T.C. Summary Opinion 2015-73
UNITED STATES TAX COURT
BRUCE R. HOFFMAN AND DEBRA S. HOFFMAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 21050-10S. Filed December 10, 2015.
Bruce R. Hoffman and Debra S. Hoffman, pro se.1
Christopher A. Pavilonis and A. Gary Begun, for respondent.
SUMMARY OPINION
GOEKE, Judge: This case was heard pursuant to the provisions of section
7463 of the Internal Revenue Code (Code) in effect when the petition was filed.2
1
Michael P. Tyson represented petitioners at trial. Mr. Tyson entered his
appearance in October 2014 and filed a motion to withdraw on February 20, 2015,
which the Court granted on February 25, 2015. Bruce R. Hoffman submitted all
briefs for petitioners.
2
Unless otherwise indicated, section references are to the Internal Revenue
(continued...)
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Pursuant to section 7463(b), the decision to be entered is not reviewable by any
other court, and this opinion shall not be treated as precedent for any other case.
Respondent determined deficiencies and accuracy-related penalties for
2004, 2005, and 2006 as follows:
Penalty
Year Deficiency sec. 6662(a)
2004 $7,114 $1,423
2005 6,613 1,323
2006 6,296 1,259
After concessions,3 the issues for decision are:
2
(...continued)
Code in effect at all relevant times, Rule references are to the Tax Court Rules of
Practice and Procedure, and dollar amounts are rounded to the nearest dollar.
3
Respondent concedes that petitioners are entitled to a reduction in other
income reported on Schedule C, Profit or Loss From Business, of $16,500 for
2005. Additionally, respondent determined that petitioners are entitled to
additional deductions on Schedules C for taxes and licenses of $1,433, $2,450, and
$2,982 for 2004, 2005, and 2006, respectively. We note that respondent listed
these additional deductions as an issue on brief but did not provide any argument.
Because respondent allowed the deductions in the notice of deficiency, made no
argument against the deductions, and presented no evidence that petitioners were
not entitled to additional deductions for taxes and licenses, this issue is deemed
conceded by respondent. See also Rule 142. The notice of deficiency also
included an itemized deduction computational adjustment and self-employment
tax computational adjustments. These issues are to be resolved in the parties’ Rule
155 computations consistent with the Court’s opinion.
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(1) whether petitioners are entitled to various deductions in excess of those
respondent allowed from petitioners’ Schedules C for the years at issue. We hold
that they are not;
(2) whether petitioners have unreported Schedule C gross receipts or sales
for the years at issue. We hold that they do;
(3) whether petitioners are liable for section 6662(a) accuracy-related
penalties for the years at issue. We hold that they are; and
(4) whether Mrs. Hoffman is entitled to relief from joint and several liability
under section 6015(b). We hold that she is.
Background
Petitioners resided in South Carolina at the time they petitioned this Court
for redetermination of the determined deficiencies and accuracy-related penalties.
Petitioners filed Forms 1040, U.S. Individual Income Tax Return, claiming
married filing jointly status for 2004, 2005, and 2006.
Mr. Hoffman obtained a bachelor’s degree in history from the University of
Maryland, a law degree from Southwestern University School of Law, and a
master’s in tax law from New York University. Mr. Hoffman has been practicing
law since 1984 and is admitted to practice in South Carolina, California, District
of Columbia, and before this Court. During the years at issue Mr. Hoffman was
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the sole member and manager of the Law Office of Bruce R. Hoffman, LLC (law
office). The law office is a general practice with an emphasis in tax, estate
planning, probate, business, and real estate.
Mrs. Hoffman holds a bachelor’s degree in political science and has no
background in finance. In 2004 and 2005 she was a substitute teacher, and in
2006 she did some work for a newspaper. She was not involved with the finances
or business operations of the law office during the years at issue.
Sometime in 2005 petitioners applied for a residential loan. Mr. Hoffman
estimated his monthly income at $15,000 on the application. Mrs. Hoffman signed
all relevant loan documents.
Notice of Deficiency
Petitioners reported the revenue and expenses attributed to the law office on
Schedules C of Forms 1040 for the years at issue. Petitioners reported Schedule C
gross receipts or sales attributable to the law office of $151,511, $143,073, and
$134,702 for 2004, 2005, and 2006, respectively. Petitioners reported Schedule C
total expenses attributable to the law office of $130,142, $140,806, and $85,357
for 2004, 2005, and 2006, respectively.
