The opinion
T.C. Summary Opinion 2011-23
UNITED STATES TAX COURT
ABDUL MED BANGURA, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 28777-09S. Filed March 8, 2011.
Abdul Med Bangura, pro se.
R. Jeffrey Knight, for respondent.
JACOBS, Judge: This case was heard pursuant to the
provisions of section 7463 of the Internal Revenue Code in effect
when the petition was filed. Pursuant to section 7463(b), the
decision to be entered is not reviewable by any other court, and
this opinion shall not be treated as precedent for any other
case.
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Respondent determined a deficiency of $33,626 in
petitioner’s Federal income tax, an addition to tax under section
6651(a)(1) of $3,431.60, and an accuracy-related penalty under
section 6662(a) of $6,725.60, for 2007. After concessions, the
issues remaining for decision are: (1) Whether petitioner is
entitled to deduct certain business expenses as reported on
Schedule C, Profit or Loss From Business; (2) whether petitioner
underreported Schedule C gross receipts by $73,036; (3) whether
petitioner is liable for an addition to tax pursuant to section
6651(a)(1); and (4) whether petitioner is liable for the section
6662(a) accuracy-related penalty.
All section references are to the Internal Revenue Code in
effect for 2007, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. Petitioner resided in
Maryland when the petition was filed.
Petitioner received a master’s degree in accounting and
taxation from Southeastern University in Washington, D.C., and is
a certified public accountant (C.P.A.). In 2007 he was licensed
in Maryland. During 2007 petitioner was the owner and sole
proprietor of AMB CPA Services, which provided tax preparation
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services for 75 to 100 clients. Petitioner is currently pursuing
a law degree.
Petitioner filed his 2007 Form 1040, U.S. Individual Income
Tax Return, on June 13, 2008, almost 2 months after it was due,
computing his tax using a filing status of “Married filing
separately”.1 He did not file Form 4868, Application for
Automatic Extension of Time To File U.S. Individual Income Tax
Return, and the record does not indicate that he otherwise
requested an extension of time to file his 2007 income tax
return. On his 2007 income tax return petitioner reported net
business income of $4,885, the difference between the reported
Schedule C gross receipts of $28,500 and the claimed Schedule C
business expenses of $23,615. The claimed business expenses
consisted of $6,800 for business supplies, $2,750 for “other
expenses”, and $14,065 for car and truck expenses.
On Schedule A, Itemized Deductions, petitioner deducted
$37,984, consisting of $5,142 for State and local taxes paid and
$32,842 for mortgage interest paid. In the notice of deficiency,
respondent disallowed the claimed Schedule A deductions on the
1
Petitioner’s wife timely filed a Form 1040 for 2007. The
return, which petitioner prepared, applied head of household
filing status, and zero taxable income was reported thereon. On
the return petitioner’s wife claimed entitlement to an earned
income credit of $1,465 and a child tax credit of $2,000.
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basis of petitioner’s failure to substantiate that he incurred
and/or paid such expenditures.2
Respondent, acting through Revenue Agent James C. Brown (the
examining agent), began an examination of petitioner’s 2007
income tax return in June 2008, as a compliance check, at the
conclusion of the audit of petitioner’s 2004, 2005, and 2006
income tax returns. In doing so, the examining agent noticed
that the relatively small amount of income petitioner reported on
his 2007 income tax return “did not support the itemized
deductions and the Schedule C expenses as stated on the tax
return.”
On June 19, 2008, after completing a financial status
analysis for 2007, the examining agent notified petitioner that
his 2007 income tax return was under examination. The examining
agent set up an initial appointment to discuss petitioner’s 2007
tax return and sent an Information Document Request (IDR) to him.
The IDR requested that petitioner provide books and records for
his tax return preparation business, including documents to
substantiate his claimed business expenses. The examining agent
wanted to discuss the IDR with petitioner at a manager’s
conference (which petitioner requested) relating to the
closing of the audit of his 2004, 2005, and 2006 tax returns.
2
Respondent concedes that petitioner is entitled to a
deduction of $4,956 for real estate taxes paid and a mortgage
interest deduction of $46,245, for a total of $51,201.
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The manager’s conference was scheduled for July 15, 2008, but at
petitioner’s request it was rescheduled to July 18. That
manager’s conference was canceled by petitioner. After
petitioner canceled the manager’s conference, the examining agent
closed the audit of petitioner’s 2004, 2005, and 2006 tax
returns, leaving open for examination the 2007 tax year.
