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

UNITED STATES TAX COURT

RONNIE J
. SM ITH AND SHEILA C. SM ITH, Pet it i o n ers v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 2 4 8 21 -1 5
. Fi l edOct o b er 1 5 , 2 0 1 8
.
Bry an W . Cad d el l, fo r p et i t i o n ers . W i l l i am F. Cas t o r, fo r res p o n den t .

M EM ORANDUM FINDINGS OF FACT AND OPINION CHIECHI, J ud g e: Res p o n d en td et erm in edd efi ci en ci es i n p et i ti o n ers ’ Fed eral i nco m e t ax (t ax ) fo r th ei r t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 0 13 o f $ 7 4 ,3 6 4, $ 7 ,1 6 4 , an d$ 9,9 2 2 , res p ect i v el y .- 2
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[* 2 ] Th e i s s u es rem ai n i n g fo r d eci s i o n are: 1 (1 ) Are p et it i o n ers req u i redfo r each o f t h ei r t ax ab le y ears 2 0 1 1 , 2 0 12 , an d 2 0 1 3 t o i n cl u d e i n i n co m e t h e am o u n to f “ [t ] o t al i n co m e” t h atth ei r wh o ll y o wn ed S co rp o rat i o n rep o rt ed i n i t s t ax retu rn fo r each o f t ho s e y ears as wel l as a cert ai n ad d it i o n al am o u n t o f i n co m e t hatres p o n d en td et erm i n edi n t h e n o t i ce fo r each o f th o s e y ears ? W e h ol d t h atth ey are. (2 ) Are p et it i o n ers en t i t ledfo r each o f t h ei r t ax ab le y ears 2 0 1 1 , 2 0 12 , an d 2 0 1 3 t o d edu ctan y

ex p en s es wi t h res p ectt o cert ai n res p ect i v e p ers on al s erv i ces th atth ey p erfo rm eddu ri n g each o f tho s e y ears ? W e h o ldth atth ey are n ot . (3 ) Are p et it i o n ers en t i t ledfo r t h ei r t ax ab l e y ear 2 0 1 1 t o d edu ct$ 21 ,9 4 0 wi th res p ect t o a cl ai m edn eto perat i n g l os s carry o v er? W e h o l dth atthey are n o t . FINDINGS OF FACT 2 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. Pet i t i o ners res i d edi n Ok l ah o m a atth e t i m e t h ey fi ledth e p et i t i o n .

1 Th ere are o t her q u es t i o ns rel at i n g t o cert ai n d et erm i n at i o n s i n th e n o t i ce o f d efi ci en cy

fo r p et i t i o n ers ’ t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 0 1 3 (n o t i ce) t h atare co m p u t at i o n al i n t h atth ei r res o l u t i o n fl o w s au t o m at i cal l y fro m o u r res o lu t i o n o f th e i s s ues th atwe ad dres s h erei n .

2 Un l es s o t h erwi s e i nd i cat ed , o u r fi nd i n g s o f fact an d o pi n i o n p ert ai n t o p et i t i o n ers ’ t ax ab l e y ears 2 0 11 , 2 0 1 2 , an d2 01 3 , th e y ears ati s su e. Fo r cl ari t y , we s o m et i m es ex p res s l y refer i n o u r fi n d i n gs o f fact an d o p i ni o n t o o n e o r m o re o f th o s e y ears .- 3
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[* 3 ] Pet i t i o ner, Ro n n i e J . Sm i t h (M r. Sm i t h ), wo rk edas an em pl o y ee o f Lu cen t Tech n o l o g ies (Lu cen t ) fo r al m o s t2 9 y ears u n ti l h e ret i redi n 1 99 9
. Si n ce h i s ret i rem en t , M r. Sm i t h recei v edatal l rel ev an tt i m es , i n cl u d i ng du ri ng 2 0 1 1, 2 0 1 2 , an d 2 0 1 3 , cert ai n ret i rem en t i n co m e fro m Lu cen t . Atal l rel ev an tt i m es , i ncl u d i ng du ri n g 2 0 1 1 , 2 01 2 , an d2 0 1 3 , M r. Sm i th recei v edSo ci al Secu ri t y b en efi t s , as d i d p et i t i o n er, Sh ei l a C. Sm i t h (M s . Sm i t h ). (W e s hal l s o m et i m es refer co l l ect i v el y t o M r. Sm i th an dM s . Sm i t h as th e Sm i t h s .) Fro m atl eas t2 0 07 th ro u g h atl eas t2 0 13 , M r. Sm i t h p erfo rm edcert ai n p ers o n al s erv i ces as a h an dym an , an dM s . Sm i t h p erfo rm edcert ai n p ers o n al s erv i ces
as an o ffi ce m an ag er fo r Hi l l cres tGo l f & Co un t ry Cl ub (Hi l l cres t ). In J u l y 2 0 0 7, p u rs u an t t o th e ad v i ce o f W arren W . Si m p s o n , wh o was th e Sm it h s ’ acco u n t an tan dth e p res i d en to f Sp ect ru m Fi n an ci al (Sp ect ru m ), an acco u nt i n g fi rm , th e Sm it h s i n co rp o rat edu n d er t he l aws o f t h e St at e o f Ok l ah o m a,
an d each o wn ed5 0 p ercen t o f t h e o u t s t an d i n g s t ocko f, Sm i t h So lu t i o n s, In c. (Sm i th So l u t i o n s ). Fo r t ax ab l e y ears 2 0 0 7 th ro u g h atl eas t2 0 13 , Sm i t h So l u t i o n s
was an S co rp o rat i o n fo r t ax p u rp o s es . Onth e d at e o n wh i ch th e Sm i th s i n co rp o rat edSm i t h So l u t i o n s , i ts b o ardo f d i rect o rs (b o ard ), wh i ch co n s i s t edo f M r. Sm i t h an dM s . Sm i t h , h el dan o rg an i zat i on al m eet i n g . Atth atm eet i n g , th e b o ard(1 ) ad o pt edth e b y l aws o f Sm i t h So l u -- 4
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[* 4 ] t i on s (b y l aws ), (2 ) el ect edM r. Sm i th as p res i d en t an dM s. Sm i t h as b o t h
s ecret ary an dtreas u rer o f Sm i t h So l u t i o n s , 3 (3 ) p as s eda res ol u t i o n t o o p en a b an k
acco u n t fo r Sm it h So l u t i o n s (b an kacco u n tres o l u t i o n ), 4 an d(4 ) p as s eda res o l u t i on au th o ri zi n g an dd i rect i n g th e p res i d en t o f Sm it h So l u t i on s “ t o en t er i nt o
em pl o y m en tco n t ract s wi th cert ai n em pl o y ees ” (em

p l oym en tco n t ract res o l u t i o n ). As n o tedab o v e, t h e em

p l o ym en tco n t ract res o lu t i o n au th o ri zedan dd i rect ed th e p res i d en to f Sm it h So l u t i on s “ t o en t er i n t o em p lo ym en tco n t ract s wi t h cert ai n
em pl o y ees ” an dreq u i redth at“ s u ch co n t ract* * * b e fo r t h e t erm an d t h e rat e
s t at edi n th e at tach ed Em p l oym en tAg reem en t s . ” Atn o t i m e d idSm i t h So l u t i o n s
en t er i nt o an y

em p l o ym en tag reem en t , wri t t en o r o ral , wi t h an y p ers o n , i n cl u d i n g M r. Sm i th o r M s . Sm i t h . At n o t i m e d i dM r. Sm i t h co n s i d er h i m s el f o r M s . Sm i t h t o b e an em

p lo y ee o f Sm i t h So l u t i o n s. Pu rs uan tt o i t s b y laws , Sm i t h So l u t i o ns was au t h ori zedt o p ay M r. Sm i t h
an d M s . Sm i t h s al ari es i n t h ei r res p ect i ve p o s i t i o n s as i t s p res id en tan di t s s ecret ary an dtreas u rer. Ho wev er, atn o t i m e d i dSm i t h So l u t i o n s p ay M r. Sm i t h o r M s .

3 Atal l rel ev an tt i m es , M r. Sm i t h an dM s . Sm i t h ret ai nedth ei r p o s i t i o n s as th e d i rect o rs an dth e o ffi cers o f Sm it h So l ut i o n s .

4 Th e d o cu m en tco n t ai n i n g th e b an k acco u n tres o l u ti o n , en t i t l ed“ RESOLUTION: OPEN BANK/ CHECKING ACCOUNTS”, d i d n o ti n cl u d e t h e n am e o f an y b an k i n t h e b l an k s pace p ro vi d edfo r s uch a d es i g n at i o n .- 5
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[* 5 ] Sm it h an y

co m p en s at i on i n th o s e res p ect iv e p o s it i on s . No r d i di t atan y t i m e p ay M r. Sm i t h o r M s . Sm i t h an y wag es o r o th er co m

p en s at io n i n s om e o t h er cap aci ty . Du ri n g atl eas t 2 0 1 1 an dm o s t o f 2 0 1 2 , Hi ll cres trecei v edm o n th l y i n v o i ces (Hi l lcres ti n vo ices ) wi th res p ectt o M s . Sm it h ’ s s erv i ces as i t s o ffi ce m an ag er. 5 Each o f t h o s e i n v oi ces s h o wedth e am o u n tdu e fo r each m on t h wi t h res pect t o th o s e s erv i ces . Th e fo ll owi n g l an g u ag e ap p eared atth e t o p o f each o f t h e Hi l l cres t i n v o i ces : Sh ei l a Sm i t h

Sm i t h So l u t i o ns , In c. FED ID# * * * * * * * * * * * * * * * Ok l ah om a Ci t y , OK 7 3 1 5 9 Th e ad dres s s h o wnatth e t o p o f each Hi l l cres t i n vo i ce i s th e Sm i t h s ’ h o m e ad

dres s . Th e b o t t o m

o f each Hi l l cres ti n v o i ce was d i g i tal l y s i g nedi n th e n am e o f

“ Sh ei l a C. Sm i t h ”. Du ri n g 2 0 1 1 , 2 01 2, an d2 0 1 3 , Hi l l cres tm ad e p aym en t s t o Sm i t h So l u t i o n s fo r M s. Sm i t h ’ s p ers o n al serv ices th att o t al ed $ 6 ,1 89 , $ 1 2 ,4 04 , an d$ 6 ,5 7 0 , 6

5 Th ere are n o Hi l l cres ti n v o i ces i n t he reco rd fo r t h e m o n t h s o f J u ly , Oct o b er, an dDecem

ber 2 0 1 2 o r fo r an y

m o n th s i n 2 0 1 3
. 6 W e fo u n dth atdu ri n g 2 0 1 3 Hi ll cres tm ad e p aym en t s t o Sm i t h So lu t i o n s t o t al i n g $ 6 ,5 7 0 fo r M s . Sm it h ’ s p ers o n al s erv i ces . Th e p art i es s t i p ul at edth atdu r- (co n ti n u ed ...)- 6
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[* 6 ] res p ect i v el y . Hi l l cres tm ad e cert ai n o f t h o s e p aym en ts b y ch eckp ay ab l e t o

“ Sm i th So l u t i on s, In c.” (Hi ll cres tch eck s ). Hi l l cres ti s s u edFo rm

1 0 9 9 -M ISC, M i s cel l an eo u s In co m e, fo r each o f 2 0 1 1 (Hi l lcres t2 0 1 1 Fo rm 1 0 9 9-M ISC), 2 0 1 2 (Hi l l cres t2 0 1 2 Fo rm 1 0 9 9-M ISC), an d 2 0 1 3 (Hi l l cres t 2 0 1 3 Fo rm 1 0 99 -M ISC). 7 (W e s h al l s o m et i m es refer co l l ect i v el y t o the Hi l l cres t2 0 1 1 Fo rm 1 0 9 9 -M ISC, t h e Hi l l cres t2 0 1 2 Fo rm 1 09 9 -M ISC, an d th e Hi l l cres t 2 0 1 3 Fo rm

