T.C. Memo. 1996-203

UNITED STATES TAX COURT

THOMAS A. JOHNSON, Petitioner v. 

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 13887-94. Filed April 29, 1996.

Thomas A. Johnson, pro se.

Stephen C. Best, for respondent.

MEMORANDUM OPINION

CLAPP, Judge: Respondent determined the following

deficiencies in petitioner's Federal income taxes, additions to

tax, and penalty:

 

 Additions to tax Penalty

 Sec. Sec. Sec. Sec.

 Year Deficiency 6651(a)(1) 6653(a)(1) 6661 6662(a)

 1988 $64,586 $6,459 $3,229 $16,147 --

 1989 754 189 -- -- $151
2

After concessions by the parties, the issues for decision

are:

(1) Whether petitioner had gross receipts during the

taxable year 1988 from a business known as Ticketline. We hold

that he did.

(2) Whether petitioner has substantiated cost of goods sold

for Ticketline for the taxable year 1988. We hold that

petitioner has substantiated cost of goods sold in the amount of

$143,004.

(3) Whether petitioner is liable for self-employment tax

for the taxable year 1988 from his activities with Ticketline. 

We hold that he is.

(4) Whether the costs associated with petitioner's

nutritional information system are deductible pursuant to section

174. We hold that they are not.

(5) Whether petitioner is liable for the addition to tax

pursuant to section 6651(a)(1) for failure to file timely 

Federal income tax returns for the taxable years 1988 and 1989. 

We hold that he is.

(6) Whether petitioner is liable for the addition to tax

pursuant to section 6653(a)(1) for negligence for the taxable

year 1988. We hold that he is.

(7) Whether petitioner is liable for the addition to tax

pursuant to section 6661 for a substantial understatement of tax

for the taxable year 1988. We hold that he is.
3

(8) Whether petitioner is liable for an accuracy-related

penalty pursuant to section 6662(a) for the taxable year 1989. 

We hold that he is.

All section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure, unless otherwise

indicated.

We have combined our findings of fact and opinion. Some of

the facts are stipulated and are so found. We incorporate by

reference the stipulation of facts and attached exhibits.

Prior to trial, respondent filed a Motion for Leave to File

Amendment to Answer. Respondent sought to amend the answer to

plead collateral estoppel pursuant to this Court's opinion in

Johnson v. Commissioner, T.C. Memo. 1993-564, affd. without

published opinion 50 F.3d 2 (2d Cir. 1995) (Johnson I), which

addressed the taxable year 1987. Respondent argues that

collateral estoppel precludes petitioner from relitigating

whether he received gross receipts from Ticketline, whether he is

entitled to deduct expenses associated with his nutritional

information system pursuant to section 174, and whether he is

liable for self-employment tax. We denied respondent's motion.

The doctrine of collateral estoppel is used to preclude a

party from relitigating issues actually and necessarily litigated

and decided in a final prior judgment by a court of competent

jurisdiction. Meier v. Commissioner, 91 T.C. 273, 282-283
4

(1988). It applies to issues of fact, issues of law, and mixed

issues of fact and law. Id. at 283.

The taxable year 1987 was at issue in Johnson I, and that

opinion was based in part on petitioner's failure to meet his

burden of proof. We have concluded that the issues now before

the Court were not necessarily litigated in Johnson I. 

Petitioner, in this proceeding, could prove different facts or

changed circumstances sufficient to distinguish this case from

Johnson I and to carry his burden of proof for the years at

issue.

Petitioner resided in Vernon, Connecticut, at the time he

filed the petition. He has a bachelor's degree in mathematics

and a master's degree in psychology. Petitioner received

training as an actuary and has consulted as a stock analyst. 

Petitioner did not receive salary or wages in 1988. Petitioner

has prepared his own income tax returns since 1981, and he

reported his income and deductions for the taxable years 1988 and

1989 on the cash receipts and disbursements method of accounting.

Ticketline

In 1985, petitioner began purchasing concert tickets from

Robert Finnimore (Finnimore) through a business known as

Ticketline. Finnimore purchased tickets to concerts, plays, and

other events and then resold the tickets at a premium.

Finnimore needed cash to purchase tickets, so petitioner

agreed to advance money to Finnimore, with the understanding that
5

petitioner would get the two best seats available for any concert

or show that he wanted to attend.

