UNITED STATES TAX COURT

T.C. Memo.

2012-26

UNITED STATES TAX COURT

SUE AND PAUL COLVIN, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No.

5899-09.

Filed

anuary 30, 2012.

Joseph T. Bambrick, Jr., for.petitioners.

Gary C. Barton and Elizabeth Downs, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

MARVEL, Judge:

In two notices of deficien y dated

December 30, 2008, respondent determined the following

deficiencies with respect to petitioners' Federal income tax:

asa gD JAN 3 0 2012.

Year

Deficiency

Penalty"

Sec. 6662(a)

1993

1998

1999

$11,015

117,903

348,079

-0$23,580.60

69,615.80

In another notice of deficiency also dated December 30,

2008, respondent determined the following deficiencies with

respect to petitioner Sue Colvin's (Ms. Colvin) Federal income

tax:

Year

Deficiency

1994 .

1995

1996

$135,389

115,201

88,015

The disputed amounts1 relate to Ms. Colvin's sole

proprietorship Sioux Transportation (Sioux).

After concessions,

the issues for decision are:

1Petitioners do not assign error to all of réspondent's

determinations in the notices of deficiency. We deem any issue

not raised in the assignments of error in the petition conceded.

See Rule 34 (b) (4), Tax Court Rules of Practice aÄd Procedure.

In

addition, petitioners concede $55,924 of the adjustment to gross

receipts reported on the 1993 Schedule C, Profit or Loss From

Business, and respondent concedes the remaining $265,000 of'that

adjustment. Accordingly, the parties resolved all issues with

respect to 1993. Respondent concedes that the adjustment to

capital gain for 1999 should be ($20,122). All Eemaining

adjustments for all years at issue·are computational.

In the

petition, petitioners challenge interest on the deficiencies, but

by separate order entered sua sponte we shall dibmiss that part

of petitioners' case challenging interest, for lack of

jurisdiction. See sec. 6601(e) (1), which provides that interest

is excluded from the definition of "tax" for pufposes of sec.

6211(a).

See White v. Commissioner,

95 T.C.

209,

213

(1990).

(1) Whether Ms. Colvin is entitled to the deduction for

other expenses reported on her 1997 Schedule C,2 Profit or.Loss

From Business, and whether petitioners are er titled to the

deductions for other expenses reported on the 1998-99 Schedules

C;

(2) whether Ms. Colvin is entitled to decrease the Schedule

C gross receipts for 1997 by $97, 497, and whe her petitioners are

entitled to decrease the Schedule C gross receipts for 1999 by

$532, 741;

(3) whether petitioners are entitled to án additional

depreciation deduction of $55,648 for 1999; and

(4) whether petitioners are liable for t e section 6662 (a)

penalty for 1998 and 1999.3

FINDINGS OF FACT

The parties have stipulated some of the facts, which we

incorporate in our findings by this reference.

Petitioners

resided in Arkansas when they filed their petition.

Petitioners

were married during the years at issue and filed joint Federal

income tax returns for 1993 and 1998-99.

Ms. Colvin filed her

2Respondent did not issue a notice of deficiency for 1997.

However, in order to decide the issues raised by Ms . Colvin with

respect to 1994, we must also decide whether she is entitled to a

net operating loss carryback from 1997 in computing her 1994 tax

liability. See sec. 6214 (b) .

3Unless otherwise indicated, . section references are to the

Internal Revenue. Code in effect for the years at issue, and Rule

references are to the Tax Court Rules of Practice and Procedure.

- 4 -

1994-97 Federal income tax returns with the filinge status of

married filing separately.

Petitioners were divorbed at the time

of trial.'

During the years at issue Ms. Colvin operated Sioux, an ,

interstate trucking company based in Springdale, Arkansas.

In

1999 Ms. Colvin also operated STI, Inc., a C corporation, which

was a trucking company also operating out of Springdale,

Arkansas.

Sioux received revenue from hauling lodds.

In 1999

Sioux also received revenue from leasing trucks to STI, Inc.

Sioux had two types of arrangements with truck drivers.

In

some years Sioux leased trucks from owner-operators, but in later

years Sioux owned trucks.

In some years, such asa1995, both

arrangements were in place.

