T.C. Memo. 2016-157
UNITED STATES TAX COURT
GREGORY A. POWER AND AMY S. POWER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 21903-14. Filed August 22, 2016.
William J. Sollmann, for petitioners.
Gary R. Shuler, Jr., for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
RUWE, Judge: In two separate notices of deficiency, respondent
determined deficiencies, additions to tax, and accuracy-related penalties as
follows:
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[*2] Gregory A. Power
Addition to Tax Accuracy-Related Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)
2007 $110,566 $26,791.50 $22,113.20
Gregory A. Power and Amy S. Power
Addition to Tax Accuracy-Related Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)
2010 $20,411 $5,102.75 $4,082.20
2011 18,434 4,608.50 3,686.80
After concessions,1 the issues remaining for decision are: (1) whether Mr. Power
incurred net operating losses (NOL) in the taxable years 1999-2002 which would
be available as carryover NOL deductions against income for the taxable years
2007-11; (2) whether Mr. Power received distributions from his wholly owned
subchapter S corporation in excess of his stock basis in the corporation for the
taxable years 2007-11; and (3) whether petitioners are liable for accuracy-related
penalties under section 6662(a) for the taxable years 2007, 2010, and 2011.
1
At trial on September 23, 2015, the parties filed a stipulation of settled
issues in which petitioners concede various adjustments that respondent made in
the notices of deficiency, including that (1) Mr. Power is liable for the addition to
tax under sec. 6651(a)(1) for the taxable year 2007 and (2) petitioners are liable
for the additions to tax under sec. 6651(a)(1) for the taxable years 2010 and 2011.
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[*3] Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for all relevant years, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of
facts, the stipulation of settled issues, and the attached exhibits are incorporated
herein by this reference.
Petitioners resided in Ohio at the time their petition was filed.
Mr. Power is a commercial real estate broker, and Mrs. Power is a former
school teacher. Mr. Power graduated from high school in 1972 and thereafter
enrolled in a general business degree program at Miami University in the fall of
1972. In the summer of 1973 Mr. Power enrolled in the business studies program
at the University of Cincinnati, but he left college after the spring semester of
1974 without completing a degree.
The State of Ohio and the Commonwealth of Kentucky issued Mr. Power
real estate broker licenses on March 5, 1976, and December 10, 1980,
respectively. Mr. Power has maintained both licenses since the respective dates of
issuance.
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[*4] Power Realty Advisors
In 1993 Mr. Power started his own real estate brokerage firm, Power Realty
Advisors, Inc. (Power Realty).2 On February 2, 1993, Power Realty filed articles
of incorporation with the Ohio secretary of state, and it elected to be treated as a
subchapter S corporation on February 19, 1993. Mr. Power is the sole shareholder
of Power Realty.
On November 6, 2006, Power Realty leased an office suite on Montgomery
Road in Cincinnati, Ohio. In 2007 Power Realty had two employees and used
Paychex as its third-party payroll provider. Debbie Berger, a secretary who is not
a certified public accountant (C.P.A.), kept and maintained the books and records
for Power Realty. In 2011 Power Realty let Ms. Berger go and downsized to a
smaller office suite on Hosbrook Road in Cincinnati, Ohio. For the taxable years
2007-11 Mr. Power maintained “Itemized Profit and Loss” and “Transactions by
Account” documents for Power Realty. Mr. Power has no formal training in tax or
accounting.
2
Mr. Power has been a licensed real estate broker for 40 years. Before
starting Power Realty in 1993, Mr. Power worked for Frederick Schmidt and
Chelsea Moore, respectively, which are real estate firms in Cincinnati, Ohio.
-5-
[*5] Power Realty’s Forms 1120S
Power Realty filed Forms 1120S, U.S. Income Tax Return for an S-
Corporation, for the taxable years 1993-2011, which were prepared by either
Attorney C. Christopher Muth or C.P.A. Andrew J. Bucher.3 When Mr. Muth
prepared returns, Mr. Power would typically provide him with one or two sheets of
paper with handwritten income and expense categories and corresponding
amounts. Mr. Power would provide underlying documentation to Mr. Muth
“[o]ccasionally, but not very frequently.” The record does not establish whether
Mr. Power followed a similar protocol for tax returns that Mr. Bucher prepared.
