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T.C. Memo. 1998-404

UNITED STATES TAX COURT

SHIGENORI KUDO AND MOTOMI KUDO, ET AL.,1 Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 10667-94, 19180-94,

19181-94,

466-95,

467-95.

Filed November 12, 1998.

John Gigounas and Edward B. Simpson, for petitioners.

Allan D. Hill, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

PARR, Judge:

Respondent determined deficiencies in, and

additions to, petitioners' Federal income taxes as follows:

Cases of the following petitioners are consolidated

herewith: Toraya Corporation, docket No. 19181-94; Yoshinori

Takao and Estate of Akiko Takao, Deceased, Yoshinori Takao,

Successor-in-interest, docket Nos. 466-95 and 467-95.

- 2 -

Shigenori Kudo and Motomi Kudo

(docket Nos. 10667-94 and 19180-94)

Year

Deficiency

Additions to Tax

Sec. 6662(a)

1990

1991

$24,000

24,030

$4,800

4,806

Yoshinori Takao and Estate of Akiko Takao, Deceased,

Yoshinori Takao, Successor-in-Interest

(docket Nos. 466-95 and 467-95)

Year

Deficiency

Sec.

6651(a)

1988

1989

1990

1991

$125,463

121,412

112,209

100,859

$31,366

----

Additions to Tax

Sec.

6653(a)(1)

6661

$6,273

----

$31,366

----

Sec.

6662(a)

-$24,282

22,442

20,172

Toraya Corporation

(docket No. 19181-94)

Year

Deficiency

Sec.

6651(a)

1988

1989

1990

1991

$98,038

64,474

47,885

24,060

$24,510

16,119

---

Additions to Tax

Sec.

6653(a)(1)

6661

$4,902

----

$24,510

----

Sec.

6662(a)

-$12,895

9,577

4,812

All section references are to the Internal Revenue Code in

effect for the taxable years in issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure, unless

otherwise indicated.

The issues for decision are set forth below.

- 3 Shigenori Kudo and Motomi Kudo

(docket Nos. 10667-94 and 19180-94)

After concessions,2 the following issues remain in dispute:

(1)

Whether petitioners Shigenori Kudo (Scott) and Motomi

Kudo (Motomi) (hereinafter collectively referred to as the Kudos)

received unreported income in the amounts of $55,979 and $57,795

for 1990 and 1991, respectively, as shown by unexplained bank

deposits made by them during those years.

We hold that they

received unreported income in the amounts decided herein.

(2)

Whether the Kudos are liable for accuracy-related

penalties for negligence under section 6662(a) for 1990 and 1991.

We hold that they are.

Yoshinori Takao and Estate of Akiko Takao, Deceased,

Yoshinori Takao, Successor-in-Interest

(docket Nos. 466-95 and 467-95)

The parties settled some of the adjustments determined in

the notices of deficiency dated Mar. 21, 1994, and July 19, 1994,

as follows:

1. The Kudos agree that the adjustments entitled "Rec'd

from Toraya Corp. & Rest." are correct to the extent of $25,230

in 1990 and $24,000 in 1991.

2. Respondent agrees that the Kudos are entitled to

additional Schedule A deductions for 1990 and 1991 in the amounts

of $21,249 and $17,634, respectively.

3. Respondent concedes the adjustment for 1991 entitled

"Taxes Paid by Employer" in the amount of $9,214.

4. The Kudos concede that the adjustment for "Taxes Paid by

Employer" for 1990 should be $6,942.

5. Respondent concedes that the adjustment entitled

"Unexplained Deposits" for 1990 in the amount of $55,979 should

be reduced to $42,506.

6. Respondent concedes that the adjustment entitled

"Unexplained Deposits" for 1991 in the amount of $57,795 should

be reduced to $53,011, by $652 representing an insurance payment

and $4,132 representing refunds of State and Federal taxes.

- 4 After concessions,3 the following issues remain in dispute:

The parties have settled some of the adjustments as

follows:

1. Respondent concedes that the adjustments for

"Unexplained Deposits" 1988 and 1989 should be reduced by $13,837

and $6,238, respectively.

2. The Takaos agree that $10,108 of the $81,933 adjustment

for "Unexplained Deposits" for 1991 attributable to deposits to

the Industrial Bank of Japan and to the Chou Trust and Banking

Co. is taxable income not reported on their 1991 return.

3. Respondent concedes the adjustments for "Dividend

Income" should be decreased as follows:

1988

$109,849

1989

85,888

1990

106,664

1991

84,855

The Takaos concede the remaining amounts under this adjustment,

which are $1,000 for each year in issue.

4. Respondent concedes the adjustments entitled "Purchase

Expenses" for all the years in issue.

5. Respondent and the Takaos agree that adjustments for

"Advertising Expenses--Schedule C" for 1990 and 1991 are settled

by reducing the amounts by $2,531 and $1,274, respectively.

6. Respondent and the Takaos agree that adjustments for

"Car and Truck Expenses--Schedule C" are settled by reducing the

amounts as follows:

1988

$3,523

1989

4,000

1990

4,010

1991

3,936

In the stipulation of settled issues the years are shown as 1988,

1990, 1991, and 1992. We assume the years should have been shown

as above inasmuch as 1992 is not involved in the instant case.

Should our assumption be erroneous, the parties should calculate

the adjustments for "Car and Truck Expenses--Schedule C" in the

Rule 155 computations in the manner necessary to comport with the

agreement of the parties.

7. Respondent concedes adjustments for "Depreciation

Expenses--Schedule C" for all years in issue.

8. Respondent concedes adjustment entitled "Repairs Expense

--Schedule C" for 1988.

9. Respondent concedes adjustment for "Supplies Expenses"-Schedule C" for all years in issue.

10. Respondent and the Takaos agree the adjustments for

"Travel Expenses--Schedule C" are settled by reducing the amounts

as follows:

1988

$2,073

(continued...)

- 5 -

(...continued)

1989

2,400

1990

2,669

1991

2,947

In the stipulation of settled issues the years are shown as 1988,

1990, 1991, and 1992. We assume the years listed should have

been shown as above inasmuch as tax year 1992 is not involved in

the instant case. Should our assumption be erroneous, the

parties should calculate the adjustments for "Travel Expenses -Schedule C" in the Rule 155 computations in the manner necessary

to comport with the agreement of the parties.

11. Respondent and the Takaos agree adjustments for "Meal

Expenses--Schedule C" for 1988 and 1989 are settled by reducing

the amounts by $2,424 and $3,000, respectively.

12. Respondent concedes adjustments for "CMA Investors

Expense--Schedule E" for 1988 and 1989.

13. Respondent concedes adjustments for "Cleaning-Schedule E" for 1989.

14. Respondent concedes adjustments for "Depreciation--T/N

Leasing--Schedule E" for 1989.

15. Respondent concedes adjustments for "Dishes Expense-Schedule C" for 1990 and 1991.

16. The Takaos concede adjustments for "Staff Meetings-Schedule C" for 1990 and 1991.

17. Respondent concedes adjustments for "Legal and

Professional--Schedule C" for 1990.

18. The Takaos concede the correctness of the $5,000

adjustment for "Itemized Deductions for State Income Tax" for

1989.

19. Respondent concedes that the $5,000 adjustment for

"Itemized Deductions for State Income Tax" for 1988 should be

reduced by $4,148.

20. The Takaos concede the correctness of the adjustments

for "Child Care--Sch. C" for 1989 and 1990 in the amounts of

$1,000 and $3,600, respectively.

21. The Takaos and respondent agree that adjustments for

"Insurance Expense--Sch. C" are reduced by $4,846 for each of the

years 1988, 1989, 1990, and 1991.

22. The Takaos and respondent agree that adjustments for

"Imputed Interest Income" are settled by reducing the dollar

amounts as follows:

1988

$30,495

1989

45,445

1990

40,644

1991

27,436

- 6 (1)

Whether petitioners Yoshinori Takao (Yoshinori) and

Akiko Takao (Akiko) (hereinafter collectively referred to as the

Takaos) received unreported taxable income in the amounts of

$122,483, $75,421, $114,935, and $109,094 for 1988, 1989, 1990,

and 1991, respectively, as shown by unexplained bank deposits

made by them during those years.

We hold that they received

unreported income in the amounts decided herein.

(2)

Whether the Takaos received additional unreported

income in the amounts of $9,000 and $58,320 for 1988 and 1989,

respectively, as shown by certain cash purchases made by them

during those years.

We hold that they received additional

unreported income in the amounts decided herein.

(3)

Whether the Takaos are entitled to investment interest

deductions in the amounts of $55,320, $38,355, $30,000, and

$13,850 for 1988, 1989, 1990, and 1991, respectively.

We hold

that they are not.

(4)

Whether the Takaos are liable for an addition to tax

for late filing under section 6651(a) for 1988.

We hold that

they are.

(5) Whether the Takaos are liable for an addition to tax for

negligence under section 6653(a)(1) for 1988 and accuracy-related

penalties for negligence under section 6662(a) for 1989, 1990,

and 1991.

We hold that they are.

- 7 (6)

Whether the Takaos are liable for an addition to tax

for substantial underpayment of tax under section 6661 for 1988.

We hold that they are.

Toraya Corporation(docket No. 19181-94)

concessions,4 the following issues remain in dispute:

After

(1)

In a stipulation of settled issues filed Dec. 4, 1995,

and an amended stipulation of settled issues filed May 14, 1996,

the parties agreed as follows:

1. Respondent concedes that adjustments for "Purchase

Expense" should be decreased as follows:

1988

$30,733

1989

5,114

1990

25,230

1991

24,000

Respondent also concedes that Toraya is entitled to an additional

$6,000 purchase expense in 1990.

2. Respondent concedes adjustments for "Amortization

Expense" for all years in issue.

3. Respondent and Toraya agree that adjustments for

"Business Travel" are settled by reducing the amounts shown as

follows:

1988

$8,931

1990

4,400

1991

3,606

4. Respondent and Toraya agree that adjustments for "Truck

Expense" for all years in issue are settled by reducing the

amounts as follows:

1988

$13,000

1989

4,123

1990

3,936

1991

2,009

5. Toraya concedes that the adjustment for "Employee

Meeting Expense" for 1988 in the amount of $6,455 is correct.

6. Respondent concedes that the adjustment for "Office

Expenses" for 1988 should be reduced by $1,800. The remaining

amounts for the years in issue under this adjustment remain in

dispute.

7. Respondent concedes adjustments entitled "Restaurant

Expenses" for 1988 and 1989.

8. Respondent concedes the adjustment for "Rent Expenses"

for 1988.

9. Respondent concedes adjustments entitled "Depreciation

Expenses -- Auto" and "Depreciation Expenses -- Other" for all

(continued...)

- 8 Whether petitioner Toraya Corp. (Toraya) received unreported

income from sales in the amounts of $94,500, $102,275, $81,506,

and $58,271 for 1988, 1989, 1990, and 1991, respectively, as

shown by cash deposits made by the Kudos5 and cash deposits and

cash purchases made by the Takaos during those years.

We hold

that Toraya received unreported income in the amounts decided

herein.

(2)

Whether Toraya is entitled to deduct payments,

classified as office expenses, made to Motomi in 1988 and 1989 in

the amounts of $7,933 and $12,000, respectively.

We hold that it

is to the extent decided herein.

(...continued)

years in issue.

10. Respondent concedes the adjustment for "Repairs

Expenses" for 1989.

11. Respondent concedes adjustments for "Earthquake Damage"

for 1989.

12. Respondent concedes the adjustment for "Payment from

Franchise Tax Board" for 1988.

13. Respondent concedes that Toraya is entitled to a

$25,460 Targeted Jobs Credit and an Investment Tax Credit of

$4,450 in 1988.

14. Toraya concedes the adjustment for "Gain on disposition

of vehicles" for 1990.

15. Respondent concedes adjustments for "Employee Benefits

Expense" for 1988 and 1989.

16. Petitioner and Toraya agree that Toraya is entitled to

deductions for imputed interest expense as follows:

1988

$10,012

1989

7,992

1990

7,699

1991

6,310

Respondent conceded on opening brief that cash deposits

into the Kudos' bank accounts in the amounts of $42,506 for 1990

and $46,871 for 1991 are not gross receipts of Toraya.

- 9 (3)

Whether Toraya is entitled to claim or treat as cost of

goods sold the payments made to Joan Takao (Joan) and Junichi

Takao (Junichi) in the amounts of $27,000 to Joan in 1988, and

$7,100 to Joan and $4,000 to Junichi in 1989.

We hold that it is

entitled to claim them to the extent decided herein.

(4)

Whether Toraya is entitled to claim as cost of goods

sold $19,917 in 1989, representing the beginning inventory

balance of a restaurant Toraya closed that year.

We hold that it

is to the extent decided herein.

(5)

Whether Toraya is liable for an addition to tax for

late filing under section 6651(a) for 1988.6

(6)

We hold that it is.

Whether Toraya is liable for an addition to tax for

negligence under section 6653(a)(1) for 1988, and accuracyrelated penalties under section 6662(a) for 1989 through 1991.

We hold that it is.

(7)

Whether Toraya is liable for an addition to tax for

substantial underpayment of tax under section 6661 for 1988.

hold that it is.

(8)

Alternatively, if the Court determines that Toraya had

unreported income from unreported sales, whether it is entitled

to theft loss deductions for 1988 through 1991.

We hold that it

is not.

Respondent conceded on opening brief that Toraya is not

liable for a late filing addition under sec. 6651(a)(1) for 1989.

- 10 FINDINGS OF FACT

Some facts have been stipulated and are so found.

The

stipulation of facts and the attached exhibits are incorporated

herein by this reference.

Facts Relating to the Kudos

When Scott and Motomi filed their petitions herein, they

resided in Burlingame, California.