1 0 99 -M ISC as th e Hi l l cres tFo rm s 1 0 9 9 -M ISC.) Th e IRM F d at a t h atth e IRS m ai n t ai n edwi t h res pect t o each o f t he Hi l l cres tFo rm s 1 0 9 9 -M ISC s h o wedth e n am e “ SHIELA [s i c] SM ITH” un d er t h e h ead i n g

6 (...co n t in u ed ) i n g 2 0 13 Hi l l cres tp ai dSm i t h So lu t i o n s $ 6 ,7 5 0 fo r M s . Sm i t h ’ s p ers o nal s erv i ces . Th e p art i es al s o s ti p u l at edth ati n th e n o t i ce res p o n den td et erm i n edfo r p et i t i o n ers ’ t ax ab l e y ear 2 01 3 t o i n cl u d e $ 6,7 5 0 i n Sch edu le C, Pro fi to r Lo s s Fro m Bu s i n es s (Sch edul e C), rel at i n g t o th e p ers o n al s erv i ces th atM s . Sm i t h ren d eredt o Hi l l cres t du ri n g th aty ear. Itap p ears t h atth ere m ay h av e b een ty

p o g rap h i cal erro rs i n th e am ou n t s s t at edi n tho s e s t ip u l at i o n s . Th e res p ect i v e am o un t s s t at ed i n t h o se s t ip u l at i o n s are cl earl y

co n t raryt o t h e fact s th atwe h av e fo un d are es t ab l i s h edb y th e reco rd , an dwe s h al l d i s reg ardth em . See Cal -M ai n e Fo o d s , In c. v . Co m m i s s i o n er, 9 3 T.C. 1 81 , 1 9 5 (1 9 8 9 ).
7 Hi l l cres t2 01 1 Fo rm

1 0 99 -M ISC, Hi l l cres t2 0 1 2 Fo rm 1 0 9 9-M ISC, an d Hi l l cres t 2 0 1 3 Fo rm

1 09 9 -M ISC are n o ti n t h e reco rd . In s t ead , co p i es o f p ert i n en t p o rt i on s o f t h e s o -cal l edIn fo rm at i o n Retu rn s M as t er Fi l e (IRM F) o n l i n e t ax p ay er s y s t em (IRM F d at a) t h atth e In t ern al Rev en u e Serv i ce (IRS) m ai n t ai n edwi t h res p ectt o t h o s e fo rm s an dth ats h o wedth e d at a t h at Hi l l cres trep ort edo n each o f th o s e fo rm s are i n th e reco rd . As d i s cu s s edb el o w, atn o t i m e was Hi l l cres t req u i redt o i s s u e Fo rm

1 0 9 9 -M ISC t o a co rp o rat i o n s u ch as Sm it h So l u t io n s .- 7
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[* 7 ] “ PAYEE ENTITY DATA”, t h e n am e “ HILLCREST GOLF & COUNTRY CLUB” u n d er t h e h ead i n g “ PAYER ENTITY DATA”, 8 an d “NONEM COM ” p ai d
o f $ 6 , 8 1 9 , $ 1 2 ,4 0 4, an d$ 6,5 7 0 fo r 2 0 1 1 , 2 0 1 2, an d2 01 3 , res p ect i v el y . Du ri n g th e p eri o dfro m

atl eas t2 0 1 1 t h ro u gh 2 0 1 2, M r. Sm i t h p eri o d i cal l y p erfo rm edcert ai n p ers o n al s erv i ces as a h an dym an fo r In teg ri s Heal t h (In t eg ri s ), Es kri d g e Ho n d a (Es kri d g e), M i ch ael an dSan dra M i l li g an (co l l ect i v el y , M i l l i

g an s), an dJ am es an dCat h y Ad am s (co l l ect i vel y , Ad am s es ). Each o f In t eg ri s , Es kri d g e, an dth e M i l l i g an s recei v edcert ai n i n v o ices rel at i n g t o M r. Sm it h ’ s p erfo rm an ce o f cert ai n p ers o n al s erv i ces (s o m et im es
co l l ect i v el y , i n v o i ces rel at i n g t o M r. Sm i t h ’ s p ers on al s erv i ces ). 9 Th e fo l l o wi n g l an g u ag e ap peared atth e t o p o f each o f t he i nv o ices rel at i n g t o M r. Sm i t h ’ s p ers o n al s erv i ces : Sm i t h So l u t i o n s , In c. Sm i t h So lu t i o n s , In c. * * * * * * * * * * * * Ok l ah o m a Ci t y , Ok l ah o m a 7 3 1 59 * * * * * * * * * * * * FED ID# * * *

8 Th e n am e “ W i l l o w CreekGo l f an d Co u nt ry Cl ub ” ap p eared u n d er t h e h ead in g “ PAYER ENTITY DATA” fo r t ax ab l e y ear 2 0 1 3
.

9 Th e reco rdd o es n o t co n t ai n an y i n v o i ces s en tt o , o r recei v ed b y , th e Ad am s es rel at i n g t o cert ai n p ers o n al s erv i ces th atM r. Sm i t h p erfo rm edfo r t h em .- 8
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[* 8 ] Th e ad dres s s h o wnatth e t o p o f each o f t h e i n v oi ces rel at i n g t o M r. Sm i t h ’ s p ers o n al s erv i ces i s t h e Sm it h s ’ h om e ad dres s . Each o f t h o s e i n v o i ces s h o wed , i n t er al i a, t h e d at e(s ) o n wh i ch M r. Sm i t h p erfo rm edcert ai n p ers o n al s erv ices , th e
n u m b er o f h o u rs th ath e wo rk edo n each d ay , an dth e h ou rl y rat e ch arg edfo r t h o s e
s erv i ces . Du ri n g atl eas t 2 0 1 1 , In t eg ri s m ad e cert ai n p aym en ts b y ch eckrel at i n g t o M r. Sm i th ’ s p erfo rm an ce o f cert ai n p ers o n al s erv ices fo r i t(In t eg ri s ch eck s ). M o s to f t h e In teg ri s ch eck s were m ad e p ay ab l e t o “ Sm i t h So lu t i o n s, In c.” Two o f th e In t eg ri s ch eck s , b o th o f wh i ch were d at edOct ob er 1 3 , 2 01 1 , were m ad e p ay ab l e t o “ Sh ei l a Sm i t h ”. Du ri n g atl eas t 2 0 1 1 an d2 0 1 2 , Es kri dg e m ad e cert ai n p aym en t s b y ch eck rel at i n g t o M r. Sm it h ’ s p erfo rm i n g cert ai n p ers on al s erv i ces fo r i t (Es kri d g e ch eck s ). M o s to f t he Es kri d g e ch eck s were m ad e p ay ab l e t o “ Sm i t h So l u ti o n s , In c.” On e o f t h e Es kri d g e ch eck s , d at edFeb ru ary 1 1 , 2 0 1 1 , was m ad e p ay ab l e t o

“ Ro n Sm i t h ”. Du ri n g atl eas t 2 0 1 1 an d2 0 1 2 , th e M i l l i g an s m ad e cert ai n p aym en t s b y ch eckrel at i n g t o M r. Sm i th ’ s p erfo rm an ce o f cert ai n p ers o n al s erv i ces fo r t h em (M i ll i g an ch eck s ). On e o f th e M i l l i g an ch eck s, d at edM ay 2 0, 2 0 11 , was m ad e- 9
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[* 9 ] p ay ab l e t o “ Sm i th So l u t io n s , In c.” Cert ai n o f t h e M i ll i g an ch eck s , d at ed J an u ary 3 0 an dJ u n e 2 0 , 2 0 12 , res p ect i v el y , were m ad e p ay ab l e t o “ Ro n Sm i t h ”. Du ri n g atl eas t 2 0 1 1 an d2 0 1 2 , th e Ad am s es m ad e cert ai n p aym en t s b y ch eckrel at i n g t o M r. Sm i th ’ s p erfo rm an ce o f cert ai n p ers o n al s erv i ces fo r t h em (Ad am s es ch eck s ). Vi rtu al l y al l o f t h e Ad am s es ch eck s were m ad e p ay ab l e t o

“ Ro n Sm i t h ”. Atal l rel ev an tt im es , p et i t i o n ers m ai nt ai n edv ari o us b an kacco u n t s at W EOKIE Cred itUn i o n (W EOKIE), i n Ok l ah o m a Ci t y , Ok l ah o m a. Pet i ti o n ers
m ai n t ai n eda s av i ng s acco u n ti d en t i fi edas “ S0 11 ” (s av i n gs acco u n t ); two ch eck

i n g acco un t s i d en t i fi edas “ S0 1 3 ” an d“ S0 1 4 ”, res p ect i v el y (S0 1 3 ch eck i n g
acco u n t an d S0 1 4 ch eck i n g acco u n t , res pect i v el y ); a m o n ey m ark etacco un t i d en t i fi edas “ S0 1 9 ” (m on ey m ark etacco u n t ); an d a cert ifi cat e o f d ep o s i tacco u n t i d en t i fi edas “ S0 2 1 ” (COD acco u n t ). (W e s h al l refer co l l ect i v el y t o t h e s av i n g s
acco u n t , th e S0 1 3 ch eck i n g acco u n t, th e S0 1 4 ch eck i n g acco u n t , th e m on ey
m ark etacco u n t , an dth e COD acco u n tas the W E OKIE acco u nt s .) Pet i t i o ners d i dn o tm ai n tai n an y b an kacco u n t i n th e n am e o f, o r o n b eh al f
o f, Sm i th So l u t i on s . Duri n g t h e y ears ati s s u e, p et i ti o n ers d ep o s i t edi n t o o n e o r
m o re o f t h e W EOKIE acco u n t s, i n t er al i a, Hi l l cres tch eck s, In t eg ri s ch eck s , Es kri d g e ch eck s , M i l l i g an ch eck s , an dAd am s es ch eck s .- 1 0 -

[* 1 0 ] Sp ect ru m

p rep aredFo rm

1 1 2 0 S, U.S. In co m e Tax Retu rn fo r an S Co rp o rat i o n (Fo rm

1 1 2 0 S), fo r Sm i t h So l u ti o ns fo r each o f i t s t ax ab l e y ears 2 0 1 1 (2 0 1 1 Fo rm

1 1 2 0 S), 2 0 1 2 (2 01 2 Fo rm 1 1 2 0 S), an d2 0 1 3 (2 0 13 Fo rm 1 12 0 S). In i t s 2 0 1 1 Fo rm

1 1 2 0 S, Sm i t h So lu t io n s cl ai m ed“ [t ] o t al i n co m e (l os s )” o f $ 2 9 ,8 0 5 co n s i s t i n g o f “ [m ] erch an tcardan d t h i rd -p art y p aym en t s ”, “ [t ] ot al d edu ct i o n s ” o f $ 2 6 ,1 2 7 , an d“ [o ] rd i n ary b u s i n es s i n co m e (l o s s)” o f $ 3 ,6 7 8 . Sm i t h So l u ti o n s ’ t o t al d edu ct i o n s o f $ 2 6 ,1 2 7 co ns i s t edo f $ 5 6 8 o f “ [r] ep ai rs an d m ai n t en an ce”, $ 8 5 o f “ [t ] ax es an dl i cen s es ”, $ 4 ,4 38 o f “ [d ] ep reci at i o n ”, an d $ 2 1 ,0 3 6 o f

“ [o ] th er d edu ct i o n s ”. Th e $ 2 1 ,0 3 6 o f o t h er d edu ct i on s co m p ri s edth e fo l l o wi n g : It em Am o u n t Acco u n t i n g $ 5 10 Au t o an d t ru ck ex p en s e 1 ,1 24 M eal s (5 0 %) 4 02 Offi ce ex p en s e 1 7 Sup pl i es 6 ,8 06 Tel ep h o n e 1 ,0 59 M ed i cal 9 ,6 06 Ho m e o ffi ce ren t 1 ,5 12 To tal 2 1 ,0 36- 1 1 -

