T.C. Memo. 2006-62
UNITED STATES TAX COURT
DAVID E. CHRISTENSEN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 13710-04, 13711-04. Filed March 30, 2006.
David E. Christensen, pro se.
Ron S. Chun, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined deficiencies in
petitioner’s Federal income tax as follows:
Year at issue Deficiency Sec. 6651(a)(1) Sec. 6662
1997 $19,104 $4,050 N/A
1998 10,666 2,658 $2,133
1999 9,260 2,243 1,852
2000 9,053 2,247 1,810
2001 7,247 1,812 1,449
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The issues to be decided are: (1) Whether petitioner failed
to report $78,491 in 1997 as income for Federal income tax
purposes; (2) whether petitioner failed to substantiate his
claimed Schedule C, Profit or Loss From Business, expenses for
1998, 1999, 2000, and 2001; (3) whether petitioner is liable for
additions to tax under section 6651(a)(1) for all years at issue;
and (4) whether petitioner is liable for accuracy-related
penalties under section 6662 for 1998, 1999, 2000, and 2001.1
FINDINGS OF FACT
Petitioner resided in Glendora, California, at the time the
petitions were filed.
During the years at issue, petitioner was employed by
various companies as a systems engineer. The work he performed
as a systems engineer was done out of his home. In addition, he
started his own company in 1998 called Connect4Less. In this
capacity, he repaired computers, programmed computers, and
developed Web sites for individuals. Petitioner also operated
Connect4Less out of his home.
Petitioner did not file a Federal income tax return for
1997. He did not make estimated tax payments for 1997.
Petitioner did not file his 1998, 1999, 2000, and 2001 Federal
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended. All Rule references are
to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated. Amounts are rounded to the nearest dollar.
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income tax returns until October 28, 2002. On February 2, 2003,
respondent prepared a substitute for return for 1997. On July
12, 2004, respondent issued notices of deficiency to petitioner
for the years at issue.
Respondent determined petitioner received taxable income in
1997 based upon the Internal Revenue Service administrative
record of petitioner’s 1997 third-party payor information
(Administrative Record). Based upon the Administrative Record,
petitioner received: (1) W-2, Wage and Tax Statement, income of
$69,990, consisting of (a) $22,438 from Auspex Systems, Inc.; (b)
$33,269 from Microcadam, Inc.; and (c) $14,283 from NPC Admin.
Services DCP (NPC); (2) 1099-INT, Interest Income, income of
$120, consisting of (a) $13 from Capital One FSB; (b) $18 from
Glendale Federal Bank; and (c) $71 from Pasadena Federal Credit
Union; and (3) 1099-R, Distributions from Pensions, Annuities,
Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts,
etc., income of $8,399 from the Public Employees’ Retirement
System, for the State of California.
Respondent disallowed petitioner’s Schedule C expenses of
$46,669, $44,451, $44,063, and $39,135 for 1998, 1999, 2000, and
2001, respectively, for lack of substantiation. The disallowance
of Schedule C expenses caused petitioner’s adjusted gross income
to increase. As a result, petitioner’s Schedule A, Itemized
Deductions, deductions were reduced by $873, $864, and $764 in
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1999, 2000, and 2001, respectively. On August 2, 2004,
petitioner timely filed petitions contesting the deficiencies for
the years at issue.
Petitioner did not cooperate with respondent in preparing
for trial. He did not identify or exchange any documents,
identify witnesses, or file a pretrial memorandum as required by
the standing pretrial order. Respondent complied with these
requirements.
On March 14, 2005, the cases were consolidated for trial.
Trial was held on this matter on March 16, 2005. The parties
submitted their stipulation of facts at the beginning of trial.
OPINION
Petitioner asserts he is not liable for respondent’s
deficiency determinations, penalties, and additions to tax
because: (1) He did not receive taxable income of $78,491 in
1997; (2) he properly substantiated his Schedule C expenses for
1998, 1999, 2000, and 2001; (3) he is not liable for additions to
tax under section 6651(a)(1) for all years at issue; and (4) he
is not liable for accuracy-related penalties under section 6662
for 1998, 1999, 2000, and 2001.
Generally the taxpayer bears the burden of proving the
Commissioner’s determinations are erroneous. Rule 142(a).
However, the burden of proof may shift to the Commissioner under
section 7491(a) if the taxpayer has produced credible evidence
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relating to the tax liability at issue, has met his
substantiation requirements, maintained records, and cooperated
with the Secretary’s reasonable requests for documents,
witnesses, and meetings.2
In this case, petitioner bears the burden of proof because
he did not: (1) substantiate his expenses; (2) maintain the
required records; and (3) cooperate with respondent’s requests.