On the basis of a bank deposits analysis, respondent determined that
petitioners had unreported income. In addition, respondent disallowed certain
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deductions that petitioners had claimed on Schedules C of the 2004, 2005, and
2006 tax returns.
Schedule C Unreported Income
During the years at issue petitioners maintained bank accounts with BB&T
and Lowcountry National Bank. In 2005 and 2006 petitioners maintained a bank
account with First Citizens Bank. And in 2006 petitioners maintained a bank
account with Regions Bank. The BB&T account appears to have been the primary
account for the law office for 2004 and 2005. The Regions Bank account appears
to have been the primary account for the law office for 2006.
Respondent subpoenaed petitioners’ bank statements because petitioners did
not provide them when requested. After reviewing bank statements and
interviewing Mr. Hoffman, respondent performed a bank deposits analysis and
removed nontaxable items. Relevant nontaxable items removed include: a
$31,790 BB&T credit line and $28,609 in BB&T credit card advances for 2004; a
$11,798 credit line advance and a $66,081 in credit card advances for 2005; and a
$33,498 First Citizens Bank advance/loan for 2006 (cumulatively, credit card
advances). After removing nontaxable items respondent determined that
petitioners had failed to report additional Schedule C gross receipts or sales of
$9,772, $15,368, and $11,367 for 2004, 2005, and 2006, respectively.
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Schedule C Deductions
Deductions for the law office for the years at issue include the following:
Expense 2004 2005 2006
Supplies $3,855 $5,621 -0-
Meals and
entertainment 2,519 3,868 $1,584
Insurance (other
than health) 9,069 8,278 8,083
Travel 6,007 8,199 6,335
Repairs and
maintenance 3,855 7,016 -0-
Bad debt 3,463 6,119 3,613
Office 39,808 39,902 22,103
During the audit Mr. Hoffman mailed respondent boxes with copies of
checks and invoices in a folder labeled business expenses for each year at issue.
The boxes contained no general ledger or spreadsheet or any other document that
indicated which expense was deducted under each category. In addition, Mr.
Hoffman testified to substantiate Schedule C expenses for the years at issue.
Because documents provided for 2005 and 2006 were undifferentiated and
unorganized, respondent allowed expense deductions for 2005 and 2006 on the
basis of the substantiated expenses for 2004. After the audit was completed,
respondent returned all boxes of documents to petitioners.
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Respondent allowed deductions for the following Schedules C expenses in
the amount specified for each year at issue:
Expense Amount
Supplies $3,264
Meals and entertainment 571
Insurance (other than health) 5,764
Travel 2,206
Repairs and maintenance 3,258
Bad debt 675
Office 18,674
On June 24, 2010 respondent issued petitioners a notice of deficiency
determining deficiencies of $7,114, $6,613, and $6,296 and penalties of $1,423,
$1,323, and $1,259 for 2004, 2005, and 2006, respectively. Petitioners timely
petitioned this Court for redetermination of the determined deficiencies and
accuracy-related penalties for the years at issue.
Document Production
On August 7, 2012, respondent sent petitioners a letter requesting that they
“provide documentation to substantiate the expenses disallowed in the notice of
deficiency” and “[a]lso, identify which deposits * * * are nontaxable for 2004,
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2005, and 2006.” Petitioners did not provide the information and documents
requested.
On February 21, 2014, respondent filed a motion to compel production of
documents. Petitioners objected to respondent’s motion, stating that “[t]he IRS
having already received and had the opportunity to review all this documentation
and information, it is burdensome and oppressive on petitioners”. In an order
dated April 30, 2014, this Court found petitioners’ objections to be groundless and
ordered them to produce the documents requested.
In a facsimile dated May 30, 2014, respondent informed petitioners that if
they needed additional records, such as credit card statements, they “may issue a
subpoena to obtain those records” and “[t]he Tax Court website * * * contains
information for issuing a subpoena to third parties.” Petitioners did not subpoena
any additional records.
On June 4, 2014, petitioners moved for reconsideration of the April 30,
2014, order. In their request for reconsideration petitioners sought a protective
order and an extension of time to comply with the April 30, 2014, order. This
Court then issued an order dated June 20, 2014, denying a protective order and
granting an extension of time. The June 20, 2014, order stated in relevant part:
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“If respondent does not have copies of [petitioners’] credit card
statements, petitioners must obtain those records from their credit card
companies or find other evidence to support their position. * * * In order
to satisfy petitioners’ burden of proving that some of the deposits are
nontaxable * * * petitioners first must produce the documents to
respondent. * * * Their failure to do so may result in the Court’s * * *
refusing to allow petitioners to introduce the requested documents as
evidence at trial”.
