Thursday, June 21, 2007

Back Taxes: In G.L. Colvin, TC Memo. 2007-157, June 19, 2007, Dkt. No. 16557-04,
the Tax Court concluded that taxpayer was not either an independent contractor or a statutory employee under Code Sec. 3121(d)(3).

The Tax Court did not allow the taxpayer to claim business expenses on a Schedule C rather than on a Schedule A. and, therefore, avoided the two-percent floor on miscellaneous itemized deductions. The Tax Court determined that taxpayers was a common law employee under Code Sec. 3121(d)(2). The determining factor was the degree of control exerted over the taxpayer by his employer. His trade or business expenses were, therefore, subject to the two-percent floor.

The taxpayer was not allowed unsubstantiated deductions in excess of those allowed by the IRS. The taxpayer did not provide any documentation that indicated the amount of mileage for which he used his personal vehicles in his employment, but instead improperly extrapolated the amount of miles driven by the amount of gas purchased. The taxpayer's claim that he paid his mother for the preparation of his business income tax return was denied because he could provide no proof that the check with which he paid ever cleared. The taxpayer also was denied additional deductions for the cost of goods sold because he failed to substantiate the cost and because he had no income from the sale of goods.

The taxpayer was denied a deduction for interest incurred in connection with a loan from his mother under Code Sec. 163 because the loan did not survive the scrutiny put on intra-family loans and because the loan and the terms of repayment and interest were not put in writing. The taxpayer was allowed a deduction for legal fees because they were in connection to a lawsuit arising out of his trade or business.


I. Burden of Proof

As a general rule, the Commissioner's determination of a taxpayer's liability is presumed correct, and the taxpayer bears the burden of proving that the determination is improper. See Rule 142(a); Welch v. Helvering [3 USTC ¶1164], 290 U.S. 111, 115 (1933). However, pursuant to section 7491(a), the burden of proof on factual issues that affect the taxpayer's tax liability may be shifted to the Commissioner where the "taxpayer introduces credible evidence with respect to * * * such issue". The burden will shift only if the taxpayer has, inter alia, complied with substantiation requirements pursuant to the Internal Revenue Code and "cooperated with reasonable requests by the Secretary for witnesses, information, documents, meetings, and interviews". Sec. 7491(a)(2). In the instant case, petitioner failed to comply with substantiation requirements and did not present credible evidence at trial. Petitioner's original bank statements were apparently lost during the tax examination. However, petitioner's lack of substantiation and failure to present credible evidence were pervasive. Accordingly, the burden of proof remains on petitioner.

II. Mailing of Notice of Deficiency

Petitioner argues that this Court lacks jurisdiction. The two requirements for this Court's jurisdiction in a deficiency case are a valid notice of deficiency issued by the Commissioner and a timely filed petition by the taxpayer. Frieling v. Commissioner [Dec. 40,284], 81 T.C. 42, 46 (1983). Because petitioner filed his petition on time, the only jurisdictional issue is the validity of the notice of deficiency.

The purpose of the mailing under section 6212 is to provide the taxpayer with notice that a deficiency has been determined against him or her, and to provide the taxpayer with an opportunity to petition this Court to challenge the Commissioner's determination.13 Id. at 53. When a taxpayer receives actual notice of a deficiency and does not suffer prejudicial delay in filing timely a petition with this Court, the notice of deficiency, even though incorrectly addressed, is valid under section 6212(a).14 Estate of Greenwood v. Commissioner, T.C. Memo. 2003-98 (citing St. Joseph Lease Capital Corp. v. Commissioner [2001-1 USTC ¶50,146], 235 F.3d 886, 891-892 (4th Cir. 2000), affg. [Dec. 51,377(M)] T.C. Memo. 1996-256; Estate of Biskis v. Commissioner [Dec. 54,312(M)], T.C. Memo. 2001-94; Estate of Citrino v. Commissioner [Dec. 44,323(M)], T.C. Memo. 1987-565). Petitioner had actual notice of the deficiency as he requested, and received, a copy of the notice of deficiency from the IRS TAS. Petitioner filed a petition that was timely and, therefore, did not suffer prejudicial delay. Accordingly, the Court concludes that the notice of deficiency is valid, and this Court has jurisdiction.

