T.C. Memo. 1997-466

UNITED STATES TAX COURT

GREGORY A. MASLOW AND MARINA MASLOW, Petitioners v

. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 12960-94. Filed October 14, 1997.

Gregory A. Maslow, pro se.

Alan R. Peregoy , for respondent.

MEMORANDUM OPINION

JACOBS, Judge : Respondent determined a deficiency of $18,800

in petitioners' Federal income tax for 1992, an a ccuracy-related

penalty of $3,760 pursuant to section 6662, and an addition to tax

of $4,801 for failure to timely file pursuant to section 6651(a)(1)

for that year. The determined deficiency arises from respondent's-2-

1 The notice of deficiency states in one instance that

the deposits for 1992 total $80,096 and in another instance

$81,029. On brief, respondent states the total deposits as

$82,072. On the basis of our holding that the unidentified

deposits are not taxable, the differing deposit amounts are of no

importance. determination that petitioners underreported their income and

overstated Schedule C deductions for 1992. The specific issues we

must resolve are:

(1) Did petitio ners underreport their income in 1992 by

$25,112? Respondent determined this amount through the bank

deposits method, showing total deposits of $82,072, 1 of which

$45,332 was reported by petitioners on their tax return and $11,628

was conceded by respondent at trial as nontaxable. We find that

the $25,112 difference came from nontaxable sources; thus, we hold

that petitioners did not underreport their 1992 income by $25,112.

(2) Must petitioners include $7,220 in income, representing

the market value of a trip to Scotland and England petitioner

Gregory A. Maslow earned in 1992 as a sales award from Kentucky

Central Life Insurance Co.? We hold they must.

(3) Are petitioners entitled to deduct various claimed

Schedule C business expenses that respondent disallowed? We hold

that petitioners are entitled to a portion, but not all, of the

claimed Schedule C business expenses, as explained in greater

detail infra

.

(4) Are petitioners liable for the accuracy-related penalty

under section 6662 for 1992 and for an addition to tax for failure-3-

t o timely file their 1992 income tax return under section

6651(a)(1)? We hold petitioners are liable for both the penalty

and the addition to tax.

All section references are to the Internal Revenue Code for

the year under consideration. All Rule references are to the Tax

Court Rules of Practice and Procedure. All dollar amounts are

rounded.

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. For convenience, we present a background

section and combine our findings of fact with our opinion under

separate issue headings.

Background

Petitioners, husband and wife, resided in Randallstown,

Maryland, at the time they filed their petition. Gregory A. Maslow

(petitioner) emigrated to th e United States from Russia in 1974.

He and Marina met (in 1986) and married (in 1988) in the United

States.

During 1992, the year under consideration, petitioner was a

general agent for several life and health insurance companies. In

addition, during 1992 he st arted a business (known as East-West

International) which was to engage in the export of goods to

Russia.

Petitioners did not file Federal income tax returns for 1988

through 1992 until they were contacted by one of resp ondent's-4-

2 See supra note 1. revenue agents (Revenue Agent Bank) in the fall of 1993. As a

result, on October 12, 1993, petitioners filed delinquent tax

returns for 1988, 1989, 1990, and 1991. On November 5, 1993, they

filed their 1992 tax return.

Petitioner did not maintain books or records pertaining to his

insurance business. Petitioners did, however, maintain a checking

account at Maryland National Bank under the name Graded Assets

Management. This account was used for both business and personal

purposes. Petitioner provided Revenue Agent Bank with bank

statements and canceled checks that detailed most, if not all, of

his 1992 business activities.

Issue 1. Did Petitioners Underreport Their 1992 Income by $25,112 ?

Due to the absence of adequate books and records, Revenue

Agent Bank r econstructed petitioners' 1992 income using a bank

deposits analysis. Through the use of this analysis, Revenue Agent

Bank determined that petitioners underreported their 1992 income by

$34,764. The $34,764 represents the difference between the

aggregate amount of deposits to petitioners' Maryland National Bank

checking account ($80,096) 2 and the income petitioners reported on

their 1992 tax return ($45,332) (the difference being the

unidentified deposits). At trial, respondent conceded that $11,628

of the original amount of unidentified deposits came from

no ntaxable sources. Hence, respondent now asserts there is only-5-

3 The differing amounts exist due to the inconsistency

between the amount of total bank deposits stated in the notice of

deficiency ($80,096 or $81,029) and respondent's brief ($82,072).

See supra note 1

. $25,112 3 ($82,072 - $45,332 - $11,628) of unidentified deposits.

