T.C. Memo. 2012-321
UNITED STATES TAX COURT
CAROL TRESCOTT, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 21320-09. Filed November 19, 2012.
Carol Trescott, pro se.
Joel D. McMahan, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
PARIS, Judge: Respondent issued a notice of deficiency determining the
following deficiencies in petitioner’s Federal income tax and additions to tax
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[*2] under sections1 6651(a)(1) and (2) and 6654:
Additions to tax
Sec. Sec. Sec.
Year Deficiency 6651(a)(1) 6651(a)(2) 6654
2002 $10,672 $2,401.20 $2,668.00 $356.63
2003 10,871 2,445.98 2,717.75 280.51
2004 11,488 2,584.80 2,872.00 329.24
2005 12,957 2,915.33 2,461.83 519.75
2006 14,132 3,179.70 1,837.16 668.81
2007 24,122 5,427.45 1,668.54 1,097.84
Respondent conceded at trial that petitioner was entitled to section 163 deductions
for mortgage interest as well as section 164 deductions for real estate taxes paid
for the years at issue. The remaining issues for decision are: (1) whether
respondent correctly determined that petitioner had gross income of $41,818,
$42,850, $44,813, $49,087, $52,676, and $80,000 for tax years 2002, 2003, 2004,
2005, 2006, and 2007, respectively; (2) whether petitioner is entitled to any
deductions under section 162 for ordinary and necessary business expenses
incurred during the years at issue; (3) whether petitioner is liable for additions to
1
Unless otherwise indicated, section references are to the Internal Revenue
Code (Code) in effect for the tax years at issue, and Rule references are to the Tax
Court Rules of Practice and Procedure.
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[*3] tax under section 6651(a)(1) for failure to file Federal income tax returns timely
for the years at issue; (4) whether petitioner is liable for additions to tax under
section 6651(a)(2) for failure to pay Federal income tax timely for the years at issue;
(5) whether petitioner is liable for additions to tax under section 6654 for failure to
make estimated tax payments for the years at issue; and (6) whether a section 6673
penalty should be imposed upon petitioner.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of
facts and the exhibits received in evidence are incorporated herein by this reference.
Petitioner resided in Florida when her petition was filed.
Petitioner has been a massage therapist licensed in the State of Florida since
1978. During the years at issue petitioner operated a massage therapy business
from her home and was paid for her massage therapy services. Petitioner did not
file any Federal income tax returns for the years at issue.2
In 2009 the Internal Revenue Service began an audit examination of
petitioner. On June 1, 2009, respondent prepared substitutes for returns under
section 6020(b) for tax years 2002 through 2007. Because petitioner dealt
primarily in cash and refused to cooperate in the examination, respondent was
2
Petitioner also did not file a Federal income tax return for tax year 2001.
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[*4] forced to determine petitioner’s income for tax years 2002 through 2006
using a combination of petitioner’s known expenses3 and Bureau of Labor
Statistics (BLS) minimum living expense information for a single person with a
mortgage in petitioner’s geographic region. For tax year 2007 respondent
determined petitioner’s income by using an amount petitioner reported on a credit
application submitted to JP Morgan-Chase Bank in February 2007.
On June 3, 2009, respondent issued to petitioner the notice of deficiency
for tax years 2002, 2003, 2004, 2005, 2006, and 2007.4 Petitioner timely filed a
petition with this Court.
OPINION
I. Respondent’s Determinations of Income
It is well established that the Commissioner’s determinations, as embodied
in his statutory notices of deficiency, are presumed correct. Welch v. Helvering,
290 U.S. 111 (1933). The presumption is procedural and transfers to the taxpayer
the burden of proving that the Commissioner’s determinations are incorrect.
Barnes v. Commissioner, 408 F.2d 65 (7th Cir. 1969), aff’g T.C. Memo.
3
Respondent was able to find records of petitioner’s mortgage payments as
well as real estate taxes paid to her county of residence by her mortgage lender.
4
The amounts reflected in the notice of deficiency are the same as those
reproduced in the above table.
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[*5] 1967-250. However, the burden of proof shifts to the Commissioner if the
taxpayer can show that the Commissioner’s determinations were arbitrary and
excessive. Helvering v. Taylor, 293 U.S. 507, 514-515 (1935); Berkery v.
