Reynolds, Charles v. CIR

In the

United States Court of Appeals

For the Seventh Circuit

____________

No. 00-2966

CHARLES REYNOLDS and BEATRICE REYNOLDS,

Petitioners-Appellants,

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

____________

Appeal from the United States Tax Court

No. 12112-97—John F. Dean, Special Trial Judge.

____________

ARGUED NOVEMBER 30, 2001—DECIDED JULY 18, 2002

____________

Before FLAUM, Chief Judge, CUDAHY, and MANION,

Circuit Judges.

CUDAHY, Circuit Judge. This dispute arises from certain

tax deductions claimed by Charles and Beatrice Reynolds

on their 1993 and 1994 tax returns. The Internal Revenue

Service (IRS) challenged the deductibility of certain ex-

penses related to a family farm business, rental properties

and to Charles Reynolds’ private law practice, which is, for

better or worse, a sideline from his full-time employment

as an IRS supervisor.1 During the pendency of this dis-

pute, the Reynolds received two brief letters from the IRS

1

Reynolds recently retired from the IRS.

2 No. 00-2966

stating that they had no outstanding liability for the 1993

and 1994 tax years. The Reynolds asserted that these let-

ters were binding admissions by the IRS, thus estopping the

agency from pursuing any further action against them. The

U.S. Tax Court rejected this argument and ruled on the

merits, allowing some of the deductions and disallowing

others. In addition, pursuant to 29 U.S.C. § 6662(a), the Tax

Court upheld a 20% accuracy-related penalty because it

found that some of the remaining errors were the result of

negligence.

The Reynolds appeal the following: (1) the evidentiary

weight given to the no-liability letters, (2) the classification

of certain legal defense costs as personal costs rather than

as business expenses related to Charles Reynolds’ private

law practice, (3) the denial of various automobile and travel

expenses related to the private law practice, farming ac-

tivity and the rental properties, and (4) the imposition of

the accuracy-related penalties. We affirm the judgment of

the Tax Court.

I.

Charles Reynolds joined the IRS in 1976, where he

worked as a revenue officer in the Chicago office. Several

years later, Reynolds graduated from law school and was

promoted to a supervisory position, which involved a case-

load of taxpayer audits. In 1987 and 1988, Reynolds re-

ceived permission from the IRS to practice law in addition

to his primary employment with the IRS. However, in 1992,

the IRS commenced an investigation of Reynolds spring-

ing from concerns that he may have been conducting his

private law practice during his workday at the IRS. To de-

fend himself, Reynolds hired a major Chicago law firm and

incurred legal expenses. The investigation was officially ter-

minated in 1995.

During 1993 and 1994, which is the time period relevant

to this dispute, Charles Reynolds operated a small part-

No. 00-2966 3

time law practice. These efforts were limited to a few real

estate closings and related activities. In 1993, Reynold’s

Schedule C for this law practice reported gross receipts

of only $700.2 However, he claimed a net loss of $6,271.

His deductions included $2,380 for legal fees related to the

IRS investigation of certain questionable on-the-job activi-

ties. Similarly, in 1994, Reynold’s Schedule C reported gross

receipts of $450 with a net loss of $10,255. This amount

included $5,615 in legal fees related to the ongoing inves-

tigation. In a subsequent audit, the IRS disallowed the

business deduction of the legal expenses, ruling that they

should instead be categorized as itemized personal expenses

on Schedule A and thus deductible to the extent they

exceeded the 2% “floor” limitation of 26 U.S.C. § 67(a).

In addition to the reclassification of the legal expense,

IRS auditors also denied various other deductions, includ-

ing automobile and travel expenses allegedly related to the

law practice, to a family farm and to rental properties. Only

the auto and travel expenses, however, are currently be-

fore us on appeal. From our own inspection of the record, we

estimate the total amount of the deductions now in dis-

pute to be approximately $3,359.3 Included in this amount

2

This case involves a discussion of various tax forms, or “Sched-

ules,” used in the preparation of a federal tax return. Schedule C

is used to calculate a profit or loss from a sole proprietorship—

e.g., a law practice. Schedule A is used to itemize various personal

expenses that are deductible under federal law. Schedule E is

used to state supplemental income or loss from various other

activities—e.g., rental income from real property. Schedule F is

used to state a profit or loss from farming activity.

3

Neither party in this case provides an intelligible summary of

precisely which automobile and travel deductions are now on

appeal nor do they give us the total amount of the claimed de-

ductions. Moreover, during the proceedings below, the Tax Court

(continued...)