On October 17, 2014, respondent filed a second motion to compel
production of documents, requesting that petitioners provide documents to
substantiate the Schedule C expenses for which deductions were disallowed in the
notice of deficiency for the years at issue. Petitioners responded that they “are
analyzing their records beginning in tax year 2004 and moving forward and will
provide the documentation requested as they progress.”
Before trial this Court ordered the parties to exchange any documents or
materials they expected to offer into evidence at trial at least 14 days before the
first day of the trial session. Petitioners did not exchange any documents.
Respondent made a motion in limine to exclude petitioners’ documents not
exchanged pursuant to the Court’s pretrial order. At trial this Court granted
respondent’s motion in limine in part to exclude documents that relate to section
274 expenses and allowed the introduction of documents that specifically relate to
nontaxable income and other deductible expenses.
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Continuances
Petitioners’ case at docket No. 12727-10L was originally set for trial
beginning February 28, 2011. On January 19, 2011, petitioners moved to
consolidate the case at docket No. 12727-10L with the case at hand and moved to
continue. This Court granted petitioners’ motions and set trial for the week of
September 9, 2013.
On May 7, 2013, petitioners again moved to continue. This Court granted
petitioners’ motion and set trial for the week of December 1, 2014.
On October 17, 2014, petitioners moved to continue a third time.
Additionally, petitioners moved for voluntary dismissal in docket No. 12727-10L.
We granted petitioners’ motion to dismiss.
On October 28, 2014, petitioners moved to have this case conducted as a
small tax case pursuant to section 7463. Petitioners also reasserted their motion to
continue and moved to have this case tried at an upcoming small case trial session
rather than the regular case trial session scheduled. This Court granted
petitioners’ motion to have the proceedings conducted as a small tax case and
denied the motion to continue.
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Discussion
I. Presumption of Correctness
As a general rule, the Court will not look behind a notice of deficiency to
examine the evidence used, the propriety of the Commissioner’s motives, or
administrative policy or procedure used in making the determination. Riland v.
Commissioner, 79 T.C. 185, 201 (1982); Greenberg’s Express, Inc. v.
Commissioner, 62 T.C. 324, 327 (1974). The rationale for this rule is that a trial
before the Tax Court is a de novo proceeding, and our decision is based on the
merits of the record before us and not on the merits of the administrative record.
Jackson v. Commissioner, 73 T.C. 394, 400 (1979); Greenberg’s Express, Inc. v.
Commissioner, 62 T.C. at 328. We have, however, recognized two limited
exceptions to the general rule: (1) where there is substantial evidence of
unconstitutional conduct by the Commissioner, and (2) in the so-called naked
assessment cases involving unreported income where the Commissioner
introduces no evidence but rests on the presumption of correctness and the
taxpayer challenges the notice of deficiency on the grounds that it is arbitrary.
Graham v. Commissioner, 82 T.C. 299, 308-309 (1984), aff’d, 770 F.2d 381 (3d
Cir. 1985); see also United States v. Janis, 428 U.S. 433, 441 (1976). In neither
circumstance has this Court held the notice of deficiency invalid. Graham v.
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Commissioner, 82 T.C. at 309; see Riland v. Commissioner, 79 T.C. at 207;
Jackson v. Commissioner, 73 T.C. at 401; Greenberg’s Express, Inc. v.
Commissioner, 62 T.C. at 328; Human Eng’g Inst. v. Commissioner, 61 T.C. 61
(1973).
The thrust of petitioners’ argument is that the notice of deficiency is invalid
because (1) respondent did not summon petitioners’ credit card records and (2)
respondent based expense deductions for 2005 and 2006 on substantiated expense
deductions for 2004. Petitioners contend that the notice of deficiency falls into the
narrow category of a “naked assessment”, requiring that “audit * * * results must
be thrown out” because “no real audit was done”. We disagree.
On the basis of petitioners’ income tax returns for the years at issue, records
petitioners supplied, subpoenaed bank statements, and oral testimony, respondent
determined the deficiencies for the years at issue. Respondent issued a report
explaining that because limited records were provided, oral testimony was
accepted for numerous items and amounts that were substantiated for 2004 were
allowed for 2005 and 2006 because the expenses were recurring. Respondent’s
determination does not constitute a “naked assessment”, and we will not look
behind the notice.