The use of bank deposits to reconstruct income is well

established. D iLeo v. Commissioner

, 96 T.C. 858, 867 (1991), affd.

959 F.2d 16 (2d Cir. 1992); Parks v. Commissioner

, 94 T.C. 654, 658

(1990); Nicholas v. Commissioner

, 70 T.C. 1057, 1064 (1978); Estate

of Mason v. Commissioner , 64 T.C. 651, 656 (1975), affd. 566 F.2d

2 (6th Cir. 19 77). "The bank deposits method assumes that all

money deposited in a taxpayer's bank account during a given period

constitutes taxable income." D iLeo v. Commissioner

, supra at 868.

But the making of a ba nk deposit per se does not mean that the

amount so deposited is income. G oe v. Commissioner

, 198 F.2d 851,

852 (3d Cir. 1952) ; Vuitch v. Commissioner , T.C. Memo. 1985-95.

However, where the Commissione r has determined that the deposits

constitute income, the taxpayer has the burden of showing the

Commissioner's determination was incorrect. See United States v.

Massei , 355 U.S. 595 (1958); Parks v. Commissioner

, supra at 661.

In expla ining the source of the unidentified deposits,

petitioner testified that he borrowed moneys in 1992 from various

finance companies--Chrysler First Co., Commercial Credit Corp., and

Rose Shanis Co. Peti tioner also testified that in 1992 he

periodically received money from his father-in-law (Roman

Shumatsky) totaling appr oximately $10,000 as well as from Roland-6-

Butler, a business associate, totaling approximately $19,000, and

that he deposited these moneys into his bank account. (Mr. Butler

and petitioner were to be involved in t he export of coffee to

Russia.) We found petitioner's testimony credible.

Mr. Shumatsky also testified and corroborated petitioner's

testimony. (Petitioner testified that he was unable to r each Mr.

Butler in order for the latter to testify.) We found the testimony

of Mr. Shumatsky credible. No witnesses testified on behalf of

respondent.

Our ultimate task is to distill truth from falsehood. As

trier of facts, we "must be careful to avoid making the courtroom

a haven for the skillful liar or a quagmire in which the honest

litigant is swallowed up." D iaz v. Commissioner

, 58 T.C. 560, 564

(1972).

On the basis of the testimony of petitioner and Mr. Shumatsky,

we are persuaded that the un explained deposits came from Messrs.

Shumat sky and Butler. Hence, petitioners have shown respondent's

determination as to the taxability of the deposits to be incorrect.

Consequently, we hold that petitioners did not underreport their

1992 income by $25,112, as determined by respondent.

Issue 2. Must Petitioners Include $7,220 Representing the Market

Value of a Trip to Scotland and England Earned by Petitioner as a

Sales Award in Income ?

Most of the insurance policies petitioner wrote were with

Kentucky Central Life Insurance Co. In 1992, petitioner received

a free trip to Scotland and England for himself and his wife as a-7-

sales award from Kentucky Central Life Insurance Co. The fair

market value of the trip was $7,220, which was reported to

petitioner on a Form 1099. Petitioners did not include the value

of this sales award in income. Petitioner claims that the trip was

a "company conference" and that he was told by his superiors at the

home offices of Kentucky Central Life Insurance Co. that the trip

"was fully tax deductible".

Except as otherwise provided by law, gross income includes all

income from whatever source derived. Sec. 61. Gross income

includes income realized in any form, whether money, property, or

services. Sec. 1.61-1(a), Income Tax Regs. Thus, if the taxpayer

performs services in exchange for another type o f service or

receipt of property, then the taxpayer must include in his/her

income the fair market value of the services or property received.

Sec. 1.61-2(d)(1), Income Tax Regs. In the instant case, the sales

award received by petitioner represents compensation for services.

Hence, we hold that petitioner must include the $7,220 fair market

value of the trip (not his estimate of what the trip was worth) in

income for 1992.

Issue 3. Are Petitioners Entitled to Various Claimed Schedule C

Business Expenses That Respondent Disallowed ?

Respondent disallowed the following expenses petitioners

claimed on Schedule C (Profit or Loss from Business) filed with

their 1992 tax return:-8-

Type of Expense Amount Claimed Amount Disallowed

A. Home-office $8,013 $6,813

B. Travel 9,923 7,220

C. Insurance 1,983 1,983

D. Phone 5,709 5,709

E. Commissions 5,184 2,006

A. Home-Office Expenses

The portion of the claimed home-office expenses disallowed by

respondent ($6,813) represents 6 months of home mortgage payments.

(Petitioner claimed he used 50 percent of his residence for

business purpos es.) Both the home and the mortgage were in the

name of petitioner's father-in-law, Mr. Shumatsky.

