T.C. Memo. 2011-192
UNITED STATES TAX COURT
ARMANDO SANDOVAL LUA AND YADIRA A. SANDOVAL, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14661-09. Filed August 11, 2011.
Sean H. Colon, for petitioners.
Kimberly A. Kazda, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: Respondent determined a $54,674 deficiency
in petitioners’ Federal income tax for 2005. After concessions,1
1
Petitioners concede that they failed to report rents
received of $5,700 on their Schedule E, Supplemental Income and
Loss. Petitioners further concede that the deduction for other
expenses claimed on their Schedule C, Profit or Loss From
Business, should be reduced by $140,221, and the mortgage
interest deduction claimed on their Schedule C should be reduced
by $1,882.
(continued...)
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the issue for decision is whether petitioners failed to report
$19,207 of income on their Schedule C, Profit or Loss From
Business, for Future Satellite Communications (Future
Satellite).2
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulations of facts and the attached exhibits are
incorporated herein by this reference. Petitioners resided in
California when they filed their petition. Petitioners are
husband and wife (hereinafter referred to individually as Mr.
Sandoval Lua and Mrs. Sandoval, respectively) who filed a joint
tax return for the 2005 tax year.
Mr. Sandoval Lua owns Future Satellite, a residential
satellite installation business. He operates Future Satellite as
a sole proprietorship, and petitioners report its income and
expenses on a Schedule C. Mr. Sandoval Lua oversees the services
1
(...continued)
Respondent concedes that petitioners’ Schedule C
depreciation expense should be increased by $4,426 and their
Schedule E depreciation or depletion expense increased by $1,649.
Respondent also concedes that petitioners’ Schedule E mortgage
interest expense should be increased by $4,673.
The parties agree that petitioners’ $1,287 expense for taxes
and licenses claimed on their Schedule C should have been
reported on their Schedule E.
2
Respondent’s determinations with respect to petitioners’
itemized deductions and self-employment tax are computational
adjustments that will be resolved by our decision on the primary
issue.
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side of the business, and Mrs. Sandoval performs the
administrative functions such as bookkeeping, ordering equipment,
and depositing checks.
In 2005 Future Satellite provided installation services on
behalf of DIRECTV, Dish Network, and Recreational Sports and
Imports (RS&I) (collectively, the satellite companies). During
the year Mr. Sandoval Lua retained the services of five or six
individuals (the installers) to perform the installations for
Future Satellite.3 Future Satellite compensated the installers
for each installation they performed.
Compensation From the Satellite Companies
Future Satellite received two forms of compensation from the
satellite companies: (1) Residuals and (2) equipment
reimbursement. With respect to the residuals, the satellite
companies paid Future Satellite a small percentage of each Future
Satellite customer’s monthly service bill.4 The satellite
companies also reimbursed Future Satellite for the cost of the
equipment Future Satellite had purchased and installed. With the
exception of two checks received from DIRECTV, the satellite
3
The installers are independent contractors, and Future
Satellite issued them Forms 1099-MISC, Miscellaneous Income.
4
For example, Mr. Sandoval Lua explained that if a
customer’s monthly service bill was $50, Future Satellite would
receive $1.50 per month.
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companies deposited electronically into one of petitioners’ bank
accounts5 all of Future Satellite’s compensation.
Compensation Collected From Customers
Future Satellite also received compensation from its
customers when the installers performed certain installation
services (additional services). The installers collected the
fees for the additional services from the customers upon
completion of the work. If the customers paid for the additional
services in cash, Future Satellite allowed the installer who
performed the additional services to keep the cash (up to the
amount Future Satellite compensated the installer for the job),
as his compensation for services rendered.6 If the customers
paid for the additional services by check or the installer
received cash in excess of his compensation, the installer
brought the checks and/or excess cash to Future Satellite’s
office. Petitioners then deposited the checks and/or cash into
5
RS&I and DIRECTV deposited Future Satellite’s
compensation electronically into petitioners’ Wells Fargo
business checking account. Dish Network deposited Future
Satellite’s compensation electronically into petitioners’ Yolo
Federal Credit Union business checking account.
6
It is not clear how much Future Satellite compensated the
installers for the additional services.
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one of their bank accounts7 and issued the installer a check in
the amount of his or her remaining compensation.
Petitioners’ 2005 Return and the IRS’s Adjustment for Unreported
Gross Receipts
Petitioners’ return preparer prepared petitioners’ Schedule
C based on a workpaper Mrs. Sandoval created and the checks
petitioners issued to the installers to complete their
compensation. The workpaper, which petitioners introduced at
trial, listed all deposits made electronically by the satellite
companies and all deposits made by Mr. Sandoval Lua or Mrs.
Sandoval after receiving the checks and/or cash from the
installers after the installers had performed additional
services.8 Petitioners’ return preparer totaled the deposits
listed on Mrs. Sandoval’s workpaper and reported these amounts on
petitioners’ Schedule C.9 Because Future Satellite allowed the
installers to keep as their compensation some of the cash they
7
Future Satellite deposited the checks and excess cash
into either their: (1) Yolo Federal Credit Union personal
checking account; (2) Yolo Federal Credit Union personal savings
accounts; or (3) Wells Fargo business checking account.
