King v. Commissioner

T.C. Memo. 1999-293

UNITED STATES TAX COURT

FATAI O. AND MARY KING, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 10781-98. Filed September 1, 1999.

Fatai O. and Mary King, pro se.

Carol-Lynn E. Moran, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

RUWE, Judge: Respondent determined a deficiency of $11,450

in petitioners' 1994 Federal income tax and an accuracy-related

penalty pursuant to section 6662(a)1 of $2,290. The notice of

1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue, and
(continued...)
 - 2 -

deficiency was based on petitioners' joint amended 1994 income

tax return filed on December 6, 1996.

The issues for decision are: (1) Whether petitioners are

entitled to the following deductions claimed on Schedule C:

Robbery from PNC Bank, $9,540; lottery shortage, $11,744; car and

truck, $3,120; repairs and maintenance, $4,944; (2) whether

petitioners had unreported gross income of $11,667 from the sale

of a newsstand and unreported interest income of $227; and (3)

whether petitioners are liable for the accuracy-related penalty

under section 6662(a).2

FINDINGS OF FACT

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. Petitioners resided in

Wyndmoor, Pennsylvania, at the time they filed their petition.

During 1994, Mr. King owned King's Newsstand. Pennsylvania

State lottery tickets were sold at King's Newsstand. As a retail

distributor of Pennsylvania State lottery tickets, Mr. King was

required to set up a lottery bank account and to submit winning

1
(...continued)
all Rule references are to the Tax Court Rules of Practice and
Procedure.
2
Petitioners have not objected to respondent's
determinations regarding self-employment tax and a deduction
resulting from that tax.
 - 3 -

lottery tickets to lottery headquarters for verification. Once a

ticket has been verified, either the money is wired to the

retailer's lottery account to pay the winning ticket or the

Pennsylvania State lottery writes a check directly to the winner.

During 1994, Mr. King made a $9,540 cash deposit into his

lottery account with PNC Bank (PNC), and he subsequently learned

that his account was not credited with the deposit. As a result,

Mr. King hired an attorney and filed a complaint in 1994 against

PNC to recover the $9,540 missing deposit.3 On June 27, 1995, a

panel of arbitrators found in favor of Mr. King. Shortly

thereafter, PNC appealed the arbitration award. On March 12,

1996, the Common Pleas Court of Philadelphia, Pennsylvania, ruled

in favor of Mr. King and ordered PNC to reimburse him. As a

result, Mr. King was reimbursed in 1996.

During 1994, petitioners owned a Hyundai automobile. Mr.

King used the Hyundai to commute to work daily.

During 1993, Mr. King sold a newsstand located at 139 North

West Corner of Chelten Avenue in Philadelphia, Pennsylvania, for

$40,000. Under the terms of the sales agreement, Mr. King

received a $5,000 deposit in 1993 and monthly payments of $972.22

with zero percent interest for 36 months. As a result, Mr. King

received 12 monthly installment payments of $972.22 each for a

3
Because of a typographical error in the stipulation,
"$9,450" should be "$9,540."
 - 4 -

total of $11,666.64 in the taxable year 1994. Also during 1994,

petitioners received $160 of interest income from Mellon Bank and

$67 of interest income from PNC.

Petitioners timely filed their joint 1994 Federal income tax

return. On December 6, 1996, petitioners filed a Form 1040X,

Amended U.S. Individual Income Tax Return, for the taxable year

1994.4

OPINION

Schedule C Deductions

The first deduction at issue involves what petitioners

claimed was a robbery loss of $9,540. The claimed $9,540 loss

actually arose from a cash deposit that Mr. King made to his

lottery account with PNC that was not properly credited to his

account.

Deductions are a matter of legislative grace, and the burden

of showing the right to deductions is on the taxpayer. See Rule

142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).

4
We note that petitioners had confusing and inconsistent
positions regarding the amounts and their sources of gross income
in their initial income tax return and their amended tax return.
For instance, in their initial income tax return, under Schedule
C, petitioners indicated that they had $30,000 of gross receipts
from the sale of cigarettes, lottery (tickets), and newspapers.
Yet, petitioners indicated that their cost of goods sold was
zero. Furthermore, in their amended return, on Schedule C,
petitioners reported that Schedule C gross income was generated
from "other income", which consisted entirely of $48,460 in
lottery commissions. See appendix.
 - 5 -