III. Statutory Employee

A. General Rules

A statutory employee may properly reflect business income and expenses in full on Schedule C of Form 1040, and thereby avoid the Schedule A, Itemized Deductions, limitations on the deduction of employee business expenses and the phaseout of itemized deductions.15 See Prouty v. Commissioner, T.C. Memo. 2002-175 (citing Rev. Rul. 90-93, 1990-2 C.B. 33). An individual qualifies as a statutory employee pursuant to section 3121(d)(3) only if such individual is not a common law employee pursuant to section 3121(d)(2). Ewens & Miller, Inc. v. Commissioner [Dec. 54,561], 117 T.C. 263, 269 (2001). Section 3121(d) defines employee, in pertinent part, as follows:

(1) any officer of a corporation; or

(2) any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee; or

(3) any individual (other than an individual who is an employee under paragraph (1) or (2)) who performs services for remuneration for any person --


(D) as a traveling or city salesman, other than as an agent-driver or commission-driver, engaged upon a full-time basis in the solicitation on behalf of, and the transmission to, his principal (except for side-line sales activities on behalf of some other person) of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments for merchandise for resale or supplies for use in their business operations; if the contract of service contemplates that substantially all of such services are to be performed personally by such individual; except that an individual shall not be included in the term "employee" under the provisions of this paragraph if such individual has a substantial investment in facilities used in connection with the performance of such services (other than in facilities for transportation), or if the services are in the nature of a single transaction not part of a continuing relationship with the person for whom the services are performed * * *

As an individual qualifies as a statutory employee only if the individual is not a common law employee, the Court will initially determine whether petitioner was a common law employee of TIG.

B. Common Law Employee

Whether an individual is an independent contractor or common law employee is a question of fact. Weber v. Commissioner [Dec. 50,087], 103 T.C. 378, 386 (1994), affd. [95-2 USTC ¶50,409] 60 F.3d 1104 (4th Cir. 1995). In the Fifth Circuit, to which this case would normally be appealable, doubtful questions should be resolved in favor of employment. Breaux & Daigle, Inc. v. United States [90-2 USTC ¶50,491], 900 F.2d 49, 52 (5th Cir. 1990). Generally, petitioner has the burden of proving error in respondent's notice of deficiency determination that he was a common law employee. See Rule 142(a); Profl. & Executive Leasing, Inc. v. Commissioner [Dec. 44,087], 89 T.C. 225, 231 (1987), affd. [88-2 USTC ¶9622] 862 F.2d 751 (9th Cir. 1988). However, respondent conceded on brief that he bears the burden of proof on the statutory employee issue because it constitutes a new matter under Rule 142.16

In determining whether a worker is a common law employee or an independent contractor, the Court generally considers: (1) The degree of control exercised by the principal; (2) which party invests in work facilities used by the individual; (3) the opportunity of the individual for profit or loss; (4) whether the principal can discharge the individual; (5) whether the work is part of the principal's regular business; (6) the permanency of the relationship; (7) the relationship the parties believed they were creating; and (8) the provision of employee benefits. See Ewens & Miller, Inc. v. Commissioner, supra at 270; Weber v. Commissioner, supra at 387; Profl . & Executive Leasing, Inc. v. Commissioner, supra at 232; Simpson v. Commissioner [Dec. 33,402], 64 T.C. 974, 984-985 (1975); Cole v. Commissioner [Dec. 56,450(M)], T.C. Memo.2006-44. All of the facts and circumstances of each case are considered, and no single factor is dispositive. Ewens & Miller, Inc. v. Commissioner, supra at 270.

1. Degree of Control

The right of the principal to exercise control over the agent, whether or not the principal does so, is the "crucial test" for the employer-employee relationship. Weber v. Commissioner, supra at 387. "The employment relationship exists when the principal retains the right to direct the manner in which the work is done, and to control the methods used in doing the work, and to control the details and means by which the desired result is accomplished." Ellison v. Commissioner [Dec. 30,394], 55 T.C. 142, 152-153 (1970). In order to obtain the requisite degree of control, "the alleged employer need not 'stand over the employee and direct every move that he makes.'" Simpson v. Commissioner, supra at 985 (citing Atl. Coast Life Ins. Col. v. United States, 76 F. Supp. 627, 630 (E.D.S.C. 1948). In fact, the employer need not set the employee's hours. Workers who set their own hours are not necessarily independent contractors. Ewens & Miller, Inc. v. Commissioner, supra at 270.

