T.C. Memo. 2017-49
UNITED STATES TAX COURT
SAEID ZOLGHADR AND MANDANA ZOLGHADR, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19241-14. Filed March 22, 2017.
Saeid Zolghadr and Mandana Zolghadr, pro sese.
Christopher R. Moran, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LAUBER, Judge: With respect to petitioners’ Federal income tax for 2006-
2009, the Internal Revenue Service (IRS or respondent) determined deficiencies,
additions to tax, and penalties as follows:
-2-
[*2] Addition to tax Penalty
Year Deficiency sec. 6651(a)(1) sec. 6662(a)
2006 $30,222 $6,260 $6,044
2007 20,845 4,167 4,168
2008 20,340 4,508 4,068
2009 3,812 -0- 762
The issues for decision are: (1) whether petitioners received unreported in-
come in 2006-2009; (2) whether petitioners are entitled to deduct expenses on
Schedules C, Profit or Loss From Business, for 2006-2009, in excess of the
amounts respondent allowed; (3) whether petitioners are entitled to deduct mort-
gage interest claimed on Schedules A, Itemized Deductions, for 2006-2009, in ex-
cess of the amounts respondent allowed; (4) whether petitioners are entitled to de-
duct mortgage interest claimed on a Schedule E, Supplemental Income and Loss,
for 2009; (5) whether petitioners are liable for late-filing additions to tax for 2006-
2008; and (6) whether petitioners are liable for accuracy-related penalties for all
years at issue. With minor exceptions, we will sustain respondent’s determina-
tions.1
1
All statutory references are to the Internal Revenue Code (Code) in effect
for the years at issue, and all Rule references are to the Tax Court Rules of Prac-
tice and Procedure. We round all monetary amounts to the nearest dollar.
-3-
[*3] FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulations
and the attached exhibits are incorporated by this reference. Petitioners resided in
Virginia when they filed their petition.
Mandana Zolghadr is a licensed dentist. She acquired a dental practice in
2002 from a group of dentists and operated this practice as a sole proprietorship
during 2006-2009 with several employees. She incurred expenses in the course of
her dentistry practice, including expenses for wages, supplies, advertising, and
depreciation on equipment. She did not maintain adequate books and records to
substantiate the expenses for her dental practice during any of the years at issue.
Petitioners owned, either jointly or individually, three houses during the
years at issue. They owned a primary residence in Vienna, Virginia (Vienna prop-
erty). They owned a rental property in McLean, Virginia (McLean property), on
which they received monthly rent of $1,200 during 2006 and 2007, $1,250 during
2008, and $1,300 during 2009. Mr. Zolghadr also owned a house in West Virginia
(West Virginia property) that he purchased in 2008, which petitioners initially
used as a weekend retreat. He later operated a car dealership on the West Virginia
property and sometimes resided there in connection with this activity.
-4-
[*4] Petitioners filed delinquent Forms 1040, U.S. Individual Income Tax Re-
turn, for 2006, 2007, and 2008; they filed a timely Form 1040 for 2009. They in-
cluded in each of these returns a Schedule C for the dental practice. For 2006 they
reported gross receipts for the dental practice of $398,864, returns and allowances
of $5,523, and total expenses of $392,108, for a net profit of $1,233. The reported
expenses were as follows:
Expense Amount
Advertising $23,097
Car and truck 558
Commissions and fees 10,146
Contract labor 3,815
Section 179/depreciation 34,809
Insurance 16,900
Interest 3,567
Legal and professional fees 1,096
Office supplies 4,763
Repairs and maintenance 6,788
Supplies 97,738
Taxes and licenses 2,055
Travel 28,250
Meals and entertainment 3,440
Utilities 4,097
Wages 149,451
Other 1,538
For 2007 they reported gross receipts of $331,315, returns and allowances
of $3,465, and total expenses of $336,455, for a net loss of $8,605. The reported
expenses were as follows:
-5-
[*5] Expense Amount
Advertising $7,239
Car and truck 568
Commissions and fees 6,781
Contract labor 623
Section 179/depreciation 15,464
Insurance 10,265
Interest 17,410
Legal and professional fees 992
Office supplies 3,820
Repairs and maintenance 1,139
Supplies 126,282
Taxes and licenses 2,845
Travel -0-
Meals and entertainment 22
Utilities 5,164
Wages 137,220
Other 621
For 2008 they reported gross receipts of $347,933, returns and allowances