In 1990 and 1991, and for

previous years, the Kudos were employed by Toraya, which owned

and operated two Japanese restaurants, one located in Berkeley,

California (Berkeley restaurant), and the other located at 1734

Post Street, in San Francisco, California (Post Street

restaurant).

The Kudos were employed at the Post Street

restaurant.7

Motomi was the manager of that restaurant.

Yoshinori and Akiko, Motomi's father and mother, owned all of the

shares of Toraya.

Akiko died about 10 months before this case

was tried.

Motomi had attended college.

She took business and

accounting courses in high school but not in college.

born and educated in Japan.

Scott was

He studied English in Hawaii and

business administration at the University of San Francisco.

Scott is generally able to speak and understand English, but he

On occasion, when her help was needed, Motomi also worked

at a restaurant located on Fillmore Street which was owned by her

parents.

- 11 is not completely fluent in or comfortable with it.

At trial,

Scott testified with the aid of an interpreter.

Motomi's duties at the Post Street restaurant generally

consisted of seating customers, answering the telephone, and

taking care of the cash register.

At times she also washed

dishes and cleaned up when there was no one else around to help.

Scott never handled the cash register or had anything to do with

cash at the Post Street restaurant.

The Kudos reported the following items of income on their

1990 and 1991 Federal income tax returns.

1990

Item

Amount

Wages

Scott

$14,400

Motomi

14,400

Total wages

Interest

Refund of State Taxes

Total

$28,800

4,263

805

$33,868

1991

Item

Wages

Scott

$19,200

Motomi

19,200

Total wages

Interest

Refund of State Taxes

Total

Amount

$38,400

4,068

540

$43,008

The Kudos received additional payments from Toraya in 1990

and 1991 as follows:

- 12 1990

Motomi

Scott

Motomi

Total

Amount

Treatment by Toraya

$25,230

3,600

7,933

$40,363

Deducted as purchase expenses

Deducted as child care expenses

Deducted as truck expenses

Deducted as office expenses

1991

Motomi

Total

Amount

Treatment by Toraya

$24,000

12,000

36,000

Deducted as purchase expenses

Deducted as office expenses

Those additional payments were not reported on the Kudos' Forms

W-2 for 1990 and 1991, and the payments were not reported as

income by them on the tax returns they filed for those years.

On the Federal income tax returns they filed for 1990 and

1991, the Kudos did not claim any itemized deductions for

expenses they incurred on Toraya's behalf.

The parties now agree

that the $25,230 and $24,000 payments Toraya made to Motomi in

1990 and 1991, respectively, are income to the Kudos.

The

parties also agree that the Kudos are entitled to additional

itemized deductions on Schedule A in the amounts of $21,249 and

$17,634 for 1990 and 1991, respectively.

Motomi handled the financial affairs for her family.

1990 and 1991, she deposited cash in the amounts of $42,506 and

$46,871, respectively, to the Kudos' bank account No. 037-439056

at Sumitomo Bank (Sumitomo account).

- 13 The Takaos and Edwin Nakamura (Nakamura) owned all of the

interests in Toraya Apartments Partnership (Toraya Apartments),

of which Nakamura was the managing general partner.

Toraya

Apartments' sole asset was a building located at 1734 Post

Street, San Francisco, California.

That building housed

apartments and the Post Street restaurant.

In 1991, the Kudos

received two checks from Toraya Apartments in the amounts of

$2,269.14 and $1,400, which were deposited in the Sumitomo

account.

The Kudos have three children, including Nicholas, who was

unable to speak until he was 8 years old.

Nicholas' problem

required the Kudos to take him to several different doctors and

various therapists and specialists.

Although at one point the

Kudos were advised that Nicholas would never speak or hear, he

began to speak when he was about 8 years old.

old at the time of trial.

He was 11 years

Nicholas' medical expenses generally

were not covered by insurance although some of his expenses may

have been reimbursed by insurance in 1990 and 1991.

The Kudos

did not claim any deductions for medical or dental expenses on

their 1990 or 1991 income tax return.

The Kudos' relatives in Japan knew of Nicholas' condition,

and from time to time they would send small amounts of money to

help pay for his treatment.8

Scott's parents had helped his

Exhibit 6, which consists of four undated letters that

apparently accompanied "small" money donations (according to the

(continued...)

- 14 brothers and sister, and they wanted to equalize matters by

helping Scott also.

The Kudos' relatives also sent cash gifts

for family occasions such as Christmas and birthdays.

Scott made one or two trips to Japan in 1990 and one trip in

1991.

From time to time tenants at Toraya Apartments or restaurant

employees would give Motomi cash, and she would write checks on

their behalf for rent and other bills.

However, the record is

devoid of specific names, dates, or amounts of any of those

transactions.

When the Takaos went on trips, Motomi sometimes paid their

bills, and she was reimbursed by them in cash.

For instance, in

1991 Motomi wrote checks totaling $770 to her parents' gardener.

In 1991 Motomi wrote checks totaling $6,009.49 to or on

behalf of her brother, Junichi, who needed money at the time

because he was going through a divorce.

During 1990 and 1991, Motomi often made separate, multiple

cash deposits on a single day, several times per week.

For

example, on January 28, 1991, Motomi made three deposits for

$100, $140, and $200.

All of the deposits were made at the same

time; i.e., on a single trip to the bank.

Motomi purportedly

made deposits in that manner because she put cash from different

(...continued)

letters), refer to Nicholas as "Takao". The exhibit was received

in evidence for the nonhearsay purpose of showing the relatives'

knowledge.

- 15 sources in separate envelopes, but she did not save the envelopes

nor keep any other contemporaneous records of the sources of the

cash.

Nakamura, a certified public accountant, prepared the Kudos'

individual Federal income tax returns for 1990, 1991, and

previous years.9

Motomi would give him a manila envelope

containing the Kudos' Forms 1099, a sheet of paper listing

charitable contributions and other deductions, and other items

she thought important.

records.

Nakamura did not request or receive bank

In preparing their income tax returns, Nakamura did not

include in the Kudos' income certain payments from Toraya,

because he viewed them as nontaxable reimbursements.

The Kudos owned a personal residence in San Bruno,

California, during 1988 and until March 1989, when they sold that

residence.

During April 1989, the Kudos purchased a personal

residence in Burlingame, California, for which they paid

$550,000.

During 1990 and 1991, the Kudos made mortgage payments

on their personal residence in the amounts of $31,827.72 and

$27,413.86, respectively.

Facts Relating to the Takaos

When they filed their petitions, the Takaos resided in

Burlingame, California.

Akiko died on June 10, 1995, at the age

of 69.

Toraya.

Nakamura also prepared the returns for the Takaos and

- 16 Yoshinori was born in the United States in 1924.

attended school here through third grade.

When he was 8 years

old, Yoshinori's father died and Yoshinori and his mother moved

to Japan.

Yoshinori completed his education through 2 years of

college in Japan.

Yoshinori married Akiko in Japan in 1951.

They moved to the United States in December 1958.

Yoshinori's

understanding of English was not very good, and he testified with

the aid of an interpreter.

Akiko was born in Japan.

very little English.

She could speak and understand

She could not write checks or drive.

Nevertheless, Akiko handled the family's personal financial

affairs and controlled all the Takaos' personal savings and bank

accounts.

During the years in issue and for prior years, the Takaos

owned individually a Japanese restaurant located at 1914 Fillmore

Street, San Francisco, California (Fillmore Street restaurant),

which was managed by the Takaos' younger son, Frank Takao.

The

Fillmore Street restaurant operated under the name "Toraya".

Yoshinori purchased the Fillmore Street restaurant, his first

restaurant, in 1965.

During the years in issue the Takaos owned 100 percent of

the shares of Toraya, which owned and operated the Berkeley

restaurant and the Post Street restaurant in 1988 and 1989.

operated also under the name "Toraya".

They

Junichi, the Takao's

oldest son, managed the Berkeley restaurant.

Toraya closed the

- 17 Berkeley restaurant in June 1989.

In 1990 and 1991, Toraya

operated only the Post Street restaurant.

During 1988 through 1991, Akiko worked at the Post Street

restaurant, usually as a hostess.

When the restaurant was busy,

however, she would write orders.

During 1988 through 1991,

Yoshinori worked mostly at the Post Street restaurant, as a chef,

although he sometimes worked also at the Berkeley restaurant.

1990 and 1991, Akiko or Motomi handled the cash at the Post

Street restaurant.

During the years in issue, the Takaos owned a two-thirds

interest in the Toraya Apartments.

The Takaos' tax returns for 1989 through 1991 indicate

Yoshinori's occupation as "Retired".

The Takaos' tax returns for

1990 and 1991 indicate Akiko's occupation as "Retired".

The Takaos reported the following items of taxable income

(or loss) on their tax returns for the years 1988 through 1991:

Amount

Item

1988

1989

1990

1991

Wages

Interest

Dividends

Refunds

Sch. C income

Capital gain

(or loss)

Other gains

(or losses)

IRA distributions

Sch. E income

Social security

Total

$7,675

45,299

-2,388

(159)

$6,440

50,643

--699

$5,000

46,553

-528

857

$4,800

40,999

-264

(14,150)

(3,000)

15,230

-67,433

174

-57,956

(7,116)

42,909

(12,500)

3,371

5,317

-25,101

- 18 For 1990, the Takaos also reported tax-exempt interest income in

the amount of $5,062.

For 1991, the Takaos also reported

nontaxable dividend distributions of $7,040.

The Takaos received income or payments from, among other

things, the following sources in 1982 through 1987:

Wages

$124,367

1982

1983

1984

1985

1986

1987

Total

$29,050

$20,000

$19,800

$19,675

$16,042

240

8,573

30,010

35,788

35,192

17,608

59,244

23,598

15,315

5,717

26,085

185

441

252

104

43,933

68,002

54,049

51,355

41,013

636

100

101

124

150

180

10,716

7,781

7,613

9,696

23,165

1,260

4,841

10,834

13,983

8,373

9,846

23,356

54,767

81,985

62,422

61,201

64,369

Interest

income:

Banks:

SF Federal

Savings

353

110,156

Sumitomo

15,786

137,268

California

First

32,008

59,075

Total

interestbanks

48,147

306,499

Other

interest:

IRS

1,714

2,368

John

Hancock

754

Edwin

Nakamura 14,917

14,917

Bruce

Bedig

-58,971

Norager,

Inc.

-1,260

USA

Publishing

-4,841

Partnership

/S-Corp.

-11

Total other

interest

16,730

83,122

Total

interest

income

389,621

Installment

sales

64,877

- 19 payments:

Silver Lake 121,819

203,413

Sierra

Lakes

183,181

321,390

Total

installment

sales

305,000

524,803

Total

1,038,791

398,927

31,903

9,328

8,460

45,909

45,910

13,059

11,844

21,487

77,812

77,813

22,387

20,304

21,487

152,579

179,598

104,609

101,180

101,898

In 1982 Nakamura gave Akiko checks in the amounts of

$305,000 and $14,000 from the Silver Lake and Sierra Lakes

installment sales.

The $305,000 check represented Yoshinori's

share of the 1982 payments.

The $14,000 check represented

Nakamura's share of the 1982 payment and constituted his profits

on the sales, which he gave to Akiko because she had lent him

money for the investments.

Akiko did not deposit the $305,000

check in the bank in the year she received it.

Akiko kept cash in her home.

Although Yoshinori was aware

that Akiko kept cash at home in a safe and in other places around

the house, he had no idea how much she had on hand at any time.

While she was living, only Akiko had the combination to the safe.

Akiko began to deposit money in banks in order to earn interest,

because Nakamura and a bank employee advised her to do so.

Akiko

maintained accounts in banks before the years in issue.

When Nakamura discovered that Akiko was keeping cash at home

and was told that Akiko was paying cash for a Mercedes Benz, he

advised her against keeping cash in the house because of gangs

which were breaking into Japanese homes where they knew that cash

- 20 was generally kept at home.

Nakamura advised Akiko to put her

money in the bank.

Motomi knew that Akiko kept cash at home, but Motomi did not

know how much cash Akiko had at hand at any time.

Motomi also

was aware that Akiko kept money in bank accounts.

At the time of

trial, Motomi did not know how much cash Akiko had at home at the

time of her death, but Motomi believed that it was a large sum.

In 1955, Akiko inherited ¥500,000 from her grandmother.10

In 1959, Akiko lent that amount to her parents so that they could

remodel an apartment they owned in Japan.

Her parents agreed to

repay the loan by sending Akiko $300 per month (i.e., the rental

value of one room in the apartment) for the rest of their lives.

Yoshinori and Akiko traveled to Japan approximately twice a year,

and sometimes Akiko brought back money given to her by her

parents.

On occasion, friends from Japan visiting the Takaos

brought money to them from Akiko's parents.

Akiko's father died

before 1988, but her mother was still alive through 1991 and

continued to repay the loan through that time.

Therefore, Akiko

received $3,600 each year in issue for the repayment of the loan

to her parents, and that amount is not taxable income to the

Takaos.

Kendo is a form of martial arts.

the kendo organization.

Yoshinori was active in

He served as president of the U.S. Kendo

Association and traveled around the United States to promote the

The record does not disclose the equivalent in dollars.

- 21 sport.

Yoshinori held the second highest kendo rank and was a

representative to the World Kendo Association in Japan.

Because

of Yoshinori's frequent travel, the Takaos gave Nakamura a power

of attorney to write checks on their behalf.

Nakamura had

handled the Takaos' financial affairs and prepared their tax

returns since 1965.

During the years in issue, the Takaos made bank deposits as

follows:

Year

Amount

1988

1989

1990

1991

$122,483

75,421

114,935

109,094

Of the 1991 deposits, $48,194, $26,244, and $7,495 were deposited

into bank accounts in Japan.

