T.C. Memo. 2004-179
UNITED STATES TAX COURT
RAGNHILD A. WESTBY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 23041-96, 23054-96. Filed August 3, 2004.
Ragnhild A. Westby, pro se.
John C. Schmittdiel, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MARVEL, Judge: In notices of deficiency dated July 29,
1996, respondent determined the following deficiencies, additions
to tax, and penalties with respect to petitioner’s Federal income
taxes:
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Docket No. 23041-96
Accuracy-
Additions to tax related
Delinquency Negligence penalty
Year Deficiency Sec. 6651(a)(1)1 Sec. 6653(a)(1) Sec. 6662(a)
1
1988 $59,032 $14,758 $3,210 --
1
1989 72,150 18,038 -- $14,430
1
1990 83,595 20,899 -- 16,719
1
Respondent determined that petitioner was liable for the
addition to tax under sec. 6651(a)(1) for each of the years 1988-
90 in an amended answer. Respondent, therefore, bears the burden
of proof with respect to the imposition of the sec. 6651(a)
addition to tax for those years. Rule 142(a).
Docket No. 23054-96
Delinquency Negligence
Year Deficiency Sec. 6651(a)(1) Sec. 6653(a)(1)
1
1987 $55,459 $13,865 $2,773
1
For 1987, in addition to imposing the 5-percent negligence
addition to tax under sec. 6653(a)(1)(A), respondent also imposed
an addition to tax equal to 50 percent of the interest due on the
tax deficiency of $55,459. See sec. 6653(a)(1)(B).
Petitioner timely filed petitions seeking a redetermination
of respondent’s adjustments for 1987-90. We consolidated the
resulting cases for purposes of trial, briefing, and opinion,
1
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. Some monetary amounts have been rounded to the
nearest dollar.
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pursuant to Rule 141(a),2 and shall refer to the consolidated
cases in the singular in this opinion.
The issues for decision are:
(1) Whether, and to what extent, petitioner failed to
report income from her law practice for the years at issue;
(2) whether, and to what extent, petitioner is entitled to
business expense deductions claimed with respect to her law
practice for the years at issue;
(3) whether, and to what extent, petitioner is entitled to
net operating loss carryforward deductions claimed for the years
at issue; and
(4) whether petitioner is liable for the addition to tax
for negligence under section 6653(a)(1) (for 1987 and 1988), the
2
For 1988, the notice of deficiency denies a deduction for
$4,028 of “Rowe Rent Expenses”, and, for 1989, it lists “Rowe
Unreported Income” of $4,200 (the Rowe adjustments). Those
amounts are included in respondent’s computation of tax
deficiencies for 1988 and 1989, as set forth in the notice of
deficiency for those years. Thomas G. Rowe (Rowe), with whom
petitioner filed joint returns for 1988 through 1990, and
respondent entered into a separate settlement of Rowe’s joint and
several tax liabilities for 1988-90. Consequently, Rowe is not a
party to this litigation. Respondent states that the Rowe
adjustments are not at issue in this case. It is not clear,
however, on what basis respondent relies in making this
statement. Although petitioner stated during the trial that she
is not claiming that she is an “innocent spouse”, there is no
indication in the record that petitioner knew about, or intended
to waive, her right to request relief under sec. 6015 regarding
the Rowe adjustments. Consequently, if respondent intends to
hold petitioner liable for the Rowe adjustments, we shall give
petitioner the opportunity to file a request for relief under
sec. 6015 before we enter a decision in this matter.
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accuracy-related penalty under section 6662(a) and (b)(1) (for
1989 and 1990), and/or the delinquency addition to tax under
section 6651(a)(1) (for each of the years at issue).3
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the first supplemental stipulation
of facts are incorporated herein by this reference.
When the petitions in this case were filed, petitioner
resided in St. Paul, Minnesota. Petitioner was married to Thomas
G. Rowe (Rowe) during the years at issue, but she and Rowe filed
joint returns only for 1988-90. Petitioner’s filing status for
1987 was married filing separate.
I. Petitioner’s Reporting of Income and Expenses From Her Law
Practice (Schedule C)
During the years at issue, and for a number of earlier
years, petitioner maintained a sole proprietorship family law
practice, although she regularly retained other attorneys to
provide services in connection with certain of her cases. Each
of the Federal income tax returns filed by petitioner (1987) and
by petitioner and Rowe jointly (1988-90), included a Schedule C,
Profit or (Loss) From Business or Profession (Sole
3
Respondent also made adjustments to petitioner’s Schedule
A, Itemized Deductions, and recomputed petitioner’s self-
employment tax for each of the years at issue. Those adjustments
are derivative of the Schedule C, Profit or (Loss) From Business
or Profession (Sole Proprietorship), adjustments and will be
resolved by our resolution of the latter.
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Proprietorship), reporting the income, expenses, and profit or
loss from petitioner’s law practice. Petitioner’s Schedules C
listed gross income, deductions, and net profit (loss) in the
following amounts:
Year Gross income Deductions Net profit (loss)
1987 $75,097 $76,198 $(1,101)
1988 128,896 121,459 7,437
1989 124,463 115,690 8,773
1990 95,730 124,543 (28,813)
II. Respondent’s Adjustments to Petitioner’s Schedule C Income
and Deductions in the Notices of Deficiency
A. Adjustments to Income
Respondent increased petitioner’s Schedule C gross income4
for the years in issue in the following amounts:
Year Adjustment
1987 $77,811
1988 117,819
1989 116,483
1990 154,069
Respondent based the adjustments to petitioner’s Schedule C gross
income on two personal financial statements that petitioner
submitted to American National Bank (ANB) in St. Paul (the
financial statements). Petitioner submitted the first financial
statement, dated December 22, 1987 (the 1987 financial
statement), in connection with her purchase of a home and the
4
Petitioner’s gross income equaled her gross receipts in
each of the years at issue because she was a cash basis taxpayer
and had no cost of goods sold during those years.
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second financial statement, dated August 8, 1989 (the 1989
financial statement), in connection with a refinancing. The
financial statements listed “Employment Income” of $77,811 and
$125,256 for 1987 and 1989, respectively. The “Employment
Income” shown on each financial statement represented
petitioner’s estimate of the gross income, unreduced by any
expenses, generated by her law practice as of the date of the
financial statement.5
In his notice of deficiency for 1987, respondent determined
that petitioner had unreported Schedule C income of $77,811,
equal to the amount of “Employment Income” listed in the 1987
financial statement. Respondent calculated the adjustment to
petitioner’s Schedule C income for 1987 by treating the
“Employment Income” shown on the 1987 financial statement as
additional unreported income from petitioner’s law practice.
Respondent did not reduce the income adjustment to take into
account petitioner’s reported Schedule C gross income of $75,097.
In his notice of deficiency for 1988-90, respondent
determined that petitioner had unreported Schedule C income for
each year based upon the $125,256 listed as “Employment Income”
in the 1989 financial statement. For 1988, respondent determined
5
Petitioner explained the entries to ANB, the financial
institution to which she submitted the financial statements, and
to the revenue agent who was assigned to conduct the examination
of her returns for the years at issue.
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the unreported income adjustment of $117,819 by subtracting
petitioner’s reported Schedule C net profit of $7,437 for 1988
from the “Employment Income” of $125,256 shown on the 1989
financial statement. For 1989, respondent determined the
unreported income adjustment of $116,483 by subtracting
petitioner’s reported Schedule C net profit of $8,773 from
$125,256. For 1990, respondent determined the unreported income
adjustment of $154,069 by adding petitioner’s reported Schedule C
net loss of $28,813 to $125,256.
B. Disallowance of Petitioner’s Schedule C Deductions
For 1988, respondent disallowed $59,038 of petitioner’s
total Schedule C deductions of $121,459, but the notice of
deficiency does not indicate which Schedule C deductions were
disallowed. For 1987, 1989, and 1990, respondent disallowed all
of petitioner’s Schedule C deductions. The sole basis for
respondent’s disallowance of petitioner’s Schedule C expenses for
each of the years at issue set forth in the notices of deficiency
was: “Since you did not establish that the business expense
shown on your tax return was paid or incurred during the taxable
year and that the expense was ordinary and necessary to your
business, we have disallowed the amount shown.”
III. Description of Petitioner’s Business Records
Petitioner, a cash basis taxpayer, did not maintain formal
journals and ledgers with respect to her law practice or record
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the results of her law practice using a formal bookkeeping
system. Instead, petitioner entered business receipts (client
payments) in handwritten ledger books. On occasion, petitioner
also entered nonbusiness receipts (receipts other than client
payments) in the ledger books. Petitioner also retained deposit
slips reflecting the deposit of client payments into various bank
accounts.
In support of her Schedule C deductions, petitioner retained
canceled checks and other bank records, cash receipts, invoices,
credit card statements, credit card receipts, and other pertinent
documents. Petitioner’s practice was to make a notation (e.g.,
the client’s name) on a canceled check that would explain the
purpose of the check. Thus, later she would be able to determine
whether it represented a deductible expense of her law practice.
Petitioner numerically coded certain of the canceled checks and
many of her business-related cash and credit card receipts and
statements. Each number represented a specific type of expense
(e.g., 1 for client entertainment, 5 for office expenses, etc.).
Petitioner divided the checks and cash receipts by type or
category of expense, placed them in separate envelopes, and
submitted the envelopes to her husband’s accountant, John R.
Aunan (Mr. Aunan), for his use in preparing the tax returns for
the years at issue.
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During the years at issue, petitioner maintained banking
relationships with at least two financial institutions–-ANB at
which petitioner maintained two checking accounts (Nos. 302-733-1
and 109-070-3), a payroll account (No. 109-139-6), and several
personal and commercial loan accounts; and First Bank at which
she maintained a checking account (No. 2624676067).6
IV. Respondent’s Review of Petitioner’s Business Records
Although petitioner produced her business records (ledger
books, checks, cash receipts, credit card receipts, credit card
statements, and other documents) to the revenue agent in
connection with the examination of her returns for 1987-90, the
revenue agent failed to examine and/or utilize petitioner’s
records for 1987, 1989, and 1990 to ascertain the accuracy of the
income and expenses claimed on petitioner’s Schedules C for those
years. With the possible exception of 1988, for which a portion
of petitioner’s Schedule C deductions was allowed, respondent
issued the notices of deficiency without examining petitioner’s
business records.
A. Schedule C Income
Sometime after respondent issued the notices of deficiency,
respondent undertook to reconstruct petitioner’s Schedule C
6
The record does not disclose when the accounts were opened
and does not include complete records for the accounts.
Petitioner also maintained other financial accounts during the
years at issue, but the record contains minimal information
concerning them.
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income for the years at issue by analyzing petitioner’s bank
deposits during those years (the bank deposits analyses). The
resulting bank deposits analyses, dated December 11, 1997,
purport to list total monthly deposits, subtract “non-taxable
deposits”, and reduce the resulting adjustment by the amount of
Schedule C gross income reported on petitioner’s return for each
of the years at issue. The bank deposits analyses developed
proposed adjustments to petitioner’s Schedule C income,
enumerated below, that were dramatically lower than the proposed
adjustments to petitioner’s Schedule C income contained in the
notices of deficiency:
Proposed adjustment
Year Notice of deficiency Deposit method
1987 $77,811 $45,767
1988 117,819 7,113
1989 116,483 47,232
1990 154,069 13,785
Immediately before trial, the parties submitted a first
supplemental stipulation of facts in which respondent conceded
the 1988 and 1990 proposed adjustments for unreported income in
their entirety,7 revised the proposed 1987 and 1989 adjustments
7
Respondent’s counsel acknowledged at trial that concerns
about a possible shift of the burden of proof to respondent
“certainly came into play when we decided to concede” the 1988
and 1990 unreported income adjustments. In fact, respondent’s
counsel candidly explained the concessions as follows: “We felt
that given the size of the discrepancy and the fact that, if the
burden of proof were shifted, * * * we likely would not carry
it.”
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consistent with the bank deposits analyses for those years, and,
in addition, conceded $11,862 of the revised proposed adjustment
for 1989. During the trial, respondent conceded $8,786 of the
revised proposed adjustment for 1987.
As a result of respondent’s bank deposits analyses and
respondent’s concessions, respondent’s proposed adjustments for
unreported Schedule C income that remain at issue are as follows:
Year Proposed adjustment
1987 $36,981
1989 35,370
In preparing the bank deposits analysis for 1987, respondent
did not obtain or review all of the relevant bank records with
respect to petitioner’s accounts and did not adequately adjust
the analysis for nontaxable items. Most significantly,
respondent did not analyze retained copies of petitioner’s
deposit slips and bank statements, did not obtain missing bank
statements or copies of deposited items from the financial
institutions with which petitioner maintained her bank accounts,
and did not adjust the deposits analysis for all of the income
sources reported on petitioner’s 1987 return.
In preparing the bank deposits analysis for 1989, respondent
attached a list of deposits made to one of the two accounts
included in the analysis, on which some but not all of the
deposit sources were listed. The deposits list apparently was
prepared from retained copies of deposit tickets. Respondent did
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not obtain or review copies of deposited items from all of the
financial institutions with which petitioner maintained accounts
during 1989. In preparing the original 1989 bank deposits
analysis, respondent failed to identify and subtract numerous
nontaxable items and did not adjust the analysis for all of the
income sources reported on petitioner’s 1989 tax return.
