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14,

.T .C .,Memo .

2010-10 9

UNITED STATES TAX COURT

THEODORE M . AND JACQUELINE GREEN, Petitioners v .

COMMISSIONER OF INTERNAL REVENUE, Responden t

Docket No . . 8247-08 .

Filed May 17, 2010 .

Theodore M . Green and-Jacqueline Green, pro sese .

Michael Park , for respondent .

MEMORANDUM FINDINGS OF FACT AND OPINIO N

Judge : Theodore M . Green (Mr . Green) and Jacqueline

is

Green (Ms . Green) petitioned the Court for redetermination of the

HAINES,

.following deficiencies in Federal income tax arid penalties :

SERVED May 17 2010

Year

Deficiency

Penalt y

Sec . 666 2

2004

2005

$3,383 .

7,188

$67 7

1,43 8

In his answer, respondent further asserted that petitioners'

underpayments of tax for both 2004 and 2005 were attributable to

fraud under section 6663 . 1

The issues for decision after concessions2 are : (1) Whethe r

.!petitioners may deduct from income for 2004 as a net operatin g

.'loss (NOL) carryforward $8,098 relating to a $166,013 damage

'award judgment that Ms . Green never received and that has no w

. .been discharged in bankruptcy ; (2) whether Social Security

disability benefits Ms . Green received in 2004 should be treated

as nontaxable worker's compensation benefits ; (3) whether

petitioners are entitled to a long-term capital loss carryover of

$3,000 for 2004 ; (4) whether petitioners failed to report pension

income of $7,978 for 2004 ; (5) whether petitioners are entitled

to deductions on Schedule A, Itemized Deductions, for medical

expenses of $53,888 and $102,242 for 2004 and 2005, respectively ;

(6) whether petitioners are liable for fraud penalties unde r

'Unless otherwise indicated, all section references are to

,the Internal Revenue Code, as amended, and all Rule reference s

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

are rounded to the nearest dollar .

2Respondent concedes that petitioners are entitled to

medical expenses of $3.55 and $4,347 for 2004 and 2005,

respectively .

_ 3

section 6663 for 2004 and 2005 ; and (7) whether petitioners are

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

2004 and 2005 . For all purposes hereafter, the term "years at

issue" .shall refer to 2004 and 2005 .

FINDINGS OF FAC T

Some of the facts have been stipulated'and are soyfound .

The stipulation of facts and the supplemental stipulation of

facts, together with the attached exhibits, pare incorporate d

herein by this reference . At the time petitioners filed their

petition, they resided in-California .

Petitioners are husband and wife . From 1985 to Septembe r

19, 2005, Mr . Green worked as a tax service representative and a s

a tax auditor for respondent .

I .

Income From Default Judgment Social Security Disability

Benefits, and Pension s

A.

Net Operating Loss Carryforward and Long-Term Capital

Los s

Before November 1989 Ms . Green worked on a General Motors

Corp . (GM) assembly line . r On November 12, 1 .989, Ms . Green was

injured at a grocery store when she was hit by a shopping cart .

Her injuries were apparently so severe that she was unable to

continue to work on the assembly line . . On November 7,8990, Ms .

Green filed a lawsuit for personal injury damages against the

individual who hit her with the shopping cart, and on November

-

4

12, 1996, Ms . Green obtained a $166,01 3 default judgment agains t

.that

individual .

On March 14, 1997, in a bankruptcy proceeding, the perso n

who hit Ms . Green with the shopping cart was discharged o f

liability to pay the $ 166,013 default judgment ,

and petitioner s

.never collected the damages . Petitioners never included any

portion of the

$166,013

judgment in taxable income, and the

.record does not establish that petitioners had any tax basis i n

the uncollected judgment .

On their 1997 joint individual income tax return petitioners

claimed an $11,068 casualty loss deduction relating to the

$166,013 uncollected judgment discharged in bankruptcy .

Petitioners attached to their 1997 tax return .a statement that

they intended to deduct the balance . of the $154,946 uncollecte d

judgment over the course of the next 15 years--$11,068 in eac h

year--as a loss carryforward under section 172 .