Commissioner, 91 T.C. 179, 186 (1988), aff’d without published opinion, 872 F.2d
411 (3d Cir. 1989).
A. Tax Years 2002 through 2006
Section 61(a)(1) defines gross income as all income from whatever source
derived including compensation for services such as wages, salaries, and bonuses.
See also sec. 1.61-2(a)(1), Income Tax Regs. Taxpayers are required to maintain
books and records sufficient to establish the amount of their gross income. Sec.
6001. If the taxpayer fails to do this, then the Commissioner is entitled to
reconstruct the taxpayer’s income through the use of any reasonable method. See
Holland v. United States, 348 U.S. 121 (1954); Giddio v. Commissioner, 54 T.C.
1530, 1532-1534 (1970). Reliance on BLS statistics in reconstructing a taxpayer’s
income has been held to be reasonable. Giddio v. Commissioner, 54 T.C. at 1533;
Bennett v. Commissioner, T.C. Memo. 1998-96.
Petitioner admits that she conducted an ongoing massage therapy business
during the years at issue. Petitioner neither filed Federal income tax returns nor
provided respondent with any books and records concerning her massage therapy
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[*6] business. Respondent did his best to reconstruct petitioner’s income by
combining petitioner’s known expenses with cost of living estimates presented by
BLS statistics for tax years 2002 through 2006. The Court finds that respondent’s
efforts to reconstruct petitioner’s income for tax years 2002 through 2006 were
reasonable and the determinations resulting from those efforts were not arbitrary or
excessive.
Petitioner failed to introduce any substantive evidence as to her income for
the years at issue. Petitioner failed to carry her burden to prove that respondent’s
determinations were incorrect. Accordingly, respondent’s determinations of gross
income for tax years 2002 through 2006 are sustained.
B. Tax Year 2007
For tax year 2007 respondent reconstructed petitioner’s income by relying on
an application for a line of credit that petitioner filled out in February 2007.
Petitioner contends that this method of reconstruction was unreasonable and that the
notice of deficiency was arbitrary and excessive.
When a taxpayer asks the Court to find a statutory notice of deficiency to be
arbitrary and excessive, he or she is asking the Court to look behind that notice. As
a general rule, the Court will not honor such a request, even though the
determination may have been based on hearsay or other inadmissible evidence.
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[*7] Dellacroce v. Commissioner, 83 T.C. 269, 280 (1984). The rationale for the
general rule is that a trial before the Court is a proceeding de novo, and
determinations therefore are to be based upon the merits of the case and not upon
the record developed at the administrative level. Greenberg’s Express, Inc. v.
Commissioner, 62 T.C. 324, 327-328 (1974).
The Court has recognized exceptions to the general rule, however, in cases
involving unreported income where the Commissioner introduced no substantive
evidence but rested on the presumption of correctness and the taxpayer challenged
the notice of deficiency on the grounds that it was arbitrary. See Jackson v.
Commissioner, 73 T.C. 394, 401 (1979). All that is required to support the
presumption of correctness is that the Commissioner’s determination have some
minimal factual predicate. Blohm v. Commissioner, 994 F.2d 1542, 1549 (11th Cir.
1993), aff’g T.C. Memo. 1991-636. It is only when the Commissioner’s assessment
is shown to be “without rational foundation” or “arbitrary and erroneous” that the
presumption should not be recognized. Pittman v. Commissioner, 100 F.3d 1308,
1317 (7th Cir. 1996), aff’g T.C. Memo. 1995-243.
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[*8] Furthermore, the Court has held that it is reasonable for the Commissioner to
reconstruct a taxpayer’s income from self-reported income figures supplied by the
taxpayer on a loan application. See Driggers v. Commissioner, T.C. Memo. 1997-
354.
Respondent presented substantive evidence of his determination in the form
of a credit application signed by petitioner in February 2007. As a result, it is the
Court’s opinion that the aforementioned exception to the general rule of refusing to
look behind the notice of deficiency is inapplicable. Even if the exception were
applicable, it cannot be said that respondent’s decision to base his determination on
the credit application was “without rational foundation” or “arbitrary and
erroneous”. The 2007 income figure respondent used was self-reported by
petitioner to a federally insured institution on a signed credit application.
