T.C. Memo. 2010-251
UNITED STATES TAX COURT
VICTOR AND DELLA JENKINS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 21092-08. Filed November 17, 2010.
Victor and Della Jenkins, pro se.
Matthew D. Carlson, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MORRISON, Judge: The petitioners, Victor and Della Jenkins
(the “Jenkinses”), filed a joint tax return for the year 2006.
Respondent, whom we will refer to as the IRS, issued a deficiency
notice determining a deficiency of $98,479, and a section 6662(a)
penalty of $19,695.80. The Jenkinses filed a petition with the
Tax Court seeking a redetermination. The IRS now concedes the
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correctness of charitable-contribution and home-mortgage
deductions that the Jenkinses claimed on their return. After
taking into account these two concessions, the remaining issues
for us to decide include: (1) the amount of the deduction to
which the Jenkinses are entitled for payments to a loan processor
(we find the amount is $156,970.89), (2) whether the Jenkinses
are entitled to deduct $16,418 in other business expenses (we
find they are not), and (3) whether the Jenkinses are liable for
the accuracy-related penalty under section 6662(a) (we find that
they are). All of the other unresolved issues involve matters
that should be resolved in the Rule 155 computations. These
computational issues are: (1) whether the self-employment tax
should be increased to $17,603, (2) whether the self-employment
tax deduction should be increased to $8,802, and (3) whether the
Jenkinses are entitled to itemized deductions as opposed to the
standard deduction.
FINDINGS OF FACT
During 2006 Victor Jenkins (“Jenkins”) worked as a
registered nurse for a company called Nursefinders, Inc. In 2006
Jenkins received $41,929 in wages from Nursefinders, Inc. The
tax treatment of these wages is not in dispute. Jenkins also
worked as a loan officer during 2006.
In his capacity as a loan officer Jenkins worked with two
mortgage brokers: American Dream Homes, and Living American
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Dreams, Inc.1 The two brokers compensated Jenkins by writing him
commission checks.2 We refer to these commission checks as
“broker checks”.
Jenkins worked with a loan processor named Therriman
Edwards.3 Jenkins and Edwards had an arrangement whereby
the two men split the amount of each broker check that Jenkins
received. Edwards was the key man in bringing in the business.
Therefore, Edwards received the larger percentage of the net
profit attributable to the broker checks. The primary reason
that Jenkins received any share at all was that he held a
California real-estate license. This permitted Jenkins to work
as a loan officer. Edwards did not have a real-estate license.
Jenkins testified that his own share of a broker check was
equal to 10 percent of the difference between the broker check
and Edwards’ out-of-pocket costs. Jenkins testified that
Edwards’ share of the broker check was equal to (1) Edwards’ out-
of-pocket costs plus (2) 90 percent of the difference between the
broker check and Edwards’ costs. As we explain later, we do not
1
A mortgage broker hires a loan officer with respect to each
loan transaction.
2
A mortgage lender works with various mortgage brokers and
compensates these mortgage brokers with commission payments. In
2006 a typical commission payment to a mortgage broker was 2 to 3
percent of the loan amount. The amounts of the checks that the
two brokers wrote to Jenkins were 90 percent of the amounts that
the brokers received from mortgage lenders.
3
A loan officer works with a loan processor.
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think that the amounts paid to Edwards were determined by this
formula.
Jenkins used a bank account at Washington Mutual for both
his loan officer business and his personal business. The bank
statements for this account and copies of checks drawn on this
account provide some information about the amounts of the
payments that Jenkins made to Edwards.
Jenkins received an information return, a Form 1099-MISC,
Miscellaneous Income, from American Dream Homes showing that
American Dream Homes paid him $94,081.45 in 2006. He received
another information return from Living American Dreams, Inc.
showing that Living American Dreams, Inc., paid him $124,571.79
in 2006. The total of those two numbers is $218,653.24.
Jenkins provided Edwards a Form 1099-MISC for the tax year
2006 showing $196,787.92 in the box for “Nonemployee
compensation”. Jenkins arrived at $196,787.92 by multiplying 90
percent by the $218,653.24 that the two brokers reported that
they had paid him.
