United States Tax Court

T.C. Memo. 2022-119

PALMARINI INC.,

Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

BENITO PALMARINI AND BERNADETTE PALMARINI,

Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

—————

Docket Nos. 1719-17, 1723-17. Filed December 7, 2022.

—————

In the years at issue, P Corp. was engaged in the 

business of online marketing and construction contracting. 

P–H, an individual, is the president of P Corp. Neither 

P Corp. nor P–H maintained books or records to determine 

their tax liabilities for 2013 and 2014, and the reporting of 

P Corp.’s income and expenses was split between P Corp.’s 

returns and P–H’s Schedules C, “Profit or Loss From 

Business”, attached to the returns he filed jointly with 

P–W.

R performed a bank deposits analysis of accounts 

owned by P Corp. and P–H and determined that P Corp. 

paid for certain personal expenses of P–H, including 

medical care, vacation, and maintenance of residential 

rental properties that he owned personally.

By a statutory notice of deficiency (“NOD”) issued in 

November 2016, R determined that P Corp. underreported 

Served 12/07/22
2

its income and that certain deductions it claimed should be 

disallowed. R also determined that P–H received 

constructive dividends from P Corp. and that certain 

deductions he claimed should be disallowed. R further 

determined that P Corp. and P–H are liable for accuracyrelated penalties for 2013 and 2014.

Held: P–H’s Schedules C are disregarded, all 

business income and expenses must be reported on 

P Corp.’s returns, and P Corp.’s payments of P–H’s 

personal expenses were constructive dividends to P–H.

Held, further, with few exceptions, Ps failed to 

substantiate deductions beyond amounts R concedes.

Held, further, P Corp., P–H, and P–W are liable for 

accuracy-related penalties for 2013 and 2014.

—————

Benito Palmarini (an officer), for petitioner in Docket No. 1719-17.

Benito Palmarini and Bernadette Palmarini, for themselves in 

Docket No. 1723-17.

Kristina L. Rico, for respondent.

TABLE OF CONTENTS

MEMORANDUM FINDINGS OF FACT AND OPINION ..................... 4

FINDINGS OF FACT .............................................................................. 5

Palmarini Inc. and its ownership..................................................... 5

Palmarini Inc.’s business activity.................................................... 5

Palmarini Inc.’s place of business.................................................... 6

Palmarini Inc.’s 2013 and 2014 returns .......................................... 6

Examination of Palmarini Inc.’s returns....................................... 14

Benito and Bernadette Palmarini.................................................. 15

Rental properties ............................................................................ 15

The Palmarinis’ 2013 and 2014 returns ........................................ 16

Examination of the Palmarinis’ returns....................................... 18

NODs to Palmarini Inc. and to the Palmarinis............................. 19

[*2]
3

Petition to Tax Court...................................................................... 19

Settled and conceded issues ........................................................... 20

OPINION................................................................................................ 24

I. Burden of proof ............................................................................... 24

II. Palmarini Inc.’s corporate income tax returns.............................. 25

A. Status as a corporation ........................................................... 25

B. Business activity ..................................................................... 25

C. Gross receipts .......................................................................... 27

D. Deductions............................................................................... 28

1. Officer compensation, salaries, and wages..................... 28

2. Repairs and maintenance................................................ 30

3. Bad debt........................................................................... 31

4. Rent.................................................................................. 33

5. Depreciation..................................................................... 33

6. Advertising....................................................................... 34

7. Other deductions ............................................................. 35

E. Constructive dividends ........................................................... 36

1. Paid out of earnings and profits...................................... 36

2. Two-part test.................................................................... 37

3. Analysis............................................................................ 38

F. Section 6662 accuracy-related penalties................................ 41

III. The Palmarinis’ individual income tax returns ............................ 42

A. Income ..................................................................................... 42

1. Wages, salaries, tips, etc. ................................................ 42

2. Constructive dividends from Palmarini Inc. .................. 42

3. Other income.................................................................... 43

B. Schedule A casualty loss deduction for 2014 ......................... 43

C. Schedule C............................................................................... 44

D. Schedule E rental properties .................................................. 45

E. Section 6662 accuracy-related penalties................................ 46

IV. Conclusion....................................................................................... 47

[*3]
4

[*4] MEMORANDUM FINDINGS OF FACT AND OPINION

GUSTAFSON, Judge: Pursuant to section 6212,1 the Internal 

Revenue Service (“IRS”) issued statutory notices of deficiency (“NOD”)

to petitioners Palmarini Inc. and Benito and Bernadette Palmarini on 

November 14, 2016, determining the following deficiencies in federal 

income tax and accuracy-related penalties under section 6662(a) for the

years 2013 and 2014:

Petitioner Year Deficiency

Penalty

sec. 6662(a)

Palmarini Inc. 2013 $219,364 $43,873

2014 175,221 35,044

Benito and 

Bernadette 

Palmarini

2013 118,955 23,791

2014 106,550 21,310

Palmarini Inc. and the Palmarinis filed timely petitions under 

section 6213(a) for redetermination of the deficiencies and penalties. 

After the parties’ concessions, there are eight remaining issues for 

decision in these consolidated cases. As to the corporation: (1) the 

amount of Palmarini Inc.’s gross receipts in 2013 and 2014; (2) whether 

Palmarini Inc. is entitled to certain income tax deductions claimed for

2013 and 2014; (3) whether Palmarini Inc. constructively issued

dividends to Mr. Palmarini in 2013 and 2014; and (4) whether Palmarini 

Inc. is liable for the section 6662 accuracy-related penalties. As to the

Palmarinis as individuals: (5) the amount of the Palmarinis’ income for

2013 and 2014; (6) the Palmarinis’ entitlement to certain income tax 

deductions claimed for 2013 and 2014; (7) whether Mr. Palmarini may 

report his advertising business on Schedule C, “Profit or Loss From 

Business”; and (8) whether the Palmarinis are liable for the section 6662 

accuracy-related penalties. To the extent not conceded by the 

Commissioner, we will uphold the IRS’s adjustments in large part, and 

1 Unless otherwise indicated, statutory references are to the Internal Revenue 

Code (Title 26 of the United States Code) as in effect at the relevant times; references 

to regulations are to Title 26 of the Code of Federal Regulations (“Treas. Reg.”) as in 

effect at the relevant times; and references to Rules are to the Tax Court Rules of 

Practice and Procedure. Some dollar amounts are rounded.
5

[*5] we will hold petitioners liable for the section 6662 accuracy-related 

penalties.

On the evidence before us, and using the burden-of-proof 

principles explained below, we find the following facts.

FINDINGS OF FACT

Palmarini Inc. is a Pennsylvania corporation with its principal 

place of business in Pennsylvania, and Benito and Bernadette Palmarini 

resided in Pennsylvania,2 when they filed their petitions in these 

consolidated cases. (Benito and other members of the Palmarini family 

are mentioned below with their first names, but references to 

“Mr. Palmarini” in this opinion are to petitioner Benito Palmarini.)

Palmarini Inc. and its ownership

Before the incorporation of Palmarini Inc., its cement business 

was a sole proprietorship operated by Francesco Palmarini (Benito’s 

father). Palmarini Inc. was incorporated in 1983, and its original 

shareholders were Benito (49.75%), his brother Pacifico Palmarini 

(49.75%), and Don Hurley (0.5%). Shortly after its incorporation, Benito 

transferred approximately two-thirds of his ownership interest in 

Palmarini Inc. to his father Francesco and his brother Manuel, and the 

shareholders of Palmarini Inc. thus became Pacifico (49.75%), Benito

(16.58%), Francesco (16.58%), Manuel (16.58%), and Don Hurley (0.5%). 

In 2007 Francesco Palmarini transferred his interest in Palmarini Inc.

back to Benito. Thereafter, the three brothers’ interests in the 

corporation were Pacifico’s 49.75%, Benito’s 33.16%, and Manuel’s 

16.58%.

Benito, Pacifico, and Manuel Palmarini each served as officers of 

Palmarini Inc.; however, Pacifico did not actively engage in the 

corporation’s business operations. During 2013 and 2014, Benito was 

the president of Palmarini Inc. and managed its operations.

Palmarini Inc.’s business activity

After its incorporation in 1983, Palmarini Inc. was primarily 

operated as a cement construction business. However, in 2013 and 2014, 

2 Absent stipulation otherwise, venue for an appeal in these cases would lie in 

the U.S. Court of Appeals for the Third Circuit. See § 7482(b).
6

[*6] revenues from affiliated online marketing3 activity undertaken by 

Benito and Manuel (and not Pacifico) were deposited into Palmarini 

Inc.’s corporate bank accounts, and associated advertising expenses 

were paid from its corporate bank accounts. Palmarini Inc. did not 

receive any revenues from cement construction work in 2013 or 2014, 

and Palmarini Inc. did not own any rental property as part of its 

business activity. On Schedule K, “Other Information”, of its original 

and amended 2013 and 2014 Forms 1120, “U.S. Corporation Income Tax 

Return”, Palmarini Inc.’s business activity is reported as “affiliate 

marketing”, except that on its latest-filed amended return for 2014, it is 

reported as “affiliate marketing (mainly) & cement work”.

We find that in 2013 and 2014 Palmarini Inc.’s cement 

construction business was virtually dormant because its only 

construction work in the years at issue was uncompensated work on one 

of Mr. Palmarini’s personal rental properties, and we find that 

Mr.Palmarini conducted the marketing activity through Palmarini Inc. 

and not through his limited liability company (“LLC”). See infra p. 15 

and Part II.B.

Palmarini Inc.’s place of business

Palmarini Inc. maintained its principal place of business at a

garage on Halstead Street in Philadelphia.4 Manuel Palmarini owned 

the Halstead Street property and received rental payments from 

Palmarini Inc. for its use of the Halstead Street garage until March 

2014, after which it became property of Palmarini Inc. Palmarini Inc.

continued improving the Halstead Street garage until it was placed into 

service as corporate property in August 2014.

Palmarini Inc.’s 2013 and 2014 returns

1. Palmarini Inc.’s record keeping

Palmarini Inc. did not maintain any books or records, a general 

ledger, or profit and loss statement, nor did it engage the services of an 

accountant or bookkeeper or use any accounting software in 2013 and 

2014. Instead, Mr. Palmarini manually reviewed the corporation’s bank 

3 Affiliated online marketing is a business activity in which an intermediary 

(“the affiliate”) hosts a link for a third party on a website and receives a commission 

when the affiliate’s link generates business for the third party.

4 The Halstead Street property is a double lot: A residential home stands on 

one lot and a stand-alone garage on the other.
7

[*7] and credit card statements to identify and distinguish corporate 

business expenses from personal expenses, then aggregated totals for 

reporting on Palmarini Inc.’s returns.

2. Preparation and filing of original and amended returns

Palmarini Inc. did not hire a return preparer to complete its 2013 

and 2014 returns. Mr. Palmarini prepared all original and amended 

returns for Palmarini Inc. for 2013 and 2014.

Palmarini Inc. timely filed its Form 1120 for 2013 on March 10, 

2014. Palmarini Inc. timely filed its Form 1120 for 2014 on March 6, 

2015.

Starting within six days after filing the original 2014 return and 

over the next three months, Palmarini Inc. filed a series of amended 

returns for both years, on one occasion signing two amended returns for 

the same year (2013) on the same day (May 1, 2015), and on several 

occasions filing amended returns (for 2013) only days apart. The 

signature dates of the original and amended returns were as follows:

2013 2014

March 10, 2014 (original)

March 6, 2015 (original)

March 12, 2015

April 4, 2015

April 7, 2015

April 25, 2015

April 28, 2015

May 1, 2015

May 1, 2015

May 5, 2015

June 25, 2015

June 27, 2015
8

[*8] The IRS accepted and processed Palmarini Inc.’s amended return 

for 2013 dated June 25, 2015, but it did not process any of the amended 

returns for 2014.

3. Accounting method

On line 1 of Schedule K of both its original 2013 return and its 

original 2014 return, Palmarini Inc. responded to the prompt “Check 

accounting method” by checking the box for the “Cash” method of 

accounting (not “Accrual”). Several of its amended returns (including 

the first 2013 amended return, filed after the original 2014 return) 

included a Schedule K, and on those schedules the “Accrual” box was 

checked; but petitioners made no showing that the reporting of income 

and expenses on the amended returns was actually revised from the 

“Cash” method originals to reflect accrual of income and expenses.

