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Nurumbi v. Commissioner (T.C. Memo. 2021-79)

On June 30, 2021, the Tax Court issued a Memorandum Opinion in the case of Nurumbi v. Commissioner (T.C. Memo. 2021-79). The primary issue presented in Nurumbi was whether the petitioner was subject to the heightened substantiation rules under IRC § 274(d), or whether the exception to such rules for vehicles for hire applied.

Held: 

Nurumbi Pimp2

Background

Nurumbi PimpThe petitioner was an Uber pimp. He maintained a stable of Uber drivers under his iron fist and gold cane.  Just guessing here.

Every week Uber would pay petitioner for his own driving activity and for that of the drivers under his Uber account, subtracting its fee and depositing the remaining funds into a Bank of America account. Petitioner would withdraw funds from the BoA account, deposit some of the withdrawn funds into the BBVA account, and retain the remainder as cash. Then he would pay the drivers their individual earnings, as shown on the Uber weekly statements, routinely withholding $250 as a vehicle rental charge and occasionally reimbursing the drivers for gas, vehicle maintenance, and other miscellaneous expenses. Some of these payments were made by electronic transfer from the BBVA account and others were made in cash.

Petitioner did not provide the drivers any documentation indicating their payment, and the drivers did not submit receipts for gas, vehicle maintenance, or other miscellaneous expenses. The drivers did not otherwise keep logs of expenses incurred while driving under petitioner’s Uber account. Petitioner did not keep a log or other document recording how much he paid the drivers, whether by BBVA transfer or in cash. Petitioner used the BBVA account not only for driver payments and vehicle expenses, but also for meal, entertainment, residential, and other miscellaneous expenses.

The Return

Petitioner prepared and untimely filed his 2015 Form 1040 on April 27, 2017. He filed as head of household, reported wages of $18,810, and claimed the earned income and child tax credits. Petitioner attached Schedule C for Auto LLC (his Uber-pimp-partnership) to his 2014 Form 1040. Auto LLC did not file Form 1065, U.S. Return of Partnership Income, for tax year 2015. Auto LLC did not file Form 8832, Entity Classification Election, in 2015.

Reopening the Record

The petitioner offered in his posttrial motion to reopen the record. The IRS objected to certain documents on grounds of relevance, unfair prejudice, hearsay, and summaries to prove content.

Reopening the record for a party to submit additional evidence lies within the Court’s discretion. Zenith Radio Corp. v. Hazeltine Research, Inc., 401 U.S. 321, 331 (1971); Butler v. Commissioner, 114 T.C. 276, 286-287 (2000); see also Nor-Cal Adjusters v. Commissioner, 503 F.2d 359, 363 (9th Cir. 1974) (“[T]he Tax Court’s ruling [denying a motion to reopen the record] is not subject to review except upon a demonstration of extraordinary circumstances which reveal a clear abuse of discretion.”), aff’g T.C. Memo. 1971-200. The Tax Court will not grant a motion to reopen the record unless, among other requirements, the evidence a party is submitting is not merely cumulative or impeaching, is material to the issues involved, and probably would change some aspect of the outcome of the case. Butler v. Commissioner, 114 T.C. at 287; see also SEC v. Rogers, 790 F.2d 1450, 1460 (9th Cir. 1986) (explaining that the trial court “should take into account, in [*9] considering a motion to hold open the trial record, the character of the additional * * * [evidence] and the effect of granting the motion”), overruled on other grounds by Pinter v. Dahl, 486 U.S. 622 (1988); Zolghadr v. Commissioner, T.C. Memo. 2017-49, at *20 (holding that the additional evidence a taxpayer submitted after trial was “little more than a digital shoebox: To the extent these documents substantiate any expenses, they substantiate expenses the IRS had already allowed”).

In deciding motions to reopen the record, courts have considered when the moving party knew that a fact was disputed, whether the evidentiary issue was foreseeable, and whether the moving party had reason for the failure to produce the evidence earlier. See, e.g., George v. Commissioner, 844 F.2d 225, 229-230 (5th Cir. 1988) (and cases cited thereat) (holding that refusal to reopen the case was not an abuse of discretion because the issue was foreseeable to the taxpayers and the Court could see no excuse for the taxpayers’ failure to produce evidence earlier), aff’g Frink v. Commissioner, T.C. Memo. 1984-669. The Tax Court also balances the moving party’s diligence against the possible prejudice to the nonmoving party. Donoghue v. Commissioner, T.C. Memo. 2019-71, at *44. In particular the Tax Court considers whether reopening the record after trial would prevent the nonmoving party from examining and questioning the evidence as it would have during the proceeding. See, e.g., Estate of Freedman v. Commissioner, T.C. Memo. 2007-61, *12; Megibow v. Commissioner, T.C. Memo. 2004-41, at *7.