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Moreover, courts have approved the Commissioner’s use of estimates,
assumptions, extrapolations, and the like in calculating a taxpayer’s income. See,
e.g., Adamson v. Commissioner, 745 F.2d 541, 547-548 (9th Cir. 1984), aff’g T.C.
Memo. 1982-371; Keogh v. Commissioner, 713 F.2d 496, 498-502 (9th Cir.
1983), aff’g Davies v. Commissioner, T.C. Memo. 1981-438. Extrapolation of
information from an earlier year to determine the extent of unreported income for
a later year may not be an unreasonable approach depending upon all the facts and
circumstances. See Day v. Commissioner, 975 F.2d 534, 538 (8th Cir. 1992),
aff’g in part, rev’g in part T.C. Memo. 1991-140; Bradford v. Commissioner, 796
F.2d 303, 306-307 (9th Cir. 1986), aff’g T.C. Memo. 1984-601; DeLorenzo v.
United States, 555 F.2d 27, 29 (2d Cir. 1977); Jackson v. Commissioner, 73 T.C.
at 403. Further, respondent’s use of extrapolation to allow recurring deductions
for 2005 and 2006 was more favorable to petitioners than denying deductions for
those years in full.
The Commissioner’s deficiency determination ordinarily is entitled to a
presumption of correctness. See Bone v. Commissioner, 324 F.3d 1289 (11th Cir.
2003), aff’g T.C. Memo. 2001-43. However, when the Commissioner determines
that a taxpayer received unreported income, the determination in the notice of
deficiency must be supported by an evidentiary foundation linking the taxpayer to
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an income-producing activity. See Blohm v. Commissioner, 994 F.2d 1542, 1549
(11th Cir. 1993), aff’g T.C. Memo. 1991-636. The Commissioner need only
provide a minimal showing that the taxpayer failed to report income. Id. The
presumption of correctness applies once the Court determines that the
Commissioner provided the minimal evidentiary showing, and the taxpayer bears
the burden of proving that the notice of deficiency is arbitrary or erroneous. See
Weimerskirch v. Commissioner, 596 F.2d 358, 362 (9th Cir. 1979), rev’g 67 T.C.
672 (1977); Jackson v. Commissioner, 73 T.C. at 401; Dunne v. Commissioner,
T.C. Memo. 2008-63.
Respondent introduced evidence that Mr. Hoffman was the sole member
and manager of the law office and deposited proceeds from his law practice into
petitioners’ bank accounts with BB&T for 2004 and 2005 and Regions for 2006.
See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986) (holding that bank deposits
evidence receipt of income). Accordingly, we conclude that respondent laid the
requisite minimal evidentiary foundation for the contested unreported income
adjustments and that respondent’s determinations are entitled to a presumption of
correctness. Therefore, petitioners bear the burden of proving that the notice of
deficiency was arbitrary or erroneous.
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II. Burden of Proof
Generally, the Commissioner’s determinations in a notice of deficiency are
presumed correct, and the taxpayer bears the burden of proving that the
determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111
(1933). If, however, a taxpayer produces credible evidence with respect to any
factual issue relevant to ascertaining the taxpayer’s tax liability and satisfies the
requirements of section 7491(a)(2), the burden of proof on any such issue shifts to
the Commissioner. Sec. 7491(a)(1). Section 7491(a)(2) requires a taxpayer to
demonstrate that he complied with the substantiation requirements, maintained all
records required under the Code, and cooperated with reasonable requests for
witnesses, information, documents, meetings, and interviews. See also Higbee v.
Commissioner, 116 T.C. 438, 440-441 (2001).
Petitioners have neither alleged that section 7491 applies nor established
that they complied with the requirements of section 7491(a)(2) to substantiate
items, to maintain required records, and to fully cooperate with respondent's
reasonable requests. Rather, petitioners argue that because “bank deposit records
were used to estimate income when there were income logs and other
documentation of income available for all three years, means that the presumption
of correctness accorded notices of deficiency do not apply here” and that the
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burden should shift to respondent. Petitioners rely on Suarez v. Commissioner, 58
T.C. 792 (1972), to argue that the “burden shifted to [r]espondent” to prove that
petitioners had unreported income. Suarez, unlike this case, involved a notice of
deficiency determination based on illegally acquired records from the taxpayer.
