Cherry v. Commissioner

T.C. Memo. 1998-360

UNITED STATES TAX COURT

POLLY M. CHERRY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 25995-96. Filed October 5, 1998.

Polly M. Cherry, pro se.

Robert S. Bloink, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WELLS, Judge: Respondent determined deficiencies in,

additions to, and penalties on petitioner's Federal income taxes

as follows:

Additions to Tax and Penalties
Year Deficiency Sec. 6651(a)(1) Sec. 6654 Sec. 6662(a)

1993 $9,791 $1,373 $275 $1,958
1994 6,876 --- 175 1,375
 - 2 -

Unless otherwise indicated 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.

The issues we must decide in the instant case are whether

petitioner is: (1) Entitled to business expenses in the amount

of $19,412 for 1993 and business expenses in the amount of

$18,519 for 1994; (2) liable for tax on unreported income for the

years in issue; (3) entitled to personal exemptions for Jasmine

S. Wilson and Brandy N. Wilson (Jasmine and Brandy Wilson) as

dependents for the years in issue; (4) entitled to file her

returns for the years in issue using head of household rates; (5)

liable for self-employment tax pursuant to section 1401 for each

of the years in issue; (6) liable for the addition to tax under

section 6651(a) for failure to timely file her 1993 return; and

(7) liable for the accuracy-related penalty provided by section

6662(a) for each of the years in issue.

FINDINGS OF FACT

Some of the facts and certain exhibits have been stipulated

for trial pursuant to Rule 91. The parties' stipulations of fact

are incorporated by reference and are found as facts in the

instant case.

At the time she filed her petition, petitioner resided in

Albany, Georgia.
 - 3 -

For each of the years in issue, petitioner was a full-time

teacher. In addition to teaching, petitioner operated a store,

P&S Fashions (P&S Fashions), from a room attached to the rear of

her house. Petitioner also was involved in Eagle Marketing Inc.

(Eagle), a network market venture. Petitioner's responsibilities

for Eagle included traveling and recruiting others to become

Eagle representatives. For both 1993 and 1994, petitioner

combined her income from P&S Fashions and from Eagle and reported

it on a single Schedule C.

On July 7, 1994, the Flint River overflowed, flooding parts

of Albany, Georgia. The flood destroyed all of petitioner's

records for 1993 for both P&S Fashions and Eagle. Petitioner,

however, did retain some expense sheets for 1994, which cover 11

months of that year and detail mileage driven and amounts spent

on food and lodging during trips taken on behalf of Eagle.

During the years in issue, petitioner provided support for

Jasmine and Brandy Wilson, who lived with her. Jasmine and

Brandy Wilson attended Martin Luther King, Jr. Elementary School

which required emergency contact cards. The cards listed

petitioner as guardian for Jasmine and Brandy Wilson and

petitioner's address was listed as their home. The cards were

stored at the school. The Flint River flood, however, destroyed

many of the records of the school. Although petitioner found the

original emergency contact cards at the school, she concluded

that they were not fit for introduction to the Court. Petitioner
 - 4 -

hand-copied the information from the original cards onto blank

cards that she subsequently presented to the Court as evidence

that the children lived with her during 1993 and 1994.

Petitioner reported her income for 1993 on a Form 1040.

Respondent received that return on July 20, 1994, almost 3 months

after it was due. On the Schedule C attached to her 1993 return,

petitioner reported business income in the amount of $1,856.22

and claimed Schedule C deductions in the amount of $23,411.65.

Petitioner reported her income for 1994 on a timely filed Form

1040. On the Schedule C attached to her 1994 return, petitioner

reported business income in the amount of $4,509 and claimed

Schedule C expenses in the amount of $22,518. Petitioner

completed Form 4822, Statement of Annual Estimated Personal and

Family Expenses (Form 4822), on which she listed total estimated

personal and family expenses for 1993 in the amount of $43,729.56

and total estimated personal and family expenses for 1994 in the

amount of $40,066.92.

Pam Ranew, a tax auditor with the Albany office of the

Internal Revenue Service, audited petitioner's 1993 and 1994

income tax returns. During the course of the audit, Ms. Ranew

reconstructed petitioner's income and expenses for both 1993 and

1994 by adding (1) petitioner's salary from teaching, (2) her

stated Schedule C income, and (3) her Federal and State tax

refunds. To reconstruct petitioner's expenses, Ms. Ranew added

(1) petitioner's Schedule C purchases and expenses, (2) expenses
 - 5 -

petitioner recorded on Form 4822, and (3) her State tax, FIT, and

FICA withheld from petitioner's salary and subtracted the amounts

petitioner claimed as Schedule C deductions for depreciation and

mileage. According to Ms. Ranew's calculations, petitioner's

expenses exceeded her income by $22,696 in 1993 and $14,021 in

1994.