The following table is a summary of pertinent items reported on Power Realty’s
Forms 1120S for the taxable years 1993-2006:
Date Ordinary Income Property
Filed Year Income or Loss Items Distributions
--- 1993 ($56,552) -0- -0-
--- 1994 (38,376) -0- -0-
5/19/00 1995 (191,044) -0- -0-
6/30/00 1996 (70,325) -0- -0-
8/18/00 1997 (19,670) -0- -0-
9/27/00 1998 (23,783) -0- -0-
5/19/00 1999 (18,056) -0- -0-
1/4/02 2000 (21,760) -0- -0-
3
Mr. Muth prepared Power Realty’s Forms 1120S for the taxable years
1993-2006 and 2010-11 and amended Forms 1120S for the taxable years 2008-09.
Mr. Bucher prepared Power Realty’s Forms 1120S for the taxable years 2007-09
and amended Form 1120S for the taxable year 2007.
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[*6] 3/26/03 2001 (9,840) -0- -0-
10/6/03 2002 (99,813) -0- -0-
9/20/04 2003 218,409 -0- -0-
9/19/05 2004 19,210 -0- -0-
10/16/06 2005 193,849 -0- $150,000
9/17/07 2006 487,266 $21,673 200,000
On its Form 1120S for the taxable year 2007 (i.e., the first taxable year in issue),
Power Realty reported on its NOL worksheet NOL carryovers as follows:
Year NOL
1999 $33,535
2000 138,685
2001 128,623
2002 217,245
Total 518,088
Power Realty compensated Mr. Power through distributions rather than
wages or salary. However, Power Realty did not report any distributions to Mr.
Power on its Forms 1120S for the taxable years 2007-11. Mr. Power used funds
from Power Realty to pay personal living expenses of petitioners for each of the
taxable years 2007-11. Furthermore, during the taxable years 2007-11 Power
Realty claimed deductions on its Forms 1120S for certain personal living expenses
of Mr. Power.
In 1986 Mr. Power purchased a three-bedroom, three-bathroom ranch on
North Clippenger Drive in Cincinnati, Ohio (Clippenger residence), for $256,000.
On July 30, 2007, Mr. Power wired $1,115,026 from two certificates of deposit
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[*7] (CDs) at U.S. Bank to National City Bank for the purchase of real property at
Tudor Hill Estates in Indian Hill, Ohio (Indian Hill property). Mr. Power
requested that the balance of the CDs ($39,725.75) be transferred to Power
Realty’s bank account. Petitioners purchased the Indian Hill property using the
money wired from U.S. Bank and $100,000 from Power Realty. In 2008
petitioners moved out of the Clippenger residence. Petitioners rented the
Clippenger residence for 2010 and the first seven months of 2011 before selling it
in 2012.
Petitioners’ Tax Returns
Mr. Power filed Forms 1040, U.S. Individual Income Tax Return, for the
taxable years 1994-2003 claiming single status. Petitioners were married on
February 14, 2004, and Mr. Power claimed married filing separately status on his
Forms 1040 for the taxable years 2004-09. Petitioners jointly filed their 2010 and
2011 Forms 1040.
Either Mr. Muth or Mr. Bucher prepared Mr. Power’s tax returns for the
taxable years 1993-2009 and petitioners’ tax returns for the taxable years 2010-
11.4 After the incorporation of Power Realty in 1993, Mr. Muth advised Mr.
4
Mr. Muth prepared (1) Mr. Power’s Forms 1040 for the taxable years 1994-
2000 and 2002-06; (2) Mr. Power’s Forms 1040X, Amended U.S. Individual
(continued...)
