Whitaker v. Comm'r

T.C. Memo. 2010-209

UNITED STATES TAX COURT

DAISY T. WHITAKER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 31355-08. Filed September 23, 2010.

Jeffrey Weiss, for petitioner.

Matthew Carlson, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HAINES, Judge: Respondent determined a deficiency of

$259,596 and an accuracy-related penalty pursuant to section

6662(a) of $51,919 with respect to petitioner’s 2003 Federal

income tax.1

1
Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1986, as amended, and all Rule
(continued...)
 -2-

The issues for decision after concessions are: (1) Whether

petitioner understated gross receipts from her mortgage broker

business reported on Schedule C, Profit or Loss From Business, by

$237,156; (2) whether petitioner is entitled to certain

deductions claimed on Schedule C; (3) whether petitioner

understated her long-term capital gain from the sale of real

property by $68,278; (4) whether petitioner is entitled to

certain rental deductions claimed on Schedule E, Supplemental

Income and Loss; (5) whether petitioner is entitled to a net

operating loss (NOL) deduction of $32,345; and (6) whether

petitioner is liable for a section 6662(a) penalty.

FINDINGS OF FACT

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

The stipulation of facts and the supplemental stipulation of

facts, together with the attached exhibits, are incorporated

herein by this reference.

At the time she filed her petition, petitioner resided in

California. During 2003 petitioner operated a mortgage broker

business in Monteca, California. The name of petitioner’s

business was Whitaker Real Estate and Financial Services.

Petitioner also operated a branch of her business in Pleasonton,

California.

1
(...continued)
references are to the Tax Court Rules of Practice and Procedure.
Amounts are rounded to the nearest dollar.
 -3-

Petitioner maintained four bank accounts. The first two

accounts were checking accounts held in her name with Washington

Mutual Bank. The third account was a joint checking account held

with Ernesto Talusan at Washington Mutual Bank. The final

account was a checking account held with Cal Fed/Citibank. This

account was used for the Pleasonton branch of petitioner’s

business. The manager of the Pleasonton branch, Cody Thai, was a

signatory and had full access to this account.

Throughout 2003 deposits were made in each account totaling

a combined $850,634 and petitioner received cash back that was

not deposited into her accounts totaling $31,607. Petitioner

reported Schedule C gross receipts from her mortgage business for

2003 of $289,011 and rents received of $50,090. Further, on Form

4797, Sales of Business Property, attached to her 2003 return,

petitioner reported a long-term capital gain of $44,601 with

respect to the sale of real property at 215 Vista Grande Avenue

in Daly City, California. Petitioner purchased this property on

December 15, 2001, for $445,000 and sold it on December 24, 2003,

for $565,000. Petitioner paid $24,118 in closing costs and

reported an adjusted basis in the subject property at the time of

sale of $520,399.

Petitioner kept records of transactions related to her

business through transactional software and Quicken accounting

software. The transactional software was used to write offers
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and draft mortgage documents. The Quicken accounting software

was used to record payments and expenses and to issue checks.

The logging of income and expenses was done weekly when there

were property closings and then again at the end of each month

when bank statements were received. Petitioner testified at

trial that she also kept books for each rental property and an

envelope for each month.

On September 19, 2008, respondent sent petitioner a notice

of deficiency. Respondent determined that petitioner had

understated her Schedule C gross receipts for her mortgage

business for 2003 by $237,156. Respondent used the bank deposits

method of income reconstruction to determine the amount of

petitioner’s unreported income. Pursuant to this analysis,

respondent took into account deposits identified as nontaxable,

including check card credits, a small electronic deposit,

deposits from Cody Thai into the Cal Fed/Citibank account that

were traceable to his personal pizza business, debit card return

items, check reversals, cashier checks dated in 2002, transfers

from petitioner’s other bank accounts, a nontaxable Federal

refund, and proceeds from a real estate sale that were deposited

in 2003.