4 No. 00-2966

are travel and automobile expenses allegedly incurred by

Charles Reynolds in the course of his law practice, includ-

ing depreciation of a 1988 Toyota Camry. Similarly, the IRS

denied travel and automobile expenses related to rental

property owned by the Reynolds in Indiana, Kentucky and

Virginia, and travel to Florida to evaluate a real estate

development project that never materialized. Finally, the

IRS denied travel and automobile expenses incurred in a

trip to a family-owned farm in Kentucky, including the de-

preciation of a 1994 Ford van, which was supposedly used

“to haul tillers, plows and farm tools from Virginia to Ken-

tucky and for use in the operation of the farm.”4 Although

the Reynolds did not keep a log of specific trips and the

3

(...continued)

discovered that the disputed travel, meals and automobile ex-

penses, including depreciation of various cars owned by the

Reynolds, had been consolidated on either Schedules C or E rather

than spread across Schedules C, E and F to reflect the costs in-

curred in each activity (i.e., law practice, rental properties or

farming). The Reynolds attempted to cure this problem by sub-

mitting additional documents that reflected a more precise break-

down. Although the Reynolds correctly point out that all expenses

listed on Schedules C, E and F are “above-the-line” deductions,

and thus their assignment to a particular Schedule has no effect

on their total tax liability, Appellant’s Br. at 27, they seem to

forget that “the taxpayer[ ] bears the burden of showing a right to

the business deduction.” A.E. Staley Mfg. Co. v. Commissioner,

119 F.3d 482, 486 (7th Cir. 1997) (citing INDOPCO, Inc. v. Com-

missioner, 503 U.S. 79, 84 (1992)). It is astonishing that the

Reynolds fail to make a clear statement on the amount of the

automobile and travel deductions they are entitled to, especial-

ly since these deductions were disallowed by the Tax Court be-

cause of inadequate substantiation under 26 U.S.C. § 274(d). The

Reynolds apparently believe that, if their argument carries the

day, the U.S. Court of Appeals will do the math for them.

4

According to tax returns filed by the Reynolds, the family farm

generated $50 in revenues in 1993 and $1,745 in 1994. In both

years, the farm operated at a net loss.

No. 00-2966 5

mileage that corresponded with each money-making ac-

tivity, Charles Reynolds retained various receipts for gas,

maintenance and repairs, and during the subsequent au-

dit, he attempted to categorize each expense and to appor-

tion it to the appropriate activities.

Nonetheless, the IRS denied the automobile and travel

deductions on various grounds, including failure to comply

with the substantiation requirements of 26 U.S.C. § 274(d).

After the IRS had made several other adverse rulings that

are not pertinent to this appeal, the agency calculated de-

ficiencies of $4,732 and $3,092 for the 1993 and 1994 tax

years, respectively, together with corresponding accuracy-

related penalties of $946 and $618, respectively.

In August of 1997, the Reynolds petitioned the U.S. Tax

Court for a redetermination of their 1993 and 1994 tax

liability. In March of 1998, while this matter was still pend-

ing before the Tax Court, the Reynolds apparently sent a

letter of inquiry to the IRS problem resolution office in Kan-

sas City, Missouri, with respect to their 1993 and 1994 tax

liabilities. It is important to note that this inquiry was not

directed to the district counsel for the IRS, who was rep-

resenting the respondent in the ongoing dispute before

the Tax Court. A month later, the Reynolds received two

short letters from the IRS, one pertaining to 1993 and the

other to 1994, that were identically worded with the ex-

ception of the specific tax amounts peculiar to each. After

listing credit adjustments for each year, both letters listed

“the amount you now owe” as “none.”

In April 1999, the case went to trial, and the Reynolds

asserted that the IRS correspondence was tantamount to

a binding admission by the government that estopped it

from litigating the present case. The Tax Court rejected

this argument as contrary to well-established law. The

court went on to consider various testimony and exhibits,

issuing a decision in part for the Reynolds and in part for

6 No. 00-2966

the IRS. The restated liability was $2,422 and $1,937 for

the 1993 and 1994 tax years, respectively, together with

corresponding accuracy-related penalties of $484.40 and

$387.40, respectively. Although the amount in controversy

in the case is relatively small, the Reynolds assert that this

appeal is being brought “to purge the taint on [Charles

Reynolds’] reputation arising from the negligence penalty

assessed against him.” We agree that money is not the

measure of all things worth fighting for, and the issues

raised here are, for the most part, serious.

II.