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[*8] Power that all income and expenses from Power Realty had to be reported on
Forms 1120S and that the resulting net income or loss would “flow through” to
Mr. Power’s individual tax return. Despite this advice, and for reasons unclear
from the record, Mr. Power split the income and expenses of Power Realty
between Schedules C, Profit or Loss From Business, attached to Forms 1040 and
Forms 1120S. The following table is a summary of the adjusted gross income and
Schedule C income/loss on Mr. Power’s Forms 1040 for the taxable years 1993-
2009:
Date Adjusted Schedule C
Filed Year Gross Income Income/Loss
10/17/94 1993 ($21,405) $83,786
1
10/18/95 1994 40,170 76,831
7/26/00 1995 28,507 (114,822)
10/31/03 1996 (136,862) (108,994)
12/31/03 1997 (298,881) (115,791)
12/31/03 1998 (439,929) (110,865)
1/21/04 1999 (547,830) (116,863)
2/8/04 2000 (685,360) (117,931)
2
1/28/04 2001 (724,882) (118,783)
4/27/04 2002 (1,059,417) (117,432)
9/30/04 2003 (978,336) (137,328)
9/28/05 2004 (1,023,334) 4,859
10/18/06 2005 (863,030) (19,335)
4
(...continued)
Income Tax Return, for the taxable years 2001 and 2008; and (3) petitioners’
Forms 1040 for the taxable years 2010-11. Mr. Bucher prepared (1) Mr. Power’s
Forms 1040 for the taxable years 2007-09 and (2) Mr. Power’s Form 1040X for
the taxable year 2007. It is unclear from the record who prepared Mr. Power’s
Form 1040 for the taxable year 2001.
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[*9] 9/17/07 2006 (429,738) (3,796)
5/9/11 2007 (358,913) (993)
5/9/11 2008 (433,183) (30,935)
5/9/11 2009 (361,673) (26,913)
1
The parties have stipulated the above-referenced dates and
amounts. However, there appear to be inconsistencies between
certain stipulated amounts and the amounts reported on the
corresponding tax returns. We have corrected these discrepancies
to comport with the underlying exhibits.
2
On May 8, 2006, respondent received from Mr. Power
a Form 1040X for the taxable year 2001, which was signed by Mr.
Muth as the tax return preparer.
Respondent received from Power Realty an amended Form 1120S for the
taxable year 2007 on June 1, 2012, and amended Forms 1120S for the taxable
years 2008 and 2009 on August 16, 2012. Because respondent received the
amended Forms 1120S during the examination process, he did not process them.
On the amended Forms 1120S for the taxable years 2007-09 Mr. Power removed
the previously claimed deductions for personal expenses.
Respondent received from Mr. Power Forms 1040X for the taxable years
2007 and 2008 on June 1 and August 16, 2012, respectively.5 On the amended
returns for 2007 and 2008 Mr. Power removed all items previously reported on
Schedules C. However, because respondent received the 2007 and 2008 amended
5
Mr. Bucher signed the 2007 amended return as the tax return preparer, and
Mr. Muth signed the 2008 amended return.
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[*10] returns during the examination of Mr. Power’s and petitioners’ returns,
respondent did not process either Form 1040X.
On June 16, 2014, respondent issued petitioners two separate notices of
deficiency. The first was issued to Mr. Power individually for the taxable year
2007, and the second was issued to petitioners jointly for the taxable years 2010
and 2011. Petitioners timely filed a petition disputing respondent’s determinations
in the notices of deficiency.
OPINION
The Commissioner’s determinations in the notice of deficiency are generally
presumed correct, and the taxpayer bears the burden of proving that those
determinations are in error. See Rule 142(a); Welch v. Helvering, 290 U.S. 111,
115 (1933). The taxpayer is required to maintain records sufficient to enable the
Commissioner to determine his or her correct tax liability. See sec. 6001; sec.
1.6001-1(a), Income Tax Regs. Pursuant to section 7491(a)(1), the burden of
proof with respect to relevant factual issues may shift to the Commissioner.
