1 Unless otherwise indicated, all section references are to

the Internal Revenue Code of 1986 as in effect for the taxable

years in issue.

T.C. Memo. 2006-110

UNITED STATES TAX COURT

ROBERT D. AND PATRICIA M. BRAUN, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 6348-04. Filed May 23, 2006.

Robert J. Gumser, for petitioners.

Sylvia L. Shaughnessy, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GALE, Judge: Respondent determined deficiencies in

petitioners' 1992 and 1993 Federal income tax of $4,293 and

$6,310, respectively, and additions to tax under section1
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6651(a)(1) of $1,053 and $1,556, respectively. The issues for

decision are (1) whether petitioners are entitled to deduct

Schedule C, Profit or Loss From Business, expenses from the real

estate loan business of petitioner Robert D. Braun, and (2)

whether petitioners are liable for additions to tax under section

6651(a)(1) for their 1992 and 1993 taxable years.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. 

The stipulation of facts and the attached exhibits are

incorporated herein by this reference. At the time they filed

the petition, Robert D. Braun (petitioner) and Patricia M. Braun

(Mrs. Braun) resided in San Diego, California. 

On their Federal income tax returns for 1992 and 1993

petitioners claimed five exemptions--themselves and their three

dependent children. Petitioners' only reported source of income

for support in both taxable years was petitioner's real estate

loan business, the results of which petitioners listed each year

on a Schedule C. On the Schedule C attached to their 1992 tax

return, petitioners reported gross receipts of $24,368 and

deducted claimed expenses of $23,408 (including office expenses

of $5,640 and advertising expenses of $1,975) for a net profit of

$960. On the Schedule C attached to their 1993 tax return,

petitioners reported gross receipts of $31,775 and deducted

claimed expenses of $30,328 (including office expenses of $6,200
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2 Because of the poor quality of the copy of petitioners'

1993 Schedule C in the record, we are unable to determine the

exact amount of advertising expenses petitioners claimed, but

note that it appears to be approximately $1,800.

and advertising expenses of less than $2,0002) for a net profit

of $1,447. 

In July 1990, the Federal Bureau of Investigation (FBI)

conducted a raid on a company petitioner operated at that time

and seized all the company's business records. Sometime after

the seizure, petitioner commenced operation of the real estate

loan business that generated the gross receipts petitioners

reported for 1992 and 1993. The FBI's investigation of

petitioner continued until October 24, 1994, when petitioner pled

guilty to one count of tax evasion under section 7201 with

respect to his 1988 taxable year and one count of mail fraud. On

January 17, 1995, petitioner was sentenced to 24 months of

incarceration with supervised release for 3 years thereafter. 

Sometime later in 1995, while petitioner was incarcerated, the

FBI returned petitioner's seized records to Mrs. Braun. 

Petitioners' 1992 and 1993 Federal income tax returns were

dated and signed April 12, 2001, and were filed with respondent

on April 20, 2001. Respondent disallowed all of petitioners'

claimed Schedule C expenses for 1992 and 1993 and issued

petitioners a notice of deficiency on April 5, 2004. Petitioners
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3 Petitioners have neither claimed nor shown entitlement to

any shift in the burden of proof pursuant to sec. 7491(a).

do not have any documentary substantiation for the expenses they

claimed on their 1992 or 1993 Schedule C. 

OPINION

Schedule C Expense Deductions

Deductions are strictly a matter of legislative grace. 

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New

Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). 

Therefore, the taxpayer bears the burden of proving that he is

entitled to the deductions claimed and of substantiating the

amounts and purposes of those deductions.3 Hradesky v.

Commissioner, 65 T.C. 87, 89-90 (1975), affd. per curiam 540 F.2d

821 (5th Cir. 1976). Section 162(a) provides that there shall be

allowed as a deduction all the ordinary and necessary expenses

paid or incurred during the taxable year in carrying on any trade

or business. Taxpayers must keep sufficient records to establish

the claimed deductions. See sec. 6001; Meneguzzo v.

Commissioner, 43 T.C. 824, 831 (1965); sec. 1.6001-1(a), Income

Tax Regs. 

To be entitled to a deduction under section 162(a), a

taxpayer is required to substantiate the deduction through the

maintenance of books and records. Generally, in the event that a

taxpayer establishes that he or she has incurred a deductible
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expense but is unable to substantiate the precise amount, the

Court may approximate the amount, bearing heavily if it chooses

against the taxpayer whose inexactitude is of his own making. 

Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). The

Court must, however, have evidence sufficient to provide a

rational basis upon which an estimate can be made. Vanicek v.

Commissioner, 85 T.C. 731, 742-743 (1985). 

Section 274(d) imposes more stringent substantiation

requirements for the deduction of traveling, automobile, and

entertainment expenses. Taxpayers must substantiate these items

by adequate records in order to claim deductions, documenting

details such as the amount and place of each separate

expenditure, the property's business and total usage, and the

date and business purpose of the expenditure or use. Sec.

274(d); sec. 1.274-5T(b), Temporary Income Tax Regs., 50 Fed.

Reg. 46014 (Nov. 6, 1985). These strict substantiation

requirements with respect to expenses for travel, meals,

entertainment, and expenses relating to the use of listed

property preclude this Court from using the "Cohan rule" to

estimate the deductible amount of such expenses. Sanford v.

Commissioner, 50 T.C. 823, 827-828 (1968), affd. per curiam 412

F.2d 201 (2d Cir. 1969). Where, however, a taxpayer establishes

that the failure to produce adequate records is due to the loss

of such records through circumstances beyond the taxpayer's
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4 If, as petitioner contends, Mrs. Braun discarded the

records for 1992 and 1993, she has failed to comply with her

(continued...)

control, the taxpayer may substantiate a deduction by reasonable

reconstruction of his expenditure or use. Sec. 1.274-5T(c)(5),

Temporary Income Tax Regs., 50 Fed. Reg. 46022 (Nov. 6, 1985). 

In all other cases, unless the stringent substantiation

requirements are met for those categories of expenses covered by

section 274(d), "No deduction * * * shall be allowed". Sec.

274(d).

As noted in our findings of fact, petitioners provided no

documentary evidence to substantiate the claimed deductions. 

Petitioner testified that he no longer had any of the receipts,

bank statements, or other documentation pertaining to the real

estate loan business he and a business associate operated during

1992 and 1993. Petitioner testified that his business records

(of a company no longer operating in 1992 and 1993) were seized

during a raid conducted by the FBI in July 1990. He further

testified that all of his business records from the initial

seizure in 1990 "and all the way through 1994 became the records

of the Federal Bureau of Investigation because of the ensuing

investigation". Petitioner testified that when the records were

returned by the FBI in 1995, he was still incarcerated and Mrs.

Braun "hauled them off to the dump" as she was "fed up with the

whole situation" that led to his arrest and conviction.4
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4(...continued)

record-keeping obligations under the Internal Revenue Code. See

sec. 6001; sec. 1.6001-1(a), Income Tax Regs.

According to petitioner, to prepare their 1992 and 1993 Federal

income tax returns, petitioners enlisted the assistance of a

certified public accountant and reconstructed income and expenses

to the best of their ability.

Petitioners produced no evidence to substantiate their

claimed expenses other than petitioner's testimony concerning

office rent and advertising expenses. Petitioner testified that

their business records for the taxable years in issue were

deliberately discarded by Mrs. Braun and not lost due to

circumstances beyond petitioners' control. Accordingly,

petitioners cannot satisfy the substantiation requirements of

section 274(d) by reconstruction of their expenditures and are

therefore not entitled to deductions for travel, automobile

expenses, meals, or entertainment. See sec. 274. 

In the absence of either substantiating documentation or

testimony, petitioners are likewise not entitled to deductions

for the remaining categories of business expenses (except office

rent and advertising) claimed on their 1992 and 1993 Schedules C. 

Because petitioner offered testimony regarding the office rent

and advertising expenses petitioners claimed on their returns, we

consider these items in turn. 

Petitioner testified that he and another individual operated
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a real estate loan business out of an office in La Jolla,

California, during 1992 and 1993. Together, petitioner and his

business associate subleased office space, consisting of four

offices and a conference room, from an attorney, according to

petitioner. Petitioner testified that his share of the $1,000

monthly office rental expense during 1992 and 1993 was $500. 

Petitioner testified that he was unable to locate the attorney to

obtain any records of these rentals. 

Petitioner's testimony concerning his office rental expenses

is uncorroborated and self-serving, and we are not required to

accept it. See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). 

We do not, for a number of reasons.

First, we believe there were other opportunities for

corroboration that petitioner has not addressed, such as

testimony from the business associate who was purportedly his colessee. 