Pursuant to 28 U.S.C. § 2072, decisions of U.S. Tax Court

are reviewable by this court. See 28 U.S.C. § 2072. The

Reynolds present four issues for review: (1) Did the Tax

Court err when it refused to consider the written no-

tices sent to the Reynolds in relation to their 1993 and

1994 tax liability? (2) Did the Tax Court err in classifying

Charles Reynolds’ legal defense expenditures as § 67(a)

itemized personal deductions rather than as § 162(a) busi-

ness expenses? (3) Did the Tax Court err in ruling that the

Reynolds had failed to adequately substantiate their

automobile and travel-related expenses on Schedule C (law

practice), Schedule E (rental properties) and Schedule F

(farming business), as required by § 274(d)? (4) Did the

Tax Court err in sustaining a § 6662(a) accuracy penalty

against the Reynolds for negligent underpayments of their

1993 and 1994 taxes?

Before considering each issue in turn, we note that a de-

cision of the Tax Court is subject to the same standards of

review “that we apply to district court determinations in a

civil bench trial: We review factual determinations, as well

as applications of legal principles to those factual determi-

nations, only for clear error.” Cline v. Commissioner, 34

F.3d 480, 484 (7th Cir. 1994); accord Toushin v. Commis-

No. 00-2966 7

sioner, 223 F.3d 642, 645-46 (7th Cir. 2000); Fruit of the

Loom, Inc. v. Commissioner, 72 F.3d 1338, 1343 (7th Cir.

1996). However, deficiencies determined by the Commis-

sioner are presumed to be correct and the taxpayer bears

the burden of proving otherwise. Pittman v. Commissioner,

100 F.3d 1308, 1313 (7th Cir. 1997).

A.

The first issue we address is whether the Tax Court erred

when it refused to treat the two no-liability letters from the

IRS (pertaining to the 1993 and 1994 tax years, respective-

ly) as binding admissions. The Reynolds claim that these

two documents are “uncontroverted binding admissions

of no deficiency,” thus mandating a judgment in their fa-

vor. However, the cases relied upon by the Reynolds in this

regard all deal with “judicial admissions,” which enter the

litigation either through the pleadings or under Rule 36 of

the Federal Rules of Civil Procedure. See, e.g., Kohler v.

Leslie Hindman, Inc., 80 F.3d 1181, 1185 (7th Cir. 1996)

(“When a party in a lawsuit makes an admission in its

pleadings or in its answer to a request for admissions, it

makes a judicial admission that can determine the outcome

of that lawsuit.” (citing Fed. R. Civ. P. 36(b))); Keller v.

United States, 58 F.3d 1194, 1199 n.8 (7th Cir. 1995) (“Ju-

dicial admissions are formal concessions in the plead-

ings, or stipulations by a party or its counsel, that are

binding upon the party making them. They may not be con-

troverted at trial or on appeal. . . . [They] have the effect

of withdrawing a fact from contention.” (quotations omit-

ted)).

Although a judicial admission has the effect of settling

an issue of fact for the purposes of the current litigation,

nothing of that exalted significance is present here. The

alleged admissions in this case were not furnished by the

IRS as part of the record before the Tax Court. In fact, the

8 No. 00-2966

weight to be accorded these letters appears to be less than

leaden.

The story unfolds as follows. The Tax Court scheduled the

matter before us now for a trial to commence on March 2,

1998. On the day of trial, the district counsel for the IRS

learned that the Reynolds had been subject to a premature

deficiency assessment for the 1993 and 1994 tax years and

motioned the Tax Court to return the case to its general

trial docket. According to the court transcript for that date,

the parties appeared to be close to settlement. The Reynolds

offered no objection to the government’s motion, and a

continuance was granted. Shortly thereafter, the Reynolds

apparently sent an inquiry to the IRS problem resolution

office in Kansas City, Missouri. On April 13, 1998, that of-

fice generated the two no-liability letters, which respec-

tively credited the Reynolds’ 1993 and 1994 tax years in

the exact amount at issue before the Tax Court. Both of

these very short letters contained the following sentence:

“This [action] is the result of your correspondence of March

18, 1998.” However, a copy of the March 18, 1998 letter is

not part of the record, presumably because it was sent to

the IRS problem resolution office in Kansas City. If the

Reynolds wanted the IRS to stipulate or to admit that

the couple owed no taxes for 1993 and 1994, they should

have directed their correspondence to the district counsel

for the IRS, who was based in Chicago and apparently was

well known to the Reynolds through previous settlement

negotiations and court appearances. The Reynolds cannot

obtain a judicial admission on the cheap.

