T.C. Memo. 1998-282
UNITED STATES TAX COURT
ROBERT A. INZANO and MARTHA O. CHAVEZ, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 2404-96. Filed August 5, 1998.
Robert A. Inzano, pro se.
Scott Hargis, for respondent.
MEMORANDUM OPINION
NAMEROFF, Special Trial Judge: This case was heard pursuant
to the provisions of section 7443A(b)(3)1 and Rules 180, 181, and
182. Respondent determined a deficiency in petitioners’ 1990
Federal income tax in the amount of $6,631 and an addition to tax
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
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under the provisions of section 6651(a)(1) in the amount of
$1,658. After a concession by petitioners regarding unreported
dividend income, the issues for decision are: (1) Whether
petitioners are able to substantiate claimed Schedule C expenses;
and (2) whether petitioners are liable for the addition to tax
for delinquency.
Background
Some of the facts have been stipulated, and they are so
found. The stipulation of facts and the attached exhibits are
incorporated herein by this reference. At the time they filed
their petition, petitioners resided in San Clemente, California.
In approximately September 1989, petitioners purchased a
business known as Joan’s Dust Busters (JDB) allegedly for
$125,000. The business of JDB was to clean a newly built home
for occupancy. JDB had contacts with several residential home
developers. Just prior to the move-in by the new owner, the
developer would contact petitioners, who would send one or more
workers (depending on the size of the home) to vacuum the new
carpets, remove “sticky stuff” from and clean newly installed
windows, and conduct other general cleaning operations. In
addition, petitioners had agreements with developers regarding
model homes, in that petitioners would have the developers’ model
homes cleaned on a regular, generally monthly, basis.
Petitioners’ purchase of JDB included some equipment, which was
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in a state of disrepair, and a few supplies, but primarily
petitioners purchased the name, goodwill, and purported contacts
of the seller. Ultimately, the petitioners discovered that the
representations by the seller were, to be charitable, overstated,
and petitioners stopped paying on the purchase price and sued the
seller. According to petitioner husband, the law suit was
unsuccessful.
JDB charged clients based upon the size of the residence to
be cleaned. Charges generally ranged from $225 to $325. The
labor costs for cleaning generally ran from $50 to $65 per person
per day. Normally, most homes could be cleaned by two persons in
a day and a half, although larger homes required more persons or
more time.
Petitioners maintained most records for JDB on a computer.
In December 1993, petitioners suffered a loss of their home from
fire. Most paper records were destroyed, and water damage to the
computer prevented any retrieval of its records.
Petitioners did not file a timely 1990 Federal income tax
return, because in the opinion of petitioner husband, there was
no tax liability. However, in response to an inquiry from
respondent’s agents, petitioners, on April 19, 1994, filed a
joint Federal income tax return, Form 1040. Included in that
return was a Schedule C for JDB reflecting income of $27,165 and
the following expenses:
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Advertising $12,940
Car and truck 5,200
Insurance 5,400
Legal 3,100
Office 6,000
Rent 6,900
Repairs and Maintence 2,100
Supplies 4,790
Tax and licenses 550
Utilities 3,150
Total 50,130
In preparing their return, petitioners had to rely upon
estimates, for their records had been lost. Thus, it is not
clear whether the income figure is accurate. Moreover,
petitioners neglected to deduct their labor costs for the
cleaning help.2 In the notice of deficiency, respondent
disallowed all claimed expenses for lack of substantiation. In
addition, respondent determined that there was no reasonable
cause for the delinquent filing and asserted the addition to tax
under section 6651(a)(1).
Discussion
Section 162(a) allows the deduction of “ordinary and
necessary” expenses paid or incurred during the taxable year in
carrying on any trade or business. Deductions are a matter of
legislative grace, and taxpayers must prove that they are
entitled to the claimed deductions. Rule 142(a); INDOPCO, Inc.
v. Commissioner, 503 U.S. 79, 84 (1992). They must keep
2
JDB had no employees. All cleaning work was done by
petitioners and “subcontractors” hired at the time work was
required.
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sufficient records to establish deduction amounts. Sec. 6001;
Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965).
Generally, except as provided by section 274(d), when evidence
shows that a taxpayer incurred a deductible expense, but the
exact amount cannot be determined, the Court may approximate the
amount. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir.