Petitioners’ reliance on Suarez here is misplaced as respondent’s determination
was based on petitioners’ bank deposit records, which were lawfully obtained by
subpoena. Thus, the burden remains with petitioners to prove that the
determinations are erroneous.
III. Unreported Income
Gross income includes “all income from whatever source derived”. Sec.
61(a). 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 may 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, 1532-1533 (1970). The Commissioner’s
reconstruction need not be exact, but it must be reasonable in the light of all the
surrounding facts and circumstances. Petzoldt v. Commissioner, 92 T.C. 661, 687
(1989).
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A. Bank Deposits Method
The “bank deposits” method has long been upheld as a reasonable means of
determining income where a taxpayer is unwilling or unable to provide adequate
books and records. DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), aff’d, 959
F.2d 16 (2d Cir. 1992); Fisher v. Commissioner, T.C. Memo. 1997-450. Bank
deposits are deemed prima facie evidence of income, and the taxpayer bears the
burden of showing that the deposits were not taxable income but were derived
from a nontaxable source. See Calhoun v. United States, 591 F.2d 1243, 1245
(9th Cir. 1978); Parks v. Commissioner, 94 T.C. 654, 658 (1990) (citing Tokarski
v. Commissioner, 87 T.C. 74). The Commissioner “must take into account any
nontaxable source or deductible expense of which * * * [he] has knowledge” in
reconstructing income using the bank deposits method. See Clayton v.
Commissioner, 102 T.C. 632, 645-646 (1994). After the Commissioner
reconstructs a taxpayer’s income and determines a deficiency, the taxpayer bears
the burden of proving that the bank deposits analysis is unfair or inaccurate. See
Id. at 645; DiLeo v. Commissioner, 96 T.C. at 883. The taxpayer must prove that
the reconstruction is in error and may do so, in whole or in part, by proving that a
deposit is not taxable. See Clayton v. Commissioner, 102 T.C. at 645.
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Using the bank deposits method, respondent determined that petitioners had
unreported income for the years at issue. Respondent determined that Mr.
Hoffman received $9,772.26, $15,368.47, and $11,366.91 of unreported income
related to the law office for 2004, 2005, and 2006, respectively. The record
indicates that petitioners’ income logs and other documentation of income were
not readily understandable. Petitioners did not produce bank statements when
they were requested; thus, respondent summoned the bank records directly from
petitioners’ banks. We conclude from the record that respondent reasonably relied
on the bank deposits method to determine petitioners’ income, and petitioners bear
the burden of proving that respondent’s bank deposits analysis is unfair or
inaccurate. See sec. 446(b); Petzoldt v. Commissioner, 92 T.C. at 693; sec. 1.446-
1(b)(1), Income Tax Regs.
B. Bank Deposits Analysis
Petitioners argue that respondent’s bank deposits analysis is inaccurate. Mr.
Hoffman contends that all income was correctly reported and that any additional
deposits were from credit card advances. Mr. Hoffman, however, has not provided
any documentation or other credible evidence supporting his contention. At trial
Mr. Hoffman was asked how he knew specific items were not taxable. In response
Mr. Hoffman testified that “the credit card statements would’ve showed that if
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* * * [respondent] summonsed those like I asked”. Respondent removed $60,399,
$77,879, and $33,494 in credit card advances from taxable income for 2004, 2005,
and 2006, respectively. Petitioners offered no objective evidence that any deposits
identified by respondent were nontaxable for the years at issue.
Section 7602 authorizes the Commissioner to issue an administrative
summons to compel the taxpayer and third parties with relevant information to
produce books and records and testify. Nothing in section 7602 requires the
Commissioner to issue a summons. Petitioners were informed by both respondent
and this Court that if they wished to obtain their credit card records, they had to
personally get them from their credit card companies. Petitioners chose not to
subpoena their credit card records and now attempt to rely on records they
themselves failed to maintain and subsequently failed to acquire. We decline to
accept Mr. Hoffman’s self-serving and unverified testimony that certain deposits
were nontaxable. See Tokarski v. Commissioner, 87 T.C. at 77.
