T.C. Memo. 2004-179

UNITED STATES TAX COURT

RAGNHILD A. WESTBY, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 23041-96, 23054-96. Filed August 3, 2004.

Ragnhild A. Westby, pro se.

John C. Schmittdiel, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

MARVEL, Judge: In notices of deficiency dated July 29,

1996, respondent determined the following deficiencies, additions

to tax, and penalties with respect to petitioner’s Federal income

taxes:
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1Unless otherwise indicated, 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. Some monetary amounts have been rounded to the

nearest dollar.

Docket No. 23041-96

 AccuracyAdditions to tax related 

Delinquency Negligence penalty 

Year Deficiency Sec. 6651(a)(1)1 Sec. 6653(a)(1) Sec. 6662(a)

1988 $59,032 1$14,758 $3,210 --

1989 72,150 118,038 -- $14,430

1990 83,595 120,899 -- 16,719

1Respondent determined that petitioner was liable for the

addition to tax under sec. 6651(a)(1) for each of the years 1988-

90 in an amended answer. Respondent, therefore, bears the burden

of proof with respect to the imposition of the sec. 6651(a)

addition to tax for those years. Rule 142(a).

Docket No. 23054-96

 Delinquency Negligence

Year Deficiency Sec. 6651(a)(1) Sec. 6653(a)(1)

1987 $55,459 $13,865 1$2,773

1For 1987, in addition to imposing the 5-percent negligence

addition to tax under sec. 6653(a)(1)(A), respondent also imposed

an addition to tax equal to 50 percent of the interest due on the

tax deficiency of $55,459. See sec. 6653(a)(1)(B).

Petitioner timely filed petitions seeking a redetermination

of respondent’s adjustments for 1987-90. We consolidated the

resulting cases for purposes of trial, briefing, and opinion,
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2For 1988, the notice of deficiency denies a deduction for

$4,028 of “Rowe Rent Expenses”, and, for 1989, it lists “Rowe

Unreported Income” of $4,200 (the Rowe adjustments). Those

amounts are included in respondent’s computation of tax

deficiencies for 1988 and 1989, as set forth in the notice of

deficiency for those years. Thomas G. Rowe (Rowe), with whom

petitioner filed joint returns for 1988 through 1990, and

respondent entered into a separate settlement of Rowe’s joint and

several tax liabilities for 1988-90. Consequently, Rowe is not a

party to this litigation. Respondent states that the Rowe

adjustments are not at issue in this case. It is not clear,

however, on what basis respondent relies in making this

statement. Although petitioner stated during the trial that she

is not claiming that she is an “innocent spouse”, there is no

indication in the record that petitioner knew about, or intended

to waive, her right to request relief under sec. 6015 regarding

the Rowe adjustments. Consequently, if respondent intends to

hold petitioner liable for the Rowe adjustments, we shall give

petitioner the opportunity to file a request for relief under

sec. 6015 before we enter a decision in this matter.

pursuant to Rule 141(a),2 and shall refer to the consolidated

cases in the singular in this opinion.

The issues for decision are:

(1) Whether, and to what extent, petitioner failed to

report income from her law practice for the years at issue;

(2) whether, and to what extent, petitioner is entitled to

business expense deductions claimed with respect to her law

practice for the years at issue; 

(3) whether, and to what extent, petitioner is entitled to

net operating loss carryforward deductions claimed for the years

at issue; and

(4) whether petitioner is liable for the addition to tax

for negligence under section 6653(a)(1) (for 1987 and 1988), the
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3Respondent also made adjustments to petitioner’s Schedule

A, Itemized Deductions, and recomputed petitioner’s selfemployment tax for each of the years at issue. Those adjustments

are derivative of the Schedule C, Profit or (Loss) From Business

or Profession (Sole Proprietorship), adjustments and will be

resolved by our resolution of the latter.

accuracy-related penalty under section 6662(a) and (b)(1) (for

1989 and 1990), and/or the delinquency addition to tax under

section 6651(a)(1) (for each of the years at issue).3

FINDINGS OF FACT

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

The stipulation of facts and the first supplemental stipulation

of facts are incorporated herein by this reference.

When the petitions in this case were filed, petitioner

resided in St. Paul, Minnesota. Petitioner was married to Thomas

G. Rowe (Rowe) during the years at issue, but she and Rowe filed

joint returns only for 1988-90. Petitioner’s filing status for

1987 was married filing separate.

I. Petitioner’s Reporting of Income and Expenses From Her Law 

 Practice (Schedule C)

During the years at issue, and for a number of earlier

years, petitioner maintained a sole proprietorship family law

practice, although she regularly retained other attorneys to

provide services in connection with certain of her cases. Each

of the Federal income tax returns filed by petitioner (1987) and

by petitioner and Rowe jointly (1988-90), included a Schedule C,

Profit or (Loss) From Business or Profession (Sole
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4Petitioner’s gross income equaled her gross receipts in

each of the years at issue because she was a cash basis taxpayer

and had no cost of goods sold during those years.

Proprietorship), reporting the income, expenses, and profit or

loss from petitioner’s law practice. Petitioner’s Schedules C

listed gross income, deductions, and net profit (loss) in the

following amounts:

Year Gross income Deductions Net profit (loss)

1987 $75,097 $76,198 $(1,101)

1988 128,896 121,459 7,437

1989 124,463 115,690 8,773

1990 95,730 124,543 (28,813)

II. Respondent’s Adjustments to Petitioner’s Schedule C Income 

 and Deductions in the Notices of Deficiency

A. Adjustments to Income

Respondent increased petitioner’s Schedule C gross income4

for the years in issue in the following amounts:

Year Adjustment

1987 $77,811

1988 117,819

1989 116,483

1990 154,069

Respondent based the adjustments to petitioner’s Schedule C gross

income on two personal financial statements that petitioner

submitted to American National Bank (ANB) in St. Paul (the

financial statements). Petitioner submitted the first financial

statement, dated December 22, 1987 (the 1987 financial

statement), in connection with her purchase of a home and the
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5Petitioner explained the entries to ANB, the financial

institution to which she submitted the financial statements, and

to the revenue agent who was assigned to conduct the examination

of her returns for the years at issue.

second financial statement, dated August 8, 1989 (the 1989

financial statement), in connection with a refinancing. The

financial statements listed “Employment Income” of $77,811 and

$125,256 for 1987 and 1989, respectively. The “Employment

Income” shown on each financial statement represented

petitioner’s estimate of the gross income, unreduced by any

expenses, generated by her law practice as of the date of the

financial statement.5

In his notice of deficiency for 1987, respondent determined

that petitioner had unreported Schedule C income of $77,811,

equal to the amount of “Employment Income” listed in the 1987

financial statement. Respondent calculated the adjustment to

petitioner’s Schedule C income for 1987 by treating the

“Employment Income” shown on the 1987 financial statement as

additional unreported income from petitioner’s law practice. 

Respondent did not reduce the income adjustment to take into

account petitioner’s reported Schedule C gross income of $75,097. 

In his notice of deficiency for 1988-90, respondent

determined that petitioner had unreported Schedule C income for

each year based upon the $125,256 listed as “Employment Income”

in the 1989 financial statement. For 1988, respondent determined
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the unreported income adjustment of $117,819 by subtracting

petitioner’s reported Schedule C net profit of $7,437 for 1988

from the “Employment Income” of $125,256 shown on the 1989

financial statement. For 1989, respondent determined the

unreported income adjustment of $116,483 by subtracting

petitioner’s reported Schedule C net profit of $8,773 from

$125,256. For 1990, respondent determined the unreported income

adjustment of $154,069 by adding petitioner’s reported Schedule C

net loss of $28,813 to $125,256.

B. Disallowance of Petitioner’s Schedule C Deductions

For 1988, respondent disallowed $59,038 of petitioner’s

total Schedule C deductions of $121,459, but the notice of

deficiency does not indicate which Schedule C deductions were

disallowed. For 1987, 1989, and 1990, respondent disallowed all

of petitioner’s Schedule C deductions. The sole basis for

respondent’s disallowance of petitioner’s Schedule C expenses for

each of the years at issue set forth in the notices of deficiency

was: “Since you did not establish that the business expense

shown on your tax return was paid or incurred during the taxable

year and that the expense was ordinary and necessary to your

business, we have disallowed the amount shown.”

III. Description of Petitioner’s Business Records

Petitioner, a cash basis taxpayer, did not maintain formal

journals and ledgers with respect to her law practice or record
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the results of her law practice using a formal bookkeeping

system. Instead, petitioner entered business receipts (client

payments) in handwritten ledger books. On occasion, petitioner

also entered nonbusiness receipts (receipts other than client

payments) in the ledger books. Petitioner also retained deposit

slips reflecting the deposit of client payments into various bank

accounts. 

In support of her Schedule C deductions, petitioner retained

canceled checks and other bank records, cash receipts, invoices,

credit card statements, credit card receipts, and other pertinent

documents. Petitioner’s practice was to make a notation (e.g.,

the client’s name) on a canceled check that would explain the

purpose of the check. Thus, later she would be able to determine

whether it represented a deductible expense of her law practice. 

Petitioner numerically coded certain of the canceled checks and

many of her business-related cash and credit card receipts and

statements. Each number represented a specific type of expense

(e.g., 1 for client entertainment, 5 for office expenses, etc.).

Petitioner divided the checks and cash receipts by type or

category of expense, placed them in separate envelopes, and

submitted the envelopes to her husband’s accountant, John R.

Aunan (Mr. Aunan), for his use in preparing the tax returns for

the years at issue.
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6The record does not disclose when the accounts were opened

and does not include complete records for the accounts. 

Petitioner also maintained other financial accounts during the

years at issue, but the record contains minimal information

concerning them.

During the years at issue, petitioner maintained banking

relationships with at least two financial institutions–-ANB at

which petitioner maintained two checking accounts (Nos. 302-733-1

and 109-070-3), a payroll account (No. 109-139-6), and several

personal and commercial loan accounts; and First Bank at which

she maintained a checking account (No. 2624676067).6

IV. Respondent’s Review of Petitioner’s Business Records

Although petitioner produced her business records (ledger

books, checks, cash receipts, credit card receipts, credit card

statements, and other documents) to the revenue agent in

connection with the examination of her returns for 1987-90, the

revenue agent failed to examine and/or utilize petitioner’s

records for 1987, 1989, and 1990 to ascertain the accuracy of the

income and expenses claimed on petitioner’s Schedules C for those

years. With the possible exception of 1988, for which a portion

of petitioner’s Schedule C deductions was allowed, respondent

issued the notices of deficiency without examining petitioner’s

business records.

A. Schedule C Income

Sometime after respondent issued the notices of deficiency, 

respondent undertook to reconstruct petitioner’s Schedule C
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7Respondent’s counsel acknowledged at trial that concerns

about a possible shift of the burden of proof to respondent

“certainly came into play when we decided to concede” the 1988

and 1990 unreported income adjustments. In fact, respondent’s

counsel candidly explained the concessions as follows: “We felt

that given the size of the discrepancy and the fact that, if the

burden of proof were shifted, * * * we likely would not carry

it.” 

income for the years at issue by analyzing petitioner’s bank

deposits during those years (the bank deposits analyses). The

resulting bank deposits analyses, dated December 11, 1997,

purport to list total monthly deposits, subtract “non-taxable

deposits”, and reduce the resulting adjustment by the amount of

Schedule C gross income reported on petitioner’s return for each

of the years at issue. The bank deposits analyses developed

proposed adjustments to petitioner’s Schedule C income,

enumerated below, that were dramatically lower than the proposed

adjustments to petitioner’s Schedule C income contained in the

notices of deficiency:

 Proposed adjustment 

Year Notice of deficiency Deposit method

1987 $77,811 $45,767

1988 117,819 7,113

1989 116,483 47,232

1990 154,069 13,785

Immediately before trial, the parties submitted a first

supplemental stipulation of facts in which respondent conceded

the 1988 and 1990 proposed adjustments for unreported income in

their entirety,7 revised the proposed 1987 and 1989 adjustments
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consistent with the bank deposits analyses for those years, and,

in addition, conceded $11,862 of the revised proposed adjustment

for 1989. During the trial, respondent conceded $8,786 of the

revised proposed adjustment for 1987.

As a result of respondent’s bank deposits analyses and

respondent’s concessions, respondent’s proposed adjustments for

unreported Schedule C income that remain at issue are as follows:

Year Proposed adjustment

1987 $36,981

1989 35,370

In preparing the bank deposits analysis for 1987, respondent

did not obtain or review all of the relevant bank records with

respect to petitioner’s accounts and did not adequately adjust

the analysis for nontaxable items. Most significantly,

respondent did not analyze retained copies of petitioner’s

deposit slips and bank statements, did not obtain missing bank

statements or copies of deposited items from the financial

institutions with which petitioner maintained her bank accounts,

and did not adjust the deposits analysis for all of the income

sources reported on petitioner’s 1987 return. 

In preparing the bank deposits analysis for 1989, respondent

attached a list of deposits made to one of the two accounts

included in the analysis, on which some but not all of the

deposit sources were listed. The deposits list apparently was

prepared from retained copies of deposit tickets. Respondent did
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not obtain or review copies of deposited items from all of the

financial institutions with which petitioner maintained accounts

during 1989. In preparing the original 1989 bank deposits

analysis, respondent failed to identify and subtract numerous

nontaxable items and did not adjust the analysis for all of the

income sources reported on petitioner’s 1989 tax return. 

