Taylor v. Comm'r

T.C. Memo. 2009-235

UNITED STATES TAX COURT

DAVID WAYNE TAYLOR, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 6632-08. Filed October 15, 2009.

David Wayne Taylor, pro se.

Caroline R. Krivacka, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

DAWSON, Judge: This deficiency case arises from a statutory

notice of deficiency respondent issued to petitioner on December

13, 2007, for the taxable years 2004 and 2005. Respondent

determined the following deficiencies in petitioner’s Federal

income taxes and additions to tax:
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Additions to Tax
Year Deficiency Sec. 6651(a)(1) Sec. 6651(a)(2) Sec. 6654

2004 $66,857 $14,631.53 $10,404.64 $1,881.67
2005 21,527 4,547.03 2,020.90 804.72

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years at issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

After concessions,1 the issues presented for decision are:

(1) Whether petitioner received, but failed to report,

income of $8,539.11 in 2004 and $19,428.25 in 2005, and if so,

whether the income constitutes self-employment income;

(2) whether petitioner received, but failed to report,

$268,189 in capital gains income in 2004 from a lawsuit

settlement;

(3) whether petitioner is entitled to claimed net operating

loss deductions in 2004 and 2005;

1
Petitioner conceded that he received, but failed to report,
(1) wage income of $17,800 in 2004 and $12,300 in 2005 and (2)
dividend income of $219 in 2004 and $245 in 2005. In the notice
of deficiency respondent determined that petitioner had
unreported gross receipts from self-employment of $37,678.11 in
2004 and $63,436.25 in 2005. In the stipulation of facts
respondent conceded $23,139 of petitioner’s self-employment gross
receipts for 2004 and $44,008 of self-employment gross receipts
for 2005, reducing the amount of omitted self-employment gross
receipts in dispute to $14,539.11 for 2004 and $19,428.25 for
2005. In respondent’s brief respondent conceded an additional
$6,000 of self-employment gross receipts for 2004, reducing the
contested amount for 2004 to $8,539. Respondent also conceded
that petitioner is not liable for the addition to tax for failure
to pay estimated tax under sec. 6654 for 2004.
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(4) whether petitioner is liable for the additions to tax

pursuant to section 6651(a)(1) and (2) for 2004 and 2005; and

(5) whether petitioner is liable for the estimated tax

addition imposed pursuant to section 6654 for 2005.

FINDINGS OF FACT

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

The stipulations of facts, with the accompanying exhibits, are

incorporated by this reference. Petitioner resided in Tennessee

when he filed his petition.

Petitioner did not file his Federal income tax returns for

2004 and 2005, and respondent prepared substitutes for returns

for both years on December 10, 2007. Petitioner received wages

of $17,800 in 2004 and $11,100 in 2005 from Sunwest P.E.O. of

Florida VII, Inc. (Sunwest). He received wages of $1,200 from

TLR in Bonita, Inc. (TLR), in 2005. Petitioner made no payments

on his 2004 and 2005 income tax liabilities other than the tax

withheld from wages he received from Sunwest in 2004 and 2005 and

from TLR in 2005; this amounted to $1,828 in 2004 and $1,318 in

2005.

Petitioner owned and operated Common Place Management, Inc.

(CPM), his wholly owned S corporation, in 2004 and 2005. The

corporation did not file any tax returns for the 2004 and 2005

tax years. During 2004 and 2005 petitioner transferred funds

from CPM’s bank account to his personal accounts.
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Petitioner also held an unspecified interest in VIP, Inc.

The record does not disclose whether VIP, Inc., is an S

corporation or whether it filed tax returns for the years at

issue.

A. Reconstruction of Petitioner’s Gross Receipts

Petitioner did not keep adequate books and records, and

respondent reconstructed petitioner’s gross receipts using the

bank deposits method.