Specifically, section 7491(a)(1) provides: “If, in any court proceeding, a taxpayer
introduces credible evidence with respect to any factual issue relevant to
ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B,
the Secretary shall have the burden of proof with respect to such issue.” Section
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[*11] 7491(a)(2) further provides that the burden of proof shifts to the
Commissioner only when the taxpayer has: (1) “complied with the requirements
under this title to substantiate any item” and (2) “maintained all records required
under this title and has cooperated with reasonable requests by the Secretary for
witnesses, information, documents, meetings, and interviews”. “Credible evidence
is the quality of evidence which, after critical analysis, the court would find
sufficient upon which to base a decision on the issue if no contrary evidence were
submitted”. Higbee v. Commissioner, 116 T.C. 438, 442 (2001) (quoting H.R.
Conf. Rept. No. 105-599, at 240-241 (1998), 1998-3 C.B. 747, 994-995).
Petitioners did not retain records to comply with the Code’s substantiation
requirements or provide credible evidence. Therefore we hold that section 7491(a)
does not apply to shift the burden of proof to respondent.
1. Net Operating Loss
The first issue for decision is whether Mr. Power incurred NOLs in the
taxable years 1999-2002 that gave rise to a $518,088 NOL carryover, which was
subsequently available to offset his gross income beginning in the taxable year
2007. In the notice of deficiency issued to Mr. Power individually, respondent
disallowed in its entirety Mr. Power’s claimed $518,088 NOL carryover deduction
to the taxable year 2007.
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[*12] Section 172 allows a taxpayer to deduct an NOL for a taxable year. The
amount of the deduction equals the aggregate of the NOL carrybacks and
carryovers to the taxable year. Sec. 172(a). Section 172(c) defines an NOL as the
excess of deductions over gross income, computed with certain modifications
specified in section 172(d). Absent an election under section 172(b)(3),6 an NOL
for any taxable year must first be carried back 2 years and then carried over 20
years.7 Sec. 172(b)(1)(A), (2), (3).
6
Sec. 172(b)(3) provides:
(3) Election to waive carryback.--Any taxpayer entitled to a
carryback period under paragraph (1) may elect to relinquish the
entire carryback period with respect to a net operating loss for any
taxable year. Such election shall be made in such manner as may be
prescribed by the Secretary, and shall be made by the due date
(including extensions of time) for filing the taxpayer’s return for the
taxable year of the net operating loss for which the election is to be in
effect. Such election, once made for any taxable year, shall be
irrevocable for such taxable year.
Although it is inconsequential to our decision, the record does not indicate that
Mr. Power made such an election.
7
In 1997 sec. 172(b)(1)(A) was amended to generally require a 2-year
carryback and a 20-year carryover for NOLs incurred in taxable years beginning
after August 5, 1997. See Taxpayer Relief Act of 1997, Pub. L. No. 105-34, sec.
1082, 111 Stat. at 950. Before this amendment sec. 172(b)(1)(A) generally
required a 3-year carryback and a 15-year carryover. NOLs and the carryback and
carryover thereof are determined pursuant to the law applicable to the year in
which the losses occurred without regard to other years to which losses are carried
(continued...)
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[*13] Petitioners bear the burden of establishing both the existence of NOLs and
the amounts of the losses that may be carried over to the taxable years 2007-11.
See Rule 142(a); Keith v. Commissioner, 115 T.C. 605, 621 (2000). An NOL
deduction is a matter of legislative grace; it is not a right. United States v.
Olympic Radio & Television, Inc., 349 U.S. 232, 235 (1955).
Petitioners’ argument, as we understand it, is that Mr. Power and Power
Realty incurred NOLs totaling $518,088 in the taxable years 1999-2002, which
were available to offset Mr. Power’s income beginning with the taxable year 2007.
Petitioners acknowledge the “absence of sufficient records” to substantiate their
claimed NOL carryover to the taxable years 2007-11; however, petitioners contend
that they “have reconstructed a reasonable loss carryover scenario in a situation
where the actual books and records * * * [are] not available to fully substantiate
the claimed net operating losses”.