B. Schedule C Deductions

Petitioner deducted the following Schedule C expenses on her

Federal income tax returns for the years at issue:

 Sch. C expense

 category 1987 1988 1989 1990

Advertising $98 $160 $513 $2,384

Bank charges 469 1,035 120 120

Car & truck 6,672 8,807 5,354 3,240

Collection fees -- -- 850 -- 

Deprec./sec. 179 2,546 11,974 2,444 1,467

Dues & pubs. 2,337 3,867 2,675 4,095

Employee benefits 2,057 2,243 5,274 3,998

Insurance 514 3,677 3,745 3,565

Interest 10,034 3,053 2,926 2,070

Legal & prof. 5,104 7,239 6,128 13,536

Rent 11,460 10,256 9,706 13,334

Supplies 4,174 12,297 13,139 7,263

Taxes 1,235 4,908 5,051 10,601

Travel 1,039 -- 1,601 1,988

Meals & enter. 896 1,961 795 3,286

Utilities & telephone 838 3,784 6,152 3,515

Wages 13,991 19,203 26,238 29,054

Moving expense 3,258 -0- -0- -0-

Process services 2,482 2,495 915 1,822

Contract services 4,637 10,618 9,617 10,079

Court fees 2,002 7,458 9,104 6,699

Miscellaneous 355 6,424 3,343 2,427

 Total Sch. C 

 deductions 76,198 121,459 115,690 124,543
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Before the trial in this case commenced, petitioner again

produced for review by respondent’s employees, including a

revenue agent and an Appeals officer, voluminous records in

support of the Schedule C deductions claimed on her returns for

the years at issue. Respondent’s review of petitioner’s records 

resulted in the preparation of itemized lists of some of

petitioner’s canceled checks, credit card expenditures, and

receipts. The lists were revised on several occasions and

admitted into evidence during trial. The lists were prepared

without any reference to the categorization of expenses claimed

on petitioner’s Schedules C for the years at issue because

respondent claimed that he could not tell how petitioner’s

expenses were grouped for reporting purposes on petitioner’s

returns.

At the beginning of trial, respondent conceded that

petitioner had deductible Schedule C expenses for the years at

issue in the following amounts:

Year Amount Exhibit No.

1987 1$50,184.70 38-R

1988 64,442.41 39-R

1989 77,162.01 40-R

1990 73,632.74 41-R

1Respondent used a subtotal ($11,144.18) instead of the

total ($12,034.71) from Sec. B of Ex. 38-R in calculating the

amount of Schedule C expenses he conceded for 1987 ($49,294.17). 

Following trial, respondent conceded additional Schedule C

deductions for each of the years at issue as follows:
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8Throughout the trial in this case, however, respondent

(continued...)

Additional Additional Total additional

Year expenses depreciation deductions 

1987 $10,785.18 $741.28 $11,526.46

1988 13,443.34 1,076.65 14,519.99

1989 8,944.60 1,076.65 10,021.25

1990 12,713.86 1,076.65 13,790.51

As a result of respondent’s concessions regarding

petitioner’s deductible Schedule C expenses, the deduction

amounts still in dispute are as follows:

Respondent’s Amount in

Year Per return concessions dispute 

1987 $76,198 $60,821 $15,377

1988 121,459 78,962 142,497

1989 115,690 87,183 28,507

1990 124,543 87,423 37,120

1The Court’s Oct. 17, 2000, order erroneously stated that,

after giving effect to respondent’s concessions, none of the

deductions claimed on petitioner’s 1988 Schedule C remained in

dispute. 

V. Return Preparation and Accountant Workpapers

Petitioner’s income tax returns for the years at issue were

prepared by Mr. Aunan. Petitioner gave Mr. Aunan her canceled

checks, cash and credit card receipts, and other documents,

categorized in the manner described above. Mr. Aunan prepared

accounting workpapers based on his review of petitioner’s

records. In so doing, Mr. Aunan grouped various categories of

petitioner’s Schedule C expenses into return preparation

categories as reflected in his workpapers.8 Mr. Aunan’s
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8(...continued)

maintained that he could not tell how Mr. Aunan had combined

petitioner’s expenses to arrive at the numbers reported on her

income tax returns for the years at issue. Respondent’s claimed

inability to understand how petitioner’s business expenses were

categorized for return filing purposes led to the detailed

listing of petitioner’s expense records without regard to actual

reporting of the expenses on the relevant tax returns. 

workpapers include a schedule summarizing petitioner’s

documentation of her Schedule C income and expenses by category

and by year. That schedule shows, for each of the years at

issue, preliminary figures, adjusting entries, and final figures

for each category of income and expense. The workpapers also

include a summary schedule for the years at issue showing the

income and expense information used by Mr. Aunan to prepare

petitioner’s Schedule C (including depreciation claimed), a

workpaper entitled “Business Interest” that lists interest paid

on petitioner’s credit cards, a depreciation schedule that shows

how Mr. Aunan calculated the depreciation claimed on petitioner’s

Schedules C, a workpaper entitled “Personal” that lists

information regarding various Schedule A itemized deductions for

each of the years at issue, a workpaper labeled “611 Dayton”

relating to a rental property that petitioner owned and sold in

1987, and a Schedule C workpaper relating to the law practice of

petitioner’s husband.
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9Mr. Aunan erroneously used $8,650 of petitioner’s loss

carryforward to offset Rowe’s Schedule C income. See Calvin v.

United States, 354 F.2d 202 (10th Cir. 1965) (cited with approval

by Rose v. Commissioner, T.C. Memo. 1973-207). 

VI. Net Operating Losses

Petitioner and Rowe deducted net operating loss (NOL)

carryforwards on their 1988-90 joint returns. The NOL

carryforwards were derived from losses claimed on Schedules C and

Schedules E, Supplemental Income Schedule, of petitioner’s 1980

and 1982 separate returns. Petitioner’s 1988-90 returns utilized

the NOL carryforwards as follows:9

 Loss carryforward

Year Schedule C income utilization 

1988 $39,621 $9,350 (1980 loss)

1989 15,485 5,714 (1980 loss)

 9,771 (1982 loss)

1990 2,492 25 (1982 loss)
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10Petitioner’s potential loss carryforward arises out of the

following reported results for 1980-86:

Reported operating Operating loss

Year income (loss) utilization 

1980 ($41,399) $7,382 carried 

 back to 1977

1981 4,354 Offset by 1980 loss

1982 (48,861) --

1983 (5,051) --

1984 14,599 Offset by 1980 loss

1985 (19,643) --

1986 (19,388) --

Petitioner also reported operating losses in 1978 and 1979

which were carried back to 1976 and 1977.

The potential NOL carryforward to the years at issue, based upon

petitioner’s 1980-86 returns as filed, is $108,007.10 

There was no examination of the NOL carryforwards during the

audit and only a minimal examination of a portion of the NOL

carryforwards by the IRS Appeals Office. In support of the

alleged NOL carryforwards, petitioner testified that, because of

serious medical problems she experienced during 1982-86, her law

practice during those years operated at a loss, generating part

of the NOL carryforwards. Petitioner testified that the Schedule

E, Supplemental Income and Loss, losses generating the remaining

part of the NOL carryforwards arose from the rehabilitation of a

rental property. Toward the end of the trial, petitioner

introduced documentation in the form of deposit slips, canceled

checks, and payment receipts for both her Schedule C and Schedule

E income and expenses during 1978-83, but she did not offer any
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testimony to explain the documentation. Petitioner did not offer

into evidence any documentation of her business income and

expenses for 1984-86.

VII. Late Filing of Petitioner’s 1987-90 Returns

Petitioner filed her 1987 return on August 26, 1992, having

requested and received two extensions, the second of which

expired on October 15, 1988. Petitioner and Rowe filed their

1988 joint return on August 27, 1992, and their 1989 and 1990

joint returns on August 25, 1992. Neither petitioner and Rowe

nor Mr. Aunan requested extensions of time to file the 1988-90

returns.

For each year at issue, petitioner gathered, organized, and

summarized her Schedule C information and delivered it to Mr.

Aunan for his use in preparing that year’s return. For the 

1988-90 years, however, petitioner did not actually deliver her

Schedule C information to Mr. Aunan until after the return due

dates. After petitioner submitted her Schedule C information to

Mr. Aunan, she followed up by asking him periodically what

additional information he needed to complete the returns. Mr.

Aunan normally responded with more requests for information;

within a day or two, petitioner would supply the requested

information to him. In 1992, petitioner “threatened” Mr. Aunan,

and the returns for all 4 years were finally completed and filed

in August of that year. 
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At one point during petitioner’s testimony, the following

exchange occurred between the Court and petitioner:

THE COURT: All right. Now, let me ask another

question. You’re a lawyer with a license at risk. You

knew you had an obligation to file a return and that

that return had to be filed timely or you were going to

have a problem.

THE WITNESS: Right.

THE COURT: Why didn’t you protect yourself

better?

THE WITNESS: I suppose I’ve asked myself that a

million times. It –- I think part of –- when I think

back on it, I was very used to going ahead and doing

things, but, in this particular situation, [Rowe] had

paid in no money for the self-employment tax, and it

appeared that he was going to have a liability on his

side of the fence. And my push to get done and his

reluctance and his being the primary contact with Aunan

was not a good combination.

But, you know, all excuses aside, I have to be

responsible for myself. And I did not do in my own

mind, which is –- what I should have done is -- I did

not fire him. I did not report him. And I did not go

to my old accountant and file a separate return, no

matter what the economic consequences.

VIII. October 17, 2000, Order

After respondent filed his status report and supplemental

status report (SSR) describing the results of the parties’

posttrial efforts to resolve outstanding issues, we issued an

order dated October 17, 2000, which (1) listed the Schedule C

income and deduction amounts remaining in dispute after

respondent’s further concessions, (2) ruled upon various

exhibits, the admissibility of which had been left open at trial,
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11Under certain circumstances, sec. 7491(a)(1), which was

enacted in 1998, shifts the burden of proof to respondent. Sec.

7491 applies to court proceedings arising in connection with

examinations beginning after July 22, 1998. Because the

examination of petitioner’s returns commenced before July 23,

1998, sec. 7491(a)(1) is inapplicable to this case.

(3) closed the trial record, (4) invited, but did not require,

the parties to file posttrial briefs, and (5) set a schedule for

the filing of briefs. Only respondent filed a posttrial brief. 

In his posttrial brief, respondent continued to argue that some

of petitioner’s alleged business expenses should be disallowed

but, with regard to certain expenses, asserted grounds for the

disallowance that were different from the ground asserted in the

notices of deficiency.

OPINION

I. Schedule C Income and Deductions

A. Burden of Proof

Normally, in a case before this Court, the taxpayer bears

the burden of proof. Rule 142(a).11 That burden has often been

interpreted to mean that the taxpayer bears the ultimate burden

of persuasion; i.e., the risk of nonpersuasion, as well as the

initial burden of production. See, e.g., Gerling Intl. Ins. Co.

v. Commissioner, 86 T.C. 468, 476 n.5 (1986).

In this case, petitioner bears the burden of proof. Rule

142(a). Because petitioner bears the burden of proof, petitioner 

has the initial burden of production, which requires her to
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introduce evidence sufficient, if believed, to demonstrate by a

preponderance of the evidence that respondent’s determination is

excessive; i.e., erroneous and/or arbitrary, “without rational

foundation”. Helvering v. Taylor, 293 U.S. 507, 514-515 (1935);

see also Pittman v. Commissioner, 100 F.3d 1308, 1317 (7th Cir.

1996), affg. T.C. Memo. 1995-243; Page v. Commissioner, 58 F.3d

1342, 1347-1348 (8th Cir. 1995), affg. T.C. Memo. 1993-398. If

petitioner successfully carries her initial burden of production

as to a particular adjustment, the burden of production; i.e.,

the burden of introducing evidence showing an adjustment is

warranted, shifts to respondent. Helvering v. Taylor, supra at

514-515; Berkery v. Commissioner, 91 T.C. 179, 186 (1988), affd.

without published opinion 872 F.2d 411 (3d Cir. 1989); Cozzi v.

Commissioner, 88 T.C. 435, 443-444 (1987); Jackson v.

Commissioner, 73 T.C. 394, 401 (1979). 

B. Unreported Income Adjustments for 1987 and 1989

In this case, the parties agree that the unreported income

adjustments arise from petitioner’s law practice. Our review of

the record confirms that there is a sufficient evidentiary base,

if one is required, to support a conclusion that petitioner was

engaged in an income-generating activity during each of the years

at issue and that petitioner has the burden of proving that

income adjustments in the notices of deficiency were arbitrary
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12In his opening statement, respondent’s counsel stated that

the bank deposits analyses were prepared because respondent’s

Appeals Office recognized that the income adjustments contained

in the notice of deficiency that were based on the 1987 and 1989

financial statements were “not a strong position for the

Service.”

and/or excessive. Rule 142(a); Welch v. Helvering, 290 U.S. 111,

115 (1933). 

At trial, petitioner proved, and respondent admitted, that

the income adjustments proposed in respondent’s notices of

deficiency for all 4 of the years at issue were derived from two

financial statements prepared by petitioner in 1987 and 1989. 

For 1987, respondent determined that petitioner had unreported

Schedule C income equal to the “Employment Income” listed on the

1987 financial statement. For 1988, 1989, and 1990, respondent

added the “Employment Income” listed on the 1989 financial

statement to the net profit or loss reported on petitioner’s

Schedules C for 1988, 1989, and 1990 to arrive at the income

adjustments for 1988-1990.

