1 Unless otherwise indicated, section references are to

the Internal Revenue Code in effect for the years at issue. Rule

references are to the Tax Court Rules of Practice and Procedure.

T.C. Summary Opinion 2003-104

UNITED STATES TAX COURT

ROBERT C. HENRY II, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 7797-01S. Filed July 25, 2003.

Robert C. Henry II, pro se.

Robert D. Kaiser, for respondent.

COUVILLION, Special Trial Judge: This case was heard

pursuant to section 74631 in effect at the time the petition was

filed. The decision to be entered in this case is not reviewable

by any other court, and this opinion should not be cited as

authority.
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Respondent determined deficiencies in petitioner's Federal

income taxes and accuracy-related penalties as follows:

 Accuracy-Related Penalty

 Year Deficiency Sec. 6662(a)

 1995 $31,272 $6,254

 1996 24,507 4,901

 1997 16,344 3,269

After concessions by the parties, noted hereafter, the

issues for decision are: (1) Whether petitioner is entitled to a

reduction in the amount of unreported gross receipts determined

by respondent in connection with petitioner's trade or business

activity for the years in question, and (2) whether petitioner,

for said years, is liable for the accuracy-related penalties

under section 6662(a).

During the years at issue, petitioner owned and operated a

funeral home as a self-employed activity. He is a licensed

embalmer, mortician, and funeral director. The business

originated with his father in 1950. Petitioner grew up working

in the business. He attended mortuary school at Cincinnati,

Ohio, graduated in 1976, and, in due course, became certified as

a mortician. He returned to his father's funeral home, and his

entire career has been with that business. Petitioner's father

died in 1981, leaving his widow and two sons, petitioner and

Allan Henry (Allan). Their mother donated the funeral home to
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petitioner and Allan. Allan was not a mortician; however, he had

a background in business, and he was responsible for the business

operations of the home, which included maintaining the books and

records and providing all information necessary to the accountant

who prepared petitioner's income tax returns. The funeral home

has never been incorporated as a business entity.

Sometime in 1981 or 1982, Allan developed a drug dependency,

and, as petitioner testified, "we had to send him away to

treatment." At that time, Allan conveyed his interest in the

funeral home to petitioner, and petitioner has since been the

sole owner of the home. Upon his return from treatment for his

drug addiction, Allan resumed his employment with the funeral

home. At some point in time, Allan resumed his dependency on

drugs, unbeknownst to petitioner.

Petitioner's time and attention were devoted exclusively to

conducting funerals and performing other attendant services. He

was not involved in the recordkeeping or business end of the

funeral home operation. He relied on his brother for that,

although he occasionally reviewed the list of people who owed

money to the home and directed the issuance of reminder notices

to such delinquents. Allan compiled all the necessary

information upon which the accountant annually prepared

petitioner's income tax returns, which included the operations of

the funeral home on Schedule C, Profit or Loss From Business. 
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For the years at issue, the gross income, expenses, and net

profit (or loss) of the funeral home were reported by petitioner

on his Federal income tax returns as follows:

 1995 1996 1997

 Gross income $43,274 $59,144 $45,430

 Total expenses 48,112 53,023 41,162

 Net profit (loss) ($ 4,838) $ 6,121 $ 4,268

The gross income amounts shown were based on reported gross

receipts of $58,552, $82,501, and $60,251, respectively, for the

3 years.

Petitioner's income tax returns for the 3 years in question

were selected for examination by the Internal Revenue Service. 

As a result of that examination, it was revealed that Allan had

been diverting funds from the funeral home's gross receipts to

support his drug dependency. Following this disclosure,

petitioner dismissed his brother from his duties with the funeral

home. The examination also revealed inadequacies in the books

and records of the funeral home, and respondent determined the

gross receipts of the business by use of the bank deposits

method. In the notice of deficiency, respondent determined that

petitioner underreported the gross receipts of the funeral home

in the amounts of $98,608, $99,779, and $73,224, respectively,

for the years in question. In making this determination,

respondent allowed and did not include in the unreported gross
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receipts determination amounts mutually agreed upon with

petitioner representing funds that Allan had diverted to fund his

drug dependency. Respondent also determined that petitioner

failed to include on his returns interest income of $138, $361,

and $15, respectively, for the 3 years in question. Petitioner

conceded the unreported interest income at trial. Petitioner

also conceded the unreported gross receipts but contends

respondent failed to allow other adjustments described below,

thus framing the principal issue before the Court.

The funeral home's gross receipts came from three sources:

(1) Payments made directly to the funeral home by the

families or relatives of the deceased;

(2) Payments received directly from insurance companies; and

(3) Payments from "Pre-need funeral contracts" that

represented the conversion of amounts previously paid by

individuals of their anticipated funeral expenses.

