T.C. Memo. 2010-285
UNITED STATES TAX COURT
NEEDHAM AND ANGELA JARMAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8770-08. Filed December 29, 2010.
Needham and Angela Jarman, pro sese.
Edwina L. Jones and Scott L. Little, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
THORNTON, Judge: Respondent determined the following
deficiencies and penalties with respect to petitioners’ Federal
income taxes for taxable years 2004 through 2006:
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Accuracy-Related
Penalty
Year Deficiency Sec. 6662(a)
2004 $14,866 $2,973
2005 11,673 2,335
2006 9,214 1,843
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years at issue, and Rule
references are to the Tax Court Rules of Practice and Procedure.
All figures are rounded to the nearest dollar.
The issues for decision are: (1) Whether for each year at
issue petitioners had unreported gross receipts from the
electrical contracting business owned by Needham Jarman
(petitioner); (2) whether petitioners’ basis in a house that they
sold in 2004 was greater than the $49,500 that respondent has
conceded; (3) whether for 2004 petitioners are entitled to a
$10,230 travel expense deduction; (4) whether for 2004
petitioners received unreported taxable interest income and an
unreported taxable State income tax refund; and (5) whether for
each year at issue petitioners are liable for the section 6662(a)
accuracy-related penalty.1
1
Angela Jarman did not appear at trial and did not execute
the stipulation of facts. At trial respondent’s counsel orally
moved pursuant to Rule 123(b) to dismiss this case as to Ms.
Jarman for lack of prosecution. The Court will grant
respondent’s motion and enter a decision as to Ms. Jarman
consistent with the decision to be entered as to petitioner.
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FINDINGS OF FACT
The parties have stipulated some facts, which we so find.
When they petitioned the Court, petitioners resided in North
Carolina.
During the years at issue petitioner was self-employed as an
electrical contractor, doing business under the name Unity
Electrical Contracting (Unity).
After his mother died on April 17, 2001, petitioner and his
three siblings inherited her house in North Carolina (the house).
At some unspecified time petitioner began using the house as
Unity’s office and storage space. On March 11, 2004, the
siblings and their spouses conveyed their interests in the house
to petitioners for no consideration. On June 11, 2004,
petitioners sold the house for gross proceeds of $70,000.
In 2004 Angela Jarman received $14 of interest income, and
petitioner received an $877 refund of 2003 State taxes.
Petitioners filed joint Federal income tax returns for 2004,
2005, and 2006. On Schedules C, Profit or Loss From Business
(Sole Proprietorship), they reported that Unity had gross
receipts of $69,597, $66,979, and $125,636 for 2004, 2005, and
2006, respectively. On the 2004 Schedule C for Unity,
petitioners claimed, among other things, $10,230 of travel
expenses. On the 2005 and 2006 Schedules C, petitioners claimed
no travel expenses but claimed fuel expenses of $8,894 and
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$8,834, respectively. Petitioners reported no income from the
2004 sale of the house.
On the basis of his bank deposits analysis, respondent
determined that petitioners had unreported income from Unity of
$16,305, $38,904, and $29,688, for 2004, 2005, and 2006,
respectively. Respondent disallowed the Schedule C travel
expenses claimed for 2004 but not the fuel expenses claimed for
2005 and 2006. Respondent also determined that with respect to
their taxable year 2004 petitioners had a $70,000 unreported
capital gain from selling the house, unreported interest income
of $14, and an unreported $877 taxable refund of 2003 State
income taxes.
OPINION
A. Burden of Proof
Petitioners have the burden of proving that respondent’s
determinations are in error. See Rule 142(a).2
B. Unreported Business Receipts
If a taxpayer fails to keep adequate records, the
Commissioner may reconstruct the taxpayer’s income by any
reasonable method that clearly reflects income. See, e.g., sec.
446(b); Holland v. United States, 348 U.S. 121, 130-132 (1954).
One acceptable method is the bank deposits method. Clayton v.
