Montoro v. Commissioner

T.C. Memo. 1997-281

UNITED STATES TAX COURT

JOAO MONTORO AND NEUZA PAULA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 6182-95. Filed June 23, 1997.

Charles L. Steel IV, for petitioners.

Jeanne Gramling, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COLVIN, Judge: Respondent determined deficiencies in

petitioners' Federal income tax and additions to tax as follows:

Additions to Tax Penalty
Sec. Sec. Sec.
1
Year Deficiency 6653(a) 6661 6662
1987 $5,592 $280 $1,398 --
1988 4,604 230 -- --
1990 33,961 -- -- $5,007
1991 96,366 -- -- 17,108
1
Respondent determined that petitioners are liable for an addition to tax for
negligence under sec. 6653(a)(1)(A) for 1987, 50 percent of the interest due on the
underpayment attributable to negligence under sec. 6653(a)(1)(B) for 1987, and an
addition to tax for negligence under sec. 6653(a)(1) for 1988.
 2

After concessions,1 the issues for decision are:

(1) Whether petitioners' taxable income from International

Best Buys was $23,574 in 1990 and $147,426 in 1991, as

petitioners contend; $131,508 in 1990 and $396,905 in 1991, as

respondent contends; or some other amount. We hold that

petitioners' income from International Best Buys was $64,910 in

1990 and $201,992 in 1991.

(2) Whether petitioners may carry back net operating losses

of $15,976 to 1987 and $15,491 to 1988. We hold that they may

not.

(3) Whether petitioners are liable for (a) additions to tax

for negligence under section 6653 for 1987 and 1988 and

substantial understatement of income tax under section 6661 for

1987; and (b) the accuracy-related penalty under section 6662(a)

for 1990 and 1991. We hold that they are.

1
Petitioners concede that they failed to report the
following income:
1990 1991
IBM tax payments for Mr. Paula $44,069 $51,271
IBM severance payment to Mr. Paula -- 36,808
Wages paid to Mrs. Paula by A&P 1,609 --
Interest 2,542 943

Respondent concedes that petitioners are entitled to a
foreign tax credit of $7,510.83 for 1991 relating to the IBM
severance payment to Mr. Paula. Respondent also concedes that
petitioners may deduct a $141 penalty they paid in 1990 as the
result of a premature withdrawal of funds from a certificate of
deposit.
The Court expects the parties to compute petitioners' self-
employment tax liability and personal exemption phase-out (if
applicable) under Rule 155.
 3

(4) Whether certain exhibits offered by respondent to

impeach the testimony of petitioner-husband are admissible. We

hold that they are not.

References to petitioner-husband are to Joao Montoro Paula.

References to petitioner-wife are to Nueza Paula. Section

references are to the Internal Revenue Code in effect for the

years in issue. Unless otherwise indicated, rule references are

to the Tax Court Rules of Practice and Procedure, and references

to income tax returns are to United States (Federal) income tax

returns.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

A. Petitioners

Petitioners lived in Raleigh, North Carolina, when they

filed the petition in this case. Petitioner-husband was born and

raised in Brazil. He graduated from college there and has

degrees in chemical engineering and business administration.

Sometime before 1972, petitioner-husband worked for Ford Motor

Co. in Brazil for 6 years and was promoted to a management

position.

Petitioners have three sons: Luiz, born in 1970; Ricardo,

born in 1972; and Leandro, born in 1975.

Petitioners have had an apartment in Brazil from 1984 until

the time of trial. Petitioners were resident aliens of the

United States during the years in issue.
 4

B. 1986 Revaluation of Brazilian Currency

On February 28, 1986, Brazil significantly revalued the

cruzeiro (Cr$). Beginning February 28, 1986, the Brazilian

currency was the cruzado (Cz$). One cruzado equals 1,000

cruzeiros.2 "Brazilian Cruzeiro/Cruzado," 1986-1987 World

Currency Yearbook, 242-249 (Philip P. Cowitt, ed. 1989). The

exchange rate was Cr$ 13,020 per U.S. dollar in February 1986 and

Cr$ 13.84 per U.S. dollar in March 1986.

C. Petitioner-Husband's IBM Employment

In 1972, petitioner-husband began to work for IBM-Brazil in

Campinas, Sao Paulo, Brazil. He worked for IBM for 18 years in

Brazil and the United States. In 1987, he began to work for IBM

in Raleigh, North Carolina. In late 1989 or early 1990, he

returned briefly to Brazil to work for IBM-Brazil. He soon took

a leave of absence from IBM and returned to the United States.

IBM wanted petitioner-husband to work in Brazil. He

resigned from IBM in January 1991 because his family wanted to

stay in the United States.

