UNITED STATES TAX COURT

ADE.

ORDED

SERVICE

T.C. Memo. 2005-288

UNITED STATES TAX COURT

RALEIGH COX AND BRENDA J. COX, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 11813-03.

Charles A. Crocker,

Filed December 15, 2005.

for petitioners.

Susan Greene, for respondent.

MEMORANDUM OPINION

HOLMES, Judge:

Tax records are the ancient Egyptians of the

modern age--plagued not by boils, frogs, flies, and lice but by

fire,

flood, mold, and theft.

The cursed tax records in this

case belonged to Raleigh Cox, who owned a business that fixed

used cars and then resold them.

When audited, Cox failed to

produce the records that. would have supported many of his claimed

business deductions, and blamed their absence on a thieving

SERVED DEC 1 5 2005

- 2 former employee.

The parties have since settled most of these

issues, but the Commissioner hardened his heart against Cox's

deductions for cash purchases of used cars.

We must decide whether to let them go.

Background

Raleigh Cox grew up in Houston..

He is a talented mechanic,

and started a small business, Washington Car Care, in 1986.

He

made the better part of his living by buying used cars--often

cars that were nowhere near working order--from local

wholesalers.

He then fixed them up, and cleaned them up, and

resold them to other dealers.

The business was not in the most

desirable section of Houston; as Cox pointedly testified, the IRS

did not contest his deduction for the cost of a guard dog.

Washington Car Care's biggest problem, however, wasn't

crime; it was thin capitalization.

There were years when Cox was

just scraping by, and he often had customers who wrote bad

checks.

This caused enough of Washington Car's checks to bounce

that banks became unwilling to finance the business.

Cox worked

his way around this problem with an old solution--a tradefinanced floor plan.

He set up the plan with Concord Motors, a used-car

wholesaler that was his main source of supply.

He and Concord

would negotiate each car's price, and he would then sign a draft

for that amount and leave it with Concord along with the car's

- 3 title (which in Texas is a car's proof of ownership).

Under the

plan, Concord gave Washington Car possession of up to $100,000worth of cars, thus giving Cox an inventory of vehicles that he

could work on.

week.

In return, Cox promised to pay Concord $2,000 a

These payments would accumulate from week to week, and Cox

would draw on their accumulated value by periodically taking back

drafts and titles for cars so that he could resell them to third

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parties at a profit.

Cox and his wife reported Washington Car's income and

deductions on a Schedule C to their 2000 income tax return, which

was prepared by Roman Spiller, their long-time accountant.

Spiller was a former IRS auditor, and had prepared.both the

Coxes' personal and business returns since 1986.

Before this

case they had never had any reason to doubt the quality of his

work.

The Schedule C for Washington Car's 2000 tax year reported

sales of $118,900, and aggregate expenses of $92,892.

But

Spiller got his signs confused and reported the difference as a

net loss.

The Commissioner's service center noticed the math

error, made the appropriate correction, and notified the Coxes

that the resulting adjustments required them to pay tax due on

the increase in taxable income, plus a penalty and interest.

Spiller prepared and submitted an amended tax return on which the

Coxes flipped the numbers from their original return, reducing

- 4 their reported sales to $92,892 and increasing their aggregate

expenses to $118,900.

(Although Spiller entered $118,900 as the

total expenses on line 28 of the amended Schedule C, the actual

sum of expenses listed equals $119,042).

Remarkably--since

Washington Car's business was buying cars to repair and resell-neither the original nor the amended Schedule C reported any cost

of goods sold.

More remarkably, Spiller submitted a second

amended 2000 return that reduced Schedule C sales to $92,500 and

expenses to $118,508.

This time, Spiller inexplicably kept the

prior net loss figure and claim of refund, and continued to

report no cost of goods sold.

This was not a good tax preparation strategy.

The IRS

audited the returns and rejected both the original and amended

Forms 1040.

The resulting notice of.deficiency included a

penalty under section 6662¹ for negligence.

Before trial, Cox

and the Commissioner stipulated that his gross receipts were

actually about $258,000 and stipulated as well that he was

entitled to deductions and allowances of about $130,000.

for trial were two issues:

Left

the deduction of what Cox claimed

were cash payments to Concord, and the penalty for negligence.

The trial was in Houston, where the Coxes lived when they filed

their petition.

¹ Unless otherwise stated, section references are to the

Internal Revenue Code and regulations as amended and in effect

for 2000.

- 5 Discussion

A.

Allowability of cash payments

It's easy to see why the Commissioner questioned Cox's claim

that he routinely made cash purchases from Concord.

Not only was

the amount involved quite large, but the most common way Cox got

cash was by writing checks to himself or his wife drawn on the

Washington Car Care account.

Cox's general ledger from 2000

lists dozens of such checks recorded as a debit to "Purchases",

which wÁs Washington Car's cost-of-goods-sold account.

He cashed

many of these checks at local grocery or convenience stores.

This pattern raised the Commissioner's suspicion that business

accounts were being used for personal expenses.

.The Commissioner's counsel vigorously grilled Cox on these

points at trial, and hammered away especially hard at his failure

to produce business records to support his claims.

But Cox's

story held up--with an honest demeanor, no hesitation, and

perfect reasonableness, he explained both the absence of records

and his own check-cashing habits.

He credibly explained that he kept most of his business

receipts and records stuffed in duffel bags, which he stored in a

loft above his repair shop.

He .also credibly testified that he

was in the habit of employing recently released prisoners,

encouraged in part to do so- by his father, a retired sergeant in

the county sheriff's office.

