Cathryn A. Simmons v. Commissioner, T.C. Memo. 2026-34 (April 22, 2026)

In a recent memorandum decision, the United States Tax Court addressed recurring substantiation issues surrounding closely held entities, commingled funds, and rental real estate deductions. The taxpayer, Cathryn A. Simmons, petitioned the Tax Court to challenge deficiency determinations issued by the Internal Revenue Service (IRS) for the 2017 and 2019 tax years, alongside a 20% accuracy-related penalty assessed under Internal Revenue Code (I.R.C.) section 6662(a) for the 2017 tax year. Following several IRS concessions prior to and following trial, the remaining issues centered on whether Ms. Simmons adequately substantiated business deductions for a partnership she co-owned, deductible expenses associated with two rental properties, and whether she qualified for the reasonable cause exception to negate the accuracy-related penalty.

Factual Background

During the years at issue, Ms. Simmons and her sister each owned a 50% membership interest in "Stuff, LC" (Stuff), a Missouri limited liability company treated as a partnership for federal tax purposes. Operating as a boutique in Kansas City, the business frequently utilized QuickBooks to track expenses, categorizing items such as cost of goods sold, interest, travel, and charitable contributions.

Because Stuff struggled to establish its own line of credit, the sisters utilized personal credit cards and personal loans obtained from family members to finance the partnership's operations. The sisters attempted to segregate the credit cards used for Stuff's expenses from their personal cards, but at least six of the credit cards utilized carried Ms. Simmons's name exclusively with no reference to the partnership. Interest accrued on these personal card balances, which the partnership subsequently recorded as interest expense. Furthermore, the partnership directly wrote checks to the sisters for "interest" relating to personal loans the sisters had taken out from their family members.

To promote the business, the partnership routinely hosted "charity parties," donating an average of 15% of its sales during a designated event to particular charitable organizations.

Separately, Ms. Simmons owned a subdivided personal residence containing two rental units. According to draft lease agreements, the tenants were responsible for paying gas and electricity utilities, though Ms. Simmons kept the utility accounts in her own name to prevent service lapses. Ms. Simmons also recorded various repair expenses for these units utilizing handwritten lists.

The Court's Analysis of the Law and Application to the Facts

The Tax Court’s analysis is heavily anchored in the fundamental tax principle that IRS deficiency determinations are presumed correct, placing the burden of proof squarely on the taxpayer to establish entitlement to claimed deductions under Tax Court Rule 142(a) and Welch v. Helvering, 290 U.S. 111, 115 (1933). Furthermore, under I.R.C. section 6001 and Treasury Regulation section 1.6001-1(a), taxpayers must maintain records sufficient to substantiate their tax attributes.

While the Court noted that the Cohan doctrine allows for the estimation of certain expenses where a taxpayer proves an expense was paid but lacks precise documentation, the Court emphasized that it "may not invoke the Cohan doctrine to estimate the amount of a deductible expense subject to the strict substantiation requirements in section 274(d)".

Automobile Expenses and Strict Substantiation

On its 2017 partnership return, Stuff claimed an automobile expense deduction of $12,939. Because passenger automobiles constitute "listed property" under section 280F(d)(4)(A)(i), these expenses fall strictly under section 274(d). Under this stringent standard, taxpayers must verify the amount, time, place, and business purpose of the expense. To satisfy this, Ms. Simmons provided three pages of QuickBooks transactions and two vehicle lease agreements. The Court denied the deduction entirely, concluding that "The record is devoid of any evidence substantiating Stuff’s business purpose, however, and Stuff is not entitled to a deduction for these expenses".

Non-Reimbursed Food

Stuff claimed an $11,377 deduction for "non-reimbursed food" expenses. The Court sustained the IRS's disallowance in full under section 162(a) because Ms. Simmons "did not adduce any evidence detailing the nature of these expenses, much less establish her entitlement to any deduction".

Interest Expense Deductions and Indebtedness

A pivotal issue for practitioners handling pass-through entities involves the deductibility of interest on personal debts used for business purposes. Under section 163(a), a taxpayer may deduct interest paid on indebtedness; however, the Court specifically noted that "a taxpayer may deduct interest expenses only if they arose from the taxpayer’s own indebtedness; a taxpayer cannot deduct interest expenses that arose from another’s indebtedness" (Chapman v. Commissioner, T.C. Memo. 2014-82).

