Glass Warehouse, LLC v. Commissioner, T.C. Memo. 2026-111, November 2, 2026

Executive Summary and Practice Insights

For tax practitioners advising closely held corporate clients, Glass Warehouse, LLC v. Commissioner serves as a stark reminder of the foundational evidentiary burdens required under the Internal Revenue Code. The decision underscores two key operational lessons for certified public accountants and enrolled agents: first, reporting shareholder payments on Form 1040 as “other income” does not satisfy the corporation’s statutory obligation under Section 162 and Section 6001 to substantiate trade or business expenses; and second, invoking a defense of reasonable cause based on professional tax reliance under Section 6664(c) requires concrete affirmative evidence of communication, full disclosure, and actual advice, rather than mere assertions that a return was prepared by an external CPA.

Factual Setting and Procedural History

Glass Warehouse, LLC (petitioner) operated as a closely held C corporation principally located in San Diego, California, with additional inventory warehouses in California and Texas. The corporation specialized in selling glass shower doors and enclosures through major online retail platforms, including Home Depot, Wayfair, and Houzz, generating annual gross receipts of approximately $4.1 million for the tax year ending June 30, 2019.

During the tax years at issue (ending June 30, 2018, and June 30, 2019), the petitioner was owned and managed by two shareholder-officers: Ryan Thatcher, who served as president and held an 80% ownership interest, and Nidal Hanna, who served as vice president and held a 20% ownership interest. Mr. Thatcher and Ms. Hanna were married during the relevant period and worked full time for the corporation, managing all day-to-day operations including sales, inventory purchasing, employee supervision, and customer acquisition.

The corporation employed approximately ten employees, including an accounting manager, Mallory Copeland, who managed payroll, accounts payable, and accounts receivable using QuickBooks software, from which data was exported to Microsoft Excel spreadsheets. The petitioner retained an external CPA firm, Ahuja & Clark, PLLC, which was provided access to the corporation’s QuickBooks accounting files.

For the tax year ending June 30, 2019, petitioner filed Form 1120 (U.S. Corporation Income Tax Return), reporting $71,250 in officer compensation on Line 12 ($35,625 allocated each to Mr. Thatcher and Ms. Hanna on Form 1125-E). On Form W-2 (Wage and Tax Statement), petitioner reported officer wages of $92,712 for Mr. Thatcher and $73,962 for Ms. Hanna. In addition, petitioner claimed a corporate deduction of $173,974 for “subcontractor fees” on Form 1120. This total included $109,819 purportedly paid to its two shareholder-officers ($98,774 to Mr. Thatcher and $11,045 to Ms. Hanna). Petitioner did not issue Form 1099-MISC or Form 1099-NEC to either shareholder-officer for 2019.

On their joint individual income tax return (Form 1040) for 2019, Mr. Thatcher and Ms. Hanna reported $166,674 in aggregate Form W-2 wages and reported the $109,819 in purported subcontractor payments as “Other income,” remitting self-employment/employment taxes thereon.

On August 18, 2022, the Internal Revenue Service issued a Notice of Deficiency determining:

For tax year 2018: A tax deficiency of $67,354 and an accuracy-related penalty under Section 6662(a) of $13,471.
For tax year 2019: A tax deficiency of $24,844 and an accuracy-related penalty under Section 6662(a) of $4,969.

In the Notice of Deficiency, respondent disallowed $118,302 of petitioner’s claimed $173,974 subcontractor expense deduction for tax year 2019 for lack of substantiation. Petitioner filed a timely petition with the United States Tax Court on November 9, 2022. Prior to trial, the parties executed a Stipulation of Settled Issues resolving all adjustments for tax year 2018 except petitioner’s liability for the Section 6662(a) penalty, while respondent conceded the Section 6662(a) penalty for tax year 2019.

Taxpayer Requests for Relief

Before the Tax Court, petitioner requested relief on two remaining contested issues:

Reversal of the Commissioner’s disallowance of $118,302 in subcontractor expenses claimed for tax year 2019 under Section 162(a).
Abatement of the $13,471 accuracy-related penalty determined under Section 6662(a) for tax year 2018 on the grounds of reasonable cause and good faith under Section 6664(c)(1).

