The opinion
T.C. Memo. 2010-209
UNITED STATES TAX COURT
DAISY T. WHITAKER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 31355-08. Filed September 23, 2010.
Jeffrey Weiss, for petitioner.
Matthew Carlson, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined a deficiency of
$259,596 and an accuracy-related penalty pursuant to section
6662(a) of $51,919 with respect to petitioner’s 2003 Federal
income tax.1
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1986, as amended, and all Rule
(continued...)
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The issues for decision after concessions are: (1) Whether
petitioner understated gross receipts from her mortgage broker
business reported on Schedule C, Profit or Loss From Business, by
$237,156; (2) whether petitioner is entitled to certain
deductions claimed on Schedule C; (3) whether petitioner
understated her long-term capital gain from the sale of real
property by $68,278; (4) whether petitioner is entitled to
certain rental deductions claimed on Schedule E, Supplemental
Income and Loss; (5) whether petitioner is entitled to a net
operating loss (NOL) deduction of $32,345; and (6) whether
petitioner is liable for a section 6662(a) penalty.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the supplemental stipulation of
facts, together with the attached exhibits, are incorporated
herein by this reference.
At the time she filed her petition, petitioner resided in
California. During 2003 petitioner operated a mortgage broker
business in Monteca, California. The name of petitioner’s
business was Whitaker Real Estate and Financial Services.
Petitioner also operated a branch of her business in Pleasonton,
California.
1
(...continued)
references are to the Tax Court Rules of Practice and Procedure.
Amounts are rounded to the nearest dollar.
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Petitioner maintained four bank accounts. The first two
accounts were checking accounts held in her name with Washington
Mutual Bank. The third account was a joint checking account held
with Ernesto Talusan at Washington Mutual Bank. The final
account was a checking account held with Cal Fed/Citibank. This
account was used for the Pleasonton branch of petitioner’s
business. The manager of the Pleasonton branch, Cody Thai, was a
signatory and had full access to this account.
Throughout 2003 deposits were made in each account totaling
a combined $850,634 and petitioner received cash back that was
not deposited into her accounts totaling $31,607. Petitioner
reported Schedule C gross receipts from her mortgage business for
2003 of $289,011 and rents received of $50,090. Further, on Form
4797, Sales of Business Property, attached to her 2003 return,
petitioner reported a long-term capital gain of $44,601 with
respect to the sale of real property at 215 Vista Grande Avenue
in Daly City, California. Petitioner purchased this property on
December 15, 2001, for $445,000 and sold it on December 24, 2003,
for $565,000. Petitioner paid $24,118 in closing costs and
reported an adjusted basis in the subject property at the time of
sale of $520,399.
Petitioner kept records of transactions related to her
business through transactional software and Quicken accounting
software. The transactional software was used to write offers
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and draft mortgage documents. The Quicken accounting software
was used to record payments and expenses and to issue checks.
The logging of income and expenses was done weekly when there
were property closings and then again at the end of each month
when bank statements were received. Petitioner testified at
trial that she also kept books for each rental property and an
envelope for each month.
On September 19, 2008, respondent sent petitioner a notice
of deficiency. Respondent determined that petitioner had
understated her Schedule C gross receipts for her mortgage
business for 2003 by $237,156. Respondent used the bank deposits
method of income reconstruction to determine the amount of
petitioner’s unreported income. Pursuant to this analysis,
respondent took into account deposits identified as nontaxable,
including check card credits, a small electronic deposit,
deposits from Cody Thai into the Cal Fed/Citibank account that
were traceable to his personal pizza business, debit card return
items, check reversals, cashier checks dated in 2002, transfers
from petitioner’s other bank accounts, a nontaxable Federal
refund, and proceeds from a real estate sale that were deposited
in 2003.