1930). The Court, however, must have some basis upon which an
estimate may be made. Vanicek v. Commissioner, 85 T.C. 731, 742-
743 (1985).
A strict substantiation requirement exists under section
274(d)(4) for certain items listed under section 280F(d)(4) such
as passenger automobiles. Taxpayers must substantiate by
adequate records the following items in order to claim automobile
deductions: The amount of each automobile expenditure, the
automobile’s business and total usage, the date of the
automobile's use, and the automobile's business purpose. Sec.
274(d); secs. 1.274-5T(b)(6), 1.274-5T(c)(1), Temporary Income
Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).
To substantiate a deduction by means of adequate records, a
taxpayer must maintain an account book, diary, log, statement of
expense, trip sheets, and/or other documentary evidence which, in
combination, are sufficient to establish each element of
expenditure or use. Sec. 1.274-5T(c)(2)(i), Temporary Income Tax
Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985). Section 274(d) is an
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exception to the Cohan rule and prohibits the estimation of these
expenses. Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968),
affd. per curiam 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a),
Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).
The loss of tax records does not leave a taxpayer helpless
in meeting his substantiation burden. In general, when a
taxpayer's records have been lost or destroyed through
circumstances beyond his control, he is entitled to substantiate
the deductions by reconstructing his expenditures through other
credible evidence. Malinowski v. Commissioner, 71 T.C. 1120,
1125 (1979); Cook v. Commissioner, T.C. Memo. 1991-590.
Before we discuss each item of expenditure, we must briefly
comment on the history of this litigation. Subsequent to the
filing of the petition on April 25, 1996, this case was first
calendared for trial in Los Angeles, California, on March 10,
1997. On that date, petitioner husband appeared and requested a
continuance on the grounds that he was trying to obtain
“additional” records from the attorney who had been handling
petitioners’ litigation against the seller of JDB. The case was
continued and recalendared for trial for June 2, 1997. On May
28, 1997, petitioners moved for a continuance on the grounds that
they had served a subpoena on Wells Fargo Bank, the successor to
their bank, First Interstate, and that there would be a delay in
the bank’s compliance therewith. Petitioners’ motion was
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granted, and the case was recalendared for September 22, 1997.
Finally, the case was continued from that date and recalendared
for January 26, 1998. The Court notes that the only records
obtained by petitioners during this entire period and submitted
in evidence were 15 canceled checks for the period June 26, 1990,
through July 12, 1990.
a. Advertising. Petitioner testified that JDB did
extensive advertising by flyer and in the “Yellow Pages” of the
telephone book. Considering the nature of the business, we are
surprised by this claim, in that petitioners’ clients were real
estate developers and not the general public. Moreover, it would
have been a simple task to contact the telephone company or
printers to obtain verification of their claimed advertising
expense. On this record, we cannot allow any amount for
advertising.
b. Car and truck. Petitioner claimed that they had two
vehicles solely for business, in addition to petitioner wife’s
personal auto, which was used for nonbusiness purposes. However,
no records were ever maintained for the vehicles’ usages, no
records were kept for the actual expenses incurred for these
vehicles, and no evidence was submitted regarding their cost.
Accordingly, because there is no compliance with the requirements
of section 274(d), no amount can be allowed for car and truck
expense.
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c. Insurance. Petitioners claim insurance expense for
their business liability insurance and for their vehicle
insurance. As to the latter, petitioners must still comply with
the provisions of section 274(d) as described above, and having
failed to do so, cannot deduct any amount for vehicle insurance.
Moreover, the record does not contain any information as to
vehicle insurance costs.
With regard to the business liability insurance, petitioners
contend that they carried a large policy with Ohio Casualty,
which required a substantial down payment and monthly payments of
$147.99. The record contains one check to the insurance broker
stated to be a monthly payment thereof. The record was left open
in this case for 60 days for petitioners to contact their
insurance company for documentary verification of their claim.
Nothing was received from petitioners in this regard.3 From this
record, we are satisfied that petitioners paid the regular
monthly premiums for the business insurance, but there is no
evidence of the existence, amount, or date of payment of the
alleged “substantial downpayment.” Accordingly, we hold that
3
Indeed, as will be noted, the record was left open for
several reasons, all to no avail. Petitioners did submit a
Motion to Supplement the Record with regard to the home office
deductions, but did not attach any documentation thereto. The
record had not been held open for this purpose, and the motion
was denied.