On their 2004 joint individual income tax return petitioner s

'claimed an NOL carryforward of $8,098 related to the uncollected

'judgment . Petitioners also claimed a long-term capital loss of

.$3,000, which petitioners considered to represent a portion o f

the uncollected judgment . '

3Petitioners did not attach a Schedule D, Capital Gains and

'Losses, to their 2004 return . On Aug . 3, 2005, respondent

.received petitioners' Schedule D, on which they claimed a longterm capital loss of $3,000 . Petitioners do not account for why

(continued . . .)

B. .

Social Security Disability Benefit s

After sustaining injuries from the shopping cart in November

1989, Ms . Green worked for`GM .' a's a decal assembler .- On' August

27, 1991, Ms . Green was involved in an industrial accident at a

GM plant . Her injuries required surgery and left her unable to

work .. On August 6, 1992, Ms . Green filed a claim for Social

Security disability benefits at the order of GM, and on December

17, 1993, Ms . Green began to receive Social Security disabilit y

benefits .

In 2004 Ms . Green received Social Security disability

benefits of $13,495 . On their .2004 return petitioners~reported

the $13,495 but did not report any amount of the $13,495 as

taxable income, on the grounds that the benefits were excludable

from income under section 104 .C .

Pension Incom e

For 2004 .the State of California-filed a Form 1099-R,

Distributions from Pensions, Annuities, Retirement or ProfitSharing Plans, IRAs, Insurance Contracts, etc ., with the IRS that

reported Mr . Green as .having received pension income of $1,578 .

Petitioners reported Mr . Green ' s pension income as taxable incom e

3( . . .continued)

the combined amount of the net operating loss (NOL) carryforward

and the long-term capital loss reported on their 2004 return is

$30 higher than the NOL carryforward of $11,068 reported on their

1997 return or--as discussed below--on each of their 2000, 2001,

and 2003 returns .

6 on their 2004 return . Also for 2004,,the GM Hourly-Rate Pension

,Trust filed a Form 1099-R with the IRS that reported Ms . Green as

`having received pension income of $8,778, of which $7,979 was

taxable . Petitioners did not include any amount of Ms . Green's

pension income as taxable on their 2004 return .

D.

Prior Litigatio n

On their 2000 and 2001 joint individual income tax returns

petitioners claimed an NOL carryforward of $11,068 relating to

the uncollected judgment . Petitioners also reported Socia l

, . .'Security disability benefits received by Ms . Green of $12,258 and

,$12,708, for 2000 and .2001, respectively, but did not report any

,amount as taxable income .

The Internal Revenue Service (IRS) issued timely notices of

deficiency for 2000 and 2001, and petitioners filed petitions

with this Court .' In a consolidated Tax Court opinion release d

on March 9, 2006,

Green v . Commissioner , T .C . Memo . 2006-3 9

(Green L), affd . 262 Fed . Appx . 790 (9th Cir . 2007), we held that

„petitioners were not entitled to deduct the NOL carryforward as a

loss under section 165 and that Ms . Green's, Social Securit y

'disability benefits were taxable for both 2000 and 2001 .

Petitioners appealed our decision in Green I to the U .S . Court of

Appeals for the Ninth Circuit . The Court of Appeals affirmed ou r

4The .cases for 2000 and 2001 became docket Nos . 2475-04 and

4970-05, respectively .

decision in .an unpublished' opinion issued on December 28, 2007• .

Mr . Green testified at trial that he appealed the decision of the

Court of Appeals to the U .S . Supreme Court . The record does no t

indicate whether petitioners filed a writ of certiorari with theSupreme Court, but it is clear that the Supreme Court did not

grant certiorari in petitioners'

case .

On their 2003 joint individual income tax return petitioners

again claimed an NOL carryforward!of $11,068 and failed to report

any of Ms . Green's Social Security disability benefitslas taxabl e

income . The IRS issued a notice of deficiency, and petitioner s

filed a petition . .' In an opinion- released on . August 7,2007,

Green v . Commissioner ,' T .C . -Memo . 2007- 217 (Green II), 1we held

that petitioners were' not entitled to deduct the NOL carryforward

and that Ms . Green's Social Security disability benefits were

taxable . Petitioners did not appeal Green II .

II .

Schedule A Medical Expense s

Petitioners claimed unreimbursed medical expensestof $1,525

on Schedule A of their 2004 return : Petitioners-claimed

unreimbursed medical expenses of $38,367 on"Schedule A'of their

2005 return . At the time of trial petitioners claimedmedical

expenses for 2004 and 2005 of $53,888 and $102,242 ,

'The case for 2003'became docket No . 5216-06 .