[* 1 1 ] Sm i t h So l u t i o n s d idn o t cl ai m as a d edu ct i o n i n i t s 2 0 1 1 Fo rm 1 1 20 S an y

“ [c] o m p en s at i o n o f o ffi cers ” o r “ [s ] al ari es an d wag es ”. Sm i t h So lu t i o n s i n cl u d edSch edul e K, Sh areh o ld ers ’ Pro Rat a Sh are It em s (Sch edul e K), wi t h i t s 2 0 11 Fo rm 1 1 2 0 S (2 0 11 Sch edu l e K). Th e 2 01 1 Sch edu l e K s h o wed“ [o ] rd i n ary

b u s i n es s i n co m e (l os s )” o f $ 3 ,6 7 8 , a “ [s ] ect i o n 1 7 9 d edu ct i on ” 1 0 o f $ 4 0 9 , an d“ [i ] n co m e/ l o s s reco n ci l i at i o n ” o f $ 3 ,2 6 9
. In i t s 2 0 1 2 Fo rm

1 1 2 0 S, Sm i t h So lu t io n s cl ai m ed“ [t ] o t al i n co m e (l os s )” o f $ 1 4 ,8 3 0 co n s i s t i n g o f “ [g ] ro s s recei p t s o r s al es ”, “ [t ] o t al d edu ct i o n s ” o f $ 3 0 ,4 2 2 , an d “ [o ] rd i n ary

b u s i n es s i n co m e (l o s s )” o f

! $ 15 ,5 9 2
. Sm i t h So l ut i o ns ’ t ot al d educt i o n s o f $ 3 0 ,4 2 2 co n s i s t edo f $ 4 3 o f “ [t ] ax es an dl i cen s es ”, $ 4 ,1 0 6 o f

“ [d ] ep reci at i o n ”, an d$ 2 6 ,2 73 o f “ [o ] t h er d edu ct i o n s ”. Th e $ 2 6 ,2 73 o f o th er d educt i o n s co m

p ri s edthe fo l l o wi n g :

1 0 Al l s ect io n referen ces are t o th e In t ern al Rev en u e Co d e (Co d e) i n effect fo r t h e y ears ati s su e. Al l Ru l e referen ces are t o t h e Tax Co u rtRu l es o f Pract i ce an d Pro cedu re.- 1 2 -

[* 1 2 ] It em Am o u n t Acco u n t i n g $ 5 60 Au t o an d t ru ck ex p en s e 4 ,9 4 6 In s u ran ce 1 ,0 8 3 M eal s (5 0 %) 3 78 Offi ce ex p en s e 9 0 6 Sup pl i es 2 ,7 0 1 Tel ep h o n e 6 2 3 M ed i cal 1 3 ,0 2 4 Ho m e o ffi ce ren t 1 ,6 21 M u l t i m ed ia 4 31 To tal 2 6 ,2 73 Sm it h So l u t i o n s d i dn o t cl ai m as a d edu ct i o n i n i t s 2 0 1 2 Fo rm 1 1 2 0S an y

“ [c] o m p en sat i o n o f o ffi cers ” o r “ [s ] al ari es an dwag es ”. Sm i t h So lu t i o n s i n cl u d edSch edul e K wi t h i t s 2 0 1 2 Fo rm 1 1 2 0S (2 0 1 2 Sch edu l e K). Th e 2 01 2 Sch edul e K s h o wed “ [o ] rd i n ary b u s i n es s i n co m e (l o s s )”
o f

! $ 1 5 ,5 9 2 , an d“ [i ] n co m e/ l o ss reco nci l i at i o n” o f

! $1 5 ,5 9 2. In i t s 2 0 1 3 Fo rm

1 1 2 0 S, Sm i t h So lu t io n s cl ai m ed“ [t ] o t al i n co m e (l os s )” o f $ 9 ,0 3 6 co n s i s t i n g o f “ [g ] ro s s recei p t s o r s al es ” o f $ 1 0 ,1 96 l es s “ [c] o s t o f g o o d s
s o l d ” o f $ 1 ,1 6 0 , “ [t ] o t al d edu ct i o n s” o f $ 2 0 ,0 8 0 , an d“ [o ] rd i n ary b u s i n es s i n co m e (l os s )” o f

! $ 1 1 ,0 4 4 . Sm i t h So l u t i o n s’ t o t al d edu ct i o n s o f $ 2 0,0 80 co n s i s t edo f- 1 3 -

[* 1 3 ] $ 4 4 o f “ [t ] ax es an d l i cen s es ”, $ 2,9 8 3 o f d ep reci at i on , an d$ 1 7 , 0 5 3 o f

“ [o ] th er d edu ct i o n s ”. Th e $ 1 7 ,0 5 3 o f o t h er d edu ct i on s co m p ri s edth e fo l l o wi n g : It em Am o u n t Acco u n t i n g $ 5 60 Au t o an d t ru ck ex p en s e 3 ,0 99 M eal s redu ced 3 70 Offi ce ex p en s e 9 43 Sup pl i es 6 ,6 91 Tel ep h o n e 8 06 Ho m e o ffi ce ren t 1 ,3 22 M u l t i m ed ia 3 ,2 62 To tal 1 7 ,0 53 Sm it h So l u t i o n s d i dn o t cl ai m as a d edu ct i o n i n i t s 2 0 1 3 Fo rm 1 1 2 0S an y

“ [c] o m p en sat i o n o f o ffi cers ” o r “ [s ] al ari es an dwag es ”. Sm i t h So lu t i o n s i n cl u d edSch edul e K wi t h i t s 2 0 1 3 Fo rm 1 1 2 0S (2 0 1 3 Sch edu l e K). Th e 2 01 3 Sch edul e K s h o wed “ [o ] rd i n ary b u s i n es s i n co m e (l o s s )”
o f

! $ 1 1 ,0 4 4 , an d“ [i ] n co m e/ l o ss reco nci l i at i o n” o f

! $1 1 ,0 4 4. Sm i t h So lu t i o n s i s s uedt o each o f M r. Sm i t h an dM s . Sm i th Sch edu l e K-1 , Sh areh ol d er’ s Sh are o f In co m e, Dedu ct i o n s , Cred i t s , et c. (Sch edu l e K-1 ), fo r each- 1 4 -

[* 1 4 ] o f i t s t ax ab le y ears 2 0 1 1 (co l l ect i v el y , 2 0 1 1 Sch edu l es K-1 ), 2 0 1 2 (co l l ect i vel y , 2 0 1 2 Sch edul es K-1 ), an d2 0 1 3 (co ll ect i v el y , 2 0 1 3 Sch edu l es K-1 ). In each o f i t s 2 0 1 1 Sch edu l es K-1 , Sm i t h So l u t i o n s s h owed$ 1,8 3 9 as each
o f M r. Sm i t h ’ s an dM s . Sm i t h ’ s s h ares o f i t s cl ai m ed “ [o ] rd i n ary b u si n es s i n co m e (l os s )” o f $ 3 ,6 78 an d$ 2 05 as each o f t h ei r s h ares o f i t s cl ai m ed“ [s ] ect io n 1 7 9 d educt i o n ” o f $ 40 9
. In each o f i t s 2 0 1 2 Sch edu l es K-1 , Sm i t h So l u t i o n s s h owed

! $ 7 ,7 9 6 as each
o f M r. Sm i t h ’ s an dM s . Sm i t h ’ s s h ares o f i t s cl ai m ed “ [o ] rd i n ary b u si n es s i n co m e (l os s )” o f

! $ 1 5 ,5 9 2
. In each o f i t s 2 0 1 3 Sch edu l es K-1 , Sm i t h So l u t i o n s s h owed

! $ 5 ,5 2 2 as each
o f M r. Sm i t h ’ s an dM s . Sm i t h ’ s s h ares o f i t s cl ai m ed “ [o ] rd i n ary b u si n es s i n co m e (l os s )” o f

! $ 1 1 ,0 4 4
. Sp ect ru m p rep aredFo rm

1 0 4 0 , U.S. In d i vi du al In co m e Tax Retu rn (ret u rn ), fo r p et i t i o n ers fo r each o f t h ei r t ax ab le y ears 2 0 1 1 (2 0 1 1 retu rn ), 2 0 1 2 (2 0 1 2 retu rn ), an d2 0 1 3 (2 01 3 ret u rn ). In th ei r 2 0 11 retu rn , p et i t i o n ers rep o rt ed , i n t er al i a, “ [w] ag es , s al ari es , t i p s , et c.” o f $ 8 9 an d“ [o ] t h er i n co m e” o f

! $ 2 1 ,9 40 wi t h res p ectt o a cl ai m edn et
o p erat i n g l o s s carry o v er. Pet i t i o n ers i n cl u d edSch edul e E, Supp l em en tal In co m e
an d Lo s s (Sch edu l e E), wi t h th ei r 2 0 11 return (2 0 1 1 Sch edu l e E). In th ei r 2 0 1 1- 1 5 -

[* 1 5 ] Sch edul e E, p et i t i o n ers cl ai m edwi t h res p ectt o Sm i t h So l u t io n s t o t al “ [n ] o n p as s i v e i n co m e fro m

Sch edu l e K-1 ” o f $ 3 ,6 7 8 , a “ [s ] ect io n 1 79 ex p en s e d edu ct i on ” o f $ 4 1 0 , an d“ [t ] o t al p art n ers h i p an d S co rp o rat i on i n co m e o r (l o ss )” o f $ 3 ,2 6 8
. In th ei r 2 0 12 retu rn , p et i t i o n ers rep o rt ed , i n t er al i a, “ [w] ag es , s al ari es , t i p s , et c.” o f $ 1 8 . Pet i ti o n ers i n cl u dedSch edu le E wi t h th ei r 2 0 12 retu rn (2 0 12 Sch ed

u l e E). In th ei r 2 0 1 2 Sch edu le E, p et i t io n ers cl ai m edwi t h res p ectt o Sm i t h So l u t i on s a t ot al “ [n ] onp as s i ve l o ss fro m Sch edu l e K-1 ” o f

! $ 15 ,5 9 2 , an d“ [t ] o t al p art n ers hi p an dS co rp o rat i o n i n co m e o r (l o ss )” o f

! $ 1 5 , 5 92
. In th ei r 2 0 13 retu rn , p et i t i o n ers rep o rt ed , i n t er al i a, n o “ [w] ag es , s al ari es , t i ps , et c.” Pet i t i o n ers i n cl ud edSch edu l e E wi t h t h ei r 2 0 1 3 retu rn(2 01 3 Sch edu l e E). Inth ei r 2 0 1 3 Sch edul e E, p et i t i o n ers cl ai m edwi t h res p ectt o Sm i t h So l u t i o n s a t ot al “ [n ] o np as s i v e l o s s fro m Sch edu l e K-1 ” o f

! $1 1 ,0 4 4 , an d“ [t ] o t al p art n ers h i p an dS co rp o rat i o n i n co m e o r (l o s s)” o f

! $ 1 1 ,0 4 4
. Res p o n d en tas si g neda rev en u e ag en tt o ex am i n e each o f Sm i t h So l u t i o n s ’ t ax ab l e y ears 2 0 1 1, 2 0 1 2 , an d 2 0 1 3
. Th ereaft er, t h e rev en u e ag en tex p an d edth at
ex am i n at i o n t o i n cl u d e each o f p et i t i o n ers ’ t ax ab l e y ears 2 0 11 , 2 01 2 , an d2 0 1 3
. Pet i t io n ers d i dn o tm ai n tai n b o o k s an d reco rd s rel at i n g t o Sm i t h So l u t i o n s an d g av e th e rev en u e ag en to n l y cert ai n red act edb an ks t at em en t s rel at i n g t o th ei r- 1 6 -