Sec. 7491(a); see Higbee v. Commissioner, 116 T.C. 438, 440-441
(2001).
A. 1997
1. Section 6201(d)
If a taxpayer asserts a reasonable dispute with respect to
any item of income reported on a third-party information return
and the taxpayer has fully cooperated with the Secretary, the
Secretary has the burden of producing reasonable and probative
information concerning that deficiency in addition to the
information return. Sec. 6201(d). In this case, petitioner did
not fully cooperate with respondent. Therefore, the Court
concludes respondent does not have the burden of production under
section 6201(d) for the 1997 tax year.
2
Sec. 7491 applies to all years at issue because the
examination of petitioner’s returns for all years at issue began
after July 22, 1998, the effective date of sec. 7491.
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2. Determination in Unreported Income Cases
The Court of Appeals for the Ninth Circuit has determined
that in order for the presumption of correctness to attach to a
deficiency determination in unreported income cases, the
Commissioner must establish “some evidentiary foundation”
connecting the taxpayer to the income-producing activity,
Weimerskirch v. Commissioner, 596 F.2d 358, 361-362 (9th Cir.
1979), revg. 67 T.C. 672 (1977), or demonstrate the taxpayer
received unreported income, Edwards v. Commissioner, 680 F.2d
1268, 1270 (9th Cir. 1982). Once there is evidence of actual
receipt of income by the taxpayer, the taxpayer has the burden of
proving that all or part of the income is not taxable. Tokarski
v. Commissioner, 87 T.C. 74, 76-77 (1986).
A deficiency determination which is not supported by some
evidentiary foundation is arbitrary and erroneous. Weimerskirch
v. Commissioner, supra at 362. In these circumstances, the
Commissioner has the burden of coming forward with evidence
establishing the existence and amount of a deficiency. Jackson
v. Commissioner, 73 T.C. 394, 401 (1979).
In this case, there is sufficient evidence linking
petitioner to all the 1997 income-producing activities except the
amounts reported by NPC. With respect to the Administrative
Record, petitioner testified: (1) He was employed by Auspex
Systems, Inc., and Microcadam, Inc, in 1997; (2) he had a
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mortgage with Glendale Federal Bank and had accounts with Capital
One and Pasadena Federal Credit Union; and (3) he received income
from the Public Employees’ Retirement System, for the State of
California. Thus, there is sufficient evidence linking
petitioner to $64,208.
However, even though the Administrative Record indicated
petitioner received $14,283 from NPC in 1997, petitioner
testified he was not employed by, nor did he receive income from,
NPC in 1997. At trial, respondent was unable to provide the
Court a Form W-2 statement from NPC or any other evidence linking
petitioner to receipt of income from NPC. Respondent informed
the Court he attempted to issue a subpoena to NPC; however, he
was unable to find its location.
The Court finds respondent’s administrative record of NPC’s
third-party information, without more, is an insufficient
evidentiary foundation, because petitioner disputes receipt of
such income. Therefore, this Court concludes respondent
presented evidence linking petitioner to only $64,208 of
unreported income in 1997, not the alleged $78,491.
Finally, petitioner provided no evidence to dispute
respondent’s determination of petitioner’s receipt of income for
1997 as reduced by the Court. Therefore, the Court finds
petitioner received taxable income of $64,208 in 1997.
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B. 1998-2001
Petitioner argues his business expenses for 1998, 1999,
2000, and 2001 were properly substantiated solely by his
testimony. The Court disagrees.
Under section 162(a), a taxpayer may deduct ordinary and
necessary business expenses incurred or paid during the taxable
year. However, deductions are a matter of legislative grace, and
the taxpayer must clearly demonstrate entitlement to the claimed
deductions. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84
(1992). The taxpayer must keep records sufficient to establish
the amount of his deductions. Secs. 162(a), 6001; sec.
1.6001-1(a), Income Tax Regs. The taxpayer bears the burden of
substantiation. Hradesky v. Commissioner, 65 T.C. 87, 90 (1975),
affd. per curiam 540 F.2d 821 (5th Cir. 1976).
Petitioner testified all substantiating documents were
either destroyed in “hard disk crashes” or lost while moving.