IV. Schedule C Expenses
Deductions are a matter of legislative grace, with the taxpayer bearing the
burden of proving entitlement to the deductions claimed. INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934). Taxpayers bear the burden of substantiating the amount and
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purpose of any claimed deduction. See Hradesky v. Commissioner, 65 T.C. 87
(1975), aff’d, 540 F.2d 821 (5th Cir. 1976). Taxpayers are required to maintain
sufficient records to establish the amounts of income and deductions. Sec. 6001;
Higbee v. Commissioner, 116 T.C. at 440; sec. 1.6001-1(a), Income Tax Regs. In
some circumstances, this Court may apply the Cohan rule to estimate an expense
that a taxpayer establishes is deductible but does not otherwise substantiate the
precise amount of. See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir.
1930). This Court may apply the Cohan rule, however, only if the record supplies
a basis upon which to estimate the deductible expense. See Vanicek v.
Commissioner, 85 T.C. 731, 742-743 (1985).
Section 162(a) allows as a deduction “all the ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any trade or
business”. See Boyd v. Commissioner, 122 T.C. 305, 313 (2004). Certain
deductions, including those relating to travel, meals, and entertainment, are subject
to heightened substantiation requirements. See sec. 274(d). In deciding whether a
taxpayer has satisfied his or her burden of substantiating a deduction, we are not
required to accept the taxpayer’s self-serving testimony. Tokarski v.
Commissioner, 87 T.C. at 77.
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Petitioners argue that they have numerous boxes of documents in support of
their claim that expenses underlying all their claimed deductions were adequately
substantiated and that these boxes should have been admitted into evidence.
Petitioners’ own counsel described the boxes as containing “a range of somewhat
organized to not organized at all; expense information, receipts, checks, their
cancelled checks, bank statements.” Respondent first requested these
substantiating documents from petitioners in August 2012 and continued to
request documents up until trial in December 2014. Petitioners, however, did not
comply with respondent’s requests.
Because petitioners did not exchange any documents, respondent made a
motion in limine to exclude all documents not exchanged. We granted
respondent’s motion in part, stating that we would “consider specific documents
that are tied to specific points of testimony or that * * * relate to [r]espondent’s
income determinations or would, in fact, support specific, well organized
discussions of Schedule C expenses that are not subject to Code section 274”. We
provided petitioners the opportunity: to include documents related to Schedule C
expenses in a supplemental stipulation of facts; to make an offer of proof at trial;
and to testify as to their expenses. Petitioners did not avail themselves of this
opportunity. At trial Mr. Hoffman provided limited testimony regarding expenses
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which did not establish the “general total amount of the [business] expenses” to
allow an estimation under Cohan. See Charron v. United States, 200 F.3d 785,
794 (Fed. Cir. 1999). We therefore sustain respondent’s disallowance of the
claimed deductions in excess of the amounts allowed.
V. Section 6662(a) Penalty
The Commissioner bears the burden of production on the applicability of an
accuracy-related penalty in that he must come forward with sufficient evidence
indicating that it is proper to impose the penalty. See sec. 7491(c); see also
Higbee v. Commissioner, 116 T.C. at 446. Once the Commissioner meets this
burden, the burden of proof remains with the taxpayer, including the burden of
proving that the penalty is inappropriate because of reasonable cause and good
faith. See Higbee v. Commissioner, 116 T.C. at 446-447. “Circumstances that
may indicate reasonable cause and good faith include an honest misunderstanding
of fact or law that is reasonable in light of all of the facts and circumstances,
including the experience, knowledge, and education of the taxpayer.” Sec.
1.6664-4(b)(1), Income Tax Regs.
Section 6662(a) and (b)(1) and (2) imposes a 20% accuracy-related penalty
if any part of an underpayment of tax required to be shown on a return is due to
negligence or disregard of rules or regulations or a substantial understatement of
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income tax. The penalty is 20% of the portion of the underpayment of tax to
which the section applies. Sec. 6662(a). Respondent determined that petitioners
are liable for an accuracy-related penalty under section 6662(a) because their
underpayments for the years at issue resulted from negligence or disregard of rules
or regulations and were due to substantial understatements of income tax as
defined by section 6662(d).
The term “negligence” includes any failure to make a reasonable attempt to
comply with the provisions of the internal revenue laws, and the term “disregard”
includes any careless, reckless, or intentional disregard. Sec. 6662(c); sec. 1.6662-
3(b)(1) and (2), 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.
Respondent argues that petitioners’ failure to keep and produce
documentation substantiating income and expenses supports the imposition of the
accuracy-related penalty for negligence for the years at issue. Respondent also
argues that as an attorney with specialized knowledge in tax law, Mr. Hoffman
should have been aware of his duty to maintain adequate records of income and
expenses.