Petitioners must prove not only that Mr. Power incurred NOLs in 1999-
2002 but also that the NOLs were not absorbed during the period beginning with
1997 (the earliest carryback year) and ending with 2006 (the last year before the
7
(...continued)
back or forward. Sec. 1.172-1(e)(1) and (2), Income Tax Regs. Because
petitioners argue that the NOL carryovers at issue were generated from 1999-
2002, we will apply sec. 172(b)(1)(A) as amended in 1997.
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[*14] first taxable year in issue). To meet this burden petitioners must introduce
convincing evidence that Mr. Power incurred NOLs in the taxable years 1999-
2002 and also prove Mr. Power’s taxable income for the period beginning with
1997 and ending with 2006. See, e.g., Leitgen v. Commissioner, T.C. Memo.
1981-525, aff’d without published opinion, 691 F.2d 504 (8th Cir. 1982).
Petitioners introduced as evidence: (1) copies of Forms 1040 for the taxable years
1994-2000 and 2002-11; (2) copies of Forms 1040X for the taxable years 2001,
2007, and 2008; (3) copies of Power Realty’s Forms 1120S for the taxable years
1993-2011; and (4) copies of Power Realty’s amended Forms 1120S for the
taxable years 2007-09. From these tax returns petitioners argue that the Court can
apply the Cohan rule to estimate the NOL carryovers to the taxable years 2007-11.
Under the Cohan rule, if a taxpayer establishes that an expense is deductible
but is unable to substantiate the precise amount, the Court may estimate the
amount, bearing heavily against the taxpayer whose inexactitude is of his or her
own making. See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930).
However, to apply the Cohan rule the Court must have some information to
estimate the proper deduction. See Vanicek v. Commissioner, 85 T.C. 731, 742-
743 (1985). Petitioners have provided no testimony or other evidence sufficient to
enable us to make a reasonable estimate of the purported NOLs. Petitioners did
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[*15] not introduce books, records, bills, or receipts to establish the income and
expenses of Power Realty for 1999-2002 or any other taxable year. To
substantiate the claimed NOLs petitioners rely exclusively on copies of tax
returns, and it is well settled that tax returns alone do not establish that a taxpayer
suffered a loss. See Lehman v. Commissioner, T.C. Memo. 2010-74, 2010 Tax Ct.
Memo LEXIS 76, at *5.
The record before us does not establish that Mr. Power incurred NOLs for
1999-2002 or any other taxable years preceding the taxable year 2007.
Furthermore, copies of tax returns are insufficient by themselves to prove that the
purported NOLs were not completely absorbed before the taxable years in issue.
See id., 2010 Tax Ct. Memo LEXIS 76, at *5-*6 (citing Stutsman v.
Commissioner, T.C. Memo. 1961-109); see also Hoopengarner v. Commissioner,
T.C. Memo. 2003-343, 2003 Tax Ct. Memo LEXIS 344, at *13. Without
additional evidence (e.g., books, records, bills, and receipts) this is not a case in
which the application of the Cohan rule would be appropriate. Accordingly, we
sustain respondent’s disallowance of Mr. Power’s claimed NOL carryover
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[*16] deductions because petitioners failed to prove facts showing that they are
entitled to those deductions.8
2. Mr. Power’s Stock Basis in Power Realty
The second issue for decision is whether Mr. Power received distributions
from Power Realty in excess of his adjusted stock basis in the S corporation. In
the notices of deficiency respondent determined, inter alia, that Power Realty
made distributions to Mr. Power of $359,860 for 2007; $60,173 for 2008;
$221,829 for 2010; and $189,447 for 2011. Respondent also determined that Mr.
Power had a zero9 stock basis in Power Realty as of January 1, 2007. Petitioners
contend that there was no distribution from Power Realty in excess of Mr. Power’s
adjusted stock basis in the S corporation. Specifically, petitioners contend that
Mr. Power had a basis in Power Realty of $510,216 in 2007 and that no
8
As a result of respondent’s adjustments in the notice of deficiency for the
taxable year 2009, a $9,885 NOL was generated and carried over into the taxable
year 2010.
