T.C. Summary Opinion 2009-117
UNITED STATES TAX COURT
RAO V. AND SUNANDA MADDURI, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4798-08S. Filed July 27, 2009.
Rao V. and Sunanda Madduri, pro sese.
Matthew A. Mendizabal, for respondent.
DEAN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect when the petition was filed. Pursuant to section 7463(b),
the decision to be entered is not reviewable by any other court,
and this opinion shall not be treated as precedent for any other
case. Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year in issue,
- 2 -
and all Rule references are to the Tax Court Rules of Practice
and Procedure.
Respondent determined a $27,874 deficiency in petitioners’
2005 Federal income tax and an accuracy-related penalty under
section 6662(a).1
In a stipulation of settled issues, respondent and Mr.
Madduri agreed that Mr. Madduri received $88,433 from Outer Bay
Technologies, Inc. (Outer Bay), as compensation for services that
should have been reported on “line 7 of petitioners’ Form 1040”
rather than on “line 1 of petitioners’ Schedule C”. Respondent
did not assert a claim under section 6214(a) for the increased
deficiency that will result from the disallowance of petitioners’
claimed deductions for section 179 expenses and section 280A
expenses for the business use of their home pursuant to sections
179(b)(3)(A) and 280A(c)(5). Petitioners did not contest
respondent’s position, which respondent argued at trial and which
was set out in respondent’s pretrial memorandum. The Court,
therefore, considers the issues tried by consent under Rule
41(b). Respondent has met his burden of proving that petitioners
are not entitled to deduct those expenses on their Schedule C,
Profit or Loss From Business. See Rule 142(a); see also secs.
1
Sunanda Madduri (Mrs. Madduri) did not appear at trial or
sign the stipulation of facts. The Court will dismiss Mrs.
Madduri for failure properly to prosecute and will enter a
decision against her consistent with the decision entered against
Rao V. Madduri (Mr. Madduri).
- 3 -
179(b)(3)(A), 280A(c)(5). In addition, Mr. Madduri did not
assert that petitioners are otherwise entitled to deduct any
portion of those expenditures as unreimbursed employee expenses
on their Schedule A, Itemized Deductions. Consequently, those
issues are deemed conceded. The issue remaining2 for decision is
whether petitioners are liable for the accuracy-related penalty
under section 6662(a).
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the exhibits received into evidence
are incorporated herein by reference. When the petition was
filed, petitioners resided in California.
During 2005 Mr. Madduri was employed by Gemstone Systems,
Inc. (Gemstone), and Outer Bay. Mr. Madduri also worked as a
software consultant for CenterBoard, Inc. (CenterBoard).
For 2005 Mr. Madduri received Forms W-2, Wage and Tax
Statement, from Gemstone and Outer Bay that reported his income
of $106,946 and $88,433.14, respectively, as “Wages, tips, other
comp.” Those Forms W-2 also show that the employers withheld
2
In the stipulation of settled issues the parties also
agreed that: (1) Petitioners received a taxable refund of $644
from the State of California during 2005 that they failed to
report; (2) adjustments to petitioners’ self-employment tax and
their deduction therefor are computational and are to be resolved
consistent with the Court’s decision pursuant to secs. 164(f),
1401, and 1402; and (3) petitioners’ claimed deductions related
to their 2002 Mercedes ML500, which was placed into service
before 2005.
- 4 -
Federal income taxes and Social Security and Medicare (FICA)
taxes and that those employers had established section 401(k)
accounts for Mr. Madduri. Mr. Madduri also received a Form 1099-
MISC, Miscellaneous Income, from CenterBoard that reported Mr.
Madduri’s income of $22,725 as nonemployee compensation. This
Form 1099-MISC shows that CenterBoard did not withhold Federal
income or FICA taxes and that it did not establish a section
401(k) account for Mr. Madduri.