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petitioners are entitled to a deduction for business insurance
for $1,775.88, representing 12 monthly payments of $147.99.
d. Legal. Petitioner stated the names of several attorneys
with whom JDB had some relationships, but he was not able to
describe those relationships or indicate the amounts of the
respective legal fees paid. The Court kept the record open for
60 days in order for petitioner to contact those attorneys to
obtain substantiating documentation. Nothing has been received
from petitioners. Accordingly, we are unable to speculate on the
amount of legal fees petitioners expended as ordinary and
necessary business expenses, or to allow a deduction for any such
fees. Vanicek v. Commissioner, supra.
e. Home office. The claimed deductions for office expense,
rent expense, and utilities all pertain to this subject. Suffice
it to say that petitioners have failed to show that they used and
maintained regularly and exclusively any part of their home for
business purposes or any verification of the claimed
expenditures. We sustain respondent’s disallowance of these
items.
f. Repairs. We are not sure what this claimed expenditure
consists of, although vehicle repairs probably make up the
largest part thereof, if not all. Any vehicular repair expenses
would be covered by the rules of section 274(d). As to any other
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repairs, no substantiating evidence was presented. We sustain
respondent’s disallowance of this item.
g. Supplies. Petitioners purchased supplies such as window
washing solution and a compound used for removing materials stuck
to glass. Canceled checks submitted verify the purchase of
supplies on July 7, 1990, for $42.50. On this record and using
our best judgment, we allow petitioners a deduction for supplies
of $600. Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).
h. Taxes and licenses. Petitioner testified that he had to
purchase a municipal business license whenever JDB had to go into
a new municipality. Each license was valid for one year. We
kept the record open for petitioners to contact the various
municipalities to obtain substantiating documentation. Nothing
was received. On this record, we have no basis upon which to
estimate or allow a deduction for expenses for licenses. Vanicek
v. Commissioner, 85 T.C. 731 (1985).
i. Labor. We find that petitioners hired outside labor to
perform the services required. We also find that petitioners
performed some of the services themselves. Canceled checks for
such labor for the period June 26, 1990, through July 7, 1990,
totaled $2,890. Based upon this record, we allow petitioners a
deduction for labor of $10,000. Cohan v. Commissioner, supra.
The final issue to be decided is whether petitioners are
liable for an addition to tax pursuant to section 6651(a)(1).
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Section 6651(a)(1) imposes an addition to tax for failure to file
timely a tax return unless it is shown that such failure is due
to reasonable cause and not willful neglect. A taxpayer can
establish reasonable cause by showing that, despite the exercise
of ordinary care and prudence, the taxpayer was unable to file
the required tax return within the prescribed time. United
States v. Boyle, 469 U.S. 241, 246 (1985); Crocker v.
Commissioner, 92 T.C. 899, 913 (1989); sec. 301.6651-1(c)(1),
Proced. and Admin. Regs. Willful neglect has been defined as a
conscious, intentional failure or reckless indifference to timely
filing a return. United States v. Boyle, supra at 245.
Petitioners have the burden of proof. Rule 142(a).
It is undisputed that petitioners did not timely file their
individual tax return for taxable year 1990. Petitioners argue
that they had no expectation that any tax was due, because JDB’s
business was not profitable.
We conclude that petitioners have not met their burden of
proof. An unverified belief that no taxes are owing does not
constitute reasonable cause of the sort that will allow
petitioners to escape the addition to tax pursuant to section
6651(a)(1). Olsen v. Commissioner, T.C. Memo. 1993-432, and
cases cited therein. The question is not whether petitioners
thought that they owed tax, but whether they knew or should have
known that they needed to file a return. Jackson v.
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Commissioner, 864 F.2d 1521, 1527 (10th Cir. 1989), affg. 86 T.C.
492 (1986); Olsen v. Commissioner, supra. Consequently, we hold
that petitioners have not established reasonable cause for their
failure to file timely their 1990 tax return. Accordingly,
petitioners are liable for the section 6651(a)(1) addition to tax
relating to their tax liability for taxable year 1990.
To reflect the foregoing and the parties’ concessions,
Decision will be entered
under Rule 155.