Sioux paid drivers per diem for

their expenses, including meals, motels, and othek expenses.

Sioux calculated per diem amounts on the basis of the number of

travel days.

Those amounts were recorded in payroll books.that

indicated travel dates but not destinations.

Besides the payroll books, Sioux had the foltlowing records

system.

Each load received a trip number that was listed in a

load book.

The drivers brought bills of lading 60 the office.

40nly Ms. Colvin was present at trial. Under the divorce

settlement, Ms. Colvin is responsible for the deficiencies.

Petitioner Paul Colvin was aware of the proceedihg and chose not

to participate.

When customers paid their bills, a Sioux employee posted the

payment in the load book .

Sioux operated on the cash basis method of accounting.

Wilson & Jackson, an accounting firm, prepared the 1993-94

returns .

Until 1998 Sioux did not have a bo kkeeper, so Ms .

Colvin totaled Sioux's gross receipts and expenses,and delivered

the information, along with Sioux's. checkbooks, to the return

preparer.

Starting with the 1995 return, Rita Wilks

(Ms . Wilks)

prepared Ms. Colvin's and petitioners' Federal income tax returns

from information Ms. Colvin furnished.

For the 1995-96 returns,

Ms . Colvin totaled all the business checks that she had written

and that had cleared the bank and gave Ms. Wilks the totals.

She

also provided Ms. Wilks a list of all expenses by category and a

statement of the total revenue .

For the depreciation schedule,

Ms . Colvin provided an equipment list .

Sometime in 1998, but before the preparation of the 1997

return, Ms. Wilks became an outside bookkeeper for Sioux.

She

used checkstubs, deposit books, bank statementis, payroll books,

and payroll reports to prepare the general ledger and profit and

loss statements for 1997-99.

She then used the bookkeeping

records to prepare the 1997-99 returns.

Procedural Background

042

On a date that does not appear in the record the Internal

Revenue Service (IRS) commenced an audit of petitibners' and Ms.

Colvin's 1993-96 returns.

In December 2000 Ms. Colvin retained

Bruce Loch (Mr. Loch), who represented petitionersi throughout the

audit.

Mr. Loch reviewed cash receipts and disbuÈsement records,

general ledgers, trip reports, payroll, and other related items

pertaining to 1993-96 and prepared a report.

Subsequently, the

IRS extended the audit to include 1997-99.

Mr. Loch reviewed the

records related to 1997-99 and participated in the audit with

respect to those years.

After respondent issued the notices of

deficiency, Mr. Loch reviewed them and prepared a summary report

of his findings.

.Petitioners filed a timely petition with this

Court.

After the case was calendared for trial, petitioners mailed

to the Court a letter requesting us to accept an expert report

prepared by Mr. Loch.

The proffered report purports to summarize

Mr. Loch's findings on the basis of his review of the notices of

deficiency.

In his report Mr. Loch reviews examination changes

proposed at various stages of the audit and describes

developments during the Appeals process.

For every year at issue

he opines "within a reasonable degree of accounting certainty" on

whether specific adjustments in the notice of deficiency were

il

Il

appropriate and on what the income tax changes and tax

liabilities should be.

Respondent filed a motion in limine seeking to exclude Mr.

Loch' s report and testimony.

Respondent contended that the

report did not comply with Rule 143 (g) , improperly addressed

legal arguments and advocated for petitioners, and was not

helpful to the Court.

Respondent also object d to the report

because it addressed matters before· the issuance of the notice of

deficiency.

Petitioners filed an opposing motion to strike.

During the calendar call we held a hearing on the motions .

We granted respondent's motion for·the reasons stated therein and

denied petitioners' motion.

We did not admit Mr. Loch's report

into evidence as an expert report and did not permit Mr. Loch to

testify as an expert witness.

Before trial the parties submitted to the Court a

stipulation of facts accompanied by 15 joint exhibits, which

included the notices of deficiency; a Form 5278, Statement-Income Tax Changes, for 1997; petitioners' Federal income tax

returns for 1993-99; Sioux's general ledgers for 1997 and 1999;

and a Form 1120, U.S. Corporation Income Tax Return, for 1999 and

the general ledger for 1999 of.STI, Inc.