To support its deduction claim, petitioner asserted that the subcontractor payments were substantiated by the trial testimony of its accounting manager, corporate accounting records, and the joint Form 1040 of the shareholder-officers. Petitioner further argued that the reporting arrangement reflected worker misclassification, for which Section 3509 provided a legal framework protecting against treasury loss. With respect to penalty relief, petitioner argued that it exercised ordinary business care by retaining a qualified external CPA firm whose signature appeared on the corporate returns.

Court’s Analysis of the Statutory Framework and Legal Standards

Judge Fung structured the Tax Court’s analysis around well-established statutory provisions and judicial precedents governing corporate tax deductions and penalty compliance.

Statutory Deductions and Burdens of Proof

Under Rule 142(a) of the Tax Court Rules of Practice and Procedure and the seminal doctrine of Welch v. Helvering, 290 U.S. 111, 115 (1933), the Commissioner’s determinations in a Notice of Deficiency are presumed correct, and the taxpayer carries the burden of proving them erroneous. While Section 7491(a) permits a shift in the burden of proof to the Commissioner under specific conditions, the court emphasized that this statutory shift “applies, however, only if the taxpayer complies with all substantiation and recordkeeping requirements under the Code.”

The court highlighted the foundational principle that tax deductions are strictly a “matter of legislative grace, and taxpayers bear the burden of proving entitlement to each deduction claimed” (INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992)). Meeting this standard requires taxpayers to demonstrate compliance with statutory authorization and Section 6001 recordkeeping obligations (Treas. Reg. § 1.6001-1(a)). Specifically, the court affirmed that “[a]dequate substantiation must establish the nature, amount, and purpose of a claimed deduction” (Higbee v. Commissioner, 116 T.C. 438, 440 (2001)). Where evidentiary gaps persist, “we must sustain the Commissioner’s determination and disallow the deduction” (Rogers v. Commissioner, T.C. Memo. 2014-141).

Deduction Criteria for Officer Compensation Under Section 162

Section 162(a)(1) permits a business deduction for ordinary and necessary expenses paid or incurred during the tax year, including a “reasonable allowance for salaries or other compensation for personal services actually rendered.” Interpreting this provision, the U.S. Court of Appeals for the Ninth Circuit—to which an appeal in this case would lie pursuant to Section 7482(b)(1)(B)—applies a two-prong test:

The amount of compensation must be reasonable; and
The payments must be made with the intent to compensate for services rendered (O.S.C. & Assocs. v. Commissioner, 187 F.3d 1116, 1119–20 (9th Cir. 1999); Elliotts, Inc. v. Commissioner, 716 F.2d 1241, 1243 (9th Cir. 1983)).

Because the Commissioner conceded the reasonableness of the overall compensation and disallowed the deduction solely for lack of substantiation, the court observed that it was unnecessary to resolve whether the payments carried compensatory intent or represented disguised dividends.

Application of Law to the Facts: Disallowance of Subcontractor Expenses

In applying the legal framework to the record, the court determined that petitioner failed to meet even minimum substantiation thresholds.

Lack of Primary Substantive Evidence

Petitioner relied heavily on the testimony of its accounting manager, Ms. Copeland. However, the court found that Ms. Copeland’s testimony described only the shareholder-officers’ ordinary, day-to-day executive duties—managing sales, inventory, personnel, and customer relations. The court noted:

“Ms. Copeland’s only testimony describing Mr. Thatcher’s services concerned his day-to-day work for the petitioner—‘manag[ing] every aspect of the company, customers, inventory buying, all of it’—including managing employees and ‘responsibility for attracting or retaining customers.’ She similarly did not offer any specific information about services provided by Ms. Hanna. And Ms. Copeland testified that she did not see Mr. Thatcher or Ms. Hanna involved in the business in any capacity beyond their day-to-day operations work.”

The court observed that while a corporation is free to structure separate subcontractor arrangements with its officers under Gregory v. Helvering, 293 U.S. 465, 469 (1935), and Menard, Inc. v. Commissioner, 560 F.3d 620, 623 (7th Cir. 2009), “[t]he record does not contain any documents or any testimony showing that such an arrangement existed.” Petitioner failed to present written subcontractor contracts, invoices, project logs, or Forms 1099. In contrast, Ms. Copeland acknowledged issuing Forms 1099 to other third-party workers whose specific subcontracted tasks she personally knew.