D. Petitioners' Assets in Brazil in 1986

2
The average official exchange rate was $1 to Cr$ 1841.50
for 1984, and $1 to Cr$ 6205.10 for 1985. Federal Reserve
Bulletin, International Statistics (Sept. 1986; Mar. 1987),
Foreign Exchange Rates. On Feb. 28, 1986, the official exchange
rate of cruzados to U.S. dollars was $1 to Cz$ 13.84. See
Norwest Corp. v. Commissioner, 108 T.C. __ n. 19 (Apr. 30, 1997).
The parties stipulated that the exchange rates for 1986 were as
listed in the Federal Reserve Bulletin: Jan. Cr$ 11345.26; Feb.
Cr$ 13020.00; Mar.-Sept. Cr$ 13.84 (after the currency reform);
Oct. Cr$ 13.98; Nov. Cr$ 14.10; and Dec. Cr$ 14.54.
 5

1. Real Property

In 1985, petitioners built a home at 909 Rua Madre Maria

Santa Margarida in Campinas, Sao Paulo. They owned the home in

1986. They also owned vacant land at Rua Jose Jorge Farah in

Campinas, a house at 108 Rua Luiz Gama in Sorocaba, and an

apartment in Mongagua. In 1986, petitioners began to build a

house on the Rua Jose Jorge Farah lot.

2. Personal Property (Telephone and Automobiles)

In 1986, petitioners owned the telephone line for the house

on Rua Madre Maria Santa Margarida. In Brazil, an individual may

buy a telephone line. Once purchased, the owner may resell it.

They also owned two automobiles, a Ford Corcel and a Volkswagen

Santana.

3. Petitioner-Husband's Inheritances

Petitioner-husband inherited Cr$ 415,200 ($30,000)3 in March

1986 from his father. In September 1986, petitioner-husband

inherited Cr$ 1,660,800 ($120,000) from his father.

4. Sale of Petitioners' Assets in Brazil in 1986

In 1986, petitioners sold all of their Brazilian assets,

except their apartment in Mongagua. Petitioners sold the

unfinished house at Rua Jose Jorge Farah to petitioner-husband's

3
U.S. dollar amounts following cruzeiro or cruzado amounts
are the contemporaneous equivalents.
 6

brother. Petitioner-husband reported the sale of these assets on

the Brazilian income tax return he filed for 1986.4 In signing

the 1986 Brazilian return, petitioner-husband attested to its

truth. Petitioners reported that, at the end of 1986, their

Brazilian assets (consisting primarily of cash) totaled Cr$

5,173,690 ($355,825). Petitioners kept the cash from the sale of

these assets in a safe in Brazil.

E. Petitioners' Trips to and Movement of Cash From Brazil

In 1990, petitioner-husband traveled to Brazil four times.

He returned to the United States from the first trip on March 16.

Petitioners' son, Leandro, played soccer for the Raleigh Flyers.

In the summer of 1990, petitioner-husband took the team to

Brazil. He returned to the United States on July 5 or 6, 1990.

He returned from his next trips on September 19 and November 16.

He brought cash from their safe on each of these trips.

Petitioners used this money to pay their rent and other living

expenses, their son's college tuition, and to provide funds for

petitioner-husband's business, International Best Buys (discussed

at par. F below).

4
Brazilian law did not require petitioner-wife to sign the
Brazilian tax return.
 7

In 1990, petitioners deposited $136,408 in nine bank

accounts (eight in the United States and one in Brazil). Of that

amount, the following is nontaxable:

Date Check/currency Amount deposited Source of funds

4/12 travelers checks $1,790 Mar. Brazil trip
4/24 Cr$ 1,679,225.87 30,531 Brazilian account
7/9 unknown 7,300 July Brazil trip
7/11 currency 3,200 July Brazil trip
8/22 travelers checks 4,000 July Brazil trip
9/25 currency 1,007 Sept. Brazil trip
9/25 currency 1,436 Sept. Brazil trip
11/20 currency/trav. check 2,088 Nov. Brazil trip
11/20 currency 6,596 Nov. Brazil trip
12/3 currency5 6,400 Transfer
12/3 check 2,250 Cashed check for friend
Total $66,598

In 1991, petitioner-husband brought cash from their safe

after each of several trips to Brazil. Petitioner-husband

sometimes kept the cash he brought from Brazil in a safe in his

Raleigh office before he deposited it in petitioners' non-

interest bearing checking accounts. Petitioners deposited

$396,905 in eight (seven U.S. and one Brazilian) bank accounts.

Of the $396,905, petitioners deposited Cr$ 14,651,647.28

($48,009) in the Bank of Itau in Brazil from their personal

assets, and they made nontaxable deposits to U.S. bank accounts

as follows:

5
This deposit was a transfer from account 157460395.
 8

Date Check/currency Amount deposited Source

1/21 currency $ 4,650 Jan. Brazil trip
1/22 currency 1,120 Jan. Brazil trip
1/23 currency 200 Jan. Brazil trip
2/1 currency 6,680 Jan. Brazil trip
4/4 currency 9,500 Apr. Brazil trip
4/4 currency 9,500 Apr. Brazil trip
4/4 currency 9,500 Apr. Brazil trip
4/5 currency 7,000 Apr. Brazil trip
4/23 check 640 PanAm refund
5/3 check 8,000 exchanged money
6/4 currency 2,900 June Brazil trip
6/21 currency 500 June Brazil trip
7/18 check 45 manufacturer's rebate
7/26 travelers checks 4,000 July Brazil trip
11/22 currency 3,000 Nov. Brazil trip
12/26 currency 4,800 Dec. Brazil trip
Total $72,035

On some of his trips to Brazil in 1991, petitioner-husband

took money from the safe and gave it to his secretary. He

instructed her to use the money to pay expenses, such as Social

Security, and to wire him the balance. Petitioners deposited the

following funds from wire transfers (from nontaxable sources) in

their U.S. accounts in 1991:

Date Amount deposited Source

4/4 $20,000 personal assets in Brazil
5/29 15,900 Money returned to manufacturer for
jewelry consignment
7/24 5,500 personal assets in Brazil
9/30 8,469 personal assets in Brazil
10/9 10,000 personal assets in Brazil
10/17 15,000 personal assets in Brazil
Total $74,869

F. International Best Buys

In February 1987, petitioner-husband started an import

business in Raleigh called International Best Buys
 9

(International) in partnership with Mrs. Joyner (Joyner). Joyner

was petitioner-husband's English teacher in the United States.

