JARAMILLO v. COMMISSIONER

T.C. Summary Opinion 2002-118

UNITED STATES TAX COURT

NATHAN JARAMILLO AND DAVINA METZGAR, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 1224-01S. Filed September 13, 2002.

Nathan Jaramillo and Davina Metzgar, pro se.

Dennis R. Onnen, for respondent.

COUVILLION, Special Trial Judge: This case was heard

pursuant to section 7463 of the Internal Revenue Code in effect

at the time the petition was filed.1 The decision to be entered

is not reviewable by any other court, and this opinion should not

be cited as authority.

1

Unless otherwise indicated, subsequent section

references are to the Internal Revenue Code in effect for the

years at issue. All Rule references are to the Tax Court Rules

of Practice and Procedure.

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Respondent determined deficiencies of $758, $1,710, and

$3,593 in petitioners' Federal income taxes, respectively, for

1997, 1998, and 1999, an addition to tax under section 6651(a)(1)

in the amount of $86 for 1998, and penalties under section

6662(a) in the amounts of $152, $342, and $719 for 1997, 1998,

and 1999, respectively.

Some of the facts were stipulated, and those facts, with the

annexed exhibits, are so found and are incorporated herein by

reference. At the time the petition was filed, petitioners'

legal residence was Albuquerque, New Mexico.

The issues for decision are: (1) Whether petitioners are

entitled to deductions for expenses incurred in a trade or

business activity during 1999; (2) whether petitioners are liable

for the addition to tax under section 6651(a)(1) for 1998; and

(3) whether petitioners are liable for the accuracy-related

penalties under section 6662(a) for each of the years in

question. In addition, the Court considers the applicability of

section 6673(a) to the facts of this case.

For the 3 years in question, petitioners itemized their

deductions on Schedule A, Itemized Deductions, of their returns.

In the notice of deficiency, respondent disallowed, for each of

the years in question, their itemized deductions for charitable

contributions and miscellaneous deductions, including

unreimbursed employee expenses and tax preparation fees. As a

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result of these adjustments, petitioners' remaining itemized

deductions for each of the years in question were less than the

standard deduction allowable under section 63(c); consequently,

respondent allowed petitioners the standard deduction for each

year. At trial, petitioners agreed that the disallowed

deductions claimed on their returns exceeded the actual amounts

they had incurred for contributions and miscellaneous expenses

and further agreed that the actual amounts they had incurred in

these two categories together with the other allowed deductions

would total less than the standard deduction for each year.

Petitioners, therefore, conceded respondent's adjustments to

their itemized deductions for the 3 years in question.

Petitioners were both employed in the years at issue at the

Isleta Casino and Resort near Albuquerque, New Mexico. In

addition, only for the year 1999, petitioners were engaged in a

trade or business activity that they described as a multilevel

marketing activity involving sales of a health drink. The

activity was discontinued after 1 year.

The first issue addresses petitioners' multilevel sales

activity. On their 1999 Federal income tax return, petitioners

reported income and deducted expenses relating to this activity

on a Schedule C, Profit or Loss From Business, as follows:

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Gross receipts $2,599

Expenses:

Car and truck $1,067

Office expenses 2,147

Supplies 3,874

Travel 1,780

Meals and entertainment 178

Utilities 762 9,808

Loss $7,209

In the notice of deficiency, respondent disallowed the deductions

for all the expenses for lack of substantiation.

Petitioners did not maintain books and records of their

income and expenses related to this activity. At trial, they

presented what appears to be a computer printout of transactions

involving their distributors along with copies of bank statements

reflecting deposits and checks issued. This information does not

present a complete or even a partial picture of the operation.

It appears, from these records, that the sales activity

operations were commingled with petitioners' personal

transactions. Petitioners produced no records that would

substantiate any of the deductions claimed, nor were any logs

maintained to support the travel and meals and entertainment

expense deductions claimed.

Section 162(a) allows a deduction for the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on a trade or business. A taxpayer is required to

maintain records sufficient to establish the amount of income and

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expenses incurred in connection with a business activity. Sec.