Mr. Madduri reported the income he received from Gemstone on
line 7 of petitioners’ 2005 Form 1040, U.S. Individual Income Tax
Return. Mr. Madduri, however, reported the income he received
from Outer Bay (and CenterBoard) on a Schedule C. Mr. Madduri
believed that he was an independent contractor rather than an
employee of Outer Bay because he had informed Outer Bay that he
was “going to * * * [Gemstone] as a regular employee” and “[he]
thought it was a short-term contract.” In short, Mr. Madduri
reported “$117,358[3] [sic] of Form W-2 wages on line 7 of their
2005 Form 1040” and a net profit of $33,7444 on their Schedule C.
3
Apparently, the rounded amount consists of: $106,946
(Gemstone “wages”) + $6,034 (Mrs. Madduri’s Macy’s wages) +
$1,935 (sec. 401(k) income excluded from Mr. Madduri’s taxable
wages in excess of the maximum allowable exclusion) + $2,441
(“medical FSA income” income excluded from Mr. Madduri’s taxable
wages in excess of the maximum allowable exclusion) = $117,356.
4
The rounded amount consists of: $88,433 (Outer Bay
“wages”) + $22,725 (CenterBoard nonemployee compensation) -
$64,761 (total expenses) - $12,653 (sec. 280A expenses for the
(continued...)
- 5 -
Respondent, on the other hand, determined that petitioners
received and failed to report “Taxable Wages Total” of $201,413,
consisting of: $106,946 (Gemstone “wages”) + $6,034 (Mrs.
Madduri’s Macy’s wages) + $88,433 (Outer Bay “wages”). In
pertinent part, respondent proposed the following adjustments:
Reported to
Item Shown on IRS or as
return corrected
Taxable “wages” $117,358 $201,413
Taxable income 151,829 240,989
Tax 32,244 60,118
Respondent, however, made no adjustments to the items
reported on petitioners’ Schedule C.
Discussion
Initially, the Commissioner has the burden of production
with respect to any penalty, addition to tax, or additional
amount. Sec. 7491(c). The Commissioner satisfies this burden of
production by coming forward with sufficient evidence that
indicates that it is appropriate to impose the penalty. See
Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the
Commissioner satisfies this burden of production, the taxpayer
must persuade the Court that the Commissioner’s determination is
in error by supplying sufficient evidence of an applicable
exception. Id.
4
(...continued)
business use of their home) = $33,744.
- 6 -
In pertinent part, section 6662(a) and (b)(1) and (2)
imposes an accuracy-related penalty equal to 20 percent of the
underpayment that is attributable to negligence or disregard of
rules or regulations or a substantial understatement of income
tax.5 A substantial understatement of income tax exists if the
amount of the understatement for the taxable year exceeds the
greater of 10 percent of the tax required to be shown on the
return for the taxable year or $5,000. Sec. 6662(d)(1)(A). The
term “understatement” means the excess of the amount of the tax
required to be shown on the return for the taxable year over the
amount of the tax imposed that is shown on the return less any
rebate as defined by section 6211(b)(2). Sec. 6662(d)(2)(A).
The amount of the understatement is reduced by the portion of the
understatement that is attributable to: (1) The taxpayer’s tax
treatment of the item if there is or was substantial authority
for the treatment; or (2) any item if the relevant facts
affecting the item’s tax treatment are adequately disclosed in
the return or in a statement attached to the return and there is
a reasonable basis for the taxpayer’s tax treatment of the item.
Sec. 6662(d)(2)(B).
5
Because the Court finds that petitioners substantially
understated their income tax, the Court need not discuss whether
they were negligent or disregarded rules or regulations. See
sec. 6662(b); Fields v. Commissioner, T.C. Memo. 2008-207.
- 7 -
Petitioners have not proven that they satisfy the
substantial authority and adequate disclosure provisions. See
sec. 6662(d)(2)(B). Thus, as determined in the notice of
deficiency, the difference between the correct and reported taxes
is $27,874, which exceeds 10 percent of the tax required to be
shown of $60,118.6 See sec. 6662(d)(1)(A). The Court therefore
finds that petitioners substantially understated their 2005
income tax and that respondent has met his burden of production.
Section 6664(c)(1), however, provides an exception to the
section 6662(a) penalty: no penalty is imposed with respect to
any portion of an underpayment if it is shown that there was
reasonable cause therefor and the taxpayer acted in good faith.