All such considerations weigh against granting petitioner’s motion to reopen the record.

Burden of Proof

Generally, the taxpayer bears the burden of proving that the IRS’s determinations are erroneous. Tax Court Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Under IRC § 7491(a)(1), “[i]f, in any court proceeding, a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B, the IRS shall have the burden of proof with respect to such issue.” Higbee v. Commissioner, 116 T.C. 438, 442 (2001). Petitioner has neither claimed nor shown that he has introduced credible evidence sufficient to shift the burden of proof to the IRS under IRC § 7491(a) as to any relevant factual issue. Therefore, petitioner generally bears the burden of proof.

Nurumbi ProofThe Ninth Circuit, to which any appeal in this case would ordinarily lie, see IRC § 7482(b)(1)(A), has held that the IRS must introduce some evidence linking the taxpayer with an alleged income-producing activity or demonstrate that the taxpayer actually received unreported income before the presumption of correctness attaches to the deficiency determination. Rapp v. Commissioner, 774 F.2d 932, 935 (9th Cir. 1985); Edwards v. Commissioner, 680 F.2d 1268, 1270-1271 (9th Cir. 1982). The requisite evidentiary foundation is minimal and need not include direct evidence. See Weimerskirch v. Commissioner, 596 F.2d 358, 360-362 (9th Cir. 1979), rev’g 67 T.C. 672 (1977).

Once the IRS has established this foundation, the burden of proof shifts to the taxpayer to prove by a preponderance of the evidence that the IRS’s determinations were arbitrary or erroneous. See Hardy v. Commissioner, 181 F.3d 1002, 1004-1005 (9th Cir. 1999), aff’g T.C. Memo. 1997-97. As discussed below, the IRS has established a sufficient evidentiary foundation to satisfy this threshold burden as it relates to his determination of petitioner’s unreported income.

Unreported Income

IRC § 61(a) provides that gross income means “all income from whatever source derived.” See Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955). A taxpayer is responsible for maintaining adequate books and records sufficient to establish his income. See IRC § 6001; DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992). As stated above, the IRS must base its determination that the taxpayer received unreported income on “some substantive evidence” for the presumption of correctness to attach. Hardy, 181 F.3d at 1004-1005.

During the year in issue petitioner earned income by driving for Uber and by having others turn Uber tricks for him (i.e., drive for Uber under his account). The Forms 1099-K and 1099-MISC that Uber issued to petitioner are supported by the Uber weekly statements and deposits into the Bank of America account. In his petition, petitioner does not dispute that the Forms 1099-K and 1099-MISC accurately reflect the amounts Uber paid him.

Schedule C Deductions

IRC § 162(a) allows a deduction for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” An expense is “ordinary” if it is “normal, usual, or customary” in the taxpayer’s trade or business or it arises from a transaction “of common or frequent occurrence in the type of business involved.” Deputy v. du Pont, 308 U.S. 488, 495 (1940). An expense is “necessary” if it is “appropriate and helpful” to the taxpayer’s business, but it need not be absolutely essential. Commissioner v. Tellier, 383 U.S. 687, 689 (1966) (quoting Welch, 290 U.S. at 113). In contrast, a taxpayer may not deduct personal, living, or family expenses unless the law expressly provides otherwise. IRC § 262(a). The determination of whether an expense satisfies the requirements of IRC § 162 is a question of fact. Cloud v. Commissioner, 97 T.C. 613, 618 (1991) (citing Commissioner v. Heininger, 320 U.S. 467, 473-475 (1943)).

Burden PlentywoodTaxpayers bear the burden of proving that they are entitled to any deductions claimed. Tax Court Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers, therefore, are required to substantiate expenses underlying each claimed deduction by maintaining records sufficient to establish the amount of the deduction and to enable the IRS to determine the correct tax liability. IRC § 6001; Higbee, 116 T.C. at 440.

Under the Cohan rule, the Court may estimate the amount of the expense if the taxpayer is able to demonstrate that he has paid or incurred a deductible expense but cannot substantiate the precise amount, as long as he produces credible evidence providing a basis for the Court to do so. Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir. 1930). For the Court to estimate the amount of an expense, there must be some basis upon which an estimate can be made. Norgaard v. Commissioner, 939 F.2d 874, 879 (9th Cir. 1991), aff’g in part, rev’g in part T.C. Memo. 1989-390. Otherwise, an allowance would amount to “unguided largesse.” Id. (quoting Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957)).