B. Schedule C Deductions
Petitioner deducted the following Schedule C expenses on her
Federal income tax returns for the years at issue:
Sch. C expense
category 1987 1988 1989 1990
Advertising $98 $160 $513 $2,384
Bank charges 469 1,035 120 120
Car & truck 6,672 8,807 5,354 3,240
Collection fees -- -- 850 --
Deprec./sec. 179 2,546 11,974 2,444 1,467
Dues & pubs. 2,337 3,867 2,675 4,095
Employee benefits 2,057 2,243 5,274 3,998
Insurance 514 3,677 3,745 3,565
Interest 10,034 3,053 2,926 2,070
Legal & prof. 5,104 7,239 6,128 13,536
Rent 11,460 10,256 9,706 13,334
Supplies 4,174 12,297 13,139 7,263
Taxes 1,235 4,908 5,051 10,601
Travel 1,039 -- 1,601 1,988
Meals & enter. 896 1,961 795 3,286
Utilities & telephone 838 3,784 6,152 3,515
Wages 13,991 19,203 26,238 29,054
Moving expense 3,258 -0- -0- -0-
Process services 2,482 2,495 915 1,822
Contract services 4,637 10,618 9,617 10,079
Court fees 2,002 7,458 9,104 6,699
Miscellaneous 355 6,424 3,343 2,427
Total Sch. C
deductions 76,198 121,459 115,690 124,543
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Before the trial in this case commenced, petitioner again
produced for review by respondent’s employees, including a
revenue agent and an Appeals officer, voluminous records in
support of the Schedule C deductions claimed on her returns for
the years at issue. Respondent’s review of petitioner’s records
resulted in the preparation of itemized lists of some of
petitioner’s canceled checks, credit card expenditures, and
receipts. The lists were revised on several occasions and
admitted into evidence during trial. The lists were prepared
without any reference to the categorization of expenses claimed
on petitioner’s Schedules C for the years at issue because
respondent claimed that he could not tell how petitioner’s
expenses were grouped for reporting purposes on petitioner’s
returns.
At the beginning of trial, respondent conceded that
petitioner had deductible Schedule C expenses for the years at
issue in the following amounts:
Year Amount Exhibit No.
1
1987 $50,184.70 38-R
1988 64,442.41 39-R
1989 77,162.01 40-R
1990 73,632.74 41-R
1
Respondent used a subtotal ($11,144.18) instead of the
total ($12,034.71) from Sec. B of Ex. 38-R in calculating the
amount of Schedule C expenses he conceded for 1987 ($49,294.17).
Following trial, respondent conceded additional Schedule C
deductions for each of the years at issue as follows:
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Additional Additional Total additional
Year expenses depreciation deductions
1987 $10,785.18 $741.28 $11,526.46
1988 13,443.34 1,076.65 14,519.99
1989 8,944.60 1,076.65 10,021.25
1990 12,713.86 1,076.65 13,790.51
As a result of respondent’s concessions regarding
petitioner’s deductible Schedule C expenses, the deduction
amounts still in dispute are as follows:
Respondent’s Amount in
Year Per return concessions dispute
1987 $76,198 $60,821 $15,377
1
1988 121,459 78,962 42,497
1989 115,690 87,183 28,507
1990 124,543 87,423 37,120
1
The Court’s Oct. 17, 2000, order erroneously stated that,
after giving effect to respondent’s concessions, none of the
deductions claimed on petitioner’s 1988 Schedule C remained in
dispute.
V. Return Preparation and Accountant Workpapers
Petitioner’s income tax returns for the years at issue were
prepared by Mr. Aunan. Petitioner gave Mr. Aunan her canceled
checks, cash and credit card receipts, and other documents,
categorized in the manner described above. Mr. Aunan prepared
accounting workpapers based on his review of petitioner’s
records. In so doing, Mr. Aunan grouped various categories of
petitioner’s Schedule C expenses into return preparation
categories as reflected in his workpapers.8 Mr. Aunan’s
8
Throughout the trial in this case, however, respondent
(continued...)
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workpapers include a schedule summarizing petitioner’s
documentation of her Schedule C income and expenses by category
and by year. That schedule shows, for each of the years at
issue, preliminary figures, adjusting entries, and final figures
for each category of income and expense. The workpapers also
include a summary schedule for the years at issue showing the
income and expense information used by Mr. Aunan to prepare
petitioner’s Schedule C (including depreciation claimed), a
workpaper entitled “Business Interest” that lists interest paid
on petitioner’s credit cards, a depreciation schedule that shows
how Mr. Aunan calculated the depreciation claimed on petitioner’s
Schedules C, a workpaper entitled “Personal” that lists
information regarding various Schedule A itemized deductions for
each of the years at issue, a workpaper labeled “611 Dayton”
relating to a rental property that petitioner owned and sold in
1987, and a Schedule C workpaper relating to the law practice of
petitioner’s husband.
8
(...continued)
maintained that he could not tell how Mr. Aunan had combined
petitioner’s expenses to arrive at the numbers reported on her
income tax returns for the years at issue. Respondent’s claimed
inability to understand how petitioner’s business expenses were
categorized for return filing purposes led to the detailed
listing of petitioner’s expense records without regard to actual
reporting of the expenses on the relevant tax returns.
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VI. Net Operating Losses
Petitioner and Rowe deducted net operating loss (NOL)
carryforwards on their 1988-90 joint returns. The NOL
carryforwards were derived from losses claimed on Schedules C and
Schedules E, Supplemental Income Schedule, of petitioner’s 1980
and 1982 separate returns. Petitioner’s 1988-90 returns utilized
the NOL carryforwards as follows:9
Loss carryforward
Year Schedule C income utilization
1988 $39,621 $9,350 (1980 loss)
1989 15,485 5,714 (1980 loss)
9,771 (1982 loss)
1990 2,492 25 (1982 loss)
9
Mr. Aunan erroneously used $8,650 of petitioner’s loss
carryforward to offset Rowe’s Schedule C income. See Calvin v.
United States, 354 F.2d 202 (10th Cir. 1965) (cited with approval
by Rose v. Commissioner, T.C. Memo. 1973-207).
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The potential NOL carryforward to the years at issue, based upon
petitioner’s 1980-86 returns as filed, is $108,007.10
There was no examination of the NOL carryforwards during the
audit and only a minimal examination of a portion of the NOL
carryforwards by the IRS Appeals Office. In support of the
alleged NOL carryforwards, petitioner testified that, because of
serious medical problems she experienced during 1982-86, her law
practice during those years operated at a loss, generating part
of the NOL carryforwards. Petitioner testified that the Schedule
E, Supplemental Income and Loss, losses generating the remaining
part of the NOL carryforwards arose from the rehabilitation of a
rental property. Toward the end of the trial, petitioner
introduced documentation in the form of deposit slips, canceled
checks, and payment receipts for both her Schedule C and Schedule
E income and expenses during 1978-83, but she did not offer any
10
Petitioner’s potential loss carryforward arises out of the
following reported results for 1980-86:
Reported operating Operating loss
Year income (loss) utilization
1980 ($41,399) $7,382 carried
back to 1977
1981 4,354 Offset by 1980 loss
1982 (48,861) --
1983 (5,051) --
1984 14,599 Offset by 1980 loss
1985 (19,643) --
1986 (19,388) --
Petitioner also reported operating losses in 1978 and 1979
which were carried back to 1976 and 1977.
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testimony to explain the documentation. Petitioner did not offer
into evidence any documentation of her business income and
expenses for 1984-86.
VII. Late Filing of Petitioner’s 1987-90 Returns
Petitioner filed her 1987 return on August 26, 1992, having
requested and received two extensions, the second of which
expired on October 15, 1988. Petitioner and Rowe filed their
1988 joint return on August 27, 1992, and their 1989 and 1990
joint returns on August 25, 1992. Neither petitioner and Rowe
nor Mr. Aunan requested extensions of time to file the 1988-90
returns.
For each year at issue, petitioner gathered, organized, and
summarized her Schedule C information and delivered it to Mr.
Aunan for his use in preparing that year’s return. For the
1988-90 years, however, petitioner did not actually deliver her
Schedule C information to Mr. Aunan until after the return due
dates. After petitioner submitted her Schedule C information to
Mr. Aunan, she followed up by asking him periodically what
additional information he needed to complete the returns. Mr.
Aunan normally responded with more requests for information;
within a day or two, petitioner would supply the requested
information to him. In 1992, petitioner “threatened” Mr. Aunan,
and the returns for all 4 years were finally completed and filed
in August of that year.
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At one point during petitioner’s testimony, the following
exchange occurred between the Court and petitioner:
THE COURT: All right. Now, let me ask another
question. You’re a lawyer with a license at risk. You
knew you had an obligation to file a return and that
that return had to be filed timely or you were going to
have a problem.
THE WITNESS: Right.
THE COURT: Why didn’t you protect yourself
better?
THE WITNESS: I suppose I’ve asked myself that a
million times. It –- I think part of –- when I think
back on it, I was very used to going ahead and doing
things, but, in this particular situation, [Rowe] had
paid in no money for the self-employment tax, and it
appeared that he was going to have a liability on his
side of the fence. And my push to get done and his
reluctance and his being the primary contact with Aunan
was not a good combination.
But, you know, all excuses aside, I have to be
responsible for myself. And I did not do in my own
mind, which is –- what I should have done is -- I did
not fire him. I did not report him. And I did not go
to my old accountant and file a separate return, no
matter what the economic consequences.
VIII. October 17, 2000, Order
After respondent filed his status report and supplemental
status report (SSR) describing the results of the parties’
posttrial efforts to resolve outstanding issues, we issued an
order dated October 17, 2000, which (1) listed the Schedule C
income and deduction amounts remaining in dispute after
respondent’s further concessions, (2) ruled upon various
exhibits, the admissibility of which had been left open at trial,
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(3) closed the trial record, (4) invited, but did not require,
the parties to file posttrial briefs, and (5) set a schedule for
the filing of briefs. Only respondent filed a posttrial brief.
In his posttrial brief, respondent continued to argue that some
of petitioner’s alleged business expenses should be disallowed
but, with regard to certain expenses, asserted grounds for the
disallowance that were different from the ground asserted in the
notices of deficiency.
OPINION
I. Schedule C Income and Deductions
A. Burden of Proof
Normally, in a case before this Court, the taxpayer bears
the burden of proof. Rule 142(a).11 That burden has often been
interpreted to mean that the taxpayer bears the ultimate burden
of persuasion; i.e., the risk of nonpersuasion, as well as the
initial burden of production. See, e.g., Gerling Intl. Ins. Co.
v. Commissioner, 86 T.C. 468, 476 n.5 (1986).
In this case, petitioner bears the burden of proof. Rule
142(a). Because petitioner bears the burden of proof, petitioner
has the initial burden of production, which requires her to
11
Under certain circumstances, sec. 7491(a)(1), which was
enacted in 1998, shifts the burden of proof to respondent. Sec.
7491 applies to court proceedings arising in connection with
examinations beginning after July 22, 1998. Because the
examination of petitioner’s returns commenced before July 23,
1998, sec. 7491(a)(1) is inapplicable to this case.
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introduce evidence sufficient, if believed, to demonstrate by a
preponderance of the evidence that respondent’s determination is
excessive; i.e., erroneous and/or arbitrary, “without rational
foundation”. Helvering v. Taylor, 293 U.S. 507, 514-515 (1935);
see also Pittman v. Commissioner, 100 F.3d 1308, 1317 (7th Cir.
1996), affg. T.C. Memo. 1995-243; Page v. Commissioner, 58 F.3d
1342, 1347-1348 (8th Cir. 1995), affg. T.C. Memo. 1993-398. If
petitioner successfully carries her initial burden of production
as to a particular adjustment, the burden of production; i.e.,
the burden of introducing evidence showing an adjustment is
warranted, shifts to respondent. Helvering v. Taylor, supra at
514-515; Berkery v. Commissioner, 91 T.C. 179, 186 (1988), affd.
without published opinion 872 F.2d 411 (3d Cir. 1989); Cozzi v.
Commissioner, 88 T.C. 435, 443-444 (1987); Jackson v.
Commissioner, 73 T.C. 394, 401 (1979).
B. Unreported Income Adjustments for 1987 and 1989
In this case, the parties agree that the unreported income
adjustments arise from petitioner’s law practice. Our review of
the record confirms that there is a sufficient evidentiary base,
if one is required, to support a conclusion that petitioner was
engaged in an income-generating activity during each of the years
at issue and that petitioner has the burden of proving that
income adjustments in the notices of deficiency were arbitrary
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and/or excessive. Rule 142(a); Welch v. Helvering, 290 U.S. 111,
115 (1933).
At trial, petitioner proved, and respondent admitted, that
the income adjustments proposed in respondent’s notices of
deficiency for all 4 of the years at issue were derived from two
financial statements prepared by petitioner in 1987 and 1989.
For 1987, respondent determined that petitioner had unreported
Schedule C income equal to the “Employment Income” listed on the
1987 financial statement. For 1988, 1989, and 1990, respondent
added the “Employment Income” listed on the 1989 financial
statement to the net profit or loss reported on petitioner’s
Schedules C for 1988, 1989, and 1990 to arrive at the income
adjustments for 1988-1990.
During trial, respondent’s counsel abandoned the income
adjustments as originally determined in the notices of deficiency
and offered as stipulated exhibits what purported to be bank
deposits analyses for the years at issue.12 Based on the bank
deposits analyses, respondent conceded the income adjustments for
1988 and 1990 in their entirety and substantially reduced the
income adjustments for 1987 and 1989.