[* 1 6 ] t ax ab l e y ear 2 0 1 1 . Co n s equ en t l y , the rev en u e ag en t o b t ai n edb y s u m m o n s es
u n red act edb an k s t at em en t s rel at i n g t o each o f p et i t i o n ers ’ t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 0 1 3
. Aft er h av in g o b tai n ed t h e u n red act edb an ks t at em en ts fo r each o f p et i

t i on ers ’ t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 0 1 3 , th e rev en u e ag en tp erfo rm eda b an k d ep os i t s an al y si s i n o rd er t o as cert ai n wh et her Sm i t h So l u t io n s h adu n d errep o rt ed th e g ro s s recei p t s th ati th adrep o rt edi n each o f i t s 2 0 11 Fo rm 1 12 0 S, 2 0 1 2 Fo rm 1 1 2 0 S, an d2 0 13 Fo rm

1 1 2 0 S. (W e s h al l refer co l l ect i v el y t o the rev en u e ag en t ’ s b an k d ep o s i t s an al y s i s fo r each o f p et i t i o n ers ’ t ax ab l e y ears 2 0 1 1 , 2 01 2 , an d2 0 1 3
as th e b an kd ep o s it s an al y s es i n ques t i o n .) As p arto f t h e b an kd ep o s i t s an al y s es i n qu es t i o n , th e rev en u e ag en t an al y zedeach d ep o s i ti n t o each o f t h e W EOKIE acco un t s du ri n g each o f t h e y ears 2 0 1 1 , 2 0 1 2 , an d 2 0 1 3 i n o rd er t o d et erm i ne t h e t o t al d ep o s i t s i n to each o f t h o s e
acco u n t s, an d th e t o t al d ep o s i t s i n t o al l o f t ho s e acco un t s , duri n g each o f t h o s e y ears . Th e rev en u e ag en tth en an al y zed each d ep o s i t i n t o th e W EOKIE acco u n t s du ri n g each o f th e y ears 2 01 1 , 2 0 12 , an d 2 0 1 3 i n an effo rt t o d et erm i n e wh et h er
an y o f t h o s e d ep o s it s was n o tt ax ab l e b ecau s e, fo r ex am p l e, i twas a l o an , a t ran s fer fro m an o th er b an kacco un t , o r an o t h er ty p e o f n o n t ax ab l e d ep o s i t . As a fi n al
s t ep i n the b an k d ep o s it s an al y ses i n ques t i o n , th e rev en u e ag en t redu cedth e t o t al- 1 7 -

[* 1 7 ] d ep o s it s i n t o t h e W EOKIE acco u n t s du ri ng each o f th e y ears 2 0 11 , 2 0 1 2 , an d 2 0 1 3 th ats h e h add et erm i n edb y th e t o t al am o un tth ats h e h add et erm i n ed
were n o n t ax ab l e d ep o s i t s i n o rd er t o arri v e atth e t o t al am o u n t o f t ax ab l e d ep o s i t s i n t o th e W EOKIE acco u n t s fo r each o f t h o s e y ears . Pu rs uan tt o t h e b an k d ep o s it s an al y s es i n qu es t io n , th e rev en u e ag en t d et erm i n edth atp et i t i o n ers h adt o tal t ax ab l e d ep os i t s fo r t h ei r t ax ab l e y ears 2 0 11 , 2 0 1 2 , an d2 0 1 3 o f $ 1 9 9 , 7 5 2 , $ 1 5 ,6 1 2 , an d$ 2 1,2 0 3 , res pect i v el y . Th e rev en u e ag en t co ncl u d edth atdu ri n g each o f th e y ears 2 01 1 , 2 0 1 2, an d 2 01 3 M r. Sm i t h i n h i s i n d i v i dual cap aci t y an d M s . Sm it h i n h er i n d i vi du al cap aci ty , an dn o tSm i t h So l u ti o n s , h adp erfo rm edcert ai n p ers o n al s erv i ces fo r cert ai n p ers o n s . Th e rev en u e ag en td eci d ed t h at co n s equ en t l y t h e t o t al t ax ab l e d ep o s i t s fo r each o f p et i

t i on ers ’ t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 0 1 3 t h ats h e h add et erm i n edp u rs u an tt o th e b an kd ep os i ts an al y s es i n qu es t io n s h ou l db e al lo cat edb et ween M r. Sm i t h an d M s . Sm i th . Th e rev en ue ag en tfu rth er co n cl u d ed t h atth e res p ect i ve am o u n t s o f t ax ab l e d ep o s i t s fo r t h o se y ears s o al l ocat eds h o ul db e i n cl ud edas g ro s s i n co m e i n
s ep arat e res p ect i v e Sch edu l es C fo r M r. Sm it h an d fo r M s . Sm i th fo r p et i t i o n ers ’ t ax ab l e y ears 2 0 1 1, 2 0 1 2 , an d 2 0 1 3
. In d eci d i ng h o w t o al l ocat e t o M s . Sm it h a p o rt i o n o f t h e t ot al t ax ab l e d ep o s i t s thats h e h add et erm i n edfo r each o f p et i t i o n ers ’ t ax ab l e y ears 2 0 11 , 2 0 1 2 ,- 1 8 -

[* 1 8 ] an d 2 0 13 , th e rev en u e ag en t b eg anb y rev i ewi n g th e Hi ll cres tFo rm s 1 0 9 9
- M ISC. Th ati s b ecau s e M s . Sm i t h h adp erfo rm edcert ai n p ers o n al s erv ices du ri n g each o f t h o s e y ears o nl y

fo r Hi l l cres t . Th e rev enu e al l o cat ed t o M s . Sm i t h fo r p et i t i o n ers ’ t ax ab l e y ears 2 0 11 , 2 0 1 2 , an d2 01 3 i s the res p ect i v e am ou n t s o f n o n em pl o y ee co m

p en s at io n thatHi l l cres ts h o wedi th adp ai d i n th e Hi ll cres tFo rm s 1 0 9 9 -M ISC du ri n g th o s e y ears fo r M s . Sm i th ’ s p ers o n al s erv i ces , i .e., $ 6 ,8 1 9 , $ 1 2 ,4 0 4 , an d$ 6 , 5 7 0 fo r 2 0 1 1 , 2 0 1 2 , an d2 0 13 , res p ect i v el y . Th e rev enu e ag en t th en redu cedth e res p ect i v e t o t al t ax ab le d ep o s i ts o f $ 1 9 9 ,7 5 2 , $ 1 5,6 1 2 , an d $ 2 1 ,2 0 3 th ats he h add et erm in edfo r p et i t i o ners ’ t ax ab l e y ears 2 0 1 1 , 2 0 1 2, an d 2 0 1 3 b y th os e res p ect i v e am o u n t s o f n on em p l o y ee co m

p en s at i o n th at Hi l l cres t p ai dfo r M s. Sm i t h’ s p ers on al s erv i ces . Th e rev en ue ag en tal l o cat ed t o M r. Sm i t h th e res p ect i v e b al an ces o f t h os e res pect i v e t o tal t ax ab le d ep o s i t s fo r t h os e y ears , i .e., $ 1 9 2 ,9 3 3, $ 3 , 2 0 8 , an d $ 1 4 ,6 3 3 fo r p et i t i o n ers ’ t ax ab l e y ears 2 01 1 , 2 0 1 2 , an d 2 0 1 3 , res p ect i v el y . Res p o n d en ti s su edth e n o t i ce t o p et i t io n ers . Inth e n o t ice, res p o nd en t d et erm i n edth ateach o f M r. Sm i t h an dM s . Sm i t h h as t h e fo ll owi n g am o u n t s o f- 1 9 -

[* 1 9 ] Sch edul e C i nco m e 1 1 fo r t h ei r t ax ab l e y ears 2 0 11 , 2 01 2 , an d2 0 13 fro m th e p erfo rm an ce o f p ers o n al s erv i ces du ri n g t h o s e y ears : 1 2 Nam e 20 1 1 2 01 2 2 01 3 M r. Sm i t h $ 1 9 2 ,9 3 3 $ 3 ,2 08 $ 1 4,6 3 3 M s . Sm i t h 6 ,8 1 9 1 2 ,4 04 6 ,5 7 0 Res p o n d en tfu rth er d et erm i n edi n th e n ot i ce t h atp et i t i o n ers are n o ten t i t l ed fo r t h ei r t ax ab l e y ear 2 0 1 1 t o a d edu ct i o n o f $ 2 1 ,9 4 0 wi t h res p ect t o a cl ai m edn et
o p erat i n g l o s s carry o v er. OPINION W e ad dres s fi rs tp et i t i on ers ’ p o s i ti o n th atth e p res um p t i o n o f co rrect n es s th ati s g en eral l y

acco rd ed t o d et erm i n at i o n s i n a n ot i ce o f d efi ci en cy d oes n o t ap p ly h ere an d t h at co n s equen t l y p et it i o n ers d o n o th av e t h e b u rd en o f es t ab l i s h i n g th atres p o n d en t’ s d et erm i n at i o n s i n t h e n o t i ce th atth ey are co nt es t i n g are erro n eo u s . Ins up p ort o f t h at p o s i t i o n , p et i t i o n ers al l eg e th atth e rev en u e ag en t “ m ad e

1 1 Th e res p ect i v e s um s o f t h e res pect iv e t o t al am ou n t s o f Sch edul e C i n co m e fo r p et i t i o n ers ’ t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 0 13 th atres p o n d en td et erm i n ed M r. Sm i th an dM s . Sm i t h h av e fo r t h o s e y ears equ al th e t o tal t ax ab l e d ep o s i t s th at th e rev en u e ag en td et erm in edo n th e b as is o f t h e b an k d ep o s i t s an al y s es i n qu es ti o n .

1 2 Res p o nd en tal s o d et erm i n edi n th e n o t i ce t o d i s al l o wth e Sch edu l e E “ To t al p art n ers h ip an dS co rp o rat i on i n co m e o r (l o s s )” t hatp et i t i on ers cl ai m edi n each o f t h ei r 2 0 11 retu rn , 2 0 1 2 retu rn , an d2 0 1 3 retu rn .- 2 0 -

[* 2 0 ] n u m ero u s m i s t ak es i n [t he] cal cu l at i o n o f t h e F4 54 9 -A [In co m e Tax Ex am i n at i o n Ch an g es at t ach edt o th e n o t i ce] , an dth os e m i s t ak es , cu m u l at i v el y , co n s t itu t e a v i o l at i o n o f t h e ‘ p res u m p t i on o f co rrect nes s ’ o n the F4 5 4 9 -A.” By way o f i l l u st rat i o n o f t h e t y p es o f cl ai m s th atp et i t i o n ers ad v an ce i n
s up p orto f t h ei r p os i ti o n th atth e p res u m p t io n o f co rrect nes s th ati s g en eral l y
acco rd edt o d et erm i n at i o n s i n a n o t i ce o f d efi ci en cy d o es n o tap p l y

h ere, p et i

t i on ers cl ai m

thatthe rev en ue ag en ts h o u l d h av e ex am i n edp et i t i o n ers ’ t ax retu rn s fo r y ears p ri o r t o t h e t ax ab l e y ears ati s su e i n o rd er t o d et erm i n e t h e v al i d i t y o f th ei r cl ai m ed d educt i o n fo r t h ei r t ax ab l e y ear 2 0 1 1 wi t h res p ectt o a cl ai m edn et
o p erat i n g l o s s carry fo rward . By way o f fu rt h er i ll u s t rat i o n , p et i t i o ners cl ai m th at cert ai n o f t he t ax ab l e d ep o s i t s th atth e rev en u e ag en td et erm i nedo n th e b as i s o f th e b an kd ep os i ts an al y s es i n qu es t io n are n ott ax ab le. W e b el i ev e t h atp et i t i o n ers are at t em p t i n g t o l o o kb eh i n d t h e n o t ice i n th i s
cas e. As a g en eral ru l e, we wi l l n o tl o o k b eh i n da n o t i ce o f d efi ci en cy t o ex am i n e th e ev i d en ce u s edo r t h e p ro p ri et y o f t h e Co m

m i s s io n er’ s m o t i v es i n m ak i n g th e Co m m i s s i o n er’ s d et erm in at i o n s . See Green berg ’ s Ex p res s , In c. v . Co m m is s i o n er, 6 2 T.C. 3 2 4 , 3 2 7 (1 9 7 4 ). W e h av e reco g n i zedtwo ex cep t i o n s t o th atg en eral ru l e. See Grah am

v . Co m m is s i o n er, 8 2 T.C. 2 9 9 , 3 0 8 -3 0 9 (1 9 8 4 ), aff’ d, 7 7 0 F.2 d3 8 1 (3 dCi r. 1 9 8 5). Fi rs t , we m ay l o o kb eh i n da n o t i ce o f d efi ci en cy wh ere t h ere i s- 2 1 -

