T.C. Memo. 1997-466
UNITED STATES TAX COURT
GREGORY A. MASLOW AND MARINA MASLOW, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12960-94. Filed October 14, 1997.
Gregory A. Maslow, pro se.
Alan R. Peregoy, for respondent.
MEMORANDUM OPINION
JACOBS, Judge: Respondent determined a deficiency of $18,800
in petitioners' Federal income tax for 1992, an accuracy-related
penalty of $3,760 pursuant to section 6662, and an addition to tax
of $4,801 for failure to timely file pursuant to section 6651(a)(1)
for that year. The determined deficiency arises from respondent's
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determination that petitioners underreported their income and
overstated Schedule C deductions for 1992. The specific issues we
must resolve are:
(1) Did petitioners underreport their income in 1992 by
$25,112? Respondent determined this amount through the bank
deposits method, showing total deposits of $82,072,1 of which
$45,332 was reported by petitioners on their tax return and $11,628
was conceded by respondent at trial as nontaxable. We find that
the $25,112 difference came from nontaxable sources; thus, we hold
that petitioners did not underreport their 1992 income by $25,112.
(2) Must petitioners include $7,220 in income, representing
the market value of a trip to Scotland and England petitioner
Gregory A. Maslow earned in 1992 as a sales award from Kentucky
Central Life Insurance Co.? We hold they must.
(3) Are petitioners entitled to deduct various claimed
Schedule C business expenses that respondent disallowed? We hold
that petitioners are entitled to a portion, but not all, of the
claimed Schedule C business expenses, as explained in greater
detail infra.
(4) Are petitioners liable for the accuracy-related penalty
under section 6662 for 1992 and for an addition to tax for failure
1
The notice of deficiency states in one instance that
the deposits for 1992 total $80,096 and in another instance
$81,029. On brief, respondent states the total deposits as
$82,072. On the basis of our holding that the unidentified
deposits are not taxable, the differing deposit amounts are of no
importance.
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to timely file their 1992 income tax return under section
6651(a)(1)? We hold petitioners are liable for both the penalty
and the addition to tax.
All section references are to the Internal Revenue Code for
the year under consideration. All Rule references are to the Tax
Court Rules of Practice and Procedure. All dollar amounts are
rounded.
Some of the facts have been stipulated and are so found. The
stipulation of facts and the attached exhibits are incorporated
herein by this reference. For convenience, we present a background
section and combine our findings of fact with our opinion under
separate issue headings.
Background
Petitioners, husband and wife, resided in Randallstown,
Maryland, at the time they filed their petition. Gregory A. Maslow
(petitioner) emigrated to the United States from Russia in 1974.
He and Marina met (in 1986) and married (in 1988) in the United
States.
During 1992, the year under consideration, petitioner was a
general agent for several life and health insurance companies. In
addition, during 1992 he started a business (known as East-West
International) which was to engage in the export of goods to
Russia.
Petitioners did not file Federal income tax returns for 1988
through 1992 until they were contacted by one of respondent's
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revenue agents (Revenue Agent Bank) in the fall of 1993. As a
result, on October 12, 1993, petitioners filed delinquent tax
returns for 1988, 1989, 1990, and 1991. On November 5, 1993, they
filed their 1992 tax return.
Petitioner did not maintain books or records pertaining to his
insurance business. Petitioners did, however, maintain a checking
account at Maryland National Bank under the name Graded Assets
Management. This account was used for both business and personal
purposes. Petitioner provided Revenue Agent Bank with bank
statements and canceled checks that detailed most, if not all, of
his 1992 business activities.
Issue 1. Did Petitioners Underreport Their 1992 Income by $25,112?
Due to the absence of adequate books and records, Revenue
Agent Bank reconstructed petitioners' 1992 income using a bank
deposits analysis. Through the use of this analysis, Revenue Agent
Bank determined that petitioners underreported their 1992 income by
$34,764. The $34,764 represents the difference between the
aggregate amount of deposits to petitioners' Maryland National Bank
checking account ($80,096)2 and the income petitioners reported on
their 1992 tax return ($45,332) (the difference being the
unidentified deposits). At trial, respondent conceded that $11,628
of the original amount of unidentified deposits came from
nontaxable sources. Hence, respondent now asserts there is only
2
See supra note 1.
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$25,1123 ($82,072 - $45,332 - $11,628) of unidentified deposits.
The use of bank deposits to reconstruct income is well
established. DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), affd.