12
In his opening statement, respondent’s counsel stated that
the bank deposits analyses were prepared because respondent’s
Appeals Office recognized that the income adjustments contained
in the notice of deficiency that were based on the 1987 and 1989
financial statements were “not a strong position for the
Service.”
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Because petitioner proved that respondent’s reliance on the
1987 and 1989 financial statements under the circumstances
involved in this case was unreasonable and resulted in
substantially distorted income adjustments, we conclude that the
adjustments to petitioner’s Schedule C income as determined by
respondent in the notices of deficiency were arbitrary and
excessive. Therefore, the burden of producing credible evidence
showing that respondent’s revised adjustments to petitioner’s
Schedule C income in each of the years 1987 and 1989 were
warranted shifted to respondent. Helvering v. Taylor, supra at
514-515; Commissioner v. Riss, 374 F.2d 161, 166 (8th Cir. 1967),
affg. in part, revg. in part and remanding T.C. Memo. 1964-190.
Respondent contends that, even if the burden of production
shifted to respondent regarding the income adjustments in the
notice of deficiency, his revised income adjustments for each of
the years 1987 and 1989 are supported by the bank deposits
analyses respondent introduced into evidence. According to
respondent, those analyses prove that petitioner deposited into
her bank accounts substantially more money during 1987 and 1989
than she reported as gross receipts on her Schedules C for those
years.
The bank deposits method has long been recognized as an
acceptable indirect method of proving a taxpayer’s understatement
of income. See Gleckman v. United States, 80 F.2d 394 (8th Cir.
- 24 -
1935); see also United States v. Abodeely, 801 F.2d 1020, 1023-
1025 (8th Cir. 1986); Caulfield v. Commissioner, T.C. Memo. 1993-
423, affd. 33 F.3d 991 (8th Cir. 1994). The bank deposits method
is often used in cases in which the taxpayer maintained
inadequate, incomplete, or unclear records. See, e.g., Holland
v. United States, 348 U.S. 121 (1954); DiLeo v. Commissioner, 96
T.C. 858, 867 (1991), affd. 959 F.2d 16 (2d Cir. 1992); Estate of
Mason v. Commissioner, 64 T.C. 651, 656 (1975), affd. 566 F.2d 2
(6th Cir. 1977).
In this case, petitioner produced records of her taxable
income, including her Schedule C income. The records included
handwritten ledger books as well as bank records such as bank
statements and deposit tickets. A review of petitioner’s income
records establishes to the Court’s satisfaction that the gross
income reported on petitioner’s Schedules C for 1987 and 1989 was
derived from petitioner’s handwritten ledger books and was not
calculated based on deposits into petitioner’s bank accounts.
The return preparer, Mr. Aunan, took the gross receipts numbers
that petitioner derived from her ledger books for the years at
issue and adjusted the numbers for any refunds made to
petitioner’s clients during the taxable years. In 1987 Mr. Aunan
made no adjustments to petitioner’s Schedule C gross receipts of
$75,097, but, in 1989, Mr. Aunan reduced the preliminary gross
receipts figure of $129,146 by client refunds of $470 and
- 25 -
$4,21313 to arrive at petitioner’s 1989 reported Schedule C gross
receipts of $124,463.
Respondent arbitrarily used entries from the 1987 and 1989
financial statements to substantially increase petitioner’s
Schedule C income in the notices of deficiency. When respondent
recognized the inherent weakness of his position, respondent
attempted to salvage his position that income adjustments were
warranted by arranging for the preparation of what purported to
be bank deposits analyses. The analyses, however, failed
adequately to adjust for nontaxable items, failed to analyze all
of petitioner’s bank accounts, and failed to adjust for all of
petitioner’s reported taxable income. Respondent did not obtain
and review all of petitioner’s bank records, including copies of
deposited items, and it is apparent from a review of the analyses
that respondent did not obtain the information necessary to
prepare a proper bank deposits analysis for either 1987 or 1989.
A review of respondent’s bank deposits analysis for 1987,
which was similar in method to the one for 1989, illustrates why
we assign no credibility to respondent’s bank deposits analyses
and related income determinations for 1987 and 1989. The 1987
bank deposits analysis is an analysis of one of petitioner’s bank
accounts that she used during that year. ANB account No. 302-
13
Respondent has conceded that client refunds of $4,213.30
are deductible.
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733-1 was an account maintained by petitioner throughout 1987
into which petitioner deposited client fees as well as amounts
unrelated to her law practice. The deposits analysis purports to
add up all of the deposits made into the account during 1987 by
month, subtract identified nontaxable deposits from the computed
total deposits, and arrive at “Gross Revenues per the Audit”.
The analysis subtracts from that number the “Gross Revenues per
the Tax Return” to arrive at respondent’s revised income
adjustment.
Respondent’s calculation of total deposits as reflected on
the 1987 bank deposits analysis contains several obvious errors.
For example, for January and July, respondent erroneously listed
total deposits shown on the relevant bank statements. For March
and December, respondent did not have copies of the relevant bank
statements, so respondent used petitioner’s income listing from
her ledger book for those months.
When respondent’s calculation of nontaxable items is
compared to the relevant bank statements for account No. 302-733-
1, even more troublesome concerns arise. Petitioner had a “Ready
Cash” line of credit that, among other uses, covered overdrafts
on the account. Respondent treated some but not all of the
“Ready Cash” deposits during 1987 as nontaxable deposits.
Respondent also failed to subtract, as nontaxable deposits, a
$5,738 disbursement on a note (July 7, 1987), a $2,625.01
- 27 -
disbursement on a note (Nov. 16, 1987), and several transfers
from account No. 109-070-3, totaling $22,509.69. Respondent also
failed adequately to adjust his calculation for the total amount
of rental income, loan repayments, and installment sale income
that petitioner received during 1987. Similar mistakes were made
in the bank deposits analysis for 1989.
Our review confirms that the simplistic bank deposits
analyses prepared and relied upon by respondent to support his
restated income adjustments against petitioner for 1987 and 1989
are simply not credible. We conclude, therefore, that
respondent’s determinations that petitioner had unreported
Schedule C income for 1987 and 1989 are erroneous, and we hold
that respondent’s determinations of unreported income for 1987
and 1989 are not sustained.
C. Schedule C Deductions
1. Applicable Legal Principles
The only basis asserted by respondent in the notices of
deficiency for disallowing petitioner’s Schedule C expenses was
petitioner’s alleged failure to establish that the expenses were
“paid or incurred during the taxable year” and were “ordinary and
necessary to * * * [petitioner’s] business.” Section 162(a)
authorizes a taxpayer to deduct ordinary and necessary business
expenses paid or incurred during the taxable year in carrying on
a trade or business. An “ordinary” expense is one incurred in a
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transaction that commonly or frequently occurs in the type of
business involved. Deputy v. DuPont, 308 U.S. 488, 495 (1940).
A “necessary” expense is one that is “appropriate and helpful” to
the taxpayer’s business. Welch v. Helvering, 290 U.S. at 113.
Expenses allowable under section 162 must be “directly connected
with or pertaining to the taxpayer’s trade or business”. Sec.
1.162-1(a), Income Tax Regs. Personal, living, and family
expenses are not deductible. Sec. 262(a).
Generally, if a claimed business expense is deductible, but
the taxpayer is unable to substantiate it fully, the Court is
permitted to make an approximation of an allowable amount (the
Cohan rule). Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d
Cir. 1930). The estimate, however, must have a reasonable
evidentiary basis. Vanicek v. Commissioner, 85 T.C. 731, 743
(1985).
Respondent asserts for the first time in his trial
memorandum that certain of petitioner’s Schedule C deductions are
also subject to the requirements of section 274. Section 274
supersedes the Cohan rule, see sec. 1.274-5T(a), Temporary Income
Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985), and imposes more
stringent substantiation requirements for travel, meals and
entertainment, gifts, and with respect to any listed property as
defined in section 280F(d)(4). Sec. 274(d). Listed property
includes any passenger automobile. Sec. 280F(d)(4)(A)(i).
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Section 274(a) provides, in pertinent part, that no deduction
otherwise allowable shall be allowed for entertainment,
amusement, or recreation expense unless the taxpayer establishes
that the expense was directly related to the active conduct of
the taxpayer’s trade or business. Section 274(b) provides, in
pertinent part, that no deduction shall be allowed under section
162 for any gift to the extent that the gift, together with other
gifts to the same individual for the same taxable year, exceeds
$25. Section 274(d) requires a taxpayer to substantiate a
claimed expense that is covered by section 274 by adequate
records or by sufficient evidence corroborating the taxpayer’s
own statement establishing the amount, time, place, business
purpose of the expense, and the business relationship to the
taxpayer of the persons entertained or receiving the gift.
Section 274(k) provides in pertinent part that no deduction is
allowed for any food or beverage expense unless the expense is
not lavish or extravagant under the circumstances and the
taxpayer or an employee of the taxpayer is present at the
furnishing of the food or beverage expense.
Section 274(n) provides that the amount allowable as a
deduction for food and beverage expense and entertainment expense
shall not exceed 80 percent of the amounts that would be
deductible but for section 274(n). However, meals that qualify
as de minimis fringe benefits are not subject to the 20-percent
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deduction disallowance imposed by section 274(n)(1). See sec.
274(n)(2)(B). Section 132(e) generally defines the term “de
minimis fringe” as “any property or service the value of which is
(after taking into account the frequency with which similar
fringes are provided by the employer to the employer’s employees)
so small as to make the accounting for it unreasonable or
administratively impracticable.” See also sec. 1.132-6(a),
Income Tax Regs.
2. Analysis
It is well established that the burden of proof with respect
to deductions claimed on a tax return generally rests on the
taxpayer. The general rule was succinctly stated by this Court
in Roberts v. Commissioner, 62 T.C. 834, 836 (1974), as follows:
Taxpayers have no inherent right to deductions; they
are matters of legislative grace. Interstate Transit
Lines v. Commissioner, 319 U.S. 590, 593 (1943); New
Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934). The taxpayer must be able to point to some
particular statute to justify his deduction and
establish that he comes within its terms. Deputy v.
Dupont, 308 U.S. 488, 493 (1940); White v. United
States, 305 U.S. 281 (1938). * * *
In Roberts, the taxpayer argued that the Commissioner’s
blanket disallowance of his business expense deductions (and a
casualty loss) without benefit of audit was arbitrary and
unreasonable and, therefore, could not form the basis for a
deficiency. In Roberts, we noted that the Commissioner’s failure
to audit the taxpayer’s records was due solely to the latter’s
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refusal to furnish any records in support of the claimed
deductions. We held that “when a taxpayer refuses to
substantiate his claimed deductions, the Commissioner is not
arbitrary and unreasonable in determining that the deductions
should be denied.” Id. at 837.
Unlike the taxpayer in Roberts, petitioner did not refuse to
substantiate her deductions. In fact, she provided voluminous
documentation on several occasions and for extended periods of
time to respondent’s revenue agent, Appeals officer, trial
counsel, and to this Court. Respondent’s blanket disallowance of
petitioner’s Schedule C deductions in the notices of deficiency
for 3 of the 4 years at issue was preceded by the revenue agent’s
apparent failure or refusal to examine the expense records that
petitioner had produced for his inspection. Although
petitioner’s expense records (consisting, for the most part, of
canceled checks, cash receipts, credit card statements, and other
pertinent documents) may not have been kept in a form pleasing to
the revenue agent, they were coded and organized by category,
they satisfied the books and records requirement of section
1.6001-1(a), Income Tax Regs., and they were auditable. See
Jackson v. Commissioner, 59 T.C. 312, 317-318 (1972).
Respondent’s disallowance of all of petitioner’s Schedule C
expenses for 3 of the 4 years at issue without any meaningful
- 32 -
examination of petitioner’s business records for those years
appears unwarranted and arbitrary.
As arbitrary as respondent’s blanket disallowance of
petitioner’s Schedule C expenses for 3 of the 4 years at issue
appears on these facts, however, it is nevertheless clear under
our jurisprudence and that of the Court of Appeals for the Eighth
Circuit that petitioner bears the burden of proof as to her
deductions. We are obligated to analyze the evidentiary record
and to weigh the evidence in order to decide if petitioner has
carried her burden of persuading this Court that respondent’s
disallowance of her Schedule C deductions for the years at issue
was erroneous and/or arbitrary. See Oliver v. Commissioner, 364
F.2d 575, 577 (8th Cir. 1966), affg. T.C. Memo. 1965-83.
The record in this case establishes that petitioner
maintained an active law practice during the years at issue. In
connection with that law practice, petitioner paid business
expenses that were categorized and deducted on her Schedules C as
advertising, car and truck, depreciation/section 179, employee
benefits, insurance, interest, legal and professional, rent,
supplies, taxes, travel, meals and entertainment, utilities,
wages, dues and subscriptions, process services, contract
services, court fees, collection fees, bank charges, and
miscellaneous expenses. With the assistance of Mr. Aunan’s
workpapers, we were able to ascertain, to a large extent, how
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petitioner’s expenses were grouped for tax return purposes. We
shall review each Schedule C expense category14 and the evidence
in support of each category to reach a conclusion regarding the
parties’ respective positions. Our conclusions are summarized in
a chart that appears at the end of this subsection on page 79.
a. Depreciation and Section 179 Expense
For the years at issue, petitioner claimed depreciation
expense deductions in the following amounts:
Year Amount
1987 $2,546
1988 11,974
1989 2,444
1990 1,467
The depreciation schedule included as part of Mr. Aunan’s
workpapers shows that the depreciation expense deductions were
calculated as follows:
14
We have not addressed separately the Schedule C category
of collection fees that was included only on petitioner’s 1989
return, but we have considered any such expenses as part of other
categories.
