T.C. Memo. 2003-321

UNITED STATES TAX COURT

 RAFAEL M. GUTIERREZ AND ROSARIO GUTIERREZ, Petitioners v. 

COMMISSIONER OF INTERNAL REVENUE, Respondent

 Docket No. 11393-02. Filed November 20, 2003.

Jeffrey D. Moffatt, for petitioners.

Jean Song, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

LARO, Judge: Petitioners petitioned the Court to

redetermine a $43,812 deficiency in their 1998 Federal income tax

and an accuracy-related penalty of $8,762.40 under section
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1 Section references are to the applicable version of the

Internal Revenue Code. Rule references are to the Tax Court

Rules of Practice and Procedure.

2 When used in a singular form, the term “petitioner” refers

to Rafael M. Gutierrez. 

6662(a).1 After concessions, we decide the following issues:

1. Whether the burden of proof has been shifted to

respondent by virtue of section 7491(a). We hold that the burden

of proof remains with petitioners. 

2. Whether petitioners underreported their Schedule C,

Profit or Loss From Business, gross receipts by $137,221. We

hold that they did.

3. Whether petitioners are liable for the accuracy-related

penalty under section 6662(a). We hold that they are.

FINDINGS OF FACT

Some facts were stipulated. The stipulated facts and the

accompanying exhibits are incorporated herein by this reference.

We find the stipulated facts accordingly. Petitioners are

married individuals who filed a joint 1998 Federal income tax

return. When the petition was filed, petitioners resided in

Palmdale, California. 

During 1998, petitioner2 owned and operated as a sole

proprietorship a billiard hall named Playa Azul. Petitioners

also owned certain residential rental real estate. On their 1998

tax return, petitioners reported total income of $95,373. Of
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3 Petitioners conceded the $2,600 of the total deficiency

amount solely for the purpose of qualifying this case for small

tax case procedure and made an appropriate request in their

petition. Ultimately, however, this case was not tried as a

small tax case. 

that amount, $59,584 was attributable to the sole proprietorship,

$27,300 was attributable to the rental real estate, $7,839 was

attributable to wages received by petitioner, and $650 was

attributable to interest income. During the subject year,

petitioners maintained five accounts with two banks, Home Savings

and Cal Fed. 

Respondent examined petitioners’ 1998 Federal income tax

return. In connection therewith, respondent considered

petitioners’ bank statements and cash transaction reports. 

Respondent determined from these statements and reports that

petitioners underreported the gross receipts of the billiard hall

sole proprietorship by $137,221. 

Petitioners concede that they received $137,221, yet did not

disclose it on their 1998 return.3 They allege that this amount

represents the proceeds from a 1997 sale to petitioner’s brother

of a market petitioners owned in Mexico. According to

petitioners, they did not pay taxes in Mexico on the proceeds

from that sale because they sold the market at its cost and hence

presumably owed no taxes on the transaction. Petitioners claim

that they are now insulated by a Treaty between United States and
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4 Petitioners refer to the Convention & Protocol for the

Avoidance of Double Taxation and the Prevention of Fiscal Evasion

with Respect to Taxes on Income, Sept. 18, 1992, U.S. - Mex., S.

Treaty Doc. No. 103-07, reprinted in 2 Tax Treaties (CCH) at

5903. 

Mexico (Treaty)4 from being taxed by the United States on their

receipt of the $137,221. Petitioners testified that the $137,221

was reported incrementally to the Immigration and Naturalization

Service upon each entry by petitioner into the United States, but

they failed to present any admissible evidence in this proceeding

to corroborate that testimony. They sought to introduce into

evidence various documents in Spanish, which they claimed would

have verified the alleged sale and the subsequent reporting of

same to the Mexican authorities. However, petitioners were

barred from using these documents at trial because they did not

translate and properly authenticate them. 

OPINION

I. Burden of Proof as to Deficiency

Taxpayers generally must prove respondent’s determinations

wrong in order to prevail. Rule 142(a)(1); Welch v. Helvering,

290 U.S. 111, 115 (1933). As one exception to this rule, section

7491(a) places upon respondent the burden of proof with respect

to any factual issue related to a taxpayers’ tax liability if

they maintained adequate records, satisfied applicable

substantiation requirements, cooperated with respondent, and

introduced during the court proceeding credible evidence on the
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5 The relevant language of sec. 7491 provides: 

SEC. 7491. BURDEN OF PROOF.

(a) Burden Shifts Where Taxpayer Produces Credible

Evidence.-- 

(1) General rule.--If, in any court

proceeding, a taxpayer introduces credible

evidence with respect to any factual issue

relevant to ascertaining the liability of the

taxpayer for any tax imposed by subtitle A or

B, the Secretary shall have the burden of

proof with respect to such issue. 

(2) Limitations.--Paragraph (1) shall

apply with respect to an issue only if-- 

(A) the taxpayer has complied

with the requirements under this

title to substantiate any item; 

(B) the taxpayer has

maintained all records required

under this title and has cooperated

with reasonable requests by the

Secretary for witnesses,

information, documents, meetings,

and interviews; * * *

6 The text of the statute requires that the taxpayer satisfy

the remaining (credible evidence) requirement as a condition of

placing the burden of proof upon respondent.

factual issues.5 Prince v. Commissioner, T.C. Memo. 2003-247. 

