UNITED STATES TAX COURT
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ALS
T.C. Memo. 2017-73
UNITED STATES TAX COURT
EDDIE BORNA AND VICTORIA BORNA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24641-11.
Filed May 1, 2017.
P-H is a real estate entrepreneur. During or before 1997, P-H
and at least two Chinese citizens who he believed were politically
influential formed a venture in China intending to prosper financially
from the Summer Olympics scheduled to be held in China in 2008.
P-H aimed to raise sufficient funds for the venture through a plan
under which he self-financed the purchase of third-party notes. The
venture failed. R determined, in part, that P-H failed to report as
income amounts that he received from the obligors of the third-party
notes.
H_ej : Ps failed to report income to the extent stated herein.
H_ejd, further, tax consequences determined as to four items that
the parties dispute as to income that respondent determined was
reportable on Schedule D, Capital Gains and Losses.
SERVED May 01 2017
-2[*2]
He]d, further, Ps may deduct sole proprietorship expenses for
rents and leases, taxes and licenses, and commissions and fees to the
extent stated herein.
H_eld, further, Ps are liable for the accuracy-related penalties to
the extent stated herein.
Solis Cooperson, for petitioners.
Steven M. Roth and Sarah A. Herson, for respondent
MEMORANDUM FINDINGS OF FACT AND OPINION
WHERRY, Judge: Petitioners petitioned the Court to redetermine
respondent's determination of the following deficiencies in their Federal income
tax for 2004, 2005, and 2006, an addition to tax under section 6651(a)(1), and
accuracy-related penalties under section 6662(a):¹
Year
Deficiency
Addition to tax
sec. 6651(a)(1)
2004
2005
2006
$267,397
943,426
340,121
$15,243
-0-0-
Accuracy-related penalty
sec. 6662(a)
$53,479
188,685
68,024
¹Unless otherwise indicated, section references are to the applicable versions
of the Internal Revenue Code of 1986, as amended for the years in issue (Code),
and Rule references are to the Tax Court Rules of Practice and Procedure. Dollar
amounts are rounded.
-3[*3] Respondent subsequently altered that determination, asserting in an amended
answer that there are increased deficiencies, addition to tax, and accuracy-related
penalties as follows:2
Year
Deficiency
Addition to tax
sec. 6651(a)(1)
2004
2005
2006
$268,918
1,060,127
479,940
$15,319
-0-0-
Accuracy-related penalty
sec. 6662(a)
$53,784
212,025
95,988
Respondent has since conceded that petitioners are not liable for the addition to
tax.
Following concessions, we decide the remaining disputed issues for the
years in issue:
1. whether petitioners failed to report income from petitioner husband Eddie
Borna's sole proprietorship;
2. the tax consequences of four items that the parties dispute as to income
that respondent determined were reportable on Schedule D, Capital Gains and
Losses;
2Respondent's alteration of the determination stemmed from respondent's
review during this proceeding of newly acquired information and documentation.
The amended answer reflected further adjustments to sole-proprietorship
unreported income and allowable expenses and to capital gains or losses.
-4[*4]
3. whether petitioners may deduct sole proprietorship expenses for rents and
leases, taxes and licenses, and commissions and fees in amounts greater than
respondent allowed; and
4. whether petitioners are liable for the accuracy-related penalties that
respondent determined.
FINDINGS OF FACT
I. Preliminaries
The parties submitted nine separate stipulations of facts and exhibits,
together with three separate stipulations of settled issues. We find the stipulated
facts and the settled issues accordingly. The stipulated facts and exhibits and the
stipulations of settled issues are incorporated herein by this reference.3
Petitioners are husband and wife. They filed joint Federal income tax
returns for 2004 through 2006 (respectively, 2004 return, 2005 return, and 2006
return; collectively, subject returns). They timely filed their petition commencing
this action, and they resided in California at that time.
3In the event of any perceived conflict between the balance of this opinion
and the parties' three stipulations of settled issues, the Court intends that the
agreed-to settlements by both parties in the stipulations of settled issues shall
control. Where the three stipulations of settled issues indicate that an issue is not
resolved and agreed to or is for trial, this opinion shall control.
-5[*5] II. Petitioners' Business Activities
A. Land Bank
Mr. Borna owned a real estate business, Land Bank of America (Land
Bank). Land Bank was in California City, California, and it has been selling land
since 1980.4 Mr. Borna operated Land Bank as a sole proprietorship.
B. Superb Properties
Superb Properties was another business in California City. Superb
Properties, although owned by others, operated under Mr. Borna's broker's license,
primarily selling real estate through real estate agents. Mr. Borna normally
received 10% of the real estate agent's commissions for the use of his real estate
broker's license.
C. Note Purchasing Business
1. Background
During or before 1997, Mr. Borna with at least two Chinese citizens who he
believed were politically influential formed a venture in China called Zhuo Zhou
Borna Plaza Real Estate Development, Ltd. (Zhuo Zhou Development). Originally
Mr. Borna conceived the idea for Zhuo Zhou Development and owned all of it.
4Petitioners also bought and sold real estate which they held in their own
names. They reported some of these sales on the subject returns, more specifically,
on Forms 6252, Installment Sales Income.
-6[*6] Early on to get going he partnered with an individual who he believed had
been or was the Finance Minister of the People's Republic of China under Mao
Zedong's government. This individual and/or his two daughters, who Mr. Borna
believed were children of the Finance Minister and one (Helen Fongii) who Mr.
Borna believed may have served in a governmental capacity, acquired a 5%
interest in Zhuo Zhou Development shortly after its formation. Zhuo Zhou
Development aimed to build a small town in China containing 15,000
condominiums, a very long strip mall, two or three schools, and a hospital plus
100,000 square meters of industrial and commercial buildings space.
Mr. Borna, from its inception, did not have sufficient funds to invest in Zhuo
Zhou Development, and he consequently sought ways to raise funds for the
venture. Mr. Borna eventually met Nigel Barrow, who aspired to join the venture.
Both Mr. Barrow and Mr. Borna anticipated that Zhuo Zhou Development would
be profitable given, inter alia, that Bank of China financing was anticipated and the
Summer Olympics were scheduled to be held in China in 2008.
The politics surrounding Zhuo Zhou Development's operation in China and
its location thousands of miles from California City made it difficult for Mr.
Barrow to participate in the venture directly. Mr. Barrow structured a plan under
which Mr. Borna would acquire from Mr. Barrow third-party notes that he owned
-7[*7] (Barrow notes).5 Mr. Borna could then use proceeds from the notes to help
fund Zhuo Zhou Development. Thereafter, Mr. Borna would pay to Mr. Barrow,
without stated interest, the principal amounts of the Barrow notes two years after
the due dates of the Barrow notes. These payments were generally scheduled to
come due during 2015.
2. The Business
Starting in or around 2002 through at least 2006, Mr. Borna acquired
approximately 100 Barrow notes from Mr. Barrow under a formal agreement that
they memorialized in writing on or about December 30, 2003. Mr. Borna acquired
the Barrow notes by contemporaneously creating financing notes (Borna notes),
each with corresponding identical principal balance due, which Mr. Borna in turn
executed and gave to Mr. Barrow. Mr. Borna promised in the Borna notes to pay
the face amount of the Barrow notes to Mr. Barrow in 2015; however, unlike the
Barrow notes, none of the Borna notes had stated interest. The Borna notes were
payable to Mr. Barrow at various dates in 2015, and no payments were due before
5The record does not include copies of all of the Barrow notes, and it appears
that in some cases Mr. Borna did not acquire an actual note but simply a debt
(usually evidenced by a deed of trust) that was owed to Mr. Barrow arising from
his sale of real estate to various third parties. For simplicity and convenience, we
use the term "Barrow note" to include those debts for which a note is not in the
record (or may never have actually been issued).
-8[*8] 2015. Each Borna note was secured by a stated percentage of Mr. Borna's
interest in Zhuo Zhou Development.
Mr. Borna was entitled to keep all payments on the Barrow notes except to
the extent that a payment was for principal. He had to account to Mr. Barrow for
all principal payments during 2015 on December 31, 2015. In lieu of making the
required principal payments to Mr. Barrow during 2015, Mr. Borna, at his sole
discretion, could assign to Mr. Barrow Mr. Borna's interests in Zhuo Zhou
Development and in a second company.
The Barrow notes generally had seven-year terms and provided for monthly
payments. The Barrow notes bore a stated annual rate of interest ranging from 5%
to 10.9%, and most of the Barrow notes that Mr. Borna acquired had stated interest
rates of 8.9% through 10.9%. Payments on the Barrow notes were applied first to
any interest due, and then to principal. Mr. Barrow and Mr. Borna knew that
collection action would be difficult, and at least some of the Barrow notes would
never be paid in full.
Mr. Borna received payments on the Barrow notes, and he paid commissions
to persons who helped collect these payments. He committed some of the
payments to Zhuo Zhou Development and spent most of the payments on personal
_9_
[*9] items such as petitioners' mortgage, insurance, and credit card charges. Mr.
Borna at the time of trial had not made any payments on the Borna notes.
Mr. Borna eventually turned over on-site management of Zhuo Zhou
Development to Mr. Barrow. The overheated Chinese real estate market crashed,
and his important contracts dissipated with the illness of the two sisters he believed
were the Finance Minister's daughters, one of whom died resulting in a loss of the
project and the Chinese Government's taking over Zhuo Zhou Development in
2007.
3. Specifics of Barrow Notes and Payments Received Thereon
The specifics of the Barrow notes and the payments that Mr. Borna received
thereon are as follows.
