UNITED STATES COURT OF APPEALS
For the Fifth Circuit
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No. 97-60252
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Jung K. and Hee S. YOON,
Petitioners-Appellants,
VERSUS
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
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Appeal from the Decision of the United States Tax Court
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March 6, 1998
Before REYNALDO G. GARZA, DUHÉ, and STEWART, Circuit Judges.
REYNALDO G. GARZA, Circuit Judge:
The Internal Revenue Service (“IRS”) used the net worth plus personal living expenses
method to determine the Yoons’ unreported income. The Tax Court modified this determination
in part, and sustained it in part. The Yoons claim error in the determination of their nondeductible
personal living expenses, and in the Tax Court’s refusal to reduce their opening net worth by the
amount of certain credit card liabilities. We find that the Tax Court did not err in the
determination of the Yoons’ nondeductible personal living expenses. We do find error, however,
in the Tax Court’s imposition on the Yoons of the burden of establishing an opening net worth.
As such, we vacate that portion of the Tax Court’s opinion and remand for a redetermination of
the Yoons’ opening net worth and the resultant deficiencies and additions to tax.
Factual and Procedural Background
A. The Yoons and JKY, Inc.
During 1989, 1990, and 1991, Jung K. Yoon and Hee S. Yoon, husband and wife, owned
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and operated a general merchandise store in South El Paso under the name L.A. Trading, which
specialized in low-cost items. Most of L.A. Trading’s customers came into the United States
from Juarez, Mexico. The Tax Court found that during those years, Mr. Yoon worked 14 hours a
day, 7 days a week, and never took a vacation.
In 1989, the Yoons operated L.A. Trading as a sole proprietorship. On January 31, 1990,
the Yoons incorporated Jung K. Yoon, Inc. (“JKY”), electing treatment as an S corporation.
JKY operated the merchandise business that the Yoons had previously operated as a sole
proprietorship. During 1990 and 1991, the Yoons owned 100% of the stock of JKY. By the end
of 1995, the Yoons closed L.A. Trading due to the downturn in the Mexican economy and the
devalued peso.
JKY’s suppliers were mainly Korean-owned businesses located primarily in Los Angeles,
California. Occasionally, Mr. Yoon entertained JKY’s suppliers in hopes of getting better prices
and better payment plans. JKY purchased over $1 million in inventory during each of the years in
issue. Mr. Yoon frequently traveled to Los Angeles to purchase merchandise. Mr. Yoon also
traveled to Las Vegas, Nevada, two or three times each year to attend trade shows and to
purchase merchandise. Mr. Yoon has no relatives in Los Angeles or Las Vegas.
The Yoons maintained several personal and business accounts in at least two banks during
1989, 1990, and 1991. The Yoons’ children also maintained bank accounts during those years.
The Yoons acquired four properties during the 1989-91 period for purchase prices
totaling more than $1.5 million. The Yoons took several loans from various lenders for these
purposes totaling almost $1.1 million, including an $80,000 loan from Jae Gilpen in 1989. The
Yoons also incurred debt related to their purchase of several automobiles during the same period.
The Yoons had personal credit card balances of $20,521.99 as of December 31, 1989,
$16,413.37 as of December 31, 1990, and $26,075.24 as of December 31, 1991.
B. The Yoons’ Income Tax Returns
Patrick Caufield prepared the Yoons’ 1989 Form 1040, U.S. Individual Income Tax
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Return (jointly filed on a cash basis), and JKY’s 1990 Form 1120S, U.S. Income Tax Return for
an S Corporation. Caufield did not review the tax returns with the Yoons because of difficulty
communicating with them due to language barriers (the Yoons immigrated to the United States
from Korea in 1975 and apparently speak mainly Korean). Thomas Hwang prepared the Yoons’
1990 and 1991 Forms 1040 (jointly filed on a cash basis) and JKY’s 1991 Form 1120S.
Caufield and Hwang did not use the cash register tapes from the business when calculating
the amount of gross receipts reported on the Yoons’ and JKY’s returns. Instead, they used
monthly written statements of JKY’s gross receipts, which the Yoons prepared.