2
Petitioners have not claimed and the record does not
suggest that sec. 7491(a) applies to shift the burden of proof to
respondent with regard to any factual issue.
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Commissioner, 102 T.C. 632, 645 (1994); DiLeo v. Commissioner, 96
T.C. 858, 867 (1991), affd. 959 F.2d 16 (2d Cir. 1992); Bevan v.
Commissioner, T.C. Memo. 1971-312, affd. 472 F.2d 1381 (6th Cir.
1973). This method assumes that if a taxpayer is engaged in an
income-producing activity and makes deposits to bank accounts,
then those deposits, less amounts identified as nonincome items,
constitute taxable income. See Clayton v. Commissioner, supra at
645-646. Where the Commissioner has used the bank deposits
method to determine deficiencies, the taxpayer bears the burden
of showing that the determinations are incorrect. See DiLeo v.
Commissioner, supra at 871; Bevan v. Commissioner, supra.
The record is devoid of any books or records of the receipts
and expenses of Unity, and petitioner does not claim to have
maintained any. Petitioner does not dispute making the deposits
underlying respondent’s bank deposit analysis. But he contends
that certain deposits were merely transfers from his personal
accounts into his business account. Respondent has conceded that
deposits totaling $3,600 in 2004 and $800 in 2005 were transfers
from petitioners’ savings account to petitioner’s business
account. Petitioners have failed to show that any additional
disputed amounts included in respondent’s analysis represent
interaccount transfers.3 Accordingly, we sustain respondent’s
3
With respect to some amounts which petitioner contends
represent interaccount transfers, the evidence indicates that
(continued...)
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determinations as to petitioners’ unreported taxable income from
Unity, except to the extent of respondent’s concessions.
C. Sale of Real Property
Gross income means all income from whatever source derived,
including gains derived from dealings in property. Sec.
61(a)(3). The gain from the sale of property is the amount
realized less the property’s adjusted basis. See sec. 1001(a).
Generally, a property’s basis is its cost. Sec. 1012. If
property is acquired from a decedent, however, the basis is the
property’s fair market value at the date of the decedent’s death,
unless the alternate valuation date is elected. Sec. 1014(a).
Where property is acquired by gift, the basis is the same in the
hands of the donee as it was in the hands of the donor, except
that, if the basis exceeds the fair market value of the property
at the time of the gift, then, for purposes of determining loss,
the basis shall be the fair market value. Sec. 1015(a).
A taxpayer’s adjusted basis for determining gain or loss is
the taxpayer’s basis, adjusted as provided in section 1016. Sec.
1011(a). Under section 1016(a)(1), the basis of property must be
adjusted for, among other things, expenditures, receipts, losses,
or other items, properly chargeable to capital.
3
(...continued)
respondent’s bank deposits analysis never included them as
taxable income in the first instance.
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In 2004 petitioners sold the house for gross proceeds of
$70,000. In the notice of deficiency respondent determined that
this entire amount represented capital gain because petitioners
had established no basis in the house. In this proceeding
respondent has conceded, on the basis of stipulated county
property records, that petitioners had a basis in the house of
$49,300. Petitioner contends that this amount should be
increased by $9,854, which he claims is the amount he paid with
respect to a mortgage on the house so that Unity could use it as
an office and storage space after his niece moved out of it at
some unspecified time.4 Petitioner has failed, however, to
substantiate either the purported mortgage debt or the payments
he purportedly made with respect to it. Furthermore, on this
record we are unable to conclude that petitioners have not
already deducted any such payments in reporting Unity’s profit or
4
More particularly, petitioner claims that after his mother
died he and his siblings agreed to let his niece live in the
house so long as she would make the payments on a mortgage that
had been obtained by unspecified persons at some unspecified
time, apparently for the purpose of remodeling the house. He
claims that after the niece fell into arrears on the mortgage
payments, he paid the bank $5,538 to keep the house out of
foreclosure and another $4,316 of mortgage payments before
selling the house.
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loss.5 Petitioner has failed to establish a basis in the house
greater than the $49,300 that respondent has conceded.