Petitioners did not

identify which entries in Sioux's general ledgérs pertained to

Sioux's deductions for 1997 and 1999 and introduced no" credible

evidence to substantiate Sioux's deductions claimed on their

returns that respondent disallows.

Instead, petitioners called

Mr. Loch to testify as a fact witness, which we allowed.

Petitioners' counsel Joseph T. Bambrick, Jr.

(Mr. Bambrick),

insisted that Mr. Loch had participated in the audit, which in

his view was not different from preparing a return, and had

reviewed Sioux's business records.

Mr. Loch testified that he became involved in this case in

December 2000 when Ms. Colvin retained him to review the revenue

agent's report and that he reviewed the revenue agent's report

for 1993-96 and Sioux's books and records for 1993-99.

Respondent objected on the ground of relevancy, and we sustained

the objections.

We explained to Mr. Bambrick, among other

things, that Mr. Loch's testimony does not prove whether

respondent's adjustments were incorrect because Mr. Loch had no

firsthand knowledge regarding the relevant facts.

Petitioners'

counsel then stated that the records had been destroyed as a

result of a flood.

We permitted Mr. Loch to proceed with his testimony but

explained to petitioners' counsel that Mr. Loch's.testimony to

the extent it attempted to substitute for business records was

lj

not helpful to the Court.

We then permitted petitioners' counsel

to proffer additional testimony of Mr. Loch.

Mri. Bambrick'.s

proffer of Mr. Loch's testimony revealed that the testimony would

show a transpositional error by the auditor and its effect on

other years and would address "supporting documents and the basis

for the various objections that the Service has", and "pure

accounting items."

Mr. Loch, however, then stated that the

transpositional error had been corrected in the notices of

deficiency that were before the Court.

Petitioners again

attempted to.introduce Mr. Loch'.s report into evidence as an

expert report or as a factual report.

Consistent with the ruling

regarding the motion in limine, we did not admit the report in

evidence.

We·explained to petitioners' counsel that identifying

accounting issues in the notices of deficiency, as opposed to

presenting credible evidence of the deductions that petitioners

claimed,

is not helpful to the Court.

OPINION

I.

. Burden of Proof

The Commissioner's determinations in a notice of deficiency

are presumed correct, and the taxpayer generaîly.bears the burden

of showing they are erroneous.

290 U.S.

111,

115

Rule 142(a); Welch v. Helvering,

(1933).. Moreover, deductio s are a matter of

legislative grace, and the taxpayer bears the burden of proving

that he is entitled to any deduction claimed.

Commissioner,

503 U.S.

of substantiation.

87,

89

(1975),

sec.

1.6001-1(a),

79,

84

(1992).

INDOPCO, Inc. v.

This includes the·burden

Sec. 6001; ·Hradesky v. Commissioner, 65 T.C.

affd. per curiam 540 F.2d 821

(e),

Income Tax Regs.

(5th Cir.

1976);

- 10 -

Pursuant to section 7491(a) (1), the burden of proof as to

factual matters may shift from the taxpayer to the.Commissioner

under certain circumstances.

The record does not allow us to

conclude that petitioners met the requirements for shifting the

burden of proof under section 7491(a) (2).

Petitioners argue that the notices of deficiency are not

entitled to the presumption of correctness and respondent bears

the burden of proof because respondent's determinations are

"without rational foundation and excessive".

However, the cases

petitioners cite, such as United States v. Janis, 428 U.S. 433

(1976), Dellacroce v. Commissioner,

83 T.C.

269

(1984), and

others are distinguishable because, unlike the case at hand, they

involved determinations of unreported income.

Petitioners also cite Coleman v. United States, 704 F.2d 326

(6th Cir. 1983), a refund case, in which the Court of Appeals for

the Sixth Circuit agreed with the taxpayers that the tax

.

assessment at issue was not entitled to the presumption of

correctness when neither the Government nor the thxpayer had

records to support the calculations.

distinguishable.

Coleman is ålso

Unlike this case, in Coleman v.d Commissioner,

supra at 329, the Government stipulated that the assessments had

no evidentiary foundation.

Respondent has not conceded that his

determinations have no evidentiary foundation.