During the audit, petitioner explained to Ms. Ranew that the

reason she was able to fund expenses in excess of her total

income from all sources was that she had received loans in 1993

and in 1994 from her sister, Mrs. Berry, and from a family friend

Mr. Lewis Peavy (Mr. Peavy). Ms. Ranew contacted both Mrs. Berry

and Mr. Peavy, but neither of them provided Ms. Ranew with any

further details as to the amount or dates of those loans and

neither of them testified at trial.

Subsequently, respondent issued a notice of deficiency

determining deficiencies in petitioner's Federal income taxes in

the amounts of $9,791 for 1993 and $6,876 for 1994. Excepting a

$4,000 deduction for business mileage, respondent disallowed all

of petitioner's claimed business expenses for 1993. Respondent

conceded by stipulation that, for the 1993 taxable year,

petitioner was entitled to additional deductions in the amounts

of $1,089 for Eagle office rent and $111.37 for sales tax paid.

Similarly, respondent disallowed all of petitioner's claimed

business expenses for 1994 with the exception of a $4,000

deduction for business mileage. Respondent conceded by
 - 6 -

stipulation that for the 1994 taxable year petitioner was

entitled to an additional deduction of $1,089 for Eagle office

rent.

In the notice of deficiency, respondent determined that

petitioner had Schedule C income in the amount of $24,552 for

1993, which, at trial, respondent conceded would be adjusted

downward so as not to include any disallowed Schedule C expenses.

Similarly, respondent determined that petitioner had Schedule C

income in 1994 in the amount of $18,530, which, at trial,

respondent conceded would be adjusted downward so as not to

include any disallowed Schedule C expenses. Additionally,

respondent conceded at trial that petitioner received $2,200 in

signatory loans during 1993 and 1994.

Respondent also determined that Jasmine and Brandy Wilson

were not the dependents of petitioner during 1993 and 1994 and,

accordingly, denied petitioner's claims to personal exemptions

for them. Additionally, respondent determined that petitioner

was not entitled to file her returns for the years in issue using

head of household rates.

Respondent also determined a deficiency in petitioner's

self-employment taxes for 1993 in the amount of $2,997, and

accorded her a corresponding income tax deduction in the amount

of $1,498. For 1994, respondent determined a deficiency in

petitioner's self-employment taxes in the amount of $1,776, and
 - 7 -

accorded her a corresponding income tax deduction in the amount

of $888.

Respondent further determined that petitioner was liable for

additions to tax and penalties arising from her 1993 and 1994

returns. For 1993, respondent determined that petitioner owed

$1,373 pursuant to section 6651(a)(1) for failure to file a

timely return, and $1,958 pursuant to section 6662(a) as an

accuracy-related penalty. For 1994, respondent determined that

petitioner owed $1,375 pursuant to section 6662(a) as an

accuracy-related penalty.1

OPINION

Disallowed Deductions

Mileage

The largest deductions claimed by petitioner on her Schedule

C's for the years in issue were $13,160 for mileage driven in

1993 and $13,050 for mileage driven in 1994. Respondent

determined that petitioner failed to substantiate her mileage

deductions as required by section 274(d) and, therefore, limited

the deduction to $4,000 for mileage for each of the years in

issue. Subject to respondent's concessions, we sustain

respondent's determination for 1993 in toto. For 1994, we

sustain respondent's determination only in part.

1
In addition, respondent determined that petitioner owed,
pursuant to sec. 6654, $275 in 1993 and $175 in 1994 for failure
to pay estimated taxes. Because petitioner filed income tax
returns for both years this Court has no jurisdiction and does
not consider these additions to tax. See sec. 6665(b)(2).
 - 8 -

Deductions are a matter of legislative grace, and 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, 440 (1934).2 Taxpayers must also substantiate the

amount and purpose of the item claimed. Hradesky v.