of $2,693, and total expenses of $316,563, for a net profit of $28,677. The report-
ed expenses were as follows:
Expense Amount
Advertising $5,939
Car and truck 5,597
Commissions and fees 2,213
Contract labor 454
Section 179/depreciation 12,275
Insurance 11,663
Interest 11,461
Legal and professional fees 1,393
Office supplies 6,802
-6-
[*6] Repairs and maintenance 1,003
Supplies 108,093
Taxes and licenses 41,905
Travel -0-
Meals and entertainment 87
Utilities 11,528
Wages 93,646
Other 2,504
For 2009 they reported gross receipts of $300,503, returns and allowances
of $3,165, and total expenses of $310,413, for a net loss of $13,075. The reported
expenses were as follows:
Expense Amount
Advertising $6,000
Car and truck -0-
Commissions and fees 8,941
Contract labor 4,518
Section 179/depreciation 12,172
Insurance 11,636
Interest 6,010
Legal and professional fees 2,542
Office supplies 21,330
Repairs and maintenance 2,431
Supplies 67,660
Taxes and licenses 57,542
Travel 2,500
Meals and entertainment 184
Utilities 5,780
Wages 99,667
Other 1,500
-7-
[*7] For 2006-2009 petitioners claimed on their Schedules A deductions for
mortgage interest expenses of $40,897, $27,280, $38,674, and $51,607, respec-
tively. For 2009 petitioners claimed on their Schedule E a deduction for mortgage
interest expense of $9,401 attributable to the West Virginia property.
The IRS selected petitioners’ 2006-2009 returns for examination. On the
basis of a bank deposits analysis the IRS determined that petitioners had omitted
rental income from the McLean property for 2006-2009 and had misreported gross
receipts from the dental practice for 2007-2009. On the basis of third-party infor-
mation reports the IRS determined that petitioners had omitted dividend income,
interest income, and retirement income for 2007. The IRS disallowed portions of
the Schedule C deductions for lack of substantiation and disallowed some or all of
the mortgage interest deductions for lack of connection to a primary or secondary
residence. The IRS determined accuracy-related penalties with respect to these
adjustments and additions to tax for late filing of petitioners’ 2006-2008 returns.
On May 20, 2014, the IRS issued petitioners a timely notice of deficiency setting
forth these adjustments, and they timely petitioned this Court.
-8-
[*8] OPINION
I. Burden of Proof
The IRS’ determinations in a notice of deficiency are generally presumed
correct though the taxpayer can rebut this presumption. Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933). The U.S. Court of Appeals for the Fourth
Circuit, the appellate venue in this case absent stipulation to the contrary, has held
that the usual presumption of correctness applies in omitted income cases where
the IRS employs a “reasonable method of determining income,” such as the bank
deposits method. Williams v. Commissioner, 999 F.2d 760, 763-764 (4th Cir.
1993), aff’g T.C. Memo. 1992-153. Other courts have required the IRS in unre-
ported income cases to establish a “minimal evidentiary showing” connecting the
taxpayer with the income-producing activity. E.g., Blohm v. Commissioner, 994
F.2d 1542, 1548-1549 (11th Cir. 1993), aff’g T.C. Memo. 1991-636. If the IRS
were required to make a “minimal evidentiary showing” here, respondent has met
that burden by introducing bank records establishing that petitioners received un-
reported income from the dental practice and the McLean property.
Petitioners thus bear the burden of proving by a preponderance of the evi-
dence that respondent’s determinations of unreported income are arbitrary or erro-
neous. See Williams, 999 F.2d at 763 (citing Helvering v. Taylor, 293 U.S. 507,
-9-
[*9] 515 (1935)); Tokarski v. Commissioner, 87 T.C. 74 (1986). Petitioners
likewise bear the burden of proving their entitlement to deductions allowed by the
Code and of substantiating the amounts of claimed deductions. See INDOPCO,
Inc. v. Commissioner, 503 U.S. 79, 84 (1992); sec. 1.6001-1(a), Income Tax Regs.
Petitioners do not contend, and they could not plausibly contend, that the burden
of proof as to any issue of fact should shift to respondent under section 7491(a).
II. Unreported Income
Section 61(a) defines gross income as “all income from whatever source de-
rived,” including income derived from business. A taxpayer must maintain books
and records establishing the amount of his or her gross income. See sec. 6001.