 During trial, respondent’s counsel abandoned the income

adjustments as originally determined in the notices of deficiency

and offered as stipulated exhibits what purported to be bank

deposits analyses for the years at issue.12 Based on the bank

deposits analyses, respondent conceded the income adjustments for

1988 and 1990 in their entirety and substantially reduced the

income adjustments for 1987 and 1989.
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Because petitioner proved that respondent’s reliance on the

1987 and 1989 financial statements under the circumstances

involved in this case was unreasonable and resulted in

substantially distorted income adjustments, we conclude that the

adjustments to petitioner’s Schedule C income as determined by

respondent in the notices of deficiency were arbitrary and

excessive. Therefore, the burden of producing credible evidence

showing that respondent’s revised adjustments to petitioner’s

Schedule C income in each of the years 1987 and 1989 were

warranted shifted to respondent. Helvering v. Taylor, supra at

514-515; Commissioner v. Riss, 374 F.2d 161, 166 (8th Cir. 1967),

affg. in part, revg. in part and remanding T.C. Memo. 1964-190. 

Respondent contends that, even if the burden of production

shifted to respondent regarding the income adjustments in the

notice of deficiency, his revised income adjustments for each of

the years 1987 and 1989 are supported by the bank deposits

analyses respondent introduced into evidence. According to

respondent, those analyses prove that petitioner deposited into

her bank accounts substantially more money during 1987 and 1989

than she reported as gross receipts on her Schedules C for those

years. 

The bank deposits method has long been recognized as an

acceptable indirect method of proving a taxpayer’s understatement

of income. See Gleckman v. United States, 80 F.2d 394 (8th Cir. 
- 24 -

1935); see also United States v. Abodeely, 801 F.2d 1020, 1023-

1025 (8th Cir. 1986); Caulfield v. Commissioner, T.C. Memo. 1993-

423, affd. 33 F.3d 991 (8th Cir. 1994). The bank deposits method

is often used in cases in which the taxpayer maintained

inadequate, incomplete, or unclear records. See, e.g., Holland

v. United States, 348 U.S. 121 (1954); DiLeo v. Commissioner, 96

T.C. 858, 867 (1991), affd. 959 F.2d 16 (2d Cir. 1992); Estate of

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

(6th Cir. 1977). 

In this case, petitioner produced records of her taxable

income, including her Schedule C income. The records included

handwritten ledger books as well as bank records such as bank

statements and deposit tickets. A review of petitioner’s income

records establishes to the Court’s satisfaction that the gross

income reported on petitioner’s Schedules C for 1987 and 1989 was

derived from petitioner’s handwritten ledger books and was not

calculated based on deposits into petitioner’s bank accounts. 

The return preparer, Mr. Aunan, took the gross receipts numbers

that petitioner derived from her ledger books for the years at

issue and adjusted the numbers for any refunds made to

petitioner’s clients during the taxable years. In 1987 Mr. Aunan

made no adjustments to petitioner’s Schedule C gross receipts of

$75,097, but, in 1989, Mr. Aunan reduced the preliminary gross

receipts figure of $129,146 by client refunds of $470 and
- 25 -

13Respondent has conceded that client refunds of $4,213.30 

are deductible.

$4,21313 to arrive at petitioner’s 1989 reported Schedule C gross

receipts of $124,463.

Respondent arbitrarily used entries from the 1987 and 1989

financial statements to substantially increase petitioner’s

Schedule C income in the notices of deficiency. When respondent

recognized the inherent weakness of his position, respondent

attempted to salvage his position that income adjustments were

warranted by arranging for the preparation of what purported to

be bank deposits analyses. The analyses, however, failed

adequately to adjust for nontaxable items, failed to analyze all

of petitioner’s bank accounts, and failed to adjust for all of

petitioner’s reported taxable income. Respondent did not obtain

and review all of petitioner’s bank records, including copies of

deposited items, and it is apparent from a review of the analyses

that respondent did not obtain the information necessary to

prepare a proper bank deposits analysis for either 1987 or 1989.

A review of respondent’s bank deposits analysis for 1987,

which was similar in method to the one for 1989, illustrates why

we assign no credibility to respondent’s bank deposits analyses

and related income determinations for 1987 and 1989. The 1987

bank deposits analysis is an analysis of one of petitioner’s bank

accounts that she used during that year. ANB account No. 302-
- 26 -

733-1 was an account maintained by petitioner throughout 1987

into which petitioner deposited client fees as well as amounts

unrelated to her law practice. The deposits analysis purports to

add up all of the deposits made into the account during 1987 by

month, subtract identified nontaxable deposits from the computed

total deposits, and arrive at “Gross Revenues per the Audit”. 

The analysis subtracts from that number the “Gross Revenues per

the Tax Return” to arrive at respondent’s revised income

adjustment. 

Respondent’s calculation of total deposits as reflected on

the 1987 bank deposits analysis contains several obvious errors. 

For example, for January and July, respondent erroneously listed 

total deposits shown on the relevant bank statements. For March

and December, respondent did not have copies of the relevant bank

statements, so respondent used petitioner’s income listing from

her ledger book for those months. 

When respondent’s calculation of nontaxable items is

compared to the relevant bank statements for account No. 302-733-

1, even more troublesome concerns arise. Petitioner had a “Ready

Cash” line of credit that, among other uses, covered overdrafts

on the account. Respondent treated some but not all of the

“Ready Cash” deposits during 1987 as nontaxable deposits. 

Respondent also failed to subtract, as nontaxable deposits, a

$5,738 disbursement on a note (July 7, 1987), a $2,625.01
- 27 -

disbursement on a note (Nov. 16, 1987), and several transfers

from account No. 109-070-3, totaling $22,509.69. Respondent also

failed adequately to adjust his calculation for the total amount

of rental income, loan repayments, and installment sale income

that petitioner received during 1987. Similar mistakes were made

in the bank deposits analysis for 1989.

Our review confirms that the simplistic bank deposits

analyses prepared and relied upon by respondent to support his

restated income adjustments against petitioner for 1987 and 1989

are simply not credible. We conclude, therefore, that

respondent’s determinations that petitioner had unreported

Schedule C income for 1987 and 1989 are erroneous, and we hold

that respondent’s determinations of unreported income for 1987

and 1989 are not sustained.

C. Schedule C Deductions

1. Applicable Legal Principles

The only basis asserted by respondent in the notices of

deficiency for disallowing petitioner’s Schedule C expenses was

petitioner’s alleged failure to establish that the expenses were

“paid or incurred during the taxable year” and were “ordinary and

necessary to * * * [petitioner’s] business.” Section 162(a)

authorizes a taxpayer to deduct ordinary and necessary business

expenses paid or incurred during the taxable year in carrying on

a trade or business. An “ordinary” expense is one incurred in a
- 28 -

transaction that commonly or frequently occurs in the type of

business involved. Deputy v. DuPont, 308 U.S. 488, 495 (1940). 

A “necessary” expense is one that is “appropriate and helpful” to

the taxpayer’s business. Welch v. Helvering, 290 U.S. at 113. 

Expenses allowable under section 162 must be “directly connected

with or pertaining to the taxpayer’s trade or business”. Sec.

1.162-1(a), Income Tax Regs. Personal, living, and family

expenses are not deductible. Sec. 262(a).

Generally, if a claimed business expense is deductible, but

the taxpayer is unable to substantiate it fully, the Court is

permitted to make an approximation of an allowable amount (the

Cohan rule). Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d

Cir. 1930). The estimate, however, must have a reasonable

evidentiary basis. Vanicek v. Commissioner, 85 T.C. 731, 743

(1985).

Respondent asserts for the first time in his trial

memorandum that certain of petitioner’s Schedule C deductions are

also subject to the requirements of section 274. Section 274

supersedes the Cohan rule, see sec. 1.274-5T(a), Temporary Income

Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985), and imposes more

stringent substantiation requirements for travel, meals and

entertainment, gifts, and with respect to any listed property as

defined in section 280F(d)(4). Sec. 274(d). Listed property

includes any passenger automobile. Sec. 280F(d)(4)(A)(i). 
- 29 -

Section 274(a) provides, in pertinent part, that no deduction

otherwise allowable shall be allowed for entertainment,

amusement, or recreation expense unless the taxpayer establishes

that the expense was directly related to the active conduct of

the taxpayer’s trade or business. Section 274(b) provides, in

pertinent part, that no deduction shall be allowed under section

162 for any gift to the extent that the gift, together with other

gifts to the same individual for the same taxable year, exceeds

$25. Section 274(d) requires a taxpayer to substantiate a

claimed expense that is covered by section 274 by adequate

records or by sufficient evidence corroborating the taxpayer’s

own statement establishing the amount, time, place, business

purpose of the expense, and the business relationship to the

taxpayer of the persons entertained or receiving the gift. 

Section 274(k) provides in pertinent part that no deduction is

allowed for any food or beverage expense unless the expense is

not lavish or extravagant under the circumstances and the

taxpayer or an employee of the taxpayer is present at the

furnishing of the food or beverage expense.

Section 274(n) provides that the amount allowable as a

deduction for food and beverage expense and entertainment expense

shall not exceed 80 percent of the amounts that would be

deductible but for section 274(n). However, meals that qualify

as de minimis fringe benefits are not subject to the 20-percent
- 30 -

deduction disallowance imposed by section 274(n)(1). See sec.

274(n)(2)(B). Section 132(e) generally defines the term “de

minimis fringe” as “any property or service the value of which is

(after taking into account the frequency with which similar

fringes are provided by the employer to the employer’s employees)

so small as to make the accounting for it unreasonable or

administratively impracticable.” See also sec. 1.132-6(a),

Income Tax Regs.

2. Analysis

It is well established that the burden of proof with respect

to deductions claimed on a tax return generally rests on the

taxpayer. The general rule was succinctly stated by this Court

in Roberts v. Commissioner, 62 T.C. 834, 836 (1974), as follows:

Taxpayers have no inherent right to deductions; they

are matters of legislative grace. Interstate Transit

Lines v. Commissioner, 319 U.S. 590, 593 (1943); New

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

(1934). The taxpayer must be able to point to some

particular statute to justify his deduction and

establish that he comes within its terms. Deputy v.

Dupont, 308 U.S. 488, 493 (1940); White v. United

States, 305 U.S. 281 (1938). * * *

In Roberts, the taxpayer argued that the Commissioner’s

blanket disallowance of his business expense deductions (and a

casualty loss) without benefit of audit was arbitrary and

unreasonable and, therefore, could not form the basis for a

deficiency. In Roberts, we noted that the Commissioner’s failure

to audit the taxpayer’s records was due solely to the latter’s
- 31 -

refusal to furnish any records in support of the claimed

deductions. We held that “when a taxpayer refuses to

substantiate his claimed deductions, the Commissioner is not

arbitrary and unreasonable in determining that the deductions

should be denied.” Id. at 837.

Unlike the taxpayer in Roberts, petitioner did not refuse to

substantiate her deductions. In fact, she provided voluminous

documentation on several occasions and for extended periods of

time to respondent’s revenue agent, Appeals officer, trial

counsel, and to this Court. Respondent’s blanket disallowance of

petitioner’s Schedule C deductions in the notices of deficiency

for 3 of the 4 years at issue was preceded by the revenue agent’s

apparent failure or refusal to examine the expense records that

petitioner had produced for his inspection. Although

petitioner’s expense records (consisting, for the most part, of

canceled checks, cash receipts, credit card statements, and other

pertinent documents) may not have been kept in a form pleasing to

the revenue agent, they were coded and organized by category,

they satisfied the books and records requirement of section

1.6001-1(a), Income Tax Regs., and they were auditable. See

Jackson v. Commissioner, 59 T.C. 312, 317-318 (1972). 

Respondent’s disallowance of all of petitioner’s Schedule C

expenses for 3 of the 4 years at issue without any meaningful
- 32 -

examination of petitioner’s business records for those years

appears unwarranted and arbitrary.

As arbitrary as respondent’s blanket disallowance of

petitioner’s Schedule C expenses for 3 of the 4 years at issue

appears on these facts, however, it is nevertheless clear under

our jurisprudence and that of the Court of Appeals for the Eighth

Circuit that petitioner bears the burden of proof as to her

deductions. We are obligated to analyze the evidentiary record

and to weigh the evidence in order to decide if petitioner has

carried her burden of persuading this Court that respondent’s

disallowance of her Schedule C deductions for the years at issue

was erroneous and/or arbitrary. See Oliver v. Commissioner, 364

F.2d 575, 577 (8th Cir. 1966), affg. T.C. Memo. 1965-83. 

The record in this case establishes that petitioner

maintained an active law practice during the years at issue. In

connection with that law practice, petitioner paid business

expenses that were categorized and deducted on her Schedules C as

advertising, car and truck, depreciation/section 179, employee

benefits, insurance, interest, legal and professional, rent,

supplies, taxes, travel, meals and entertainment, utilities,

wages, dues and subscriptions, process services, contract

services, court fees, collection fees, bank charges, and

miscellaneous expenses. With the assistance of Mr. Aunan’s

workpapers, we were able to ascertain, to a large extent, how
- 33 -

14We have not addressed separately the Schedule C category

of collection fees that was included only on petitioner’s 1989

return, but we have considered any such expenses as part of other

categories.

petitioner’s expenses were grouped for tax return purposes. We

shall review each Schedule C expense category14 and the evidence

in support of each category to reach a conclusion regarding the

parties’ respective positions. Our conclusions are summarized in

a chart that appears at the end of this subsection on page 79.

a. Depreciation and Section 179 Expense

For the years at issue, petitioner claimed depreciation

expense deductions in the following amounts:

Year Amount

1987 $2,546

1988 11,974

1989 2,444

1990 1,467

The depreciation schedule included as part of Mr. Aunan’s

workpapers shows that the depreciation expense deductions were

calculated as follows:
- 34 -

15Ordinarily, we do not include citations to the record in

our opinions. In this case, however, references to line items in

(continued...)