[* 2 1 ] s ub s t an t ial ev i d en ce o f u n co n s t i tu t i o n al co ndu ct b y th e Co m m is s i o n er. See i d . at3 0 8 . Seco n d , we m ay l o o kb eh i n da n o t i ce o f d efi ci en cy wh ere t h e Co m

m i s s i on er o f In t ern al Rev en u e i n t ro du ces n o ev i d en ce b u ti n s t eadres t s o n th e p res u m p t i o n o f co rrect n es s an dth e t ax pay er ch al l en g es the n o t ice o n t h e g ro u n d s that i t is arb i trary . See i d
. at 3 0 8 -3 0 9
. No n e o f p et i t i o n ers ’ cl ai m s s up p o rt s th ei r p o s i ti o n t h atth e p res um p t i o n o f
co rrect nes s th ati s g en eral l y acco rd edt o d et erm i n at i o ns i n a n o t i ce o f d efi ci en cy d o es no tap p l y

h ere an dthatco n s equ en t ly p et it i on ers d o n o t h av e t h e b u rd eno f
es t ab l i s h in g th atres p o n d en t’ s d et erm i n at i o n s i n th e n o t i ce t h atthey are co n t es t in g
are erro n eo u s . Th e reco rdi s d ev o i do f an y ev i d en ce o f u nco n s t i tu t i o n al co n du ct b y res p o n d en t , l etal on e an y s ub s t an t i al ev id en ce o f un co n s t i tu t i o n al co n du ct . In ad d it i o n , res p o n d en ti s n o tm erel y rel y i n g o n th e p res u m

pt i on o f co rrect nes s th ati s g en eral l y acco rd ed t o d et erm i n at i o n s i n a n ot i ce o f d efi ci en cy ; res p o nd en t i n t ro du cedcert ai n d o cu m en t ary an d t es t i m o n i al ev i d en ce i n t h i s cas e. Onth e reco rdb efo re u s , we h o l dth atwe wi l l n o tl o o kb eh i n d t he n o t i ce t h at
res p o n d en t i s s uedt o p et i t io n ers fo r t h ei r t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 0 1 3 . On th atreco rd , we fu rt h er h o ldth atth e p res u m p t i o n o f co rrect n es s t hati s g en eral l y
acco rd edt o d et erm i n at i o n s i n a n o t i ce o f d efi ci en cy ap p l i es t o th e d et erm i n at i o n s i n the n o t i ce t h atres p o n d en t i s s u edt o p et it i o n ers fo r t h os e y ears . W e al s o h o l d- 2 2 -

[* 2 2 ] th atp et i t i o n ers b ear t h e b u rd en o f es t ab l i s h in g th atres p o n d en t ’ s d et erm i n at i on s i n t he n o ti ce t hatrem ai n ati s s u e are erro n eo u s . Befo re tu rn i n g t o t h e i s s u es th atrem ai n fo r o u r co n s i d erat i o n , we ad dres s p et i t i o n ers ’ at t em

p t s o n b ri ef t o d i s reg ardcert ai n s t ip u lat i o n s i n t h e s t i pu l at i o n o f fact s t h atthe p art i es s i g n edan d t h atwe m ad e p arto f t h e reco rdatth e b eg i n n i n g o f th e t ri al i n t h i s cas e. Ru l e 9 1 (e) p ro v i d es th ata s t ip u l at i o n, t o t h e ex t en t o f i t s t erm s , i s t o b e t reat edas a co n cl u s i v e ad m i s si o n b y th e p art i es t o th e s t i p u lat i o n , u n l es s o th erwi se p erm i t t ed b y u s o r ag reedup o n b y

th os e p art i es . W e wi l l n o t p erm i ta p art y

t o a s t i p u l at i o n t o qu al i fy , ch an g e, o r co n trad i cta s t i p u lat i on i n wh o l e o r i n p artex cep tth atwe m ay d o s o wh ere ju s ti ce req u i res . See i d. Onth e reco rdb efo re u s , we h o l dth atju st i ce d o es n otreq u i re u s t o s etas i d e
an y o f t h e s t i p u lat i o n s th atp et it i o n ers at t em p tt o d is reg ard o n b ri ef. See i d . On th atreco rd , we fu rt h er h o ldth at , ex cep tas s t at eds up ra n o t e 6 , an d as d i s cu s s ed b el o w wi th res p ectt o th e Hi ll cres tFo rm s 1 09 9 -M ISC, we fi n dn o ev i d en ce t h ati s cl earl y co n t raryt o an y

o f t h o s e s t ip u l at i o n s , an dwe wi l l n o td i s reg ardth em . See Cal -M ai n e Fo o d s , In c. v . Co m m i s s i o n er, 9 3 T.C. 1 8 1, 1 9 5 (1 9 8 9 ). On e fi n al m at t er th atwe ad dres s b efo re co ns i d eri n g th e i s s u es th at rem ai n fo r d eci s i o n i s th atp et it i o n ers ’ b ri efs are rep l et e wi th fact u al al l eg at i o ns th atare
n o tes t ab l i s h edb y

th e reco rd i n th i s cas e. By way o f i l l u s t rat i o n , p et it i on ers co n -- 2 3 -

[* 2 3 ] t en dth atth ey

m ai nt ai n ed“ a Bal an ce Sh eet , a Pro fi tan dLo s s [s i c] , an d
ex t en s i v e o t h er b o o k s an dreco rd s ” rel at in g t o Sm i t h So l u ti o n s . Th e reco rdi s d ev oi do f an y

s u ch d ocu m en t s . An o t h er ex am pl e o f an u n s up p o rt ed fact u al al l eg at i o n th atp et i t i o n ers ad v an ce o n b ri ef i s th ei r al l eg at i o n th at cert ai n d ep o s i t s th at
res p o n d en t d et erm i nedare t ax ab l e are i n factn o n t ax ab l e g i ft s an d/ o r i n h eri t an ces th atth ey recei vedfro m

M s . Sm i t h ’ s m o t h er. Th e reco rdi s d ev oi d o f rel i ab l e
ev i d en ce es t ab l i s h i n g t h atal l eg at i o n . W e wi l l n o t rel y o n an y o f p et i t i o n ers ’ fact ual al l eg at i o n s t h atare n o tes t ab l i s h edb y t h e reco rdi n o rd er t o res o l v e t h e i s su es p res en t ed
. W e n o wtu rn t o t h e i s s u es th atwe m u st d eci de. W e ad dres s fi rs twh et h er p et i t i o n ers are req u iredfo r each o f t h ei r t ax ab l e y ears 2 0 11 , 2 0 1 2 , an d2 0 1 3 t o i n cl u d e i n i n co m e t he am ou n to f “ [t ] o t al i n co m e” t h at t hei r wh o l l y o wn edS
co rp o rat i o n rep o rt ed i n each o f i t s 2 0 1 1 Fo rm 1 1 2 0 S, 2 0 1 2 Fo rm 1 1 2 0S, an d2 0 1 3 Fo rm 1 1 2 0 S as wel l as a cert ai n ad d i t i o n al am o u n t o f i n co m e t h atres p o n d en t d et erm i n edi n th e n o t i ce fo r each o f t h o s e y ears . Ino rd er t o res o l v e th ati s s u e, we
m u std eci d e wh et h er t he res p ect i v e p ers o n al s erv i ces th atM r. Sm i t h an dM s . Sm it h p erfo rm edfo r cert ai n p ers o n s du ri ng 2 0 1 1, 2 0 12 , an d2 0 1 3 were p erfo rm ed i n thei r res pect i ve i n di v i du al cap aci t i es o r as em p lo y ees o r o t h er ag en t s o f Sm i t h So l u ti o n s .- 2 4 -

[* 2 4 ] It is wel l es t ab l is h ed t h ati n co m e m u s tb e t ax edt o the act u al earn er o f t h e i n co m e. See, e.g ., Un i t edSt at es v . Bas y e, 4 1 0 U.S. 4 41 (1 9 7 3 ); Co m m is s i o n er v . Cu l bert s o n , 3 3 7 U.S. 7 3 3 (1 9 4 9 ); Lu cas v . Earl , 2 8 1 U.S. 1 1 1 (1 9 3 0). “ Inth e
co rp o rat e co nt ex t , h o wev er, t h e act u al earn er t es tm ay b e i n ad equ at e b ecau s e a
co rp o rat i o n can earn i n co m e o n l y th ro u g h th e p ers o nal s erv i ces o f i t s em p l o y ees
an d ag en t s .” Haag v . Co m m i s si o n er, 8 8 T.C. 6 04 , 6 1 1 (1 9 87 ), aff’ dwi t h o u t p ub l i s h edo p i n i o n, 8 5 5 F.2 d8 5 5 (8 t h Ci r. 1 9 88 ). Wh ere a co rp o rat i o n rel ies o n th e p ers o n al s erv i ces o f an em p l o y ee t o p ro du ce i n co m e, th e qu es t i o n ari s es wh et h er t h e co rp o rat i o n i s actu al l y co n du ct i n g th e b u si n es s o r wh et h er t h e em p l o y ee i s co n duct i n g th e b u s in es s i n h i s /h er i n di v i du al cap aci t y . Th e rel ev an tt es t i s wh o co n tro ls th e earn i n g o f t h e i n co m e. See, e.g ., Haag v . Co m m i s s i o n er, 8 8 T.C. at6 1 1 ; Verci o v . Co m m i ss i o n er, 7 3 T.C. 1 2 4 6, 1 2 53 (1 9 80 ). In Un i tedSt at es v . Hart s h o rn , 7 5 1 F.3 d1 1 9 4 (1 0 t h Ci r. 2 01 4 ), th e U.S. Co u rto f Ap p eal s fo r t h e Ten t h Ci rcu i t(Co u rt o f Ap p eal s ), the co u rtt o wh ich an ap p eal i n thi s cas e wo u ld n o rm al l y l i e, was as k edt o d eci d e wh et her t o s u s t ai n an i n jun ct i o n u n d er s ect i o n 7 4 0 8 t h atth e U.S. Di s t ri ctCo urtfo r t h e Di s t ri ct o f Ut ah h ad i m p o s edag ai ns t an i n d i v i du al fo r p ro m o t i n g an ab u si v e t ax s h el t er i n v i o l at i on o f s ect i o n 6 7 00 . Ino rd er t o d eci d e th at i s s ue, t h e Co u rt o f Ap p eal s co n s i dered wh et h er a m i n i s t er o f a ch u rch i s req u i red t o i n cl ud e i n i n co m e an dp ay t ax- 2 5 -