- 34 -
Year Depreciation expense
acq. Asset Cost 1987 1988 1989 1990
1987 Furniture
& fixtures $10,543 $2,109 $3,374 $2,024 $1,215
Computer 2,186 437 700 420 252
1988 Furniture
1
& fixtures 2,630 2,630
1
Computer 5,270 5,270
Total depreciation
and sec. 179 exp. 2,546 11,974 2,444 1,467
1
These amounts were claimed as sec. 179 expenses.
The detail in Mr. Aunan’s workpapers shows that, during 1987,
petitioner purchased furniture costing $3,003 and a copier
costing $3,069 and made leasehold improvements costing $4,471.
The total of these three items is $10,543, the amount used by Mr.
Aunan in calculating the depreciation expense attributable to
furniture and fixtures for the years at issue. The detail also
shows that, during 1987, petitioner purchased a computer costing
$2,186, a figure that ties into Mr. Aunan’s depreciation
schedule.
Documents introduced into evidence at trial establish the
following:
(1) Petitioner purchased a computer for $2,186 during 1987
(Ex. 38-R, line 211).15
15
Ordinarily, we do not include citations to the record in
our opinions. In this case, however, references to line items in
(continued...)
- 35 -
(2) Petitioner expended $4,471.12 for office improvements
during 1987 (Ex. 38-R, lines 222-228).
(3) Petitioner purchased a copier for $3,068.64 during 1987
(Ex. 38-R, lines 323-332).
(4) Petitioner purchased computer furniture for $3,003.09
during 1987 (Ex. 38-R, lines 212-218).
(5) Petitioner purchased office furniture and computer-
related items during 1988 totaling at least $5,632.26.16
Respondent has conceded that petitioner expended the above-
listed amounts and that petitioner may depreciate these items but
attempts to reconfigure petitioner’s deduction by offering a
different depreciation alternative (7-year depreciation). We
reject respondent’s attempt to recalculate petitioner’s
depreciation and section 179 expense deduction because
respondent, who raised this issue for the first time in a
supplemental status report filed after trial, had the burden of
producing evidence regarding the proposed recalculation and
15
(...continued)
the summary exhibits, Exhibits 38-R through 41-R, will assist the
parties in understanding which items we are allowing petitioner
to deduct and in preparing the Rule 155 computations.
16
Our inability to account for the full cost of items
purchased during 1988 and included in the sec. 179 expense
deduction claimed by petitioner is attributable to the fact that
petitioner’s depreciation and sec. 179 records were unbundled
during the pretrial review of petitioner’s records and mixed in
with petitioner’s office supplies records. We have no doubt,
however, that petitioner expended the amounts claimed for 1988
(Ex. 39-R, lines 228-238, 241, 243-246, 248-259).
- 36 -
failed to introduce any evidence to show that the recalculation
is required.
Petitioner has substantiated her depreciation and section
179 expense deduction for each of the years at issue, and the
deductions in the amounts claimed are allowed.
b. Bank Service Charges
Petitioner deducted bank service charges on her Schedules C
for the years at issue as follows:
Year Amount
1987 $469
1988 1,035
1989 120
1990 120
A review of petitioner’s bank records establishes that
petitioner incurred service charges, insufficient funds charges,
returned item charges, and miscellaneous other charges such as
those for check orders. For example, during 1987, with regard to
petitioner’s ANB account No. 302-733-1 alone, petitioner paid
$184.25 in service charges, $413 in insufficient fund and
returned item charges, and $84.75 in check charges for 10 months
(bank statements for 2 months were missing). Although all of
petitioner’s bank records were not introduced into evidence, we
have no doubt that in each of the years at issue petitioner paid
bank charges related to her law practice. Applying the Cohan
rule, we allow petitioner the deductions claimed for bank service
charges for each of the years at issue.
- 37 -
c. Dues and Publications
For the years at issue, petitioner claimed deductions for
dues and publications as follows:
Year Amount
1987 $2,337
1988 3,867
1989 2,675
1990 4,095
Mr. Aunan’s workpapers reveal that the dues and publications
category on petitioner’s returns included expenses paid by
petitioner during the years at issue for her law library, bar and
other dues, continuing professional education, and her reception
room subscriptions as follows:
Year Law library CPE, dues & subs. Total
1987 $1,552 $785 $2,337
1988 3,530 337 3,867
1989 1,996 679 2,675
1
1990 1,468 2,627 4,095
1
It appears from a review of Mr. Aunan’s workpapers that he
erroneously included the amount of $1,468 twice when calculating
petitioner’s 1990 deduction for dues and publications.
The record establishes that:
(a) During 1987, petitioner paid office book expenses of
$1,552.44 (Ex. 38-R, lines 152-160), continuing education
expenses of $549.20 (Ex. 38-R, lines 726-732), office magazine
expenses of $47.92 (Ex. 38-R, lines 124-126), and dues and
publications expenses of $2,321.48 (Ex. 38-R, lines 996-997,
1000-1003, 1016, 1033, 1038, 1045, 1051-1052, 1060, 1064, 1123,
- 38 -
1128-1129, 1135, 1144, 1151, 1157, 1172, 1174, 1176), for a total
amount documented of $4,471.04.
(b) During 1988, petitioner paid office book expenses of
$3,678.04 and subscriptions and memberships of $360.52, for a
total amount documented of $4,038.56 (Ex. 39-R, lines 25-32, 35-
38, 42-63).
(c) During 1989, petitioner paid office book and
subscription expenses of $1,974 (Ex. 40-R, lines 166-184, 186-
205) and a fee of $50 to the Minnesota Women Lawyers Association
(Ex. 40-R, line 142), for a total amount documented of $2,024.
In addition, Mr. Aunan’s workpapers suggest that when he was
working on petitioner’s return for 1989, petitioner also had
given him documentation of two other expense items of $412 and
$217.
(d) During 1990, petitioner paid office book and
subscription expenses of $1,475.07, professional organization
fees of $310.50, continuing legal education expenses of $247.50,
and office book expenses of $278.90, for a total amount
documented of $2,311.97 (Ex. 41-R, lines 120-147, 428-431, 846-
852, 1290-1297).
Petitioner is entitled to deduct dues and subscriptions
expenses in each of the years at issue in the amounts summarized
above and set forth in the chart on page 79 of this opinion.
- 39 -
d. Legal and Professional
For the years at issue, petitioner claimed deductions for
legal and professional fees paid in connection with her law
practice as follows:
Year Amount
1987 $5,104
1988 7,239
1989 6,128
1990 13,536
Mr. Aunan’s workpapers reveal that the following entries
comprised the deducted amounts:
(a) For 1987, amounts of $158, $1,620, $760, and $2,566, for
a total amount deducted of $5,104;
(b) for 1988, amounts of $4,962 and $2,277, for a total
amount deducted of $7,239;
(c) for 1989, amounts of $4,965, $88 and $1,075, for a total
amount deducted of $6,128;
(d) for 1990, amounts of $18,066 and $10,470, reduced by a
$15,000 payment to James Van Valkenburg, for a total amount
deducted of $13,536.
Our review of the record reveals the following:
(a) During 1987, petitioner paid fees to other attorneys of
$2,566, fees to law clerks of $760.02, fees to experts of
$1,620.20, and fees for medical records of $158, for a total
expenditure of $5,104.22 (Ex. 38-R, lines 250-261, 317-319, 766-
777, 750-754).
- 40 -
(b) During 1988, petitioner paid fees to other professionals
of $7,145.55 and printer expenses of $2,277.63, for a total
expenditure of $9,423.18 (Ex. 39-R, lines 67-100, 680-692).
(c) During 1989, petitioner paid fees to other professionals
in the aggregate amount of $6,140.18 (Ex. 40-R, lines 91-119).
(d) During 1990, petitioner paid fees to other professionals
in the aggregate amount of $28,533.59. After reducing the amount
paid by the $15,000 payment to Mr. Van Valkenburg, the total
expenditure documented by petitioner was $13,533.59 (Ex. 41-R,
lines 538-585).
Petitioner is entitled to deduct legal and professional fees
in each of the years at issue in the amounts summarized above and
set forth in the chart at page 79 of this opinion.
e. Process Services
For the years at issue, petitioner claimed deductions for
process services obtained as part of her law practice as follows:
Year Amount
1987 $2,482
1988 2,495
1989 915
1990 1,822
Mr. Aunan’s workpapers reveal that the following entries
comprised the deducted amounts:
(a) For 1987, a cumulative amount of $2,482;
(b) for 1988, amounts of $2,373 and $122, for a total amount
deducted of $2,495;
- 41 -
(c) for 1989, amounts of $607, $300 and $8, for a total
amount deducted of $915;
(d) for 1990, amounts of $1,816 and $7, for a total amount
of $1,823.17
Our review of the record reveals the following:
(a) During 1987, petitioner paid, and respondent concedes
the deductibility of, courier services totaling $2,541.70 (Ex.
38-R, lines 74-114).
(b) During 1988, petitioner paid, and respondent concedes
the deductibility of, process service fees totaling $2,373.28
(Ex. 39-R, lines 599-648).
(c) During 1989, petitioner paid, and respondent concedes
the deductibility of, process service fees and other
transportation expenses totaling $570.70 (Ex. 40-R, lines 377-
398).
(d) During 1990, petitioner paid, and respondent concedes
the deductibility of, process server fees of $556.08 and
messenger service fees of $1,353.08, the total of which is
$1,909.16 (Ex. 41-R, lines 506-524, 607-646).
Petitioner is entitled to deduct process service and
transportation expenses in each of the years at issue in the
17
Although the amounts shown on Mr. Aunan’s workpapers total
$1,823, the amount claimed on the tax return was $1,822.
- 42 -
amounts summarized above and set forth in the chart at page 79 of
this opinion.
f. Court Fees
For the years at issue, petitioner claimed deductions for
court fees paid in connection with her law practice as follows:
Year Amount
1987 $2,002
1988 7,458
1989 9,104
1990 6,699
Mr. Aunan’s workpapers reveal that the following entries
comprised the deducted amounts:
(a) For 1987, amounts of $357, $1,924, and $221, for a total
amount deducted of $2,002 (it appears that a computational
mistake was made here as the total of the listed amounts is
$2,502);
(b) for 1988, amounts of $6,176 and $1,282, for a total
amount deducted of $7,458;
(c) for 1989, amounts of $7,890, $955, and $259, for a total
amount deducted of $9,104;
(d) for 1990, amounts of $3,357, $20, $193, $2,196, and
$933, for a total amount deducted of $6,699.
Our review of the record reveals the following:
(a) During 1987, petitioner paid, and respondent concedes
the deductibility of, court fees of $1,933.65 (Ex. 38-R, lines
- 43 -
353-423) and $759 (Ex. 38-R, lines 966-995), for a total amount
documented of $2,692.65.
(b) During 1988, petitioner paid, and respondent concedes
the deductibility of, court fees of $1,548.25 (Ex. 39-R, lines
386-433), $2,947.88 (Ex. 39-R, lines 437-530), and $57.50 (Ex.
39-R, lines 1647-1654), for a total amount documented of
$4,553.63.
(c) During 1989, petitioner paid, and respondent concedes
the deductibility of, court fees of $10.61 (Ex. 40-R, line 220),
$944.57 (Ex. 40-R, lines 270, 272-326), and $7,316.23 (Ex. 40-R,
lines 662-729, 731-752, 754-755, 757, 759-760, 762-789, 793, 797-
800, 804, 806, 808-812, 815-825, 827-844), for a total amount
documented of $8,271.41.
(d) During 1990, petitioner paid, and respondent concedes
the deductibility of, court fees of $3,113.45 (Ex. 41-R, lines
435-502) and expert fees of $3,796.57 (Ex. 41-R, lines 589-603),
for a total amount documented of $6,910.02.
Petitioner is entitled to deduct court and expert fees in
each of the years at issue in the amounts summarized above and as
set forth in the chart at page 79 of this opinion.
g. Contract Services
For the years at issue, petitioner claimed deductions for
contract services obtained as part of her law practice as
follows:
- 44 -
Year Amount
1987 $4,637
1988 10,618
1989 9,617
1990 10,079
Mr. Aunan’s workpapers reveal that the following entries
comprised the deducted amounts:
(a) For 1987, amounts of $3,849 and $788, for a total amount
deducted of $4,637;
(b) for 1988, a cumulative amount of $10,618;
(c) for 1989, amounts of $9,490 and $127, for a total amount
deducted of $9,617;
(d) for 1990, a cumulative amount of $10,079.
Our review of the record reveals the following:
(a) During 1987, petitioner paid, and respondent concedes
the deductibility of, contract services of $3,849.52 (Ex. 38-R,
lines 39-60) and $788.25 (Ex. 38-R, lines 790-799), for a total
amount documented of $4,637.77.
(b) During 1988, petitioner paid, and respondent concedes
the deductibility of, contract services of $10,759.31 (Ex. 39-R,
lines 696-755).
(c) During 1989, petitioner paid, and respondent concedes
the deductibility of, contract services of $9,748.39 (Ex. 40-R,
lines 575-658 (excluding items conceded by petitioner)).
- 45 -
(d) During 1990, petitioner paid, and respondent concedes
the deductibility of, contract services of $10,079.24 (Ex. 41-R,
lines 18-49).