1. Bank Deposits 2004

Petitioner maintained checking account No. xxxx6225 and

savings account No. xxxx3713 at AmSouth Bank in 2004. The

AmSouth account No. xxxx6225 was exclusively petitioner’s account

until September 17, 2004, when his wife was added as a coowner of

the account. Petitioner deposited $167,493.79 into the AmSouth

account in 2004.

In the notice of deficiency respondent excluded the

following deposits to AmSouth account No. xxxx6225 from

petitioner’s gross receipts in 2004:

Deposit Amount

Return of capital from VIP, Inc. $41,500.00
Lawsuit proceeds 68,188.65
Transfers 24,087.76
Returned checks 10,851.30
Petitioner’s net wages 14,611.00
Interest 15.99
Total amount excluded in 2004 159,254.70
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In the notice of deficiency respondent determined that

petitioner deposited gross receipts totaling $8,239.09 into the

AmSouth account No. xxxx6225 in 2004.

Petitioner held account No. xxxx9851 at Jax Federal Credit

Union in 2004 after he married Elizabeth Taylor. He and his wife

deposited $37,490.35 into the Jax account in 2004. In the notice

of deficiency respondent excluded from petitioner’s gross

receipts $8,051.28 attributable to the direct deposit of Mrs.

Taylor’s wages and 5 cents attributable to interest. In the

notice of deficiency respondent determined that petitioner

deposited gross receipts of $29,439.02 into the Jax account in

2004.

In the stipulation of facts respondent conceded that an

additional $23,139 deposited in the Jax account is not included

in petitioner’s gross receipts in 2004. In respondent’s brief

respondent conceded that an additional $6,000 deposited into the

Jax account is not included in petitioner’s gross receipts in

2004. Thus respondent asserts petitioner deposited $300.02 of

gross receipts into the Jax account in 2004.

Respondent asserts petitioner had unreported gross receipts

totaling $8,539.11 that were deposited into the AmSouth and Jax

accounts in 2004.
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2. Bank Deposits 2005

Petitioner held account No. xxxx9851 at Jax Federal Credit

Union in 2005. He and his wife deposited $276,248.22 into the

Jax account in 2005.

In the notice of deficiency respondent excluded the

following deposits from the computation of petitioner’s gross

receipts in 2005:

Deposit Amount

Personal injury settlement $111,355.98
Transfers 68,700.00
Petitioner’s wife’s wages 22,689.33
Petitioner’s wages 10,043.00
Interest/dividends 23.66
Total amount excluded in 2005 212,811.97

In the stipulation of facts respondent conceded that an

additional $44,008 deposited into the Jax account in 2005 is

attributable to Mrs. Taylor and is not included in computing

petitioner’s gross receipts. Respondent asserts that petitioner

deposited gross receipts totaling $19,428.25 into the Jax account

in 2005.

B. Receipt of Lawsuit Settlement Proceeds

In 2004 petitioner received $268,189 pursuant to a

settlement agreement with Rose & Ken, Inc., a Florida corporation

owned by his brother, Kendall Taylor, and his sister-in-law, Rose

Taylor. The settlement proceeds were not paid to petitioner from

Rose & Ken, Inc., for personal injury or illness. They resulted

from a lawsuit that originated between his brother and his
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parents. Petitioner and two other siblings subsequently became

parties to the litigation.

The litigation began after petitioner’s brother purchased

the family’s marina business from their parents, who believed

that the business was being sold to all their children in equal

parts.

Petitioner was not responsible for any loans or financing

related to the purchase of the family business. His brother

Kendall entirely financed the purchase of the family business and

never transferred a share of the business to petitioner and his

other siblings.

Petitioner’s brother filed suit against petitioner’s parents

relating to the transfer of the real property. The parents

counterclaimed against the brother with allegations of fraud,

misrepresentation, and breach of the duty of fair dealing. The

parents alleged in the counterclaims that the brother improperly

failed to transfer portions of the business to petitioner and his

siblings as the parents had intended.