When a taxpayer’s records have been destroyed or lost due to
circumstances beyond the taxpayer’s control, such as fire, flood,
earthquake, or other casualty, the taxpayer has a right to
substantiate the deductions by a reasonable reconstruction of the
expenditures or uses. Sec. 1.274-5T(c)(5), Temporary Income Tax
Regs., 50 Fed. Reg. 46022 (Nov. 6, 1985). If documentation is
unavailable, the Court may, although it is not required to do so,
accept the taxpayer’s testimony to substantiate the deduction.
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See Boyd v. Commissioner, 122 T.C. 305, 320 (2004); Watson v.
Commissioner, T.C. Memo. 1988-29.
During petitioner’s testimony, he contradicted himself,
admitted to errors in the Schedules C relative to expenses, and
in some instances could not recall what the claimed expenses
were. Further, petitioner did not make a good faith effort to
reconstruct his expenses, provide documentation, or provide
corroborating evidence to bolster the credibility of his
testimony. See Tokarski v. Commissioner, supra at 77; Smith v.
Commissioner, T.C. Memo. 1998-33. Therefore, the Court finds
petitioner’s testimony was insufficient to substantiate his
deductions. Boyd v. Commissioner, supra; Watson v. Commissioner,
supra.
Finally, petitioner failed to reconstruct his records,
submit any documentation, or otherwise provide sufficient
evidentiary basis for the Court to estimate his expenses under
the Cohan rule. See Cohan v. Commissioner, 39 F.2d 540, 543-544
(2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743
(1985).
Therefore, the Court sustains respondent’s determination
disallowing petitioner’s Schedule C expenses of $46,669, $44,451,
$44,063, and $39,135 for 1998, 1999, 2000, and 2001,
respectively. As a result of the above, the Court sustains
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respondent’s determination disallowing Schedule A deductions of
$873, $864, and $765, in 1999, 2000, and 2001, respectively.
C. Penalties and Additions to Tax
1. Section 6651(a)(1)
Pursuant to section 7491(c), respondent has the burden of
production with respect to any penalty, addition to tax, or
additional amounts. The burden of production only requires
respondent to come forward with sufficient evidence indicating it
is appropriate to impose additions to tax. Higbee v.
Commissioner, 116 T.C. 438, 446 (2001). In this case, respondent
has carried the requisite burden of production with respect to
the additions to tax under section 6651(a)(1).
Section 6651(a)(1) imposes an addition to tax for failure to
file a required return on or before the prescribed filing date,
unless it is shown that such failure is due to reasonable cause
and not due to willful neglect. A showing of reasonable cause
requires the taxpayer to demonstrate he exercised ordinary
business care and prudence and nevertheless was unable to file
the return by the due date. Sec. 301.6651-1(c), Proced. & Admin.
Regs.
Petitioner did not file a return for 1997, and he did not
timely file his 1998, 1999, 2000, and 2001 tax returns.
Petitioner did not offer a legitimate explanation for these
failures. Thus, petitioner is liable for additions to tax for
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failure to timely file under section 6651(a)(1) in 1997, 1998,
1999, 2000, and 2001, in amounts to be determined under Rule 155
calculations.
2. Section 6662
Section 6662 imposes an accuracy-related penalty upon any
underpayment of tax resulting from a substantial understatement
of income tax. The penalty is equal to 20 percent of any
underpayment that constitutes a substantial understatement of
income tax. Sec. 6662(a). The term “substantial understatement”
is defined as the greater of: (1) 10 percent of the tax required
to be shown on the return for the taxable year, or (2) $5,000.
Sec. 6662(d). Petitioner reported tax on his income tax returns
and respondent determined deficiencies based upon corrected tax
resulting in understatements of the following amounts:
Tax year Tax on return Corrected tax Understatement
1998 $979 $11,645 $10,666
1999 96 9,356 9,260
2000 156 9,209 9,053
2001 -0- 7,323 7,247
In this case, the amount of the understatement for each of
the years 1998, 1999, 2000, and 2001 is more than 10 percent of
the tax required to be shown and greater than $5,000. Thus,
petitioner substantially understated his income tax for 1998,
1999, 2000, and 2001. Thus, respondent has met the burden of
production, and petitioner, having failed to show reasonable
cause, substantial authority, or other basis for reducing the
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understatement, is liable for the section 6662 penalty for 1998,
1999, 2000, and 2001.
The Court, in reaching its holding, has considered all
arguments made and concludes that any arguments not mentioned
above are moot, irrelevant, or without merit.
To reflect the foregoing,
Decisions will be entered
under Rule 155.