Petitioners did not offer into evidence the corporation’s returns 

for any years before 2013, nor any company books reflecting an accrual 

method; and the only evidence that those earlier returns might have 

used an accrual method is the trial testimony of Mr. Palmarini, which 

we did not find credible on the point. His description of his preparation 

of the returns (viewing bank and credit card statements and tallying 

expenses reported there, see infra p. 26) gave no indication of accruing 

expenses rather than deducting them when paid. Petitioners made no 

contention as to, and offered no evidence showing, Palmarini Inc.’s

requesting the IRS’s consent to a change of accounting method, in 

compliance with section 446(e). We find that in fact Palmarini Inc. used 

the cash method of accounting and did not request consent to a change 

to the accrual method. See infra Part II.D.3.

4. Gross receipts

Palmarini Inc.’s gross receipts in 2013 and 2014 were entirely 

from affiliated online marketing, and not from Palmarini Inc.’s former 

cement activity. Consistent with the IRS’s bank deposits analysis 

(“BDA”) (described below at pages 14–15), we find that Palmarini Inc. 

received gross receipts of $959,248 in 2013 and $937,532 in 2014.

These were not amounts that Palmarini Inc. reported. Rather, on 

its original return for 2013, Palmarini. Inc. reported gross receipts of 

$812,629; but on its amended return filed March 12, 2015 (and also on 

those filed April 4 and April 25, 2015), it reported $894,963. On line 1 

of Part I of its amended return filed April 28, 2015, it reported in 

column (b) a reduction of $27,927 and in column (c) a “Correct amount” 
9

[*9] of $866,986 as its gross receipts. Column (b) requires “explain in 

Part II”, but Part II gives no explanation for this reduction. Palmarini 

carried over this lower amount to its subsequent amended returns, and 

the IRS apparently used it as its starting point in the notice of deficiency 

for 2013, discussed below.

On its original return for 2014, which was the apparent starting 

point of the IRS’s examination of Palmarini Inc.’s 2014 return, discussed

below, Palmarini Inc. reported gross receipts of $659,799. However, the 

IRS apparently overlooked the fact that Palmarini Inc. admitted that 

this amount was an error. Palmarini Inc. reported $943,281 in Part I of 

its amended return filed April 7, 2015, and admitted in Part II a 

“miscalculation of total income”. (It also reported the larger amount on 

its subsequent amended returns for 2014.)

Entities that paid Palmarini Inc. issued to it (and filed with the 

Government) Forms 1099–MISC, “Miscellaneous Income”, showing 

payments that totaled $628,149 for 2013 and $672,362 for 2014. 

Palmarini Inc. agrees that it received gross receipts of those amounts; 

but the Commissioner contends (and we find, as stated above and 

explained in Part II.B below) that these amounts were not the sum total 

of its gross receipts.

5. Officer compensation and salaries and wages

We find that Palmarini Inc. paid officer compensation of zero for

2013 and 2014, and salaries and wages of $58,100 in 2013 and $76,500 

in 2014. See infra Part II.D.1. Benito and Manuel Palmarini were the 

only persons who performed work for Palmarini Inc. in 2013 and 2014, 

and they did so not only in their capacities as officers but also as laborers

for their work on one of Mr. Palmarini’s personal rental properties. On 

its 2013 return Palmarini Inc. claimed deductions of $92,400 on line 12 

for “Compensation of officers” and $15,000 on line 13 for “Salaries and 

wages”; but on its 2014 return it did not claim any such deductions. 

During 2013 and 2014 Palmarini Inc. did not report to the IRS on a 

Form W-2 any wages paid to anyone, nor did it file any associated 

employment tax returns (Form 940, “Employer’s Annual Federal 

Unemployment (FUTA) Tax Return”, and Form 941, “Employer’s 

Quarterly Federal Tax Return”) or pay any employment taxes. After the 

IRS selected Palmarini Inc.’s 2013 and 2014 returns for examination, 

the corporation filed with the IRS two Forms 1099 reporting nonemployee compensation to two officers, Benito and Manuel Palmarini,

for 2014 (but not for 2013). In anticipation of trial in these cases, Benito 
10

[*10] Palmarini created invoices from himself to Palmarini Inc. to 

substantiate the Form 1099 issued to him by Palmarini Inc.

6. Repairs and maintenance

Palmarini Inc. incurred no expenses to repair or maintain its own 

property in 2013 and 2014, see infra Part II.D.2, but the corporation did 

expend money in 2013 and 2014 to repair and maintain residential 

properties owned personally by Mr. Palmarini. Palmarini Inc. claimed 

a $114,719 deduction for repairs and maintenance on its 2013 return

and did not claim any deduction for repairs and maintenance on its 2014

return. This 2013 deduction is related to Palmarini Inc.’s use of Benito 

and Manuel Palmarini’s personally owned residential properties for 

storage of its machinery and equipment used in its (inactive) 

construction business. Palmarini Inc. also stored its machinery and 

equipment at the Halstead Street garage (which also served as its 

principal place of business), the lower level of a building on Chandler 

Street, and at a building on Knorr Street. See infra pp. 15–16.

7. Bad debt deductions

On line 15 of its original return for 2013, filed in March 2014,

Palmarini Inc. claimed a deduction for “Bad debts” of $80,541. On line 

15 of its original return for 2014, filed in March 2015, Palmarini Inc.

claimed a deduction for “Bad debts” of $81,900. Both those amounts 

were revised on amended returns:

Six days later, on March 12, 2015, Palmarini Inc. increased its 

2013 bad debt deduction to $123,429. On April 7, 2015, it reduced the 

2014 bad debt deduction from $81,900 to zero, explaining: “Line 15 error 

on original return. Miscalculation as bad debt was taken as a deduction

on ‘2013’ return.” The later amended returns for 2014 likewise reported 

no bad debt deduction. But for 2013 the amendments continued:

On April 25, 2015, Palmarini increased the 2013 bad debt 

deduction from $123,429 to $204,056, explaining: “Total deductions 

increased by $80,630.06 due to underreporting bad debt loss”. Three 

days later, on April 28, 2015, the bad debt deduction was increased 

again, this time by about $33,000 to $237,458. We find on that amended 

return no legible explanation for the increase.

These bad debt deductions are based on an alleged unpaid 

balance of approximately $240,000 owed to Palmarini Inc. by Epic Media 

Group for affiliated online advertising services in 2011. At trial 
11

[*11] Mr. Palmarini alleged that in 2011 Epic Media Group had

reported, on Form 1099, payments made to Palmarini Inc. of $205,000

and that he had reported that income on Palmarini Inc.’s 2011 return. 

(Neither that return nor a Form 1099 was offered in evidence.) The 

unpaid balance for advertising services was later (on an unspecified 

date) allegedly negotiated down to $83,000; however, Epic Media Group 

failed to pay even this discounted amount and instead paid only $5,000

to Palmarini Inc. Mr. Palmarini alleges that he determined the debt to 

be worthless in 2013. (Although the precise amounts are difficult to 

understand, it seems that he first claimed on the original 2013 return 

an amount ($80,630) that roughly corresponded to the negotiated (but 

unpaid) lower amount ($83,000), and that he eventually claimed on 

amended returns an amount ($237,458) that roughly corresponded to 

the gross debt ($240,000)). If this is true, it is impossible to explain the 

intermediate amounts reported on some of the amended returns. 

Petitioners presented no documentary evidence to substantiate the 

accrual of the receivable (and the reporting of the accrued income) in 

2011 (or any other year) or the write-off of the unpaid debt in 2013.5 We 

find that the receivable was neither accrued nor written off as alleged

and that no bad debt deduction is allowable. See infra Part II.D.3.

8. Rents

We find that Palmarini Inc. made recurring payments to Manuel 

Palmarini totaling $12,187 in 2013 and $13,387 in 2014 as rent, for the 

corporation’s use of the Halstead Street garage as its principal place of 

business. Palmarini Inc. claimed no rent deduction on its original 2013 

return but claimed a rent deduction of $18,129 on its first amended 2013 

return.6 The corporation did not claim any deduction for rents for 2014 

but proved at trial that rent payments were made until March 2014. 

5 The Court engaged in this colloquy with Mr. Palmarini:

THE COURT: . . . Did you make any entry on your books to write off that debt 

in 2013?

THE WITNESS: Yes.

THE COURT: Does—do you want to show me that?

THE WITNESS: It was on my income tax return. I put it down.

THE COURT: I’m talking about the company books.

THE WITNESS: No. I don’t have the company books here. 

6 The explanation on the amended return states: “On previous return—$18,129 

payable for rents on line 16 not included”.
12

[*12] This expense consisted of regular payments made by Palmarini 

Inc. to Manuel Palmarini in his capacity as owner of the Halstead Street 

garage, for Palmarini Inc.’s use of the garage as its principal place of 

business and for storage of its machinery and equipment.

9. Depreciation

Palmarini Inc. claimed a $6,035 deduction for depreciation on its 

2013 return and did not claim a deduction for depreciation for 2014. The 

2013 depreciation was claimed for a 2013 Ford F-150 pickup truck that 

was used in Palmarini Inc.’s cement construction business but owned by 

Mr. Palmarini personally. Palmarini Inc. maintains its entitlement to 

depreciate the cost of the truck, but because there is no evidence from 

which we can determine any business use percentage of the truck, we 

find that its business ownership and use are not substantiated. See 

infra Part II.D.5. We further find that Palmarini Inc. is entitled to 

depreciate the cost of the Halstead Street garage after it became the 

corporation’s property and was placed in service in August 2014, and the 

Commissioner has conceded a depreciation deduction of $1,671 for 2014.

10. Advertising

Palmarini Inc. reported deductions for advertising expenses of 

$345,433 for 2013 and $577,156 for 2014. We find, consistent with the 

Commissioner’s contention, that Palmarini Inc. paid $386,628 for 

advertising in 2013 and $452,390 for advertising in 2014 as part of its 

affiliated online marketing business. The 2013 amount is larger than 

Palmarini Inc. reported, so it is undisputed. The amount we allow for 

2014 is smaller because we find that two alleged expenditures are not 

substantiated. See infra Part II.D.6.

11. Other deductions

Palmarini Inc. reported no line 26 “Other deductions” on its 

original returns for 2013 and 2014; and although it now claims such 

deductions for each year, we find that it has substantiated none. See 

infra Part II.D.7. The evolution of its reporting of “Other deductions” 

was as follows.
13

[*13] a. 2013

Palmarini Inc.’s original Form 1120 for 2013, and the first 

amended return filed March 12, 2015, claimed no “Other deductions” on 

line 26. Rather, such deductions were claimed only on the amended 

returns and in amounts that changed substantially over three months:

The second amended return filed April 4, 2015, claimed $18,129

and explained in Part II, “Explanation of Changes to Items in Part I”: 

“On previous return—$18,129 payable for rents on line 16 not included”.

The fourth amended return filed April 28, 2015, claimed $16,511, 

(not zero or $18,129, as on previous returns). A statement attached to 

the fourth amended return, entitled “2013 Other Deductions”, presents 

almost illegible entries totaling that amount, apparently from various 

sources (including “Cardpayments”, “Amex”, “Visa card”, and “Paid 

cash”).

The sixth amended return, dated May 1, 2015, claimed a further 

reduced amount—$14,826—that was itemized in an attached statement 

entitled “1120 Line 26 Other Deduction 2013”, which presents entries 

totaling that amount that are stated to be derived from, inter alia, 

“Amex card ending 51007”, “BOA card ending 9744”, “Visa card ending 

2031”, and “Cash to wife”.

The seventh amended return for 2013, filed June 25, 2015, 

claimed a much larger amount—$38,290. The explanation in Part II 

states: “More deductions found in Line 26—Form 1120.” An attached 

statement entitled “Form 1120—Line 26—Other Deductions” presents 

entries totaling $38,290 derived from, inter alia, “Amex card ending 

51007”, “Bank of America card ending 9141”, “Credit card end 3031”, 

“Card ending 7732”, and “Card ending C68-640”.

b. 2014

Palmarini Inc.’s original Form 1120 for 2014, and the first and 

second amended returns filed for that year, claimed no “Other 

deductions” on line 26. Rather such deductions were claimed only on 

the final amended return, filed June 27, 2015, which claimed $57,337. 
14

[*14] The explanation states: “More deductions taken for Line 26 missed 

in earlier return.”

Examination of Palmarini Inc.’s returns

Palmarini Inc.’s 2013 and 2014 returns were selected by the IRS 

for examination and assigned to Revenue Agent Christine Berntsen. 

The starting point for the IRS’s examination was the last-filed amended 

return for 2013 (dated June 25, 2015) and the original return for 2014

(dated March 6, 2015).