Respondent determined petitioner’s total unreported income
for tax year 2003 by removing these nontaxable items from the sum
of cumulative deposits in petitioner’s accounts and the cash back
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petitioner received during 2003 and further subtracting
petitioner’s reported taxable income
In addition to determining that petitioner had understated
her Schedule C gross receipts with respect to her mortgage
business for tax year 2003, respondent denied certain deductions
for Schedule C expenses claimed with respect to her business.
The disallowed Schedule C expenses comprised the following items:
Expense Amount
1
Car and truck expenses $10,230
Commissions and fees 99,369
Depreciation and section 179 16,082
Office expenses 19,472
Travel expenses 11,112
Business gifts 4,527
Total 160,792
1
In the notice of deficiency, respondent denied petitioner’s
claimed deductions for car and truck expenses of $19,689. In his
opening brief, however, respondent alleges that petitioner is not
entitled to a deduction of $10,230 for car and truck expenses.
The Court has not been able to determine which number is correct;
however, that number should be reflected in the assessed
deficiency.
Petitioner testified that at least a portion of her travel
expenses is attributable to a trip to Europe with friends that
she purchased as a gift to herself for her 50th birthday.
With respect to petitioner’s sale of real property at 215
Vista Grande Avenue in Daly City, California, respondent
determined petitioner’s adjusted basis in the property to be
$452,121, resulting in a long-term capital gain on the sale of
the property of $112,879, or $68,278 more than petitioner
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reported.2 Respondent further disallowed Schedule E rental
expense deductions of $121,893 and an NOL carryforward of $32,345
petitioner claimed for 2003.3
OPINION
I. Burden of Proof
Respondent’s determinations in the notice of deficiency are
presumed correct, and petitioner would ordinarily bear the burden
of proving that respondent’s determinations are incorrect. See
Rule 142(a)(1). Petitioner does not argue that the burden of
proof shifts to respondent pursuant to section 7491(a), nor has
she shown that the threshold requirements of section 7491(a) have
been met for any of the determinations at issue. Accordingly,
the burden of proof remains on petitioner to prove that
respondent’s determination of a deficiency in her income tax is
erroneous.
2
Respondent’s opening brief is inconsistent in its
references to petitioner’s understatement of her long-term
capital gain for 2003. Pages 3 and 28 refer to an understatement
of petitioner’s long-term capital gain of $78,278. On the other
hand, page 15 refers to an understatement of $68,228. Further,
on page 10 respondent stated petitioner’s adjusted basis in the
subject property to be $452,121, for a total gain on the sale of
the subject property of $112,879. We find the understatement to
be $112,879 less the $44,601 long-term capital gain petitioner
reported, or $68,278.
3
Respondent’s opening brief concedes that petitioner paid
real estate taxes of $21,867 for 2003, leaving in dispute
Schedule E rental expense deductions of $100,026.
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II. Schedule C Gross Receipts
If a taxpayer has not maintained business records or the
taxpayer’s business records are inadequate, the Commissioner is
authorized to reconstruct the taxpayer’s income by any method
that, in the Commissioner’s opinion, clearly reflects that
taxpayer’s income. Sec. 446(b); Parks v. Commissioner, 94 T.C.
654, 658 (1990); A.J. Concrete Pumping, Inc. v. Commissioner,
T.C. Memo. 2001-42. The Commissioner’s reconstruction need not
be exact, but it must be reasonable in the light of all the
surrounding facts and circumstances. A.J. Concrete Pumping, Inc.
v. Commissioner, supra.
The use of the bank deposits method of income reconstruction
has long been sanctioned by the courts. DiLeo v. Commissioner,
96 T.C. 858, 867 (1991), affd. 959 F.2d 16 (2d Cir. 1992). Bank
deposits are prima facie evidence of income. Id. at 868. The
bank deposits method assumes that all money deposited in a
taxpayer’s bank account during a given period constitutes taxable
income. Price v. United States, 335 F.2d 671, 677 (5th Cir.