In connection with the audit of his 2004, 2005, and 2006 tax
returns, petitioner told the examining agent that he was not
required to provide the Internal Revenue Service with any records
or documentation other than those which had been submitted with
his income tax returns. Indeed, petitioner never provided the
examining agent with documents of any kind with respect to years
2004, 2005, and 2006 during the audit for those years. Nor did
petitioner respond to the IDR for 2007.
On September 2, 2008, the examining agent (1) mailed
petitioner a second IDR for 2007, and (2) issued bank summonses
to obtain information with respect to two bank accounts known to
be held by petitioner. Petitioner filed a motion in Federal
court (the record does not reveal which Federal court) to quash
the summonses. That motion was denied. Thereafter the bank
complied with respondent’s summonses. The information the bank
provided was insufficient to show that petitioner received any
material amount of income during 2007. Of the two accounts
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summoned, one showed that it had been closed and the other showed
deposits of approximately $1,000.
Inasmuch as petitioner did not respond to the second IDR and
because the bank records were not “illuminating”, in December
2008 the examining agent mailed a third IDR for 2007 to
petitioner. Petitioner did not provide any information or
documentation in response to this IDR.
The examining agent then used the source and application of
funds method to reconstruct petitioner’s income for 2007,
applying the guidelines set forth in the Internal Revenue Manual
(IRM). The examining agent used this method to determine
petitioner’s income indirectly because the Schedule C business
expenses and claimed Schedule A itemized deductions exceeded the
income reported on petitioner’s 2007 income tax return.
The source and application of funds method reconstructs the
estimated amount of the taxpayer’s income by determining the
excess of the taxpayer’s expenditures for the year over his known
sources of income. The examining agent calculated petitioner’s
expenditures to be $101,536 by adding (1) petitioner’s Schedule A
deductions of mortgage interest and real estate taxes paid
totaling $51,201;3 (2) petitioner’s Schedule A State and local
3
As mentioned supra note 2, respondent conceded that
petitioner is entitled to Schedule A deductions totaling $51,201,
which is greater than the $37,984 claimed on petitioner’s 2007
tax return. The examining agent used this greater amount in
(continued...)
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tax deduction of $186; (3) petitioner’s Schedule C expenses for
business supplies and what petitioner listed as “other expenses”
totaling $9,550;4 and (4) an estimate of petitioner’s personal
living expenses for 2007 of $40,599. From the $101,536, the
examining agent subtracted $28,500, the amount petitioner
reported as Schedule C gross receipts. Thus, the examining agent
determined petitioner had an excess application of funds, i.e.,
unreported income for 2007, totaling $73,036 ($101,536 -
$28,500).
In estimating petitioner’s personal living expenses (e.g.,
food, housing, transportation, etc.) the examining agent used the
Bureau of Labor Statistics (BLS) Consumer Expenditure Survey (the
survey) for the south region, which is the region for Maryland.
The estimate for personal living expenses includes mortgage
interest expense, property taxes, and State and local taxes.
Because the examining agent used petitioner’s actual expenses
with respect to the mortgage interest, property taxes, and State
and local taxes, he subtracted the survey’s estimates for these
items from his calculation.
3
(...continued)
reconstructing petitioner’s 2007 income.
4
The examining agent did not include petitioner’s claimed
Schedule C car and truck expenses of $14,065 in his
reconstruction of petitioner’s income because there was a
possibility that depreciation (a noncash item) was included in
those expenses.
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Although the examining agent used the business expenses set
forth on Schedule C in reconstructing petitioner’s income, he
determined that deductions for these expenses should be
disallowed for lack of substantiation. The examining agent also
determined that for 2007 petitioner was liable for an addition to
tax pursuant to section 6651(a)(1) for failure to file a timely
return and an accuracy-related penalty pursuant to section
6662(a).
Discussion
I. Disallowed Deductions
Deductions are a matter of legislative grace, and taxpayers
bear the burden of proving that they are entitled to all
deductions claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner,
503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934). Moreover, taxpayers must substantiate the
amount and purpose of the item deducted. Hradesky v.
Commissioner, 65 T.C. 87, 89-90 (1975), affd. per curiam 540 F.2d
821 (5th Cir. 1976). Taxpayers are required to maintain records
that are sufficient to enable the Commissioner to determine their
correct tax liability. See sec. 6001; Meneguzzo v. Commissioner,
43 T.C. 824, 831-832 (1965); sec. 1.6001-1(a), Income Tax Regs.
Under certain circumstances, if a taxpayer establishes
entitlement to a deduction but not the amount of the deduction,
the Court may estimate the amount allowable, Cohan v.