Accordingly, respondent’s determinations are presumed correct.
At trial petitioner did not produce any evidence beyond self-serving
testimony that respondent’s income determinations were incorrect. Petitioner was
asked repeatedly by respondent’s counsel to produce evidence relating to
petitioner’s income for the years at issue. Instead of attempting to prove her true
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[*9] income, petitioner only denied that respondent’s determinations were accurate.5
Petitioner failed to carry her burden of proving that respondent’s determination was
incorrect. Accordingly, respondent’s determination of gross income for tax year
2007 is sustained.
II. Business Expenses
Section 162(a) allows a deduction for ordinary and necessary expenses paid
or incurred in carrying on a trade or business. An expense is ordinary if it is
customary or usual within a particular trade, business, or industry, or relates to a
transaction of common or frequent occurrence in the type of business involved.
Deputy v. du Pont, 308 U.S. 488, 495 (1940). An expense is necessary if it is
appropriate and helpful for the business. See Commissioner v. Heininger, 320 U.S.
467, 471 (1943). Taxpayers must keep sufficient records to substantiate any
deductions otherwise allowed by the Code. Sec. 6001; Rule 142(a).
Petitioner failed to keep sufficient records of her business transactions or
expenses for any of the years at issue. Although petitioner prepared an estimated
expense spreadsheet representing purported expenses for the years at issue, she
5
While the Court notes that the income attributed to petitioner for tax year
2007 was substantially more than for the other years at issue, petitioner failed to
take advantage of several opportunities to provide any income information for tax
year 2007.
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[*10] furnished very little evidence to substantiate any of the expenses claimed.
The items of expense discussed below are the only ones for which petitioner
provided any evidence in substantiation beyond her estimated expense spreadsheet
and self-serving testimony. Accordingly, petitioner has failed to carry her burden of
proof with respect to all other items of expense for the years at issue.
A. Telephone Expenses
Petitioner furnished telephone bills she paid for a secondary telephone line
used in relation to her massage therapy business. The amounts she paid for the
years at issue were as follows:
2002 2003 2004 2005 2006 2007
Amount paid $741.97 $584.35 $636.09 $619.65 $657.18 $684.69
Petitioner adequately established that the telephone account listed on the
records was indeed a secondary telephone line unrelated to her personal telephone.
Furthermore, the Court accepts petitioner’s testimony that said records relate to a
phone used in the day-to-day operations of her massage therapy business. The
Court finds that those expenses were ordinary and necessary in carrying on her
massage therapy business. Accordingly, petitioner is entitled to section 162
deductions for expenses paid in relation to this telephone line.
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[*11] B. Massage Therapy License Expenses
If a taxpayer establishes that he or she paid a deductible business expense but
cannot substantiate the precise amount, the Court may estimate the amount of the
deductible expense, bearing heavily upon the taxpayer whose inexactitude is of his
own making. See Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir. 1930). 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).
Petitioner has sufficiently established that she was a massage therapist
licensed in the State of Florida for the years at issue. The parties have stipulated
that petitioner has been a licensed massage therapist for a number of years and
have included certificates of verification in the stipulations of fact. Petitioner
claimed her yearly licensing fees to have been $310 for each year at issue but
did not offer any physical evidence to substantiate the precise amount. The Court
takes judicial notice that according to the Florida Department of Health, through
which official State licensure is issued, the yearly renewal for an individual
massage therapy license is $155 and the yearly renewal for a massage therapy
establishment is also $155, and that these fees are required to be paid in
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[*12] conjunction.6 The Court finds that petitioner is entitled to a section 162
licensing expense deduction of $310 for each of the years at issue.
C. Business Use of Home Deductions
Section 280A, in general, provides that no deduction is allowed with respect
to the use of a taxpayer’s personal residence. However, an exception is granted
where the deduction is allocable to a portion of the dwelling unit which is
exclusively used on a regular basis: (1) as the principal place of business for any
trade or business of the taxpayer; (2) as a place of business which is used by
patients, clients, or customers in meeting or dealing with the taxpayer in the normal
course of his trade or business; or (3) in the case of a separate structure which is not
attached to the dwelling unit, in connection with the taxpayer’s trade or business.