Exhibit #¹
Amount
1017-P $95,000
1040-P
52,000
1069-P
20,800
1070-P
48,000
1071-P
16,000
1072-P
22,500
1073-P
32,000
1074-P2 52,000
1075-P2
16,800
1076-P2 176,000
1077-P2 144,000
1078-P2 101,250
1079-P
21,600
Interest
Date of
rate
Barrow note
6.9
9.9
9.9
9.9
9.9
9.9
9.9
9.9
9.9
9.9
8.9
8.9
9.9
12/19/2004
4/3/2004
8/1/2004
1/29/2004
10/21/2002
8/3/2004
7/6/2004
10/23/2002
3/3/2003
9/15/2002
7/31/2002
7/31/2002
9/9/2004
Total payments received
2004
2005
2006
$50,448
16,819
4,987
20,501
2,913
-0-06,774
2,189
33,262
18,760
13,190
8,501
-0-0$15,021 $9,466
3,435
2,748
11,213 13,348
2,118 2,939
21,531
-0-0-06,427 9,997
2,076 3,230
25,453 39,759
17,797 27,683
12,513 19,464
3,825
3,253
- 10 [*10]
Exhibit #
1080-P3
1081-P3
1082-P3
1083-P3
1084-P3
1085-P3
1086-P3
1087-P3
1088-P
1089-P
1090-P
1091-P
1092-P
1093-P
1094-P
1095-P
1096-P
1097-P
1098-P4
1099-P
1100-P4
1101-P5
1102-P5
1103-P
1104-P6
1105-P6
1106-P
1107-P
1108-P
1109-P
1110-P
1111-P
1112-P
1113-P7
1114-P7
Amount
Interest
rate
Date of
Barrow note
Total payments received
2004
2005
2006
105,500
140,000
40,000
52,500
20,000
290,000
296,000
158,000
296,000
30,490
18,000
28,000
22,000
17,600
20,000
17,600
16,000
17,500
12,000
14,000
14,400
59,500
28,000
296,000
36,000
12,000
29,000
20,000
18,000
28,000
16,000
15,200
24,000
44,000
30,000
7.9
5.9
5.9
7.9
5.9
5.9
10.9
5.9
10.9
9.9
9.9
9.9
9.9
9.9
9.9
9.9
9.9
8.9
9.9
9.9
9.9
8.9
9.9
10.9
9.9
9.9
--9.9
9.9
9.9
9.9
9.9
9.9
9.9
9.9
11/20/2002
5/20/2002
5/20/2002
7/24/2003
5/20/2002
7/1/2002
2/27/2004
2/25/2002
2/27/2004
11/14/2004
10/27/2003
9/21/2004
6/15/2004
6/15/2004
8/19/2004
8/04/2004
7/14/2004
9/12/2004
2/16/2003
4/09/2003
5/11/2003
7/27/2004
7/27/2004
2/27/2004
5/7/2004
5/7/2004
8/22/2004
4/24/2004
11/28/2003
9/21/2004
7/6/2004
6/15/2004
7/6/2004
3/22/2003
3/22/2003
8,979
11,915
3,404
4,468
1,702
24,680
25,191
13,446
33,287
30,724
6,238
15,256
8,640
3,820
4,162
6,661
2,959
-0-03,081
7,646
25,263
11,888
32,397
10,277
3,426
28,105
13,258
5,504
12,366
4,957
4,252
8,224
5,223
3,561
29,516
39,168
11,191
14,688
5,595
81,135
82,814
44,205
10,829
-02,681
10,128
4,872
3,000
2,648
2,912
15,000
-04,431
2,085
5,317
9,631
4,532
34,771
14,206
4,735
-01,589
2,419
3,336
1,849
2,541
3,212
4,944
3,371
15,869
21,059
6,017
7,897
3,008
43,621
44,524
23,766
13,536
-02,979
8,937
3,542
2,913
2,643
2,913
-0-02,991
2,549
3,589
9,631
4,532
18,973
9,470
3,157
-03,641
2,719
3,290
2,905
2,012
4,005
3,860
2,632
- 11 [*11]
Exhibit #
Interest
Date of
rate
Barrow note
Amount
1115-P
1116-P
1117-P
1118-P
1119-P
1120-P
1121-P
1122-P
1123-P
1124-P
1125-P
1126-P8
1127-P
1128-P
1129-P
1130-P
1131-P
1132-P
1133-P
1134-P
1135-P
1136-P
20,800
40,000
45,000
49,500
15,000
35,000
105,000
17,600
15,200
45,000
30,000
30,000
29,600
66,000
71,332
120,000
35,200
21,600
80,000
52,000
28,000
36,000
9.9
9.9
7.9
--6.9
9.9
7.9
9.9
9.9
7.9
9.9
9.9
9.9
7.9
9.9
9.9
9.9
9.9
9.9
9.9
9.9
1137-P
---
---
1138-P
1139-P
1140-P
1141-P8
15,600
30,000
19,000
75,000
9.9
9.9
--6.9
ll42-P
---
---
l l43-P
1144-P
1145-P
l l46-P
1147-P
1148-P
1149-P
14,000
14,800
20,000
14,400
21,600
16,000
52,000
9.9
9.9
9.9
9.9
9.9
9.9
9.9
3/26/2004
7/9/2005
3/6/2005
7/15/2005
4/9/2005
6/5/2005
4/22/2005
4/24/2004
7/24/2003
7/22/2005
2/22/2005
2/22/2005
10/18/2004
2/10/2005
5/8/2005
2/26/2006
1/14/2006
9/2/2004
2/26/2006
11/20/2005
3/6/2005
12/20/2006
---
Total payments received
2004
2005
2006
21,139
-0-0-0-0-0-05,212
-0-0-0-0980
-0-0-0-07,500
-031,080
-0-0-
-0-040,213
-062,493
-049,746
-016,861
2,031
36,707
-042,735
-03,962
3,508
600 2,000
31,138
-0-0-030,647 3,406
8,000
8,000
51,561
8,203
26,881
9,797
-0- 64,100
-013,277
4,397 3,968
-0- 29,768
13,350 3,528
10,075 4,634
-06,300
-0-
-0-
-0-
5,864
-018,617
-0-
1,549
14,586
-076,619
2,582
-0-08,515
---
-0-
-0-
-0-
10/23/2003
1/10/2004
1/15/2004
6/1 8/2003
11/28/2004
10/4/2003
5/10/2004
2,549
1,788
-01,501
1,787
3,111
16,747
2,317
779
-01,703
20,681
842
9,466
2,317
-0-0238
2,134
265
8,606
6/15/2004
2/27/2005
6/26/2004
2/12/2005
- 12 [*12]
Exhibit #
Amount
1150-P
1151-P
1152-P9
1153-P9
1154-P
1155-P
1156-P
1157-P
1158-P
1159-P
1160-P
1161-P¹°
1162-P¹°
1163-P
20,000
14,400
27,500
19,500
13,200
16,400
13,600
15,000
14,000
20,800
12,000
29,600
40,000
16,000
Interest
Date of
rate Barrow note
9.9
9.9
6.9
6.9
9.9
9.9
9.9
9.9
8.9
9.9
9.9
9.9
9.9
9.9
6/10/2003
5/22/2003
7/15/2002
7/26/2002
6/17/2003
8/23/2003
5/17/2003
10/21/2002
4/4/2004
3/26/2004
10/28/2002
7/23/2002
9/15/2002
8/5/2002
Total payments received
2004
2005
2006
5,641
3,092
4,634
3,286
2,750
3,023
2,264
2,248
8,018
1,750
993
5,378
7,267
3,005
"34,528
5,726 6,508
1,971
2,383
4,634 4,634
3,286 3,286
2,500 3,500
2,212 2,248
1,814 2,503
1,664 2,823
1,796 2,021
2,450 3,450
-0-03,419 2,441
4,620 3,298
1,989 2,498
1,180,749 643,837
¹We list the Barrow notes by exhibit number rather than by
issuer name because the identities of the issuers are not relevant to our
analysis.
2As to the Barrow note in Exhibit 1076-P, Mr. Borna received
payments of $10,333, $3,702, and $5,924 in the respective years in
issue. In addition, as to the five Barrow notes in Exhibits 1074-P
through 1078-P, Mr. Borna received other payments totaling $63,842,
$60,564, and $94,209 in the respective years in issue. The record,
however, does not allow us to find the specific portions of those other
payments that apply to each of the notes. We apportion the total other
payments for each year among the notes in accordance with the ratio
that the amount of each note bears to the total amount of these notes.
3As to the eight Barrow notes in Exhibits 1080-P through
1087-P, Mr. Borna received payments totaling $93,785, $308,312, and
$165,761 in the respective years in issue. The record, however, does
not allow us to find the specific portions of those payments that apply
to each of the notes. We apportion the total other payments for each
- 13 [*13] year among the notes in accordance with the ratio that the amount of
each note bears to the total amount of these notes.
4As to the two Barrow notes in Exhibits 1098-P and 1100-P,
Mr. Borna received payments totaling $9,748 and $6,580 in 2005 and
2006, respectively. The record, however, does not allow us to find the
specific portions of those payments that apply to each of the notes.
We apportion the total other payments for each year among the notes
in accordance with the ratio that the amount of each note bears to the
total amount of these notes.
5As to the two Barrow notes in Exhibits 1101-P and 1102-P,
Mr. Borna received payments totaling $37,151, $14,163, and $14,163
in the respective years in issue. The record, however, does not allow
us to find the specific portions of those payments that apply to each of
the notes. We apportion the total other payments for each year among
the notes in accordance with the ratio that the amount of each note
bears to the total amount of these notes.
6As to the two Barrow notes in Exhibits 1104-P and 1105-P,
Mr. Borna received payments totaling $13,703, $18,941, and $12,627
in the respective years in issue. The record, however, does not allow
us to find the specific portions of those payments that apply to each of
the notes. We apportion the total other payments for each year among
the notes in accordance with the ratio that the amount of each note
bears to the total amount of these notes.
7As to the two Barrow notes in Exhibits 1113-P and 1114-P,
Mr. Borna received payments totaling $8,784, $8,315, and $6,492 in
the respective years in issue. The record, however, does not allow us
to find the specific portions of those payments that apply to each of
the notes. We apportion the total other payments for each year among
the notes in accordance with the ratio that the amount of each note
bears to the total amount of these notes.
