The sole issue for decision is whether petitioners are entitled to deduct $28,307 in expenses that John Y. Ding (petitioner) claimed on Schedule C, Profit or Loss From Business, for 2004An individual was not entitled to deduct any Schedule C trade or business expenses claimed in connection with a failed consulting venture that had no clients and generated no income. The expenses were incurred during the start-up phase of the business prior to the commencement of an active trade or business and, therefore, were nondeductible start-up costs. Certain expenses claimed on Form 1040 Schedule C, however, were incurred in connection with his separate trade or business as an employee-manager of a manufacturing firm. To the extent deemed substantiated under the Cohan rule, these unreimbursed expenses were deductible as itemized employee business expenses on Form 1040 Schedule A. The portion of the taxpayer's home office expense deduction related to his employment in the manufacturing firm was also deductible as an itemized deduction. In determining whether the office was used exclusively for business purposes, its use in the consulting venture could be counted. The office was also required for the convenience of the taxpayer's employer since the employer did not provide him with an office and he needed a central location to conduct his managerial and administrative responsibilities. Telephone expenses deemed attributable to the taxpayer's employment were also allowed. Based on the volume of phone calls made in the evenings and nights and the taxpayer's responsibilities, it was highly probable that the expenses were for a second line as required by Code Sec. 262(b)


John Y. Ding and Linda H. Zhang v. Commissioner., U.S. Tax Court, T.C. Summary Opinion 2009-186, (Dec. 7, 2009)
Docket No. 18253-07S. Filed December 7, 2009.
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Discussion

Taxpayers may deduct ordinary and necessary expenses that they pay in connection with operating a trade or business. Sec. 162(a); Boyd v. Commissioner, 122 T.C. 305, 313 (2004). Generally, the performance of services as an employee constitutes a trade or business. Primuth v. Commissioner, 54 T.C. 374, 377 (1970). To be “ordinary” the expense must be of a common or frequent occurrence in the type of business involved. Deputy v. du Pont, 308 U.S. 488, 495 (1940). To be “necessary” an expense must be appropriate and helpful to the taxpayer's business. Welch v. Helvering, supra at 113. Additionally, the expenditure must be “directly connected with or pertaining to the taxpayer's trade or business”. Sec. 1.162-1(a), Income Tax Regs.
For such expenses to be deductible the taxpayer must not have the right to obtain reimbursement from his employer. See Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), affg. T.C. Memo. 1984-533. Section 262(a) disallows deductions for personal, living, or family expenses.
If a taxpayer establishes that an expense is deductible, but is unable to substantiate the precise amount, we may estimate the amount, bearing heavily against the taxpayer whose inexactitude is of his own making. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). The taxpayer must present sufficient evidence for the Court to form an estimate, because without such a basis, any allowance would amount to unguided largesse. Williams v. United States, 245 F.2d 559, 560-561 (5th Cir. 1957); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).
Section 274 overrides the Cohan rule with regard to certain expenses. Sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). Section 274 requires more stringent substantiation for travel, meals, and listed property, defined under section 280F(d)(4) to include passenger automobiles, computers or peripheral equipment, and cellular telephones. Section 274(d) requires taxpayers to provide adequate records or sufficient other evidence establishing the amount, time, place, and business purpose of the expense to corroborate the taxpayer's statements. Thus, even if such an expense would otherwise be deductible under Cohan, section 274 may still prohibit a deduction if the taxpayer does not have sufficient substantiation. Sec. 1.274-5T(a), Temporary Income Tax Regs., supra.
B. Business Expenses v. Startup Expenses
While section 162 generally allows a deduction for ordinary and necessary expenses paid in connection with carrying on a trade or business, the trade or business must be functioning as a business at the time the taxpayer incurred the expenses. Hardy v. Commissioner, 93 T.C. 684, 687 (1989), affd. in part and remanded in part per order (10th Cir., Oct. 29, 1990); Woody v. Commissioner, T.C. Memo. 2009-93; Glotov v. Commissioner, T.C. Memo. 2007-147; sec. 1.162-1(a), Income Tax Regs. For this purpose, “A taxpayer is not carrying on a trade or business under section 162(a) until the business is functioning as a going concern and performing the activities for which it was organized.” Glotov v. Commissioner, supra. Until that time, expenses related to the activity are not ordinary and necessary expenses deductible under section 162 or section 212 (expenses incurred for the production of income), but instead are “start-up” or “pre-opening” expenses. Hardy v. Commissioner, supra at 687-688.