Sec. 280A(c)(1).
Petitioner has introduced evidence to show that she is a licensed massage
therapist. Petitioner has also provided testimony and other evidence sufficient to
show that she operated her massage therapy business from a portion of her home
designated exclusively for business use. However, even granting petitioner that
her home office qualifies for the exception under section 280A(c)(1), she has
6
See generally Massage Therapy Renewal Information, Florida Department of
Health, http://www.doh.state.fl.us/mqa/renewal/marenewal/ma_renewal.html.
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[*13] failed to substantiate any expenses beyond the mortgage interest and the real
estate taxes that respondent has already conceded. Petitioner produced no utility
bills or insurance bills to substantiate the pro rata deductions she claimed on her
estimated expense spreadsheet. Additionally, petitioner did not allege that she was
entitled to any depreciation for the business portion of her home, much less provide
any evidence to that effect.
Petitioner provided adequate substantiation for the mortgage interest and real
estate tax deductions respondent conceded. Petitioner also provided adequate
evidence with which to calculate the percentage of her home that was dedicated to
business use. However, respondent has already conceded both of these items as
allowable deductions on Schedule A, Itemized Deductions, under sections 163 and
164. Petitioner has not established that she is entitled to any expenses related to the
business use of her home greater than respondent has already allowed.
III. Additions to Tax
A. Section 6651(a)(1) Addition to Tax
Failure to file a tax return by the date prescribed leads to a mandatory
addition to tax unless the taxpayer shows that such failure was due to reasonable
cause and not due to willful neglect. Sec. 6651(a)(1). For each month the return is
late, an addition to tax equal to 5% of the amount of tax required to be shown on
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[*14] the return shall be assessed, not exceeding 25% in the aggregate. Id. Under
section 7491(c), the Commissioner has the burden of production to show that the
imposition of an addition to tax under section 6651(a)(1) is appropriate. The parties
have stipulated that petitioner did not file Federal income tax returns for the years at
issue. Therefore, respondent has met his burden of production.
The burden of proving reasonable cause and lack of willful neglect falls on
the taxpayer. Rule 142(a); United States v. Boyle, 469 U.S. 241, 249 (1985);
Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). Reasonable cause exists
where a return is late despite the taxpayer’s exercising “ordinary business care and
prudence”. Sec. 301.6651-1(c), Proced. & Admin. Regs. Circumstances that are
considered to constitute reasonable cause are typically those outside of the
taxpayer’s control, for example: (1) unavoidable postal delays; (2) timely filing of a
return with the wrong office; (3) death or serious illness of the taxpayer or a member
of the taxpayer’s immediate family; (4) taxpayer’s unavoidable absence from the
United States; (5) destruction by casualty of taxpayer’s records or place of business;
and (6) reliance on the erroneous advice of an Internal Revenue Service officer or
employee. McMahan v. Commissioner, 114 F.3d 366, 369 (2d Cir. 1997), aff’g
T.C. Memo. 1995-547.
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[*15] Petitioner stipulated that she did not file Federal income tax returns for the
years at issue. Petitioner’s only argument was that she had studied the Code and
found no section which she believed imposed an income tax on her. This does not
fall under any of the reasonable cause circumstances enumerated above and, in fact,
was based on a misguided and self-serving interpretation of established tax law.
Accordingly, the Court sustains the additions to tax under section 6651(a)(1).
B. Section 6651(a)(2) Addition to Tax
Section 6651(a)(2) imposes an addition to tax on taxpayers for their failure to
pay timely the amount of tax shown on a return. A substitute for return prepared by
the Commissioner under section 6020(b) is treated as a return filed by the taxpayer
for purposes of section 6651(a)(2). Sec. 6651(g)(2); see also, e.g., Wheeler v.
Commissioner, 127 T.C. 200, 208-209 (2006), aff’d, 521 F.3d 1289 (10th Cir.
2008).