C. The IRS Revenue Agent’s Examination of the Yoons’ Returns
During an examination of the Yoons’ returns, the IRS requested bank receipts and other
documents from the Yoons. The Yoons did not produce check registers or all of the bank
statements and canceled checks from their various accounts or other records necessary for the
revenue agent to adequately determine their taxable income. Consequently, the IRS reconstructed
the Yoons’ income using the net worth method for 1989 and the bank deposits method on JKY
combined with the net worth method on the Yoons personally for 1990 and 1991.
The net worth method calculates income by determining a taxpayer’s net worth at the
beginning and end of a period. The difference is the increase in net worth. An increase in net
worth, plus nondeductible expenditures (such as personal living expenses), less nontaxable
receipts, may be considered taxable income. If the resulting figure for any year is substantially
greater than the taxable income reported by the taxpayer for that year, the IRS claims the excess
represents unreported taxable income. See Holland v. United States, 348 U.S. 121, 125 (1954).
For the year 1989, the IRS determined that the Yoons spent $124,929 on personal living
expenses and had a total of $158,166 in unreported income:
Net Worth at end of 1989 $505,106
(Net Worth at end of 1988) (299,653)
Change in Net Worth $205,453
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Personal Living Expenses 124,929
Adjusted Gross Income as Corrected $330,382
(Adjusted Gross Income per Return) (172,216)
1989 Unidentified Income $158,166
For 1990, the IRS determined that the Yoons spent $138,810 on personal living expenses and had
$208,261 of unreported income:
Net Worth at end of 1990 $629,844
(Net Worth at end of 1989) (505,106)
Change in Net Worth $124,738
Personal Living Expenses 138,810
(Cash Withdrawal from JKY Capital Account) (18,000)
Adjusted Gross Income as Corrected $245,548
(Adjusted Gross Income per Return) (37,287)
1990 Unidentified Income $208,261
For 1991, the IRS determined that the Yoons spent $186,248 on personal living expenses and had
$205,562 of unreported income:
Net Worth at end of 1991 $1,008,268
(Net Worth at end of 1990) (611,844)
Change in Net Worth $396,424
Personal Living Expenses 186,248
(Cash Withdrawal from JKY Capital Account) (133,100)
Adjusted Gross Income as Corrected $499,572
(Adjusted Gross Income per Return) (244,010)
1991 Unidentified Income $205,562
Accordingly, The IRS determined and assessed the following deficiencies and additions to
tax against the Yoons:
Additions to Tax
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§ 6651(a)(1) § 6663(a) Civil
Year Deficiency Delinquency Penalty Fraud Penalty
1989 $47,002 -- $35,251
1990 76,128 -- 56,528
1991 83,068 $9,071 61,157
D. The Tax Court
The Yoons filed a timely petition in Tax Court. At trial on December 5, 1995, the IRS
conceded the fraud penalties under § 6663, instead asserting negligence penalties under § 6662(a).
The IRS also conceded a $38,000 adjustment for 1990.
The Yoons and their C.P.A., Caufield, prepared their own analysis of personal living
expenses which reflected $48,719 spent on personal living expenses in 1989, $97,860 in 1990,
and $94,106 in 1991. Initially, the government successfully objected to the introduction of this
analysis at trial, but during the trial, the Yoons’ counsel offered to waive all objections to the
government’s exhibits if the government would withdraw its objections to the Yoons’ exhibits,
including the Yoons’ personal living expense analysis. The government accepted this offer after
trial, but noted that the acceptance did not constitute agreement that the Yoons’ analysis was
accurate.