In fact,

respondent asserts that his determinations a e supported by the

evidence and are correct.

We conclude that the.notices of deficie cy are entitled to

the presumption of correctness and petitioners bear the burden of

proof.s

II.

Procedural Matters

A.

Mr. Loch's Report and Testimony

In their posttrial briefs, petitioners contend that the

Court erred by refusing to allow Mr. Loch to testify as an expert

witness or as a fact witness..regarding errors in the notices of

deficiency.'

Petitioners contend that Mr. Lo h negotiated with

the revenue agent and the Appeals employee and was thoroughly

familiar with the facts.

According to petitioners, the Court

should have allowed Mr. Loch to testify as an expert witness

because the case involves.technical subjects, such as a net

operating loss carryover.

sPetitioners contend in their posttrial brief that

respondent presented no admissible evidence to call into question

petitioners' records "to support the alleged deficiency".

However, because the notices of deficiency are entitled to the

presumption of correctness and because petitioners bear the

burden of proof, respondent does not need to present such

evidence.

Contrary to petitioners' assertion, we allowed Mr. Loch to

testify as a fact witness to the extent he had any firsthand

knowledge of information relevant to this case. Mr. Loch's

testimony was not helpful because he was not Sioux's bookkeeper

or the return preparer for the years at issue.

- 12 -

Generally, under rule 702 of the Federal Rules of Evidence,

expert testimony is admissible if it assists the Cburt to

understand the evidence or to determine a fact in Îissue.

Sunoco,

Inc.

& Subs. v. Commissioner,

118 T.C.

181,

183

See

(2002).

Il

Mr. Loch's opinion about whether respondent's adjustments in the

notices of deficiency are proper does not "assist the trier of

fact to understand the evidence or to determine a fact in issue".

See Fed. R. Evid. 702.

Mr. Loch's report stated petitioners'

litigation position, summarized concessions and the remaining

contested items, and set forth his opinion as to whether the

contested adjustments are proper.

In short, Mr. Loch's expert

report attempted to tell the Court how to decide the issues, was

not helpful, and was irrelevant.

As we observed in Boltar,

L.L.C. v. Commissioner,

326,

136 T.C.

335

(2011):||

"we may fairly

reject the burden on the parties and on the Court® created by

unreasonable, unreliable, and irrelevant expert testimony."

B.

Petitioners' Hearsay Objections

Before trial the parties submitted to the Court a

stipulation of facts accompanied by 15 joint exhibits, including

the notices of deficiency.

Neither party reserved any objection

to any of the stipulations or to the attached joint exhibits.

At the commencement of trial petitioners' counsel objected

to the notices of deficiency as hearsay.

He stated that because

the IRS employee who had prepared them was not ayailable for

- 13 -

cross-examination, the notices of deficiency were inadmissible as

hearsay.

We .overruled petitioners' objectio , explaining that

petitioners failed to reserve it in the stipúlation of facts.

In the. posttrial briefs petitioners contend that we erred when we

.admitted the 15 exhibits, because they were hearsay.

Petitioners

allege they were denied their due process ri hts when they were

not permitted to cross-exam1ne the IRS emploýee who prepared the

notices of deficiency as to how the notices of deficiency were

prepared.

Rule 91(d) provides that "Any objection to all or any part

of a stipulation should be noted in the stipulation, but the

Court will consider any objection to a stipul ted matter made at

the commencement of the trial or for good cause shown made during

the trial."

In addition, stipulations, like contracts, bind

parties to the terms actually agreed upon.

Commissioner,

87 T . C .

1451,

1454

(1986) .

R le 91(e); Stamos v.

The interpretation of a

stipulation is determined primarily by ascert ining the intent of

the parties, and we construe the language of

stipulation

pursuant to rules applicable to the construct on of contracts.

Stamos v. Commissioner, supra at 1455.

The preamble of the stipulation of facts states that the

parties have the right to object to the admission of any facts

and exhibits in evidence on the grounds of rel vancy and

- 14 -

materiality.7

The preamble also states that either party has the

right to object on other grounds, but only if the objection was

expressly reserved in the stipulations.