During the examination Palmarini Inc. did not provide any books 

or records reflecting its calculations of its gross income for 2013 or 2014. 

Accordingly, Agent Berntsen performed a BDA, whereby the IRS issued

summonses to all banks at which Palmarini Inc. held accounts and sent 

letters to third parties to verify the type of income reflected by the 

deposits into the corporate accounts. Agent Berntsen determined that 

Palmarini Inc. received gross receipts of $959,248 in 2013 and $937,532 

in 2014 (amounts greater than those reported on its returns). Agent 

Berntsen’s 2013 gross income amount was greater by about $65,000

than the largest amount that Palmarini Inc. had reported on a 2013 

return (i.e., $894,963 on amended returns); but her 2014 amount was 

about $6,000 less than the amount Palmarini Inc. reported on its 

amended return filed April 7, 2015 (i.e., $943,281). As is stated above 

at page 9 and is explained below in Part II.B, we find Agent Berntsen’s 

analysis reliable and convincing.

Agent Berntsen then performed a disbursement analysis using 

Palmarini Inc.’s bank and credit card statements. Those statements 

listed both business expenses of the corporation and personal expenses 

of Mr. Palmarini. To distinguish between business and personal

expenses, Agent Berntsen surveyed each line item on Palmarini Inc.’s 

bank and credit card statements, as well as check stub descriptions 

when available, and allowed deductions for all expenses that she 

determined were reasonably related to Palmarini Inc.’s business 

activities, which (on the basis of the income and expenses reflected on 

the corporate bank statements) she determined to be affiliated online 

marketing. In her analysis she did not allow Palmarini Inc. deductions 

for either personal expenses or for those which had no ascertainable

business purpose, and all personal expenses borne by Palmarini Inc.

were recharacterized as a constructive dividend to Mr. Palmarini in his 

capacity as shareholder.
15

[*15] On the basis of her BDA of 2013 and 2014, Agent Berntsen 

determined to increase Palmarini Inc.’s income for underreported gross 

receipts and disallowed deductions. Agent Berntsen also determined a 

constructive dividend to Mr. Palmarini as president and shareholder, 

and she determined that Palmarini Inc. is liable for accuracy-related 

penalties under section 6662.

Benito and Bernadette Palmarini

During 2013 and 2014, petitioner Bernadette Palmarini worked 

as a procurement analyst for the U.S. Department of Defense. She 

received wages of $78,049 in 2013 and $81,333 in 2014. Mr. Palmarini 

has worked as a cement contractor for Palmarini Inc. (an activity 

virtually dormant in the years at issue) and was paid wages of $58,100 

in 2013 and $76,500 in 2014 by Palmarini Inc. for his work building the 

Neshaminy Street garage. Mr. Palmarini also received constructive 

dividends from Palmarini Inc. of $116,741 in 2013 and $62,798 in 2014. 

See infra Part II.E. Mr. Palmarini is also the owner of Affiliated 

Marketing Online, LLC (“AMOLLC”), a single-member LLC engaged in 

the business of affiliated online marketing. However, Mr. Palmarini

viewed all accounts of Palmarini Inc. and AMOLLC as his own and used

them as needed for both business and personal purposes; and as is 

stated above, we find that Mr. Palmarini operated the affiliated online 

marketing business not through AMOLLC but through Palmarini Inc.

Rental properties

Mr. Palmarini owned the following residential properties. He

hired professional real estate management companies to manage the 

renting of these properties to tenants, and some of them were used both 

for paying tenants and for storage of equipment for Palmarini Inc. Mr. 

Palmarini is responsible for paying the utility costs associated with 

Palmarini Inc.’s use of these properties for storage of its equipment. 

(The parties have come to agreement about the income and some of the 

expenses from these properties, but some expenses remain in dispute. 

See infra Part III.D.)

1. Chandler Street

The Chandler Street property is a duplex: the upstairs unit is a 

residence rented to tenants, and the downstairs unit is used by 

Palmarini Inc. as a business office. Palmarini Inc. did not pay rent to 

Mr. Palmarini for its use of the Chandler Street property. In March 

2014 Benito Palmarini conveyed the Chandler Street property plus 
16

[*16] $30,000 (paid by Palmarini Inc.) to Manuel Palmarini in exchange 

for the Halstead Street property. After that transaction, Manuel 

Palmarini held title to the Chandler Street property.

2. Knorr Street

The Knorr Street property is a double duplex: one common floor 

leads to two residential units on the right and two on the left (for a total 

of four residential units); and a separate, lower level was used by 

Palmarini Inc. for storage of its machinery and equipment. Palmarini 

Inc. did not pay rent to Mr. Palmarini for its use of the Knorr Street 

property.

3. Neshaminy Street

The Neshaminy Street property is a single-family home. 

Mr. Palmarini purchased the Neshaminy Street property in 2007 with 

Michael Smyth (each owning a one-half undivided interest). In 2009

Mr. Palmarini acquired full ownership of the Neshaminy Street 

property from Michael Smyth. Thereafter, Mr. Palmarini began a series 

of extensive renovations continuing from 2009 until 2011. He eventually 

attempted to sell the property but was unsuccessful (in part) because 

the property did not have a garage. He decided to build a garage for the 

Neshaminy Street property using the construction assets of Palmarini 

Inc. During 2013 and 2014, Palmarini Inc. was building a garage for the 

Neshaminy Street property, and the labor was performed by Benito and 

Manuel Palmarini.

4. Gypsy Lane

The Gypsy Lane property is a single-family home. The 

Palmarinis purchased the property on April 11, 2008, for $145,000 and 

sold it at a loss on April 12, 2013, for $105,000.

The Palmarinis’ 2013 and 2014 returns

The Palmarinis filed their original return for 2013 on March 4, 

2014. They then filed three amended returns for 2013, the first of which 

was filed April 1, 2015, and the last two of which were not accepted by 

the IRS.

The Palmarinis filed their original return for 2014 on 

February 24, 2015. They then filed two amended returns for 2014, the 

first of which was filed on April 8, 2015, and the second of which was not 
17

[*17] accepted by the IRS. The Palmarinis did not use a paid return 

preparer for their 2013 and 2014 federal income tax returns. Mr. 

Palmarini prepared all their original and amended returns for 2013 and 

2014.

1. Casualty loss deduction

In July 2014 a series of severe storms caused trees at the 

Palmarinis’ personal residence to fall on their fence, destroying 

approximately 20 feet of the fence (two sections with a post in the 

middle). The Palmarinis reported the damage to their insurance 

company, which determined the value of the damage to be 

approximately $3,360 and issued to the Palmarinis a check for $860 (the 

remainder after their $2,500 deductible) in settlement of their claim.

The Palmarinis received an estimate of $16,950 to remove and 

replace the damaged portions of the fence. However, the manufacturer 

of the original fence was no longer in business, and the replacement 

sections would not have matched the original fence. Mr. Palmarini 

sought an estimate to replace the entire fence (22 sections) and was 

quoted $62,850. The Palmarinis spent $1,000 on repairs and then 

claimed a $44,5117 deduction for casualty loss on their 2014 return, on 

the basis that the fair market value of their home declined due to having 

a mismatched fence. We find that the insurance company’s valuation of 

the damage was reasonable, and that the proper amount of the casualty 

loss would be the $2,500 “deductible” not paid by the insurance 

company, subject to the limitation on itemized deductions discussed 

below in Part III.B.

2. Schedule C for Affiliated Marketing Online LLC

Included with the Palmarinis’ 2013 and 2014 returns were

Schedules C for AMOLLC. The Schedule C for each year reported only 

gross receipts and advertising expenses, and each one reflects a net loss. 

(Because the gross receipts, the expenses, and the business activity itself 

are properly allocated to Palmarini Inc., as we found above at page 6, 

7 The amount of the casualty loss the Palmarinis reported on Form 4684, 

“Casualties and Thefts”, is $54,400, and the amount of the deduction claimed (as 

limited by section 165(h)(1) and (2)) is $44,511.
18

[*18] we find that AMOLLC has no gross receipts, no deductions, and 

no losses for 2013 and 2014.)

3. Schedule E rental properties

The Palmarinis did not include with their 2013 return a 

Schedule E, “Supplemental Income and Loss”, reporting their income 

and expenses from their rental properties, but they did include a 

Schedule E with their 2014 return reporting a net loss for the year and 

a corresponding $25,000 deduction pursuant to section 469(i).

Examination of the Palmarinis’ returns

The IRS selected the Palmarinis’ 2013 and 2014 returns for 

examination and assigned them to Agent Berntsen. The starting point 

for the examination of the Palmarinis’ 2013 return was their first 

amended return filed on April 1, 2015; and the starting point for the 

examination of their 2014 return was their first amended return filed 

on April 8, 2015.

During the examination the Palmarinis did not provide any 

original books or records showing how they calculated gross receipts for 

AMOLLC in 2013 and 2014. Accordingly, Agent Berntsen performed a 

BDA for AMOLLC and the Palmarinis individually. Agent Berntsen 

determined to reduce the Palmarinis’ “other” income to an amount less 

than they reported on their 2013 and 2014 returns and to increase their 

qualified dividend income because of her determination that 

Mr. Palmarini received constructive dividends from Palmarini Inc. for

2013 and 2014.

Agent Berntsen further determined to disallow all deductions 

claimed on Schedules A, “Itemized Deductions”, for lack of 

substantiation. (Before trial the parties agreed on the itemized 

deductions except for the casualty loss.)

As to the Schedules C for AMOLLC, the agent determined to 

reduce gross receipts for 2013, to increase gross receipts for 2014, and to 

disallow all deductions for advertising for both years because the 

expenses were paid from Palmarini Inc.’s (rather than AMOLLC’s) bank 

accounts. (The IRS later disallowed the Schedule C deductions in their

entirety for both years, moving all income to elsewhere on the 

Palmarinis’ returns or attributing it to Palmarini Inc.’s Forms 1120.)
19

[*19] Agent Berntsen also determined to include Schedules D, “Capital 

Gains and Losses”, to report the gain and loss from sales of stock and 

the sale of the Gypsy Street property. (The parties agreed before trial 

that the Palmarinis were entitled to a $3,000 loss deduction for each 

year.)

And as to the Schedule E rental properties, Agent Berntsen

determined to increase rents received, to disallow all deductions claimed 

for 2013 and 2014,8 and to suspend the amount of the Palmarinis’ 

passive loss in excess of their passive income. (The parties later agreed 

as to the amounts of rental income the Palmarinis received in 2013 and 

2014 as well as the amounts of substantiated Schedule E deductions, 

but the Palmarinis maintain their entitlement to additional amounts of 

certain Schedule E deductions as specified below.)

NODs to Palmarini Inc. and to the Palmarinis

The IRS issued to Palmarini Inc. and to the Palmarinis

concurrent NODs for 2013 and 2014 on November 14, 2016, determining 

deficiencies in federal income tax and accuracy-related penalties under 

section 6662 for both years. Attached to each NOD were Letters 950, 

which proposed penalties and informed the Palmarinis of their appeal 

rights. The Letters 950 were signed by Mary Unger (Group Manager),

Agent Berntsen’s immediate supervisor during the examination of 

Palmarini Inc.’s and the Palmarinis’ 2013 and 2014 returns.

Petition to Tax Court

Palmarini Inc. timely filed its petition in the Tax Court on 

January 23, 2017. The Palmarinis timely filed their petition in the Tax 

Court on January 23, 2017. These cases were consolidated for trial and 

were tried in Philadelphia, Pennsylvania.

8 As we noted, the Palmarinis did not attach a Schedule E reporting income 

and expenses from their rental properties to their original 2013 return, but they did 

attach a Schedule E to their amended 2013 return filed April 23, 2015. Agent Berntsen 

treated the Palmarinis as having claimed for 2013 the amounts reported on the 

Schedule E attached to their amended return.
20

[*20] Settled and conceded issues

During the pendency of these cases, the Palmarinis provided

documentation supporting some of their reported expenses. Agent 

Berntsen reviewed the documents and issued a revised examination 

report for both Palmarini Inc. and the Palmarinis, which the 

Commissioner adopts as his position in these cases. The revised report

for Palmarini Inc. made the following changes: (1) advertising expense

deductions previously disallowed on Schedule C were allowed to

Palmarini Inc. because the corporation paid AMOLLC’s credit card bill; 

(2) Palmarini Inc. was allowed deductions for rent of the Halstead

property while it was owned by Manuel Palmarini; (3) Palmarini Inc.

was allowed a deduction for 2014 for depreciation of improvements to 

the Halstead property after Palmarini Inc. placed it in service as 

corporate property in August 2014.