D. Travel Expense Deduction
A taxpayer may deduct ordinary and necessary expenses paid
or incurred during the taxable year in carrying on a trade or
business if the taxpayer maintains sufficient records to
substantiate the expenses. Secs. 162(a), 6001; sec. 1.6001-1(a),
Income Tax Regs. Section 274(d) imposes strict substantiation
requirements for, among other things, traveling expenses and
expenses relating to listed property, defined in section
280F(d)(4)(A)(i) to include passenger automobiles. See sec.
1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov.
6, 1985). Under these requirements, the taxpayer must
substantiate the claimed deduction with adequate records, or by
sufficient evidence corroborating the taxpayer’s own statement,
showing the amount of the expense, the time and place of the use
of the listed property, and the business purpose. Sec. 274(d);
5
On the Schedule C for Unity attached to petitioners’ 2004
joint Federal income tax return, petitioners claimed a $4,344
deduction for “Repairs and maintenance”. We note that this
deduction, unexplained in the record, approximates the $4,316 of
mortgage payments that petitioner claims to have made after
allegedly taking over the mortgage payments from his niece. The
record, which does not contain petitioners’ earlier tax returns,
does not foreclose the possibility that other amounts of mortgage
payments might have been claimed as deductions against Unity’s
operations in earlier years.
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see also sec. 1.274-5T(b)(6), (c)(2), Temporary Income Tax Regs.,
50 Fed. Reg. 46016, 46017 (Nov. 6, 1985).
Rather than account for expenses item by item, the taxpayer
may determine the ordinary and necessary expenses of the business
use of a vehicle by using a standard mileage rate prescribed by
the Commissioner. Sec. 1.274-5(j)(2), Income Tax Regs. For 2004
the standard mileage rate was 37.5 cents. Rev. Proc. 2003-76,
sec. 5.01, 2003-2 C.B. 924, 925. A taxpayer who uses the
standard mileage rate to determine the ordinary and necessary
expenses of using a vehicle must still substantiate the amount of
each business use (i.e., the business mileage) and the time and
business purpose of each use. Sec. 1.274-5(j)(2), Income Tax
Regs.
On the 2004 Schedule C for Unity petitioners claimed $10,230
of travel expenses. Attempting to substantiate this claimed
deduction, petitioner relies on mileage logs which indicate that
he drove 49,535 miles in 2004. But applying the 2004 standard
mileage rate to 49,535 miles would result in a mileage allowance
of $18,576 rather than the $10,230 petitioners actually claimed.
Petitioners have not explained the discrepancy. Two possible
explanations are: (1) The claimed travel expenses were not
actually based on the mileage logs; or (2) petitioners implicitly
concede that the mileage shown on the mileage logs is greatly
overstated. In any event, we find that the mileage logs are
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unreliable. The mileage numbers, which appear as uniform
handwritten notations in the margins of notebook paper on which
jobs are listed at generally indecipherable locations, appear
likely to have been added at one time after the fact. Except for
a relatively few entries that end with the numeral 5, all the
mileage entries are multiples of 10. At trial petitioner
admitted that he regularly rounded up his mileage. In many
instances, identical mileage is recorded for different
destinations.6 The mileage entries also contain other
discrepancies that cause us to conclude that the mileage logs are
unreliable.7 Petitioners have not supplemented the mileage logs
with material corroborating evidence. We conclude that
petitioners have failed to meet the strict substantiation
requirements of section 274(d).
Generally, if a taxpayer establishes that deductible
expenses were incurred but fails to establish the amounts, we may
estimate the amounts allowable, provided that evidence in the
record provides a rational basis for the estimate. Cohan v.
6
For instance, for the first 3 months of 2004 the mileage
logs include 21 entries that show identical mileage of 110 miles,
even though the trips were to at least six different
destinations.
7
In some instances, another number has been written over the
original entry to increase the number of miles claimed. In one
log entry, petitioner listed travel of 25 miles to and from a
particular location, whereas several other entries list 125 miles
traveled to and from the same location.