Neither the preamble nor

any of the stipulation paragraphs contain any objections by

either party to any of the exhibits.

Petitioners have offered no

compelling reason why we should not enforce the terms of the

preamble to which the parties agreed.

Accordingly, petitioners'

objections to the admission of the joint exhibits are untimely,

and we reject petitioners' argument.

III. The Adiustments'at Issue

A.

Schedule C Other Expenses

1.

1997 Schedule C Other Expenses

N

For 1997 respondent disallowed deductions for $12,409 of

Schedule C other expenses.

The explanation attached to the Form

5278 shows that respondent calculated this amount" on the basis of

the analysis of Sioux's business checking account"s and the cash

7The preamble states:

It is hereby stipulated that, for the purpose of this

case, the following statements may be accepted as facts

and all exhibits referred to herein and attached hereto

may be accepted as authentic and are incorpdrated in

this stipulation and made a part hereof; provided,

however, that either party has the right to object to

the admission of any such facts and exhibits in

evidence on the grounds of relevancy and materiality,

but not on other grounds unless expressly reserved

herein, and provided, further, that either party may

introduce other and further evidence not inconsistent

with the facts herein stipulated.

- 15 expenses reported.

Petitioners contend that in that analysis

respondent improperly disallowed a meals and entertainment

expense deduct ion of $70 , 4 25 .

However, re sp ndent subtract s

$70,425 as the nondeductible portion of the meals and

entertainment expense, as his methodology regulres.

Respondent's

methodology in fact is consistent with the 1997 Schedule C on

which Ms. Colvin also reported $70,425 as the nondeductible

portion of the meals and entertainment expense.

See sec. 274 (n) .

Neither party explains what specific expense disallowance

resulted in the $12,409 adjustment.

Because petitioners bear the

burden of proof and they failed to convince us that respondent's

determination is incorrect, we sustain respondent's

determination.

2.

1998 and 1999 Schedule C Other Expenses

On the 1998 and 1999 Schedules C petitioners reported other

expenses of $2, 692, 486 and $2, 423, 943, respectively .

Ms . Wilks

explained at trial that under the "other expenses" category Sioux

reported per diem expenses paid to drivers.

I s. Wilks calculated

the amounts by totaling per diem amounts in the payroll book.

The per diem amounts reimbursed the truck dri ers for meals,

motels, and other expenses while away from home.

In the notice

of deficiency respondent disallowed $88,548 and $872,318 of those

expenses for 1998 and 1999, respectively.

- 16 -

Generally, section 162(a) allows a taxpayer to deduct

ordinary and necessary.expenses of carrying on the taxpayer's

trade or business.

Section 274 (n) (3) (B) limits the amount

allowable as a deduction under section 162 for any$ expense for

food, beverages, or entertainment to 55 percent ofd the amount of

the expense that otherwise would be allowable as af deduction.8

The taxpayer must maintain sufficient records to substantiate the

deduction.

See sec. 6001; Petzoldt v. Commissioner, 92 T.C. 661,

686 (1989).

It is petitioners' failure to -substantiate the

disallowed portion of the per diem expenses that is at issue.

Mr. Bambrick stated at trial that "if you want all of those

records, we certainly will furnish them here, in Washington or

someplace else, but what I'm saying to you is, there's going to

be literally a hundred thousand records that we may have to bring

in."

Mr. Bambrick later reiterated that if petitioners. brought

in documents, they would be in barrels, and reviewing every truck

trip and expense would take weeks.

He stated that he was ready

to produce those documents at a location convenieht to'the Court.

However, Mr. Bambrick then claimed that the records had been

destroyed in a flood.

Respondent's counsel contends that

8The return explains this expense as "Travel Allowance x

55%". We assume this means that petitioners deducted the per

diem expenses subject to the limitation of sec. 274 (n) (3).

- l'7 petitioners had nearly 6 years to raise the

..ssue of the

destroyed records and to attempt to reconstr ct any damaged

records.

Ms. Colvin then testified that someone had broken into the

storage building where she kept records for approximately 1990-

2000 and tore copper lines out of the walls, causing flooding.'

According to Ms. Colvin, no one realized there was a flood for

several months.

The records were stored in

oxes that became

soaked, and the records had to be scooped up off the floor.