When a taxpayer does not keep accurate books and records, the IRS may deter-
mine his or her income “under such method as, in the opinion of the Secretary,
does clearly reflect income.” Sec. 446(b); see Petzoldt v. Commissioner, 92 T.C.
661, 693 (1989). And where the taxpayer has unexplained bank deposits, the IRS
may employ the bank deposits method to estimate his or her income. Estate of
Hague v. Commissioner, 132 F.2d 775 (2d Cir. 1943), aff’g 45 B.T.A. 104 (1941);
Estate of Mason v. Commissioner, 64 T.C. 651, 657 (1975), aff’d, 566 F.2d 2 (6th
Cir. 1977). The IRS has great latitude in reconstructing a taxpayer’s income, and
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[*10] the reconstruction “need only be reasonable in light of all surrounding facts
and circumstances.” Petzoldt, 92 T.C. at 687.
Bank deposits are prima facie evidence of income. The bank deposits meth-
od starts with the presumption that all money deposited in a taxpayer’s bank ac-
count during a given period constitutes taxable income. Price v. United States,
335 F.2d 671, 677 (5th Cir. 1964). This presumption is rebutted to the extent the
deposits are shown to include nontaxable amounts, and “the Government must
take into account any non-taxable source * * * of which it has knowledge.” Ibid.;
DiLeo v. Commissioner, 96 T.C. 858, 868 (1991), aff’d, 959 F.2d 16 (2d Cir.
1992).
After the IRS reconstructs a taxpayer’s income and determines a deficiency,
the taxpayer bears the burden of proving that the IRS’ implementation of the bank
deposits method was unfair or inaccurate. See Clayton v. Commissioner, 102 T.C.
632, 645 (1994); DiLeo, 96 T.C. at 871-872. The taxpayer may do so by showing
(among other things) that certain deposits came from nontaxable sources. See
Clayton, 102 T.C. at 645. Nontaxable sources include funds attributable to inter-
account bank transfers and returned checks as well as “loans, gifts, inheritances, or
assets on hand at the beginning of the taxable period.” Burgo v. Commissioner,
- 11 -
[*11] 69 T.C. 729, 743 n.14 (1978) (quoting Troncelliti v. Commissioner, T.C.
Memo. 1971-72).
The revenue agent (RA) employed the bank deposits method to reconstruct
petitioners’ income. After obtaining copies of petitioners’ bank statements by
issuing summonses to their banks, the RA used the statements (which are part of
the record) to prepare schedules listing all deposits. After eliminating nontaxable
receipts of which she was aware, the RA prepared and provided to petitioners
schedules that determined unreported income attributable to the McLean property
for 2006-2009 and to the dental practice for 2007-2009.
Petitioners reported rental income from the McLean property of $14,400
annually for 2006-2008 and $12,000 for 2009. The RA determined that petition-
ers had underreported rental income by $200, $800, $1,200, and $3,600 for 2006-
2009, respectively. At trial petitioners conceded that they had underreported their
rental income. They contend that the unreported income should not be taxable
because it corresponded to rent increases they received in exchange for performing
repairs and maintenance to the property.
This contention is meritless. Rent is specifically included in the definition
of gross income, sec. 61(a)(5), and represents payment “received or accrued for
the occupancy of real estate or the use of personal property,” sec. 1.61-8(a), In-
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[*12] come Tax Regs. The Code provides no exclusion from gross income where
(as commonly occurs) the lessor incurs expenses for repairs or maintenance in
consideration of receiving rent. We accordingly find that petitioners received
unreported rental income from the McLean property in the amounts stated above.
With respect to the dental practice, the RA initially performed a bank de-
posits analysis that considered all of petitioners’ bank accounts, both business and
personal. After petitioners provided additional documentation to her, the RA fo-
cused her analysis chiefly on one of the business bank accounts, a SunTrust Bank
account ending in 5432 (SunTrust account). On the basis of this analysis she de-
termined that petitioners had understated gross receipts by $6,504 and $12,890 for
2007 and 2008, respectively, and had overstated gross receipts by $27,770 for
2009. Petitioners contend that the RA failed to account for certain nontaxable
items allegedly deposited into this account.
With respect to 2007, petitioners produced a bank statement for November
2007 listing a “miscellaneous credit” of $1,329 that they contend should have been
allowed as an offset against the net taxable deposits. But they failed to establish
the nature of this credit; Dr. Zolghadr testified vaguely that it was for “excess de-
posits” with the bank. We find that petitioners have failed to carry their burden of
- 13 -
[*13] showing error in the RA’s analysis. We will therefore sustain respondent’s
determination of unreported income attributable to the dental practice for 2007.