8
Mrs. Sandoval created the workpaper by going down each of
petitioners’ monthly bank statements line by line and entering
Future Satellite’s deposits in a separate document.
9
Mrs. Sandoval’s workpaper showed that Future Satellite
had gross income of $995,438, and petitioners’ return preparer
reported that Future Satellite had gross receipts of $933,448 and
other income of $63,627. Petitioners reported higher gross
income on their return than stated on Mrs. Sandoval’s workpaper
because the totals on the workpaper accounted for customer
reimbursements made after petitioners had filed their return.
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collected after performing additional services, these amounts
were not deposited into petitioners’ bank accounts and therefore
not reported on petitioners’ Schedule C. However, petitioners
calculated Future Satellite’s allowable deduction for
compensation paid based on the checks issued to the installers,
not the total amount the installers received in cash and
checks.10 Thus, petitioners did not deduct the amounts of cash
the installers kept as their compensation.
In 2006 IRS Revenue Agent Terry Gann (Mr. Gann) audited
petitioners’ 2005 tax return. During their initial meeting Mr.
Gann reviewed the invoices Future Satellite issued to its
customers after providing additional services. The invoices
showed that Future Satellite earned $19,207 for the additional
services.11 Mr. Gann concluded, on the basis of his discussions
10
If a customer paid an installer by check, the installer
would deliver the check to Mr. Sandoval Lua or Mrs. Sandoval, who
would then deposit it (and report it as income) and issue the
installer a check to compensate him for his services (and include
the amount in Future Satellite’s allowable deduction for
compensation paid).
11
The invoices are not part of the record, and the record
does not show how much of the $19,207 was collected in cash or by
check. Respondent informally requested that petitioners provide
him with copies of the invoices, but petitioners refused. On
Apr. 27, 2010, 1 week before trial, respondent served on
petitioners a subpoena duces tecum requiring petitioners to bring
the invoices with them to trial. On May 3, 2010, petitioners
filed a motion to quash subpoena, which the Court granted.
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with Mr. Sandoval Lua,12 that petitioners did not report as
income the $19,207 that Future Satellite earned for the
additional services. Mr. Gann did only a cursory review of
petitioners’ bank statements to see whether the amounts collected
by the installers had been deposited.
OPINION
I. Burden of Proof
Generally, the Commissioner’s determination of a deficiency
is presumed correct, and the taxpayer has the burden of proving
it wrong. Rule 142(a);13 Welch v. Helvering, 290 U.S. 111, 115
(1933). However, in unreported income cases, the presumption of
correctness does not attach unless the Commissioner first
establishes some evidentiary foundation linking the taxpayer with
the alleged income-producing activity.14 See Weimerskirch v.
12
See infra p. 9.
13
Unless otherwise indicated, all section references are
to the Internal Revenue Code in effect for the year at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
14
Although Weimerskirch v. Commissioner, 596 F.2d 358 (9th
Cir. 1979), revg. 67 T.C. 672 (1977), dealt specifically with
illegal unreported income, it is now well established that the
Court of Appeals for the Ninth Circuit applies the Weimerskirch
rule in all cases of unreported income where the taxpayer
challenges the Commissioner’s determination on the merits. E.g.,
Edwards v. Commissioner, 680 F.2d 1268, 1270 (9th Cir. 1982) (in
that case, involving unreported income from an income-generating
auto repair business owned by the taxpayer, the court stated:
“We note, however, that the Commissioner’s assertion of
deficiencies are presumptively correct once some substantive
evidence is introduced demonstrating that the taxpayer received
(continued...)
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Commissioner, 596 F.2d 358 (9th Cir. 1979), revg. 67 T.C. 672
(1977); Golsen v. Commissioner, 54 T.C. 742, 756-757 (1970),
affd. 445 F.2d 985 (10th Cir. 1971); Laszloffy v. Commissioner,
T.C. Memo. 2010-258. The requisite evidentiary foundation is
minimal. See Banister v. Commissioner, T.C. Memo. 2008-201,
affd. 418 Fed. Appx. 637 (9th Cir. 2011).
The Ninth Circuit has made it clear * * * that once the
government has carried its initial burden of introducing
some substantive evidence linking the taxpayer with
income-producing activity, the taxpayer has the burden to
rebut the presumption of correctness of respondent’s
deficiency determination by establishing by a preponderance
of the evidence that the deficiency determination is
arbitrary or erroneous. * * *
Petzoldt v. Commissioner, 92 T.C. 661, 689 (1989); see also Hardy
v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999), affg. T.C.
Memo. 1997-97; Rapp v. Commissioner, 774 F.2d 932, 935 (9th Cir.
1985).
