BRACEY v. COMMISSIONER

T.C. Memo. 1998-254

UNITED STATES TAX COURT

ALVIN VICTOR BRACEY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 11485-94. Filed July 13, 1998.

Alvin Victor Bracey, pro se.

Susan M. Pinner, for respondent.

MEMORANDUM OPINION

GALE, Judge: Respondent determined the following

deficiencies in, addition to, and fraud penalties on petitioner's

Federal income taxes:1

1
All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
(continued...)
 - 2 -

Addition to Tax Fraud Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6663

1990 $66,299 $3,315 $49,724
1991 52,593 - 0 - 39,445

Respondent also determined as an alternative to fraud that the

underpayments for 1990 and 1991 are subject to accuracy-related

penalties under section 6662(b)(1) and (2).

Respondent has conceded the addition to tax under section

6651(a)(1) for 1990 and the fraud penalties, and the parties have

reached agreement with respect to each adjustment determined in

the notice of deficiency. However, with certain exceptions2 the

parties dispute the applicability of the accuracy-related

penalties to the agreed adjustments. Thus the remaining issue

for decision is whether petitioner is liable for accuracy-related

penalties under section 6662(b)(1) and (2) with respect to the

underpayment arising from certain of the agreed-upon adjustments.

1
(...continued)
indicated.
2
On brief respondent concedes that the sec. 6662(b)(1)
penalty does not apply to the portion of the 1990 underpayment
attributable to an adjustment involving petitioner's
contributions to an individual retirement account and the portion
of the 1991 underpayment attributable to adjustments involving
Schedule C mortgage interest expenses. Respondent's position
regarding the sec. 6662(b)(2) penalty with respect to the
foregoing adjustments is not entirely clear. To the extent
respondent has not conceded these adjustments for purposes of
sec. 6662(b)(2), we find on the basis of the record in this case
that petitioner had reasonable cause under sec. 6664(c) with
respect thereto.
 - 3 -

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.

At the time the petition was filed, petitioner resided in

Houston, Texas.

Prior to and during the years in issue, petitioner operated

a "wear lining" business as a sole proprietorship, in which he

developed and sold linings used in pneumatic handling systems

that pulverize and transfer coal into coal-burning industrial

boilers, primarily in power plants. Petitioner visited customers

in the north central and northeastern United States to solicit

orders for such wear linings, arranged for their manufacture by a

third party, and subsequently supervised installation of the

linings at a customer's plant. The conduct of petitioner's

business required extensive travel, which petitioner estimated at

60,000 to 80,000 miles per year.

For recordkeeping in his wear lining business, petitioner

kept a copy of the invoices issued to a customer when an order

was placed and then attached a copy of the check when payment was

received on the invoice. Petitioner kept separate files for

invoices awaiting payment and for paid invoices. It was from

these invoices that petitioner calculated the gross receipts from

the wear lining business reported on Schedule C of his 1990 and

1991 returns. He did not maintain any ledger or journal with

respect to gross receipts.
 - 4 -

With respect to travel expenses incurred in his wear lining

business, petitioner's recordkeeping consisted of a mileage log

and a diary of appointments containing information regarding

where he went, with whom he spoke, and the subject matter. With

respect to lodging, petitioner did not have receipts to document

his expenses. Instead, he claimed lodging expenses as a

deduction for travel on his Schedule C by using a per diem

estimate that he found in an Internal Revenue Service

publication.

In addition to the expenses incurred in his wear lining

business, petitioner claimed Schedule C deductions for expenses

incurred in connection with certain real property acquisitions in

Florida. Sometime in 1990, petitioner acquired three properties

in Florida and had a house built on one of them with the

intention of leaving the wear lining business and beginning a

homebuilding business. The remaining two lots were undeveloped

when purchased by petitioner. During the years in issue,

petitioner had the lots cleared and filled to meet elevations

required by applicable flood laws and arranged for water service

to one of them. At some point in 1991, petitioner returned to

the wear lining business and tried to rent the house in Florida.

He obtained insurance coverage for the house based on its

intended use as a rental property. Petitioner was not successful

in finding a tenant in 1991 and eventually moved into the house

himself. On Schedule C of his 1990 return, petitioner deducted
 - 5 -

legal fees that he paid in connection with the purchase of the

Florida house. On Schedule C of his 1991 return petitioner

deducted depreciation expense with respect to the house.

Petitioner prepared and filed Federal income tax returns for

the years in issue without consulting an accountant or other tax

professional.