1964). When the bank deposits method is employed, however, the
Commissioner must take into account any nontaxable source or
deductible expense of which he has knowledge. Id.
Nothing in the record indicates that respondent’s method of
calculating petitioner’s Schedule C gross receipts was erroneous
or unreasonable. Respondent conducted a detailed analysis of
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each of petitioner’s bank accounts for 2003. In determining
petitioner’s Schedule C gross receipts, respondent removed all of
petitioner’s deposits that were not subject to tax for 2003,
including all items in connection with Cody Thai’s pizza business
and all cashier’s checks dated before 2003.
Petitioner contends that respondent did not exclude certain
nontaxable items in determining her 2003 gross receipts,
including approximately $90,000 of additional deposits
attributable to Cody Thai and approximately $200,000 in cashier’s
checks that were converted from other accounts. Petitioner
testified at trial that because of a pending divorce in early
2002, her funds were in jeopardy of being misappropriated by her
estranged spouse. Accordingly, to protect these funds, she
claims that she began converting them into cashier’s checks for
future use. Petitioner has failed, however, to produce any
documentation or other evidence adequate to prove that any of the
deposits respondent included in the gross receipts of her
mortgage business are traceable to a nontaxable source.
Accordingly, we sustain respondent’s determination regarding
petitioner’s Schedule C gross receipts.
III. Schedule C Deductions
Deductions are a matter of legislative grace, and the
taxpayer must prove she is entitled to the deductions claimed.
Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
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(1934). Section 162(a) provides that “There shall be allowed as
a deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business”. Taxpayers are required to maintain records sufficient
to establish the amounts of allowable deductions and to enable
the Commissioner to determine the correct tax liability. Sec.
6001; Shea v. Commissioner, 112 T.C. 183, 186 (1999).
Items described in section 274 are subject to strict
substantiation rules. No deduction shall be allowed for, among
other things, traveling expenses, entertainment expenses, gifts,
and expenses with respect to listed property (including passenger
automobiles) “unless the taxpayer substantiates by adequate
records or by sufficient evidence corroborating the taxpayer’s
own statement”: (1) The amount of the expense or other item; (2)
the time and place of the travel, entertainment or use, or date
and description of the gift; (3) the business purpose of the
expense or other item; and (4) in the case of entertainment or
gifts, the business relationship to the taxpayer of the
recipients or persons entertained. Sec. 274(d).
If a factual basis exists to do so, the Court may in another
context approximate an allowable expense, bearing heavily against
the taxpayer who failed to maintain adequate records. Cohan v.
Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); see sec.
1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov.
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6, 1985). However, in order for the Court to estimate the amount
of an expense, the Court must have some basis upon which an
estimate may be made. Vanicek v. Commissioner, 85 T.C. 731, 742-
743 (1985). Without such a basis, any allowance would amount to
unguided largesse. Williams v. United States, 245 F.2d 559, 560-
561 (5th Cir. 1957). We may not use the Cohan doctrine, however,
to estimate expenses covered by section 274(d). See Sanford v.
Commissioner, 50 T.C. 823, 827 (1968), affd. per curiam 412 F.2d
201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary Income Tax Regs.,
supra.
A. Car and Truck Expenses
Passenger automobiles and any other property used as a means
of transportation are “listed property” as defined by section
280F(d)(4). Secs. 274(d)(4), 280F(d)(4)(A)(i). Accordingly, car
and truck expenses must satisfy the strict substantiation
requirements of section 274. Petitioner has provided entries
from the Quicken accounting software as evidence of car and truck
expenses incurred in 2003. These entries were made by petitioner
and do not provide sufficient evidence that such expenses were
actually incurred because she has not provided receipts or any
additional documentation supporting these expenses. Accordingly,
petitioner has failed to meet the substantiation requirements of
section 274, and we sustain respondent’s determination with
regard to the car and truck expenses.
