Arberg v. Comm'r

T.C. Memo. 2007-244

UNITED STATES TAX COURT

LEE B. ARBERG AND MELISSA A. QUINN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15376-05. Filed August 27, 2007.

Prior to 1999, a brokerage account at E Trade
Securities, Inc., was established in the name of P-W.
For 1999, P-W filed a separate return reporting capital
gain income from activity in the E Trade account. For
2000, Ps contend that losses generated in the E Trade
account are entitled to ordinary income treatment by
reason of a business of P-H as a trader in securities
and that various expenses should be allowed as
deductions of the securities trading business and/or a
consulting business of P-H.

Held: Gains and losses in the E Trade account
must be attributed to P-W and are capital in nature.

Held, further, Ps are not entitled to expense
deductions in excess of those allowed by R.

Held, further, Ps are liable for the accuracy-
related penalty pursuant to sec. 6662, I.R.C., for
2000.
 - 2 -

Roger D. Lorence, for petitioners.

Stephen R. Takeuchi, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WHERRY, Judge: Respondent determined a Federal income tax

deficiency for petitioners’ 2000 taxable year in the amount of

$167,221 and a penalty pursuant to section 6662(a) in the amount

of $33,444.1 After concessions, the principal issues for

decision are:

(1) Whether petitioners are entitled to report claimed gains

and losses in ordinary income on account of an alleged business

of petitioner Lee B. Arberg (Mr. Arberg) as a trader in

securities within the meaning of section 475(f)(1);

(2) whether petitioners are entitled to deduct various

business expenses claimed in connection with the securities

trading and/or a consulting business of Mr. Arberg; and

(3) whether petitioners are liable for the section 6662(a)

accuracy-related penalty for 2000.

Certain additional adjustments; e.g., to itemized deductions, are

computational in nature and will be resolved by concessions made

and our holdings on the foregoing issues.

1
Unless otherwise indicated, section references are to the
Internal Revenue Code of 1986, as amended and in effect for the
year in issue, and Rule references are to the Tax Court Rules of
Practice and Procedure.
 - 3 -

FINDINGS OF FACT

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

The stipulations of the parties, with accompanying exhibits, are

incorporated herein by this reference.2 At the time the petition

was filed in this case, Mr. Arberg resided in Florida and

petitioner Melissa A. Quinn (Ms. Quinn) resided in Georgia.

Employment and Trading Activities

Mr. Arberg was born in 1968 and graduated from Princeton

University in 1990 with a major in history. Upon graduation, he

was employed by the Cummins Engine Company in Columbus, Indiana.

He worked in the company’s mergers and acquisitions division,

focusing on financial and valuation analysis. After

approximately 2 years, Mr. Arberg went to work for Hemisphere

Trading Company, an investment adviser based in Memphis,

2
The parties filed a stipulation of facts and exhibits at
the trial session in Jacksonville, Florida. Both parties
subsequently filed an opening brief including proposed findings
of fact. Respondent’s proposed findings incorporated verbatim
various of the stipulated facts, and petitioners included a
number of consistent paraphrases. On reply brief, petitioners’
response to respondent’s requested findings consists of the
following: “Petitioners object to Respondent’s Requested
Findings of Fact in their entirety and request that this Court
adopt Petitioners’ Requested Findings of Fact in their entirety.”
While the Court has taken the findings proposed in petitioners’
opening brief into account in finding the facts set forth infra,
the obvious overbreadth of their approach on reply brief complies
with neither the letter nor the spirit of Rule 151(e)(3). In
effect, this severely truncated approach has deprived petitioners
of the full extent of their opportunity to set forth an
objection, as to each proposed finding of fact, afforded by the
Rule.
 - 4 -

Tennessee, and he remained there for roughly 5 years. At

Hemisphere Trading Company, Mr. Arberg was in charge of portfolio

management trading, and his duties included both executing trades

and supervising trades executed by other employees.

During the mid- to late-1990s, Mr. Arberg also served on the

board of directors of the company SI Diamond Technology, Inc.,

and provided consulting services to the entity. The consulting

services were directed toward conducting a valuation relating to

a proposed merger and acquisition transaction. Mr. Arberg’s

compensation for that work consisted primarily of stock options,

which Mr. Arberg apparently sold at a gain in the late 1990s.

Sporadic additional services may have been provided to SI Diamond

Technology, Inc., or a successor entity in the early 2000s.

Following his work at Hemisphere Trading Company,

Mr. Arberg’s next principal employment was for Lasertron, a

subsidiary of Oak Industries, Inc. Lasertron was involved in the

fiber optics and photonics business, and Mr. Arberg was engaged

in 1999 to provide a valuation of that business, again with a

view towards a potential merger or acquisition transaction. The

work culminated with the signing in November of 1999, and the

closing in January of 2000, of an agreement for the sale of Oak

Industries, Inc., and its Lasertron subsidiary to Corning, Inc.,

creating a division referred to as Corning Lasertron.

Mr. Arberg’s work for Lasertron ended with the closing of the
 - 5 -

sale. He was compensated with salary and stock options, which

options he exercised in early 2000.

Ms. Quinn was born in 1969 and graduated from the University

of Delaware in 1987 with a major in economics. She then went to

work for Lehman Brothers, Inc., in New York City. She was

employed as an institutional trader, executing at the

institutional desk trades of large blocks of stock for major

accounts. Mr. Arberg and Ms. Quinn met through her role as a

“sell side” trader and his as a “buy side” client of Lehman

Brothers, Inc., during his employment at Hemisphere Trading

Company. Ms. Quinn took a position as an institutional trader

with Salomon Smith Barney, Inc., in Atlanta, Georgia, in 1997 or

1998. Mr. Arberg and Ms. Quinn were married in Atlanta in May of

1998.

Mr. Arberg began buying and selling securities for his own

account in 1992, and he continued that activity through at least

2000. Petitioners testified that by 1998 Mr. Arberg had begun to

invest in extensive computer and telecommunications equipment and

access to specialized stock information services, such as those

referred to as the Bloomberg and InstaNet systems. Mr. Arberg

concentrated his activities in industry sectors with which he had

experience, particularly those involving telecommunications and

fiber optics. He described his strategy as follows:

A I would, without a doubt, consider myself a
position trader, where you’re taking the position
 - 6 -

versus someone who is trying to trade for TICS
[ticks?]. When I say TICS, I mean, if a stock is
trading at 10 1/8, a TIC trader would buy a [sic] 10
and try to sell it at 10 1/4, make 25 cents, and say,
thank you and goodbye. I mean, that’s something that I
felt I was ever [sic] good at. I understand the
fundamentals of a company. So I did position trading.
You know, position trading is probably 60 to 70 percent
of the trading done on Wall Street.

Q What was the average length of time that you
held each position?

A Well, the average length of time can’t be
predetermined. Whereas a TIC trader would say, Okay,
I’m buying at 10, as soon as it hits 10-1/4, I’m out
and gone; and if it trades at 9-7/8, I’m out, because
you’re playing for the TICs. A position trader would
say that this, and relative to other groups on my
spreadsheet, it’s undervalued or overvalued. Because
it’s undervalued, it should at least migrate towards
the mean. That’s what I’m trying to wait for. I don’t
know how long that migration may be. At the same time,
you’ve got to be careful of your losses.

I mean, I can’t say, you know what, it’s 20
percent undervalued, but this is the way we were paying
our mortgage payments. So I can think all day long
that it’s 20 percent undervalued , but if it goes to 50
percent undervalued, we’d be mowing lawns.