The parties have stipulated that

those deposits were rents received from an apartment building the

Takaos owned in Tokyo, Japan.

building was completed in 1991.

Construction of the apartment

The parties have stipulated

further that only $10,108 of the Japanese bank deposits is

taxable income, rather than the $81,933 determined in the notice

of deficiency.

The rental deposits in the Japanese banks were

not reported on the Takaos' 1991 return, because Nakamura

believed that, since Japanese tax returns were filed, there was

no need to report the income on the U.S. returns because of the

foreign tax credit.

- 22 Of the above-listed unexplained deposits, the following

consisted of cash deposits:

Year

Amount

1988

1989

1990

1991

$85,500

46,955

39,000

11,400

On November 23, 1988, Akiko used $9,000 in cash to purchase

a cashier's check.

On February 1, 1989, Yoshinori paid $55,320

in cash to purchase a Mercedes Benz.

On April 19, 1989, Akiko

used $3,000 in cash to purchase a traveler's check.

During March 1983, Yoshinori, Nakamura, Harry Norager, and a

Dr. Morrison became shareholders in Norager, Inc. (Norager).

April 1, 1983, Norager purchased the Capri Restaurant from Pier

29, Inc. (Pier 29).

The purchase price was $600,000, consisting

of $400,000 in cash, which was borrowed from Alameda First Bank,

and a note in the amount of $200,000 given to the former owners

of the Capri Restaurant.

The Takaos owned a 25-percent interest

in the capital stock of Norager.

Operation of the Capri

Restaurant was Norager's only business activity.

Dr. Morrison

withdrew from the venture in 1984, and Henry Norager withdrew in

1986, leaving only Nakamura and Yoshinori with interests in the

venture after 1986.

On December 31, 1987, Nakamura executed a promissory note on

behalf of Norager wherein Norager promised to pay Yoshinori the

sum of $94,000 with interest from that date at the rate of 10

percent per year.

The due date of any unpaid principal and

- 23 accrued interest was December 31, 1992, although Norager had the

right to pay all or part of the amount due before that due date.

During 1986, the Takaos lent Honkers Sound Co., Inc.

(Honkers), at least $102,000.

and sold stereo equipment.

1991.

Honkers operated a stereo store

Honkers ceased doing business during

Honkers was owned by Henry M. Hong and Carol J. Hong.

In the Government's opening brief, respondent concedes that

the Takaos are entitled to a capital loss deduction for 1991 for

bad debt losses from loans to Honkers and Norager and to an

ordinary loss deduction of $12,500 for 1991 resulting from their

ownership of shares in Norager.

On May 20, 1986, Nakamura executed a promissory note on

behalf of Toraya Apartments wherein Toraya Apartments agreed to

pay Akiko or Yoshinori $100,611.60 with interest from that date

at the rate of 12 percent per year.

The due date of the

promissory note was May 20, 1996, but Toraya Apartments had the

right to pay some or all of the amount due before that due date.

Investment Interest

In 1988, Nakamura wrote a check for $55,323.18 to Pier 29

from a "special account" that was in his name although the money

in the account belonged to Yoshinori.

The check purportedly was

interest on a loan that arose from the purchase of an operating

license for the Capri Restaurant and certain furniture and

fixtures from Pier 29.

- 24 For 1988, the Takaos filed Form 4952, Investment Interest

Expense Deduction, with their tax return on which is reflected

"Interest expense on investment debts paid or accrued in 1988" in

the amount of $55,320, "Allowed investment interest expense" in

the amount of $49,299, and "Disallowed investment interest

expense" in the amount of $6,021.

The Takaos reported

"Deductible investment interest" in the amount of $49,299 on

Schedule A--Itemized Deductions for 1988.

For 1989, the Takaos filed Form 4952, Investment Interest

Expense Deduction, with their tax return on which is reflected

"Investment interest expense paid or accrued in 1989" in the

amount of $32,334, "Disallowed investment interest expense from

1988" in the amount of $6,021, "Investment interest expense

deduction" in the amount of $38,355, and "Disallowed investment

interest expense" in the amount of zero.

The Takaos reported

"Deductible investment interest" in the amount of $38,355 on

Schedule A--Itemized Deductions for 1989.

On Schedule B of the

tax return he filed for 1989, Nakamura reported income of $30,000

from Yoshinori.

For 1990, the Takaos filed Form 4952, Investment Interest

Expense Deduction, with their tax return on which is reflected

"Investment interest expense paid or accrued in 1990" in the

amount of $30,000, "Investment interest expense deduction" in the

amount of $30,000, and "Disallowed investment interest expense"

in the amount of zero.

The Takaos reported "Deductible

- 25 investment interest" in the amount of $30,000 on Schedule A-Itemized Deductions for 1990.

On the return he filed for 1990,

Nakamura reported $30,000 interest income from Yoshinori.

The

payment purportedly consisted of (1) interest on a loan from

Nakamura to the Takaos to enable Yoshinori to make a payment on a

loan he owed his sister, Sachiko Hada (Hada), and (2) service

charge interest.

The record is silent as to the purpose of the

Hada loan or the nature of the transaction for which the service

charge interest was calculated.

On April 1, 1990, the Takaos and

Nakamura signed a promissory note in which the Takaos promised to

pay Hada $117,000 in two payments, with the first payment of

$40,000 due on or before August 17, 1990, and the second payment

of $77,000 due on or before August 17, 1991.

secure payment on the loan.

Nakamura agreed to

No interest was due on the loan if

timely principal payments were made.

Subsequently, on August 17,

1990, Yoshinori signed a note promising to pay Nakamura $32,000,

with interest at the rate of 1.25 percent per month, computed

from and after August 17, 1990.

The note specified that Nakamura

could designate payments on the note as an application of accrued

interest.

The note indicated that proceeds from the loan from

Nakamura would be used for the first payment of the "Hada loan".

For 1991, the Takaos filed Form 4952, Investment Interest

Expense Deduction, with their tax return on which is reflected

"Investment interest expense paid or accrued in 1991" in the

amount of $13,850, "Investment interest expense deduction" in the

- 26 amount of $13,850, and "Disallowed investment interest expense"

in the amount of zero.

The Takaos reported "Deductible

investment interest" in the amount of $13,850 on Schedule A-Itemized Deductions for 1991, purportedly based on imputed

interest on a loan from Hada.11

Throughout their association, Yoshinori was involved in

several financial dealings with Nakamura, and he trusted and

relied on Nakamura.

Yoshinori delegated many of his financial

affairs to Nakamura.

Nakamura is listed as a signatory on the

Takaos' business checking account.

He prepared the Takaos' tax

returns for the years 1988 through 1991 as well as Toraya's tax

returns for the same years.

The Takaos' 1988 tax return was filed October 3, 1990.

Respondent granted the Takaos an extension to file their 1988 tax

return until October 15, 1989.

Facts Relating to Toraya

When it filed its petition, Toraya maintained its principal

place of business in San Francisco, California.

Toraya was an

accrual basis taxpayer.

In 1985, Toraya began changing its restaurants' menus from

standard sitdown restaurant fare to sushi bar fare.

However, the

restaurants did not maintain a straight sushi bar menu.

At that

time, the sushi bar concept was known in Japan, but not common in

There is no evidence that any interest was in fact paid,

that it was declared by Hada, or whether it would have qualified

as investment interest.

- 27 the San Francisco area.

Yoshinori traveled to Japan and other

places to learn how to operate a sushi bar restaurant and to

investigate and purchase necessary equipment.

In 1988 and 1989, Toraya operated the Post Street restaurant

and the Berkeley restaurant.

After June 30, 1989, Toraya

operated only the Post Street restaurant because Toraya closed

the Berkeley restaurant after Junichi, who served as manager of

that restaurant, left the San Francisco area.

On its 1988 return, Toraya claimed $9,733 in office expenses

of which $7,933 purportedly was paid to Motomi to reimburse her

for expenses she incurred in maintaining an office in her home.

On its 1989 return, Toraya claimed $12,000 in office expenses all

of which purportedly was paid to Motomi to reimburse her for

expenses she incurred in maintaining an office in her home.

Junichi is Yoshinori and Akiko's son (and Motomi's brother).

Joan was Junichi's wife during the years 1988 and 1989.

were subsequently divorced.12

They

Although Junichi managed the day-

to-day operations of the Berkeley restaurant, Joan handled its

financial affairs (in a manner similar to the way Motomi handled

the financial affairs for the Post Street restaurant).

That is,

Junichi would take home the receipts from the restaurant, the

waitress tags, the cash register receipts, and all the charge

tickets, and Joan would reconcile the cash register tape to the

At the time of trial, Junichi was living in Hawaii and

Joan in the State of Washington. Junichi and Joan are not

parties in this case.

- 28 daily receipts.

She kept a daily sales journal, and at the end

of the month she would total up that journal and send it to

Nakamura, so that he could calculate the sales tax and pay it.

Junichi purchased food for the Berkeley restaurant.

During

1988 and part of 1989, Nakamura would write a check to Joan on

Toraya's account, and she would deposit it in an account Joan

maintained at a bank located two blocks from the Berkeley

restaurant.

Junichi would then draw out cash as needed to pay

for food for the Berkeley restaurant.

Junichi used cash because

the best produce markets in the San Francisco area supplying

Japanese restaurants were run by Japanese families who accepted

cash only.

In 1988 and 1989, Toraya wrote the following checks to Joan:

1988

Date

1/15

2/20

3/28

4/22

5/20

6/2

6/20

6/27

7/15

8/6

9/8

9/22

10/20

11/5

12/5

12/12

Total

Check No.

Amount

Memo notation

762

773

785

790

794

797

801

803

805

811

818

821

826

830

833

834

$1,500

1,500

2,000

1,500

2,700

600

1,700

1,500

1,000

1,500

1,300

24,300

-Purchases, cash

Pur.

Purchases

-Purchases

Purchases

----------

- 29 1989

Date

1/9

2/3

2/21

3/21

4/25

Total

Check No.

Amount

Memo notation

839

844

845

850

856

$1,500

1,500

1,100

7,100

----Payroll

In 1989, Toraya wrote the following checks to cash which

were endorsed by Junichi:

Date

Check No.

Amount

Memo notation

5/15

5/31

6/28

860

863

865

$1,000

1,000

2,000

Produce

Sushi bar/food

Jun Remb Produce

The checks were signed by Nakamura and drawn on Toraya's

bank account.

Until Joan left Junichi, Nakamura made the checks

payable to Joan, because the custom in the Takao families was for

the women to handle the money.

On its 1988 and 1989 tax returns, Toraya treated the

payments to Joan and the checks payable to cash and endorsed by

Junichi as purchases in the cost of goods sold section of the

returns.

Toraya's general ledger shows that the 1989 beginning

inventory for the Berkeley restaurant in the amount of $19,917

remained on its records when that restaurant was closed on June

30, 1989.

Inventory remaining when the Berkeley restaurant was

closed was transferred to Toraya's Post Street restaurant.

- 30 Toraya's beginning inventory reported on its 1989 return

included the Berkeley inventory plus the Post Street inventory.

At the end of 1989 only the Post Street restaurant was open.

its 1989 tax return Toraya wrote off the $19,917 Berkeley

restaurant beginning inventory as a purchases expense.

Toraya's inventory was not commingled with the Fillmore

Street restaurant's inventory or transferred to the Fillmore

Street restaurant.

The Fillmore Street restaurant was a straight

Sushi bar and served mostly fish dishes.

The Post Street and

Berkeley restaurants served more meat dishes.

Frozen meat could

be transferred, but frozen fish was not appropriate for sushi.

Toraya's tax returns reflect the following gross receipts,

cost of goods sold (COGS), taxable income before net operating

loss (NOL), and unappropriated retained earnings per Toraya's

books and records for the years 1988 through 1991:

Gross receipts

COGS

Taxable income

before NOL

Retained earnings

per books

1988

1989

1990

1991

$922,439

340,311

$648,927

232,303

$449,608

152,934

$421,608

132,107

(4,983)

(1,361)

5,315

(13,929)

162,390

160,153

$164,492

132,322

Nakamura advised the Takaos that every cash transaction

should be rung up.

He also advised the Takaos to check the

waitress tags against the cash register tapes at the end of the

day to make sure that every transaction was recorded.

Nakamura

- 31 did not observe personally the counting of the cash at the

restaurants.

Nakamura prepared Toraya's tax returns for the years ending

1988, 1989, 1990, and 1991.

In preparing Toraya's tax returns,

Nakamura believed that he was picking up all taxable sales.

did not have waitress tags from daily sales, cash receipt

records, or bills and statements from the restaurants.

Toraya filed its 1988 calendar year tax return on or about

July 21, 1990.

It filed its 1989 calendar year tax return on or

about August 26, 1990.

Toraya had an extension to file the 1989

return to September 15, 1990.

Respondent concedes that Toraya

timely filed its 1989 return.

OPINION

The Commissioner's deficiency determination is normally

entitled to a presumption of correctness, Rapp v. Commissioner,

774 F.2d 932, 935 (9th Cir. 1985), and the burden of proving the

determination erroneous generally rests on the taxpayer, Rule

142(a); Welch v. Helvering, 290 U.S. 111 (1933).

However, in the

case of unreported income, the rule in the Court of Appeals for

the Ninth Circuit (to which this case is appealable) is that the

presumption in favor of the Commissioner arises only where it is

supported by a minimal factual foundation linking the taxpayer

with income-producing activity.

See, e.g., Palmer v. United

States, 116 F.3d 1309, 1313 (9th Cir. 1997); Rapp v.

Commissioner, supra; Delaney v. Commissioner, 743 F.2d 670, 671

- 32 (9th Cir. 1984), affg. T.C. Memo. 1982-666; Edwards v.

