T.C. Memo. 2007-165
UNITED STATES TAX COURT
ELIZABETH LAI, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 142-05. Filed June 26, 2007.
Kevin O’Connell, for petitioner.
Wesley F. McNamara, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: Respondent determined deficiencies and
penalties with respect to petitioner’s 1999, 2000, and 2001
Federal income tax as follows:
- 2 -
Penalties
Year Deficiency Sec. 6662(a)1 Sec. 6663
1999 $45,969.00 $2,434.20 $25,348.50
2000 42,401.00 -- 31,778.25
2001 38,393.00 -- 28,761.00
After concessions,2 the issues remaining for decision are: (1)
Whether petitioner failed to report income from La Belle Vie,
petitioner’s nail salon business; (2) whether petitioner is
liable for the section 6662(a) penalty for 1999 for the
underpayment attributable to unsubstantiated deductions; (3)
whether petitioner is liable for the civil fraud penalty pursuant
to section 6663 for a portion of the 1999 deficiency and the
entire 2000 and 2001 deficiencies; (4) whether, in the
alternative, if petitioner is found not to be liable for the
civil fraud penalty pursuant to section 6663 on any portion of
the underpayment for any of the years in issue, petitioner is
liable for the accuracy-related penalty on such portion of the
underpayment pursuant to section 6662.
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
2
The parties stipulated that petitioner received small
amounts of interest and dividend income in each of the 3 years at
issue that were not reported on petitioner’s income tax returns.
The parties also stipulated that petitioner incurred a $30
capital loss in 2001 that petitioner did not report on her 2001
income tax return. In her briefs, petitioner concedes that she
cannot substantiate $38,211 in business expenses for 1999.
- 3 -
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts, the supplemental stipulations of facts,
and the attached exhibits are incorporated herein by this
reference. At the time petitioner filed her petition, she
resided in Oregon.
General Background
Petitioner was born in Vietnam on December 25, 1953. In
1977, petitioner immigrated to the United States. Petitioner and
her 13 living siblings were all born and raised in Vietnam. The
numerous members of petitioner’s extended family live in Vietnam
and various locations in the United States. During 1999, 2000,
and 2001, some of petitioner’s siblings who still lived in
Vietnam were arranging their financial affairs in anticipation of
moving to the United States. Petitioner speaks limited English.
Petitioner’s Nail Salon Business
During 1999, 2000, and 2001, petitioner operated as a sole
proprietorship La Belle Vie, a nail beauty salon in a shopping
mall in Oregon. Petitioner opened her first nail salon in Oregon
in 1987. Petitioner handled the banking and finances of La Belle
Vie, depositing the credit card receipts every day and the cash
receipts approximately once a week. Petitioner paid herself a
“salary” from La Belle Vie by writing checks to herself from La
- 4 -
Belle Vie bank accounts. Petitioner also received tips from her
work at La Belle Vie during 1999, 2000, and 2001.
Petitioner’s Banking and Investment Accounts
During 1999, 2000, and 2001, petitioner maintained bank
accounts at both Key Bank and U.S. Bank. She maintained two
checking accounts at Key Bank in her own name. Petitioner
maintained a checking account at U.S. Bank under “La Belle Vie”
and a money market account under “Elizabeth T. Lai Sole Prop La
Belle Vie”. Petitioner used the Key Bank accounts as her
personal accounts and the U.S. Bank accounts as her business
accounts.
Petitioner deposited and withdrew money from her personal
accounts at Key Bank as follows:
Year Cash Deposits Total Deposits Withdrawals
1999 $85,590.88 $113,766.37 $116,275.50
2000 63,300.00 94,096.74 95,728.48
2001 112,800.00 151,145.22 135,502.02
Petitioner’s withdrawals from her personal accounts at Key Bank
included payments for home and car loans, utilities, clothes, and
other personal expenditures.