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Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930), if the
taxpayer provides some rational basis on which an estimate may be
made, Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).
A. Business Supplies
Petitioner deducted Schedule C business supply expenses of
$6,800 on his 2007 income tax return. At trial petitioner
admitted he did not provide the examining agent with any
documentation that would substantiate any of the claimed
expenses. Nor did petitioner submit any substantiating documents
at trial.
Petitioner asserts that he was “frantically busy learning
how to establish and carry on a CPA practice but had little time
to document the expenses” and that his failure in this regard was
an “honest belief that the petitioner was not doing anything
wrong.” We do not find petitioner’s assertion credible.
Petitioner was a C.P.A. operating a tax preparation business. He
knew, or should have known, that a taxpayer is required to
substantiate all claimed deductions. Because petitioner failed
to provide any documentary evidence to substantiate the claimed
Schedule C business expenses, we have no reasonable basis on
which to estimate the amount of expenses he incurred.
Consequently, we sustain respondent’s disallowance of a deduction
for these expenses.
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B. “Other Expenses”
Petitioner deducted “other expenses” of $2,750 on Schedule
C. With respect to these expenses, petitioner stated: “Other
expenses of $2,750 may have been my, I think that has to do with
my enhanced educational [sic].” Petitioner was unable to recall
the exact nature of the educational expenses but felt they
probably were for classes taken in pursuit of a law degree.
Petitioner failed to substantiate these expenses. Again, we
have no reasonable basis on which to estimate the amount of
expenses petitioner incurred. Moreover, even had petitioner
substantiated these expenses, educational expenses are not
deductible if they are part of a course of study that will
qualify the taxpayer in a new trade or business. Sec. 1.162-
5(b)(3), Income Tax Regs. Consequently, we sustain respondent’s
disallowance of the deduction for these expenses.
C. Car and Truck Expenses
Cars and trucks are “listed property” pursuant to section
280F(d)(4). “[L]isted property” is subjected to the heightened
substantiation requirements of section 274(d). Again, petitioner
provided no substantiation with respect to these expenses.
Indeed, petitioner was unclear as to whether he used his vehicle
for both business and personal use. Consequently, we sustain
respondent’s disallowance of a deduction for these expenses.
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II. Unreported Income
In determining the tax deficiency for 2007, the examining
agent reconstructed petitioner’s income using the source and
application of funds method.
Section 6001 requires all taxpayers to maintain sufficient
records to determine their correct tax liabilities. Where a
taxpayer fails to keep the required books and records, or if the
records the taxpayer maintains do not clearly reflect income, the
Commissioner is authorized by section 446 to reconstruct the
taxpayer’s income in accordance with a method that clearly
reflects the full amount of income received. Petzoldt v.
Commissioner, 92 T.C. 661, 686-687 (1989); Meneguzzo v.
Commissioner, supra at 831. The income reconstruction method
used need only be reasonable in light of all the surrounding
facts and circumstances. Petzoldt v. Commissioner, supra at 687.
The source and application of funds method is well accepted
as an appropriate method of reconstructing a taxpayer’s income.
United States v. Johnson, 319 U.S. 503, 517 (1943). This income
reconstruction method is based upon the assumption that the
amount by which a taxpayer’s cash expenditures during the year
exceed the taxpayer’s known sources of income is income unless
the taxpayer can show that the expenditures were made from a
nontaxable source of funds. A deficiency determined by the use
of this income reconstruction method is presumptively correct,
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and the burden of proof is upon the taxpayer to demonstrate
otherwise. DeVenney v. Commissioner, 85 T.C. 927, 930-931
(1985). To meet his burden, the taxpayer must prove either that
someone else made the expenditures or that the funds used were
obtained from a nontaxable source such as a loan, an inheritance,
or assets on hand at the beginning of the year. Id. at 931.
In Holland v. Commissioner, 348 U.S. 121, 135-136 (1954),
the Supreme Court limited the Commissioner’s use of the net worth
method of reconstructing income by requiring the Commissioner to
track down relevant leads furnished by the taxpayer which are
reasonably susceptible of being checked and by requiring the
Commissioner to show that increases in net worth are attributable
to currently taxable income. This Court has held this limitation
to be applicable in cases involving the source and application of
funds method. DeVenney v. Commissioner, supra at 931. However,
in Meier v. Commissioner, 91 T.C. 273, 296 (1988), we stated:
Before the safeguards in Holland are triggered, * * *
[the taxpayer] must either explain the source of or provide
alternative nontaxable sources for the discrepancy in his
expenditures and his reported income. This explanation
commences respondent’s investigative requirements under
Holland. * * *
Petitioner testified that his wife helped pay the family
expenses. Yet a review of her tax return shows that she did not
have sufficient income to pay petitioner’s expenses.5 Moreover,
5
Petitioner’s wife’s 2007 tax return shows total income of
(continued...)