959 F.2d 16 (2d Cir. 1992); Parks v. Commissioner, 94 T.C. 654, 658
(1990); Nicholas v. Commissioner, 70 T.C. 1057, 1064 (1978); Estate
of Mason v. Commissioner, 64 T.C. 651, 656 (1975), affd. 566 F.2d
2 (6th Cir. 1977). "The bank deposits method assumes that all
money deposited in a taxpayer's bank account during a given period
constitutes taxable income." DiLeo v. Commissioner, supra at 868.
But the making of a bank deposit per se does not mean that the
amount so deposited is income. Goe v. Commissioner, 198 F.2d 851,
852 (3d Cir. 1952); Vuitch v. Commissioner, T.C. Memo. 1985-95.
However, where the Commissioner has determined that the deposits
constitute income, the taxpayer has the burden of showing the
Commissioner's determination was incorrect. See United States v.
Massei, 355 U.S. 595 (1958); Parks v. Commissioner, supra at 661.
In explaining the source of the unidentified deposits,
petitioner testified that he borrowed moneys in 1992 from various
finance companies--Chrysler First Co., Commercial Credit Corp., and
Rose Shanis Co. Petitioner also testified that in 1992 he
periodically received money from his father-in-law (Roman
Shumatsky) totaling approximately $10,000 as well as from Roland
3
The differing amounts exist due to the inconsistency
between the amount of total bank deposits stated in the notice of
deficiency ($80,096 or $81,029) and respondent's brief ($82,072).
See supra note 1.
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Butler, a business associate, totaling approximately $19,000, and
that he deposited these moneys into his bank account. (Mr. Butler
and petitioner were to be involved in the export of coffee to
Russia.) We found petitioner's testimony credible.
Mr. Shumatsky also testified and corroborated petitioner's
testimony. (Petitioner testified that he was unable to reach Mr.
Butler in order for the latter to testify.) We found the testimony
of Mr. Shumatsky credible. No witnesses testified on behalf of
respondent.
Our ultimate task is to distill truth from falsehood. As
trier of facts, we "must be careful to avoid making the courtroom
a haven for the skillful liar or a quagmire in which the honest
litigant is swallowed up." Diaz v. Commissioner, 58 T.C. 560, 564
(1972).
On the basis of the testimony of petitioner and Mr. Shumatsky,
we are persuaded that the unexplained deposits came from Messrs.
Shumatsky and Butler. Hence, petitioners have shown respondent's
determination as to the taxability of the deposits to be incorrect.
Consequently, we hold that petitioners did not underreport their
1992 income by $25,112, as determined by respondent.
Issue 2. Must Petitioners Include $7,220 Representing the Market
Value of a Trip to Scotland and England Earned by Petitioner as a
Sales Award in Income?
Most of the insurance policies petitioner wrote were with
Kentucky Central Life Insurance Co. In 1992, petitioner received
a free trip to Scotland and England for himself and his wife as a
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sales award from Kentucky Central Life Insurance Co. The fair
market value of the trip was $7,220, which was reported to
petitioner on a Form 1099. Petitioners did not include the value
of this sales award in income. Petitioner claims that the trip was
a "company conference" and that he was told by his superiors at the
home offices of Kentucky Central Life Insurance Co. that the trip
"was fully tax deductible".
Except as otherwise provided by law, gross income includes all
income from whatever source derived. Sec. 61. Gross income
includes income realized in any form, whether money, property, or
services. Sec. 1.61-1(a), Income Tax Regs. Thus, if the taxpayer
performs services in exchange for another type of service or
receipt of property, then the taxpayer must include in his/her
income the fair market value of the services or property received.
Sec. 1.61-2(d)(1), Income Tax Regs. In the instant case, the sales
award received by petitioner represents compensation for services.
Hence, we hold that petitioner must include the $7,220 fair market
value of the trip (not his estimate of what the trip was worth) in
income for 1992.
Issue 3. Are Petitioners Entitled to Various Claimed Schedule C
Business Expenses That Respondent Disallowed?
Respondent disallowed the following expenses petitioners
claimed on Schedule C (Profit or Loss from Business) filed with
their 1992 tax return:
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Type of Expense Amount Claimed Amount Disallowed
A. Home-office $8,013 $6,813
B. Travel 9,923 7,220
C. Insurance 1,983 1,983
D. Phone 5,709 5,709
E. Commissions 5,184 2,006
A. Home-Office Expenses
The portion of the claimed home-office expenses disallowed by
respondent ($6,813) represents 6 months of home mortgage payments.
