T.C. M em o . 2 0 1 8 -1 2 7

UNITED STATES TAX COURT

M ARTHA G. SM ITH AND GEORGE S. LAKNER, ET AL., 1 Pet i t i o n ers v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t
Do ck etNo s . 8 84 7 -1 2 , 2 5 7 1 4 -1 2 Fi l edAu gu s t 1 3 , 2 0 1 8
.

1 2 2 9 3-1 4
.
Edward J
. Ley d en , fo r p et i t i o n ers . Rach el L. Ro l l i n s an dJ effreyE. Go l d , fo r res p o n d en t .

M EM ORANDUM FINDINGS OF FACT AND OPINION LAUBER, J u d g e: W i th res p ectt o p et i t i o ners ’ Fed eral i n co m e t ax fo r 2 0 0 7 -2 0 1 1 , th e In tern al Rev en u e Serv i ce (IRS o r res p o n d en t ) d et erm i n ed

1 Cas es o f t h e fo l l owi ng p et i t i o n ers are co n s o l i d at edh erewi th : M art ha G. Sm it h an dGeo rg e S. Lakn er, d o ck etNo
. 2 5 7 1 4 -1 2; an dGeo rg e S. Lakner an d M art h a G. Sm it h , d o ck etNo . 1 2 2 93 -1 4
.- 2
-

[* 2 ] d efi ci en ci es i n t ax , ad d i t i o n s t o t ax u n der s ect i o n 6 6 5 1 (a)(1 ), an d p en al t i es
u n d er s ect i o n s 6 66 2 (a) an d 6 6 6 3 (a), 2 as fo l lo ws : Addi t i on t o t ax Penal t ies Year Def

i ci encysec. 6651( a) ( 1) Sec. 6662( a) Sec. 6663( a) 2007 $27,339 $5,621 $5,468 - 0- 2008 106,999 25,472 - 0- $80,249 2009 16,148 2,836 3,230 - 0- 2010 313,914 15,448 - 0- 235,210 2011 163,468 17,762 - 0- 122,601 Aft er v ari o u s co n ces s i on s (d i s cu s s edb el o w), the i ss u es fo r d eci s i o n are wh et h er p et i ti o n ers fo r v ari ou s y ears : (1 ) recei v edu n rep o rt edi nco m e; (2 ) are
en t i t l edt o d edu ct i o n s cl ai m ed o n Sch edul es A, It em i zedDedu ct i o n s, i n am o u n ts g reat er t h an res p o n den th as al l o wed ; (3 ) are en t i t l edt o d edu ct i o n s cl ai m edo n Sch edu l es C, Pro fi t o r Lo ss Fro m Bu s i n es s , i n am o u n ts g reat er t h an res p on d en t h as al l owed ; (4 ) are en t it l edt o l o s s es cl ai m ed o n Sch edu l es E, Sup p l em en t al In co m e an d Lo s s ; (5 ) are en t it l edt o d edu ct i o n s fo r n eto p erat i n g l o s s es (NOLs ); (6 ) are l i ab l e fo r l at e-fi l in g ad d i t i o n s t o t ax u n der s ect i o n 6 6 5 1 (a)(1 ); an d (7 ) are

2 Al l s t atut o ry

referen ces are t o th e In t ern al Rev en u e Co de (Co d e) i n effect fo r t h e y ears ati s su e, an d al l Ru l e referen ces are t o th e Tax Co u rtRu les o f Pract i ce an dPro cedu re. W e ro u n d al l m o n et ary am o u nt s t o th e n eares t d o l l ar.- 3
-

[* 3 ] l i ab l e fo r accu racy -rel at edp en al t i es . 3 W i th m in o r ex cep t i o n s , we wi l l s u s t ai n
res p o n d en t’ s d et erm i n at i o n s . FINDINGS OF FACT So m e o f t h e fact s h av e b een s ti p u lat ed an dare s o fo u n d. Th e s t ip u l at i o n s o f fact an dth e at t ach ed ex hi bi t s are i nco rp o rat edb y th i s referen ce. Pet i t i o n ers , wh o are h u s b an d an dwi fe, res id edi n W as hi n g to n , D.C., wh en th ey fi l edth ei r p et i t i o n s . A. Back g ro u n d Pet i t i o ner Geo rg e S. Lakn er i s a d i s t i n g u i s h edd oct o r an dp sy ch i at ri s t . He h as h el dt each i n g p o si t i on s atCo l u m b ia Un i v ers it y , Harv ardUn iv ers i ty , an d Geo rg e W as h in gt o n Un iv ers i ty . Befo re h e b eg an t each i n g , h e h ad a l o n g career i n th e U.S. Arm

y , du ri n g wh i ch h e was s t at io n edat v ari o u s m i l i t ary i n s t al lat i o n s i n th e Un i t edSt at es an do vers eas . He h as wo rk edwi th t h e Nat i o nal Gu ard , th e Vet
eran s Adm in is trat i o n (VA), an dth e Nat i o n al In s t i tu tes o f Heal th , al l i n h is cap aci ty as a p s y ch i at ri s t . Dr. Lakn er jo i n edth e Arm y i n 1 97 6 an dro s e t h ro u g h th e ran k s t o b eco m e a
co l o n el . Fro m

1 9 99 t o 2 0 0 1 h e was em p l o y ed b y th e VA M ed i cal Cen t er i n Lo m a Li n d a, Cal i fo rn i a. Du ri n g th atem p l o y m en t h e rai s edco n cern s wi th h i s s up eri o rs

3 In th e n o ti ce o f d efi ci en cy fo r 2 0 08 , 2 0 1 0 , an d2 0 1 1 , th e IRS as s ert ed , as al t ern at i v es t o th e frau d p en al t i es , accu racy -rel at edp en al ti es u nd er s ect i o n 6 6 6 2 (a).- 4
-

[* 4 ] th atv et eran s wi th m en tal h eal th p ro b l em s were recei v i n g i n ad equ at e care. In No v em b er 2 0 01 th e VA t erm i n at edh i s em p lo ym en t . In J an uary2 0 0 2 Dr. Lakn er fi l ed a Co m p lai n to f Em

p l oym en tDi s cri m i n at i on wi th the Equ al Em

p l o ym en tOp p o rtu n i ty

Co m m i s s i o n (EEOC), an dthe fo l
l o wi n g m o n th h e fi ledan am en d edEEOC co m p lai n t. Inb o th co m

p l ai nt s h e al
l eg edth ath e h adb een th e v i ct i m o f d i s cri m i nat i o n o n th e b as is o f rel i g i on , n at i o n al o ri gi n , ag e, an d/ o r d i s ab i l i ty . Inth e al t ern at i v e h e al l eg edth ath e h ad b een fi red
as a rep ri s al fo r p ro t ect ed act i v i ty i n wh i ch h e h aden gag ed . Th e reco rdi s u n cl ear
as t o th e s t atu s o f h i s co m p l ai ntb et w een 2 0 0 2 an d2 0 1 0
. Aft er l eav i n g th e VA, Dr. Lak n er was d ep l o y edt o Bo s n i a, wh ere h e was
s ev erel y i n juredb y a ro ad s i d e b o m

b i n 2 0 0 3 . Wh i l e reco v eri n g fro m h i s wo u n d s h e was d ep l o y edt o Ko s o v o . He al l eg es thati n Ko s o vo h e was co n fi n edfo r s ev eral m o n th s i n m i l i t ary i n s t al l at i on s b ecau se t he Army b el i ev edth atth e VA’ s t erm i
n at i o n o f h i s em

p l o ym en tren d eredh i s co n t i n u edm i l i tarys erv i ce u n l awfu l
. Aft er ret u rn i n g t o th e Un i t edSt at es Dr. Lakn er wen to n i n act i v e s t atu s i n 2 0 0 6 an dret i redfro m

th e Arm y i n 2 0 0 8 . Aro u n dth att i m e h e s t art ed a m ed i cal
co n su l t i n g p ract i ce t h ath e o perat eddu ri n g th e y ears ati s s u e. Th e reco rdi s u n cl ear as t o th e ex actn atu re o f h i s co n su l ti n g p ract i ce.- 5
-

[* 5 ] In J an uary2 0 1 0 th e EEOC h el da h eari ng o n Dr. Lakn er’ s co m p l ai n t s . Duri n g th i s h eari ng h is at t o rn ey rep res en t edth atth e s o l e i s s u e fo r ad j u d icat i o n was wh et h er Dr. Lakn er’ s em p l o ym en th adb een u nl awfu l l y t erm i n at edb y

the VA. Dr. Lakner t es t i fi edth ath e h adfi l edh i s co m p l ai n t b ecau s e h e b el i ev edthe VA h ad d i s cri m i n at edag ai n s t h im fo r b ei n g J ewi s h . Th e h eari n g tran s cri p tco n t ai n s n o referen ce t o an y

p h y s i cal s i ckn es s o r i n

jury s uffered b y

Dr. Lakn er. In J an uary2 0 1 0 Dr. Lakn er reach eda s et t lem en twi th th e VA. Un d er t h i s
s et t l em en th e recei v eda l u m p -s u m p aym en to f $ 3 2 8 ,0 00 , rep res en t i n g p ecu n i ary
an d n o np ecu n iaryd am ag es ; $ 1 7 2 ,0 0 0 fo r at t o rn ey s ’ fees ; an d $ 1 7 8 ,5 5 2 fo r accru edan nu al l eav e. Th e VA rep o rt ed the l at ter am o u n tt o h i m o n a Fo rm

W -2 , W ag e an dTax St at em en t . Pet i t i o ner M art ha G. Sm i th was a l i cen s edp ro p erty m an ag er du ri n g 2 0 0 7
- 2 0 1 1 . Sh e was em

p l o y edb y Real t o r Cat h i e Gi l l , In c., wh ere s h e s up erv is edth e fi rm ’ s p ro p ert y

m an ag em en ts erv i ces . Sh e al s o wo rk edas an i n d ep en d en tp ro p erty m an ag er. Du ri n g s o m e o r al l o f t hes e y ears p et i t io n ers o wn ed , jo i n t ly o r i n d i
v i du al l y , as m an y

as s i x ren t al p ro pert i es : fo u r i n W as h i ng t on , D.C., o n e i n Cal i
fo rn i a, an d o n e i n Co n n ect i cu t . M s. Sm i th m an ag edthes e ren t al p ro p ert i es .- 6
-

[* 6 ] B. Pet i t i o n ers ’ Tax Retu rn s Pet i t i o ners jo i nt l y

fi leda d el i n qu en tFo rm

1 0 4 0 , U.S. In di v idu al In co m e Tax Retu rn , fo r each y ear at i s su e. Th ey i ncl u d edi n each retu rn a Sch edu l e C. On each Sch edu l e C t h ey

rep o rt ed i n co m e an dex p en s es fo r Dr. Lakn er’ s m ed ical
co n su l t i n g b u s i n es s an dM s . Sm i th ’ s ren t al real es t at e act i v it y , wi th o u ti den t i fy i n g wh i ch i t em s rel at edt o wh i ch b u s i n es s . 1
. 2 00 7 Retu rn Fo r 2 0 0 7 p et it i o n ers rep o rt edn eg at i ve ad ju s t edg ro s s i n co m e (AGI) o f $ 6 7 ,1 0 6 . Onth ei r Sch edu l e C t h ey rep o rt edg ro s s recei p t s o f $ 58 ,4 0 0 an d t o t al
ex p en s es o f $ 13 0,2 1 3, fo r a n etl o s s o f $ 7 1 ,8 13 . Th e rep o rt edex p en s es were as fo l l o w s : I tem Amount

