Marason v. Commissioner

T.C. Memo. 1996-7

UNITED STATES TAX COURT

KEITH F. MARASON, Petitioner v. COMMISSIONER
OF INTERNAL REVENUE, Respondent

Docket No. 23471-93. Filed January 16, 1996.

On the facts, Held: respondent's application of
bank deposits method to determine petitioner's gross
income in the absence of books and records approved,
with one modification; held, further, miscellaneous
deductions redetermined; held, further, petitioner
liable for additions to tax under sec. 6651(a)(1),
I.R.C., for 1988, 1989, and 1990; the addition to tax
under sec. 6653(a)(1), I.R.C., for 1988; and the
accuracy-related penalty under sec. 6662(a), I.R.C.,
for 1989 and 1990.

David L. Gibson, for petitioner.

Margaret S. Rigg, for respondent.
 MEMORANDUM FINDINGS OF FACT AND OPINION

NIMS, Judge: Respondent determined income tax deficiencies,

additions to tax, and penalties with respect to petitioner's

taxable years 1988, 1989, and 1990, as follows:

Additions to Tax Penalties
Taxable Income Tax Sec. Sec. Sec. Sec.
Year Deficiency 6651(a)(1) 6653(a)(1) 6661 6662(a)

1988 $5,324 $1,331 $379 $1,331 -0-
1989 17,696 4,424 -0- -0- $3,539
1990 23,701 5,925 -0- -0- 4,740

Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code in effect for the years in

issue. All Rule references are to the Tax Court Rules of

Practice and Procedure.

After concessions, the issues for decision are:

1. Did petitioner have unreported income of $1,5241 in 1988

and $32,086 in 1990?

2. How much is petitioner entitled to deduct as Schedule C

expenses? After substantial concessions by both parties, the

following amounts remain in contention:

Category 1988 1989 1990

Depreciation -0- $(627) $(1,003)
Office expense $697 1,355 1,934
Supplies 524 4,637 -0-

1
This number is derived using the unreported income figures in the
Notice of Deficiency. The numbers from the Stipulation of Facts differ by $3.
 - 3 -

Travel2 3,553 11,493 7,906
Contract labor3 -0- 5,846 3,518
Insurance expense 2074 589 755
Miscellaneous Exp. -0- -0- 484
Self-employment -0- -0- 2,532
tax deduction

Total 4,981 23,293 16,126

3. Is petitioner liable for the addition to tax for late

filing under section 6651(a)(1) for each of the years in issue?

4. Is petitioner liable for the addition to tax for

negligence under section 6653(a)(1) for 1988?

5. Is petitioner liable for the negligence penalty under

section 6662 for 1989 and 1990?

6. Is petitioner liable for the 10-percent addition to tax

under section 72(t) for early distribution from a qualified

retirement plan in 1988.

Petitioner resided in San Francisco, California, when he

filed his petition. Some of the facts have been stipulated and

are incorporated herein by this reference. For convenience we

have divided our findings of fact and opinion into separate

parts, and in most parts, because of the confused record, have

combined our findings of fact and opinion.

2
These figures include travel expenses that petitioner deducted under
contract labor expenses.
3
These figures exclude travel expenses that petitioner deducted under
contract labor expenses.
4
The amount respondent disallowed is $1,120. The parties stipulated a
disallowance of $1,220. Accordingly, since respondent disallowed $1,120 and
petitioner concedes $913, the difference is $207.
 - 4 -

Issue 1. Unreported Income

FINDINGS OF FACT

Petitioner has been a certified public accountant since

1973. In 1987 he left his employment at Coopers and Lybrand and

started his own business, which he maintained during the years at

issue. At the time of trial, petitioner was employed by B.D.O.

Seidman in San Francisco as a senior manager in the audit

department. During the years in issue, petitioner billed clients

on an hourly basis, and periodically he sent invoices to his

clients. He deposited payments into his bank accounts.