Q The original 1040 for 2000 doesn’t show any
long term gain or loss. Did you ever hold any
positions in 1998 for long term gain or loss?

* * * * * * *

A Not on purpose. When I say, not on purpose,
that would not be the reason. It would happen because
I would have a spreadsheet of names, and on those
names, I’d find something that was 20 to 30 percent
undervalued. If it’s creeping up and it’s now 10
percent undervalued compared to the group, there’s no
necessary reason for me to sell it just to sell it.
I’d sell it just because it went above that median
valuation.

Q In 1999?
 - 7 -

A It would be the same situation.

Q In 2000?

A It would be the same situation.

By 1998, Mr. Arberg was conducting securities trades through

accounts held in his name at Charles Schwab and/or Salomon Smith

Barney. At some point during 1998 or 1999 not clear from the

record, a brokerage account in the name of Ms. Quinn was opened

at E Trade Securities, Inc. Because of employee trading

restrictions imposed as a result of her position with Salomon

Smith Barney, Ms. Quinn was required to, and did, obtain the

permission of her superior to establish the E Trade account.

According to petitioners, a principal source of funding for the E

Trade account was compensation Mr. Arberg received from his

consulting work.

Tax Reporting

Petitioners filed separate Federal income tax returns for

1998 and 1999. They then filed a joint Form 1040, U.S.

Individual Income Tax Return, for 2000. For 1998, Mr. Arberg

reported wage income of $76,766 and included with his return a

Schedule C, Profit or Loss From Business, for a business

characterized as “Mark to Market Trading”.3 The Schedule C

3
The complete copy of Mr. Arberg’s Form 1040 for 1998 in
the record is an unsigned copy provided by petitioners to the
Internal Revenue Service (IRS) during the examination of
Mr. Arberg’s 1999 return, addressed infra. The return was
(continued...)
 - 8 -

reflected gross income of $49,777, expenses of $176,452, and a

resultant net loss of $126,675. The expenses comprised mortgage

interest of $5,799, office expenses of $3,240, travel of $6,147,

meals and entertainment of $1,421, utilities of $3,987, and other

expenses of $155,858. The other expenses were explained as

follows:

Tax payer elects to be a mark to market trader.
Code Section 475 (f) (1) (A)
Losses on mark to market trades and holdings at year end-
see attached schedule.

The attached schedule listed 17 securities lots, each with a date

acquired and date sold between January 7 and September 18, 1998,

and reflected a net loss on the transactions of $155,858.29.

Appended below the listing was the statement: “As of 12/31/98,

there were no open positions to mark to market.” The

transactions were conducted through the account held in Mr.

Arberg’s name at Charles Schwab. A Schedule D, Capital Gains and

Losses, was also attached to the return and repeated in an

annotation that “Tax Payer elects to be a mark to market trader

under code section 475 (f)(1)(A)”.

3
(...continued)
introduced by respondent at trial and was admitted into evidence.
The parties also included amongst the stipulated exhibits a copy
of a Schedule C characterized in the attendant stipulation as
having been attached to the 1998 return. The Court is satisfied,
given the discussions at trial and particularly in light of fact
that the Schedule C attached to the unsigned return is identical
to the stipulated copy, that the unsigned copy of the complete
1998 return is an accurate representation of the return filed by
Mr. Arberg for that year.
 - 9 -

For 1999, Mr. Arberg again filed a separate return showing

wage income ($84,114 (rounded) from Lasertron) and also attaching

a Schedule C for a “MARK TO MARKET TRADING” business. The

Schedule C reported gross income of zero, expenses of $34,779

(comprising $2,790 for car and truck expenses, $20,754 for travel

expenses, and $11,235 for other expenses), and a net loss of

$34,779. The $11,235 for other expenses was described as: “LOSS

ON MARKET TRADES AND HOLDINGS AT DECEMBER 31, 1999”. An attached

schedule listed three securities lots, each with a respective

date acquired and date sold between February 3 and October 13,

1999, for the $11,235 total net loss on the transactions. These

trades were apparently conducted through an account in

Mr. Arberg’s name at Salomon Smith Barney. As in 1998, a

Schedule D was also attached to the 1999 return and bore the

notation “TAXPAYER HAS ELECTED BO [sic] BE A MARK TO MARKET

TRADER UNDER IRC SECT. 475(F)(1)(A)”.

Ms. Quinn likewise filed a separate return for 1999. The

return reported, inter alia, wage income of $131,730 and net

short-term capital gains from Schedule D of $196,121. The

$196,121 in net short-term capital gains was derived from gross

short-term sales proceeds of $761,300 shown on the Schedule D.

The trades underlying the reported capital gains on stock sales

were conducted through the E Trade account in Ms. Quinn’s name.
 - 10 -

For 2000, petitioners filed a joint Form 1040 reporting wage

income of $2,150,838 ($2,022,517.92 of which was earned by

Mr. Arberg from Corning Lasertron) and a $481,348 loss from an

attached Schedule C for Mr. Arberg’s “MARK TO MARKET TRADING”

business. The Schedule C detailed the following:

Gross income $65,372

Expenses:
Other Interest 42,570
Legal and professional services 75,495
Office expense 2,378
Travel 30,072
Meals and entertainment 1,332
Other expenses 394,873

Total Expenses 546,720

Net loss 481,348

Attached statements described the gross income as “MARK TO MARKET

GAINS ON OPEN POSITIONS AT 12/31/2000” and listed the components

of the other expenses:

Loss on market trades and holdings
at December 31, 2000 $380,595
Telephone expenses 5,616
Computer expenses 5,755
Training/seminars 2,907

The $380,595 loss was calculated by deducting cost basis from

$34,910,868 in gross proceeds less commissions received on trades

during 2000 in the E Trade account in Ms. Quinn’s name. E Trade

Securities, Inc., reported to the Internal Revenue Service (IRS)

stock and bond sales in the name of Ms. Quinn totaling

$34,910,781 for 2000.
 - 11 -

IRS Examinations

Mr. Arberg’s 1999 tax return was examined by the IRS, and a

notice of deficiency was issued to Mr. Arberg on June 19, 2002.

In the notice, the IRS disallowed the $20,754 in travel expenses

and $2,790 of car and truck expenses claimed on the Schedule C

and instead recharacterized those amounts as miscellaneous

unreimbursed employee expenses on Schedule A, Itemized

Deductions. The changes resulted in a deficiency of $135.

Mr. Arberg on July 3, 2002, signed a Form 5564, Notice of

Deficiency Waiver, agreeing to immediate assessment and

collection of the proposed deficiency, which waiver was received

by the IRS in August of 2002.

Meanwhile, on September 18, 2001, the IRS commenced an

examination of petitioners’ joint return for 2000. During that

examination, in March of 2002, petitioners provided the IRS with

an unsigned joint Form 1040X, Amended U.S. Individual Income Tax

Return, for 2000 and an unsigned revised Form 1040 for 2000

reflecting the changes noted on the Form 1040X. The returns were

not intended to be filed or processed but purported to set forth

petitioners’ position for purposes of the audit. As relevant

here, the principal difference between the original and the

revised returns pertained to the reporting of the originally

claimed Schedule C loss.
 - 12 -

Petitioners’ revised position entailed two Schedules C for

Mr. Arberg. One addressed his business as a “Trader in

Securities - Mark-to-Market accounting”. That Schedule C

reported zero gross income and claimed expenses of $1,207 for

depreciation, $42,570 for other interest, $2,378 for office

expenses, $1,067 for supplies, $1,000 for travel, and $4,311 for

other expenses (comprising $2,907 for trading seminars and $1,404

for trading telephone). The resultant net loss for the alleged

securities business was $52,533.