The revised report for the Palmarinis made the following changes: 

(1) the Schedule C deductions were disallowed entirely, the advertising 

items were moved to Palmarini Inc.’s corporate returns, and the 

remaining items of income were moved to “other” income on the 

Palmarinis’ returns; (2) the Palmarinis were allowed deductions on

Schedule A for substantiated expenses; (3) the Palmarinis were allowed 

deductions for their Schedule E rental properties; and (4) the 

constructive dividend determination was reduced by excluding expenses 

to be reported by Palmarini Inc. We will order the parties to recompute 

petitioners’ liabilities pursuant to Rule 155; and when they do so, they

will take into account both the foregoing agreed items and our 

resolutions of the following disputed items.

The items listed below remain in dispute for Palmarini Inc., and 

we find for the reasons stated above and explained below that the 

amounts in the right-hand column were income actually received and 

expenses actually paid for deductible business purposes:
21

[*21]

2013

Item Return NOD

Revised 

report

Amount 

in dispute

Amount 

allowed

Gross receipts $866,986 $959,248 $963,248 $335,0999 $959,248

Advertising (345,433) (314,190) (386,628) -0- (386,628)

Bad debt (237,458) -0- -0- (237,458) -0-

Officer 

compensation (92,400) -0- -0- (92,400) -0-

Salaries and 

wages (15,000) -0- -0- (15,000) (58,100)

Repairs and 

maintenance (114,719) -0- -0- (114,719) -0-

Rent expense (18,229) -0- (12,187) -0-10 (12,187)

Depreciation (6,035) -0- -0- (6,035) -0-

Other 

deductions (38,290) -0- -0- (38,290) -0-

2014

Item Return NOD

Revised 

report

Amount 

in dispute

Amount 

allowed

Gross receipts $659,799 $937,532 $937,532 $265,1709 $937,532

Advertising (577,157) (421,901) (452,390) (87,146)11 (452,390)

Bad debt (81,900) -0- -0- (81,900) -0-

Salaries and 

wages (76,500)

Rent expense -0- -0- (13,387) (5,191)10 (13,387)

Depreciation -0- -0- (1,671) -0- (1,671)

Other 

deductions -0- -0- -0-

9 Palmarini Inc. admits that it received gross receipts of $628,149 in 2013 and 

$672,362 in 2014 (the total amounts on Forms 1099 issued to it for each year).

10 Palmarini Inc. agrees to accept the Commissioner’s revised determination of 

rents paid in 2013 but alleges it is entitled to an $18,578 deduction for rents paid in 

2014.
22

[*22] The items listed below remain in dispute for Mr. and Mrs.

Palmarini, and we find for the reasons stated above and explained below 

that the amounts in the right-hand column were income actually 

received and expenses actually paid for deductible purposes:

2013

Item Return NOD

Revised 

report

Amount 

in dispute

Amount 

allowed

Wages, salaries, 

tips, etc. $78,048 n/a n/a n/a $136,148

Other income 129,400 $60,000 $13,750 -0- 13,750

Qualified 

dividends -0- 328,931 261,716 $261,716 116,741

Sch. C–

Gross receipts 135,037 13,750 -0- 135,037 -0-

Advertising (194,090) -0- -0- (194,090) -0-

Business use 

of home (61,660) -0- -0- (61,660) -0-

Sch. E–

Chandler St.

repairs (18,845) -0- -0- (18,845) -0-

Chandler St.

insurance (985) -0- 9012 1075 90

Chandler St.

depreciation 0 n/a n/a n/a 376

Knorr St.

other (29,450) -0- -0- (29,450) -0-

Gypsy Ln.

utilities (404) -0- -0- (404) -0-

Gypsy Ln.

repairs (3,810) -0- -0- (3,810) -0-

Gypsy Ln.

insurance (330) -0- -0- (330) -0-

11 Palmarini Inc. alleges it is entitled to a $539,536 deduction for advertising 

expenses in 2014.

12 The Commissioner’s revised determination, based on documents provided by 

the Palmarinis, asserts that in 2013 the Palmarinis received insurance proceeds, $922,

in excess of their insurance expense, $832, for Chandler St. in 2013 and that the net 

proceeds of $90 be included in their income. This determination is sustained for the 

reasons explained below in Part III.D.
23

[*23]

2014

Item Return NOD

Revised 

report

Amount 

in dispute

Amount 

allowed

Wages, salaries, 

tips, etc. $81,333 n/a n/a n/a $157,833

Other income 71,200 $1,200 $9,108 -0- 9,108

Qualified 

dividends -0- 386,054 226,794 $226,794 62,798

Sch. A–

Casualty loss (54,400) -0- -0- (54,400) (2,500)

Sch. C–

Gross receipts (2,200) (9,108) -0- (2,200) -0-

Advertising (30,238) -0- -0- (30,238) -0-

Other (3,657) -0- -0- (3,657) -0-

Sch. E–

Knorr St.

other (740) -0- -0- (740) -0-

Knorr St.

utilities (6,706) -0- (4,729) (1,977) (4,729)

Knorr St.

depreciation (9,820) -0- (732) (9,188) (732)

Halstead St.

taxes (2,783) -0- -0- (2,783) -0-

Halstead St.

depreciation (8,288) -0- -0- (8,288) -0-

Halstead St.

cleaning and 

maintenance

(1,134) -0- -0- (1,134) -0-

Halstead St.

insurance (2,570) -0- -0- (2,570) -0-

Neshaminy St.

depreciation (14,182) -0- -0- (14,182) -0-

Neshaminy St.

cleaning and 

maintenance

(2,800) -0- (1,220) (1,580) (1,220)
24

[*24] OPINION

I. Burden of proof

Generally, the Commissioner’s determination of a deficiency is 

presumed correct, and the taxpayer has the burden of proving it wrong. 

Welch v. Helvering, 290 U.S. 111, 115 (1933); see also Rule 142(a)(1). 

However, where the Commissioner alleges that a taxpayer 

underreported income, he must “provide some predicate evidence 

connecting the taxpayer to the charged activity” before the presumption 

of correctness attaches to his determination. Gerardo v. Commissioner, 

552 F.2d 549, 554 (3d Cir. 1977), aff’g in part, rev’g in part T.C. Memo. 

1975-341. Determinations of constructive dividends (as in these cases) 

are determinations of underreported income. And to support such 

determinations, the Commissioner must establish a sufficient 

connection between the income and the taxpayer before the presumption 

of correctness attaches to his determination of a constructive dividend. 

See, e.g., Austin Otology Assocs. v. Commissioner, T.C. Memo. 2013-293, 

at *23; D’Errico v. Commissioner, T.C. Memo. 2012-149, 103 T.C.M. 

(CCH) 1802, 1809. Once the Commissioner connects the taxpayer with

the unreported income, the taxpayer then bears the burden of proving 

that he did not receive the income and that the Commissioner’s 

determination of a deficiency is incorrect. See Walker v. Commissioner, 

757 F.2d 36, 38 (3d Cir. 1985), rev’g and remanding T.C. Memo. 1983-

538; see also Rule 142(a).

Important for such proof are the taxpayer’s records. The 

taxpayer’s record-keeping requirements for the income tax are set forth 

in section 6001, which requires that—

Every person liable for any tax imposed by this title, or for 

the collection thereof, shall keep such records, render such 

statements, make such returns, and comply with such 

rules and regulations as the Secretary may from time to 

time prescribe. [Emphasis added.]

Those rules and regulations that the Secretary has prescribed are found 

in Treasury Regulation section 1.6001-1; and as is relevant here, they 

require a taxpayer to “keep such permanent books of account or records

. . . 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”, id. § 1.6001-1(a), and to retain such 

books or records “for inspection by authorized internal revenue officers 
25

[*25] or employees . . . so long as the contents thereof may become 

material in the administration of any internal revenue law”, 

id. § 1.6001-1(e).

II. Palmarini Inc.’s corporate income tax returns

A. Status as a corporation

As a C corporation (as defined in sections 7701(a)(3) and 

1361(a)(2)), Palmarini Inc. is a separate federal income tax-paying 

entity, distinct from its shareholders. As the Supreme Court explained 

in Moline Properties, Inc. v. Commissioner, 319 U.S. 436, 438–39 (1943) 

(footnotes omitted):

The doctrine of corporate entity fills a useful purpose 

in business life. Whether the purpose be to gain an 

advantage under the law of the state of incorporation or to 

avoid or to comply with the demands of creditors or to serve 

the creator’s personal or undisclosed convenience, so long 

as that purpose is the equivalent of business activity or is 

followed by the carrying on of business by the corporation, 

the corporation remains a separate taxable entity.

By choosing to incorporate, Palmarini Inc.’s shareholders assumed both 

the benefits and burdens of the corporate form, and they may not 

disregard its separate status if they find it is disadvantageous for tax 

purposes. See Commissioner v. Nat’l Alfalfa Dehydrating & Milling Co., 

417 U.S. 134, 149 (1974) (“[W]hile a taxpayer is free to organize his 

affairs as he chooses, nevertheless, once having done so, he must accept 

the tax consequences of his choice, whether contemplated or not, and 

may not enjoy the benefit of some other route he might have chosen to 

follow but did not.” (citations omitted)). Accordingly, in these cases we 

must determine the proper tax consequences to Palmarini Inc. and to

the Palmarinis of the income and expenses shared between them and 

allocated amongst their tax returns.

B. Business activity

A taxpayer’s gross income includes “all income from whatever 

source derived”. § 61(a). If a taxpayer fails to keep adequate records, 
26

[*26] the Commissioner may determine the existence and amount of the 

taxpayer’s income by any method that clearly reflects income. § 446(b).

Because Palmarini Inc. did not maintain adequate records, the 

Commissioner used the bank deposits method of proof to reconstruct 

Palmarini Inc.’s taxable income for 2013 and 2014 according to the cash 

receipts and disbursements method of accounting.13 See § 446(c)(1). Use 

of a BDA to determine unreported income is well-recognized, and it 

begins by assuming that all bank deposits are taxable income14 unless 

the taxpayer can show otherwise. Estate of Mason v. Commissioner, 

64 T.C. 651, 656–57 (1975), aff’d, 566 F.2d 2 (6th Cir. 1977). We see no 

flaw15 in the Commissioner’s BDA here, and we point out that 

Mr. Palmarini’s method of using his bank and credit card statements to 

distinguish business and personal expenses, categorizing those 

expenses, and calculating the totals is substantially the same. 

Furthermore, there is no evidence from which to determine Palmarini 

Inc.’s taxable income in 2013 and 2014 other than its bank and credit 

card statements.

The Commissioner’s BDA revealed that Palmarini Inc. received 

all its revenues in 2013 and 2014 from affiliated online marketing 

activities and incurred substantial advertising expenses. The

Commissioner determined Palmarini Inc.’s primary business activity in 

2013 and 2014 to be affiliated online marketing, and his determination 

is not inconsistent with Palmarini Inc.’s own reporting on its 2013 and 

2014 returns. Palmarini Inc. reported its business activity to be affiliate 

marketing and reported significant gross receipts and expenses from 

13 Under the cash receipts and disbursements method, income is recorded in 

the year received and expenses are deducted in the year paid. Treas. Reg. § 1.461-

1(a)(1); see also §§ 451(a), 461(a).

14 However, the Commissioner must take into account any nontaxable items or 

deductions for which he has knowledge. DiLeo v. Commissioner, 96 T.C. 858, 868 

(1991), aff’d, 959 F.2d 16 (2d Cir. 1992).

15 Palmarini Inc. contends that the Commissioner’s BDA method does not 

clearly reflect its income for 2013 and 2014 because Palmarini Inc. may not receive 

income from its affiliated online marketing business until 90–180 days after earning 

its right to payment. However, the Commissioner’s use of the cash receipts and 

disbursements method of accounting resolves this concern, since it measures actual 

receipt of the income. Furthermore, this Court has long held that “[w]hen a taxpayer 

keeps no books or records, has large bank deposits, and offers no plausible explanation 

of such deposits, the Commissioner is not arbitrary or capricious in resorting to the 

bank deposit method for computing income.” Estate of Mason, 64 T.C. at 657; see also

Clayton v. Commissioner, 102 T.C. 632, 645 (1994); DiLeo, 96 T.C. at 867.
27

[*27] affiliated online marketing. The bad debt deduction Palmarini 

Inc. claimed for 2013 and 2014 relates to unpaid advertising services. 