Section 165(a) allows a deduction for any loss sustained in the

taxable year. However, before a loss may be claimed as a

deduction, it must be evidenced by a closed or completed

transaction. See United States v. S.S. White Dental

Manufacturing Co., 274 U.S. 398, 401 (1927); Ramsay Scarlett &

Co. v. Commissioner, 61 T.C. 795, 807 (1974), affd. 521 F.2d 786

(4th Cir. 1975); Applegate v. Commissioner, T.C. Memo. 1992-156;

sec. 1.165-1(b), Income Tax Regs.5 If a claim for reimbursement

exists and there is a reasonable prospect of recovery, the loss

is not deductible until it can be ascertained with reasonable

certainty whether reimbursement will be received. See Ramsay

Scarlett & Co. v. Commissioner, supra; sec. 1.165-1(d)(2)(i) and

(3), Income Tax Regs. In determining whether a taxpayer had a

reasonable prospect for reimbursement, the fact that the taxpayer

has filed a lawsuit to recover the loss gives rise to an

inference that he or she had such a prospect. See Ramsay

Scarlett & Co. v. Commissioner, supra at 812-813; see also Dawn

5
Sec. 1.165-1(b), Income Tax Regs., provides:

To be allowable as a deduction under section 165(a), a
loss must be evidenced by closed and completed
transactions, fixed by identifiable events, and, except
as otherwise provided in section 165(h) and §1.165-11,
relating to disaster losses, actually sustained during
the taxable year. Only a bona fide loss is allowable.
Substance and not mere form shall govern in determining
a deductible loss.
 - 6 -

v. Commissioner, 675 F.2d 1077 (9th Cir. 1982), affg. T.C. Memo.

1979-479.

Mr. King hired an attorney and filed a claim against PNC in

1994 for PNC's failure properly to credit his account. Mr. King

was prosecuting his claim with reasonable diligence in 1994, and

a substantial possibility existed that he would recover his money

from PNC. A panel of arbitrators ruled in favor of Mr. King in

1995, several months before he filed an amended tax return for

1994. Mr. King's claim was ultimately upheld by the Common Pleas

Court of Philadelphia, Pennsylvania, and he was reimbursed by

PNC. Because Mr. King had a reasonable prospect of recovery in

1994, petitioners are not entitled to the loss deduction on their

amended joint return for that year.

The second deduction at issue involves an alleged $11,744

lottery shortage. Petitioners argue that Mr. King was

responsible for paying off two winning lottery tickets with his

own money because one of his newsstand employees had lost the

winning tickets. Normally, the Pennsylvania Bureau of State

Lottery pays for winning lottery tickets by wiring money to the

retailer's lottery account. If the retailer pays the winning

ticket before the money is wired, then the retailer is reimbursed

from the lottery. Petitioners produced two checks drawn on Mr.

King's lottery bank account. Mr. King testified that those

checks were paid to two lottery winners because a former
 - 7 -

employee, whose last name he could not recall, accepted the

winning lottery tickets from the two customers and then lost the

tickets. Each check was for $7,500.

The question is whether the purpose of the checks was for

lottery winnings and, if so, whether Mr. King received the normal

reimbursement from the State Lottery Bureau. Petitioners did not

explain the difference between the amount of the claimed

deduction and the total amount of the two checks. Neither check

indicates that it represents lottery winnings. One check

contains a notation that it was for "Lic #4617(731) Pattison

Newsstand". The other check contains a notation that it was for

"Lic #16170(43) Oxford Newsstand". Except for Mr. King's

testimony,6 we have no other evidence of the purpose of the

checks or the source of the money used to cover the checks. On

the basis of this record, we find that petitioners have not

proven that they are entitled to this deduction.

6
We are not bound to accept Mr. King's testimony at face
value if it is improbable, unreasonable, or questionable. See
Geiger v. Commissioner, 440 F.2d 688 (9th Cir. 1971), affg. per
curiam T.C. Memo. 1969-159; Davis v. Commissioner, 88 T.C. 122,
140-141 (1987), affd. 866 F.2d 852 (6th Cir. 1989); Tokarski v.
Commissioner, 87 T.C. 74, 77 (1986); Nicholas v. Commissioner, 70
T.C. 1057, 1064 (1978).
 - 8 -

The third deduction concerns claimed car and truck expenses

of $3,120.7 The substantiation requirements under section 274

apply to passenger automobiles. See secs. 274(d)(4),

280F(d)(4)(A)(i).8 Normally, deductions for automobile expenses

are not allowed unless the taxpayer substantiates the deduction

through either adequate records or the taxpayer's own detailed

statement that is corroborated by sufficient evidence. See sec.

274(d)(4). At a minimum, the taxpayer must substantiate: (1)

The amount of the expense, (2) the time and place the expense was

incurred, and (3) the business purpose for an expenditure or use

with respect to listed property. See sec. 274(d); sec. 1.274-

5T(b)(6)(i), (iii), Temporary Income Tax Regs., 50 Fed. Reg.

46016 (Nov. 6, 1985).