Petitioner-husband and Joyner formed International to sell

costume jewelry that they imported from Brazil. Petitioners did

not attach a Schedule C (Profit or Loss From Business (Sole

Proprietorship)) for International to their 1987 and 1988

returns.

In 1989, Joyner transferred her interest in International to

petitioner-wife. The record does not show how much petitioners

invested in the partnership or how much they paid Joyner for her

interest. In 1989, petitioner-husband bought silver jewelry for

International to sell in the United States. He attended trade

shows in San Antonio and other places to try to sell merchandise.

Petitioner-husband began to work full-time for International

in 1990. International's sales of jewelry were poor, and the

company lost money in 1990 and 1991. In 1990 and 1991,

International was a sole proprietorship. Petitioners attached a

Schedule C for International to their 1990 and 1991 returns.

International began to export electronic components to

Brazil in 1990. Petitioner-husband continued to export

electronic components to Brazil in 1991 and stopped importing

jewelry from Brazil. His export sales grew in 1991 and 1992.

International had gross receipts of $64,910 in 1990, $201,992 in

1991, about $400,000 in 1992, and about $1.3 million in 1993.
 10

G. Petitioners' U.S. Tax Returns

1. Petitioners' Tax Return Preparer

Michael Perkins (Perkins), a certified public accountant in

Raleigh, prepared petitioners' tax returns for tax years 1989 to

1993. Perkins and petitioner-husband have been friends for more

than 10 years. Their sons played soccer together. Perkins and

his son accompanied petitioner-husband on the soccer team's trip

to Brazil in 1990.

Perkins reviewed some receipts for earlier years to ensure

that petitioner-husband complied with U.S. tax requirements for

deducting business and travel expenses, but he primarily relied

on the worksheets furnished by petitioner-husband. At trial,

Perkins did not remember whether he saw sales receipts, invoices,

journals, or ledgers for International for the years in issue.

2. Petitioner-Wife's Import Business

Petitioner-wife's import sales business had gross receipts

of $4,900 in 1990. Petitioners included that amount in the gross

receipts reported on petitioner-husband's Schedule C for

International for 1990. Petitioners did not file a separate

Schedule C for petitioner-wife's import sales business with their

original 1990 return. Petitioners reallocated $4,900 from

petitioner-husband's International business to petitioner-wife's

Schedule C attached to their amended return for 1990.

Petitioner-wife had costs of goods sold and expenses totaling
 11

$3,752 from her import sales business in 1990, as petitioners

reported on their amended return for 1990.

3. International

Petitioners reported that International had gross receipts

of $23,574 in 1990 and $147,426 in 1991, cost of goods sold and

expenses of $39,550 in 1990 and $162,917 in 1991, and losses of

$15,976 in 1990 and $15,491 in 1991.

Petitioner-husband deducted Schedule C expenses for

International of $22,963 in 1990 and $30,234 in 1991. The

parties agree that petitioners' taxable income should be

decreased by $1,119 in 1990 and increased by $4,670 in 1991

because of changes to International's Schedule C expenses for

those years.

4. Net Operating Loss Carrybacks

Petitioners reported net operating losses of $15,976 on

their original return ($14,448 on the amended return) for 1990

and $15,491 on their return for 1991. Petitioners elected to

carry the net operating losses back to 1987 and 1988 by filing

Forms 1045. Petitioners' net operating losses equaled the

Schedule C losses from International in 1990 and 1991.

H. Respondent's Examination

Revenue Agent Margaret Davis (Davis) began to examine

petitioners' returns for 1990 and 1991 late in 1992. Davis asked

petitioners for the books and records of International, including
 12

receipts and disbursements journals, the general ledger, work

papers, adjusting journal entries, canceled checks, bank

statements, and deposit slips for all accounts for 1990.

Petitioners gave her some of the bank statements, but did not

give her International's books and records. In November 1992,

Davis asked petitioners for their canceled checks from December

1, 1989, to January 31, 1991. Petitioner-husband told her that

he had destroyed them.

On November 4, 1992, Davis asked petitioner-husband how much

cash on hand he had. Davis did not specify whether "cash on

hand" included cash petitioners may still have had in Brazil.

Petitioner-husband did not understand it to include cash

petitioners had in Brazil. Petitioner-husband told Davis that he

had less than $500 in cash on hand at the beginning and end of

1990.

Petitioner-husband told Davis that he brought no more than

$8,000 each time he returned from Brazil, two or three times a

year.

On November 19, 1992, petitioner-husband told Davis that he

had kept money in a safe in a house in Brazil until he sold the

house in 1990. After he sold the house, he kept the safe

elsewhere in Brazil. Petitioner-husband initially told Davis

that he did not know whether he had more or less than $10,000 in
 13

the safe, and that the money in the safe came from savings from

his years of working for IBM and inheritances from his father.