Commissioner, 65 T.C. 87, 89-90 (1975), affd. per curiam 540 F.2d

821 (5th Cir. 1976). Taxpayers are required to maintain records

that are sufficient to enable the Commissioner to determine their

correct tax liability. See sec. 6001; Meneguzzo v. Commissioner,

43 T.C. 824, 831-832 (1965); sec. 1.6001-1(a), Income Tax Regs.

Under certain circumstances, however, if a taxpayer establishes

the entitlement to a deduction but does not establish the amount

of the deduction, the Court may estimate the amount allowable,

Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930), if

the taxpayer provides some rational basis on which an estimate

may be made. Vanicek v. Commissioner, 85 T.C. 731, 742-743

(1985).

For deductions arising from business travel, meals,

entertainment, and use of listed property defined in section

2
This case was decided without considering the changes in
burden of proof arising out of the Internal Revenue Service
Restructuring & Reform Act of 1998 (RRA 1998), Pub. L. 105-206,
sec. 3001, 112 Stat. 685, 726-727, because those changes apply
only "to court proceedings arising in connection with
examinations commencing after the date of the enactment of this
Act." RRA of 1998 was enacted on July 22, 1998.
 - 9 -

280F(d)(4),3 however, section 274(d) requires taxpayers to

substantiate:

by adequate records or by sufficient evidence
corroborating the taxpayer's own statement (A) the
amount of such expense or other item, (B) the time and
place of the travel, entertainment, amusement,
recreation, or use of the facility or property, or the
date and description of the gift, (C) the business
purpose of the expense or other item * * *

Section 274(d) is an exception to the Cohan rule and

prohibits the estimation of such 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).

For deductions involving the use of listed property, the

Commissioner is authorized to establish mileage allowances that

are deemed to satisfy the substantiation requirements as to

amount. Sec. 1.274(d)-1, Income Tax Regs. The specific mileage

allowance for 1993 was 28 cents a mile. Rev. Proc. 92-104, 1992-

2 C.B. 583, 584. The specific mileage allowance for 1994 was 29

cents a mile. Rev. Proc. 93-51, 1993-2 C.B. 593, 594. Time and

place of the mileage expense can be substantiated by a

"contemporaneous log of business mileage or by otherwise

establishing a taxpayer's business travel." Smith v.

Commissioner, 80 T.C. 1165, 1173 (1983). Business purpose may be

3
Sec. 280F(d)(4) defines listed property to include passenger
automobiles.
 - 10 -

ascertained from surrounding facts and circumstances. Id.; sec.

1.274-5(c)(2)(ii)(B), Income Tax Regs.

In the instant case, petitioner did not produce any records

for travel taken during 1993. Rather, petitioner testified that

all of her records for 1993 were destroyed in the Flint River

flood on July 7, 1994. Section 1.274-5T(c)(5), Temporary Income

Tax Regs., provides a limited exception to the heightened

substantiation requirement under section 274(d):

Where the taxpayer establishes that the failure to
produce adequate records is due to the loss of such
records through circumstances beyond the taxpayer's
control, such as destruction by fire, flood,
earthquake, or other casualty, the taxpayer shall have
a right to substantiate a deduction by reasonable
reconstruction of his expenditures or use.

Taxpayers whose records are lost due to casualty must

reasonably reconstruct them to gain the benefits of the

deduction. Gizzi v. Commissioner, 65 T.C. 342, 345-346 (1975).

In the instant case, although petitioner has shown that her

records were lost in the Flint River flood, she made no attempt

to reconstruct those records for 1993. Consequently, the record

contains no basis on which the Court can allow a deduction for

1993 beyond the amounts respondent has allowed.

As to 1994, petitioner has submitted 11 months of expense

sheets detailing dates, destinations, mileage driven, and, in

most cases, the purpose of the trip by petitioner during such

period. We conclude that the expense sheets, together with

petitioner's testimony at trial, sufficiently substantiate
 - 11 -

16,125.69 miles traveled in petitioner's vehicles for Eagle

during 1994. Petitioner offered no additional evidence to

substantiate the remaining 28,874.31 miles that she claimed in

computing her deduction. Consequently, we hold that petitioner

is entitled to a further deduction for 1994 only to the extent

that a mileage deduction computed on the basis of 16,125.69 miles

exceeds the amount already allowed by respondent as a deduction

for business mileage.