Respondent determined petitioner’s total unreported income

for tax year 2003 by removing these nontaxable items from the sum

of cumulative deposits in petitioner’s accounts and the cash back
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petitioner received during 2003 and further subtracting

petitioner’s reported taxable income

In addition to determining that petitioner had understated

her Schedule C gross receipts with respect to her mortgage

business for tax year 2003, respondent denied certain deductions

for Schedule C expenses claimed with respect to her business.

The disallowed Schedule C expenses comprised the following items:

Expense Amount
1
Car and truck expenses $10,230
Commissions and fees 99,369
Depreciation and section 179 16,082
Office expenses 19,472
Travel expenses 11,112
Business gifts 4,527
Total 160,792
1
In the notice of deficiency, respondent denied petitioner’s
claimed deductions for car and truck expenses of $19,689. In his
opening brief, however, respondent alleges that petitioner is not
entitled to a deduction of $10,230 for car and truck expenses.
The Court has not been able to determine which number is correct;
however, that number should be reflected in the assessed
deficiency.

Petitioner testified that at least a portion of her travel

expenses is attributable to a trip to Europe with friends that

she purchased as a gift to herself for her 50th birthday.

With respect to petitioner’s sale of real property at 215

Vista Grande Avenue in Daly City, California, respondent

determined petitioner’s adjusted basis in the property to be

$452,121, resulting in a long-term capital gain on the sale of

the property of $112,879, or $68,278 more than petitioner
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reported.2 Respondent further disallowed Schedule E rental

expense deductions of $121,893 and an NOL carryforward of $32,345

petitioner claimed for 2003.3

OPINION

I. Burden of Proof

Respondent’s determinations in the notice of deficiency are

presumed correct, and petitioner would ordinarily bear the burden

of proving that respondent’s determinations are incorrect. See

Rule 142(a)(1). Petitioner does not argue that the burden of

proof shifts to respondent pursuant to section 7491(a), nor has

she shown that the threshold requirements of section 7491(a) have

been met for any of the determinations at issue. Accordingly,

the burden of proof remains on petitioner to prove that

respondent’s determination of a deficiency in her income tax is

erroneous.

2
Respondent’s opening brief is inconsistent in its
references to petitioner’s understatement of her long-term
capital gain for 2003. Pages 3 and 28 refer to an understatement
of petitioner’s long-term capital gain of $78,278. On the other
hand, page 15 refers to an understatement of $68,228. Further,
on page 10 respondent stated petitioner’s adjusted basis in the
subject property to be $452,121, for a total gain on the sale of
the subject property of $112,879. We find the understatement to
be $112,879 less the $44,601 long-term capital gain petitioner
reported, or $68,278.
3
Respondent’s opening brief concedes that petitioner paid
real estate taxes of $21,867 for 2003, leaving in dispute
Schedule E rental expense deductions of $100,026.
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II. Schedule C Gross Receipts

If a taxpayer has not maintained business records or the

taxpayer’s business records are inadequate, the Commissioner is

authorized to reconstruct the taxpayer’s income by any method

that, in the Commissioner’s opinion, clearly reflects that

taxpayer’s income. Sec. 446(b); Parks v. Commissioner, 94 T.C.

654, 658 (1990); A.J. Concrete Pumping, Inc. v. Commissioner,

T.C. Memo. 2001-42. The Commissioner’s reconstruction need not

be exact, but it must be reasonable in the light of all the

surrounding facts and circumstances. A.J. Concrete Pumping, Inc.

v. Commissioner, supra.

The use of the bank deposits method of income reconstruction

has long been sanctioned by the courts. DiLeo v. Commissioner,

96 T.C. 858, 867 (1991), affd. 959 F.2d 16 (2d Cir. 1992). Bank

deposits are prima facie evidence of income. Id. at 868. The

bank deposits method assumes that all money deposited in a

taxpayer’s bank account during a given period constitutes taxable

income. Price v. United States, 335 F.2d 671, 677 (5th Cir.