-

8

respectively .' These sums included expenditures related to

transportation expenses, housekeeping expenses, gas and electri c

' .bills, and accrued but unpaid general medical

A.

expenses .

Transportation Expense s

After her accident at the GM plant in 1991 Ms .

Green wa s

'unable to drive an automobile . For 2004 and 2005 petitioners

hired Christopher McGrath (Mr . McGrath) to be Ms . Green' s

, .,personal driver . Mr . McGrath drove Ms . Green to her numerous

doctor's appointments,-the grocery store, and to have her hair

and nails done . Mr . McGrath did not possess any medical

,trainin'g, and he drove a Honda Civic that was not modified in any

,way to transport a physically disabled individual . Neither Mr .

.McGrath nor petitioner,s kept a log or records showing the date s

and times Mr . McGrath drove Ms . : Green to her medical

;,appointments .

Ms . Green paid only a portion of Mr . McGrath's service fees .

The balance of Mr . McGrath's invoices for transporting Ms . Gree n

was billed .to Sedgwick Management Co . . (Sedgwick), a car servic e

provider . In 2004 and 2005 Ms . Green paid Mr . McGrath $135 an d

6At the time petitioners filed their 2004 and 2005 returns,

,,they believed . that GM would pay many of their accrued medica l

expenses . As GM failed to pay, petitioners at-trial claimed

;medical expenses in addition to those reported on their returns .

$2,365, respectively, while Mr . McGrath billedSedgwick $756 and

$13,235, respectively : '

B.

Housekeeping Expense s

Ms . Green's injuries also prevented her from performing

household chores . For 2004 and 2005 petitioners hired two

housekeepers to clean the house, cook the meals, and serve Ms .

Green at petitioners' home . Petitioners paid these housekeepers

$17,770 and $16,380

C .

in 2004 and 2005, respectively .

Gas and Electric Bill s

For-2004' petitioners paid $1,566 and $2,179 for their gas

and electric bills, respectively . For2005 petitioner paid $585

and $1,950 for their gas and electric bills, respectively .

D.

Method of Accountin g

On their°1985 joint income,-tax,"return petitioners-reported . :

that they operated-a small tax service business . On their

Schedule C, Profit or Loss From . Business, . attached to their 1985

return, petitioners elected to report their Schedule Cincome and

expenses on an accrual basis . For 2004 and 2005 petitioners were

not engaged in a Schedule C business .

'Sedgwick failed to pay Mr . McGrath's"invoices in full for

the years at issue, .and Mr . McGrath currently has liens against

Sedgwick for the unpaid portions of his service fees fo r

transporting Ms . Green .

I

10 III .

Present Litigatio n

On January 17, 2008,

respondent sent petitioners a notice o f

deficiency for the years at issue . On April 7, 2008, petitioners

filed a petition with this Court . On June 11, 2008, . respondent

filed an answer which alleged that petitioners were subject t o

fraud penalties for the years at issue under section 6663 .

,September 2, 2008, petitioners filed a reply to respondent' s

answer, which denied the allegations of fraud . On May 14, 2009 ,

respondent filed an amendment to answer which asserted collatera l

.estoppel as an affirmative defense to whether petitioners ar e

entitled to exclude their Social Security disability benefits

from income under section 104 and deduct an NOL carryforward

under section 165 for 2004 . A trial was held on May 14, 2009, i n

Los Angeles, California . At trial petitioners argued that they

were entitled to deduct medical expenses for 2004 and 2005 in

excess of those listed on their respective returns .

OPINION

Burden of Proo f

Respondent's determinations in the notice of deficiency ar e

presumed correct, and petitioners bear the burden of proving that

respondent's determinations are incorrect .' See Rule 142(a)(1) .

'Petitioners do not argue that the burden of proof shifts

to respondent pursuant to sec . 7491(a), nor have they shown that

the threshold requirements of sec . 7491(a) have been met for any

of the determinations at issue .

- 11 Respondent has the burden of proof, by clear and convincing

evidence with respect to his determination of fraud . See Rule

142(b) .

II .

Net Operating Loss,Carryforward-and Social Security Benefit s

Petitioners argue that they are entitled to deduct under,

section 165 an NOL carryforward of $8,098-for 2004 related to the

uncollected judgment of-$166,013 which Ms . Green was awarded as a

result of her shopping cart accident . Petitioners also argu e

that the Social Security disability benefits of $13,495 that . Ms .