On March 29, 1994, petitioner-husband gave Davis a revised

estimate of the amount of his cash which included the proceeds

from the sale of petitioners' assets in Brazil.

Davis did a bank deposits analysis to estimate petitioners'

income for 1990 and 1991. She examined petitioners' bank

accounts. She sought to exclude from her analysis sources of

income which she thought were nontaxable, including transfers

between accounts, expense reimbursements, and offsetting wire

transfers. She apparently did not believe that petitioners had a

significant amount of money in Brazil as of December 31, 1989.

Petitioners deposited $136,408 in nine bank accounts in

1990. They reported that they had received $23,574 of that

amount as Schedule C gross receipts on their 1990 return.

Respondent subtracted $23,574 and gross receipts of $4,900

allocated to petitioner-wife, and determined that petitioners had

understated their taxable income for 1990 by $107,934.

Petitioners deposited $396,905 in eight bank accounts in

1991, $147,426 of which they reported on their 1991 return as

Schedule C gross receipts. Respondent determined that

petitioners had understated their taxable income for 1991 by

$249,479 ($396,905 - $147,426).
 14

OPINION

A. Admissibility of Exhibits AG and AH

Three days before the trial in this case, respondent's

counsel found in the files for this case a currency transaction

report (Exhibit AG) and a criminal referral report prepared by

the NCNB National Bank of North Carolina (Exhibit AH) and sent to

the Office of the Comptroller of the Currency. Respondent's

counsel had seen these documents before, but had not thought that

they were significant. On the day before the trial, respondent's

counsel called petitioners' counsel and told him that respondent

might call Rose Wiseman (Wiseman), an administrative assistant at

NationsBank in Raleigh, as a rebuttal witness. Respondent had

not listed Wiseman as a witness. Respondent's counsel gave him

Wiseman's name and telephone number, but did not give him a copy

of Exhibits AG and AH. Petitioners' counsel did not contact

Wiseman.

At trial, petitioner-husband testified that he made three

cash deposits totaling $28,500 on April 4, 1991, but that he did

not remember the denominations of the currency he deposited.

Respondent called Wiseman to impeach his testimony. During

Wiseman's testimony, respondent offered Exhibits AG and AH into

evidence. Exhibit AG reports that John M. Paula made a $28,500

cash deposit on April 4, 1991, and that the deposit was made to

three accounts and consisted of $28,500 in $100 bills and larger.
 15

Exhibit AH is a form Wiseman prepared and sent to the Comptroller

of the Currency entitled "Criminal Referral Report". Wiseman

prepared Exhibit AH based on information she received from the

teller who handled the deposits. The report states:

Mr. Paula came into the Towne North Branch of NCNB
National Bank and made deposits totaling $28,500, in
new, crisp $100 bills. The deposits were made into
three separate accounts. The teller became suspicious
because of the large dollar amount and the new bills.

At trial, petitioners objected to the introduction into

evidence of Exhibits AG and AH because respondent did not

exchange them with petitioners before offering them into

evidence.

Five months before this case was calendared for trial, the

Court's standing pretrial order was served on the parties. It

stated in part:

Any documents or materials which a party expects to
utilize in the event of trial (except for impeachment),
but which are not stipulated, shall be identified in
writing and exchanged by the parties at least 15 days
before the first day of the trial session.

Materials not provided in compliance with our pretrial

orders may be excluded from evidence. Rules 104(c)(2), 132(b);

Moretti v. Commissioner, 77 F.3d 637, 644 (2d Cir. 1996).

Respondent contends that Exhibits AG and AH impeach the

testimony of petitioner-husband and, thus, need not be exchanged

15 days ahead of the first day of the trial session. We

disagree. Respondent offered the currency transaction report
 16

into evidence to show that petitioner-husband had made three cash

deposits of $9,500 each on April 4, 1991, to three bank accounts.

However, Exhibit AG does not differ substantially from his

testimony. The bank's criminal referral report said that

petitioner-husband deposited $28,500 in "new, crisp $100 bills"

in three bank accounts. Respondent contends that this impeaches

petitioner-husband's testimony that the money he deposited was

from cash he had in his safe in Brazil since 1989. We disagree.

The fact that the $100 bills were new and crisp in 1991 does not

establish that the bills were issued after 1986; they may simply

have been uncirculated. Thus, Exhibit AH does not impeach

petitioner-husband's testimony that the cash he deposited was

from his safe in Brazil.

Respondent contends that petitioner-husband's lack of memory

about the nature of the April 4, 1991, deposits is analogous to a

denial. Respondent relies on United States v. DiCaro, 772 F.2d

1314, 1321-1322 (7th Cir. 1985); United States v. Rogers, 549

F.2d 490, 496 (8th Cir. 1976). Respondent's reliance on those

cases is misplaced. In United States v. DiCaro, supra at 1321-

1322, a witness had testified to certain facts before a grand

jury but claimed to have forgotten those facts by the time of

trial. See, e.g., United States v. Murphy, 696 F.2d 282, 284

(4th Cir. 1982) (witness' lack of memory impeached by his prior

grand jury testimony); United States v. Rogers, 549 F.2d 490,
 17

495-496 (8th Cir. 1976) (witness' lack of memory impeached by

prior written statement given to FBI agent). That is not the

case here. Petitioner-husband did not previously state or

testify that he deposited new $100 bills; his lack of specific

memory is believable under the circumstances, unlike the cases

respondent cites. Thus, the documents do not impeach petitioner-

husband's lack of memory.