1964). When the bank deposits method is employed, however, the

Commissioner must take into account any nontaxable source or

deductible expense of which he has knowledge. Id.

Nothing in the record indicates that respondent’s method of

calculating petitioner’s Schedule C gross receipts was erroneous

or unreasonable. Respondent conducted a detailed analysis of
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each of petitioner’s bank accounts for 2003. In determining

petitioner’s Schedule C gross receipts, respondent removed all of

petitioner’s deposits that were not subject to tax for 2003,

including all items in connection with Cody Thai’s pizza business

and all cashier’s checks dated before 2003.

Petitioner contends that respondent did not exclude certain

nontaxable items in determining her 2003 gross receipts,

including approximately $90,000 of additional deposits

attributable to Cody Thai and approximately $200,000 in cashier’s

checks that were converted from other accounts. Petitioner

testified at trial that because of a pending divorce in early

2002, her funds were in jeopardy of being misappropriated by her

estranged spouse. Accordingly, to protect these funds, she

claims that she began converting them into cashier’s checks for

future use. Petitioner has failed, however, to produce any

documentation or other evidence adequate to prove that any of the

deposits respondent included in the gross receipts of her

mortgage business are traceable to a nontaxable source.

Accordingly, we sustain respondent’s determination regarding

petitioner’s Schedule C gross receipts.

III. Schedule C Deductions

Deductions are a matter of legislative grace, and the

taxpayer must prove she is entitled to the deductions claimed.

Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
 -9-

(1934). Section 162(a) provides that “There shall be allowed as

a deduction all the ordinary and necessary expenses paid or

incurred during the taxable year in carrying on any trade or

business”. Taxpayers are required to maintain records sufficient

to establish the amounts of allowable deductions and to enable

the Commissioner to determine the correct tax liability. Sec.

6001; Shea v. Commissioner, 112 T.C. 183, 186 (1999).

Items described in section 274 are subject to strict

substantiation rules. No deduction shall be allowed for, among

other things, traveling expenses, entertainment expenses, gifts,

and expenses with respect to listed property (including passenger

automobiles) “unless the taxpayer substantiates by adequate

records or by sufficient evidence corroborating the taxpayer’s

own statement”: (1) The amount of the expense or other item; (2)

the time and place of the travel, entertainment or use, or date

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

expense or other item; and (4) in the case of entertainment or

gifts, the business relationship to the taxpayer of the

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

If a factual basis exists to do so, the Court may in another

context approximate an allowable expense, bearing heavily against

the taxpayer who failed to maintain adequate records. Cohan v.

Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); see sec.

1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov.
 -10-

6, 1985). However, in order for the Court to estimate the amount

of an expense, the Court must have some basis upon which an

estimate may be made. Vanicek v. Commissioner, 85 T.C. 731, 742-

743 (1985). Without such a basis, any allowance would amount to

unguided largesse. Williams v. United States, 245 F.2d 559, 560-

561 (5th Cir. 1957). We may not use the Cohan doctrine, however,

to estimate expenses covered by section 274(d). See Sanford v.

Commissioner, 50 T.C. 823, 827 (1968), affd. per curiam 412 F.2d

201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary Income Tax Regs.,

supra.

A. Car and Truck Expenses

Passenger automobiles and any other property used as a means

of transportation are “listed property” as defined by section

280F(d)(4). Secs. 274(d)(4), 280F(d)(4)(A)(i). Accordingly, car

and truck expenses must satisfy the strict substantiation

requirements of section 274. Petitioner has provided entries

from the Quicken accounting software as evidence of car and truck

expenses incurred in 2003. These entries were made by petitioner

and do not provide sufficient evidence that such expenses were

actually incurred because she has not provided receipts or any

additional documentation supporting these expenses. Accordingly,

petitioner has failed to meet the substantiation requirements of

section 274, and we sustain respondent’s determination with

regard to the car and truck expenses.
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B. Commissions and Fees

Respondent determined that petitioner is entitled to deduct

only $51,071 of the $150,440 of Schedule C commissions and fees

claimed for 2003. Outside of entries from the Quicken accounting

software, petitioner has failed to provide any documentation of

these commissions and fees. Further, because petitioner has

failed to maintain adequate records, we do not have a basis for

estimating any costs in excess of those respondent permitted.

