxpayers have not met their burden of proof necessary for each of the
three categories of expenses.
First, taxpayers submitted a carbon copy of a check dated February 10, 1997,
written from Barbara Ormsby’s account to the order of Ormand Ormsby. (Ptf’s Ex 187). The
handwritten term “U/R” appears on the bottom left corner of the duplicate check. Taxpayers
testified that Barbara Ormsby wrote that check to cover the purchase of items for United
Recycling, such as ladders, uniforms, and parts for a plant vehicle. Taxpayers did not submit,
however, any evidence that such purchases were ever made or that the total of those alleged
expenditures totaled exactly $3,000. On that basis, the court finds that taxpayers have not met
2
The department argues that many alleged expenditures and payments taxpayers made to or on behalf of
United Recycling were capital contributions. In this opinion, the court never addresses that argument because
taxpayers have failed in each instance to offer proof necessary to establish that they may deduct those alleged
expenditures or payments. The reasoning in this opinion should not be read to indicate that the department’s
argument was incorrect.
OPINION
Page 18.
their burden of proof necessary to establish that the $3,000 check that taxpayers allege Barbara
Ormsby issued to Ormand Ormsby was for his job related expenses that were unreimbursed by
United Recycling.
Second, taxpayers submitted a self-prepared spreadsheet listing 15 independent
transactions at Costco totaling $1,595.55 that they allege were made wholly for the benefit of
United Recycling. (Ptf’s Ex 137). Taxpayers offered copies of checks totaling $1,058.67 that
appear to have been cashed by Costco that correspond to nine of those transactions. (Ptf’s Exs
138-42). Taxpayers did not submit receipts detailing any of those purchases. Moreover,
taxpayers testified that it was not uncommon for them to commingle personal purchases or
purchases for Ormand Ormsby’s financial consulting business with those for United Recycling.
On this record, therefore, the court finds that taxpayers have not met their burden of proof
necessary to establish that the $1,595.55 they allegedly spent at Costco for the benefit of United
Recycling was in fact spent for United Recycling.
Third, taxpayers submitted canceled checks totaling $640.36 that they allege were
also written to various businesses for the benefit of United Recycling. (Ptf’s Exs 188-94). Once
again, taxpayers failed to offer detailed receipts. In addition, taxpayers did not offer any
testimonial evidence as to why Ormand Ormsby issued those checks. On this record, therefore,
the court finds that taxpayers have not met their burden of proof necessary to establish that the
$613.41 they allegedly spent at a number of retail establishments was in fact spent for the benefit
of United Recycling.
Based on the foregoing, the court finds that taxpayers have not met their burden
necessary to prove that Ormand Ormsby had any unreimbursed job expenses in the 1997 personal
OPINION
Page 19.
income tax year. The court concludes, therefore, that taxpayers may not deduct unreimbursed job
expenses allegedly attributable to Ormand Ormsby on their 1997 Schedule A.
C.
Taxpayers’ Third Claim For Relief - 1996 Schedule C Expenses
In their second amended complaint, taxpayers asserted that they were entitled to
deductions for Schedule C expenses attributable to Ormand Ormsby’s financial consulting
business in the amount of $119,863 for the 1996 personal income tax year. In particular,
taxpayers specified amounts they claimed for automobile, equipment lease, legal and
professional, and depreciation expenses. The auditor determined that taxpayers could take
deductions in the amount of $16,402 on their Schedule C and denied the remaining amount of
$103,461. At the outset of trial, the department reserved its position as to whether it would
accept or reject the auditor’s conclusions as to the deductibility of each individual Schedule C
line item. At trial, therefore, the parties litigated Schedule C line-by-line.
1.
Lines 8, Advertising; and 15, Insurance
On their 1996 Schedule C, taxpayers claimed the following: (1) $264 for
advertising on line 8; and (2) $84 for insurance on line 15. Both at audit and at trial, the
department contended that taxpayers may not claim any Schedule C deduction for advertising
because taxpayers could not offer substantiation for the expense. (See Def’s Ex BC). Although
not litigated by either party at trial, the auditor found that taxpayers could not substantiate the
insurance expense deductions taxpayers made on line 15 of their 1996 Schedule C. Taxpayers
did not provide any evidence as to the validity of either of those expenses. On this record, the
court finds that taxpayers have not met their burden of proof as to the advertising and insurance
expenses that they claimed on their 1996 Schedule C. The court concludes, therefore, that
OPINION
Page 20.
taxpayers may not take deductions for advertising expenses on line 8 and insurance expenses on
line 15 of their 1996 Schedule C.
2.
Line 10, Car and Truck Expenses
In their second amended complaint, taxpayers allege that they have deductible
automobile expenses in the amount of $7,450. In their trial memorandum, taxpayers reduced that
amount to $4,003. At trial, the parties stipulated to a Schedule C, line 10, deduction for
automobile expenses in the amount of $2,002. The parties did not elaborate, and the record does
not indicate, how the parties came to that mutually agreed on figure.
Despite that apparent stipulation on the record, taxpayers, in their summation
brief, inexplicably renewed their claim for an automobile expense deduction in the amount of
$4,003. From the record, the court cannot discern any basis from which taxpayers could properly
assert that they are entitled to $4,003 for automobile expenses on Schedule C for 1996.
Taxpayers did not introduce any evidence that indicates they had any deductible automobile
expenses during 1996. In fact, the only reference to automobile expenses is the $7,450 taxpayers
claimed on their Schedule C - a figure they had already abandoned in their pretrial brief.