9
Respondent computed Mr. Power’s stock basis in Power Realty as of
January 1, 2007, as follows: (1) ordinary income of $338,408; plus (2) ordinary
dividends of $33,079; equals (3) a stock basis of $371,487 before distributions;
minus (4) distributions of $359,860; equals (5) stock basis of $11,627 before non-
deductible expenses and depletion; minus (6) nondeductible expenses of $11,418;
equals (7) stock basis of $209 before allowable losses and deductions; minus (8)
sec. 179 deduction of $8,006 and charitable contribution deduction of $11,686;
equals (9) a stock basis of zero.
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[*17] distributions in excess of that basis were made to Mr. Power from Power
Realty for any of the taxable years 2007-11.
Section 1366(a)(1) provides that an S corporation shareholder determines
his or her tax liability by taking into account his or her pro rata share of the S
corporation’s income, losses, deductions, or credits for the S corporation’s taxable
year ending with or in the shareholder’s taxable year. The shareholder may not
take into account, however, S corporation losses and deductions for any taxable
year in excess of the shareholder’s adjusted basis in the S corporation’s stock and
debt. Sec. 1366(d)(1). Generally, section 1368(b) provides that distributions from
an S corporation with no accumulated earnings and profits are not included in the
gross income of the shareholder to the extent that they do not exceed the adjusted
basis of the shareholder’s stock, and any excess of adjusted basis is treated as gain
from the sale or exchange of property. Section 1367 provides that basis in S
corporation stock is increased by income passed through to the shareholder under
section 1366(a)(1) and decreased by, inter alia, distributions not includable in the
shareholder’s income pursuant to section 1368.
A shareholder may increase his or her basis in an S corporation if he or she
makes an economic outlay to or for the benefit of the S corporation. Goatcher v.
United States, 944 F.2d 747, 751 (10th Cir. 1991); Estate of Leavitt v.
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[*18] Commissioner, 875 F.2d 420, 422 (4th Cir. 1989), aff’g 90 T.C. 206 (1988).
An economic outlay for this purpose is an actual contribution of cash or property
by the shareholder to the S corporation or a transaction that leaves the S
corporation indebted to the shareholder. Sec. 1366(d)(1). A taxpayer must
establish that he has acquired basis in the referenced stock and, to the extent that
he does, that his basis was not reduced to zero because of losses claimed in years
predating the subject year. Arnold v. Commissioner, T.C. Memo. 2003-259, 2003
Tax Ct. Memo LEXIS 258, at *8; Hogan v. Commissioner, T.C. Memo. 1999-365,
1999 Tax Ct. Memo LEXIS 420, at *7. A taxpayer who fails to prove that he or
she has any basis in an S corporation is considered to have a zero basis in that
corporation. Thomson v. Commissioner, T.C. Memo. 1983-279, aff’d without
published opinion, 731 F.2d 889 (11th Cir. 1984). Thus, petitioners bear the
burden of proving that Mr. Power had sufficient basis in Power Realty.
Mr. Power did not maintain a basis schedule for his Power Realty stock. To
establish Mr. Power’s basis in his Power Realty stock, petitioners offered Power
Realty’s Forms 1120S for the taxable years 1993-2011 and a reconstructed stock
basis chart attached as an appendix to their posttrial brief. To begin with, the
Forms 1120S do not include sufficient information for us to establish Mr. Power’s
basis in Power Realty. See Fehlhaber v. Commissioner, 94 T.C. 863, 869 (1990),
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[*19] aff’d, 954 F.2d 653 (11th Cir. 1992). It is also unclear how petitioners
calculated Mr. Power’s stock basis in Power Realty using Forms 1120S given that
Power Realty’s income and expenses were improperly divided between Mr.