Section 195 governs the deductibility of startup expenses, providing in pertinent part that the taxpayer must capitalize the expenditures and “Except as otherwise provided in this section, no deduction shall be allowed for start-up expenditures.” Sec. 195(a). The taxpayer may elect to amortize the capitalized startup costs evenly over a period of not less than 60 months, “beginning with the month in which the active trade or business begins”. 1 Sec. 195(b). When a taxpayer's endeavor never rises to the status of an active trade or business, the taxpayer may not amortize the startup costs. See Bernard v. Commissioner, T.C. Memo. 1998-20.
Therefore, the threshold issue here is whether petitioner completed the startup phase and became actively engaged in a trade or business during 2004. Courts have adopted a facts and circumstances test focusing on whether the taxpayer has satisfied all of the following three factors: (1) Whether the taxpayer undertook the activity intending to earn a profit; (2) whether the taxpayer was regularly and actively involved in the activity; and (3) whether the taxpayer's activity has actually commenced. See Woody v. Commissioner, supra; McManus v. Commissioner, T.C. Memo. 1987-457, affd. without published opinion 865 F.2d 255 (4th Cir. 1988).
We find that petitioner intended to earn a profit; however, petitioner did not establish that he was regularly and actively engaged in his consulting efforts or that the business actually began in 2003 or 2004. Petitioner failed to attract a single client or generate a single dollar or yuan in income in 2003 or 2004. Petitioner acknowledged that his business model “needed to be more thought out and well planned out than what I started to do”, adding “Well, it just looked so easy when everybody else was doing it”. Petitioner further acknowledged that he was going to try to launch the activity again at a later date.
Thus, petitioner's own candid testimony together with the record as a whole establishes that petitioner was not carrying on an active trade or business in 2003 or 2004. Therefore, we sustain respondent's characterization that the business expenses petitioner reported for 2004 are not Schedule C trade or business expenses.
III. Petitioner's Schedule A Unreimbursed Employee Business Expenses
The holding above, however, does not end the case. As noted in respondent's notice of deficiency, some of the 2004 expenses that petitioner claimed on Schedule C may qualify as Schedule A unreimbursed employee business expenses related to his job at Leggett & Platt. Consequently, we will now examine the business expenses petitioner reported on Schedule C for possible reclassification to Schedule A as 2004 unreimbursed employee business expenses.
A. Car and Truck Expenses
Petitioner deducted $7,496 in car and truck expenses for 2004 for a 2000 Lexus he placed in service on January 1, 2003, the date he started his consulting efforts. Petitioner reported that in 2004 he drove the Lexus 7,590 miles for business. Despite the mileage information, petitioner used actual costs to determine his car expense deduction, inputting the information regarding his automobile expenses into his computer and relying on his tax preparation software to determine the maximum deductions for depreciation and other car expenses.
Because of the nondeductibility of petitioner's startup expenses relating to his consulting efforts, the only deductible use of an automobile would be in connection with his employment with Leggett & Platt. Petitioner has not established that he used his car in connection with his employment with Leggett & Platt. Even if the car expenses were employment related, petitioner has also not shown that the expenses were not reimbursable by Leggett & Platt. Therefore, petitioner is not entitled to deduct any of the car and truck expenses as unreimbursed employee business expenses for 2004.
B. Travel and Meals and Entertainment Expenses
Petitioner reported $7,438 of business travel expenses away from home and $1,075 of business meals and entertainment expenses on his 2004 Schedule C. Petitioner testified that he paid these expenses in connection with his consulting efforts during three trips he made to Asia during 2004. We have already found that the expenses petitioner paid in conjunction with his consulting efforts are nondeductible startup expenses. Further, some of the traveling expenses may have been for personal family expenses. Petitioner's mother lives in northern China, and his wife's mother recently moved back to China. They also have other relatives in Beijing and other cities. Moreover, Leggett & Platt reimbursed petitioner for all of his 2004 foreign travel business expenses, including meals and lodging.
In summary, none of petitioner's 2004 traveling expenses are deductible as unreimbursed employee business expenses. Instead, petitioner's 2004 travel and meals and entertainment expenses were either nondeductible startup or personal expenses.