With respect to 2008, respondent concedes that the RA should have elimi-
nated a $10,000 deposit attributable to a nontaxable loan from Dr. Zolghadr’s
sister. This leaves in question $2,890 of deposits for 2008. Petitioners contend
that a $5,000 deposit was a loan from Dr. Zolghadr’s mother, but the only evi-
dence they submitted was documentation showing that a $5,000 cash deposit was
made. They produced no loan agreement or other evidence to show that this de-
posit corresponded to a loan from Dr. Zolghadr’s mother (or anyone else). And
we do not accept Dr. Zolghadr’s testimony on this point, which we did not find
credible. See Tokarski, 87 T.C. at 74. We accordingly find that petitioners re-
ceived during 2008 unreported income of $2,890 from the dental practice.
With respect to 2009, the RA determined that petitioners overstated their
gross receipts by $27,700, chiefly by misclassifying inter-account transfers as re-
ceipts of the dental practice. Petitioners seek to exclude another $1,500 of depos-
its, alleging that these were payments for overdraft protection. But all the docu-
ments to which they point concern overdraft protection in accounts other than the
SunTrust account, which was the only account on which the RA performed a bank
deposits analysis. We therefore sustain respondent’s determination that peti-
- 14 -
[*14] tioners for 2009 overstated gross receipts attributable to the dental practice
by $27,770.
The IRS also determined, on the basis of third-party information reports,
that petitioners had received the following taxable income in 2007: (1) $24 of
dividend income from MetLife; (2) $678 of retirement income from an individual
retirement account distribution; and (3) $2,139 of interest income from three banks
and an LLC. Petitioners conceded at trial that they received, but failed to report,
each of these items. We sustain respondent’s determination in each respect.
III. Schedule C Expenses
Deductions are a matter of legislative grace. The taxpayer bears the burden
of proving that reported business expenses were actually incurred and were “ordi-
nary and necessary.” Sec. 162(a); Rule 142(a). The taxpayer also bears the bur-
den of substantiating expenses underlying his claimed deductions by keeping and
producing records sufficient to enable the IRS to determine the correct tax liabil-
ity. Sec. 1.6001-1(a), (e), Income Tax Regs. The failure to keep and present such
records counts heavily against a taxpayer’s attempted proof. Rogers v. Commis-
sioner, T.C. Memo. 2014-141, 108 T.C.M. (CCH) 39, 43. In certain circumstances
the Court may approximate the amount of an expense if the taxpayer proves it was
incurred but cannot substantiate the exact amount. Cohan v. Commissioner, 39
- 15 -
[*15] F.2d 540, 543-544 (2d Cir. 1930). But the taxpayer must provide some basis
for such an estimate. Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).
Section 274(d) imposes stricter substantiation requirements for deductions
claimed for expenses of travel, meals, and entertainment. No such deduction is
allowed unless the taxpayer substantiates, by adequate records or by sufficient
evidence corroborating his own statements, the amount, time and place, and busi-
ness purpose for each expenditure. Sec. 274(d); sec. 1.274-5T(a), (b), and (c),
Temporary Income Tax Regs., 50 Fed. Reg. 46014-46017 (Nov. 6, 1985). A court
may not apply the Cohan rule to approximate expenses covered by section 274(d).
Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968), aff’d per curiam, 412
F.2d 201 (2d Cir. 1969).
During the examination petitioners produced bank statements, a modest
volume of invoices and bills, and QuickBooks summaries with little supporting
documentation. After review of these documents the RA allowed deductions for
significant expenses in most expense categories; for certain categories (such as
wages and health insurance) she allowed deductions larger than those petitioners
had claimed. Respondent contends that the remaining deductions were properly
disallowed because the expenses were not substantiated or were personal ex-
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[*16] penses. See sec. 262(a) (denying deduction for “personal, living, or family
expenses”).
