# UNITED STATES TAX COURT

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## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

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:

1

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.
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.
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)

2

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:
3

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 -

3

(...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:
4

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.

4

(...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
5

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.

We

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.

6

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

7

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
Motomi
Scott
Motomi
Total

Amount

Treatment by Toraya

$25,230
3,600
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
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.

In

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

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

8

(...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.

9

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.

He

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.

In

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)

--

(3,000)

(3,000)

--

--

--

15,230
-67,433

174
-57,956

(7,116)
87
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

$19,800

$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

18

--

636

--

--

100

101

124

150

180

--

--

--

--

--

10,716

7,781

7,613

9,696

23,165

--

1,260

--

--

--

--

4,841

--

--

--

--

--

--

--

11

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
99
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

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

10

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).

On

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

11

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

12

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
1,500
1,500
1,500
2,700
600
1,700
1,500
1,500
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
1,500
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.

On

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.

He

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
500
1,000
$4,500

$2,500
500
1,000
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.

It

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
1

Amount
$85,500
5,000
5,200
2,500
1,000
2,000
1,601
6,112
15,568
124,481
1
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
1
6,238
61,800

1

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
2,000
1,688
10,081
109,102
1

71,825
37,277

1

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.
13

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
--

3,600
--

3,600
--

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.

As

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.

14

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)),
(C) any interest which is taken into account under
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.
(C) Personal property used in short sale.--For
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.
15

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

15

(...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.
(C) Investment expenses.--The term "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).
16

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.
(C) Terms.--For purposes of this paragraph, the
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
17

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).

An

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
register tapes and to count credit charge slips and record them
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
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.

On

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%
64
61
61

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

18

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

18

(...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.

19

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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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A7f9e40b42db168f3. Public record. Not legal advice.