Approximately 2 months before the trial Ms. Colvin cleaned out

the building, at which point the documents we e unreadable .

Colvin testified that no other documents are available.

Ms .

Mr.

Bambrick claims that Mr. Loch had reviewed those records and used

them f or his report .

After trial and as directed by the Court, respondent's

counsel provided petitioners with respondent's workpapers to

assist the parties in supplementing the record if the parties

could agree on additional stipulations.

The parties did not

agree on the admissibility of the workpapers, nor did they offer

9After trial petitioners submitted to respondent's counsel

and the Court (1) a letter dated Feb. 23, 2010, from Omni

Plumbing, Inc., indicating that on May 22, 2004, Ms. Colvin

requested an emergency service call because of the water in the

building and (2) a receipt from Omni. Plumbing. However, the

parties did not stipulate that the documents were admissible as

evidence.

We note that the documents petition rs proffered

indicate that the water problem occurred on or before May 22,

2004.

- 18 -

any additional stipulated facts or documents.

In the absence of

a stipulation, respondent now contends that a substantial portion

of respondent's workpapers is irrelevant because by examining

them we would "look behind the notice of deficiency."

We agree.

See Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324, 327

(1974).

Some of the documents appear to be copies of various

documents that petitioners submitted to the revenue agent during

audit.

Petitioners did not identify any relevant portions of the

documents or workpapers and did not move to reopen the record.

The joint status report describes petitioners' position as

follows:

"The following pages of * * *

[the documents]

contain

relevant factual information to either support and/or not support

the statements made by and/or on behalf of the Tax Payer [sic]

and/or the Service".

Consequently, we limit our review to the

record and do not consider unstipulated documents submitted by

either party after trial ended.

burden of proof.

Petitioners properly bear the

See Rule 142(a).

Generally, section 274 (d) provides that no deduction is

allowable for traveling expenses (including meals and lodging

while away from home), unless the deduction is substantiated in

accordance with the strict substantiation requirements of section

274 (d) and the regulations promulgated thereunder.

1.274-5T(c) (5), Temporary Income Tax Regs.,

Section

50 Fed. Reg. 46022

(Nov. 6, 1985), provides that when a taxpayer's

ecords have been

- 19 -

destroyed or lost due to circumstances beyond his control, he is

generally allowed to substantiate his deductions by reasonable

reconstruction of his expenditures .

A taxpa er is required to

try to salvage or reconstruct what he can.

Commissioner, T.C. Memo. 2007-12.

See, e.g., Chong v.

If the taxpayer establishes

that the records were destroyed, he must nevertheless

substantiate each element of each expenditure under section 274.

See Boyd v. Commissioner,

122 T.C.

305,

320-321

(2004).

Petitioners argue that they presented un¼ontradicted

evidence as to how their records were prepared and maintained and

how the tax returns were filed.

We disagree.

The oral testimony

presented at trial addressed the paperflow and recordkeeping in

very general terms only.

Petitioners presented no credible

evidence, for example, of how_ many.drivers they had, how long on

average they were away from home, or how much the per diem amount

was.

Petitioners .failed to reasonably reconstruct the per diem

expenditures within the meaning of section 1.274-5T(c) (5),

Temporary Income Tax Regs., supra, and we sust in respondent's

determination.

B.

Schedule C Gross Receipts-

Respondent made no adjustment to petition rs' Schedule C .

gross receipts .

Petitioners contend that Schedule C gross

receipts should be reduced by $97,497 and $532,741 for 1997 and

1999, respectively.

ll

- 20 Sioux operated on a cash basis method of. accoùnting.

For .

1997 it reported Schedule C gross receipts of $4,797,495, and its

general ledger for 1997 shows the same amount of gross receipts.

On the 1999 Schedule C it reported gross receipts of $3,697,917,

and.the general ledger shows the same amount of gross receipts.

Petitioners presented no credible evidence to prove that the

gross receipts reported on Ms. Colvin's and petitioners' 1997 and

1999 Schedules C, respectively, were not correct. " Accordingly,

we reject petitioners' argument that Sioux's Schedule C gross

receipts, as claimed on Ms. Colvin's and petitioners' 1997 and

1999 returns, respectively, should be reduced.