In the tables below we set forth for each year the Schedule C expenses peti-
tioners reported on their return, the amount the RA allowed as a deduction for
each category of expense, and the amount remaining in dispute:
2006 Amount claimed Amount allowed Amount in dispute
Interest $3,567 -0- $3,567
Advertising 23,097 $22,772 325
Health insurance -0- 4,614 -0-
Utilities 4,097 3,813 284
Repairs and
maintenance 6,788 636 6,152
Insurance 16,900 5,808 11,092
Depreciation and
section 179 expense 34,809 16,044 18,765
Taxes and licenses 2,055 5,500 -0-
Office supplies 4,763 3,669 1,094
Car and truck 558 -0- 558
Commissions and fees 10,146 7,314 2,832
NOL carryforward 42,773 -0- 42,773
Other 1,538 75 1,463
Wages 149,451 141,797 7,654
Meals and
entertainment 3,440 65 3,375
- 17 -
[*17]
Travel 28,250 -0- 28,250
Supplies 97,738 56,068 41,670
2007 Amount claimed Amount allowed Amount in dispute
Interest $17,410 -0- $17,410
Advertising 7,239 $2,870 4,369
Health insurance -0- 5,028 -0-
Utilities 5,164 4,702 462
Repairs and
maintenance 1,139 741 398
Insurance 10,265 4,671 5,594
Depreciation and
section 179 expense 15,464 12,599 2,865
Taxes and licenses 2,845 5,710 -0-
Office supplies 3,820 2,875 945
Car and truck 568 -0- 568
Commissions and fees 6,781 3,334 3,447
NOL carryforward 24,241 -0- 24,241
Other 621 75 546
Wages 137,220 146,093 -0-
Supplies 126,282 54,704 71,578
Legal and professional
fees 992 1,156 -0-
Contract labor 623 813 -0-
- 18 -
[*18]
2008 Amount claimed Amount allowed Amount in dispute
Interest $11,461 -0- $11,461
Advertising 5,939 $209 5,730
Health insurance -0- 5,920 -0-
Utilities 11,528 4.965 6,563
Repairs and
maintenance 1,003 830 173
Insurance 11,663 5,675 5,988
Taxes and licenses 41,905 15,627 26,278
Office supplies 6,802 6,412 390
Car and truck 5,597 -0- 5,597
Commissions and fees 2,213 1,963 250
NOL carryforward 51,703 -0- 51,703
Other 2,504 75 2,429
Wages 93,646 129,455 -0-
Supplies 108,093 63,321 44,772
2009 Amount claimed Amount allowed Amount in dispute
Interest $6,010 -0- $6,010
Advertising 6,000 -0- 6,000
Health insurance -0- $6,780 -0-
Utilities 5,780 5,122 658
Repairs and
maintenance 2,431 600 1,831
Insurance 11,636 9,269 2,007
- 19 -
[*19]
Taxes and licenses 57,542 20,809 46,733
Office supplies 21,330 5,087 16,243
Commissions and fees 8,941 2,111 6,830
NOL carryforward 30,772 -0- 30,772
Other 1,500 -0- 1,500
Wages 99,667 138,156 -0-
Travel 2,500 -0- 2,500
Supplies 67,660 34,146 33,514
Legal and professional
fees 2,542 1,978 564
Contract labor 4,518 -0- 4,518
At trial petitioners produced few contemporaneous records for the dental
practice. They produced tabulations of alleged expenses with attached Quick-
Books summaries (prepared just before trial), miscellaneous printouts of Excel
spreadsheets for the SunTrust account, other bank account statements, handwritten
“personal lists” that allegedly separated business from personal expenses, and a
letter that Dr. Zolghadr had sent to the RA. They also presented testimony from
Dr. Zolghadr, which we found confusing and in most respects not credible.
At the close of trial the Court left the record open to allow petitioners to
submit additional documentary evidence that they had allegedly forgotten to bring
with them to trial. They submitted two CD-ROMs containing more QuickBooks
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[*20] summaries (again prepared just before trial) and various bank statements and
invoices. This additional evidence is little more than a digital shoebox: To the ex-
tent these documents substantiate any expenses, they substantiate expenses that the
IRS had already allowed.
After carefully reviewing the evidence, we conclude that the deductions pe-
titioners claimed (in excess of amounts respondent allowed) for advertising, util-
ities, repairs and maintenance, insurance, depreciation, taxes and licenses, office
supplies, commissions and fees, travel, supplies, legal and professional fees, con-
tract labor, and “other expenses” have not been substantiated or have not been
shown to be business related. We sustain respondent’s determination to disallow
these deductions to that extent. We also sustain respondent’s determination to
allow additional deductions that petitioners had not claimed as set forth in the
tables above. We will briefly address the remaining items.
