T.C. Memo. 2021-52

UNITED STATES TAX COURT

ANDREW MITCHELL BERRY AND SARA ALEXINE BERRY, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

ANDREW MITCHELL BERRY AND SARA BERRY, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 6584-19, 11180-19. Filed May 5, 2021.

Andrew Mitchell Berry and Sara Alexine Berry, pro sese.

Kris H. An and Joanne H. Kim, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

KERRIGAN, Judge: In these consolidated cases, respondent issued notices

of deficiency for 2014 and 2015 (years in issue). For 2014 respondent determined

a deficiency of $68,569, a $13,714 section 6662(a) accuracy-related penalty, and a

Served 05/05/21
- 2 -

[*2] $16,144 addition to tax pursuant to section 6651(a)(1). For 2015 respondent

determined a deficiency of $65,588 and a $13,118 section 6662(a)

accuracy-related penalty. Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure. We round all monetary

amounts to the nearest dollar.

After the parties’ concessions, the issues for consideration are: (1) whether

$8,700 and $1,200 for 2014 and 2015, respectively, should be recharacterized as

petitioners’ other income and not gross receipts of Phoenix Construction and

Remodeling, Inc. (Phoenix), (2) whether Phoenix is entitled to deduct car racing

expenses for 2014 and 2015, (3) whether Phoenix is entitled to a deduction

pursuant to section 179 for an excavator and a utility trailer for 2014, (4) whether

Phoenix has cost of goods sold of $33,294 for building permits for 2014,

(5) whether petitioners are entitled to deduct depreciation of $8,000 reported on

Schedule C, Profit or Loss From Business, for 2015, (6) whether petitioners are

liable for an addition to tax pursuant to section 6651(a)(1) for 2014, and

(7) whether petitioners are liable for the accuracy-related penalty pursuant to

section 6662(a) for 2014.
- 3 -

[*3] FINDINGS OF FACT

Some of the facts are stipulated and are so found. Petitioners resided in

California when they filed their petition.

During the years in issue Andrew Berry (petitioner husband) worked as a

realtor and reported his income on Schedules C. He also participated in car racing

during the years in issue. In 2014 and 2015 he earned $8,700 and $1,200,

respectively, from winning drag racing tournaments. He assigned these winnings

to Phoenix. For the years in issue Phoenix paid expenses related to petitioner

husband’s race car driving.

For the years in issue Phoenix was an S corporation owned equally by

petitioner husband and his father Ronald Berry (Mr. Berry). Phoenix was

involved in construction projects in San Luis Obispo, California. Petitioners

claimed 50% of Phoenix’s flowthrough profits and losses on Schedules E,

Supplemental Income and Loss, for 2014 and 2015.

Phoenix had four bank accounts and petitioners had three during the years

in issue. Phoenix used QuickBooks software to keep track of its records.

On June 13, 2016, Phoenix filed its 2014 Form 1120S, U.S. Income Tax

Return for an S Corporation, reporting gross income of $1,664,364 and cost of

goods sold of $1,329,575, including $150,414 for building permits. Phoenix
- 4 -

[*4] claimed a section 179 deduction totaling $135,297 for 11 items, including an

excavator and a utility trailer.

On May 24, 2016, petitioners filed their 2014 Form 1040, U.S. Individual

Income Tax Return. Petitioners’ 2014 income tax return was due October 15,

2015. On February 7, 2019, an IRS revenue agent’s supervisor signed a Civil

Penalty Approval Form approving the penalty determined in the notice of

deficiency issued March 11, 2019. On February 8, 2019, a 30-day letter was sent

to petitioners.

The notice of deficiency for 2014 included adjustments pursuant to the

examination of Phoenix’s 2014 return. In the notice respondent determined that

petitioners underreported their Schedule E income from Phoenix. Respondent

disallowed petitioners’ claimed section 179 deduction and cost of goods sold for

building permits, but he later conceded that certain expenses were allowable on

the basis of additional documentation petitioners provided. After the issuance of

the notice of deficiency, respondent verified the purchase of a tile saw and

adjusted the disallowed section 179 deduction to take it into account. Respondent

allowed some of the building permits as cost of goods sold but continued to

disallow $33,294 of the reported building permits.
- 5 -

[*5] On or about October 15, 2016, petitioners filed their 2015 Form 1040. On

their 2015 Schedule C they reported a depreciation expense of $8,000. In the

notice of deficiency for 2015 respondent disallowed all Schedule C expenses, but

respondent later conceded that all the expenses were allowable except for the

$8,000 depreciation expense.

OPINION

Generally, the Commissioner’s determinations in a notice of deficiency are

presumed correct, and the taxpayer bears the burden of proving that those

determinations are erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111,

115 (1933). Under section 7491(a), in certain circumstances, the burden of proof

may shift from the taxpayer to the Commissioner. Petitioners have not claimed or

shown that they have met the specifications of section 7491(a) to shift the burden

of proof to respondent as to any relevant factual issue.

Deductions are a matter of legislative grace, and a taxpayer must prove his

or her entitlement to a deduction. INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). 