Petitioner’s Purchase of a Cashier’s Check in 2000
On September 29, 2000, petitioner used cash to purchase a
cashier’s check of $55,204 from U.S. Bank. Petitioner did not
withdraw the $55,204 that she used to purchase the cashier’s
check from any of her personal or business accounts. Petitioner
- 5 -
purchased the cashier’s check with funds from Gioni Birkenfeld,
petitioner’s former daughter-in-law and the mother of
petitioner’s grandchild, and with funds that came indirectly from
Hong Lai, petitioner’s sister. Gioni Birkenfeld gave petitioner
$17,000. Hong Lai, who lived in Vietnam at the time, arranged
for several relatives in the United States to give money to
petitioner. When those relatives later traveled to Vietnam, Hong
Lai repaid them the amounts they paid petitioner, which the
relatives would use during their trips in Vietnam.3 Acting on
Hong Lai’s behalf, petitioner then used the cash she received
from the relatives to pay for the remaining portion of the
cashier’s check for which Gioni Birkenfeld did not pay.
On October 2, 2000, petitioner purchased a residence in
Portland, Oregon, apparently using the cashier’s check as a
downpayment. Gioni Birkenfeld lived in the residence for 14
months after it was purchased, during which time she assumed
responsibility for mortgage payments of approximately $1,500 per
month. Hong Lai lived in the residence for a brief period when
she arrived in the United States in 2003. The residence was sold
in September 2003.
3
A vital factual underpinning of petitioner’s actions in
this case is her (and her family’s) reluctance to transport
money--particularly large sums of U.S. dollars--between Vietnam
and the United States in ordinary banking transactions.
Petitioner and her family apparently feared that Vietnamese
officials would seize the money if discovered.
- 6 -
Preparation of Petitioner’s Income Tax Returns
Petitioner engaged Thanh Nguyen (Mr. Nguyen), an enrolled
agent, to prepare her 1999, 2000, and 2001 Federal income tax
returns. Petitioner filed Forms 1040, U.S. Individual Income Tax
Return, for 1999, 2000, and 2001. Petitioner attached to each of
those returns Schedules C, Profit or Loss From Business,
reporting the following gross receipts, cost of goods sold, and
expenditures for La Belle Vie:
Gross Cost of Business
Year Receipts Goods Sold Deductions Net Profit
1999 $428,595 $63,845 $331,957 $31,933
2000 412,763 85,618 272,495 54,650
2001 466,770 38,897 338,417 88,760
Petitioner’s business records consisted of her bank
statements and canceled checks, and the parties agree that Mr.
Nguyen prepared the returns based solely on canceled checks and
statements from petitioner’s U.S. Bank accounts. Petitioner did
not inform Mr. Nguyen of her tip income at the time.
Petitioner did not report any of her tip income on her
Federal income tax returns for the years at issue. Petitioner
did not mention the tip income to Mr. Nguyen because she did not
believe that tips were taxable. Indeed, petitioner became aware
that tip income was taxable only when she was informed as such by
her attorney during preparation for the trial of this case.
- 7 -
Examination of Petitioner’s Income Tax Returns
Petitioner’s 1999 income tax return was selected by
respondent for examination. Revenue Agent Daren Cedergreen
(Agent Cedergreen) conducted the examination, which began in
2002.
On February 14, 2002, Agent Cedergreen met with petitioner
and Mr. Nguyen, who agreed to represent petitioner during the
examination, at La Belle Vie. During that meeting, petitioner
stated, inter alia, that all her income came from La Belle Vie,
that she did not have a safe deposit box, and that she did not
receive any loans during 1999.
On September 23, 2002, Agent Cedergreen met again with
petitioner and Mr. Nguyen at Mr. Nguyen’s office. During that
meeting, petitioner stated that the deposits in her Key Bank
accounts represented loan proceeds and loan repayments from
family and friends in the United States and Vietnam. Petitioner
also said that she maintained a safe deposit box at Key Bank.
At the meeting, petitioner showed Agent Cedergreen seven
letters (the first set of letters) that she believed were
authored by relatives and acquaintances. The letters, many of
which are written in Vietnamese, discuss loans between petitioner
and her friends and family made during late 1998 and 1999.
During the meeting of September 23, 2002, petitioner filled
out a questionnaire indicating that her routine cash expenditures
- 8 -
for personal items such as groceries, gas for her car, and other
needs amounted to $9,760 during 1999.