The other Schedule C dealt with a business labeled

“Consultant”. Reported gross income was again zero, and the

expenses enumerated were $1,068 for supplies, $29,072 for travel,

$1,332 for meals and entertainment, and $4,212 for other expenses

(telephone). Those figures led to a net loss of $35,684 for the

consultant business, and a total claimed Schedule C loss for both

business of $88,217.

The revised position also incorporated a Form 4797, Sales of

Business Property, reporting an ordinary loss of $313,413. An

attached statement detailed that the claimed loss was computed

from three components: (1) A $380,595 loss on trader

transactions in the E Trade Securities account (calculated by

subtracting an aggregate basis of $35,291,463 from an aggregate

sales price of $34,910,868); (2) a $65,372 gain on trader

transaction in the E Trade Securities account; and (3) a $1,810
 - 13 -

transfer commission rebate. Hence, with a few concessions,

petitioners’ revised position essentially restructured the

reporting of their claimed business losses. The position did

not, however, alter the substance of their stance that activity

in the E Trade account should generate ordinary income and losses

because Mr. Arberg qualified as a trader in securities and that

various business expenses incurred by him were deductible under

section 162.

The examination culminated in the issuance of a notice of

deficiency to petitioners’ for 2000 on May 18, 2005. The notice

was based on the reporting in the original return. Respondent

therein disallowed all income and expenses claimed on the

Schedule C but permitted a portion of the disallowed expenses as

miscellaneous unreimbursed employee expenses (principally of Mr.

Arberg) or investment expenses (of Ms. Quinn) on Schedule A. The

attached explanation of adjustments noted, inter alia, that

“Melissa A. Quinn had not elected to use the Mark to Market

Accounting Method for her trades in securities or commodities”

and that petitioners had not established that the claimed

expenses were incurred and/or paid for ordinary and necessary

business purposes. The instant petition and litigation followed.
 - 14 -

OPINION

I. Preliminary Matters

A. Amendment to Answer

Trial in this case was held on February 7, 2007. On

April 16, 2007, respondent filed a motion for leave to file

amendment to answer and lodged therewith the corresponding

amendment to answer. Respondent seeks through the amendment to

conform the pleadings to the evidence adduced at trial and, based

on that evidence, specifically to raise the duty of consistency

as an affirmative defense supporting the determination made in

the notice of deficiency. Petitioners on April 27, 2007, filed

an objection to respondent’s motion, generally alleging

dilatoriness and prejudice. Since opening briefs had meanwhile

been filed on April 24 and 27, 2007, the Court advised the

parties by order dated May 2, 2007, that it intended to rule on

the motion in conjunction with the opinion otherwise addressing

the substantive matters in this case and that the parties should

prepare their reply briefs so as to deal with the duty of

consistency in the event that respondent’s motion was ultimately

granted.

Rule 41 governs amended and supplemental pleadings. Rule

41(a) covers amendments generally and provides in effect that

after a responsive pleading is served or 30 days if no responsive

pleading is permitted, “a party may amend a pleading only by
 - 15 -

leave of Court or by written consent of the adverse party, and

leave shall be given freely when justice so requires.” Like rule

15(a) of the Federal Rules of Civil Procedure, from which it is

derived, Rule 41(a) reflects “a liberal attitude toward amendment

of pleadings.” 60 T.C. 1089 (explanatory note accompanying

promulgation of Rule 41). As such, it tempers Rules 34(b) and

39, which essentially deem waived any issue or affirmative

defense not pleaded. The U.S. Supreme Court has interpreted the

“freely given” language of the rule 15(a) as follows:

If the underlying facts or circumstances relied upon by
a plaintiff may be a proper subject of relief, he ought
to be afforded an opportunity to test his claim on the
merits. In the absence of any apparent or declared
reason--such as undue delay, bad faith or dilatory
motive on the part of the movant, repeated failure to
cure deficiencies by amendments previously allowed,
undue prejudice to the opposing party by virtue of
allowance of the amendment, futility of amendment,
etc.--the leave sought should, as the rules require, be
“freely given.” * * * [Foman v. Davis, 371 U.S. 178,
182 (1962).]

Respondent’s motion is premised particularly on Rule

41(b)(1), which reads:

(b) Amendments To Conform to the Evidence: (1)
Issues Tried by Consent: When issues not raised by the
pleadings are tried by express or implied consent of
the parties, they shall be treated in all respects as
if they had been raised in the pleadings. The Court,
upon motion of any party at any time, may allow such
amendment of the pleadings as may be necessary to cause
them to conform to the evidence and to raise these
issues, but failure to amend does not affect the result
of the trial of these issues.
 - 16 -

Whether to permit such an amendment to conform pleadings to the

evidence is a matter within the sound discretion of the Court.

E.g., Commissioner v. Estate of Long, 304 F.2d 136, 142-144 (9th

Cir. 1962); Estate of Quick v. Commissioner, 110 T.C. 172, 178

(1998); Bhattacharyya v. Commissioner, T.C. Memo. 2007-19. It is

well settled both that amendment under Rule 41 may be allowed at

any time in a Tax Court proceeding through entry of decision and

that an affirmative defense may properly be pleaded through the

vehicle of a motion to conform under Rule 41(b)(1). E.g.,

Commissioner v. Finley, 265 F.2d 885, 888 (10th Cir. 1959), affg.

O’Shea v. Commissioner, T.C. Memo. 1957-15 and T.C. Memo. 1957-

16; LeFever v. Commissioner, 103 T.C. 525, 538 & n.16 (1994),

affd. 100 F.3d 778 (10th Cir. 1996); Stromsted v. Commissioner,

53 T.C. 330, 340 & n.5 (1969); Pierce v. Commissioner, T.C. Memo.

2003-188.

The touchstone in evaluating whether to allow an amendment

to conform pleadings to the evidence is the existence of unfair

surprise or prejudice to the nonmoving party. E.g., Foman v.

Davis, supra at 182; Estate of Quick v. Commissioner, supra at

178-180; Kroh v. Commissioner, 98 T.C. 383, 387-389 (1992);

Markwardt v. Commissioner, 64 T.C. 989, 998 (1975); Bhattacharyya

v. Commissioner, supra; Pierce v. Commissioner, supra. Such

surprise or prejudice, in turn, rests largely on evidentiary and

other considerations bearing on the nonmovant’s opportunity to
 - 17 -

respond. For instance, this and other courts may take into

account whether the nonmovant would be prevented from presenting

evidence that might have been introduced if the matter had been

raised earlier; whether the evidence that supports the unpleaded

issue was introduced without objection; whether the movant

delayed unduly in raising the matter; and the like. E.g., Foman

v. Davis, supra at 182; United States v. Shanbaum, 10 F.3d 305,

312-313 (5th Cir. 1994); Estate of Quick v. Commissioner, supra

at 178-180; LeFever v. Commissioner, supra at 538 & n.16; Kroh v.

Commissioner, supra at 388-389; Law v. Commissioner, 84 T.C. 985,

990-993 (1985); Markwardt v. Commissioner, supra at 998;

Bhattacharyya v. Commissioner, supra; Pierce v. Commissioner,

supra.