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even though petitioner’s wife was present in the courtroom, she
did not testify. Because she did not testify, we assume her
testimony would not have corroborated her husband’s testimony.
See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158,
1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947).
Petitioner presented no other source of income or
explanation. Instead he argued that he was able to get money by
“hustling and bustling”, and he testified: “If I stand here
right now to tell you exactly how I came through with all of
those monies, I would be, I am under oath, cautious of it * * *
but certainly lots of people helped.” On the record before us,
we conclude that the examining agent’s use of the source and
application of funds method was reasonable.
Petitioner objects to the examining agent’s use of the
survey to estimate his personal living expenses, asserting his
actual living expenses were less than the survey estimates and
therefore use of the survey is inappropriate. Petitioner refused
to provide the examining agent with documentation of his
expenses, which is the very reason the examining agent was forced
to rely on the survey to estimate petitioner’s personal living
expenses.
5
(...continued)
$32,918, tuition expenses of $4,000, State and local income tax
of $1,504, and unreimbursed employee expenses of $21,466. Thus,
petitioner’s wife had but $5,948 of disposable income for 2007.
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We have previously held that the Commissioner has “great
latitude” in determining a taxpayer’s tax liability, particularly
where the taxpayer refuses to cooperate. See Giddio v.
Commissioner, 54 T.C. 1530, 1533 (1970). With no other option
available, use of the survey to estimate petitioner’s personal
living expenses provides a reasonable estimate of his income.
Petitioner next asserts:
Respondent has not carried their [sic] burden of proving
that petitioner actually received the $101,000 because
respondent used a modified statistical method mixing average
Amounts [sic] for actual amounts in his use of the indirect
method Which [sic] has never been used in history of the
Treasury regulations * * *.
Thus, petitioner objects to the examining agent’s use of
petitioner’s actual expenses where available (i.e., his mortgage
interest expense, his real estate tax expense, and his State and
local tax expense) as opposed to estimates used in the survey.
We find petitioner’s assertion unpersuasive. The IRM states
that BLS data (i.e., the survey) may be used to reconstruct
income and that this statistical data may be used in conjunction
with other available information, including information from a
taxpayer’s tax return. IRM pt. 4.10.4.6.1.3.1(1) (Sept. 11,
2007). The IRM provides that statistical data should be used as
the sole source of information only when all three of the
following conditions are met: (a) The taxpayer produces income
other than as an employee; (b) the taxpayer is a nonfiler; and
(c) the taxpayer is uncooperative. Id. Condition (b) is not
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herein present. Thus, the examining agent was obliged by the IRM
to use petitioner’s known actual expenses in reconstructing his
income. We find respondent’s use of both the personal living
expense estimates (as set forth in the survey) and petitioner’s
actual expenses reasonable under the circumstances.
However, the examining agent erred to an extent in
calculating petitioner’s cash expenditures (i.e., the application
of funds). The examining agent disallowed the amounts petitioner
claimed on Schedule C for business supplies and “other expenses”,
$6,800 and $2,750, respectively, a total of $9,550,6 because
petitioner failed to substantiate these expenses. But the
examining agent used these disallowed unsubstantiated amounts in
determining petitioner’s cash expenditures. We believe it was
not reasonable for the examining agent to disallow expenses for
lack of substantiation on the one hand and then, on the other
hand, claim that those unsubstantiated amounts reflect
petitioner’s expenditures. See Cheesman v. Commissioner, T.C.
Memo. 1994-509.7 Consequently, we hold that the examining agent
may not use petitioner’s disallowed Schedule C expenses to
6
As noted supra note 4, the examining agent did not include
petitioner’s claimed car and truck expenses in his reconstruction
of petitioner’s income.
7
In Cherry v. Commissioner, T.C. Memo. 1998-360, the
Commissioner conceded at trial that a proper reconstruction of
the taxpayer’s income using the source and application of funds
method would not include any deductions claimed by the taxpayer
but disallowed by the Commissioner.
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reconstruct his income. Because of this error, respondent must
recalculate petitioner’s 2007 unreported income. This can be
done in the Rule 155 computation.