Green received in 2004 constitute worker's compensation under

section 104 and are thus not includable in gross income .

Respondent contends that petitioners are precluded under the

doctrine of collateral estoppel from relitigating these, issues .

We agree with respondent .

Collateral estoppel exists for the ` .`dual purpose of

protecting litigants from the burden of relitigating ar identical

issue and of promoting judicial economy by preventing unnecessary

or redundant litigation ." -Meier v . Commissioner , 91 TC . 273,

282'(1988) ; see also Montana v . United-States , 440 U .S . 147, 153154 (1979) ;

Parklane Hosiery Co . v . Shore , 439 U .S . : 322, 326

(1979) . In general, the doctrine . of collateral estoppel

forecloses relitigation of issues actually litigated and

necessarily decided in a prior suit .

Shore ,

supra at 326 n .5 ;

Parklane Hosiery Co .

Meier v . Commissioner ,

V.

supra at 282 ;

- 12 Peck v . .Commissioner , 90 T .C . 162, 166 (1988), affd . 904 F .2d 52 5

(9th Cir . 1990) .

This Court, expanding upon three factors identified by the

Supreme Court in Montana v . United States ,

supra at 155, has se t

forth five prerequisites . necessary for the application in factua l

!contexts of collateral estoppel :

-

(1) The issue in the second suit must be identical

in all respects with the one decided in the first suit .

(2) There must be a final judgment rendered by a

court of competent jurisdiction .

(3) Collateral estoppel may be invoked against

parties and their privies to the prior judgment .

(4) The parties must actually have litigated the

issues. and the resolution of these issues must have

been essential to the prior decision .

(5) The controlling facts and applicable legal

rules must remain unchanged from those in the prior

.litigation .

[ Peck v . Commissioner , supra at 166-167 ; citations

omitted .]

.

All five requirements are satisfied in the instant case :

(1) The issues of whether petitioners are entitled to exclud e

their, Social .Security disability benefits from income and deduct

an NOL carryforward are identical to the issues litigated i n

,'Green I and Green II ; (2) final judgment was rendered in both

.,cases ; (3) the parties in Green .I and Green II are identical t o

those in the instant case ; (4) the parties litigated the issues

and the resolution of those issues was essential to the decision

- 13 in both Green I and Green II ; and (5) the controlling facts and

applicable legal rules concerning the issues in the instant cas e

are unchanged from those in}Green I and Green II .

Accordingly, the doctrine of'collateral estoppel applies ,

and petitioners are precluded from`relitigating the net operating

loss carryforward and Social Security benefits issues raise"d in

Green I and Green II .

III .

Long-Term Capital Los s

Section 1211 provides that in the case of noncorporate

taxpayers, capital losses are deductible only to the extent of

capital gains plus $3,000 .' When capital losses exceedlcapital

gains by more than,$3,000, the excess may be carried over to

later taxable years to reduce capital gains or a limited amount

of ordinary income . 'Sec . 1212(b) . A long-term capital loss is

the loss from the sale or exchange of a capital asset held fo r

longer than 1 year . Sec . 1222(,4) .

Mr . Green testified at trial that the $3,000 capital loss

was'not from the sale of a capital asset but rather constituted a

recharacterization of a portion of the $11,068 NOL carryforward

that respondent had previously disallowed . The recordydoes no t

indicate that the loss is related to the sale of a capital asset .

Accordingly, we sustain respondent's determinations regarding the

long-term capital loss .

- 14 DIV .

Pension Income

Petitioners argue that Ms . Green's $8,778 of pension incom e

for 2004 constituted worker's compensation . Petitioners clai m

that GM issued the Form 1099-R•out of vindictiveness agains t

petitioners and that the proceeds had been categorized a s

worker's compensation in prior years .

Petitioners offered no evidence that Ms . Green's pensio n

income was payment of worker's compensation . At trial Mr . Gree n

testified that GM was either "ignorant or malicious" in issuin g

::the Form 1099-R but the record is devoid of anything t o

corroborate .this claim . Accordingly, we sustain respondent' s

determination regarding petitioners' pension income .

V.

Deductions for Medical Expense s

Petitioners argued at trial that they incurred medical .

expenses of $54, 888 and $ 102,242 for 2004, and 2005, respectively .