At some point after this meeting, respondent expanded the
scope of the examination to include petitioner’s 2000 and 2001
returns.
Agent Cedergreen met with petitioner, Mr. Nguyen, and Bob
Bradley (who was also representing petitioner), at respondent’s
Portland, Oregon, office on August 14, 2003. At this meeting,
petitioner again explained that the large deposits into her
personal accounts represented loan proceeds and loan repayments
from friends and family. Petitioner estimated that she received
more than $70,000 in loans in 2000 and more than $120,000 in
loans in 2001.
During the meeting of August 14, 2003, Agent Cedergreen
questioned petitioner about her purchase of a cashier’s check on
September 29, 2000. Petitioner initially did not remember that
she purchased a cashier’s check in 2000 or 2001 and stated that
she did not make such a purchase. After further questioning,
petitioner recalled that she purchased a cashier’s check on
behalf of Ms. Birkenfeld for the purpose of purchasing a
residence in which Ms. Birkenfeld would live. Petitioner
recalled that Ms. Birkenfeld agreed to give the house to Hong Lai
when Hong Lai came to the United States.
- 9 -
On or about August 19, 2003, petitioner hired C.P.A. Jerry
Levey to help represent her during the examination.
On October 29, 2003, petitioner provided Agent Cedergreen
with 50 additional letters (the second set of letters). The
letters indicate that some of petitioner’s friends and family in
Vietnam sent cash to petitioner for safekeeping or investment in
anticipation of their immigration to the United States.
According to the letters, friends and family of petitioner who
traveled from Vietnam to the United States would deliver the
money to petitioner in amounts ranging from $3,000 to $17,000.
Petitioner subsequently discovered that the first set of
letters was not written by their purported authors. Shortly
after she received the original letters in the mail, petitioner
gave them to her mother to read and store. When petitioner asked
her mother for the letters during the examination of her returns,
petitioner’s mother could not find them and instead attempted to
replicate the originals. Petitioner’s mother attempted to
reconstruct the loan amounts mentioned in the letters from
memory. When petitioner learned of her mother’s actions,
petitioner promptly notified Mr. Levey of her discovery, and
petitioner and Mr. Levey subsequently informed respondent that
the first set of letters was authored by petitioner’s mother.
Petitioner maintained at both the audit and at trial that the
- 10 -
content of the second set of letters was authentic and that the
letters were written by their purported authors.
At all stages of the examination, progress was significantly
hampered by misunderstandings due to language barriers, poor
translations, cultural differences between petitioner and
respondent’s employees, and petitioner’s somewhat guarded
approach towards government officials. For example, petitioner
originally told Agent Cedergreen that she did not receive any
loans during 1999 despite the fact that she simultaneously
volunteered the existence of her Key Bank accounts which
contained significant, unexplained deposits which she would later
attribute to intrafamily loans. At subsequent meetings,
petitioner offered Agent Cedergreen detailed information on
several loan transactions, apparently without believing that the
information contradicted her previous statements.
The Notice of Deficiency
In a notice of deficiency dated October 5, 2004, respondent
determined deficiencies and penalties as stated supra. Aside
from those adjustments which the parties have conceded, the
deficiencies are composed of four elements: (1) Inclusion of
petitioner’s additional bank deposits as unreported income for
each year; (2) inclusion of $9,760 of cash income for each year;
(3) inclusion of the amount of the cash used to purchase the
cashier’s check in gross income for 2000; and (4) adjustments to
- 11 -
petitioner’s reported itemized deductions, personal exemptions,
self-employment tax, and child tax credit.
For all 3 years at issue, respondent conducted a bank
deposit analysis to determine the total deposits in petitioner’s
business and personal bank accounts. Respondent excluded
deposits that, in his determination, represented nontaxable
sources, including transfers between petitioner’s accounts.
Respondent determined that the remaining amount was taxable
income.
Respondent added $9,760 of income to petitioner’s reported
adjusted gross income for each year. According to respondent,
this figure represented the amount of petitioner’s annual cash
expenditures for personal expenses based on the form petitioner
filled out at her meeting with Agent Cedergreen on September 23,
2002. Because petitioner withdrew nearly zero cash from her
personal and business accounts during 1999, 2000, and 2001,4
respondent determined that the $9,760 represented additional
income.