We turn first to the applicability of the section 6662(b)(1)

penalty. We consider each agreed adjustment (except as indicated

supra note 2) to determine whether the resulting portion of the

underpayment is attributable to "Negligence or disregard of rules

or regulations" as provided in that section. "Negligence" for

this purpose includes "any failure to make a reasonable attempt

to comply with the provisions of * * * [the Internal Revenue

Code]", and "disregard" includes "any careless, reckless, or

intentional disregard". Sec. 6662(c). Respondent's

determination of an accuracy-related penalty is presumptively

correct, and petitioner bears the burden of proving the

determination wrong. Rule 142(a); Monahan v. Commissioner, 109

T.C. 235 (1997); Hitchins v. Commissioner, 103 T.C. 711, 719

(1994); Neely v. Commissioner, 85 T.C. 934, 947 (1985); Bixby v.

Commissioner, 58 T.C. 757, 791-792 (1972). In deciding whether

the accuracy-related penalty for negligence applies, the test is

whether there was a lack of due care or a failure to act

prudently under the circumstances. Hitchins v. Commissioner,

supra. Thus, the taxpayer must show that he acted reasonably and
 - 6 -

prudently and exercised due care in choosing the treatment of the

items in issue. Allen v. Commissioner, 925 F.2d 348, 353 (9th

Cir. 1991), affg. 92 T.C. 1 (1989); Neely v. Commissioner, supra

at 947-948. The section 6662(b)(1) penalty shall not in any

event be imposed with respect to any portion of an understatement

as to which the taxpayer acted with reasonable cause and in good

faith. Sec. 6664(c)(1).

Unreported Gross Receipts

In the notice of deficiency, respondent determined that

petitioner had unreported Schedule C gross receipts of $132,330

in 1990 and $58,107 in 1991. Respondent now concedes that

petitioner did not have any unreported gross receipts in 1991,

and the parties have stipulated that the unreported gross

receipts in 1990 were $12,911 rather than $132,330. Citing

Sindik v. Commissioner, T.C. Memo. 1996-47, respondent contends

that the underpayment arising from the unreported receipts is

attributable to negligence because petitioner failed to keep

adequate books and records. In particular, respondent argues

that petitioner was negligent in keeping only invoices and in

failing to maintain a ledger or journal in which he separately

recorded information regarding his gross receipts.

Taxpayers are required to keep such records "as are

sufficient to establish the amount of gross income * * * required

to be shown" on the return. Sec. 1.6001-1(a), Income Tax Regs.

The regulations further provide that negligence for purposes of
 - 7 -

section 6662(b)(1) and (c) includes "any failure by the taxpayer

to keep adequate books and records". Sec. 1.6662-3(b)(1), Income

Tax Regs. There is no requirement that a taxpayer maintain any

specific type of ledger or journal, so long as his overall

recordkeeping is sufficient to establish the amount of his

income. Petitioner's business required travel to such an extent

that he essentially worked out of his automobile. In the

circumstances, we are not persuaded that respondent's insistence

on ledgers is realistic or appropriate. Petitioner's method of

retaining his invoices in paid and unpaid categories was

apparently "adequate" for 1991, as the parties have now

stipulated that there was no underreporting of gross receipts in

that year. As for 1990, petitioner failed to report $12,911 of a

total of $242,788 in gross receipts. While the unreported amount

is not inconsequential, we are not persuaded that it constitutes

either "negligence", which includes "any failure to make a

reasonable attempt to comply with the provisions" of the Internal

Revenue Code, or "disregard of rules or regulations", which

includes "any careless, reckless, or intentional disregard".

Sec. 6662(c). We believe that petitioner was making a

reasonable, though flawed, attempt to keep track of his gross

receipts in the circumstances. Respondent's reliance on Sindik

v. Commissioner, supra, is misplaced. The taxpayer in that case

kept no records at all, which we found was a failure to make any

reasonable attempt to comply and therefore negligent. Here, we
 - 8 -

find that the underpayment arising from the unreported gross

receipts in 1990 is not subject to the accuracy-related penalty

provided in section 6662(b)(1).

