The case of Franklin v. Commissioner, TC Memo 2025-8, involves a dispute between Ana M. Franklin (the petitioner) and the Commissioner of Internal Revenue (the respondent) regarding deficiencies in the petitioner’s federal income tax for 2015 and 2018. The court consolidated the cases for trial, briefing, and opinion.

Facts of the Case

Petitioner’s Role: The petitioner was the Sheriff of Morgan County, Alabama, from 2011 to 2019. As sheriff, she was responsible for feeding the inmates in the county jail.
Jail Food Funding: The State of Alabama provided a monthly allowance for feeding inmates, and the sheriff could retain any surplus funds. The federal government provided a separate allowance for federal inmates.
Consent Decree: A consent decree required the county to provide a nutritionally adequate diet to inmates. A prior sheriff was found to have violated the consent decree and was held in contempt for misusing the funds. Amended Paragraph 22 of the consent decree stipulated that all funds for feeding inmates must be used exclusively for that purpose and the sheriff would not be personally responsible for any shortfall in funds.
Jail Food Money Account: The petitioner established a checking account (the jail food money account) to receive the state and federal funds for feeding the inmates.
Loan to Priceville Partners: In 2015, the petitioner withdrew $160,000 from the jail food money account. She lent $150,000 of that amount to Priceville Partners, a car dealership, with the expectation of a 17% interest rate, based on a recommendation by her boyfriend. The loan was not documented with a promissory note. Priceville Partners turned out to be a Ponzi scheme, and the loan was not repaid. In December 2016, the petitioner’s boyfriend repaid the $150,000 on behalf of Priceville Partners, and she deposited the funds in the Traditions Bank account.
Contempt of Court: In January 2017, the court found that the petitioner had violated the consent decree by removing the $160,000 from the jail food account. She was held in civil contempt and fined a nominal amount, because she had returned the funds. At that time, the court also terminated the provision of the consent decree restricting the use of jail food funds.
2015 Tax Return: The petitioner filed her 2015 tax return in December 2017, reporting wages and other income, but not reporting any income from the withdrawal of funds from the jail food account. She later pleaded guilty to willful failure to file a tax return for 2015.
2018 Tax Return: On her 2018 return, the petitioner reported wages and other income. She also included a Schedule C, listing her business as “Sheriff’s Jail Food Account” and reporting gross income of $44,967 with an offsetting deduction for legal and professional expenses of the same amount, related to legal and tax issues resulting from her actions regarding the jail food account.
Notices of Deficiency: The IRS issued notices of deficiency for both 2015 and 2018, determining that the petitioner owed additional taxes. In the 2015 notice, the IRS initially determined the $155,000 withdrawn from the jail food account was unreported gross receipts from a trade or business, but later amended this to allege the funds were income from embezzlement. For 2018, the IRS disallowed the deduction of $44,967, arguing that the petitioner was not operating a trade or business and the expenses were not deductible.

Court’s Decision and Application of Law

2015 Unreported Income: The court determined that the $155,000 withdrawn from the jail food account was a loan, not embezzlement income.
- The court cited Commissioner v. Glenshaw Glass Co. for the definition of gross income as all accessions to wealth and James v. United States and Howard v. Commissioner for the inclusion of income from illegal activity like embezzlement. However, loan proceeds are excluded from gross income because of the corresponding obligation to repay, as noted in Todd v. Commissioner.
- The court distinguished between unauthorized loans and embezzlement, noting that a taxpayer has income when they acquire earnings without the recognition of an obligation to repay. The court cited Hobson v. Commissioner and Beasley v. Commissioner to support this distinction.
- The court noted the factors in determining if a debt is bona fide from Todd v. Commissioner, including a promise to repay, interest, a repayment schedule, and if the parties conducted themselves as if the transaction was a loan. The court also cited Moore v. United States and Roberts v. Commissioner as to the intention of the lender and borrower that the loan be repaid.
- The court found that while the withdrawal violated the consent decree, the petitioner intended to repay the funds. The court also pointed out that the petitioner was never charged with embezzlement or theft.
- Because the court determined it was a loan, not embezzlement, the petitioner was not entitled to an NOL (Net Operating Loss) carryback for 2015.
2015 Addition to Tax: The court sustained the addition to tax for failure to timely file, as the petitioner did not establish reasonable cause and pleaded guilty to the charge.
- The court cited Higbee v. Commissioner regarding the addition to tax for failure to timely file under section 6651(a)(1), noting that the Commissioner bears the burden of production, but the taxpayer must prove reasonable cause.
2018 Trade or Business: The court determined that the petitioner was not engaged in a separate trade or business of operating the jail food money account during 2018.
- The court cited Commissioner v. Groetzinger for the lack of a definition of “trade or business” in the code and the need for an examination of facts in each case.
- The court examined whether the petitioner intended to make a profit, was regularly involved, and if the activity had commenced, citing Sestak v. Commissioner and Weaver v. Commissioner.
- The court determined that the petitioner’s activity was connected to her duties as sheriff and not a separate business activity.
2018 Expense Deductions: The court disallowed the deduction for legal and professional expenses.
- The court cited sections 162(a) for deductions for ordinary and necessary business expenses, 262 for non-deductible personal expenses and 67(g) for the suspension of miscellaneous itemized deductions for 2018 through 2025.
- The court noted that while an employee can be considered to be in a trade or business, under O’Malley v. Commissioner and Primuth v. Commissioner, the expenses would be considered miscellaneous itemized deductions and are not deductible for 2018.
- The court further reasoned that even if the legal expenses were related to her status as an employee, they would still be considered non-deductible miscellaneous itemized deductions.
- The tax preparation expenses were also disallowed, citing section 212(3) and Crouch v. Commissioner. They are treated as miscellaneous itemized deductions, which are suspended for the 2018 tax year.

Conclusion

The court ruled that the $155,000 was an unauthorized loan, not embezzlement income, and that petitioner was not entitled to an NOL carryback for that year. The court upheld the addition to tax for the failure to timely file in 2015. For 2018, the court determined that the petitioner was not operating a separate trade or business and disallowed the claimed deduction for legal and professional services. Decisions will be entered under Rule 155.