Year Depreciation expense

acq. Asset Cost 1987 1988 1989 1990 

1987 Furniture

& fixtures $10,543 $2,109 $3,374 $2,024 $1,215

Computer 2,186 437 700 420 252

1988 Furniture

& fixtures 2,630 

12,630

Computer 5,270 

15,270 

 Total depreciation

 and sec. 179 exp. 2,546 11,974 2,444 1,467

1These amounts were claimed as sec. 179 expenses.

The detail in Mr. Aunan’s workpapers shows that, during 1987,

petitioner purchased furniture costing $3,003 and a copier

costing $3,069 and made leasehold improvements costing $4,471. 

The total of these three items is $10,543, the amount used by Mr.

Aunan in calculating the depreciation expense attributable to

furniture and fixtures for the years at issue. The detail also

shows that, during 1987, petitioner purchased a computer costing

$2,186, a figure that ties into Mr. Aunan’s depreciation

schedule.

Documents introduced into evidence at trial establish the

following:

(1) Petitioner purchased a computer for $2,186 during 1987

(Ex. 38-R, line 211).15
- 35 -

15(...continued)

the summary exhibits, Exhibits 38-R through 41-R, will assist the

parties in understanding which items we are allowing petitioner

to deduct and in preparing the Rule 155 computations.

16Our inability to account for the full cost of items

purchased during 1988 and included in the sec. 179 expense

deduction claimed by petitioner is attributable to the fact that

petitioner’s depreciation and sec. 179 records were unbundled

during the pretrial review of petitioner’s records and mixed in

with petitioner’s office supplies records. We have no doubt,

however, that petitioner expended the amounts claimed for 1988

(Ex. 39-R, lines 228-238, 241, 243-246, 248-259). 

(2) Petitioner expended $4,471.12 for office improvements

during 1987 (Ex. 38-R, lines 222-228).

(3) Petitioner purchased a copier for $3,068.64 during 1987

(Ex. 38-R, lines 323-332).

(4) Petitioner purchased computer furniture for $3,003.09

during 1987 (Ex. 38-R, lines 212-218).

(5) Petitioner purchased office furniture and computerrelated items during 1988 totaling at least $5,632.26.16

Respondent has conceded that petitioner expended the abovelisted amounts and that petitioner may depreciate these items but

attempts to reconfigure petitioner’s deduction by offering a

different depreciation alternative (7-year depreciation). We

reject respondent’s attempt to recalculate petitioner’s

depreciation and section 179 expense deduction because

respondent, who raised this issue for the first time in a

supplemental status report filed after trial, had the burden of

producing evidence regarding the proposed recalculation and
- 36 -

failed to introduce any evidence to show that the recalculation

is required. 

Petitioner has substantiated her depreciation and section

179 expense deduction for each of the years at issue, and the

deductions in the amounts claimed are allowed.

b. Bank Service Charges

Petitioner deducted bank service charges on her Schedules C

for the years at issue as follows:

Year Amount

1987 $469

1988 1,035

1989 120

1990 120

A review of petitioner’s bank records establishes that

petitioner incurred service charges, insufficient funds charges,

returned item charges, and miscellaneous other charges such as

those for check orders. For example, during 1987, with regard to

petitioner’s ANB account No. 302-733-1 alone, petitioner paid

$184.25 in service charges, $413 in insufficient fund and

returned item charges, and $84.75 in check charges for 10 months

(bank statements for 2 months were missing). Although all of

petitioner’s bank records were not introduced into evidence, we

have no doubt that in each of the years at issue petitioner paid

bank charges related to her law practice. Applying the Cohan

rule, we allow petitioner the deductions claimed for bank service

charges for each of the years at issue.
- 37 -

c. Dues and Publications

For the years at issue, petitioner claimed deductions for

dues and publications as follows: 

Year Amount

1987 $2,337

1988 3,867

1989 2,675

1990 4,095

Mr. Aunan’s workpapers reveal that the dues and publications

category on petitioner’s returns included expenses paid by

petitioner during the years at issue for her law library, bar and

other dues, continuing professional education, and her reception

room subscriptions as follows:

Year Law library CPE, dues & subs. Total

1987 $1,552 $785 $2,337

1988 3,530 337 3,867

1989 1,996 679 2,675

1990 1,468 2,627 14,095

1It appears from a review of Mr. Aunan’s workpapers that he

erroneously included the amount of $1,468 twice when calculating

petitioner’s 1990 deduction for dues and publications.

The record establishes that:

(a) During 1987, petitioner paid office book expenses of

$1,552.44 (Ex. 38-R, lines 152-160), continuing education

expenses of $549.20 (Ex. 38-R, lines 726-732), office magazine

expenses of $47.92 (Ex. 38-R, lines 124-126), and dues and

publications expenses of $2,321.48 (Ex. 38-R, lines 996-997,

1000-1003, 1016, 1033, 1038, 1045, 1051-1052, 1060, 1064, 1123,
- 38 -

1128-1129, 1135, 1144, 1151, 1157, 1172, 1174, 1176), for a total

amount documented of $4,471.04.

(b) During 1988, petitioner paid office book expenses of

$3,678.04 and subscriptions and memberships of $360.52, for a

total amount documented of $4,038.56 (Ex. 39-R, lines 25-32, 35-

38, 42-63).

(c) During 1989, petitioner paid office book and

subscription expenses of $1,974 (Ex. 40-R, lines 166-184, 186-

205) and a fee of $50 to the Minnesota Women Lawyers Association

(Ex. 40-R, line 142), for a total amount documented of $2,024. 

In addition, Mr. Aunan’s workpapers suggest that when he was

working on petitioner’s return for 1989, petitioner also had

given him documentation of two other expense items of $412 and

$217.

(d) During 1990, petitioner paid office book and

subscription expenses of $1,475.07, professional organization

fees of $310.50, continuing legal education expenses of $247.50,

and office book expenses of $278.90, for a total amount

documented of $2,311.97 (Ex. 41-R, lines 120-147, 428-431, 846-

852, 1290-1297).

Petitioner is entitled to deduct dues and subscriptions

expenses in each of the years at issue in the amounts summarized

above and set forth in the chart on page 79 of this opinion.
- 39 -

d. Legal and Professional

For the years at issue, petitioner claimed deductions for

legal and professional fees paid in connection with her law

practice as follows:

Year Amount

1987 $5,104

1988 7,239

1989 6,128

1990 13,536

Mr. Aunan’s workpapers reveal that the following entries

comprised the deducted amounts:

(a) For 1987, amounts of $158, $1,620, $760, and $2,566, for

a total amount deducted of $5,104;

(b) for 1988, amounts of $4,962 and $2,277, for a total

amount deducted of $7,239;

(c) for 1989, amounts of $4,965, $88 and $1,075, for a total

amount deducted of $6,128;

(d) for 1990, amounts of $18,066 and $10,470, reduced by a

$15,000 payment to James Van Valkenburg, for a total amount

deducted of $13,536.

Our review of the record reveals the following:

(a) During 1987, petitioner paid fees to other attorneys of

$2,566, fees to law clerks of $760.02, fees to experts of

$1,620.20, and fees for medical records of $158, for a total

expenditure of $5,104.22 (Ex. 38-R, lines 250-261, 317-319, 766-

777, 750-754).
- 40 -

(b) During 1988, petitioner paid fees to other professionals

of $7,145.55 and printer expenses of $2,277.63, for a total

expenditure of $9,423.18 (Ex. 39-R, lines 67-100, 680-692).

(c) During 1989, petitioner paid fees to other professionals

in the aggregate amount of $6,140.18 (Ex. 40-R, lines 91-119).

(d) During 1990, petitioner paid fees to other professionals

in the aggregate amount of $28,533.59. After reducing the amount

paid by the $15,000 payment to Mr. Van Valkenburg, the total

expenditure documented by petitioner was $13,533.59 (Ex. 41-R,

lines 538-585).

Petitioner is entitled to deduct legal and professional fees

in each of the years at issue in the amounts summarized above and 

set forth in the chart at page 79 of this opinion.

e. Process Services

For the years at issue, petitioner claimed deductions for

process services obtained as part of her law practice as follows:

Year Amount

1987 $2,482

1988 2,495

1989 915

1990 1,822

Mr. Aunan’s workpapers reveal that the following entries

comprised the deducted amounts:

(a) For 1987, a cumulative amount of $2,482;

(b) for 1988, amounts of $2,373 and $122, for a total amount

deducted of $2,495;
- 41 -

17Although the amounts shown on Mr. Aunan’s workpapers total

$1,823, the amount claimed on the tax return was $1,822.

(c) for 1989, amounts of $607, $300 and $8, for a total

amount deducted of $915;

(d) for 1990, amounts of $1,816 and $7, for a total amount 

of $1,823.17

Our review of the record reveals the following:

(a) During 1987, petitioner paid, and respondent concedes

the deductibility of, courier services totaling $2,541.70 (Ex.

38-R, lines 74-114).

(b) During 1988, petitioner paid, and respondent concedes

the deductibility of, process service fees totaling $2,373.28

(Ex. 39-R, lines 599-648). 

(c) During 1989, petitioner paid, and respondent concedes

the deductibility of, process service fees and other

transportation expenses totaling $570.70 (Ex. 40-R, lines 377-

398).

(d) During 1990, petitioner paid, and respondent concedes

the deductibility of, process server fees of $556.08 and

messenger service fees of $1,353.08, the total of which is

$1,909.16 (Ex. 41-R, lines 506-524, 607-646).

Petitioner is entitled to deduct process service and

transportation expenses in each of the years at issue in the
- 42 -

amounts summarized above and set forth in the chart at page 79 of

this opinion.

f. Court Fees

For the years at issue, petitioner claimed deductions for

court fees paid in connection with her law practice as follows:

Year Amount

1987 $2,002

1988 7,458

1989 9,104

1990 6,699

Mr. Aunan’s workpapers reveal that the following entries

comprised the deducted amounts:

(a) For 1987, amounts of $357, $1,924, and $221, for a total

amount deducted of $2,002 (it appears that a computational

mistake was made here as the total of the listed amounts is

$2,502);

(b) for 1988, amounts of $6,176 and $1,282, for a total

amount deducted of $7,458;

(c) for 1989, amounts of $7,890, $955, and $259, for a total

amount deducted of $9,104;

(d) for 1990, amounts of $3,357, $20, $193, $2,196, and

$933, for a total amount deducted of $6,699.

Our review of the record reveals the following:

(a) During 1987, petitioner paid, and respondent concedes

the deductibility of, court fees of $1,933.65 (Ex. 38-R, lines
- 43 -

353-423) and $759 (Ex. 38-R, lines 966-995), for a total amount

documented of $2,692.65.

(b) During 1988, petitioner paid, and respondent concedes

the deductibility of, court fees of $1,548.25 (Ex. 39-R, lines

386-433), $2,947.88 (Ex. 39-R, lines 437-530), and $57.50 (Ex.

39-R, lines 1647-1654), for a total amount documented of

$4,553.63.

(c) During 1989, petitioner paid, and respondent concedes

the deductibility of, court fees of $10.61 (Ex. 40-R, line 220),

$944.57 (Ex. 40-R, lines 270, 272-326), and $7,316.23 (Ex. 40-R,

lines 662-729, 731-752, 754-755, 757, 759-760, 762-789, 793, 797-

800, 804, 806, 808-812, 815-825, 827-844), for a total amount

documented of $8,271.41.

(d) During 1990, petitioner paid, and respondent concedes

the deductibility of, court fees of $3,113.45 (Ex. 41-R, lines

435-502) and expert fees of $3,796.57 (Ex. 41-R, lines 589-603),

for a total amount documented of $6,910.02.

Petitioner is entitled to deduct court and expert fees in

each of the years at issue in the amounts summarized above and as

set forth in the chart at page 79 of this opinion.

g. Contract Services

For the years at issue, petitioner claimed deductions for

contract services obtained as part of her law practice as

follows:
- 44 -

Year Amount

1987 $4,637

1988 10,618

1989 9,617

1990 10,079

Mr. Aunan’s workpapers reveal that the following entries

comprised the deducted amounts:

(a) For 1987, amounts of $3,849 and $788, for a total amount

deducted of $4,637;

(b) for 1988, a cumulative amount of $10,618;

(c) for 1989, amounts of $9,490 and $127, for a total amount

deducted of $9,617;

(d) for 1990, a cumulative amount of $10,079.

Our review of the record reveals the following:

(a) During 1987, petitioner paid, and respondent concedes

the deductibility of, contract services of $3,849.52 (Ex. 38-R,

lines 39-60) and $788.25 (Ex. 38-R, lines 790-799), for a total

amount documented of $4,637.77.

(b) During 1988, petitioner paid, and respondent concedes

the deductibility of, contract services of $10,759.31 (Ex. 39-R,

lines 696-755).

(c) During 1989, petitioner paid, and respondent concedes

the deductibility of, contract services of $9,748.39 (Ex. 40-R,

lines 575-658 (excluding items conceded by petitioner)).
- 45 -

(d) During 1990, petitioner paid, and respondent concedes

the deductibility of, contract services of $10,079.24 (Ex. 41-R,

lines 18-49).