Respondent has the burden to prove that substitutes for returns satisfying
the requirements of section 6020(b) were prepared. See Cabirac v. Commissioner,
120 T.C. 163, 170 (2003); Gleason v. Commissioner, T.C. Memo. 2011-154. A
return for section 6020(b) purposes must be subscribed, it must contain sufficient
information from which to compute the taxpayer’s tax liability, and the return
form and any attachments must purport to be a “return”. Spurlock v.
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[*16] Commissioner, T.C. Memo. 2003-124. The Court has held that these
requirements have been met where the substitutes for returns consist of Forms 4549-
A, Income Tax Examination Changes; Forms 886-A, Explanation of Items; and
Forms 13496, IRC Section 6020(b) Certification, and the forms contain the
taxpayer’s name and Social Security number and sufficient information to compute a
tax liability. Gleason v. Commissioner, T.C. Memo. 2011-154.
Respondent’s substitutes for returns included Forms 4549-A, 886-A, and
13496. Furthermore, they contained petitioner’s name and Social Security number
and sufficient information upon which to compute a tax liability. Accordingly,
respondent’s substitutes for returns constitute valid section 6020(b) returns deemed
to have been filed by petitioner for the purposes of section 6651(a)(2).
Respondent has shown that the prepared substitutes for returns for the years
at issue were valid. Petitioner did not make any payments toward her Federal
income tax liabilities for the tax years at issue. Respondent has therefore satisfied
the burden of production under section 7491(c) with respect to the section
6651(a)(2) addition to tax. Petitioner did not introduce evidence to show that her
failure to pay was due to reasonable cause. Accordingly, petitioner is liable for the
additions to tax under section 6651(a)(2).
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[*17] C. Section 6654 Addition to Tax
Section 6654(a) imposes an addition to tax for a taxpayer’s underpayment of
estimated income tax. The addition to tax is calculated with reference to four
installment payments each equal to 25% of the required annual payment. Sec.
6654(c)(1), (d)(1)(A). The annual payment is the lesser of (1) 90% of the tax shown
on the return for the taxable year (or, if no return is filed, 90% of the tax for such
year), or (2) 100% of the tax shown on the taxpayer’s return for the preceding
taxable year. Sec. 6654(d)(1)(B). Option (2) does not apply where a taxpayer has
not filed a return for the preceding taxable year. Sec. 6654(d)(1)(B)(ii).
For the tax years at issue respondent introduced evidence to prove that
petitioner had Federal income tax liabilities, petitioner was required to file Federal
income tax returns, petitioner did not file returns, and petitioner did not make any
estimated tax payments.7 Therefore, respondent met his burden under section
7491(c) to show that, for each tax year at issue, petitioner had a required annual
payment under section 6654(d)(1)(B) but did not make any estimated tax payments.
7
Additionally, respondent introduced evidence that petitioner did not file a
Federal income tax return for tax year 2001. Accordingly, petitioner’s estimated tax
for each year could not be based on the amount of tax reported for the previous
year.
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[*18] Petitioner had taxable income for the years at issue. Petitioner did not make
any estimated tax payments for tax years 2002 through 2007. In her filings with the
Court petitioner did not allege that any of the statutory exemptions under section
6654(e) applies. Petitioner is therefore liable for the section 6654(a) additions to
tax.
D. Section 6673 Penalty
Section 6673 allows the Court to impose a penalty, payable to the United
States, and not in excess of $25,000, whenever it appears that (1) the proceedings
before it have been instituted or maintained by the taxpayer primarily for delay, (2)
the taxpayer’s position in such proceeding is frivolous or groundless, or (3) the
taxpayer unreasonably failed to pursue available administrative remedies.
Respondent has moved for imposition of such a penalty because of
petitioner’s lack of cooperation and reliance on frivolous arguments early in the
Court proceeding. However, petitioner has since renounced many of her frivolous
positions and was reasonably cooperative at trial. The Court will refrain from
imposing such a penalty at this time; however, petitioner is hereby warned that
penalties may be imposed in the future if she again decides to advance frivolous
arguments. Accordingly, respondent’s motion to impose a penalty under section
6673 will be denied.
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[*19] The Court has considered all arguments the parties have made, and to the
extent not discussed herein, we find that they are moot, irrelevant, or without merit.
To reflect the foregoing,
Order and decision will
be entered under Rule 155.