In his argument that petitioner was a common law employee, respondent relies predominately on the employment agreement and the TIG Employee Handbook Manual (employee manual). Respondent contends that TIG controlled the details of petitioner's work because the employment agreement provides that the "Employee shall perform such duties as are customarily performed by an Account Executive, and such other duties as the President of Employer * * * may require from time to time". Respondent then asserts, based on the employee manual, that "Such duties include TIG's requirement that Petitioner attend weekly meetings. TIG prescribed appropriate dress for Petitioner. TIG specified how its telephones, software, and company vehicles were to be used." Respondent also presented as evidence a "WRITTEN WARNING NOTICE" from Mr. Rasmussen, petitioner's supervisor, that reprimanded petitioner for argumentative comments made during a "lunch-nlearn" session with a vendor of TIG.

Petitioner contends that he set his own work hours and sales territory, defined the manner in which he performed his tasks, worked principally from home, and was not required to utilize TIG's support staff or attend routine meetings. Other than his own testimony, petitioner did not provide any substantiation of these facts.

The Court concludes that respondent has met his burden of proof as to the degree of control that TIG exercised over petitioner. The documentary evidence that respondent presented indicates that TIG had the right to control, whether or not exercised, how petitioner performed his work. This is particularly exemplified by the "WRITTEN WARNING NOTICE" issued by Mr. Rasmussen and the employment history it recites. Accordingly, this "crucial" factor weighs in favor of employee status.

2. Investment in Facilities

The fact that a worker provides his or her own tools, or owns a vehicle that is utilized for work, is indicative of independent contractor status. Id. at 271 (citing Breaux & Daigle, Inc. v. United States, [90-2 USTC ¶50,491], 900 F.2d at 53). Additionally, maintenance of a home office is consistent with independent contractor status, although alone it does not constitute sufficient basis for a finding of independent contractor status. Lewis v. Commissioner [Dec. 49,516(M)], T.C. Memo. 1993-635.

Petitioner owned two vehicles and claimed he utilized both for work purposes for 2000, although the extent of such use is disputed. The employment agreement provided that petitioner was to maintain motor vehicle insurance at all times and that all other related expenses were his responsibility. The record reflects that petitioner worked at least part-time from home. Petitioner claimed as a Schedule C deduction $3,191 for business use of his home, which respondent allowed. Accordingly, the Court concludes that this factor tends to weigh in favor of independent contractor status.

3. Opportunity for Profit or Loss

Compensation on a commission basis is entirely consistent with an employer-employee relationship. Tex. Carbonate Co. v. Phinney, 307 F.2d 289, 292 (5th Cir. 1962); Capital Life & Health Ins. Co. v. Bowers, 186 F.2d 943, 944-945 (4th Cir. 1951). While petitioner could have conceivably suffered some loss as a result of his sales activity for TIG, he may still be an employee under the common law test if his risk of loss was negligible. See Lewis v. Commissioner, supra. Petitioner worked for TIG for approximately 6 months in 2000. Petitioner was paid a nonrecoverable draw in the amount of $5,000 for the first 4 months, and then $2,500 for the fifth and sixth months. Thereafter, petitioner's draw was recoverable against his sales commission on a month-to-month basis. In 2000, petitioner was entitled to a nonrecoverable draw for the entire period he worked; therefore, petitioner's risk of loss was negligible, if not nil. The Court concludes that this factor weighs in favor of an employer-employee relationship.

4. Right To Discharge

Employers typically have the power to terminate employees at will. Ellison v. Commissioner, supra at 155. The employment agreement provided that TIG could terminate petitioner at will with or without cause or notice. Notably, TIG exercised its termination right. Accordingly, the Court concludes that this factor weighs in favor of an employer-employee relationship.

5. Integral Part of Business

Petitioner contends that he was not an integral part of TIG's business. Petitioner claims that TIG was a "diverse company with separate divisions that sold" the following: (1) Services, (2) computer hardware, (3) office furnishings, (4) office supplies, (5) outside help-desk functions, and (6) "Application Service Processing". Petitioner further asserts that TIG performed computer training and installed networking cable and telephone systems. As a result, petitioner argues that he "was not a key connection with customers, only one of many resources available to them", and was therefore not an integral part of TIG's business. However, the fact that TIG had several separate divisions does not affect the analysis of whether petitioner's services were integral to TIG. Petitioner's services could have been integral to the division in which he worked, which would indicate that petitioner was an employee. See Ewens & Miller, Inc., v. Commissioner [Dec. 54,561], 117 T.C. at 272-273.

Respondent was silent on the issue. The Court concludes that this factor is neutral and indicates neither independent contractor status nor employee status.