C. Office Expenses and Supplies
Petitioner deducted $977 in office expenses and $780 in supplies on his 2004 Schedule C. Petitioner testified that about 70 to 80 percent of these expenditures were for his employment with Leggett & Platt, and the remainder were for his consulting efforts. Because Leggett & Platt did not reimburse petitioner for expenses associated with working from home, and because we find that these expenditures were ordinary and necessary business expenses, we apply Cohan, concluding that petitioner may deduct 70 percent of the expenditures as unreimbursed employee business expenses for 2004, as follows: $684 for office expense and $546 for supplies. The remaining 30 percent of the expenses are nondeductible startup expenses.
D. Home Office Expenses
Generally, a taxpayer may not deduct expenses paid in connection with the business use of a home. Sec. 280A(a). However, a taxpayer may deduct expenses allocable to a portion of his home if, in pertinent part, he uses the space exclusively on a regular basis as his principal place of business, or as a place of business where he meets patients, clients, or customers in the normal course of his business. Sec. 280A(c)(1)(A) and (B). The definition of “principal place of business” for this purpose includes a portion of the home that the taxpayer uses for the administrative or management activities of his trade or business if there is no other fixed location for those activities. Sec. 280A(c)(1).
The exclusive use requirement of section 280A(c)(1) “is an all-or-nothing standard”. Hamacher v. Commissioner, 94 T.C. 348, 357 (1990). Thus, for example, if a taxpayer uses his den as the principal place for conducting his attorney business but also uses the den for personal purposes, then the taxpayer may not deduct any expenses related to the den. S. Rept. 94-938, at 148 (1976), 1976-3 C.B. (Vol. 3) 49, 186. Congress' intent in enacting section 280A was to exclude taxpayers from converting otherwise “‘nondeductible personal, living, and family expenses’” into “‘deductible business expenses’” merely because they had some connection with a business activity. Hamacher v. Commissioner, supra at 357 (quoting S. Rept. 94-938, supra at 147, 1976-3 C.B. (Vol. 3) at 185.
Where a taxpayer uses his home office for more than one business, the taxpayer satisfies the exclusive use test only if each business is one of the types described in section 280A(c)(1). Hamacher v. Commissioner, supra at 357-358. Although we found that petitioner's consulting activities were a nondeductible startup activity, we are nonetheless satisfied that petitioner's consulting activity is of the type described by section 280A(c)(1); he met potential clients there, it was the principal place of his activity, and the consulting was not a personal, family, or living usage. Similarly, as discussed below, petitioner's use of the basement for his work as an employee of Leggett & Platt is also a type of business described by section 280A(c)(1). Accordingly, petitioner satisfies the “all-or-nothing” exclusive use test.
A taxpayer, such as petitioner, who is an employee must also satisfy an additional requirement that his exclusive use is “for the convenience of his employer.” Sec. 280A(c). Neither the Code nor the regulations define that phrase. Caselaw, however, holds that an employee satisfies the requirement when the employee maintains the home office as a condition of his employment or as necessary for the functioning of the employer's business or as necessary for the employee to properly perform his duties. Hamacher v. Commissioner, supra at 358. In contrast, the home office must not “be ‘purely a matter of personal convenience, comfort, or economy’ with respect to the employee.” Id. (quoting Sharon v. Commissioner, 66 T.C. 515, 523 (1976), affd. 591 F.2d 1273 (9th Cir. 1978).
Petitioner's activities were essential to Leggett & Platt. He was responsible for overseeing the corporation's Asian operations, planning, and budgeting work. These responsibilities required that he conduct telephone calls late at night with Leggett & Platt facilities in Asia and that he maintain necessary records for his managerial and administrative duties. Though petitioner may have enjoyed the convenience and comfort of working from home, Leggett & Platt did not furnish him with an office. Cf. Tokh v. Commissioner, T.C. Memo. 2001-45. Petitioner had nowhere else to regularly and properly perform these responsibilities.
Therefore, we conclude that petitioner's home office was for the convenience of the employer and overall that petitioner has satisfied the requirements of section 280A with respect to business use of the home for 2004. We must, however, continue our inquiry to separate the expenses between the deductible expenses he paid with respect to his employment with Leggett & Platt and the nondeductible expenses he paid related to his startup consulting activities.