Commissioner, 680 F.2d 1268, 1270 (9th Cir. 1982); Weimerskirch

v. Commissioner, 596 F.2d 358, 360-361 (9th Cir. 1979) ("the

Commissioner must offer some foundational support for the

deficiency determination before the presumption of correctness

attaches to it"), revg. 67 T.C. 672 (1977).

Once the Government

has carried its initial burden of introducing some minimal

evidence linking the taxpayer with income-producing activity, the

burden shifts to the taxpayer to rebut the presumption by

establishing by a preponderance of the evidence that the

deficiency determination is arbitrary or erroneous.

Rapp v.

Commissioner, supra at 935; Adamson v. Commissioner, 745 F.2d

541, 547 (9th Cir. 1984), affg. T.C. Memo. 1982-371; United

States v. Stonehill, 702 F.2d 1288, 1294 (9th Cir. 1983).

Respondent has established petitioners' connection with an

income-producing activity, such as the restaurant, rental

property, the lending of money, and the sale of real estate.

Therefore, petitioners bear the burden of proving that respondent

erred.

Section 6001 requires all taxpayers to maintain adequate

books and records of taxable income.

In the absence of adequate

records, the Commissioner is authorized to reconstruct a

taxpayer's income by any reasonable method that clearly reflects

the taxpayer's income.

Sec. 446(b); Holland v. United States,

348 U.S. 121, 130-132 (1954); Cracchiola v. Commissioner, 643

- 33 F.2d 1383, 1385 (9th Cir. 1981), affg. per curiam T.C. Memo.

1979-3; Parks v. Commissioner, 94 T.C. 654, 658 (1990).

One of

these methods, the bank deposits and cash expenditure method, has

long been sanctioned by the courts.

Clayton v. Commissioner, 102

T.C. 632, 645 (1994); see, e.g., United States v. Soulard, 730

F.2d 1292 (9th Cir. 1984); United States v. Hall, 650 F.2d 994

(9th Cir. 1981).

Bank deposits are prima facie evidence of income, and the

Commissioner need not prove a likely source of that income.

Clayton v. Commissioner, supra at 645; Tokarski v. Commissioner,

87 T.C. 74, 77 (1986).

The bank deposits method assumes that all

money deposited in a taxpayer's bank account during a given

period constitutes taxable income, but the Government must take

into account any nontaxable source or deductible expense of which

it has knowledge.

Clayton v. Commissioner, supra at 646; DiLeo

v. Commissioner, 96 T.C. 858, 868 (1991), affd. 959 F.2d 16 (2d

Cir. 1992).

The taxpayer has the burden of proving that the

deposits came from a nontaxable source.

See Calhoun v. United

States, 591 F.2d 1243, 1245 (9th Cir. 1978); Ruark v.

Commissioner, 449 F.2d 311, 312 (9th Cir. 1971), affg. per curiam

T.C. Memo. 1969-48.

The Kudos

Unreported Income

In the notice of deficiency respondent determined that for

1990 the Kudos had unreported income as shown by unexplained bank

- 34 deposits of $55,979.

Respondent now concedes that the adjustment

for 1990 should be reduced to $42,506.

to the ground for the reduction.

The record is silent as

For 1991, respondent determined

that the Kudos had unreported income as shown by unexplained bank

deposits of $57,795.

Respondent now concedes that $625 of the

unexplained deposits came from a nontaxable insurance payment and

that $4,132 came from nontaxable tax refunds.

Thus, the amount

at issue for 1991 is $53,011.

The Kudos testified that they received some insurance

reimbursements and contributions from relatives for medical

expenses of their son Nicholas.

However, the testimony was not

specific as to amounts, sources, or dates.

Similarly, Motomi and

Scott testified that they periodically received gifts from

relatives in Japan for holidays and other celebrations.

Motomi

also testified that she sometimes wrote checks to pay bills for

tenants of the apartments and restaurant employees who did not

have bank accounts, and they gave her the cash.

She also paid

her parents' gardener when they traveled and was repaid in cash

when they returned.

Again, the testimony was vague.

The Court

is not required to accept unsubstantiated testimony.

Geiger v.

Commissioner, 440 F.2d 688, 689-690 (9th Cir. 1971), affg. per

curiam T.C. Memo. 1969-159.

Nevertheless, we believe that the Kudos did receive some

amounts of this nature and that those amounts were deposited in

the bank.

We thus find that the Kudos are entitled to reductions

- 35 of their unexplained bank deposits in addition to those conceded

by respondent as follows:

Item

Insurance reimbursements,

contributions from relatives

for Nicholas

Other gifts from relatives

Reimbursements--parents

Reimbursements--check writing

Total reductions

1990

1991

$2,500

500

1,000

$4,500

$2,500

500

1,000

$5,000

Although Scott testified that he made one or two trips to

Japan in 1990 and one in 1991, bringing back money both times, we

do not allow any additional amounts based on that testimony.

is too vague for us to make findings regarding the dates and

amounts.

Neither do we allow anything in 1991 for repayment of a

loan to Motomi's brother, Junichi.

Although there is evidence

that a loan was made in that year, the record is silent as to

when, if ever, or in what amounts or form, Junichi repaid it.

With regard to the remaining unexplained bank deposits, we

sustain respondent.

We turn now to the penalties for 1990 and 1991 under section

6662(a).

Section 6662(a)

Respondent determined that the Kudos are liable for

accuracy-related penalties for negligence under section 6662(a)

for 1990 and 1991.

Petitioners contend that the Kudos were not

negligent, because they relied in good faith on Nakamura to

prepare their tax returns properly for those years.

Respondent

contends that petitioners failed to prove that the Kudos had

- 36 reasonable cause for understating their income on their returns

for 1990 or 1991, and respondent contends that the

understatements constitute negligence within the meaning of

section 6662(a)(1).

Section 6662(a) imposes a penalty in an amount equal to 20

percent of the underpayment of tax attributable to one or more of

the items set forth in section 6662(b).

Respondent asserts that

the entire underpayment of petitioners’ tax was due to negligence

or intentional disregard of rules or regulations, sec.

6662(b)(1), and to a substantial understatement, sec. 6662(b)(2).

Petitioners bear the burden of proving that respondent's

determination is erroneous.

Rule 142(a); Axelrod v.

Commissioner, 56 T.C. 248, 258-259 (1971).

“Negligence” includes a failure to make a reasonable attempt

to comply with the provisions of the internal revenue laws.

6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.

Sec.

“Disregard”

includes any careless, reckless, or intentional disregard of

rules or regulations.

Tax Regs.

Sec. 6662(c); sec. 1.6662-3(b)(2), Income

There is a substantial understatement of income tax if

the amount of the understatement for the taxable year exceeds the

greater of (1) 10 percent of the tax required to be shown on the

return or (2) $5,000.

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

For purposes of

section 6662(d)(1), "understatement" is defined as the excess of

tax required to be shown on the return over the amount of tax

that is shown on the return reduced by any rebate within the

meaning of section 6211(b)(2).

Sec. 6662(d)(2)(A).

Any

- 37 understatement is reduced by the portion of the understatement

attributable to an item for which there is substantial authority

for the treatment by the taxpayer or where the relevant facts

affecting the item's tax treatment are adequately disclosed in

the return or in a statement attached to the return.

Sec.

6662(d)(2)(B).

The Kudos’ failure to maintain and to produce reliable

records of their financial transactions and taxable income

supports a conclusion of negligence.

Crocker v. Commissioner, 92

T.C. 899, 917 (1989); Schroeder v. Commissioner, 40 T.C. 30, 34

(1963).

Moreover, they cannot avoid the penalty on the grounds

of reliance on their tax preparer, because the Kudos did not

provide Nakamura with bank records or other records of the bank

deposits sufficient to prepare their returns accurately.

Chem. Corp. v. Commissioner, 88 T.C. 654, 662 (1987).

Metra

The

evidence justifies imposition of the penalty for negligence

and/or substantial understatement for each year.

We apply the penalty only to the portion of the

understatement attributable to unexplained bank deposits and to

the "Taxes Paid by Employer" issue for 1990, not to other items

raised in the notice of deficiency.

The Takaos

Unreported Income

Respondent contends that the Takaos had unreported income

for the years in issue, as evidenced by the unexplained bank

- 38 deposits and cash purchases described below.

Except to the

extent conceded, petitioners contend that the Takaos did not

underreport their income.

Unexplained Bank Deposits

In the notices of deficiency for 1988 through 1991,

respondent determined that the Takaos had unexplained bank

deposits in the amounts set forth below.

However, respondent

concedes that the adjustments for unexplained bank deposits

should be reduced as shown below.

Additionally, petitioners

concede that the Takaos' 1991 Japanese rental income was

understated as described below.

For 1988, the unexplained bank deposits and respondent's

concession are as follows:

Source

Cash deposits to accounts in United States

Check from USA Publishing

Checks from Toraya Apartments

Check from Robert Wong

Check from Toraya Corp.

Check from Motomi

Check from Thomas Timbale

Deposits to Transamerica account

Deposits from unknown sources

Total

Less amount conceded

Unexplained deposits in issue

Amount

$85,500

5,000

5,200

2,500

1,000

2,000

1,601

6,112

15,568

124,481

13,837

110,644

In a stipulation of settled issues, respondent conceded that

the adjustment for "Unexplained deposits" in the notice of

deficiency for 1988 should be reduced $13,837, but respondent did

not identify the source or sources from which the conceded

amounts came. For purposes of the discussion below, we assume

that the source is either cash deposits to accounts in the United

States or deposits from unknown sources. Should our assumption

be incorrect, the parties should make the appropriate correction

- 39 in their Rule 155 calculation in order that the calculation

comports with respondent's concession.

For 1989, the unexplained bank deposits and respondent's

concession are as follows:

Source

Cash deposits to accounts in United States

Check from USA Publishing

Check from Robert Wong

Check from Motomi

Check from Thomas Timbale

Deposits to Transamerica account

Check from Kanda A.G.

Check from Fusaku Aaoyaga

Total

Less amount conceded

Unexplained deposits in issue

Amount

$43,955

6,000

5,500

3,000

5,276

3,644

163

500

68,038

6,238

61,800

In a stipulation of settled issues, respondent conceded that

the adjustment for "Unexplained deposits" in the notice of

deficiency for 1989 should be reduced $6,238, but respondent did

not identify the source or sources from which the conceded

amounts came. For purposes of the discussion below, we assume

that the source is either cash deposits to accounts in the United

States or deposits from unknown sources. Should our assumption,

be incorrect, the parties should make the appropriate correction

in their Rule 155 calculation in order that the calculation

comports with respondent's concession.

For 1990, the unexplained bank deposits are as follows:

Source

Cash deposits to accounts in United States

Checks from Toraya Apartments

Check from Motomi

Check from Yashitaki Aoyagi

Check from California Physicians

Check from Nakamura

Deposits from unknown sources

Unexplained deposits in issue

Amount

$39,000

7,000

2,295

521

3,357

32,000

30,761

114,934

For 1991, the unexplained bank deposits and petitioners'

concession are as follows:

- 40 Source

Amount

Cash deposits to accounts in United States

Deposits to accounts in Japan

Check from USA Publishing

Check from Toraya Apartments

Check from Alameda County

Deposits from unknown sources

Total

Less deposits to accounts in Japan

conceded

Unexplained deposits in issue

$11,400

81,933

2,000

1,688

10,081

109,102

71,825

37,277

The Takaos agree that $10,108 of the $81,933 deposited to

accounts in Japan is taxable income from rents that was not

reported on their 1991 tax return.

As we stated supra, bank deposits are prima facie evidence

of income, and respondent need not prove its likely source.

Clayton v. Commissioner, 102 T.C. at 645; Petzoldt v.

Commissioner, 92 T.C. 661, 695-696 (1989); Tokarski v.

Commissioner, 87 T.C. at 77.

Petitioners have the burden of

proving that the unexplained bank deposits came from a nontaxable

source.

Calhoun v. United States, 591 F.2d at 1245; Ruark v.

Commissioner, 449 F.2d at 312.

Petitioners contend that a nontaxable source of the

unexplained bank deposits consists of cash sent to the Takaos

from Akiko's mother in Japan.

Petitioners assert further that

another nontaxable source consists of a cash hoard that Akiko had

accumulated before January 1, 1988, from cash the Takaos received

between 1982 through 1987 from Akiko's parents, from interest

income ($389,621) paid to the Takaos between 1982 and 1987, and

from payments they received from the sales of the Silver Lake and

- 41 Sierra Lakes properties (according to petitioners over $314,000

in 1982 plus an additional $524,803 in later years).13

Respondent contends that Yoshinori's testimony regarding any

nontaxable sources for the unexplained bank deposits was vague

and inconsistent.

Respondent maintains that Yoshinori failed to

establish the amount the Takaos received between 1982 and 1987

from the alleged nontaxable sources.

In addition, respondent

asserts that Yoshinori has not established that the Takaos did

not spend some or all of those funds or deposit them into their

bank accounts during those years.

Except to the extent explained below, we agree with

respondent that petitioners have not established a nontaxable

source for the unexplained bank deposits.

Cash From Japan

Petitioners testified that during the years in issue Akiko

brought back money from Japan, or received it in the mail from

her mother, as repayment on a loan Akiko made to her parents in

1959.

We have found that Akiko received $3,600 during each of

Without deciding at this time how much the Takaos

actually received in installment sales payments from the Silver

Lake and Sierra Lakes properties between 1982 and 1987, it

appears that petitioners have miscalculated the total amount that

the Takaos received from those sales by counting twice the

$305,000 purportedly received in 1982. See table supra p. 18,

which reflects that a total of $524,803 was received between 1982

and 1987 from installment payments from the two properties,

including $305,000 received in 1982. The $524,803 total agrees

with the amounts reported on the Takaos' tax returns for 1982

through 1987 as payments received from the Silver Lake and Sierra

Lakes sales.