The department, however, did introduce evidence indicating that the department
auditor had concluded that taxpayers could deduct as much as $4,956 for automobile expenses
for 1996. (Def’s Ex D). Taxpayers have not asserted that the reasoning underlying that
determination is still valid. Moreover, the department stated at the outset of the trial that it
reserved its position on all matters related to this case, regardless the position taken by the
auditor or the decision of the magistrate in the previous proceeding. As to deductible automobile
expenses, the department maintained that the agreed on figure of $2,002 was the appropriate
OPINION
Page 21.
amount. On this record, the court cannot find any reason to disturb the agreement the parties
stipulated to at trial in favor of the unsupported position advocated by taxpayers in their
summation brief. The court concludes, therefore, that taxpayers may claim $2,002 for
automobile expenses on Schedule C, line 10, of their 1996 personal income tax return.
3.
Line 11, Commissions and Fees
On their 1996 Schedule C, line 11, taxpayers purported to claim a deduction for
commissions and fees. The deduction was stated as a negative number, which the court
concludes would result in an addition to income. At trial, taxpayers testified that they did not
know what that amount was for and that they could not substantiate it. The auditor was also
unable to substantiate that amount and therefore reduced the deduction, or inclusion in this case,
to $0. The department did not have a position on this matter at trial. On this record, the court
finds that neither the taxpayers nor the department has shown that taxpayers must include $155
for commissions and fees into the expense portion--i.e., a reduction of taxpayers’ overall
deduction--of Schedule C for 1996. The court concludes, therefore, that taxpayers may claim $0
for commissions and fees on line 11 of their 1996 Schedule C.
4.
Line 13, Depreciation
On their 1996 Schedule C, line 13, taxpayers deducted $11,735 for depreciation.
The auditor found and accepted $3,551 for depreciation of business equipment associated with
Ormand Ormsby’s financial consulting business. At trial, the department offered an additional
$717 for depreciation related to the use of Ormand Ormsby’s vehicle in connection with that
business, for a total of $4,268. After unsuccessfully attempting to determine the basis or bases
for the additional $7,467 worth of depreciation, taxpayers agreed to accept $4,268 as the correct
OPINION
Page 22.
figure. On the basis of that agreement, the court concludes that they may claim $4,268 for
depreciation on line 13 of their 1996 Schedule C.
5.
Line 17, Legal and Professional Services
On their 1996 Schedule C, line 17, taxpayers deducted $54,882 for legal and
professional services. In their second amended complaint, taxpayers divided that amount into
two categories: (1) a loan to United Recycling for $50,000 in 1996; and (2) legal and professional
expenses of $4,882 in 1996. In their trial memorandum, taxpayers stated that “the loan expense
of $50,000 for 1997 * * * should be reflected in the 1996 Schedule C at $53,900 resulting in an
adjustment or combining of claims.” (Ptf’s Trial Memo). At trial, however, taxpayers asserted
that they claimed the following under line 17: (1) $51,900 for loans to United Recycling; and (2)
$4,882 for legal and professional expenses.
a.
Loans to United Recycling
Taxpayers offered three canceled checks written from Ormand Ormsby’s
account to United Recycling totaling $51,900. (Ptf’s Exs 94, 95). Taxpayers did not present any
legal basis, however, for claiming those payments to United Recycling as a legal or professional
expense of Ormand Ormsby’s financial consulting business. In fact, no legal basis exists under
which taxpayers could claim those payments on line 17 of their 1996 Schedule C. For that
reason alone, the court concludes that taxpayers may not deduct the $51,900 they paid to United
Recycling on line 17 of their 1996 Schedule C.
By way of implication, taxpayers asserted at trial that they should be able
to claim some form of a deduction for the $51,900 he transferred to United Recycling out of his
account because he never received a payment from United Recycling in return. Essentially,
OPINION
Page 23.
taxpayers argued that they should be able to deduct the total as a bad debt. In support of their
argument, taxpayers rely on Artstein v. Commissioner, 29 TCM (CCH) 961 (1970). Taxpayers’
reliance on Artstein is flawed for a number of reasons, the most important of which is found in
the excerpt they quoted in their trial summation brief. That excerpt states that a “taxpayer’s
payment is not treated as a worthless debt until the year in which the right of subrogation or other
similar right becomes totally worthless, or partially worthless in the case of an agreement that
arose in the course of the taxpayer’s trade or business.” (Ptf Sum at 11). Here the record
illustrates that United Recycling operated well into 1999, and perhaps as long as 2000.
Moreover, Ormand Ormsby testified that he received payroll checks from United Recycling that
he was able to cash through the end of 1997. The court concludes, therefore, that even if the
payments to United Recycling could be classified as a loan, and on this record the court finds that
taxpayers have not met their burden of proof as to that contention, taxpayers may not properly
deduct those payments as a bad debt or as a Schedule C deduction in neither the 1996 nor the
1997 personal income tax years.
b.
Legal and Professional Fees
Although taxpayers allege that they had $4,882 worth of legal and
professional fees in 1996, they only submitted into evidence one canceled check totaling
$2,436.40 which they alleged was for legal fees. When questioned as to why taxpayers made that
payment, however, Ormand Ormsby testified that he paid Leonard D. DuBoff (DuBoff)
$2,436.40 in satisfaction of debts he owed in conjunction with the rental of office space and
equipment. Ormand Ormsby conceded that, although DuBoff is an attorney, the payment was
not for legal services. Taxpayers did not offer any other evidence of payments for legal or
OPINION
Page 24.
professional fees. The court finds that taxpayers have not met their burden necessary to prove
that they made any legal or professional fee payments during the 1996 personal income tax year.