Lodging Expenses

In the notice of deficiency, respondent completely

disallowed petitioner's claimed travel expenses for his wear

lining business in the amounts of $34,398 and $37,422 for 1990

and 1991, respectively. Respondent now concedes that the claimed

amounts are allowable except to the extent of lodging expenses of

$10,374 in 1990 and $11,286 in 1991. Respondent argues for the

negligence penalty because petitioner failed to substantiate the

lodging expenses as required by section 274(d). The parties'

dispute centers on petitioner's failure to produce receipts for

his claimed lodging expenses. Petitioner testified credibly that

he maintained a diary of his business travel in which he recorded

his appointments, including time, place, substance of the

discussion, and follow-up. Petitioner concedes, however, that he

did not use actual receipts to calculate the lodging expenses

claimed, but instead used a per diem amount that he obtained from

an IRS publication. We take judicial notice of IRS Publication

17, "Your Federal Income Tax" (1990), which the agency published

for use in preparing 1990 returns. In a section specifically

devoted to the records required to support deductions for

business travel, the publication states:
 - 9 -

Documentary evidence. Documentary evidence is required to
support all lodging expenses (however, see Per diem
allowance or reimbursement, earlier) while traveling away
from home. [IRS Pub. 17, ch. 28, at 149 (1990).]

The parenthetical refers the reader to that portion of the

publication where a procedure for accounting for expenses,

including lodging expenses, on the basis of a per diem amount

rather than actual expenditures is explained. While it is true

that as a self-employed individual petitioner was not eligible to

use the per diem method, the Publication is not exceedingly clear

on this point, and we accept that petitioner could have

misunderstood this based on the language quoted above. We note

in this regard that in the most recent version of Publication 17,

"Your Federal Income Tax" (1997), of which we also take judicial

notice, the section on "Documentary evidence" has been

substantially revised to make clearer the limited circumstances

in which the per diem method may be used for lodging expenses.

Documentary evidence. You generally must have documentary
evidence, such as receipts, canceled checks, or bills, to
support your expenses. However, this evidence is not needed
if any of the following apply:

1) You have meals or lodging expenses
while traveling away from home for
which you account to your employer
under an accountable plan and you
use a per diem allowance method that
includes meals and/or lodging.
[IRS Pub. 17, ch. 28, at 186 (1997).]

Section 1.6664-4(b)(1), Income Tax Regs. (as effective for

the years in issue), provides that reasonable cause for purposes

of the accuracy-related penalties includes "an honest
 - 10 -

misunderstanding of fact or law that is reasonable in light of

the experience, knowledge and education of the taxpayer." In

these circumstances, we believe that petitioner's use of a per

diem method to calculate his lodging expenses was an "honest

misunderstanding" constituting reasonable cause under section

6664(c)(1). Thus, the underpayments arising from the disallowed

travel expenses are not subject to accuracy-related penalties

under section 6662(b)(1) or (2).

Employee Benefit Program

Petitioner has conceded that he is not entitled to a $1,086

deduction claimed on Schedule C of his 1990 return for employee

benefit programs. Respondent contends that the amount represents

petitioner's medical expenses that were not deductible on

Schedule A because they did not exceed 7.5 percent of adjusted

gross income, see sec. 213(a), and asserts that a section

6662(b)(1) penalty is appropriate because the deduction had no

basis in law or fact. Petitioner offered no explanation or

argument with respect to the deduction or the penalty. On this

record, we find that the underpayment arising from this

disallowed deduction is subject to the accuracy-related penalty

under section 6662(b)(1).

1990 Interest Expense

On Schedule C of his 1990 return, petitioner claimed

interest expenses of $10,603 for "Mortgage" and $10,210 for

"Other". With respect to the first amount, petitioner now
 - 11 -

concedes that it is not allowable as a deduction in 1990.

Petitioner admitted that this interest was paid by him in 1989

and offered by way of explanation that he did not have his bank

statement available in time to claim the amount on his 1989

return, and so he claimed it on his 1990 return. We find this

constitutes "disregard of rules or regulations" within the

meaning of section 6662(b)(1).

With respect to "Other" interest of $10,210, the parties

have stipulated that petitioner is not entitled to any deduction

on Schedule C for "Other" interest but instead is entitled to a

mortgage interest deduction of $7,730 on Schedule A of his 1990

return. Petitioner has offered no explanation for the $2,480 in

claimed interest to which he now concedes he is not entitled. In

the absence of any substantiation for this amount, we find that

the underpayment arising from its disallowance is attributable to

negligence. Sec. 1.6662-3(b)(1), Income Tax Regs.

1990 Legal Expenses

Petitioner claimed $10,556 in legal expenses in Schedule C

of his 1990 return to which the parties now stipulate he was not

entitled. The amount represents legal fees petitioner paid in

connection with the purchase of a house in Florida as part of his

efforts to commence a homebuilding business. Petitioner now

concedes that the amounts should have been capitalized and added

to the basis of the house. Petitioner did not seek any

professional advice with respect to taking the deduction. We
 - 12 -

believe in any event that the rules with respect to the treatment

of legal fees incurred in connection with the purchase of real

estate are relatively simple and clear. Thus, we do not find

reasonable cause for the error under section 6664(c)(1). On this

record, we sustain respondent's determination that the

underpayment arising from this disallowed deduction is subject to

an accuracy-related penalty under section 6662(b)(1).