Commissions/fees $2,247 Insurance (other than health) 9,001 L e g al/professional services 31,369 Office supplies 862 Travel 2,389 Meals/entertainment 1,035 Utilities 4,441 Other 78,869 Total 130,213 Fo r 2 0 0 7 p et it i o n ers cl ai m edo n Sch edu l e A th e fo l l o wi n g d edu ct io n s :
m ed i cal ex p en s es o f $ 4,0 2 3 , St at e an dl o cal t ax es o f $ 2 2 ,7 3 1, an dh om e m o rt g ag e i n t eres to f $ 3 1 ,0 1 1 . Th ey al s o cl ai m ed an NOL d edu ct i o n o f $ 8 5,2 5 8
.- 7
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[* 7 ] 2
. 2 00 8 Retu rn Fo r 2 0 0 8 p et it i o n ers rep o rt edn eg at i ve AGI o f $ 13 6 ,6 8 5. Onthei r Sch ed
u l e C t h ey

rep o rt edg ro s s recei p t s o f $ 7 7 ,2 0 0 an d t o t al ex pen s es o f $ 1 9 1,3 5 0 , fo r a
n etl o s s o f $ 1 1 4,1 5 0. Th e rep o rt edex p en ses were as fo l l o ws : I tem Amount Commissions/fees $4,162 Insurance (other than health) 9,900 L e g al/professional services 43,362 Office supplies 1,247 Travel 2,257 Meals/entertainment 864 Utilities 4,762 Other 124,796 Total 191,350 Fo r 2 0 0 8 p et it i o n ers cl ai m edo n Sch edu l e A th e fo l l o wi n g d edu ct io n s :
m ed i cal ex p en s es o f $ 5,7 2 0 , St at e an dl o cal t ax es o f $ 3 4 ,2 1 0, an dh om e m o rt g ag e i n t eres to f $ 5 8 ,2 4 6 . Th ey al s o cl ai m ed an NOL d edu ct i o n o f $ 9 9,3 8 3
. 3
. 2 00 9 Retu rn Fo r 2 0 0 9 p et it i o n ers rep o rt edn eg at i ve AGI o f $ 19 3 ,4 7 1. Onthei r Sch ed
u l e C t h ey

rep o rt edg ro s s recei p t s o f $ 6 6 ,6 1 7 an d t o t al ex pen s es o f $ 1 7 6,1 2 1 , fo r a
n etl o s s o f $ 1 0 9,5 0 4. Th e rep o rt edex p en ses were as fo l l o ws : I tem Amount Commissions/fees $2,911 Insurance (other than health) 12,026 L e g al/professional services 40,561- 8
- Office supplies 1,440 Travel 1,999 Meals/entertainment 845 Utilities 4,021 Other 112,318 Total 176,121 Fo r 2 0 0 9 p et it i o n ers cl ai m edo n Sch edu l e A th e fo l l o wi n g d edu ct io n s :
m ed i cal ex p en s es o f $ 5,7 0 3 , St at e an dl o cal t ax es o f $ 2 7 ,1 3 6, an dh om e m o rt g ag e i n t eres to f $ 3 5 ,1 8 1 . Th ey al s o cl ai m ed an NOL d edu ct i o n o f $ 1 62 ,0 3 0
. 4
. 2 01 0 Retu rn Fo r 2 0 1 0 p et it i o n ers rep o rt edn eg at i ve AGI o f $ 22 6 ,6 9 3. Onthei r Sch ed
u l e C t h ey

rep o rt edg ro s s recei p t s o f $ 8 3 ,3 5 0 an d t o t al ex pen s es o f $ 1 6 6,5 4 4 , fo r a
n etl o s s o f $ 8 3 , 1 9 4
. Th e rep ort edex p en s es were as fo l l o ws : I tem Amount Insurance (other than health) $7,902 L e g al/professional services 637 Office supplies 2,640 Travel 1,324 Meals/entertainment 597 Utilities 3,753 Other 149,691 Total 166,544 Fo r 2 0 1 0 p et it i o n ers cl ai m edo n Sch edu l e A th e fo l l o wi n g d edu ct io n s :
m ed i cal ex p en s es o f $ 4,1 8 7 , St at e an dl o cal t ax es o f $ 2 3 ,5 0 4, h o m e m o rt g ag e i n t eres t o f $ 3 9 ,1 44 , an du n rei m b u rs edem

p l o y ee ex p en s es o f $ 7 0 0 . Th ey al s o cl ai m edan NOL d edu ct io n o f $ 2 1 9 ,8 5 5
. [* 8 ]- 9
-

[* 9 ] 5
. 2 01 1 Retu rn Fo r 2 0 1 1 p et it i o n ers rep o rt edn eg at i ve AGI o f $ 81 ,3 4 4
. Onth ei r Sch edu l e C t h ey rep o rt edg ro ss recei pt s o f $ 2 0 ,7 4 8 an dt o t al ex p en s es o f $ 1 0 3,5 5 4 , fo r a n et l o s s o f $ 8 2 ,8 0 6. Th e rep o rt edex p en s es were as fo l l ows : I tem Amount Commissions/fees $1,900 Insurance (other than health) 1,763 Office supplies 4,101 Meals/entertainment 1,593 Other 94,197 Total 103,554 Fo r 2 0 1 1 p et it i o n ers cl ai m edo n Sch edu l e A th e fo l l o wi n g d edu ct io n s :
m ed i cal ex p en s es o f $ 4,3 9 7 , St at e an dl o cal t ax es o f $ 3 7 ,8 0 3, an dh om e m o rt g ag e i n t eres to f $ 8 ,5 1 4 . Th ey

cl ai m edan NOL d edu ct io n o f $ 2 5 0 ,7 7 3 an drep o rt edo n Sch edu l e E a real es t at e n etl o s s o f $ 2 5 ,0 0 0. 6
. IRS Ex am i n at io n Th e IRS s el ect edp et i t i o n ers ’ 2 00 7 -2 0 11 retu rn s fo r ex am i n at i o n. Onth e b as i s o f a b an kd ep os i ts an al y s i s th e IRS d et erm i n edth atp et i t i o ners h ado m i t t ed
ren t al i n co m e fro m al l o f t h ei r ren t al p ro p ert i es fo r 2 0 0 8 an d 2 01 0 ; h ad o m i t t ed g ro s s recei p ts fro m

Dr. Lakn er’ s m ed ical co ns u lt i ng b u s i n es s fo r 2 00 8 an d2 0 1 0 ;
an d h ado m i t t eda t ax ab le s et t l em en tp aym en tfro m th e VA fo r 2 0 1 0
. Th e IRS d i d- 1 0 -

[* 1 0 ] n o tp erfo rm a b an kd ep o s i t s an al y si s fo r th e o th er y ears b u t d et erm i n edthat p et i t i o n ers h ado m i t teds p eci fi c i t em s o f g ro s s i nco m e fo r 2 0 07 , 2 0 0 9 , an d2 0 1 1
. Th e IRS d i sal l owedfo r l acko f s ub s tan t i at i on s o m e o f t h e d edu ct io n s cl ai m edo n p et it i o n ers ’ Sch edu l es A an dal l o f t h e d edu ct i o n s cl ai m edo n th ei r Sch edu l es C. Aft er m ak i n g v ari o u s co m p u t at io n al ad

ju s t m en t s th atare n o t at i s su e h ere, 4 th e IRS d et erm i n edth e d efi ci en ci es s etfo rt h s up ra p . 2
. Th e IRS al so d et erm i n edl at e-fi l i ng ad d i t i o n s t o t ax fo r al l fi ve y ears ; accu racy -rel at edp en al t i es fo r 2 0 0 7 an d 2 0 0 9; frau dp en al t i es fo r 2 0 0 8 , 2 0 1 0 , an d 2 0 1 1 ; an daccu racy -rel at ed p en al t i es as al t ern at i v es t o th e frau dp en al t i es fo r t h e l at t er t h ree y ears . Th e IRS i s s u edp et i t i o n ers three t i m el y n o t i ces o f d efi ci en cy --o ne fo r 2 0 0 7,
o n e fo r 2 0 0 9 , an dth e t h i rdfo r 2 0 0 8 , 2 01 0 , an d2 0 11 --s et t i n g fo rth th e d efi ci en ci es , ad d i t i o n s t o t ax , an d p en al t i es n o t edab o v e. Pet i t i o n ers t i m el y p et i t i o nedth is Co u rtfo r red et erm i n at i o n . W e co n s o l i d at edth e t h ree cas es fo r p u rp o s es o f t ri al , b ri efi n g , an d o p i n io n . Th e cas es were p art i al l y tri edi n Sep t em

b er 2 0 13 , an da fu rt her t ri al was h el di n Decem b er 2 0 1 6
.

4 Th e IRS m ad e co m

p u t at i o n al ad

ju s t m en t s t o th e t ax ab l e p o rt i o n s o f p et i
t i on ers ’ So ci al Secu ri ty

i n co m e fo r al l y ears , i tem izedd edu ct io n s fo r 2 0 0 8 -2 0 1 1 , an d p ers on al ex em

p t io n s fo r 2 0 0 8 . W e l eav e t h es e ad ju s t m en t s t o th e p art i es ’ Ru l e 1 5 5 co m

pu t at i o n s.- 1 1 -

[* 1 1 ] OPINION I. Bu rd en o f Pro o f Th e IRS’ d et erm i n at i o ns i n a n o t i ce o f d efi ci en cy are g en eral l y

p res u m ed
co rrect , an dt ax pay ers b ear t h e b u rd eno f p ro vi n g t h em erro n eo u s . Ru l e 1 4 2 (a); W el ch v . Hel v eri n g , 2 9 0 U.S. 1 1 1 , 1 1 5 (1 9 3 3). Fo r t h e p res u m p t i o n o f co rrect n es s t o at t ach t o a d efi ci en cy d et erm i n at i o n o f u nrep o rt edi n co m e, t h e Co m m i s si o n er
m u stg en eral l y

es tab l i s h a “ m i n i m al ev i d en t i ary s h o wi n g ” co n n ect in g th e t ax p ay er wi th th e i n co m e-p ro du ci n g act i v i ty , s ee Bl o h m v . Co m m i ss i o n er, 9 9 4 F.2 d1 5 4 2 , 1 5 4 8 -1 5 4 9 (1 1 th Ci r. 1 9 9 3), aff’ g T.C. M em o . 1 9 91 -6 3 6 , o r d em o n s trat e t h atth e t ax p ay er act u al l y

recei v edu n rep o rt edi n co m e, s ee Ed ward s v . Co m m i s si o n er, 6 8 0 F.2 d1 2 6 8 , 1 2 7 0 (9 th Ci r. 1 9 8 2 ). On ce t h e Co m m i s s i o n er m ak es th e req u i red th res ho l ds h o wi n g , th e b u rd en o f p ro o f s h i ft s t o th e t ax p ay er t o p ro v e b y a p rep o n d eran ce o f t h e ev i d en ce t h atth e Co m m i s si on er’ s d et erm i n at i o n s are arb i traryo r
erro neo u s . Hel v eri ng v . Tay l o r, 2 9 3 U.S. 5 0 7 , 5 1 5 (1 9 3 5 ); To k ars k i v . Co m m i s s i on er, 8 7 T.C. 7 4 (1 9 8 6 ). To s at i s fy h i s b u rd eno f p ro du ct i o n reg ard i ng u n rep o rt edi n co m e fo r 2 0 0 8
an d 2 0 1 0 , res p o n den ti n tro du ced b an k reco rd s o b t ai n eddu ri n g t h e IRS au d i t . Th es e reco rd s es t ab l is h th atp et i t i o n ers recei v edu n rep o rt edi n co m e fro m Dr. Lak
n er’ s m ed i cal co n s u l t i n g b u s i n es s an dfro m M s . Sm i th ’ s ren t al real es t at e act i v i t y .- 1 2 -