[* 2 5 ] o n i n co m e t h ath e/ s h e earn s i n h i s/ h er n o rm al em pl o ym en t as a m i n i s t er an d
as s i g n s t o h i s /h er ch urch . In o rd er t o res o l v e t h atqu es t i on , th e Co u rto f Ap p eal s fi rs tad dres s ed “ wh et her a m in i s t er’ s i n co m e i s t ax ex em p to n l y i f h e recei ves i tas
an ag en t o f t he ch u rch o r wh et her * * * i t i s s u ffi ci en tth ata m i n is t er as s i g n s
earn i n g s t o h is ch u rch p u rs u an tt o a v o w o f p o v ert y .” Hart s h o rn , 7 5 1 F.3 dat 1 1 9 8 . Inan s weri n g th atl at t er q u es ti o n , th e Co u rto f Ap p eal s ex am i ned t h e d eci s i o n s o f cert ai n o t h er U.S. Co u rt s o f Ap peal s i n t h e s o -cal l edv ow-o f-p o v ert y
co n tex t . Th e Co u rto f Ap p eal s co n cl u d edo n t h e b as i s o f t h atrev i ew t h atth o s e
o th er co u rt s h ad h el d t h at a m i ni s t er m u stb e act in g as an ag en t o f t h e m i ni s t er’ s ch u rch i n o rd er fo r t h e m i ni s ter’ s i n co m e t o b e ex em p t fro m t ax . See i d . at1 2 0 0
. In Hart s h o rn , th e Co u rto f Ap p eal s ad o p t edth e fact s an d ci rcu m s t an ces ap p ro ach th atth e U.S. Co u rto f Ap p eal s fo r t h e Fed eral Ci rcu i t h adad o p t edi n a
v o w-o f-p o vert y

co n t ex ti n Fo g art y

v . Un i t ed St at es , 7 8 0 F.2 d1 0 0 5 (Fed . Ci r. 1 9 8 6 ), as th e ap pro pri at e t es tt o u s e i n o rd er t o d et erm i n e wh et h er a m i n i s t er i s act i ng as an ag en to f t h e m in i s ter’ s ch u rch i n earn i n g i n co m e. Acco rd i n g t o th e Co u rto f Ap p eal s , u n d er s u ch a fact s an dci rcu m s t an ces ap p ro ach “ co urt s m ay
co n si d er v ari o u s fact o rs p ert i n en tt o t h e rel at i o n sh i p s b et ween th e rel i g i o us o rd er
an d th e m i n i s t er, b et ween th e m i n i s ter an dth e t h i rd -p art y em p l o y er, an d b etween th e em p lo y er an d t h e o rd er.” Hart s ho rn , 7 5 1 F.3 dat1 2 0 0 . (W e s h al l refer t o th e- 2 6 -

[* 2 6 ] fact s an dci rcu m st an ces ap p ro ach th at t h e Co u rto f Ap p eal s ad o p t edi n Hart s h o rnas the Hart s ho rn t es t .) Al th ou g h the u l ti m at e i s s u e i n Hart s h o rn was wh et h er t o s us t ai n an i n jun ct i on , we b el i ev e t hatthe Co u rto f Ap p eal s wo u l d ap p l y th e Hart s h orn t es ti n d et erm i n i ng wh et h er p et i t io ners are req u i redfo r each o f th ei r t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 0 1 3 t o i n cl u d e i n i nco m e t h e am o u nto f “ [t ] ot al i nco m e” t h atth ei r wh o l l y o wn edS co rp o rat io n rep o rt ed i n each o f i t s 2 0 1 1 Fo rm 1 1 20 S, 2 01 2 Fo rm 1 1 2 0 S, an d2 0 13 Fo rm

1 1 2 0 S. In o u r ju ri s p ru d en ce we h av e ap p l i edth e s o -cal l ed two -p ro ng t es t an n ou n cedi n J o h n s o n v . Co m m i s s i on er, 7 8 T.C. 8 8 2 , 8 9 1 (1 9 8 2), aff’ dwi th o u tp ub l i s h edo p i n i o n , 7 3 4 F.2 d2 0 (9 t h Ci r. 1 9 8 4 ), i n d et erm i n i n g wh o
earn s i n co m e i n a co rp o rat e co n t ex t . Ho wev er, we wo u ld reach t h e s am e res u l ti n
res o l vi n g th e i s s u e p res en t edh ere wh et h er we ap p l y th e Hart s h orn t es to r t h attw o p ro n g t es t . W e b eg i n b y

ex am i n i n g t h e rel at i o n s h ip du ri n g the y ears ati s s u e b et ween Sm it h So l u t i o n s an d each o f M r. Sm i t h an dM s . Sm i t h , s ee Hart s ho rn , 7 5 1 F.3 dat 1 2 0 0 , i n o rd er t o as cert ai n wh et h er each o f t h os e rel at i o ns h ip s en ab l edSm i t h So l u ti o n s t o ex erci s e co nt ro l o v er t h e p ro v i s i o n t o cert ai n p ers o n s o f cert ai n p ers o n al s erv i ces b y each o f t h em an do v er t h e recei p to f t h e p aym en ts fo r t h o s e
res p ect i ve s erv i ces . Pet i t i o n ers co n t en dth atth e b y laws o f Sm it h So l u t io n s co n -- 2 7 -

[* 2 7 ] s t i tu t ed“ t he co n t ro l l i n g wri t t en ag reem en t ” b et w een Sm i th So lu ti o n s an d each o f M r. Sm i t h an dM s . Sm i t h 1 3 an dth at t h o s e b y l aws “p ro v i d e[] a m ean s fo r th e s et ti n g o f s al ary

fo r co m p en s at i o n o f i t s o ffi cers (Pet i t i on ers )”. Th e b y l aws o f Sm i t h So l u t i o n s co n t ai n n o t h i n g b u tty p i cal b o il erp l at e rel at i n g t o th e res p o n s i b i l it i es th at t h e Sm i th s o wedt o Sm i t h So l ut i o ns as co rp o rat e d i rect o rs an do ffi cers . Th o s e b y l aws d o n o tes t ab li s h th atth e Sm i t h s o wed
an y co n tract u al du t i es t o Sm i t h So l u t i o ns t o p erfo rm an y p ers o n al s erv i ces o n i t s b eh al f. No t h i n g i n th e b y l aws o f Sm i t h So l u t i on s o r i n an y o t h er ev i d en ce i n th e
reco rdes t ab li s hes t h at Sm i t h So l u t i o n s was ab le t o co n t ro l th e p erfo rm an ce o f
res p ect i ve p ers o n al s erv i ces b y M r. Sm i t h an dM s . Sm i t h . See Hart s h o rn , 7 5 1 F.3 dat 1 20 0 ; Haag v . Co m m i s si o n er, 8 8 T.C. at6 1 2 . No r d o th o s e b y l aws 1 4

1 3 Acco rd in g t o p et i t i on ers , “ [t ] h e By l aws d o cu m en twas draft edb y an at t o rn ey wh o s ho u l d h av e kn o wnth e l eg al req u irem en ts fo r a co n tro l li n g wri t t en ag reem en t .”

1 4 On e p ro vi s io n o f th e Sm i t h So l u t i o n s b y l aws en t i t l ed “ Dep o s i ts ” s t at ed th at“ [a] l l fu nd s o f t h e Co rp o rat i o n n o to t h erwi s e em p l o y eds h al l b e d ep o s i t ed fro m t i m e t o t i m e t o th e cred ito f t h e Co rp o rat i o n i n s uch b an k s , tru s t co m p an i es o r o th er d ep o s i t ori es as th e Bo ardo f Di rect o rs m ay s el ect .” Th atp ro vi s i o n d o es n o tad dres s th e p erfo rm an ce o f res p ect i v e p ers o n al s erv i ces b y M r. Sm i t h an dM s . Sm it h . No r d o es i ti n d i cat e wh atfu n d s are “ fu n d s o f th e Co rp o rat i o n n o t o th erwi s e em

p l o y ed ”. W e n ot e th ati n t he b an k acco un t res o lu t i o n th e Sm i t h So l u ti o n s ’ b o ardd i dn o td es ig nat e i n th e b l an ks p ace p ro v i d edth e n am e o f a b an k o r o th er d ep o s i t ory i n st i tu t io n i n t o wh i ch “ [a] l l fu n ds o f t h e Co rp o rat i o n n o t o th erwi s e em

p l o y eds h al l b e d ep o s i t edfro m t i m e t o t i m e”.- 2 8 -

[* 2 8 ] es t ab l is h th at Sm i th So l u t i o n s “p o s s es s edth e act u al p o wer t o co n t ro l th e recei p t o f fu n d s ”, Pacel la v . Co m m i ss i on er, 7 8 T.C. 6 0 4 , 6 2 2 (1 9 8 2 ), fo r th e p erfo rm an ce o f t h o s e res p ect iv e p ers o n al s erv i ces , s ee Hart s h o rn , 7 5 1 F.3 dat1 2 0 0
. An o th er s i g n i fi can tfact o r i n d et erm in i n g wh et h er Sm i th So l u t i o n s i n fact
earn edth e i n co m e th at i trep ort edi n i t s 2 0 1 1 Fo rm 1 12 0 S, i t s 2 0 1 2 Fo rm

1 1 2 0 S,
an d i t s 2 0 1 3 Fo rm

1 1 2 0 S rel at es t o th e em

p l o ym en tco n tract res ol u t i o n t h ati t s b o ardad o p t ed . Th atres o l u t i o n au t h o ri zedan d d i rect edthe p res i d en to f Sm i t h So l u ti o n s “ t o en t er i n t o em pl o ym en tco n tract s wi t h cert ai n em p l o y ees ” an d requ i redth at“ s u ch co n t ract* * * b e fo r t h e t erm an dth e rat e s t at edi n t h e at t ach ed Em p l o ym en t Ag reem en t s .” Atn o t i m e d i d Sm i t h So l u t i o ns en t er i n t o an y em p l oy m en tag reem en t , wri t t en o r o ral , wi t h an y p ers o n , i n cl u di n g M r. Sm i t h o r M s . Sm it h . M o reo v er, atn o t i m e d i dM r. Sm i th co n s id er h i m s el f o r M s . Sm i t h t o b e an
em pl o y ee o f Sm i t h So l u ti o n s . Inad d i t i o n, t he reco rdi s d ev o i do f ev i d en ce es t ab

l i sh i n g t h atSm i th So l u t io n s wo u l dh av e an y l eg al reco u rs e ag ai ns tM r. Sm i t h an d M s . Sm i th i f t h ey

s t o p pedp erfo rm i n g th ei r res pect i v e p ers o nal s erv i ces fo r cert ai n p ers o n s . See Verci o v . Co m m i s s i o n er, 7 3 T.C. at1 25 4
. It al s o i s s i gn i fi can tth atSm i t h So l u t i o n s n ev er co m p en s at edM r. Sm i t h an d M s . Sm i th fo r t he p erfo rm an ce o f t h ei r res p ect iv e p ers o n al s erv i ces fo r cert ai n p ers o n s . No r d i d Sm i t h So l u t i on s rep o rti n i t s 2 01 1 Fo rm 1 1 2 0 S, 2 0 1 2 Fo rm- 2 9 -

[* 2 9 ] 1 1 2 0 S, an d2 01 3 Fo rm 1 1 2 0 S an y

co m p en s at io n o f o ffi cers o r s al ari es o f
em pl o y ees . M oreo v er, M r. Sm i t h an dM s . Sm it h d i dn o trep o rti n thei r 2 0 1 1 retu rn , 2 0 1 2 retu rn , an d2 01 3 retu rn an y wag es o r o t h er co m

p en s at i o n t h atSm i t h So l u ti o n s p ai d t h em du ri n g 2 01 1 , 2 0 12 , an d 2 0 1 3 . Th at i s b ecau s e Sm i t h So l u t i on s n ev er p ai dthem

an y wag es o r o t h er co m

p en sat i o n . See Ru ck m an v . Co m m i s s i o n er, T.C. M em o . 1 9 9 8 -8 3 , 1 9 98 W L 7 7 9 87 , at* 5
. W e al s o fi n d i ts i gn i fi can ti n d et erm i n i n g wh et h er Sm it h So l u t io n s i n fact
earn edth e i n co m e th at i trep ort edi n i t s 2 0 1 1 Fo rm 1 12 0 S, i t s 2 0 1 2 Fo rm