In general, section 280A denies a deduction with respect to a

home office used by persons such as petitioner unless the home

office is exclusively used on a regular basis either (1) as the

principal place of business for any trade or business of such a

person, (2) as a place of busi ness which is used by patients,

clients, or customers in meeting or dealing with the person in the

normal course of the person's trade or business, or (3) in the case

of a separate structure that is not attached to the home, in

connection with the person's trade or business.

Petiti oner failed to prove that the portion of his home

claimed as an office expense was exclusively used on a regular

basis either as the principal place of his insurance or export

business or as a place of business used to meet customers or

clients. See sec. 280A. Indeed, the record shows that petitioner

did not me et his customers at his home but rather conducted his-9-

insurance activities by traveling to t he homes of his customers.

The record further indicates that (1) petitioner occasionally, but

not regularly, met other insurance agents at his residence, and (2)

petitioner had an outside office for 3 months during 1992.

Because petitioner did not satisfy the requirements of section

280A, we sustain respondent's disallowance of petitioners' $6,813

claimed home-office expenses. See C ommissioner v. Soli man , 506

U.S. 168 (1993).

B. Travel Expenses

Respondent disallowed $7,220 of the claimed $9,923 travel

expenses, determining that petitioners deducted, rather than

included in income , the $7,220 travel award by Kentucky Central

Life Insurance Co. referred to sup ra . Respondent allowed the

balance of the claimed $9,923 travel expenses ($2,703) as

automobile travel expenses incurred in connection with petitioner's

insurance business.

Petitioner claims that $7,220 of the claimed travel expenses

relates to trips to Israel (February 13-16, 1992), Russia (May 16-

2 0, 1992), Brussels (September 15-24, 1992), and Luxem bourg

(November 17, 1992), in connection with the startup of his export

business and has no connection with the travel award by Kentucky

Central Life Insurance Co. Even if we accept petitioner's claim,

nonetheless, petitioner failed to substantiate the costs of those

trips. See sec. 274(d)(1). Moreover, petitioner did not file a

Schedule C for his export business activities.-10-

Deductions are a matter of legislative grace, and in general

taxpayers bear the burden of proving that they are entitled to the

d eductions claimed. Rule 142(a); I NDOPCO, Inc. v. Commiss ioner

,

503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering

, 292 U.S.

435 (1934). Taxpayers must keep sufficient records to establish

the amount of their deductions. See sec. 6001; M eneguzzo v.

Commissioner

, 43 T.C. 824, 831-832 (1965); sec. 1.6001-1(a), Income

Tax Regs. Moreover, a taxpayer who claims a deduction bears the

burden of substantiating the amount and purpose of the item

claimed. H radesky v. Commissioner

, 65 T.C. 87, 90 (1975), affd.

per curiam 540 F.2d 821 (5th Cir. 1976); sec. 1.6001-1(a), Income

Tax Regs.

Because petitioner failed to substantiate his purported travel

costs, we sustain re spondent's disallowance of the $7,220 in

question. Moreover, insofar as the purported travel expenses

represent startup business costs, they would not be deductible in

1992 because petitioner's export business did not begin operations

until 1993. See sec. 195; G arrett v. Commissioner

, T.C. Memo.

1997-231.

C. Insurance Expenses

Respondent disallowed the clai med insurance expenses on the

basis that petitioner failed to substantiate the business purpose

of the deduction. Petitioner claims the insurance expenses related

to his automobile insurance; respondent, on the other hand, asserts

petitioner told Revenue Agent Bank that the insurance was for his-11-

personal residence. In this regard, respondent's notice of

deficiency states, in pertinent part:

Taxpayer is an ins urance agent and works for various

insurance companies as a salesman. Taxpayer stated that

he had an office in the home. The taxpayer was asked to

provide substantiation for his expense as we ll as the

insurance policy on his home and failed to do so.

Taxpayer then stated that his expense is for his car but

failed to bring any records to verify this statement.

In general, section 274(d) provides that no deduction shall be

allowed as a trade or business expense for any traveling expenses

or with respect to any listed property, as defined in section

280F(d)(4), unless the taxpayer substantiates by adequate records

or by sufficient evidence corroborating the taxpayer's own

statement the business purpose of the expense. A pas senger

automobile is a "listed property" within the purview of section

280F(d)(4).

Petitioner failed to provide the requisite substantiation that

would enable petitioners to deduct the purported insurance expenses

on the automobile allegedly used in connection with petitioner's

insurance business. Moreover, respondent did allow a deduction

(under the heading "travel expenses", see supra ) in the amount of

$2,7 03 as automobile travel expenses incurred in connection with

petitioner's insurance business. Accordingly, we sustain

respondent's disallowance of the claimed $1,983 of insurance

expenses.