On this record, therefore, the court concludes that taxpayers may not claim any deduction for
legal and professional fees on line 17 of their 1996 Schedule C.
6.
Line 18, Office Expense
On their 1996 Schedule C, line 18, taxpayers claimed $1,147 for office expense.
The auditor concluded that taxpayers could only claim $356 as office expenses under line 18,
primarily due to lack of substantiation and because taxpayers had duplicated expenses in this
category with expenses they had taken in other categories. At trial, taxpayers did not dispute the
auditor’s conclusion with respect to office expenses. The court concludes, therefore, that
taxpayers may claim $356 for office expenses on line 18 of their 1996 Schedule C.
7.
Lines 20a, Vehicle, Machinery, and Equipment Rent or Lease; and 16, Other
Interest
On their 1996 Schedule C, line 20a, and in their second amended complaint
taxpayers claimed $18,128 for other vehicle, machinery, and equipment rent or lease payments.
In their pretrial memorandum, however, taxpayers reduced that amount to $10,617. At trial,
Ormand Ormsby testified that the amounts were attributable to two pieces of equipment that he
had purchased and leased to United Recycling. When asked why he had reduced the amount
taxpayers initially claimed on their 1996 Schedule C, Ormand Ormsby testified that he only
intended to include the interest portion of the payment as a deduction. Ormand Ormsby also
testified that United Recycling had made a number of the payments, but he did not indicate
whether he had reduced the amount of interest he deducted by the amount of those payments.
Moreover, Ormand Ormsby testified that the portion of the depreciation taxpayers abandoned in
OPINION
Page 25.
arriving at their agreement on depreciation expense under line 13 of taxpayers’ 1996 Schedule C
was actually depreciation on the equipment; thus, taxpayers had claimed double deductions for
the same item.
After a discussion with the department, taxpayers conceded that the $10,617 was
not attributable to equipment purchase or lease. Taxpayers then asserted that they should be
allowed to deduct the amount on line 16b, other interest, of their 1996 Schedule C. At trial and
in its summation brief, the department contended that the best solution is to consider the leases as
if they had been transactions between United Recycling and the equipment sellers. Under that
arrangement Ormand Ormsby would presumably only have been a guarantor and would not have
been able to claim any deductions related to the leases during 1996 and 1997. Moreover,
taxpayers would not have had to include any payments from United Recycling to Ormand
Ormsby in their 1996 personal income. For their part, taxpayers maintained their position that
the arrangement was a valid lease between Ormand Ormsby and United Recycling for which
taxpayers may claim Schedule C deductions.
The court agrees with the department. On this record, the court finds that
taxpayers have not met their burden necessary to prove that a lease actually existed between
Ormand Ormsby and United Recycling for property owned by Ormand Ormsby. Taxpayers
submitted two documents purporting to be sales agreements between Ormand Ormsby and two
equipment sellers. (Ptf’s Exs 157, 167). Although one document does in fact list Ormand
Ormsby as the “Buyer (Debtor),” the other document is nearly illegible. (Id.). Taxpayers did not
submit any lease agreement between taxpayers and United Recycling.
Perhaps most damaging to taxpayers’ position, however, was the testimony of
OPINION
Page 26.
Ormand Ormsby, who testified that he only “cosigned” for the equipment because the seller
would not sell directly to United Recycling. Ormand Ormsby indicated that he merely acted as a
guarantor and that he intended for United Recycling to make all the payments. In fact, Ormsby
testified that United Recycling made ten of the payments for one of the pieces of equipment in
1996. Ormand Ormsby also testified that United Recycling made the down payment for that
piece of equipment.
Finally, the auditor’s report as to the lease arrangements between Ormand Ormsby
and United Recycling also includes information damaging to taxpayers’ position. (Def’s Ex D).
For example, the auditor found that under the purported lease, United Recycling would make
estimated payments to taxpayers in the amount of $64,576.80 over the life of the purported lease,
for a piece of equipment with a purchase price of $8,595.00.
Based on this record, the court finds that taxpayers have not met their burden of
proof to establish that a valid lease existed between Ormand Ormsby and United Recycling. The
court also finds that the substance of the transactions between Ormand Ormsby, United
Recycling, and the equipment sellers indicated that Ormand Ormsby acted as a guarantor for
United Recycling. As a result, the court concludes that taxpayers may not make any 1996
Schedule C deductions for the purported lease arrangements between Ormand Ormsby and
United Recycling. Nor are taxpayers required to include rental receipts from the transactions,
although, in fact, they did not do so on their 1996 federal income tax return.
8.
Line 20b, Other Business Property Rent or Lease
On their 1996 Schedule C, line 20b, taxpayers claimed $4,594 for other business
property rent or lease payments. The auditor concluded, however, that taxpayers could actually
OPINION
Page 27.
deduct $6,130, a net increase of $1,536. Despite that apparent positive result, taxpayers argued at
trial that they could only deduct $4,594. The department reserved its position at trial, pending
the admission of evidence by taxpayers. Taxpayers admitted into evidence seven cancelled
checks totaling $3,694. (Ptf’s Exs 98-101). The department was willing to stipulate to that
amount.
Ormand Ormsby testified that he had made three additional rent payments to his
mother in the amount of $300 each for an additional total of $900. On the basis of that
testimony, taxpayers asserted that they should be permitted to deduct $4,594. Other than
Ormand Ormsby’s testimony, however, taxpayers did not submit any proof of a rental agreement
between Ormand Ormsby and his mother, such as a receipt, verifying that Ormand Ormsby’s
mother received the alleged cash payments or a copy of a rental agreement.