Petitioner is entitled to deduct amounts paid for contract

services in each of the years at issue in the amounts summarized

above and set forth in the chart at page 79 of this opinion.

h. Moving Expenses

For 1987, petitioner claimed a deduction for moving expenses

in the amount of $3,258. Mr. Aunan’s workpapers reveal that the

amount deducted consisted of expenses of $412 and $2,846. Our

review of the record reveals that petitioner paid, and respondent

concedes the deductibility of, office moving expenses of $412.25

(Ex. 38-R, lines 336-340) and $2,845.82 (Ex. 38-R, lines 169-

173), for a total amount documented of $3,258.07.

Petitioner is entitled to deduct moving expenses of

$3,258.07 for 1987, as conceded by respondent and as shown on the

chart at page 79 of this opinion.

i. Insurance

For the years at issue, petitioner claimed deductions for

insurance paid in connection with her law practice as follows:

Year Amount

1987 $514

1988 3,677

1989 3,745

1990 3,565
- 46 -

Mr. Aunan’s workpapers reveal that the following entries

comprised the deducted amounts:

(a) For 1987, a cumulative amount of $514;

(b) for 1988, a cumulative amount of $3,677;

(c) for 1989, amounts of $3,578 and $167, for a total amount

deducted of $3,745;

(d) for 1990, amounts of $376, $397, and $2,792, for a total

amount deducted of $3,565.

Our review of the record reveals the following:

(a) In July, November, and December 1987, petitioner paid

amounts to State Farm Insurance totaling $414.92, all of which

respondent concedes are deductible (Ex. 38-R, lines 311-313).

(b) At various times during 1987, petitioner also paid for

employee health insurance from Blue Cross/Blue Shield and travel

insurance from Sid Murray Co. and Mutual of Omaha in amounts

totaling $541.97, all of which respondent concedes are deductible

(Ex. 38-R, lines 232-241). Some monthly payments to Blue Cross/

Blue Shield are not listed and appear to be missing.

(c) At various times during 1987, petitioner also paid

additional amounts to State Farm Insurance ($342.27) (Ex. 38-R,

lines 1017-1018) and the Administrator MSBA Plan ($21.60) (Ex.

38-R, line 1021) that respondent does not concede but we conclude

are deductible.
- 47 -

(d) During 1988, petitioner made payments to Blue Cross/Blue

Shield for employee health insurance ($1,010.32) (Ex. 39-R, lines

104-110), DCA for unspecified insurance ($397) (Ex. 39-R, lines

126-127), and Minnesota Department of Jobs & Training for

unemployment compensation insurance ($382.44) (Ex. 39-R, lines

140-147), all of which respondent concedes are deductible.

(e) During 1988, petitioner also made payments of $1,586.90

to State Farm Insurance Co. for office and equipment insurance

and for car insurance (Ex. 39-R, lines 116-125), $144.03 to

Confederation Life Insurance Co. for office insurance (Ex. 39-R,

lines 111-114), and $39 to Mutual of Omaha and Sid Murray Co. for

travel insurance (Ex. 39-R, lines 115, 131-132). Although

respondent does not concede that these amounts are deductible, we

hold that the above-listed items are deductible, and we note that

respondent has conceded similar items for 1989.

(f) During 1989, petitioner made payments to State Farm

Insurance for office insurance, to Sid Murray Co. and Mutual of

Omaha for travel insurance, to Blue Cross/Blue Shield for

employee health insurance, to Confederation Life Insurance Co.

for office insurance, to Lutheran Brotherhood for office

insurance, and miscellaneous other companies, totaling $2,768.80,

all of which respondent concedes are deductible.

(g) During 1989, petitioner paid additional office insurance

that respondent does not concede is deductible but that we hold
- 48 -

is deductible. The additional documented amounts total $1,096.51

(Ex. 40-R, lines 474-476, 479, 481-482).

(h) During 1990, petitioner paid employee life insurance,

employee health insurance, and workers’ compensation and

unemployment insurance totaling $1,543.64, all of which

respondent concedes are deductible (Ex. 41-R, lines 9-14, 842-

843; SSR dated 9/10/99).

(i) During 1990, petitioner also made payments to Blue

Cross/Blue Shield, Sid Murray Co. and Mutual of Omaha for office

and travel insurance ($518.98) that petitioner documented and

respondent concedes are deductible (Ex. 41-R, lines 365-368, 378-

379).

(j) During 1990, petitioner made other insurance payments,

the amount and business purpose of which she documented at trial. 

Although respondent does not concede that these payments are

deductible, we hold that they are deductible because petitioner

has credibly testified with regard to their business purpose. 

The payments total $1,303.19 (Ex. 41-R, line 369).

Petitioner is entitled to deduct business insurance that she

paid in each of the years at issue in the amounts summarized

above and shown on the chart at page 79 of this opinion.

j. Utilities

For the years at issue, petitioner claimed deductions for

utilities as follows:
- 49 -

Year Amount

1987 $838

1988 3,784

1989 6,152

1990 3,515

Mr. Aunan’s workpapers reveal that the following entries

comprised the deducted amounts:

(a) For 1987, a cumulative amount of $838;

(b) for 1988, amounts of $2,449, $1,318, $14, and $3, for a

total amount deducted of $3,784;

(c) for 1989, amounts of $1,257, $4,404, $458, and $33, for

a total amount deducted of $6,152;

(d) for 1990, amounts of $3,385, $17 and $113, for a total

amount deducted of $3,515.

Our review of the record reveals the following:

(a) For 1987, petitioner documented, and respondent conceded

the deductibility of, $1,572.19 and $333.45 of payments to

Northwestern Bell (Ex. 41-R, lines 142-143, 146-148, 1068-1069,

and SSR dated 9/10/99, line 1093) and utility payments to NSP in

October and December of $419.21 (Ex. 38-R, lines 825-826), for a

total amount documented of $2,324.85.

(b) For 1988, petitioner documented, and respondent conceded

the deductibility of, telephone expenses paid to American Paging,

US West, and Northwestern Bell of $2,757.51 (Ex. 39-R, lines 315-

326, 328, 330, 333-334). Petitioner also documented, but

respondent does not concede the deductibility of, utility
- 50 -

expenses paid to NSP totaling $1,317.82 (Ex. 39-R, lines 668-

676). Because petitioner has substantiated the payments to NSP,

which are consistent with utility payments in other years that

respondent did concede, we conclude that the payments to NSP

during 1988 are deductible utility expenses.

(c) For 1989, petitioner documented, and respondent concedes

the deductibility of, payments to NSP of $1,715.43 (Ex. 40-R,

lines 357-363, and SSR dated 9/10/99) and telephone and Metagram

expenses totaling $4,331.05 (Ex. 40-R, lines 331-334, 337-344,

346-347, 349-351, 353).

(d) For 1990, petitioner documented payments of $3,401.87

(the amount of which equals the sum of two of the three entries

on Mr. Aunan’s workpapers) (Ex. 41-R, lines 330-354). Of the

payments documented, respondent concedes the deductibility of

certain payments made to US West Cellular, NSP, American Paging,

AT&T, and US West Communications totaling $3,012.53 (Ex. 41-R,

lines 335-345, and SSR dated 9/10/99). Petitioner testified at

trial that she was entitled to additional amounts for cellular

phone service and for certain AT&T expenses for the office

phones. We accept petitioner’s testimony as credible, and we

allow her additional phone expense of $233.74 (Ex. 41-R, lines

331-334, 346, 348).
- 51 -

18Petitioner disputes respondent’s failure to allow

additional expenditures that she made and deducted as office

supplies. In many but not all instances, petitioner credibly

(continued...)

Petitioner is entitled to deduct utility expenses in each of

the years at issue in the amounts summarized above and shown on

the chart at page 79 of this opinion.

k. Supplies

For the years at issue, petitioner claimed deductions for

supplies purchased for her law practice as follows:

Year Amount

1987 $4,174

1988 12,297

1989 13,139

1990 7,263

Mr. Aunan’s workpapers, which describe this category of

expenses as “Office Supplies & Postage”, reveal that the

following entries comprised the deducted amounts:

(a) For 1987, amounts of $2,106, $653, and $1,415, for a

total amount deducted of $4,174;

(b) for 1988, amounts of $4,076, $1,195, $5,932, and $1,094,

for a total amount deducted of $12,297;

(c) for 1989, amounts of $6,762, $2,088, $378, $1,450,

$2,422, and $39, for a total amount deducted of $13,139;

(d) for 1990, amounts of $1,423, $3,307, $619, and $1,914,

for a total amount deducted of $7,263.

Our review of the record reveals the following:18
- 52 -

18(...continued)

testified regarding the business purpose of the expenditure at

trial, and/or the documentation presented at trial contains a

contemporaneous notation of the business purpose of the item. In

addition, respondent has conceded the deductibility of other

expenses that could be categorized as supplies. We shall account

for these additional expenses as miscellaneous expenses later in

this analysis.

(a) During 1987, petitioner paid for, and documented for

purposes of this case, office supplies and postage summarized

below, the deductibility of which respondent has conceded:

Office postage $653.36 (Ex. 38-R, lines 4-29)

Office supplies 2,015.75 (Ex. 38-R, lines 427-481, 

 excl. 438, 445, 447, 455)

Sec. B postage 359.37 (Ex. 38-R, lines 918-932)

Sec. B supplies 1,181.29 (Ex. 38-R, lines 938-951,

 excl. 947)

Total 4,209.77

(b) During 1988, petitioner paid for, and documented for

purposes of this case, office supplies and postage summarized

below, the deductibility of which respondent has conceded:

Office supplies $3,607.36 (Ex. 39-R, lines 197-259 (in 

 amount allowed column))

Office supplies 2,960.81 (Ex. 39-R, lines 271-309)

Postage, etc. 2,520.70 (Ex. 39-R, lines 542-573)

Sec. B off. supplies 183.82 (Ex. 39-R, lines 1313-1433 

 (in amount allowed column))

Sec. B postage 141.99 (Ex. 39-R, lines 1571-1589)

Total 9,414.68

(c) During 1989, petitioner paid for, and documented for

purposes of this case, office supplies and postage summarized

below, the deductibility of which respondent has conceded:
- 53 -

Office supplies $7,954.92 (Ex. 40-R, lines 4-87 

 (amount allowed column plus 

 line 65))

Office postage 378.46 (Ex. 40-R, lines 123-127)

Office furniture 38.00 (Ex. 40-R, line 214)

Postage 2,041.23 (Ex. 40-R, lines 432-468 

 (amount allowed column))

Sec. B off. supplies 13.59 (Ex. 40-R, line 1445)

Sec. B postage 79.97 (Ex. 40-R, lines 1451-1465)

Sec. B additional

 supplies 279.28 (Ex. 40-R, lines 1666-1763

_________ (amount allowed column))

Total 10,785.45

(d) During 1990, petitioner paid for, and documented for

purposes of this case, office supplies and postage summarized

below, the deductibility of which respondent has conceded:

Office supplies $3,330.25 (Ex. 41-R, lines 210-260)

Office expense 1,064.73 (Ex. 41-R, lines 264, 266- 

 267,271, 273-277, 279-285, 

 299, 302-304; SSR dated 

 9/10/99)

Copier 844.36 (Ex. 41-R, lines 358-361)

Printing expenses 619.31 (Ex. 41-R, lines 383-391)

Postage 1,422.78 (Ex. 41-R, lines 395-415)

Sec. B off. supplies 1,151.08 (Ex. 41-R, lines 1242-1285 

 (amount allowed column))

Sec. B off. misc. 117.63 (Ex. 41-R, lines 1312-1343 

 (amount allowed column))

Sec. B postage (cash) 108.45 (Ex. 41-R, lines 1348-1363)

Sec. B credit card 2,501.32 (Ex. 41-R, lines 1395-1424 

 (amount allowed column))

Sec. B printing 17.21 (Ex. 41-R, line 1598)

Sec. C credit card 244.14 (Ex. 41-R, lines 1668-1669, 

 1679-1681)

Total 11,421.26

Petitioner is entitled to deduct payments made for supplies

in each of the years at issue in the amounts summarized above and

shown on the chart at page 79 of this opinion.
- 54 -

l. Wages and Employee Benefits

For the years at issue, petitioner claimed deductions for

wages and employee benefits paid in connection with her law

practice as follows:

 Year Wages Employee Benefits

 1987 $13,991 $2,057

 1988 19,203 2,243

 1989 26,238 5,274

 1990 29,054 3,998

Mr. Aunan’s workpapers reveal that the following entries

comprised the deducted amounts:

(a) For 1987, the wage deduction was derived by adding

expenditures of $3,042 and $10,949, and the employee benefit

deduction was an aggregate amount of $2,057.

(b) For 1988, the wage deduction was derived by adding

expenditures of $15,766 and $3,437, and the employee benefit

deduction was derived by adding expenditures of $2,076, $134, and

$33.

(c) For 1989, the wage deduction was derived by adding

expenditures of $22,270 and $3,968, and the employee benefit

deduction was derived by adding expenditures of $3,275, $1,314,

$437, and $248.

(d) For 1990, the wage deduction was an aggregate amount of

$29,054, and the employee benefit deduction was derived by adding

expenditures of $3,797, $62, $109, and $30.
- 55 -

Our review of the record reveals the following:

(a) During the years at issue, petitioner employed one or

more employees in her law office and maintained a payroll account

through which she paid her employees’ salaries and related

withholdings.

(b) Petitioner did not introduce into evidence at trial all

of her payroll records or her Forms W-2, Wage and Tax Statement,

for the years at issue. Nevertheless, petitioner’s testimony and

other documents establish that petitioner paid salaries,

employment taxes, and employee benefits during each of the years

at issue.

