William M. Hawkins and Laura C. Hawkins v. Commissioner

T.C. Summary 2003-154

UNITED STATES TAX COURT

WILLIAM M. HAWKINS AND LAURA C. HAWKINS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 11334-99S. Filed October 21, 2003.

William M. Hawkins, pro se.

Ronald T. Jordan, for respondent.

CARLUZZO, Special Trial Judge: This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed. Unless otherwise

indicated, subsequent section references are to the Internal

Revenue Code in effect for the years in issue. Rule references

are to the Tax Court Rules of Practice and Procedure. The

decision to be entered is not reviewable by any other court, and

this opinion should not be cited as authority.
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Respondent determined deficiencies in petitioners’ Federal

income taxes, additions to tax, and penalties as follows:

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

1992 $25,952 $5,929 $5,190
1993 5,914 870 1,183
1994 12,751 2,597 2,550

The issues for decision for each year in issue are: (1)

Whether petitioners underreported income; (2) whether petitioners

are entitled to depreciation deductions greater than those

respondent allowed; (3) whether petitioners are entitled to a

deduction for charitable contributions; (4) whether petitioners

had reasonable cause for their failure to file a timely Federal

income tax return; and (5) whether the underpayment of tax

required to be shown on petitioners’ Federal income tax return is

due to negligence.

Background

Some of the facts have been stipulated and are so found.

Petitioners are husband and wife. They filed an untimely Federal

income tax return for each year in issue. At the time the

petition was filed, they resided in Indianapolis, Indiana.

William M. Hawkins (petitioner) is an attorney. He has

practiced law since 1971 and did so as a sole practitioner during

the years in issue. Petitioners’ Federal income tax return for

each year in issue includes a Schedule C, Profit or Loss From

Business, on which income and expenses attributable to
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petitioner’s law practice are reported. Petitioner maintained a

checking account for his law practice (the business account),

kept individual client records, and saved receipts for expenses

incurred in his law practice. Otherwise he kept no formal books

of account or other accounting records to track income earned and

expenses incurred in his law practice.

Petitioners own numerous residential real estate properties

that were held for rent or rented during the years in issue (the

rental properties). Some of the rental properties were rented

pursuant to Federal or State rent subsidy programs. Petitioners’

Federal income tax return for each year in issue includes a

Schedule E, Supplemental Income and Loss, on which income and

expenses attributable to the rental properties are reported.

Petitioner used the business account to pay expenses incurred in

connection with the rental properties. He also saved expense

receipts. Other than the business account and the expense

receipts, petitioner kept no formal books of account or other

accounting records to track income earned and expenses incurred

in connection with the rental properties.

Petitioners also maintained a joint checking account during

the years in issue (the joint account). Expenses related to

petitioner’s law practice and the rental properties were not paid

from the joint account. However, some personal expenses were

paid with checks drawn on the business account.
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Petitioners’ joint 1992 Federal income tax return was filed

on April 19, 1995, their 1993 return was filed on April 16, 1996,

and their 1994 return was filed on April 16, 1997. Petitioner

prepared each of these returns. Items reported on the Schedules

C are summarized as follows:

Year Gross Income Total expenses Profit/(Loss)

1992 $28,850 $46,719 ($17,869)
1993 29,500 46,505 (17,005)
1994 24,500 45,318 (20,818)

Items reported on the Schedules E are summarized as follows:

Year Rents received Total expenses Income/(Loss)

1992 $85,820 $151,975 ($66,155)
1993 101,968 140,733 (38,765)
1994 128,216 120,482 7,734

The examination of petitioners’ returns began in March

1996.1 Petitioner failed to provide the revenue agent with all

of the documents that she requested from him. As best can be

determined from the record, the revenue agent did not issue any

summonses to petitioners or third parties. Business account bank

statements and canceled checks were provided to the revenue

agent, as was petitioner’s check register for the business

account. Petitioner also provided a check register for the joint

account, but the register included only entries made from April

through December 1992. The revenue agent concluded that

petitioners’ income could not be determined from the books and

1
Sec. 7491 is therefore inapplicable.
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records with which she was provided. She decided to reconstruct

petitioners’ income using the cash T-account method and computed

petitioners’ unreported income for each year in issue as follows:

Year Income per return Expenses Unreported income

1992 $171,718 $311,882 $140,164
1993 191,844 239,445 47,601
1994 180,735 215,195 34,460

Using a ratio derived from the incomes reported on the

Schedules C and E, the revenue agent allocated the unreported

income between those schedules as follows:

Year Schedule C Schedule E Total

1992 $35,041 $105,123 $140,164
1993 10,472 37,129 47,601
1994 5,514 28,946 34,460

The revenue agent relied on depreciation schedules that

were apparently created in connection with an examination of

petitioners’ returns for years preceding 1992 and brought the

schedules forward to the years in issue. As a result,

petitioners’ depreciation deductions were adjusted (reduced) as

follows:

Year Schedule C Schedule E Total

1992 $11,629 $13,239 $24,868
1993 11,916 14,105 26,021
1994 16,011 14,594 30,605

The revenue agent did not question the charitable

contribution deduction claimed for any year in issue.
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Respondent issued a notice of deficiency to petitioners on

March 19, 1999. For each year in issue, respondent: (1)

Increased petitioners’ income by the unreported income amount

listed above; (2) reduced depreciation deductions claimed on the

Schedule C and Schedule E; (3) made statutory adjustments to

petitioners’ self-employment tax, self-employment tax deduction,

and itemized deductions; (4) imposed an addition to tax for

petitioners’ failure to file a timely return; and (5) imposed an

accuracy-related penalty for negligence or disregard of rules or

regulations.