At most, the two no-liability letters are extrajudicial

admissions, which are admissible as evidence and may be

weighed by the factfinder according to their probative value.

See Murrey v. United States, 73 F.3d 1448, 1455 (7th Cir.

1996) (distinguishing between a “judicial admission” and an

“extrajudicial admission”); Keller, 58 F.3d at 1199 n.8

(distinguishing between “judicial admission” and other ad-

No. 00-2966 9

missions which are treated as evidence). In the case before

us, the letters have virtually no probative value. The letters

appear to have been computer generated and do not ref-

erence in any way the litigation that has been pending

before the Tax Court. The letters state that the Reynolds’

“account” was “adjusted.” Because the Reynolds could not

be lawfully assessed with a tax deficiency until the Tax

Court issued a decision favorable to the IRS, see 26 U.S.C.

§ 6213(a), these letters most likely reflect an adjustment

for a premature deficiency assessment. Unfortunately, we

don’t know what information the IRS office in Kansas

City was acting upon because the correspondence which

prompted the IRS reply is not part of the record.

Further, the settlement or closure of a civil tax dispute

with the IRS is a matter controlled by statute. See 26 U.S.C.

§§ 7121 (closing agreements), 7122 (compromises). These

provisions provide the exclusive method for settling civil tax

disputes with finality. See Brooks v. United States, 833 F.2d

1136, 1145 (4th Cir. 1987) (holding that “[s]ection 7122 is

the exclusive method by which tax cases may be compro-

mised”); Whitney v. United States, 826 F.2d 896, 897-98 (9th

Cir. 1987) (holding that “section 7121 of the Internal Rev-

enue Code is the exclusive means whereby tax disputes can

be settled”); Hagadone v. Commissioner, 98 T.C.M. (RIA)

352 (“It is well established that as a general rule the Com-

missioner is finally and conclusively bound by an agreement

with a taxpayer only if the parties enter into a closing

agreement under the provisions of section 7121.”). The Tax

Court correctly observed that the record “is devoid of any

evidence that petitioners and respondent entered into a

valid closing or compromise agreement.” On the evidentiary

weight to be given to the no-liability letters, we are in

agreement with the Tax Court. The letters get the petition-

ers no closer to their goal.

10 No. 00-2966

B.

The next issue before us is whether the Tax Court erred

when it ruled that legal defense costs incurred by Charles

Reynolds during the 1993 and 1994 tax years were miscella-

neous itemized deductions, which are subject to the 2%

floor contained in 26 U.S.C. § 67(a), rather than business

expenses related to the private law practice, which are fully

deductible under 26 U.S.C. § 162(a). The legal costs at is-

sue here are related to the IRS investigation of Charles

Reynolds’ alleged on-the-job misconduct—i.e., that he may

have been conducting his private law practice during his

official hours of employment at the IRS.

The Reynolds’ primary argument is that Charles

Reynolds’ ability to practice law on a part-time basis had

to be approved through appropriate IRS channels. Thus,

an adverse ruling could have led to the withdrawal of

this approval and thus terminated his practice of law. The

Reynolds also claim that an adverse ruling would have

negatively affected Charles Reynolds’ legal reputation,

which would have caused him to lose law-related business.

Following this logic, the Reynolds maintain that all of

the legal defense costs for 1993 and 1994 ($5,615 and

$2,380, respectively) were properly listed as Schedule C

business expenses.

In response, the government correctly argues that this

issue is governed by the “origin of the claim” doctrine,

which was first articulated by the Supreme Court in United

States v. Gilmore, 372 U.S. 39 (1963). In Gilmore, the tax-

payer attempted to deduct substantial legal expenses in-

curred in protracted divorce litigation with his estranged

wife as a “business” expense related to income-producing

property rather than as a “personal” expense. The taxpayer

justified his position by arguing that the divorce litigation

involved the disposition of three car dealerships owned

by the taxpayer. He contended that the conservation of

No. 00-2966 11

these income-producing assets depended upon his ability to

retain a controlling stock interest in them.5 Moreover, if

certain scandalous allegations were proven to be true, the

taxpayer’s franchisor might have grounds to cancel his

dealerships. The Court rejected the taxpayer’s position,

holding:

[T]he characterization, as “business” or “personal,” of

the litigation costs of resisting a claim depends on

whether or not the claim arises in connection with the

taxpayer’s profit-seeking activities. It does not depend

on the consequences that might result to a taxpay-

er’s income-producing property from a failure to de-

feat the claim, for . . . “that would carry us too far”

and would not be compatible with the basic lines of

expense deductibility drawn by Congress.