Section 1.6664-4(b)(1), Income Tax Regs., incorporates a facts
and circumstances test to determine whether the taxpayer acted
with reasonable cause and in good faith. The most important
factor is the extent of the taxpayer’s effort to assess his
proper tax liability. Id. “Circumstances that may indicate
reasonable cause and good faith include an honest
misunderstanding of fact or law that is reasonable in light of
* * * the experience, knowledge and education of the taxpayer.”
Id.
6
The Court notes that these figures will increase to take
into account the parties’ concessions and adjustments for
computational matters. See supra note 2.
- 8 -
Mr. Madduri testified that through an innocent mistake he
reported on Schedule C the income he received as compensation for
services even though Outer Bay reported the income as “Wages,
tips, other comp.” on a Form W-2 that was provided to him. Mr.
Madduri testified that he believed that he was not an employee of
Outer Bay because he was working as a short-term contractor
performing consulting. Mr. Madduri testified that when he asked
Outer Bay for a Form 1099, he was told that because there were
only a few months left on the contract, Outer Bay wanted to
continue on a Form W-2 since he was on a Form W-2 in the
preceding year and did not have his own corporation. According
to Mr. Madduri: “Turbo-tax [allowed him] to put W-2 into
Schedule C, so then [he] thought it is legal.”
Mr. Madduri had the responsibility to determine and to
substantiate his status as an independent contractor in order to
report his income on Schedule C. See sec. 6001; Higbee v.
Commissioner, supra at 440; Rusley v. Commissioner, T.C. Memo.
2003-2; D’Acquisto v. Commissioner, T.C. Memo. 2000-239; see also
secs. 31.3121(d)-1(c)(2), 31.3401(c)-1(a) and (b), Employment Tax
Regs. Mr. Madduri did not do so. Mr. Madduri performed no
inquiry whatsoever into his status as an independent contractor
or employee. Mr. Madduri consciously reported the Outer Bay
income on a Schedule C and relied solely on his mistaken belief
that he was an independent contractor.
- 9 -
Moreover, in view of the facts and circumstances here, the
Court finds that Mr. Madduri’s mistaken belief was neither
reasonable nor in good faith. Specifically, Mr. Madduri worked
as a software consultant for CenterBoard and received in 2005 a
Form 1099-MISC, reporting his income as nonemployee compensation,
while Outer Bay and Gemstone provided him with Forms W-2,
reporting his income as “Wages, tips, other comp.”; Outer Bay and
Gemstone funded a section 401(k) account for Mr. Madduri while
CenterBoard did not;7 Outer Bay and Gemstone withheld Federal
income and FICA taxes while CenterBoard did not; his salary, work
hours, and projects at Outer Bay did not significantly change in
2005 despite the purported consulting contract; and he willingly
accepted the Form W-2 from Outer Bay and did not seek corrected
Forms W-2 or 1099-MISC from Outer Bay. See D’Acquisto v.
Commissioner, supra. In addition, Mr. Madduri provided no
evidence of the purported consulting contract with Outer Bay and
called no witnesses to corroborate his testimony about the
purported consulting contract. See id. Although Mr. Madduri
explained that Outer Bay was acquired by Hewlett-Packard and that
it allegedly said that it could not help him, the Court,
nonetheless, does not accept his self-serving explanation. See
7
The terms “qualified pension, profit-sharing, and stock
bonus plans” include trusts “created or organized in the United
States and forming part of a stock bonus, pension, or profit-
sharing plan of an employer for the exclusive benefit of his
employees or their beneficiaries”. Sec. 401(a) (emphasis added).
- 10 -
Urban Redev. Corp. v. Commissioner, 294 F.2d 328, 332 (4th Cir.
1961) (the Court may reject a taxpayer’s uncorroborated
testimony), affg. 34 T.C. 845 (1960).
In short, petitioners have not established that they acted
with reasonable cause and in good faith. Respondent’s
determination is sustained.
To reflect the foregoing,
An appropriate order will
be issued, and decision will
be entered under Rule 155.