Discussion

Section 6001 requires a taxpayer to maintain sufficient

records to allow for the determination of the taxpayer’s correct

tax liability. Petzoldt v. Commissioner, 92 T.C. 661, 686

(1989). If a taxpayer fails to maintain or does not produce

adequate books and records, the Commissioner is authorized to

reconstruct the taxpayer’s income, sec. 446(b); Petzoldt v.

Commissioner, supra at 686-687, and it is well settled that

indirect methods may be used to do so, Holland v. United States,

348 U.S. 121 (1954). The Commissioner’s reconstruction need only

be reasonable in light of all the surrounding facts and

circumstances. Petzoldt v. Commissioner, supra at 687; Giddio v.

Commissioner, 54 T.C. 1530, 1533 (1970); Schroeder v.

Commissioner, 40 T.C. 30, 33 (1963).
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In this case, petitioners’ unreported income for each year

in issue was determined by use of the cash transactions method,

commonly referred to as a “cash T analysis”, which includes a

table with income items (debits) on the left side of the “T”

account and expenses (credits) on the right side of the “T”

account. See, e.g., Owens v. Commissioner, T.C. Memo. 2001-143.

This method in some ways resembles the source and application of

funds method. Balken v. Commissioner, T.C. Memo. 1994-375, affd.

without published opinion 72 F.3d 133 (8th Cir. 1995). Its

purpose is “to measure a taxpayer’s reported income against

expenditures to determine whether more was spent than was

reported.” Rifkin v. Commissioner, T.C. Memo 1998-180, affd.

without published opinion 225 F.3d 663 (9th Cir. 2000). The

suggestion is, of course, that the excess of expenditures over

reported income represents unreported income. Id.

According to respondent’s long-ago-published training

materials, the cash T-account analysis is used as a preliminary

to one of the more commonly used and more sophisticated indirect

methods of reconstructing a taxpayer’s income, such as the net

worth method, bank deposits method, source and application of

funds method, or specific item method. See, e.g., Rifkin v.

Commissioner, supra; 60 Stand. Fed. Tax Rept. (CCH) (1973).

In this case, petitioners’ failure to maintain adequate

books and records justified the use of an indirect method to
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reconstruct their income. According to petitioner, the excess of

expenditures over reported income for each year is accounted for

by a cash hoard that he maintained in a safe in his house. The

revenue agent rejected petitioner’s claim, and we do likewise.

See, e.g., Parks v. Commissioner, 94 T.C. 654, 663 (1990).

Rejecting petitioner’s cash hoard claim, however, does not

require us to accept respondent’s computation. Although we find

that respondent’s use of an indirect method is appropriate, the

analysis itself is not without problems. For example, the

revenue agent acknowledged that her analysis might have

overstated petitioners’ unreported income for each year insofar

as she included in her analysis expenditures that petitioners

paid by check, plus all itemized deductions, without adjusting

for duplications for those itemized deductions that were paid by

check.

Other problems exist with respect to the revenue agent’s

analysis. For example, her analysis for 1992 includes an

expenditure of $26,600 for new roofs for one or more of the

rental properties. With respect to this item, the revenue agent

relied on handwritten entries on the above-referenced

depreciation schedules but could not identify who made the

notations or why they were made. Petitioner denied that any

amount was expended for new roofs on any of his rental properties

during 1992, and we accept his testimony on the point.
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We are also troubled by assumptions the revenue agent made

on account of a lack of records from the joint account. The

check register that the revenue agent used covered only 9 months

of 1992. She averaged the monthly expenditures made during those

9 months and applied that amount to the 3 remaining months not

covered by the check register. She then applied the average

monthly expenditures for 1992 to 1993 and 1994. We consider this

inappropriate and unreasonable given that petitioners’ joint

checking account records could have been obtained from

petitioners’ bank.

On the other hand, we reject petitioner’s implausible claim

that the source of many of the expenditures included in the

revenue agent’s analysis was a cash hoard that he kept in a safe

in his residence. See De Venney v. Commissioner, 85 T.C. 927,

933 (1985) (“[T]he existence of a cash hoard is endlessly claimed

by taxpayers to explain the existence of otherwise unexplained

sources of funds. It is rare indeed that a taxpayer successfully

proves this contention.”). After careful consideration of the

record, we accept respondent’s analysis subject to the following

adjustments. For 1992, the following expenditures must be

eliminated from respondent’s cash T-account computation: (1)

Itemized deductions; (2) personal expenditures estimated through

the use of monthly averages; and (3) the $26,600 expenditure for

new roofs. For 1993 and 1994, personal expenditures determined
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with reference to checking account information from 1992 must be

eliminated from respondent’s computation.