Here, as noted, respondent seeks to amend the answer to

raise the affirmative defense of the duty of consistency as an

alternative or supplemental position in support of the determined

deficiency. Respondent argues that the duty of consistency

should prevent petitioners from maintaining that ownership of the

E Trade account, or the losses generated by trades therein, are

attributable to other than Ms. Quinn. As will be explained in

greater detail below, two items of evidence offer the primary

support for this position. The most crucial element is testimony

by Ms. Quinn at trial concerning the reporting of transactions in

the E Trade account on her 1999 tax return. This testimony was
 - 18 -

solicited by counsel for respondent on cross-examination, and the

question generated no objection from petitioners’ counsel. That

testimony is then corroborated by copies of records maintained in

IRS computer systems with respect to Ms. Quinn’s 1999 return.

The records were offered as an exhibit by respondent’s counsel at

trial and were, after review, admitted without objection from

petitioners’ counsel.

Petitioners filed an objection to respondent’s motion for

leave to file amendment to answer. The 2-page document makes a

number of references to “dilatoriness” on the part of respondent

and contains repeated statements to the effect that respondent

has failed to offer reasons why amendment was not sought prior to

trial. Petitioners also allude generally to “prejudice”, but in

only one context do they expound upon such allegations with

anything that might be considered a more particularized

explanation of how they would be disadvantaged: “Respondent’s

dilatory motion will seriously impede the filing of Post-Trial

Briefs in this case, as Respondent’s Motion will not be decided

upon by this Court until after the submission of Petitioners’

Post-Trial Brief. Petitioners will therefore be prejudiced in

their compliance with this Court’s post-trial briefing schedule.”

Petitioners further suggest that their cooperation should have

bearing on our disposition of the motion.
 - 19 -

With respect to petitioners’ principal complaint that

respondent is guilty of extreme and unexplained dilatoriness, the

Court cannot agree. Respondent’s motion is made expressly as a

motion to conform the pleadings to the evidence. As such, it is

premised on Rule 41(b)(1) and must necessarily be brought after

the underlying issues have been tried. Respondent also notes

specifically that the testimony and evidence introduced at trial

led respondent to raise the duty of consistency defense that is

the subject of the amendment sought. The reason for moving at

this juncture, posttrial, is clear. Furthermore, given that

transcripts of the proceedings would typically have been received

by the parties in early March, and respondent would have required

a reasonable period of time to review the testimony, research the

issue, and prepare the motion and amendment, the April 16, 2007,

filing date would not appear to signal any unreasonable delay.

Concerning petitioners’ generalized references to prejudice,

they have failed even to suggest that they possess relevant

evidence that would have been introduced had the issue been

earlier raised. See Lilley v. Commissioner, T.C. Memo. 1989-602

(“Petitioner does not suggest that he has evidence which might

have been offered at trial to overcome” an affirmative defense

raised under Rule 41.), affd. without published opinion 925 F.2d

417 (3d Cir. 1991). Nor do they suggest any manner in which

their preparation or strategy for trying the case might have
 - 20 -

differed. As to their more targeted references to the briefing

schedule, the Court acted to assuage such concerns by advising

the parties to address the duty of consistency in their reply

briefs and extending the time for them to do so. Finally,

regarding their allusions to cooperation, the Court would simply

note that respondent in this case filed a motion to compel

production of documents and a motion to compel responses to

interrogatories, both of which the Court found appropriate to

grant. Suffice it to say that the record does not support any

suggestion on petitioners’ part that their cooperation has been

exemplary.

On reply brief, petitioners essentially reprise their

objections to permitting respondent to raise the duty of

consistency posttrial and, in apparent disregard of the warning

in the Court’s May 2, 2007, order, make no meaningful attempt to

address the substance of the affirmative defense. In opposing

amendment, they also make the somewhat baffling allegation that

respondent’s motion to amend is premised on a contention that

respondent only learned at trial of petitioners’ position that

Ms. Quinn was restricted from trading in securities on account of

her employment. Respondent, however, takes no such stance.

As previously explained, the critical information obtained

at trial on which respondent’s motion is based pertains to

Ms. Quinn’s 1999 tax reporting. Petitioners’ assertions as to
 - 21 -

the restrictions on Ms. Quinn’s trading activities were expressly

articulated in both the petition and their pretrial memorandum

(and in a letter, a copy of which they attached to their reply

brief, sent to the IRS during the examination process). Nothing

in respondent’s submissions can reasonably be interpreted to

propound otherwise. Most importantly, petitioners continue to

make only generalized references to surprise and disadvantage,

without providing any specifics as to how they might be

prejudiced in presenting relevant evidence.

Hence, the Court is faced with a situation where the

evidence on which respondent’s amendment is based was introduced

at trial without objection from petitioners and where petitioners

have not offered any particularized explanation of how their

opportunity to present their case will be prejudiced by

permitting the amendment.4 Accordingly, the Court concludes that

the issue of the duty of consistency was tried by implied consent

and that the answer may properly be amended under Rule 41(b)(1)

to conform to the evidence introduced at trial. Respondent’s

motion shall be granted.

4
Interestingly, much of the balance of petitioners’ reply
brief is devoted to an argument that petitioners’ uncontroverted
testimony must be given substantial weight. That, i.e.,
crediting Ms. Quinn’s testimony with respect to her 1999
reporting, is essentially what the Court will do to the extent
that respondent’s position as to the duty of consistency is
sustained.
 - 22 -

B. Burden of Proof

As a general rule, the Commissioner’s determinations are

presumed correct, and the taxpayer bears the burden of proving

error therein. Rule 142(a); Welch v. Helvering, 290 U.S. 111,

115 (1933). Additionally, taxpayers are required to maintain

records sufficient to establish the existence and amount of all

items reported on the tax return, including both income and

offsets or deductions therefrom. Sec. 6001; Hradesky v.

Commissioner, 65 T.C. 87, 89-90 (1975), affd. 540 F.2d 821 (5th

Cir. 1976); sec. 1.6001-1(a), Income Tax Regs. Deductions in

particular are a matter of “legislative grace”, and “a taxpayer

seeking a deduction must be able to point to an applicable

statute and show that he comes within its terms.” New Colonial

Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); see also Rule

142(a).

There exist, however, several exceptions that may modify the

foregoing general rule. One is section 7491, with principles

relevant to deficiency determinations set forth in subsection (a)

and rules governing penalties and additions to tax addressed in

subsection (c).

Section 7491(a)(1) may shift the burden to the Commissioner

with respect to factual issues affecting liability for tax where

the taxpayer introduces credible evidence, but the provision

operates only where the taxpayer establishes that he or she has
 - 23 -

complied under section 7491(a)(2) with all substantiation

requirements, has maintained all required records, and has

cooperated with reasonable requests for witnesses, information,

documents, meetings, and interviews. See H. Conf. Rept. 105-599,

at 239-240 (1998), 1998-3 C.B. 747, 993-994. Here, petitioners

have made no argument directed towards burden of proof and

consequently have not shown that all prerequisites for a shift of

burden have been met. In addition, leaving aside issues of

substantiation recounted more fully below, the above-mentioned

motions to compel production of documents and responses to

interrogatories would suggest that petitioners’ cooperation has

been less than exemplary. The Court therefore cannot conclude

that section 7491(a) effects any shift of burden in the instant

case.

Section 7491(c) provides that “the Secretary shall have the

burden of production in any court proceeding with respect to the

liability of any individual for any penalty, addition to tax, or

additional amount imposed by this title.” The Commissioner

satisfies this burden of production by “[coming] forward with

sufficient evidence indicating that it is appropriate to impose

the relevant penalty” but “need not introduce evidence regarding

reasonable cause, substantial authority, or similar provisions.”

Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Rather, “it is

the taxpayer’s responsibility to raise those issues.” Id. The
 - 24 -

Court’s conclusions with respect to burden under section 7491(c)

will be detailed infra in conjunction with our discussion of the

section 6662(a) penalty.

In a similar vein, section 6201(d) states:

SEC. 6201(d). Required Reasonable Verification of
Information Returns.--In any court proceeding, if a
taxpayer asserts a reasonable dispute with respect to
any item of income reported on an information return
filed with the Secretary under subpart B or C of part
III of subchapter A of chapter 61 by a third party and
the taxpayer has fully cooperated with the Secretary
(including providing, within a reasonable period of
time, access to and inspection of all witnesses,
information, and documents within the control of the
taxpayer as reasonably requested by the Secretary), the
Secretary shall have the burden of producing reasonable
and probative information concerning such deficiency in
addition to such information return.

Again, to the extent that respondent in determining the

disputed deficiency may have relied upon third-party information

returns reporting matters related to pertinent securities

transactions, the full cooperation prerequisites for application

of section 6201(d) would appear to render the statute inoperative

here.

Lastly, a further exception is relevant to this proceeding.

The Commissioner bears the burden of proof with respect to any

affirmative defense or new matter raised in the answer. Rule

142(a)(1). As just described, by amendment to answer respondent

here expressly pleads the duty of consistency as an affirmative

defense. See Cluck v. Commissioner, 105 T.C. 324, 331 n.11

(1995) (characterizing the duty of consistency as an affirmative
 - 25 -

defense). To summarize, then, the burden rests on petitioners to

establish facts to overcome the determinations made in the notice

of deficiency or to support any revised position raised during

the examination of their 2000 return. Respondent, however, must

shoulder the burden of showing applicability of the duty of

consistency to the extent that respondent seeks to rely on the

doctrine to prevent petitioners from taking a position contrary

to one maintained in a prior year. See Janis v. Commissioner,

T.C. Memo. 2004-117 (noting the Commissioner’s burden of proof on

a duty of consistency defense), affd. 461 F.3d 1080 (9th Cir.

2006), affd. 469 F.3d 256 (2d Cir. 2006).

II. Treatment of Securities Transactions

A. Contentions of the Parties

Petitioners argue that gains and losses derived from

transactions in the E Trade account are properly treated as

ordinary, rather than capital, in nature. Their position in this

regard rests on two principal contentions. First, they assert

that the trades in the E Trade account are properly treated as

trades of Mr. Arberg, not Ms. Quinn. As support for this claim

they look to an alleged power of attorney, to trust law in the

State of Georgia, and to what they characterize as the “legal

preclusion doctrine”. Second, they maintain that Mr. Arberg

qualifies as a trader within the meaning of section 475.
 - 26 -

Conversely, respondent advances as a primary position that

ownership of and trades in the E Trade account must be attributed

to Ms. Quinn. Respondent has noted in this connection both the

duty of consistency and the Danielson rule, as well as the

insufficiency of any theory premised on a power of attorney. As

an alternative position, respondent maintains that even if the

account and trades are attributed to Mr. Arberg, he fails to

qualify as a trader in securities for purposes of section 475.

B. General Rules Re: Federal Tax Treatment of Securities

Transactions and Trading

For Federal tax purposes, transactions in securities are

conducted in one of three capacities; i.e., as a dealer, a

trader, or an investor, and the tax treatment of a given

transaction turns upon which of these characterizations applies.

E.g., King v. Commissioner, 89 T.C. 445, 457-459 (1987); Chen v.

Commissioner, T.C. Memo. 2004-132; Boatner v. Commissioner, T.C.

Memo. 1997-379, affd. without published opinion 164 F.3d 629 (9th

Cir. 1998). Dealers are those who are engaged in the business of

buying and selling securities and whose business involves sales

to customers. E.g., King v. Commissioner, supra at 457; Chen v.

Commissioner, supra; Boatner v. Commissioner, supra. Securities

in the hands of dealers are therefore excluded from the

definition of a capital asset, falling within the exception for

“property held by the taxpayer primarily for sale to customers in
 - 27 -

the ordinary course of his trade or business”. Sec. 1221(a)(1);

see also King v. Commissioner, supra at 457-458; Chen v.

Commissioner, supra; Boatner v. Commissioner, supra. As a

result, a dealer’s sales of securities are the equivalent of

sales of inventory and produce ordinary gains and losses. E.g.,

King v. Commissioner, supra at 457-458; Chen v. Commissioner,

supra; Boatner v. Commissioner, supra. Attendant business

expenses are deductible under section 162(a) and interest is not

subject to the restrictions under section 163(d) on the deduction

of “investment interest”. E.g., King v. Commissioner, supra at

457, 460.

Traders, like dealers, are engaged in the trade or business

of selling securities, but they do so for their own account.

E.g., Groetzinger v. Commissioner, 771 F.2d 269, 274-275 (7th

Cir. 1985), affg. 82 T.C. 793 (1984), affd. 480 U.S. 23 (1987);

Moller v. United States, 721 F.2d 810, 813 (Fed. Cir. 1983); King

v. Commissioner, supra at 457-458; Chen v. Commissioner, supra;

Boatner v. Commissioner, supra. Hence, their securities are not

excluded from the definition of a capital asset due to the

absence of customers, and sales thereof produce capital gains and

losses under generally applicable principles. E.g., King v.

Commissioner, supra at 457; Chen v. Commissioner, supra; Boatner

v. Commissioner, supra. Because of the trade or business

context, however, expenses are deductible under section 162(a)
 - 28 -

and the interest limitations of section 163(d) do not apply.

E.g., King v. Commissioner, supra at 457-463; Boatner v.

Commissioner, supra.

Investors likewise buy and sell for their own account, but

they are not considered to be in the trade or business of selling

securities. E.g., Groetzinger v. Commissioner, supra at 274-275;

Moller v. United States, supra at 813; King v. Commissioner,

supra at 458-459; Chen v. Commissioner, supra; Boatner v.

Commissioner, supra; Mayer v. Commissioner, T.C. Memo. 1994-209.

Expenses are deductible only under section 212 as itemized

deductions, and deduction of interest is restricted by section

163(d). E.g., King v. Commissioner, supra at 460-461; Boatner v.

Commissioner, supra; Mayer v. Commissioner, supra. Their

transactions, too, are capital in nature. E.g., King v.

Commissioner, supra at 457-459; Chen v. Commissioner, supra;

Boatner v. Commissioner, supra.

Nonetheless, a distinction, relevant here, exists between a

trader and an investor with respect to capital treatment. Only a

trader, and not an investor, is entitled to make a mark-to-market

election pursuant to section 475(f), with the consequence that

gains and losses are treated as ordinary in character under

section 475(d)(3)(A)(i) and (f)(1)(D). E.g., Vines v.

Commissioner, 126 T.C. 279, 287-288 (2006); Knish v.

Commissioner, T.C. Memo. 2006-268; Lehrer v. Commissioner, T.C.
 - 29 -

Memo. 2005-167; Chen v. Commissioner, supra. Ordinary losses are

thereby made available to offset ordinary income and are not

subject to the $3,000 (or $1,500) limitation imposed by section

1211(b) on the deduction by an individual of capital losses in

excess of capital gains. E.g., Vines v. Commissioner, supra at

288; Knish v. Commissioner, supra; Lehrer v. Commissioner, supra;

Chen v. Commissioner, supra.

C. Attribution of E Trade Transactions

The doctrine of the duty of consistency, also known as

“quasi-estoppel” is among the equitable principles applicable in

this Court. E.g., Herrington v. Commissioner, 854 F.2d 755, 757

(5th Cir. 1988), affg. Glass v. Commissioner, 87 T.C. 1087

(1986); Cluck v. Commissioner, 105 T.C. at 331; LeFever v.