The record indicates that some form of purported rental arrangement existed
between Ormand Ormsby and his mother in which Ormand Ormsby rented space to temporarily
house his financial consulting business. Of the substantiated amount of $3,694 that the
department accepted as payments for rent, $900 of that amount was for three $300 payments
Ormand Ormsby made to his mother. (Ptf’s Exs 100-01). One check dated July 8, 1996, states
in the “memo” field that the check is payment of “Rent, 7/96.” (Ptf’s Ex 100). Another check,
dated September 28, 1996, states that it is in payment of “Rent: August 1996.” (Id.). The other
check is dated November 21, 1996, and it merely states that it is for “Rent.” (Ptf’s Ex 101).
The court finds, however, that the record does not conclusively establish what
type of rental arrangement Ormand Ormsby had with his mother. On one hand, the record could
demonstrate that Ormand Ormsby paid rent monthly and that he made payments for September,
OPINION
Page 28.
October, and December by cash. On the other hand, the record could demonstrate that
Ormand Ormsby rented from his mother on an as needed basis. As to the additional $900 rent
that taxpayers allege they paid by cash, therefore, the court finds that taxpayers have not met their
burden necessary to prove that those payments were ever made.
Although, taxpayers may not claim the additional $900 cash payment as rent
expense, that does not necessarily mean that taxpayers may only deduct the $3,694 that the
department was willing to stipulate to at trial. As discussed above, taxpayers did pay DuBoff
$2,436.40 on December 17, 1996, for payment in satisfaction of a lease obligation. The auditor
properly attributed that amount to office rental expense in computing a rental expense figure of
$6,130 for 1996. (Def’s Ex D). The court concludes, therefore, that taxpayers may deduct
$6,130.40 for office rent expense on line 20b of their 1996 Schedule C.
9.
Line 21, Repairs and Maintenance
On their 1996 Schedule C, line 21, taxpayers claimed $2,073 for repairs and
maintenance. The auditor disallowed that deduction because of lack of substantiation for the
expenditures. At trial, taxpayers did not offer any evidence to substantiate those expenditures.
On this record, therefore, the court concludes that taxpayers may not claim any deduction for
repairs and maintenance on line 21 of their 1996 Schedule C.
10.
Line 22, Supplies
On their 1996 Schedule C, line 22, taxpayers claimed $3,114 for supplies. The
auditor concluded that taxpayers could not substantiate the actual expenditures and, therefore,
denied any deduction for supplies. At trial taxpayers submitted a number of canceled checks into
evidence. Ormand Ormsby testified that those expenditures fell into one of three categories:
OPINION
Page 29.
(1) expenses commingled between United Recycling and Ormand Ormsby’s financial consulting
business; (2) solely Ormand Ormsby’s financial consulting business expenses; and (3) solely
United Recycling expenses.
a.
Commingled Expenses
In support of their claimed deduction for supplies, taxpayers submitted
copies of canceled checks issued to Deluxe Checks and to Costco. (Ptf’s Exs 126-30). Ormand
Ormsby testified that those checks represented commingled expenditures were attributable to his
personal business and to United Recycling. Ormand Ormsby estimated that 10% of the
expenditures were directly related to his personal business. Taxpayers did not offer any
substantiation for the expenditures.
In the case of the check issued to Deluxe Checks, the “memo” field
indicates that the check was for “Biz Checks.” (Ptf’s Ex 126). Ormand Ormsby did not indicate
which business the checks were attributable to, if in fact the expenditure was only for either his
personal business or United Recycling. As to the checks taxpayers issued to Costco, none of
those checks indicate for what they were issued. Taxpayers testified that they made various
purchases at Costco, including personal expenditures. On this record, the court could just as
easily find that taxpayers issued those checks for taxpayers’ household expenditures as it could
find that they were for one of Ormand Ormsby’s business endeavors. On that basis, the court
finds that taxpayers have not met their burden necessary to prove that they made the alleged
commingled expenditures solely for business purposes. The court concludes, therefore, that
taxpayers may not deduct any of the alleged commingled expenditures as a supply expense on
line 22 of their 1996 Schedule C.
OPINION
Page 30.
b.
Expenditures Solely For Ormand Ormsby’s Personal Business
Taxpayers submitted into evidence three canceled checks that they allege
were issued for software and program updates for Ormand Ormsby’s financial consulting
business. (Ptf’s Exs 131-32). Ormand Ormsby testified that each of the expenditures was for his
business, but was unable to provided any substantiation in the form of a receipt or other
documentation. The court cannot discern from the record what those expenditures were for or
whether they were used solely for Ormand Ormsby’s personal business. Taxpayers admitted in
their summation brief, however, that Ormand Ormsby only used one computer system for both
family personal and personal business purposes, arguing that the maintenance of two systems
would have been “counterproductive.” (Ptfs’ Sum at 8). On the basis of that admission and on
the record as a whole, the court finds that taxpayers have not met their burden necessary to prove
that the alleged supply expenditures were in fact made for Ormand Ormsby’s personal business.
The court concludes, therefore, that taxpayers may not deduct any of the alleged personal
business expenditures as a supply expense on line 22 of their 1996 Schedule C.
c.