The legislative history of section 7491(a) clarifies that

taxpayers must prove that they have complied with the recordkeeping, substantiation, and cooperation requirements before that

section places the burden of proof upon the Commissioner.6 H.

Conf. Rept. 105-599, at 239 (1998), 1998-3 C.B. 747, 993 (“The

taxpayer has the burden of proving that it meets each of these
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conditions, because they are necessary prerequisites to

establishing that the burden of proof is on the Secretary.”). 

The legislative history provides further as to the term “credible

evidence”, which is not defined in the statute, that

Credible evidence is the quality of evidence which,

after critical analysis, the court would find

sufficient upon which to base a decision on the issue

if no contrary evidence were submitted (without regard

to the judicial presumption of IRS correctness). A

taxpayer has not produced credible evidence for these

purposes if the taxpayer merely makes implausible

factual assertions, frivolous claims, or tax

protestor-type arguments. The introduction of evidence

will not meet this standard if the court is not

convinced that it is worthy of belief. If after

evidence from both sides, the court believes that the

evidence is equally balanced, the court shall find that

the Secretary has not sustained his burden of proof. 

[Id. at 240-241, 1998-3 C.B. at 994-995.]

We have in previous cases involving section 7491 applied the

definition of the term “credible evidence” as discerned from the

legislative history. E.g., Higbee v. Commissioner, 116 T.C. 438,

442-443 (2001); Forste v. Commissioner, T.C. Memo. 2003-103;

Managan v. Commissioner, T.C. Memo. 2001-192. We do likewise

here. We conclude that section 7491(a) does not apply to place

the burden of proof upon respondent in that petitioners have

failed to introduce during this proceeding credible evidence on

any factual issue. Petitioners’ testimony, the only evidence in

the record as to this subject, lacked credibility in that it was

inconsistent and incoherent. 
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We also note that section 7491(a) is inapplicable here in

that we do not find that petitioners maintained adequate records

or satisfied applicable substantiation requirements. See Prince

v. Commissioner, supra. We hold that the burden of proof remains

with petitioners. 

II. Understatement of Income

The deficiency determination made by respondent enjoys the

presumption of correctness, and the burden of proving otherwise

rests with petitioners. Rule 142(a); Rapp v. Commissioner, 774

F.2d 932, 935 (9th Cir. 1985). However, in the case of

underreported income, the usual presumption in favor of

respondent arises only if respondent’s allegations are supported

by a minimal factual foundation linking the taxpayer with an

income-producing activity. Palmer v. United States, 116 F.3d

1309, 1313 (9th Cir. 1997). 

Here, respondent has established that petitioners, in 1998,

(1) had been engaged in an income-producing activity, to wit, 

their ownership and operation of the billiard hall and (2) had

accumulated net deposits in the amount of $266,186, which is

greater than the amount reported by them as taxable income by

$137,221. Petitioners do not contest either the fact that they

had owned and operated Playa Azul, or the fact that their bank

deposits are in excess of their taxable income by the amount

claimed by respondent. 
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In the absence of adequate record-keeping by petitioners,

which is mandated by section 6001, the Commissioner is authorized

to reconstruct petitioners’ income by any reasonable method that

clearly reflects income. See, e.g., sec. 446(b); Holland v.

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

Commissioner, 643 F.2d 1383, 1385 (9th Cir. 1981), affg. per

curiam T.C. Memo. 1979-3. One of the acceptable methods of

reconstructing income is the bank deposits method. Clayton v.

Commissioner, 102 T.C. 632, 645 (1994); DiLeo v. Commissioner, 96

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

deposits are considered prima facie evidence of income, and

respondent need not prove a likely source of that income. 

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

v. Commissioner, 64 T.C. 651, 656-657 (1975), affd. 566 F.2d 2

(6th Cir. 1977). Under the bank deposits method, it is assumed

that all money deposited in petitioners’ bank accounts during the

period in question, minus any money coming from a nontaxable

source and deductible expenses known by the Commissioner,

constitutes taxable income. Clayton v. Commissioner, supra at

645-646. 

Petitioners do not dispute the existence of the excess

amount in their bank accounts as calculated by respondent, and

they fail to establish why this amount should not be taxed. 

Petitioners assert that the excess amount represents the proceeds
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7 Petitioners state that they owed no taxes on the

transaction because they sold the market at its cost.

from the sale of a market in Mexico to petitioner’s brother. 

They further contend that they have complied with the applicable

laws and regulations with respect to that sale in Mexico.7

Therefore, according to petitioners, the excess amount in

question is not taxable in the United States pursuant to the

Treaty, as well as by virtue of sections 871 and 992. 