372 U.S. at 48 (emphasis in original) (footnote omitted)

(quoting Lykes v. United States, 343 U.S. 118, 125 (1952)).

In the case before us, the origin of the claim lies in

Charles Reynold’s conduct as an IRS employee, not in his

trade or business as a self-employed attorney. Charles

Reynolds incurred these legal costs because an IRS investi-

gation had been commenced to determine whether he was

5

Gilmore addressed the deductibility of legal expenses related

to the conservation of income-producing property under §§ 23(a),

24(a) of the 1939 Code, and its successor statutes, 26 U.S.C.

§§ 212, 262, of the 1954 Code. See 372 U.S. at 40 & n.3. However,

it is well settled in that the holding of Gilmore also applies to the

deductibility of legal expenses under § 162(a). See Anchor Coupl-

ing Co., Inc. v. United States, 427 F.2d 429, 433 (7th Cir. 1970)

(applying Gilmore to determine deductibility of legal expenses

under § 162(a)); see also Dana Corp. v. United States, 174 F.3d

1344, 1350-51 (Fed. Cir. 1999) (same); Kopp’s Co. v. United States,

636 F.2d 59, 60-61 (4th Cir. 1980) (same); Nadiak v. Commis-

sioner, 356 F.2d 911, 912 (2d Cir. 1966) (same); Berry Petroleum

Co. v. Commissioner, 104 T.C. 584, 618-22 (1995) (same).

12 No. 00-2966

practicing law during his prescribed hours of employment

at the IRS. Under Gilmore, the business-related conse-

quences that may flow from the IRS’s inquiry—that it may

result in withdrawal of IRS approval for the part-time law

practice or damage to Charles Reynolds’ professional rep-

utation—do not control the question whether the fees are

deductible as a business expense. Since the taxpayer bears

the burden of showing that he has a right to a business

deduction, A.E. Staley Mfg. Co., 119 F.3d at 486, and no

additional arguments have been advanced on this issue, the

Reynolds cannot prevail. The disputed legal fees are

properly classified as miscellaneous itemized deductions,

which are subject to the 2% floor contained in § 67(a).

C.

The Reynolds next assert that the Tax Court erred when

it denied deductions for various automobile and travel

expenses that were purportedly made in connection with

the law practice, the rental properties or farming activity.

The Tax Court ruled that none of the expenses at issue

were deductible because the Reynolds had failed to satisfy

the substantiation requirements of 26 U.S.C. § 274(d). At

the outset, we note that a determination that a taxpayer

has failed to come forward with sufficient evidence to sup-

port a deduction, including a failure to comply with the

§ 274(d) substantiation requirements, is generally viewed

as a finding of fact that is reviewed for clear error. See, e.g.,

Yoon v. Commissioner, 135 F.3d 1007, 1012, 1016 (5th Cir.

1998) (reviewing § 274(d) ruling for clear error); Buelow v.

Commissioner, 970 F.2d 412, 415 (7th Cir. 1992) (“The tax

court determination that a taxpayer has failed to come for-

ward with sufficient evidence to support a deduction is a

factual finding subject to reversal only if found to be clearly

erroneous.”). The tax code precludes a deduction for various

enumerated items, including auto and travel expenses,

No. 00-2966 13

unless a taxpayer substantiates “by [1] adequate records or

[2] by sufficient evidence corroborating the taxpayer’s own

statement” the following five elements: the amount, date,

time, place and business purpose of the expense. 26 U.S.C.

§ 274(d); see also Dowell v. United States, 522 F.2d 708, 714

(5th Cir. 1975).

Here, the Reynolds fall far short of the necessary show-

ing. Based on the regulations under § 274(d), the Reynolds

cannot avail themselves of the “adequate records” language

of § 274(d) because they did not maintain logs for each

vehicle in their household to reflect their use in the law

practice, rental property management or farming activities.

See 26 C.F.R. § 1.274(d)(2) (1993) (stating that substan-

tiation by adequate records requires a taxpayer “to main-

tain an account book, diary, log, statement of expense,

trip sheets, or similar record” that is made “at or near the

time of the expenditure or use”). Although Treasury reg-

ulations implementing § 274(d) clearly state that “adequate

records” are not the only method of establishing eligibility,

alternative methods are disfavored—and for good reason.