Furthermore, Mr. Palmarini acknowledges that Palmarini Inc. did not 

receive any revenues from cement construction in 2013 or 2014. The 

only income-generating activity Palmarini Inc. engaged in in 2013 and 

2014 was affiliated online marketing, and advertising income was 

deposited into (and expenses for advertising were paid from) Palmarini 

Inc.’s bank accounts. Although in preparing the returns Mr. Palmarini 

ostensibly allocated income and expenses from the affiliate marketing 

activity between Palmarini Inc. and AMOLLC, he made no showing of 

any fact-based distinction between such activity conducted for or 

through Palmarini Inc. and other such activity conducted for or through 

AMOLLC. Rather, he allocated expenses to AMOLLC’s return only to 

generate losses reportable on Schedule C on the Palmarinis’ individual 

returns that would then offset Mrs. Palmarini’s otherwise taxable 

income. For all these reasons, we agree with the Commissioner’s revised 

determination that all advertising income and expenses are properly 

reportable on Palmarini Inc.’s returns for 2013 and 2014.

C. Gross receipts

Palmarini Inc. failed to maintain books and records that would 

have facilitated the determination of its income, and it proposes instead 

that its income should be deemed to consist of only the amounts that 

third parties reported on Forms 1099 as having paid to it—i.e., less than 

$700,000 in each year—thereby excusing itself from liability for any 

income it received that the payor did not happen to report to the IRS. 

This approach would let Palmarini Inc. benefit from its own failure, 

which we will not do. Rather, we consider the positions it has taken on 

its returns and discover that it has in fact reported gross receipts in 

amounts greater than those for which it now contends: It reported gross 

receipts of $894,963 on one of its amended 2013 returns and gross 

receipts of $943,281 on its amended 2014 returns. It has never 

explained where those numbers came from nor why they are not correct, 

and we think it highly unlikely that Palmarini Inc. would have reported

more gross receipts than it received. The Commissioner’s BDA

determined that Palmarini Inc. received gross receipts of $959,248 for

2013 and gross receipts of $937,532 for 2014, and the Commissioner has 

accordingly satisfied his burden to provide predicate evidence 

connecting Palmarini Inc. to its underreported gross receipts. Because 

Palmarini Inc. does not demonstrate any flaw in the Commissioner’s 
28

[*28] methodology or calculations,16 the Commissioner’s determinations 

of Palmarini Inc.’s gross receipts for 2013 and 2014 are sustained.

D. Deductions

When deductions are in dispute, the taxpayer must satisfy the 

specific requirements for any deduction claimed. INDOPCO, Inc. v. 

Commissioner, 503 U.S. 79, 84 (1992). A taxpayer must also maintain 

records adequate to substantiate his income and deductions. § 6001. 

Amounts reported on tax returns, even though signed under penalty of 

perjury, are insufficient to substantiate the deductions claimed thereon. 

Wilkinson v. Commissioner, 71 T.C. 633, 639 (1979) (first citing Roberts

v. Commissioner, 62 T.C. 834, 837 (1974); and then citing Halle v. 

Commissioner, 7 T.C. 245 (1946), aff’d, 175 F.2d 500 (2d Cir. 1949)).

We must resolve Palmarini Inc.’s entitlement to the following 

deductions.

1. Officer compensation, salaries, and wages

Under section 162(a)(1), a taxpayer may deduct “a reasonable 

allowance for salaries or other compensation for personal services 

actually rendered” as an ordinary and necessary business expense. The 

test for determining the deductibility of compensation payments is 

(1) whether they are reasonable in amount and (2) whether they are in 

fact payments purely for services. Treas. Reg. § 1.162-7(a). 

Furthermore, only payments intended as compensation are deductible, 

and compensatory intent is a question of fact. Paula Constr. Co. v. 

Commissioner, 58 T.C. 1055, 1058–59 (1972), aff’d, 474 F.2d 1345 (5th

Cir. 1973). The taxpayer bears the burden of proving compensatory 

16 Palmarini Inc. argues that the amount of gross receipts determined by the 

IRS in excess of the aggregate amount reported on Forms 1099 issued to Palmarini 

Inc. in 2013 and 2014 should be considered gifts to Palmarini Inc. However, whether 

a transfer is a gift is a question of fact, Commissioner v. Duberstein, 363 U.S. 278, 288 

(1960), and we reject this characterization (a) because Palmarini Inc. received these 

payments in the ordinary course of its business, see § 61(a)(2), and alternatively 

(b) because Palmarini Inc. has not carried its burden of proving any donor’s intention 

to make a gift, see Commissioner v. Duberstein, 363 U.S. at 285; see also Robertson v. 

United States, 343 U.S. 711, 713 (1952) (“[P]ayment for services rendered . . . is in no 

sense a gift”). Similarly, all of Palmarini Inc.’s attempts to recharacterize as gifts its 

payments to others fail for lack of evidence of Palmarini Inc.’s intention to make gifts.
29

[*29] intent. King’s Court Mobile Home Park, Inc. v. Commissioner, 

98 T.C. 511, 514 (1992).

a. Officer compensation

Palmarini Inc. claimed a $92,400 deduction for officer 

compensation on its 2013 return, and no deduction for 2014. The 

Commissioner disallowed Palmarini Inc.’s deduction on the basis of lack 

of substantiation that the payments were made and that they were 

made purely for the services of the officers. The fact that Palmarini Inc. 

did not file any associated Forms W–2 or employment tax returns 

(Forms 940 and 941) nor pay any associated employment taxes, see

§§ 3101, 3102, 3111, 3301, and the fact that Mr. Palmarini did not report 

any wage income from Palmarini Inc. on his 2013 individual income tax 

return, both weigh against its contention that such payments were 

made.

Palmarini Inc. responds that its Form 1125–E, “Compensation of 

Officers”, attached to its 2013 return substantiates its deduction for 

officer compensation. However, this reporting form attached to the 

return does not prove that any amounts intended as compensation were 

in fact paid to officers, and Palmarini Inc.’s bank records do not show 

any payments that could be so interpreted. Palmarini Inc.’s deduction 

for officer compensation is disallowed for lack of substantiation.

b. Salaries and wages

Palmarini Inc. also claimed a $15,000 deduction for salaries and 

wages on its 2013 return and no deduction for 2014. The Commissioner 

disallowed this deduction for lack of substantiation. We hold that 

Palmarini Inc. is entitled to deduct the payments made to Mr. Palmarini 

in return for his labor building the Neshaminy Street garage.

Mr. Palmarini testified at trial that he and Manuel Palmarini 

worked for Palmarini Inc. renovating the garage at Neshaminy Street. 

He produced invoices reflecting payments made to him for his labor 

which (although not contemporaneous) reference check numbers 

corresponding with disbursements that the Commissioner identified as 

“cash” and included in his proposed constructive dividend to 

Mr. Palmarini. These payments are recurring, and they corroborate 

Mr. Palmarini’s testimony that they were payments for his labor on the 

Neshaminy Street garage. Palmarini Inc. is entitled to deduct $58,100 
30

[*30] for 2013 and $76,500 for 2014 for wages paid to Mr. Palmarini for 

his labor.17

2. Repairs and maintenance

Section 263(a)(1) requires that the cost “for permanent 

improvements or betterments made to increase the value of any 

property” be capitalized, not immediately deducted. Only “[t]he cost of 

incidental repairs which neither materially add to the value of the 

property nor appreciably prolong its life, but keep it in an ordinarily 

efficient operating condition, may be deducted as an expense” in the 

current year. Treas. Reg. § 1.162-4 (2011);18 see also Treas. Reg. 

§ 1.263(a)-3(i)(1)(i). On the other hand, amounts paid for improvements, 

see Treas. Reg. § 1.263(a)-3(d), betterments, see id. para. -3(j), 

restorations, see id. para. -3(k), or adaptations, see id. para. -3(l), of real 

property are considered capital expenditures.

Palmarini Inc. claimed on its 2013 return a $114,719 deduction 

for repairs and maintenance and no such deduction for 2014. Palmarini 

Inc. now argues that it should be allowed a $97,990 deduction for repairs 

and maintenance for 2013 and a $183,578 deduction for repairs and 

maintenance for 2014 for expenses on the following properties: 

(1) Halstead Street garage; (2) Halstead Street home; (3) Chandler 

Street ground floor; (4) Knorr Street ground floor; and (5) Neshaminy 

Street. The Commissioner disallowed Palmarini Inc.’s deduction for 

17 In an income tax deficiency case, we lack jurisdiction to determine any 

employment tax consequences in the absence of a notice of determination of worker 

classification issued to the petitioner. See Charlotte’s Office Boutique, Inc. v. 

Commissioner, 121 T.C. 89, 103 (2003) (“It is the Commissioner’s determination of 

worker classification that provides the predicate for our jurisdiction under 

section 7436(a) . . . .”), supplemented by T.C. Memo. 2004-43, aff’d, 425 F.3d 1203 (9th 

Cir. 2005); see also Povolny Group, Inc. v. Commissioner, T.C. Memo. 2018-37, at *7–9 

(determining employment tax deficiencies in an income tax deficiency case where the 

Commissioner also issued to the taxpayer a notice of determination of worker 

classification). However, because it appears no employment tax returns were filed 

with respect to amounts paid as wages to Mr. Palmarini, the statute of limitations for 

assessment of any associated employment taxes likely remains open under 

section 6501(a). 

18 Treasury Regulation section 1.162-4 (2011) (quoted above) was replaced by 

Temporary Treasury Regulation section 1.162-4T (2013), see T.D. 9564, 2012-14 I.R.B. 

614, which became final as of January 1, 2014, see T.D. 9636, 2013-43 I.R.B. 331. 

Although this regulation was redrafted and given new organization, its underlying 

policy is identical. See Treas. Reg. § 1.162-4(a) (2014) (“A taxpayer may deduct 

amounts paid for repairs and maintenance to tangible property if the amounts paid 

are not otherwise required to be capitalized”).
31

[*31] repairs and maintenance in its entirety because the repairs were 

not made to property owned by Palmarini Inc.

We sustain the Commissioner’s determination that Palmarini

Inc.’s deductions for repairs and maintenance should be disallowed in 

full for lack of substantiation. To the extent that these deductions are 

substantiated and relate to Palmarini Inc.’s principal place of business 

at the Halstead Street garage, they will be allowed, see infra Part II.D.5, 

as depreciation after the garage became corporate property. The 

remainder of Palmarini Inc.’s deductions relate to properties owned 

individually by Mr. Palmarini. Palmarini Inc. cannot take a deduction 

for repairs and maintenance to property it neither owned nor leased, see, 

e.g., Arevalo v. Commissioner, 124 T.C. 244, 251 (2005) (“[W]hen a 

taxpayer never actually owns the property in question, the taxpayer is 

not allowed to claim deductions for depreciation”), aff’d, 469 F.3d 436 

(5th Cir. 2006), even if it paid the expense and used these properties for 

business purposes. Furthermore, to the extent that these alleged 

expenditures for “repairs and maintenance” of Mr. Palmarini’s rental 

properties might be capital expenditures that could be deductible to 

Palmarini Inc. as depreciation of improvements to leased property, see

Treas. Reg. §§ 1.162-11(b)(1), 1.263(a)-3(f), Palmarini Inc. did not offer 

sufficient evidence to enable us either to conclude that such a leasehold 

arrangement existed between Mr. Palmarini and Palmarini Inc. in 2013 

and 2014 or to distinguish between repairs and maintenance done to 

areas used by Palmarini Inc. or areas occupied by residential tenants.

3. Bad debt

Section 166(a) grants a taxpayer a deduction for any bona fide 

debt that becomes wholly or partially worthless within the taxable year. 

To prove entitlement to a bad debt deduction, the taxpayer must show 

(1) the existence of a bona fide debt, (2) incurred in connection with a 

trade or business, (3) that became worthless within the taxable year. 

See § 166. “A bona fide debt is a debt which arises from a debtor-creditor 

relationship based upon a valid and enforceable obligation to pay a fixed 

or determinable sum of money”, Treas. Reg. § 1.166-1(c), and whether a 

debtor-creditor relationship exists is a question of fact, Fisher v. 

Commissioner, 54 T.C. 905, 909 (1970). Factors indicating a bona fide 

debt include whether: (1) evidence of indebtedness exists; (2) any 

security is requested; (3) there has been a demand for repayment; (4) the 

parties’ records reflect the transaction as a loan; (5) any payments have 
32

[*32] been made; and (6) interest was charged. See Sundby v. 

Commissioner, T.C. Memo. 2003-204, 86 T.C.M. (CCH) 58, 61 (2003).