Petitioner is entitled to deduct amounts paid for contract
services in each of the years at issue in the amounts summarized
above and set forth in the chart at page 79 of this opinion.
h. Moving Expenses
For 1987, petitioner claimed a deduction for moving expenses
in the amount of $3,258. Mr. Aunan’s workpapers reveal that the
amount deducted consisted of expenses of $412 and $2,846. Our
review of the record reveals that petitioner paid, and respondent
concedes the deductibility of, office moving expenses of $412.25
(Ex. 38-R, lines 336-340) and $2,845.82 (Ex. 38-R, lines 169-
173), for a total amount documented of $3,258.07.
Petitioner is entitled to deduct moving expenses of
$3,258.07 for 1987, as conceded by respondent and as shown on the
chart at page 79 of this opinion.
i. Insurance
For the years at issue, petitioner claimed deductions for
insurance paid in connection with her law practice as follows:
Year Amount
1987 $514
1988 3,677
1989 3,745
1990 3,565
- 46 -
Mr. Aunan’s workpapers reveal that the following entries
comprised the deducted amounts:
(a) For 1987, a cumulative amount of $514;
(b) for 1988, a cumulative amount of $3,677;
(c) for 1989, amounts of $3,578 and $167, for a total amount
deducted of $3,745;
(d) for 1990, amounts of $376, $397, and $2,792, for a total
amount deducted of $3,565.
Our review of the record reveals the following:
(a) In July, November, and December 1987, petitioner paid
amounts to State Farm Insurance totaling $414.92, all of which
respondent concedes are deductible (Ex. 38-R, lines 311-313).
(b) At various times during 1987, petitioner also paid for
employee health insurance from Blue Cross/Blue Shield and travel
insurance from Sid Murray Co. and Mutual of Omaha in amounts
totaling $541.97, all of which respondent concedes are deductible
(Ex. 38-R, lines 232-241). Some monthly payments to Blue Cross/
Blue Shield are not listed and appear to be missing.
(c) At various times during 1987, petitioner also paid
additional amounts to State Farm Insurance ($342.27) (Ex. 38-R,
lines 1017-1018) and the Administrator MSBA Plan ($21.60) (Ex.
38-R, line 1021) that respondent does not concede but we conclude
are deductible.
- 47 -
(d) During 1988, petitioner made payments to Blue Cross/Blue
Shield for employee health insurance ($1,010.32) (Ex. 39-R, lines
104-110), DCA for unspecified insurance ($397) (Ex. 39-R, lines
126-127), and Minnesota Department of Jobs & Training for
unemployment compensation insurance ($382.44) (Ex. 39-R, lines
140-147), all of which respondent concedes are deductible.
(e) During 1988, petitioner also made payments of $1,586.90
to State Farm Insurance Co. for office and equipment insurance
and for car insurance (Ex. 39-R, lines 116-125), $144.03 to
Confederation Life Insurance Co. for office insurance (Ex. 39-R,
lines 111-114), and $39 to Mutual of Omaha and Sid Murray Co. for
travel insurance (Ex. 39-R, lines 115, 131-132). Although
respondent does not concede that these amounts are deductible, we
hold that the above-listed items are deductible, and we note that
respondent has conceded similar items for 1989.
(f) During 1989, petitioner made payments to State Farm
Insurance for office insurance, to Sid Murray Co. and Mutual of
Omaha for travel insurance, to Blue Cross/Blue Shield for
employee health insurance, to Confederation Life Insurance Co.
for office insurance, to Lutheran Brotherhood for office
insurance, and miscellaneous other companies, totaling $2,768.80,
all of which respondent concedes are deductible.
(g) During 1989, petitioner paid additional office insurance
that respondent does not concede is deductible but that we hold
- 48 -
is deductible. The additional documented amounts total $1,096.51
(Ex. 40-R, lines 474-476, 479, 481-482).
(h) During 1990, petitioner paid employee life insurance,
employee health insurance, and workers’ compensation and
unemployment insurance totaling $1,543.64, all of which
respondent concedes are deductible (Ex. 41-R, lines 9-14, 842-
843; SSR dated 9/10/99).
(i) During 1990, petitioner also made payments to Blue
Cross/Blue Shield, Sid Murray Co. and Mutual of Omaha for office
and travel insurance ($518.98) that petitioner documented and
respondent concedes are deductible (Ex. 41-R, lines 365-368, 378-
379).
(j) During 1990, petitioner made other insurance payments,
the amount and business purpose of which she documented at trial.
Although respondent does not concede that these payments are
deductible, we hold that they are deductible because petitioner
has credibly testified with regard to their business purpose.
The payments total $1,303.19 (Ex. 41-R, line 369).
Petitioner is entitled to deduct business insurance that she
paid in each of the years at issue in the amounts summarized
above and shown on the chart at page 79 of this opinion.
j. Utilities
For the years at issue, petitioner claimed deductions for
utilities as follows:
- 49 -
Year Amount
1987 $838
1988 3,784
1989 6,152
1990 3,515
Mr. Aunan’s workpapers reveal that the following entries
comprised the deducted amounts:
(a) For 1987, a cumulative amount of $838;
(b) for 1988, amounts of $2,449, $1,318, $14, and $3, for a
total amount deducted of $3,784;
(c) for 1989, amounts of $1,257, $4,404, $458, and $33, for
a total amount deducted of $6,152;
(d) for 1990, amounts of $3,385, $17 and $113, for a total
amount deducted of $3,515.
Our review of the record reveals the following:
(a) For 1987, petitioner documented, and respondent conceded
the deductibility of, $1,572.19 and $333.45 of payments to
Northwestern Bell (Ex. 41-R, lines 142-143, 146-148, 1068-1069,
and SSR dated 9/10/99, line 1093) and utility payments to NSP in
October and December of $419.21 (Ex. 38-R, lines 825-826), for a
total amount documented of $2,324.85.
(b) For 1988, petitioner documented, and respondent conceded
the deductibility of, telephone expenses paid to American Paging,
US West, and Northwestern Bell of $2,757.51 (Ex. 39-R, lines 315-
326, 328, 330, 333-334). Petitioner also documented, but
respondent does not concede the deductibility of, utility
- 50 -
expenses paid to NSP totaling $1,317.82 (Ex. 39-R, lines 668-
676). Because petitioner has substantiated the payments to NSP,
which are consistent with utility payments in other years that
respondent did concede, we conclude that the payments to NSP
during 1988 are deductible utility expenses.
(c) For 1989, petitioner documented, and respondent concedes
the deductibility of, payments to NSP of $1,715.43 (Ex. 40-R,
lines 357-363, and SSR dated 9/10/99) and telephone and Metagram
expenses totaling $4,331.05 (Ex. 40-R, lines 331-334, 337-344,
346-347, 349-351, 353).
(d) For 1990, petitioner documented payments of $3,401.87
(the amount of which equals the sum of two of the three entries
on Mr. Aunan’s workpapers) (Ex. 41-R, lines 330-354). Of the
payments documented, respondent concedes the deductibility of
certain payments made to US West Cellular, NSP, American Paging,
AT&T, and US West Communications totaling $3,012.53 (Ex. 41-R,
lines 335-345, and SSR dated 9/10/99). Petitioner testified at
trial that she was entitled to additional amounts for cellular
phone service and for certain AT&T expenses for the office
phones. We accept petitioner’s testimony as credible, and we
allow her additional phone expense of $233.74 (Ex. 41-R, lines
331-334, 346, 348).
- 51 -
Petitioner is entitled to deduct utility expenses in each of
the years at issue in the amounts summarized above and shown on
the chart at page 79 of this opinion.
k. Supplies
For the years at issue, petitioner claimed deductions for
supplies purchased for her law practice as follows:
Year Amount
1987 $4,174
1988 12,297
1989 13,139
1990 7,263
Mr. Aunan’s workpapers, which describe this category of
expenses as “Office Supplies & Postage”, reveal that the
following entries comprised the deducted amounts:
(a) For 1987, amounts of $2,106, $653, and $1,415, for a
total amount deducted of $4,174;
(b) for 1988, amounts of $4,076, $1,195, $5,932, and $1,094,
for a total amount deducted of $12,297;
(c) for 1989, amounts of $6,762, $2,088, $378, $1,450,
$2,422, and $39, for a total amount deducted of $13,139;
(d) for 1990, amounts of $1,423, $3,307, $619, and $1,914,
for a total amount deducted of $7,263.
Our review of the record reveals the following:18
18
Petitioner disputes respondent’s failure to allow
additional expenditures that she made and deducted as office
supplies. In many but not all instances, petitioner credibly
(continued...)
- 52 -
(a) During 1987, petitioner paid for, and documented for
purposes of this case, office supplies and postage summarized
below, the deductibility of which respondent has conceded:
Office postage $653.36 (Ex. 38-R, lines 4-29)
Office supplies 2,015.75 (Ex. 38-R, lines 427-481,
excl. 438, 445, 447, 455)
Sec. B postage 359.37 (Ex. 38-R, lines 918-932)
Sec. B supplies 1,181.29 (Ex. 38-R, lines 938-951,
excl. 947)
Total 4,209.77
(b) During 1988, petitioner paid for, and documented for
purposes of this case, office supplies and postage summarized
below, the deductibility of which respondent has conceded:
Office supplies $3,607.36 (Ex. 39-R, lines 197-259 (in
amount allowed column))
Office supplies 2,960.81 (Ex. 39-R, lines 271-309)
Postage, etc. 2,520.70 (Ex. 39-R, lines 542-573)
Sec. B off. supplies 183.82 (Ex. 39-R, lines 1313-1433
(in amount allowed column))
Sec. B postage 141.99 (Ex. 39-R, lines 1571-1589)
Total 9,414.68
(c) During 1989, petitioner paid for, and documented for
purposes of this case, office supplies and postage summarized
below, the deductibility of which respondent has conceded:
18
(...continued)
testified regarding the business purpose of the expenditure at
trial, and/or the documentation presented at trial contains a
contemporaneous notation of the business purpose of the item. In
addition, respondent has conceded the deductibility of other
expenses that could be categorized as supplies. We shall account
for these additional expenses as miscellaneous expenses later in
this analysis.
- 53 -
Office supplies $7,954.92 (Ex. 40-R, lines 4-87
(amount allowed column plus
line 65))
Office postage 378.46 (Ex. 40-R, lines 123-127)
Office furniture 38.00 (Ex. 40-R, line 214)
Postage 2,041.23 (Ex. 40-R, lines 432-468
(amount allowed column))
Sec. B off. supplies 13.59 (Ex. 40-R, line 1445)
Sec. B postage 79.97 (Ex. 40-R, lines 1451-1465)
Sec. B additional
supplies 279.28 (Ex. 40-R, lines 1666-1763
_________ (amount allowed column))
Total 10,785.45
(d) During 1990, petitioner paid for, and documented for
purposes of this case, office supplies and postage summarized
below, the deductibility of which respondent has conceded:
Office supplies $3,330.25 (Ex. 41-R, lines 210-260)
Office expense 1,064.73 (Ex. 41-R, lines 264, 266-
267,271, 273-277, 279-285,
299, 302-304; SSR dated
9/10/99)
Copier 844.36 (Ex. 41-R, lines 358-361)
Printing expenses 619.31 (Ex. 41-R, lines 383-391)
Postage 1,422.78 (Ex. 41-R, lines 395-415)
Sec. B off. supplies 1,151.08 (Ex. 41-R, lines 1242-1285
(amount allowed column))
Sec. B off. misc. 117.63 (Ex. 41-R, lines 1312-1343
(amount allowed column))
Sec. B postage (cash) 108.45 (Ex. 41-R, lines 1348-1363)
Sec. B credit card 2,501.32 (Ex. 41-R, lines 1395-1424
(amount allowed column))
Sec. B printing 17.21 (Ex. 41-R, line 1598)
Sec. C credit card 244.14 (Ex. 41-R, lines 1668-1669,
1679-1681)
Total 11,421.26
Petitioner is entitled to deduct payments made for supplies
in each of the years at issue in the amounts summarized above and
shown on the chart at page 79 of this opinion.
- 54 -
l. Wages and Employee Benefits
For the years at issue, petitioner claimed deductions for
wages and employee benefits paid in connection with her law
practice as follows:
Year Wages Employee Benefits
1987 $13,991 $2,057
1988 19,203 2,243
1989 26,238 5,274
1990 29,054 3,998
Mr. Aunan’s workpapers reveal that the following entries
comprised the deducted amounts:
(a) For 1987, the wage deduction was derived by adding
expenditures of $3,042 and $10,949, and the employee benefit
deduction was an aggregate amount of $2,057.
(b) For 1988, the wage deduction was derived by adding
expenditures of $15,766 and $3,437, and the employee benefit
deduction was derived by adding expenditures of $2,076, $134, and
$33.
(c) For 1989, the wage deduction was derived by adding
expenditures of $22,270 and $3,968, and the employee benefit
deduction was derived by adding expenditures of $3,275, $1,314,
$437, and $248.
(d) For 1990, the wage deduction was an aggregate amount of
$29,054, and the employee benefit deduction was derived by adding
expenditures of $3,797, $62, $109, and $30.
- 55 -
Our review of the record reveals the following:
(a) During the years at issue, petitioner employed one or
more employees in her law office and maintained a payroll account
through which she paid her employees’ salaries and related
withholdings.
(b) Petitioner did not introduce into evidence at trial all
of her payroll records or her Forms W-2, Wage and Tax Statement,
for the years at issue. Nevertheless, petitioner’s testimony and
other documents establish that petitioner paid salaries,
employment taxes, and employee benefits during each of the years
at issue.