The Jenkinses filed a Form 1040, U.S. Individual Income Tax
Return, for 2006. They attached a Schedule C, Profit or Loss Frm
Business, for a business that they described as the “Mortgage
Lender” business.4 On the Schedule C the Jenkinses reported
4
The “Mortgage Lender” label was erroneous. Jenkins did not
act as a mortgage lender but as a loan officer.
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gross receipts of $221,131 and gross income of $221,131. They
reported total expenses of $213,206, of which $196,788 was
“Wages”. As Jenkins would explain to the Court, this $196,788
represented the payments he made to Edwards. Besides the
$196,788, the remainder of the Schedule C expenses was $16,418.
This $16,418 in expenses was described on the return only in
broad categories and their corresponding amounts. The names of
the categories and the amounts are listed later in our opinion.
The trial record does not reveal any other information about
these amounts. The net profit from the business was reported as
$7,925, which is $221,131 minus $213,206. The IRS does not
contest the accuracy of the $221,131 that the Jenkinses reported
as gross income and gross receipts from the business.
Edwards filed a 2006 income-tax return with the IRS. He
reported that he earned $96,788 in gross receipts. Suspiciously,
this number is precisely $100,000 less than the $196,788 that
Jenkins claimed as a deduction for “Wages”.
The IRS sent a deficiency notice to the Jenkinses
determining a deficiency of $98,479 and a section 6662(a) penalty
of $19,695.80. One of the adjustments in the deficiency notice
was the reduction of the $213,206 that the Jenkinses had claimed
for Schedule C deductions to zero. The deficiency notice
explained that “the record keeping requirements under Internal
Revenue Code Section 6001 have not been met, and you have not
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complied with our request for substantiation of your Schedule C”.
The IRS now concedes that Jenkins paid Edwards commissions of
$69,325 during tax year 2006 and that Jenkins is entitled to a
business deduction of that amount. At the time the Jenkinses
filed their petition, they resided in California.
OPINION
1. Amount of Deduction for Jenkins’ Payments to Edwards
a. The Nine Payments Documented by Copies of Jenkins’
Personal Checks to Edwards and Corresponding Entries on
Bank Statements
The trial record contains copies of nine checks Jenkins
wrote to Edwards. These checks were drawn on Jenkins’ Washington
Mutual bank account. For each check, the bank statements
reflect, under the heading “Checks Paid”, the check number, the
check amount, and the payment date. Each of these items is
consistent with the information on the copies of the checks.
Other entries on the bank statement show that a “Customer
Deposit” was made on the same date (or almost the same date) as
the payment date of each check. The amount of each “Customer
Deposit” entry is somewhat greater than the amount of the
corresponding check.
For example, check No. 1012, dated March 2, 2006, is made
out from Jenkins to Edwards. The amount on the check is $10,000.
The bank statement contains a corresponding entry, under the
heading of “Checks Paid”, for check No. “1012”, a date of March
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3, 2006, and an amount of $10,000. The bank statement contains
an entry on March 2, 2006 for a “Customer Deposit” of $11,920.50.
Including the example described above, there were nine
transactions in which the documentation is similar. They are
summarized as follows:
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Nine Payments to Edwards Evidenced by Checks to Edwards and Simultaneous
Large Deposits to Jenkins’ Bank Account
Date and Amount Information on Bank Statement Amount of Payment to
of “Customer Check to Entry for Same Edwards (as claimed by
Deposit” Entry Edwards Check Jenkins - identical to
on Bank amounts conceded to be
Statement correct by IRS)
Check #1012 Check #1012
3/2/06 3/2/06 3/3/06
$11,920.50 $10,000 $10,000 $10,000
Check #1034 Check #1034
7/25/06 7/25/06 7/25/06
$9,791 $8,191 $8,191 8,191
Check #1032 Check #1032
7/31/06 7/31/06 7/31/06
$13,914 $12,942 $12,942 12,942
Check #1033 Check #1033
8/1/06 8/1/06 8/1/06
$9,396 $8,600 $8,600 8,600
Check #1037 Check #1037
8/16/06 8/16/06 8/16/06
$5,189.40 $4,929 $4,929 4,929
Check #1036 Check #1036
8/30/06 8/30/06 8/30/06
$2,250 $2,125 $2,125 2,125
Check #1038 Check #1038
9/1/06 9/1/06 9/1/06
$10,168.56 $9,380 $9,380 9,380
Check #1047 Check #1047
10/18/06 10/17/06 10/18/06
$8,758.63 $8,075 $8,075 8,075
Check #1046 Check #1046
11/9/06 11/8/06 11/9/06
$5,533.20 $5,083 $5,083 5,083
Total 69,325
The IRS has conceded that Jenkins is entitled to deduct $69,325
for his payments to Edwards. This is the total amount of these
nine checks.