Accordingly, petitioner has failed to meet her burden of proof,

and we sustain respondent’s determination with regard to the

commissions and fees.

C. Depreciation and Section 179 Expenses

Subject to certain limitations, taxpayers purchasing

qualifying property may elect under section 179 to deduct the

cost of the property in the year the property is placed in

service. Qualifying section 179 property includes tangible

property that is depreciable under section 168 and is described

in section 1245(a)(3) or computer software that is depreciable

under section 167, but only if the property is acquired for use

in an active trade or business. Sec. 179(d)(1). The record does

not substantiate that petitioner placed in service during 2003

any section 179 property. Accordingly, petitioner has failed to

meet her burden of proof, and we sustain respondent’s

determination with regard to the section 179 expenses.
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D. Office Expenses

Petitioner has not introduced any evidence to substantiate

deductions claimed for office expenses in 2003. Further,

petitioner has not introduced any evidence outside of the Quicken

accounting software ledger to provide the Court with a basis for

estimating office expenses incurred as part of her trade or

business. Accordingly, we sustain respondent’s determination

with regard to the office expenses.

E. Travel Expenses

The heightened substantiation requirements of section 274

also apply to travel expenses. Sec. 274(d)(1). Petitioner

testified that her travel expenses included a trip to Europe with

her friends for her 50th birthday. Despite testifying that her

trip to Europe was in part for business, petitioner has not

provided any evidence of costs incurred during this trip for

purposes of her trade or business. Moreover, petitioner has not

provided any documentation to evidence any business-related

travel expenses in 2003. Accordingly, we sustain respondent’s

determination with regard to the travel expenses.

F. Business Gifts

The heightened substantiation requirements of section 274

also apply to gifts. Sec. 274(d)(3). Petitioner has not

introduced any evidence to support her claimed deduction for
 -13-

business gifts. Accordingly, we sustain respondent’s

determination with regard to the business gifts.

IV. Long-Term Capital Gain

The gain from the sale or other disposition of property is

the excess of the taxpayer’s amount realized over the property’s

adjusted basis. Sec. 1001(a). A taxpayer must establish the

basis of property for purposes of determining the amount of gain

or loss the taxpayer must recognize. “Proof of basis is a

specific fact which the taxpayer has the burden of proving.”

O’Neill v. Commissioner, 271 F.2d 44, 50 (9th Cir. 1959), affg.

T.C. Memo. 1957-193.

Petitioner provided little documentation in support of her

claimed basis in the property at 215 Vista Grande Avenue in Daly

City, California. In her statement supporting Form 4797 attached

to her 2003 tax return, petitioner calculated the basis of the

subject property by adding the following items to its original

purchase price: (1) “Credits to buyer” of $35,000; (2)

commissions of $13,250; (3) closing costs of $5,955; (4) capital

improvements of $14,600; and (5) additional closing costs on

purchase of $12,100. Petitioner further provided a “seller final

closing statement” showing certain costs and fees associated with

the sale of the subject property. Of the costs petitioner listed

in her statement supporting Form 4797, only closing costs
 -14-

totaling $24,118 are supported by the “seller closing final

statement.”

Petitioner did not testify to, and did not provide any

documentation to support, the other components of her claimed

basis. In fact, in petitioner’s opening post trial brief, she

does not dispute respondent’s determination regarding her long-

term capital gain from the sale of the subject property and fails

to acknowledge the issue. Accordingly, petitioner has failed to

carry her burden of proof, and we sustain respondent’s

determination with regard to the long-term capital gain.