Meals and Travel

On the Schedule C attached to her 1993 return, petitioner

claimed $1,380 as a deduction for travel, meals, and

entertainment. Respondent denied those deductions for lack of

substantiation under section 274(d). As with her claimed mileage

for 1993, petitioner claims that all of her 1993 records were

destroyed by the Flint River flood. Although the destruction

caused by the flood excuses petitioner from certain of the

rigorous requirements of section 274(d), petitioner failed to

make a reasonable reconstruction of those records pursuant to

section 1.274-5T(c)(5), Temporary Income Tax Regs, supra.

Consequently, we cannot allow her a deduction for those expenses.

On the Schedule C attached to her 1994 return, petitioner

claimed $803 as a deduction for travel, meals, and entertainment.

Section 1.274-5T(c)(2)(iii), Temporary Income Tax Regs., 50 Fed.

Reg. 46019 (Nov. 6, 1985), provides:

(iii) Documentary evidence. Documentary evidence,
such as receipts, paid bills, or similar evidence
 - 12 -

sufficient to support an expenditure shall be required
for--

(A) Any expenditure for lodging while
traveling away from home, and

(B) Any other expenditure of $25 or more,
except, for transportation charges, documentary
evidence will not be required if not readily
available.

Petitioner introduced no documentary evidence to

substantiate any of these claimed deductions. Although the

expense sheets submitted for 1994 include records of some meals

which cost petitioner less than $25, petitioner failed to

introduce any evidence reflecting the meals for which petitioner

claimed a deduction. Accordingly, we sustain respondent on such

deductions. Sec. 274(d); sec. 1.274-5T(a), Temporary Income Tax

Regs., 50 Fed. Reg. 46014 (Nov. 6 1985).

Remaining Deductions

Petitioner also claimed deductions for other business

related expenses in the amount of $8,871.65 for 1993 and

$7,600.36 for 1994. Respondent denied such deductions because

petitioner failed to substantiate them. By stipulation,

respondent conceded that petitioner was entitled to deduct

$1,200.37 in 1993 for Eagle office rent and sales tax paid and

$1,089 in 1994 for Eagle office rent.

Because the remaining expenses are for items not covered by

section 274, we are permitted to estimate them if we are

convinced from the record that the taxpayer has incurred such

expenses. Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).
 - 13 -

For the Court to make such estimation "there [must] be sufficient

evidence to satisfy the trier that at least the amount allowed in

the estimate was in fact * * * incurred, for the stated purpose".

Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957);

Vanicek v. Commissioner, 85 T.C. at 742-743.

Petitioner produced only a few isolated receipts to

substantiate her remaining deductions and called no witnesses to

support her claim to those deductions. Petitioner herself did

not testify with regard to those expenses. Accordingly, there is

no reasonable basis for the Court to estimate the amount of

expenses incurred. Vanicek v. Commissioner, supra at 742-743.

Consequently, we deny those additional deductions.

Unreported Income

In determining the amount of the deficiencies for 1993 and

1994, respondent reconstructed petitioner's income using the

source and application of funds method, or cash method.4

If a taxpayer's books and records are inadequate for the

purpose of ascertaining the taxpayer's income, the Commissioner

is authorized to reconstruct the taxpayer's income by whatever

method will clearly reflect income. Sec. 446; Petzoldt v.

Commissioner, 92 T.C. 661, 686-687 (1989). The cash method is

designed to reconstruct the income of a taxpayer who consumes his

income during the year and does not invest it. Id. at 694. It

4
This method has been referred to by both names. See
DeVenney v. Commissioner, 85 T.C. 927, 930 (1985).
 - 14 -

is based on the assumption that the amount by which a taxpayer's

expenditures during a taxable year exceed his reported income has

taxable origins unless the taxpayer can show that the

expenditures were made from nontaxable sources. DeVenney v.

Commissioner, 85 T.C. 927, 930-931 (1985). A proposed deficiency

based on the use of the source and application of funds method is

presumed correct, and the taxpayer bears the burden of showing

that the reconstruction of income through such method does not

accurately reflect income. Price v. United States, 335 F.2d 671,

677-678 (5th Cir. 1964). To meet his burden, the taxpayer must

prove either that someone else made the expenditures or that the

funds used were obtained from nontaxable sources such as loans,

inheritances, or assets on hand at the beginning of the taxable

period. DeVenney v. Commissioner, supra at 931

In Holland v. Commissioner, 348 U.S. 121 (1954), the Supreme

Court limited the Commissioner's use of the net worth method of

restructuring income by requiring the Commissioner to track down

relevant leads furnished by the taxpayer which are reasonably

susceptible of being checked and by requiring the Commissioner to

show that increases in net worth are attributable to currently

taxable income. In DeVenney v. Commissioner, 85 T.C. at 931, we

held that such limitations were applicable to cases involving the

cash method. In Meier v. Commissioner, 91 T.C. 273, 296 (1988),

however, we stated that "Before the safeguards in Holland are

triggered, the [taxpayer] must either explain the source of or
 - 15 -

provide alternative nontaxable sources for the discrepancy in his

expenditures and his reported income. This explanation commences

respondent's investigative requirements under Holland."