Petitioner kept no formal set of books for 1988 or 1990. As

a consequence, respondent determined petitioner's income for

those years using the bank deposits analysis method.

The following is a summary of respondent's bank deposit

analysis for 1988:
 - 5 -

1988

Deposits to:
1. Bank of Guam $20,378
#107202861

2. Pacific Bank 7,500
#1250-401445

3. Wells Fargo Bank 36,982
#0295-235527

Add:
Cash withdrawn
at time of deposits 1,630

Gross Deposits: 66,490

Less:
Transfers (16,610)
Nontaxable items (5,786)

Taxable deposits: 44,094

Less:
Schedule C
gross income (33,673)

Additional income: 10,4245

The "cash withdrawn at time of deposits" line reflects notations

on deposit slips showing amounts of cash returned to petitioner

by the bank tellers after petitioner had made the deposits.

Respondent has conceded $8,900 of the $10,424 additional income

reflected in the 1988 bank deposit analysis. Accordingly, the

amount remaining in dispute for 1988 is $1,524.

5
Respondent's Notice of Deficiency uses this number, although there is
a $3 subtraction error.
 - 6 -

The following is a summary of respondent's bank deposit

analysis for 1990:

1990

Deposits to:
1. Bank of Guam $68,534
#107202861

2. Wells Fargo Bank 43,260
#0025-085119

3. Wells Fargo Bank 82,135
#0295-235527
On October 1, 1990
transferred to
#0025-722398

Add:
Cash withdrawn
at time of deposits 1,250

Gross deposits: 195,179

Less:
Transfers (62,650)
Rounding (13)
Nontaxable items (5,008)

Taxable deposits: 127,508

Less:
Schedule C
gross income (81,687)

Additional income: 45,8236

At trial, respondent conceded $13,737 of the $45,823 additional

income reflected in the 1990 bank deposit analysis. Accordingly,

the amount remaining in dispute for 1990 is $32,086.

6
This number comes from respondent's Notice of Deficiency. There is a
$2 subtraction error.
 - 7 -

Petitioner reported as income only the amounts reported on

Forms 1099 that he received from payors. The gross receipts

that respondent determined for the years at issue compared to the

gross receipts petitioner showed on his returns are as follows:

1988 1990

Wells Fargo #25-8511 $43,261
Wells Fargo #295-23527 $16,216 20,113
Pacific Bank 1250-401445 7,500 -0-
Bank of Guam 107202861 20,378 68,534
Less:
Transfers:
Merrill Lynch 4,400
Gross receipts per exam 44,094 127,508
Gross receipts per return 33,673 81,687
Adjustment 10,421 45,821

In 1988 petitioner had accounts in three banks: Wells Fargo

Bank, Pacific Bank, and Bank of Guam. Respondent's agent

included all of them in his bank deposits analysis.

In 1990 petitioner had three principal bank accounts, two in

Wells Fargo Bank and one in Bank of Guam. Respondent disregarded

four other accounts maintained by petitioner as being

inconsequential. Respondent's agent totaled petitioner's

deposits, added in the cash that petitioner received when making

deposits, and subtracted interaccount transfers and nontaxable

items to determine petitioner's total deposits for 1988 and 1990.

OPINION

The use of the bank deposits method for computing income has

long been sanctioned by the Courts. When a taxpayer keeps no

books or records and has large bank deposits, the Commissioner is
 - 8 -

not arbitrary or capricious in resorting to the bank deposits

method. DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), affd.

959 F.2d 16 (2d Cir. 1992). The fact that the Commissioner was

not completely correct does not invalidate the method employed.

Id. at 868.

In the absence of books and records in this case, respondent

analyzed petitioner's bank records and prepared schedules that

summarized all of the transactions occurring in the accounts

during 1988 and 1990. Respondent identified any deposits which

represented nontaxable income or interaccount transfers, or which

were receipts of income reported on petitioner's tax return.