- 42 the years in issue in repayment for the loan.

taxable to the Takaos.

That amount is not

Petitioners have not proved through

testimony or other evidence that they received any cash from her

mother above the $3,600 which we have allowed.

Petitioners

further have not proved that the Takaos brought into the United

States from Japan any money other than money received for the

repayment of the loan.

Accordingly, the understatement of income

is reduced $3,600 for each of the years in issue for loan

repayments received from Akiko's mother.

Cash Hoard

Under the cash deposits method of determining unreported

income, it is important to establish the amount of cash on hand

at the beginning of the years in issue, because a large amount of

undeposited cash could provide a likely source for the

unexplained bank deposits.

1298.

United States v. Soulard, 730 F.2d at

Petitioners have the burden to establish the amount of any

cash hoard accumulated before the beginning of the years in issue

as well as the amount from that cash hoard that Akiko deposited

during the years in issue.

See Calhoun v. United States, supra.

Petitioners have not shown that the proceeds from the sales

of properties, or interest income, or money from relatives

received before January 1, 1988, were not deposited before that

date.

Conversely, there is evidence that one or both of the

Takaos had deposited a significant amount of money in various

bank accounts before that date.

For example, a schedule of

- 43 income received between 1982 and 1987 admitted into evidence, see

table supra p. 18, indicates that the Takaos received interest

income from banks during that period of $306,499.

Interest of

that amount would suggest that the Takaos maintained a

substantial principal balance in the banks during those years.

Yoshinori, Motomi, and Nakamura testified that Akiko

maintained a cash hoard in her home before and during the years

in issue as well as at the time of her death.

However, none of

them knew the amount of cash Akiko had on hand as of January 1,

1988, or the cash that remained at the end of the years in issue.

They did not know whether any deposits Akiko made during the

years in issue came from that cash hoard.

Yoshinori testified that Akiko began depositing money in

1988 after an employee of the bank advised Akiko she could earn

interest on deposits.

Petitioners also contend that Akiko made

deposits from her cash hoard after Nakamura warned her in 1989

that it was dangerous to keep cash in the house.

That testimony

seems to be belied by the apparently large principal balances

Akiko maintained in bank accounts before and during the years in

issue.

It also is contradicted by Motomi's testimony that Akiko

had a large sum of money on hand at the time of her death.

We do

not doubt that Akiko kept some cash on hand in years before and

during the years in issue.

However, we are unable to find from

this record the amount, if any, of the questioned cash deposits

that came from cash accumulated before January 1, 1988.

- 44 Accordingly, petitioners have failed to prove Akiko's cash hoard

constituted a nontaxable source for the unexplained bank

deposits.

Specific Checks

Petitioners suggest in their brief that deposits from Motomi

made during 1988, 1989, and 1990 were reimbursements for money

Akiko gave her for purchases, that deposits from U.S.A.

Publishing made in 1988 and 1989 were loan repayments made on a

loan the Takaos made to that entity in 1982, that the deposit

from California Physicians in 1990 was a refund for a medical

payment, and that the deposit from Alameda County in 1991 was

some type of refund.

brief as proof.

This Court does not consider statements in

Rule 143(b); Niedringhaus v. Commissioner, 99

T.C. 202, 214 n.7 (1992); Viehweg v. Commissioner, 90 T.C. 1248,

1255 (1988); Evans v. Commissioner, 48 T.C. 704, 709 (1967),

affd. per curiam 413 F.2d 1047 (9th Cir. 1969).

Petitioners

presented no evidence at trial in support of their contentions

that the deposits were made for the reasons asserted.

Accordingly, petitioners have not established that those deposits

came from a nontaxable source.

Petitioners suggest on brief that the checks from Toraya

Apartments deposited in 1988, 1990, and 1991 were rental income

that was reported already on the Takaos' returns for those years.

The record shows that Toraya Apartments was a partnership of

which Nakamura was the managing general partner, and that the

- 45 partnership maintained its own checking account.

The questioned

checks are for the amounts of $5,200, $7,000, and $2,000 for

1988, 1990, and 1991, respectively.

The Takaos reported passive

losses of $2,696 and $2,310 from Toraya Apartments for 1988 and

1991, respectively, and passive income of $2,768 from Toraya

Apartments for 1990.

Neither Nakamura nor Yoshinori testified as

to the nature of the disputed checks.

We are not persuaded that

the disputed checks from Toraya constitute rental income already

included in income.

Petitioners speculate that the deposit in the amount of

$1,000 from Toraya for 1988 was salary already reported in

income.

Yoshinori reported Form W-2 wages from Toraya for 1988

of $2,400, and Akiko reported Form W-2 wages from Toraya for 1988

of $5,275.

Yoshinori did not testify regarding the nature of the

$1,000 check from Toraya or about the manner in which Toraya paid

his or Akiko's salary.

Statements in briefs are not evidence.

Rule 143(b); Niedringhaus v. Commissioner, supra; Viehweg v.

Commissioner, supra; Evans v. Commissioner, supra.

Under the

circumstances, we are not persuaded that the $1,000 was included

in income for 1988 as wages.

Petitioners contend that the $32,000 check from Nakamura

deposited in 1990 was a loan and not income.

that he lent Yoshinori money in 1990.

Nakamura testified

The record also contains a

promissory note dated August 17, 1990, in which Yoshinori

promises to pay Nakamura $32,000.

On the basis of that evidence,

- 46 we find that the $32,000 check from Nakamura constituted a loan

to Yoshinori; therefore, it was not taxable income to the Takaos.

Other Unexplained Bank Deposits

Petitioners assert that the remaining deposits for which

there is no explanation do not exceed reported income.

Under the

bank deposits method, generally bank deposits for the year are

totaled and nontaxable amounts are eliminated.

constitutes a reconstructed gross income.

The balance

Taxable income then is

calculated in the usual way using the reconstructed gross income.

If the resulting figure differs from the taxable income reported

on the tax return for that year, the difference is presumed to

constitute unreported taxable income.

F.2d at 997 n.4.

United States v. Hall, 650

We cannot ascertain from the record the total

amount of bank deposits the Takaos made during each of the years

in issue.

Rather, for each year the parties refer to the amounts

in issue as "unexplained deposits".

Petitioners have not shown

that the deposits in dispute represent total deposits for the

years in issue.

Consequently, we are not persuaded that the

remaining deposits, in effect, are included already in reported

income.

Accordingly, with regard to the remaining unexplained

bank deposits, except to the extent that any of the remaining

unexplained bank deposits were included in respondent's

concession in a stipulation of settled issues, we sustain

respondent.

- 47 On the basis of the foregoing, we conclude that unexplained

bank deposits in the following amounts constitute unreported

taxable income to the Takaos for the following years:

Unexplained deposits

in issue

Less:

Money from parents

Check from Nakamura

Unreported income

from deposits

1988

1989

1990

1991

$110,644

$61,800

$114,934

$37,277

3,600

32,000

107,044

58,200

111,334

1,677

Cash Purchases

On November 23, 1988, Akiko used $9,000 cash to purchase a

cashier's check.

On February 1, 1989, Yoshinori used $55,320

cash to purchase a Mercedes Benz.

On April 19, 1989, Akiko used

$3,000 cash to purchase a traveler's check.

Respondent contends

that the source of the cash to make those purchases for 1988 and

1989 was unreported income.

Petitioners contend that the Takaos

used cash from Akiko's cash hoard to make the cash purchases.

Both Yoshinori and Nakamura testified that the cash for the

purchase of the Mercedes Benz came from Akiko's cash hoard.

we discussed above, although we do not doubt that Akiko

maintained a cash hoard, the record does not establish the amount

of cash on hand as of the beginning of the years in issue, or the

amount that Akiko used from funds accumulated before that time.

Nevertheless, on the basis of the testimony relating to the

purchase of the Mercedes Benz, we believe that at least some

portion of the cash for the automobile came from cash accumulated

- 48 before January 1, 1988.

We find that $20,000 of the cash for the

Mercedes Benz came from Akiko's cash hoard accumulated before the

beginning of the years in issue; therefore, unreported income

should be reduced accordingly.

With regard to the remaining

unreported income from cash purchases, we sustain respondent.

Investment Interest Deduction

In the notices of deficiency respondent determined that the

Takaos were not entitled to deductions for investment interest

they claimed on Schedules A of their tax returns in the following

amounts:

Year

Amount

1988

1989

1990

1991

$49,299

38,355

30,000

13,850

Petitioners contend that for each of the years in issue the

Takaos are entitled to investment interest deductions for

interest payments they made during those years on bona fide

debts.

Respondent contends that petitioners have failed to

establish that the Takaos paid interest to qualified creditors

for those years.

Additionally, respondent contends that the

Takaos did not have any qualified investment income against which

any qualified investment interest expenses could be offset.

Section 163(a) provides the general rule that there shall be

allowed as a deduction all interest paid or accrued within the

taxable year on indebtedness.

Limitations on that general rule,

- 49 however, may limit or prohibit a taxpayer from deducting

indebtedness interest.

Sec. 163.

For example, section 163(h)

provides that a taxpayer other than a corporation may not deduct

personal interest.14

Sec. 163(h).

Excluded from the definition

of personal interest is investment interest.

Sec. 163(h)(2)(B).

Sec. 163(h)(2) provides, in pertinent part, as follows:

(2) Personal interest.--For purposes of this

subsection, the term "personal interest" means any interest

allowable as a deduction under this chapter other than-(A) interest paid or accrued on indebtednes

properly allocable to a trade or business (other than

the trade or business of performing services as an

employee),

(B) any investment interest (within the meaning of

subsection (d)),

section 469 in computing income or loss from a passive

activity of the taxpayer,

(D) any qualified residence interest (within the

meaning of paragraph (3)), and

(E) any interest payable under section 6601 on any

unpaid portion of the tax imposed by section 2001 for

the period during which an extension of time for

payment of such tax is in effect under section 6163 or

6166 or under section 6166A (as in effect before its

repeal by the Economic Recovery Tax Act of 1981).

- 50 Investment interest is defined in section 163(d)(3) as

follows:

(3) Investment interest.--For purposes of this

subsection-(A) In general.--The term "investment interest"

means any interest allowable as a deduction under this

chapter (determined without regard to paragraph (1))

which is paid or accrued on indebtedness properly

allocable to property held for investment.

(B) Exceptions.--The term "investment interest"

shall not include-(i) any qualified residence interest (as

defined in subsection (h)(3)), or

(ii) any interest which is taken into

account under section 469 in computing income or

loss from a passive activity of the taxpayer.

purposes of this paragraph, the term "interest"

includes any amount allowable as a deduction in

connection with personal property used in a short sale.

Section 163(d) provides limitations on the amount of

investment interest that is deductible in a year.

For years

before 1987, the investment interest deduction is limited to net

investment income15 plus $10,000.

Over the years 1987 through

Sec. 163(d)(4) defines net investment interest as

follows:

(4) Net investment income.--For purposes of this

subsection-(A) In general.--The term "net investment income"

means the excess of-(i)

investment income, over

(continued...)

- 51 1990, the $10,000 in excess of net investment income is phased

out.

Sec. 163(d)(6).

For years after 1990, the investment

interest deduction is limited to the taxpayer's net investment

income for the year.

Sec. 163(d)(1).

The amount of investment

interest not deductible in a year is carried over to the next

(...continued)

(ii)

investment expenses.

(B) Investment income.--The term "investment

income" means the sum of-(i) gross income (other than gain described

in clause (ii)) from property held for investment,

and

(ii) any net gain attributable to the

disposition of property held for investment.

expenses" means the deductions allowed under this

chapter (other than for interest) which are directly

connected with the production of investment income.

(D) Income and expenses from passive activities.-Investment income and investment expenses shall not

include any income or expenses taken into account under

section 469 in computing income or loss from a passive

activity.

(E) Reduction in investment income during phasein of passive loss rules.--Investment income of the

taxpayer for any taxable year shall be reduced by the

amount of the passive activity loss to which section

469(a) does not apply for such taxable year by reason

of section 469(m). The preceding sentence shall not

apply to any portion of such passive activity loss

which is attributable to a rental real estate activity

with respect to which the taxpayer actively

participates (within the meaning of section 469(i)(6))

during such taxable year.

- 52 year and treated as investment interest for that year.

Sec.

163(d)(2).

Section 163(d)(5)16 defines property held for investment to

include (i) property which normally produces income described in

section 469(e)(1), and (ii) an interest in an activity involving

the conduct of a trade or business which is not a passive

activity and in which the taxpayer does not materially

participate.

Sec. 163(d)(5); Russon v. Commissioner, 107 T.C.

263, 268-269 (1996).

Income described in section 469(e) includes

Sec. 163(d)(5) provides as follows:

(5) Property held for investment.--For purposes of

this subsection-(A) In general.--The term "property held for

investment" shall include-(i) any property which produces income of a

type described in section 469(e)(1), and

(ii) any interest held by a taxpayer in an

activity involving the conduct of a trade or

business-(I) which is not a passive activity, and

(II) with respect to which the taxpayer

does not materially participate.

(B) Investment expenses.--In the case of property

described in subparagraph (A)(i), expenses shall be

allocated to such property in the same manner as under

section 469.

terms "activity", "passive activity", and "materially

participate" have the meanings given such terms by

section 469.

- 53 "'interest, dividends, annuities, or royalties not derived in the

ordinary course of a trade or business', sometimes known as

portfolio income."

Russon v. Commissioner, supra at 267 (quoting

section 469(e)(1)).

Interest expense on a debt generally is allocated in the

same manner as the debt to which the interest expense relates is

allocated.