[* 1 2 ] An dth ey

es t ab l i sh th atDr. Lakner i n 2 0 1 0 recei v edfro m th e VA a ch eckfo r $ 3 2 8 ,0 0 0 . Res p o n den th as th erefo re m ad e wh at ev er “ m i n i m al ev i den t i ary s h o wi n g ” h e m i g h tb e req ui redt o m ak e. Hi s d et erm i n at io ns o f u n rep o rt edi n co m e are th u s en t i t l edt o th e g en eral p res u m p ti o n o f co rrect n es s. See Po wers tei n v . Co m m i s s i o n er, T.C. M em o . 2 0 1 1 -2 7 1 , 1 02 T.C.M
. (CCH) 4 97 , 5 06
. Pet i t i o ners th u s b ear t h e b u rd eno f p ro v i n g b y a p rep on d eran ce o f t h e ev i
d en ce th atres p o n d en t ’ s d et erm i n at i o n s o f u n rep o rt edi n co m e are arb it rary o r erro n eo u s . See W i l li am s v . Co m m i ss i o n er, 9 99 F.2 d 7 6 0 , 7 6 3 (4 th Ci r. 1 9 93 ) (ci t i n g Hel v eri n g v . Tay l o r, 2 93 U.S. at5 1 5 ), aff’ g T.C. M em o. 1 9 9 2 -1 5 3 ; To k ars k i , 8 7 T.C. at7 7 . Pet i t i o n ers l ik ewi s e b ear t h e b u rd eno f p ro v i n g th ei r en t i t l em en tt o d educt i o n s al l o wedb y

the Co d e an do f s ub s t an t i at i n g the am o u n t s o f cl ai m ed d educt i o n s . See INDOPCO, In c. v . Co m m i s s i o n er, 5 0 3 U.S. 7 9 , 8 4 (1 9 9 2); s ec. 1 .6 00 1 -1 (a), In co m e Tax Reg s . Pet i t i o ners d o n o tco n ten d , an dth ey co ul dn o t p l au s i b l y co nt en d , th atth e b u rd en o f p ro o f as t o an y i s s u e o f fact s h o u lds h i ftt o
res p o n d en t u n der s ect i o n 7 4 9 1 (a). II. Un rep o rt edIn co m e Sect io n 6 1 (a) d efi n es g ro s s i n co m e as “ al l i n co m e fro m wh at ev er s o u rce d eri v ed ,” i ncl ud in g i nco m e d eri v edfro m b u s i n es s . Ex cl u s i o n s fro m g ro s s i n co m e
are n arro w l y

co ns tru ed . Co m

m i s s i o n er v . Sch l ei er, 5 1 5 U.S. 3 2 3 , 3 2 8 (1 9 95 );- 1 3 -

[* 1 3 ] Co m

m i s si o n er v . Gl en s h aw Gl as s Co ., 3 4 8 U.S. 4 2 6 , 4 2 9 -4 3 0 (1 9 55 ); Hel v eri n g v . Cl iffo rd , 3 0 9 U.S. 3 3 1 , 3 3 4 (1 9 4 0 ). A t ax p ay er m u stm ai n t ai n b o o k s
an d reco rd s es t ab l i sh i n g th e am o u n to f h i s o r h er g ro ss i nco m e. See s ec. 6 0 0 1
. Wh en a t ax pay er d o es n o tk eep accu rat e b o o k s an dreco rd s , th e IRS m ay d et erm i n e h i s o r h er i n co m e “ u n d er s u ch m et h o d as , i n the o p i ni o n o f t h e Secret ary , d o es cl earl y

refl ecti n co m e.” Sec. 4 4 6 (b ); s ee Pet zo l dtv . Co m m i s s i o n er, 9 2 T.C. 6 6 1 , 6 9 3 (1 9 8 9). An d wh ere t he t ax p ay er h as u nex p lai n edb an k d ep o s i t s , th e IRS
m ay em p l o y th e b an kd ep o s i ts m et h o dt o es t i m at e i nco m e. Es t at e o f Hag u e v . Co m m i s s i o n er, 1 3 2 F.2 d7 7 5 (2 dCi r. 1 9 43 ), aff’ g 4 5 B.T.A. 1 04 (1 9 4 1 ); Es t at e o f M as o n v . Co m

m i ss i o n er, 6 4 T.C. 6 5 1 , 6 5 7 (1 9 7 5 ), aff’ d , 5 6 6 F.2 d 2 (6 th Ci r. 1 9 7 7 ). Th e IRS h as g reat l at i tu d e i n reco n s tru ct i n g a t ax p ay er’ s i n co m e, an dth e
reco n s tru ct i o n “ need o n l y b e reas o n ab l e i n l i g h t o f al l s u rro u nd i ng fact s an dci rcu m s t an ces .” Pet zo ld t, 9 2 T.C. at6 87
. Ban kd ep o s i t s are p ri m a faci e ev i den ce o f i nco m e. Th e b an kd ep os i t s m et h
o ds t art s wi th th e p res um p t i o n th atal l m o n ey

d ep o s i t edi nt o a t ax p ay er’ s b an kacco u ntdu ri n g a g i v en p eri o dco n s t i tu t es t ax ab l e i nco m e. Pri ce v . Un i tedSt at es , 3 3 5 F.2 d6 7 1, 6 7 7 (5 th Ci r. 1 9 64 ). Th i s p res u m p t i o n i s reb u t t edt o th e ex t en tth e d ep os i t s are s h o wnt o i n cl u d e n o n t ax ab le am o un t s , an d“ th e Go v ern m en tm u s t t ak e i n t o acco u n tan y

n o n -t ax ab l e s o u rce * * * o f wh i ch i th as kn o wl ed g e.” Ib i d
. ;- 1 4 -

[* 1 4 ] Di L eo v . Co m

m is s i o n er, 9 6 T.C. 8 5 8 , 8 6 8 (1 9 9 1 ), aff’ d , 9 5 9 F.2 d1 6 (2 d Ci r. 1 9 92 ). Aft er t h e IRS reco n s tru ct s a t ax p ay er’ s i n co m e an dd et erm i n es a d efi ci en cy , th e t ax p ay er b ears the b urd eno f p ro v in g th atth e IRS’ i m p lem en t at i on o f t h e b an k d ep os i t s m et h o dwas u n fai r o r i n accu rat e. See Cl ayt o n v . Co m m i ss i o n er, 1 0 2 T.C. 6 3 2 , 6 4 5 -6 4 6 (1 9 94 ); Di Leo , 9 6 T.C. at8 7 1 -8 7 2
. Th e t ax p ay er m ay d o s o b y
s h o wi n g (am on g o th er t h in gs ) t h atcert ai n d ep os i t s cam e fro m n o n t ax ab l e s o u rces . See Cl ayt o n , 1 0 2 T.C. at6 4 5 . No n t ax ab le s ou rces i n cl u d e fu n d s at tri b ut ab l e t o i n t eracco u ntb an k tran s fers an d ret u rn edch eck s as wel l as “ l o an s , g i ft s, i n h eri t an ces , o r as s et s o n h an d at th e b eg i n n i n g o f t h e t ax ab l e p eri o d
. ” Bu rg o v . Co m m i s s i o n er, 6 9 T.C. 7 2 9, 7 4 3 n .1 4 (1 9 78 ) (qu o t i n g Tro ncel l it i v . Co m m i s s io n er, T.C. M em o . 1 97 1 -7 2 ). A. Un rep o rt edIn co m e fo r 2 00 8 an d2 0 1 0 Fi n d i n g t h atp et it i o n ers l ack edad equ at e b o ok s an dreco rd s fo r 2 0 08 an d 2 0 1 0 , th e rev en u e ag en t (RA) em p l o y ed th e b an kd ep o s i t s m et ho dt o reco n s tru ct th ei r i n co m e fo r t h o s e y ears . Aft er o bt ai n in g p et i t i o n ers ’ b an ks t at em en t s b y i s s u i n g s u m

m o n s es t o th ei r b an k s , th e RA u s edth e s t at em en t s (wh i ch are p arto f t h e
reco rd ) t o p rep are s ch edu l es l is t i n g al l d ep o s i t s . Aft er el im i n at i n g n o n t ax ab l e recei p t s o f wh i ch h e was aware, an dfu rt h er redu ci n g th e t ot al b an k d ep os i t s b y th e- 1 5 -

[* 1 5 ] i n co m e p et i t i o ners rep ort edo n th ei r retu rn s , th e RA p rep aredan dp ro v i d ed t o p et i ti o n ers s ch edu l es th atd et erm i n edu nrep o rt edi n co m e. Th e RA d et erm i n ed th atth is u n rep o rt edi nco m e was at tri b u t ab l e t o Dr. Lakner’ s m ed i cal co n s u l t i n g b u s i n es s , M s . Sm i th ’ s ren tal real es t at e act i vi ty , th e VA s et t l em en tp aym en t , an da
s ep arat e l i t i g at io n s et t lem en to f ani ns u ran ce cl ai m . Pet i t i o ners d o n otch al l en g e t h e RA’ s u s e o f t h e b an kd ep os i t s m et h o do r h i s d et erm i n at i o n th atth ei r co n s u lt i n g an dren t al i n co m e was t ax ab le. Rat h er, t h ey
co n ten d th ath e m i s ap pl iedth e b an kd ep o si ts m etho db y : (1 ) fai li n g t o ex cl u d e t h e VA s et t l em en tp aym en t , (2 ) fai l i n g t o ex cl u d e o th er al leg ed l y n o n t ax ab l e am o u n t s , an d (3 ) m i s ch aract eri zi n g cert ai n recei pt s as ren t al i nco m e.

1
. VA Set t l em en tPaym en t Pet i t i o ners as s ertth atat l eas tp arto f th e VA s et t l em en tp aym en t th eyrecei v edi n 2 0 1 0 was n o nt ax ab le b ecau s e i trep res en t edd am ag es fo r t h e p h y s i cal i n jury Dr. Lakn er s u s t ai nedi n Bo s n i a i n 2 0 03 . Pro ceed s fro m l i t ig at i o n s et tl em en ts
co n st i tu t e g ro s s i n co m e u n les s th e t ax p ay er p ro v es th atth e p ro ceed s fal l wi th i n a
s p eci fi c s t atut o ry

ex cl u si o n . Sch l ei er, 5 1 5 U.S. at3 2 8-3 3 7 ; Sav e v . Co m m i s s i o n er, T.C. M em o . 2 0 09 -2 0 9, 9 8 T.C.M . (CCH) 2 1 8, 2 1 8 . Th e ex cl u s i o n fro m g ro s s i n co m e up o n wh i ch p et i t i o n ers rel y ap pears i n s ect i on 1 0 4 (a)(2 ). It p ro v i d es th at g ro s s i n co m e d o es n o ti ncl u d e d am ag es recei v ed“ o n acco un t o f p ers o n al p h y s ical- 1 6 -

[* 1 6 ] i n juri es o r p h y s i cal s ickn es s . ” Fo r t h i s p u rp o s e, “ em o ti o n al d i s tres s s h al l
n o tb e t reat ed as a p h y s i cal i n jury o r p h y s i cal s i ckn es s .” Sec. 1 0 4(a) (p en ul t i m at e
s en t en ce). Wh en d am ag es are recei v edu n d er a s et t l em en t ag reem en t, th e n atu re o f t h e cl ai m th atwas th e act ual b as i s fo r t h e s et t lem en td et erm in es wh et h er t h e d am ag es
are ex cl u d ab l e u n d er s ect i o n 1 0 4 (a)(2 ). Un i tedSt at es v . Bu rk e, 5 0 4 U.S. 2 2 9 , 2 3 7 (1 9 9 2). “ Th e n atu re o f th e cl ai m ” i s ty p i cal l y d et erm i nedb y

referen ce t o th e t erm s
o f t h e ag reem en t . See Kn uck l es v . Co m m i s s io n er, 3 4 9 F.2 d6 1 0 , 6 1 3 (1 0 th Ci r. 1 9 6 5 ), aff’ g T.C. M em o . 1 9 6 4 -3 3 ; Ro b i n s o n v . Co m m is s i o n er, 1 02 T.C. 1 1 6 , 1 2 6 (1 9 9 4), aff’ di n p art , rev ’ di n p art , an drem an d edo n an o th er i ss u e, 7 0 F.3 d3 4 (5 t h Ci r. 1 9 95 ). If t h e s et t l em en t ag reem en td o es n otex p l ici t l y s t at e wh i ch cl ai m s th e p aym en t was m ad e t o s et t l e, “ the i nt en to f t he p ay o r * * * i s cri t i cal .” Lo n go ri a v . Co m m i s s i o n er, T.C. M em o . 2 0 0 9 -1 6 2 , 9 8 T.C.M . (CCH) 1 1 , 1 5 ; s ee Geo rg e v . Co m m i s s i o n er, T.C. M em o . 2 0 1 6 -1 5 6 , 1 1 2 T.C.M . (CCH) 2 3 9 , 2 4 0
. Th e i n ten to f t he p ay o r m ay b e d et erm i n edb y co n s id eri n g al l rel ev an tfact s , i n cl u d i n g th e am o u n tp ai d , th e ci rcu m s t an ces l ead i n g t o th e s et t l em en t , an dth e al
l eg at io n s i n th e i n

juredp art y ’ s co m

p l ai n t . Green v . Co m

m is s i o n er, 5 0 7 F.3 d8 5 7 , 8 6 8 (5 th Ci r. 2 0 07 ), aff’ g T.C. M em o . 2 0 05 -2 5 0 ; Ben t v . Co m m i s s io n er, 8 7 T.C. 2 3 6 , 2 4 5 (1 9 8 6), aff’ d , 8 3 5 F.2 d6 7 (3 dCi r. 1 9 87 ). “ [T] h e n ature o f u n d erl y i n g- 1 7 -