Respondent contends that the documents are admissible under

rule 801(d)(2)(A) of the Federal Rules of Evidence as admissions

by a party. We disagree. Since respondent did not exchange the

documents with petitioners in compliance with the standing

pretrial order, they are admissible only to impeach testimony, by

agreement of the parties, or for good cause shown. Respondent

has not shown good cause for not complying with the pretrial

order. Respondent knew 2 years before trial that petitioners

contended that the money they deposited was from their Brazilian

funds and should have exchanged Exhibits AG and AH with

petitioners as part of the stipulation process. Respondent's

failure to exchange the documents led to the type of surprise

that the pretrial order and Rule 91 were designed to prevent.

Barkley Co. v. Commissioner, 89 T.C. 66, 70 (1987); see Branerton

Corp. v. Commissioner, 61 T.C. 691 (1974). We conclude that

Exhibits AG and AH are not admissible.
 18

B. Deficiency

1. Respondent's Use of the Bank Deposits Method

We must decide whether, as respondent contends, petitioners had

unreported income in the amounts of $107,934 in 1990 and $249,479 in

1991. Respondent reconstructed petitioners' income using the bank

deposits method. Petitioners agree that they deposited $136,408 in

their bank accounts in 1990 and $396,905 in 1991.

If a taxpayer does not maintain adequate books and records,

respondent may reconstruct a taxpayer's income by any reasonable

method which clearly reflects income, sec. 446(b); Holland v.

United States, 348 U.S. 121, 130-132 (1954), including the bank

deposits method. Parks v. Commissioner, 94 T.C. 654, 658 (1990);

Estate of Mason v. Commissioner, 64 T.C. 651, 656 (1975), affd.

566 F.2d 2 (6th Cir. 1977). Bank deposits are prima facie

evidence of income. Tokarski v. Commissioner, 87 T.C. 74, 77

(1986); Estate of Mason v. Commissioner, supra at 656-657. Where

the taxpayer suggests a nontaxable source, the Commissioner must

either connect the bank deposits to a likely source of taxable

income or negate the nontaxable source alleged by the taxpayer.

Kramer v. Commissioner, 389 F.2d 236, 239 (7th Cir. 1968), affg.

T.C. Memo. 1966-234.

Respondent's determination is presumed to be correct, and

petitioners bear the burden of proving otherwise. Rule 142(a);

Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioners bear

the burden of proving that unexplained deposits are not taxable
 19

to them. DiLeo v. Commissioner, 96 T.C. 858, 869 (1991), affd.

on other grounds 959 F.2d 16 (2d Cir. 1992); Parks v.

Commissioner, supra at 658.

2. Whether Petitioner-Husband's Testimony Was Generally
Credible

Petitioners contend that they had the money for the bank

deposits in Brazil before 1990 and brought it to the United

States in 1990 and 1991. Respondent contends that petitioner-

husband's testimony regarding their Brazilian funds is self-

serving and lacks credibility.

We decide whether a witness is credible based on objective

facts, the reasonableness of the testimony, the consistency of

statements made by the witness, and the demeanor of the witness.

Quock Ting v. United States, 140 U.S. 417, 420-421 (1891); Wood

v. Commissioner, 338 F.2d 602, 605 (9th Cir. 1964), affg. 41 T.C.

593 (1964); Pinder v. United States, 330 F.2d 119, 124-125 (5th

Cir. 1964); Concord Consumers Housing Coop. v. Commissioner, 89

T.C. 105, 124 n.21 (1987). We may discount testimony which we

find to be unworthy of belief, but we may not arbitrarily

disregard testimony that is competent, relevant, and

uncontradicted, Conti v. Commissioner, 39 F.3d 658, 664 (6th Cir.

1994), affg. 99 T.C. 370 (1992), and T.C. Memo. 1992-616;

Demkowicz v. Commissioner, 551 F.2d 929, 931-932 (3d Cir. 1977),

revg. T.C. Memo. 1975-278; Banks v. Commissioner, 322 F.2d 530,

537 (8th Cir. 1963), affg. in part and remanding in part T.C.

Memo. 1961-237; Loesch & Green Constr. Co. v. Commissioner, 211
 20

F.2d 210, 212 (6th Cir. 1954), revg. and remanding a Memorandum

Opinion of this Court. Petitioner-husband's testimony was

plausible and, we believe, generally truthful.

3. Whether Respondent Investigated Leads

Petitioners argue that respondent did not investigate

relevant leads to their nontaxable sources of deposits. We

disagree. Petitioners first told Davis that they had a

substantial cash hoard in Brazil in March 1994. Respondent could

not independently verify how much money they had in Brazil.

Respondent determined that International was a likely source of

petitioners' deposits. Petitioners did not give respondent

International's books and records so respondent could not verify

the extent to which International was a likely source of income.