Commissioner, 103 T.C. at 541; Janis v. Commissioner, T.C. Memo.

2004-117. The doctrine, derived from R.H. Stearns Co. v. United

States, 291 U.S. 54 (1934), rests upon the premise that a

taxpayer has a duty to be consistent in the tax treatment of

items and will not be permitted to benefit from the taxpayer’s

own prior error or omission. E.g., Herrington v. Commissioner,

supra at 757; Shook v. United States, 713 F.2d 662, 666-667 (11th

Cir. 1983); Beltzer v. United States, 495 F.2d 211, 212 (8th Cir.

1974); Estate of Letts v. Commissioner, 109 T.C. 290, 296 (1997),

affd. without published opinion 212 F.3d 600 (11th Cir. 2000);
 - 30 -

LeFever v. Commissioner, supra at 541; Janis v. Commissioner,

supra.

This duty operates to preclude the taxpayer from taking a

position in an earlier year and a contrary position in a later

year, after expiration of the statute of limitations on the

earlier year. E.g., Herrington v. Commissioner, supra at 757;

Shook v. United States, supra at 667; Beltzer v. United States,

supra at 212; Estate of Letts v. Commissioner, supra at 296;

Cluck v. Commissioner, supra at 331; LeFever v. Commissioner,

supra at 541-542; Janis v. Commissioner, supra. In practice, the

doctrine “prevents a taxpayer from claiming that he or she should

have paid more tax before and so avoiding the present tax.”

Estate of Letts v. Commissioner, supra at 296. An exception

exists in that the doctrine is not applicable to pure questions

of law, as opposed to questions of fact and mixed questions of

fact and law. E.g., Herrington v. Commissioner, supra at 758;

Estate of Letts v. Commissioner, supra at 302.

Both this and other courts, including the Court of Appeals

for the Eleventh Circuit, to which appeal in the instant case

would normally lie, identify three elements as conditions

precedent to application of the duty of consistency: (1) The

taxpayer has made a representation of fact or reported an item

for tax purposes in one year; (2) the Commissioner has acquiesced

in or relied on that fact for that year; and (3) the taxpayer
 - 31 -

desires to change the representation previously made in a later

year after the statute of limitations bars adjustments for the

earlier year. E.g., Herrington v. Commissioner, supra at 758;

Shook v. United States, supra at 667; Beltzer v. United States,

supra at 212; Estate of Letts v. Commissioner, supra at 297;

Cluck v. Commissioner, supra at 332; LeFever v. Commissioner,

supra at 543; Janis v. Commissioner, supra.

Turning to the case at bar, the Court first considers

whether petitioners have in their tax reporting made a pertinent

representation of fact. In this connection, “a taxpayer’s

treatment of an item on a return can be a representation that

facts exist which are consistent with how the taxpayer reports

the item on the return.” Estate of Letts v. Commissioner, supra

at 299-300. Throughout this proceeding, petitioners have

maintained that, from the time the E Trade account was

established in 1998, Mr. Arberg conducted all trading activity

taking place therein. Nonetheless, on her separate tax return

for 1999, Ms. Quinn reported proceeds from transactions in the E

Trade account as capital gain. Conversely, on his separate tax

return for 1999, Mr. Arberg did not report any proceeds from

transactions in the E Trade account, whether as ordinary income

or otherwise.

The above-described reporting constitutes a representation

that Ms. Quinn is the owner of the E Trade account, that gains
 - 32 -

and losses therein are properly attributable to her, and that

such transactions are capital in nature. Accordingly, the first

element for the duty of consistency is satisfied.

The second inquiry is whether respondent acquiesced in or

relied on the facts attested by petitioners’ reporting. Caselaw

establishes that the necessary acquiescence exists where a

taxpayer’s return is accepted as filed; examination of the return

is not required. E.g., Estate of Letts v. Commissioner, supra at

300; LeFever v. Commissioner, supra at 543-544; Bentley Court II

Ltd. Pship. v. Commissioner, T.C. Memo. 2006-113. Here,

respondent accepted Ms. Quinn’s 1999 return reporting capital

gain as filed. Mr. Arberg’s 1999 return was examined and changes

were made, but no adjustment to include gains from transactions

in the E Trade account was involved. The resultant deficiency

was agreed to by Mr. Arberg and assessed by the IRS. Hence, the

second element poses no barrier to application of the duty of

consistency.

The third question probes whether the taxpayer is changing a

representation previously made after the time to assess

additional tax for the earlier year has passed. Petitioners, as

reflected in their joint return and revised return for 2000 and

in their arguments herein, seek to alter their 1999 reporting

position to contend that ownership of and/or proceeds of

transactions in the E Trade account are attributable to
 - 33 -

Mr. Arberg and are ordinary in nature. Furthermore, the record

indicates and respondent states that any opportunity to assess

additional taxes for 1999 based on this changed position would

have expired, and petitioners have at no time alleged to the

contrary.

The general statue of limitations on assessment pursuant to

section 6501(a) is 3 years from the date the return is filed.

The statutory period for a 1999 return would therefore typically

terminate in 2003. To the extent it could be argued that

petitioners’ change in position was timely disclosed to the IRS,

the Court would reject any such suggestion in the unique

circumstances of this case. Although petitioners filed their

2000 return in April of 2001 and provided their revised 2000

return in March of 2002, Mr. Arberg on July 3, 2002, signed a

Form 5564, Notice of Deficiency Waiver, with respect to 1999.

The last documentary submission reflected by the record as having

been given to the IRS, prior to expiration of the period of

limitations for 1999, regarding petitioners’ 1999 and 2000

reporting of the E Trade account would thus seem to reaffirm the

original 1999 reporting of the account as other than

Mr. Arberg’s.

Additionally, as of the time motions to compel were filed in

this case in December of 2006, respondent represented that

petitioners still had not provided documentation of the transfers
 - 34 -

of cash employed to open the E Trade account or of the trades

conducted therein. Given this convoluted trail, the Court agrees

with respondent that the substance of what petitioners had

claimed at various junctures and were now claiming concerning the

E Trade account only became clear enough adequately to disclose a

change in position and support a duty of consistency argument

through testimony elicited at trial. On these facts, the Court

concludes that all three elements for application of the duty of

consistency are met.

Where the three prongs of the test are met, the consequence

is that the Commissioner may act as if the previous

representation remains true, even if it is not, and the taxpayer

is barred from asserting to the contrary. E.g., Herrington v.

Commissioner, 854 F.2d at 758; Estate of Letts v. Commissioner,

109 T.C. at 297; Janis v. Commissioner, T.C. Memo. 2004-117.

Hence, petitioners here are properly estopped from claiming that

ownership of or proceeds from transactions in the E Trade account

are attributable to other than Ms. Quinn. As a result,

petitioners’ various arguments regarding attribution to

Mr. Arberg, even if otherwise legally meritorious, cannot be

sustained. The Court therefore need not further consider

petitioners’ contentions with respect to an alleged power of

attorney, to trust law in the State of Georgia, or to their so-

called legal preclusion doctrine.
 - 35 -

However, for the sake of completeness, the Court would note

briefly that even if the Court were to deny respondent’s motion

and/or rule against respondent on the duty of consistency

argument, none of the theories advanced by petitioners would be

sufficient to overcome the form of the E Trade account and thus

to show that transactions therein should be considered those of

Mr. Arberg. To highlight a few shortcomings, the Court would

begin by observing that petitioners have generally failed to

introduce evidence that would establish the factual predicate for

the doctrines they cite.