Generally, an S corporation shareholder determines his or her tax liability by

taking into account a pro rata share of the S corporation’s income, losses,

deductions, and credits. Sec. 1366(a)(1). Where a notice of deficiency includes
- 6 -

[*6] adjustments for S corporation items with other items unrelated to the

S corporation, we have jurisdiction to determine the correctness of all adjustments. 

See Winter v. Commissioner, 135 T.C. 238 (2010).

A taxpayer claiming a deduction on a Federal income tax return must

demonstrate that the deduction is allowable pursuant to a statutory provision and

must further substantiate that the expense to which the deduction relates has been

paid or incurred. Sec. 6001; Hradesky v. Commissioner, 65 T.C. 87, 89-90

(1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976).

Gross Receipts

A taxpayer may not determine the nature of his or her income merely by

using a particular form, or by labeling it as he or she wishes, but must report his or

her income according to the economic realities of the situation. Walker v.

Commissioner, 101 T.C. 537, 544 (1993) (citing Frank Lyon Co. v. United States,

435 U.S. 561 (1978)).

Petitioners contend that petitioner husband’s race car winnings should be

included in Phoenix’s gross receipts. In support of this contention Mr. Berry

testified that Phoenix paid the entry fees for petitioner husband’s car races. 

Petitioner husband testified that he raced under the name “Berry Racing”, which

he described on his Facebook account as a family drag racing team. During the
- 7 -

[*7] years in issue petitioner husband’s racing crew wore shirts emblazoned with

“Berry Racing”.

The evidence does not show that car racing was part of Phoenix’s business. 

Because income earned by petitioner husband as a race car driver is not income

derived from Phoenix’s business of remodeling and construction, it should not be

included in Phoenix’s gross receipts. Therefore, we sustain respondent’s

recharacterization of $8,700 and $1,200 as other income for 2014 and 2015,

respectively.

Race Car Expenses

Section 162 permits taxpayers to deduct all ordinary and necessary business

expenses paid or incurred during the taxable year. An ordinary expense is one that

commonly or frequently occurs in the taxpayer’s business, Deputy v. du Pont, 308

U.S. 488, 495 (1940), and a necessary expense is one that is appropriate and

helpful in carrying on the taxpayer’s business, Commissioner v. Heininger, 320

U.S. 467, 471 (1943); sec. 1.162-1(a), Income Tax Regs. Petitioners failed to

show the connection between Phoenix’s construction business and the reported

race car expenses.

Even if we concluded that the race car expenses were ordinary and

necessary expenses pursuant to section 162, we are not able to determine which
- 8 -

[*8] expenses would be deducted as race car expenses. Petitioners did not provide

evidence identifying which expenses in Phoenix’s records were related to race

cars. We sustain respondent’s denial of deductions for race car expenses for 2014

and 2015.

Phoenix’s Section 179 Deduction

Section 179 provides that a taxpayer may elect to treat the cost of any

section 179 property as an expense which is not chargeable to a capital account. If

a taxpayer makes such an election, the cost shall be allowed as a deduction for the

taxable year in which the section 179 property is placed in service. Sec. 179(a). 

Section 179 property includes tangible property that is section 1245 property

required for use in the active conduct of a trade or business. Sec. 179(d)(1)(B). 

To be entitled to a section 179 deduction a taxpayer must maintain records

reflecting how and from whom the section 179 property was acquired and when it

was placed in service. Sec. 1.179-5(a), Income Tax Regs.

For 2014 Phoenix claimed a section 179 deduction for 11 items. 

Respondent initially disallowed the deduction for all 11 items. Petitioners contend

that they should be allowed a deduction for the utility trailer and the excavator. 

While Phoenix properly elected to treat the utility trailer and the excavator as
- 9 -

[*9] section 179 property, it failed to substantiate the section 179 deduction for

either item.

In February 2014 Mr. Berry purchased a utility trailer. He testified that the

trailer was purchased to store materials at a remote jobsite. He further testified

that trailer could be sold for a profit. There is no evidence to support his

testimony.

On the contrary respondent’s revenue agent testified that in 2018 petitioner

husband listed for sale a trailer that was used to transport race cars. The evidence

does not support petitioner’s claim that the trailer was used for Phoenix’s

construction-related activities. Accordingly, respondent’s disallowance of the

section 179 deduction for the utility trailer is sustained.

Mr. Berry testified that Phoenix purchased an excavator in 2014 and

provided an undated bill of sale. Petitioners provided evidence to show that

petitioner husband made a cash withdrawal and used a money order to purchase

the excavator. They did not provide any evidence that connected the cash

withdrawal and the purchase of the excavator. Therefore, petitioners failed to

meet their burden to show entitlement to a section 179 deduction for the

excavator.
- 10 -

[*10] Cost of Goods Sold

Cost of goods sold is an offset subtracted from gross receipts in determining

gross income, secs. 1.61-3(a), 1.61-6(a), Income Tax Regs., and is not a deduction,

see Metra Chem Corp. v. Commissioner, 88 T.C. 654, 661 (1987). Any amount

claimed as cost of goods sold must be substantiated, and taxpayers are required to

maintain records sufficient for this purpose. Sec. 6001; Nunn v. Commissioner,

T.C. Memo. 2002-250, slip op. at 16; sec. 1.6001-1(a), Income Tax Regs.