Heightened Substantiation Requirements under IRC § 274

Certain business expenses are subject to the heightened substantiation requirements of IRC § 274(d). IRC § 274(d) supersedes the Cohan rule. Treas. Reg. § 1.274-5T(a). Specifically, IRC § 274(d) contemplates that no deduction or credit shall be allowed on the basis of the taxpayer’s mere approximations or unsupported testimony. To meet the requirements of IRC § 274(d), a taxpayer must substantiate the following by adequate records or by sufficient evidence corroborating the taxpayer’s own statement: (1) the amount of the expense, (2) the time and place of the travel or use, and (3) the business purpose of the expense.

To substantiate by adequate records, the taxpayer must provide: (1) an account book, log, or similar record, and (2) documentary evidence, which together are sufficient to establish each element with respect to an expenditure. Treas. Reg. § 1.274-5T(c)(2)(i). Although a contemporaneous log is not required, corroborative evidence to support a taxpayer’s reconstruction “must have a high degree of probative value to elevate such statement” to the level of credibility of a contemporaneous record. Treas. Reg. § 1.274-5T(c)(1).

If a taxpayer cannot substantiate each element of an expense with adequate records, he may do so “by other sufficient evidence”, namely “[b]y his own statement, whether written or oral, containing specific information in detail as to such element” and “[b]y other corroborative evidence sufficient to establish such element.” Treas. Reg. § 1.274-5T(c)(3).

The Limited “Vehicle for Hire” Exception to IRC § 274

Nurumbi TaxiA taxpayer must meet these heightened substantiation requirements to claim a deduction “with respect to any listed property (as defined in IRC § 280F(d)(4)).” IRC § 274(d)(4). IRC § 280F(d)(4)(A)(ii) defines listed property to include “any property used as a means of transportation.” IRC § 280F(d)(4)(C) provides, however, that listed property does not include “property substantially all of the use of which is in a trade or business of providing to unrelated persons services consisting of the transportation of persons or property for compensation or hire.” See Howard v. Commissioner, T.C. Memo. 2015-38, at *11-*12 (holding that a taxpayer’s expenses incurred with respect to a truck used in long-distance trucking were not subject to heightened substantiation requirements of IRC § 274(d)(4)); Baker v. Commissioner, T.C. Memo. 2014-122, at *6 (holding that a taxpayer’s expenses incurred with respect to a Mack Truck tractor used to haul tank trailers were not subject to heightened substantiation requirements of IRC § 274(d)(4)).

In order to avail oneself of this exception, however, the petitioner must show that substantially all of the use of the vehicles in question was “in a trade or business of providing to unrelated persons services consisting of the transportation of persons or property for compensation or hire.” IRC § 280F(d)(4)(C). The petitioner failed to do so. At all. Even a little bit.

Nurumbi TruckerUnlike the taxpayers’ vehicles in Baker and Howard, which were used in commercial trucking and therefore less likely to be used for personal purposes, petitioner’s vehicles were SUVs or passenger trucks. Petitioner did not introduce evidence that he had a separate vehicle for personal use. He did not keep track of how the drivers used his vehicles, did not have a contract with those drivers restricting their use of his vehicles, and stored vehicles at his personal residence. Therefore, petitioner failed to show that his vehicle expenses satisfy the IRC § 280F(d)(4)(C) exception. Accordingly, his vehicles are listed property under IRC § 280F(d)(4)(A)(ii), and he must satisfy the heightened substantiation requirements under IRC § 274(d). He failed to do so.

Nurumbi LazyWhile some of petitioner’s documents show expenses that may have related to his business, the Tax Court observes that “he failed to do the work necessary to separate personal expenses from business expenses or provide the underlying documents for those expenses.” See Rutz v. Commissioner, 66 T.C. 879, 882-886 (1976) (disallowing business expense deductions because the taxpayer could not establish the business purpose for each expense); Longino v. Commissioner, T.C. Memo. 2013-80 (disallowing travel-related business expense deductions because the taxpayer did not differentiate his travel purposes between business and personal), aff’d, 593 F. App’x 965 (11th Cir. 2014).  A harsh truth, courtesy of Judge Pugh.

(T.C. Memo. 2021-79) Nurumbi v. Commissioner

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