Irrelevance of Individual Return Reporting and Section 3509 Arguments

The court firmly rejected petitioner’s argument that reporting $109,819 as “Other income” on the shareholders’ personal Form 1040 substantiated the corporate deduction:

“How a shareholder reports an item on a personal tax return does not control how the corporation reports that same item on its own tax return because a corporation is generally recognized as a tax entity separate from its shareholders.” (Moline Props., Inc. v. Commissioner, 319 U.S. 436, 438–39 (1943)).

Quoting Higgins v. Smith, 308 U.S. 473, 477 (1940), the court stressed that “[a] taxpayer is free to adopt [any] organization for his affairs as he may choose and having elected to do some business as a corporation, he must accept the tax disadvantages.”

The court also dismissed petitioner’s reliance on Section 3509 worker misclassification relief, emphasizing:

“Section 3509 does not turn amounts that would otherwise not be subject to withholding tax, such as contractor expenses, into deductible Form W–2 wages just because the Code provides a mechanism to hold an employer liable in an actual worker misclassification situation.”

Because petitioner offered no factual evidence of misclassification or underlying contract work, the $118,302 disallowance was sustained in full.

Application of Law to the Facts: Section 6662(a) Accuracy-Related Penalty

The remaining controversy centered on the 20% accuracy-related penalty imposed under Section 6662(a) for tax year 2018.

Corporate Penalty Burdens and Statutory Thresholds

Under Section 6662(b)(2) and Section 6662(d)(1)(B), a substantial understatement of income tax for a subchapter C corporation occurs if the understatement exceeds the lesser of 10% of the tax required to be shown on the return (or, if greater, $10,000) or $10,000,000. For 2018, petitioner reported tax of $92,775, whereas the tax required to be shown was $107,775, resulting in a substantial understatement under the statute.

Significantly, the court clarified the statutory burden of proof rules under Section 7491(c). While the Commissioner holds the burden of production regarding penalties for individual taxpayers, Section 7491(c) “applies only to individuals, not corporations, so respondent bears no burden of production here” (NT, Inc. v. Commissioner, 126 T.C. 191, 195 (2006)). Consequently, petitioner carried the burden of establishing an affirmative defense under Section 6664(c).

(The court confirmed IRS compliance with Section 6751(b) written supervisory approval requirements through Exhibit 4-J, noting under Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 29 F.4th 1066, 1074 (9th Cir. 2022), that written approval was timely executed prior to notice issuance).

Failure to Establish Reasonable Cause and Professional Reliance

To establish the affirmative defense of reasonable cause and good faith under Section 6664(c)(1), a taxpayer must demonstrate that it “exercised ordinary business care and prudence as to the disputed item” (Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 98 (2000)). Under Neonatology Associates, reasonable reliance on a professional tax advisor requires satisfying three specific evidentiary elements:

The advisor was a competent professional with sufficient expertise to justify reliance;
The taxpayer provided necessary and accurate information to the advisor; and
The taxpayer actually relied in good faith on the advisor’s judgment (Neonatology Assocs., 115 T.C. at 99).

The court found petitioner’s defense entirely unbefitting these requirements:

“The record is devoid of any testimony or other evidence of any information petitioner provided to an adviser regarding its tax position. At trial petitioner introduced no evidence showing that it sought or received any advice from Ahuja & Clark, the paid preparer identified on petitioner’s return... No witness testified about any interaction with any return preparer regarding the preparation of, or the positions taken on, petitioner’s return.”

Refusing to accept unsworn assertions by petitioner’s trial counsel, the court cited Rule 143(c) of the Tax Court Rules of Practice and Procedure and Niedringhaus v. Commissioner, 99 T.C. 202, 214 n.7 (1992), emphasizing that “[s]tatements in briefs . . . do not constitute evidence.”

Holding petitioner liable for the Section 6662(a) penalty, Judge Fung concluded with a clear regulatory standard:

“Simply hiring a tax preparer does not insulate a taxpayer from the consequences of the tax positions on its return.” (Treas. Reg. § 1.6664-4(b)(1)).

Judicial Conclusions and Primary Holdings

The United States Tax Court concluded its analysis with two binding determinations:

Petitioner failed to substantiate $118,302 in claimed subcontractor expenses for the tax year ending June 30, 2019, and is not entitled to a deduction under Section 162(a).
Petitioner is liable for the Section 6662(a) accuracy-related penalty for the tax year ending June 30, 2018, based on a substantial understatement of income tax, having failed to establish reasonable cause under Section 6664(c)(1).

Decision was ordered to be entered under Rule 155.

Prepared with assistance from Gemini Notebook.