1. Furniture, Repairs and Maintenance, and Utilities
Petitioner reported on his 2004 Schedule C that he spent $1,215 for furniture, $4,196 for repairs and maintenance, and $1,782 for utilities in 2004 related to his business use of his basement. Petitioner testified that he paid these expenditures for finishing the remodeling and maintaining his basement in 2004.
As noted earlier, petitioner divided about one-half of the basement space into a conference area for his consulting activities. The record gives no indication that petitioner used the conference area for his employment with Leggett & Platt. Accordingly, one-half of the basement expenditures are nondeductible startup costs. With respect to the other half of the expenditures, petitioner testified further that he split his time in the basement office evenly between Leggett & Platt and his consulting activities. Because we have already found that petitioner's home office was for the convenience of his employer, petitioner is eligible to deduct the portion of his office expenditures pertaining to Leggett & Platt.
Consequently, separating the conference room and excluding one-half of the office expenditures, we apply Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930), to conclude that for 2004, petitioner may deduct $304 ($1,215 × 1/2; × 1/2;) of his furniture purchases, 2 $1,049 ($4,196 × 1/2 × 1/2;) of his basement repairs and maintenance expense, and $446 ($1,782 × 1/2 × 1/2) of his basement utility expenses as unreimbursed employee business expenses for the business use of his home. The remainder of these expenses for 2004 are nondeductible startup expenses.
2. Computer, Printer, Fax, and Telephone
On his 2004 Schedule C petitioner deducted $1,910 for a new computer he purchased in 2004, $495 in printer expenses, $296 for fax expenses, and $687 for telephone expenses. Petitioner testified that he used his computer and printer “primarily for my consulting business” and that his fax and telephone expenses were split “roughly half and half” between his consulting activities and his employment with Leggett & Platt.
Section 280F(d)(4)(A)(iv) includes computers and peripherals as listed property. However, section 280F(d)(4)(B) provides an exception for computer or peripheral equipment used at a regular place of business, including a portion of the home qualifying under section 280A(c)(1) (requiring in pertinent part that the portion of the dwelling unit must be the principal place of business for the trade or business). Verma v. Commissioner, T.C. Memo. 2001-132. Petitioner qualifies for the exception of section 280F(d)(4)(B) because, as noted above, his home served as his principal place of business for his employment with Leggett & Platt.
With respect to the telephone expense, a taxpayer may not deduct the cost of basic local telephone service for the first telephone line provided to a residence, because the expenditure is a personal expense. Sec. 262(b). The record is silent as to the number of lines to petitioner's home. Respondent made no assertion that petitioner's telephone expenses related to a first telephone line. Given petitioner's work circumstance of residing in Massachusetts with responsibility for Asian operations and his need to communicate regularly with corporate headquarters in Missouri, we conclude that a significant portion of the telephone use would have been for long distance calls. Moreover, because of the number of people residing in his home, the location of the telephone in an office in the basement beneath a 3,000-square-foot home, and the volume of calls that petitioner made during the evenings and nights, we find it highly probable that the telephone expenses petitioner claimed for 2004 were for a second telephone line that he maintained exclusively for business.
Returning to the analysis of all of the equipment expenses, we apply Cohan, finding that “primarily for my consulting business” means 75 percent of the use, and that “roughly half and half” means 50 percent of the use. Thus, petitioner may deduct as 2004 unreimbursed employee business expenses the following items: Computer expenses of $478 ($1,910 × 25 percent), 3 printer expenses of $124 ($495 × 25 percent), fax expenses of $148 ($296 × 50 percent), and telephone expenses of $344 ($687 × 50 percent). The remainder of petitioner's 2004 equipment expenses are nondeductible startup expenses.
To reflect the foregoing,
Decision will be entered under Rule 155.

Footnotes


1
For startup expenses that were incurred after Oct. 22, 2004, sec. 195(b) allows the taxpayer to elect to deduct a limited amount of the capitalized startup costs for the year of which the active trade or business begins, and to deduct the remainder over 180 months of amortization beginning with the month in which the active trade or business begins. See sec. 1.195-1T(b), (d), Temporary Income Tax Regs., 73 Fed. Reg. 38913 (July 8, 2008).
2
Deductible in the first year, 2004, under sec. 179, Election To Expense Certain Depreciable Business Assets.
3
Also deductible in the first year, 2004, under sec. 179.