• Petitioners reported section 179 expenses for 2006 and 2007. Dr. Zol-
ghadr testified that these amounts were partially attributable to section 179 ex-
penses carried forward from prior years. Section 179(a) allows a taxpayer to elect
to expense, rather than capitalize, qualified business property. Qualified business
property must be: (1) tangible property to which section 168 applies; (2) section
1245 property; and (3) property “acquired by purchase for use in the active con-
- 21 -
[*21] duct of a trade or business.” Sec. 179(d). The taxpayer is required to main-
tain records reflecting how and from whom the section 179 property was acquired
and when it was placed in service. Sec. 1.179-5(a), Income Tax Regs.
In order to expense qualified business property, a taxpayer must make an
election to do so by specifying the property to which the election applies and mak-
ing the election on his tax return. Sec. 179(c). The election is normally made by
attaching Form 4562, Depreciation and Amortization, to the taxpayer’s return.
Visin v. Commissioner, T.C. Memo. 2003-246, aff’d, 122 F. App’x 363 (9th Cir.
2005). If a taxpayer makes this election, he is entitled to a current deduction that
cannot exceed the taxable income derived from the active conduct of his business
during the year. Sec. 179(b)(3)(A). If the taxpayer cannot expense the full
amount, the unused portion is carried forward indefinitely. Sec. 179(b)(3)(B). If
the taxpayer fails to make the election, he waives the benefits of section 179. See
Patton v. Commissioner, 116 T.C. 206 (2001); Verma v. Commissioner, T.C.
Memo. 2001-132; Fors v. Commissioner, T.C. Memo. 1998-158.
Petitioners have failed to meet the substantiation requirements of section
179. Although they filed Forms 4562 for 2006 and 2007, they failed to establish
when and from whom they had purchased the supposed equipment, and they failed
to establish that they had made a valid section 179 election for years before 2006
- 22 -
[*22] (as would be required to carry forward pre-2006 amounts). The only evi-
dence they submitted was a partially legible sales contract showing a purchase of
unspecified equipment for $597 and copies of emails apparently sent by Dr. Zolg-
hadr. These documents do not satisfy the statutory requirements, and we therefore
sustain respondent’s disallowance of the claimed section 179 expense deductions.
• Petitioners reported an NOL carryforward for each year. Dr. Zolghadr
testified that the NOLs were attributable to a condominium unit she purchased in
2002 from a failing dental practice. Unless an exception applies, an NOL must
first be carried back 2 years and then carried forward 20 years. Sec. 172(b)(1)(A).
If a taxpayer claims an NOL deduction, he must file with his return “a concise
statement setting forth * * * all material and pertinent facts relative thereto, in-
cluding a detailed schedule showing the computation” of the NOL deduction. Sec.
1.172-1(c), Income Tax Regs.
Petitioners have satisfied none of these requirements. They did not attach to
any of their returns a concise statement including material and relevant facts or a
detailed schedule showing computation of the NOL amount. They have not ex-
plained how a condominium could give rise to an NOL for a dental practice. They
did not prove that Dr. Zolghadr’s dental practice actually incurred losses before
2006 or (if it did) that the NOL had not previously been carried back. On the latter
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[*23] point the only evidence was Dr. Zolghadr’s testimony that the NOLs were
reported on petitioners’ prior returns; this was a statement of their position, not
proof. See Whitaker v. Commissioner, T.C. Memo. 2010-209. Because petition-
ers have failed to prove that an allowable NOL existed, we will sustain respon-
dent’s disallowance of the NOL carryforward deductions for 2006-2009.
• Petitioners claimed deductions for each year for interest expenses alleg-
edly connected to the dental practice. Mrs. Zolghadr testified that this interest was
paid on loans obtained to purchase dental equipment. We did not find this testi-
mony credible. In support she provided bank statements (none of which were for
business bank accounts) that listed “finance charges.” Petitioners provided no evi-
dence that these finance charges were paid on business rather than personal loans.
We will therefore sustain respondent’s disallowance of these deductions.
• Petitioners reported wage expenses for the dental practice for each year.