6. Permanency of the Relationship

A transitory work relationship may weigh in favor of independent contractor status. Ewens & Miller, Inc. v. Commissioner, supra at 273 (citing Herman v. Express Sixty-Minutes Delivery Serv., Inc., 161 F.3d 299, 305 (5th Cir. 1998)). The principal's right to discharge the worker, and the worker's right to quit, at any time, is an important factor. Id. Petitioner's position at TIG was for renewable 1-year terms. It was also at will and terminable by either party at any time, with or without cause or notice, and petitioner was in fact terminated. The Court concludes that petitioner's position was transitory as he worked for TIG for less than 13 months.17 Accordingly, this factor weighs in favor of independent contractor status.

7. Relationship the Parties Thought They Created

The offer and employment agreement refer to workers, such as petitioner, as employees, and to TIG as the employer. Notably, TIG did not check the box on line 15 of petitioner's 2000 Form W-2 indicating that he was a statutory employee. It is evident that for taxable year 2000 TIG thought of petitioner as an employee based on the employment agreement, and that TIG treated petitioner as a common law employee based on Forms W-2 and W-4, Employee's Withholding Allowance Certificate.18 Thus, the Court concludes that petitioner and TIG intended to create an employer-employee relationship.

8. Provision of Employee Benefits

The offer and employment agreement provide that TIG employees are eligible to participate in a health insurance plan and a section 401(k) plan. These are benefits that are typically provided to employees rather than independent contracts. See Weber v. Commissioner [Dec. 50,087], 103 T.C. at 393-394. Although petitioner did not participate in TIG's health insurance plan because he was covered by his girlfriend's health insurance, and did not participate in TIG's section 401(k) plan, the benefits were available to him if needed. See id. Accordingly, this factor tends to weigh in favor of employee status.

9. Conclusion

The relationship between petitioner and TIG had aspects that were characteristic of an employer and employee relationship and others characteristic of a principal and independent contractor relationship. After weighing the above factors, the Court concludes that petitioner was a common law employee of TIG for the 2000 taxable year.

Petitioner was a common law employee of Daou Systems during his employment from August 1995 to March 1997. As a result, the settlement he received from Daou Systems in 2000 is related to his common law employment. Petitioner claims to have conducted a computer assembly and consulting business, Computer Consulting Forum Company, in 2000. As discussed infra, petitioner's lack of gross sales, as well as lack of substantiation, leads the Court to conclude otherwise.

C. Statutory Employee

As the Court has concluded that petitioner was a common law employee of TIG for taxable year 2000, petitioner is precluded from being a statutory employee pursuant to section 3121(d)(3). Accordingly, petitioner is not entitled to deduct expenses on Schedule C.

IV. Petitioner's Deductions

In light of the Court's conclusion that petitioner is not entitled to deduct expenses on Schedule C, the Court must now decide whether petitioner is entitled to deduct expenses incurred in connection with his employment on Schedule A. See sec. 67(a).

A. Schedule A Deductions

An individual performing services as an employee may deduct miscellaneous itemized deductions incurred in the performance of services as an employee only to the extent such expenses exceed 2 percent of the individual's adjusted gross income. Sec. 67(a).

B. General Deduction Rules

Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving that he is entitled to any claimed deductions. INDOPCO, Inc. v. Commissioner [92-1 USTC ¶50,113], 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering [4 USTC ¶1292], 292 U.S. 435, 440 (1934). Taxpayers must maintain records relating to their income and expenses and must prove their entitlement to all claimed deductions, credits, and expenses in controversy. See Sec. 6001; Rule 142(a).

Pursuant to section 162(a), a taxpayer is entitled to deduct all of the ordinary and necessary business expenses paid or incurred during the taxable year in carrying on a trade or business. The deduction for an employed individual's unreimbursed business expenses under section 162 is claimed on Form 2106, Employee Business Expenses, and included in the miscellaneous itemized deductions taken on Form 1040 Schedule A. Expenses incurred in the performance of services as an employee are to be reported and memorialized as required by the regulations promulgated under section 162. See sec. 1.162-17(a), Income Tax Regs. The taxpayer bears the burden of proving that the claimed expenses were ordinary and necessary according to section 162. The employee must show the relationship between the expenditures and the employment. See Evans v. Commissioner [Dec. 33,003(M)], T.C. Memo. 1974-267, affd. in part, revd. in part [77-2 USTC ¶9596] 557 F.2d 1095 (5th Cir. 1977). In certain instances, the taxpayer must meet specific substantiation requirements in addition to the requirements of section 162. See sec. 274.

