McCARRON v. COMMISSIONER

T.C. Summary Opinion 2004-13

UNITED STATES TAX COURT

JAMES J. McCARRON III AND MICHELLE McCARRON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8383-00S. Filed February 9, 2004.

James J. McCarron III, pro se.

Richard A. Stone, for respondent.

DEAN, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time that the petition was filed. Unless otherwise

indicated, subsequent 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 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 for failure to file, and accuracy-

related penalties as follows:

Addition to Tax Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)

1993 $16,305 $3,668.63 $3,261.00
1994 13,875 3,492.30 2,775.00
1995 11,689 -0- 2,337.80

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

received unreported income during 1993, 1994, and 1995; (2)

whether petitioners are entitled to deductions on Schedule A,

Itemized Deductions, and deductions on Schedule C, Profit or Loss

From Business, for 1993, 1994, and 1995 in excess of those

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

earned income credits for 1993, 1994, and 1995; (4) whether

petitioners are liable for additions to tax for 1993 and 1994 for

failure to file timely returns; and (5) whether petitioners are

liable for accuracy-related penalties for 1993, 1994, and 1995.

Background

The stipulation of facts and the exhibits received into

evidence are incorporated herein by reference. Petitioners

resided in Silver Spring, Maryland, at the time the petition was

filed.

1
The amounts of any liabilities for and deductions of self-
employment taxes depend on the resolution of the other issues in
this case.
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At trial, respondent moved to dismiss the case as to

petitioner Michelle McCarron for failure to prosecute. Mrs.

McCarron did not sign the stipulation of facts or appear at the

trial on her own behalf. The Court will grant respondent's

motion to dismiss Mrs. McCarron for lack of prosecution. The

Court will enter a decision in this case in an amount that will

apply to both Mr. and Mrs. McCarron. See Estate of Mason v.

Commissioner, 64 T.C. 651, 652 (1975), affd. 566 F.2d 2 (6th Cir.

1977).

Mr. McCarron was a tax return preparer and stockbroker

during the years in issue. Mrs. McCarron did temporary work

during 1993 through 1995 and was a horse riding instructor during

1995.

Petitioners failed to file timely their tax returns for

1990, 1991, and 1992. As a result, those tax years were selected

for examination as part of the Nonfiler Initiative pertaining to

tax return preparers.

The examination revealed petitioners had unreported income

of $620 in 1990, $8,124 in 1991, and $10,073 in 1992. In those

years petitioners also had unexplained bank deposits of $14,214,

$7,988, and $9,676, respectively. The examination of the returns

at issue here, for 1993, 1994, and 1995, commenced as a

continuation of the earlier examination.
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Petitioners filed delinquent income tax returns for 1993 and

1994. The 1993 return was filed on December 19, 1996, and the

1994 return was filed on June 10, 1996. Petitioners' 1995 return

was timely filed. Attached to each return was a Schedule A and

Schedules C. Petitioners reported adjusted gross income of

$18,731, $16,756, and $17,353 for 1993, 1994, and 1995,

respectively.

A. Examination of Petitioners' Tax Returns

In a letter dated November 1, 1996,2 petitioners were

informed that respondent was proceeding with the examination of

their 1993 tax year, for which a return had not yet been filed.

Additionally, the examination had been expanded to include the

Forms 1040, Individual Income Tax Return, they filed for 1994 and

1995. Forms 4564, Information Document Request (IDRs), were

enclosed with the letter. Because of the audit results of

petitioners' prior years, unreported income and the lack of

substantiation of business deductions were significant areas of

inquiry.

Mr. McCarron (petitioner) met with respondent on December

19, 1996, and presented an original delinquent return for 1993

for filing. Petitioner did not have any documentation used in

2
Sec. 7491, which shifts the burden of proof to the
Secretary in certain circumstances, is inapplicable to this case.
See Warbelow's Air Ventures, Inc. v. Commissioner, 118 T.C. 579,
582 n.8 (2002) (sec. 7491 is effective for court proceedings
arising in connection with examinations commencing after July 22,
1998), affd. 80 Fed. Appx. 16 (9th Cir. 2003).
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calculating the income and deductions shown on the return or any

of the information requested in the IDRs. Petitioners also

failed to provide information for their 1994 or 1995 return.

Respondent issued a notice of deficiency for 1993, 1994, and

1995 in which various adjustments were made to petitioners'

income and deductions and additions to tax and penalties were

determined.