Consequently, with the exception hereinafter noted, respondent

has properly reconstructed petitioner's gross income under the

bank deposits method. Respondent made substantial concessions in

connection with her bank deposit analysis, both before and during

the trial. We have examined petitioner's remaining objections

and find that all but one have either been taken into account in

respondent's analysis or are unsupported by the record.

Petitioner claims that respondent failed to reduce the

additional income computation for 1990 by $1,500, the amount of

an interbank transfer from petitioner's account at the Bank of

Guam to his account at Wells Fargo Bank. The record shows two

$1,500 checks drawn on the Bank of Guam, and two deposits, each

in the amount of $1,500, into petitioner's Wells Fargo Bank

account, all within the April 1, 1990, to April 6, 1990, time
 - 9 -

frame. We conclude that both of the $1,500 checks reflect

transfers, but respondent has treated only one as a transfer. We

therefore agree with petitioner that 1990 gross income as

determined by respondent, and as reduced by respondent's

concessions noted in our Findings of Fact, should be further

reduced by an additional $1,500.

Issue 2. Miscellaneous Deductions

FINDINGS OF FACT AND OPINION

In 1988 petitioner opened an office located at 100 Pine

Street in downtown San Francisco and continued to rent this

office space during the three years in issue. Respondent allowed

the amount of the rent as a deduction in each year. Petitioner

resided in a studio apartment at 770 California Street, San

Francisco, during these years. His apartment was six blocks from

his office.

a. Office Expense

Although petitioner did not seek to deduct any part of his

apartment rent as a business deduction, he claimed the use of his

apartment as an office and sought to deduct as office expense the

cost of many furnishings for his apartment. The amount claimed

on each return as office expenses, the amounts allowed by

respondent, and the adjustments to petitioner's claimed Schedule

C office expenses are as follows:

1988 1989 1990

Per return $1,881 $9,078 $4,828
 - 10 -

Per exam 1,184 2,246 1,953
Adjustment 697 6,832 2,875

A $697 claimed deduction for 1988, which respondent

disallowed, was for halogen lighting in petitioner's apartment.

The $697 was an unallowable personal expense under section 262.

In 1989, petitioner purchased shelving, file cabinets, and a

drop-leaf desk from Performance Audio for use in his apartment.

These purchases represent personal items that are nondeductible

under section 262.

In the same year, petitioner bought from House of Music and

sought to deduct merchandise costing $5,477.30. Petitioner

concedes this item on brief.

In 1990, petitioner purchased for use in his home two items

from the World of Sound, described on the invoice as "THE

AUDIO/VIDEO SPECIALISTS", costing $565.78 and $2,309,

respectively. In his brief petitioner concedes $941 previously

claimed as office expense for 1990. He has failed to establish

that the items purchased were for business use, and not for

personal use. Respondent's disallowance of these items is

sustained.

b. Supplies

Respondent made the following adjustments to petitioner's

claimed Schedule C "supplies" expenses:
 - 11 -

1988 1989 1990

Per return $4,558 $14,729 $7,028
Per exam 4,034 3,346 3,3317
Adjustment 524 11,3818 3,697

Petitioner offered no testimony or other evidence to

identify, describe, or justify the $524 amount disallowed for

1988. Consequently, respondent's disallowance is sustained.

Unlike 1988 and 1990, petitioner produced some books and

records for 1989. The 1989 supplies adjustment is complicated.

Petitioner had two 1989 accounts, called "office expenses" and

"books and reference materials", respectively. According to his

records, his "office expenses" amounted to $20,838 and his "books

and reference materials" cost $3,889, a total of $24,729.

Petitioner deducted $10,000 of the $24,729 under depreciation as

a section 179 expense and deducted the rest, $14,729, on the

"supplies" line of Schedule C of the 1989 return.