C.

Depreciation Deduction

On the 1999 Schedule C petitioners reported å depreciation

deduction of $240,392.

In the notice of deficiency respondent

allowed an additional depreciation.deduction of $81,461.

Petitioners contend that the additional depreciation deduction

should be $137,309.

Petitioners bear the burden of proof, see

Rule 142, but they presented no credible evidence or explanation

to establish they are entitled to any additional depreciation

deduction.

Accordingly, petitioners are not entitled to the

additional depreciation deduction.

IV.

Section 6662(a)

Penalty for 1998 and 1999

Generally, section 6662(a) and (b) (1) authorizes the

Commissioner to impose a 20-percent penalty on the portion of an

- 21 -

underpayment of income tax attributable to negligence or

disregard of rules or regulations .

The term "negligence"

includes any failure to make. a reasonable attempt to comply with

the provisions of the internal revenue laws, and the term

"disregard" includes any careless, reckless, br intentional

disregard.

Regs.

Sec .

6662 (c) ; sec .

1. 6662-3 (b) (1)

and (2) ,

Income Tax

Disregard of rules or regulations is careless if "the

taxpayer does not exercise reasonable diligen e to determine the

correctness of a return position" and is reckless if "the

taxpayer makes little or no effort to determine whether a rule or

regulation exists, under circumstances which demonstrate a

substantial deviation from the standard of conduct that a

reasonable person would observe . "

Sec . 1. 6662 -3 (b) (2) , Income

Tax Regs.; see also Neely v. Commissioner, 85 T.C. 934, 947

(1985) .

Section 6662 (a) and (b) (2) . also authorizes the Commissioner

to impose a 20-percent penalty if there is an underpayment due

to a substantial understatement of income tax.

An

"understatement" means the excess of the amount of the tax

required to be shown on the return over the am unt of the tax

which is shown on the return, reduced by any rebate.

6662 (d) (2) (A) .

Sec.

An understatement is substantial in the case of

an individual if the amount of the understatement for the taxable

- 22 -

year exceeds the greater of 10 percent of the tax required to be

shown on the return or $5,000.

Sec. 6662(d) (1) (A).

The Commissioner bears the burden 'of production with respect

to the taxpayer's liability for the section 6662(a) penalty and

must produce sufficient evidence indicating that it is

appropriate. to impose the penalty.

See sec. 7491(c).

Once the

Commissioner meets his burden of production, the tiaxpayer must

come forward with persuasive evidence that the Codmissioner's

determination is incorrect or that the taxpayer hard reasonable

cause or substantial authority for the position.

Commissioner,

116 T.C. 438, 447

¡See Higbee v.

(2001).

The exact amount of the understatement shall be computed as

part of the Rule 155 calculations.

Even if the understatement is

not substantial, respondent met his burden of production with

respect to negligence by showing that petitioners claimed

deductions to which they were not entitled.

Petitioners had the burden of producing sufficient evidence

to prove that respondent's penalty determinations5 are incorrect.

See id. at 446-447.

Petitioners argue that the penalties do not

apply because respondent failed to introduce any evidence.

However, once the Commissioner meets his burden of production

under section 7491(c), the taxpayer bears the burden of showing

that the.determination is incorrect.

Petitioners failed to

- 23 establish that they were not negligent or that the substantial

understatement penalty should not apply.1°

We have considered the remaining arguments made by the

parties and, to the extent not discussed above, conclude those

arguments are irrelevant, moot, or without merit .

To reflect the foregoing,

Decision wi .1 be entered under

Rule 155 .

1°Sec. 6664 (c) (1) provides an exception frot the penalty

determination with respect to any portion of an underpayment if

the taxpayer shows that there was reasonable cause for such

portion and that the taxpayer acted in good fait h with respect to

such portion.

Reliance upon the advice of a ta professional may

establish reasonable cause and good faith.

See United States v.

Boyle, 469 U.S.

241,

250

(1985).

Petitioners dd not argue that

the exception of sec. 6664(c) (1) to the sec. 6662(a) accuracyrelated penalty applies, .nor does the record allow us to conclude

that relief is appropriate..