Petitioner expected the advances to be returned, but this

did not happen with regularity. To gain some control over the

payment process, petitioner made the necessary arrangements so

that customers could use a credit card to pay Finnimore for

tickets. Petitioner controlled the credit card receipts and also

set up a bank account in the name of Ticketline (Ticketline

account) to hold those receipts. This arrangement made the money

accessible to petitioner rather than having it go through

Finnimore, who otherwise might have kept a fair amount of it. 

Petitioner had sole signatory authority on the Ticketline

account. Credit card receipts were deposited directly to the

Ticketline account, and petitioner made periodic deposits into

that account of any money sent to him by Finnimore. He regularly

advanced moneys from this account to Finnimore for the purchase

of tickets.

During 1988, petitioner had signatory authority over three

other accounts: The Todge Trust account, the Universal Life

Church, Inc. (ULC) account, and an equity line of credit. 

Petitioner occasionally advanced moneys from these accounts for

the purchase of tickets by Finnimore.

Finnimore did not execute promissory notes for the funds he

received from petitioner. Petitioner reported no interest income

for 1988 related to the funds advanced to Finnimore.
6

The parties agree that during 1988 petitioner made deposits

to the Ticketline account of approximately $172,279. Respondent,

using the bank deposits and cash expenditures method, determined

this amount to be unreported income. Respondent concedes that

this figure should be reduced to $167,949.

In the notice of deficiency, respondent did not allow for

the cost of tickets sold, but respondent concedes that petitioner

must have had some cost of goods sold. Respondent calculated

cost of goods sold of $70,635 and is willing to concede this

amount. Respondent calculated this amount using the ratio of

cost of goods sold to gross receipts for the taxable year 1987 as

set forth in Johnson I.

Where a taxpayer has failed to maintain adequate records of

the amount and source of his income, and the Commissioner has

determined that the deposits are income, the taxpayer must show

that the Commissioner's determination is incorrect. Estate of

Mason v. Commissioner, 64 T.C. 651, 657 (1975), affd. 566 F.2d 2

(6th Cir. 1977). In the absence of adequate books and records,

the Commissioner may reconstruct a taxpayer's income by any

reasonable method of accounting which clearly reflects income. 

Sec. 446; Holland v. United States, 348 U.S. 121, 130-132 (1954). 

The bank deposits method has long been approved by the courts as

a method for computing income. Estate of Mason v. Commissioner,

supra at 656. Bank deposits are prima facie evidence of income. 
7

Tokarski v. Commissioner, 87 T.C. 74, 77 (1986); Estate of Mason

v. Commissioner, supra at 656-657.

Petitioner argues that the advances from the various

accounts were loans to Finnimore and that the deposits to the

Ticketline account were repayments on the loans. The existence

of a loan is a question of fact to be decided on the basis of all

the facts. Beaver v. Commissioner, 55 T.C. 85, 91 (1970). Some

of the relevant factors are: Whether the parties were dealing at

arm's length; whether the loan was in writing; whether the loan

provided for interest; whether repayments were made; whether

there was a business purpose for making the loan; and whether

payments are not contingent on profits. See Beaver v.

Commissioner, supra; Arlen v. Commissioner, 48 T.C. 640, 648

(1967).

Petitioner had no promissory note or repayment schedule for

the alleged loans. Petitioner submitted a document that he

claimed was a loan ledger. The document does not mention loans

to or repayments from Finnimore and does not establish that

petitioner made loans to Finnimore. Petitioner claims that he

began charging Finnimore interest in 1988, but petitioner

reported no interest income from the alleged loans. Petitioner

knew that he would not be repaid if Finnimore did not resell the

tickets, and we find that ticket sales were the only source of

repayment from Finnimore. 
8

We find that the deposits to the Ticketline account were

income to petitioner and were not loan repayments from Finnimore. 

See Dean v. Commissioner, 57 T.C. 32, 45 (1971).

Petitioner argues in the alternative that, if the $167,949

is income from the sale of tickets, he is entitled to reduce the

income by the cost of the tickets sold. Petitioner did not keep

adequate records of the moneys he advanced to Finnimore. 

Petitioner, therefore, looks to numerous canceled checks and cash

withdrawals, which he maintains were advances to Finnimore. 

Petitioner argues that checks payable to cash, in even amounts of

$1,000 or more, were moneys he advanced to Finnimore for the

purchase of tickets. Petitioner concedes that some small portion

of those checks was retained by him for personal purposes but

argues that the balance went to Finnimore for the purchase of

tickets. The amounts set forth in the appendix reflect the

amounts advanced to Finnimore after allowing for petitioner's

concessions. We find that petitioner advanced to Finnimore for

the purchase of tickets $69,700 from the Ticketline account,

$13,300 from the Todge Trust account, $43,250 from the equity

credit line, and $5,000 from the ULC account. These payments are

detailed in the appendix.