1 1 2 0 S,
an d i t s 2 0 1 3 Fo rm

1 1 2 0 S t h atth ere was n o co n tract u al rel at io n s hi p o r s i m i l ar i n d i ci u m b et ween Sm i th So l u ti o n s an dthe p ers o n s u s i n g th e res pect i v e p ers o n al
s erv i ces o f M r. Sm i t h an dM s . Sm i t h t h atreco gn i zed o r ack n o wl ed g ed t h atSm i t h So l u ti o n s co n t ro l ledthem i n th e p erfo rm an ce o f t h o s e res p ect i v e s erv i ces . See, e.g ., Hart s h o rn , 7 51 F.3 d at1 2 0 0 ; Ru ck m an v . Co m m i ss i o n er, 1 9 9 8 W L 7 7 9 8 7 , at
* 5
. W i t h res p ect t o th e p ers o n al s erv ices thatM s . Sm i t h p erfo rm ed fo r Hi l l cres t , p et i t i o n ers rel y

o n th e Hi l l cres ti n v o i ces th ati trecei v eddu ri n g 2 0 1 1 an d2 0 1 2 as a fact or wei g h i n g i n th ei r fav o r i n d et erm i ni n g wh et h er Sm i t h So l ut i o n s i n fact
earn edth e i n co m e th at i trep ort edi n i t s 2 0 1 1 Fo rm 1 12 0 S, i t s 2 0 1 2 Fo rm

1 1 2 0 S,
an d i t s 2 0 1 3 Fo rm

1 1 2 0 S. Th o s e i n v o i ces co n t ai n edth e s am e cap t i o n . Th atcap -- 3 0 -

[* 3 0 ] t i o n s h o wedth e n am e “ Sm it h So l u t i on s , In c.” Ho wev er, th e n am e “ Sh ei l a Sm it h ” al s o ap peared i m

m ed i at el y ab ov e t h e n am e “ Sm i t h So lu t i o n s , In c.” W e are
u n ab le t o fi n do n th e b as i s o f the Hi l lcres ti n v oi ces th atHi l lcres t recei veddu ri n g 2 0 1 1 an d2 0 1 2 th atHi l l cres treco g n i zedo r u n d ers to o dthati t was co nt ract i n g wi t h Sm it h So l u t i o n s fo r cert ai n p ers o n al s erv i ces o f M s . Sm i t h , an d n o t wi th M s . Sm it h i n h er i n d i v i du al cap aci t y . No r are we ab le t o fi n dfro m th os e i n v o i ces th at Hi l l cres t reco g n i zedo r u nd ers t o o dth atSm i t h So l ut i o ns was ex erci s i n g co n t ro l
o v er M s . Sm i t h wi t h res p ectt o th e p ers o n al s erv i ces th ats h e p erfo rm ed fo r i t . Pet i t i o ners al s o rel y

o n th e Hi l l cres tch eck s th at were p ay ab l e t o “ Sm i t h So l u ti o n s , In c.” as a fact o r wei g h i n g i n th ei r fav o r i n d et erm i n i ng wh et her Sm i t h So l u ti o n s i n factearn ed t h e i n co m e t h ati t rep o rt edi n i t s 2 0 11 Fo rm 1 12 0 S, i t s 2 0 1 2 Fo rm

1 1 20 S, an di t s 2 0 1 3 Fo rm 1 1 2 0 S. Al t h ou g h th o se ch eck s es t ab l i s h th at Hi l l cres t was aware o f t h e ex i s t en ce o f Sm i t h So lu t i o n s, they d o n o tes t ab l i s h th at Hi l l cres t reco g n i zedo r u nd ers t o o dth ati twas co n tract i n g wi t h Sm i th So l u t i o n s fo r th e p erfo rm an ce o f cert ai n pers o n al s erv i ces b y M s. Sm i t h. W e are n o tp ers u ad ed th atHi l l cres t m ad e th e Hi l l cres tch eck s p ay ab l e t o Sm i t h So l ut i o n s b ecau s e i t
co n si d eredSm i t h So lu t i o n s as (1 ) t h e co n t ract in g p arty fo r t h e p ers o n al s erv i ces th atM s . Sm i th p erfo rm edfo r i t , (2 ) t h e en t i t y th atex erci s edco n t ro l o ver M s . Sm it h wi th res pect t o th e p erfo rm an ce o f th os e s erv i ces , an d(3 ) t h e en t i t y th atwas- 3 1 -

[* 3 1 ] en ti t l edt o co m

p en s at i o n fo r t h o s e s erv i ces . W e b el i ev e t h atHi l l cres tm ad e th e Hi l l cres t ch eck s p ay ab l e t o Sm i t h So l u t io n s b ecau s e M s . Sm it h as ked i tt o d o
s o . Pet i t i o ners al s o p o i ntt o th e Hi l lcres t2 0 1 1 Fo rm 1 0 99 -M ISC, t h e Hi l l cres t 2 0 1 2 Fo rm

1 0 99 -M ISC, an d t h e Hi l l cres t 2 01 3 Fo rm 1 0 9 9 -M ISC as fav o rab l e fact s i n d et erm i n i ng wh et her Sm i t h So l u t i o n s i n fact earn edth e i n co m e t hati t rep o rt edi n i t s 2 0 1 1 Fo rm 1 1 2 0 S, i t s 2 0 1 2 Fo rm

1 1 2 0 S, an d i ts 2 0 1 3 Fo rm 1 1 2 0 S. 1 5 Th e IRM F d at a th atth e IRS m ai n t ai n edwi t h res p ectt o each o f t h e Hi l l cres t Fo rm s 1 0 9 9 -M ISC s h o wedth e n am e “ SHIELA [s i c] SM ITH ” u nd er t h e h ead in g “ PAYEE ENTITY DATA”, t h e n am e “ H ILLCREST GOLF & COUNTRY CLUB” u n d er t h e h ead in g “ PAYER ENTITY DATA”, 1 6 an d“NONEM COM ” p ai do f $ 6,8 1 9, $ 1 2 ,4 04 , an d$ 6 ,5 7 0 fo r 2 0 1 1 , 2 0 1 2 , an d 2 0 13 , res p ect i vel y . Al t h o u g h th e p art ies st i p u l at edth atth e Hi l l cres tFo rm s 1 0 9 9 -M ISC were

“ i s s u ed t o Sm i t h So l u t i o n s”, t h ats t i p u l at i o n i s cl earl y co n t raryt o th e fact s th atwe h av e fo u n dare es t ab li s h edb y th e reco rd , an dwe s h al l d is reg ardi t . See Cal -M ai n e

1 5 Th e Hi l l cres t2 0 11 Fo rm 1 0 99 -M ISC, t h e Hi l l cres t2 0 1 2 Fo rm 1 0 9 9
- M ISC, an dth e Hi ll cres t 2 0 1 3 Fo rm 1 0 9 9 -M ISC are n o ti n t h e reco rd . In s t ead , co p ies o f p ert in en tp ort i on s o f t h e IRM F d at a t h atth e IRS m ai n t ai n edwi th res p ect t o tho s e fo rm s an dth ats h o w edth e d at a t h at Hi ll cres trep o rt edo n each o f t h o s e fo rm s are i n t h e reco rd
.

1 6 See s up ra n o t e 8
.- 3 2 -

[* 3 2 ] Fo o d s , In c. v . Co m m i s s i on er, 9 3 T.C. at 1 9 5 . W e fi n d o n th e b as i s o f t h e IRM F d at a t h atHi l lcres tu n d ers t o o dth ati th ad p ai dM s . Sm i t h n o n em p l oy ee
co m p en s at i o n fo r t h e p ers o n al s erv i ces th ats h e h adp erfo rm edfo r i t . Iti s s i g n i fi can ti n th i s reg ardth atatn o t i m e was Hi l l cres treq u i redt o i s s u e Fo rm 1 0 9 9
- M ISC t o a co rp o rat i o n s u ch as Sm i t h So l u t i o n s . On l y i f a s erv i ce p ro v i d er i s o t her th an a co rp o rat i o n i s t h e p ers o n fo r wh o m p ers on al s erv i ces are ren d ered du ri n g a t ax ab l e y ear req u ired t o i s s u e Fo rm 1 0 9 9-M ISC s h o wi n g th e co m pen s at i o n th at th e p ers o n p ai dduri n g th e t ax ab l e y ear t o s u ch a s erv i ce p ro v i d er. See s ec. 1 .6 04 1 -3 (p )(1 ), In co m e Tax Reg s . W i t h res p ect t o th e res p ect i v e p ers o nal s erv i ces th atM r. Sm i th p erfo rm ed fo r In teg ri s , Es kri d g e, t h e M i l l i g an s , an dth e Ad am s es , p et i t i o ners rel y o n cert ai n i n v o i ces th ateach o f In t eg ri s , Es kri d g e, an dth e M i ll i g an s recei v edrel at i n g t o th e p erfo rm an ce o f t h o s e res p ect iv e p ers o n al s erv i ces fo r t hem as a fact or wei g h i n g i n th ei r fav or i n d et erm i n i n g wh et h er Sm i t h So lu t i o n s i n factearn edth e i n co m e t h at i t rep ort edi n i t s 2 0 11 Fo rm 1 1 2 0 S, i t s 2 0 12 Fo rm 1 12 0 S, an di t s 2 01 3 Fo rm 1 1 2 0 S. 1 7 Th o s e i nv o i ces co n t ai n edth e s am e cap t i o n . Th e n am e “ Sm it h So l u t i o n s, In c.” ap p eared atth e t o p o f each o f t h o se i nv o i ces . M r. Sm it h ’ s n am e d i dn o t

1 7 Th e reco rdd oes n o tco n t ai n an y i n v o i ces s en tt o , o r recei v edb y , th e Ad am s es rel at i n g t o cert ai n p ers o n al s erv i ces th atM r. Sm i t h p erfo rm edfo r t h em .- 3 3 -

[* 3 3 ] ap pear i n t h e cap t i o n atth e t o p o f t h o se i n v o ices . As was tru e o f t h e Hi l l

cres t i n v o i ces rel at in g t o cert ai n p ers o n al s erv i ces th atM s. Sm i t h p erfo rm edfo r Hi l l cres t, we are u n ab l e t o fi n do n th e b as i s o f t he i n v o i ces th ateach o f In t eg ri s , Es kri d g e, an dth e M il l ig an s recei v edth ateach o f In t eg ri s , Es kri d g e, an dth e M i l li g an s reco gn i zedo r u n ders t o o d t h ati twas co n tract i ng wi t h Sm i t h So l ut i o n s fo r cert ai n p ers o n al s erv i ces o f M r. Sm i t h , an dn o twi t h M r. Sm it h i n h i s i n d i v i d

u al cap aci t y . No r are we ab l e t o fi n dfro m t h o s e i n vo i ces th ateach o f In t eg ri s , Es kri d g e, an dth e M il l ig an s reco g n i zedo r u n d ers t o o dth atSm i t h So l u t i o n s was
ex erci s i ng co n tro l o v er M r. Sm i t h wi t h res p ectt o t h e p ers o n al s erv i ces th ath e p erfo rm edfo r i t. Pet i t i o ners al s o rel y

o n th e In t eg ri s ch eck s , th e Es kri d g e ch eck s , the M i l

l i gan ch eck s , an dth e Ad am s es ch eck s rel at in g t o the p erfo rm an ce o f res p ect i v e p ers o n al s erv i ces b y M r. Sm i t h fo r t h em as a fact o r wei g h in g i n t h ei r fav o r i n d et erm i n i ng wh et h er Sm it h So l u t i o n s i n factearn edth e i n co m e t h ati t rep o rt edi n i t s 2 0 1 1 Fo rm