(Petitioner claimed he used 50 percent of his residence for
business purposes.) Both the home and the mortgage were in the
name of petitioner's father-in-law, Mr. Shumatsky.
In general, section 280A denies a deduction with respect to a
home office used by persons such as petitioner unless the home
office is exclusively used on a regular basis either (1) as the
principal place of business for any trade or business of such a
person, (2) as a place of business which is used by patients,
clients, or customers in meeting or dealing with the person in the
normal course of the person's trade or business, or (3) in the case
of a separate structure that is not attached to the home, in
connection with the person's trade or business.
Petitioner failed to prove that the portion of his home
claimed as an office expense was exclusively used on a regular
basis either as the principal place of his insurance or export
business or as a place of business used to meet customers or
clients. See sec. 280A. Indeed, the record shows that petitioner
did not meet his customers at his home but rather conducted his
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insurance activities by traveling to the homes of his customers.
The record further indicates that (1) petitioner occasionally, but
not regularly, met other insurance agents at his residence, and (2)
petitioner had an outside office for 3 months during 1992.
Because petitioner did not satisfy the requirements of section
280A, we sustain respondent's disallowance of petitioners' $6,813
claimed home-office expenses. See Commissioner v. Soliman, 506
U.S. 168 (1993).
B. Travel Expenses
Respondent disallowed $7,220 of the claimed $9,923 travel
expenses, determining that petitioners deducted, rather than
included in income, the $7,220 travel award by Kentucky Central
Life Insurance Co. referred to supra. Respondent allowed the
balance of the claimed $9,923 travel expenses ($2,703) as
automobile travel expenses incurred in connection with petitioner's
insurance business.
Petitioner claims that $7,220 of the claimed travel expenses
relates to trips to Israel (February 13-16, 1992), Russia (May 16-
20, 1992), Brussels (September 15-24, 1992), and Luxembourg
(November 17, 1992), in connection with the startup of his export
business and has no connection with the travel award by Kentucky
Central Life Insurance Co. Even if we accept petitioner's claim,
nonetheless, petitioner failed to substantiate the costs of those
trips. See sec. 274(d)(1). Moreover, petitioner did not file a
Schedule C for his export business activities.
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Deductions are a matter of legislative grace, and in general
taxpayers bear the burden of proving that they are entitled to the
deductions claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner,
503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S.
435 (1934). Taxpayers must keep sufficient records to establish
the amount of their deductions. See sec. 6001; Meneguzzo v.
Commissioner, 43 T.C. 824, 831-832 (1965); sec. 1.6001-1(a), Income
Tax Regs. Moreover, a taxpayer who claims a deduction bears the
burden of substantiating the amount and purpose of the item
claimed. Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd.
per curiam 540 F.2d 821 (5th Cir. 1976); sec. 1.6001-1(a), Income
Tax Regs.
Because petitioner failed to substantiate his purported travel
costs, we sustain respondent's disallowance of the $7,220 in
question. Moreover, insofar as the purported travel expenses
represent startup business costs, they would not be deductible in
1992 because petitioner's export business did not begin operations
until 1993. See sec. 195; Garrett v. Commissioner, T.C. Memo.
1997-231.
C. Insurance Expenses
Respondent disallowed the claimed insurance expenses on the
basis that petitioner failed to substantiate the business purpose
of the deduction. Petitioner claims the insurance expenses related
to his automobile insurance; respondent, on the other hand, asserts
petitioner told Revenue Agent Bank that the insurance was for his
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personal residence. In this regard, respondent's notice of
deficiency states, in pertinent part:
Taxpayer is an insurance agent and works for various
insurance companies as a salesman. Taxpayer stated that
he had an office in the home. The taxpayer was asked to
provide substantiation for his expense as well as the
insurance policy on his home and failed to do so.
Taxpayer then stated that his expense is for his car but
failed to bring any records to verify this statement.
In general, section 274(d) provides that no deduction shall be
allowed as a trade or business expense for any traveling expenses
or with respect to any listed property, as defined in section
280F(d)(4), unless the taxpayer substantiates by adequate records
or by sufficient evidence corroborating the taxpayer's own
statement the business purpose of the expense. A passenger
automobile is a "listed property" within the purview of section
280F(d)(4).
Petitioner failed to provide the requisite substantiation that
would enable petitioners to deduct the purported insurance expenses
on the automobile allegedly used in connection with petitioner's
insurance business. Moreover, respondent did allow a deduction
(under the heading "travel expenses", see supra) in the amount of
$2,703 as automobile travel expenses incurred in connection with
petitioner's insurance business. Accordingly, we sustain
respondent's disallowance of the claimed $1,983 of insurance
expenses.