Respondent evaluated petitioner's "office expenses" and

"books and reference materials" separately, and disallowed $7,703

of petitioner's office expenses for 1989, $6,744 of which

petitioner conceded on brief. The conceded amount includes a

computer that cost $6,056 and which was returned on the day it

was purchased, but which petitioner nevertheless claimed as a

7
$3,331 is the amount respondent determined. The parties, however,
mistakenly stipulated $3,697, which we simply disregard.
8
There is a $2 subtraction error in petitioner's favor, which we
accept.
 - 12 -

deduction on his 1989 return. The remaining difference between

the $7,703 disallowed by respondent and the $6,744 conceded by

petitioner consists of miscellaneous items purchased at The

Sharper Image, which petitioner has failed to prove were

deductible business expenses.

After the $7,703 disallowance of the claimed $20,838 claimed

office expenses, respondent allowed $10,000 as first-year expense

under section 179, and required depreciation of the remaining

$3,134 in subsequent years. Petitioner claims that respondent

made a $3,134 math error. He simply does not understand that

respondent capitalized this amount rather than disallowing it

entirely. Respondent's treatment of this amount is sustained.

As to the $3,889 "books and reference materials", which

petitioner sought to deduct as "supplies", respondent disallowed

$543. Of the $543, $429 was for course materials on real estate,

and $113.89 was unexplained. Petitioner testified that the two

real estate courses were used to educate himself because many of

his clients were involved in real estate. We accept petitioner's

testimony on this point and believe there is a sufficient nexus

between petitioner's accounting practice related to real estate

clients and these courses to justify the deduction of their $429

cost. Respondent's disallowance of the remaining $113.89 is

proper due to the lack of any evidence supporting the deduction.

Respondent disallowed petitioner's 1990 claimed deduction of

$3,697 for supplies, which petitioner concedes.
 - 13 -

c. Travel Expense

Findings of Fact and Opinion

In addition to deducting some transportation cost under

travel expenses, petitioner also deducted other transportation

costs under contract labor. To avoid confusion we have combined

with the travel expenses the expenses claimed for contract labor

to the extent that they represent work done to petitioner's

Porsche or other costs of transportation. Respondent disallowed

travel expenses of $3,5539 in 1988 as well as $11,92910 in 1989

and $8,65611 in 1990. Petitioner concedes $436 of claimed travel

expense for 1989, for a $373 Amtrak ticket used by petitioner's

mother when she visited him and for $63 in parking tickets.

Petitioner also concedes $300 for 1990.

Petitioner claimed to own two cars during the years at

issue, a 1982 Porsche and a 1957 Volkswagen (VW). Since his

Porsche was in the shop from late 1988 to sometime in 1990,

petitioner briefly rented a car from Avis, and also rented a BMW

from Joseph Clare. Petitioner claims that he used the Porsche

and the rented cars solely for business but admitted at trial

that he did not keep a mileage log, and testified only summarily

that he used the cars to visit clients. Nevertheless, respondent

9
Petitioner deducted this entire amount under contract labor.
10
Both the Stipulation of Facts and the Notice of Deficiency derive
this number by attempting to subtract $6,095 from $18,027. Thus, there is a
$3 error in petitioner's favor that we accept.
11
Petitioner deducted $3,520 of this amount as contract labor.
 - 14 -

concedes that petitioner used these cars (except the alleged VW)

50 percent for business.

Petitioner insists that for personal trips he used only his

1957 VW, but admitted that the VW had high mileage and was not

"reliable". Neither the revenue agent nor the Court was shown

any reliable evidence the VW even existed. Therefore, in the

absence of any objective evidence regarding petitioner's use of

the Porsche and the rented cars for business, it is reasonable to

infer a substantial degree of personal use of these cars. We

accept respondent's determination of 50-percent business use of

these cars.

Petitioner acquired the Porsche in 1982 for $10,000. In

late 1988 he took the Porsche to Perl's Body Shop for major

repair work, which Perl's failed to perform after completely

dismantling the car. Petitioner retrieved the car, including all

the disassembled parts, in 1990.