[* 1 7 ] cl ai m s can n otb e d et erm i n edfro m a g en eral rel eas e t h ati s b ro ad an d i n cl u s i v e.” Ah m ed v . Co m m i ss i o n er, T.C. M em o . 2 0 1 1 -2 9 5 , 1 0 2 T.C.M . (CCH) 6 0 7 , 6 0 8 , aff’ d , 4 98 F. Ap p ’ x 9 1 9 (1 1 th Ci r. 2 01 2 ). In h i s EEOC co m

p l ai n t s Dr. Lakn er al l eg edth atth e VA h ad t erm i n at edh i s
em pl o y m en tb ecau s e o f h i s J ewi s h an ces try an drel i gi o n an d as rep ri sal fo r h i s ad v ocacyo n b eh al f o f v et eran s wi th p s y ch o l og i cal i l l n es s . Hi s o ri g in al an d
am en d edco m

p l ai nt s were fi l edi n 2 0 0 2
. Th ey d i dn o tm en t i o n (n o r co u l dth ey p o s s i b l y h av e m en t i o n ed ) t h e i n

jury h e s u s t ai n edi n 2 00 3
. Th e EEOC h eari n g was h el di n 2 0 1 0 . Duri n g th ath eari n g Dr. Lakn er’ s at t o rn ey s t at ed th at th e s o l e i s s u e fo r ad ju di cat io n was wh et h er Dr. Lakn er’ s em p l o ym en twi th th e VA h adb een u n l awfu l l y t erm i n at ed i n 2 0 0 1. Nei ther h is co m p l ai n tn o r t h e h eari n g tran s cri p tco n t ai n s an y referen ce t o p hy si cal i n

j u ry o r p h y s i
cal s i ckn es s . Th e s et t l em en tag reem en tb et ween Dr. Lakn er an dth e VA s t at es th ati tres o l v es al l m at t ers h e h adrai s edi n h i s co m p l ai n t . Th e VA ag reedt o p ay $ 3 2 8 ,0 0 0 i n p ecu n i ary

an dn o np ecu n iaryd am ag es , m ak e a l um p -s u m p aym en tfo r accru ed
an n ual l eav e, an d p ay

Dr. Lakn er’ s at to rn ey ’ s fees . Th ere i s n o m en t i o n o f an y p h y s i cal i n

jury h e h ads u ffered . Inex ch an g e fo r t h e VA’ s p aym en t s , Dr. Lakn er ag reedt o “ wi th draw, i n th ei r en t i ret y , al l d i s cri m i nat i on co m p l ai n t s . ” Ap artfro m- 1 8 -

[* 1 8 ] Dr. Lakn er’ s t es t i m on y attri al , th ere i s n o ev id en ce t h atth e EEOC s et t l em en tp aym en trep res en tedco m p en s at i o n fo r t he i n

juri es h e s u s t ai n edi n Bo s n i a. Dr. Lakn er co n t en d s t h atth e i n jury h e s us t ai n ed i n Bo s ni a was ex acerb at ed b y h i s al l eg ed co n fi n em en ti n Ko s ov o an dth atth e VA s et t l em en tag reem en th ad

“ l i n k ag e” t o th o s e ev en t s . Bu t i n d eci d i n g wh eth er a s et t l em en tp aym en ti s ex cl u d ab l e u n d er s ect io n 1 0 4 (a)(2 ), th e cru ci al qu es t i o n i s wh et h er t h e s et t l em en t
am ou n twas actu al l y

p ai d t o redres s a p h y s i cal i n jury . See M o l i n a v . Co m m i s s i o n er, T.C. M em o . 2 0 13 -2 2 6, 1 0 6 T.C.M . (CCH) 3 71 , 3 7 3 . Dr. Lakn er al leg edn o p h y s i cal i n

jury i n h is EEOC co m

p l ai n t s , an d th e s et t l em en t ag reem en t cl earl y
s t at es th atth e VA s et t l edth e cas e i n co n s i d erat i o n o f h is ag reem en tt o wi th draw

“ al l d i s cri m i n at i on co m

p l ai n t s ” h e h adm ad e. Gi v in g p ri m acy t o t h e t erm s o f t h e
s et t l em en tag reem en tan dt o “ th e i n t en t o f t h e p ay o r,” Lo n g o ri a, 9 8 T.C.M . (CCH) at1 5 , we fi n dth atth e VA i nt en d edt o s et t l e, an dd i d s et t l e, Dr. Lakn er’ s cl ai m s o f d i s cri m i n at i o n b as ed o n rel ig i o n , n at i on al o ri g i n , an drep ri s al
. 5 W e acco rd i n g l y

5 Dr. Lakn er al s o ag reed t o wai v e “ hi s ri g h tt o p u rs u e fu tu re cau s es o f act i o n ag ai n s tth e Ag en cy

b as ed o n fact s i n ex i s t en ce as o f t h e d at e o f * * * th i s Ag reem en t .” W e h av e fo u n ds u ch g en eral , p ro s p ect i v e wai v ers i n ad equ at e t o s ho w th at a s et t lem en tp aym en twas m ad e fo r a p h y s i cal i nju ry . See Dev i n e v . Co m m i s s i o n er, T.C. M em o . 2 0 17 -1 1 1, 1 1 3 T.C.M . (CCH) 1 49 6 , 1 4 9 9 . Inan y ev en t , ev en i f p et i t i o n ers co u l ds h o w thats o m e p o rt i o n o f t he $ 3 28 ,0 0 0 s et t l em en t was at tri
b u t ab l e t o p h y s i cal i n

jury , th ey h av e o ffered n o ev i d en t i ary b as is fo r cal cu l at i n g th atp o rt i o n an d wo u l dth u s fai l t o m eetth ei r b u rd en o f p ro o f.- 1 9 -

[* 1 9 ] h o l dth atth e $ 3 2 8 ,0 0 0 VA s et t l em en tp aym en twas n otrecei v ed“ o n acco u n t
o f p ers o n al p h y s i cal i n

juri es o r p hy s i cal s i ckn es s ” an di s th erefo re n o tex cl u d ab l e fro m g ro s s i n co m e u n d er s ect i on 1 0 4 (a)(2 ). 2
. Oth er In co m e fo r 2 0 0 8 an d2 0 1 0 Du ri n g 2 0 0 8 an d2 0 1 0 p et i ti o ners m ai nt ai n ed 1 0 t o 1 2 p ers o nal b an kacco u nt s i n t o wh i ch th ey

m ad e d ep o si t s. Wh en p erfo rm i n g h i s b an kd ep o s i t s an al y s i s, the RA s ubt ract edfro m p et i t i o n ers ’ t o t al d ep os i t s fo r 2 0 0 8 an d 2 0 1 0 n on t ax ab l e t ran s fers o f $ 2 1 6,3 5 7 an d$ 5 23 ,7 9 5 , res p ect i v el y . Th es e cal cu l at i o n s y i el d ed n ett ax ab le d ep o s i t s o f $ 3 0 5 ,3 2 7 an d $ 8 8 5 ,6 84 , res p ect i v el y . Fro m th es e
s u m s h e s ub tract edth e g ro ss i n co m e p et i t io n ers h ad rep o rt edo n th ei r 2 0 0 8 an d 2 0 1 0 t ax retu rn s , i .e., $ 1 7 9,4 0 5 an d $ 1 8 6 ,4 2 0 , res pect i v el y . Th is y i el d edn etu n rep o rt edi n co m e o f $ 1 25 ,9 2 2 fo r 2 0 0 8 an d $ 6 9 9 ,2 6 4 fo r 2 0 10 . Us i n g i n fo rm at i o n i n the b an kreco rd s , th e RA al l o cat edth i s u n rep ort edi n co m e i n to th ree cat eg o ri es (t he $ 3 2 8 ,0 0 0 VA s et t lem en tp aym en ti s i n cl ud edi n the Sch edu l e C t o t al fo r 2 0 1 0 ): I tem 2008 2010 L itig ation settlement proceeds -0- $275,000 Medical consulting(Schedule C) $92,887 334,175 Rental real estate (Schedule E) 33,035 90,089 Total 125,922 699,264- 2 0 -

[* 2 0 ] Th e l i ti g at i o n p ro ceed s o f $ 2 7 5,0 0 0 refl ect edan i n s uran ce s et tl em en tp et i
t i on ers recei vedi n 2 01 0 fo l l owi n g a cas ual ty l os s t o o n e o f t h ei r ren t al h om es . Th i s l o s s was cau s edb y

a n ei g hb o r wh o d i du n au th o ri zedwo rko n h i s p ro p ert y , res u l ti n g i n a l an d s l i de t h at d am ag edth e ret ai n i n g wal l o n p et i t i o n ers ’ p ro p ert y . Res po n d en tco n ced edi n h i s p o s t -tri al b ri ef t h atth es e i n s u ran ce p ro ceed s were ex cl u d ab l e fro m

g ro ss i n co m e an dh en ce t h at th e $ 2 7 5,0 0 0 was a n o n tax ab l e d ep o s i t . Pet i t io n ers ’ u n rep o rt edi n co m e fo r 2 0 1 0 , i n cl u d in g t h e VA s et t l em en tp aym en t , i s th u s redu cedt o $ 42 4 ,2 6 4
. Pet i t i o ners h av e s upp l i edn o cred i b l e ev i d en ce t h at wo u l dju s t i fy el i m i n at i n g an y o th er b an k d ep o s i t s as n o n t ax ab le i t em s . Pet i ti o n ers h av e s t i pu l at edth at th ey d i dn o trecei v e an y g i ft s o r i n h eri t an ces du ri n g t h es e y ears . Co n traryt o th ei r
co n ten t i o n , th e RA co rrect l y acco un t edfo r i n teracco u n ttran s fers o f $ 15 8 ,4 4 3 fo r 2 0 0 8 an d$ 7 6 ,1 2 2 fo r 2 0 1 0
. Pet i t i o n ers as s ertthata $ 7 1 9 ch eckth at Dr. Lakn er recei v edfro m

the VA i n 2 0 0 8 was ex cl u dab l e fro m g ro s s i n co m e u n d er s ect i o n 1 0 4 , b u tth ey

p ro vi dedn o cred i b l e ev i d en ce t h atth e VA m ad e t h i s p aym en to n
acco u n t of d i s ab i l i ty , p h y s i cal i n jury , o r p h y s i cal s ickn es s . Th ere i s l i k ewi s e n o fact u al b as i s fo r p et i t i o n ers ’ as s ert i o n thatth e RA erred i n ch aract eri zi ng cert ai n b an kd ep o s i t s as ren tal i n co m e. Each d ep o s i tth atth e RA ch aract eri zedas ren tco rres p o n d edt o a ch eckth atn am edo ne o r b o th p et i t i o n ers as- 2 1 -