.These consisted of the following amounts : (1) Medical

expense s

conceded by respondent of $355 and $4,347 for 2004 and 2005 ; _

,respectively ; (2) transportation costs of $891 and $15,600 fo r

2004 and 2005, respectively ; ( 3) housekeeper expenses of $17,77 0

and $16, 380 for 2004 and 2005 ,

respectively ; ( 4) gas and , electri c

.expenses of $3,755 and $2,537 for 2004 and 2005, respectively ;

and (5) accrued but unpaid medical expenses of $31,127 and

$63,381 for 2004 and 2005, respectively .

- 15' Section 213(a) . allows for the deduction of paid expenses

"not compensated for by .insurance or otherwise, for medical care

of the taxpayer, his spouse, or a dependent *. * * to the extent

that such expenses exceed 7 .5 percent of adjusted . gross income . "

We have characterized section 213 as carving Put "a-limite d

exception" to the general rule .in section 262 that prohibits the

deduction of personal, living, or family expenses .

Commissioner , 62 T .C .

Jacobs v .

813, 818 (1974) . The deductibility of the

expenses at issue hinges on whether they were paid for,

petitioner's medical care . If so, they are deductible ; medical

expenses under section 213 . If not,- they are nondeductibl e

personal expenses under section 262 .

The term "medical care" includes amounts paid "for the

diagnosis, cure, mitigation, treatment, or prevention of disease,

or for the purpose of affecting any structure or function of the

body" . Sec . 213(d)(1)(A) . The regulations provide that

"Deductions for expenditures for medical care allowable under

section 213 will be confined strictly . toexpenses incurred

primarily for the prevention or alleviation of a physical o r

1

mental defect or illness ." Sec . 1 .213-1(e)(1) .(ii), Income Tax

Regs . Furthermore, to substantiate : medical and dental expenses

under section 2 .13, the taxpayer must furnish the name and address

of each person to whom payment was made and the amount anddat e

of each payment .

See sec . 1 .213-1(h), Income Tax Regs :

16 As discussed below, petitioners have failed to meet thei r

;,burden of substantiating any of their claimed medical

,Therefore, no deductions for medical

expenses .

expenses will be allowe d

:,beyond those respondent has already conceded .

A.

Transportation Cost s

Petitioners claim that the amounts charged by Mr . McGrat h

for transporting Ms . Green in 2004 and 2005 constitute deductible

medical expenses . First, petitioners are not entitled to claim

the amounts billed to Sedgwick as medical expenses .9 Petitioner s

,,,have presented no evidence to show that they were in any way

,associated with the payment's made by Sedgwick to Mr . McGrath, an d

Sedgwick has failed to fully pay Mr . McGrath for the amounts

billed .

With regard to petitioners' out-of-pocket expenses,

transportation costs related to personal errands are

nondeductible personal expenses . Sec . 262 ;

Haines v .

Commissioner , 71 T .,C . . 644, 646 .(1979) . Although respondent

!concedes that transportation costs associated with driving Ms .

; .Green to doctor's appointments may be deductible medical

expenses, petitioners have failed to provide any records to

substantiate the amounts of those expenses or the dates and times

those expenses were incurred . See sec . 1 .213-1(h), Income Ta x

'Petitioners paid Mr . McGrath $135 in 2004 and $2,365 in

2005 for his services as a driver . Mr . McGrath-billed Sedgwick

; 1,$756 in 2004 and $13,235 in 2005 for transporting Ms . Green .

17 Regs . The record indicates that a large number, if not the

majority, of Ms . Green's trips with Mr . McGrath were to run

personal errands .10 Therefore, we find that petitioners have not

met their burden to show that their travel costs constitute

medical expenses .

As a general rule, if the trial record provides sufficient

evidence that the taxpayer has incurred a deductible expense, but

the taxpayer is unable to substantiate adequately the precise

amount of the deduction to which he or she is otherwise entitled,

the Court may estimate the amount of the deductible expense and

allow the deduction to that extent .

F .2d 540, 543-544 (2d Cir . 1930) ;

T .C . 731, 742-743 (1985) ;

Cohan v . Commissioner , 39

Vanicek v . Commissioner , 8 5

Sanford v . Commissioner , 50 T .C . 823,

827-828 (1968), affd . per curiam 412 F .2d 201 (2d Cir . 1969) ;

sec . 1 .274-5T(a), Temporary Income Tax Regs ., 50 Fed . Reg . 46014

(Nov . 6, 1985) . In these instances, the Court is permitted to

make as close an approximation of the allowable expense as it

can, bearing heavily against the taxpayer whose inexactitude is

of his or her own making .