Petitioner paid $6,254 for tickets using his credit card,

and this amount is allowable as cost of goods sold.

Petitioner contends that he purchased tickets directly from

a ticket agent with check No. 1076 in the amount of $2,500 and
9

from a second ticket agent with check No. 1083 in the amount of

$3,000. We agree, and we find that the $5,500 is allowable as

cost of goods sold. 

Petitioner estimated that he purchased tickets for

Ticketline with $3,130 of automatic teller machine (ATM)

withdrawals from the Todge Trust account. The $3,130 of ATM

withdrawals from the Todge Trust account consists of

approximately 17 withdrawals, none of which exceeds $300. 

Petitioner has not shown that the $3,130 in ATM withdrawals was

for the purchase of tickets and not for personal expenditures. 

Petitioner argues that several items labeled "debit memo" on his

bank statements represent either deductible expenses or cash

withdrawals used for the purchase of tickets. The record does

not support petitioner's argument. Petitioner provided the bank

statements showing the "debit memo" notations. On brief,

petitioner has attempted to explain the "debit memo" items, but

factual representations on brief are not evidence. We sustain

respondent's determination as to these items.

Based on the above findings, we conclude that petitioner has

substantiated cost of goods sold for the Ticketline business in

the amount of $143,004, which consists of $69,700 from the

Ticketline account, $13,300 from the Todge Trust account, $43,250

from the equity credit line, $5,000 from the ULC account, $6,254

of credit card purchases, and $5,500 of purchases directly from

ticket agents.
10

Respondent concedes a $3,173.21 deduction for credit card

service fees and a $30.82 deduction for bank fees, and we find

that petitioner paid $279.09 for Ticketline advertising expenses

in 1988.

Petitioner argues that he paid $4,545.40 of other Ticketline

expenses. These expenditures related to Finnimore's obligations

for items such as office lease payments, car payments, car

insurance, and rent on Finnimore's apartment. These expenditures

were not ordinary and necessary expenses of Ticketline, and we

sustain respondent's determination as to these items.

Self-Employment Tax

Section 1401 imposes a tax on net earnings of $400 or more

from self-employment income, defined as gross income derived from

carrying on a trade or business, less allowable deductions. Sec.

1402(a) and (b). The parties agree that petitioner is liable for

self-employment taxes if we find that he had unreported income in

1988. We have so found. Thus, petitioner is liable for selfemployment taxes under section 1401.

Nutritional Information System

Around 1987, petitioner began developing a nutritional

information system that he called the "Food Store". Petitioner

envisioned nutritional information stored in a computer to help

grocery shoppers select food based on its nutritional value. 

Initially, petitioner intended to feature the nutritional

information system in his own natural foods store. Petitioner
11

abandoned the idea of opening his own store and instead focused

on the nutritional information system.

Petitioner paid the firm of Nordli Wilson to help him locate

compatible business associates. In 1987, Sharon Akabas (Akabas),

a nutritionist recommended by Nordli Wilson, helped petitioner

develop the nutritional information needed for his system. 

Akabas has a doctorate in nutrition and exercise physiology, and

she served as an adjunct professor at the University of

Bridgeport, Connecticut, while she consulted with petitioner. 

Akabas attempted to simplify nutritional data contained in a

database managed by the U.S. Department of Agriculture. 

Petitioner and Akabas attended conferences related to nutrition

or nutritional data banks. Petitioner and Akabas had no written

contract.

Petitioner also consulted with Paul Voiland (Voiland) and

Steve Hendricken (Hendricken) during the development of the

nutritional system. Petitioner advertised for a manager in a

natural foods store, and Voiland responded. Voiland had worked

in the natural food business for 14 years with experience in

retail, wholesale, and production. He advised petitioner about

natural food stores, how they are set up, and the types of

products sold in them. Voiland also drafted and modified store

floor plans for petitioner. Hendricken helped petitioner prepare

a business plan. Petitioner had no written contract with either

Voiland or Hendricken.
12

Petitioner compiled a notebook titled "The Food Comparison

Machine" with a copyright date of 1991. The notebook explains

petitioner's nutritional information system.