- 14 [*14]
8As to the two Barrow notes in Exhibits 1126-P and 1141-P,
Mr. Borna received payments totaling $107,266 and $11,921 in 2005
and 2006, respectively. The record, however, does not allow us to
find the specific portions of those payments that apply to each of the
notes. We apportion the total other payments for each year among the
notes in accordance with the ratio that the amount of each note bears
to the total amount of these notes.
9As to the two Barrow notes in Exhibits 1152-P and 1153-P,
Mr. Borna received payments totaling $7,920 in each of the years in
issue. The record, however, does not allow us to find the specific
portions of those payments that apply to each of the notes. We
apportion the total other payments for each year among the notes in
accordance with the ratio that the amount of each note bears to the
total amount of these notes.
*As to the two Barrow notes in Exhibits 1161-P and 1162-P,
Mr. Borna received payments totaling $12,645, $8,039, and $5,739 in
the respective years in issue. The record, however, does not allow us
to find the specific portions of those payments that apply to each of
the notes. We apportion the total other payments for each year among
the notes in accordance with the ratio that the amount of each note
bears to the total amount of these notes.
"Our rounding of the individual payments for 2004 has resulted
in the total payments' being $2 greater than they actually were.
D. Rental Income
During all three of the taxable years in issue, petitioners received rent from
various persons for property they leased to those persons. Petitioners deposited the
rent into the Land Bank accounts discussed infra.
- 15 [*15] III. Bank Accounts
A. Bank of America Accounts 7874 and 8887
Mr. Borna owned and controlled Land Bank accounts at Bank of America
ending in 7874 and 8887 (account 7874 and account 8887, respectively).6 All
receipts from sales in the name of Mr. Borna, all moneys that Mr. Borna received
on the Barrow notes, and all rent that Mr. Borna received were deposited into
account 7874 (or starting about February 10, 2006, into account 8887).
Mr. Borna was responsible for the Land Bank check register. He retrieved
the statements and looked at them to see whether checks had cleared. He or
someone else made the deposits.
B. Bank of the Sierra Account 9280
During 2006, Mr. Borna owned and controlled an account at Bank of the
Sierra ending in 9280 (account 9280).
C. CitiBank Account 6516
Mrs. Borna received wages from an independent employer, Macy's, Inc.,
during each year in issue. Those wages, net of certain amounts withheld (including
$48 in 2006 for a contribution to the United Way) were deposited into her
CitiBank account ending in 6516 (account 6516).
6At least once, the trial transcript refers incorrectly to the latter account as
account number 2887.
- 16 [*16] D. Accounts 1692 and 2484
Superb Properties maintained two accounts at Mojave Desert Bank. These
accounts ended in numbers 1692 and 2484 (account 1692 and account 2484,
respectively).
IV. Preparation of the Subject Returns
Solis Cooperson's firm prepared the subject returns. Each subject return
included, among other forms and schedules, a Schedule C, Profit or Loss From
Business, and a Schedule D.
Mr. Borna understood that he and his wife signed the subject returns under
penalty of perjury and were responsible for their accuracy. Mr. Borna did not
review the subject returns. Petitioners did not give Mr. Cooperson all of the
relevant documents (e.g., all of the notes and deeds of trust) related to the Borna
note transactions before the preparation of the subject returns.
V. Audit
A. Overview
Respondent began auditing the 2004 return and later expanded the audit to
include the 2005 return and the 2006 return. Respondent's revenue agent, Daniel
Huh, met on various occasions with Mr. Cooperson in his capacity as petitioners'
representative.
- 17 [*17] During the audit petitioners did not give Mr. Huh everything that he
requested from them, in part because that many of petitioners' business and tax
returns were lost as a result of a series of burglaries of Land Bank's and Superb
Properties' offices and storage locations and of petitioners' personal residence in
California City. Included in the lost property were two computers that stored
business records. Mr. Huh eventually issued bank summonses and multiple
information document requests to get information that he sought.
Since the audit and after the issuance of the notice of deficiency, petitioners'
attorney's accounting assistant, Ms. Wang, has made a yeoman's effort to
reconstruct petitioners' records primarily utilizing copies of petitioners' canceled
checks obtained from Mr. Borna's and his businesses' banks. This effort has been
both arduous and tiring because of the number of transactions at issue, the fact that
many checks did not identify the reason for the check on the memo line, and the
passage of time. Consequently, many alleged expenses and income items remain
in dispute although the parties have tried hard to resolve as many substantiation
issues as possible, with some success.
- 18 [*18] B. Bank Deposits Analysis
1. Analysis During Audit
Mr. Huh prepared the following bank deposits analysis (BDA) to reconcile
petitioners' bank deposits to the income reported on the subject returns.
2004
2005
2006
Net deposits from account 1692
Net deposits from account 2484
Net deposits from account 7874
Net deposits from account 6516
Net deposits from account 8887
Net deposits from account 9280
Total net deposits
$217,843
112,698
1,263,604
38,399
-0-01,632,544
$546,880
44,568
3,033,599
46,081
-0-03,671,128
$416,930
13,900
545,388
39,138
1,033,139
36,245
¹2,084,739
Escrow deposits
Gross receipts per Schedules C
Installment sales interest per tax returns
197,013
201,493
62,907
443,026
217,612
105,217
251,583
414,197
146,382
State tax refund per tax returns
2,673
-0-
-0-
Rents received per tax returns
Ms. Borna's net wages per tax returns
Installment sales payments received per
tax returns (excluding interest income)
Total reductions
Unexplained deposits
34,923
37,901
31,387
36,772
64,280
238,780
495,568
53,436
327,650
1,032,478
887,450
600,066 ¹2,783,679
¹1,242,871
841,868
Additional Schedule D gross sales
319,500
1,055,000
352,000
Additional Schedule C gross receipts
280,566
1,728,679
489,868
¹We note a discrepancy of $1.
- 19 [*19]
2Mr. Huh improperly included the $48 contribution in this
amount. The parties should correct this error in their computations
under Rule 155.
Mr. Huh requested proof of petitioners' escrow deposits for the years in
issue. Mr. Borna provided information for 2004, but not for 2005 or 2006. Mr.
Huh determined petitioners' escrow deposits for 2005 and 2006 by multiplying
each year's total net deposits by the ratio of the escrow deposits for 2004 over the
total net deposits for 2004.
Mr. Huh arrived at the additional Schedule C gross receipts by subtracting
from the unexplained deposits the amounts that he determined were additional
Schedule D sales. As to the Schedule D sales, Mr. Huh identified the properties
that Mr. Borna purchased and sold by reviewing Kern County property
transactions for 2004, 2005, and 2006 where Mr. Borna was listed as the grantee or
grantor. Mr. Huh calculated the selling and purchase prices (tax basis) by dividing
the property tax paid by the property tax transfer tax rate of .11%. Mr. Huh
matched up a sale by Mr. Borna with the unreported purchase (tax basis) to
establish the gain, if any, on property sold and not reported.7
7Mr. Huh's computations were not always accurate or carefully checked. As
a result, the Court has given them reduced credibility when weighing the evidence.
- 20 [*20]
2. Analysis After Audit
During this proceeding Revenue Agents Laura Hurtado and Sunny Lee
reviewed Mr. Huh's BDA and revised it to include cash out from deposits on two
accounts. Cash out represents the amount of cash that is taken out at the time of
deposit. Cash out is important because some banks reflect only the net amount of
the deposit on a bank statement, and a review is required to make sure that all
income is actually reported.
Mr. Huh's BDA did not include any cash out. The revised BDA (revised
BDA) included for the respective years in issue cash outs of $27,800, $20,273, and
$13,000 for account 7874. For 2006, the revised BDA also included cash out of
$8,000 for account 8887.
Ms. Hurtado and Mr. Lee in the revised BDA also adjusted the Schedule D
gross sales. They listed properties that were identified as sold but not reported by
Mr. Borna. They took into account amounts determined to be Mr. Borna's
purchase price, the sale price, amounts received, costs incurred at the time of
purchase, and the capital gain realized.
The escrow amounts in the BDA for 2005 and 2006 correspondingly
changed in the revised BDA. At trial, respondent conceded an additional
adjustment to acknowledge a division error by Mr. Huh in computing the selling
- 21 [*21] price, by a factor of 10 pointed out by the Court, which had resulted in a
large price discrepancy as reflected on Mr. Huh's examination work papers. This
error and others were apparently corrected later in the examination and the
preparation of the statutory notice of deficiency. Other mathematical and/or
factual errors were not corrected.
The revised BDA is as follows:
2004
2005
2006
Net deposits from account 1692
Net deposits from account 2484
Net deposits from account 7874
Net deposits from account 6516
Net deposits from account 8887
Net deposits from account 9280
Total net deposits
$217,843
112,698
1,291,404
38,399
-0-01,660,344
$546,880
44,568
3,053,872
46,081
-0-03,691,401
$416,930
13,900
558,388
39,138
1,041,139
36,245
¹2,105,739
Escrow deposits
Gross receipts per Schedules C
Installment sales interest per return
State tax refund per tax returns
Rents received per tax retums
Ms. Borna's net wages per tax returns
Installment sales payments received per
tax returns (excluding interest income)
Total reductions
Unexplained deposits
197,013
201,493
62,907
2,673
34,923
37,901
438,013
217,612
105,217
-031,387
36,772
249,862
414,197
146,382
-064,280
38,780
495,568
53,436
327,650
1,032,478
627,866
882,437
2,808,964
1,241,151
864,588
Additional Schedule D gross sales
101,680
198,400
25,500
Additional Schedule C gross receipts
526,186
2,610,564
839,088
¹We note a discrepancy of $1.