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b. Seven Payments to Edwards Documented by Entries for
Large Deposits to and Large Withdrawals from Jenkins’
Account
There are seven instances in which Jenkins’ bank statement
has an entry for a “Customer Deposit” and, on the same date, a
withdrawal. The amount of each withdrawal is a relatively large
fraction of the amount of the corresponding “Customer Deposit”.
For example, the Washington Mutual bank statement shows that on
April 12, 2006, there was a “Customer Deposit” of $12,797.44. It
also shows that on 4/12/06, there was a “Transfer Withdrawal” of
$11,517.44.
Jenkins testified that the $12,797.44 deposit entry
reflected that he had deposited a broker check in that amount.
He testified that the entry for a “Transfer Withdrawal” of
$11,517.44 reflected that he transferred that amount from his
bank account at Washington Mutual to Edwards’ account at the same
bank. The IRS argues that the documentary evidence is inadequate
to support the proposition that Jenkins made a payment of
$11,517.44 to Edwards. We find, however, that the bank
statement, combined with Jenkins’ testimony, is sufficient to
demonstrate that Jenkins paid Edwards the $11,517.44 recorded on
the bank statement. We make a similar conclusion for six other
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payments for which there is similar documentary and testimonial
evidence. All seven payments can be summarized thus:
Seven Payments to Edwards Evidenced by Entries for Large Deposits and Large
Withdrawals
Date and Amount of Date and Amount of Amount Paid to Edwards
“Customer Deposit” Entry “Transfer Withdrawal” or (as claimed by Jenkins -
on Bank Statement “Customer Withdrawal” identical to amounts
Entry on Bank Statement determined by the Court)
4/12/06 4/12/06 (Transfer
$12,797.44 withdrawal) $11,517.44
$11,517.44
4/21/06 4/21/06 (Transfer
$12,011.57 withdrawal) 11,281.00
$11,281
4/25/06 4/25/06 (Customer
$10,099.13 withdrawal) 9,144.00
$9,144
6/2/06 6/2/06 (Customer
$14,536.04 withdrawal) 13,947.69
$13,947.69
6/2/06 6/2/06 (Customer
$7,906.50 withdrawal) 7,645.50
$7,645.50
6/27/06 6/27/06 (Customer
$10,636.86 withdrawal) 9,483.00
$9,483
10/3/06 10/3/06 (Transfer
$9,756.40 withdrawal) 9,088.00
$9,088
Total 72,106.63
c. Three Payments From Jenkins to Edwards Documented by an
Entry in the Bank Statement Showing That Jenkins
Deposited a Small Amount
There are three transactions for which the sole written
evidence of a payment from Jenkins to Edwards is entries on
Jenkins’ Washington Mutual bank statement showing that there were
three relatively small customer deposits made to Jenkins’ bank
account. For example, the bank statement reflects that a
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“Customer Deposit” of $1,137 was made on March 17, 2006. On the
basis of this $1,137 entry, Jenkins testified that he must have
received a check from the broker for $11,370; i.e., $1,137
divided by 10 percent. Jenkins cashed the broker check rather
than depositing it, which explains why there is no bank statement
entry corresponding to the amount of the broker check. Of the
$11,370 that he estimated was the proceeds from the cashing of
the broker check, Jenkins said that he gave Edwards 90 percent;
i.e., $10,233. He said that he deposited to his own bank account
the remaining 10 percent; i.e., $1,137. Jenkins gave similar
testimony with respect to two other transactions for which the
written documentation is comparable to this one. He estimated
that for all three transactions, his total payments to Edwards
were $26,894.88.