B. Petitioners' Income

Petitioners held bank accounts at Sandy Spring National Bank

(Sandy Spring) during 1993 through 1995 and at John Hanson

Savings Bank (John Hanson) during 1993 and 1994. Respondent

conducted a bank deposits analysis to determine: (1) The amount

of fees petitioner received in connection with his Schedule C

business as a tax return preparer; (2) which checks petitioner

received in connection with his Schedule C business activities as

a stockbroker; and (3) the identity of other unexplained

deposits.

Using the Internal Revenue Service's (IRS) Return Preparer

Listing Information Database, respondent compiled a report of the

individual income tax returns bearing petitioner's Social

Security number and identifying him as the paid return preparer

during the years in issue. The database revealed that petitioner

prepared individual returns in each year as follows:
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1993 143 returns
1994 139 returns
1995 236 returns

Petitioner gave respondent information indicating that he

had prepared returns as follows:

1993 82 returns
1994 76 returns
1995 66 returns

Respondent compared the IRS database listing to the

corresponding deposits of fees into petitioners' bank accounts

and identified an additional 69 returns prepared by petitioner in

1995 alone. Ten of those returns were business returns which

would not have appeared in the IRS database. For tax year 1995,

at least 111 returns and their related preparation fees were not

identified as having been deposited, in whole or in part.

Respondent determined petitioners had omitted gross receipts

received from petitioner's Schedule C tax return preparation

business of $10,885 for 1993, $12,247 for 1994, and $14,135 for

1995.

After reducing total unexplained bank deposits by unreported

fees identified by respondent as well as income reported on Forms

W-2, Wage and Tax Statement, and Forms 1099-MISC, Miscellaneous

Income, respondent's analysis determined petitioners had

remaining unexplained bank deposits as follows:

1993 $24,508
1994 26,300
1995 12,095
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Petitioner failed to provide any documentation proving that these

deposits were from nontaxable sources.

During 1993 and 1994, petitioner also worked for Mr. Ragnar

Sundstrom preparing tax returns. Mr. Sundstrom filed Forms 1099-

MISC for payments he made to petitioner for services rendered.

During 1993, petitioner received two additional checks from

Mr. Sundstrom totaling $7,772.03: Check No. 4307 for $3,000 and

check No. 4315 for $4,772.03 (the Sundstrom payments). The

notation on check No. 4307 states "friendship". The notation on

check No. 4315 states "Bal of friendship payment".

Petitioner contends the Sundstrom payments were loans, but

he never gave respondent any evidence or documentation to support

his claim. Further, petitioner did not take any action to

produce Mr. Sundstrom to testify about the nature of the

payments.

C. Petitioners' Deductions and Credits

Petitioners claimed itemized deductions as follows:

1993 1994 1995

Real estate taxes $1,715 $1,687 $1,734
Home mortgage interest 5,237 4,866 4,337
Cash charitable contributions 190 310 215
Noncash charitable contributions -0- -0- 500
Total 7,142 6,863 6,786
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Respondent limited petitioners deductions for cash

charitable contributions to those amounts evidenced by canceled

checks as follows:

1993 $75
1994 10
1995 60

For the $500 noncash charitable contribution claimed on

their 1995 return, petitioners submitted documentation consisting

of a Salvation Army receipt for one refrigerator and four bags of

clothes. Petitioners attributed a value of $500 to the total

contribution. Respondent reduced the value of the contribution

to $350: $150 for the refrigerator and $50 for each bag of

clothes.

The reduction of the charitable contribution deduction for

1995 reduced petitioners' total itemized deductions to $6,481.

The standard deduction for joint filers in 1995 was $6,550.

Respondent applied the higher amount of the standard deduction in

calculating the tax due for 1995.

Additionally, petitioners claimed various deductions on

their 1993, 1994, and 1995 Schedules C for their tax preparation,

stock brokerage, and horse riding instruction activities.

Respondent allowed deductions for the business expenses that were

sufficiently documented by canceled checks. Respondent

disallowed many of the deductions, including a $287 deduction for

self-employment health insurance, because petitioners failed to
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substantiate them and failed to establish that the amounts were

expended for a business purpose.

Petitioners knew respondent had questioned their

documentation of expenses in prior years. Here, petitioners

failed to respond to documentation requests via the IDRs and did

not present any evidence at trial to demonstrate their

entitlement to additional deductions on their returns.

For each of the years in issue, petitioners also claimed

earned income credits for their two children of $602 in 1993;

$1,506 in 1994; and $1,860 in 1995. Respondent determined

petitioners were not eligible to claim these credits, and

petitioners knew respondent had denied their claimed earned

income credits in prior years.