- 22 [*22] The parties eventually agreed to remove from the revised BDA the balances
in account 1692 and in account 2484. Thus, on the basis of this agreement,
respondent now asserts that the additional Schedule C gross receipts for the
respective years in issue are as follows:
2004
Additional Schedule C gross receipts
Net deposits from account 1692
Net deposits from account 2484
Total adjustment
2005
2006
$526,186 $2,610,564 $839,088
(217,843)
(546,880) (416,930)
(112,698)
( 44,568) (13,900)
330,541
591,448 430,830
Additional Schedule C gross receipts
(as adjusted)
195,645
2,019,116
408,258
VI. Schedule C Expenses for Taxes and Licenses
Petitioners claimed on the subject returns that they were entitled to deduct
for 2004, 2005, and 2006 $56,403, $681, and $697, respectively, for taxes and
licenses. Respondent allowed $5,703 for 2004, and the deduction amounts claimed
for 2005 and 2006. For the respective years in issue, petitioners submitted at trial
negotiated checks for reported taxes and licenses expenses totaling $47,197,
$96,917, and $18,584.
- 23 [*23] VII. Schedule C Rent Expenses
Petitioners claimed on the subject returns that they were entitled to deduct
for 2004, 2005, and 2006 $24,377, $24,238, and $24,369, respectively, as Schedule
C rent expenses. Respondent allowed $7,210, $7,210, and $6,089, respectively.
Petitioners did not give Mr. Huh any checks to support the deduction for rent
expenses for 2004. Therefore, Mr. Huh allowed a conservative estimate amount
based on that allowed for the subsequent tax years. For the respective years in
issue, petitioners submitted at trial for rent expenses negotiated checks totaling
$76,125, $43,438, and $66,564.
In 2004, Mr. Borna paid $1,600 to Aspen Investment as a reported office
rental expense. Danny Jones is associated with Aspen Investment. A Land Bank
check for $50,929 made payable to him was cashed by Danny Jones on June 14,
2006. The check indicates that it is for "notes 4076 [and] 4079".
VIII. Schedule C Commissions Expenses
A. Overview
Mr. Borna paid commissions ranging from 10% to 50% for property that he
owned individually and sold through Land Bank. Petitioners paid and reported
"commission and other expenses" on the Forms 6252 filed with the subject returns.
These amounts related to properties that Mr. Borna owned. The "other expenses"
- 24 [*24] represented costs paid for, among other things, grading, taxes, licenses, and
escrow fees. Petitioners also paid commissions and other expenses on other
unreported property sales; those expenses included costs such as grading, taxes,
licenses, and escrow fees.
B. 2004
For 2004, petitioners deducted $58,121 as Schedule C commissions
expenses. Respondent allowed $14,462.
Petitioners did not give Mr. Huh checks to support the claimed commissions
expenses. Mr. Huh used the amounts reflected on various Forms 1099 to
determine what he considered to be the commissions paid. He determined that
petitioners paid $444,273 in commissions for both Schedule C and D transactions.
In calculating the allowable commissions allocated to Schedule C, he considered
Mr. Borna's statement that he paid 3% to 5% commissions on Schedule C sales
and 20% commissions on Schedule D sales. Mr. Huh determined it was closer to
1% to 3% on Schedule C sales and allowed 3%. He multiplied his determination
of Schedule C gross receipts as adjusted by 3%, resulting in $14,462. He
determined the total of petitioners' Schedule D sales per his calculations and
allowed Schedule D commissions based on 20%. For 2004, the amount he allowed
for Schedule D was $429,811.
-25 [*25] C. 2005
For 2005, petitioners deducted $100,811 as Schedule C commissions
expenses. Respondent allowed $58,389.
Mr. Huh determined that petitioners paid $508,103 in commissions for both
Schedules C and D. In calculating the allowable commissions allocated to
Schedule C, Mr. Huh used petitioners' accounting records and Mr. Cooperson's
statements. Mr. Huh allowed 3% for Schedule C sales per his calculations. Mr.
Huh multiplied the Schedule C gross receipts as adjusted by him by 3%, resulting
in $58,311. Mr. Huh determined the total of petitioners' Schedule D sales per his
calculations and allowed Schedule D commissions based on 20%. For 2005, the
amount of commissions allowed for Schedule D is $449,714.
D. 2006
Petitioners deducted $376,697 as Schedule C commissions expenses.
Respondent allowed $27,122.
Mr. Huh determined that petitioners paid $357,897 in commissions for both
Schedules C and D. In calculating the allowable commissions allocated to
Schedule C sales, Mr. Huh allowed 3% per his calculations. Mr. Huh multiplied
the Schedule C gross receipts as adjusted by him by 3%, to come up with $27,122.
Mr. Huh determined the total of petitioners' Schedule D sales per his calculations
- 26 [*26] and allowed Schedule D commissions based on 20%. For 2006, the amount
allowed for Schedule D was $330,775.
IX. Notice of Deficiency
The notice of deficiency lists the following adjustments:
Sch Cl--Taxes and licenses
Sch Cl--Rent/lease-Other business property
Sch Cl--Commissions and fees
Sch Cl--Additional sales from
Sch C properties
Sch D--S T Gain/Loss
Forms 6252/4684/6781/8824
Sch El--Rents Received
S/E AGI adjustment
Itemized deductions
Exemptions
Total
2004
2005
2006
$50,700
-0-
-0-
17,167
43,659
$17,028
42,422
$18,280
349,575
280,566
1,728,679
489,868
299,000
34,923
(14,673)
21,340
4,650
737,332
674,986
31,387
(38,563)
69,203
7,680
2,532,822
64,290
38,105
(18,187)
18,839
-0960,770
X. Amended Answer
The amended answer lists the following revised adjustments:
Sch Cl--Taxes and licenses
Sch Cl--Rent/lease-Other business property
Sch Cl--Commissions and fees
Sch El--Rents received
Sch Cl--Additional sales from
Sch C properties
Capital gain or loss
2004
2005
2006
$50,700
-0-
-0-
17,167
36,291
34,923
$17,028
15,966
31,387
$18,280
339,099
38,105
526,186
68,667
2,610,564
141,597
839,088
100,283
- 27 [*27]
S/E AGI adjustment
Itemizeddeductions
Exemptions
Total
(13,860)
21,602
4,650
746,326
(40,979)
69,203
7,680
2,852,446
(21,862)
26,260
-01,339,253
OPINION
I. Perception of Mr. Borna and Mr. Huh and of Certain Exhibits
A. Mr. Borna
Mr. Borna testified at length. The Court did not perceive him to be entirely
credible, and we consider portions of his testimony to be unreliable. We are not
required to rely on unreliable testimony, and we do not consider aspects of his
testimony sufficiently reliable to establish petitioners' positions with respect to
certain of the issues at hand. See Neonatology Assocs., P.A. v. Commissioner, 115
T.C. 43, 84-87 (2000), aff'd, 299 F.3d 221 (3d Cir. 2002); see also Ruark v.
Commissioner, 449 F.2d 311, 312 (9th Cir. 1971), aff'g per curiam T.C. Memo.
1969-48; Clark v. Commissioner, 266 F.2d 698, 708-709 (9th Cir. 1959), aff'g in
part and remanding T.C. Memo. 1957-129.
Nor do we rely on the principal vis-a-vis interest allocations that petitioners
set forth in various payment schedules that they offered into evidence to
characterize sole proprietorship receipts (or portions thereof) as nontaxable returns
of principal. We consider those documents to be untrustworthy. For example, as
- 28 [*28] to one of the schedules, Exhibit 1181-P, Mr. Borna helped prepare the entries
in that exhibit contemporaneously with the trial in this case; and as discussed
supra, we find that his testimony (which includes his statements as to the accuracy
of the exhibit) is unreliable. We also have further reservations as to the accuracy
of that exhibit in that, as discussed inRa, we find that petitioners' bookkeeping was
substandard. We also note that Mr. Borna's testimony and overall understanding
of the amount of principal that he received vis-a-vis the amount of interest that he
received has not always been consistent.
B. Mr. Huh
Mr. Huh also testified extensively at the trial. The Court's impression of his
testimony and audit efforts was that he was annoyed with the status of petitioners'
books and records and lack thereof. He was more interested in the burden of proof
than in determining the correct amount of tax even when, because of his efforts and
bank deposits methodology, canceled checks and other documents were available
to assist him in determining allowable deductions. Further, he made computations
which had to be corrected by other Internal Revenue Service personnel, including
Revenue Agents Laura Hurtado and Sunny Lee, at the request of respondent's
- 29 [*29] counsel. We give little evidentiary weight to Mr. Huh's testimony and,
except to the extent stated herein, to his work product.8
II. Burden of Proof
A. General Rules
The Commissioner's determinations in a deficiency notice are generally
presumed correct, and taxpayers generally bear the burden of proving those
determinations wrong. See Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115
(1933). The Court of Appeals for the Ninth Circuit, to which an appeal of this case
ordinarily would lie, absent a stipulation to the contrary, has held that the
presumption of correctness attaches to a notice of deficiency in unreported income
cases only when the Commissioner establishes a minimal evidentiary foundation
linking the taxpayer to the source of the unreported income. See Palmer v. U.S.
I_RS, 116 F.3d 1309, 1312-1313 (9th Cir. 1997); Weimerskirch v. Commissioner,
596 F.2d 358, 360-362 (9th Cir. 1979), rev'g 67 T.C. 672 (1977). Once such a
foundation is established, the burden shifts to the taxpayer to prove by a
preponderance of the evidence the portion of the unreported income that is not
taxable. See Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999), aff'g
T.C. Memo. 1997-97; Palmer, 116 F.3d at 1312-1313; see also Helvering v.
8We note, however, that we agree with Mr. Huh's conclusion that petitioners
failed to report significant amounts of income that Mr. Borna's businesses realized.
- 30 [*30] Taylor, 293 U.S. 507, 515 (1935); Tokarski v. Commissioner, 87 T.C. 74,
76-77 (1986).