Cohan v . Commissioner ,

supra at 544 .

However, in order for the Court to estimate the amount of an

expense, the Court must have some basis upon which an estimate

may be made .

Vanicek v . Commissioner ,

supra at 742-743 . Withou t

10Mr . McGrath testified that he drove Ms . Green to her

doctor's appointments as well as to run her personal e'rrands such

as grocery shopping, hair styling, and manicures . I

.

18 such a basis, any allowance would amount to unguided largesse .

Williams v . United States , 245 F .2d 559, 560-561 (5th Cir . 1957) .

The record provides no satisfactory basis for estimating th e

amounts of petitioners' transportation costs that may have been

used for trips to the doctor's office . as opposed to the hai r

s,stylist .

Consequently ,

the Court will not apply the

to estimate the amounts of petitioners '

Cohan rule

transportation costs tha t

may constitute medical expenses .

B.

Housekeeper Cost s

Petitioners claim that the amounts they paid to their

housekeepers in 2004 and 2005 constitute medical expenses . The

housekeepers did not render medical care but were required

because Ms . Green, according to Mr . Green's testimony at trial,

`%maintains a complete, meticulous, excellent, clean" home, and

"does not like filth in any way, shape or fashion ." Although

petitioners' zeal for cleanliness may have resulted in a

psychological benefit to Ms . Green, it was not "for the

diagnosis, cure, mitigation, treatment, or prevention of disease,

or for the purpose of affecting any structure or function of the

body" . See sec . 213(d)(1)(A) . Expenses incurred which are

merely beneficial to the general health of an individual are not

deductible .

Gardner v . Commissioner , T .C . Memo . 1983-541 ; sec .

.1 .213-1(e)(1)(ii), Income Tax Regs . Moreover, the salary and

cost of room and board for housekeepers hired on the advice of a

- 19 doctor are not deductible•medical :expenses .

Borgmann v . .

Commissioner , 438 F .2d 1211, (9th Cir . 1971), affg . T .C . Memo .

1969-129 . Accordingly, petitioners have failed to show that

their payments to their housekeepers constitute . medical expenses .

C.

Gas and Electric Bill s

Petitioners seek to deduct their gas and electric bills for

the years at issue as medical expenses . In general, the cost o f

maintaining a household, including amounts paid for utilities ,

are personal expenses which are not deductible . Sec .. 1 .2621(b)(3), Income Tax Regs . Petitioners testified at trial that

they paid some of their gas and electric bills in order to power

a heating pool and several devices that were therapeutic for Ms .

Green . Where a living expense is•used primarily for the

alleviation of an ailment, a medical deduction is allowable to

the extent of the excess cost attributable to the medical

purpose .

Gardner v . Commissioner , su ra ; see also Randolph v .

Commissioner , 67 T .C . 481 (1976) ;

Harris v . Commissioner , 46 T .C .

672 (1966) . Petitioners have failed to demonstrate what portion

of their gas and electric bills was used-to power devices

employed primarily for the alleviation of Ms . Green's medical

problems and whether their utility costs were higher as a result

of the devices . Therefore, we find that their gas and electric

bills do not constitute medical expenses .

- 20 D.

Accrued but Unpaid Medical Expense s

At trial petitioners claimed a balance of medical expens e

deductions of $31,127 and $63,381 for 2004 and 2005,

respectively . Petitioners argue that these expenses are accrued

medical expenses that have not yet been paid . Petitioners

further argue that they were accrual basis taxpayers for the

years at issue and base this assertion on their election to treat

`their Schedule C business on an accrual basis on their 1985

return .

Petitioners' method of accounting is irrelevant . Medical

expenses may be deducted only in the year of actual payment .

Sec . 1 .213-1(a)(1), Income Tax Regs . As far as the record is

concerned,, petitioners' allegedly accrued but unpaid medical

expenses appear to have been conjured out of thin air .

Petitioners have failed to substantiate any of their medical

expenses not otherwise conceded by respondent, and the Court is

left with no basis upon which'to estimate them . Accordingly,

other than those respondent has conceded, we allow none of

petitioners' claimed medical expense deductions for the years at

issue .