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B. Commissions and Fees
Respondent determined that petitioner is entitled to deduct
only $51,071 of the $150,440 of Schedule C commissions and fees
claimed for 2003. Outside of entries from the Quicken accounting
software, petitioner has failed to provide any documentation of
these commissions and fees. Further, because petitioner has
failed to maintain adequate records, we do not have a basis for
estimating any costs in excess of those respondent permitted.
Accordingly, petitioner has failed to meet her burden of proof,
and we sustain respondent’s determination with regard to the
commissions and fees.
C. Depreciation and Section 179 Expenses
Subject to certain limitations, taxpayers purchasing
qualifying property may elect under section 179 to deduct the
cost of the property in the year the property is placed in
service. Qualifying section 179 property includes tangible
property that is depreciable under section 168 and is described
in section 1245(a)(3) or computer software that is depreciable
under section 167, but only if the property is acquired for use
in an active trade or business. Sec. 179(d)(1). The record does
not substantiate that petitioner placed in service during 2003
any section 179 property. Accordingly, petitioner has failed to
meet her burden of proof, and we sustain respondent’s
determination with regard to the section 179 expenses.
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D. Office Expenses
Petitioner has not introduced any evidence to substantiate
deductions claimed for office expenses in 2003. Further,
petitioner has not introduced any evidence outside of the Quicken
accounting software ledger to provide the Court with a basis for
estimating office expenses incurred as part of her trade or
business. Accordingly, we sustain respondent’s determination
with regard to the office expenses.
E. Travel Expenses
The heightened substantiation requirements of section 274
also apply to travel expenses. Sec. 274(d)(1). Petitioner
testified that her travel expenses included a trip to Europe with
her friends for her 50th birthday. Despite testifying that her
trip to Europe was in part for business, petitioner has not
provided any evidence of costs incurred during this trip for
purposes of her trade or business. Moreover, petitioner has not
provided any documentation to evidence any business-related
travel expenses in 2003. Accordingly, we sustain respondent’s
determination with regard to the travel expenses.
F. Business Gifts
The heightened substantiation requirements of section 274
also apply to gifts. Sec. 274(d)(3). Petitioner has not
introduced any evidence to support her claimed deduction for
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business gifts. Accordingly, we sustain respondent’s
determination with regard to the business gifts.
IV. Long-Term Capital Gain
The gain from the sale or other disposition of property is
the excess of the taxpayer’s amount realized over the property’s
adjusted basis. Sec. 1001(a). A taxpayer must establish the
basis of property for purposes of determining the amount of gain
or loss the taxpayer must recognize. “Proof of basis is a
specific fact which the taxpayer has the burden of proving.”
O’Neill v. Commissioner, 271 F.2d 44, 50 (9th Cir. 1959), affg.
T.C. Memo. 1957-193.
Petitioner provided little documentation in support of her
claimed basis in the property at 215 Vista Grande Avenue in Daly
City, California. In her statement supporting Form 4797 attached
to her 2003 tax return, petitioner calculated the basis of the
subject property by adding the following items to its original
purchase price: (1) “Credits to buyer” of $35,000; (2)
commissions of $13,250; (3) closing costs of $5,955; (4) capital
improvements of $14,600; and (5) additional closing costs on
purchase of $12,100. Petitioner further provided a “seller final
closing statement” showing certain costs and fees associated with
the sale of the subject property. Of the costs petitioner listed
in her statement supporting Form 4797, only closing costs
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totaling $24,118 are supported by the “seller closing final
statement.”
Petitioner did not testify to, and did not provide any
documentation to support, the other components of her claimed
basis. In fact, in petitioner’s opening post trial brief, she
does not dispute respondent’s determination regarding her long-
term capital gain from the sale of the subject property and fails
to acknowledge the issue. Accordingly, petitioner has failed to
carry her burden of proof, and we sustain respondent’s
determination with regard to the long-term capital gain.