Depreciation Deductions

Petitioners have failed to offer any evidence to contradict

respondent’s partial disallowance of their depreciation

deductions. Petitioner suggested he had depreciation schedules

that would support the allowance of those deductions and was

given ample time following trial to provide these schedules, but

he failed to do so. Respondent is sustained on this issue.

Charitable Contribution Deductions

Respondent disallowed the charitable contribution deduction

petitioners claimed for each year in issue. The revenue agent

testified that she did not question those deductions during the

examination of petitioners’ returns. Furthermore, the deductions

were taken into account in respondent’s cash T-account analysis.

On the basis of petitioner’s testimony, we find that petitioners

are entitled to the charitable contribution deductions as claimed

on their returns.

Section 6651 Addition to Tax

The failure to file a timely Federal income tax return

results in a mandatory addition to tax unless the taxpayer shows

that the failure was due to reasonable cause and not due to

willful neglect. Sec. 6651(a). The taxpayer bears the heavy

burden of proving both of these elements. United States v.
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Boyle, 469 U.S. 241, 245 (1985) (defining “willful neglect” as

the conscious, intentional failure or reckless indifference on

the part of the taxpayer to file a return, and “reasonable cause”

as the inability to file a return within the prescribed period of

time, despite having exercised ordinary business care and

prudence).

Petitioners failed to file a timely Federal income tax

return for each year. The record is nearly devoid of evidence

pertaining to this issue. When prompted by this Court to explain

the untimely filing of their returns, petitioner responded as

follows:

I’ll tell you exactly. Your Honor, I found that I was
paying more taxes than I was required to pay. And I,
negligence on my side, I began to ask for an extension
because I felt like this. You don’t have to pay penalty,
you don’t have to pay no late charge, as long as you have
money coming back. And you do it within three years.

There is no evidence that petitioners exercised reasonable

business care and prudence, and the above quote suggests that the

untimely filing of petitioners’ returns was due to petitioner’s

willful neglect. Petitioners have failed to carry their burden

of proof and respondent is sustained on this issue.

Section 6662 Penalty

Under section 6662, a penalty is imposed on that portion of

an underpayment of the tax required to be shown on a return if

the underpayment is due to negligence or disregard of rules or

regulations. Sec. 6662(a) and (b)(1). Negligence is defined to
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include any failure to make a reasonable attempt to comply with

the provisions of the Internal Revenue Code. Sec. 6662(c). It

is further defined as the failure to do what a reasonable person

with ordinary prudence would do under the same or similar

circumstances. Neely v. Commissioner, 85 T.C. 934, 947 (1985).

Disregard is defined to include any careless, reckless, or

intentional disregard. Sec. 6662(c). An accuracy-related

penalty will not be imposed with respect to any portion of an

underpayment as to which the taxpayer acted with reasonable cause

and in good faith. Sec. 6664(c)(1). Whether the taxpayer acted

with reasonable cause and in good faith depends on the pertinent

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

Circumstances that may indicate reasonable cause and good faith

include the extent of the taxpayer’s effort to properly assess

the tax liability and an honest misunderstanding of fact or law

that is reasonable in light of the taxpayer’s experience,

knowledge, and education. Id. The taxpayer bears the burden of

proving that he or she did not act negligently or disregard rules

or regulations. Rule 142(a); Welch v. Helvering, 290 U.S. 111,

115 (1933).

Petitioner is not an unsophisticated taxpayer but an

experienced attorney, licensed since 1971. He operates his own

law practice and owns approximately 18 investment properties.

This experience is relevant in deciding whether he acted
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negligently with respect to the underpayments of tax required to

be shown on petitioners’ returns. See Pelton & Gunther v.

Commissioner, T.C. Memo. 1999-339; Estate of Holland v.

Commissioner, T.C. Memo. 1997-302 (positions taken on return not

reasonable in light of the fact that one of the executors was an

experienced attorney). Furthermore, petitioners failed to

maintain adequate books and records from which their Federal

income tax liability could be established. See Sowards v.

Commissioner, T.C. Memo. 2003-180; Brodsky v. Commissioner, T.C.

Memo. 2001-240; sec. 1.6662-3(b)(1), Income Tax Regs. After

careful consideration of all pertinent facts and circumstances,

we find that petitioners did not act with reasonable cause and in

good faith and that the underpayments of tax required to be shown

on their returns are due to petitioners’ negligence. Respondent

is sustained on this issue.

Reviewed and adopted as the report of the Small Tax

Division.

To reflect the foregoing,

Decision will be

entered under Rule 155.