The practice at petitioner's funeral home was to issue

receipts only for the payments directly made to the home

described in situation (1) above. Although statements were

issued in situations (2) and (3) above, no receipts were issued

for such payments. In submitting the income and expense

information to petitioner's income tax return preparer each year,

Allan submitted only the direct payments received from customers

and did not submit the income received in situations (2) and (3)
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above. Petitioner agreed to respondent's determination of

unreported gross receipts but contended at trial that the bank

deposits method utilized by respondent failed to include

adjustments for the following:

(1) $325 paid to the funeral home during 1995 that

represented reimbursement of amounts paid by the funeral home to

a cemetery for the burial of a former employee of the funeral

home during 1993;

(2) Certain deposits made to the funeral home's bank account

during 1995 that represented payments by friends of petitioner

who, along with petitioner, went on a vacation cruise; and

(3) Certain intra-account transfers of approximately $40,000

between the checking and savings accounts of the funeral home

during 1996 that were not adjusted by respondent (and thus were

counted twice).

On this record, the Court agrees with petitioner that the

unreported gross receipts for 1995 should be reduced by $325. 

The Court is satisfied from petitioner's testimony that the $325

represented reimbursement for an amount paid by petitioner during

1993 for which petitioner did not claim a deduction for Federal

income tax purposes. At trial, respondent conceded, in

connection with petitioner's second argument above, that

petitioner was entitled to a reduction of $3,080 in the

determined gross receipts for 1995. As to petitioner's third
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contention above, relating to intra-account transfers, since no

documentary evidence was submitted to substantiate that argument,

the Court finds that petitioner is not entitled to an additional

reduction of the determined unreported gross receipts for 1996.

The Court next considers respondent's determination that

petitioner is liable for the accuracy-related penalties under

section 6662(a) for each of the years in question.

Section 6662(a) provides for an accuracy-related penalty

equal to 20 percent of any portion of an underpayment of tax

required to be shown on the return that is attributable to the

taxpayer's negligence or disregard of rules or regulations. Sec.

6662(a) and (b)(1). Negligence consists of any failure to make a

reasonable attempt to comply with the provisions of the Internal

Revenue Code and disregard consists of any careless, reckless, or

intentional disregard. Sec. 6662(c). The courts have refined

the Code definition of negligence as a lack of due care or

failure to do what a reasonable and prudent person would do under

similar circumstances. An exception applies when the taxpayer

demonstrates (1) there was reasonable cause for the underpayment,

and (2) the taxpayer acted in good faith with respect to the

underpayment. Sec. 6664(c). Whether the taxpayer acted with

reasonable cause and in good faith is determined by the relevant

facts and circumstances. The most important factor is the extent

of the taxpayer's effort to assess the proper tax liability. 
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Stubblefield v. Commissioner, T.C. Memo. 1996-537; sec. 1.6664-

4(b)(1), Income Tax Regs. Under section 1.6664-4(b)(1),

"Circumstances that may indicate reasonable cause and good faith

include an honest misunderstanding of fact or law that is

reasonable in light of all of the facts and circumstances,

including the experience, knowledge, and education of the

taxpayer."

The deficiencies in this case, except for the nominal

unreported interest income amounts, are solely attributable to

the actions of Allan in not providing to petitioner's income tax

return preparer, an accountant, all the sources of receipts of

petitioner's business income. In addition, Allan was addicted to

drugs, although the Court acknowledges that the deficiencies

determined by respondent do not include income that was diverted

by Allan to sustain his drug habit. Nonetheless, the Court is

satisfied from the evidence that petitioner was not aware of the

problem with Allan and was unaware that Allan was under reporting

the gross receipts of the funeral home to petitioner's return

preparer. Not until petitioner's returns were examined by

respondent did petitioner learn that substantial amounts of his

income were being diverted by Allan for his drug addiction, and

that Allan was not providing the correct gross receipts

information to the return preparer. Petitioner acknowledged at

trial that, after the 1996 and 1997 returns were prepared, his
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accountant (and return preparer) indicated to him that he had

some concern about the returns, that "your taxes are not what

they should be", and there was something that did not "measure

up". Petitioner discussed this concern with Allan, who assured

him that the information on the returns was accurate. Petitioner

trusted Allan at the time and made no further inquiries into the

matter. Moreover, petitioner's accountant never suggested any

specific areas on the returns that were suspect. After the audit

of his returns and the reasons for the shortcomings came to

light, petitioner dismissed his brother from the business and

conceded to the adjustments, except for the issues discussed,

portions of which were conceded by respondent and, in one

instance, allowed by the Court.

On this record, the Court holds that petitioner is not

liable for the accuracy-related penalties under section 6662(a)

for the 3 years in question. The circumstances described satisfy

the Court that there was an honest ignorance of the facts by

petitioner regarding Allan's actions in failing to report all the

gross receipts of the business. However, the Court sustains

petitioner's liability for the accuracy-related penalties for the

3 years in question for that portion of the deficiencies

attributable to the unreported interest income.
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Reviewed and adopted as the report of the Small Tax Case

Division.

 Decision will be entered

 under Rule 155.