Stuff reported $16,901 in interest expenses comprising both loan interest and credit card interest. Regarding the loans, while the sisters had promissory notes with their family members, there were no legal documents establishing that the partnership itself owed a debt to the sisters. Dismissing the unverified oral testimony, the Court applied the precedent that "A taxpayer’s general statement that his or her expenses were incurred in pursuit of a trade or business is not sufficient to establish that the expenses had a reasonably direct relationship to any such trade or business" (Hopkins v. Commissioner).

Regarding the credit cards, because the cards were maintained in Ms. Simmons's individual name, she failed to prove that the interest constituted the partnership's indebtedness rather than her own. Furthermore, even if the indebtedness belonged to the partnership, the Court ruled she failed to substantiate the underlying purchases to eliminate commingling concerns, stating, "we are left with the sisters’ unsupported confidence that the credit card interest and finance charges stemmed only from business activity, which is insufficient to support the deductions".

Advertising Versus Charitable Contributions

Another highly relevant technical issue addressed by the Court involves the intersection of partnership charitable contributions and ordinary business expenses. Under section 703(a)(2)(C), partnerships are barred from deducting charitable contributions at the entity level; instead, they must flow through to the partners' individual returns. However, the Court acknowledged that "Payments that qualify as charitable contributions are not deductible as ordinary and necessary business expenses under section 162 if they fail to qualify as legitimate business expenses" (Pace v. Commissioner).

The Court ruled in favor of the taxpayer on the conceptual deductibility of the charity parties, recognizing them as a mechanism for sales generation. The Court colorfully noted, "By tying charitable contributions to sales on a particular day, Stuff leveraged the milk of human kindness to encourage customers to visit its store and purchase its merchandise". The Court concluded that these were indeed legitimate business expenses under section 162. However, the Court strictly limited the deduction to the amounts already conceded by the IRS because the partnership's QuickBooks entries suffered from a "dearth of information that would allow us to evaluate the nature of the alleged expenses or their business purposes," and lacked contemporaneous written acknowledgments or receipts for the remainder of the claimed amounts.

Rental Real Estate Deductions

Regarding Ms. Simmons's Schedule E rental properties, she attempted to deduct $15,679 for repairs in 2019 and a combined total of $6,764 for utilities across 2017 and 2019. Based on a handwritten spreadsheet, the IRS conceded $5,644 of the repair costs. Ms. Simmons could not verify expenses beyond this concession because she failed to demonstrate that her receipts "established amounts spent on repairs in excess of the amounts reported on her spreadsheet, rather than amounts spent on maintenance and cleaning or advertising".

The Court entirely disallowed the utility deductions. Under section 212, ordinary and necessary expenses paid for the production of rental income are deductible, but the underlying lease agreements explicitly required the tenants to reimburse Ms. Simmons for the utility payments. As the tenants were ultimately responsible for the financial burden, Ms. Simmons was barred from claiming the deduction herself.

Accuracy-Related Penalty

The IRS asserted a 20% accuracy-related penalty under section 6662(a) and (b)(1) for the portion of the underpayment attributable to negligence. Treasury Regulation section 1.6662-3(b)(1) specifically defines negligence to include a taxpayer's failure to properly substantiate items claimed on a return.

The Commissioner met his burden of production by establishing that Ms. Simmons failed to maintain sufficient records, shifting the burden to the taxpayer to establish reasonable cause and good faith under section 6664(c). Ms. Simmons offered only a general statement requesting penalty relief without supporting evidence. Reaffirming a strict standard for tax professionals to heed, the Court ruled against her, holding that "A conclusory denial of this sort is insufficient to demonstrate reasonable cause" (Ataya v. Commissioner).

Conclusions

The Tax Court upheld the IRS’s deficiency determinations for the unsubstantiated portions of the partnership's business deductions and the rental property expenses. Notably, the Court firmly established that a pass-through entity cannot deduct interest on debt held in an individual owner's name absent formal loan documentation cementing the entity's distinct legal obligation to repay the debt. The Court also sustained the 20% accuracy-related penalty, determining that inadequate recordkeeping constitutes negligence and that a taxpayer cannot rely on general, unsupported assertions to claim the reasonable cause defense.

Prepared with assistance from NotebookLM.