The Commissioner disallowed Palmarini Inc.’s bad debt 

deductions for 2013 and 2014 in full because they do not relate to a bona 

fide debt and they lack substantiation. We agree. There was no loan 

from Palmarini Inc. to Epic Media Group—rather, the relationship 

between them was business-consumer and not debtor-creditor. 

Palmarini Inc. is not permitted to take a bad debt deduction for 2013 

and 2014 for an unpaid invoice from 2011. We agree with the 

Commissioner’s determination that Palmarini Inc.’s bad debt 

deductions for 2013 and 2014 must be disallowed.

The circumstances in which a debt consisting of an unpaid 

receivable may support a loss deduction are not present here. The 

regulations provide that “[a] debt arising out of the receivables of an 

accrual method taxpayer is deemed to be an enforceable obligation . . . 

to the extent that the income such debt represents have been included 

in the return of income for the year for which the deduction as a bad 

debt is claimed or for a prior taxable year.” Treas. Reg. § 1.166-1(c) 

(emphasis added). However, in 2013 and 2014 Palmarini Inc. was a cash 

basis taxpayer. See supra Part II.B. The corporation so stated on its 

original returns for the year and did not make any credible showing that 

it had ever filed returns on any other basis.

It is possible for a taxpayer to change methods of accounting, so 

one can posit an accrual-method taxpayer who accrued income in 2011 

as the result of a receivable that later became worthless in 2013, after 

the taxpayer had become a cash-method taxpayer. However, 

section 446(e) provides: “[A] taxpayer who changes the method of 

accounting on the basis of which he regularly computes his income in 

keeping his books shall, before computing his taxable income under the 

new method, secure the consent of the Secretary.” (Emphasis added.) 

The provision is mandatory.

There is no evidence supporting the position that the unpaid 

balance from Epic Media Group was accrued as income in a prior year, 

nor that Palmarini Inc. requested the IRS’s consent to change from its 

supposed 2011 accrual method to the cash basis method it reported on 

its original returns for the years at issue.
33

4. Rent

Section 162(a)(3) allows a deduction for rental expenses, provided 

that the payment is made as a condition to the continued use or 

possession (for the purposes of the trade or business) of property in 

which the taxpayer has no title and no equity.

Palmarini Inc. claimed a $18,229 deduction for rents paid on its 

2013 return, and no deduction for 2014. In his revised report, the 

Commissioner allowed Palmarini Inc. a $12,187 deduction for 2013 and 

a $13,387 deduction for 2014 for rent of the Halstead Street garage while 

it was owned by Manuel Palmarini. Palmarini Inc. accepts the 

Commissioner’s revised determination as to 2013 but argues that it 

should be allowed to deduct an additional $5,191 for rent for 2014 

because $18,578 is the total amount of payments issued by Palmarini 

Inc. to Manuel Palmarini in 2014. However, Manuel Palmarini owned 

Halstead Street only until March 2014, after which it became property 

of Palmarini Inc. Palmarini Inc. cannot deduct rent payments for 

Halstead Street after the property became its own. See § 162(a)(3). We 

therefore sustain the Commissioner’s revised determinations for rents 

paid in 2013 and 2014.

5. Depreciation

Section 167(a) allows a deduction for depreciation of property 

“used in the trade or business” or “held for the production of income”. To 

prove entitlement to a deduction for depreciation, a taxpayer must show 

(1) the existence of a trade or business; (2) that the property in question 

is used in the trade or business; and (3) a depreciable basis in the asset

by showing the cost of the property, its useful life, as well as any 

previously allowable depreciation. See, e.g., Cluck v. Commissioner, 105 

T.C. 324, 337 (1995).

Palmarini Inc. claimed a $6,035 deduction for depreciation on its 

2013 return, and no deduction for 2014. In his revised report the 

Commissioner disallowed Palmarini Inc.’s depreciation deduction for 

2013 and allowed a $1,671 deduction for depreciation of the Halstead 

property after it was acquired by Palmarini Inc. and put into service in 

August 2014. Palmarini Inc. does not allege that it is entitled to an 

additional amount for depreciation for 2014, so that determination will 

be sustained.

Palmarini Inc. argues that, in addition, it is entitled to depreciate 

the cost of its pickup truck for 2013. The Commissioner disallowed this 

[*33]
34

[*34] deduction because the truck was not property of Palmarini Inc. 

The bill of sale for the truck suggests that it is property of Mr. Palmarini 

and that it has mixed business and personal use; and a taxpayer 

claiming depreciation of a mixed-use asset must show the relevant 

proportions of business and personal use. See §§ 274(d), 280F(b), (d)(4); 

see also Finney v. Commissioner, T.C. Memo. 1980-23, 39 T.C.M. (CCH) 

938, 950–51 (holding that the taxpayer has the burden to prove the 

percent of business use); Treas. Reg. §§ 1.167(a)-2, 1.280F-2T(i)(1). 

Because there are no adequate records to ascertain the business use 

percentage of the truck, we cannot determine the proper amount of any 

depreciation deduction, and the deduction must be disallowed for lack of 

substantiation and failure of proof. See Rule 142(a).

6. Advertising

“[A]dvertising and other selling expenses” that “pertain to the 

taxpayer’s trade or business” are generally deductible under section 162 

as an “ordinary and necessary” expense. See Treas. Reg. § 1.162-1(a)(1). 

Here, Palmarini Inc. claimed (and the IRS allowed) advertising 

expenses related to its affiliated online marketing business.19

a. 2013

Palmarini Inc. deducted $345,433 for advertising expenses on its 

2013 return, and the Commissioner determined that it paid $386,628 for 

advertising expenses in 2013. Because the Commissioner determined

an amount greater than what Palmarini Inc. claimed on its 2013 return, 

and Palmarini Inc. does not allege it is entitled to a greater amount, 

there is no additional amount in dispute,20 and the Commissioner’s 

determination is sustained.

b. 2014

Palmarini Inc. deducted $577,156 for advertising expenses on its 

2014 return, and the Commissioner determined that it paid $452,390 for 

19 Given the nature of affiliated online marketing—incurring expense to place 

ads for customers—we think the technically correct character of this deduction for 

supposed advertising expenses might instead be cost of goods sold. However, 

Mr. Palmarini reported the expenses as advertising, and the IRS allowed them as such, 

and we will not disturb the parties’ agreed-to characterization. 

20 The principal dispute regarding advertising expenses is whether 

Mr. Palmarini should be allowed to report them on his Schedule C for AMOLLC. See

infra Part III.C. 
35

[*35] advertising expenses in 2014. Palmarini Inc. alleges that it is 

entitled to deduct an additional $87,137 for advertising expenses for

2014, comprised of $52,252 paid to Media Traffic and $34,885 paid to an 

unspecified Bank of America account.

Regarding the $52,252 paid to Media Traffic, the report from 

Media Traffic on which Palmarini Inc. relies for substantiation is in the 

stipulation of facts that the Commissioner reviewed in making his 

revised determination, but it is unclear whether the Commissioner 

included this amount in his allowance for advertising expenses for 2014. 

We assume he did not (and we therefore consider whether this might be 

an additional deductible amount), but the report from Media Traffic is,

by itself, insufficient to substantiate an additional deduction, because it 

neither specifies whether the amounts shown are revenues or expenses

nor shows whether the expenses (if expenses) were in fact paid by 

Palmarini Inc. See § 461(a) (requiring deductions to be taken “under the 

method of accounting used”); Treas. Reg. § 1.461-1(a)(1) (requiring cashmethod taxpayers to claim deductions “for the taxable year in which 

paid”). And regarding the $34,885 paid to the unspecified Bank of 

America account, we do not have any account statements from which to 

verify the specific amounts paid, to whom payments were made, and 

their business purpose. See § 162(a) (allowing deductions for expenses 

“paid . . . in carrying on any trade or business”); § 6001 (requiring the 

keeping of records). Accordingly, Palmarini Inc. has failed to carry its 

burden of proving that it is entitled to deduct additional amounts for 

advertising in excess of the Commissioner’s revised determination, and 

the Commissioner’s revised determination is sustained.

7. Other deductions

Palmarini Inc. deducted $38,290 for “other” expenses on its latest

amended 2013 return and deducted $57,337 on its latest amended 

return for 2014 (filed June 27, 2015). Palmarini Inc. further alleges that 

it is entitled to an additional $165,122 deduction for “other” expenses for

2013 from a VIST bank account ending in -2508. And Palmarini Inc.

now argues for an additional $128,550 deduction for “other” expenses for

2014 from the same bank account. The classification given to these 

expenses in Palmarini Inc.’s post-trial brief is mostly advertising

expenses, expenses related to Mr. Palmarini’s rental properties, or 

unspecified expenses. Mr. Palmarini also claimed at trial that he 

believes there is a third American Express card issued to him personally 

that the Commissioner did not consider when revising his 

determinations. Mr. Palmarini provided a year-end summary sheet 
36

[*36] from American Express to substantiate what he alleges are 

further business deductions to which he should be entitled, and he 

points to Palmarini Inc.’s bank statements showing that it paid 

$364,261 to American Express in 2013 and $467,369 in 2014.

However, we find his testimony not credible and his documentary 

evidence not convincing. Palmarini Inc.’s disorganized recordkeeping (if 

it can be called recordkeeping) does not enable one to verify the business 

purpose and specific amounts paid for “other” expenses. His documents

show a tangle of business and personal, of capital and ordinary, and of 

mixed lines of potential business. His information was in such disarray 

that he himself, preparing returns in the months after the close of the 

years at issue, was unable to determine with reasonable certainty his 

own deductible expenses, so he filed a series of amended returns 

claiming deductions inexplicably “not included” in a return filed days 

before, or stating “[m]ore deductions found in Line 26.”

He now insists that he had (and that he presented to the IRS 

statements from) “10 credit cards with huge charge expenses on them in 

2013”; but he offers no explanation as to why he did not report the 

expenses from those cards on his sixth and seventh amended returns for 

2013, on which he did report expenses attributed to “Amex card ending 

5107”, “BOA card ending 9744”, “Visa card ending 2031”, “Bank of 

America card ending 9141”, “Credit card ending 7732”, and “Card ending 

C68-640”. The years that have passed since he prepared those amended 

returns in 2015 have not improved the situation, as papers scatter, 

memories fade, document retention periods expire. The best time to 

tally business expenses for 2013 and 2014 was when the returns were 

due, in 2014 and 2015; but Mr. Palmarini now unwittingly discredits his 

own contemporaneous reporting by years-late allegations of substantial 

additional expenses. To the extent that Palmarini Inc. argues for 

deductions greater than the Commissioner has elsewhere conceded, it 

has failed to carry its burden of proof, and the Commissioner’s revised 

determination is sustained.

E. Constructive dividends

1. Paid out of earnings and profits

Section 301(c) controls the treatment of distributions of property

from a corporation to its shareholders. § 301(a). Under section 301(c)(1),

a shareholder must include in gross income any portion of the 

distribution which is a dividend (i.e., it is paid out of the corporation’s 
37

[*37] earnings and profits, see § 316(a)).21 On the basis of Palmarini 

Inc.’s gross receipts less allowed deductions for 2013 and 2014, it did 

have sufficient earnings and profits to issue dividends to Mr. Palmarini. 

See § 316(a).

2. Two-part test

Dividends may be formally declared or constructive. A 

constructive dividend arises “[w]here a corporation confers an economic 

benefit on a shareholder without the expectation of repayment, . . . even 

though neither the corporation nor the shareholder intended a 

dividend.” Magnon v. Commissioner, 73 T.C. 980, 993–94 (1980); see 

also C.F. Mueller Co. v. Commissioner, 479 F.2d 678, 683 (3d Cir. 1973) 

(“A taxpayer who is a shareholder has been held to have received a 

constructive dividend when he receives an economic benefit through a 

diversion of corporate earnings and profits”), aff’g 55 T.C. 275 (1970). 

“However, ‘not every corporate expenditure which incidentally confers

economic benefit on a shareholder is a constructive dividend.’ The

crucial test of the existence of a constructive dividend is whether ‘the

distribution was primarily for the benefit of the shareholder.’” Magnon, 

73 T.C. at 994 (emphasis added) (quoting Loftin & Woodard, Inc. v. 

United States, 577 F.2d 1206, 1214 (5th Cir. 1978)). Thus, there is a 

two-part test to determine a constructive dividend: (1) the expense must 

be nondeductible to the corporation, and (2) it must represent some 

economic gain, benefit, or income to the shareholder. See, e.g., Dobbe v. 