(c) For 1987, petitioner documented expenses characterized

as employee benefit expenses of $1,159.55 (Ex. 38-R, lines 174-

183), six deposits into the payroll account on various dates in

May, November, and December 1987 totaling $3,041.72 (Ex. 38-R,

lines 816-821), and additional salary and daycare payments of

$946.86 in August 1987 (Ex. 38-R, lines 1112-1117), the

deductibility of which respondent has conceded.

(d) For 1988, petitioner documented salary payments of

$15,766.34 (Ex. 39-R, lines 833-865), additional salary payments

of $1,218.52 to Cynthia O. Ransom during May 1988 (Ex. 39-R,

lines 1294-1297), and daycare expenses in April and May 1988 of

$72 (Ex. 39-R, lines 1291-1293), the deductibility of which

respondent has conceded.
- 56 -

(e) For 1989, petitioner documented salary payments of

$22,288.21 (Ex. 40-R, lines 509-532) and daycare expenses of

$1,591.80 paid for one of her employees (Ex. 40-R, lines 551-

571), the deductibility of which respondent has conceded.

(f) For 1990, petitioner documented salary payments of

$6,658.20 (Ex. 41-R, lines 98-116) and $18,707.32 (Ex. 41-R,

lines 856-873), the deductibility of which respondent has

conceded.

Although petitioner did not introduce all of her payroll

records into evidence, we are convinced that her failure to do so

was more likely than not the result of the sheer volume of

documentation with which she was dealing at trial and the lack of

attention paid by both petitioner and respondent to the actual

Schedule C categories. Petitioner, however, credibly testified

at trial that she paid salaries, a telephone allowance, life

insurance, health insurance, school and summer childcare

expenses, and automobile expenses (including car insurance, a gas

allowance, and car payments) to or for the benefit of her

employees during 1987, 1988, and part of 1989. We also note that

the documented amounts if annualized would generate an annual

figure consistent with, or larger than, the amounts claimed on

petitioner’s Schedules C for the years at issue. We shall apply

the Cohan rule to uphold petitioner’s wage and employee benefits

deductions for each of the years at issue. 
- 57 -

Petitioner paid wages and provided employee benefits in the

amounts deducted in each of the years at issue as shown on the

chart at page 79 of this opinion.

m. Car and Truck

For the years at issue, petitioner claimed deductions for 

car and truck expenses paid in connection with her law practice

as follows:

Year Amount

1987 $6,672

1988 8,807

1989 5,354

1990 110,399

1This amount includes car lease payments of $7,159 claimed

as rent.

Mr. Aunan’s workpapers reveal that the following items of

car and truck expenses were taken into account in calculating the

deductions for the years at issue:

Year Car lease Repairs Gas Total

1987 $3,634 $1,647 $76

 1,398 300 54 $7,109

1988 6,228 631 2,689 9,548

1989 5,190 519

 71

 3 5,783

1990 8,076 1,424 517

 601 33

 877 11,528
- 58 -

Our review of the record reveals the following:

(a) During 1987, 1988, and 1989, petitioner leased two cars

for business purposes--a 1988 Toyota Camry from Wilkens Toyota

for general office use (driven by the process server, law clerk,

courier, and petitioner) and a 1987 Toyota Tercel from GE Credit

Auto Leasing for her secretary’s use. Petitioner had another car

for her personal use.

(b) During 1990, petitioner leased three cars for business

purposes--a Toyota Tercel, a Toyota Camry, and a Hyundai that was

leased in March 1990.

(c) For 1987, petitioner documented, and respondent concedes

the deductibility of, car expenses of $2,426.15 (Ex. 38-R, lines

283-297), $5,099.07 (Ex. 38-R, lines 1005-1015), and $1,231 (Ex.

38-R, lines 809-812; SSR dated 9/10/99), for a total amount

documented of $8,756.22. 

(d) For 1988, petitioner documented, and respondent concedes

the deductibility of, car expenses of $7,582.50 (Ex. 39-R, lines

355-382; SSR dated 9/10/99), $478.90 (Ex. 39-R, lines 577-595),

and $439.82 (Ex. 39-R, lines 1744-1764; SSR dated 9/10/99), for a

total amount documented of $8,501.22.

(e) For 1989, petitioner documented, and respondent concedes

the deductibility of, car expenses of $4,409.13 (Ex. 40-R, lines

223-239; SSR dated 9/10/99), $1,236.30 (Ex. 40-R, lines 402-428),

$748.78 (Ex. 40-R, lines 1533-1538, 1540-1559; SSR 9/10/99), and
- 59 -

$43.90 (Ex. 40-R, lines 1787-1790), for a total amount documented

of $6,438.11.

(f) For 1990, petitioner documented, and respondent concedes

the deductibility of, car expenses of $7,713.61 (Ex. 41-R, lines

1176-1222; SSR dated 9/10/99), and $245.44 (Ex. 41-R, lines 1483-

1496), for a total amount documented of $7,959.05.

Petitioner paid car and truck expenses in connection with

her law practice in each of the years at issue in the amounts

summarized above and shown on the chart at page 79 of this

opinion.

n. Rent

For the years at issue, petitioner claimed deductions for

rent in connection with her law practice as follows:

Year Amount

1987 $11,460

1988 10,256

1989 9,706

1990 

16,175

1Total rent expense claimed ($13,334) reduced by car lease

payments ($7,159) that were included as part of rent expense on

petitioner’s 1990 return.

Mr. Aunan’s workpapers show totals only and do not contain any

information identifying the rental expenses claimed.

Our review of the record reveals the following:

(1) During each of the years at issue, petitioner leased

office space that she used for her law practice.
- 60 -

(2) During 1987, petitioner entered into a predevelopment

purchase agreement for office space described as Suite 11, 1410

Energy Park Drive, that required her to pay $85,000 for the

office once the development work was completed. For

approximately 4 months before petitioner actually moved into

Suite 11, she rented Suite 8 and used it as her temporary law

office. Petitioner paid $955 per month to the Trah Partnership

for 4 months (Ex. 38-R, lines 164-165, 1066-1067), and respondent

has conceded that these amounts are deductible.

(3) In July 1987, petitioner moved into Suite 11 but did not

close on the purchase agreement because she could not get the

developer to schedule the closing. Petitioner maintained her law

office in Suite 11 until 1990 when the developer’s interest in

the property, 1410 Energy Park Drive, was foreclosed.

(4) When petitioner first moved into Suite 11 in July 1987,

she agreed to pay rent at the rate of $1,239.47 per month until

the closing under the purchase agreement was held. Petitioner

expected this arrangement to be of short duration. No closing,

however, was ever scheduled. Sometime after she moved into Suite

11, petitioner ceased paying rent to the developer in an effort

to force a closing under the purchase agreement. Petitioner was

sued for unpaid rent and resolved the litigation by escrowing 

approximately $10,000 in 1990 to settle the claim. However, the
- 61 -

escrowed funds were not released, if at all, until sometime after

1990.

(5) Petitioner paid architect and designer fees with respect

to Suite 11. Petitioner also paid for the improvements made to

Suite 11.

(6) In October 1989, petitioner’s law office was

burglarized. The burglary caused damage to the doorway, but the

developer refused to repair the damage. Petitioner made the

necessary repairs.

(7) By the time petitioner’s tax returns for the years at

issue were prepared, the developer’s interest in 1410 Energy

Drive had been foreclosed. It is reasonable to assume,

therefore, that all amounts paid with respect to Suite 11 during

the years at issue, except for the development costs that were

depreciated (Ex. 38-R, lines 222-228) and the interest on the

business loan, were deducted by Mr. Aunan as rent. However, the

record does not give us sufficient information to estimate the

amount of rent or rent equivalent that petitioner paid during

1988-90.

We conclude that petitioner paid rent for her law office

during 1987 in the amount of $3,820, as shown on the chart at

page 79 of this opinion. We lack sufficient information to

estimate petitioner’s rent expense for 1988-90.
- 62 -

o. Taxes

For the years at issue, petitioner claimed deductions for

taxes as follows:

Year Amount

1987 $1,235

1988 4,908

1989 5,051

1990 10,601

Mr. Aunan’s workpapers, which describe the tax expense

category as “P/R Taxes”, reveal that the following entries

comprised the deducted amounts:

(a) For 1987, amounts of $491 and $744, for a total amount

deducted of $1,235;

(b) for 1988, amounts of $382 and $4,526, for a total amount

deducted of $4,908;

(c) for 1989, a single amount of $2,799 is listed, but the

final expense figure shown on Mr. Aunan’s workpapers is $5,051,

the total amount deducted on petitioner’s return;

(d) for 1990, a total amount of $10,601.

Our review of the record reveals the following:

(a) For 1987, petitioner documented two payments to the IRS,

in September and December 1987, and one payment to the Commission

of Revenue, in September 1987, totaling $490.98 (Ex. 38-R, lines

803-805). Respondent concedes the deductibility of these

payments.
- 63 -

(b) For 1988, petitioner documented $5,113.77 of payments to

the IRS ($4,034.98) and the Minnesota Department of Revenue

($850.90) and deposits into petitioner’s payroll account

($227.89) covering the months of February, May, July, August, and

October 1988 (Ex. 39-R, lines 652-664). Of the amounts

documented, petitioner concedes that $1,200.97 was deposited into

the payroll account (and presumably was claimed as a wage

deduction), and respondent concedes the deductibility of the

payments to the Minnesota Department of Revenue.

(c) For 1989, petitioner documented $3,068.20 of payments to

the IRS ($2,324.64) and to the Minnesota Department of Revenue,

the Minnesota Department of Jobs, the Minnesota UC Fund, the

Commissioner of Revenue, and the Employee Benefit Administration

($743.56) (Ex. 40-R, lines 257-266). Respondent conceded the

deductibility of all of these payments.

(d) For 1990, petitioner documented $11,253.01 of payments

to the IRS ($9,888.44), the Department of Revenue ($1,167.19),

and the Minnesota Department of Jobs ($197.38) (Ex. 41-R, lines

809-838) but provided no information regarding the nature or

purpose of the payments. Respondent has not conceded that any of

these payments is deductible.

(e) During each of the years at issue, petitioner paid wages

to employees and had an obligation to pay the employer’s share of

Federal Insurance Contributions Act (FICA) and Federal
- 64 -

19Respondent already has conceded that $2,324.64 of this

amount is deductible. We have calculated the amount allowed as a

deduction for 1989 to eliminate any duplication.

Unemployment Tax Act (FUTA) taxes, see secs. 3111(a) and (b)(6),

3301, as well as the employer’s share of State employment and

unemployment taxes. Such taxes are deductible when paid in

carrying on the employer’s trade or business. Sec. 162(a). 

Although we cannot precisely ascertain from the record the exact

amount of FICA and FUTA taxes paid by petitioner, we shall apply

the Cohan rule and allow deductions for the employer’s share of

FICA and FUTA taxes, calculated on the wages that we have held

are deductible in each of the years at issue. The following

rates were in effect with respect to FICA (old-age, survivors,

and disability insurance (sec. 3111(a)) and hospital insurance

(sec. 3111(b)(6))), and FUTA (sec. 3301) for each of the years at

issue:

Year FICA FUTA

Old Age Hospital

1987 5.7 percent 1.45 percent 6 percent

1988 6.06 percent 1.45 percent 6.2 percent

1989 6.06 percent 1.45 percent 6.2 percent

1990 6.2 percent 1.45 percent 6.2 percent

Applying these rates to the wages allowed as deductions in each

of the years at issue results in deductions for the employer’s

share of FICA and FUTA tax of $1,839.82 for 1987, $2,632.74 for

1988, $3,597.23 for 1989,19 and $4,023.98 for 1990.
- 65 -

Petitioner is entitled to deduct tax payments in each of the

years at issue in the amounts conceded by respondent and allowed

under the Cohan rule. The amounts are shown on the chart at page

79 of this opinion.

p. Interest

For the years at issue, petitioner claimed deductions for

interest paid in connection with her law practice as follows:

Year Amount

1987 $10,034

1988 3,053

1989 2,926

1990 2,070

Mr. Aunan’s workpapers include a workpaper labeled “Business

Interest”, which contains the following entries:

 1987 1988 1989 1990

Citibank MasterCard $260.00 $319.50 $365.45 $258.66

Amex Gold

Citibank Visa -- 202.07 270.63 235.71

Citibank Preferred -- -- 232.16 581.82

First Card 365.93 790.58 910.97 870.01

Amex Green 1.47 17.04 81.37

TCF Visa -- -- 284.59 -- 

 625.93 1,313.62 2,080.84 2,027.57

The total amount of credit card interest in each year was then

rounded and added to amounts characterized as “Capital Loan” to

arrive at the total business interest deducted in each of the

years at issue:
- 66 -

Year Credit Card Capital Loan Total

1987 $626 $9,408 $10,034

1988 1,314 1,739 3,053

1989 2,081 845 2,926

1990 2,028 42 2,070

Our review of the record reveals the following:

(a) Petitioner maintained various credit card accounts that

she used for business purposes during the years at issue.

(b) During each of the years at issue, petitioner paid

interest expense attributable to her business use of her credit

card accounts.

(c) Petitioner documented interest expense paid on her

Citibank Visa account for 1988 of $202.07. 

(d) Petitioner documented, and respondent concedes the

deductibility of, interest expense paid on petitioner’s Citibank

MasterCard account for 1989 of $390.62 (Ex. 40-R, lines 1841,

1848, 1852).

(e) Petitioner documented the existence of a business loan

with ANB, the purpose of which was to finance leasehold

improvements. The face amount of the loan was $19,342.33, and it

carried an annual interest rate of 10.25 percent.

(f) Petitioner documented that she paid interest on the

business loan in the following amounts: 1988--$1,738.71, 1989--

$844.55, 1990--$42.44.