D. Additions to Tax and Penalties

Respondent determined that petitioners are liable for

additions to tax under section 6651(a)(1) for failure to file

timely their tax returns for 1993 and 1994. For each of the

years in issue, respondent also determined that petitioners are

liable for an accuracy-related penalty under section 6662(a).

Discussion

Respondent's determinations in the notice of deficiency are

presumed correct, and generally, petitioners bear the burden of

proving that respondent's determination of income tax
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deficiencies is incorrect. See Welch v. Helvering, 290 U.S. 111,

115 (1933).

A. Petitioners' Income

It is a taxpayer's responsibility to maintain adequate books

and records sufficient to establish his or her income. See sec.

6001; DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), affd. 959

F.2d 16 (2d Cir. 1992). When a taxpayer fails to maintain

adequate records, the Commissioner may determine income under the

bank deposits method. DiLeo v. Commissioner, supra at 867.

A bank deposit is prima facie evidence of income. Id. at

868; Tokarski v. Commissioner, 87 T.C. 74, 77 (1986); Estate of

Mason v. Commissioner, 64 T.C. at 656; see also Hague Estate v.

Commissioner, 132 F.2d 775, 777-778 (2d Cir. 1943), affg. 45

B.T.A. 104 (1941). The bank deposits method of reconstruction

assumes that all money deposited into a taxpayer's account is

taxable as income unless the taxpayer can show a nontaxable

source for the income. See Price v. United States, 335 F.2d 671,

677 (5th Cir. 1964); DiLeo v. Commissioner, supra at 868. The

use of the bank deposits method for computing income has long

been sanctioned by the courts. DiLeo v. Commissioner, supra at

867; Estate of Mason v. Commissioner, supra at 656.

The fact that the Commissioner was not completely correct

does not invalidate the method employed. Marcello v.

Commissioner, 380 F.2d 494 (5th Cir. 1967), affg. in part and
 - 11 -

revg. in part T.C. Memo. 1964-302; Halle v. Commissioner, 175

F.2d 500, 503 (2d Cir. 1949), affg. 7 T.C. 245 (1946). Thus,

petitioners, not respondent, bear the burden of proving that

respondent's determination of underreported income, computed

using the bank deposits method of reconstructing income, is

incorrect. Parks v. Commissioner, 94 T.C. 654, 658 (1990);

Nicholas v. Commissioner, 70 T.C. 1057, 1064 (1978).

Petitioner gave respondent incomplete information regarding

his return preparation income and failed to deposit all the fees

he received. Petitioner also failed to call Mr. Sundstrom, a

witness he claimed could corroborate that certain deposits were

loan proceeds. Given the importance of Mr. Sundstrom in

substantiating this purported loan, the Court assumes from his

absence that his testimony would not have corroborated

petitioner's testimony. Frierdich v. Commissioner, 925 F.2d 180,

185 (7th Cir. 1991), affg. T.C. Memo. 1989-393; see also Wichita

Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946)

(holding that if a party having the burden of proof fails to call

a witness who is available to testify, and that witness could

corroborate the taxpayer's testimony, the taxpayer's failure to

do so creates a presumption that the witness's testimony would

have been unfavorable), affd. 162 F.2d 513 (10th Cir. 1947).
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The Court holds that respondent’s determination of

additional income in the amounts set forth in the notice of

deficiency is sustained.

B. Petitioners' Deductions

1. Schedule C and Schedule A Deductions

Section 162(a) allows a taxpayer deductions for ordinary and

necessary business expenses incurred during the taxable year in

carrying on a trade or business. Deductions, however, are a

matter of legislative grace, and the taxpayer bears the burden of

proving the entitlement to any deductions claimed. See INDOPCO,

Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Rockwell v.

Commissioner, 512 F.2d 882 (9th Cir. 1975), affg. T.C. Memo.

1972-133.

Generally, a taxpayer must establish that deductions taken

pursuant to section 162 are ordinary and necessary business

expenses and must maintain records sufficient to substantiate the

amounts of the deductions claimed. Sec. 1.6001-1(a), Income Tax

Regs. Under section 6001, petitioner bears the sole

responsibility for maintaining his business records.

If a claimed business expense is deductible, but the

taxpayer is unable to substantiate it, the Court is permitted to

make as close an approximation as it can, bearing heavily against

the taxpayer whose inexactitude is of his or her own making.

Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). The
 - 13 -

estimate, however, must have a reasonable evidentiary basis.

Vanicek v. Commissioner, 85 T.C. 731, 743 (1985). With respect

to certain business expenses, section 274 supersedes the Cohan

doctrine. See sec. 1.274-5T(a), Temporary Income Tax Regs., 50

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

Applying more stringent substantiation requirements, section

274(d) disallows deductions for traveling expenses, gifts, and

meals and entertainment, as well as for "listed property", unless

the taxpayer substantiates by adequate records or by sufficient

evidence corroborating the taxpayer's own statement: (1) The

amount of the expense; (2) the time and place of the expense; (3)

the business purpose of the expense; and (4) the business

relationship to the taxpayer of the persons involved in the

expense.

Petitioners' charitable contribution deductions are governed

by section 170. Section 170(a) allows a deduction for any

charitable contribution to or for the use of an organization

described in section 170(c), payment of which is made during the

taxable year and verified under regulations prescribed by the

Secretary. In general, the amount of a charitable contribution

made in property other than money is the fair market value of the

donated property at the time of the contribution. Hewitt v.

Commissioner, 109 T.C. 258, 261 (1997), affd. without published
 - 14 -

opinion 166 F.3d 332 (4th Cir. 1998); sec. 1.170A-1(c)(1), Income

Tax Regs.

To be eligible for a charitable contribution deduction for

property, petitioners must, among other requirements, establish

the fair market value of the property at the time of the

contribution and show the method they used to estimate the value.

See Jennings v. Commissioner, T.C. Memo. 2000-366, affd. 19 Fed.

Appx. 351 (6th Cir. 2001); sec. 1.170A-13(b)(2)(ii), Income Tax

Regs. Petitioners attached a form provided by the Salvation Army

upon which petitioners had written the amount of $500. They

presented no detailed information regarding the property, its

cost, or the manner in which the $500 amount claimed as a

deduction was determined.

Respondent disallowed all or part of petitioners' Schedule C

and Schedule A deductions, as well as their "above-the-line"

deduction for self-employment health insurance, because of lack

of substantiation. Petitioners did not keep books and records

which would support an allowance of deductions in excess of the

amounts respondent has already allowed, and they did not produce

any documentary evidence at trial. The only available evidence

as to any of petitioners' expenses in excess of those documented

by canceled checks is petitioner's own self-serving testimony,

which we are not required to accept, and which we do not, in
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fact, find to be credible. See Niedringhaus v. Commissioner, 99

T.C. 202, 219 (1992).

In view of their failure to substantiate, the Court holds

that petitioners are not entitled to deductions in excess of the

amounts allowed by respondent in the notice of deficiency.

Respondent's determinations are sustained.

Since the remaining itemized deductions respondent allowed

for tax year 1995 were less than the standard deduction for that

year, respondent allowed petitioners the higher amount of the

standard deduction. See Wilkinson v. Commissioner, 71 T.C. 633,

635 (1979). Respondent's determination is sustained.

2. Earned Income Credit

Section 32(a)(1) allows an eligible individual an earned

income credit against the individual’s income tax liability.

However, section 32(a)(2) limits the amount of credit allowable.

Section 32(a)(2) specifies the amounts of adjusted gross

income at which the earned income credit is phased out and the

taxpayer is no longer eligible for the credit. In the case of an

eligible individual with two qualifying children, the phaseout

amounts are: $12,200 for 1993, Rev. Proc. 92-102, 1992-2 C.B.

579; $11,000 for 1994, sec. 32(b)(2)(B); and $11,290 for 1995,

Rev. Proc. 94-72, 1994-2 C.B. 811.

The Court has sustained respondent's determinations that

petitioners had additional income in the amounts set forth in the
 - 16 -

notice of deficiency. The result is that petitioners' adjusted

gross income for 1993, 1994, and 1995 increased by $43,165,

$38,547, and $26,230, respectively. These adjusted gross income

amounts exceed the earned income credit phaseout amounts. The

Court holds, therefore, that petitioners are not entitled to

earned income credits for 1993, 1994, and 1995.

C. Additions to Tax and Penalties

1. Addition to Tax Under Section 6651(a)(1)

Section 6651(a)(1) imposes an addition to tax for failure to

file a timely tax return. The addition to tax is equal to 5

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

return if the failure to file is not for more than 1 month. Id.

An additional 5 percent is imposed for each month or fraction

thereof in which the failure to file continues, to a maximum of

25 percent of the tax. Id. The addition to tax is imposed on

the net amount due. Sec. 6651(b).