After trial, the Tax Court issued its opinion upholding the Commissioner’s determinations
in part. The IRS filed computations pursuant to Tax Court Rule 155, to which the Yoons
objected. On January 15, 1997, the Tax Court entered a decision redetermining the taxes and
penalties based on those computations:
Additions to Tax
§ 6651(a)(1) § 6662(a) Negligence
Year Deficiency Delinquency Penalty Penalty
1989 $43,977 -- $8,795
1990 58,150 -- 11,630
1991 52,351 $13,087 10,470
The Yoons appealed to this Court, which has jurisdiction pursuant to 26 U.S.C. §
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7482(a)(1) (“The United States Courts of Appeals . . . shall have exclusive jurisdiction to review
the decisions of the Tax Court, except as provided in section 1254 of Title 28 of the United States
Code, in the same manner and to the same extent as decisions of the district courts in civil actions
tried without a jury . . . .”). The Yoons argue that the Tax Court clearly erred by sustaining the
IRS’ computation of their personal living expenses, and that the Tax Court erred as a matter of
law by failing to reduce their net worth as of December 31, 1989 by $20,521, which the Tax
Court found the Yoons owed on credit card liabilities as of December 31, 1989.
Discussion
A. Standard of Review and the Presumption of Correctness
This Court reviews the Tax Court’s approval of the IRS Commissioner’s determination of
taxable income under the clearly erroneous standard of review. Webb v. Commissioner of
Internal Revenue, 394 F.2d 366, 372 (5th Cir. 1968). Similarly, this Court reviews the Tax
Court's finding that a taxpayer has failed to come forward with sufficient evidence to support a
deduction under the clearly erroneous standard of review. Sandvall v. Commissioner of Internal
Revenue, 898 F.2d 455, 458 (5th Cir. 1990).
Furthermore, it is well settled that the courts afford IRS determinations of deficiency a
presumption of correctness. E.g., United States v. Janis, 428 U.S. 433, 440-41 (1976);
Helvering v. Taylor, 293 U.S. 507, 515 (1935); Portillo v. Commissioner of Internal Revenue,
932 F.2d 1128, 1133 (5th Cir. 1991); Webb, 394 F.2d at 372. To rebut this presumption, the
taxpayer bears the burden of proving by a preponderance of the evidence that the determination is
arbitrary or erroneous. Portillo, 932 F.2d at 1133.
B. The Tax Court erroneously placed the burden of establishing an opening net worth
on the Yoons; therefore, the Tax Court’s refusal to reduce the Yoons’ 1989 net
worth for $20,521 was erroneous as a matter of law.
The Tax Court erred by not reducing the Yoons’ 1989 net worth for $20,521 of credit
card liabilities existing at the end of 1989. Under the net worth method, “an essential condition . .
. is the establishment, with reasonable certainty, of an opening net worth, to serve as a starting
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point from which to calculate future increases in the taxpayer’s assets.” Holland, 348 U.S. at
132; Curtis v. Commissioner of Internal Revenue, 623 F.2d 1047, 1049 (5th Cir. 1980)
(explaining that “in a net worth case, the Government, having concluded that the taxpayer’s
records are inadequate as a basis for determining income tax liability, attempts to establish an
‘opening net worth’ or total net value of the taxpayer’s assets at the beginning of a given year.”).
It is clear that the government bears the burden of establishing the opening net worth with
reasonable certainty. United States v. Smith, 890 F.2d 711, 713 (5th Cir. 1989) (“Essential to this
[net worth] methodology is the taxpayer's opening net worth. The government must prove the
taxpayer's opening net worth . . . with reasonable certainty.”); Campfield v. Commissioner of
Internal Revenue, T.C. Memo 1996-383, 1996 WL 467816, 72 T.C.M. (CCH) 425 (U.S. Tax Ct.
1996) (“[I]n light of the standards set forth in Holland v. United States, 348 U.S. 121 (1954), and
United States v. Massei, 355 U.S. 595 (1958) . . . the Commissioner must establish, with
reasonable certainty, an opening net worth as a starting point from which to calculate future
increases in the taxpayer's assets.”), aff’d, ___ F.3d ___, 1997 WL 829260 (2d Cir. 1997).
Accordingly, the Tax Court erred when it placed the burden of establishing an opening net
worth on the Yoons. The Tax Court held: “Petitioners failed to provide any reliable evidence
from which we can establish or even estimate their credit card liabilities as of December 31, 1988,
or January 1, 1989[.] Thus, we cannot adjust respondent’s net worth determination for 1989 by
any credit card liabilities.” This ruling flies in the face of the necessary condition of the net worth
method that the government establish an opening net worth with reasonable certainty.