As to an alleged power of attorney, petitioners have not

proffered even one document related to any such grant of

authority. Furthermore, even if the record corroborated a power

of attorney in favor of Mr. Arberg, that fact would actually cut

against petitioners’ position, indicating instead that Mr. Arberg

was acting on Ms. Quinn’s behalf and dealing with her property,

not his own.

Likewise, to show either a resulting or a constructive trust

under Georgia law, petitioners would need as a threshold matter

to establish the source of the funding for the E Trade account.

See Ga. Code Ann. secs. 53-12-91, 53-12-92, 53-12-93 (1997). Yet

petitioners did not introduce any document related to tracing the

moneys deposited in the E Trade account (or, for that matter,

even to the opening of the account) and only testified generally
 - 36 -

that funds came from Mr. Arberg’s work. They made no explicit

claim regarding an exclusive source and certainly offered no

information as to the possibility of prior commingling, nor did

they discuss or address any other potentially relevant issues.

Lastly, with respect to their so-called legal preclusion

doctrine, petitioners have again failed to make a predicate

factual showing. See Commissioner v. First Sec. Bank of Utah,

N.A., 405 U.S. 394, 395, 403 (1972) (declining to permit

allocation of income by the Commissioner under section 482 to a

taxpayer “that he did not receive and that he was prohibited from

receiving”). Although petitioners state on brief that Ms. Quinn

was prohibited due to her employment from beneficially owning a

securities account or trading in securities for her own account,

they testified that she received permission from her supervisor

to establish the E Trade account. They introduced no evidence or

testimony to delineate the parameters or conditions of any such

permission, so the Court is unable to evaluate limitations as to

this particular account.

Accordingly, without even delving into the host of legal

strictures and requisites that would bear upon the applicability

of petitioners’ theories, the Court is satisfied that patent

deficiencies in the underlying factual record would short circuit

petitioners’ attempts to reach their desired result through these

avenues. Therefore, the transactions in the E Trade account must
 - 37 -

be treated as those of Ms. Quinn, whether because of the duty of

consistency or because petitioners have failed to meet their

burden of proof in overcoming the basis for respondent’s

deficiency determinations.

As a consequence of the above; i.e., that transactions in

the E Trade account cannot be treated as those of Mr. Arberg, in

conjunction with the fact that petitioners have never contended

or proffered evidence to show that Mr. Arberg engaged in trading

through other accounts in 2000 or that Ms. Quinn was a trader in

securities, the Court need not probe further into the

qualifications for trader status. A priori, one to whom

particular securities transactions cannot be attributed cannot be

said to be in the business of trading those securities for his or

her own account. Section 475(f) trader status and attendant

ordinary loss treatment is thus unavailable in any event.

III. Expense Deductions

Deductions are a matter of “legislative grace”, and “a

taxpayer seeking a deduction must be able to point to an

applicable statute and show that he comes within its terms.” New

Colonial Ice Co. v. Helvering, 292 U.S. at 440; see also Rule

142(a). As a general rule, section 162(a) authorizes a deduction

for “all the ordinary and necessary expenses paid or incurred

during the taxable year in carrying on any trade or business”.

An expense is ordinary for purposes of this section if it is
 - 38 -

normal or customary within a particular trade, business, or

industry. Deputy v. Du Pont, 308 U.S. 488, 495 (1940). An

expense is necessary if it is appropriate and helpful for the

development of the business. Commissioner v. Heininger, 320 U.S.

467, 471 (1943). Section 262, in contrast, precludes deduction

of “personal, living, or family expenses.”

The breadth of section 162(a) is tempered by the requirement

that any amount claimed as a business expense must be

substantiated, and taxpayers are required to maintain records

sufficient therefor. Sec. 6001; Hradesky v. Commissioner, 65

T.C. at 89-90; sec. 1.6001-1(a), Income Tax Regs. When a

taxpayer adequately establishes that he or she paid or incurred a

deductible expense but does not establish the precise amount, we

may in some circumstances estimate the allowable deduction,

bearing heavily against the taxpayer whose inexactitude is of his

or her own making. Cohan v. Commissioner, 39 F.2d 540, 544 (2d

Cir. 1930). There must, however, be sufficient evidence in the

record to provide a basis upon which an estimate may be made and

to permit us to conclude that a deductible expense, rather than a

nondeductible personal expense, was incurred in at least the

amount allowed. Williams v. United States, 245 F.2d 559, 560

(5th Cir. 1957); Vanicek v. Commissioner, 85 T.C. 731, 742-743

(1985).
 - 39 -

Furthermore, business expenses described in section 274 are

subject to rules of substantiation that supersede the doctrine of

Cohan v. Commissioner, supra. Sanford v. Commissioner, 50 T.C.

823, 827-828 (1968), affd. 412 F.2d 201 (2d Cir. 1969); sec.

1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov.

6, 1985). Section 274(d) provides that no deduction shall be

allowed for, among other things, traveling expenses,

entertainment expenses, gifts, and expenses with respect to

listed property (as defined in section 280F(d)(4) and including

passenger automobiles, computer equipment, and cellular

telephones) “unless the taxpayer substantiates by adequate

records or by sufficient evidence corroborating the taxpayer’s

own statement”: (1) The amount of the expenditure or use; (2)

the time and place of the expenditure or use, or date and

description of the gift; (3) the business purpose of the

expenditure or use; and (4) in the case of entertainment or

gifts, the business relationship to the taxpayer of the

recipients or persons entertained. Sec. 274(d).

On this issue, petitioners neither at trial nor on brief

offered argument directed towards the deductibility of any of the

specific expenses disallowed or recharacterized by respondent.

Rather, their contentions seem to be confined to the following

generalized paragraph on reply brief:

Similarly, Respondent repeatedly contends in his Brief
(e.g., at 10, 11) that Petitioners failed to
 - 40 -

substantiate the deductions claimed in the return for
the year in issue, 2000. Again, this is a fantasy on
the part of Respondent’s counsel. For example, Exhibit
8-P, containing documentary support for itemized
deductions for the year in issue, is nearly one inch
thick.

The referenced exhibit is in fact Exhibit 7-P (Exhibit 8-R is a

5-page copy of respondent’s interrogatories to petitioners) and

consists of dozens of pages of photocopied tickets, receipts,

bills, and invoices, some of which are illegible, interspersed

with a few lists purporting to summarize totals by category.

None of the materials establish a connection between the expense

incurred and any particular business activity of petitioners.

As alluded to previously, respondent disallowed certain of

the expenses in their entirety while permitting a large

percentage to be claimed as miscellaneous deductions on Schedule

A. Petitioners’ failure to address individual expenditures

leaves their position at this juncture unclear. To the extent

that they continue to maintain that the expenses should be

allowed on Schedule C as attributed to a securities trading

and/or consulting business of Mr. Arberg, suffice it to say that

nothing in the record links any given outlay to a sole

proprietorship venture conducted by Mr. Arberg, much less

demonstrates any rational basis for allocating many of the

claimed items between the alleged securities trading and

consulting as separate Schedule C business activities.
 - 41 -

Even more fundamentally, the Court would reiterate that the

lack of securities trades attributable to Mr. Arberg preempts the

contention that he was involved in a securities trading business

through the E Trade account. Similarly, the following nebulous

testimony hardly establishes the bona fides and contours of a

consulting business in 2000 or suggests types of expenses that

might have been incurred:

Q When were the services for SI Diamond
completed?