Petitioner reported on Schedules C of his Federal income tax

returns the following expenses for the Food Store:

 1988 1989

Supplies $4,829 $2,383.06

Legal and professional fees 20,231 23,999.01

Dues and publications 1,635 0

Meals and entertainment 98 56.30

Travel 674 502.78

Utilities 1,851 2,056.38

Rent or lease 0 947.14

 Total 29,318 29,944.67

Petitioner reported no gross receipts or sales for the Food

Store in 1988 or 1989.

Petitioner contends that his expenditures related to the

nutritional information system are deductible pursuant to section

174 as computer software developmental costs.

Petitioner must prove that he is entitled to the claimed

deductions. Rule 142(a); Welch v. Helvering, 290 U.S. 111

(1933). Research or experimental expenses, for purposes of

section 174, are research and developmental costs in the

experimental or laboratory sense. Mayrath v. Commissioner, 41

T.C. 582, 590 (1964), affd. 357 F.2d 209 (5th Cir. 1966). 
13

Respondent acknowledges that the cost of developing computer

software may qualify as research and experimental expenses.

Petitioner contends that expenditures for "utilities" and

"rent or lease" relate to the business use of his home. 

Petitioner's wife testified that one room in their home was

petitioner's office. We have insufficient evidence regarding the

portion of petitioner's home used for business purposes, and he

offered no evidence regarding the hours spent at his home for

business purposes or the business activities performed at his

home. We find that petitioner has not substantiated the

expenditures related to the business use of his home. We sustain

respondent's determination as to these items.

Petitioner has shown that the remaining expenditures he

reported on the Schedules C were associated with the Food Store,

and we now turn to whether they are deductible pursuant to

section 174.

Petitioner paid consulting fees to Voiland, Hendricken, and

Akabas. Voiland testified that he advised petitioner about

natural foods stores, how they are set up, and the types of

products sold in them. Voiland's advice included drawing and

modifying floor plans for a natural foods store. Hendricken

helped petitioner prepare a business plan. We find that these

activities did not relate to the development of computer

software.
14

Akabas testified that she reviewed the scientific literature

on various nutritional issues, translated the literature into

laypersons' terms, decided how to deliver nutritional information

to the consumer, gathered nutritional information on various food

products, reviewed several newsletters and journals related to

nutrition, used her contacts at large corporations to obtain

nutritional information on their products, reviewed computer

magazines and manuals, and organized a group of college students

to test petitioner's system. Akabas also attempted to simplify

nutritional data contained in a database managed by the U.S.

Department of Agriculture. Petitioner and Akabas attended

conferences related to nutrition or nutritional data banks. 

Nothing in the record indicates that Akabas' activities were

research in the experimental or laboratory sense or constituted

the development of computer software.

The documents submitted in evidence do not show that

petitioner ever developed any computer software. Petitioner

submitted five letters he received from various grocery

executives relating to the nutritional system. One letter was

written in 1991, and four were written in 1992. The various

executives refer to petitioner's "demonstration notebook",

"proposal", "program", and "writeup". Petitioner submitted a

notebook titled "The Food Comparison Machine", which explains

petitioner's system. We presume the pages in the notebook

illustrate what would appear on a computer screen, but we find
15

that these illustrations do not qualify as the development of

computer software. Petitioner submitted a letter from an

attorney dated December 11, 1992, the topic of which is the

patentability of petitioner's system. Nothing in the letter

indicates that petitioner was developing computer software in

1988 or 1989.

We presume that some of the nutritional information culled

by Akabas found its way into the notebook titled "The Food

Comparison Machine". Nonetheless, petitioner provided no

evidence coupling the various expenditures to any research or

experiment in nutritional science or computer software in 1988 or

1989. Petitioner repeatedly described his activities as the

development of computer software. However, the record does not

support petitioner's characterization of his activities, and his

subjective belief is not determinative. See Mayrath v.

Commissioner, supra at 590-591. We conclude that the

expenditures are not deductible as research or experimental

expenses under section 174. Accordingly, it is unnecessary to

consider whether they were in connection with a trade or business

or whether a proper election was made. We sustain respondent's

determination.

Additions to Tax Under Section 6651(a)(1)

Respondent determined an addition to tax under section

6651(a)(1) for each year in issue, asserting that petitioner

failed to file timely a Federal income tax return.
16

Petitioner's 1988 and 1989 Federal income tax returns were

due on August 15, 1989, and August 15, 1990, respectively. 