III. Addition to Tax Under Section 6651(a)(1)
Section 6651(a)(1) imposes an addition to tax for a
taxpayer’s failure to timely file an income tax return unless the
failure to file is due to reasonable cause and not willful
neglect. This addition to tax consists of adding to the amount
required to be shown as tax on the return 5 percent of the amount
of such tax for each complete or partial month in which the
failure to file continues, up to a maximum of 25 percent in the
aggregate. Id. Respondent has the burden of production pursuant
to section 7491(c). To satisfy that burden, respondent must
produce sufficient evidence demonstrating that it is appropriate
to impose the addition to tax. See Higbee v. Commissioner, 116
T.C. 438, 446 (2001). Once respondent has met his burden of
production, petitioner must come forward with evidence sufficient
to persuade the Court that respondent’s determination is
incorrect. Id. at 447.
Respondent has satisfied his burden of production. The
record clearly reflects that petitioner did not timely file his
2007 income tax return. And petitioner has not demonstrated that
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his failure to timely file his 2007 income tax return was due to
reasonable cause8 and not due to willful neglect.
Petitioner asserts that he filed late because respondent was
auditing his 2004, 2005, and 2006 tax returns and “in my view, if
these people were going hunting or fishing towards me, or
whatever is motivating them, I’ll wait until there is a
resolution on those audits before I file my tax return for 2007.”
Petitioner’s assertion that he delayed filing until the examining
agent completed auditing his 2004, 2005, and 2006 tax returns,
even if relevant, does not constitute reasonable cause. See
Glowinski v. Commissioner, 25 T.C. 934, 936 (1956), affd. 243
F.2d 635 (D.C. Cir. 1957). Petitioner is therefore liable for
the section 6651(a)(1) addition to tax. However, respondent must
recompute the amount of the addition to tax to reflect the
recalculation of petitioner’s 2007 unreported income. This can
be done in the Rule 155 computation.
IV. Section 6662(a) Accuracy-Related Penalty
Section 6662(a) imposes a 20-percent penalty on the portion
of an underpayment of tax attributable to, inter alia, negligence
or disregard of rules or regulations, as provided in section
6662(b)(1); or a substantial understatement of income tax, as
8
Reasonable cause requires a taxpayer to demonstrate that he
exercised ordinary business care and prudence but nonetheless was
unable to file a return within the prescribed time. United
States v. Boyle, 469 U.S. 241, 245-246 (1985); Bruner v.
Commissioner, T.C. Memo. 1998-246.
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provided in section 6662(b)(2). Negligence includes any failure
to make a reasonable attempt to comply with the provisions of the
Internal Revenue Code. Sec. 6662(c). Negligence also includes
any failure by the taxpayer to keep adequate books and records or
to substantiate items properly. Sec. 1.6662-3(b)(1), Income Tax
Regs. The term “disregard” includes any careless, reckless or
intentional disregard. Sec 6662(c).
The section 6662(a) accuracy-related penalty does not apply
where the taxpayer shows that there was reasonable cause for the
underpayment and that he acted in good faith. Sec. 6664(c)(1).
Such a showing depends on the facts and circumstances of each
case and includes the knowledge and experience of the taxpayer
and the reliance on the advice of a professional, such as an
accountant. Sec. 1.6664-4(b)(1), Income Tax Regs.
Respondent has the burden of production pursuant to section
7491(c). To satisfy that burden, respondent must produce
sufficient evidence showing that it is appropriate to impose the
penalty. See Higbee v. Commissioner, supra at 446. On the
record before us, respondent has satisfied his burden by
producing evidence that petitioner failed to keep books and
records and failed to substantiate his claimed deductions.
Petitioner has not demonstrated that there was reasonable
cause for the underpayment and that he acted in good faith.
Petitioner is a C.P.A. and holds a master’s degree in accounting
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and taxation. Yet when asked by the examining agent to provide
documentation to substantiate his claimed business expenses, he
failed to do so. Petitioner asserted that this was not
negligence; rather, “it’s more or less when you’re starting out
doing something, like a medical doctor doing operations or maybe
a lawyer representing somebody in the courtroom, you have a lot
to learn. You do make mistakes here and there.” We find
petitioner’s cavalier attitude unacceptable. This is not what a
reasonable person would do, particularly a C.P.A.
We hold petitioner liable for the section 6662(a) accuracy-
related penalty. However, respondent must recompute the penalty
according to our holding that there must be a recalculation of
petitioner’s 2007 unreported income. Again, this can be done in
the Rule 155 computation.
We have considered all of petitioner’s contentions that are
not discussed herein, and we conclude they are without merit,
irrelevant, and/or moot.
To reflect the foregoing and respondent’s concessions,
Decision will be entered
under Rule 155.