Respondent’s adjustments on these items largely favored petitioners. For 2006 the
IRS determined that they had overstated wage expenses by $7,654; for 2007-2009
the IRS determined that they had understated wage expenses by $8,873, $35,809,
and $38,489, respectively. Petitioners nevertheless challenge the disallowance for
2006; the Forms W-3, Transmittal of Wage and Tax Statements, that they supplied
to support their challenge, however, show wage expenses $10,000 lower than the
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[*24] adjusted amount the IRS has allowed. Petitioners offered no credible
evidence on this point, and we will accordingly sustain respondent’s deter-
minations for all four years.
IV. Mortgage Interest
A. Schedule A Mortgage Interest
Section 163(h)(1) generally disallows a deduction for personal interest. For
individual taxpayers, an exception to this rule is “qualified residence interest.”
Sec. 163(h)(2)(D). Qualified residence interest is interest that is paid or accrued
during the taxable year on “acquisition indebtedness” or “home equity indebted-
ness” with respect to any “qualified residence” of the taxpayer. Sec. 163(h)(3)(A).
A “qualified residence” includes the taxpayer’s “principal residence” and one
other home “which is selected by the taxpayer for purposes of this subsection for
the taxable year and which is used by the taxpayer as a residence.” Sec.
163(h)(4)(A)(i). Both “acquisition indebtedness” and “home equity indebtedness”
must be secured by the qualified residence. Sec. 163(h)(3)(B)(i)(II), (C)(i).
For 2006 petitioners claimed a Schedule A mortgage interest deduction of
$40,897, which was attributable to four loans. The IRS allowed a deduction of
$29,897, attributable to two loans secured by the Vienna property. The IRS cor-
rectly disallowed the interest deduction for the third loan because petitioners had
- 25 -
[*25] deducted the same interest on Schedule E as a rental expense of the McLean
property. The IRS correctly disallowed the interest deduction for the fourth loan,
an $80,000 line of credit, because petitioners provided no evidence that this loan
was secured by any real property. We thus sustain respondent’s determination for
2006.
For 2007 petitioners claimed a Schedule A mortgage interest deduction of
$27,280. The IRS increased this deduction by $2,579. Petitioners agree with this
adjustment.
For 2008 petitioners claimed a Schedule A mortgage interest deduction of
$38,674. The IRS allowed a deduction of $29,772, attributable to the two loans
secured by the Vienna property. At trial petitioners produced a Form 1098, Mort-
gage Interest Statement, issued by Wachovia showing interest paid on two loans.
However, the IRS had already allowed a deduction for the interest on one of these
loans, and petitioners produced no evidence to show that the other loan was se-
cured by a primary or secondary residence. We thus sustain respondent’s determi-
nation for 2008.
For 2009 petitioners claimed a Schedule A mortgage interest deduction of
$51,607. The IRS allowed $31,431 of this deduction, again attributable to the two
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[*26] loans secured by the Vienna property.2 Petitioners again produced a Form
1098 showing interest paid on two loans. But as was true for 2008, the IRS had
already allowed a deduction for the interest paid on one of the loans, and pe-
titioners failed to provide any evidence that the other loan was secured by any real
property. The IRS disallowed an interest deduction with respect to a fourth loan;
petitioners on brief did not dispute the basis for this disallowance, and we deem it
conceded. We accordingly sustain respondent’s determinations for 2009 in full.
B. Schedule E Mortgage Interest
For 2009 petitioners filed a Schedule E reporting income from leasing space
for a billboard on their West Virginia property. On this Schedule E they reported
mortgage interest expense of $9,401. They substantiated this expense with a Form
1098 from BB&T Bank and a $146,250 mortgage note secured by the property.
A “qualified residence” for purposes of section 163 includes the taxpayer’s
primary residence and one other home “which is used by the taxpayer as a resi-
dence (within the meaning of section 280A(d)(1)).” To meet the latter require-
ment the taxpayer must use the home “for personal purposes for a period exceed-
ing the greater of 14 days or 10% of the number of days during the year for which
2
The interest deduction on the second loan was limited because of the
$100,000 cap on home equity indebtedness. See sec. 163(h)(3)(C)(ii).
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[*27] the unit is rented at fair rental.” Sec. 280A(d)(1). Since petitioners did not
rent the West Virginia home, the 14-day test supplies the governing standard here.
Dr. Zolghadr testified that when her husband purchased the property in mid-
2008 it was used initially as their secondary residence.3 Petitioners began re-
ceiving rental income from the billboard shortly thereafter, and in 2009 Mr. Zol-
ghadr engaged in some sort of car dealership activity on the property. In connec-
tion with this activity, Dr. Zolghadr testified that her husband often resided at the
property for extended periods because of its distance from their home in Vienna.