Generally, a claimed expense (other than those subjected to heightened scrutiny under section 274) may be deductible even where the taxpayer is unable to fully substantiate it, if there is an evidentiary basis for doing so. Cohan v. Commissioner [2 USTC ¶489], 39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner [Dec. 42,468], 85 T.C. 731, 742-743 (1985); Sanford v. Commissioner [Dec. 29,122], 50 T.C. 823, 827-828 (1968), affd. per curiam [69-2 USTC ¶9491] 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). In these instances, the Court is permitted to make as close an approximation of the allowable expense as it can, bearing heavily against the taxpayer whose inexactitude is of his or her own making. Cohan v. Commissioner, supra.

C. Automobile Mileage

Pursuant to section 162, expenses relating to the use of an automobile that a taxpayer pays or incurs while commuting between the taxpayer's residence and the taxpayer's place of business or employment are not deductible because such expenses are personal, and not business, expenses. Sec. 1.162-2(e), Income Tax Regs. Automobile mileage deductions are also subject to the strict substantiation requirements of section 274(d). Where petitioner shows that his automobile expenses satisfy the requirements of section 162, but fails to establish that his records satisfy the heightened substantiation requirements of section 274(d), the expenses will not be allowable.

Section 274(d) applies to: (1) Any traveling expense, including meals and lodging away from home; (2) entertainment, amusement, and recreational expenses; or (3) the use of "listed property", as defined in section 280F(d), including personal computers and passenger automobiles. To deduct such expenses, the taxpayer must substantiate by adequate records or sufficient evidence to corroborate the taxpayer's own testimony: (1) The amount of the expenditure or use, which includes mileage in the case of automobiles; (2) the time and place of the travel, entertainment, or use; (3) its business purpose; and in the case of entertainment, (4) the business relationship to the taxpayer of each expenditure or use. Sec. 274(d)(4).

To satisfy the adequate records requirement of section 274, a taxpayer must maintain records and documentary evidence that in combination are sufficient to establish each element of an expenditure or use. Sec. 1.274-5T(c)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). Although a contemporaneous log is not required, corroborative evidence to support a taxpayer's reconstruction of the elements of the expenditure or use must have "a high degree of probative value to elevate such statement" to the level of credibility of a contemporaneous record. Sec. 1.274-5T(c)(1), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).

In lieu of substantiating the actual amount of any expenditure relating to the business use of a passenger automobile, a taxpayer may use a standard mileage rate as established by the IRS. See sec. 1.274-5(j)(2), Income Tax Regs. The standard mileage rate is to be multiplied by the number of business miles traveled. The use of the standard mileage rate establishes only the amount deemed expended with respect to the business use of a passenger automobile. Id. The taxpayer must still establish the amount (i.e., business mileage), the time, and the business purpose of each use. Id.

Petitioner claimed a car and truck deduction of $6,033 on his 2000 Schedule C. Respondent allowed only $780 of the claimed deduction. At trial, petitioner produced little additional documentation. Petitioner was unable to identify which of his two vehicles, the Volkswagen or the Honda, was "Vehicle 1" on his Schedule C. Petitioner explained that he arrived at his total mileage figure of 18,200 by estimation based on his fuel expenditures for taxable year 2000, divided by the average miles per gallon for his two vehicles.19 Petitioner has failed to meet the substantiation requirements of section 274 to establish his automobile mileage. Accordingly, petitioner is allowed a miscellaneous itemized Schedule A deduction in the amount of $780, subject to the overall 2-percent of adjusted gross income limitation.

D. Loan Interest

Pursuant to section 163(a), interest is deductible. However, personal interest generally is not deductible. Sec. 163(h). Debt arrangements between family members are subject to a high level of scrutiny. Zohoury v. Commissioner [Dec. 40,498(M)], T.C. Memo. 1983-597. The following factors are used to scrutinize intrafamily loans: (1) Whether a specific rate of interest is charged to the taxpayer for the use of the money; (2) whether there is a specific date for repayment; (3) whether there is a written instrument evidencing the debt; (4) whether there is a legitimate purpose for obtaining the loan; (5) whether the taxpayer intended to repay the debt; (6) whether the relative receiving the payments on the loan was impecunious; and (7) whether the loan has economic substance. Id.

Petitioner claimed $5,195 in interest expenses on his Schedule C for 2000. Respondent disallowed the entire deduction. Petitioner's only substantiation was a copy of a check he had issued to his mother in the amount of $5,000. Notations on the check indicate that the $5,000 was to be put towards numerous uses, including loan payment and interest in the amount of $4,575, petitioner's March 2000 mortgage in the amount of $425, and a car loan in the amount of $300. At trial, petitioner testified that he was unsure how much of the $5,000 check constituted interest.