Respondent’s revenue agent examined Phoenix’s QuickBooks records. For

six entries related to building permits in 2014 the revenue agent found duplicate

entries and disallowed the duplicates. Petitioners did not substantiate entitlement

to the disallowed duplicates. Respondent’s disallowance of duplicate entries of

$33,294 for 2014 is sustained.

Schedule C Deduction

For property used in a trade or business or held for the production of

income, a depreciation deduction is allowed for reasonable exhaustion and wear

and tear. Sec. 167(a). Petitioners reported a depreciation expense of $8,000 on

their 2015 Schedule C. Petitioners contend that the $8,000 was for petitioner

husband’s truck that he “used to meet clients, and look at jobs, and go to

meetings”.
- 11 -

[*11] To substantiate entitlement to a depreciation deduction, a taxpayer must

establish the property’s depreciable basis by showing the cost of the property, its

useful life, and the previously allowable depreciation. Cluck v. Commissioner,

105 T.C. 324, 337 (1995). In addition, a claimed deduction with respect to any

“listed property”, a category including “any passenger automobile”, is subject to

the heightened substantiation requirements under section 274(d)(4). See sec.

280F(d)(4) (defining “listed property”).

Petitioners failed to provide any showing of the cost of the truck, when it

was placed in service, the business percentage use of the vehicle, and the

previously allowed depreciation. Accordingly, the disallowance of a deduction for

depreciation for 2015 is sustained.

Section 6651(a)(1) Addition to Tax

Section 6651(a)(1) imposes an addition to tax if the taxpayer fails to file his

or her income tax return by the required due date (including any extension of time

for filing). A taxpayer has the burden of proving that failure to timely file was due

to reasonable cause and not willful neglect. See sec. 6651(a)(1); Higbee v.

Commissioner, 116 T.C. 438, 447 (2001).

Under section 7491(c) the Commissioner bears the burden of producing

evidence with respect to the liability of the taxpayer for any additions to tax. See
- 12 -

[*12] Higbee v. Commissioner, 116 T.C. at 446-447. For 2014 petitioners filed

their income tax return after the due date. Therefore, respondent’s burden of

production has been met. Petitioners did not establish that their failure to timely

file was due to reasonable cause. Accordingly, the section 6651(a)(1) addition to

tax is sustained for 2014.

Section 6662(a) Penalty

The Commissioner bears the burden of production with respect to the

penalty imposed by section 6662(a). Sec. 7491(c). This burden of production

includes producing evidence that the Commissioner has complied with the

procedural requirements of section 6751(b). Frost v. Commissioner, 154 T.C. 23,

34 (2020). Once the Commissioner meets this burden, the taxpayer must come

forward with contrary evidence. Id.

The Commissioner must show compliance with section 6751(b)(1), which

requires that certain penalties be personally approved in writing by the immediate

supervisor of the individual making the determination. See Graev v.

Commissioner, 149 T.C. 485, 493 (2017), supplementing and overruling in part

147 T.C. 460 (2016).

The record indicates that written supervisory approval for the assertion of an

accuracy-related penalty for 2014 was given on February 7, 2019, and that a
- 13 -

[*13] 30-day letter was sent to petitioners on February 8, 2019. Respondent has

satisfied the burden of production with regard to the supervisory approval

requirement of section 6751(b), and petitioners do not contend otherwise. See

Flume v. Commissioner, T.C. Memo. 2020-80, at *34.

Section 6662(a) imposes a 20% accuracy-related penalty on any portion of

an underpayment of tax required to be shown on a return if, as provided by section

6662(b)(1), the underpayment is attributable to “[n]egligence or disregard of rules

or regulations.” Negligence includes “any failure to make a reasonable attempt to

comply” with the internal revenue laws, and “disregard” includes “any careless,

reckless, or intentional disregard.” Sec. 6662(c). Negligence also includes any

failure by the taxpayer to keep adequate books and records or to substantiate items

properly. Sec. 1.6662-3(b)(1), Income Tax Regs. Petitioners did not keep records

as required by section 6001. Their underpayment was attributable to negligence.

The accuracy-related penalty does not apply with respect to any portion of

the underpayment for which the taxpayer shows that he or she had reasonable

cause and acted in good faith. Sec. 6664(c)(1); see Higbee v. Commissioner, 116
- 14 -

[*14] T.C. at 446-447. Petitioners did not contest the section 6662(a) penalty, and

therefore the penalty is sustained for 2014.

1

We have considered all arguments made by the parties, and to the extent not

mentioned or addressed, they are irrelevant or without merit.

To reflect the foregoing,

Decisions will be entered under

Rule 155.

1Respondent also alleged that petitioners were liable for the sec. 6662(a) and

(b)(2) accuracy-related penalty for 2014 for a substantial understatement of

income tax. Because we find that petitioners were negligent and that they did not

provide evidence that they acted with reasonable cause or in good faith, we need

not address whether they substantially understated their income tax for 2014.