4. Whether Respondent Subtracted Nontaxable Sources of
Deposits in Reconstructing Petitioners' Income

Respondent contends that respondent properly reconstructed

petitioners' income for 1990 and 1991 using the bank deposits

method by subtracting from petitioners' income nontaxable sources

of deposits including transfers between bank accounts, expense

reimbursements, and offsetting wire transfers. As discussed

below, we conclude that respondent did not subtract all

nontaxable sources of deposits to petitioners' U.S. bank

accounts.

Respondent contends that petitioners have not proven that

their bank deposits in 1990 and 1991 were from cash that they had

at the end of 1989. Respondent contends that petitioners kept
 21

poor records, did not show how much cash they had on December 31,

1989, and gave inconsistent estimates of their cash on hand on

that date. Respondent points out that petitioner-husband

initially told Davis that he had less than $500 in cash at the

beginning and end of 1990. We believe that petitioner-husband's

answer was consistent because he did not think Davis intended

cash on hand to include money he had in Brazil.

Petitioner-husband initially told Davis that he brought no

more than $8,000 from Brazil two or three times a year. However,

he made that statement to Davis before he told her about the

significant amount of funds petitioners had in Brazil at the end

of 1989. We are convinced that petitioner-husband brought more

than $8,000 twice a year in 1990 and 1991.

As discussed above, we believe much of petitioner-husband's

testimony about petitioners' cash on hand in 1990.

5. Values Stated on Petitioners' Brazilian Tax Returns

Petitioners contend that their 1986 Brazilian tax return

shows that they had $534,160 (in U.S. dollars) in cash on

December 31, 1986. We disagree. Petitioners reported on their

1986 Brazilian return that they had Cr$ 4,753,690 ($326,939) in

cash and the apartment in Mongagua worth Cr$ 420,000 ($28,886),

for a total of $355,825.

Petitioner-husband testified that petitioners had $328,975

in cash and $209,244 for the "difference of the sales" in

December 1986, which they contend is supported by deeds showing
 22

the purchase and sale of petitioners' real property in Brazil.

Petitioner-husband did not define the phrase the "difference of

the sales". As discussed below, we find that petitioners had

$326,939 in cash in December 1989.

Petitioner-husband testified that he sold the Rua Jose Jorge

Farah property for $150,000 and the house at Rua Madre Maria

Santa Margarida for $140,000. Respondent points out that these

amounts are inconsistent with the amounts petitioners reported on

their 1986 Brazilian return. We agree. Petitioner-husband

reported that he sold the Rua Jose Jorge Farah property for Cr$

1,660,000 ($119,942) and the Rua Madre Maria Santa Margarida

house for Cr$ 1,972,600 ($135,667) on petitioners' 1986 Brazilian

return.

Statements in a U.S. Federal tax return are admissions under

Rule 801(d)(2) of the Federal Rules of Evidence and will not be

overcome without cogent evidence that they are wrong. Waring v.

Commissioner, 412 F.2d 800, 801 (3d Cir. 1969), affg. per curiam

T.C. Memo. 1968-126; Estate of Hall v. Commissioner, 92 T.C. 312,

337-338 (1989); Lare v. Commissioner, 62 T.C. 739, 750 (1974),

affd. without published opinion 521 F.2d 1399 (3d Cir. 1975). In

signing the Brazilian return, petitioner-husband attested to its

truth. We believe it is appropriate to apply this doctrine to

petitioners' Brazilian returns. Thus, we find that petitioners

sold the Rua Jose Jorge Farah property for $119,942 and the Rua
 23

Madre Maria Santa Margarida house for $135,667 as reported on

their 1986 Brazilian return.

6. Petitioners' Deposits from Nontaxable Sources

a. Petitioners' Contentions

Petitioners contend that petitioner-husband brought $8,000

back from a trip to Brazil on July 17, 1991, and deposited it 2

days later. We disagree. The July 19, 1991, deposit was made by

wire transfer. We have not included this amount as a nontaxable

source of funds.

Petitioners contend that petitioner-husband made a $20,000

deposit to one of his joint accounts with Mr. Simoes on September

25, 1990, from nontaxable funds. We disagree. Petitioner-

husband told Davis that Mr. Simoes gave him $20,000 to buy parts

or to pay Underwriters' Laboratories. In contrast, petitioner-

husband testified that Mr. Simoes gave him the money to buy

samples, that Mr. Simoes lent him the $20,000, and that the money

was to pay Mr. Simoes' expenses while he was in the United

States. Petitioner-husband's explanations are inconsistent, and

we have not included this amount in petitioners' nontaxable

sources of funds.

Petitioners contend that a $29,307 wire transfer from the

Cayman Islands to one of their accounts in August 1991 was money

Mr. Arnaldo was holding for petitioner-husband in Brazil. We

disagree because Mr. Arnaldo's name is not on the record of the
 24

wire transfer. We have not included this amount in petitioners'

nontaxable sources of funds.

b. Respondent's Contentions

Respondent contends that the inheritance check petitioner-

husband received from his father was worth about $120, using the

August 1986 exchange rate of Cz$ 13.84. We disagree.

Respondent's contention about the value of petitioner-husband's

inheritance is contrary to the stipulated exchange rates for

dollars and cruzeiros in August 1986.

Respondent points out that petitioner-husband told Davis

that there were no records of the inheritance check he received

from his father, but at trial he offered into evidence a copy of

the check for Cr$ 1,660,800 ($120,000). We admitted the check

because petitioner-husband had given respondent the number of the

check about a month before trial.