(c) For 1987, petitioner documented expenses characterized
as employee benefit expenses of $1,159.55 (Ex. 38-R, lines 174-
183), six deposits into the payroll account on various dates in
May, November, and December 1987 totaling $3,041.72 (Ex. 38-R,
lines 816-821), and additional salary and daycare payments of
$946.86 in August 1987 (Ex. 38-R, lines 1112-1117), the
deductibility of which respondent has conceded.
(d) For 1988, petitioner documented salary payments of
$15,766.34 (Ex. 39-R, lines 833-865), additional salary payments
of $1,218.52 to Cynthia O. Ransom during May 1988 (Ex. 39-R,
lines 1294-1297), and daycare expenses in April and May 1988 of
$72 (Ex. 39-R, lines 1291-1293), the deductibility of which
respondent has conceded.
- 56 -
(e) For 1989, petitioner documented salary payments of
$22,288.21 (Ex. 40-R, lines 509-532) and daycare expenses of
$1,591.80 paid for one of her employees (Ex. 40-R, lines 551-
571), the deductibility of which respondent has conceded.
(f) For 1990, petitioner documented salary payments of
$6,658.20 (Ex. 41-R, lines 98-116) and $18,707.32 (Ex. 41-R,
lines 856-873), the deductibility of which respondent has
conceded.
Although petitioner did not introduce all of her payroll
records into evidence, we are convinced that her failure to do so
was more likely than not the result of the sheer volume of
documentation with which she was dealing at trial and the lack of
attention paid by both petitioner and respondent to the actual
Schedule C categories. Petitioner, however, credibly testified
at trial that she paid salaries, a telephone allowance, life
insurance, health insurance, school and summer childcare
expenses, and automobile expenses (including car insurance, a gas
allowance, and car payments) to or for the benefit of her
employees during 1987, 1988, and part of 1989. We also note that
the documented amounts if annualized would generate an annual
figure consistent with, or larger than, the amounts claimed on
petitioner’s Schedules C for the years at issue. We shall apply
the Cohan rule to uphold petitioner’s wage and employee benefits
deductions for each of the years at issue.
- 57 -
Petitioner paid wages and provided employee benefits in the
amounts deducted in each of the years at issue as shown on the
chart at page 79 of this opinion.
m. Car and Truck
For the years at issue, petitioner claimed deductions for
car and truck expenses paid in connection with her law practice
as follows:
Year Amount
1987 $6,672
1988 8,807
1989 5,354
1
1990 10,399
1
This amount includes car lease payments of $7,159 claimed
as rent.
Mr. Aunan’s workpapers reveal that the following items of
car and truck expenses were taken into account in calculating the
deductions for the years at issue:
Year Car lease Repairs Gas Total
1987 $3,634 $1,647 $76
1,398 300 54 $7,109
1988 6,228 631 2,689 9,548
1989 5,190 519
71
3 5,783
1990 8,076 1,424 517
601 33
877 11,528
- 58 -
Our review of the record reveals the following:
(a) During 1987, 1988, and 1989, petitioner leased two cars
for business purposes--a 1988 Toyota Camry from Wilkens Toyota
for general office use (driven by the process server, law clerk,
courier, and petitioner) and a 1987 Toyota Tercel from GE Credit
Auto Leasing for her secretary’s use. Petitioner had another car
for her personal use.
(b) During 1990, petitioner leased three cars for business
purposes--a Toyota Tercel, a Toyota Camry, and a Hyundai that was
leased in March 1990.
(c) For 1987, petitioner documented, and respondent concedes
the deductibility of, car expenses of $2,426.15 (Ex. 38-R, lines
283-297), $5,099.07 (Ex. 38-R, lines 1005-1015), and $1,231 (Ex.
38-R, lines 809-812; SSR dated 9/10/99), for a total amount
documented of $8,756.22.
(d) For 1988, petitioner documented, and respondent concedes
the deductibility of, car expenses of $7,582.50 (Ex. 39-R, lines
355-382; SSR dated 9/10/99), $478.90 (Ex. 39-R, lines 577-595),
and $439.82 (Ex. 39-R, lines 1744-1764; SSR dated 9/10/99), for a
total amount documented of $8,501.22.
(e) For 1989, petitioner documented, and respondent concedes
the deductibility of, car expenses of $4,409.13 (Ex. 40-R, lines
223-239; SSR dated 9/10/99), $1,236.30 (Ex. 40-R, lines 402-428),
$748.78 (Ex. 40-R, lines 1533-1538, 1540-1559; SSR 9/10/99), and
- 59 -
$43.90 (Ex. 40-R, lines 1787-1790), for a total amount documented
of $6,438.11.
(f) For 1990, petitioner documented, and respondent concedes
the deductibility of, car expenses of $7,713.61 (Ex. 41-R, lines
1176-1222; SSR dated 9/10/99), and $245.44 (Ex. 41-R, lines 1483-
1496), for a total amount documented of $7,959.05.
Petitioner paid car and truck expenses in connection with
her law practice in each of the years at issue in the amounts
summarized above and shown on the chart at page 79 of this
opinion.
n. Rent
For the years at issue, petitioner claimed deductions for
rent in connection with her law practice as follows:
Year Amount
1987 $11,460
1988 10,256
1989 9,706
1
1990 6,175
1
Total rent expense claimed ($13,334) reduced by car lease
payments ($7,159) that were included as part of rent expense on
petitioner’s 1990 return.
Mr. Aunan’s workpapers show totals only and do not contain any
information identifying the rental expenses claimed.
Our review of the record reveals the following:
(1) During each of the years at issue, petitioner leased
office space that she used for her law practice.
- 60 -
(2) During 1987, petitioner entered into a predevelopment
purchase agreement for office space described as Suite 11, 1410
Energy Park Drive, that required her to pay $85,000 for the
office once the development work was completed. For
approximately 4 months before petitioner actually moved into
Suite 11, she rented Suite 8 and used it as her temporary law
office. Petitioner paid $955 per month to the Trah Partnership
for 4 months (Ex. 38-R, lines 164-165, 1066-1067), and respondent
has conceded that these amounts are deductible.
(3) In July 1987, petitioner moved into Suite 11 but did not
close on the purchase agreement because she could not get the
developer to schedule the closing. Petitioner maintained her law
office in Suite 11 until 1990 when the developer’s interest in
the property, 1410 Energy Park Drive, was foreclosed.
(4) When petitioner first moved into Suite 11 in July 1987,
she agreed to pay rent at the rate of $1,239.47 per month until
the closing under the purchase agreement was held. Petitioner
expected this arrangement to be of short duration. No closing,
however, was ever scheduled. Sometime after she moved into Suite
11, petitioner ceased paying rent to the developer in an effort
to force a closing under the purchase agreement. Petitioner was
sued for unpaid rent and resolved the litigation by escrowing
approximately $10,000 in 1990 to settle the claim. However, the
- 61 -
escrowed funds were not released, if at all, until sometime after
1990.
(5) Petitioner paid architect and designer fees with respect
to Suite 11. Petitioner also paid for the improvements made to
Suite 11.
(6) In October 1989, petitioner’s law office was
burglarized. The burglary caused damage to the doorway, but the
developer refused to repair the damage. Petitioner made the
necessary repairs.
(7) By the time petitioner’s tax returns for the years at
issue were prepared, the developer’s interest in 1410 Energy
Drive had been foreclosed. It is reasonable to assume,
therefore, that all amounts paid with respect to Suite 11 during
the years at issue, except for the development costs that were
depreciated (Ex. 38-R, lines 222-228) and the interest on the
business loan, were deducted by Mr. Aunan as rent. However, the
record does not give us sufficient information to estimate the
amount of rent or rent equivalent that petitioner paid during
1988-90.
We conclude that petitioner paid rent for her law office
during 1987 in the amount of $3,820, as shown on the chart at
page 79 of this opinion. We lack sufficient information to
estimate petitioner’s rent expense for 1988-90.
- 62 -
o. Taxes
For the years at issue, petitioner claimed deductions for
taxes as follows:
Year Amount
1987 $1,235
1988 4,908
1989 5,051
1990 10,601
Mr. Aunan’s workpapers, which describe the tax expense
category as “P/R Taxes”, reveal that the following entries
comprised the deducted amounts:
(a) For 1987, amounts of $491 and $744, for a total amount
deducted of $1,235;
(b) for 1988, amounts of $382 and $4,526, for a total amount
deducted of $4,908;
(c) for 1989, a single amount of $2,799 is listed, but the
final expense figure shown on Mr. Aunan’s workpapers is $5,051,
the total amount deducted on petitioner’s return;
(d) for 1990, a total amount of $10,601.
Our review of the record reveals the following:
(a) For 1987, petitioner documented two payments to the IRS,
in September and December 1987, and one payment to the Commission
of Revenue, in September 1987, totaling $490.98 (Ex. 38-R, lines
803-805). Respondent concedes the deductibility of these
payments.
- 63 -
(b) For 1988, petitioner documented $5,113.77 of payments to
the IRS ($4,034.98) and the Minnesota Department of Revenue
($850.90) and deposits into petitioner’s payroll account
($227.89) covering the months of February, May, July, August, and
October 1988 (Ex. 39-R, lines 652-664). Of the amounts
documented, petitioner concedes that $1,200.97 was deposited into
the payroll account (and presumably was claimed as a wage
deduction), and respondent concedes the deductibility of the
payments to the Minnesota Department of Revenue.
(c) For 1989, petitioner documented $3,068.20 of payments to
the IRS ($2,324.64) and to the Minnesota Department of Revenue,
the Minnesota Department of Jobs, the Minnesota UC Fund, the
Commissioner of Revenue, and the Employee Benefit Administration
($743.56) (Ex. 40-R, lines 257-266). Respondent conceded the
deductibility of all of these payments.
(d) For 1990, petitioner documented $11,253.01 of payments
to the IRS ($9,888.44), the Department of Revenue ($1,167.19),
and the Minnesota Department of Jobs ($197.38) (Ex. 41-R, lines
809-838) but provided no information regarding the nature or
purpose of the payments. Respondent has not conceded that any of
these payments is deductible.
(e) During each of the years at issue, petitioner paid wages
to employees and had an obligation to pay the employer’s share of
Federal Insurance Contributions Act (FICA) and Federal
- 64 -
Unemployment Tax Act (FUTA) taxes, see secs. 3111(a) and (b)(6),
3301, as well as the employer’s share of State employment and
unemployment taxes. Such taxes are deductible when paid in
carrying on the employer’s trade or business. Sec. 162(a).
Although we cannot precisely ascertain from the record the exact
amount of FICA and FUTA taxes paid by petitioner, we shall apply
the Cohan rule and allow deductions for the employer’s share of
FICA and FUTA taxes, calculated on the wages that we have held
are deductible in each of the years at issue. The following
rates were in effect with respect to FICA (old-age, survivors,
and disability insurance (sec. 3111(a)) and hospital insurance
(sec. 3111(b)(6))), and FUTA (sec. 3301) for each of the years at
issue:
Year FICA FUTA
Old Age Hospital
1987 5.7 percent 1.45 percent 6 percent
1988 6.06 percent 1.45 percent 6.2 percent
1989 6.06 percent 1.45 percent 6.2 percent
1990 6.2 percent 1.45 percent 6.2 percent
Applying these rates to the wages allowed as deductions in each
of the years at issue results in deductions for the employer’s
share of FICA and FUTA tax of $1,839.82 for 1987, $2,632.74 for
1988, $3,597.23 for 1989,19 and $4,023.98 for 1990.
19
Respondent already has conceded that $2,324.64 of this
amount is deductible. We have calculated the amount allowed as a
deduction for 1989 to eliminate any duplication.
- 65 -
Petitioner is entitled to deduct tax payments in each of the
years at issue in the amounts conceded by respondent and allowed
under the Cohan rule. The amounts are shown on the chart at page
79 of this opinion.
p. Interest
For the years at issue, petitioner claimed deductions for
interest paid in connection with her law practice as follows:
Year Amount
1987 $10,034
1988 3,053
1989 2,926
1990 2,070
Mr. Aunan’s workpapers include a workpaper labeled “Business
Interest”, which contains the following entries:
1987 1988 1989 1990
Citibank MasterCard $260.00 $319.50 $365.45 $258.66
Amex Gold
Citibank Visa -- 202.07 270.63 235.71
Citibank Preferred -- -- 232.16 581.82
First Card 365.93 790.58 910.97 870.01
Amex Green 1.47 17.04 81.37
TCF Visa -- -- 284.59 --
625.93 1,313.62 2,080.84 2,027.57
The total amount of credit card interest in each year was then
rounded and added to amounts characterized as “Capital Loan” to
arrive at the total business interest deducted in each of the
years at issue:
- 66 -
Year Credit Card Capital Loan Total
1987 $626 $9,408 $10,034
1988 1,314 1,739 3,053
1989 2,081 845 2,926
1990 2,028 42 2,070
Our review of the record reveals the following:
(a) Petitioner maintained various credit card accounts that
she used for business purposes during the years at issue.
(b) During each of the years at issue, petitioner paid
interest expense attributable to her business use of her credit
card accounts.
(c) Petitioner documented interest expense paid on her
Citibank Visa account for 1988 of $202.07.
(d) Petitioner documented, and respondent concedes the
deductibility of, interest expense paid on petitioner’s Citibank
MasterCard account for 1989 of $390.62 (Ex. 40-R, lines 1841,
1848, 1852).