By comparing petitioner's known income with her stated and

known expenditures, respondent determined that petitioner had

$22,696 of unreported income for 1993 and $14,021 of unreported

income for 1994. At trial, respondent conceded that a proper

reconstruction of petitioner's income would not include any

deductions claimed by petitioner but disallowed by respondent.

Petitioner testified that the reason her expenditures

exceeded her stated earnings was because of loans she received.

At trial, respondent conceded that petitioner received $2,200 in

signatory loans. Petitioner argues that the balance of the loans

were personal loans received from her sister, Mrs. Berry and from

a friend Mr. Peavy. Ms. Ranew contacted both Mrs. Berry and Mr.

Peavy, neither of whom provided Ms. Ranew with any further

details as to the amount or dates of the loans. Respondent

argues that petitioner's two businesses, P&G Fashions and Eagle,

were the sources of taxable income.

We conclude that respondent has fulfilled the requirement of

Holland v. Commissioner, supra. Respondent contacted Mrs. Berry

and Mr. Peavy thereby satisfying the requirement that leads to

sources of nontaxable income supplied by the taxpayer be tracked

down. By pointing to P&S Fashions and petitioner's Eagle
 - 16 -

activities, respondent has pointed to likely sources of taxable

income.

At trial, petitioner neither provided documentary evidence

of the loans from Mrs. Berry or Mr. Peavy nor called them to

testify regarding those loans. Accordingly, petitioner has

failed to prove that the funds used to pay the excess of expenses

over known income are from a nontaxable source. Consequently,

respondent's position regarding petitioner's unreported income is

sustained.

Dependent Exemptions

Petitioner claimed a personal exemptions on behalf of

Jasmine and Brandy Wilson as dependents on both her 1993 and her

1994 returns. Respondent denied the exemptions. Section 151

allows a taxpayer to claim an exemption for each dependent.

Section 152 defines a dependent as:

any of the following individuals over half of whose
support, for the calendar year in which the taxable
year of the taxpayer begins, was received from the
taxpayer (or is treated under subsection (c) or (e) as
received from the taxpayer):

* * * * * * *

(9) An individual (other than an individual who
at any time during the taxable year was the spouse,
determined without regard to sec. 7703, of the
taxpayer) who, for the taxable year of the taxpayer,
has as his principal place of abode the home of the
taxpayer and is a member of the taxpayer's household.

A taxpayer claiming an exception for a dependent bears the

burden of showing that the support he provided to the dependent

constituted more than one-half of the total support of the
 - 17 -

claimed dependent. Cobb v. Commissioner, 28 T.C. 595, 597

(1957). To fulfill that burden, the taxpayer must establish not

only what he contributed toward the dependent's support, but also

must show, in some way, that the support given by the taxpayer

exceeded one-half of the dependent's total support. Vance v.

Commissioner, 36 T.C. 547, 549 (1961). If the taxpayer fails to

introduce any evidence regarding the total amount of the support

received by the dependent for the taxable year, the Court cannot

conclude that the taxpayer has contributed more than one-half of

the dependent's total support. Stafford v. Commissioner, 46 T.C.

515, 518 (1966).

Petitioner produced no evidence to show how much support she

provided for Jasmine and Brandy Wilson. Petitioner also failed

to produce any evidence as to their total support. Accordingly,

petitioner has not carried her burden of proof. Consequently,

respondent's position regarding the dependency exemptions is

sustained.

Head of Household Filing

Respondent denied petitioner head of household filing status

for 1993 and 1994. The relevant portions of section 2(b)

provide:

(b) Definition of Head of Household

(1) In general.--For purposes of this subtitle, an
individual shall be considered a head of a household if
and only if, such individual is not married at the
close of his taxable year * * *, and either--
 - 18 -

(A) maintains as his home a household which
constitutes for more than one-half of such taxable year
the principal place of abode, as a member of such
household,
of--

* * * * * * *

(ii) any other person who is a dependent of
the taxpayer, if the taxpayer is entitled to a
deduction for the taxable year for such person
under section 151 * * *

Because we have found that petitioner has failed to prove

that Jasmine and Brandy Wilson were the dependents of petitioner

during the years in issue we find that petitioner is not entitled

to file as a head of household for those years.