Debt is allocated by tracing disbursements of the

debt proceeds to specific expenditures.

Seymour v. Commissioner,

109 T.C. 279, 282-283 (1997); Hickman v. Commissioner, T.C. Memo.

1997-545; sec. 1.163-8T(a)(3), Temporary Income Tax Regs., 52

Fed. Reg. 24999 (July 2, 1987).

Interest expense allocated to an

investment expenditure is treated for purposes of section 163(d)

as investment interest.

Sec. 1.163-8T(a)(4)(i)(C), Temporary

Income Tax Regs., 52 Fed. Reg. 25000 (July 2, 1987).

The term

"investment expenditure" means an expenditure (other than a

passive activity expenditure) properly chargeable to capital

account with respect to property held for investment within the

meaning of section 163(d)(5)(A) or an expenditure in connection

with the holding of the property.

Sec. 1.163-8T(b)(3), Temporary

Income Tax Regs., 52 Fed. Reg. 25000 (July 2, 1987).

Debt is

allocated to expenditures in accordance with the use of the debt

proceeds.

Sec. 1.163-8T(c)(1), Temporary Income Tax Regs., 52

Fed. Reg. 25000 (July 2, 1987).

- 54 1988 Investment Interest Deduction

For 1988, petitioners assert that the Takaos are entitled to

an investment interest deduction in the amount of $49,299, for

the accrued interest payment of $55,323.18 they made in 1988 on a

loan Pier 29 made to Norager.

Petitioners maintain that the

balance of the interest payment may be carried over to 1989.

Respondent contends that petitioners have not established

that Yoshinori had any relationship to the "special account" from

which Nakamura paid the $55,323.

Respondent contends further

that petitioners have not shown that the Takaos owed any money to

Pier 29.

Respondent additionally asserts that petitioners have

failed to establish that the claimed interest constitutes

investment interest.

It has long been established that for interest to be

deductible under section 163(a), the interest must be on the

indebtedness of the taxpayer and not the indebtedness of another.

Borchert v. United States, 757 F.2d 209, 211 (8th Cir. 1985);

Golder v. Commissioner, 604 F.2d 34, 35 (9th Cir. 1979), affg.

T.C. Memo. 1976-150; Smith v. Commissioner, 84 T.C. 889, 897

(1985), affd. without published opinion 805 F.2d 1073 (D.C. Cir.

1986); Rushing v. Commissioner, 58 T.C. 996 (1972).

Nakamura

presented conflicting testimony regarding who was liable on the

note, Norager, a corporation, or Yoshinori and himself.

Moreover, it appears that the assets acquired with the loan

proceeds belonged to Norager, not to the Takaos.

Thus,

- 55 petitioners have failed to establish that the Takaos, who owned

stock in Norager, were personally liable on the debt to Pier 29,

or that they had an interest in the property during the years at

issue.

Accordingly, we sustain respondent's determination on the

investment interest issue for 1988.

In light of our holding, we

do not address respondent's remaining arguments relating to this

issue.

1989 Investment Interest Deduction

For 1989, petitioners claim that they are entitled to an

investment interest deduction of $38,355, consisting of the

carryover of investment interest from 198817 plus $30,000

interest Yoshinori paid to Nakamura on amounts Yoshinori owed

Nakamura.

Nakamura testified that the $30,000 represented

expenses he had incurred relating to an earlier audit that he had

In the Government's brief, respondent erroneously stated

that the Takaos claimed an investment interest expense deduction

of $55,320 on Schedule A--Itemized Deductions of their 1988

return. The Form 4952, Investment Interest Expense Deduction,

filed with the Takaos' 1988 return shows "Interest expense on

investment debts paid or accrued" in 1988 in the amount of

$55,320, "Allowed investment interest expense" in the amount of

$49,299, and "Disallowed investment interest expense" in the

amount of $6,021. The Takaos reported "Deductible investment

interest" in the amount of $49,299 on Schedule A for 1988. The

Form 4952 filed with the Takaos' 1989 return shows "Investment

interest expense paid or accrued" in 1989 in the amount of

$32,334, "Allowed investment interest expense" in the amount of

$38,355, and "Disallowed investment interest expense" in the

amount of zero. The Takaos reported "Deductible investment

interest" in the amount of $38,355 on Schedule A for 1989.

Petitioners do not explain the $2,334 discrepancy in the amount

of investment interest expense they claimed they paid in 1989 on

Form 4952 ($32,334) and the amount they now claim in their brief

($30,000). In light of our holding on the 1989 investment

interest deduction, see infra, we do not resolve the discrepancy.

- 56 passed on to Yoshinori "because personal interest is not

deductible."

On the return he filed for 1989, Nakamura reported

$30,000 in interest income from Yoshinori.

Respondent contends that petitioners did not establish that

the Takaos had any loan obligations to anyone in 1989 that

carried any interest obligations in the amounts claimed by the

Takaos, or that the Takaos made any interest payments in that

dollar amount during 1989.

Respondent additionally asserts that

petitioners have failed to establish that the claimed interest

constitutes investment interest.

Respondent also contends that

the Takaos did not have investment income against which any

investment interest expense may be deducted.

Petitioners presented no evidence showing that the Takaos

used the loan proceeds to which the interest payments relate to

acquire or hold property held for investment as defined in

section 163(d)(5).

proof on this issue.

Thus, they have failed in their burden of

Accordingly, we sustain respondent's

determination for 1989.

In light of our holding, we do not

address respondent's remaining arguments relating to this issue.

1990 Investment Interest Deduction

For 1990, petitioners claim that the Takaos are entitled to

an investment interest deduction of $30,000 for interest they

paid to Nakamura on service charges and on a loan Nakamura made

to Yoshinori in 1990 in order for Yoshinori to make a payment on

- 57 the loan from Hada.

On the return he filed for 1990, Nakamura

reported $30,000 in interest income from Yoshinori.

Respondent contends that petitioners did not establish that

the Takaos had any loan obligations to anyone in 1990 that

carried any interest obligations in the amounts claimed by the

Takaos, or that the Takaos made any interest payments in that

dollar amount during 1990.

Respondent additionally asserts that

petitioners have failed to establish that the claimed interest

constitutes investment interest.

Respondent also contends that

the Takaos did not have investment income against which any

investment interest expense may be deducted.

Petitioners presented no evidence showing that the Takaos

used the loan proceeds to which the interest relates to acquire

or hold property held for investment as defined in section

163(d)(5).

Thus, they have failed in their burden of proof on

this issue.

Accordingly, we sustain respondent's determination

for 1990.

In light of our holding, we do not address

respondent's remaining arguments relating to this issue.

1991 Investment Interest Deduction

For 1991, petitioners contend the Takaos are entitled to an

investment interest deduction of $13,850 for imputed interest on

the loan from Hada.

Respondent contends that petitioners have failed to

establish that any payment was made to Hada during 1991 or that,

if a payment was made, that the payment was not principal.

Respondent additionally asserts that petitioners have failed to

- 58 establish that the claimed interest constitutes investment

interest.

Respondent also contends that the Takaos did not have

investment income against which any investment interest expense

may be deducted.

Petitioners presented no evidence showing that the Takaos

used the loan proceeds to which the interest relates to acquire

or hold property held for investment as defined in section

163(d)(5).

Thus, they have failed in their burden of proof on

this issue.

Accordingly, we sustain respondent's determination

for 1991.

In light of our holding, we do not address

respondent's remaining arguments relating to this issue.

We turn now to the additions to tax and penalties respondent

determined for the years in issue.

Section 6651(a)

Respondent determined that the Takaos are liable for an

addition to tax for late filing under section 6651(a) for 1988,

because they failed to timely file their Federal income tax

return for that year.

Petitioners contend that the Takaos relied

on Nakamura to timely file their return.

Respondent contends

that the Takaos did not prove that the failure to timely file was

due to reasonable cause.

We agree with respondent.

Section 6651(a)(1) imposes an addition to tax of 5 percent

of the amount of the tax due for each month a return is

delinquent, up to a maximum of 25 percent.

The addition to tax

is not applicable if it is shown that the failure is due to

reasonable cause and not willful neglect.

Sec. 6651(a)(1);

- 59 United States v. Boyle, 469 U.S. 241, 245 (1985).

Petitioners

have the burden of proving that the failure to file was due to

reasonable cause and not to willful neglect.

Niedringhaus v.

Commissioner, 99 T.C. at 220-221; Baldwin v. Commissioner, 84

T.C. 859, 870 (1985).

To prove "reasonable cause", taxpayers

must show that they exercised ordinary business care and prudence

but nevertheless were unable to file the return within the

statutorily prescribed time.

Crocker v. Commissioner, 92 T.C.

899, 913 (1989); sec. 301.6651-1(c)(1), Proced. & Admin. Regs.

Generally, taxpayers may establish reasonable cause by proving

that they reasonably relied on the advice of an accountant or

attorney that it was unnecessary to file a return and later found

that the advice was erroneous or mistaken.

United States v.

Boyle, supra at 250; Estate of Paxton v. Commissioner, 86 T.C.

785, 820 (1986).

We have held that reasonable reliance on the

erroneous advice of an attorney with respect to the due date of a

return may constitute "reasonable cause" within the meaning of

section 6651(a)(1).

Estate of La Meres v. Commissioner, 98 T.C.

294, 318 (1992).

The law is well settled, however, that "reliance on an agent

to actually file the return, no matter how reasonable, will not,

as a matter of law, constitute reasonable cause for a late filing

under section 6651(a)(1)."

Id. at 314.

The Supreme Court made

clear in United States v. Boyle, supra, that a taxpayer's

reliance on an agent to perform a nondelegable duty is different

- 60 from a taxpayer's reliance on an expert's advice.

Estate of La

Meres v. Commissioner, supra at 314.

The record contains no explanation as to why the Takaos'

1988 return was not timely filed.

Petitioners have not shown

that the Takaos' failure to file timely returns was due to good

faith reliance on Nakamura's erroneous advice, rather than

reliance on him to perform their nondelegable duty to file that

return.

Petitioners have not satisfied their burden of proving

that the Takaos had reasonable cause for not timely filing their

1988 return, and, accordingly, we sustain respondent's

determination of the addition to tax under section 6651(a).

Sections 6653(a)(1) and 6662(a)

Respondent determined that the Takaos are liable for an

addition to tax under for negligence under section 6653(a)(1) for

1988 and accuracy-related penalties for negligence under section

6662(a) for 1989, 1990, and 1991.

Petitioners contend that the

Takaos are not liable for the addition to tax or accuracy-related

penalties for negligence, because they relied in good faith on

Nakamura to prepare their tax returns properly for the years in

issue.

Respondent contends that petitioners failed to prove that

the Takaos had reasonable cause for understating their income on

their returns for 1988 through 1991, and that the understatements

constitute negligence within the meaning of section 6653(a)(1)

and section 6662(a)(1).

We agree with respondent.

Section 6653(a)(1) imposes an addition to tax equal to 5

percent of the underpayment if any part of the deficiency was due

- 61 to negligence or intentional disregard of rules or regulations.

Section 6662(a) imposes a penalty in an amount equal to 20

percent of the underpayment of tax attributable to one or more of

the items set forth in section 6662(b).

Section 6662(b)(1)

applies an accuracy-related penalty to the portion of an

underpayment attributable to negligence or disregard of rules or

regulations.

Petitioners bear the burden of proving that

respondent's determination is erroneous.

Rule 142(a); Axelrod v.

Commissioner, 56 T.C. at 258-259.

“Negligence” includes a failure to make a reasonable attempt

to comply with the provisions of the internal revenue laws.

Secs. 6653(a)(3), 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.

“Disregard” includes any careless, reckless, or intentional

disregard of rules or regulations.

Sec. 6662(c); Crocker v.

Commissioner, 92 T.C. at 916; Neely v. Commissioner, 85 T.C. 934,

947-948 (1985); sec. 1.6662-3(b)(2), Income Tax Regs.

The Takaos’ failure to maintain and to produce reliable

records of their financial transactions and taxable income

supports a conclusion of negligence.

Crocker v. Commissioner,

supra at 917; Schroeder v. Commissioner, 40 T.C. at 34.

Moreover, they cannot avoid the addition to tax or penalty on the

basis of reliance on their tax preparer, because they did not

provide Nakamura with records or other information sufficient to

prepare their returns accurately.

Metra Chem. Corp. v.

Commissioner, 88 T.C. 654, 662 (1987).

The evidence justifies

- 62 imposition of the addition to tax or penalties for negligence for

each year.

For 1988, we apply the addition to tax to the entire

understatement of tax.

Sec. 6653(a)(1).

For years after 1988,

the penalty applies only to the portion of the understatement

attributable to negligence.

Sec. 6662(a).

For those years,

petitioners did not prove that any of the adjustments conceded by

the Takaos or decided by the Court in favor of respondent were

not attributable to negligence.

Accordingly, for 1989 through

1991, we apply the penalty to the entire understatement of tax.

Section 6661

Respondent determined that the Takaos are liable for an

addition to tax for substantial underpayment of tax under section

6661 for 1988.

Petitioners contend that the Takaos are not

liable for the addition to tax under section 6661, because they

relied in good faith on Nakamura to properly prepare their tax

returns for the years in issue.

Respondent contends that the

Takaos are liable for the addition to tax under section 6661,

because petitioners failed to prove that the Takaos (1) acted in

good faith or had reasonable cause for the understatement of

income on the 1988 return or (2) disclosed the understatement on

their return for that year.

We agree with respondent.

Section 6661 imposes an addition to tax of 25 percent of any

underpayment attributable to a substantial understatement of tax.

- 63 Sec. 6661(a); Pallottini v. Commissioner, 90 T.C. 498, 500-503

(1988).