Expenditures Solely For United Recycling
Taxpayers submitted into evidence a number of canceled checks that they
allege Ormand Ormsby issued for supplies for United Recycling. (Ptf’s Exs 132-36). The
department contends that, to the extent those expenditures were intended for United Recycling,
taxpayers may not deduct them as an expense of Ormand Ormsby’s business. Moreover, the
department contends that those expenditures should be classified as contributions to the capital of
United Recycling by Ormand Ormsby, a shareholder in that corporation. The court does not have
to address the department’s arguments, however, because even assuming that the expenditures
OPINION
Page 31.
were potentially deductible, the court nonetheless finds that taxpayers have not met their burden
of proof.
Taxpayers assert that the canceled checks represent expenditures made by
Ormand Ormsby on behalf of United Recycling. All but one of those checks were issued to
Home Depot and G.I. Joe’s; the same companies and the same types of checks for which
taxpayers previously claimed as an unreimbursed job related expense for Ormand Ormsby.
Taxpayers did not explain why one seemingly arbitrary group of checks issued to those
companies should be treated as unreimbursed job related expenses whereas another seemingly
arbitrary group of checks should be treated as a Schedule C deduction. Nonetheless, the court
finds that mere copies of canceled checks cannot satisfy taxpayers’ burden of proof absent some
substantiation, such as store receipts, that would indicate that those expenditures were
attributable to a legitimate business outlay.
Similarly, the court finds that the sole remaining check also lacks
substantiation. That check was paid to the order of United Creditors Alliance and was signed by
a representative of United Creditors Alliance as an authorized signatory for Ormand Ormsby.
(Ptf’s Ex 132). Taxpayers testified that the check was to be paid to Metro Machinery for an
expense attributable to United Recycling. Taxpayers did not indicate what that expense was for
nor did they provide any additional documentation that would link that check to either United
Recycling or Metro Machinery. Based on this record, therefore, the court concludes that
taxpayers may not deduct any of the alleged United Recycling expenditures as a supply expense
on line 22 of their 1996 Schedule C.
11.
OPINION
Line 24a, Travel
Page 32.
On their 1996 Schedule C, line 24a, taxpayers claimed $2,320 for travel. The
auditor concluded that taxpayers could not substantiate the actual expenditures; therefore, the
auditor denied any deduction for travel. At trial, Ormand Ormsby testified that he had made two
trips to San Francisco, California, for business related purposes. Taxpayers did not submit any
evidence, however, that substantiates Ormand Ormsby’s testimony.
Taxpayers have not met their burden of proof necessary to claim a deduction for
travel expenses. Ormand Ormsby merely testified that he made two trips. He did not testify as to
how he spent $2,320 on those trips. The record contains no information about plane fares, car
rental, or hotel expenditures. Moreover, the record does not contain any substantiation that a trip
or trips actually occurred or that the trips had a business purpose. See 26 USC § 274(d)
(substantiation required). On this record, therefore, the court concludes that taxpayers may not
make a deduction for travel on line 24a of their 1996 Schedule C.
12.
Line 24b, Meals and Entertainment
On their 1996 Schedule C, line 24b, taxpayers claimed $564 for meals and
entertainment. The auditor concluded that taxpayers could only substantiate $178 worth of meals
and entertainment expenses after applying the 50% limitation. Taxpayers did not submit any
admissible evidence, including testimonial evidence, from which the court could find that
taxpayers made any deductible meals and entertainment expenditures. Despite that lack of
evidence, the department nonetheless offered to accept a deduction in the amount of $178. On
the basis of that concession only, the court concludes that taxpayers may deduct $178 for meals
and entertainment expenses on line 24b of their 1996 Schedule C.
13.
OPINION
Line 25, Utilities
Page 33.
On their 1996 Schedule C, line 25, taxpayers claimed a deduction in the amount
of $3,714 for utilities. Despite limited substantiation from taxpayers, the auditor concluded that
taxpayers could deduct $1,080 for utilities. Although the department characterized the auditor’s
calculation as “arbitrary,” the department did not take a specific position as to the deductibility of
utility expense on taxpayers’ 1996 Schedule C.
At trial, taxpayers reasserted their right to deduct $3,714 for utility expenses. In
support of that assertion, taxpayers submitted into evidence copies of canceled checks issued to
U.S. West Communications and to Nentel totaling $5,047.94. (Ptf’s Exs 103-11). Ormand
Ormsby testified, however, that those payments included payments for taxpayers’ home
telephone and home fax machine. Moreover, Ormand Ormsby testified that some of the Nentel
payments were attributable to phones used in part or wholly by or for United Recycling.
Taxpayers did not submit any substantiation for those payments, such as copies of bills from U.S.
West and Nentel, from which the court could discern what part, if any, was attributable
specifically to Ormand Ormsby’s financial consulting business or to United Recycling.
On this record, taxpayers have not met their burden necessary to prove the amount
of utility expense specifically attributable to Ormand Ormsby’s financial consulting business.
The department did not expressly deny, however, that the auditor was at fault for allowing $1,080
for telephone expenses during 1996. On the record as a whole, therefore, the court concludes
that taxpayers may deduct $1,080 for utility expenses on line 25 of their 1996 Schedule C.
14.
Line 26, Wages
On their 1996 Schedule C, line 26, taxpayers claimed $4,788 for wages. The
auditor concluded that taxpayers could not substantiate the actual expenditures; therefore, the
OPINION
Page 34.
auditor denied any deduction for wages. At trial, Ormand Ormsby testified that he had
improperly received $4,770 for having acted as a conservator and had been advised by his
attorney to return the money. On the basis of that recommendation, Ormand Ormsby testified
that he “backed out” that income by issuing a 1096 from his financial consulting business for that
amount. Taxpayers did not offer any substantiation for that transaction. Even assuming the
legitimacy of such a transaction and ignoring the fact that the dollar amounts involved do not
reconcile, the court finds that taxpayers have not met their burden necessary to prove that they
had legitimate wage expense, a payment for services of an employee, in 1996. Based on the
record, therefore, the court concludes that taxpayers may not take a wage deduction on line 26 of
their 1996 Schedule C.