(e) Petitioner documented the existence of a business loan
with ANB, the purpose of which was to finance leasehold
improvements. The face amount of the loan was $19,342.33, and it
carried an annual interest rate of 10.25 percent.
(f) Petitioner documented that she paid interest on the
business loan in the following amounts: 1988--$1,738.71, 1989--
$844.55, 1990--$42.44.
Although petitioner did not introduce all of her credit card
records for each of the years at issue into evidence, we are
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satisfied from the documentation that was introduced that
petitioner maintained the credit card accounts in question and
that she used them for her law practice. We are also satisfied
that, at the time Mr. Aunan prepared petitioner’s returns for the
years at issue, he had documentation of the credit card interest
paid by petitioner during the years at issue.
With respect to the capital loan interest deducted,
petitioner produced copies of information returns that confirmed
the interest expense paid with respect to petitioner’s business
loans for 1988, 1989, and 1990. The amounts documented
corresponded exactly with the amounts shown on Mr. Aunan’s
workpapers. Although petitioner did not introduce into evidence
copies of her interest statements for 1987, we believe that there
is a sufficient factual predicate in the record to support a
finding that petitioner incurred interest expense attributable to
her business loans and credit card accounts as claimed on her
1987 Schedule C.
Petitioner paid interest expenses as claimed on her
Schedules C for the years at issue and reflected on the chart at
page 79 of this opinion.
q. Travel
For the years at issue, petitioner claimed deductions for
business travel as follows:
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Year Amount
1987 $1,039
1988 --
1989 1,601
1990 1,988
Mr. Aunan’s workpapers reveal that the following entries
comprised the deducted amounts:
(a) For 1987, a cumulative amount of $1,039;
(b) for 1989, a cumulative amount of $1,601;
(c) for 1990, amounts of $12 and $1,976, for a total amount
deducted of $1,988.
Mr. Aunan’s workpapers also show a $9 entry for travel for 1988,
but that amount was not deducted as travel on petitioner’s 1988
Schedule C. Instead, it appears Mr. Aunan added the $9 item to
Miscellaneous Expense and deducted it as such on petitioner’s
1988 Schedule C.
Our review of the record reveals the following:
(a) For 1987, petitioner documented, and respondent concedes
the deductibility of, business travel expenses of $520, $53.07,
$104.74, $258, $10, $310, and $310, totaling $1,565.81 (Ex. 38-R,
lines 1134, 1190-1191, 1193-1196).
(b) For 1988, petitioner documented, and respondent concedes
the deductibility of, business travel expenses (including baggage
and flight insurance) totaling $832.50 (Ex. 39-R, lines 1841-
1843, 1878-1880).
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(c) For 1989, petitioner documented, and respondent concedes
the deductibility of, business travel expenses totaling $947
(Ex.40-R, lines 1849-1851).
(d) For 1990, petitioner documented, and respondent concedes
the deductibility of, business travel expenses of $856.13 (Ex.
41-R, lines 1374-1385) and $463.59 (Ex. 41-R, lines 1661-1663),
for a total of $1,319.72.
Petitioner paid business travel expenses during each of the
years at issue in the amounts summarized above and reflected in
the chart at page 79 of this opinion.
r. Advertising and Meals & Entertainment
For the years at issue, petitioner claimed deductions for
advertising and for meals and entertainment in connection with
her law practice as follows:
Year Advertising Meals & ent. Total
1987 $98 $896 $994
1988 160 1,961 2,121
1989 513 795 1,308
1990 2,384 3,286 5,670
Mr. Aunan’s workpapers reveal that the following entries
comprised the deducted amounts:
(a) For “Promotion & Advertising”, cumulative amounts of
$98, $160, and $513 for 1987, 1988, and 1989, respectively, and
amounts of $1,253 and $1,131, for a total amount deducted of
$2,384 for 1990;
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(b) for entertainment, amounts of $951 and $169, totaling
$1,120 for 1987; amounts of $2,093, $316, and $42, totaling
$2,451 for 1988; amounts of $472 and 522, totaling $994 for 1989;
and amounts of $1,844, $478, $269, and $1,516, totaling $4,107
for 1990 before application of the section 274(n) limitation.
Our review of the record reveals the following:
(a) Petitioner maintained voluminous records to document
her practice of entertaining, and purchasing gifts for, clients,
employees, referral sources, judges, and other members of the
legal community throughout the years at issue.
(b) In his notices of deficiency, respondent did not assert
section 274 as a ground for disallowing any of petitioner’s
deductions for business promotion/advertising or for meals and
entertainment. Respondent only asserted a section 162 standard
as the basis for his proposed disallowance of petitioner’s
deductions.
(c) Petitioner testified extensively at trial regarding the
identity of the person who was entertained or to whom a gift was
given, as well as the business purpose of many of the individual
items comprising her business promotion and meals and
entertainment expenses. The date and amount of the expenditures
were documented by invoices, canceled checks, credit card and
other receipts, and other records. In some cases, receipts
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retained by petitioner as part of her business records were no
longer legible.
(d) For 1987, petitioner presented documentation of the
following expenditures that were listed on Exhibit 38-R in the
following categories:20
Category Line Nos. Amount
Bachman’s (bus. gifts) 64-70 $118.96
Client entertainment 485-521 971.63
Credit cards 1171, 1173, 1175, 1,496.72
1181-1189, 1192,
1197-1232
(e) For 1988, petitioner presented documentation of the
following expenditures that were listed on Exhibit 39-R in the
following categories:
Category Line Nos. Amount
Client & employee gifts
& entertainment 1183-1297 $8,126.48
Client gifts 1593-1608 139.46
Employee benefits 1612-1637 195.49
Office party 1641-1643 131.66
Client entertainment 1677-1740 935.18
Of the expense items listed on lines 1183-1297, respondent
conceded that $2,266.55 was deductible, and the nature of the
expenses indicates that they were not entertainment expenses.
During trial, petitioner conceded that some of the items were not
20
Petitioner “conceded” several of the smaller expense
items; i.e., she did not offer any additional evidence regarding
them, because she was interested in getting to the “large items”.
She did not concede that the items were not deductible, however,
and she did document the date and amount of the expense and the
identity of the payee as reflected on Exhibits 38-R through 41-R.
- 72 -
deductible and testified that other items were misclassified but,
nevertheless, were deductible business expenses.
(f) For 1989, petitioner presented documentation of the
following expenditures that were listed on Exhibit 40-R in the
following categories:
Category Line Nos. Amount
Client gifts 148-162 $465.13
Employee & client
gifts & entertainment 950-1076 3,365.06
Client gifts 1469-1481 178.62
Client entertainment 1485-1529 747.61
1
American Express 1796-1835 1,118.95
1
Some of these items, which do not appear to be meal or
entertainment expenses, have been conceded by respondent. The
amount shown has been reduced by the conceded amounts.
(g) For 1990, petitioner presented documentation of the
following expenditures that were listed on Exhibit 41-R in the
following categories:
Category Line Nos. Amount
Business promotion 151-166 $1,252.94
Client gifts 193-206 534.09
Employee gifts 877-883 543.37
Client entertainment 887-964 1,909.23
Business promotion 1303-1306 429.31
Client entertainment 1439-1478 1,074.75
Client gifts 1579-1593 484.17
After reviewing petitioner’s documentation and testimony, we
have no doubt that a properly conducted audit of petitioner’s
meals and entertainment and business promotion records could have
resulted in a reasonable dispute regarding whether the
requirements of section 162 have been satisfied with respect to
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each expense item and, if so, whether section 274 should operate
to preclude deductions for some of the items. We also have no
doubt, however, that petitioner had deductible meals and
entertainment expenses and purchased deductible business gifts
for clients, referral sources, and other professional people in
each of the years at issue. We also note that the documentation
presented by petitioner that was reviewed and summarized by
respondent in Exhibits 38-R through 41-R substantially exceeds
the deductions claimed by petitioner for advertising (business
promotion) and meals and entertainment in each of the years at
issue:
Year Total on return Total on exhibits
1987 $994 $2,587.31
1988 2,121 9,528.27
1989 1,308 5,875.37
1990 5,670 6,227.86
Recognizing the flaws in each party’s position, we conclude only
that petitioner paid advertising/business promotion and meals and
entertainment expenses in sufficient amounts to support the
deductions claimed in each of the years at issue.
s. Miscellaneous
For the years at issue, petitioner claimed deductions for
miscellaneous business expenses as follows:
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Year Amount
1987 $355
1988 6,424
1989 3,343
1990 2,427
Mr. Aunan’s workpapers reveal that the following entries
comprised the deducted amounts:
(a) For 1987, parking expenses of $35 and miscellaneous
expenses of $320, for a total deducted of $355;
(b) for 1988, travel expenses of $9 and miscellaneous
expenses of $6,415, for a total deducted of $6,424;
(c) for 1989, miscellaneous expenses of $2,878 and $465, for
a total deducted of $3,343;
(d) for 1990, miscellaneous expenses of $2,398 and parking
expenses of $29, for a total deducted of $2,427.
Our review of the record reveals the following:
(a) During 1987, petitioner paid the following Schedule C
expenses that have not been previously allocated in this analysis
to any other Schedule C category:
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Conceded by
Category Ex./line Nos. Amount respondent?
Various 38-R/33-35 $223.76 Yes
Parking 38-R/118-120 13.25 Yes
Various 38-R/130-133 371.25 Yes
Various 38-R/266-267 12.25 Yes
Various 38-R/277-279 22.00 Yes
Various 38-R/742-743 142.68 Yes
Various 38-R/758-762 357.23 Yes
Various 38-R/781-786 250.61 Yes
Various 38-R/860 30.00 Yes
Various 38-R/904-917 1,131.68 Yes
Various 38-R/936 581.00 Yes
Various 38-R/958-965,
998-999,
1004 932.96 Yes
Various 38-R/1037 7.00 Yes
Various 38-R/1042-1044,
1046-1050,
1053-1055 1,326.08 Yes
Various 38-R/1059 17.23 Yes
Various 38-R/1071-1075 165.39 Yes
Various 38-R/1087 37.00 Yes
Various 38-R/1091 300.00 Yes
Various 38-R/1098-1108
1110 686.10 Yes
Various 38-R/1142 97.85 Yes
Various 38-R/1152 15.00 Yes
6,720.32
(b) During 1988, petitioner paid the following Schedule C
expenses that have not been previously allocated in this analysis
to any other Schedule C category:
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Conceded by
Category Ex./line Nos. Amount respondent?
Various 39-R/4-21 $1,052.20 Yes
Luth. Broth. 39-R/128-130,
133-134 274.62 No
CLE Book 39-R/138 40.00 No
Various 39-R/139 32.33 Yes
Various 39-R/151-193 1,034.18 Yes
(including 165) No
Misc. supp. 39-R/200,203,
206,
209-212 432.82 No
Misc. supp. 39-R/214-222,
1
226 222.17 No
Various 39-R/239-240 110.50 No
Various 39-R/534-538 81.25 Yes
Client exp. 39-R/1132-1134 5,111.56 No
Various 39-R/1437-1567 535.22 Yes
Various 39-R/1787,1791,
1802-1803,
1805, 1810,
1812,
1815-1816 333.58 Yes
Various 39-R/1826-1828,
1830-1832 290.82 Yes
Various 39-R/1839-1840,
1845-1846,
1849-1855,
1857-1858 151.77 Yes
Various 39-R/1864,1870,
1876-1877,
1881 165.37 Yes
9,868.39
1
The amount allowed with regard to these items is based on
petitioner’s testimony at trial, which we find credible.
(c) During 1989, petitioner paid the following Schedule C
expenses that have not been previously allocated in this analysis
to any other Schedule C category:
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Conceded by
Category Ex./line Nos. Amount Respondent?
Off. supp. 40-R/13 $34.75 No
Off. supp. 40-R/15 19.46 No
Off. supp. 40-R/16 151.04 No
Off. supp. 40-R/21-24 74.51 No
Off. supp. 40-R/29-30 14.51 No
Off. supp. 40-R/40 5.25 No
Off. supp. 40-R/47 24.85 No
Off. supp. 40-R/58-60 160.64 No
Client exp. 40-R/209-210 16.70 Yes
Client exp. 40-R/547 4,000.00 No
Client exp. 40-R/805 17.00 Yes
Client exp. 40-R/826 2.00 No
Client exp. 40-R/1181, 1182 1,020.47 No
Auto 40-R/1533-1536 38.26 Yes
Parking 40-R/1568-1662 340.31 Yes
Off. supp. 40-R/1682 142.18 No
Off. supp. 40-R/1778 24.80 No
Off. supp. 40-R/1779-1780 269.25 Yes
Auto 40-R/1816-1817 261.82 Yes
Various 40-R/1831-1833 237.62 Yes
Off. subs. 40-R/1835 24.00 No
Various 40-R/1842, 1847,
1854-1856,
1858-1860 330.96 Yes
7,210.38
(d) During 1990, petitioner paid the following Schedule C
expenses that have not been previously allocated in this analysis
to any other Schedule C category:
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Conceded by
Category Ex./line Nos. Amount Respondent?