Petitioners presented no admissible evidence to support any

of their contentions. Their testimony is without merit because

it is inconsistent, incoherent, and unreliable. For example,

petitioner testified that his brother still owed him in 1998

approximately $130,000 from the purported sale. He also

testified that in 1998 he brought from Mexico $175,000, which is

a larger amount than what his brother allegedly owed him at that

time. Because petitioners claim no other source of the excess

amount besides the sale of the market to petitioner’s brother,

these two parts of testimony are irreconcilable. 

Furthermore, if anything, petitioners’ testimony supports

the conclusion opposite from their contentions. For instance,

although petitioner testified that he paid taxes in Mexico, he

also stated that he did not report income from sale of the

business to his brother to any authority in Mexico. Whatever

legitimate explanation may exist for that fact, it certainly
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undermines petitioners’ contentions that their income would be

doubly taxed if they were to pay taxes on the proceeds from that

sale in the United States. 

Petitioners failed to corroborate their testimony by any

documentary evidence. They attempted to introduce several

documents in Spanish, which allegedly would have confirmed the 

existence of a contract between petitioner and his brother for

the sale of the market, as well as petitioners’ written

communications with the Mexican Government in connection with

that sale and other tax-related matters. Because petitioners

failed to properly translate and authenticate the documents in

question, despite the Court’s order to do so, they were barred

from using them at trial. 

Aside from petitioners’ failure to substantiate their

contentions with respect to the foreign source of the unreported

income, their reliance on the Treaty to avoid the U.S. tax is

misguided. By filing a joint Federal income tax return for 1998,

petitioners in effect admitted that neither of them was a

nonresident alien during the year in question. See sec.

6013(a)(1). To the extent petitioners contend that they were not

U.S. residents during 1998, they presented no evidence to that

effect. Consequently, by virtue of the Treaty, petitioners are

entitled to no exemption from U.S. tax, but only to a foreign tax

credit for income taxes paid to the Mexican Government. 
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8 Respondent also alleged negligence on part of petitioners

for the purpose of providing an additional ground for imposing an 

accuracy-related penalty. In that we decide the accuracy-related

penalty issue on the basis of understatement, we need not and do

not address this argument. 

Petitioners proffered no evidence to prove such payment. 

Therefore, as U.S. citizens or residents, petitioners must pay

U.S. taxes in full, and the Treaty provides no relief to them in

the present case. 

We observe that despite petitioners’ allegations, sections

871 and 992 have no application here. Section 871 does not apply

because petitioners are residents of the United States. 

Likewise, section 992 does not apply because petitioners’

billiard hall was not a corporation. 

In view of the above, we hold that petitioners have failed

to establish that the excess bank deposits came from a nontaxable

source or were otherwise exempt from U.S. tax. Accordingly, we

sustain respondent’s determination with respect to the unreported

income in the amount of $137,221. 

III. Accuracy-Related Penalty

Section 6662 provides that a taxpayer may be liable for a

penalty of 20 percent on the portion of an underpayment which is

attributable to, among other things, substantial understatement

of tax.8 The term “understatement” for that purpose means the

excess of the amount of tax required to be shown on the return

for the taxable year, over the amount of tax imposed which is
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shown on the return, reduced by any rebate. Sec. 6662(d)(2)(A). 

The term “substantial understatement” is defined as the greater

of 10 percent of the tax required to be shown on the return for

the taxable year, or $5,000. Sec. 6662(d)(1)(A). Also, the

amount of understatement is reduced to the extent it is

attributable to a position (1) for which there is substantial

authority, or (2) which the taxpayer adequately disclosed on his

return and for which there is reasonable basis. Sec.

6662(d)(2)(B). We do not find that either of these conditions

applies here. Accordingly, the base to which the accuracyrelated penalty would apply equals the full underpayment, or

$43,812 in this case. 

The penalty may not be imposed with respect to an

underpayment if the taxpayer’s actions regarding it can be

justified by a reasonable cause and were in good faith. Sec.

6664(c)(1). Pertinent facts and circumstances determine whether

this exculpatory provision applies in a particular case. Sec.

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

Respondent bears the burden of production with respect to

the accuracy-related penalty. Sec. 7491(c). In order to meet

this burden, respondent must produce sufficient evidence

establishing that it is appropriate to impose this penalty. Once

respondent has done so, the burden of proof is upon petitioners

to establish reasonable cause and good faith. Higbee v.
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Commissioner, 116 T.C. 438, 449 (2001). 

Here, respondent has satisfied his burden of production by

showing that petitioners’ understatement was substantial as it

exceeded the requisite statutory amount. Petitioners have not

established that their failure to pay Federal income tax

liability in full was due to a reasonable cause. The record is

devoid of any reliable evidence in favor of the conclusion urged

by petitioners; namely, that the excess bank deposit amount was

not subject to U.S. tax. Petitioners gave inconsistent and

incoherent testimony and failed to comply with the Court’s

requests to have the documents proffered by them properly

translated and certified, so as to render them admissible. 

Accordingly, we hold the “reasonable cause” exception

inapplicable and sustain the imposition of the substantial

understatement penalty. 

We have considered all arguments made by the parties and

have rejected those arguments not discussed herein as irrelevant

or without merit. 

Decision will be entered

for respondent