6001; sec. 1.6001-1(a), Income Tax Regs. Moreover, in the case

of travel expenses and certain other expenses, such as

entertainment, gifts, and the use of listed properties under

section 280F(d)(4)(A), section 274(d) imposes stringent

substantiation requirements to document more particularly the

nature and amount of such expenses. Petitioners' records that

were submitted into evidence do not suffice to substantiate the

expenses claimed on their returns, including those expenses that

would be subject to section 274(d). The Court recognizes that

petitioners realized gross income of $2,599 and certainly

incurred some expenses in the production of those gross receipts.

Except for expenses that are subject to substantiation under

section 274(d), where the Court is satisfied that expenses were

incurred in the production of income but the taxpayer has not

established the amount of the deduction, the Court is allowed to

estimate an allowable amount. Cohan v. Commissioner, 39 F.2d 540

(2d Cir. 1930). Pursuant to Cohan, the Court allows petitioners

a deduction of $450 for expenses related to their trade or

business activity for 1999. In all other respects, respondent is

sustained on this issue.

With respect to the second issue, the addition to tax under

section 6651(a)(1) for 1998, petitioners agreed that their return

for that year was not filed timely, and they presented no

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evidence that they had applied for or had been granted an

extension for the late filing of their return. Although

petitioners knew that their return had not been filed timely,

they were not concerned because their returns reflected an

overpayment of taxes. Section 6072(a) provides that income tax

returns must be filed on or before the 15th day of April

following the close of the taxable year, subject to exceptions

not applicable here, unless the failure to file timely is due to

reasonable cause and not due to willful neglect. Petitioners'

belief at the time their return was filed that they had overpaid

their taxes does not constitute reasonable cause for a late

filing on a deficiency subsequently determined by respondent.

E.g., Hintze v. Commissioner, T.C. Memo. 2001-70. Respondent,

accordingly, is sustained on this issue.

With respect to the accuracy-related penalties under section

6662(a), petitioners contend they should be absolved of liability

for the penalties because they relied on their income tax return

preparer. Petitioners' returns were prepared by Robin Beltran.2

Section 6662(a) provides for an accuracy-related penalty

equal to 20 percent of any portion of an underpayment of tax

required to be shown on the return that is attributable to the

taxpayer's negligence or disregard of rules or regulations. Sec.

2

This case is one of numerous cases heard by the Court

involving tax returns prepared by Mr. Beltran.

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6662(a) and (b)(1). Negligence consists of any failure to make a

reasonable attempt to comply with the provisions of the Internal

Revenue Code, and disregard consists of any careless, reckless,

or intentional disregard. Sec. 6662(c). The courts have refined

the Code definition of negligence as a lack of due care or

failure to do what a reasonable and prudent person would do under

similar circumstances. Allen v. Commissioner, 925 F.2d 348, 353

(9th Cir. 1991), affg. 92 T.C. 1 (1989). Section 1.6662-3(b)(1),

Income Tax Regs., provides that "Negligence is strongly indicated

where * * * a taxpayer fails to make a reasonable attempt to

ascertain the correctness of a deduction * * * on a return which

would seem to a reasonable and prudent person to be 'too good to

be true' under the circumstances".

An exception applies when the taxpayer demonstrates (1)

there was reasonable cause for the underpayment, and (2) the

taxpayer acted in good faith with respect to the underpayment.

Sec. 6664(c). Whether the taxpayer acted with reasonable cause

and in good faith is determined by the relevant facts and

circumstances. The most important factor is the extent of the

taxpayer's effort to assess the proper tax liability.

Stubblefield v. Commissioner, T.C. Memo. 1996-537; sec. 1.6664-

4(b)(1), Income Tax Regs. Under section 1.6664-4(b)(1), Income

Tax Regs., "Circumstances that may indicate reasonable cause and

good faith include an honest misunderstanding of fact or law that

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is reasonable in light of all of the facts and circumstances,

including the experience, knowledge, and education of the

taxpayer." Moreover, a taxpayer is generally charged with

knowledge of the law. Niedringhaus v. Commissioner, 99 T.C. 202,

222 (1992). Although a taxpayer is not subject to the addition

to tax for negligence where the taxpayer makes honest mistakes in

complex matters, the taxpayer must take reasonable steps to

determine the law and to comply with it. Id.

Under certain circumstances, a taxpayer may avoid the

accuracy-related penalty for negligence where the taxpayer

reasonably relied on the advice of a competent professional.

Sec. 1.6664-4(b)(1), Income Tax Regs.; see sec. 6664(c); Freytag

v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011

(5th Cir. 1990), affd. 501 U.S. 868 (1991). However, reliance on

a professional adviser, standing alone, is not an absolute

defense to negligence; it is only one factor to be considered.