15.
Line 27, Other Expenses
On their 1996 Schedule C, line 27, taxpayers claimed $5,131 for other expenses.
At audit, the auditor concluded that taxpayers could deduct only $151 worth of expenses
apparently related to Ormand Ormsby’s use of Pitney Bowes equipment. The department did not
expressly deny that the auditor was at fault for allowing $151 for Ormand Ormsby’s use of that
equipment during the 1996 personal income tax year.
At trial, taxpayers submitted into evidence two canceled checks totaling $400
which were issued to the Multnomah Athletic Club (MAC). (Ptf’s Ex 145). Ormand Ormsby
testified that he deducted $1,993 for the MAC payments but he could not establish why those
were other expenses of his financial consulting business. In fact, he testified that he went to the
MAC on doctor’s orders to attend to his personal health.
Taxpayers did not offer any other evidence from which the court could find that
OPINION
Page 35.
taxpayers can meet their burden of proof as to other expenses. The department did not expressly
deny, however, that the auditor was at fault for allowing $151 for Ormand Ormsby’s use of
Pitney Bowes equipment during 1996. On the record as a whole, therefore, the court concludes
that taxpayers may deduct $151 for other expenses on line 27 of their 1996 Schedule C.
D.
Taxpayers’ Third Claim For Relief: 1997 Schedule C Expenses
In their second amended complaint, taxpayers asserted that they were entitled to
deductions for Schedule C expenses attributable to Ormand Ormsby’s financial consulting
business in the amount of $61,853 for the 1997 personal income tax year. In particular,
taxpayers specified amounts they claimed for automobile expenses, equipment lease expenses,
loans to United Recycling, legal and professional expenses, and depreciation expenses. The
auditor determined that taxpayers could take Schedule C deductions in the amount of $6,412 and
denied the remaining $55,441 for a variety of reasons. At the outset of trial, the department
reserved its position as to whether it would accept or reject the auditor’s conclusions as to the
deductibility of each individual Schedule C line item. At trial, therefore, the parties litigated
Schedule C line-by-line.
1.
Line 10, Car and Truck Expenses
As with vehicle expenses in 1996, discussed above, the parties agreed at trial to a
deduction in the amount of $569. Despite taxpayers’ desire to abandon that agreement in their
summation brief, the court finds no basis in the record to disturb the parties’ agreement. The
court concludes, therefore, that taxpayers may deduct $569 for vehicle expenses on line 10 of
their 1997 Schedule C.
2.
Lines 8, Advertising; 11, Commissions and Fees; 15, Insurance; 17, Legal and
Professional Services; 21, Repairs and Maintenance; 22, Supplies; 24, Travel and
OPINION
Page 36.
Meals and Entertainment; 25, Utilities; and 27, Other Expenses
Although taxpayers generally alleged in their second amended complaint that they
wished to challenge the auditor’s conclusion as to deductions taken for advertising, commission
and fees, insurance, legal and professional, repairs and maintenance, supplies, travel, meals and
entertainment, utilities, and other expenses, taxpayers did not offer any evidence from which the
court could find that the auditor was incorrect. Similarly, although the department initially
announced its intention to reserve its position as to all Schedule C deductions, the department did
not expressly disavow any of the auditor’s conclusions. On this record, therefore, the court
concludes that no changes shall be made to the auditor’s position as to the following 1997
Schedule C deductions: line 8, advertising; line 11, commissions and fees; line 15, insurance;
line 17, legal and professional services; line 21, repairs and maintenance; line 22, supplies; line
24, travel and meals and entertainment; line 25, utilities; and line 27, other expenses.
3.
Line 13, Depreciation
On their 1997 Schedule C, line 13, taxpayers deducted $11,917 for depreciation.
The auditor found and accepted $665 for depreciation of business equipment associated with
Ormand Ormsby’s financial consulting business. At trial, the department offered an additional
$737 for depreciation related to the use of Ormand Ormsby’s vehicle in connection with that
business, for a total amount of deductible depreciation of $1,402. Taxpayers could not provide a
legitimate basis for deducting the additional $10,515 worth of depreciation. Testimony related to
the alleged leases between Ormand Ormsby and United Recycling indicated that the additional
depreciation was most likely attributable to those leases.
Despite having agreed to an amount for 1996 depreciation, taxpayers and the
OPINION
Page 37.
department did not stipulate to an amount for 1997. The court finds that taxpayers have not
submitted the evidence to satisfy their burden of proof necessary to justify a increased
depreciation deduction. On this record, therefore, the court concludes that taxpayers may claim
$1,402 for depreciation on line 13 of their 1997 Schedule C.
4.