Essentially, the Tax Court’s ruling and the IRS’ assessment amount to an arbitrary
increase in the Yoons’ opening net worth based on the absence of evidence of that amount at the
end of 1989 and, as such, the presumption of correctness does not apply. As this Court explained
in Portillo, “[i]n these types of unreported income cases, the Commissioner would not be able to
choose to rely solely upon the naked assertion that the taxpayer received a certain amount of
unreported income for the tax period in question.” 932 F.2d at 1134. In other words, the IRS
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may not rely solely on the presumption of correctness. See Carson v. United States, 560 F.2d
693, 697-698 (5th Cir. 1977) (upholding determination that taxpayer had wagering income, but
disallowing similar determination for earlier periods where Commissioner relied solely on
presumption of correctness for earlier period). Accordingly, this ruling was erroneous as a matter
of law.
The government’s asserted explanations for the failure to consider the Yoons’ 1989 credit
card liabilities fall far short of the mark. At oral argument, the government acknowledged that
“the IRS does have to establish opening net worth.” The government next correctly pointed out
that the case law in this area does not require mathematical precision in the IRS’ determination of
opening net worth; however, as noted, the cases do require “reasonable certainty,” which at least
requires more than the IRS’ mere assumption of the existence of income. See Holland, 348 U.S.
at 132; Campfield, T.C. Memo 1996-383, 1996 WL 467816, 72 T.C.M. (CCH) 425 (U.S. Tax
Ct. 1996).
The government’s asserted line of reasoning would impermissibly shift the burden of
proving an opening net worth away from the IRS and onto the taxpayers. The government’s
attorney argued that the IRS was justified in not considering the 1989 credit card balances
because “that may have been the same balance that [the Yoons] had at beginning of 1989, and
[the Yoons] didn’t produce any evidence on that.” Refusing to consider the Yoons’ liabilities at
the end of the first year at issue is the same as simply adding the amount of those liabilities to the
Yoons’ opening net worth for purposes of determining a change in net worth.
We cannot and will not condone such an end-run around the government’s clearly
established burden of proof. As the Supreme Court has observed, “[w]hile we cannot say that
the[] pitfalls inherent in the net worth method foreclose its use, they do require the exercise of
great care and restraint.” Holland, 348 U.S. at 129. The Court clearly instructed that when
reviewing net worth determinations, “[a]ppellate courts should review the cases, bearing
constantly in mind the difficulties that arise when circumstantial evidence as to guilt is the chief
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weapon of a method that is itself only an approximation.” Id.
In contrast to the government’s position at oral argument, Carson does not support the
IRS’ arbitrary refusal to consider the 1989 credit card balances in its determination of the Yoons’
opening net worth. Carson, which involved wagering income, reinforced the government’s
obligation to provide some factual foundation for its assessments: “While we realize the
difficulties the Commissioner encounters in assessing deficiencies in circumstances such as are
presented here, we nevertheless must insist that the Commissioner provide some predicate
evidence connecting the taxpayer to the charged activity if effect is to be given his presumption of
correctness.” 560 F.2d at 697 (citing Gerardo v. Commissioner of Internal Revenue, 552 F.2d
549, 554 (3d Cir. 1977)).
Where the burden lies on the government to produce some factual predicate for an
assessment, the government may not discharge that burden simply by imposing a naked
assessment and then pointing out that the taxpayers did not produce evidence to rebut that
assessment. Janis, 428 U.S. at 441. Taxpayers do bear the burden of maintaining accounting
records which enable them to file a correct tax return, e.g., Webb, 394 F.2d at 371, and in the
absence of such records the IRS may compute the taxpayer’s income by any reasonable method
that clearly reflects income, 26 U.S.C. § 446(b) (1997); however, a tax determination without
rational foundation is “not properly subject to the usual rule with respect to the burden of proof in
tax cases.” Janis, 428 U.S. at 441 (citing Helvering v. Taylor, 293 U.S. 507, 514-515 (1935)).