[* 2 1 ] p ay ees an dei th er (1 ) b o re t h e n o t at i o n “ ren t ” o n th e m em o l in e o r (2 ) s h o wedan ad dres s m at ch i n g t h e ad dres s o f o n e o f p et it i on ers ’ ren t al p ro p ert i es . Pet i
t i on ers as s ertth atth e RA d oub l e-co u n tedcert ai n d ep o s it s b y treat i n g th em

as ren t , b u tth ey h av e s up p li edn o ev i d en t i ary s up p ortfo r t h atas s ert i o n . In s u m , we fi n d th at pet i t i o n ers h av e fai l edt o carryth ei r b u rd en o f s h o wi n g
erro r i n th e RA’ s b an kd ep o s i t s an al y s i s fo r 2 0 08 o r 2 0 1 0 , ap artfro m th e erro n eo u s i n cl u s i o n o f t h e $ 2 7 5 ,0 0 0 i n s u ran ce s et t l em en t as co nced ed b y res p o n d en t . W e acco rd in g l y fi n dth atp et i t i o n ers h adu n rep o rt edi n co m e o f $ 1 25 ,9 2 2 fo r 2 0 0 8
an d $ 4 2 4 ,2 6 4 fo r 2 0 1 0 , al lo cab l e b etween Sch edu l e C an dSch edu l e E as s h o wn
o n th e t ab l e ab o v e. See s up ra p . 1 9. B. Un rep o rt edIn co m e fo r 2 00 7 , 2 0 0 9, an d 2 01 1 Fo r 2 0 0 7 p et it i o n ers co n ced e t h atth ey fai l ed t o rep ortt ax ab l e i nt eres ti n co m e o f $ 3 4 ,3 5 7. Fo r 2 0 1 1 res p o n d en tco n ced es th at a $ 2 8 , 7 35 d i s tri b u t i o n p et i
t i on ers recei vedfro m

an IRA acco u n t was n o ti n cl u d ab l e i n g ro s s i n co m e. W e th u s s u s t ai n res p o n d en t ’ s d et erm i n at i o n o f u n rep ort edi nco m e fo r 2 0 07 , b utn o tfo r 2 0 1 1
. Fo r 2 0 0 7 an d2 00 9 p et it i o n ers co n ten dth at th e RA erred i n al l o cat i n g i n co m e b et ween Sch edu l e C an dSch edul e E. Fo r b o th y ears p et i ti o n ers l u m p edt o g et h er, o n a s i ng l e Sch edu l e C, t h e i nco m e an dex p en s es co n nect edwi th Dr. Lak
-- 2 2 -

[* 2 2 ] n er’ s m ed i cal co n s u l t i n g b u s i n es s an dth e i n co m e an dex p en s es co nn ect ed wi th M s . Sm i th ’ s ren t al real es t at e act i v i ty . Th e l at ter am o u n t s s ho u l dh av e b een rep o rt edo n Sch edu l e E. Gi v en th e d i s arrayi n p et i t i o ners ’ reco rd keep i n g, u n t an gl i ng th e t wo s tream s o f i n co m e an dex p en s es was n o eas y t as k. Us i ng i n fo rm at i o n i n p et i ti o n ers ’ b an k reco rd s , th e RA d et erm i n edth at$ 5 8 ,4 00 o f Sch edu l e C g ro ss recei p t s fo r 2 0 0 7 an d$ 6 6 ,6 17 o f Sch edu l e C g ro s s recei p t s fo r 2 00 9 s h o u l db e rech aract eri zedas ren t al i n co m e an dtran s ferredt o Sch edu l e E. Pet i t i o n ers h av e n o t
s h o wnth atth i s d et erm i n at i on was arb i traryo r erro n eo us . III. Sch edu l e A Dedu ct i o n s Fo r 2 0 0 8 p et it i o n ers cl ai m eda d edu ct io n o f $ 5 8 ,2 4 6 fo r h o m e m o rt g ag e i n t eres tex p en se. Th e IRS red uced th e al l owab l e d edu ct i o n t o $ 3 5 ,6 6 9 , d et erm i ni n g th atp et i t i o n ers h adfai l edt o s ub s t an t i at e t h e rem ai n der. Pet i t i o n ers i n tro du ced
n o cred i b l e ev i d en ce t o s up p orta d edu ct i o n l arg er t h an th e IRS h as al l o w ed
. Fo r 2 0 0 8, 2 0 1 0 , an d2 0 1 1 p et i t io n ers d edu ct edSt at e an dl o cal t ax es o f $ 3 4 ,2 1 0 , $ 2 3,5 0 4, an d$ 37 ,8 03 , res p ect i v el y . Th e IRS i n t h e n o t ice o f d efi ci en cy d i s al lo wedth es e d edu ct i o n s i n th ei r en t i ret y . Inh i s p os t -t ri al b ri ef res p o n d en t
co n ced edth atp et i t io n ers are en t i t l edt o St at e t ax d edu ct i o n s o f $ 4 , 1 9 7 fo r 2 0 0 8 , $ 4 ,1 2 0 fo r 2 01 0 , an d $ 3 2 , 3 9 0 fo r 2 0 1 1 . Pet i t io n ers i n tro du cedn o cred i b l e ev i
-- 2 3 -

[* 2 3 ] d en ce t o s ub s t an t i at e d edu ct i o n s fo r St at e t ax es i n am o un t s l arg er t han
res p o n d en t h as co n ced ed
. 6 IV. Sch edu l e C Dedu ct i o n s Dedu ct i o n s are a m at t er o f l eg i s l at i v e g race. Th e t ax p ay er b ears the b u rd en
o f p ro v i n g th atrep o rt ed b u s i n es s ex p en s es were act u al l y i n cu rred an dwere “ o rd i
n ary an dn eces s ary .” Sec. 1 62 (a); Ru l e 1 4 2 (a); INDOPCO, In c., 5 0 3 U.S. at8 3
. Th e t ax p ay er al s o b ears th e b u rd en o f s ub s t an t i at i n g ex p en s es u n d erl y in g h i s cl ai m edd edu ct i on s b y

k eep i ng an dp ro du ci n g reco rd s s uffi ci en tt o en ab l e t h e IRS t o d et erm i n e h i s co rrectt ax l iab i l i ty . Sec. 1 .6 0 0 1 -1 (a), (e), In co m e Tax Reg s . Th e fai l u re t o k eep an d p res en ts u ch reco rd s co u n t s h eav i l y ag ai n s t a t ax p ay er’ s at t em p t edp ro o f. Ro g ers v . Co m m i s s io n er, T.C. M em o . 2 0 1 4 -1 4 1 , 1 0 8 T.C.M
. (CCH) 3 9 , 4 3 . In cert ai n ci rcu m s t an ces th e Co u rtm ay ap pro x i m at e th e am o u n t o f
an ex pen s e i f t h e t ax p ay er p ro v es th ati twas i n cu rredb utcan n o ts ub st an t i at e t h e
ex actam o u n t . Co h an v . Co m m i s s i o n er, 3 9 F.2 d5 40 , 5 4 3 -5 4 4 (2 dCi r. 1 9 3 0 ). Bu t th e t ax p ay er m

u stp ro v i d e s o m e b as i s fo r s u ch an es ti m at e. Van i cekv . Co m m i s s i on er, 8 5 T.C. 7 3 1 , 7 4 2 -7 4 3 (1 9 85 ).

6 Pet i t i on ers co n t en d t h at“ th ere i s a s ub st an t i al p o ss i b i l i ty ” t hatth ei r d i s al
l o wedSch edul e A ex p en s e d edu ct i o n s were at tri b u t ab l e t o t h ei r ren t al p ro pert i es . As n o t edi n th e t ex t , th ey s up p l i edn o cred i b l e ev i d en ce t o s ubs t an t i at e t he ex p en s es , reg ard l es s o f t h e s ch edu l e o n wh i ch th ey m i g h tp ro p erl y

b e rep o rt ab l e.- 2 4 -

[* 2 4 ] Sect io n 2 7 4 (d ) i m

p o s es s tri cts ub st an t i at i o n req ui rem en t s fo r d edu ct i o n s cl ai m edfo r ex pen s es o f t rav el in g (i n cl u d in g m eal s an d l od g in g wh i l e awayfro m h o m e), g i ft s , an den t ert ai n m en t . No s u ch d edu ct i o n i s al l owedu n l es s th e t ax p ay er
s ub s t an t i at es , b y

ad equ at e reco rd s o r b y

s u ffi ci en tev i den ce co rro b orat i n g h i s o wn
s t at em en t s , th e am o u n t, t i m e an dp l ace, an db u s i n es s p u rp o s e fo r each ex p en d i
tu re. Sec. 2 7 4(d ); s ec. 1
. 2 7 4 -5 T(a), (b ), an d (c), Tem p oraryIn co m e Tax Reg s ., 5 0 Fed
. Reg . 4 6 0 1 4 -4 6 0 1 7 (No v . 6 , 1 9 8 5 ). A co u rtm ay n o tap p l y the Co h an ru l e t o ap p ro x i m at e ex p en ses co v eredb y s ect i o n 2 7 4 (d ). San fo rdv . Co m m i s s i o n er, 5 0 T.C. 8 2 3 , 8 2 7 -8 28 (1 9 6 8), aff’ d p er cu ri am , 4 1 2 F.2 d2 0 1 (2 dCi r. 1 9 6 9). Fo r 2 0 0 7-2 01 1 p et i t i o ners cl ai m edd edu ct i o ns o n Sch edu l e C i n th e res p ect i ve am o u n t s o f $ 1 30 ,2 1 3 , $ 1 9 1 ,3 5 0 , $ 1 76 ,1 2 1 , $ 1 6 6 ,5 4 4 , an d$ 1 0 3 ,5 5 4 . W i th
m i n o r ex cep t io n s , the IRS d i sal l o wedth es e d edu ct io n s fo r l acko f s ubs t an t i at i o n
o r b ecau se t h ey

co n s t i tu t ed “p ers o n al , l i v i n g , o r fam il y ex pen s es . ” See s ec. 2 6 2 (a). W e s u s t ai n th es e d et erm i n at i o ns s ub jectt o cert ai n co n ces si o n s b y res p o n den tas n o t edb el o w. 7

7 Pet i t i on ers l um

p edt o g et h er o n thei r Sch edu l es C ex p en s es al l eg ed l y i n cu rredb o th i n Dr. Lakn er’ s m ed i cal co n s u lt in g b u s i n es s an di n th e ren t al real es t at e act i v i ty . To th e ex t en tth atp et i t i o n ers h av e s ub s tan t i at edex p en s es p ro p erl y rep o rt ab l e o n Sch edul e E rath er t h an Sch edu l e C, we h av e n o t edth ati n th e t ex t b el o w.- 2 5 -

[* 2 5 ] A. 2 00 7 an d 2 0 09 To s ub s tan t i at e th ei r ex p en s es fo r 2 0 0 7 an d2 0 0 9 , p et i t i o n ers p ro v i d edat tri al n u m ero u s recei p t s an di n v o i ces , o rd er co nfi rm at i o n em ai ls , can cel edch eck s , b an k s tat em en t s , an dh an dwri t ten s u m m ari es . Becau s e t h es e d o cu m en t s were h i g h l y d i s o rg an i zed , we i n s tru ct edp et i t i on ers t o at t ach t o th ei r p o s t -t ri al b ri efs
s p read s h eet s l in k i n g each cl ai m edd edu ct i o n t o s p eci fi c s ub st an t i at i ng d o cu m en t s i n the reco rd . Th e s p read s h eet s p et i ti o n ers s up p li ed d i dn o td o th i s i n a h el p fu l o r p l au s i b l e way . W e wi l l b ri efl y ad dres s each cat eg o ry

o f ex p en s es p et i t i o n ers cl ai m t o h av e p ai d : • M eal s , En t ert ai n m en t, an dBu s i n es s Gi ft s : Pet i ti o n ers cl ai m edd edu ct i o n s fo r g ro cerys h op p i n g , ai rl i n e an d car ren t al ex p en s es , d i n i n g o u t atn u m ero u s res t au ran t s , an d al leg edb us i nes s g i ft s i n th e fo rm o f wi n e, d es s ert s , fl o wers , an dg i ft card s . Th es e ex p en s es are s ub jectt o th e s tri cts ub st an t i at i on req u i rem en t s o f
s ect i on 2 7 4 (d ). See San fo rd , 5 0 T.C. at8 2 7 ; s ec. 1 .2 7 4-5 T(a), Tem p o rary In co m e Tax Reg s . Pet it i o n ers d i dn o ts at i s fy th es e req u i rem en t s b ecau s e t h ey fai ledt o
s up p ly an y cred i b le ev id en ce es t ab l i s h i n g th e t i m e, p l ace, an d/ o r b u si n es s p u rp o s e fo r t h es e ex p en d i tu res . • Pro fes s i o n al Serv ices : Pet i t i o n ers cl ai m edd edu ct io n s fo r l eg al fees , ap p rai s al fees , an dacco u n t i n g fees . Su ch ex p en s es are d edu ct i b l e o n Sch edul e C- 2 6 -