The settlement petitioner received was to resolve the

counterclaims brought in the lawsuit, and petitioner received the

funds as damages for never having received the share of the

business his parents intended for him to have.
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C. Claimed Net Operating Losses

Petitioner was involved in several businesses and

corporations before the years at issue. In his petition he

claimed net operating loss deductions for 2004 and 2005 but did

not identify the entity purportedly giving rise to the losses or

the amounts thereof. However, at trial petitioner stated that

the business which incurred the losses was Volusia Fertilizer &

Chemical, Inc. (Volusia), a Florida S corporation he had owned in

prior years. Petitioner bought Volusia in 1999 for $48,000.

Volusia filed Forms 1120S, U.S. Income Tax Return for an S

Corporation, for 2001, 2002, and 2003. The returns reported net

operating losses (NOLs) of $74,611 for 2001, $45,576 for 2002,

and $46,204 for 2003. Petitioner’s 2001 return reported an NOL

of $61,382 resulting from a “Prior Year NOL” of $69,440

offsetting income of $8,058. Petitioner’s 2002 return reported

an NOL of $126,135 resulting from current year losses of $56,705

and the “Prior Year NOL” of $69,440 offsetting income of $10.

His 2001 and 2002 returns contained a statement waiving the right

to carry back the losses. Volusia’s 2003 income tax return was

examined, and the Internal Revenue Service (IRS) allowed the

claimed loss of $46,204 by issuing a no-change letter.

Petitioner did not establish the amount of income in 2002 or

2003 that was offset by the Volusia NOL and did not establish his

basis in the stock and debt of Volusia in 2004 or 2005.
 - 9 -

OPINION

Generally, the Commissioner’s determinations set forth in

the notice of deficiency are presumed correct, and the taxpayer

bears the burden of showing the determinations are in error.

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

Section 7491(a), however, shifts the burden of proof to the

Commissioner with respect to a factual issue affecting the tax

liability of a taxpayer who meets certain conditions.

Petitioner has neither claimed nor shown that he satisfied

the requirements of section 7491(a) to shift the burden of proof

to respondent with respect to any factual issue affecting the

deficiencies in his taxes. Accordingly, petitioner bears the

burden of proof. See Rule 142(a).

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. “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). The Commissioner, however, does not have the obligation

to introduce evidence regarding reasonable cause. Instead, the

taxpayer bears the burden of proof with regard to that issue.

Higbee v. Commissioner, supra at 446-447.
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A. Bank Deposits

Gross income means all income from whatever source derived,

including income derived from business. Sec. 61. Petitioner

conducted business through CPM, an S corporation the income of

which flowed through to petitioner, its sole shareholder. CPM

did not file a Federal income tax return in 2004 or 2005, and

petitioner failed to maintain records reflecting his business

income in 2004 and 2005.

Respondent reconstructed petitioner’s income using the bank

deposits method. Absent some explanation, petitioner’s bank

deposits represent income subject to tax, and the Commissioner’s

use of the bank deposits method of income reconstruction has long

been sanctioned by the courts. See DiLeo v. Commissioner, 96

T.C. 858, 868 (1991), affd. 959 F.2d 16 (2d Cir. 1992). The

Commissioner need not show a likely source of the income when

using the bank deposits method, but he must take into account any

nontaxable items or deductible expenses of which he had

knowledge. See Price v. United States, 335 F.2d 671, 677 (5th

Cir. 1964).

On the basis of deposits into petitioner’s bank accounts,

respondent contends that petitioner received, but failed to

report, certain gross receipts from self-employment of $8,539.11

in 2004 and $19,428.25 in 2005. In computing petitioner’s

unreported income using the bank deposits method, respondent
 - 11 -

excluded (1) petitioner’s wage income; (2) $41,500 in return of

capital from VIP, Inc.; (3) petitioner’s wife’s directly

deposited wage income; (4) personal injury settlement proceeds;

(5) nontaxable transfers; and (6) returned checks. Respondent

removed additional deposits attributable to petitioner’s wife.

Respondent asserts that the remaining deposits are income from

petitioner’s business activities conducted through CPM and are

therefore subject to income tax.