V. Schedule E Rental Expenses

Respondent alleges that petitioner has failed to

substantiate her Schedule E rental expenses outside of payments

totaling $21,867 for real estate taxes with respect to four

properties. We agree. The record is devoid of any credible

evidence that substantiates petitioner’s Schedule E rental

expenses for which she claims deductions and which have not been

conceded by respondent.

With respect to mortgage interest deductions claimed on

Schedule E, the only documentation petitioner provided is the

Quicken accounting software ledger. Petitioner testified that

she kept books for each rental property and an envelope for each

month; however, she has not produced these records for the Court.

Accordingly, petitioner has not met her burden of proof, and we
 -15-

sustain respondent’s determination with respect to the Schedule E

rental expenses.

VI. Net Operating Loss

Petitioner bears the burden of establishing both the

existence and amount of NOL carrybacks and carryforwards. Rule

142(a); Keith v. Commissioner, 115 T.C. 605, 621 (2000); Lee v.

Commissioner, T.C. Memo. 2006-70. We may consider facts relating

to years not in issue that are relevant to the claimed NOLs.

Sec. 6214(b). The only evidence petitioner has presented in

support of her claimed NOL carryforward was her 2001 and 2002

Federal income tax returns. Her tax returns only set forth her

claim to the NOL and do not establish her entitlement thereto.

See Roberts v. Commissioner, 62 T.C. 834, 837 (1974). The fact

that a return is signed under penalty of perjury is not by itself

sufficient to substantiate deductions claimed on the return.

Wilkinson v. Commissioner, 71 T.C. 633, 639 (1979); Emerson v.

Commissioner, T.C. Memo. 2001-186. Accordingly, petitioner has

not met her burden of proof, and we sustain respondent’s

determination with respect to the NOL.

VII. Section 6662(a) Penalty

Section 6662(a) and (b)(2) imposes an accuracy-related

penalty upon any underpayment of tax resulting from a substantial

understatement of income tax. The penalty is equal to 20 percent

of the portion of any underpayment attributable to a substantial
 -16-

understatement of income tax. Id. The term “substantial

understatement” is defined as exceeding the greater of: (1) 10

percent of the tax required to be shown on the return for the

taxable year or (2) $5,000. Sec. 6662(d)(1)(A). Section 6662(a)

and (b)(1) also imposes a penalty equal to 20 percent of the

amount of an underpayment attributable to negligence or disregard

of rules or regulations. Negligence includes any failure to make

a reasonable attempt to comply with the provisions of the

Internal Revenue Code, including any failure to maintain adequate

books and records or to substantiate items properly. Sec.

6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.

Petitioner’s failure to produce records substantiating her

Schedule C gross receipts, Schedule C deductions, long-term

capital gain, Schedule E rental expenses, and NOL carryforward

supports the imposition of the accuracy-related penalty for

negligence for 2003. The applicability of section 6662(b)(2)

will depend on the magnitude of the understatement of tax as

calculated under Rule 155. If petitioner’s understatement of

income tax as calculated under Rule 155 exceeds the greater of

$5,000 or 10 percent of the tax required to be shown on the

return in 2003, respondent will have met his burden of production

under section 7491(c). If not, respondent will have failed to

meet his burden of production under section 7491(c).
 -17-

An accuracy-related penalty is not imposed on any portion of

the underpayment as to which the taxpayer acted with reasonable

cause and in good faith. Sec. 6664(c)(1). The taxpayer bears

the burden of proof with regard to those issues. Higbee v.

Commissioner, 116 T.C. 438, 446 (2001). Petitioner has failed to

show reasonable cause, substantial authority, or any other basis

for reducing the penalties. Accordingly, pending a final

calculation of petitioner’s understatement under Rule 155, we

find petitioner liable for the section 6662 penalty for 2003 as

commensurate with respondent’s concessions and our holding. See

id.

In reaching our holdings herein, we have considered all

arguments made, and, to the extent not mentioned above, we

conclude they are moot, irrelevant, or without merit.

To reflect the foregoing,

Decision will be entered

under Rule 155.