[* 2 6 ] o n l y

i f i n cu rredi n co n nect i o n wi th th e t ax p ay er’ s trad e o r b u s i n es s . Ken t o n
v . Co m m i s s i o n er, T.C. M em o . 2 0 0 6 -1 3 ; Tes tv . Co m m i s s i o n er, T.C. M em o. 2 0 0 0
- 3 6 2 , aff’ d , 4 9 F. Ap p ’ x 9 6 (9 th Ci r. 2 0 0 2 ). As p u rp ort eds ubs t an t i at i o n p et i t i o n ers
s up p li edcan cel ed ch eck s o r i n v o i ces s h o wi n g l awy ers o r o th er p ro fes s i o n al s as p ay ees . Pet i t i o n ers h av e p ro vi d edn o ev i den ce t h atwo ul den ab l e t h e Co u rtt o d et erm i n e wh eth er t h e cl ai m edp aym en t s h adan y co n nect i o n wi th Dr. Lakn er’ s
co n su l t i n g b u s i n es s o r wi th M s. Sm i th ’ s ren t al real es t at e act i v i ty . W e t h erefo re
s u s t ai n th e d i s al lo wan ce o f al l d edu ct i o ns i n th i s cat eg ory . • Pro fes s i o n al an dLi cen s i n g Fees : To s ub s t an t i at e t h es e ex p en s es p et i t i o n ers o ffered can cel edch eck s m ad e o u tt o the D.C. Treas u rer an dv ari o u s m ed i cal
as s o ci at io n s . W e s u st ai n d i s al l o wan ce o f al l d edu ct i o n s i n th i s cat eg ory b ecau s e p et i t i o n ers h av e fai l ed t o p ro ve t h atth e can cel edch eck s co rres p o n d edt o o rd i n ary
an d n eces s ary

ex p en ses o f Dr. Lakn er’ s co n s ul t i n g b u s i n es s . • M ai nt en an ce: Res p o n den th as co n ced edth atp et i t i o n ers h av e s ub s t an t i at ed$ 1 00 o f d edu ct i b le m ai nt en an ce ex p en s es fo r 2 0 0 7 . Th e IRS p ro p erl y d i s al
l o wedd edu ct i o n s fo r t h e o th er rep o rt edex p en s es i n th i s cat eg o ry b ecau s e th ey were p ers o n al , were i n cu rredo u t s i d e the y ears at i ss u e, o r were n o ts h o wn t o h av e
an y co n nect i o n wi th Dr. Lakner’ s co ns u l t i n g b u s i n es s o r wi th p et i t i o n ers ’ ren t al p ro p ert i es .- 2 7 -

[* 2 7 ] • M i s cel lan eo u s Pro p ert y -Rel at ed Ex p en s es : Pet i ti o n ers s ub m it t eda l arg e
s t acko f can cel ed ch eck s , recei p t s , an di n v o i ces s h o wi ng p aym en t s t o n u m ero u s
u t i l i ty co m p an i es , s erv ice co m

p an i es , i n s uran ce co m

p an i es , an dret ai l s t o res (s u ch
as M acy ’ s , Ho m e Dep o t , an dBed Bat h an d Bey o n d). Pet i t i o n ers d o n ot co n t en d th atan y o f t h es e ex p en s es was p ro p erl y d edu ct i b l e o n Sch edu l e C. Res p o n d en t h as co nced edth atp et i t i o n ers are en t i t l ed t o a Sch edu l e E d educt i o n o f $ 5 3 2 fo r i m p ro v em en t s t o a ren t al p ro p ert y i n 2 0 0 9
. W e d i dn o t fi n dcred i b l e p et i t i o n ers ’ t es t i m o ny th atan y o f the o th er rep o rt edex p en s es rel at edt o thei r ren t al p ro p ert i es
as o p po s edt o th ei r p ers o n al res i d en ce. Pet i t i o n ers h av e n o tcarri edth ei r b u rd en o f p ro v in g th atth es e ex p en s es were p ro p erl y d edu ct i b l e. See s ec. 2 6 2 ; To k ars k i , 8 7 T.C. at7 7
. • Pro p ert y

Tax an dM o rt g ag e In t eres t : As p u rp o rt eds ubs t an ti at i o n fo r Sch edu l e C ex pen s es i n 2 00 7 an d2 0 0 9 , p et i t i on ers ’ s p read s heet l i s tedreal p ro p ert y t ax es an dh om e m o rt g ag e i n t eres tth atthey h ads ep arat el y

cl ai m edas i t em i zed d educt i o n s o n Sch edu l e A. Th e IRS al l o wedal l o f t h e i t em i zedd edu ct i on s th at p et i t i o n ers cl ai m edfo r 2 0 0 7 an d2 0 0 9 . Pet i t i o n ers h av e fai l ed t o s ub s t an t i at e an y d educt i o n s fo r p ro p ert y

t ax es o r i n t eres t b ey o n dthe am o u n t s t h e IRS al l owedas i t em i zedd edu ct io n s .- 2 8 -

[* 2 8 ] • IRA Co n tri bu t i o n s: As p u rp o rt eds ub s t an t i at io n fo r t h ei r Sch edu le C ex
p en ses , p et i t i on ers ’ s pread s heet s l i s t edIRA co n tri b u t i o n s o f $ 2 ,0 0 0 fo r 2 0 0 7 an d 2 0 0 9 . Pet i t i o n ers s ep arat el y cl ai m ed o n l i n e 3 2 o f t h ei r Fo rm 1 0 40 fo r each y ear,
an d th e IRS al l o wed , an IRA co n tri b u t i o n d edu ct io n o f $ 2 ,0 0 0 . Pet i t i o ners h av e fai l edt o p ro v e t h atth ey

are en t i t l edt o IRA d edu ct i o ns l arg er th anth o s e res p o n d
en th as al l o wed
. • Ch ari t ab l e Co n tri b u t i o ns : As p u rp o rt eds ub st an t i at io n fo r t h ei r Sch edu l e C ex p en s es , p et it i on ers ’ s pread s h eetl i s t ed ch ari t ab l e co n tri b u t i o ns o f $ 2 ,4 3 0 fo r 2 0 0 7 . Pet it i on ers fo r 2 0 0 7 s ep arat el y cl ai m edo n Sch edu l e A, an d th e IRS al
l o wed , a ch ari t ab l e co n tri bu t i o n d edu ct io n o f $ 2,1 0 0 . Pet i t i o n ers h av e fai l edt o p ro v e th atth ey

are en t i t l ed t o a ch ari t ab l e co n tri b ut i o n d edu ct io n fo r 2 0 07 i n ex ces s o f t h e am o u n tres p o n d en tal l o wedo n Sch edu l e A. • Oth er Ex p en s es : On th ei r s p read s h eet fo r 2 0 07 p et i ti o n ers l i s t edan ex p en se o f $ 1 5 9 fo r “ p ro fes s i on al trai ni n g . ” Res p o n d en tco n ced edth atp et i t i o n ers
s ub s t an t i at ed$ 4 0 o f t h i s ex p en s e. W e fi n dth atth ey h av e n o ts ub s t an t i at edth e rem ai n d er.- 2 9 -

[* 2 9 ] B. 2 00 8 , 2 0 1 0 , an d 2 0 1 1 Fo r 2 0 0 8, 2 0 1 0 , an d2 0 1 1 , the IRS d i s al lo wed m o s to f p et i t i o n ers ’ cl ai m ed Sch edu l e C ex pen s e d edu ct i o n s, d et erm i n i ng th at th ey h ads ubs t an t i at ed o nl y

th e fo l l o w i n g : I tem 2008 2010 2011

Travel $2,257 $1,324 -0- Meals/entertainment 864 957 $1,593 Total 3,121 2,281 1,593 Pet i t i o ners h av e p ro du cedn o i n v o i ces , b an k s tat em en t s, cred i tcards t at em en t s , o r o th er cred i b l e d o cu m en t at i o n t o s ub s t an t iat e t h e ex i s t en ce o r am o u n to f
an y o th er Sch edu le C ex p en s es . W e reject thei r req u es tthatwe es ti m at e t h ei r d educt i b l e ex p en s es b ecau s e t h ey h av e p ro vi dedn o ev i d en t i ary b as i s o n wh i ch we
co u ldb as e s u ch an es t i m at e. See No rg aardv . Co m m i s s i o n er, 9 3 9 F.2 d8 7 4 , 8 7 9 (9 th Ci r. 1 9 9 1 ) (req u i ri n g the t ax p ay er t o p res en tcred ib l e ev i d en ce fro m wh i ch th e Co u rtcan m ak e an es t i m at e u n d er t h e Co h an ru l e), aff’ g i n p art , rev ’ g i n p artT.C. M em o. 1 9 8 9 -3 9 0
. W e fi n dth atp et i ti o n ers h av e n o ts ubs t an ti at edSch edu l e C
ex p en s es fo r 2 0 0 8 , 2 0 10 , o r 2 0 1 1 i n ex ces s o f th e am o u n t s res p o n d en th as al l o wed
.- 3 0 -

[* 3 0 ] V. Sch edu l e E Lo ss Onth ei r Sch edu l e E fo r 2 0 1 1 p et i t io n ers rep o rt ed i n co m e o f $ 1 3 ,0 4 5 fro m two ren t al p ro pert i es an dn eg at i v e i n co m e o f $ 3 8 ,0 4 5 fro m th ree ren t al p ro p ert i es , p ro duci n g an al leg edren t al real es t at e l o s s o f $ 25 ,0 0 0
. Th ey rep ort edth e fu l l
am ou n to f t h atl os s o n l i n e 1 7 o f t h ei r Fo rm 1 0 4 0. In th e n o t i ce o f d efi ci en cy th e IRS d is al l o wedan y

d edu ct i o n fo r t h atl o ss , s t at i ng : “ Yo ur ren tal l o s s was d i s al
l o wedb ecau s e * * * y o uare n o ta real es t at e p ro fes s i o nal an dy o u r m o d i fi edad
ju s t edg ro s s i n co m e i s o ver $ 1 5 0 , 0 0 0 .” Th e Co d e al l o ws an i n d i v i du al wh o act i v el y p art i ci p at es i n a ren t al real es t at e act i v i ty

t o d edu ct ag ai ns to rd i n ary i n co m e up t o $ 2 5 ,0 00 o f l o ss es fro m th at act i vi ty i f AGI i s l es s t han $ 1 5 0 ,0 0 0 . See s ec. 4 6 9(i )(1 ), (2 ), an d (3 ). Res p o n d en t
co n ced es th atM s . Sm i th act i v el y p art i ci p at edi n th e ren t al real es t at e act i v it y du ri n g 2 0 11 . In l i g h t o f t h e ad ju s t m en t s t o i n co m e t h atwe h av e s us t ai n ed , h o wev er, p et i t i o n ers ’ AGI fo r 2 0 1 1 was s ub s t an t ial l y i n ex ces s o f $ 1 5 0,0 0 0 . Thu s , as s u m i n g arg u en d o t h atp et i t i o n ers h av e s ub s t an t i at edth ei r cl ai m edreal es t at e l os s , th ey
can n otd edu ct an y

p o rt i o n o f i tu n l es s M s . Sm i th du ri ng 2 0 1 1 was a “ real es t at e p ro fes s i on al ,” i .e., a t ax p ay er en g ag edi n a “ real p ro p ert y b us i n es s ” wi th i n th e
m ean i n g o f s ect i o n 4 6 9 (c)(7 ).- 3 1 -