Power’s Schedules C and Power Realty’s Forms 1120S. Further, petitioners
stipulate that Mr. Power was compensated by Power Realty through distributions
(not wages or salary) and that petitioners used Power Realty’s checking account to
pay substantial personal expenses during the taxable years 2007-11. On the basis
of the record before us, petitioners have not established that Mr. Power had basis
in Power Realty stock or that he did not receive distributions from Power Realty as
respondent determined in the notices of deficiency. Accordingly, we conclude
that Mr. Power’s adjusted stock basis in Power Realty was zero and that he
received distributions from Power Realty as respondent determined in the notices
of deficiency.
3. Miscellaneous Issues
In the notices of deficiency respondent made various adjustments to income
and expenses affecting Mr. Power’s and petitioners’ taxable income for the taxable
years 2007-11. At trial on September 23, 2015, the parties filed with the Court a
stipulation of settled issues in which petitioners agreed to most of respondent’s
adjustments in the notices of deficiency. However, certain issues remained
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[*20] unresolved after the filing of the stipulation of settled issues, including:
(1) adjustments to deductions claimed on Schedules A, Itemized Deductions, for
the taxable years 2007-11 and (2) adjustments to personal exemptions for the
taxable years 2007, 2009, and 2010. Petitioners provided no evidence or argument
concerning these remaining issues. Consequently, petitioners are deemed to have
conceded these issues pursuant to Rule 34(b)(4).10 To the extent that these
adjustments are dependent upon our decisions above--and thus are computational--
they are to be resolved in the parties’ Rule 155 computations.
4. Accuracy-Related Penalties
In separate notices of deficiency, respondent determined that Mr. Power (for
the taxable year 2007) and petitioners (for the taxable years 2010 and 2011) are
liable for accuracy-related penalties pursuant to section 6662(a) and (b)(1) and (2)
for negligence or substantial understatements of income tax. Respondent bears the
burden of production with respect to these penalties. See sec. 7491(c). To meet
10
In the notice of deficiency respondent indicates that petitioners’ taxable
income on their filed 2010 return is “0.00” and adjusts this number upward by
“111,593.00”, resulting in a revised taxable income of “111,593.00”. It appears
that the taxable income reported on petitioners’ filed Form 1040 for the taxable
year 2010 is -$270,633 and, thus, the $111,593 upward adjustment should be made
from this amount. However, petitioners made no argument concerning this
apparent discrepancy. To the extent that this is in fact an error, it should be
resolved by the parties in their Rule 155 computations.
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[*21] this burden, respondent must produce evidence establishing that it is
appropriate to impose the penalties. Once respondent has done so, the burden of
proof is on petitioners to show that the penalties do not apply. See Higbee v.
Commissioner, 116 T.C. at 449.
Negligence includes any failure to make a reasonable attempt to comply
with the provisions of the internal revenue laws and 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); see also 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. Mr. Power individually, and
petitioners jointly, exhibited a lack of due care in failing to accurately report
income and properly substantiate expenses for the taxable years 2007-11. The
record establishes that petitioners used funds from Power Realty for personal
expenses and did not retain records pertinent to the taxable years 2007-11.
Furthermore, Mr. Power did not supply his tax return preparer (Mr. Muth) with
adequate information or underlying documentation to prepare personal or
corporate tax returns and inexplicably ignored Mr. Muth’s advice to report all
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[*22] activity of Power Realty on Forms 1120S. Respondent has met his burden
of production with respect to the section 6662(a) penalties for negligence.
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 argue that they relied in good
faith on tax return preparers to prepare accurate income tax returns. However, the
record indicates that petitioners provided Mr. Muth with insufficient information
to prepare their personal and corporate tax returns and ignored certain of Mr.
Muth’s advice. Accordingly, we hold that Mr. Power (for 2007) and petitioners
(for 2010 and 2011) are liable for the section 6662(a) penalties for negligence.
In reaching our decision, we have considered all arguments made by the
parties, and to the extent not mentioned or addressed, they are irrelevant or
without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.