Washington Car's records went

- 6 missing in 2002, and Cox convinced us that one of his evidently

not-quite-rehabilitated employees stole one of the duffels, no

doubt thinking it contained cash instead of canceled checks,

receipts, and bank statements.

shortly thereafter.)

(That employee disappeared

It was also about this time that Spiller

died after heart surgery, preceded by what Cox thought to be a

serious

(and probably illegal substance-related)

illness, leaving

him without his long-time accountant when the IRS began its

audit.

Cox quickly did the right thing and hired a new

accountant, Katie Beal, to help recreate his business records.

Beal had few of the original receipts, and none of the checks or

bank records to review, as they had been in the stolen duffel

bag.

But her careful piecing together of the available

information corroborates Cox's story.

We conclude that the records really were stolen.

Cox

credibly explained the circumstances regarding their

disappearance:

it is quite believable that an ex-convict who had

access to the area where most of the records were kept might take

the duffel bags thinking there was more in them than just

records.

And what written evidence exists supports Cox's story.

He had kept the general ledger for Washington Car upstairs at his

shop, and Beal and he got copies from the bank of the statements

that had been stolen.

Our close side-by-side scrutiny of those

statements and the general ledger shows that the ledger

reasonably matches the statements for those purchases Cox made.

from Concord by check.

expenses.)

(And the Commissioner has conceded those

We infer from that that the ledger is accurate when

it shows that cash--even cash obtained by cashing checks at

grocery stores and gas stations--was going to Concord on a

regular basis to pay for cars.

Cox also insisted the owners of

Concord give him receipts, and he kept them too--fortunately not

stuffing them into the missing duffel bag.

Those receipts also

match--not perfectly, but in more than enough instances for us to

believe that the ledger and remaining records are legitimate.

Cox.also credibly explained why he didn't just write checks

to Concord.

As he told it, his relationship with Concord had

begun with his making payments by check, but there were times

that his business account had insufficient funds, or at least

insufficient collected funds, to make the checks good.

This made

Concord's owners leery of accepting his checks and for most of

2000 they demanded that he pay cash, accepting checks only

occasionally when he warned them that he was short, and they

agreed to hold off presenting them for payment.

And the existing

documents also show combinations of checks to Concord and cash

payments totaling about $2000/week, which corroborates Cox's

testimony.

Cox also credibly explained his practice of cashing checks

made out to himself or his wife--he did so because Spiller

- 8 advised him to create a paper trail of the cash withdrawals that

he was using to pay Concord.

(We note that cashing checks at

other merchants, with whom he did not have an ongoing business

relationship, would both delay their presentment for payment and

not immediately result in the repossession of any of his

inventory if they bounced.)

So we find that Cox is entitled to a deduction for his cash

expenses.

The parties did not stipulate the precise amount at

stake, but they did stipulate that Washington Car (or the

company's sometime alter ego, Washington Car Rental) had receipts

for payments totaling $76,600 from Washington Car Care.

Two

additional receipts show payments from Concord to Washington Car

of $10,000; however, Cox testified at trial that he mistakenly

switched the names of the companies on the "to" and "from" lines,

and that Concord never made any refund payments to the Company.

We believe Cox's testimony that these receipts were actually for

payments made to Concord.

Therefore, the total amount of the

purchases from Concord is $86,600, of which $16,100 was paid by

check.

Because the Commissioner has already conceded the $16,100

paid by check, we hold that Cox should be allowed an additional

$70,500 deduction for cash purchases as a cost of goods sold.

B.

Section 6662 Penalty

The only other issue for us to decide is whether the Coxes

are liable for an accuracy-related penalty.

In his notice of

_ 9 _

deficiency, the Commissioner does not specify why he imposed the

penalty, but there are only two possibilities:

(1) negligence;

or (2) a substantial understatement.

Part of this penalty will disappear with the portion of the

underpayment traceable to the cash purchases that we have

allowed.

Section 6664 may provide a defense to the remainder--

under either the negligence or substantial understatement

042

theory--"if it is shown that there was a reasonable cause * * *

and that the taxpayer acted in good faith."

Sec. 6664(c)(1).

The regulations issued under this section require that our

analysis be conducted "on a case-by-case basis, taking into

account all pertinent facts and circumstances."

4(b),

Sec. 1.6664-

Income Tax Regs.

The crucial fact here is that the Coxes relied in good faith

on Spiller to correctly prepare their tax return based on the

financial records and receipts they gave him.

This was

reasonable--he was a former IRS auditor, and had competently done

their taxes in the past before his evidently rapid decline and

death.

While a taxpayer cannot hide behind a tax preparer or

adviser, we have often held that·a taxpayer who supplies his

preparer with accurate information relating to the return is not

negligent in relying upon the preparer's advice.

Kurzet v.

Commissioner, T.C. Memo. 1997-54, affd., revd., and remanded on

other issues, 222 F.3d 830

(10th Cir. 2000).

We do not fault the

Coxes for the errors on their return when the mistakes stemmed

- 10 from their accountant's lack of professional care.

Reinhardt v.

Commissioner, T.C. Memo. 1993-397 (no negligence .when an

"incorrect return is the result of the preparer's mistakes").

We

also take into account the Coxes' educational and business

experlence.

See Pratt v. Commissioner, T.C. Memo. 2002-279.

The

trial showed that Cox, though gifted in his field, knew little of

accounting.

Such men should especially be able to rely on a

preparer if they give him their business records, holding no

information back, as we specifically find that he did.

Given

Cox's genuine lack of knowledge of accounting, we do not construe

his actions as constituting negligence or disregard of tax law.

See Neelv v. Commissioner, 85 T.C. 934,

947-48

(1985).

To reflect the settlement of the other issues in this case,

Decision will be entered under

Rule 155.