[* 3 1 ] Sect io n 4 6 9 (a) g en eral l y d i s al l o ws a cu rren td edu ct i o n fo r a “p as s i v e act i vi ty l o s s ” i n cu rred b y

an i n di v i du al . Sect io n 4 69 (c) d efi n es “p as s iv e act iv i ty ” t o i n cl u d e an act i v i ty

i n v o lv i n g a t rad e o r b u s i n es s i n wh i ch th e t ax p ay er d oes n o t

“ m at eri al l y

p art i ci p at e” an d“ an y

ren t al act i v it y ” reg ard l es s o f wh et h er t h e t ax p ay er m at eri al ly

p art i ci p at es . Sec. 4 6 9 (c)(1 ), (2 ), (4 ). Bu ts ect i o n 4 6 9(c)(7 ) p ro v i d es th atth e ren t al real es t at e act iv it y o f a real es t at e p ro fes s i o n al i s n o tp er s e p as s i v e. See Ko s o n en v . Co m

m i s s i o n er, T.C. M em o . 2 0 00 -1 0 7 , 7 9 T.C.M . (CCH) 1 7 6 5 , 1 7 6 7 ; s ec. 1
. 4 6 9 -9 (b )(6 ), (c)(1 ), In co m e Tax Reg s . If a real es t at e p ro fes s i o n al
m at eri al l y

p art i ci p at es i n a ren tal real es t at e act i v i ty , thatact iv i ty i s t reat edas n o n p as s i v e, an dth e s ect i o n 4 6 9 (a) d i sal l o wan ce d o es n o tap pl y . See Sh iekh v . Co m m i s s i o n er, T.C. M em o . 2 0 1 0 -1 2 6 , 9 9 T.C.M . (CCH) 1 5 26 , 1 52 8 ; Fo wl er v . Co m m i s s i o n er, T.C. M em o . 2 0 0 2 -2 2 3 , 8 4 T.C.M . (CCH) 2 8 1, 2 8 4; s ec. 1 .4 6 9 -9 (e)(1 ), In co m e Tax Reg s . To qu al i fy

as a real es t at e p ro fes s i o n al , a t ax p ay er m u s t(am o n g o th er th i n g s ) “ perfo rm [] m ore t h an 7 5 0 h o u rs o f s erv i ces duri n g the t ax ab l e y ear i n real p ro p erty trad es o r b u s in es s es i n wh i ch * * * [s h e] m at eri al l y p art ici p at es .” Sec. 4 6 9 (c)(7 )(B)(i i ). Th e t ax p ay er m u s ts at i s fy

th e 7 5 0 -h o u r requ i rem en tp ers o n al l y ; p art i ci p at i o n i n th e real es t at e act i v i ty b y the t ax p ay er’ s s p o u s e i s n o tat tri b u t edt o th e t ax p ay er fo r t h i s p u rp o s e. Od eri o v . Co m m is s i o n er, T.C. M em o . 2 0 1 4-3 9 , 1 0 7- 3 2 -

[* 3 2 ] T.C.M . (CCH) 1 2 1 4, 1 21 5 ; s ec. 1 .4 6 9 -9 (c)(4 ), In co m e Tax Reg s . M o reo v er,

“p ers o n al s erv i ces p erfo rm edas an em p l o y ee s h al l n o tb e t reat ed as p erfo rm ed i n real p ro p ert y

trad es o r b u s i n es s es ” u n l es s “ s u ch em p l o y ee i s a 5 -p ercen t o wn er
* * * i n t h e em

p lo y er.” Sec. 4 6 9 (c)(7 )(D)(i i ). Du ri n g 2 0 1 1 M s . Sm i th was em p l o y edb y Real t o r Cat h i e Gi l l , In c., wh ere
s h e s uperv i s ed th e fi rm ’ s p ro p erty m an ag em en ts erv i ces . Th ere i s n o ev i d en ce th ats h e h el da 5 % o wn ers h i p i n t eres t (o r an y o wn ers h i p i n t eres t ) i n th at fi rm . Her
s erv i ces ren d ered as an em p lo y ee t h erefo re d o n otco u n ti n d et erm i n i n g wh et h er
s h e m etth e 7 5 0 -h o ur req u i rem en t . Pet i t i o ners h av e p ro du cedn o d o cu m en t ary ev i den ce o f an y

k i n dt o s ub s t an t i at e t h e n u m

b er o f h o u rs th atM s . Sm i th o r Dr. Lakn er d ev o t edt o thei r ren t al p ro p ert i es . M s . Sm i th d idn o tt es t i fy attri al . Dr. Lakn er t es t i fi edth ath is wi fe
s p en t 5 0 0 t o 6 00 h o u rs an n u al l y , an dth ath e s p en tan o th er 1 , 0 0 0 t o 1 ,2 0 0 h o u rs
an n ual l y , m an ag i n g t h o s e p ro p ert i es . Th ere was n o d o cu m en t ary s upp o rt fo r t h es e
as s ert i o n s , wh i ch were atb es t“b al l parkg ues s t i m at es ,” an dwe d i d n o tfi n dDr. Lakner’ s t es t i m o ny

cred i b l e. See M o s s v . Co m m i s s i o n er, 1 3 5 T.C. 3 65 , 3 6 9 (2 0 1 0); To k ars k i , 8 7 T.C. at7 7 . Fi n d i n g as we d o th at n ei th er p et i ti o n er was a real- 3 3 -

[* 3 3 ] es t at e p ro fes s i o n al du ri n g 2 0 1 1 , we s u s t ai n res p o n d en t ’ s d i s al l o wan ce o f t h e $ 2 5 ,0 0 0 Sch edu le E l o s s d edu ct i o n p et i t i o n ers cl ai m edfo r t haty ear. 8 VI. NOLs Onl i n e 2 1 o f th ei r 2 0 07 -2 0 1 1 retu rn s , cap t i o n ed “ Oth er In co m e,” p et i t i o n ers cl ai m ed“ neto p erat i n g l o s s carry o v er[s ] ” i n th e fo l lo wi n g am o u n t s : Year NOL 2007 $85,258 2008 99,383 2009 162,030 2010 219,855 2011 250,773 Res po n d en td i s al l o wedth es e NOL d edu ct i o n s en t i rel y , an d p ro p erl y s o . A t ax p ay er m ay

g en eral l y d edu ct , as an NOL fo r a t ax ab l e y ear, an am o u n t equ al t o th e s u m

o f t h e NOL carry o vers an d carryback s t o thaty ear. Sec. 1 7 2 (a). A t ax pay er cl ai m i n g an NOL d edu ct i o n m u s tfi le wi th h i s retu rn “ a co n ci s e s t at em en ts et t i n g fo rt h th e am o u n to f t h e * * * [NOL] d edu ct i o n cl ai m edan d al l m at eri al an dp ert i n en t fact s rel at i v e th eret o , i n cl ud i n g a d et ai l eds ch edu l e s h owi n g th e
co m p u t at i o n o f t h e * * * [NOL] d edu ct io n .” Sec. 1 .1 7 2 -1 (c), In co m e Tax Reg s.

8 Pet i t i on ers d i dn otcl ai m an y ren tal real es tat e l o s s es o n th ei r return s fo r 2 0 0 7 -2 0 1 0 an dd i dn oti n cl ud e a Sch edul e E i n an y o f t h o s e ret u rn s . Th ey h av e n o ts ub s t an t i at ed , fo r an y o f th o s e y ears , ren t al real es t at e ex p en ses i n ex ces s o f th e Sch edu l e E i n co m e t h at res p o n d en t h as d et erm in ed . Thu s , th ey are n o ten t i t l ed t o an y d edu ct i o n s fo r real es tat e l o ss es fo r 2 0 0 7, 2 0 0 8 , 2 0 0 9 , o r 2 0 1 0.- 3 4 -

[* 3 4 ] Pet i t i o n ers b ear t h e b u rd en o f es tab l is h i n g b o th th e ex i s t en ce o f NOLs fo r p ri o r y ears an dthe NOL am o u n t s th atm ay p ro p erl y b e carri edfo rwardt o th e y ears ati ss u e. See Ru l e 1 4 2 (a); Kei th v . Co m m i s s io n er, 1 1 5 T.C. 6 05 , 6 21 (2 0 00 ). Th e $ 8 5 ,2 5 8 NOL d edu ct i o n p et it i on ers cl ai m edfo r 2 0 0 7 al l eg ed l y rep res en t edth e carry fo rwardo f l o s ses p et i t i o n ers h adi n cu rredi n 2 0 0 4 -2 0 06 . Pet i t i o n ers d i dn o tat t ach t o thei r 2 0 0 7 retu rn th e ex p l an at o ry s tat em en treq u i redb y th e reg u l at i o n s . Th ey

o ffered n o ev i d en ce t h atth ey h ads u s tai n edb o n a fi d e l o s s es du ri n g 2 0 0 4 -2 00 6 , ap artfro m s ub m i t t i n g co pi es o f t h e t ax retu rn s o n wh i ch th ey rep o rt edth o s e l os s es . M erel y cl ai m in g a l o s s d o es n o ts ub s t an t i at e i t . See Co b u rn
v . Co m m i s s i o n er, T.C. M em o . 2 0 1 4 -1 1 3 , 1 0 7 T.C.M . (CCH) 1 5 51 , 1 5 5 8 (“ A t ax p ay er’ s return i s m erel y

a s t at em en to f t h e t ax p ay er’ s p o s i t i o n an dcan no tb e u s ed t o s ub s t an t i at e a d edu ct io n.”); s ee al s o Go u l d v . Co m m i s s i o ner, 1 3 9 T.C. 4 1 8 , 4 4 7 (2 0 1 2), aff’ d , 5 5 2 F. Ap p ’ x 2 5 0 (4 th Ci r. 2 0 1 4 ). Th e NOL carry fo rwardd edu ct i o n s p et it i o n ers cl ai m ed fo r 2 0 0 8-2 0 1 1 res u l t edfro m

th e $ 8 5 ,2 5 8 NOL carry fo rwardfro m 2 0 0 4 -2 0 06 (t o wh ich th ey were
n o ten ti t l ed ) an dth e n eg at i v e AGI t h ey rep o rt edfo r 2 00 7 -2 0 1 0 (i n t h e ag g reg at e
am ou n to f $ 6 2 3 ,9 5 5 ). As a res u l to f t h e ad j u s t m en t s we h av e s u st ai ned , requ i ri n g i n cl u s i o n o f u n rep o rt edi n co m e an dd i s al l owi n g p et i t i o n ers ’ cl ai m edSch edu l e C l o s s d edu ct i o n s, p et i ti o n ers wi ll h av e s ubs t an t i al p o s i t i v e AGI fo r each y ear at i s -- 3 5 -

[* 3 5 ] s u e. Becau se t h ey

h av e n o o p erat i n g l o s s es t o carryfo rward , th e IRS p ro p erl y d i s al l o wedal l o f t h ei r cl ai m edNOL d edu ct i o n s . VII. Ad d it i on s t o Tax Sect io n 6 6 5 1 (a)(1 ) p ro v i d es fo r an ad d i t io n t o t ax o f 5 % o f t h e t ax req u i red t o b e s h own o n th e ret u rn fo r each m o n th o r fract i o n th ereo f fo r wh i ch th ere i s a fai l u re t o fi l e t he ret urn , n o tt o ex ceed 2 5 % i n t o t o . Th e p art i es h av e s t i p u l at ed th atp et i t i o n ers ’ 2 0 07 -2 0 1 1 retu rn s were fi l ed l at e. Res p o n d en th as th us m eth i s b u rd eno f p ro du ct i o n u n d er s ect i o n 7 49 1 (c). A t ax p ay er wh o fi l es h i s retu rn l at e i s l i ab l e fo r th e s ect i o n 6 6 51 (a)(1 ) ad d i
t i on t o t ax u n l es s h e s h o ws thath i s fai l u re was du e t o reas o n ab l e cau s e an dn o t du e t o w i l l fu l n eg lect . Un i t edSt at es v . Bo y l e, 4 6 9 U.S. 2 4 1, 2 4 5 (1 9 8 5). Pet i t i on ers fi rs tas s ertthatDr. Lakn er’ s d ep l o ym en to v ers eas co n s t i tu tes reas o n ab l e cau s e fo r t h ei r fai l u re t o fi le t i m el y . Bu tDr. Lakn er ret urn edt o th e Un i t edSt at es fro m
o v ers eas d ep l o ym en ti n 2 0 0 6 . Pet i t i o n ers h av e o ffered n o co g en t ex p l an at i o n wh y h i s o v ers eas m il i t ary

s erv i ce du ri n g 2 0 06 an dp ri or y ears ren d eredth em u nab l e t o fi le t i m el y

retu rn s fo r 2 0 0 7 -2 0 1 1 , th e fi rs t o f wh i ch was n o t du e fo r fi l i n g u n t i l Ap ri l 2 0 08
. Al t ern at i v el y , p et it i o n ers co n t en d th at“ s i g n i fi can t h eal th p ro b l em s ” m ad e i t i m p o s s ib l e fo r t h em

t o fi l e t h ei r retu rn s o n t im e. Pet i t i o n ers i n tro du cedn o cred
-- 3 6 -