One of the two issues raised in the petition relates to the

amount of gross receipts determined by respondent. Specifically,

petitioner alleges that some of the funds deposited were the

return of capital. Respondent allowed $41,500 as the nontaxable

return of capital from petitioner’s business entities.

Petitioner has not stated how much additional income should be

excluded as return of capital. Furthermore, petitioner provided

no information or documentation to support allowing a larger

amount to be excluded as return of capital.

We hold that petitioner received income of $8,539 in 2004

and $19,428.25 in 2005 from conducting CPM’s business. However,

income from conducting the business of an S corporation is not

subject to self-employment tax. Ding v. Commissioner, 200 F.3d

587, 588 (9th Cir. 1999) (S corporation passthrough items are not

included in calculating self-employment tax liability under

section 1402(a)), affg. T.C. Memo. 1997-435; Veterinary Surgical
 - 12 -

Consultants, P.C. v. Commissioner, 117 T.C. 141, 145 (2001)

(“Section 1366 permits use of S corporation passthrough items

only in calculating tax liability under chapter 1, not tax

liability under chapters 21 and 23--in which the Federal

employment tax provisions for FICA and FUTA are located.”), affd.

sub nom. Yeagle Drywall Co. v. Commissioner, 54 Fed. Appx. 100

(3d Cir. 2002). Moreover, an officer who performs substantial

services for a corporation and who receives remuneration in any

form for those services is considered an employee. Veterinary

Surgical Consultants, P.C. v. Commissioner, supra at 144-145.

We hold that the deposits of the income from CPM into

petitioner’s bank accounts are wages paid to him.

B. Lawsuit Settlement Proceeds

Respondent’s position regarding this issue is that

petitioner received, but failed to report, $268,189 of taxable

lawsuit settlement proceeds in 2004.

Proceeds derived from litigation are subject to taxation

unless specifically awarded for personal physical injury or

physical sickness. Secs. 61(a), 104(a)(2). Petitioner received

$268,189 from Rose & Ken, Inc., in 2004. Respondent’s revenue

agent treated the income as the proceeds from the sale of

property in which the petitioner had no basis. The entire amount

was included in petitioner’s income, but long-term capital gain

treatment was allowed in the notice of deficiency.
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Petitioner did not raise in his petition any challenge to

the inclusion of this income, the taxation of the income at the

capital gains rate, or the determination that he had no basis to

reduce the amount of gain. However, petitioner argued for the

first time at trial that he had a sufficient basis in the

proceeds, which were received pursuant to the lawsuit settlement,

to result in a large loss rather than a capital gain.

Petitioner asserted that his brother bought the business

from his parents on behalf of himself and other siblings and that

his brother obtained the financing for the purchase. Petitioner

did not personally provide any funds for the purchase of the

business.

Petitioner’s parents apparently intended for petitioner and

his siblings to receive equal shares of their business. The

brother and his wife filed suit against petitioner’s parents in

an attempt to obtain title to realty that may or may not have

been included in the original sale of the business by the

parents. Petitioner’s parents then counterclaimed for the

failure to distribute ownership of the business to petitioner and

his siblings, who subsequently were added as parties to the suit.

Petitioner submitted two documents at trial to support his

contention that he had basis in his interest in the business.

The most telling document was an answer filed by his parents in

response to the complaint filed by petitioner’s brother. The
 - 14 -

answer includes counterclaims relating to petitioner and the

other siblings.

According to the factual allegations set forth in the answer

to the complaint and confirmed by petitioner, the cause of action

for the lawsuit was the failure to transfer interests in the

business to petitioner and his siblings. The net result of the

lawsuit was not an award of a portion of the company’s ownership.

The settlement was a payment of $268,189 in lieu of any interest

in the business. Petitioner was awarded the amount to compensate

for the fact that his brother failed to transfer to petitioner

his share of the business. Petitioner did not sell his share of

the business for $268,189 but essentially received damages for

never having received his share of the business. Petitioner did

not purchase a share of the business, nor did he receive it as a

gift from his brother or his parents. He has clearly not

established that he had any basis to reduce the amount of gain.