We believe that the entry for a deposit of $1,137 to the
Washington Mutual bank account reflected Jenkins’ share of a
broker check. We also believe that around the time of this
deposit, Jenkins paid Edwards for Edwards’ share of the broker
check. However, we come to a different conclusion from Jenkins’
regarding how much Jenkins paid Edwards. The method used by
Jenkins is unacceptable. If one attempts to apply this method to
other payments to Edwards for which there is documentary evidence
as to the actual amount, the method fails to predict the actual
amount. For example, as we have found, Jenkins received a broker
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check of $11,920.50 and paid Edwards $10,000 from that check.
Yet the method Jenkins used would have predicted that Edwards’
share would be $10,728.45 ($11,920.50 times 90 percent). To take
another example, we found that Jenkins received a broker check of
$9,791 and paid Edwards $8,191. Yet the method Jenkins used
would have predicted $8,812. We therefore find the method
unreliable.5
If a taxpayer is entitled to a deduction, but it is not
possible to determine the exact amount of the deduction, the Tax
Court may estimate the amount. Cohan v. Commissioner, 39 F.2d
540, 543-544 (2d Cir. 1930). In making this estimate, the Court
may resolve uncertainties against the taxpayer, because it is the
taxpayer’s fault that there is not enough information to
accurately calculate the deduction. Id. For the reasons set
forth below, we have decided to determine the amount of each of
5
In determining the amounts of the three payments to
Edwards, we did not rely on Jenkins’ testimony that Edwards’
share of each broker check was equal to Edwards’ costs plus 90
percent of the difference between the broker check and his costs.
This amount is mathematically equivalent to 90 percent of the
broker check, plus 10 percent of his costs. (Suppose that b is
the amount of the broker check, c is Edwards’ out-of-pocket
costs, and e is Edwards’ share of the broker check. Jenkins
testified that: e = c + .9(b-c). This is algebraically
equivalent to: e = .9b + .1c.) But if we apply this formula to
the $11,920.50 broker check, the formula would predict that
Edwards would receive 90 percent of the broker check (i.e.
$10,728.45) plus costs. But in fact Edwards actually received
only $10,000. Therefore, the formula is incorrect. And, even if
the formula was correct, we would not have enough information to
use the formula. One of the terms of the formula is Edwards’
costs. We do not know this amount.
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the three payments to Edwards by multiplying the amount of each
corresponding deposit by 5.2.
The derivation of the 5.2:1 ratio is as follows. For each
of the 16 transactions for which we have already determined the
amount that Jenkins paid Edwards, we calculated the ratio between
Jenkins’ share of the broker check and Edwards’ share of the
broker check. The transactions for which the ratio was the
highest were (1) the $11,920.50 broker check deposited on March
2, 2006, of which Edwards’ share, $10,000, bears approximately a
5.2 ratio to Jenkins’ share, $1,920.50, and (2) the $9,791 broker
check deposited on July 25, 2006, of which Edwards’ share,
$8,191, bears approximately a 5.1 ratio to Jenkins’ share,
$1,600.
Using this 5.2 ratio, we find that: (1) the $1,137 deposit
Jenkins made on March 17, 2006, corresponded to a $5,912.40
payment to Edwards, (2) the $793.27 deposit Jenkins made on March
17, 2006, corresponded to a $4,125 payment to Edwards, and (3)
the $1,058.05 deposit Jenkins made on March 30, 2006,
corresponded to a $5,501.86 payment to Edwards. The total of
these three payments is $15,539.26.