Respondent disallowed the following amounts as business

expenses in 1988 for work on the Porsche:

Item Amount

Perl's Body Shop $3,400
Red McClintock 146
Stoddard Imported Cars 7
Total 3,553

As stated, Respondent disallowed the entire amount as a

business expense, but determined that 50 percent could be

depreciated.
 - 15 -

Respondent disallowed the following amounts in 1989:

Item Amount

Parking at 770 California Street $1,950
(petitioner's residence)
50 percent of car rental 1,500
payments to J. Clare
50 percent of Avis Rental 617
Car payments
Parking tickets 63
50 percent DMV renewals 115
and miscellaneous
Amtrak 373
Porsche auto invoices 7,311
Total 11,929

Respondent disallowed the following amounts in 1990:

Item Amount
Rod McClintock $2,600
Ray Johnson 200
Perl's Body Shop 647
S&D Towing 73
50 percent of car rental 450
payments to J. Clare
Non-itemized amounts 4,236
Total 8,206

As to the 1989 and 1990 expenditures related to travel,

respondent either disallowed the entire amount in some cases,

disallowed 50 percent of them in other cases, and required

capitalization of the full amount of the rest. With regard to

those required to be capitalized, respondent allowed depreciation

on 50 percent of the capitalized amounts.

We generally agree with respondent's determination.

Petitioner testified that he received an estimate that convinced

him that merely to paint the car, and return it to the condition
 - 16 -

it was in when first delivered to Perl's, would cost $6,500.

Respondent determined that the 1989 Porsche auto invoices in the

amount of $7,311, and, for 1990, $3,937 of the $5,107 claimed

expenses, should be capitalized.

In our judgment, the expenditures represent amounts expended

in restoring property which are required to be capitalized under

section 263(a)(2). The regulations explain that amounts that are

paid or incurred to add to the value of property or to

substantially prolong its useful life may not be deducted, but

must be treated as a capital expenditure. They are to be

distinguished from amounts paid or incurred for incidental

repairs and maintenance of property. Sec. 1.263(a)-1(a) and (b),

Income Tax Regs.; cf. sec. 1.162-4, Income Tax Regs. In Clark v.

Commissioner, T.C. Memo. 1969-241, we held that the cost of

reconditioning a nine-year-old pickup truck added to the value of

the pickup and appreciably prolonged its life; the cost was

therefore required to be capitalized. The same rationale applies

here.

For 1989, respondent disallowed the entire $1,950

expenditure for parking. We agree with the disallowance, since

petitioner failed to show that any part of the cost of parking

was not a nondeductible commuting expense. See Walker v.

Commissioner, 101 T.C. 537, 545 (1993); secs. 1.262-1(b)(5),

1.162-2(e), Income Tax Regs.
 - 17 -

For the above reasons, we agree with respondent's

determination regarding the remaining 1989 and 1990 travel

expense items.

d. Contract Labor

Findings of Fact and Opinion

Petitioner claimed deductions for "contract labor", that is,

for secretarial help and other assistance, for each of the three

years at issue. The amounts petitioner claimed, the amounts

respondent allowed, and the amounts respondent adjusted are as

follows:

1988 1989 1990
Per return12 $-0- $17,921 $20,992
Per exam -0- 10,720 17,474
Adjustment -0- 7,201 3,518

Respondent states on brief that petitioner was allowed a

deduction for those people for whom petitioner filed Forms 1099.

The $7,201 adjustment for 1989 consists of the following:

Payee Amount
Joseph Clare $1,355
Gina Cagampan 3,110
Shelly Jue 1,059
Patrick Marason 800
Miscellaneous 877
Total 7,201

The 1990 adjustment consists of the following:

Payee Amount
Marilyn Yee $420
Patrick Marason 508

12
We have reduced these numbers by the amount of the contract labor
expenses dealt with under travel expenses.
 - 18 -

Huda Mustapha 396
Shelly Jue 2,100
Unidentified 94
Total 3,518

For 1989 respondent concedes the $1,355 payment to Joseph

Clare, and we deem petitioner to have conceded the $877

miscellaneous amount, which he failed to discuss in either of his

briefs. After concessions only the payments to Shelly Jue, Gina

Cagampan, and Patrick Marason remain in dispute for 1989.