The lawsuit settlement proceeds did not constitute the proceeds

from the sale of the business interest but rather damages for an

interest never received. Accordingly, we conclude that the

entire amount is subject to tax, and we sustain respondent’s

determination that petitioner had long-term capital gain of

$268,189 in 2004.
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C. Claimed Net Operating Loss Deductions

Deductions are a matter of legislative grace, and the

taxpayer bears the burden of proving entitlement to any claimed

deduction. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84

(1992). As a part of that burden, a taxpayer must substantiate

the amounts of his claimed deductions. A taxpayer is required to

maintain records sufficient to establish the amount of any

deduction claimed. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.

Respondent contends that petitioner failed to prove he is

entitled to his claimed net operating loss deductions for 2004

and 2005 because he has not established his basis in Volusia and

therefore the NOLs cannot be carried forward to 2004 and 2005

absent clear information showing that petitioner had a sufficient

basis remaining in those years. While petitioner testified that

he thought he had bought the Volusia business for about $48,000

and indicated he probably put another $10,000 into the business

property, he submitted no documentary evidence to support his

testimony.

The term “net operating loss” is defined in section 172(c)

to mean the excess of allowable deductions over gross income.

Section 172(a) allows a net operating loss deduction for the

aggregate of net operating loss carrybacks and carryovers to the

taxable year. Section 172(b)(1)(A) generally provides that the
 - 16 -

period for an NOL carryback is 2 years and that the period for an

NOL carryover is 20 years.

A taxpayer may not claim net operating losses from an S

corporation in excess of the sum of the shareholder’s bases in

stock and debt of the S corporation. Sec. 1366(d)(1). Before a

shareholder in an S corporation can claim an NOL, the shareholder

must determine his adjusted basis in the S corporation. To have

a basis in an S corporation, a shareholder must make an actual

economic outlay. See Miller v. Commissioner, T.C. Memo. 2006-125

(and cases cited therein).

While petitioner failed to identify in his petition the

entity purportedly giving rise to the NOL, he subsequently stated

that the business was Volusia, his Florida S corporation in prior

years. Volusia filed Forms 1120S for 2001, 2002, and 2003 and

reported losses for each year. Volusia’s 2003 return was

examined, and the IRS sustained the claimed loss in that year.

At no time during the examination or after the filing of the

petition did petitioner establish his basis in Volusia.

Volusia’s tax returns do not support the conclusion that

petitioner had a sufficient basis to claim net operating loss

deductions in the years at issue. Accordingly, even assuming

that Volusia’s returns are correct and it incurred losses each

year before the years in issue, petitioner cannot carry an NOL
 - 17 -

forward to 2004 or 2005 absent clear information showing that he

had a sufficient basis in the business.

Petitioner claimed the NOL deductions on his 2001 and 2002

income tax returns. A taxpayer claiming an NOL deduction for a

taxable year must file with the tax return for that year a

concise statement setting forth the amount of the NOL deduction

claimed and all material and pertinent facts, including a

detailed schedule showing the computation of the NOL deduction.

Sec. 1.172-1(c), Income Tax Regs. A taxpayer may elect to

relinquish the carryback period with respect to an NOL for any

taxable year, thereby using the loss to offset income only in

future years. Sec. 172(b)(3). To carry forward or carry back

net operating losses, the taxpayer must prove the amount of the

net operating loss carryforward or carryback and that his gross

income in other years did not offset that loss. Sec. 172(c);

Jones v. Commissioner, 25 T.C. 1100, 1104 (1956), revd. and

remanded on other grounds 259 F.2d 300 (5th Cir. 1958).