Commissioner, T.C. Memo. 2000-330, 80 T.C.M. (CCH) 577, 587, aff’d,

61 F. App’x 348 (9th Cir. 2003). But it should be borne in mind that 

where the Commissioner has determined a constructive dividend as 

unreported income, he bears the burden of production to show a 

connection between that income and the taxpayer. See, e.g., Austin 

Otology Assocs., T.C. Memo. 2013-293, at *23; D’Errico, 103 T.C.M. 

(CCH) at 1809. Ordinarily, the Commissioner’s showing that a 

corporate expenditure produced a benefit to the shareholder implicitly 

satisfies his burden of production to connect the shareholder-taxpayer 

with the underreported income; however, as we will show, the 

21 If the distribution exceeds the corporation’s earnings and profits, the excess 

is first a return of capital to the extent of the shareholder’s adjusted basis in the 

corporation’s stock, see § 301(c)(2); and any further remainder is treated as a long-term

capital gain, see § 301(c)(3).
38

[*38] Commissioner’s method of determining constructive dividends is, 

in some instances in these cases, problematic.

The Commissioner’s initial determination of constructive 

dividends to Mr. Palmarini ($328,931 in 2013 and $386,054 in 2014) 

reflected the difference between Palmarini Inc.’s total disbursements

and its allowed deductible expenses for those years. That is, the 

Commissioner initially assumed that any expenditure by Palmarini Inc.

that was not deductible was a dividend to Mr. Palmarini. The 

Commissioner’s revised determination of constructive dividends 

($261,716 in 2013 and $226,794 in 2014) acknowledged certain 

additional expenditures conceded to be deductible by Palmarini Inc., but 

his revised determination still calculates the constructive dividends to 

Mr. Palmarini to be total disbursements less allowable deductions. 

However, this shorthand method of calculating a constructive dividend

does not satisfy the Commissioner’s burden of production to connect 

unreported income with Mr. Palmarini. See Ashby v. Commissioner, 

50 T.C. 409, 418 (1968) (“The fact that the full amounts have been 

disallowed as deductions to the corporation does not necessarily mean 

that the full amounts are to be treated as dividends to the individual”).

For each expense included in the constructive dividends, the 

Commissioner must first establish a connection with Mr. Palmarini and 

then show that the payment was primarily for his benefit. See Gerardo

v. Commissioner, 552 F.2d at 554; Magnon, 73 T.C. at 994.

3. Analysis

a. Payments lacking description

The Commissioner put into evidence lead sheets showing his 

revised determinations of constructive dividends to Mr. Palmarini in 

2013 and 2014. The lead sheets show Palmarini Inc.’s gross receipts and

allowed deductions, categorize Palmarini Inc.’s nondeductible expenses 

and give totals, and identify expenses that were removed from the 

constructive dividend to arrive at the revised amounts. For certain 

expenses the Commissioner included description lines specifying what 

the payments were for, while for others there were no such descriptions. 

The expenses lacking descriptions categorically fail to satisfy the 

Commissioner’s burden to connect the payments to Mr. Palmarini, see

Gerardo v. Commissioner, 552 F.2d at 554, and likewise fail to show that 

the payments were primarily for his benefit, see Magnon, 73 T.C. at 994.

All categories of expenses without accompanying descriptions must 

accordingly be removed from the constructive dividend determination.
39

b. Payments for the benefit of relatives

Furthermore, not every expense for which the Commissioner did 

include a description shows a sufficient connection with Mr. Palmarini. 

For example, there are categories labeled “Manuel Palmarini”,22 “Dora

Pasquali bill payment”, and “Pacifico Palmarini bill payment”. The 

Commissioner’s descriptions identify Dora Pasquali as Mr. Palmarini’s 

mother, and the evidence shows that Manuel and Pacifico are Benito’s 

brothers—but these two brothers are also shareholders and officers of 

Palmarini Inc. for whose benefit the payments could well have been 

made. Manuel was active in the business; and Pacifico held a greater 

share of the company than Benito. Although it is not unreasonable to 

speculate that Benito could have authorized these payments by 

Palmarini Inc. in his capacity as an officer, such authorization does not 

necessarily connect these payments to Benito Palmarini as income, nor 

show that these payments were primarily for his benefit. In our view, 

the most reasonable supposition is that the payments to Manuel and 

Pacifico are primarily for their own benefit. The payments to their 

mother are primarily for her benefit; and if we postulate that a payment 

to her gives rise to an indirect benefit to her son, then that indirect

benefit flows to each son equally. The categories labeled “Manuel 

Palmarini”, “Dora Pasquali bill payment”, and “Pacifico Palmarini bill 

payment” must therefore be removed from the constructive dividends. 

The cash category represents payments made to Mr. Palmarini for his 

labor (deductible to Palmarini Inc. as wages, see supra Part II.D.1.b, and

included in Mr. Palmarini’s income as such, see infra Part III.A.1), and 

those payments must also be removed from the constructive dividends.

c. “No statements provided”

The Commissioner also included the $34,885 paid to an 

unspecified Bank of America account, see supra Part II.D.6.b, in his 

determination of a constructive dividend for 2014, and he gives the 

description “no statements provided”. This contention seems to attempt 

to bypass the Commissioner’s burden of production—i.e., to show benefit 

to Mr. Palmarini by showing that he failed to offer evidence disproving 

a benefit. But a payment to an unspecified bank account, without more 

information, proves neither a benefit to Mr. Palmarini nor income to 

22 This $10,000 expense is a distinct category from the $12,187 expense labeled 

“Manuel Palmarini bill payment” that the Commissioner removed from the 

constructive dividend and allowed as rent payment for Palmarini Inc.’s use of the 

Halstead Street garage. 

[*39]
40

[*40] him. Just as this expense lacks substantiation to be a deduction

to Palmarini Inc., it lacks substantiation to be deemed income to Mr. 

Palmarini, and therefore should not be characterized as a constructive 

dividend.

d. Personal and rental expenses

The Commissioner explicitly identified the following categories of 

Palmarini Inc.’s expenditures as being for the benefit of Mr. Palmarini

personally: (1) maintenance and upkeep of his Schedule E rental 

properties; (2) medical bills for himself and his family; (3) a family trip 

to Italy; and (4) a personal vehicle. Checks written from Palmarini Inc.’s

account (authorized by Mr. Palmarini) do indeed bear descriptions 

relating to his personal rental properties, healthcare for himself and his 

family, personal travel, and his personal vehicle, and they clearly 

establish a connection with him and demonstrate that the expenses 

were primarily for his benefit. Furthermore, there is an expense 

category labeled simply “Ben Palmarini”; it has no further description, 

but it establishes a sufficient connection with Mr. Palmarini. Given the 

Commissioner’s showing, the burden to prove that these expenses 

should not be treated as constructive dividends therefore shifted to 

Palmarini Inc. and to Mr. Palmarini. See Rule 142(a); Walker v. 

Commissioner, 757 F.2d at 38. Petitioners do not meet that burden.

Mr. Palmarini argues that Palmarini Inc. uses his personal rental 

properties for the business purpose of storing its equipment, and that 

therefore its payments related to these properties are deductible 

business expenses of Palmarini Inc. in the nature of rent, rather than a 

constructive dividend to him. Although we accept that Palmarini Inc.

may have made some use of these properties for business purposes, 

there is no documented rental agreement between Palmarini Inc. and 

Mr. Palmarini for the corporation’s use of the properties, nor are there 

any recurring payments from which to infer that anything like a rental 

arrangement existed. Furthermore, these payments by Palmarini Inc. 

are to third parties, rather than to Mr. Palmarini, and the description 

lines simply state the address of the property and specify neither the 

work done nor its business purpose. Palmarini Inc.’s expenses for 

maintenance and improvements to Mr. Palmarini’s personal rental 

properties represent a constructive dividend to him, see, e.g., Magnon, 

73 T.C. at 994; and, to the extent set out in the Commissioner’s revised 

examination report and the parties’ stipulation of settled issues, 

Mr. Palmarini may deduct the third parties’ expenditures as rental 

expenses on Schedule E.
41

[*41] Mr. Palmarini further asserts that Palmarini Inc.’s corporate 

bylaws provide for paying the cost of medical care and of a vacation for 

officers and their families. No copy of Palmarini Inc.’s corporate bylaws 

was produced in these cases; but even if we assume their existence, a 

corporation’s bylaws do not overrule the federal income tax 

consequences of a corporation’s distributions to its shareholders. 

Financial benefits to be paid to officers have their federal tax 

consequences even if bylaws authorize those benefits to be paid. 

Palmarini Inc.’s payment of personal expenses for Mr. Palmarini and his 

family must be included in his income as a constructive dividend. See, 

e.g., Dobbe, 80 T.C.M. (CCH) at 587–88.

On the basis of these burden-of-proof principles, we hold that 

Mr. Palmarini received constructive dividends from Palmarini Inc. of 

$116,741 for 2013 and $62,798 for 2014. An itemization of the 

constructive dividends for 2013 and 2014 is included in the Appendix.

F. Section 6662 accuracy-related penalties

Section 6662(a) imposes an “accuracy-related penalty” equal to 

20% of the portion of an underpayment of tax that is attributable to the 

taxpayer’s negligence or disregard of rules or regulations, see

§ 6662(b)(1), or that is attributable to any substantial understatement 

of income tax, see § 6662(b)(2). Section 6662(c) defines negligence to be 

“any failure to make a reasonable attempt to comply with the provisions 

of this title [i.e., title 26 U.S.C., the Internal Revenue Code]”; and

negligence also includes “any failure by the taxpayer to keep adequate 

books and records or to substantiate items properly”. Treas. Reg. 

§ 1.6662-3(b)(1). Section 6662(d)(1)(B) provides that, for corporations,

an understatement of income tax is “substantial” if it exceeds the lesser 

of either 10% of the tax that should have been reported on the return

(or, if greater, $10,000) or $10 million.

Because Palmarini Inc. is not an “individual” within the meaning 

of section 7491(c), that section’s burden-shifting provisions in the case 

of “any individual” do not apply, and the burden remains on Palmarini 

Inc. to prove it should not be held liable for the section 6662(a) accuracyrelated penalties. Palmarini Inc. argues that it should not be held liable 

for the accuracy-related penalties because the IRS examination process 

lasted too long, and it cites Internal Revenue Manual 4.10.2.2.2 (Feb. 11, 

2016) (establishing the agency’s goal of completing examinations of 

business income tax returns within 27 months after the date the return 

is filed). It would be ironic if a taxpayer who had chaotic and incomplete 
42

[*42] records could escape penalty because it took the IRS a long time 

to puzzle out its income and deductions—but that is not the case. “It is 

a well-settled principle that the Internal Revenue Manual does not have 

the force of law, is not binding on the IRS, and confers no rights on 

taxpayers.” McGaughy v. Commissioner, T.C. Memo. 2010-183, 

100 T.C.M. (CCH) 144, 148. The only deadline that the IRS was 

required to meet in order to assess a deficiency in federal income tax was

the 3-year period of limitations established by section 6501(a). Here, the 

3-year period for assessment would have expired on April 15, 2017, for

the year 2013, and on April 15, 2018, for the year 2014; and the NOD

was timely issued to Palmarini Inc. on November 14, 2016, before either 

period expired. Section 6503(a)(1) provides that, upon the taxpayer’s 

filing of a petition in the Tax Court, the period of limitations for 

assessment shall be suspended “until the decision of the Tax Court 

becomes final[], and for 60 days thereafter.” The periods for assessment 

of the deficiencies in federal income tax against Palmarini Inc. for 2013 

and 2014 therefore remain open during the pendency of these cases.

We are satisfied that Palmarini Inc. is liable for section 6662 

accuracy-related penalties for 2013 and 2014 under either a negligence 

theory based on its failure to maintain adequate records or on a

substantial understatement theory based on the extent of its 

underreported income and overstated deductions.

III. The Palmarinis’ individual income tax returns

A. Income

1. Wages, salaries, tips, etc.

Mr. Palmarini’s wage income includes the payments he received 

from Palmarini Inc. for his labor on the Neshaminy Street garage, see 

supra Part II.D.1.b: $58,100 for 2013 and $76,500 for 2014.

2. Constructive dividends from Palmarini Inc.

The Palmarinis reported $1,344 of dividend income on their 2013 

return, and no dividend income for 2014. The Palmarinis’ dividend 

income must include the constructive dividends that Mr. Palmarini 

received from Palmarini Inc., see supra Part II.E: $116,741 for 2013 and 
43

[*43] $62,798 for 2014, see § 301(c)(1). This makes the Palmarinis’ total 

dividend income $118,085 for 2013 and $62,798 for 2014.