V. Schedule E Rental Expenses
Respondent alleges that petitioner has failed to
substantiate her Schedule E rental expenses outside of payments
totaling $21,867 for real estate taxes with respect to four
properties. We agree. The record is devoid of any credible
evidence that substantiates petitioner’s Schedule E rental
expenses for which she claims deductions and which have not been
conceded by respondent.
With respect to mortgage interest deductions claimed on
Schedule E, the only documentation petitioner provided is the
Quicken accounting software ledger. Petitioner testified that
she kept books for each rental property and an envelope for each
month; however, she has not produced these records for the Court.
Accordingly, petitioner has not met her burden of proof, and we
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sustain respondent’s determination with respect to the Schedule E
rental expenses.
VI. Net Operating Loss
Petitioner bears the burden of establishing both the
existence and amount of NOL carrybacks and carryforwards. Rule
142(a); Keith v. Commissioner, 115 T.C. 605, 621 (2000); Lee v.
Commissioner, T.C. Memo. 2006-70. We may consider facts relating
to years not in issue that are relevant to the claimed NOLs.
Sec. 6214(b). The only evidence petitioner has presented in
support of her claimed NOL carryforward was her 2001 and 2002
Federal income tax returns. Her tax returns only set forth her
claim to the NOL and do not establish her entitlement thereto.
See Roberts v. Commissioner, 62 T.C. 834, 837 (1974). The fact
that a return is signed under penalty of perjury is not by itself
sufficient to substantiate deductions claimed on the return.
Wilkinson v. Commissioner, 71 T.C. 633, 639 (1979); Emerson v.
Commissioner, T.C. Memo. 2001-186. Accordingly, petitioner has
not met her burden of proof, and we sustain respondent’s
determination with respect to the NOL.
VII. Section 6662(a) Penalty
Section 6662(a) and (b)(2) imposes an accuracy-related
penalty upon any underpayment of tax resulting from a substantial
understatement of income tax. The penalty is equal to 20 percent
of the portion of any underpayment attributable to a substantial
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understatement of income tax. Id. The term “substantial
understatement” is defined as exceeding the greater of: (1) 10
percent of the tax required to be shown on the return for the
taxable year or (2) $5,000. Sec. 6662(d)(1)(A). Section 6662(a)
and (b)(1) also imposes a penalty equal to 20 percent of the
amount of an underpayment attributable to negligence or disregard
of rules or regulations. Negligence includes any failure to make
a reasonable attempt to comply with the provisions of the
Internal Revenue Code, including any failure to maintain adequate
books and records or to substantiate items properly. Sec.
6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.
Petitioner’s failure to produce records substantiating her
Schedule C gross receipts, Schedule C deductions, long-term
capital gain, Schedule E rental expenses, and NOL carryforward
supports the imposition of the accuracy-related penalty for
negligence for 2003. The applicability of section 6662(b)(2)
will depend on the magnitude of the understatement of tax as
calculated under Rule 155. If petitioner’s understatement of
income tax as calculated under Rule 155 exceeds the greater of
$5,000 or 10 percent of the tax required to be shown on the
return in 2003, respondent will have met his burden of production
under section 7491(c). If not, respondent will have failed to
meet his burden of production under section 7491(c).
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An accuracy-related penalty is not imposed on any portion of
the underpayment as to which the taxpayer acted with reasonable
cause and in good faith. Sec. 6664(c)(1). The taxpayer bears
the burden of proof with regard to those issues. Higbee v.
Commissioner, 116 T.C. 438, 446 (2001). Petitioner has failed to
show reasonable cause, substantial authority, or any other basis
for reducing the penalties. Accordingly, pending a final
calculation of petitioner’s understatement under Rule 155, we
find petitioner liable for the section 6662 penalty for 2003 as
commensurate with respondent’s concessions and our holding. See
id.
In reaching our holdings herein, we have considered all
arguments made, and, to the extent not mentioned above, we
conclude they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.