At the risk of the reader’s eyes glazing over, we will quote

at length the “rules of substantiation” as they appeared

in the 1993 Code of Federal Regulations,6 especially since

they bear on the accuracy-related penalties that the

Reynolds also appeal:

[A] taxpayer must substantiate each element of an

expenditure or use . . . by [1] adequate records or [2]

by sufficient evidence corroborating his own state-

ment . . . . A contemporaneous log is not required, but

a record of the elements of an expenditure or of a

6

The 1993 version governs the 1993 tax year and could have

provided guidance to the Reynolds in their recordkeeping efforts.

Based on our own brief review, however, the 2002 version of this

regulation is substantially the same as the one in effect in 1993.

14 No. 00-2966

business use of listed property made at or near the time

of the expenditure or use, supported by sufficient

documentary evidence, has a high degree of credibility

not present with respect to a statement prepared sub-

sequent thereto when generally there is a lack of ac-

curate recall. Thus, the corroborative evidence required

to support a statement not made at or near the time

of the expenditure or use must have a high degree of

probative value to elevate such statement or evidence

to the level of credibility reflected by a record made

at or near the time of the expenditure or use supported

by sufficient documentary evidence. The substantiation

requirements of section 274(d) are designed to encour-

age taxpayers to maintain the records, together with

documentary evidence, as provided in paragraph (c)(2)

of this section [entitled “Substantiation by adequate

records”].

26 C.F.R. § 1.274-5T(c)(1) (1993) (emphasis added).

The implications of this passage are unmistakable. Com-

plete, contemporaneous records are the preferred method

of substantiation. Taxpayers who pursue alternative meth-

ods will have to present evidence that is equally credible

and probative, which will be difficult.

When a taxpayer cannot substantiate his deduction with

“adequate records,” the Treasury Regulations specifically

lay out the method for substantiation “by other sufficient

evidence.” A taxpayer must establish each element of a

§ 274(d) business expense “(A) By his own statement,

whether written or oral, containing specific information in

detail as to such element; and (B) By other corrobora-

tive evidence sufficient to establish such element.” § 1.274-

5T(c)(3)(i) (1993).

This alternate method was utilized by the Reynolds at

trial. Specifically, Charles Reynolds testified as to the

business purpose of each deduction and attempted to sub-

No. 00-2966 15

stantiate his account by presenting various documents that

purported to reconstruct the date, amount and proper

categorization of the claimed expenses. To prepare these

exhibits, Reynolds relied on voluminous receipts and can-

celled checks from the 1993 and 1994 tax years; a “represen-

tative” sample of these receipts was made available for

inspection and then submitted into the record.

The Tax Court ultimately found this testimony and evi-

dence unconvincing. For example, Charles Reynolds created

a two-page chart entitled “Reconstruction of Mileages Driv-

en,” which categorizes his 1993 auto expenses by month and

profit-making activity (i.e., law practice, farm or rental

properties). At the bottom of the chart, 3,715 miles were

attributed to the “farm” for trips on April 22, June 13, July

28 and October 11. However, the only elaboration of the

business purpose of the trips was the term “crops,” which

appears next to the dates. Charles Reynolds’ testimony on

his farming activities also undermined his case, since the

Tax Court found it “vague, confusing, and evasive.” But

perhaps the most damaging detail was an admission by

Reynolds that no crops were grown on his farm during the

1993 tax year.

Expenses attributed to the rental properties suffered

similar problems. For the 1993 tax year, the Reynolds at-

tributed 3,646 miles and $995.30 in hotel bills to two trips

to Virginia, where they own rental property. Yet, the only

business explanation for this substantial deduction is the

elliptical phrase “cleaning, leasing.” The corroborating evi-

dence, in combination with Charles Reynolds’ testimony

on the nature of these trips, simply does not have the “high

degree of probative value” necessary to put it on a par with

“adequate records” documentation. § 1.274-5T(c)(1); see

also Masat v. Commissioner, 784 F.2d 573, 575 (5th Cir.

1986) (ruling that mere fact that taxpayer owns out-of-state

property does not satisfy his or her burden of proving that

16 No. 00-2966

the travel expenses were motivated by business rather

personal reasons).

Of the four corroborating summaries presented at trial,

the 1993 chart is the most comprehensive breakdown.

Unfortunately, it does not contain the type of specific de-

tail mandated by the Treasury Regulations; all of the travel

and car maintenance expenses are listed by month rath-

er than by specific trip. See § 1.274-5T(c)(3)(i) (in the

absence of contemporaneous written evidence, requiring

“specific information in detail” as to each element of a

§ 274(d) deduction). The listed figures are presumably the

sum of adding together the voluminous receipts, though

only “representative” receipts were included in the record.7

But as the Tax Court correctly observed, many of these

receipts are for automobile repairs having no apparent

relationship to any particular trip or business. Section

§ 274(d) requires the taxpayer to prove the amount, date,

time, place and business purpose of each claimed expense.