Respondent determined that petitioners failed to report certain items of
income, and the evidence at hand establishes a minimal evidentiary foundation
linking petitioners to the source of that unreported income. The primary source for
the unreported income is Mr. Borna's sole proprietorship. We conclude that
petitioners bear the burden of proof as to the deficiencies determined in the notice
of deficiency. Our conclusion applies to both the unreported income and to the
disallowed deductions underlying those deficiencies.°
B. Section 7491(a)
Section 7491(a)(1) provides an exception to the general rules on burden of
proof by shifting the burden of proof to the Commissioner as to any factual issue
relevant to a taxpayer's liability for tax if the taxpayer meets certain conditions.¹°
These conditions require in part that individual taxpayers establish that they
°Respondent in the amended answer asserts that petitioners are liable for
deficiencies in amounts greater than the amounts determined in the notice of
deficiency. While respondent bears the burden of proof as to any increased
deficiency, see Rule 142(a)(1), we do not find any increased deficiency in this
case.
¹°Sec. 7491(a)(1) generally provides that "[i]f, in any court proceeding, a
taxpayer introduces credible evidence with respect to any factual issue relevant to
ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B, the
Secretary shall have the burden of proof with respect to such issue."
- 31 [*31] complied with the substantiation requirements set forth in the Code, that they
maintained all records required by the Code, and that they cooperated fully with
the Commissioner's reasonable requests for, among other things, information and
documents. See sec. 7491(a)(2);" Estate of Dieringer v. Commissioner, 146 T.C.
117, 127-128 (2016).
We hold that section 7491(a) does not apply to shift the burden of proof to
respondent. This is because we do not find that petitioners cooperated with
respondent's reasonable requests for documents and information or that petitioners
established their compliance with the substantiation and recordkeeping
requirements of the Code. Petitioners assert that they fully cooperated with Mr.
Huh throughout the audit, that they answered all of his questions, and that they
gave him all of the documents that he requested (except to the extent of certain
documents which petitioners claim were stolen). We disagree on each of these
points. The record establishes, and we find as facts, that petitioners did not
cooperate with Mr. Huh, that petitioners did not give Mr. Huh all of the documents
that he requested (e.g., Mr. Huh was required to get a significant amount of
"Sec. 7491(a)(2) provides that the general rule of sec. 7491(a)(1) applies to
an individual taxpayer only if "the taxpayer has complied with the requirements
under this title to substantiate any item; * * * [and] the taxpayer has maintained all
records required under this title and has cooperated with reasonable requests by the
Secretary for witnesses, information, documents, meetings, and interviews".
- 32 [*32] information directly from third parties), and that petitioners did not timely
supply Mr. Huh with all of the information that he requested.
III. Unreported Income
A. Overview
Gross income includes all income from whatever source derived, including
gross income derived from business. See sec. 61(a)(2). This definition sweeps
broadly to reach all accessions to wealth over which a taxpayer has complete
control. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955). A
taxpayer's receipt of an item of income "constitutes taxable income when its
recipient has such control over it that, as a practical matter, he derives readily
realizable economic value from it", and a taxpayer has dominion and control of the
item when the taxpayer is free to use the item at will. Rutkin v. United States, 343
U.S. 130, 137 (1952). A taxpayer's use of funds for personal purposes indicates
dominion and control, even if those funds are in an account titled in someone else's
name. See, e.g., Gardner v. Commissioner, T.C. Memo. 2013-67, at *13.
Taxpayers are required to maintain books and records sufficient to establish
the amount of their gross income. See sec. 6001. When taxpayers fail that
requirement, the Commissioner may reconstruct their income using any reasonable
method. See Holland v. United States, 348 U.S. 121, 130-131 (1954); see also
- 33 [*33] DiLeo v. Commissioner, 96 T.C. 858, 867 (1991) ("The use of the bank
deposits method for computing income has long been sanctioned by the courts."),
a_fCd, 959 F.2d 16 (2d Cir. 1992).
The record establishes, and we find, that petitioners failed to maintain the
requisite books and records as to Mr. Borna's sole proprietorship or to properly
reconstruct any stolen records. See Gizzi v. Commissioner, 65 T.C. 342, 346
(1975) (noting that taxpayers whose records are lost on account of a casualty are
required to reasonably reconstruct their missing records). We conclude, therefore,
that respondent properly undertook a BDA to determine petitioners' income and
that respondent properly determined through this BDA that petitioners
underreported their income for the years in issue. A BDA is a reasonable method
of reconstructing income, and the Commissioner may rely on a BDA to reconstruct
a taxpayer's income where the taxpayer failed to maintain sufficient records. See
Nicholas v. Commissioner, 70 T.C. 1057, 1064 (1978). Bank deposits are
considered prima facie evidence of a taxpayer's receipt of taxable income. See
Parks v. Commissioner, 94 T.C. 654, 658 (1990) (citing Tokarski v.
Commissioner, 87 T.C. 74, 77 (1986)).
After the Commissioner reconstructs a taxpayer's income and determines a
deficiency, as he has done here, the taxpayer bears the burden of proving that the
- 34 [*34] use of the BDA was unfair or inaccurate. See Clayton v. Commissioner, 102
T.C. 632, 645 (1994). The taxpayer may do so by showing (among other things)
that certain deposits came from nontaxable sources. See id. Nontaxable sources
include funds attributable to interaccount bank transfers and returned checks, as
well as "loans, gifts, inheritances, or assets on hand at the beginning of the taxable
period." Burgo v. Commissioner, 69 T.C. 729, 743 n.14 (1978) (quoting
Troncelliti v. Commissioner, T.C. Memo. 1971-72); see also Clayton v.
Commissioner, 102 T.C. at 645-646.
B. Sole Proprietorship Income
Respondent asserts that petitioners failed to report sole proprietorship
income for each year in issue. According to the amended answer, as adjusted to
reflect the parties' agreement as to the deposits into accounts 1692 and 2484,
petitioners' unreported sole proprietorship income for the respective years in issue
totals $195,645, $2,019,116, and $408,258.
Petitioners argue that most of the unreported deposits are not taxable income
to them because, they assert, those deposits represent the payment of principal on
the Barrow notes. According to petitioners, the principal payments represent a
dollar-for-dollar return in the basis that Mr. Borna received in the Barrow notes
- 35 [*35] through his issuance of the Borna notes.¹² We disagree with petitioners'
argument. We do not find that all of the disputed amounts are a return of basis, as
petitioners claim.
Mr. Borna received numerous payments on the Barrow notes, and those
payments are naturally characterized as principal or interest. Stated interest is
computed from the stated interest rates in the Barrow notes. Petitioners, as cash
basis taxpayers, must recognize all interest that Mr. Borna received on the Barrow
notes, see sec. 61(a)(4), notwithstanding what his bases may be in those notes.
Respondent asserts on brief that petitioners received unreported stated
interest for the respective years in issue of $33,480, $69,327, and $57,586. We
have reviewed respondent's calculations underlying those amounts and note further
that petitioners have not, in their answering brief, specifically identified any error
in the mechanics of those calculations. We sustain respondent's position that
petitioners failed to recognize for each year in issue stated interest from Mr.
Borna's sole proprietorship. We also sustain respondent's calculations of the
amounts of unreported stated interest, except to the extent that the numbers in
respondent's calculations would change on account of our findings of fact, which
we set forth supra section II.C.3 (pp. 9-11), or our holding as to respondent's
¹²In this vein, petitioners assert, the deposits are not receipts of Mr. Borna's
sole proprietorship but are receipts from the sale of capital assets.
- 36 [*36] asserted prepayments, discussed infra p. 38. To the extent that those
numbers would change on account of those findings and holding, we direct the
parties, in their Rule 155 computations, to recalculate the amounts in accordance
with our findings of fact supra section II.C.3 (pp. 9-11) and holding
p. 38.
Section 483 generally imputes interest to a contract for the sale or exchange
of property if the contract has "total unstated interest", sec. 483(a), and unstated
interest is not a part of a purchaser's basis in the property, see sec. 1.483-1(a)(2)(i),
Income Tax Regs. As relevant here, section 483 applies to such a contract if the
contract provides for deferred payments and the total payments due under the sales
contract are equal to or less than $250,000. See secs. 483(c), (d), 1274(c)(3). If
section 483 applies, a portion of the total unstated interest is imputed to each
deferred payment of principal. See sec. 483(a). Section 483(b) requires that
certain deferred payments be discounted to present value in order to ascertain
whether there is total unstated interest and, therefore, whether section 483 applies.
Section 483(b) and (c) requires that total unstated interest be computed by
discounting deferred payments under the method required by section 1274(b)(2)
and by using discount rates tied to the applicable Federal rate (AFR).¹³ The
amount of each note's unstated interest is generally the difference between its
¹³The AFRs are published each month as revenue rulings in the Internal
Revenue Bulletins.
- 37 [*37] stated principal amount and the present value of the payments due thereunder
as determined under section 1.483-2, Income Tax Regs.
Petitioners argue that Mr. Borna received a dollar-for-dollar basis in the
Barrow notes on account of his issuance of the Borna notes. We disagree. The
Borna notes lacked any stated interest and thus had unstated interest under section
483 and section 1.483-2, Income Tax Regs. The amount included in basis on
account of a promissory note issued to acquire nonpublicly traded property such as
the Barrow notes is the stated principal amount of the note, reduced by any
unstated interest. See sec. 1.1012-1(g)(1), Income Tax Regs. Mr. Borna's basis in
each Barrow note thus equals the corresponding Borna note's stated principal
amount less unstated interest. See id.