7
Petitioners claimed expenses of $3,120 for car and truck,
$1,025 for insurance, and $2,935 for legal and professional
services in their amended return but nothing for the same items
in their original return. On the other hand, petitioners claimed
$250 for advertising expenses, $500 for office expenses, and
$17,500 for supplies in their original income tax return, while
claiming no deduction for advertising or office expenses and only
$171 for supplies in their amended return. See appendix.
8
Sec. 274(d)(4) provides, in part, that "No deduction or
credit shall be allowed * * * with respect to any listed property
(as defined in section 280F(d)(4))".

Sec. 280F(d)(4)(A)(i) provides that the "term 'listed
property' means * * * any passenger automobile".
 - 9 -

The "adequate records" standard requires that a taxpayer

maintain an account book, diary, log, statement of expense, trip

sheet, or other similar record that contains entries of

expenditures made at or near the time of the expenditure. In

addition, a taxpayer must supply documentary evidence, such as

receipts, paid bills, or similar evidence sufficient to support

an expenditure. See sec. 1.274-5T(c)(2)(i), (iii), Temporary

Income Tax Regs., 50 Fed. Reg. 46017, 46019 (Nov. 6, 1985).

Alternatively, taxpayers who are unable to satisfy the adequate

records requirement are still entitled to a deduction for

expenses that they can substantiate with other corroborative

evidence. See sec. 1.274-5T(c)(3), Temporary Income Tax Regs.,

50 Fed. Reg. 46020 (Nov. 6, 1985).

The only evidence offered to substantiate these expenses was

receipts for automobile repair bills totaling $2,708.48, a copy

of a $500 check dated January 8, 1995, with a notation on the

check indicating that it was used for car insurance on a "1986

Mercury Topez [sic]", and Mr. King's self-serving testimony.

Since Mr. King testified that the expenses he seeks to deduct

relate to the Hyundai, the check relating to the Mercury Topaz is

irrelevant.
 - 10 -

Mr. King testified that he used the Hyundai to pick up

newspapers but argues on brief9 that he sold only Pennsylvania

State lottery tickets at his newsstand.10 Additionally, Mr. King

could not recall whether he owned one or two automobiles in 1994

but testified that his family never used the Hyundai to visit the

doctor, go to church, or even to pick up groceries. Finally, Mr.

King testified that the Hyundai was used to commute to work

daily. We sustain respondent's disallowance, since petitioners

did not meet their burden of proof by providing either adequate

records or a detailed statement corroborated by sufficient

evidence to substantiate their deduction.

The fourth deduction concerns claimed repair and maintenance

expenses in the amount of $4,944. To document these repair and

maintenance expenditures, Mr. King presented three invoices with

an aggregate value of $5,950. However, petitioners claimed only

a $4,944 deduction and offered no explanation for the variance.

One of the invoices, a $4,500 invoice for concrete work, was not

admitted into evidence because petitioners failed to provide it

to respondent before trial, in accordance with this Court's

9
"The petitioners sells [sic] only Pennsylvania Lottery
[tickets] at the Newsstands. No candy, cigarettes or Newspapers
were sold at the Newsstands."
10
Petitioners' amended return reported that Schedule C
income was entirely from lottery commissions, while their
original return reported the source of Schedule C income from
"Newsstand - selling cigarettes, lottery [tickets], newspapers."
 - 11 -

pretrial order to produce all relevant documents.11 Even if the

invoice had been admitted into evidence, it would not have been

given weight since the date on the invoice appeared to have been

altered, and there was a question as to whether the same invoice

was used in a prior taxable year.

The second invoice, for $820, was from an awning company.

The invoice had been altered. The name and street address of a

person other than petitioners were crossed out and Mr. King's

name was printed above it, and the year of the invoice was also

partially crossed out. As evidence that he actually paid for the

$820 awning, Mr. King produced various checks amounting to

$2,172.26 and made payable to Discover and American Express,12

11
Before trial, petitioners were served with the Court's
Standing Pre-Trial Order requiring them to exchange any documents
that they expected to be used at trial with respondent at least
15 days before the first day of the trial session. Subsequently,
and on two separate occasions, respondent requested that
petitioners provide business record entries, canceled checks,
invoices, receipts, and other documentation to establish amounts
they paid for various Schedule C expenses and to verify amounts
they received from the installment sale of a newsstand. Because
of petitioners' failure to provide any of the requested
documentation, this Court ordered petitioners to comply with
respondent's request for production of documents. We note that
petitioners are not entirely unfamiliar with the Tax Court Rules
of Practice and Procedure. They filed a petition pro se in this
Court in 1996. In that case, this Court found petitioners'
records unreliable, and the Court of Appeals for the Third
Circuit affd. without published opinion. See King v.
Commissioner, T.C. Memo. 1998-69, affd. without published opinion
___ F.3d ___ (3d Cir., May 12, 1999).
12
The checks payable to Discover totaled $1,836.78, and the
(continued...)
 - 12 -

with a handwritten note on each check stating "newsstand awning".