Petitioner's Liability for Self-Employment Tax

Section 1401 provides that a tax shall be imposed on the

self-employment income of every individual. Petitioner has the

burden of proving that she is not liable for self-employment

taxes. Rule 142(a). Petitioner has failed to offer any evidence

or make any arguments that she is not liable for self-employment

taxes. Consequently, we hold that petitioner is liable for self-

employment taxes.

Petitioner's Failure To File Timely Her 1993 Return

Respondent determined that petitioner was liable for the

addition to tax provided by section 6651(a) for 1993. Where a

taxpayer fails to file an income tax return on the date

prescribed for filing, section 6651(a)(1) imposes an addition to

tax equal to 5 percent of the amount required to be shown on the

return, with an additional 5 percent to be added for each
 - 19 -

additional month or partial month during which the failure

continues, not exceeding 25 percent in the aggregate. The

addition to tax does not apply where the taxpayer demonstrates

that the failure to file timely was due to reasonable cause and

not willful neglect. Sec. 6651(a)(1). The question whether a

failure to file timely is due to reasonable cause and not willful

neglect is one of fact, on which petitioner bears the burden of

proof. Rule 142(a); Lee v. Commissioner, 227 F.2d 181, 184 (5th

Cir. 1955), affg. a Memorandum Opinion of this Court.

Petitioner has produced no evidence explaining the late

filing of her 1993 return. Accordingly, we hold that petitioner

is liable for the section 6651 addition to tax.

Accuracy-Related Penalty

Respondent determined that petitioner is liable for an

accuracy-related penalty pursuant to section 6662. Section

6662(a) imposes a 20-percent penalty on the portion of an

underpayment of tax that is attributable to, inter alia,

negligence or disregard of rules or regulations. The term

"negligence" includes any failure to make a reasonable attempt to

comply with the provisions of the Code, including failure to

exercise due care, failure to do what a reasonable person would

do under the circumstances, or failure to keep adequate books and

records to substantiate items properly. Sec. 1.6662-3(b)(1),

Income Tax Regs. The term "disregard" includes any careless,

reckless or intentional disregard of the Code or of the temporary
 - 20 -

and final regulations issued pursuant to the Code. Sec. 6662(c);

sec. 1.6662-3(b)(2), Income Tax Regs.

The accuracy-related penalty does not apply to any portion

of an underpayment with respect to which it is shown that there

was a reasonable cause and that the taxpayer acted in good faith.

Sec. 6664(c)(1). The decision as to whether the taxpayer acted

with reasonable cause and in good faith depends on all pertinent

facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs.

The most important factor is the extent of the taxpayer's efforts

to assess the proper tax liability. Id. Circumstances that may

indicate reasonable cause and good faith include an honest

misunderstanding of fact or law that is reasonable in light of

the experience, knowledge, and education of the taxpayer. Id.

Petitioner bears the burden of proof. Rule 142(a); ASAT Inc. v.

Commissioner, 108 T.C. 147, 175 (1997).

As to the disallowed deductions for 1993 and 1994,

petitioner failed to prove that her lack of substantiation was in

good faith or due to reasonable cause. Similarly, petitioner

failed to show that she acted in good faith and due to reasonable

cause in underreporting her income for both years in issue.

Therefore, we hold that an accuracy-related penalty attributable

to such amounts is appropriate.

However, we hold that the accuracy-related penalty does not

apply to the portion of the underpayment attributable to

petitioner's claimed exemption on behalf of Jasmine and Brandy
 - 21 -

Wilson. Petitioner testified to her support of the children and

went to great lengths to show that they, in fact, lived with her

during 1993 and 1994. Although petitioner failed to satisfy her

burden of proof as to how much support she provided the children

in relation to their total support they received, given that she

has no technical training in the tax law we think her failure was

due to an honest misunderstanding of the law. Consequently, to

the extent the understatement of tax was based on such claimed

exemptions, we hold that petitioner is not liable for the

accuracy-related penalty pursuant to sec. 6662(a).

To reflect the foregoing,

Decision will be entered

under Rule 155.