The existence of these elements simply cannot be discerned

in any of the Reynolds’ reconstructed summaries.

The automobile and travel expenses for the Reynolds’

farming activities (Schedule F) and rental properties

(Schedule E) clearly fail because of inadequate substantia-

tion. See 26 C.F.R. § 1.274-5T(c)(1) (stating that non-con-

temporaneous evidence “must have a high degree of proba-

tive value” to establish eligibility for deduction). Although

7

The government emphasizes the fact that the Reynolds’ “repre-

sentative” sample is both incomplete and arbitrary in what is does

and does not support, but additional receipts would not have

helped the Reynolds’ case. Rather, the testimony and corroborat-

ing summaries, which were presented at trial, were insufficient

to establish the required elements of § 274(d). See Dowell, 522

F.2d at 714 (holding that a “virtual blizzard of bills, chits and

other papers” does not satisfy the “expenditure by expenditure

determination” required by § 274(d)).

No. 00-2966 17

we believe that the auto and travel expenses attributed

to the law practice (Schedule C) share similar defects,

they also suffer the more fundamental problem of being

nondeductible commuting expenses.

According to Reynolds, the mileage attributed to his law

practice resulted from travel between his home and a title

company, where he handled several real estate closings

for his clients. In general, commuting expenses between

home and work are personal and therefore nondeductible.

See Commissioner v. Flowers, 326 U.S. 465, 473-74 (1946);

accord H B & R, Inc. v. United States, 229 F.3d 688, 690

(8th Cir. 2000) (“Flowers established the general rule that

an employee’s expenses in commuting from home to work

are personal, not deductible business expenses.”); 26 C.F.R.

§ 1.262-1(b)(5) (“The taxpayer’s costs of commuting to

his place of business or employment are personal expenses

and do not qualify as deductible expenses.”). However, if a

taxpayer maintains a home office as a principal place of

business, and periodically travels to other sites to meet with

clients or otherwise conduct their business, then these

traveling costs are deductible as a business expense. That

said, the taxpayer bears the burden of producing sufficient

evidence to show that his “principal place of business” is, in

fact, a home office. Browning v. Commissioner, 890 F.2d

1084, 1087 (9th Cir. 1989). Here, the Tax Court noted that

during the 1993 and 1994 tax years, Charles Reynolds

failed to claim a home office deduction. While failure to

claim the deduction alone does not settle the issue of the

traveling costs, the court also stated that Charles Reynolds

“offered no evidence and made no argument that his ‘prin-

cipal place of business’ was at his home.” Notwithstanding

conclusory assertions contained in the Reynolds’ brief, the

record, as we read it, wholly supports this assessment.

Therefore, we conclude that none of the Schedule C auto

and travel expenses are deductible.

18 No. 00-2966

D.

The final issue on appeal is whether the Tax Court erred

in upholding an accuracy-related penalty under 26 U.S.C.

§ 6662 for the negligent underpayment of income taxes. The

term “negligence” is defined by statute to include “any

failure to make a reasonable attempt to comply with the

provisions of this title.” § 6662(c). The 1993 implementing

regulation states:

The term negligence includes any failure to make a

reasonable attempt to comply with the provisions of the

internal revenue laws or to exercise ordinary and rea-

sonable care in the preparation of a tax return. “Negli-

gence” also includes any failure by the taxpayer to keep

adequate books and records or to substantiate items

properly.

26 C.F.R. § 1.662-3(b)(1) (1993). At the outset, we note that

a finding of negligence under § 6662 is a finding of fact that

we review for clear error. See Hayden v. Commissioner, 204

F.3d 772, 775 (7th Cir. 2000). In addition, determinations

of negligence by the Commissioner “are presumed to be

correct, and the taxpayer has the burden of proving that the

penalties are erroneous.” Id. (citing Welch v. Helvering, 290

U.S. 111, 115 (1933); Forseth v. Commissioner, 845 F.2d

746, 749 (7th Cir. 1988)).

The Reynolds attempt to rebut the presumption of cor-

rectness by claiming that they have satisfied the “good

faith” affirmative defense, which is also provided by statute.