The addition to tax is applicable unless a taxpayer

establishes that the failure to file was due to reasonable cause

and not willful neglect. Sec. 6651(a). If a taxpayer exercised

ordinary business care and prudence and was nonetheless unable to

file the return by the date prescribed by law, then reasonable

cause exists. Sec. 301.6651-1(c)(1), Proced. & Admin. Regs. To

prove reasonable cause, a taxpayer must show that he exercised

ordinary business care and prudence but nevertheless could not
 - 17 -

file the return when it was due. See Crocker v. Commissioner, 92

T.C. 899, 913 (1989); sec. 301.6651-1(c)(1), Proced. & Admin.

Regs. "Willful neglect" means a "conscious, intentional failure

to file or reckless indifference." United States v. Boyle, 469

U.S. 241, 245 (1985).

Petitioners failed to offer any evidence that their failure

to timely file their 1993 and 1994 tax returns was due to

reasonable cause and not willful neglect. In fact, petitioners

offered no explanation at all. This is particularly troubling

given that petitioner is a tax return preparer. The Court

sustains respondent's determination that petitioners are liable

for the additions to tax under section 6651(a)(1).

2. Accuracy-Related Penalty Under Section 6662(a)

Respondent also determined petitioners are liable for an

accuracy-related penalty pursuant to section 6662(a) for each of

the years in issue. Section 6662(a) imposes a penalty of 20

percent of the portion of the underpayment which is attributable

to, inter alia, negligence or disregard of rules or regulations.

Sec. 6662(b)(1). Negligence is the "'lack of due care or failure

to do what a reasonable and ordinarily prudent person would do

under the circumstances.'" Neely v. Commissioner, 85 T.C. 934,

947 (1985) (quoting Marcello v. Commissioner, 380 F.2d at 506).

It includes any failure by the taxpayer to keep adequate books

and records or to substantiate items properly. Sec.
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1.6662-3(b)(1), Income Tax Regs. The term "disregard" includes

any careless, reckless, or intentional disregard. Sec. 6662(c).

No penalty shall be imposed if it is shown that there was

reasonable cause for the underpayment and the taxpayer acted in

good faith with respect to the underpayment. Sec. 6664(c). The

determination of whether a taxpayer acted with reasonable cause

and in good faith is made on a case-by-case basis, taking into

account all pertinent facts and circumstances. The most

important factor is the extent of the taxpayer's effort to assess

the taxpayer's proper tax liability. "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."

Sec. 1.6664-4(b)(1), Income Tax Regs. (emphasis added); see

Reynolds v. Commissioner, 618 296 F.3d 607, 618 (7th Cir. 2002),

affg. T.C. Memo. 2000-20. This subjective analysis operates, in

effect, to hold knowledgeable tax professionals to a higher

standard of care than a regular taxpayer. See Reynolds v.

Commissioner, supra at 618 ("experience, knowledge and education"

proviso was fatal to taxpayer who was attorney, C.P.A., and IRS

audit supervisor); Knoll v. Commissioner, T.C. Memo. 2003-277

(lawyer experienced in tax-advantaged financing liable for

accuracy-related penalty for negotiating and structuring

settlement agreement to secure tax advantages valid in form but
 - 19 -

lacking substance); Mitchell v. Commissioner, T.C. Memo. 2001-269

(lawyer-accountant held liable for accuracy-related penalty for

deducting farm losses with no credible plan to make profit);

Emerson v. Commissioner, T.C. Memo. 2001-186 (lawyer liable for

accuracy-related penalty for failing to keep adequate records

required by section 6001).

Petitioner has been a tax return preparer since at least

1990. Between 1993 and 1995, he prepared at least 500 tax

returns and was paid for his services. Given petitioner's

experience in preparing tax returns and his knowledge that

petitioners were previously held liable for omitting income and

failing to substantiate expenses, this Court concludes that he

failed to act with reasonable cause and in good faith in

determining his tax liability. See Wilkerson v. Commissioner,

T.C. Memo. 1998-68 (C.P.A. and wife, experienced return preparers

who failed to report fees and other income, were held liable for

negligence penalty). The Court holds that petitioners are liable

for the accuracy-related penalties under section 6662(a).

Reviewed and adopted as the report of the Small Tax Case

Division.
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To reflect the foregoing,

An order of dismissal will be

entered as to petitioner Michelle

McCarron, and decision will be

entered under Rule 155.