A substantial understatement of income tax is defined as

an understatement of tax that exceeds the greater of 10 percent

of the tax required to be shown on the return for the year or

$5,000, whichever is greater.

Sec. 6661(b)(1)(A).

understatement is the amount required to be shown on the return

less the amount actually shown on the return.

6661(b)(2)(A).

Sec.

The Commissioner may waive the addition to tax if

the taxpayer had reasonable cause for the understatement and

acted in good faith.

Sec. 6661(c).

Petitioners bear the burden

of proving that respondent's imposition of additions to tax under

section 6661 is erroneous.

Rule 142(a); Tweeddale v.

Commissioner, 92 T.C. 501, 506 (1989).

Petitioners did not present any evidence at trial which

would prove that the Takaos had reasonable cause for the

understatement or that they acted in good faith in omitting the

income from their 1988 return.

Accordingly, we sustain

respondent's determination as to the addition to tax under

section 6661 for 1988.

Toraya

Office Expenses Deduction

In the notice of deficiency for 1988 and 1989, respondent

determined that Toraya was not entitled to deduct $9,733 and

$12,000, respectively, for "Office Expenses" claimed on Toraya's

returns for those years.

In a stipulation of settled issues,

- 64 respondent conceded that Toraya is entitled to deduct $1,800 as

"Office Expenses" for 1988.

The remaining adjustments for

"Office Expenses" for 1988 and 1989 remain in issue.

Petitioners contend that for 1988 and 1989 Toraya is

entitled to deduct as office expenses $7,933 and $12,000,

respectively, that it paid to Motomi to reimburse her for

expenses she incurred in establishing an office in her home at

Nakamura's request.

Petitioners maintain that Motomi used the

office, among other things, to reconcile waitress tags to cash

on the daily sales registers.

Petitioners contend that the

payments were not gifts to Motomi.

Petitioners assert that the

payments served a business necessity and that Motomi would be

taxable for the payments, unless she can establish that she may

deduct her home office expenses on the Kudos' tax returns.

Respondent contends that petitioners have failed to

substantiate that the payments to Motomi had a business purpose.

Respondent asserts that petitioners did not establish the

character and dollar amount of Motomi's alleged expenses, that

reimbursement of those expenses was properly authorized by

Toraya, that Motomi accounted for her expenses to Toraya, and

that Motomi was required to work at home.

Thus, respondent

maintains, petitioners have failed to establish that the claimed

office expenses are deductible business expenses.

Respondent

- 65 contends further that no deduction of the expenses is permissible

absent an accounting by Motomi of her expenses to Toraya.

Deductions are a matter of legislative grace, and

petitioners must prove that Toraya is entitled to the claimed

Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S.

deductions.

79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435

(1934).

Section 162(a) provides a deduction for "ordinary and

necessary" expenses paid or incurred during the taxable year in

carrying on any trade or business.

To sustain their burden of

proof, petitioners must establish that the claimed office

expenses are "normal, usual or customary" in Toraya's trade or

business and reasonable in relation to the purpose of that

Deputy v. duPont, 308 U.S. 488, 495 (1940); United

business.

States v. Haskel Engg. & Supply Co., 380 F.2d 786, 788-789 (9th

Cir. 1967).

They must establish that the expenses bear "a

proximate and direct relationship to the taxpayer's trade or

business."

Carroll v. Commissioner, 51 T.C. 213, 218 (1968),

affd. 418 F.2d 91 (7th Cir. 1969).

Furthermore, Toraya must keep

sufficient records to establish deduction amounts.

Sec. 6001;

Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965).

Motomi is the daughter of the Takaos, Toraya's sole

shareholders.

Therefore, transactions between Motomi and Toraya

should be closely scrutinized to ascertain whether payments to

her by Toraya constitute bona fide business expenses which would

be deductible under section 162.

See Harwood v. Commissioner, 82

- 66 T.C. 239, 258 (1984), affd. without published opinion 786 F.2d

1174 (9th Cir. 1986); see also Schaefer v. Commissioner, T.C.

Memo. 1994-444.

Toraya has the burden of establishing that the

payments to Motomi served a business purpose and were reasonable

in amount.

Motomi testified that she maintained an office in her home

to count credit card charges, to calculate the hours worked by

Toraya's employees for preparing the payroll twice monthly, and,

if she had time, to check the waitress tags to make sure they

were added correctly.

She stated that she recalled receiving

money from Toraya to reimburse her for her office expenses, but

she could not remember how much she received, when it was paid,

or for which expenses she was reimbursed.

Nakamura testified

that Toraya's board of directors authorized him to reimburse

Motomi for the expenses she incurred in establishing an office in

her home in San Bruno, California.

Nakamura stated that he

considered the money paid to Motomi to be nontaxable to the Kudos

because it was a reimbursement of her expenses.

Both Motomi and Nakamura testified that Toraya had agreed

to reimburse Motomi for the expenses she incurred in maintaining

an office in her home on Toraya's behalf.

There is no evidence

that Toraya agreed to compensate Motomi for her time or efforts

in performing those activities.

Consequently, Toraya must prove

that the payments to Motomi reimbursed expenses she incurred on

Toraya's behalf and that they were reasonable.

The record,

- 67 however, lacks specificity as to the amounts Motomi incurred in

1988 and 1989 in performing business-related activities in her

home on Toraya's behalf, or even as to how Toraya arrived at the

amounts it paid to Motomi in those years.

In our view, the

amounts claimed appear excessive for the alleged purpose.

Accordingly, Toraya has failed to prove that these payments to

Motomi were business related and reasonable in amount.

Nonetheless, we are persuaded that Motomi performed some

business-related activities pertaining to Toraya in her home and

incurred some expense for that purpose.

Under those

circumstances we may make a reasonable estimate, bearing heavily

against the taxpayer whose inexactitude is of his or her own

making.

Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir.

1930).

We find that Toraya is entitled to deduct $520 for each

of 1988 and 1989 for reimbursement of Motomi's expenses incurred

in performing business-related activities in her home on Toraya's

behalf.

Adjustments to Purchases Expense

In the notices of deficiency for 1988, 1989, 1990, and 1991,

respondent reduced Toraya's "Purchases Expense" included in cost

of goods sold for those years by $57,733, $36,131, $25,230, and

$24,000, respectively, on the ground that Toraya had not

established that the those amounts were for purchases or were

paid during those years.

Subsequently, in a stipulation of

settled issues, respondent conceded that for 1988, 1989, 1990,

- 68 and 1991 those adjustments should be reduced by $30,733, $5,114,

$25,230, and $24,000, respectively.

Thus, for 1988 and 1989,

$27,000 and $31,017, respectively, of the adjustments for

"Purchases Expense" remain in issue.

Payments to June and Junichi

Petitioners contend that for 1988 and 1989 Toraya is

entitled to deduct $27,000 and $11,100, respectively, as

"Purchases Expense" for payments made to Joan and Junichi.

Petitioners claim that Nakamura wrote checks from Toraya's

checking account payable to Joan and, after Joan left, payable to

cash in order for Junichi to purchase food for the Berkeley

restaurant.

Petitioners assert that, even if Joan and Junichi

had misused the money Toraya gave them to purchase food for the

Berkeley restaurant, Toraya is entitled to the deduction.

They

contend that the payments to Joan and Junichi were not gifts or

constructive dividends.

Respondent contends that the record does not establish that

the payments to Joan and Junichi served a business purpose.

Respondent asserts that petitioners did not prove that Joan

performed any services relating to the Berkeley restaurant or

that Junichi made any food purchases for the restaurant.

Junichi is the son and Joan is the daughter-in-law of the

Takaos, Toraya's sole shareholders.

Therefore, transactions

between Junichi and Joan and Toraya should be closely scrutinized

to ascertain whether payments to them by Toraya constitute bona

- 69 fide business expenses which would be deductible under section

162.

See Harwood v. Commissioner, supra at 258; see also

Schaefer v. Commissioner, supra.

Toraya has the burden of

establishing that the payments to Junichi and Joan served a

business purpose and were reasonable in amount.

The record shows that during the years in issue it was

Toraya's practice to give money to the restaurants' managers

(Motomi in the case of the Post Street restaurant and Junichi in

the case of the Berkeley restaurant) to purchase food and

supplies for the restaurants.

At trial, petitioners introduced

checks payable to Joan in 1988 and 1989 totaling $24,300 and

$7,100, respectively.

Petitioners introduced additional checks

payable to cash in 1989 and endorsed by Junichi totaling $4,000.

Nakamura testified that Toraya gave these checks in order for

Junichi to make cash purchases of food for the Berkeley

restaurant.

Five checks written to Joan in 1988, totaling

$8,000, carried a notation indicating "purchases" or a derivation

thereof on the memo line.

One check written to Joan in 1989,

totaling $1,100, carried the notation "Payroll" on the memo line.

The other checks written to Joan had no notation on the memo

line.

The checks written to cash and endorsed by Junichi all had

notations on the memo lines indicating that the checks were for

produce.

Neither Junichi nor Joan testified at trial.

We are persuaded that Junichi purchased food for the

Berkeley restaurant.

For 1988, petitioners submitted checks

- 70 totaling $24,300.

We are not persuaded that Toraya paid Joan or

Junichi more than that amount in 1988 for purchases for the

Berkeley restaurant.

totaling $11,100.

For 1989, petitioners submitted checks

Of those checks, we exclude from the amount

deductible the check dated June 28, 1989, in the amount of

$2,000, payable to cash and endorsed by Junichi.

Nakamura

testified that Joan left the California area in April 1989, and

that Junichi was preparing to close down the Berkeley restaurant.

The restaurant closed on June 30, 1989.

We are not persuaded

that Toraya give Junichi the $2,000 to purchase food for the

restaurant.

In addition, we exclude the check dated April 25,

1989, payable to Joan, in the amount of $1,100, and containing a

notation indicating its purpose was "Payroll".

We are not

persuaded that the check was for food purchases or that that

payment was not deducted as compensation.

Accordingly, we hold

that for 1988 and 1989 the allowable deductions for purchases by

Joan and Junichi are $24,300 and $8,000, respectively.

Berkeley Restaurant Inventory

Petitioners contend that Toraya is entitled to write off for

1989, $19,917 as purchases for the Berkeley restaurant's

inventory.

Petitioners maintain that at the beginning of 1989

the Berkeley restaurant had an inventory balance of $19,917, and

on June 30, 1989, when the restaurant was closed, it had an

inventory balance of zero.

Petitioners maintain that whatever

inventory remained on hand when the restaurant closed its doors

- 71 was either discarded or transferred to the Post Street restaurant

during 1989 and that Toraya is entitled to include the $19,917 as

"Purchases Expense" for 1989.

Respondent contends that Toraya's writeoff of the Berkeley

restaurant's inventory was improper.

Respondent asserts that

petitioners gave contradictory explanations as to what happened

to the Berkeley restaurant's inventory when the restaurant

closed--claiming both that it was abandoned and that it was

transferred to the Post Street restaurant.

Respondent maintains

that, if the inventory was not abandoned, the Post Street

restaurant's inventory should have been adjusted to show the

addition of the Berkeley restaurant inventory.

Petitioners

counter that the Berkeley restaurant's inventory already was

included in Toraya's opening inventory in its general ledger and,

therefore, the Post Street restaurant's inventory did not need to

be adjusted when the Berkeley restaurant was closed in 1989.

Gross income of a taxpayer who uses inventory is calculated

by subtracting cost of goods sold from gross receipts.

Molsen v.

Commissioner, 85 T.C. 485, 498 (1985); sec. 1.61-3(a), Income Tax

Regs.

Cost of goods sold generally is calculated by subtracting

inventory on hand at the end of the year from the sum of

inventory on hand at the beginning of the year and the cost of

any purchases made during the year.

Molsen v. Commissioner,

supra; see also sec. 1.162-1(a), Income Tax Regs.

- 72 Respondent does not challenge the value of the Berkeley

restaurant's 1989 beginning inventory.

Petitioners contend that

Toraya combined the Berkeley restaurant's and the Post Street

restaurant's beginning inventories in calculating its gross

income for 1989.

We have found that the Berkeley restaurant

closed in June 1989, and that any usable inventory was

transferred to the Post Street restaurant.

Toraya would not be

entitled to write off any of the Berkeley restaurant's inventory

that remained on hand at yearend, because that inventory was not

abandoned but was transferred to the Post Street restaurant and

was includable in closing inventory for 1989.

Toraya, however,

would be entitled to claim as part of its cost of goods sold any

of the Berkeley restaurant's 1989 beginning inventory that was

used or abandoned during 1989.

Accordingly, we hold that for

1989, in the Rule 155 computations, in calculating Toraya's cost

of goods sold for the year, after taking into account any

adjustments to Toraya's cost of goods sold for the year agreed to

by the parties or decided by this Court, the Post Street

restaurant's closing inventory should be subtracted from the sum

of the Post Street and Berkeley restaurants' beginning inventory

and the allowable purchases by the Post Street and Berkeley

restaurants during 1989.

Unreported Income

Respondent determined that Toraya had unreported income,

consisting of (1) unexplained cash deposits into the bank

- 73 accounts of the Takaos for 1988 through 1991, (2) certain cash

purchases by the Takaos in 1988 and 1989, and (3) unexplained

cash deposits into the bank accounts of the Kudos for 1990 and

1991.

Respondent concedes that cash deposits into the bank

accounts of the Kudos in 1990 and 1991 in the amounts of $42,506

and $46,871 do not constitute gross receipts of Toraya for those

years.

Additionally, we have decided, as discussed above in the

section relating to unreported income of the Takaos, that $3,600

per year of the unexplained cash deposits by the Takaos came from

the repayment of a loan by Akiko's parents and, thus, was not

taxable to the Takaos.