For 2000, respondent determined $55,204 of additional
income. That amount reflects petitioner’s cash purchase of the
cashier’s check discussed supra. Because petitioner did not
withdraw cash from any of her bank accounts to provide the funds
4
Petitioner wrote one check to cash in 1999 in the amount
of $3,500. Respondent accordingly reduced his deficiency
determination by that amount for 1999.
- 12 -
used to purchase the cashier’s check, respondent determined that
the cash petitioner used to purchase the cashier’s check was
unreported income.
Finally, respondent adjusted the amounts of petitioner’s
reported itemized deductions, personal exemptions, self-
employment tax, and child tax credit in accordance with the above
determinations.
OPINION
Deficiencies
Generally, the Commissioner’s determinations of deficiencies
in a notice of deficiency are presumed correct, and the taxpayer
bears the burden of showing that the Commissioner’s
determinations are in error. See Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933).5 The U.S. Court of Appeals
for the Ninth Circuit (to which an appeal of this matter would
lie) has held that the Commissioner must establish “some
evidentiary foundation” connecting the taxpayer with the income-
producing activity, Weimerskirch v. Commissioner, 596 F.2d 358,
361-362 (9th Cir. 1979), revg. 67 T.C. 672 (1977), or demonstrate
that the taxpayer actually received unreported income, see
Edwards v. Commissioner, 680 F.2d 1268, 1270 (9th Cir. 1982) (the
5
Petitioner has neither claimed nor shown that she
satisfied the requirements of sec. 7491(a) to shift the burden of
proof to respondent with regard to any factual issue affecting
her liability for the income tax deficiencies. Accordingly,
petitioner bears the burden of proof. See Rule 142(a).
- 13 -
Commissioner’s assertion of a deficiency is presumptively correct
once some substantive evidence is introduced demonstrating that
the taxpayer received unreported income), for the presumption of
correctness to attach to the deficiency determination in
unreported income cases. If the Commissioner introduces some
evidence that the taxpayer received unreported income, the burden
shifts to the taxpayer to show by a preponderance of the evidence
that the deficiency was arbitrary or erroneous. See Hardy v.
Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999), affg. T.C.
Memo. 1997-97.
The Commissioner has broad powers under section 446 to
compute the taxable income of a taxpayer. Sec. 446; Petzoldt v.
Commissioner, 92 T.C. 661, 693 (1989). Generally, such
computation is made using the taxpayer’s regularly employed
method of accounting. Sec. 446(a). If the taxpayer’s method of
accounting does not clearly reflect income, then the method used
shall be the method which, in the Commissioner’s opinion, clearly
reflects income. Sec. 446(b); see Palmer v. U.S. IRS, 116 F.3d
1309, 1312 (9th Cir. 1997).
“The use of the bank deposit method for computing income has
long been sanctioned by the courts.” Estate of Mason v.
Commissioner, 64 T.C. 651, 656 (1975), affd. 566 F.2d 2 (6th Cir.
1977). “A bank deposit is prima facie evidence of income and
respondent need not prove a likely source of that income.”
- 14 -
Tokarski v. Commissioner, 87 T.C. 74, 77 (1986) (citing Estate of
Mason v. Commissioner, supra at 656-657).
Respondent has introduced adequate evidence to show that
petitioner received unreported income during 1999, 2000, and
2001. With regard to respondent’s determinations that resulted
from respondent’s bank deposit analyses, respondent is not
required to show a link between petitioner’s bank deposits and a
likely taxable source of income. See, e.g., Tokarski v.
Commissioner, supra; Kudo v. Commissioner, T.C. Memo. 1998-404,
affd. 11 Fed. Appx. 864 (9th Cir. 2001). Respondent’s
determinations regarding the cashier’s check and petitioner’s
cash income are founded on statements from third parties such as
banks and brokerage firms, and on petitioner’s admissions that
she received cash income that she failed to report on her tax
returns. Moreover, petitioner’s nail salon business clearly
qualifies as an income-producing activity. See, e.g., Hamilton
v. Commissioner, T.C. Memo. 2004-66 (ownership of interests in
businesses sufficient to prove likely source of unreported
income). Respondent has therefore introduced adequate
substantive evidence to show that petitioner received unreported
income in the amounts determined, and, as noted supra, the burden
of proof falls on petitioner to demonstrate that respondent’s
determinations are arbitrary or erroneous.