Second, we find petitioner's contention that the records for

his 1992 and 1993 business activities were discarded somewhat

suspect. Petitioner testified that the FBI seized his records in

1990, and his wife discarded them when they were returned in

1995. But the business activities at issue were conducted in

1992 and 1993. Even conceding that petitioner was under FBI

investigation during 1992 and 1993 (as his guilty plea occurred

in October 1994), we have some difficulty accepting petitioner's
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5 Mrs. Braun is a party in this case, represented by

counsel, and jointly liable for any deficiencies that are

redetermined herein. As noted earlier, if petitioner's testimony

concerning the discarding of the records by Mrs. Braun is

accepted, then Mrs. Braun failed to comply with record-keeping

requirements. 

vague claim that his 1992 and 1993 business records also "became

the records of the Federal Bureau of Investigation because of the

ensuing investigation". In any event, since petitioner concedes

the records were returned in 1995, the linchpin of his missing

records rationale is that Mrs. Braun discarded them. Yet she did

not testify at or even attend the trial.5

Third, petitioner pled guilty to income tax evasion and mail

fraud, which are crimes involving dishonesty. See Fed. R. Evid.

609(a)(2).

Fourth, and perhaps most importantly, when questioned how he

supported himself, his wife, and three children if the expenses

of his business offset its income except to the extent of $960 in

1992 and $1,447 in 1993, petitioner was vague and nonresponsive. 

Given their magnitude in relation to reported income, the

expenses petitioner claims to have incurred are not credible.

Fifth, even if we were persuaded that petitioners incurred

rental expenses for the years in issue, we must have some

rational basis on which to estimate them. See Vanicek v.

Commissioner, 85 T.C. at 742-743. Petitioners offered no

evidence that the claimed rent of $1,000 per month (of which
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petitioner purportedly supplied half) was the approximate fair

rental value or an otherwise reasonable cost of the space rented.

Sixth, for essentially the same reasons, we are also not

persuaded that petitioner incurred the advertising expenses he

claims for each year. We would add only that petitioner

testified that his advertising expenditures were "over a thousand

dollars a month" and yet only approximately $2,000 was claimed in

each of the 2 years in issue. Thus, his testimony bears no

rational relationship to the claimed expenses. In his testimony,

petitioner also claimed that the expenditures were for

advertising on a local AM radio station, yet insofar as the

records discloses, there was no effort to obtain corroboration

from the station.

Because, for the foregoing reasons, petitioner's testimony

does not persuade us, and there is no other evidence to support

the claimed deductions, we sustain respondent's disallowance of

all deductions claimed on the Schedules C in 1992 and 1993. 

Section 6651(a)(1) Addition to Tax

Section 6651(a)(1) imposes an addition to tax for failure to

file a return when due "unless it is shown that such failure is

due to reasonable cause and not due to willful neglect". The

addition equals 5 percent for each month that the return is late,

not to exceed 25 percent in total. The Commissioner has the

burden of production with respect to the liability of an
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6 Petitioner claimed that, on the advice of counsel,

petitioners did not file tax returns while the FBI investigation

was in progress. That investigation concluded in October 1994,

however, more than 6 years before the returns were filed. 

individual for an addition to tax under section 6651(a)(1). Sec.

7491(c). The burden of showing reasonable cause under section

6651(a) remains on the taxpayer. Higbee v. Commissioner, 116

T.C. 438, 446-448 (2001). "Reasonable cause" requires a taxpayer

to demonstrate that he exercised ordinary business care and

prudence and nevertheless was unable to file the return by the

due date. United States v. Boyle, 469 U.S. 241, 246 (1985); sec.

301.6651-1(c), Proced. & Admin. Regs. Willful neglect is defined

as a "conscious, intentional failure or reckless indifference." 

United States v. Boyle, supra at 245.

Petitioners' 1992 and 1993 tax returns were not filed until

April 20, 2001. Respondent has, accordingly, met his burden of

production with regard to the section 6651(a)(1) addition to tax. 

See sec. 7491(c). Petitioners have offered no explanation for

their untimely filing, nor have they produced any evidence to

establish any reasonable cause for their failure to file before

the due date for each return.6 We therefore sustain respondent's

determination of additions to tax under section 6651(a)(1) for

1992 and 1993. 
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To reflect the foregoing,

Decision will be entered

for respondent.