3. Other income

The Commissioner identified deposits into AMOLLC’s bank 

accounts that were not advertising income, and he proposes to reclassify 

these items as “other” income on the Palmarinis’ returns. The 

Palmarinis reported “other” income of $129,400 on their 2013 return and 

$71,200 on their 2014 return (listing the type and amount for both years 

as “1099 MISC-Gambling”). In his revised report, the Commissioner 

proposes to reduce the Palmarinis’ “other” income to $13,750 for 2013 

and to $9,108 for 2014. The Palmarinis agree to the Commissioner’s 

determinations and there is no additional amount in dispute.

B. Schedule A casualty loss deduction for 2014

Section 165 allows a taxpayer a deduction for casualty losses

incurred during the year that are not compensated by insurance or 

otherwise. The amount of the deduction equals the difference between 

the fair market value of the property before and after the casualty, to 

the extent of the taxpayer’s adjusted basis in the property. Treas. Reg. 

§ 1.165-7(b)(1)(i). Treasury Regulation section 1.165-7(a)(2)(ii) further 

provides that a deduction for casualty loss may be valued as the cost of 

repair where (a) the repair is necessary to restore the property to its precasualty condition, (b) the cost of repair is not excessive, (c) the repairs 

do not exceed the actual damage suffered, and (d) the repairs do not 

increase the value of the property beyond its pre-casualty value. 

However, section 165(h) limits a deduction for casualty losses in two 

ways: first by allowing a deduction only for casualty losses greater than 

$100, see § 165(h)(1); and second by allowing a deduction for casualty 

losses only to the extent that the loss exceeds the sum of the taxpayer’s 

personal casualty gain for the taxable year plus 10% of the taxpayer’s 

adjusted gross income (“AGI”), see § 165(h)(2)(A).

The Palmarinis deducted $44,511 for casualty losses on their 

2014 return based on the alleged decrease in the value of their home due 

to the damaged fence. The Commissioner proposes to fully disallow this 

casualty loss deduction for lack of substantiation of the decrease in the 

value of the property. We agree that the Palmarinis’ casualty loss 

deduction should be disallowed, but for a reason different from what the 

Commissioner argues. The Palmarinis claimed their deduction in the 

amount of what Mr. Palmarini said would have been the cost to replace 
44

[*44] the entire fence, despite his having paid only about $1,000 on 

repairs of the damaged portion. Assuming his replacement estimate to 

be correct, that $60,000 expenditure would have given him a brand new 

fence, not the used fence he owned before the damage was done. There 

are no receipts reflecting the cost of restoration work actually done, only 

estimates and Mr. Palmarini’s testimony that the value of his property 

was reduced by having a mismatching fence. Although he put 

photographs into evidence that do show the damaged fence, there is no 

appraisal reflecting the extent of the decrease in value of the property 

as a result of the casualty. See Treas. Reg. § 1.165-7(a)(2)(i). The best 

evidence by which we can quantify the amount of the loss is not the 

Palmarinis’ expenditure of $1,000 (since there is no evidence that these 

limited repairs were an indication of the lost value), but is instead the 

insurance company’s damage estimate of $3,360, of which the insurance 

company paid $860 (after a deductible of $2,500) in settlement of the 

Palmarinis’ claim. Because the Palmarinis were thus compensated by 

insurance to the extent of $860, their net casualty loss for 2014 is the 

$2,500 “deductible” for which they received no compensation. See

§ 165(h)(2)(A)(i). The Palmarinis are entitled to deduct only the portion 

of their net casualty loss that is greater than 10% of their AGI, but any 

AGI amount greater than $25,000 would require the disallowance of the 

entire $2,500 net loss. The Palmarinis’ 2014 AGI (even before inclusion 

of the amounts determined as income in Part III.A above) is greatly in 

excess of $25,000, so their casualty loss deduction must be disallowed. 

See § 165(h)(2)(A).

C. Schedule C

The Palmarinis’ Schedules C for 2013 and 2014 reported gross 

receipts and deducted advertising expenses in excess of those gross 

receipts, showing a net loss. Although all advertising income and 

expenses were deposited into and paid out of Palmarini Inc.’s corporate 

bank accounts, Mr. Palmarini split the reporting of these items between 

Palmarini Inc.’s returns and the Palmarinis’ Schedules C for AMOLLC. 

He argues that his advertising business belongs on Schedule C because 

AMOLLC is a distinct business from Palmarini Inc. and because some 

Forms 1099 reporting advertising revenues were issued to him under 

his personal Social Security number. Such a division of business 

activities between an individual and his corporation may sometimes be 

appropriate, but in this instance it is not supported by the 

preponderance of the evidence. The amount of advertising income 

reported on the Forms 1099 that were issued to Mr. Palmarini was 

marginal compared to the amount of advertising income reported on the 
45

[*45] Forms 1099 that were issued to Palmarini Inc. And even taking 

as true that Mr. Palmarini intended that those Forms 1099 issued to 

Palmarini Inc. be issued to him under his personal Social Security 

number, the income was in fact deposited into Palmarini Inc.’s corporate 

accounts.

Notably, Mr. Palmarini admitted that his primary objective in 

preserving his Schedules C was to generate a loss to offset Bernadette

Palmarini’s wages and reduce the amount of individual income tax 

owed. This is precisely the kind of manipulative reporting for tax 

purposes prohibited by the separate entity doctrine of Moline Properties

v. Commissioner, 319 U.S. at 439 (“[B]ecause the taxpayer had adopted 

the corporate form for purposes of his own[,] [t]he choice of the 

advantages of incorporation to do business . . . required the acceptance 

of the tax disadvantages”). We therefore agree with the Commissioner 

that all advertising income and expenses must be reported on Palmarini 

Inc.’s 2013 and 2014 corporate income tax returns, that miscellaneous 

gross receipts reported on Schedules C must be moved to “other” income

on the Palmarinis’ 2013 and 2014 returns, and that the remainder of the 

Palmarinis’ Schedule C deductions should be disallowed.

D. Schedule E rental properties

The Palmarinis did not attach a Schedule E to their first amended 

return for 2013 (the starting point of the IRS’s examination for that 

year).23 The Palmarinis claimed a $25,000 loss from rental real estate 

on their 2014 return. The Commissioner initially proposed to limit the 

Palmarinis’ losses on Schedule E to the extent of their passive income. 

See § 469(a), (c), (d). However, in his revised report, the Commissioner 

determined that the Palmarinis underreported rental income for 2013 

and 2014, and that their rental activities produced an overall profit of 

$5,784 for 2013 and $1,834 for 2014. The parties have stipulated the 

amounts of rents received, as well as amounts of certain deductible 

expenses, in 2013 and 2014. To the extent there remain Schedule E 

deductions in dispute, we will uphold the Commissioner’s revised 

determinations because the Palmarinis did not maintain adequate 

records and have failed to carry their burden of proving entitlement to 

deductions in excess of the amounts the Commissioner conceded. 

However, we will diverge from the Commissioner’s revised 

23 The Palmarinis did report the income and expenses associated with their 

rental properties on their second and third amended returns for 2013, but the IRS did

not accept them. 
46

[*46] determination regarding the deduction for repairs and 

maintenance of Chandler Street in 2013.

Expenses for repairs and maintenance may be deducted for the 

current year only to the extent they are not required to be amortized as 

capital expenditures. See § 263. From the records reviewed by the 

Commissioner in making his revised determination, we identify $10,340 

paid for “repairs and maintenance” to Chandler Street in 2013 and zero

in 2014. These expenses were paid by Palmarini Inc. and are included 

in the constructive dividend Mr. Palmarini received in 2013. To the 

extent these expenses represent income to Mr. Palmarini through a 

constructive dividend, we will allow him (as the Commissioner has for 

other Schedule E deductions) to correspondingly deduct them on 

Schedule E. However, because the Palmarinis did not maintain 

adequate records, we do not know whether the work done was ordinary

“repair and maintenance” or whether instead it produced a capital 

benefit to the property that will last for more than one year; nor do we 

know their adjusted basis in Chandler Street as of 2013. We therefore 

assume that these 2013 expenditures were capital and that the 

Palmarinis’ adjusted basis in Chandler Street consisted only of these 

expenditures totaling $10,340, and we will accordingly allow them a 

$376 deduction for 2013 for depreciation of Chandler Street (based on 

an adjusted basis of $10,340 depreciated using the straight-line method 

with a recovery period of 27.5 years). See §§ 167(a), (c), 168(a), (b),

and (c).

E. Section 6662 accuracy-related penalties

For an individual (as for a corporation, discussed above), the 

section 6662(a) and (b)(1) and (2) accuracy-related penalty applies to the 

portion of an underpayment of tax required to be shown on a return that 

is attributable to either (1) the taxpayer’s negligence or disregard of 

rules or regulations or (2) a substantial understatement of income tax, 

defined for an individual by section 6662(d)(1)(A) as exceeding either

10% of the tax that should have been reported on the return or $5,000, 

whichever is greater.

The Commissioner bears the burden of production with respect to 

the liability of an individual for any penalty. § 7491(c). To satisfy his 

burden, the Commissioner must present sufficient evidence to show that 

it is appropriate to impose the penalty in the absence of available 

defenses. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). One 

element of the Commissioner’s burden of production is to show 
47

[*47] compliance with section 6751(b)(1), which requires the individual 

making the penalty determination to obtain written supervisory 

approval of the initial determination to assert any penalty. See Graev 

v. Commissioner, 149 T.C. 485, 493 (2017), supplementing and 

overruling in part 147 T.C. 460 (2016). Once the Commissioner meets 

his burden of production on penalties, the taxpayer must come forward 

with persuasive evidence that the Commissioner’s showing is incorrect. 

Higbee, 116 T.C. at 447; see also Rule 142(a). Or he may defend against 

the penalty with a showing of “reasonable cause” and “good faith” under 

section 6664(c)(1).

Here the Commissioner showed that Agent Berntsen received 

supervisory approval to assert the section 6662 accuracy-related penalty 

before sending to the Palmarinis the 30-day letter containing her 

proposed report (which was the first formal communication of the 

penalty determination to the Palmarinis) and has satisfied his burden 

of production to show compliance with the supervisory approval 

requirements of section 6751(b)(1).

We are satisfied (as with Palmarini Inc.) that the Palmarinis are

liable for section 6662 accuracy-related penalties for 2013 and 2014 

under either a negligence theory based on their failure to maintain 

adequate records or on a substantial understatement theory based on 

the extent of their underreported income and overstated deductions. 

Furthermore, the Palmarinis have not shown any “reasonable cause”, 

see § 6664(c); Treas. Reg. § 1.6664-4, that would justify relief from the 

section 6662 accuracy-related penalties.

IV. Conclusion

The Commissioner’s revised determinations are sustained in 

part, to the extent set out above. To reflect the parties’ concessions and 

the foregoing,

Decisions will be entered under Rule 155.
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[*48] APPENDIX

Constructive dividends from Palmarini Inc. to 

Benito Palmarini in 2013 and 2014

The following is an itemization of the amounts Benito Palmarini 

received as constructive dividends from Palmarini Inc. in 2013. (The 

Commissioner’s greater total is itemized on his Exhibit 79–R.)

Description Amount

Bartons Carpet

(renovation work) $1,558

Ben Palmarini 9,000

Brener Heating & 

Air Conditioning

(renovation work)

4,000

Fred Morning 

(rental mowing) 4,677

Jerry Toscano 

(renovation work) 5,568

Kevin Burcz 

(lawnscaping) 3,375

Magazine Center for 

Wellness (medical 

expenses for Benito)

16,075

McCafferty Ford 

(personally owned 

truck)

1,848

Michael Russo

(worked on rental 

properties)

58,000

Michael Smyth 10,340

Paul Weiss 

(electricianNeshaminy rental 

property)

2,300

Total $116,741
49

[*49] The following is an itemization of the amounts Benito Palmarini 

received as constructive dividends from Palmarini Inc. in 2014. (The 

Commissioner’s greater total is itemized on his Exhibit 80–R.)

Description Amount

AMEX card #0-

51007 (European 

cruise for family)

$14,979

Ben Palmarini 11,874

Jerry Toscano 9,733

Jessica Palmarini

(daughter) 110

Kevin Burcz (lawn 

maintenance for 

properties)

3,610

Magazine Center for 

Wellness (medical 

expenses for Benito)

5,055

McCafferty Ford 

(personally owned 

truck)

103

Michael Russo 

(worked on rental 

properties)

2,468

Michael Smyth 10,000

Reinard Agency

(insurance company 

for rental properties)

4,490

VW of Langhorne 

(daughter’s car) 376

Total $62,798