- 15 -
In addition to her own testimony, petitioner offered
testimony from her sisters Hong Lai and Sharon Huynh, and her
daughter Victoria Lai Hutchins to support her contention that the
deposits into her personal accounts represent loan proceeds and
repayments from intrafamily loans. Petitioner also offered the
second set of letters that she gave to Agent Cedergreen during
the examination of petitioner’s 1999, 2000, and 2001 income tax
returns.
Petitioner, Hong Lai, Sharon Huynh, Victoria Lai Hutchins
all testified that petitioner participated in several intrafamily
loans during the years at issue in an effort to help family
members establish financial stability as they arrived and settled
in the United States. Petitioner testified that she deposited
the proceeds of several loans into her personal accounts during
the years at issue. Hong Lai, who had indepth knowledge of her
extended family’s financial affairs, corroborated that several
letters from the second set were authentic and that she
recognized the handwriting and signatures of her sisters in
Vietnam on 31 of the letters.6 Sharon Hunyh’s and petitioner’s
testimony regarding the letters corroborated Hong Lai’s
testimony.
6
Although petitioner’s witnesses testified that additional
letters were authentic, some pertain to loan transactions that
occurred in years other than the years at issue.
- 16 -
We decide whether a witness is credible on the basis of
objective facts, the reasonableness of the testimony, and the
demeanor of the witness. Quock Ting v. United States, 140 U.S.
417, 420-421 (1891); Wood v. Commissioner, 338 F.2d 602, 605 (9th
Cir. 1964), affg. 41 T.C. 593 (1964); Dozier v. Commissioner,
T.C. Memo. 2000-255. Having had the opportunity to observe the
above-mentioned witnesses at trial, we find petitioner, Hong Lai,
Sharon Huynh, and Victoria Lai Hutchins to be honest, forthright,
and credible. Based on this testimony and the 31 letters from
the second set of letters, we find that petitioner deposited
proceeds she received from intrafamily loans into her personal
accounts as follows:
Year Amount Deposited
1999 $74,500
2000 68,800
2001 74,000
The above-mentioned amounts are loan proceeds. Loan
proceeds do not constitute income to a taxpayer. Commissioner v.
Tufts, 461 U.S. 300, 307 (1983). We therefore hold that the
above-mentioned amounts are not income to petitioner.
Moreover, the record establishes that the cash petitioner
used to purchase the cashier’s check in 2000 did not represent
unreported income to petitioner. We find the testimony of Hong
Lai, Gioni Birkenfeld, and petitioner credible with regard to the
cashier’s check, and we believe that petitioner used funds that
- 17 -
Hong Lai and Gioni Birkenfeld lent to petitioner to purchase the
cashier’s check on their behalf. As noted supra, loan proceeds
do not constitute income to a taxpayer. Id. We therefore hold
that the amount of the cashier’s check does not represent income
to petitioner.7
Based on the credible documentary evidence and credible
corroborating testimony, petitioner has established by a
preponderance of the evidence that a portion of the disputed
determinations is erroneous. However, petitioner has not carried
her burden of proof with regard to the remaining portion of the
deficiency. We therefore partially uphold respondent’s
determination.
7
Generally, the Commissioner may assess taxes only within
3 years after a taxpayer files his or her income tax return.
Sec. 6501(a). However, if a taxpayer omits from gross income an
amount properly includible therein which is in excess of 25
percent of the amount of gross income stated in the return, the
Commissioner may assess income taxes for that year at any time
within 6 years after the return was filed. Sec. 6501(e)(1)(A).