Lines 16b, Other Interest; 20a, Vehicle, Machinery, and Equipment Rent or Lease
On their 1997 Schedule C, line 16b, taxpayers deducted $0 for other interest and
on line 20a, taxpayers deducted $13,779 for vehicle, machinery, and equipment rent or lease. In
their trial memo, taxpayers reduced that latter figure to $5,252. At trial, however, taxpayers
asserted that the $5,252 should be claimed under line 16b, other interest, and that they should not
have made a deduction on line 20a, vehicle, machinery, and equipment rent or lease. As noted in
the above discussion related to 1996 Schedule C deductions, the court finds that no valid lease
existed between Ormand Ormsby and United Recycling and that he stood, at most, as a guarantor
of an obligation of United Recycling. As a result, the court concludes that taxpayers may not
make any Schedule C adjustments - e.g., deductions for interest or depreciation - for the
purported lease arrangements between Ormand Ormsby and United Recycling on their 1997
Schedule C. Nor are taxpayers required to include rental receipts from the transactions, although,
in fact, they did not do so on their 1997 federal income tax return.
5.
Line 18, Office Expense
On their 1997 Schedule C, line 18, taxpayers claimed $12,772 for office expense.
The auditor concluded that taxpayers may only claim $219 for office expense. At trial, taxpayers
submitted into evidence a number of canceled checks which they purported to be payments for
office supplies. (Ptf’s Exs 179-81, 187-94). Taxpayers did not submit any substantiation, such
OPINION
Page 38.
as receipts, from which the court could determine for what purpose, or for what business,
taxpayers had made the payments. On this record, the court finds that taxpayers have not met
their burden necessary to prove that they made the payments for deductible office expenses. The
court concludes, therefore, that taxpayers may deduct $219 for office expense on line 18 of their
1997 Schedule C.
E.
Taxpayers’ Fourth Claim For relief: Dependent Deduction
In their second amended complaint, taxpayers asserted that they were entitled to claim a
personal exemption deduction for their daughter, Brianna Ormsby, apparently for both the 1996
and 1997 personal income tax years. The department concedes that taxpayers may take a
personal exemption for Brianna Ormsby for the 1996 personal income tax year. During the first
day of trial, the department alerted taxpayers to the fact that Brianna Ormsby had filed a personal
income tax return in 1997, in which she claimed for herself her personal exemption. After
reviewing that information, taxpayers abandoned their personal exemption claim as to Brianna
Ormsby for the 1997 personal income tax year. Based on the foregoing, the court concludes that
taxpayers may only claim a personal exemption deduction for Brianna Ormsby for the 1996
personal income tax year.
F.
Taxpayers’ Fifth Claim For Relief: Deduction For One-half of Self-employment Taxes
Imposed
In their second amended complaint, taxpayers assert that the court should vacate the
department’s assessment of additional self-employment taxes in the amounts of $3,788 and
$2,223 for the 1996 and 1997 personal income tax years, respectively. In fact, the department
did not assess additional self-employment taxes; rather, the department granted taxpayers
deductions for one-half of the self-employment taxes taxpayers would have been imposed after
OPINION
Page 39.
properly computing taxpayers self-employment income. See 26 USC § 164(f)(1). The
department contends, therefore, that the court should set the amount of the deduction for one-half
of self-employment taxes commensurate with the actual amount of self-employment income
derived as a result of the court’s conclusions in this case. The court agrees with the department.
The court concludes, therefore, that taxpayers’ may deduct one-half of the self-employment taxes
for the 1996 and 1997 personal income tax years that would have been imposed pursuant to
26 USC § 1401 based on the self-employment income derived from the results of this opinion.
Id.
G.
Taxpayers’ Sixth Claim For Relief: Interest and Penalties
In their second amended complaint, taxpayers assert that the court should vacate the
department’s assessment of interest and penalties in this case. The department contends that
interest is a function of the actual tax due and that an award of penalties is mandated by law in
cases in which a taxpayer understates personal income by $15,000. The department is correct.
As to interest, to the extent that taxpayers are in arrears as a result of this decision,
interest shall be added to the recomputed tax bill taxpayers owe. As to penalties,
ORS 314.402(1) states that,
“If the [department] determines that there is a substantial understatement of
taxable income for any taxable year under any law imposing a tax on or measured
by net income, there shall be added to the amount of tax required to be shown on
the return a penalty equal to 20 percent of the amount of underpayment of tax
attributable to the understatement of taxable income.”
(Emphasis added.). That statute goes on to define a “substantial understatement” as an
understatement of income by $15,000. ORS 314.402(2). Those statutory provisions are
mandatory. Here the court has found that taxpayers’ 1996 and 1997 personal income, just from
OPINION
Page 40.
improper Schedule C deductions alone, was overstated by at least $15,000, without any
corresponding decreases to taxpayers’ gross income. The court concludes, therefore, that a
penalty in the amount of 20 percent of the amount of the underpayment of tax attributable to the
understatement of taxable income shall be assessed against taxpayers.
H.
Attorney Fees
Both parties claimed an award of reasonable fees and expenses. Under ORS 305.490(2),
the court may award reasonable attorney fees and expenses to a taxpayer only if the court awards
a refund claimed by the taxpayer or if the court denies in part or wholly an additional assessment
of taxes claimed by the department. Neither of those events occurred in this case. First, the court
has not granted a refund to taxpayers. Second, although the department did make limited
concessions and agreements in this case, those concessions and agreements are not equivalent to
the court denying additional assessment of taxes claimed by the department. Indeed, those
concessions and agreement removed from this court consideration of certain items the parties
initially disputed. The court concludes, therefore, that taxpayers may not recover any expenses
or fees.
The department’s claim for reasonable attorney fees arises under ORS 20.105. Under that
statute, the court may award reasonable attorney fees to the department if the department is the
prevailing party upon a finding that the appealing party, in this case taxpayers, has presented
claims, defenses, or grounds for appeal that lack a reasonably objective basis. ORS 20.105(1).