A In the late 1990s.

Q Did there come a time that you performed
services for SI Diamond later?

A Yes, I think I did again. In 2001 or 2002, I
think I did again. Actually, I know I did. So again,
no, 2003, I think it was.

Q Did those services commence in late 2000?

A It’s possible, yes. I mean, I would have to
see a piece of paper to remind me.

In this connection, it is also noteworthy that the Schedule C for

the alleged consulting business incorporated in petitioners’

revised Form 1040 for 2000 reports no gross receipts.

Accordingly, multiple grounds exists for the sustaining of

respondent’s determinations. In general, the collection of

photocopied receipts, etc., is, absent further explanation,

insufficient even to satisfy the threshold section 162

requirement of showing that the amount was paid or incurred in

carrying on a particular trade or business. A fortiori, for the
 - 42 -

travel, meals and entertainment, and computer expenses, such

evidence necessarily falls short of meeting the heightened

substantiation requisites of section 274. The dearth of relevant

testimony compounds these shortcomings, and the disallowed or

questionable nature of the alleged underlying businesses raises

yet another barrier.

In addition, with respect to the $42,570 claimed as other

interest, certain further rules come into play. The record

establishes that $42,569.95 was incurred as margin interest on

the E Trade account. However, because the Court has concluded

that activity in the E Trade account must be attributed to

Ms. Quinn, and because no claim or showing has been made that

Ms. Quinn conducted a securities trading business, the

limitations of section 163(d) with respect to investment interest

would be applicable. Moreover, since petitioners have offered no

substantiation concerning any offsetting investment income, the

Court is not in a position to evaluate petitioners’ situation

within the strictures of section 163(d) and thereby to conclude

that any amount would be allowable for deduction in 2000 or

available for carryover in future years.

To summarize, petitioners are not entitled to claimed

expenses except as allowed by respondent as miscellaneous

deductions on Schedule A.
 - 43 -

IV. Accuracy-Related Penalty

Subsection (a) of section 6662 imposes an accuracy-related

penalty in the amount of 20 percent of any underpayment that is

attributable to causes specified in subsection (b). Subsection

(b) of section 6662 then provides that among the causes

justifying imposition of the penalty are: (1) Negligence or

disregard of rules or regulations and (2) any substantial

understatement of income tax.

“Negligence” is defined in section 6662(c) as “any failure

to make a reasonable attempt to comply with the provisions of

this title”, and “disregard” as “any careless, reckless, or

intentional disregard.” Caselaw similarly states that

“‘Negligence is a lack of due care or the failure to do what a

reasonable and ordinarily prudent person would do under the

circumstances.’” Freytag v. Commissioner, 89 T.C. 849, 887

(1987) (quoting Marcello v. Commissioner, 380 F.2d 499, 506 (5th

Cir. 1967), affg. on this issue 43 T.C. 168 (1964) and T.C. Memo.

1964-299), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S.

868 (1991). Pursuant to regulations, “‘Negligence’ also includes

any failure by the taxpayer to keep adequate books and records or

to substantiate items properly.” Sec. 1.6662-3(b)(1), Income Tax

Regs.

A “substantial understatement” is declared by section

6662(d)(1) to exist where the amount of the understatement
 - 44 -

exceeds the greater of 10 percent of the tax required to be shown

on the return for the taxable year or $5,000 ($10,000 in the case

of a corporation). For purposes of this computation, the amount

of the understatement is reduced to the extent attributable to an

item: (1) For which there existed substantial authority for the

taxpayer’s treatment thereof, or (2) with respect to which

relevant facts were adequately disclosed on the taxpayer’s return

or an attached statement and there existed a reasonable basis for

the taxpayer’s treatment of the item. See sec. 6662(d)(2)(B).

An exception to the section 6662(a) penalty is set forth in

section 6664(c)(1) and reads: “No penalty shall be imposed under

this part with respect to any portion of an underpayment if it is

shown that there was a reasonable cause for such portion and that

the taxpayer acted in good faith with respect to such portion.”

Regulations interpreting section 6664(c) state:

The determination of whether a taxpayer acted with
reasonable cause and in good faith is made on a case-
by-case basis, taking into account all pertinent facts
and circumstances. * * * Generally, the most important
factor is the extent of the taxpayer’s effort to assess
the taxpayer’s proper tax liability. * * * [Sec.
1.6664-4(b)(1), Income Tax Regs.]

Reliance upon the advice of a tax professional may, but does

not necessarily, demonstrate reasonable cause and good faith in

the context of the section 6662(a) penalty. Id.; see also United

States v. Boyle, 469 U.S. 241, 251 (1985); Freytag v.

Commissioner, supra at 888. Such reliance is not an absolute
 - 45 -

defense, but it is a factor to be considered. Freytag v.

Commissioner, supra at 888.

In order for this factor to be given dispositive weight, the

taxpayer claiming reliance on a professional must show, at

minimum: “(1) The adviser was a competent professional who had

sufficient expertise to justify reliance, (2) the taxpayer

provided necessary and accurate information to the adviser, and

(3) the taxpayer actually relied in good faith on the adviser’s

judgment.” Neonatology Associates, P.A. v. Commissioner, 115

T.C. 43, 99 (2000), affd. 299 F.3d 221 (3d Cir. 2002); see also,

e.g., Charlotte’s Office Boutique, Inc. v. Commissioner, 425 F.3d

1203, 1212 & n.8 (9th Cir. 2005) (quoting verbatim and with

approval the above three-prong test), affg. 121 T.C. 89 (2003);

Westbrook v. Commissioner, 68 F.3d 868, 881 (5th Cir. 1995),

affg. T.C. Memo. 1993-634; Cramer v. Commissioner, 101 T.C. 225,

251 (1993), affd. 64 F.3d 1406 (9th Cir. 1995); Ma-Tran Corp. v.

Commissioner, 70 T.C. 158, 173 (1978); Pessin v. Commissioner, 59

T.C. 473, 489 (1972); Ellwest Stereo Theatres of Memphis, Inc. v.

Commissioner, T.C. Memo. 1995-610.

As previously indicated, section 7491(c) places the burden

of production on the Commissioner. The notice of deficiency

issued to petitioners asserted applicability of the section

6662(a) penalty on account of both negligence and/or substantial

understatement. See sec. 6662(b). Respondent on brief likewise
 - 46 -

discusses both bases. Petitioners, on the other hand, proffer no

argument on brief with respect to the penalty, and at no time

have they adduced any testimony or other evidence directed

specifically thereto. They apparently rely on the position that

they are not liable for the deficiency from which the penalty

derives.

The record in this case satisfies respondent’s burden of

production under section 7491(c) with respect to both negligence

and substantial understatement. The dearth of pertinent records,

the unexplained inconsistencies in treatment of the E Trade

account and Mr. Arberg’s various alleged businesses, and an

understatement well in excess of the statutory 10 percent or

$5,000 limit are illustrative. With this threshold showing, the

burden shifts to petitioners to establish that they acted with

reasonable cause and in good faith.

One key feature of this litigation preempts any conclusion

of good faith. Petitioners have never attempted to explain why

they claimed capital treatment when the E Trade account generated

gains, then changed course the following year to claim ordinary

income treatment when the account generated losses. Absent some

offer of justification, the appearance of manipulation or

selective application of the tax rules to achieve an advantage is

unavoidable. The Court sustains imposition of the section

6662(a) accuracy-related penalty.
 - 47 -

To reflect the foregoing,

An appropriate order and

decision for respondent will

be entered.