VI .

Fraud Penalt y

In order to show fraud under section 6663, respondent must

prove : (1) An underpayment exists ; and (2) petitioners intended

to evade taxes known to be owing by conduct intended to conceal ,

d

21 mislead, or otherwise prevent the collection of taxes . See Park s

v . Commissioner , 94 T .C . 654, 660-661 (1990) . .

A.

Underpayment of Ta x

Respondent must first show by clear and convincing evidence

that petitioners had an underpayment o .f tax in each of the years

at issue . As discussed above, respondent has shown that

petitioners received income from Social Security disability

benefits and pensions . on which they failed to pay tax for 2004 .

Respondent has also shown that petitioners claimed deductions for

medical expenses, NOL carryforwards, and long-term capital losses

for 2004, and medical expenses for 2005, to which they, were not

entitled and which resulted in underpayments of tax . Therefore,

respondent has satisfied his burden of proof on this issue fo r

t

both 2004 and 2005 .

B .

Fraudulent Inten t

Because direct evidence of fraud is rarely available, fraud

may be proved by circumstantial evidence and reasonable

inferences from the facts .

Petzoldt v . Commissioner , :92 T .C .

661, 699 (1989) . Courts have developed a nonexclusive list of

factors, or "badges of fraud", that demonstrate fraudulent

intent .

Niedringhaus v . Commissioner , 99 T .C . 202, 211 (1992) .

These badges of fraud include : (1) Understating income, (2)

maintaining inadequate records, (3) implausible or inconsistent

explanations of behavior, (4) concealment of income or assets,

W

- 22 (5) failing to cooperate with tax authorities, (6) engaging in

illegal activities, (7) an intent to mislead which may b e

inferred from a pattern of conduct, (8) lack of credibility o f

the taxpayer's testimony, (9) filing false documents, (10) .

failing to file tax returns, and (11)

also

.dealing in cash .

Spies v . United States , 317 U .S . 492, 499 (1943) ;

Id . ;

see

Morse v .

Comm issioner , 419 F .3d 829, 832 (8th Cir . 2005), affg . T .C . Memo .

~Ik

2003-332 ;

Recklitis v . Commissioner , 91 T .C . 874, 910 (1988) .

Although no single factor is necessarily sufficient to establish

fraud, the combination of a number of factors constitutes

persuasive evidence .

Niedringhaus v . Commissioner ,

supra at 211 . .

.Respondent must prove fraud for each year at issue . See id .

210 ;

Ferguson v . Commissioner , T .C . Memo . 2004-90 . Petitioners'

behavior with respect to their income may be evaluated in the

light of these factors, as,follows .

1 .

Understated Income

Respondent has shown that petitioners understated their

income for 2004 . This factor is mitigated by petitioners' .

.inclusion of their Social Security disability benefits on their

2004 return as proceeds excluded from taxable income by section

104 . Respondent argues that petitioners had reason to know at

the time they filed their 2004 return that their positio n

regarding the benefits was incorrect because respondent had

already issued notices of deficiency determining that the

- .23 benefits were taxable for 2001 and 2002 . At the time petitioners

filed their 2004 return, however, no court had issued a decision

regarding the issue .

Petitioners also .omitted pension income on their 2004

return . This factor militates,in favor of a finding of fraud .

2 .

Inadequate Record s

The record indicates that petitioners did not keep adequat e

records for either 2004 or 2005 . They failed to substantiate th e

bulk of their medical expense deductions for each of the years a t

issue .

3 .

Implausible Behavio r

Petitioners believed, at the time they filed -their 200 4

return, that the taxation of their Social Security disability

benefits and the allowance of their NOL carryforward presente d

valid legal disputes to be decided by the courts . Although Mr .

Green, a former IRS agent, placed too much faith in his tax

analytical skills, his behavior with regard to tax reporting ha s

been consistently plausible : petitioners first notified the IRS

in 1997 of their attempt to claim a casualty .loss deduction and

kept the theory alive through petitions and appeals as long as

possible . Less easy to countenance are the large claimed medical

expense deductions . However, both petitioners credibly testified

to the extent of their medical problems and have maintained a

consistent position reflecting their belief that they Were

- 24 entitled to medical expense deductions . Petitioners also had a

consistent, if flawed, rationale for not reporting Ms . Green's G M

pension income and for reporting a long-term capital loss fo r

2004 .