Depreciation

Petitioner claimed $6,970 of depreciation on Schedule C of

his 1991 return to which the parties now stipulate he was not

entitled. The amount represents depreciation claimed with

respect to the house petitioner purchased in Florida in 1990.

Petitioner held the house throughout 1991, attempted to rent it,

and obtained insurance designed to provide coverage for a rental.

He was unsuccessful in renting the house and eventually moved

into it himself, although the record does not disclose when.

Respondent asserts that it was negligent for petitioner to

depreciate a house that he never rented and into which he

eventually moved. We think petitioner's negligence depends upon

whether, given the circumstances, he reasonably believed that the

property was depreciable.

Section 167(a) allows a depreciation deduction only if the

property is either used in a trade or business or held for the

production of income. The phrase "held for the production of

income" includes the expectation of gain from the disposition of
 - 13 -

property as well as recurring income such as rent. Mitchell v.

Commissioner, 47 T.C. 120, 128 (1966). In light of petitioner's

other real estate activities in Florida, we believe he originally

acquired and held the house with the expectation of realizing

gain upon its disposition. We conclude that petitioner

reasonably believed that the house was depreciable. Therefore,

he had reasonable cause and acted in good faith, and the

underpayment arising from the disallowed depreciation is not

attributable to negligence. Secs. 6662(b)(1), 6664(c)(1); see

Rezazadeh v. Commissioner, T.C. Memo. 1996-245, affd. without

published opinion 132 F.3d 36 (7th Cir. 1997).

Miscellaneous Expenses

The following chart lists various additional expenses

claimed by petitioner on Schedule C for 1990 and 1991 that were

challenged by respondent. The second column shows the amount to

which the parties have stipulated that petitioner is entitled,

the third column shows the amounts originally claimed by

petitioner on his returns, and the fourth column shows the

difference; i.e., the amount petitioner claimed to which he now

concedes he is not entitled.

Expense Stipulated Claimed Difference

1990 Taxes $2,719 $3,100 $381
1991 Taxes 4,976 6,139 1,163
1990 Utilities 1,637 1,861 224
1991 Miscellaneous1 7,101 9,942 2,841

1
Aggregate figure for legal fees, utilities, insurance, and
rent.
 - 14 -

With respect to all amounts in the fourth column, respondent

contends on brief that there was no substantiation. Petitioner

has offered no explanation with respect to the amounts he

concedes were claimed improperly. In the absence of any

substantiation for these amounts, we find that the underpayment

arising from their disallowance is attributable to negligence.

Sec. 1.6662-3(b)(1), Income Tax Regs.

Substantial Understatement of Tax

Alternatively, respondent determined that the accuracy-

related penalty applies due to a substantial understatement of

income tax pursuant to section 6662(b)(2). Section 6662(d)(1)(A)

provides that a substantial understatement occurs when the

understatement (of tax) exceeds the greater of $5,000 or 10

percent of the amount of tax required to be shown on the return.

Generally, the understatement is the amount of tax required to be

shown on the return over the amount of tax imposed which is shown

on the return, reduced by that portion of the understatement

attributable to: (i) The tax treatment of an item for which

there was substantial authority; or, (ii) an item with respect to

which the relevant facts affecting its treatment were adequately

disclosed on the return or in a statement attached thereto. Sec.

6662(d)(2)(A) and (B). Petitioner has not provided any authority

for the positions taken on his returns. Petitioner argues for

relief from penalties because he made full disclosure (when

audited) of all the facts and circumstances surrounding the
 - 15 -

various entries on his return. Petitioner misunderstands, and

does not meet, the requirement of section 6662(d)(2)(B), which is

that disclosures be on the return or a statement attached

thereto. Petitioner made no such disclosure. See sec. 1.6661-

4(a), Income Tax Regs. Accordingly, there is no reduction in the

understatement.

The question of whether there is a substantial

understatement of income tax thus depends upon the amount of the

understatement, which will be addressed in the Rule 155

computation. The understatement shall not include any portion of

the underpayment for which we have herein found there was

reasonable cause under section 6664(c)(1).

We have considered all other arguments made by petitioner

and found them to be either irrelevant or without merit.

To reflect the foregoing and concessions,

Decision will be entered

under Rule 155.