The relevant provision states that no penalty shall be

imposed for underpayment of taxes if the taxpayer can

demonstrate “that there was a reasonable cause for such

portion and that the taxpayer acted in good faith with re-

spect to such portion.” 26 U.S.C. § 6664(c). The Treasury

Regulation that implements this statute further elaborates:

The determination of whether a taxpayer acted with

reasonable cause and in good faith is made on a case-

by-case basis, taking into account all pertinent facts

No. 00-2966 19

and circumstances. The most important factor is the

extent of the taxpayer’s effort to assess the taxpayer’s

proper tax liability. Circumstances that may indicate

reasonable cause and good faith include an honest

misunderstanding of fact or law that is reasonable in

light of the experience, knowledge and education of the

taxpayer.

26 C.F.R. § 1.6664-4(b)(1) (1993) (emphasis added). Here,

the “experience, knowledge and education” proviso is fatal

for Charles Reynolds, who is a licensed attorney, certified

public accountant and IRS audit supervisor.8

As evidence of good faith, the Reynolds argue that they

classified their 1993 and 1994 using the CCH Master Tax

Guide, which is a treatise containing annotations to rele-

vant statutes, regulations and case law. Assuming arguendo

that reliance on an established secondary source can be

the basis of a § 6664(c) good-faith defense, the Reynolds

fail to direct us to the specific passages of the CCH Master

Tax Guide upon which they reasonably relied.

The Reynolds next assert that their 1994 tax return was

prepared using a commercial software program called Turbo

Tax, which they claim is a “tax preparer” and is subject to

IRS penalties. See Rev. Rul. 85-187, 1985-2 C.B. 338 (stat-

ing that a firm “that furnishes a computerized tax return

preparation service to tax practitioners is an income tax

preparer when the program used goes beyond mere mechan-

ical assistance”). This argument, however, goes nowhere.

In order to demonstrate an “honest misunderstanding

of fact or law” under § 1.6664-4(b)(1), the Reynolds must

at least make the threshold showing that reliance on

Turbo Tax caused them to make substantive errors in their

8

During cross-examination at trial, Charles Reynolds stated that

he is a licensed CPA in the state of South Carolina. In addition,

Reynolds is now retired from the IRS.

20 No. 00-2966

tax preparation. Even then, the mere fact of reliance may

not be enough. See § 1.6664-4(b)(1) (1993) (“Reliance on

an information return or on the advice of a professional

(such as an appraiser, attorney or accountant) does not

necessarily demonstrate reasonable cause and good faith.”).

Finally, the Reynolds defend their failure to allocate their

automobile expenses to Schedules C, E and F as the “con-

sidered judgment of a tax professional who recognized that

absolutely NO tax impact flowed from the allocation itself.”

The gist of the Reynolds’ argument is that no tax conse-

quences flow from the apportionment of expenses between

the Schedules since they all constitute “above-the line”

deductions used to calculate adjusted gross income. Yet, the

fact that all the claimed deductions were above-the-line

obscures the more fundamental problem that a more precise

allocation was not made because the Reynolds’ business

records were not adequately organized and thorough. At

trial, Charles Reynolds stated that “[a] more rigorous ap-

plication of the allocation guidelines or the application of

the mileage guidelines between Schedules C, Schedules E

and Schedule F would have required a substantial amount

of work, okay, in terms of . . . tying the receipts back to

support the mileage in each of these items.” But without

making these allocations, the required elements of substan-

tiation under § 274(d) cannot be met. Because of his sub-

stantial education and experience in tax law and adminis-

tration, we must impute basic knowledge of the elements of

substantiation to Charles Reynolds. We therefore uphold

the § 6662(a) accuracy-related penalties in their entirety.9

9

The accuracy-related penalties are calculated in relation to

specific underpayments. However, with the exception of an unfo-

cused argument on auto and travel expenses, the Reynolds’s brief

did not make good-faith defense arguments directed at any

specific underpayment penalty. The fact that the Reynolds failed

(continued...)

No. 00-2966 21

III.

For the forgoing reasoning, the judgment of the Tax Court

is AFFIRMED.

A true Copy:

Teste:

________________________________

Clerk of the United States Court of

Appeals for the Seventh Circuit

9

(...continued)

to substantiate various travel expenses has no bearing on ac-

curacy-related penalties for an underpayment resulting from

other tax errors. For example, the Reynolds failed to make any

argument that a good-faith defense applied to Charles Reynolds’

legal defense fees, which were erroneously deducted during the

1993 and 1994 tax years. Without a reasoned analysis, we can-

not disturb the Commissioner’s negligence determination, which

is presumptively correct. See Hayden, 204 F.3d at 775.

USCA-97-C-006—7-18-02