In the matter before us, the notice of deficiency was issued on
Oct. 5, 2004. Petitioner filed her 1999 income tax return on or
about Oct. 20, 2000. Thus, without regard to application of the
sec. 6663 fraud penalty, discussed infra, unless sec. 6501(e)
applies, that year falls outside the period of limitations, and
respondent may not assess additional tax for 1999. It appears
that the 6-year period of sec. 6501(e) may not apply to
petitioner’s 1999 tax year. See sec. 6501(e)(1)(A)(i). If,
pursuant to the parties’ Rule 155 calculations, sec. 6501(e) does
not apply to petitioner’s 1999 tax year, respondent may not
assess additional taxes for 1999. Sec. 6501(a).
- 18 -
Penalties
A. Section 6663
Section 6663 imposes a penalty equal to 75 percent of the
portion of any underpayment which is attributable to fraud. Sec.
6663(a). The penalty in the case of fraud is a civil sanction
provided primarily as a safeguard for the protection of the
revenue and to reimburse the Government for the heavy expense of
investigation and the loss resulting from a taxpayer’s fraud.
Helvering v. Mitchell, 303 U.S. 391, 401 (1938). Fraud is
intentional wrongdoing on the part of the taxpayer with the
specific purpose to evade a tax believed to be owing. McGee v.
Commissioner, 61 T.C. 249, 256 (1973), affd. 519 F.2d 1121 (5th
Cir. 1975).
The Commissioner has the burden of proving fraud by clear
and convincing evidence. Sec. 7454(a); Rule 142(b). To satisfy
this burden, the Commissioner must show: (1) An underpayment
exists; and (2) the taxpayer intended to evade taxes known to be
owing by conduct intended to conceal, mislead, or otherwise
prevent the collection of taxes. Parks v. Commissioner, 94 T.C.
654, 660-661 (1990). The Commissioner must meet this burden
through affirmative evidence because fraud is never imputed or
presumed. Petzoldt v. Commissioner, 92 T.C. at 699; Recklitis v.
Commissioner, 91 T.C. 874, 909-910 (1988); Beaver v.
Commissioner, 55 T.C. 85, 92 (1970).
- 19 -
The Commissioner must prove that a portion of the
underpayment for each taxable year in issue was due to fraud.
Profl. Servs. v. Commissioner, 79 T.C. 888, 930 (1982). If the
Commissioner establishes that any portion of an underpayment in a
particular year is attributable to fraud, the entire underpayment
is treated as attributable to fraud, except with respect to any
portion of the underpayment which the taxpayer establishes (by a
preponderance of the evidence) is not attributable to fraud.
Sec. 6663(b).
The existence of fraud is a question of fact to be resolved
from the entire record. Gajewski v. Commissioner, 67 T.C. 181,
199 (1976), affd. without published opinion 578 F.2d 1383 (8th
Cir. 1978).
Respondent has failed to meet his heavy burden of
establishing by clear and convincing evidence that petitioner had
the requisite fraudulent intent for any of the years at issue.
Several aspects of petitioner’s conduct are markedly inconsistent
with fraudulent intent. At her first meeting with Agent
Cedergreen, petitioner voluntarily disclosed the existence of her
personal accounts, the very accounts in which respondent alleges
that she hid her income. When petitioner discovered that the
first set of letters she had presented were not originals, she
disclosed that information to respondent. Petitioner also freely
disclosed her unreported tip income and that she had cash
- 20 -
expenditures for personal expenses even though she had nearly
zero cash withdrawals from her bank accounts. In effect,
petitioner consistently drew respondent’s attention to those
areas in which her explanations were less than satisfactory.
Such behavior is hardly consistent with intent “to conceal,
mislead, or otherwise prevent the collection of taxes”. Katz v.
Commissioner, 90 T.C. 1130, 1143 (1988).
Petitioner contradicted herself on a few occasions during
the examination and at trial. However, having had the
opportunity to observe petitioner as a witness at trial, and
considering that many of her contradictions and disclosures could
not have advanced her cause, we do not attribute petitioner’s
contradictions to fraudulent intent. Rather, we attribute them
to a series of misunderstandings and to petitioner’s fear of
governmental attention due to negative experiences with foreign
governments.