Although petitioner did not introduce all of her credit card

records for each of the years at issue into evidence, we are
- 67 -

satisfied from the documentation that was introduced that

petitioner maintained the credit card accounts in question and

that she used them for her law practice. We are also satisfied

that, at the time Mr. Aunan prepared petitioner’s returns for the

years at issue, he had documentation of the credit card interest

paid by petitioner during the years at issue.

With respect to the capital loan interest deducted,

petitioner produced copies of information returns that confirmed

the interest expense paid with respect to petitioner’s business

loans for 1988, 1989, and 1990. The amounts documented

corresponded exactly with the amounts shown on Mr. Aunan’s

workpapers. Although petitioner did not introduce into evidence

copies of her interest statements for 1987, we believe that there

is a sufficient factual predicate in the record to support a

finding that petitioner incurred interest expense attributable to

her business loans and credit card accounts as claimed on her

1987 Schedule C.

Petitioner paid interest expenses as claimed on her

Schedules C for the years at issue and reflected on the chart at

page 79 of this opinion.

q. Travel

For the years at issue, petitioner claimed deductions for

business travel as follows:
- 68 -

Year Amount

1987 $1,039

1988 --

1989 1,601

1990 1,988

Mr. Aunan’s workpapers reveal that the following entries

comprised the deducted amounts:

(a) For 1987, a cumulative amount of $1,039;

(b) for 1989, a cumulative amount of $1,601;

(c) for 1990, amounts of $12 and $1,976, for a total amount

deducted of $1,988.

Mr. Aunan’s workpapers also show a $9 entry for travel for 1988,

but that amount was not deducted as travel on petitioner’s 1988

Schedule C. Instead, it appears Mr. Aunan added the $9 item to

Miscellaneous Expense and deducted it as such on petitioner’s

1988 Schedule C.

Our review of the record reveals the following:

(a) For 1987, petitioner documented, and respondent concedes

the deductibility of, business travel expenses of $520, $53.07,

$104.74, $258, $10, $310, and $310, totaling $1,565.81 (Ex. 38-R,

lines 1134, 1190-1191, 1193-1196).

(b) For 1988, petitioner documented, and respondent concedes

the deductibility of, business travel expenses (including baggage

and flight insurance) totaling $832.50 (Ex. 39-R, lines 1841-

1843, 1878-1880).
- 69 -

(c) For 1989, petitioner documented, and respondent concedes

the deductibility of, business travel expenses totaling $947

(Ex.40-R, lines 1849-1851).

(d) For 1990, petitioner documented, and respondent concedes

the deductibility of, business travel expenses of $856.13 (Ex.

41-R, lines 1374-1385) and $463.59 (Ex. 41-R, lines 1661-1663),

for a total of $1,319.72.

Petitioner paid business travel expenses during each of the

years at issue in the amounts summarized above and reflected in

the chart at page 79 of this opinion.

r. Advertising and Meals & Entertainment

For the years at issue, petitioner claimed deductions for

advertising and for meals and entertainment in connection with

her law practice as follows:

Year Advertising Meals & ent. Total

1987 $98 $896 $994

1988 160 1,961 2,121

1989 513 795 1,308

1990 2,384 3,286 5,670

Mr. Aunan’s workpapers reveal that the following entries

comprised the deducted amounts:

(a) For “Promotion & Advertising”, cumulative amounts of

$98, $160, and $513 for 1987, 1988, and 1989, respectively, and

amounts of $1,253 and $1,131, for a total amount deducted of

$2,384 for 1990;
- 70 -

(b) for entertainment, amounts of $951 and $169, totaling

$1,120 for 1987; amounts of $2,093, $316, and $42, totaling

$2,451 for 1988; amounts of $472 and 522, totaling $994 for 1989;

and amounts of $1,844, $478, $269, and $1,516, totaling $4,107

for 1990 before application of the section 274(n) limitation.

Our review of the record reveals the following:

(a) Petitioner maintained voluminous records to document

her practice of entertaining, and purchasing gifts for, clients,

employees, referral sources, judges, and other members of the

legal community throughout the years at issue.

(b) In his notices of deficiency, respondent did not assert

section 274 as a ground for disallowing any of petitioner’s

deductions for business promotion/advertising or for meals and

entertainment. Respondent only asserted a section 162 standard

as the basis for his proposed disallowance of petitioner’s

deductions.

(c) Petitioner testified extensively at trial regarding the

identity of the person who was entertained or to whom a gift was

given, as well as the business purpose of many of the individual

items comprising her business promotion and meals and

entertainment expenses. The date and amount of the expenditures

were documented by invoices, canceled checks, credit card and

other receipts, and other records. In some cases, receipts
- 71 -

20Petitioner “conceded” several of the smaller expense

items; i.e., she did not offer any additional evidence regarding

them, because she was interested in getting to the “large items”.

She did not concede that the items were not deductible, however,

and she did document the date and amount of the expense and the

identity of the payee as reflected on Exhibits 38-R through 41-R.

retained by petitioner as part of her business records were no

longer legible.

(d) For 1987, petitioner presented documentation of the

following expenditures that were listed on Exhibit 38-R in the

following categories:20

 Category Line Nos. Amount

Bachman’s (bus. gifts) 64-70 $118.96

Client entertainment 485-521 971.63

Credit cards 1171, 1173, 1175, 1,496.72

 1181-1189, 1192,

 1197-1232

(e) For 1988, petitioner presented documentation of the

following expenditures that were listed on Exhibit 39-R in the

following categories:

 Category Line Nos. Amount

Client & employee gifts

 & entertainment 1183-1297 $8,126.48

Client gifts 1593-1608 139.46

Employee benefits 1612-1637 195.49

Office party 1641-1643 131.66

Client entertainment 1677-1740 935.18

Of the expense items listed on lines 1183-1297, respondent

conceded that $2,266.55 was deductible, and the nature of the

expenses indicates that they were not entertainment expenses. 

During trial, petitioner conceded that some of the items were not
- 72 -

deductible and testified that other items were misclassified but,

nevertheless, were deductible business expenses.

(f) For 1989, petitioner presented documentation of the

following expenditures that were listed on Exhibit 40-R in the

following categories:

 Category Line Nos. Amount

Client gifts 148-162 $465.13

Employee & client

 gifts & entertainment 950-1076 3,365.06

Client gifts 1469-1481 178.62

Client entertainment 1485-1529 747.61

American Express 

11796-1835 1,118.95

 

1Some of these items, which do not appear to be meal or

entertainment expenses, have been conceded by respondent. The

amount shown has been reduced by the conceded amounts.

(g) For 1990, petitioner presented documentation of the

following expenditures that were listed on Exhibit 41-R in the

following categories:

 Category Line Nos. Amount

Business promotion 151-166 $1,252.94

Client gifts 193-206 534.09

Employee gifts 877-883 543.37

Client entertainment 887-964 1,909.23

Business promotion 1303-1306 429.31

Client entertainment 1439-1478 1,074.75

Client gifts 1579-1593 484.17

After reviewing petitioner’s documentation and testimony, we

have no doubt that a properly conducted audit of petitioner’s

meals and entertainment and business promotion records could have

resulted in a reasonable dispute regarding whether the

requirements of section 162 have been satisfied with respect to
- 73 -

each expense item and, if so, whether section 274 should operate

to preclude deductions for some of the items. We also have no

doubt, however, that petitioner had deductible meals and

entertainment expenses and purchased deductible business gifts

for clients, referral sources, and other professional people in

each of the years at issue. We also note that the documentation

presented by petitioner that was reviewed and summarized by

respondent in Exhibits 38-R through 41-R substantially exceeds

the deductions claimed by petitioner for advertising (business

promotion) and meals and entertainment in each of the years at

issue:

Year Total on return Total on exhibits

1987 $994 $2,587.31

1988 2,121 9,528.27

1989 1,308 5,875.37

1990 5,670 6,227.86

Recognizing the flaws in each party’s position, we conclude only

that petitioner paid advertising/business promotion and meals and

entertainment expenses in sufficient amounts to support the

deductions claimed in each of the years at issue.

s. Miscellaneous

For the years at issue, petitioner claimed deductions for

miscellaneous business expenses as follows:
- 74 -

Year Amount

1987 $355

1988 6,424

1989 3,343

1990 2,427

Mr. Aunan’s workpapers reveal that the following entries

comprised the deducted amounts:

(a) For 1987, parking expenses of $35 and miscellaneous

expenses of $320, for a total deducted of $355;

(b) for 1988, travel expenses of $9 and miscellaneous

expenses of $6,415, for a total deducted of $6,424;

(c) for 1989, miscellaneous expenses of $2,878 and $465, for

a total deducted of $3,343;

(d) for 1990, miscellaneous expenses of $2,398 and parking

expenses of $29, for a total deducted of $2,427.

Our review of the record reveals the following:

(a) During 1987, petitioner paid the following Schedule C

expenses that have not been previously allocated in this analysis

to any other Schedule C category:
- 75 -

Conceded by

Category Ex./line Nos. Amount respondent?

Various 38-R/33-35 $223.76 Yes

Parking 38-R/118-120 13.25 Yes

Various 38-R/130-133 371.25 Yes

Various 38-R/266-267 12.25 Yes

Various 38-R/277-279 22.00 Yes

Various 38-R/742-743 142.68 Yes

Various 38-R/758-762 357.23 Yes

Various 38-R/781-786 250.61 Yes

Various 38-R/860 30.00 Yes

Various 38-R/904-917 1,131.68 Yes

Various 38-R/936 581.00 Yes

Various 38-R/958-965,

 998-999,

 1004 932.96 Yes

Various 38-R/1037 7.00 Yes

Various 38-R/1042-1044,

 1046-1050,

 1053-1055 1,326.08 Yes

Various 38-R/1059 17.23 Yes

Various 38-R/1071-1075 165.39 Yes

Various 38-R/1087 37.00 Yes

Various 38-R/1091 300.00 Yes

Various 38-R/1098-1108

 1110 686.10 Yes

Various 38-R/1142 97.85 Yes

Various 38-R/1152 15.00 Yes

 6,720.32

(b) During 1988, petitioner paid the following Schedule C

expenses that have not been previously allocated in this analysis

to any other Schedule C category:
- 76 -

 Conceded by

Category Ex./line Nos. Amount respondent?

Various 39-R/4-21 $1,052.20 Yes

Luth. Broth. 39-R/128-130,

 133-134 274.62 No

CLE Book 39-R/138 40.00 No

Various 39-R/139 32.33 Yes

Various 39-R/151-193 1,034.18 Yes

 (including 165) No

Misc. supp. 39-R/200,203,

 206,

 209-212 432.82 No

Misc. supp. 39-R/214-222,

 226 

1222.17 No

Various 39-R/239-240 110.50 No

Various 39-R/534-538 81.25 Yes

Client exp. 39-R/1132-1134 5,111.56 No

Various 39-R/1437-1567 535.22 Yes

Various 39-R/1787,1791,

 1802-1803,

 1805, 1810,

 1812,

 1815-1816 333.58 Yes

Various 39-R/1826-1828,

 1830-1832 290.82 Yes

Various 39-R/1839-1840,

 1845-1846,

 1849-1855,

 1857-1858 151.77 Yes

Various 39-R/1864,1870,

 1876-1877,

 1881 165.37 Yes

 9,868.39

1The amount allowed with regard to these items is based on

petitioner’s testimony at trial, which we find credible.

(c) During 1989, petitioner paid the following Schedule C

expenses that have not been previously allocated in this analysis

to any other Schedule C category:
- 77 -

 Conceded by

Category Ex./line Nos. Amount Respondent?

Off. supp. 40-R/13 $34.75 No

Off. supp. 40-R/15 19.46 No

Off. supp. 40-R/16 151.04 No

Off. supp. 40-R/21-24 74.51 No

Off. supp. 40-R/29-30 14.51 No

Off. supp. 40-R/40 5.25 No

Off. supp. 40-R/47 24.85 No

Off. supp. 40-R/58-60 160.64 No

Client exp. 40-R/209-210 16.70 Yes

Client exp. 40-R/547 4,000.00 No

Client exp. 40-R/805 17.00 Yes

Client exp. 40-R/826 2.00 No

Client exp. 40-R/1181, 1182 1,020.47 No

Auto 40-R/1533-1536 38.26 Yes

Parking 40-R/1568-1662 340.31 Yes

Off. supp. 40-R/1682 142.18 No

Off. supp. 40-R/1778 24.80 No

Off. supp. 40-R/1779-1780 269.25 Yes

Auto 40-R/1816-1817 261.82 Yes

Various 40-R/1831-1833 237.62 Yes

Off. subs. 40-R/1835 24.00 No

Various 40-R/1842, 1847,

 1854-1856,

 1858-1860 330.96 Yes

 7,210.38

(d) During 1990, petitioner paid the following Schedule C

expenses that have not been previously allocated in this analysis

to any other Schedule C category:
- 78 -

Conceded by

 Category Ex./line Nos. Amount Respondent?