Petitioner did not allege any amount of the NOL deduction to

which he believes he was entitled in 2004 and 2005. He did not

provide a detailed schedule showing the computation of the NOL

during the examination, nor was such a schedule attached to his

2001 or 2002 income tax return. Petitioner asserts that because

Volusia’s 2003 return reported a loss, and because his own 2001

and 2002 returns claimed an NOL, he should be permitted to carry
 - 18 -

forward unspecified losses to 2004 and 2005, the years at issue

herein. Petitioner’s 2001 and 2002 returns did contain a

statement waiving the right to carry back the losses.

A tax return is not evidence of the truth of the facts

stated in it. Lawinger v. Commissioner, 103 T.C. 428, 438

(1994). Thus the Commissioner’s failure to disallow a loss

claimed on a return for one year does not estop the Commissioner

from disallowing an NOL carryover of that loss to a future year.

Rollert Residuary Trust v. Commissioner, 80 T.C. 619, 636 (1983),

affd. on another issue 752 F.2d 1128 (6th Cir. 1985). Each

taxable year stands alone, and the Commissioner may challenge in

a succeeding year what was condoned or agreed to in a former

year. Auto. Club of Mich. v. Commissioner, 353 U.S. 180 (1957);

Black v. Commissioner, T.C. Memo. 2007-364.

In summary, although respondent acknowledges that the

petitioner owned an S corporation that claimed losses, petitioner

on this record has not met his burden of proving that he is

entitled to claim a specific amount of net operating loss

deduction for 2004 or 2005.

D. Section 6651(a)(1) and (2) Additions to Tax

Petitioner did not assign error in his petition with respect

to respondent’s determinations of the additions to tax imposed

for petitioner’s failure to file his Federal income tax returns

and to pay the taxes due for 2004 and 2005. Apparently,
 - 19 -

petitioner has conceded them. See Swain v. Commissioner, 118

T.C. at 363-365. In any event, even if we assume that petitioner

is considered to have raised the issues in his brief testimony at

the trial, respondent has met his burden of production by showing

that petitioner was required to file his Federal income tax

returns for 2004 and 2005 and pay the taxes due, and he failed to

do so. Moreover, with respect to section 6651(a)(2), for each

year respondent prepared a substitute for return which meets the

requirements of section 6020(b). See Wheeler v. Commissioner,

127 T.C. 200, 208-210 (2006), affd. 521 F.3d 1289 (10th Cir.

2008).

Finally, on this record petitioner has neither alleged nor

shown that there was reasonable cause for not filing his income

tax returns and paying the taxes due for those years.

Accordingly, we hold that petitioner is liable for the additions

to tax under section 6651(a)(1) and (2) for 2004 and 2005.

E. Section 6654 Additions to Tax

Section 6654(a) imposes an addition to tax for a taxpayer’s

failure to make estimated tax payments calculated with reference

to four required installment payments of the taxpayer’s estimated

tax liability. Sec. 6654(c)(1). Each required installment of

estimated tax is equal to 25 percent of the required annual

payment. Sec. 6654(d)(1)(A). The required annual payment is the

lesser of (1) 90 percent of the tax shown on the individual’s
 - 20 -

return for that year (or, if no return is filed, 90 percent of

his or her tax for such year), or (2) if the individual filed a

return for the immediately preceding taxable year, 100 percent of

the tax shown on that return.2 Sec. 6654(d)(1)(B).

Petitioner had no Federal income tax liability for 2003. As

previously indicated, respondent conceded the estimated tax

addition for 2004. Petitioner made no estimated tax payments for

2005 but had $1,318 in taxes withheld from his wages during the

year. We hold that, if $1,318 is less than 100 percent of

petitioner’s tax for 2004 or 90 percent of his tax for 2005

computed under Rule 155, which appears unlikely, then petitioner

is liable for the addition to tax pursuant to section 6654 for

2005.

We have considered the arguments raised by both parties,

and, to the extent not discussed, we conclude that they are

irrelevant or without merit.

To reflect the parties’ concessions and our disposition of

the disputed issues,

Decision will be entered

under Rule 155.

2
If an individual’s adjusted gross income shown on the
previous year’s return exceeds $150,000, a higher percentage may
apply. See sec. 6654(d)(1)(C).