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Petitioners do not contend that they acted with reasonable cause and in good
faith in the preparation of their income tax returns. Rather, petitioners argue that
they had legitimate arguments for all deductions claimed; however, petitioners
failed to present any documentation supporting their claim. And petitioners did
not present any arguments in brief or at trial relating to specific deductions
claimed.
We agree with respondent. Consequently, we hold that petitioners are liable
for accuracy-related penalties under section 6662(a) for the years at issue with the
amounts of those penalties to be determined by the parties in their Rule 155
computations.
VI. Relief From Joint and Several Liability
In general, married taxpayers who file a joint return are jointly and severally
liable for the tax arising from the return. Sec. 6013(d)(3). Section 6015 allows a
spouse to obtain relief from joint and several liability in certain circumstances.
Except as otherwise provided in section 6015, the taxpayer bears the burden of
proving that she is entitled to section 6015 relief. Rule 142(a). Both the scope
and standard of review in cases requesting relief from joint and several liability are
de novo. Porter v. Commissioner, 132 T.C. 203, 210 (2009).
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A taxpayer may seek relief from joint and several liability under section
6015(b) if: (1) the taxpayer has filed a joint return for the taxable year, (2) on the
return there is an understatement of tax attributable to the other taxpayer, (3) the
taxpayer establishes that in signing the return she did not know and had no reason
to know of the understatement, (4) taking into account the facts and circumstances,
it is inequitable to hold the taxpayer liable for the deficiency attributable to the
understatement, and (5) the taxpayer elects relief from joint and several liability
within two years of the beginning of the collection activities. These conditions are
stated in the conjunctive, and the taxpayer must satisfy all five in order to be
awarded relief. Alt v. Commissioner, 119 T.C. 306, 313 (2002), aff’d, 101 F.
App’x 34 (6th Cir. 2004).
Respondent contends that Mrs. Hoffman failed to satisfy the third
requirement.
If this case were appealable, appeal would lie in the Fourth Circuit.
Because the Court of Appeals for the Fourth Circuit has not spoken on this issue,
we will apply the standard of whether “a reasonably prudent taxpayer under the
circumstances of the spouse at the time of signing the return could be expected to
know that the tax liability stated was erroneous or that further investigation was
warranted.” Bokum v. Commissioner, 94 T.C. 126, 148 (1990) (quoting Stevens
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v. Commissioner, 872 F.2d 1499, 1505 (11th Cir. 1989), aff’g T.C. Memo. 1988-
63), aff’d, 992 F.2d 1132 (11th Cir. 1993). In establishing that she had no reason
to know, the taxpayer must show that she was unaware of the circumstances that
gave rise to the error and was not merely unaware of the tax consequences. Id. at
145-146; Purcell v. Commissioner, 86 T.C. 228, 237-238 (1986), aff’d, 826 F.2d
470, 473-474 (6th Cir. 1987). This standard applies to an understatement of tax
resulting from underreporting income and from improperly claiming deductions.
Bokum v. Commissioner, 94 T.C. at 148.
Respondent argues that Mrs. Hoffman knew or had reason to know of the
understatement of tax attributable to the underreporting of gross receipts on the
Schedules C because (1) she had signature authority over the family’s bank
accounts and (2) she signed a mortgage application which estimated Mr.
Hoffman’s monthly gross income higher than was reported on the income tax
returns for 2004 and 2005.
Mrs. Hoffman was not involved with the law office business and had no
knowledge of the law office income. Additionally, we are not persuaded that an
estimate of income on the loan application gave Mrs. Hoffman reason to know of
the underreported income.
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A review of the return would have revealed Mr. Hoffman’s reported gross
receipts and claimed business expense deductions. However, a review of these
items on the return would not necessarily have revealed that Mr. Hoffman’s gross
receipts were underreported or that his expense deductions were overstated. See
Phemister v. Commissioner, T.C. Memo. 2009-201.
Taking into account all of the facts and circumstances that may be drawn
from the record, we conclude that it would be inequitable to hold Mrs. Hoffman
liable for the deficiencies in tax attributable to Mr. Hoffman. Accordingly, Mrs.
Hoffman has satisfied all the requirements for relief under section 6015(b) with
respect to the understatements of tax for the years at issue. We hold that she is
entitled to relief under section 6015(b).
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.
Because of concessions and computational adjustments,
Decision will be entered under
Rule 155.