In order for reliance on a professional adviser to relieve a

taxpayer from the negligence penalty, the taxpayer must establish

that the professional adviser on whom he or she relied had the

expertise and knowledge of the relevant facts to provide informed

advice on the subject matter. Freytag v. Commissioner, supra at

888.

Petitioners made no effort to ascertain the professional

background and qualifications of their return preparer. They

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knew that their claimed deductions were not based on the amounts

they actually expended. That circumstance should have prompted

petitioners to determine whether such representations by their

return preparer were correct. They did not consult other tax

professionals to verify the accuracy of the returns prepared by

Mr. Beltran or the representations he made to them regarding

their deductions. The Court is satisfied from the record that

Mr. Beltran knew, or had reason to know, all the relevant facts

upon which, had he been a qualified professional, he could have

accurately advised petitioners on the amount of their allowable

deductions. Mr. Beltran listed unrealistic amounts as deductions

on petitioners' returns, which they conceded at trial.

Petitioners knew they were required under the law to substantiate

deductions claimed on their returns. The circumstances should

have prompted them to look beyond and ascertain the accuracy of

their preparer's representations. Petitioners, therefore, made

no effort to assess their tax liabilities correctly. On this

record, the Court sustains respondent on the section 6662(a)

accuracy-related penalties for the years in question.

Section 6673(a) authorizes the Court to require a taxpayer

to pay to the United States a penalty not exceeding $25,000 when,

in the Court's judgment, proceedings have been instituted or

maintained by the taxpayer primarily for delay or where the

taxpayer's position in the proceeding is frivolous or groundless.

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At trial, petitioners recognized that their disallowed itemized

deductions were false and could not be sustained. They conceded

those adjustments. Petitioners knew that they could deduct only

amounts that they had actually paid. They made no attempt to

determine the qualifications of their return preparer and,

moreover, did not seek other professional advice to satisfy the

accuracy of their returns. Petitioners cited no legal authority

to the Court that, under similar facts, would exonerate them from

the penalties under section 6662(a). Prior to Mr. Beltran's

preparation of petitioners' returns, petitioners prepared drafts

of their returns, which they presented to Mr. Beltran. On these

drafts, petitioners did not claim itemized deductions. Mr.

Beltran's arrangement with petitioners was that his tax

preparation fees would be 10 percent of the refunds calculated on

the returns prepared by him to the extent such refunds exceeded

the refunds calculated by petitioners on the drafts of their

returns. Mr. Beltran represented to petitioners that records

were not necessary to substantiate deductions, and they were

entitled to deductions based on a percentage of their income. He

further advised petitioners not to respond to inquiries of

respondent with regard to their returns, including respondent's

counsel in preparation of this case for trial. Petitioners

adhered to that advice and only in the few days before trial did

they submit one document that was grossly inadequate to

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substantiate expenses claimed on the returns. The notice sent to

petitioners from the Court setting this case for trial called to

the parties attention the requirement that the parties contact

each other promptly and cooperate fully in the preparation and

presentation of the case. Petitioners' failure to do this,

pursuant to Mr. Beltran's advice, satisfies the Court that

petitioners instituted and maintained this proceeding primarily

for delay.

The function of this Court is to provide a forum to decide

issues relating to liability for Federal taxes. Any reasonable

and prudent person, under the facts presented to the Court,

should have known that petitioners' claimed deductions could not

have been sustained, and petitioners knew that. This Court does

not and should not countenance the use of this Court as a vehicle

for disgruntled litigants to proclaim the wrongdoing of another,

their return preparer, as a basis for relief from penalties that

were determined by respondent on facts that clearly are not

sustainable. Golub v. Commissioner, T.C. Memo. 1999-288.

Petitioners, therefore, have interfered with the Court's function

to the detriment of other parties having cases with legitimate

issues for the Court to consider. Petitioners have caused

needless expense and wasted resources, not only for the Court,

but for its personnel, respondent, and respondent's counsel.

Under these circumstances, the penalty under section 6673 is

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warranted, and petitioners will be ordered to pay a penalty of

$500 to the United States under section 6673(a).

Reviewed and adopted as the report of the Small Tax Case

Division.

Decision will be entered

under Rule 155.