D. Phone Expenses
Respondent disallowed the claimed telephone expenses on the
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basis that petitioner failed to provide substantiation for these
expenses. A substantial portion of the claimed expenses was for
foreign country calls that pertained to the startup of petitioner's
export business. However, a portion of the telephone expenses was
in connection with petitioner's insurance business.
Under certain circumstances, if claimed deductions are not
adequately substantiated, we may estimate them, provided we are
convinced that the taxpayer has incurred such expenses and we have
a basis upon which to make an estimate. Cohan v. Commissioner, 39
F.2d 540 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 743
(1985). Based on the record presented, using our best estimate, and
giving consideration to section 262(b),4 we find, and thus hold,
that petitioners are entitled to a deduction for telephone expenses
in the amount of $1,500 for 1992. See, e.g., Velinsky v.
Commissioner, T.C. Memo. 1996-180.
E. Commissions Expenses
4
SEC. 262. PERSONAL, LIVING, AND FAMILY EXPENSES.
(a) General Rule.--Except as otherwise
expressly provided in this chapter, no
deduction shall be allowed for personal,
living, or family expenses.
(b) Treatment of Certain Phone
Expenses.--For purposes of subsection (a), in
the case of an individual, any charge
(including taxes thereon) for basic local
telephone service with respect to the 1st
telephone line provided to any residence of
the taxpayer shall be treated as a personal
expense.
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Petitioners claimed $5,184 as commissions expenses. A portion
of this amount represented offices expenses ($1,053), and the
balance represented commissions paid to other insurance agents
($4,131). In the notice of deficiency, respondent allowed all but
$2,006 of the claimed $5,184.
Petitioner testified that the disallowed $2,006 represented
payments to Edward Levenson, who obtained an insurance policy that
petitioner wrote and for which he received a commission.
Respondent, on brief, concedes that petitioner is entitled to a
deduction in the amount of $1,053 for office expenses and $2,006
for the payments to Mr. Levenson. Respondent now asserts that
$2,125 should be disallowed as commissions expenses ($5,184 -
($1,053 + $2,006)), claiming petitioner testified that he paid no
other commissions in 1992. Respondent misunderstands petitioner's
testimony; petitioner did not concede any part of the claimed
commissions expenses.
On the basis of respondent's concession that the $2,006 paid
to Mr. Levenson is deductible, and because that amount was the only
amount challenged in the notice of deficiency with regard to the
claimed $5,184 of commissions expenses, we hold that petitioners
are entitled to a Schedule C deduction for commissions expenses in
the amount of $5,184, as claimed.
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Issue 4. Delinquency Addition to Tax and Accuracy-Related Penalty
Respondent determined the section 6651(a)(1) addition to tax
for failure to timely file a 1992 income tax return and the section
6662 accuracy-related penalty for negligence.
Section 6651(a)(1) provides for an addition to tax for failure
to file a timely return. A taxpayer may avoid the addition to tax
by establishing that the failure to file a timely return was due to
reasonable cause and not willful neglect. Rule 142(a); United
States v. Boyle, 469 U.S. 241, 245-246 (1985).
Petitioners failed to timely file their 1992 tax return. They
did not present any evidence establishing that their delinquent
filing was due to reasonable cause. Indeed, the evidence reveals
that they knew that they were required to file income tax returns
but did not do so until contacted by respondent's revenue agent.
Section 6662 imposes a penalty equal to 20 percent of the
portion of the underpayment that is attributable to negligence. In
order to avoid this penalty, petitioners must prove that they were
not negligent. Negligence is defined as the failure to exercise
the due care that a reasonable, prudent person would exercise under
similar circumstances. Zmuda v. Commissioner, 731 F.2d 1417, 1422
(9th Cir. 1984), affg. 79 T.C. 714 (1982); Neely v. Commissioner,
85 T.C. 934, 947 (1985).
Petitioners failed to exercise the due care that a reasonable
prudent person would have exercised by (1) failing to maintain
adequate books and records, (2) failing to report the $7,220 sales
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award as income, and (3) overstating Schedule C deductions.
Accordingly, we sustain respondent's determination that petitioners
are liable for both the section 6651(a)(1) addition to tax and the
section 6662 penalty for 1992.
To reflect the foregoing,
Decision will be entered
under Rule 155.