Respondent asserts on brief that petitioners received market discount income
for the respective years in issue of $142,421, $277,099, and $203,031, an assertion
due in part to the fact that the Borna notes did not provide for any interest. We
have reviewed respondent's calculations underlying those amounts and note further
that petitioners have not in their answering brief specifically identified any error in
the mechanics of those calculations. For the reasons stated above, we sustain
respondent's position that petitioners failed to recognize for each year in issue
market discount income from Mr. Borna's sole proprietorship. We also sustain
- 38 [*38] respondent's calculations of the amounts of market discount income, except
to the extent that the numbers in respondent's calculations would change on
account of our findings of fact, which we set forth supra section II.C.3 (pp. 9-11),
or our holding as to respondent's asserted prepayments, discussed immediately
below. To the extent that those numbers would change on account of those
findings and holding, we direct the parties, in their Rule 155 computations, to
recalculate the amounts in accordance with our findings of fact in the justreferenced pages.
Respondent also asserts that petitioners must recognize certain payments that
third parties made to Mr. Borna after certain Borna notes were issued but before
the "start date" of those notes. More specifically, respondent asserts, petitioners
must recognize for the respective years in issue $220,184, $138,875, and $59,200.
We disagree. To the extent that third parties paid Mr. Borna amounts before a
note's start date, we find and hold that those payments are prepayments made on
the corresponding notes. We therefore reject respondent's position that petitioners
failed to recognize these payments as income (except to the extent that the
payments would be stated or unstated interest within the realm of our discussion of
those items supra). We direct the parties, in their Rule 155 computations, to reflect
this holding consistently with that discussion.
- 39 [*39] Finally, respondent asserts that petitioners must recognize short-term capital
gain with respect to six Barrow notes (notes 1089-P, 1115-P, 1118-P, 1120-P,
1126-P, and 1141-P) that respondent asserts were paid off shortly after Mr. Borna
acquired them. We agree with respondent that petitioners realized short-term
capital gains to the extent that our findings of fact, which we set forth supra
section II.C.3 (pp. 9-11), and our holding as to respondent's asserted prepayments,
discussed supra p. 38, establish as to each note respectively that petitioners
received principal payments on the note in excess of Mr. Borna's basis in the note.
Mr. Borna's basis in each note equals the present value of the note. We direct the
parties, in their Rule 155 computations, to reflect this holding consistently with our
discussion herein.
C. Schedule D Income
1. Background
The parties agree that petitioners received and failed to report Schedule D
income. This income stems from additional sales of property that petitioners
personally owned. The parties have settled all issues as to this matter except for
four items. We address these items seriatim.
- 40 [*40]
2. Items in Dispute
a. $1,000 Sales Expense
The parties dispute whether petitioners may deduct a $1,000 sales expense in
connection with the sale of a parcel of Kern County, California, property (referred
to as APN 294-010-01) for $10,000 in 2004. Petitioners did not report this sale on
their tax return because they believed no gain was realized. Petitioners originally
claimed sales expenses of $2,650.
Petitioners failed to adduce any credible evidence on this issue, and the
record does not otherwise persuade us that petitioners are entitled to deduct the
$1,000 in dispute. We hold for respondent on this issue on the basis of petitioners'
failure to meet their burden of proof.¹4
b. Amounts Received in Connection With Certain Sales
In or before 2003, petitioners purchased properties referred to as APN
212-251-18, APN 203-168-01, APN 203-166-02, and APN 203-166-03. They sold
the properties in 2004, but the buyers rescinded the sales in 2005. Petitioners
argue that rescission of the sales means that they did not realize any income on the
sales. We disagree.
¹4Respondent's opening brief sets forth no assertion that petitioners did not
realize any portion of the $10,000 in proceeds as gain. We therefore do not
consider that issue.
- 41 [*41] Tax liability is generally based on transactions that occur during the taxable
year, without regard to transactions in later years. See Security Flour Mills, Co. v.
Commissioner, 321 U.S. 281, 285-286 (1944). In this vein, a cash method
taxpayer who receives proceeds under a claim of right and without restriction as to
their disposition is currently taxed on the receipt in the taxable year of receipt even
if, in a later taxable year, some or all of the proceeds must be returned. See Burnet
v. Sanford & Brooks Co., 282 U.S. 359, 363-364 (1931).
With respect to the referenced four sales, the sales occurred in 2004 and the
rescissions occurred in 2005. Petitioners therefore, as cash basis taxpayers, must
report any gain or loss on the sales for 2004. Accord Felt v. Commissioner, T.C.
Memo. 2009-245, 98 T.C.M. (CCH) 372, 377 (2009), a[d, 433 F. App'x 293 (5th
Cir. 2011).
c. Repossessed Properties
On December 18, 1991, petitioners purchased properties referred to as APN
305-050-14 and APN 305-071-15. Kern County sold those properties in 2004 for
back taxes of $4,250 and $1,707, respectively, that petitioners owed. Petitioners'
basis in each property was $1,800.
Petitioners maintain that they did not realize any gain or loss on the
county's sale of the properties. Instead, as we understand their position, they
- 42 [*42] sustained a loss when the county took those properties, equal to their costs
for the properties. We disagree. A tax sale of property is a disposition of the
property. Petitioners therefore realized a long-term capital gain of $2,450 on one
of the properties ($4,250 - $1,800) and a long-term capital loss of $93 on the other
property ($1,707 - $1,800).
d. Sales Expenses and Basis for APN 302-330-35
On May 26, 2005, petitioners sold property referred to as APN 302-330-35
that they had purchased on March 2, 2005. Respondent concedes that petitioners
may claim a sales expense of $15,650 and that petitioners had a basis in the sold
property of $9,900. Petitioners request higher amounts as to both items.
Specifically, petitioners claim a cost basis of $19,000 (apparently including $5,500
of improvements), but they provided no backup evidence; and Exhibit 1042-P
would seem to disprove a commission expense above $15,650.
Although petitioners provided Exhibit 1042-P, which addressed this sales
transaction, they failed to adduce any credible evidence on theses issues.
Petitioners bear the burden of disproving respondent's determination as to this
matter. See Rule 142(a). They have failed to do so. We conclude that petitioners
are not entitled to a sales expense in excess of $15,650 or to a basis in excess of
$9,900.
- 43 [*43] IV. Sole Proprietorship Expenses
A. Preliminary
We decide whether petitioners may deduct sole proprietorship expenses for
taxes and licenses, rent and lease, and commissions and fees in amounts greater
than respondent allowed. The amounts of these expenses that petitioners reported
on their tax returns and the amounts that respondent disallowed and allowed in the
notice of deficiency are as follows:
Yeg
Type of expense
Amount
reported
2004
Taxes and licenses
$56,403
$50,700
$5,703
Rent and lease
24,377
17,167
7,210
Commissions and fees
Taxes and licenses
58,121
681
43,659
-0-
14,462
681
Rent and lease
Commissions and fees
24,238
100,811
17,028
42,422
7,210
58,389
Taxes and licenses
Rent and lease
Commissions and fees
697
24,369
376,697
-018,280
349,575
697
6,089
27,122
2005
2006
Amount
disallowed
Amount
allowed
As discussed infia, petitioners currently argue that they may deduct amounts
different from those they claimed, and respondent currently concedes that
petitioners may deduct amounts different from those determined in the notice of
deficiency.
- 44 [*44] B. Substantiation of Deductions
A second difficulty here is that the record before us falls short of providing
adequate substantiation for all of petitioners' costs. Deductions are a matter of
"legislative grace", and "a taxpayer seeking a deduction must be able to point to an
applicable statute and show that he comes within its terms." New Colonial Ice Co.
v. Helvering, 292 U.S. 435, 440 (1934); see also Rule 142(a). The applicable
section here, section 162(a), generally allows "a deduction [for] all the ordinary
and necessary expenses paid or incurred during the taxable year in carrying on any
trade or business". An expense is ordinary if it is "normal, usual, or customary"
within a particular trade, business, or industry. See Deputy v. du Pont, 308 U.S.
488, 495 (1940). An expense is necessary if it is appropriate and helpful for the
development of the business. See Commissioner v. Heininger, 320 U.S. 467, 471
(1943). The breadth of section 162(a) is tempered by the requirement that any
amount reported as a business expense must be substantiated, and taxpayers are
required to maintain records sufficient therefor. See sec. 6001; Hradesky v.
Commissioner, 65 T.C. 87, 89-90 (1975), M, 540 F.2d 821 (5th Cir. 1976); sec.
1.6001-1(a), Income Tax Regs.
When a taxpayer adequately establishes that he or she paid or incurred a
deductible expense but does not establish the precise amount, we may in some
- 45 [*45] circumstances estimate the allowable deduction, bearing heavily against the
taxpayer whose inexactitude is of his or her own making. See Cohan v.
Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). There must, however, be
sufficient evidence in the record to provide a basis upon which an estimate may be
made and to permit us to conclude that a deductible expense, rather than a
nondeductible personal expense, was incurred in at least the amount allowed. See
Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957); Vanicek v.
Commissioner, 85 T.C. 731, 742-743 (1985).
Three categories of expenses are in dispute for 2004, 2005, and 2006. The
categories are (1) taxes and licenses; (2) rent and lease expenses; and
(3) commissions and fees expenses. The disputes are detailed in the parties' "Third
Stipulation of Settled [and Unsettled] Issues" filed by the Court's Clerk as a
Stipulation of Settled Issues. Because of a stolen computer with at least some, if
not all, of the business records and somewhat shoddy overall recordkeeping,
petitioners have had to report their expenses by reconstructing their records
utilizing copies of their canceled checks apparently obtained from their banks.
C. Expenses in Issue
The specific amounts in dispute per the parties' stipulation are as follows.
These amounts take into account respondent's amended answer.
- 46 [*46]
1. Schedule C Business Expenses
a. 2004
The parties have stipulated for 2004:
Expense category
Amounts
reported
by petitioners
Amounts
allowed per
respondent
Amounts
remaining
in dispute
Taxes and licenses
¹$47,197
$15,618
$16,373
Rent/lease--Other
business property
76,125
14,090
62,034
¹249,696
30,654
211,176
Commissions and
fees
¹These are the amounts listed on petitioners' tally sheets.