Respondent has established the requisite evidentiary
foundation linking petitioners with an income-producing activity,
Future Satellite. Consequently, respondent has met his burden of
connecting petitioners with the unreported income determined in
the notice of deficiency, and respondent’s determination is
presumed to be correct.
14
(...continued)
unreported income. Weimerskirch v. Commissioner, 596 F.2d 358,
360 (9th Cir. 1979).”).
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II. Analysis
A. Fees Collected by the Installers and Returned to
Petitioners
The installers brought the checks and any cash received in
excess of the amount they kept as their compensation to Future
Satellite’s office. Petitioners contend that they reported these
amounts on their Schedule C because they deposited the checks and
cash into one of their bank accounts and their return was based
on the workpaper Mrs. Sandoval created listing all deposits
related to Future Satellite. Respondent argues that Mr. Sandoval
Lua admitted to Mr. Gann that petitioners did not report as
income any of the $19,207 Future Satellite earned for the
additional services15 and petitioners have not provided any
documentation to support their argument that they deposited the
checks and cash the installers brought them and then reported
those amounts on their Schedule C.
Petitioners both credibly testified that they deposited the
checks and cash given to them by the installers into one of their
15
Mr. Sandoval Lua and Mr. Gann have different
recollections of what was said during their meetings. Mr.
Sandoval Lua claims that he told Mr. Gann he was unsure whether
petitioners had reported as income the $19,207 Future Satellite
earned for the additional services (he later explained to Mr.
Gann that petitioners deposited and reported the portion of the
$19,207 the installers collected for the additional services and
brought to Future Satellite’s office, i.e., the amounts the
installers did not keep as their compensation). Mr. Gann claims
that Mr. Sandoval Lua stated that petitioners did not report as
income any of the $19,207 Future Satellite earned for the
additional services.
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bank accounts. At trial they provided monthly statements from
each of their bank accounts showing each deposit made as well as
the workpaper Mrs. Sandoval created and later provided to
petitioners’ return preparer listing all of Future Satellite’s
deposits. Petitioners’ bank statements, when viewed alongside
Mrs. Sandoval’s workpaper, confirm that Mrs. Sandoval listed each
of Future Satellite’s deposits on the workpaper she prepared for
petitioners’ return preparer. Additionally, comparing the
amounts on Mrs. Sandoval’s workpaper with the gross receipts and
other income reported on petitioners’ Schedule C establishes that
petitioners’ return preparer reported all of the amounts listed
on Mrs. Sandoval’s workpaper on petitioners’ return.16
Accordingly, petitioners have provided sufficient evidence
to prove that they deposited the checks and excess cash into one
of their bank accounts and later reported these amounts on their
Schedule C.
B. Cash Kept by the Installers as Compensation for
Services Rendered
Petitioners admit that they did not report as income the
cash portion of the $19,207 that Future Satellite earned for the
additional services and allowed the installers to keep as their
compensation. They argue, however, that they did not deduct as
compensation paid the amounts of cash the installers kept as
their compensation, and therefore any increase in income should
16
See supra note 9.
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be offset by the unclaimed deduction for compensation paid.
Respondent counters that petitioners cannot substantiate the
exact amount of the cash the installers kept as their
compensation for services rendered.
Taxpayers bear the burden of coming forward with evidence as
to the amount of offsetting expenses, if any. See Rule 142(b);
Elwert v. United States, 231 F.2d 928, 933 (9th Cir. 1956);
Lenihan v. Commissioner, T.C. Memo. 2006-259; Temple v.
Commissioner, T.C. Memo. 2000-337, affd. 62 Fed. Appx. 605 (6th
Cir. 2003). When taxpayers establish that they have incurred
deductible expenses but are unable to substantiate the exact
amounts, we can estimate the deductible amounts, but only if the
taxpayers present sufficient evidence to establish a rational
basis for making the estimates. See Cohan v. Commissioner, 39
F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85
T.C. 731, 742-743 (1985). In estimating the amount allowable, we
bear heavily upon the taxpayer whose inexactitude is of his or
her own making. See Cohan v. Commissioner, supra at 544.
Petitioners have established that the cash Future Satellite
earned and allowed the installers to keep constituted the
installers’ compensation for additional services rendered and
therefore was an ordinary and necessary trade or business expense
deductible under section 162(a)(1). Respondent is correct that
petitioners cannot determine exactly how much of the $19,207 they
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allowed the installers to keep as their compensation for services
rendered; however, based on the record petitioners have proved
that they would be entitled to an offsetting deduction in the
exact amount of the portion of the $19,20717 kept by the
installers as their compensation. Accordingly, petitioners have
shown that they incurred unclaimed offsetting deductible expenses
in the exact amounts of the income they failed to report and
therefore owe no tax on the unreported income.18
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.
17
We note that $19,207 is less than 1 percent of Future
Satellite’s reported gross income of $995,438.
18
Petitioners’ failure to report the additional amount as
income does not result in an increase in self-employment tax.
Self-employment tax is imposed on self-employment income, which
is the net earnings from a trade or business less allowable
deductions under sec. 162. See secs. 1401 and 1402.