Notably, petitioner did not have a written loan agreement. The loan was based on an oral agreement. Petitioner's mother kept records relating to the loan in a written journal. Those records indicate that petitioner was not held to a strict repayment schedule and that the interest rate fluctuated. Petitioner has failed to satisfy the requirements to deduct interest on an intrafamily loan. Accordingly, the Court sustains respondent's determination on this issue.

E. Accounting Fees

Petitioner claimed $1,750 in fees he allegedly paid to his mother for accounting services, tax preparation, and representation, on his 2000 Form 1040 Schedule C. Respondent disallowed the entire deduction. The only substantiation petitioner offered was an invoice from his mother's business that indicated petitioner paid $500 for her services. The invoice specifically referenced payment by check No. 6718, which apparently never cleared petitioner's bank account. Petitioner has failed to substantiate his claimed accounting, tax preparation, and representation fees. Accordingly, the Court sustains respondent on this issue. Petitioner is not entitled to a deduction for accounting fees.

F. Cost of Goods Sold

"The cost of goods purchased for resale, with proper adjustment for opening and closing inventories, is deducted from gross sales in computing gross income." Sec. 1.162-1(a), Income Tax Regs. A taxpayer may also deduct the cost of supplies and materials consumed in the operation of his or her business during the taxable year. See sec. 1.162-3, Income Tax Regs.

Petitioner claimed on Schedule C $3,323 for CGS. Respondent disallowed $659 of petitioner's CGS. Petitioner asserted that he purchased the items constituting his CGS for use in his sales activity for TIG and then provided substantiation for $58.50 in computer software.20 The remaining items listed as his CGS were allegedly used in his computer assembly and consulting business, Computer Consulting Forum Company. Petitioner claimed to have assembled and sold some computers at cost during the 2000 taxable year, although he failed to provide substantiation. Notably, petitioner's 2000 Federal tax return did not report any gross receipts from the alleged sales.

The regulations promulgated under section 162 clearly provide that CGS is deductible from "gross sales". Petitioner did not report any "gross sales" from his computer assembly business. Petitioner failed to substantiate the cost of materials and supplies allegedly used in his computer assembly business. Further, petitioner's testimony established that he purchased items he believed were CGS, such as the Palm Pilot, for use, not for resale. Petitioner has failed to substantiate the CGS disallowed by respondent. Accordingly, the Court sustains respondent on this issue. Petitioner is entitled to $2,664 in CGS for taxable year 2000.

G. Legal Fees

Generally, legal fees are deductible on a Schedule C only if the matter with respect to which the fees were incurred originated in the taxpayer's trade or business and only if the claim is sufficiently connected to that business. Test v. Commissioner [Dec. 54,133(M)], T.C. Memo. 2000-362 (citing United States v. Gilmore [63-1 USTC ¶9285], 372 U.S. 39 (1963)), affd. [2002-2 USTC ¶50,692] 49 Fed. Appx. 96 (9th Cir. 2002). Expenses not incurred in a trade or business activity but in the production or collection of income are deductible only as miscellaneous itemized deductions on Schedule A. See secs. 67(b), 212(l); Test v. Commissioner, supra. It is well established that even though a taxpayer's employee status may be regarded as a trade or business, legal fees stemming from a taxpayer's employee status are not deductible in computing adjusted gross income but are to be treated as miscellaneous itemized deductions. Test v. Commissioner, supra.

The case Smyth v. Daou Systems, Inc., No. 97-CV-02013 (S.D. Cal. filed Nov. 7, 1997), is related to petitioner's former employment with Daou Systems. As a result of the litigation, petitioner recovered a total of $8,000 from Daou Systems (which was subject to withholding). The net amount of $5,918.82 was actually paid to petitioner's attorney, Mr. Conger, who deducted his legal fees of $1,689.65 and paid the remainder to petitioner. The Court concludes that petitioner is entitled to deduct $1,689.65 as a miscellaneous itemized expense on Schedule A, subject to the overall 2-percent of adjusted gross income limitation.

The Court has considered all of petitioner's contentions, arguments, requests, and statements. To the extent not discussed herein, we conclude that they are meritless, moot, or irrelevant.

To reflect the foregoing and concessions by both parties,

Decision will be entered under Rule 155.

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