D. Phone Expenses

Respondent disallowed the claimed telepho ne expenses on the-12-

4 SEC. 262. PERSONAL, LIVING, AND FAMILY EXPENSES.

(a) General Rule.--Except as otherwise

expressly provided in this chapter, no

deduction shall be allowed for personal,

living, or family expenses.

(b) Treatment of Certain Phone

Expenses.--For purposes of subsection (a), in

the case of an individual, any charge

(including taxes thereon) for basic local

telephone service with respect to the 1st

telephone line provided to any residence of

the taxpayer shall be treated as a personal

expense. basis that petitioner failed to provid e substantiation for these

expenses. A substantial portion of the claimed expenses was for

foreign country calls that pertained to the startup of petitioner's

export business. However, a portion of the telephone expenses was

in connection with petitioner's insurance business.

U nder certain circumstances, if claimed deductions are not

adequately substantiated, we may estimate them, provide d we are

convinced that the taxpayer has incurred such expenses and we have

a basis upon which to make an estimate. C ohan v. Commissioner

, 39

F.2d 540 (2d Cir. 1930); Vanicek v. Commissioner

, 85 T.C. 731, 743

(1985). Based on the record presented, using our best estimate, and

giving consideration to section 262(b), 4 we find, an d thus hold,

that petitioners are entitled to a deduction for telephone expenses

in the amount of $1,500 for 1992. See, e.g., Velinsky v.

Commissioner , T.C. Memo. 1996-180.

E. Commissions Expenses-13-

Petitioners claimed $5,184 as commissions expenses. A portion

of this amount represented offices expenses ($1,053), and the

balance represented comm issions paid to other insurance agents

($4,131). In the notice of deficiency, respondent allowed all but

$2,006 of the claimed $5,184.

Petitioner testified that the disallowed $2,006 represented

payments to Edward Levenson, who obtained an insurance policy that

petitioner wrote and for whi ch he received a commission.

Respondent, on brief, concedes that petitioner is entitled to a

deduction in the amount of $1,053 for office expenses and $2,006

for the payments to Mr. Levenson. Respondent now asserts that

$2,125 should be disallowed as commissions expenses ($5,184

-

($1,053 + $2,006)), claiming petitioner testified that he paid no

other commissions in 1992. Respondent misunderstands petitioner's

testimony; petitioner did not concede any part of the claimed

commissions expenses.

On the basis of respondent's concession that the $2,006 paid

to Mr. Levenson is deductible, and because that amount was the only

amount challenged in the notice of deficiency with regard to the

clai med $5,184 of commissions expenses, we hold that petitioners

are entitled to a Schedule C deduction for commissions expenses in

the amount of $5,184, as claimed.-14-

Issue 4. Delinquency Addition to Tax and Accuracy-Related Penalty

Respondent determined the section 6651(a)(1) addition to tax

for failure to timely file a 1992 income tax return and the section

6662 accuracy-related penalty for negligence.

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

to file a timely return. A taxpayer may avoid the addition to tax

by establishing that the failure to file a timely return was due to

reasonable cause and not willful neglect. Rule 142(a); United

States v. Boyle , 469 U.S. 241, 245-246 (1985).

Petitioners failed to timely file their 1992 tax return. They

did not present any evidence establish ing that their delinquent

filing was due to reasonable cause. Indeed, the evidence reveals

that they knew that they were required to file income tax returns

but did not do so until contacted by respondent's revenue agent.

Section 6662 imposes a penalty equal to 20 percent of the

portion of the underpayment that is attributable to negligence. In

order to avoid this penalty, petitioners must prove that they were

not negligent. Negligence is defined as the failure to exercise

the due care that a reasonable, prudent person would exercise under

similar circumstances. Z muda v. Commissioner

, 731 F.2d 1417, 1422

(9th Cir. 1984), affg. 79 T.C. 714 (1982); Neely v. Commissioner

,

85 T.C. 934, 947 (1985).

Petitioners failed to exercise the due care that a reasonable

prudent person would have exercised by (1) failing to maintain

adequate books and records, (2) failing to report the $7,220 sales-15-

award as income, and (3) overstati ng Schedule C deductions.

Accordingly, we sustain respondent's determination that petitioners

are liable for both the section 6651(a)(1) addition to tax and the

section 6662 penalty for 1992.

To reflect the foregoing,

Decision will be entered

under Rule 155

.