We also decided, as discussed above, that

during 1989 Akiko used $20,000 of a cash hoard accumulated before

1988 to purchase a car for Yoshinori and, thus, that amount also

was not taxable to the Takaos.

not

It follows that those amounts are

unreported receipts of Toraya.

Accordingly, unreported

income of Toraya remaining in issue is as follows:

Year

Per the notices

of deficiency

1988

1989

1990

1991

$94,500

102,275

81,506

58,271

Unreported income

Less respondent's Less amounts from

concessions

nontaxable sources

--$42,506

46,871

$3,600

23,600

3,600

Amount

in issue

$90,900

78,675

35,400

7,800

Petitioners deny that Toraya had any unreported income for

the years in issue.

Petitioners contend that the unexplained

deposits into the Takaos' bank accounts did not come from the

restaurants owned and operated by them or Toraya.

Petitioners

- 74 assert that it would have been impossible for those restaurants

to generate the sales necessary to produce the amount of

unreported income determined by respondent.

Petitioners maintain

that the restaurants' method of accounting for cash assured that

all cash was accounted for and that there was no skimming of cash

during the years in issue.

Bank deposits are prima facie evidence of income.

Tokarski

v. Commissioner, 87 T.C. at 77; see also United States v.

Conaway, 11 F.3d 40, 43 (5th Cir. 1993) ("the evidence of bank

deposits suffices to raise the inference that the taxpayer's

income came from a taxable source").

We have decided above that

the Takaos had unreported income as evidenced by unexplained bank

deposits and cash purchases.

Respondent need not prove a likely

source of that unreported income.

Petzoldt v. Commissioner, 92

T.C. at 695-696; Tokarski v. Commissioner, supra at 77.

Here,

however, a likely source exists in sales receipts of the

restaurant owned by them and the restaurants owned by Toraya, of

which the Takaos were the sole shareholders.

Petitioners bear

the burden of proving that Toraya did not underreport its income.

Rule 142(a); Calhoun v. United States, 591 F.2d at 1245;

Truesdell v. Commissioner, 89 T.C. 1280 (1987).

Petitioners presented expert testimony by John Shimmon

(Shimmon) in support of their contention that the restaurants

could not have unreported sales receipts.

Shimmon stated that in

the restaurant business the difference between cost of sales and

- 75 gross profit is the "purchase markup".

He indicated that in

California restaurants markups range from 125 percent to 225

percent, depending upon the quality of the restaurant, with

higher grade restaurants having higher percentage markups.

According to Shimmon, for a sales tax audit the California State

Board of Equalization uses a yardstick of a 100-percent markup on

food purchases to test the accuracy of total reported sales.

the basis of data from the income tax returns of Toraya and the

Takaos, Shimmon calculated the following purchase markups for

Toraya's restaurants and the Takaos' Fillmore Street restaurant

to be as follows:

Purchases Markup

Toraya

Fillmore St.

171%

186%

179

178

194

186

219

173

Year

1988

1989

1990

1991

Additionally, Shimmon stated that according to the Golden

Gate Restaurant Association, normal cash sales reported are only

30 percent of total sales.

For the restaurants in issue, Shimmon

calculated that their reported cash sales equaled the following

percentages of total reported sales:

Year

Percentage

1988

1989

1990

1991

60%

Shimmon concluded that the restaurants' ratio of gross

profit to cost of sales and the restaurants' ratio of cash sales

- 76 to total sales show that the restaurants could not have had any

unreported sales for the years in issue.

The percentage markup

figures upon which Shimmon relied represent an average of all

grades of restaurants.

Shimmon considered the restaurants in

question to be medium-grade restaurants.

Respondent contends that petitioners have failed to

establish that respondent's determination was erroneous.

Respondent maintains that the source of the Takaos' unexplained

cash deposits was unreported gross receipts from Toraya.

Respondent argues that the Court should give little weight to

Shimmon's testimony, because his conclusions were based on

computerized records that are not in the record; thus, his

calculations cannot be verified.

We weigh expert testimony in light of the expert's

qualifications as well as all the other credible evidence in the

record.

Estate of Newhouse v. Commissioner, 94 T.C. 193, 217

(1990).

We are not bound by the opinion of any expert witness,

and we will accept or reject that expert testimony when, in our

best judgment based on the record, it is appropriate to do so.

Id.; Chiu v. Commissioner, 84 T.C. 722, 734 (1985).

While we may

choose to accept the opinion of one expert in its entirety,

Buffalo Tool & Die Manufacturing Co. v. Commissioner, 74 T.C.

441, 452 (1980), we may also be selective in the use of any

portion of that opinion, Parker v. Commissioner, 86 T.C. 547, 562

(1986).

- 77 We are not persuaded by Shimmon's testimony that Toraya

reported all of its gross receipts for the years in issue.

Shimmon relied on a average range of markups based on all types

and sizes of restaurants in arriving at his conclusion that

Toraya accurately reported its sales receipts for the years in

issue.

It appears to us that many factors would affect the

markup a specific restaurant could support, including type, size,

and popularity.

Toraya restaurants were sushi bar restaurants.

The record does not indicate what a typical markup for that type

of restaurant was during the years in issue.

Toraya restaurants as medium grade.

Shimmon rated the

The record does not indicate

the typical markup for that grade of restaurant.

For the same

reasons, we are not persuaded that Shimmon's comparison of cash

sales to total sales is persuasive.

Additionally, Shimmon's calculations, based on the figures

reported on the tax returns, show markups for each year in issue

that are well in excess of the 100-percent markup yardstick that

the California Board of Equalization used to test the accuracy of

reported sales.

Shimmon concluded that this result strongly

supported a finding that the unexplained bank deposits did not

arise from restaurant sales.

In our view, however, the

differential also demonstrates the hazard of relying on averages

based on all types and sizes of restaurants in concluding that

the income of a specific restaurant was or was not understated.

- 78 Moreover, in calculating the markup taking into account

respondent's increase in gross receipts, Shimmon accepted as

accurate the reductions to purchases expense determined by

respondent on audit.

Following concessions by the parties and

our decision relating to that issue, see supra, Shimmon's figures

are no longer accurate.

Rather, after taking into consideration

the adjustments to the unreported income and cost of goods sold

determined by respondent as discussed supra, the restaurants'

markups for the years in issue fall below the 225-percent top

range used by Shimmon.18

Consequently, the adjusted purchases

Using totals for the two restaurants owned by Toraya and

the one restaurant owned by the Takaos, the adjusted markups are

computed as follows:

1988

1989

1990

1991

Gross

receipts

per

return

$1,286,571

$997,067

$810,958

$740,860

Unreported

income

90,900

78,675

35,400

7,800

Adjusted

gross

receipts

1,377,471

1,075,742

846,358

748,660

Cost of

goods sold

per return

467,757

357,634

279,183

249,129

Adjustment to

purchases

(3,000)

(3,100)

6,000

Adjusted cost

of goods sold

464,757

354,534

285,183

249,129

(continued...)

- 79 markups do not support petitioners' contention that the

restaurants could not have underreported their sales.

Only two of the three restaurants in issue during the years

in issue were owned by Toraya.

We are persuaded that some

portion of the unreported income is attributable to the

restaurants owned by Toraya and the balance is attributable to

the restaurant owned by the Takaos.

The portion attributable to

the sole proprietorship would not be taxable to Toraya.

When we are convinced that some portion of alleged

unreported income was, in fact, chargeable to the taxpayer, we

may estimate the amount of the income even in the absence of

precise records and testimony, bearing heavily upon the taxpayer

who is responsible for the uncertainty.

Henry Schwartz Corp. v.

Commissioner, 60 T.C. 728, 744 (1973); see Llorente v.

Commissioner, 74 T.C. 260, 268 (1980), affd. in part, revd. in

part on other grounds and remanded 649 F.2d 152 (2d Cir. 1981).

Here, the restaurants all operated under the "Toraya" name,

and they all served Japanese food.

We find that the unreported

income should be allocated to each restaurant on the basis of the

(...continued)

Adjusted

gross

profit

912,714

721,208

561,175

499,531

Purchases

markup

196%

203%

197%

201%

- 80 ratio of gross receipts of that restaurant to total gross

receipts19 of all restaurants.

Accordingly, for each year the

unreported income in issue is allocable to the Toraya-operated

restaurants and to the Fillmore Street restaurant as follows:

Year

Toraya

restaurants

Fillmore St.

restaurant

Total unreported

income

1988

1989

1990

1991

$65,175

51,217

19,612

4,438

$25,725

27,458

15,788

3,362

$90,900

78,675

35,400

7,800

The unreported income attributable to the Toraya restaurants is

taxable to it.

Petitioners' Alternative Positions

Petitioners contend, in the alternative, that Toraya, an

accrual basis taxpayer, is entitled to deduct additional sales

tax and California franchise taxes for the years in issue to the

extent that its gross receipts are increased to reflect

underreported income.

Respondent concedes that petitioners are

entitled to the additional sales tax and California franchise tax

deductions for the years in issue.

Accordingly, the additional

deductions are to be included in the Rule 155 computations.

Year

Total

gross

receipts

1988

1989

1990

1991

$1,286,571

997,067

810,958

740,860

Gross

receiptsToraya

$922,439

648,927

449,608

421,608

Percentage

Gross

receiptsFillmore St.

Percentage

71.7%

65.1%

55.4%

56.9%

$364,132

348,140

361,350

319,252

28.3%

34.9%

44.6%

43.1%

- 81 Petitioners further contend, in the alternative, that Toraya

is entitled to a theft loss to the extent that its gross receipts

are increased to reflect underreported income, because the cash

was never deposited in Toraya's bank accounts and must have been

unlawfully diverted before receipt by Toraya.

Respondent

contends that petitioners have presented no evidence to establish

that Toraya is entitled to a theft loss for the gross receipts

not deposited into Toraya's bank accounts but deposited into the

Takaos' bank accounts or used by them.

We agree with respondent.

Accordingly, no deduction for theft losses relating to the

unreported income is allowable.

We turn now to the additions to tax and penalties for the

years in issue.

Section 6651(a)

Respondent determined that Toraya is liable for an addition

to tax for late filing under section 6651(a) for 1988, because it

failed to timely file its Federal income tax return for that

year.

Petitioners contend that Toraya relied on Nakamura to

timely file its return.

Respondent contends that Toraya did not

prove that the failure to timely file was due to reasonable

cause.

We agree with respondent.

The record contains no explanation as to why Toraya's 1988

return was not timely filed.

Petitioners have not shown that

Toraya's failure to timely file its 1988 return was due to good

faith reliance on Nakamura's erroneous advice rather than

- 82 reliance on him to perform Toraya's nondelegable duty to file

that return.

United States v. Boyle, 469 U.S. at 245; Estate of

La Meres v. Commissioner, 98 T.C. at 318.

Petitioners have not

satisfied their burden of proving that Toraya had reasonable

cause for not timely filing its 1988 return.

Niedringhaus v.

Commissioner, 99 T.C. at 220-221; Baldwin v. Commissioner, 84

T.C. at 870.

Accordingly, we sustain respondent's determination

of the addition to tax under section 6651(a) for 1988.

Sections 6653(a)(1) and 6662(a)

Respondent determined that Toraya is liable for an addition

to tax for negligence under section 6653(a)(1) for 1988 and

accuracy-related penalties for negligence under section 6662(a)

for 1989, 1990, and 1991.

Petitioners contend that Toraya is not

liable for the addition to tax or accuracy-related penalties for

negligence, because it relied in good faith on Nakamura to

properly prepare its tax returns for the years in issue.

Respondent contends that petitioners failed to prove that Toraya

had reasonable cause for understating its income on its returns

for 1988 through 1991 and that the understatements are due to

negligence within the meaning of sections 6653(a)(1) and

6662(a)(1).

We agree with respondent.

Toraya's failure to maintain and to produce reliable records

of its financial transactions and taxable income supports a

conclusion of negligence.

Crocker v. Commissioner, 92 T.C. at

917; Schroeder v. Commissioner, 40 T.C. at 34.

Moreover, Toraya

- 83 cannot avoid the addition to tax or penalties on the basis of

reliance on its tax preparer, because it did not provide Nakamura

with the records or other information sufficient to prepare its

returns accurately.

at 662.

Metra Chem. Corp. v. Commissioner, 88 T.C.

The evidence justifies imposition of the addition to tax

and penalties for negligence.

For 1988, we apply the addition to tax to the entire

understatement of tax.

Sec. 6653(a)(1).

For years after 1988,

the penalty applies only to the portion of the understatement

attributable to negligence.

Sec. 6662(a).

For those years,

petitioners did not prove that any of the adjustments conceded by

Toraya or decided by the Court in favor of respondent were not

attributable to negligence.

Accordingly, for 1989 through 1991,

we apply the penalty for negligence to the entire understatement

of tax for each year.

Section 6661

Respondent determined that Toraya is liable for an addition

to tax for substantial underpayment of tax under section 6661 for

1988.

Petitioners contend that Toraya is not liable for the

addition to tax under section 6661, because it relied in good

faith on Nakamura to properly prepare its tax returns for the

years in issue.

Respondent contends that Toraya is liable for

the addition to tax under section 6661, because petitioners

failed to prove that Toraya (1) acted in good faith or had

reasonable cause for the understatement of income on the 1988

- 84 return or (2) disclosed the understatement on its return for that

year.

We agree with respondent.

Petitioners did not present any evidence at trial which

would prove that Toraya had reasonable cause for the

understatement or that it acted in good faith in omitting the

income from its 1988 return or in overstating its deductions.

Rule 142(a); Tweeddale v. Commissioner, 92 T.C. at 506.

Accordingly, we sustain respondent's determination as to the

addition to tax under section 6661 for 1988.

To reflect the foregoing and the concessions of the parties,

Decisions will be entered

under Rule 155.

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