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Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v.
Commissioner, 85 T.C. 731, 742-743 (1985). In the case of travel
expenses and expenses paid or incurred with respect to listed
property, however, section 274(d) overrides the Cohan doctrine,
and these expenses are deductible only if the taxpayer meets the
stringent substantiation requirements of section 274(d). Berkley
Mach. Works & Foundry Co. v. Commissioner, 623 F.2d 898, 906-907
(4th Cir. 1980), revg. T.C. Memo. 1977-177; Sanford v.
Commissioner, 50 T.C. 823, 827 (1968), affd. 412 F.2d 201 (2d
Cir. 1969); sec. 1.274-5T(a), Temporary Income Tax Regs., supra.
Because petitioners have failed to meet those stringent
substantiation requirements, we sustain respondent’s
determination disallowing the deduction for travel expenses
petitioners claimed on their 2004 joint Federal income tax
return.8
E. Interest Income and State Income Tax Refund
Respondent determined that petitioners failed to report on
their 2004 joint return a $877 refund of 2003 State income taxes
and $14 of interest income. Petitioners have not disputed
8
For 2005 and 2006 petitioners claimed, and respondent did
not disallow, deductions for fuel expenses. At trial petitioner
asserted that he is entitled to deduct larger amounts of travel
expenses (although he has not specified particular amounts) on
the basis of his mileage logs. His mileage logs for 2005 and
2006, however, suffer the same defects as those just discussed.
For this reason, if for no other, we must reject petitioner’s
contention.
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receiving these amounts and have advanced no argument that these
amounts are not properly included in their taxable income. We
sustain respondent’s determinations as to these items.
F. Accuracy-Related Penalties
Respondent determined that for each year at issue
petitioners are liable for an accuracy-related penalty pursuant
to section 6662(a) and (b)(1) and (2) for negligence or
substantial understatement of income tax. Respondent bears the
burden of production with respect this penalty. Sec. 7491(c).
To meet this burden, respondent must produce evidence
establishing that it is appropriate to impose this penalty. Once
respondent has done so, the burden of proof is upon petitioners.
See Higbee v. Commissioner, 116 T.C. 438, 449 (2001).
Negligence includes any failure to make a reasonable attempt
to comply with the provisions of the internal revenue laws and is
the failure to exercise due care or the failure to do what a
reasonable and prudent person would do under the circumstances.
Sec. 6662(c); Neely v. Commissioner, 85 T.C. 934, 947 (1985);
sec. 1.6662-3(b)(1), Income Tax Regs. 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. Petitioners failed to keep adequate books and records and
to properly substantiate claimed deductions. Respondent has
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carried his burden of production with respect to the section
6662(a) penalties for negligence.
Section 6662(a) and (b)(2) imposes a 20-percent
accuracy-related penalty on any portion of a tax underpayment
that is attributable to any substantial understatement of income
tax, defined in section 6662(d)(1)(A) as an understatement that
exceeds the greater of 10 percent of the tax required to be shown
on the return or $5,000. The exact amounts of petitioners’
underpayments will depend upon the Rule 155 computations, taking
into account respondent’s concessions and in accordance with our
findings and conclusions. To the extent that those computations
establish, as seems likely, that petitioners have substantial
understatements of income tax, respondent has also met his burden
of production in this regard. See Prince v. Commissioner, T.C.
Memo. 2003-247.
The accuracy-related penalty does not apply with respect to
any portion of the underpayment for which it is shown that the
taxpayer had reasonable cause and acted in good faith. Sec.
6664(c)(1). Petitioners have made no attempt to explain their
failure to report income, to keep adequate books and records, and
to substantiate items properly. We hold that for each year at
issue petitioners are liable for a section 6662(a) penalty for
negligence and, alternatively, for substantial understatements of
income tax insofar as the Rule 155 computations show any.
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To reflect the foregoing and respondent’s concessions,
An appropriate order
will be issued, and decision
will be entered under Rule
155.