As this Court eloquently noted in Carson: “The tax collector's presumption of correctness has a
herculean muscularity of Goliathlike reach, but we strike an Achilles’ heel when we find no
muscles, no tendons, no ligaments of fact.” 560 F.2d at 696; see also Portillo, 932 F.2d at 1133
(“In these types of unreported income cases, the Commissioner would not be able to choose to
rely solely upon the naked assertion that the taxpayer received a certain amount of unreported
income for the tax period in question.”).
C. The Tax Court’s ruling sustaining most of the IRS revenue agent’s
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determinations of the Yoons’ personal living expenses was not clearly
erroneous.
The IRS revenue agent’s determinations of the Yoons’ personal living expenses, as
modified by the Tax Court, were not arbitrary or erroneous; therefore, the presumption of
correctness applies, and the Tax Court’s rulings in that regard were not clearly erroneous. As
stated, taxpayers must maintain accounting records which enable them file a correct tax return.
E.g., Webb, 394 F.2d at 371. Where a taxpayer keeps no books, or keeps books that are
inadequate, Internal Revenue Code § 446(b) authorizes the IRS to compute the taxpayer’s income
by any reasonable method that clearly reflects income. 26 U.S.C. § 446(b) (1997); see also
Woodall v. Commissioner of Internal Revenue, 964 F.2d 361, 364 (5th Cir. 1992) (approving use
of bank deposits plus cash expenditures method of calculating income). The taxpayer bears the
burden of demonstrating “any unfairness or inadequacy in the method.” Id. The presumption of
correctness applies here, because the IRS attempted to substantiate the charges of unreported
income “by some other means, such as by showing the taxpayer's net worth, bank deposits, cash
expenditures, or source and application of funds.” Portillo, 932 F.2d at 1133-34.
1. The IRS’ application of a 10% discount to determine the Yoons’ 1989
personal living expenses was not clearly erroneous.
The IRS’ implementation of a 10% discount to determine the Yoons’ 1989 personal living
expenses was justified as a reasonable method of calculation that clearly reflects income. 26
U.S.C. § 446(b) (1997); see also Woodall, 964 F.2d at 364. At trial, the Yoons offered their own
calculation of personal living expenses, which also based the 1989 personal living expenses on a
10% discount of the 1990 personal living expenses. The Yoons’ 1990 figure was considerably
lower than the IRS’ 1990 figure, but the Yoons’ use of a 10% discount belies their argument that
the IRS’ use of that discount was arbitrary and capricious.
2. The Tax Court’s refusal to subtract certain expenditures allegedly not
incurred in 1989 from the Yoons’ 1990 personal living expenses prior to
applying the 10% discount was not clearly erroneous.
The Tax Court’s refusal to accept the Yoons’ calculation of their 1990 personal living
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expenses for purposes of applying a discount to determine 1989 personal living expenses was not
clearly erroneous. The Yoons argue that they incurred certain expenditures in 1990 that they did
not incur in 1989, namely $24,265 in income taxes and $18,000 in life insurance premiums. The
Yoons argue that the IRS should have applied the discount to their 1990 personal living expenses
less these expenditures. The Tax Court noted, however, that the Yoons offered no explanation
for their failure to produce any books and records for 1989. Although the Yoons offered their
accountant’s summary of 1989 personal living expenses, the summary itself amounts to nothing
more than a handwritten assertion, without any substantiating documentation, that the income tax
and life insurance payments did not exist in 1989. Accordingly, the court had no way of
corroborating the Yoons’ assertion that they did not incur these expenses in 1989.
The computation of personal living expenses is qualitatively different from the
establishment of an opening net worth, of which the government bears the burden of producing
some evidence. See Toledano v. Commissioner of Internal Revenue, 362 F.2d 243, 246 (5th Cir.
1966) (“As to the amount of the living expenses, the Commissioner relies on his presumption of
correctness. In the absence of rebutting evidence or a showing such evidence would be more than
usually difficult to obtain, the Tax Court was justified in finding the presumption of correctness
was not overcome.”) (citations omitted). We have already found that the IRS’ use of a 10%
discount to determine 1989 personal living expenses was not arbitrary. The Yoons cannot
overcome the reasonableness of that method merely by asserting the nonexistence of certain
expenses in 1989 when the very reason for the use of a 10% discount was the absence of records
for 1989. This is especially true in light of the presumption of correctness in favor of the
government. Based on the record, the Tax Court’s finding that the Yoons failed to produce “any
books and records” for 1989 and did not explain that failure was not clearly erroneous; therefore,
the Tax Court correctly sustained the IRS’ determination of 1989 personal living expenses.