The IRS’s position is that we should be making no estimate
at all and that the deduction for these three transactions should
be zero. It points out there is no written evidence proving that
the three deposits actually represented Jenkins’ shares of the
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broker checks and no written evidence that Jenkins made a
corresponding payment to Edwards for Edwards’ share. But, as we
noted above, we believe Jenkins’ testimony that the deposits to
his account did correspond to broker checks and that he made
corresponding payments to Edwards. We have estimated the
payments to Edwards in these three transactions.
The three transactions discussed in this section can be
summarized as follows:
Three Payments to Edwards Evidenced In Writing by Small “Customer Deposit”
Entries
Date and Amount of
“Customer Deposit” Amount of Broker Amount of Payment Amount of
Entry on Bank Check (per to Edwards (per Payment to
Statement Jenkins) Jenkins) Edwards (Per
Court)
3/17/06 $11,370 $10,233 (90% of $5,912.40
$1,137 ($1,137/10%) $11,370) ($1,137*5.2)
3/17/06 $7,932.70 $7,139.43 (90% of $4,125.00
$793.27 ($793.27/10%) $7,932.70) ($793.27*5.2)
3/30/06 $10,580.50 $9,522.45 $5,501.86
$1,058.05 ($1,058.05/ 10%) ($10,580.50) ($1,058.05*5.2)
Total Deposits = Total= Total=
$2,988.32 $26,894.88 $15,539.26
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d. Conclusion
Of the three categories of payments described above, we have
determined that Jenkins is entitled to a deduction of $156,970.89
($69,325 + $72,106.63 + $15,539.26). This figure is less than
the $168,326.51 amount claimed by Jenkins.6 It is greater than
the corresponding amount urged by the IRS, $69,345. We are not
persuaded that Jenkins made any payments to Edwards other than
the 19 discussed in this opinion.
2. Remaining Schedule C Expenses
Of the $213,206 in expenses claimed as deductions on the
Schedule C, $196,788 was labeled “Wages”. The rest of the
expenses, amounting to $16,418, were described on the tax return
as:
Car and truck expense $2,546
Insurance (other than health) 81
Rent or lease (other business property) 500
Supplies 130
Taxes and licenses 76
Utilities 286
Business credit card 10,450
Car rental 127
Seminar airfare 1,134
Hotel 337
Ink cartilages (sic) 160
Business cards 100
Real estate book 491
Total 16,418
6
Jenkins did not argue that his payments to Edwards were
equal to $196,787.92, the amount that Jenkins deducted on his
return for these payments.
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Even though he claimed the $16,418 in expenses on his Schedule C,
Jenkins did not introduce any evidence to prove that he was
entitled to deduct it.7 We sustain the IRS’s determination in
its deficiency notice that the remaining Schedule C deductions
should be disallowed.
3. The Section 6662(a) Penalty
The IRS bears the burden of producing evidence that the
Jenkinses are liable for the section 6662(a) penalty. See sec.
7491(c). The Jenkinses were negligent within the meaning of
section 6662(c). Their recordkeeping was extremely poor. The
IRS has carried its burden of producing evidence. The portion of
the underpayment attributable to the Schedule C deductions that
the Jenkinses erroneously claimed was due to negligence.
The disallowed Schedule C deductions also resulted in an
“understatement” of income tax within the meaning of section
6662(d)(2). Whether there is a “substantial understatement” of
income tax within the meaning of section 6662(d)(1)(A) is a
mathematical matter to be resolved after the parties have
completed Rule 155 computations.
7
Instead, Jenkins introduced into evidence a list of
expenses that he says he could have deducted but did not. The
purpose of the exhibit was to show the Court that his handling of
his tax return showed indifference rather than any sort of
fraudulent intent. He did not ask the Court to incorporate the
new deductions on the exhibit into its determination of his tax
liability. In any event, that spartan list of additional
deductions would not have proven he was entitled to the
additional deductions.
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The Jenkinses have the burden of proving that they are not
liable for the penalty because of reasonable cause, substantial
authority, or a similar provision. See Higbee v. Commissioner,
116 T.C. 438, 447 (2001). They have not satisfied their burden
of proof.
Decision will be entered
under Rule 155.