4 . .

Concealment of Incom e

Petitioners did not actively conceal income or assets . The

,Social Security disability benefits they received were listed on

their 2004 return . Petitioners did not report Ms . Green's GM

pension income, but they also made no attempt to conceal it when

their return came under audit .

5.

Compliance With Tax Official s

Petitioners fully complied with the audit process and all

court proceedings .

6 .

Illegal Activitie s

Petitioners never engaged in illegal activities .

7 .

Pattern of Misconduct With Intent To Mislead

Petitioners did not engage in a pattern of conduct to

mislead tax authorities . . As previously stated, petitioners

honestly believed they were entitled to exclude their Social

Security disability benefits and the GM pension from income and

deduct the uncollected judgment resulting from the shopping cart

incident . Petitioners were also under the impression that they

were entitled to additional medical expense deductions for

transportation costs, housekeeping costs, and gas and electric

- 25 i

bills for the years at issue . The record does not indicate that

petitioners attempted to deduct large and unsubstantiated medical

expenses on their returns for prior years .

8 .

Credibility ofTestimon y

Petitioners' testimony was generally' credible with-regard t o

their intent .

9 .

False Document s

Petitioners never intentionally . filed a false document .

10 .

Failing to File Tax Return s

Petitioners timely filed their 2004 and .2005 returns .

11 .

Dealing in Cas h

.Petitioners did not deal in cash .

As a result of the paucity .of badges of . fraud, wepfind .that

respondent has failed to show=by clear and convincing evidence

that petitioners filed their 2004 and 2005 returns with the

intent to evade tax .

VII . Accuracy-Related'Penalt y

Section 6662(a) and (b)(2) imposes-an accuracy-related

penalty upon any underpayment of tax resulting from a substantial

understatement of=income tax . The penalty is equal to 20 percent

of the, portion of any underpayment-attributable to a substantia l

understatement of income tax .

Id .

The term "substantial

understatement" is defined as .exceeding the greater of (1) .10

percent of the tax required to be-shown on the return for the

Z

26 taxable year, or (2) $5,000 . Sec . 6662(d)(1)(A) . Section

'6662(a) .and (b)(1) also imposes a penalty equal to 20 percent of

,the amount of an underpayment attributable to negligence o r

,'`disregard of rules or regulations . Negligence includes any

failure to make a reasonable attempt to comply with the

provisions of the Internal Revenue Code . Sec . 6662(c) .

We hold that petitioners are liable for the penalty for

negligence in 2004 and substantial understatement of income tax

in 2005 . Petitioners' failure to produce records substantiating

their medical expenses, NOL deductions, and Social Securit y

disability benefit exclusions supports the imposition of the

accuracy-related penalty for negligence for 2004 . Petitioners'

understatement of income tax as reflected in the notice of

,deficiency is greater than $5,000 and 10 percent of the ta x

!;required to be shown on the return in 2005 . Thus, respondent has

met his burden of production under section 7491(c) .

An accuracy-related penalty is not imposed on any portion of

the underpayment as to which the taxpayer acted with reasonable

cause and in good faith . Sec . 6664(c)(1) . The taxpayer bears

the burden of proof with regard to those issues .

Higbee v .

Commissioner , 116 T .C . 438, 446 (2001) . Petitioners have failed

to show reasonable cause, substantial authority, or any other

basis for reducing the penalties . Mr . Green was a tax service

representative with the IRS for over a decade . With thi s

ti

- 27 background, he had a wider range of knowledge of tax matters than

do members, of the general public . See Kendrix v . Commissioner ,

T .C . Memo . 2006-9 . The Court sympathizes with petitioners for

the injuries that have afflicted them over the years .

Unfortunately, given the dearth of evidence to substantiate

petitioners' medical expenses, NOL deductions, and Social

Security disability benefit exclusions, we are unable to mitigate

the penalties . Accordingly, we find . petitioners liable for the

section 6662 penalty for 2004 and 2005 as commensurate F . with

respondent's concessions and our holding . See Higbee v .

Commissioner ,

supra at 446 .

In reaching our holdings herein, we have considered all

arguments made, and, to the extent not mentioned above, we

conclude they are moot, irrelevant ; or without merit .

To reflect the foregoing,

Decision will be entere d

under Rule 155 .