3. The Tax Court’s ruling sustaining the IRS revenue agent’s classification of
certain unidentified expenses as personal living expenses was not clearly
erroneous.
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The IRS agent’s classification as personal living expenses of the $17,411 discrepancy
between the Yoons’ 1990 bank statements and the checks that the Yoons provided was not
arbitrary or erroneous. The Tax Court noted the revenue agent’s testimony that this amount
represented “the difference between the bank account balances and the analysis of personal living
expenses for 1990 provided to respondent [IRS] by petitioners [the Yoons].” The Tax Court also
noted the agent’s testimony that the Yoons did not provide any explanations or canceled checks
to support any other treatment of this amount, and that the Yoons “also failed to offer any
explanation of the difference . . . .” Id.
The Tax Court’s findings in this regard are supported by the record, and the Yoons have
not identified any contrary evidence in the record that would render the Tax Court’s findings
clearly erroneous. The Yoons assert that the revenue agent classified this amount as personal
living expenses without any consideration of the purpose of the expenditures; however, as noted,
in order to overcome the government’s presumption of correctness, the Yoons bear the burden of
producing adequate records for determining income. Allocation of this amount as personal living
expenses was reasonable; therefore, the Tax Court’s finding that the Yoons failed to meet their
burden is not clearly erroneous. See Toledano, 362 F.2d at 246.
Similarly, the Yoons’ argument that the IRS arbitrarily classified other unidentified
expenses as personal living expenses must also fail. The Tax Court found that the Yoons failed to
identify the specific instances when this occurred and failed to offer any proof that these expenses
were not personal living expenses. This finding was not clearly erroneous. As such, the Yoons
failed to meet their burden of providing accurate records as to these expenses; therefore, it was
reasonable for the IRS to classify these expenses as personal living expenses. See Toledano, 362
F.2d at 246.
4. The Tax Court’s ruling sustaining the IRS revenue agent’s classification of
the Yoons’ personal credit card payments as personal living expenses was not
clearly erroneous.
The Yoons also take issue with the Tax Court’s treatment of all payments on personal
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credit cards as personal living expenses; however, as the Tax Court noted, the Yoons did not
produce evidence sufficient to support treatment of these expenses as business deductions. The
Yoons argue that some of these payments represented personal business expenses. As evidence
of the business nature of these expenses, the Yoons point to the Tax Court’s own findings of fact
that Mr. Yoon never took a vacation, that JKY’s suppliers were located primarily in Los Angeles,
that Mr. Yoon occasionally entertained JKY’s suppliers for business purposes, that Mr. Yoon
traveled to Las Vegas for business purposes, and that Mr. Yoon had no relatives in Los Angeles
or Las Vegas.
The Tax Court did not clearly err when it determined that the schedules of credit card
charges that the Yoons’ accountant, Caufield, prepared were not reliable and did not support
treatment of these expenses as deductible business expenses. In order to prove entitlement to
deductions for travel and entertainment expenses, a taxpayer must meet the specific substantiation
requirements of § 274(d), including the date, time, place, amount, and business purpose of the
expense, as well as the business relationship between the taxpayer and the people he or she
entertained. 26 U.S.C. § 274(d); see Dowell v. United States, 522 F.2d 708, 714 (5th Cir. 1975),
cert. denied, 426 U.S. 920 (1976); see also 26 U.S.C. § 274(n) (1982) (limiting travel and
entertainment deductions to 80% for the years 1989, 1990, and 1991) (pre-1993 amendment).