Shelly Jue was petitioner's apartment mate. Petitioner does

not discuss what business services she is alleged to have

rendered. Patrick Marason was petitioner's brother. Petitioner

testified that Patrick has an accounting degree and that he

assisted petitioner with his client files and office work,

including maintenance of a mailing list. Neither Cagampan, Jue,

nor Patrick Marason was called to testify, nor did petitioner

furnish them with Forms 1099. Without objective evidence we are

unable to accept petitioner's uncorroborated testimony that they

performed services for his business in either 1989 or 1990.

Gina Cagampan, however, had worked with petitioner at the

same firm before he left it to join Coopers & Lybrand. She had

worked as a secretary then, and it is reasonable to infer that

their relationship remained work related. Respondent does not

dispute that petitioner paid Cagampan $3,110 in 1989. A

deduction for that amount will therefore be allowed.
 - 19 -

Petitioner failed to produce any evidence regarding the 1990

payments of $420 to Marilyn Yee and $396 to Huda Mustapha, nor

does he explain the unidentified $94. These amounts are

therefore disallowed.

e. Insurance

Findings of Fact and Opinion

Respondent adjusted petitioner's deductions for insurance

for the three years in issue, allowing deductions for health

insurance but disallowing life and disability insurance

deductions and 50 percent of car insurance deductions.

Petitioner states on brief that $755 representing car insurance

remains in dispute, but does not explain how he arrives at that

amount. Petitioner testified that he had additional expenses for

payments to California State Automobile Association (CSAA), but

did not show that those amounts were in addition to the amounts

respondent allowed for insurance. We therefore accept

respondent's determination as to the disallowed insurance

expense.

f. Miscellaneous

Petitioner claimed a "Miscellaneous" deduction of $713 on

his 1990 return, but does not explain the deduction. It is

therefore disallowed.
 - 20 -

g. Self-employment Tax Deduction

The amount of the allowable deduction for one-half of the

self-employment tax imposed by section 1401 will be recomputed

under Rule 155.

Issue 3. Additions to Tax and Penalties

Respondent determined additions to tax for late filing for

all years in issue. Petitioner claimed that he was delayed in

filing his returns because he moved his papers to different

locations several times. The record does not support this

assertion. Petitioner is therefore liable for the additions to

tax for late filing as determined by respondent.

Respondent determined an addition to tax for negligence

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

for negligence under section 6662(a) for 1989 and 1990.

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

is applicable if all or part of an underpayment of tax is due to

negligence or intentional disregard of rules or regulations. The

accuracy-related penalty under section 6662(a) is applicable if

all or part of an underpayment of tax is attributable, among

other things, to negligence or disregard of rules or regulations.

We need not extend this opinion by rehashing the many

instances in each of the years in issue in which petitioner
 - 21 -

understated his gross income or blatantly claimed deductions that

he knew or should have known were for personal expenses and

therefore unallowable. Petitioner has the burden of proof on the

additions to tax and penalty issues, which he has failed to

carry. Bixby v. Commissioner, 58 T.C. 757 (1972); see

Grzegorzewski v. Commissioner, T.C. Memo. 1995-49. Respondent's

determinations are therefore sustained.

Respondent has conceded the substantial understatement

penalty under section 6661 for 1988.

Respondent determined a 10-percent penalty under section

72(t) in the amount of $60 for a premature distribution made in

1988 from petitioner's Keogh account, a qualified retirement

plan. Petitioner does not address this issue in either of his

briefs, and it is therefore deemed conceded.

To reflect the above,

Decision will be entered

under Rule 155.