Respondent points out that petitioner-husband told Davis

that he was uncertain whether he had more or less than $10,000 in

the safe. Respondent contends that this is inconsistent with

petitioner-husband's later claim that he kept a large amount of

cash in the safe. Respondent's point seeks to make something out

of nothing. We believe that petitioner-husband kept money in the

safe in Brazil but did not initially tell Davis the amount.

Petitioner-husband wrote to Davis in March 1994 and revised his

estimate of petitioners' cash on hand to include funds from the

sale of petitioners' Brazilian assets.
 25

Respondent contends that petitioner-husband told Davis

during the examination that wire transfers to petitioners' bank

accounts were from Brazilian business customers who wired sales

revenue to him. Petitioner-husband later told Davis and

testified that other people, including his sister, sent him money

from Brazil.

Petitioner-husband testified that only petitioners had

access to their safe in Brazil. Respondent contends that

petitioner-husband told Davis that wire transfers from MTB,

Cayman Islands, were sales revenue from a customer (MTB), but

later told her and testified that three or four people, including

his secretary and his sister, wired him money from Brazil. He

told Davis that his sister asked a person with an account outside

of Brazil to wire the money.

We believe that petitioner-husband satisfactorily explained

the wire transfers to petitioners' U.S. accounts. Petitioner-

husband credibly testified that, as his business started to grow

and he needed more money to invest in it, he had several people,

including his sister and his secretary, wire money from Brazil to

petitioners' U.S. accounts. He testified that, on some of his

trips to Brazil, he took money from the safe, gave it to his

secretary to pay expenses such as Social Security, and she wired

him the balance. He also testified that MTB is a bank and denied

telling Davis that it was a customer. He also testified that he

collected a few thousand dollars from two customers in Brazil.
 26

Petitioner-husband credibly testified that $58,969 of the

1991 wire transfers (including $50,500 from the Cayman Islands)

to petitioners' bank accounts were from his own money in Brazil.

His testimony is consistent with the documentary evidence. We

have found that other wire transfers were from taxable sources.

On March 29, 1994, petitioner-husband told Davis that he had

obtained the funds for a $6,400 deposit in December 1990 from his

funds in Brazil on a November 16, 1990, trip. In contrast, he

testified that the deposit resulted from a bank-to-bank transfer.

Bank records corroborate his testimony; there was a $6,400

withdrawal from account 157460395 on December 3, 1990, and a

$6,400 deposit to account 6269-258236 on December 3, 1990.

Respondent contends that petitioners' deposits to their

accounts were not made from cash petitioner-husband brought from

Brazil because petitioner-husband or petitioner-wife waited up to

1 month after petitioner-husband returned to the United States to

deposit money in one of their accounts. We disagree for the most

part. Petitioner-husband sometimes kept the money in a safe in

his Raleigh office before he deposited it in his non-interest

bearing checking accounts. To the extent that petitioner-husband

did not convince us that deposits were from nontaxable sources,

we did not include those deposits as a nontaxable source of

funds.

Respondent contends that the fact that petitioner-husband

used the 108 Rua Luiz Gama address as his address on his 1989
 27

adjusted Brazilian tax return and 1991 Brazilian tax return shows

that petitioners did not sell that house in September 1986. We

disagree; we give more weight to the fact that petitioners

reported the sale of and paid tax on the Rua Luiz Gama property

on their 1986 Brazilian tax return than we do to the fact that

petitioner-husband used that address on his 1989 and 1991

Brazilian returns, filed when petitioners were no longer living

in Brazil.

Respondent argues that petitioners did not have a

substantial amount of funds in 1990 because petitioner-husband

testified6 that he spent all of the money he brought from Brazil

to the United States accompanying the Raleigh Flyers soccer team

to tournaments in the United States for 5 years. We disagree.

We do not believe that petitioner-husband meant that he actually

spent all of his money following the soccer team.

c. Conclusion

Petitioners owned and sold real property and other assets in

Brazil in 1986, and petitioner-husband brought cash into the

United States when he returned from trips to Brazil. About half

of petitioners' deposits in 1990 and 1991 came from the cash that

6
Petitioner-husband testified as follows:

Q * * * why did you take a soccer team to Brazil?

A * * * I was following since 19-- five years, that I was
following that team, you know, expending all the money that I
brought from Brazil in hotels, in tournaments, here in the United
States, you know, following * * * [those] boys.
 28

they had accumulated by the end of 1986 from the sale of most of

their Brazilian assets and inheritances they received in 1986.

We find that, of the disputed deposits, $66,597.25 in 1990 and

$194,913 in 1991 came from petitioners' funds in Brazil and from

other nontaxable sources, such as transfers between accounts,

cashing checks or exchanging money for friends, the PanAm refund,

and a manufacturer's rebate. Petitioners have not shown that the

source of the funds for the remaining items in dispute was

nontaxable. We conclude that petitioners had income from

International of $64,911 for 1990 and $201,992 for 1991.

C. Net Operating Loss Carrybacks

Petitioners contend that they had losses of $15,976 in 1990

and $15,491 in 1991 which they may carry back to 1987 and 1988.