Respondent, however, asserts that these amounts include some
duplicated items. Neither the parties nor the record explains the
discrepancy of $15,206 between, on the one hand, the difference of
$31,579 in the total claimed taxes and licenses expense of $47,197
and the total of the amount allowed by respondent of $15,618 and, on
the other hand, the amount remaining in dispute of $16,373. The
same is true as to the discrepancy of $7,866 between, on the one hand,
the difference in total claimed commissions and fees expense of
$249,696 and the amount allowed by respondent of $30,654 and, on
the other hand, the amount remaining in dispute of $211,176.
Of the disputed taxes and licenses amount of $16,373 respondent would
allow $11,655 and $2,160 as Schedule A "Other Miscellaneous Itemized
Expense[s]". The remaining disputed amount comprises seven payments made to
the County Recorder Office totaling $2,558.
- 47 [*47]
b. 2005
The parties have stipulated for 2005:
Expense category
Taxes and
licenses
Rent/lease-Other business
property
Amounts
claimed by
petitioners
Amounts
allowed per
respondent
Amounts
remaining
in dispute
$96,917
$105,776
¹$11,830
51,226
15,288
¹28,878
316,392
48,684
¹285,432
Commissions and
fees
¹The table's taxes and licenses amounts are confusing since
respondent allowed more than petitioners claimed. The additional
amount allowed was $8,859 which does not jive with the $11,830
shown in the parties' stipulated table. The correct amount would
seem to be a negative $8,859, rather than the $11,830 in the stipulated
table. Nor is there an explanation for the discrepancy of $7,060 of the
claimed rent/lease expense of $51,226 and the total of the amount
allowed by respondent of $15,288 and the amount remaining in
dispute of $28,878, which together total $44,166. Nor is there an
explanation for the apparent discrepancy of $17,724 of the claimed
commissions and fees of $316,392 and the total of the amount allowed
by respondent of $48,684 and the amount remaining in dispute of
$285,432, which together total $334,116.
- 48 [*48]
c. 2006
The parties have stipulated for 2006:
Expense category
Amounts
reported by
petitioners
Amounts
allowed per
respondent
Amounts
remaining
in dispute
$18,584
$13,936
¹$4,583
66,564
12,267
¹54,291
58,386
7,853
50,532
Taxes and
licenses
Rent/lease--Other
business
property
Commissions and
fees
¹The apparent discrepancy between the stipulated total reported
taxes and licenses expenses of $18,584 and the total of the amount
allowed by respondent, $13,936, and the amount remaining in dispute
of $4,583, which together total $18,519, is not explained by the
record. Nor is the discrepancy of $6 between the claimed rent/lease
expense of $66,564 and the amount allowed by respondent of $12,267
and the amount remaining in dispute of $54,291, which together total
$66,558.
2. Positions
a. Taxes and Licenses
i. 2004
Petitioners argue that they may deduct, for 2004, taxes and licenses expenses
of $47,197. Petitioners presented at trial negotiated checks totaling that amount.
Respondent concedes that petitioners may deduct $15,618.
- 49 [*49] The parties continue to dispute as to this year the deductibility of $16,373.
The amounts and payees of the negotiated checks underlying the $16,373 are as
follows:
Check payee
Check amount
L.A. County Tax Collector
Kern County Tax Collector
County Recorder Office
County Recorder Office
County Recorder Office
County Recorder Office
County Recorder Office
County Recorder Office
County Recorder Office
Total
$2,160
11,655
823
370
54
123
151
411
626
16,373
Respondent objects to the claimed deduction of these payments on the
grounds that petitioners were already allowed a $3,712 Schedule C business
expense deduction for 2004 recorder fees and petitioners have not established that
the $2,558 is not included in the $3,712. Given that the disputed amount is derived
solely from the canceled checks used to reconstruct petitioners' records, we agree
with respondent that if anything the allowed deduction here may be overgenerous.
Respondent concedes that petitioners may deduct the $2,160 and $11,655
amounts as miscellaneous itemized deductions, as opposed to deducting the
amounts as a business expense. While petitioners reserved the right to try to prove
- 50 [*50] those amounts could be deducted elsewhere they failed to do so. We will
allow these two amounts as miscellaneous itemized deductions.
ii. 2005
Petitioners argue that they may deduct for 2005 taxes and licenses expenses
of $96,917. Respondent concedes that petitioners may deduct $105,776. We will
allow petitioners to deduct $105,776 without further comment.¹³
iii. 2006
Petitioners argue that they may deduct for 2006 taxes and licenses expenses
of $18,584. Respondent concedes that petitioners may deduct $13,936.
The parties continue to dispute as to this year the deductibility of $4,583.
The $4,583 represents a check payable to the Los Angeles County Tax Collector.
Respondent asserts that the $4,583 is deductible as a miscellaneous itemized
deduction. While petitioners reserved the right to try to prove it could be deducted
elsewhere, they fail to do so. The Court will allow this amount as a miscellaneous
itemized deduction.
¹sIn addition to the $105,776 that we allow, respondent concedes that
petitioners may deduct $7,807 as a miscellaneous itemized deduction. The $7,807
represents check 8630 paid from account 7874 to the L.A. County Tax Collector.
We allow this miscellaneous itemized deduction in full.
-51 [*51]
iv. Analysis
Mr. Borna testified that he paid taxes on three groups of property: property
he personally owned, property he owned for sale to third parties, and property that
Mr. Barrow sold to third parties. He did not, however, identify to which of those
groups each of the 10 remaining disputed checks related.
Respondent asserts that petitioners have failed to show that the amounts
remaining in dispute were not already allowed as deductions. As to the County
Recorder Office payments, we agree. Petitioners reported on their Forms 6252
"commission and other expenses". The amounts reported included taxes and
licenses. Petitioners also incurred "commission and other expenses" on unreported
sales of property, which also included taxes and licenses. We conclude it is
probable that the County Recorder Office payments were included in these
deductions. Consequently, we are not persuaded that petitioners may deduct any of
those remaining disputed amounts as Schedule C expenses.
b. Rent and Lease
i. 2004
Petitioners argue that they may deduct for 2004 rent and lease expenses of
$76,125. Petitioners presented at trial negotiated checks in the total amount of
$76,125. Respondent concedes that petitioners may deduct $14,090.
- 52 [*52] The parties continue to dispute as to this year the deductibility of $62,035.
The $62,035 is attributable to six checks totaling that amount, payable to Aspen
Investments. Five of the checks are for $1,600; the sixth check is for $54,035.
ii. 2005
Petitioners argue that they may deduct for 2005 rent and lease expenses of
$51,226. Petitioners presented at trial negotiated checks in the total amount of
$51,226. Respondent concedes that petitioners may deduct $15,288.
The parties continue to dispute as to this year the deductibility of $28,878,
which represents checks payable as follows:
Payee
Allan/Daisy Paredes
Danny Jones ALC PSP
Danny Jones ALC PSP
Danny Jones ALC PSP
Danny Jones ALC PSP
Danny Jones ALC PSP
Danny Jones ALC PSP
Danny Jones ALC PSP
Danny Jones ALC PSP
Danny Jones ALC PSP
Legaspi
Total
Amount
$15,459
1,121
2,243
1,121
1,121
1,121
1,121
1,121
1,454
1,121
1,875
28,878
- 53 [*53]
iii. 2006
Petitioners argue that they may deduct for 2006 rent and lease expenses of
$66,564. Petitioners presented at trial negotiated checks in the total amount of
$66,564. Respondent concedes that petitioners may deduct $12,267.
The parties continue to dispute, as to this year, the deductibility of $54,291.
The $54,291 represents checks payable as follows:
Payee
Amount
Danny Jones ALC PSP
Danny Jones ALC PSP
Danny Jones ALC PSP
Danny Jones ALC PSP
$50,928
1,121
1,121
1,121
Total
54,291
iv. Analysis
a. 2004
For 2004, the notation on check 8053 for $54,035 appears to be, in part,
"payoff". Mr. Borna testified that he "rented a huge place from [Aspen
Investment] * * * for a few months * * * to hold [an] event * * * to capture the
client. * * * We invite different speakers, and they talk. And then the people, they
come to the event. We get their name, and we will call them. My agent would call
them and ask them to sell - to buy property. * * * it was for the rental of * * * that
place." The check indicates it was for "payoff net at 3235 Aspen Mall". Mr.
- 54 [*54] Borna explained that "we give them a notation that I'm going to pay you
before middle of the year, so that's why this was pay off that." This check appears
not to be for rent but for a payoff of a real estate transaction. The Court concludes
that the amount is excessive for an event rental and is more consistent with a
note(s) payoff. Further support for this conclusion can be found in the 2006 check
1047 for $50,929, paid to Danny Jones (who is Aspen Investments), which
petitioners also claim as a rent expense deduction. The notations on the check,
"notes 4076 [and] 4079," indicate that it was a payment made on two notes, rather
than a payment of rent. Mr. Borna did not produce a lease agreement associated
with either of these large reported expenses.
An overwhelming amount of the rent expense in dispute for each year,
$62,035 for 2004, $11,543 for 2005, and $54,291 for 2006, relates to Danny Jones
d.b.a Aspen Investment, yet petitioners did not call him or any of his associates or
employees at the trial or attempt to introduce by sworn affidavit Aspen Investments
business records. See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C.
1158, 1165 (1946) (noting the presumption that if produced the evidence would be
unfavorable "is especially true where * * * the party failing to produce the
evidence has the burden of proof"), afCd, 162 F. 2d 513 (10th Cir. 1947).
- 55 [*55] Respondent asserts that petitioners have failed to show that the amounts
remaining in dispute were not already allowed as deductions. Petitioners reported
on their Forms 6252 "commission and other expenses"; the amounts reported
included taxes and licenses. Petitioners also incurred "commission and other
expenses" on unreported sales of property, which also included taxes and licenses.
Respondent has not challenged the already-allowed deductions and has introduced
no evidence that certain of the claimed rent or lease expense deductions have
already been allowed.