The Tax Court’s analysis of § 274(d)’s substantiation requirements was not inconsistent
with its findings of fact so as to render that analysis clearly erroneous. The Tax Court noted that
the underlying credit card statements were not part of the record in this case, and that the Yoons’
schedules themselves showed that certain statements were not available when Caufield prepared
the schedules. Furthermore, the court noted that the Yoons had not indicated which expenditures
they had already deducted on JKY’s 1990 and 1991 returns. These circumstances justify the Tax
Court’s conclusion that the Yoons’ proffered evidence of entitlement to business expense
deductions was not reliable.
The Yoons urge that the alleged business nature of these expenses is relevant only to a
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calculation of personal living expenses, which they argue is qualitatively different from a
deduction and, therefore, does not require substantiation; however, we view this as a distinction
without a difference. The Yoons’ failure to maintain adequate records necessitated the
government’s use of the net worth plus personal living expenses method of calculating income.
They cannot thereafter claim that the same failure to produce records somehow exempts them
from the substantiation requirements of § 274(d). At any rate, § 274(d) requires substantiation
for a “deduction or credit.” Under the net worth plus personal living expenses method of
calculating income, personal living expenses are evidence of income, therefore, arguing for a
business expense credit or deduction under that method is no different from arguing for such a
deduction or credit when calculating income by some other method. As such, § 274(d)’s
substantiation requirements clearly apply to the Yoons’ assertion of business expenses.
Furthermore, we reject the alternative argument that, if § 274(d)’s substantiation
requirements do apply, the Yoons qualify for an exception to those requirements. At oral
argument, the Yoons’ attorney raised 26 C.F.R. § 1.274-5T(c)(3), which allows for substantiation
by other sufficient evidence where a taxpayer has not obtained adequate records, and 26 C.F.R. §
1.274-5T(c)(4), which governs substantiation in exceptional circumstances, i.e., where the
inherent nature of the situation prevents the taxpayer from obtaining adequate records or other
sufficient evidence. The exception for substantiation by “other sufficient evidence” requires
corroborative evidence sufficient to establish the substantiation elements. 26 C.F.R. § 1.274-
5T(c)(3) (1997). The exception for exceptional circumstances requires corroboration by evidence
possessing the “highest degree of probative value possible under the circumstances.” 26 C.F.R. §
1.274-5T(c)(4) (1997). As previously noted, however, the Tax Court did not clearly err when it
determined that the Yoons’ proffered corroborative evidence was not reliable. As such, the
Yoons are unable to satisfy the corroborative evidence requirements of §§ 1.274-5T(c)(3) and
1.274-5T(c)(4).
5. The Tax Court’s ruling regarding payments in excess of $80,000 to Gilpen, a
known creditor, was not clearly erroneous.
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The Yoons’ argument that the revenue agent arbitrarily treated $38,321 of payments in
1991 to Gilpen, a known creditor, as personal living expenses is unclear and conclusory. The IRS
recognized an $80,000 loan from Gilpen, and classified it as a liability. The Yoons argued before
the Tax Court that there was an additional $40,000 loan from Gilpen. The court found that there
was no evidence of this second loan, other than Mr. Yoon’s uncorroborated testimony. The court
did, however, note the existence of canceled checks reflecting $109,320 of payments to Gilpen in
1991. Accordingly, the Tax Court held that the Yoons were entitled to a $29,320 interest
deduction in 1991, representing the difference between the amount paid to Gilpen and the
$80,000 loan which the IRS recognized as a liability. There is no reference in the Tax Court
opinion to any other payments to Gilpen, and the Yoons’ citation to the Tax Court transcript does
not support the existence of the second loan. As such, the Tax Court did not err. Actually, the
Tax Court corrected the IRS revenue agent’s determination by allowing deductions for all 1991
payments to Gilpen of which the Tax Court had evidence, thereby making the Yoons’ argument
based on the arbitrariness of the revenue agent’s classification a moot point.
Conclusion
The Tax Court’s rulings sustaining the IRS’ determination of the Yoons’ personal living
expenses were not clearly erroneous; however, the Tax Court did erroneously impose the burden
of establishing an opening net worth on the Yoons. Accordingly, we hereby vacate that portion
of the Tax Court’s opinion and remand to the Tax Court for a redetermination of the Yoons’
opening net worth and the resultant deficiencies and additions to tax.
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