Miscell. 41-R/265, 269,

 270, 278,

 286, 290,

 307 $730.49 No

Off. furn. 41-R/311-319,

 321-325 782.75 No

Parking 41-R/419-424 28.50 Yes

Admin. fees 41-R/528-529 20.00 Yes

Court rpt. 41-R/533-534 192.52 Yes

Fees to attys. 41-R/549 9,051.55 No

 (out of $15,000)

Client fees 41-R/654-655,

 657-659 255.47 Yes

Client fees 41-R/656, 661 1,640.90 No

Emp. benef. 41-R/682-686,

 693-699 842.37 No

Rental exp. 41-R/703-712 2,304.35 Yes

Bus. prom. 41-R/1303-1304,

 1306 364.40 Yes

Prof. fee 41-R/1368 25.00 Yes

Client fee 41-R/1390 1.62 Yes

Parking 41-R/1501-1503,

 1505-1524,

 1530-1574 241.30 Yes

Auto 41-R/1682-1683 23.50 Yes

 16,504.72

t. Reconciliation

A comparison of the Schedule C expenses allowed pursuant to

the foregoing analysis with the Schedule C expenses claimed on

petitioner’s Federal income tax returns for the years at issue

reveals the following:
- 79 -

1987 1988 1989 1990

 Per

Return

 Per

 Opinion

 Per

Return

 Per

 Opinion

Per

Return

 Per

 Opinion

 Per

Return

 Per

 Opinion

Advertising $98 $98.00 $160 $160.00 $513 $513.00 $2,384 $2,384.00

Bank charges 469 682.00 1,035 1,035.00 120 120.00 120 120.00

Car & truck 6,672 8,756.22 8,807 8,501.22 5,354 6,438.11 3,240 7,959.05

Depreciation 2,546 2,546.00 11,974 11,974.00 2,444 2,444.00 1,467 1,467.00

Dues & pubs. 2,337 4,471.04 3,867 4,038.56 2,675 2,653.00 4,095 2,311.97

Employee ben. 2,057 2,057.00 2,243 2,243.00 5,274 5,274.00 3,998 3,998.00

Insurance 514 1,320.76 3,677 3,559.69 3,745 3,865.31 3,565 3,365.81

Interest 10,034 10,034.00 3,053 3,053.00 2,926 2,926.00 2,070 2,070.00

Legal & prof. 5,104 5,104.22 7,239 9,423.18 6,128 6,140.18 13,536 13,533.59

Rent 11,460 3,820.00 10,256 --- 9,706 --- 13,334 ---

Supplies 4,174 4,209.77 12,297 9,414.68 13,139 10,785.45 7,263 11,421.26

Taxes 1,235 2,330.80 4,908 3,483.64 5,051 4,340.79 10,601 4,023.98

Travel 1,039 1,565.81 --- 832.50 1,601 947.00 1,988 1,319.72

Meals & ent. 896 896.00 1,961 1,961.00 795 795.00 3,286 3,286.00

Utilities 838 2,324.85 3,784 4,075.33 6,152 6,046.48 3,515 3,246.27

Wages 13,991 13,991.00 19,203 19,203.00 26,238 26,238.00 29,054 29,054.00

Moving exps. 3,258 3,258.07 --- --- --- --- --- ---

Process serv. 2,482 2,541.70 2,495 2,373.28 915 570.70 1,822 1,909.16

Contract serv. 4,637 4,637.77 10,618 10,759.31 9,617 9,748.39 10,079 10,079.24

Court fees 2,002 2,692.65 7,458 4,553.63 9,104 8,271.41 6,699 6,910.02

Collect. fees --- --- --- --- 850 --- --- ---

Miscellaneous 355 6,720.32 6,424 9,868.39 3,343 7,210.38 2,427 16,504.72

76,198 84,057.98 121,459 110,512.41 115,690 105,327.20 124,543 124,963.79

The chart summarizes the Schedule C expenses that we have

concluded, based on a preponderance of the evidence, petitioner

is entitled to deduct in each of the years at issue. As

reflected in the chart, petitioner has substantiated Schedule C

expenses for each of the years 1987 and 1990 in excess of those

claimed on her tax returns for those years. The chart also
- 80 -

reveals that, for 1988 and 1989, petitioner has substantiated

Schedule C expenses in amounts that are less than the amounts

claimed on her tax return for each year. 

The chart also illustrates what should be obvious by now--

respondent’s determination disallowing her Schedule C expenses

for the years at issue was arbitrary and unreasonable. We cannot

explain how the audit process malfunctioned so badly, but it is

readily apparent that the malfunction occurred. The disallowance

of petitioner’s business expenses after petitioner had produced

auditable business records for considered review by the revenue

agent and others has resulted in significant expenditures of time

on the part of petitioner, respondent’s counsel, and this Court

to conduct what was, in effect, an audit. This case has amply

demonstrated that the litigation process is not well suited for

the exchange of information that should occur in a properly

conducted audit.

 D. Net Operating Losses

Unlike the record made by petitioner with respect to her

Schedule C income and deductions, the record made by petitioner

with respect to her NOL carryforward deductions does not

establish that respondent’s determinations disallowing

petitioner’s NOL carryforward deductions were erroneous. 

Although petitioner alluded to the fact that respondent did not

examine the NOLs during his examination of the years at issue,
- 81 -

petitioner did not clearly testify that she produced to the

revenue agent the records necessary to support the NOL carryover

deductions claimed for the return years at issue. More

importantly, although petitioner introduced some documentation at

trial with respect to her claimed NOL deductions, the

documentation was insufficient to support a finding that she is

entitled to all or any portion of such carryforwards. 

The principal problem with the trial record is that the

documentation, although substantial, is incomplete in many

respects. For example, petitioner introduced no records for 1977

or 1984-86 and insufficient records for 1980 and 1982, the years

in which petitioner claimed net operating losses, to enable us to

verify the losses or to show how the losses were absorbed in

other years.

Under the foregoing circumstances, we hold that petitioner

has failed to prove she is entitled to any portion of the

reported 1980-86 NOL carryforward.

II. Additions to Tax and Penalties

A. Section 6651(a)(1) Addition to Tax

Section 6651(a)(1) imposes a penalty equal to 5 percent of

the tax due for each month of delayed filing beyond the due date

(including extensions) up to a maximum of 25 percent “unless it

is shown that such failure [to file] is due to reasonable cause

and not due to willful neglect”.
- 82 -

Petitioner was well aware that her 1987 return and the 1988-

90 joint returns with her husband were not filed timely. All

four returns were filed between August 25, and August 27, 1992,

well after the due dates, including the extended due date for

1987. For 1988-90, petitioner did not furnish the accountant

with information he needed to prepare the returns until after the

return due dates.

Although petitioner testified that the late filings were

largely attributable to her husband’s failure to gather his tax

information and pay his self-employment tax and/or to the

accountant’s delay in completing the returns, she failed to

pursue available alternatives such as insisting on the timely

filing of her 1987 return, timely filing a “married filing

separate return” for 1988-90, or demanding that her husband and

his accountant complete and file the joint returns for 1988-90 by

their due dates using the best information available (and, if

necessary, filing amended returns when the rest of the

information became available). Petitioner’s failure to ensure

that her returns were filed timely under these circumstances

supports the imposition of the delinquency addition to tax. See

Estate of Thomas v. Commissioner, T.C. Memo. 2001-225. 

Consequently, we sustain respondent’s imposition of the section

6651(a)(1) delinquency addition to tax for each of the years at

issue, recomputed in accordance with this opinion.
- 83 -

B. Negligence Addition to Tax Under Section 6653

Section 6653(a), applicable to petitioner’s 1987 and 1988

taxable years, authorizes the imposition of an addition to tax

for negligence. It provides that, if any part of any

underpayment is due to negligence or disregard of rules or

regulations, an addition equal to the sum of 5 percent of the

underpayment and, for 1987, an amount equal to 50 percent of the

interest payable under section 6601 with respect to the portion

of such underpayment attributable to negligence for the period

from the underpayment due date to the assessment date (or if

earlier, the tax payment date) shall be added to the tax. For

purposes of section 6653(a), negligence is defined to include

“any failure to make a reasonable attempt to comply with the

provisions of this title”, and disregard is defined to include

“any careless, reckless, or intentional disregard.” Sec.

6653(a)(3).

Respondent contends that petitioner is liable for the

section 6653(a) addition to tax for negligence “because she

failed to use reasonable care in ascertaining and reporting her

tax liabilities” for 1987 and 1988. Specifically, respondent

argues that petitioner is liable for the addition to tax because

she “failed to keep adequate accounting records and claimed a

large NOL deduction with little or no support.” Respondent does

not argue, however, that petitioner’s failure to file timely
- 84 -

returns is a basis for imposing the addition to tax under section

6653(a).

It is well established that a taxpayer’s failure to keep

records is a basis for imposing the addition to tax under section

6653(a). See, e.g., Taylor v. Commissioner, T.C. Memo. 1988-389,

affd. without published opinion 887 F.2d 259 (lst Cir. 1989). As

numerous cases have illustrated, however, the IRS and taxpayers

can often differ regarding what constitutes a failure to keep

records sufficient to support liability under section 6653(a). 

Section 1.6001-1, Income Tax Regs., provides:

any person subject to tax under subtitle A of the Code

(including a qualified State individual income tax

which is treated pursuant to section 6361(a) as if it

were imposed by chapter 1 of subtitle A), or any person

required to file a return of information with respect

to income, shall keep such permanent books of account

or records, including inventories, as are sufficient to

establish the amount of gross income, deductions,

credits, or other matters required to be shown by such

person in any return of such tax or information.

Respondent contends that the cited regulation required petitioner

to maintain “adequate accounting records”. He supports his

argument by focusing primarily on one exhibit introduced into

evidence by petitioner and generally disparaging petitioner’s

records. Although petitioner chose not to file a posttrial

brief, she adamantly asserted at trial that she maintained

voluminous records and that, while the records were not formal or

perfect, they were routinely maintained in an organized form,

were produced to the accountant who prepared her returns for the
- 85 -

years at issue, and adequately documented the income and expenses

from her law practice.

Our review of the evidentiary record, when filtered through

the parties’ arguments, convinces us that petitioner should not

be held liable for the addition to tax under section 6653(a)

based on respondent’s contention that she failed to keep adequate

records. As we have stated previously, we found petitioner’s

testimony, including her testimony regarding her record keeping

and her production of records during the audit, to be credible. 

In addition, the documents petitioner produced at trial amply

demonstrated that she maintained records and that the records

were auditable. Moreover, we accept petitioner’s testimony that

she produced those records for examination by respondent’s

revenue agent and Appeals officer on several different occasions

over a period of several years. We are left with the impression

that any gaps in petitioner’s records at trial were more likely

than not the result of the passage of time, the multiple and

delayed reviews of petitioner’s records by respondent and others,

and petitioner’s difficult personal circumstances before and

during trial.

Respondent contends that petitioner’s record keeping was

inadequate, and therefore negligent, because she failed to

maintain formal books of account as required by section 1.6001-1,

Income Tax Regs., she failed to employ “competent help” to
- 86 -

prepare her tax returns, and she failed to furnish that help with

the “necessary information” to file proper and timely returns. 

Respondent in his brief states: “It is evident petitioner failed

to do so because she was unable to adequately reconstruct her

expenses”. We disagree. It simply does not follow from

petitioner’s failure to reconstruct completely her Schedule C

expenses at trial that she failed to maintain adequate records or

that she failed to hire competent help as respondent suggests. 

Petitioner conceded at trial that she did not maintain

formal books of account such as a general ledger or a cash

receipts and disbursements journal. However, petitioner

maintained voluminous records of her income and expenses, as she

amply demonstrated at trial. We are convinced that the

evidentiary gaps in the record, including the lack of

documentation regarding petitioner’s NOL carryforwards, are not

the result of negligent record keeping, as respondent alleges,

but are due to petitioner’s financial and personal difficulties

that arose following the years at issue. For example, petitioner

testified that she had other records such as client and bank

records, which would have enabled her to fill the evidentiary

gaps, but she simply did not have the financial and personal

resources to retrieve the records from storage and analyze those

records under the circumstances. We have no doubt, however, that

such records exist.
- 87 -

21Neither party raised or addressed the issue of whether

both the addition to tax under sec. 6651 and the accuracy-related

penalty may be applied to the underpayment for a taxable year in

which the taxpayer failed to file a timely return. Consequently,

we do not discuss the issue even though it may provide an

alternative ground for decision.

We hold that petitioner is not liable for the addition to

tax under section 6653(a) for any of the years at issue.

C. Accuracy-Related Penalty Under Section 6662

Section 6662, applicable to petitioner’s 1989 and 1990

years, authorizes the imposition of a 20-percent penalty for

specified types of misconduct, including negligence or disregard

of rules or regulations. Sec. 6662(a) and (b). Section 6662(c)

adopts the same definitions of “negligence” and “disregard” as

those utilized in section 6653 before its repeal.

Respondent contends that petitioner is liable for the

accuracy-related penalty for 1989 and 1990 due to her alleged

negligent record keeping and makes the same arguments with

respect to section 6662 that he made with respect to section

6653. Consequently, we incorporate by reference our discussion

of respondent’s arguments under section 6653,21 and we hold that

petitioner did not negligently fail to maintain required records,

as respondent contends.
- 88 -

III. Conclusion

We have analyzed all of the testimony, exhibits, and

stipulations in this unwieldy record in an effort to fairly and

justly decide the issues presented by this case. The task has

not been easy due largely to respondent’s failure to examine

petitioner’s documentation before issuing the notices of

deficiency in this case and respondent’s blanket disallowance of

all of petitioner’s Schedule C expenses for 3 of the 4 years at

issue. As petitioner conceded more than once at trial, however,

petitioner must also take some responsibility for the gaps in the

record presented to this Court. By failing to maintain formal

books of account to summarize and organize her voluminous

documentation, petitioner left herself exposed to the problems

presented by this case and must accept a less than perfect

result.

We have considered all of the arguments expressly or

inferentially raised in this case by either party, and, to the

extent not discussed, we find them to be irrelevant or without

merit.

In light of the foregoing and to reflect concessions made by

the parties,

Decisions will be entered

under Rule 155.