[* 3 6 ] i b l e ev id en ce t o s up p o rtth i s as s ert i on . Th ey i n s i s t edthro u g h o utth e t ri al th atth ey act i v el y en g ag edi n a m ed i cal co n s u l t i n g b u s i n es s an d a ren t al real es t at e act i vi ty du ri ng the t ax y ears ati s s u e. Th ei r retu rn s fo r each y ear were p rep aredb y a cert ifi edp ub l i c acco u n t an t(CPA) at “ Ph y s i ci an s ’ Tax Serv i ce.” If i l l h eal th d i d
n o tp rev en tp et i ti o n ers fro m m an ag in g th ei r co m m erci al affai rs , we fi ndn o b as i s fo r co n cl u d i n g th at i l l h eal th p rev en t edth em fro m fu rn i s hi n g i nfo rm at i on t i m el y t o th ei r retu rn p rep arer. See Po p pe v . Co m m i s s i o n er, T.C. M em o . 2 0 1 5 -2 05 , 1 1 0 T.C.M . (CCH) 4 0 1 , 4 0 6 -4 0 7 (reject i n g i l l h eal th d efen s e wh ere t ax p ay er as a s ecu ri t ies trad er “ en gag [ed ] i n act i v i t ies th at req u ireda h i gh d eg ree o f co ncen trat io n
an d ab i l i ty

t o an al y ze an do rg an i ze i n fo rm at i o n”); Hard i n v . Co m m i s si o n er, T.C. M em o. 2 0 1 2 -1 6 2 , 1 0 3 T.C.M . (CCH) 1 86 1 , 1 8 6 2 -1 8 63 (reject in g i l l h eal th d efen s e wh ere t ax p ay er was ab le t o m an ag e h i s b u s i n es s affai rs , i n cl ud i ng m an ag i n g two ren t al p ro pert i es , s el l i n g o n e o f t h em , an db ei n g em p l o y edfu l l t i m e). In s u m , we co n cl u d e t h atp et i ti o ners h av e fai ledt o carryth ei r b u rd en o f p ro v in g th atth ey

h adreas o n ab l e cau s e fo r fai li n g t o fi l e t h ei r 2 0 0 7 -2 0 1 1 retu rn s
o n t i m e. W e t hu s s us t ai n t h e ad d i t i o n t o t ax u n d er s ect i o n 6 6 5 1 (a)(1 ) fo r each y ear.- 3 7 -

[* 3 7 ] VIII. Pen al t ies In h i s p o s t-t ri al b ri ef res p o n d en tco n ced edth atp et i ti o n ers are n o tl i ab l e fo r frau d p en al t ies u n d er s ect i o n 6 6 6 3 , as the IRS h add et erm i n edi n t h e n o t i ce o f d efi ci en cy fo r 2 0 08 , 2 0 1 0 , an d 2 0 1 1 . Bu tres p o n d en tco nt en d s th atp et i t i o n ers are l i ab l e fo r accu racy -rel at edp en al t i es u n d er s ect i o n 6 6 6 2 (a) fo r al l fi v e y ears . W e ag ree wi th th ats ub m i s s i o n . Th e Co d e i m

p os es a 2 0 % p en al ty

o n th e p ort i on o f an y

u n d erp aym en to f t ax at tri b u t ab l e t o “ [n ] eg l i g en ce o r d i s reg ard o f ru l es an d reg u l at i o n s ” o r “ [a] ny s ub
s t an t ial u n d ers t at em en to f i nco m e t ax .” Sec. 6 6 6 2(a) an d(b )(1 ) an d (2 ). Neg l i
g en ce i n cl u d es “ an y

fai l u re t o m ak e a reas on ab l e at t em p t t o co m p l y ” wi th t h e i n t ern al rev en u e l aws . Sec. 6 6 6 2 (c). An u n d ers t at em en to f i n co m e t ax i s “ s ub s t an t i al ” i f i t ex ceed s th e g reat er o f $ 5,0 0 0 o r 1 0 % o f t he t ax req u i redt o b e s h o wno n th e ret urn . Sec. 6 6 6 2 (d )(1 )(A). Un d er s ect i o n 7 49 1 (c) res p o n d en tb ears th e b u rd en o f p ro du ct i o n wi th res p ectt o t h e l i ab i l i ty

o f an y i n d i v i du al fo r an y

p en al ty . See Hi g b ee v . Co m m i s s i o n er, 1 1 6 T.C. 4 3 8 , 4 4 6 (2 0 01 ). Res p o n d en t h as s at i sfi edh i s b urd en o f p ro du ct i o n
as t o n eg l i gen ce b y s ho wi n g th atp et i t i o n ers fo r each y ear fai ledt o rep o rtal l o f th ei r t ax ab l e i n co m e an dfai l edt o m ai n t ai n an y m ean i n g fu l b o o k s an dreco rd s fo r th ei r b us i n es s act i v it ies . See s ec. 1 .6 6 6 2 -3 (b )(1 ), In co m e Tax Reg s .- 3 8 -

[* 3 8 ] In Graev v . Co m

m i s s i on er, 1 4 9 T.C. _

_ (Dec. 2 0 , 2 0 17 ), s up p l em en t i n g an d
o v erru l i ng i n p art1 4 7 T.C. 4 6 0 (2 0 1 6 ), we h el dthatres po n d en t ’ s b u rd en o f p ro du ct i o n u n d er s ect i on 7 49 1 (c) al s o i n cl u d es es tab l is h i n g co m p li an ce wi th s ect i o n 6 7 5 1 (b ). Th ats ect i o n req u ires th atp en al t i es b e “ p ers o n al l y ap p ro ved(i n wri t i ng ) b y th e i m m ed iat e s up erv i s o r o f t h e i n d i vi du al m ak i n g s uch d et erm i n at i o n .” See Ch ai v. Co m

m is s i o n er, 8 5 1 F.3 d1 9 0 , 2 2 1 (2 d Ci r. 2 0 1 7 ), aff’ g i n p art , rev ’ g i n p artT.C. M em o . 2 0 1 5 -4 2
. Fo r 2 0 0 7 an d2 00 9 t h e reco rdi ncl u d es co pi es o f Ci v i l Pen al ty Ap p ro v al Fo rm s s ig n edb y

th e i m m ed i at e s up erv i s o r o f t h e rev en u e ag en twh o ex am i n ed p et i t i o n ers ’ retu rn s , ap p ro v i n g i m p o s i t i o n o f s ect i o n 6 66 2 (a) p en al t i es ag ai n s tp et i ti o n ers fo r t ho s e y ears . Fo r 2 0 0 8 , 2 0 1 0 , an d 2 0 1 1 th e reco rdi n cl u d es co p i es o f a Ci v il Pen al ty

Ap p ro v al Fo rm , s i g n edb y th e i m m ed iat e s up erv i s o r o f t h e rev en ue ag en t wh o ex am i n edp et i t i o n ers ’ retu rn s , ap p ro v i n g i m p o s i t i o n o f s ect i o n 6 6 6 3 frau d p en al t ies an d(i n th e al t ern at i ve) s ect i o n 6 6 62 (a) accu racy -rel at edp en al t i es ag ai n s tp et i t i o n ers fo r t h o s e y ears . W e acco rd i n g l y fi n d thatres po n den th as s at i sfi edh i s b u rd en o f p ro du ct i o n t o s h o w co m p l ian ce wi th s ect i o n 6 75 1 (b ). No p en al ty

i s i m p o sed wi th res p ectt o an y p o rt i o n o f an u n derp aym en ti f t h e t ax p ay er act edwi th reas o n ab le cau s e an d i n g o o d fai th wi th res p ectth eret o . See
s ec. 6 6 64 (c)(1 ). Th e t ax p ay er g en eral l y b ears th e b u rd en o f p ro v i n g reas o n ab l e- 3 9 -

[* 3 9 ] cau s e an d g o o dfai th . Hi g b ee, 1 1 6 T.C. at4 4 6 . Reas o n ab l e cau se can b e
s h o wnb y g o o d -fai th rel i an ce o n th e ad v i ce o f a qu al i fi edt ax p ro fes s io n al . Sec. 1 .6 66 4 -4 (b )(1 ), (c), In co m e Tax Reg s . Wh et h er t h e t ax pay er act u al l y rel i es o n th e ad v ice an dwh eth er s u ch rel i an ce i s reas o n ab l e p res en tqu es t i on s o f fact . Neo n at o l o g y As s o cs ., P.A. v
. Co m

m i s s i o n er, 1 1 5 T.C. 4 3 , 9 8 (2 00 0 ), aff’ d , 2 9 9 F.3 d2 2 1 (3 dCi r. 2 0 0 2); s ec. 1 .6 6 6 4 -4 (c)(1 ), In co m e Tax Reg s . Fo r rel i an ce t o b e reas o n ab l e, t h e t ax pay er m

u s t (am o n g o th er t hi n gs ) h av e p ro v i d ed“ n eces s ary an daccu rat e i n fo rm at io n t o t h e ad v is er.” Neo nat o l o g y As s o cs ., P.A., 1 1 5 T.C. at9 9
. Pet i t i o ners co n t en dth atth ey m ad e a g oo d -fai th effo rt t o d et erm in e th ei r Fed eral i nco m e t ax l i ab i l i ti es co rrect l y b ecau s e t h ey h i reda CPA t o p rep are t h ei r retu rn s . Pet i t i o n ers d i d n o t cal l th e CPA t o t es t i fy at tri al . Th ey

o ffered n o ev i
d en ce t o s h o w thath e was a co m p et en tad v i s er o r t h atth ey actu al l y rel i ed o n h i m i n g o o d fai th
. Al l o f t h e ad

ju s tm en t s we h av e s us t ai n edi n thi s cas e i n v ol v e u n rep ort ed i n co m e an d u n sub s t an ti at edd edu ct i o n s . As s u m i n g arg u en d o th at p et it i on ers ’ CPA was co m

p et en t , i t i s o b vi ou s th atp et i t i on ers d i dn o ts up p l y h i m wi th al l

“ n eces s ary

an daccu rat e i n fo rm at i o n ” n eed edt o p rep are t h ei r 2 0 0 7 -2 01 1 retu rn s p ro p erl y . Ib i d. W e co n cl u d e t h e “ reas o n ab l e cau s e” ex cep t i on d o es n o tap p l y an d th atal l o f t h e u n d erp aym en t s (as red et erm i n ed ) are at tri b u tab l e t o n eg li g en ce. Al
-- 4 0 -

[* 4 0 ] t ern at i v el y , i n t h e ev en tth e Ru l e 1 55 co m pu t at i o ns s h o w th atthe v ari o u s
u n d ers t at em en t s o f i nco m e t ax ex ceed the g reat er o f $ 5 , 0 0 0 o r 1 0 % o f t h e am o u n t s req u i redt o b e s h o wno n th e res p ect i v e ret u rn s , we co ncl u d e th atth o s e u nd erp ay m en t s are at tri b u t ab l e t o s ub s t an t i al u n d ers t at em en t s o f i n co m e t ax fo r wh i ch
reas on ab l e cau s e h as n o t b een s h o wn . To refl ectthe fo reg o i n g , Deci s i o n s wi l l b e en t eredu n der Ru l e 1 5 5
.