Finally, and most importantly, the evidence before us is
sufficiently credible to convince us that petitioner did actually
participate in the kind of intrafamily transactions which would
explain the deposits in her personal accounts, though the record
is not sufficiently detailed to establish that all of the
deposits into petitioner’s personal accounts represent proceeds
from such transactions. We therefore do not sustain respondent’s
imposition of the section 6663 penalty.
- 21 -
B. Burden of Production
Section 7491(c) provides that the Commissioner will bear the
burden of production with respect to the liability of any
individual for additions to tax and penalties. “The
Commissioner’s burden of production under section 7491(c) is to
produce evidence that it is appropriate to impose the relevant
penalty, addition to tax, or additional amount.” Swain v.
Commissioner, 118 T.C. 358, 363 (2002); see also Higbee v.
Commissioner, 116 T.C. 438, 446 (2001). Once the Commissioner
has done so, the burden of proof is upon the taxpayer to
establish reasonable cause and good faith. Higbee v.
Commissioner, supra at 449.
C. Section 6662(a)
Pursuant to section 6662(a), a taxpayer may be liable for a
penalty of 20 percent of the portion of an underpayment of tax
(1) attributable to a substantial understatement of tax or (2)
due to negligence or disregard of rules or regulations. Sec.
6662(b). The term “understatement” means the excess of the
amount of tax required to be shown on a return over the amount of
tax imposed which is shown on the return, reduced by any rebate
(within the meaning of section 6211(b)(2)). Sec. 6662(d)(2)(A).
Generally, an understatement is a “substantial understatement”
when the understatement exceeds the greater of $5,000 or 10
percent of the amount of tax required to be shown on the return.
- 22 -
Sec. 6662(d)(1)(A). The term “negligence” in section 6662(b)(1)
includes any failure to make a reasonable attempt to comply with
the Code. Sec. 6662(c). Negligence has also been defined as the
failure to exercise due care or the failure to do what a
reasonable person would do under the circumstances. See Allen v.
Commissioner, 92 T.C. 1, 12 (1989), affd. 925 F.2d 348, 353 (9th
Cir. 1991); Neely v. Commissioner, 85 T.C. 934, 947 (1985). The
term “disregard” includes any careless, reckless, or intentional
disregard. Sec. 6662(c). Failure to keep adequate records may
be evidence not only of negligence, but also of intentional
disregard of regulations. See sec. 1.6662-3(b)(1) and (2),
Income Tax Regs.; see also Benson v. Commissioner, T.C. Memo.
2007-113.
In the matter before us, respondent has met the burden of
production imposed on him by section 7491(c). Respondent has
shown that petitioner failed to keep adequate records for the
years at issue. To avoid application of the penalty, petitioner
must therefore demonstrate that the underpayments of tax for
1999, 2000, and 2001 were due to reasonable cause and good faith.
See sec. 6664(c)(1); Higbee v. Commissioner, supra at 449.
The decision as to whether a taxpayer acted with reasonable
cause and in good faith depends upon all the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. Relevant
factors include the taxpayer’s efforts to assess his or her
- 23 -
proper tax liability, including the taxpayer’s reasonable and
good faith reliance on the advice of a professional such as an
accountant. See id. However, reliance on the advice of a
professional tax advisor does not necessarily establish
reasonable cause and good faith. Id. Particularly, reliance on
the advice of a tax professional is not reasonable when a
taxpayer fails to disclose a fact that he or she knows, or
reasonably should know, is relevant to the proper tax treatment
of an item. Sec. 1.6664-4(c)(1)(i), Income Tax Regs.
Petitioner has not demonstrated that any of her
underpayments are due to reasonable cause and good faith.
Petitioner did not mention her tip income to Mr. Nguyen during
his preparation of petitioner’s income tax returns. Although
petitioner may have believed that tip income was not taxable,
that belief is not reasonable. Petitioner has failed to
demonstrate that she acted with reasonable cause and good faith
with regard to any particular portion of the underpayments in
this case. Therefore, to the extent that we uphold respondent’s
determination of deficiencies for the years at issue, we conclude
that petitioner is liable for the section 6662(a) penalties.
To reflect the foregoing,
Decision will be entered
under Rule 155.