Respondent seems to believe that petitioners must establish the negative that
there is no needle in the haystack. We do not agree. If respondent believes
deductions for the items were allowed under some other category, respondent
should have challenged the expenses under that category as well as the expenses
here or produced evidence, as he has with respect to commissions, that the expense
deductions claimed here were already allowed elsewhere.
We are persuaded by petitioner's testimony, canceled checks, and the regular
periodic payments for essentially similar amounts that the five checks, each for
$1,600, represent rent expenses incurred in 2004; and we find no creditable
evidence that these rent expenses were allowed as deductions elsewhere. Thus
petitioners have carried their burden of proof, by a preponderance of the evidence,
- 56 [*56] that these payments should be, and they shall be, allowed as deductible rent
expenses.
b. 2005
The amounts remaining in dispute include seven checks to Danny Jones for
$1,121. As with 2004, we are persuaded that these checks represent rent payments
which are deductible and will be allowed for 2005. The balance of the unagreed
rent and lease expense consists of a check for $15,459 to Allan/Daisy Paredes, two
checks to Danny Jones for $2,243 and $1,454, and a check to Legaspi for $1,875.
We will allow as a deductible rent expense the $2,243 check, which we conclude is
a payment for two months of the $1,121 regular rent. We will not, however, allow
any deduction for the $1,454 check (which Mr. Borna curtly identified as rent with
no elaboration to explain the unique amounts, although asked "why?") or the
$15,459 check to Allan/Daisy Paredes (which Mr. Borna identified as a "referral
check"), or the $1,875 check to Legaspi which indicates it is a "referral" and may
in fact be a referral fee per Mr. Borna's testimony. We conclude petitioners have
failed to bear their burden of proof as to these checks. As Mr. Borna
acknowledged, these checks, if deducted at all, would be deductible as
commissions and fees, not as rent or lease expenses. We decide infra Mr. Borna's
allowable deduction for 2005 commissions and fees.
- 57 [*57]
c. 2006
The amounts remaining in dispute for 2006 include three checks to Danny
Jones for $1,121 each and the aforementioned check for $50,928. As mentioned
above, the notations on this check of "note 4076 [and] 4079" indicate that the
check reflects payments made on two notes rather than rent. Consequently, the
$50,928 amount will not be allowed. However, as with 2004 and 2005, the three
checks for $1,121 will be allowed as deductible rent expenses for the same reasons
discussed above.
c. Commissions and Fees
i. 2004
Petitioners argue that they may deduct for 2004 commissions and fees
expenses of $249,649. Petitioners presented at trial negotiated checks in the total
amount of $249,696. Respondent concedes that petitioners may deduct $30,654.
The parties continue to dispute as to this year the deductibility of $211,176.
The $211,176 represents 18 checks totaling $107,668, payable to Elizabeth
PeCayo; 11 checks totaling $29,737, payable to Rosalinda Garcia; 11 checks
totaling $18,000, payable to Gary Young; 1 check for $2,750, payable to Efinegie
Ventura; 1 check for $2,250, payable to Famie Ventura; 2 checks totaling $17,145,
payable to Flor De Lys Barawid; 1 check for $5,000, payable to Brian Borna;
- 58 [*58] 9 checks totaling $2,664, payable to Transasia real estate services for
Mdelma; 1 check for $1,254, payable to Zalco Co.; 6 checks totaling $4,410,
payable to David Galdamez; 4 checks totaling $19,238, payable to cash; 1 check
for $260, payable to Joseph Nolan; and 1 check for $500, payable to James
PeCayo.¹6 Respondent concedes that petitioners may deduct $13,738 of the checks
payable to cash as a miscellaneous itemized deduction.
ii. 2005
Petitioners argue for 2005 that they may deduct commissions and fees
expenses of $316,392. At trial, petitioners presented negotiated checks totaling
$316,392. Respondent concedes that petitioners may deduct $48,684.
The parties continue to dispute as to this year the deductibility of $285,432.
The $285,432 represents 21 checks totaling $176,909, payable to Elizabeth
PeCayo; 11 checks totaling $30,823, payable to Rosalinda Garcia; 1 check for
$10,000, payable to Rosalinda Lising; 7 checks totaling $27,485 payable to Lemie
Ventura; 1 check for $12,030, payable to Flor De Lys Barawid; 1 check for $2,400,
payable to Mel Mantuario; 2 checks totaling $3,000, payable to Robert Williams; 1
check for $2,000, payable to David Galdamez; 1 check for $405, payable to Maria
¹6We recognize that the checks referenced in this sentence total $210,876.
The parties have not explained the $300 difference between the $211,176 and the
$210,876.
- 59 [*59] Galdamez; 1 check for $300, payable to Marco Galdamez; 1 check for $333,
payable to Mdelma; 1 check for $2,000, payable to Disnordas Sosnaski; 1 check
for $10,000, payable to Paulita Tajiboy; 1 check for $739, payable to McGraw
Insurance; 1 check for $250, payable to Mid Valley; 1 check for $5,860, payable to
Mayiga; and 1 check for $898, payable to Al Gagnon.
iii. 2006
Petitioners argue that they may deduct for 2006 commissions and fees
expenses of $58,386. Petitioners presented at trial negotiated checks totaling
$58,386. Respondent concedes that petitioners may deduct $7,853.
The parties continue to dispute for this year the deductibility of $50,532.
The $50,532 represents 8 checks totaling $43,857, payable to Rosalinda Garcia; 1
check for $1,400, payable to Lemie Ventura; 1 check for $2,786, payable to Gade 1
Travel; 1 check for $1,739, payable to Gina Dancel; 1 check for $500, payable to
Disnordas Sosnaski; and 1 check for $250, payable to David Galdamez.
iv. Analysis
Petitioners have failed to show that the 2004, 2005, and 2006 items
remaining in dispute are deductible as they claim. Petitioners paid and claimed
deductions for "commission and other expenses" on the Forms 6252 filed with
their tax returns and paid commission expenses concerning unreported property
- 60 [*60] sales (full and installment). We cannot determine whether respondent has
already allowed deductions for the commissions in dispute. We find, for example,
that some disputed items include payments that respondent has already allowed.
Many of the payees on the checks petitioners presented at trial are the same
individuals paid commissions with respect to property Mr. Borna owned and sold,
both reported and unreported. These are PeCayo, David Galdamez, Rosalinda
Garcia, and Flor de Lys Barawid. Likewise, numerous checks petitioners
presented bear no notation as to the property to which they relate, and Mr. Borna
failed to clarify that point at trial.
3. Other for 2004
Respondent concedes and we agree that petitioners may deduct $1,550 as
legal and professional fees. This $1,550 was paid through 10 checks. Respondent
also concedes that petitioners may deduct another $27,533 as a miscellaneous
itemized deduction. We allow both miscellaneous itemized deductions.
V. Accuracy-Related Penalties
Respondent determined for each year in issue that petitioners are liable for
an accuracy-related penalty under section 6662(a). Respondent bears a burden of
production with respect to those determinations. See sec. 7491(c); Rule 142(a)(2).
Respondent may meet this burden by producing sufficient evidence indicating that
- 61 [*61] it is appropriate to impose the accuracy-related penalty on petitioners. See
Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001).
Section 6662(a) imposes a 20% accuracy-related penalty on the
underpayment of tax required to be shown on a return. Section 6662(b)(1) imposes
an accuracy-related penalty on the portion of an underpayment which is
attributable to negligence or to disregard of rules or regulations. Negligence
includes "any failure to make a reasonable attempt to comply with the provisions"
of the Code "or to exercise ordinary and reasonable care in the preparation of a[n]
[income] tax return." See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.
"'Negligence' also includes any failure by the taxpayer to keep adequate books and
records or to substantiate items properly." See sec. 1.6662-3(b)(1), Income Tax
Regs. '"[D]isregard' includes any careless, reckless or intentional disregard of
rules or regulations." See id. subpara. (2). Section 6662(b)(2) imposes an
accuracy-related penalty on the portion of an underpayment which is attributable to
a substantial understatement of income tax. In the case of individual taxpayers, a
substantial understatement of income tax exists if the amount of the understatement
exceeds the greater of 10% of the tax required to be shown on the return or $5,000.
S_e_e sec. 6662(d)(1)(A).
- 62 [*62] We find that respondent has met his burden of production. The record
establishes, and we find, that petitioners were negligent and disregarded rules and
regulations in that they failed to report significant amounts of taxable income for
each year in issue, they failed to maintain adequate books and records, they failed
to substantiate items properly, and they were in careless, reckless, or in intentional
disregard of rules and regulations applicable to the payment of Federal income tax.
Respondent also meets his burden of production to the extent that any of
petitioners' understatements meets the statutory definition of a "substantial
understatement".
Once the Commissioner has met the burden of production, as he has here,
the taxpayer must come forward with persuasive evidence that the imposition of a
penalty is inappropriate because, for example, the taxpayer acted with reasonable
cause and in good faith. See sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at
448-449. Petitioners made no argument in their posttrial brief that imposition of
the accuracy-related penalties is inappropriate. While petitioners' attorney Mr.
Cooperson prepared petitioners' 2004, 2005, and 2006 Federal income tax returns,
he did this using solely the information provided by petitioners and was never
consulted for any tax advice concerning the source, accuracy, or computations of
the tax information petitioners provided to him. Since accurate and complete
- 63 [*63] information was not provided to the tax return preparer, petitioners, who did
not even review the tax returns, had no right to rely on the prepared tax returns as
being accurate and in accordance with the Code for the years in issue here. See
Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 99. Consequently, we
conclude that imposition of the accuracy-related penalties is not inappropriate and
sustain respondent's determination that an accuracy-related penalty under section
6662(a) applies for each year in issue.
VI. Epilogue
We have considered all arguments that the parties made and have rejected
those arguments not discussed here as without merit.
To reflect the foregoing,
Decision will be entered under
Rule 155.
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