Her testimony on this point was credible, and we find that Mr. Zolghadr resided in
the West Virginia home for more than 14 days during 2009.
We conclude that petitioners have met their burden of showing that the
West Virginia property was a secondary residence and that one or both petitioners
resided in it for more than 14 days during 2009. Although petitioners erroneously
reported the mortgage interest on Schedule E, we find that they are entitled to an
additional Schedule A mortgage interest deduction of $9,401 for 2009.
3
Mr. Zolghadr is fluent only in Farsi, and because of language difficulties he
did not testify at trial.
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[*28] V. Additions to Tax and Penalties
Section 6651 provides for an addition to tax of 5% of the tax required to be
shown on the return for each month or fraction thereof for which there is a failure
to file the return, not to exceed 25% in toto. The parties stipulated that petitioners’
2006 and 2007 returns were not filed until October 5, 2009, and that their 2008 re-
turn was not filed until November 1, 2009. Because all three returns were indis-
putably filed late, respondent has met his burden of production under section
7491(c).
A taxpayer who files his return late is liable for this addition to tax unless he
shows that his failure was due to reasonable cause and not due to willful neglect.
Sec. 6651(a)(1); United States v. Boyle, 469 U.S. 241, 245 (1985). In their peti-
tion, petitioners did not assign error to respondent’s determination that they are
liable for late-filing additions to tax. See Rule 34(b)(4) (adjustments to which
error is not assigned are deemed conceded); Swain v. Commissioner, 118 T.C.
358, 358 (2002). In any event, petitioners produced no evidence that their late
filings were due to reasonable cause, and we accordingly sustain the additions to
tax.
The Code imposes a 20% penalty on the portion of any underpayment of tax
attributable to “[n]egligence or disregard of rules and regulations” or “[a]ny sub-
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[*29] stantial understatement of income tax.” Sec. 6662(a) and (b)(1) and (2).
Negligence includes “any failure to make a reasonable attempt to comply” with the
internal revenue laws. Sec. 6662(c). An understatement of income tax is “sub-
stantial” if it exceeds the greater of $5,000 or 10% of the tax required to be shown
on the return. Sec. 6662(d)(1)(A). Under section 7491(c) respondent bears the
burden of production with respect to the liability of any individual for any penalty.
See Higbee v. Commissioner, 116 T.C. 438, 446 (2001).
No penalty is imposed with respect to any portion of an underpayment if the
taxpayer acted with reasonable cause and in good faith with respect thereto. The
taxpayer bears the burden of proving reasonable cause and good faith. Id. at 444-
447. Reasonable cause can be shown by good-faith reliance on the advice of a
qualified tax professional. Sec. 1.6664-4(b)(1), (c), Income Tax Regs. Whether
the taxpayer actually relies on the advice and whether such reliance is reasonable
present questions of fact. Neonatology Assocs., P.A. v. Commissioner, 115 T.C.
43, 98 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002); sec. 1.6664-4(c)(1), Income Tax
Regs. For reliance to be reasonable, the taxpayer must prove (among other things)
that he provided “necessary and accurate information to the adviser.” Neonatol-
ogy Assocs., 115 T.C. at 99.
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[*30] Respondent has met his burden of production with respect to petitioners’
negligence. They presented virtually no credible evidence with respect to their
underreporting of income. They maintained wholly inadequate books and records
for Dr. Zolghadr’s dental practice. And most of the records they did provide were
cobbled together shortly before trial and lacked credibility.
Petitioners have woefully failed to establish that they made a good-faith
effort to determine their Federal income tax liabilities correctly. Although they
hired a tax return preparer for their returns, they presented no credible evidence
regarding what if any records they provided to that person to substantiate their
income and expenses. Nor have they shown that their return preparer was compe-
tent; the preparer’s unquestioning acceptance of their obviously inflated Schedule
C expenses, in the absence of any plausible books and records, suggests otherwise.
We accordingly conclude that all of the underpayments (as redetermined) are at-
tributable to negligence. Alternatively, in the event the Rule 155 computations
show that the various understatements of income tax exceed the greater of $5,000
or 10% of the amounts required to be shown on the respective returns, we con-
clude that those underpayments are attributable to substantial understatements of
income tax for which reasonable cause has not been shown.
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[*31] To reflect the foregoing,
Decision will be entered
under Rule 155.