Section 172 allows a taxpayer to deduct net operating

losses. Petitioners bear the burden of proving that they had net

operating losses in 1990 and 1991. Rule 142(a); United States v.

Olympic Radio & Television, Inc., 349 U.S. 232, 235 (1955).

Petitioners must prove the amount of the net operating loss

carryback. Sec. 172(c); Jones v. Commissioner, 25 T.C. 1100,

1104 (1956), revd. and remanded on other grounds 259 F.2d 300

(5th Cir. 1958); Vaughan v. Commissioner, 15 B.T.A. 596, 600

(1929). Petitioners did not report income of $89,556 in 1990 and

$143,588 in 1991. Petitioners did not show that they had net

operating losses for 1990 and 1991 after taking into account the
 29

income they did not report for those years. Thus, we sustain

respondent on this issue.

D. Additions to Tax and Penalty

1. Negligence

Negligence is a lack of due care or failure to do what a

reasonable and ordinarily prudent person would do under the

circumstances. Zmuda v. Commissioner, 731 F.2d 1417, 1422 (9th

Cir. 1984), affg. 79 T.C. 714 (1982); Marcello v. Commissioner,

380 F.2d 499, 506 (5th Cir. 1967), affg. in part and remanding

in part 43 T.C. 168 (1964) and T.C. Memo. 1964-299; Neely v.

Commissioner, 85 T.C. 934, 947 (1985). Petitioners must show

that they acted reasonably and prudently and exercised due care.

Neely v. Commissioner, supra.

Petitioners argue that they are not liable for additions to

tax for negligence and substantial understatement and the

accuracy-related penalty because they relied on their accountant

to prepare accurate returns for them for 1990 and 1991.

Petitioners point out that Perkins testified that petitioner-

husband prepared summaries of his business activities for 1990

and 1991, and that Perkins believed the summaries were accurate.

Good faith reliance on the advice of a competent,

independent tax professional may offer relief from the imposition

of the addition to tax for negligence. United States v. Boyle,

469 U.S. 241, 251 (1985); Leonhart v. Commissioner, 414 F.2d 749,

750 (4th Cir. 1969), affg. T.C. Memo. 1968-98; Otis v.
 30

Commissioner, 73 T.C. 671, 675 (1980). Petitioners bear the

burden of proving that their reliance on professional advice was

reasonable. Rule 142(a); Freytag v. Commissioner, 89 T.C. 849,

888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S.

868 (1991).

Petitioners failed to explain why they did not report the

IBM tax payments for petitioner-husband for 1990 and 1991 or his

IBM severance payment in 1991, petitioner-wife's wages from A&P

for 1990, or their interest income for 1990 and 1991. See supra,

p. 2, note 1. Petitioners have not shown that their erroneous

claim that they had net operating loss carrybacks to 1987 and

1988 was not due to negligence. Pappas v. Commissioner, 78 T.C.

1078, 1092 (1982) (taxpayer negligently omitted income for 1976,

resulting in a net operating loss for 1976 which he carried back

to 1973; taxpayer liable for negligence for 1973 and 1976). We

hold that petitioners are liable for the addition to tax for

negligence for 1987 and 1988.

2. Substantial Understatement

Section 6661(a) imposes an addition to tax of 25 percent of

the amount of any underpayment attributable to a substantial

understatement of income tax in any taxable year. A substantial

understatement exists if in any year the amount of the

understatement exceeds the greater of 10 percent of the tax

required to be shown on the return or $5,000. Sec.

6661(b)(1)(A). An understatement is the amount required to be
 31

shown on the return less the amount actually shown on the return.

Sec. 6661(b)(2)(A).

Petitioners contend that they are not liable for the

addition for substantial understatement because they acted in

good faith in relying on Perkins in filing their 1990 and 1991

returns. We disagree for the reasons stated at par. B-1, above.

We sustain respondent's determination on this issue.

3. Accuracy-Related Penalty

Taxpayers are liable for a penalty equal to 20 percent

of the part of the underpayment due to negligence or disregard of

rules or regulations or to a substantial understatement of income

tax. Sec. 6662(a), (b)(1) and (2). Negligence includes a

failure to make a reasonable attempt to comply with the internal

revenue laws or to exercise ordinary and reasonable care in the

preparation of a tax return. Sec. 6662(c). An understatement is

substantial if it exceeds the greater of 10 percent of the tax

required to be shown on the return or $5,000. Sec.

6662(d)(1)(A). Petitioners bear the burden of proving that they

are not liable for the accuracy-related penalty imposed by

section 6662(a). Rule 142(a).

Petitioners argue that they are not liable for the accuracy-

related penalty because they relied on their accountant to

prepare accurate returns for them for 1990 and 1991. Petitioners

point out that Perkins testified that petitioner-husband prepared

summaries of his business activities for 1990 and 1991, and that
 32

Perkins believed there was no reason to question the accuracy of

those summaries. We disagree.

As discussed at par. B-1, above, petitioners offered no

evidence showing what information or documentation they provided

to Perkins concerning their IBM payments, wages from A&P, or

interest income, and they did not explain why they did not report

various income items for 1990 and 1991 including the income from

International. We hold that petitioners are liable for the

accuracy-related penalty for 1990 and 1991 because they have not

shown that they reasonably relied on Perkins.

Decision will be entered

under Rule 155.