Miscell. 41-R/265, 269,
270, 278,
286, 290,
307 $730.49 No
Off. furn. 41-R/311-319,
321-325 782.75 No
Parking 41-R/419-424 28.50 Yes
Admin. fees 41-R/528-529 20.00 Yes
Court rpt. 41-R/533-534 192.52 Yes
Fees to attys. 41-R/549 9,051.55 No
(out of $15,000)
Client fees 41-R/654-655,
657-659 255.47 Yes
Client fees 41-R/656, 661 1,640.90 No
Emp. benef. 41-R/682-686,
693-699 842.37 No
Rental exp. 41-R/703-712 2,304.35 Yes
Bus. prom. 41-R/1303-1304,
1306 364.40 Yes
Prof. fee 41-R/1368 25.00 Yes
Client fee 41-R/1390 1.62 Yes
Parking 41-R/1501-1503,
1505-1524,
1530-1574 241.30 Yes
Auto 41-R/1682-1683 23.50 Yes
16,504.72
t. Reconciliation
A comparison of the Schedule C expenses allowed pursuant to
the foregoing analysis with the Schedule C expenses claimed on
petitioner’s Federal income tax returns for the years at issue
reveals the following:
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1987 1988 1989 1990
Per Per Per Per Per Per Per Per
Return Opinion Return Opinion Return Opinion Return Opinion
Advertising $98 $98.00 $160 $160.00 $513 $513.00 $2,384 $2,384.00
Bank charges 469 682.00 1,035 1,035.00 120 120.00 120 120.00
Car & truck 6,672 8,756.22 8,807 8,501.22 5,354 6,438.11 3,240 7,959.05
Depreciation 2,546 2,546.00 11,974 11,974.00 2,444 2,444.00 1,467 1,467.00
Dues & pubs. 2,337 4,471.04 3,867 4,038.56 2,675 2,653.00 4,095 2,311.97
Employee ben. 2,057 2,057.00 2,243 2,243.00 5,274 5,274.00 3,998 3,998.00
Insurance 514 1,320.76 3,677 3,559.69 3,745 3,865.31 3,565 3,365.81
Interest 10,034 10,034.00 3,053 3,053.00 2,926 2,926.00 2,070 2,070.00
Legal & prof. 5,104 5,104.22 7,239 9,423.18 6,128 6,140.18 13,536 13,533.59
Rent 11,460 3,820.00 10,256 --- 9,706 --- 13,334 ---
Supplies 4,174 4,209.77 12,297 9,414.68 13,139 10,785.45 7,263 11,421.26
Taxes 1,235 2,330.80 4,908 3,483.64 5,051 4,340.79 10,601 4,023.98
Travel 1,039 1,565.81 --- 832.50 1,601 947.00 1,988 1,319.72
Meals & ent. 896 896.00 1,961 1,961.00 795 795.00 3,286 3,286.00
Utilities 838 2,324.85 3,784 4,075.33 6,152 6,046.48 3,515 3,246.27
Wages 13,991 13,991.00 19,203 19,203.00 26,238 26,238.00 29,054 29,054.00
Moving exps. 3,258 3,258.07 --- --- --- --- --- ---
Process serv. 2,482 2,541.70 2,495 2,373.28 915 570.70 1,822 1,909.16
Contract serv. 4,637 4,637.77 10,618 10,759.31 9,617 9,748.39 10,079 10,079.24
Court fees 2,002 2,692.65 7,458 4,553.63 9,104 8,271.41 6,699 6,910.02
Collect. fees --- --- --- --- 850 --- --- ---
Miscellaneous 355 6,720.32 6,424 9,868.39 3,343 7,210.38 2,427 16,504.72
76,198 84,057.98 121,459 110,512.41 115,690 105,327.20 124,543 124,963.79
The chart summarizes the Schedule C expenses that we have
concluded, based on a preponderance of the evidence, petitioner
is entitled to deduct in each of the years at issue. As
reflected in the chart, petitioner has substantiated Schedule C
expenses for each of the years 1987 and 1990 in excess of those
claimed on her tax returns for those years. The chart also
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reveals that, for 1988 and 1989, petitioner has substantiated
Schedule C expenses in amounts that are less than the amounts
claimed on her tax return for each year.
The chart also illustrates what should be obvious by now--
respondent’s determination disallowing her Schedule C expenses
for the years at issue was arbitrary and unreasonable. We cannot
explain how the audit process malfunctioned so badly, but it is
readily apparent that the malfunction occurred. The disallowance
of petitioner’s business expenses after petitioner had produced
auditable business records for considered review by the revenue
agent and others has resulted in significant expenditures of time
on the part of petitioner, respondent’s counsel, and this Court
to conduct what was, in effect, an audit. This case has amply
demonstrated that the litigation process is not well suited for
the exchange of information that should occur in a properly
conducted audit.
D. Net Operating Losses
Unlike the record made by petitioner with respect to her
Schedule C income and deductions, the record made by petitioner
with respect to her NOL carryforward deductions does not
establish that respondent’s determinations disallowing
petitioner’s NOL carryforward deductions were erroneous.
Although petitioner alluded to the fact that respondent did not
examine the NOLs during his examination of the years at issue,
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petitioner did not clearly testify that she produced to the
revenue agent the records necessary to support the NOL carryover
deductions claimed for the return years at issue. More
importantly, although petitioner introduced some documentation at
trial with respect to her claimed NOL deductions, the
documentation was insufficient to support a finding that she is
entitled to all or any portion of such carryforwards.
The principal problem with the trial record is that the
documentation, although substantial, is incomplete in many
respects. For example, petitioner introduced no records for 1977
or 1984-86 and insufficient records for 1980 and 1982, the years
in which petitioner claimed net operating losses, to enable us to
verify the losses or to show how the losses were absorbed in
other years.
Under the foregoing circumstances, we hold that petitioner
has failed to prove she is entitled to any portion of the
reported 1980-86 NOL carryforward.
II. Additions to Tax and Penalties
A. Section 6651(a)(1) Addition to Tax
Section 6651(a)(1) imposes a penalty equal to 5 percent of
the tax due for each month of delayed filing beyond the due date
(including extensions) up to a maximum of 25 percent “unless it
is shown that such failure [to file] is due to reasonable cause
and not due to willful neglect”.
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Petitioner was well aware that her 1987 return and the 1988-
90 joint returns with her husband were not filed timely. All
four returns were filed between August 25, and August 27, 1992,
well after the due dates, including the extended due date for
1987. For 1988-90, petitioner did not furnish the accountant
with information he needed to prepare the returns until after the
return due dates.
Although petitioner testified that the late filings were
largely attributable to her husband’s failure to gather his tax
information and pay his self-employment tax and/or to the
accountant’s delay in completing the returns, she failed to
pursue available alternatives such as insisting on the timely
filing of her 1987 return, timely filing a “married filing
separate return” for 1988-90, or demanding that her husband and
his accountant complete and file the joint returns for 1988-90 by
their due dates using the best information available (and, if
necessary, filing amended returns when the rest of the
information became available). Petitioner’s failure to ensure
that her returns were filed timely under these circumstances
supports the imposition of the delinquency addition to tax. See
Estate of Thomas v. Commissioner, T.C. Memo. 2001-225.
Consequently, we sustain respondent’s imposition of the section
6651(a)(1) delinquency addition to tax for each of the years at
issue, recomputed in accordance with this opinion.
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B. Negligence Addition to Tax Under Section 6653
Section 6653(a), applicable to petitioner’s 1987 and 1988
taxable years, authorizes the imposition of an addition to tax
for negligence. It provides that, if any part of any
underpayment is due to negligence or disregard of rules or
regulations, an addition equal to the sum of 5 percent of the
underpayment and, for 1987, an amount equal to 50 percent of the
interest payable under section 6601 with respect to the portion
of such underpayment attributable to negligence for the period
from the underpayment due date to the assessment date (or if
earlier, the tax payment date) shall be added to the tax. For
purposes of section 6653(a), negligence is defined to include
“any failure to make a reasonable attempt to comply with the
provisions of this title”, and disregard is defined to include
“any careless, reckless, or intentional disregard.” Sec.
6653(a)(3).
Respondent contends that petitioner is liable for the
section 6653(a) addition to tax for negligence “because she
failed to use reasonable care in ascertaining and reporting her
tax liabilities” for 1987 and 1988. Specifically, respondent
argues that petitioner is liable for the addition to tax because
she “failed to keep adequate accounting records and claimed a
large NOL deduction with little or no support.” Respondent does
not argue, however, that petitioner’s failure to file timely
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returns is a basis for imposing the addition to tax under section
6653(a).
It is well established that a taxpayer’s failure to keep
records is a basis for imposing the addition to tax under section
6653(a). See, e.g., Taylor v. Commissioner, T.C. Memo. 1988-389,
affd. without published opinion 887 F.2d 259 (lst Cir. 1989). As
numerous cases have illustrated, however, the IRS and taxpayers
can often differ regarding what constitutes a failure to keep
records sufficient to support liability under section 6653(a).
Section 1.6001-1, Income Tax Regs., provides:
any person subject to tax under subtitle A of the Code
(including a qualified State individual income tax
which is treated pursuant to section 6361(a) as if it
were imposed by chapter 1 of subtitle A), or any person
required to file a return of information with respect
to income, shall keep such permanent books of account
or records, including inventories, as are sufficient to
establish the amount of gross income, deductions,
credits, or other matters required to be shown by such
person in any return of such tax or information.
Respondent contends that the cited regulation required petitioner
to maintain “adequate accounting records”. He supports his
argument by focusing primarily on one exhibit introduced into
evidence by petitioner and generally disparaging petitioner’s
records. Although petitioner chose not to file a posttrial
brief, she adamantly asserted at trial that she maintained
voluminous records and that, while the records were not formal or
perfect, they were routinely maintained in an organized form,
were produced to the accountant who prepared her returns for the
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years at issue, and adequately documented the income and expenses
from her law practice.
Our review of the evidentiary record, when filtered through
the parties’ arguments, convinces us that petitioner should not
be held liable for the addition to tax under section 6653(a)
based on respondent’s contention that she failed to keep adequate
records. As we have stated previously, we found petitioner’s
testimony, including her testimony regarding her record keeping
and her production of records during the audit, to be credible.
In addition, the documents petitioner produced at trial amply
demonstrated that she maintained records and that the records
were auditable. Moreover, we accept petitioner’s testimony that
she produced those records for examination by respondent’s
revenue agent and Appeals officer on several different occasions
over a period of several years. We are left with the impression
that any gaps in petitioner’s records at trial were more likely
than not the result of the passage of time, the multiple and
delayed reviews of petitioner’s records by respondent and others,
and petitioner’s difficult personal circumstances before and
during trial.
Respondent contends that petitioner’s record keeping was
inadequate, and therefore negligent, because she failed to
maintain formal books of account as required by section 1.6001-1,
Income Tax Regs., she failed to employ “competent help” to
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prepare her tax returns, and she failed to furnish that help with
the “necessary information” to file proper and timely returns.
Respondent in his brief states: “It is evident petitioner failed
to do so because she was unable to adequately reconstruct her
expenses”. We disagree. It simply does not follow from
petitioner’s failure to reconstruct completely her Schedule C
expenses at trial that she failed to maintain adequate records or
that she failed to hire competent help as respondent suggests.
Petitioner conceded at trial that she did not maintain
formal books of account such as a general ledger or a cash
receipts and disbursements journal. However, petitioner
maintained voluminous records of her income and expenses, as she
amply demonstrated at trial. We are convinced that the
evidentiary gaps in the record, including the lack of
documentation regarding petitioner’s NOL carryforwards, are not
the result of negligent record keeping, as respondent alleges,
but are due to petitioner’s financial and personal difficulties
that arose following the years at issue. For example, petitioner
testified that she had other records such as client and bank
records, which would have enabled her to fill the evidentiary
gaps, but she simply did not have the financial and personal
resources to retrieve the records from storage and analyze those
records under the circumstances. We have no doubt, however, that
such records exist.
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We hold that petitioner is not liable for the addition to
tax under section 6653(a) for any of the years at issue.
C. Accuracy-Related Penalty Under Section 6662
Section 6662, applicable to petitioner’s 1989 and 1990
years, authorizes the imposition of a 20-percent penalty for
specified types of misconduct, including negligence or disregard
of rules or regulations. Sec. 6662(a) and (b). Section 6662(c)
adopts the same definitions of “negligence” and “disregard” as
those utilized in section 6653 before its repeal.
Respondent contends that petitioner is liable for the
accuracy-related penalty for 1989 and 1990 due to her alleged
negligent record keeping and makes the same arguments with
respect to section 6662 that he made with respect to section
6653. Consequently, we incorporate by reference our discussion
of respondent’s arguments under section 6653,21 and we hold that
petitioner did not negligently fail to maintain required records,
as respondent contends.
21
Neither party raised or addressed the issue of whether
both the addition to tax under sec. 6651 and the accuracy-related
penalty may be applied to the underpayment for a taxable year in
which the taxpayer failed to file a timely return. Consequently,
we do not discuss the issue even though it may provide an
alternative ground for decision.
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III. Conclusion
We have analyzed all of the testimony, exhibits, and
stipulations in this unwieldy record in an effort to fairly and
justly decide the issues presented by this case. The task has
not been easy due largely to respondent’s failure to examine
petitioner’s documentation before issuing the notices of
deficiency in this case and respondent’s blanket disallowance of
all of petitioner’s Schedule C expenses for 3 of the 4 years at
issue. As petitioner conceded more than once at trial, however,
petitioner must also take some responsibility for the gaps in the
record presented to this Court. By failing to maintain formal
books of account to summarize and organize her voluminous
documentation, petitioner left herself exposed to the problems
presented by this case and must accept a less than perfect
result.
We have considered all of the arguments expressly or
inferentially raised in this case by either party, and, to the
extent not discussed, we find them to be irrelevant or without
merit.
In light of the foregoing and to reflect concessions made by
the parties,
Decisions will be entered
under Rule 155.