Mr. King did not give any breakdown of those amounts, nor did he

provide a monthly statement from Discover or American Express

which presumably would have provided a breakdown of all the

charges on his Discover and American Express cards.

Finally, Mr. King produced an invoice from an acrylics

company for approximately $630 that does not contain a

description of what was sold. According to Mr. King, the invoice

represented the purchase of new candy racks, which are still

being used. However, in petitioners' brief, they argue that no

candy was sold at his newsstand. We also note that petitioners'

amended return reports that Schedule C income was entirely from

lottery commissions. Petitioners have not established their

entitlement to these claimed repair and maintenance deductions.13

Unreported Income

The next issue is whether petitioners had unreported income

of $11,667 from the sale of a newsstand and unreported interest

income of $227. Petitioners argue that the proceeds from the

sale of the newsstand were not omitted from their return, but

12
(...continued)
check payable to American Express was for $335.48.
13
We note that even if the expenses were substantiated, they
appear to be capital in nature, which would require
capitalization, absent a sec. 179 election.
 - 13 -

rather, were incorrectly reported as $14,067 in rental income in

petitioners' amended tax return.14

In general, section 61(a)(3) requires gains derived from the

sale of property to be included in gross income. Petitioners

failed to prove that they reported the $11,667 by incorrectly

including it in the $14,067 reported as rental income on their

amended return. Other than Mr. King's testimony that he made a

mistake, petitioners offered no evidence or explanation for the

difference in the amount realized from the newsstand sale during

1994 and the amount included under rental income. Petitioners

offered no evidence that they had a basis in the newsstand other

than zero. Therefore, we uphold respondent's determination that

petitioners had additional gross income of $11,667.15

Petitioners stipulated that they received $160 of interest

income from Mellon Bank and $67 of interest income from PNC Bank

during the taxable year 1994. Since these amounts were not

reported on their 1994 amended return, we sustain respondent's

adjustment increasing petitioners' income by these amounts.

14
Petitioners did not report any rental income in their
original income tax return.
15
Petitioners do not argue, nor do they provide sufficient
facts to establish, that the gain on the sale of the newsstand
qualifies for capital gain treatment, or that the gain would not
be subject to recapture under sec. 1245 or 1250.
 - 14 -

Accuracy-Related Penalty

The final issue is whether petitioners are liable for the

accuracy-related penalty under section 6662(a) for 1994. Section

6662(a) imposes a penalty in an amount equal to 20 percent of the

portion of the underpayment of tax attributable to a taxpayer's

negligence or any substantial understatement of income tax. See

sec. 6662(a) and (b)(1) and (b)(2).

Section 6662(c) provides that the term "negligence" includes

any failure to make a reasonable attempt to comply with the

provisions of this title, and the term "disregard" includes any

careless, reckless, or intentional disregard of rules or

regulations. The Commissioner's determination that a taxpayer

was negligent is presumptively correct, and the burden is on the

taxpayer to show lack of negligence. See Hall v. Commissioner,

729 F.2d 632, 635 (9th Cir. 1984), affg. T.C. Memo. 1982-337;

Marcello v. Commissioner, 380 F.2d 499, 506-507 (5th Cir. 1967),

affg. in part and remanding in part 43 T.C. 168 (1964); Bixby v.

Commissioner, 58 T.C. 757, 791 (1972). An understatement of tax

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

required to be shown on the return for the taxable year or

$5,000. See sec. 6662(d)(1)(A)(i) and (ii). The

accuracy-related penalty will apply unless petitioners can

demonstrate that there was reasonable cause for the underpayment
 - 15 -

and that they acted in good faith with respect to the

underpayment. See sec. 6664(c).

Petitioners failed to maintain adequate records.

Petitioners presented no evidence to show that they acted with

reasonable cause or good faith. Petitioners did not meet their

burden of proving that they were not negligent and that there was

no substantial understatement of income tax. Respondent's

deficiency determination of $11,450, which we uphold, exceeds 10

percent of the amount required to be shown on the return and is

more than $5,000. We, therefore, hold that petitioners are

liable for an accuracy-related penalty of 20 percent.

Decision will be entered for

respondent.
 - 16 -

APPENDIX

Original Return Amended Return

Gross receipts or sales $30,000 -0-

Cost of goods -0- -0-

Gross profit 30,000 -0-

Other income -0- $48,460

Gross income 30,000 48,460

Expenses:

Advertising $250 -0-

Car & truck -0- 3,120

Insurance -0- 1,025

Legal & professional -0- 2,935
service

Office expense 500 -0-

Repairs & maintenance 5,000 4,944

Supplies 17,500 171

Taxes & licences 200 910

Travel 2,500 -0-

Meals & entertainment1 1,000 -0-

1
Net of 50-percent limitation.