Petitioner filed his 1988 Federal income tax return on September

27, 1989, and he filed his 1989 Federal income tax return on

September 18, 1991. Petitioner presented no evidence to show

that the untimely filings were due to reasonable cause and not

due to willful neglect. We sustain respondent's determination

that petitioner is subject to an addition to tax under section

6651(a)(1) in each year.

Negligence Addition to Tax and Penalty

Respondent determined that petitioner is liable for an

addition to tax under section 6653(a)(1) for the taxable year

1988 and that petitioner is liable for a penalty under section

6662(a) for the taxable year 1989. Section 6653(a)(1) imposes an

addition to tax equal to 5 percent of the underpayment if any

part of the underpayment is attributable to negligence. Section

6662(a) imposes a penalty equal to 20 percent of the portion of

the underpayment which is attributable to negligence.

Negligence is defined as the lack of due care or the failure

to do what a prudent person would do under the circumstances. 

Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir. 1967),

affg. in part and remanding in part 43 T.C. 168 (1964); Neely v.

Commissioner, 85 T.C. 934, 947 (1985). Petitioner must prove

that the negligence addition to tax and the penalty do not apply. 

Bixby v. Commissioner, 58 T.C. 757, 791 (1972).
17

Failure to keep adequate records is some evidence of

negligence. Marcello v. Commissioner, supra at 507; Magnon v.

Commissioner, 73 T.C. 980, 1008 (1980). Petitioner did not

maintain adequate records regarding the funds disbursed to or

received from Finnimore. Petitioner argues that he loaned funds

to Finnimore; yet, none of the advances carried the indicia of a

loan.

Petitioner offered no evidence connecting his nutritional

system to computer software or any other research or experiment. 

Petitioner deducted items for the business use of his home, but

he failed to produce evidence supporting the deductions.

We conclude that the underpayments for the taxable years

1988 and 1989 are attributable to negligence.

Addition to Tax Under Section 6661

Respondent determined that petitioner is liable for an

addition to tax under section 6661 for the taxable year 1988. 

Section 6661(a) provides for an addition to tax equal to 25

percent of the amount of any underpayment attributable to a

substantial understatement of income tax. Pallottini v.

Commissioner, 90 T.C. 498, 501 (1988). An understatement is

substantial if it exceeds the greater of $5,000 or 10 percent of

the tax required to be shown on the return. Sec. 6661(b). The

amount of the understatement may be reduced under section

6661(b)(2)(B) for amounts adequately disclosed or supported by

substantial authority. Respondent's determination of the
18

addition to tax is presumed correct, and petitioner must prove

otherwise. Rule 142(a); Hall v. Commissioner, 729 F.2d 632, 635

(9th Cir. 1984), affg. T.C. Memo. 1982-337; Bixby v.

Commissioner, supra at 791-792.

Petitioner makes no argument with regard to substantial

authority or adequate disclosure, and we find that no such

argument exists. If recomputation of petitioner's tax liability

reflects a substantial understatement, petitioner is liable for

the addition to tax.

To reflect the foregoing and the concessions by the parties,

Decision will be entered

under Rule 155.
19

APPENDIX

Ticketline Account

 Date Check Number Ticket Expense

 Feb. 9 1058 $3,000

 Feb. 26 1060 6,000

 Mar. 7 1062 2,000

 Mar. 10 1065 1,000

 Mar. 18 1067 2,000

 Mar. 24 1068 3,000

 Mar. 28 1069 1,000

 Mar. 29 1070 5,000

 Apr. 4 1071 2,000

 Apr. 15 1075 10,000

 May 24 1085 5,000

 June 6 1086 5,500

 June 24 1087 4,000

 July 11 1089 3,000

 July 21 1091 4,700

 Aug. 29 1095 6,000

 Sept. 9 1097 3,000

 Sept. 19 1100 3,500

 Total 69,700

Todge Trust Account

 Date Check Number Ticket Expense

 Feb. 5 1576 $1,300

 Feb. 25 1585 2,000

 June 30 1698 2,000

 Aug. 31 1759 2,500

 Sept. 19 1782 1,500

 Oct. 19 1808 4,000

 Total 13,300
Equity Credit Line

 Date Check Number Ticket Expense

 July 9 101 $3,000

 July 25 102 2,450

 Aug. 4 103 5,000

 Aug. 5 104 2,000

 Aug. 12 105 10,000

 Sept. 9 106 7,000

 Sept. 15 108 3,400

 Nov. 10 111 4,000

 Dec. 3 113 6,400

 Total 43,250

ULC Account

 Date Check Number Ticket Expense

 Jan. 25 137 $5,000