This court has recently stated that, “to determine whether taxpayer has acted in an objectively
unreasonable fashion, [the] court considers whether taxpayer’s claims were entirely devoid of
legal or factual support based on the substantive law governing the claims at the time [the
OPINION
Page 41.
taxpayer] proceeded in this division.” Patton v. Dept. of Rev., __ OTR __ (2004). In making its
determination, the court may consider the entire record available to the court, including the
decision of the magistrate. Id.
In their second amended complaint, taxpayers made seven claims for relief. Of those,
three claims--a deduction for one-half of self-employment taxes imposed, interest and penalties,
and reasonable fee--were dependent on the outcome of the four substantive tax claims. Within
those four substantive claims, the court has made rulings as to at least three dozen independent
personal income tax items or categories of items.
The court has found that the vast majority of those claims must be denied because
taxpayers have not met their burden of proof by failing to offer proper substantiation. Taxpayers
have been on notice since the audit that they must provide substantiation for their claims. The
auditor sent taxpayers a 19-page audit summary that made many references to the need of
substantiation. Moreover, the magistrate also made several references to the lack of
substantiation. Despite those warnings, taxpayers appealed many alleged reductions in income
and deductions to this division without proper substantiation. For those items that taxpayers
appealed without proper substantiation, especially in light of the fact that the auditor and the
magistrate had warned taxpayers of the need to produce substantiation, the court finds that those
claims were made without an objectively reasonable basis. The court notes that the majority of
the department’s attorney fees may have been expended defending those issues and that most of
the time at trial was dedicated to taxpayers’ attempts to search through a number of apparently
disorganized boxes of records.
Taxpayers and the department made a number of agreements at trial. In some, but not all,
OPINION
Page 42.
of those agreements, taxpayers reduced their claims in order to secure an agreement. In some
cases the parties agreed to an amount at or below the amount that the auditor or magistrate had
determined to be appropriate. Moreover, despite agreement on at least two disputed tax issues,
taxpayers inexplicably asserted that the court should award a higher deduction amount. The
court finds, therefore, that in cases in which the parties agreed to a deduction or reduction in
income in excess of the auditor’s conclusion or the magistrate’s decision, taxpayers are not
required to pay reasonable attorney fees associated with those items. The court further finds that,
in cases in which the agreement between the parties resulted in a reduction in the amount of a
deduction, taxpayers shall pay reasonable attorney fees to the department. Finally, in cases in
which taxpayers inexplicably sought to disavow a stipulation in their summation brief, taxpayers
shall pay reasonable attorney fees that the department expended in its post-trial briefing in order
to defend against a groundless position.
I.
Damages
The department requested an award of damages should the court determine that
taxpayers’ positions are frivolous or groundless under ORS 305.437. A “frivolous position” is
one that lacks a reasonably objective basis. ORS 305.437. Having made a limited award of
reasonable attorney fees to the department, the court has concluded that a number of taxpayers’
positions were without an objectively reasonable basis.
The court notes that taxpayers made numerous and substantial computational errors that
were almost always in their favor. Taxpayers also made highly suspect misclassifications of
certain deductions and income reductions. For example, taxpayers apparently reduced their 1997
taxable income by nearly $15,000 by taking as a deduction from or reduction to income the same
OPINION
Page 43.
$4,800 amount for which they were unable to substantiate. When asked to clarify their position
on that issue, taxpayers first conceded that they had made at least one computational error that
resulted an improper $4,800 deduction. Taxpayers then attempted to justify another $4,800
worth of deductions by offering a seemingly arbitrary group of cancelled checks.
The court finds that most of taxpayers’ positions are without objectively reasonable basis
in fact or law and that the record raises serious doubts about taxpayers’ good faith in proceeding
with their appeal to this division. Under ORS 305.437, therefore, the court shall award damages
to the department in an amount of $1,000.
V. CONCLUSION
Based on the foregoing reasons, the court concludes that taxpayers’ personal income tax
returns for the 1996 and 1997 personal income tax years shall be adjusted in accordance with the
findings and conclusions of this opinion. Now, therefore,
IT IS THE DECISION OF THE COURT that taxpayers’ personal income for the 1996
and 1997 personal income tax years shall be adjusted in accordance with the conclusions in this
opinion;
IT IS FURTHER DECIDED that taxpayers’ Schedule A and Schedule C itemized
deductions and inclusions for the 1996 and 1997 personal income tax years shall be determined
in accordance with this opinion;
IT IS FURTHER DECIDED that taxpayers may take a personal exemption for their
daughter, Brianna Ormsby, for the 1996 personal income tax year only;
IT IS FURTHER DECIDED that taxpayers’ deduction for one-half of self-employment
taxes imposed shall be computed in accordance with the conclusions in this opinion;
OPINION
Page 44.
IT IS FURTHER DECIDED that taxpayers shall pay interest and penalties in accordance
with the conclusions in this opinion;
IT IS FURTHER DECIDED that taxpayers shall pay reasonable attorney fees in
accordance with the conclusions of this opinion; and
IT IS FURTHER DECIDED that taxpayers shall pay damages to the department in the
amount of $1,000.
Costs to Defendant.
Dated this ____ day of November 2004.
______________________________
Henry C. Breithaupt
Judge
THIS DOCUMENT WAS SIGNED BY JUDGE HENRY C. BREITHAUPT ON
NOVEMBER 24, 2004, AND FILE STAMPED ON NOVEMBER 24, 2004.
THIS IS A PUBLISHED DOCUMENT.
OPINION
Page 45.