1 1 20 S, i t s 2 0 1 2 Fo rm

1 1 2 0 S, an di t s 2 0 1 3 Fo rm 1 1 20 S. Al t h o ug h th o s e ch eck s es t ab l i s h thateach o f In t eg ri s , Es kri d g e, th e M i l l i g an s , an dthe Ad am s es was aware o f t h e ex i s t en ce o f Sm i t h So l u t i o n s , th ey d o n otes t ab l i s h th at each o f t h o s e p ers o n s reco gn izedo r u n d ers t o odth ateach was co n t ract i n g wi t h Sm it h So l u t i o n s fo r t h e p erfo rm an ce o f cert ai n p ers o n al s erv ices b y M r. Sm i t h
.- 3 4 -

[* 3 4 ] W e are n o tp ers u ad edthateach o f In t eg ri s , Es kri d g e, t h e M il l ig an s , an dth e Ad am s es m ad e th e ch eck s th ateach o f t h em h adwri t t en p ay ab l e t o Sm i t h So l u t i on s b ecau s e each co ns i d ered Sm i t h So l u t i o ns as (1 ) t he co n t ract i ng p art y fo r cert ai n res p ect i ve p ers on al s erv i ces th atM r. Sm it h p erfo rm ed fo r each o f th em , (2 ) t h e en t i t y

th atex erci sedco n t ro l o v er M r. Sm i th wi t h res p ectt o th e p erfo rm an ce o f t h o s e res p ect i v e s erv ices , an d(3 ) t h e en ti t y th at was en ti t ledt o co m p en sat i o n fo r t h os e res p ect i v e s erv i ces . W e b el i ev e t h ateach o f In t eg ri s , Es kri d g e, th e M i l l i g an s , an dthe Ad am ses m ad e t h e ch eck s th ateach o f t h em h adwri t t en p ay ab l e t o Sm i t h So l u t i o n s b ecau s e M r. Sm i t h as k edeach o f t h em t o d o s o . Bas edup on o ur ex am i n at i o n o f t h e en t i re reco rdb efo re u s , we fi n dth at p et i t i o n ers h av e fai l ed t o carryth ei r b urd en o f es t ab l is h i n g thatth ey d i dn o tearn th e i n co m e t h atSm i t h So lu ti o n s rep o rt edas “ [t ] o t al i n co m e” i n each o f i t s 2 0 1 1 Fo rm 1 1 2 0 S, 2 0 12 Fo rm

1 1 2 0 S, an d2 0 1 3 Fo rm

1 1 2 0S. W e tu rn n ex tt o wh et her p et i t io n ers are req u i redfo r each o f t h ei r t ax ab l e y ears 2 0 1 1 , 2 0 1 2, an d2 01 3 t o i n cl u d e i n i n co m e a cert ai n ad d i t i o n al am o u n to f i n co m e th atres p o n d en td et erm i n edi n th e n o t i ce fo r each o f t h o s e y ears o n th e b as i s o f t h e b an kd ep o s i t s an al y s es i n qu es t i on . Iti s p et i t io n ers ’ p o s i t i o n t h atth ey
are n o treq ui red t o do s o . Ins up p o rto f th atp o s i t i o n , p et i ti o n ers arg u e t h atcert ai n- 3 5 -

[* 3 5 ] o f t h e t ax ab l e d ep o si t s thatth e rev en u e ag en td et erm i n edo n th e b as is o f t h e b an k d ep o s i t s an al y s es i n qu es t i o n are n ott ax ab l e. Befo re ad dres s i ng p et i ti o n ers ’ arg u m en t s reg ard i n g cert ai n al l eg edn o n t ax ab l e d ep o s i t s th atth ey m ai n t ai n the rev en u e ag en ti n cl u d edi n t ax ab le d ep o s i t s fo r each o f t h ei r t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 0 13 , we n o t e t h at we ex am i n ed th e b an kd ep os i ts an al y s es i n qu es t io n an d co n s id eredth e t es t i m o n y o f t h e rev en u e ag en t reg ard in g t h o se an al y s es , wh i ch we fo u n dt o b e cred i b l e. W e co n cl u d e, as
s u m m ari zedb el o w , th at t h e rev en u e ag en t co n du ct edth e b an kd ep o s it s an al y s es i n qu es ti o n i n acco rd an ce wi t h ap p l i cab l e l aw. Th e rev en u e ag en tas k ed p et i t i o n ers t o p ro v i d e h er wi t h an y

b o o k s o r reco rd s th atth ey m ai n t ai n edfo r Sm i t h So l u t i o n s fo r t h e t ax ab l e y ears ati s s u e. Pet i t i o n ers i n fo rm edth e rev en u e ag en tthatth ey d i d
n o th av e an y

b o ok s an d reco rd s . Pet i ti o n ers p ro v i d edth e rev en u e ag en t o n l y wi t h a red act edv ers i o n o f t he b an kreco rd s rel at i n g t o th e W EOKIE acco u n t s fo r t h ei r t ax ab l e y ear 2 01 1 . Th e rev en u e ag en tth en d eci d edt o u s e t h e b an kd ep o s i t s m et h

o di n o rd er t o d et erm in e t he am o u n to f p et i t i o n ers ’ t ax ab l e i n co m e fo r each o f th ei r t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 0 1 3. See Ni ch o l as v . Co m m i s si o n er, 7 0 T.C. 1 0 5 7 , 1 0 6 4 (1 97 8 ); s ee al s o Pet zo l d tv . Co m m is s i o n er, 9 2 T.C. 6 6 1 , 6 9 3 (1 9 8 9 ). In co n du ct i n g th e b an kd ep o s i ts an al y s es i n qu es t i o n , th e rev enu e ag en twas req u i redt o , an dwe fi n dth ats h e d i d , t ak e i nt o acco u ntan y n o nt ax ab le s ou rce o f a- 3 6 -

[* 3 6 ] d ep o s ito f wh i ch s h e h adkn o wl ed g e. See Cl ayt o n v . Co m m i s s i o n er, 1 0 2 T.C. 6 3 2 , 6 4 5 -6 46 (1 9 9 4).

“ A b an kd ep o s i ti s p ri m a faci e ev i d en ce o f i nco m e an dres p o n den tn eedn o t p ro v e a l i k el y

s o u rce o f t h ati n co m e.” To kars k i v . Co m m is s i o n er, 8 7 T.C. 7 4 , 7 7 (1 9 8 6). Pet i ti o n ers b ear t h e b u rd en o f p ro v i n g t h atres p o nd en t ’ s d et erm in at i o n s o f i n co m e b as edo n th e b an kd ep o s i t s m et h o d are erro neo u s . See Cl ayt o n v . Co m m i s s i o n er, 1 0 2 T.C. at6 4 5 . Pet i t i o n ers m ay s at i s fy th atb u rd en b y

es t ab l i s h i n g th atth e d ep o si t s thatrem ai n ati s s u e are d eri vedfro m a n o n t ax ab l e s o u rce. See Ni ch o l as v . Co m

m i s s i o n er, 7 0 T.C. at1 0 6 4
. W e ad dres s n o wp et i t i on ers ’ arg u m en t s reg ard i ng cert ai n al l eg edn on t ax ab l e d ep os i t s th atth ey

m ai n t ai n t h e rev enu e ag en ti n cl u d ed i n t ax ab l e d ep o s i t s fo r each o f t h ei r t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 01 3 . W i t h res p ectt o th ei r t ax ab l e y ear 2 0 1 1 , p et i t i o n ers p oi ntt o fo u r s u ch al l eg edn on t ax ab l e d ep o s i t s (al l eg ed2 0 1 1
n o n t ax ab l e d ep o s it s ). Pet i t i o n ers cl ai m th ata $ 2 5 ,0 0 0 d ep o s i ti n t o th e S0 1 3 ch eck i n g acco un ti n Ap ri l 2 0 11 was “ fro m th e p ro ceed s o f t h e s al e o f a v i n t ag e 1 9 3 6 Fo rdth atwas o wn edb y Pet i t i o n er wi fe’ s m ot h er, M arg aret Cl ab o rn . ” Acco rd i n g t o p et i t i on ers , M s . Sm it h ’ s m o t h er “ co n t ract ed Pet i t i o ners t o s el l * * * [t h e
v eh icl e] fo r h er”, an daft er t h e s al e o f t h e v eh i cl e M s . Sm it h ’ s m o t h er “ g i ft edth e p ro ceed s o f t h e s al e t o t h e Pet i t i o n ers .” Pet i t i o ners cl ai m t h atth ey “pro v i dedco m -- 3 7 -

[* 3 7 ] p l et e d ocu m en tat i o n of t h i s d ep o s i t t o Ap p eal s an dt o Res p o n d en t p ri o r t o tri al du ri n g th e p ret ri al co n feren ce”, b u twere “ d en i edth e o p p o rtu n i t y t o s t i p u l at e th i s ev i d en ce b y

th e Res p o nd en t ”. Pet i t i o ners al s o co n t en dth ata $ 1 ,5 5 0 d ep o s i t i n to th e S0 1 3 ch eck i ng
acco u n t in Oct o ber 2 0 1 1 was “ fro m th e p ro ceed s o f t h e s al e o f fu rn i tu re fro m M s . Cl ab orn ” an d t h at“ [t ] h es e p ro ceed s were g i ft edb y M s . Cl ab o rn t o Pet it i o n ers fo l l o w i n g th e s al e.” W i t h res p ectt o th at $ 1,5 5 0 d ep o s i t , p et i t i o ners al s o cl ai m th at th ey “p ro v id edco m

p l et e ex p l an at i on o f t h i s d ep o s i tt o Ap p eal s an dt o Res po n d en t p ri o r t o t ri al duri n g th e p ret ri al co n feren ce” b u t were “ d en iedth e o p po rtu ni t y t o
s t ip u l at e t o th i s ev i den ce b y th e Res p o n d en t ”. Th e l as ttwo al l eg ed2 0 1 1 n o n t ax ab l e d ep o s it s are t wo d ep o s i t s o f $ 1 3 6 ,0 0 0
an d $ 9 0 0 , res p ect iv el y , i n t o th e COD acco u n tth atwere m ad e o n th e s am e d ay o n Au g u s t2 9 , 2 0 1 1 . Pet i ti o n ers cl ai m th ateach o f t h o s e al l eg ed2 0 1 1 n o n t ax ab l e d ep os i t s was a n o nt ax ab le t ran s fer fro m o ne o f t hei r acco u n t s i n t o an o th er o f t h ei r
acco u n t s (i n t eracco u n ttran s fer). In s up po rto f t h ei r cl ai m , p et i t i o ners p o i n tt o a b an k s tat em en tfo r Au g u s t2 0 1 1 wh ich s h o wedth e fo l l o wi ng d es cri p t i on s fo r t h e
res p ect i ve d ep os i ts i n t o th e COD acco u n to n Au g us t2 9 , 2 01 1 , o f $ 1 3 6,0 0 0 an d $ 9 0 0 : “ NEW ACCOUNT DEPOSIT TRANSFER--SM ITH, SHEI” an d “ DEPOSIT TRANSFER--SM ITH, SHEILA C”, res p ect i v el y . W i t h res p ectt o th e $ 1 3 6 ,0 0 0- 3 8 -

[* 3 8 ] d ep o s iti n to th e COD acco u n t , p et i t i o ners al s o co n ten dth ati ti s “ n otl o g i cal fo r a ret i redh an dym an , wh o n o rm al l y h adg ro s s i n co m e o f ap p ro xi m at el y $ 3 0 ,0 0 0 each y ear, t o s ud d en ly

recei v e 4 -5 t i m es h i s an n u al i n co m e i n o n e l u m p s u m ”. W i t h res p ect t o th ei r t ax ab l e y ear 2 0 1 2 , p et it i o n ers p o in tt o o n e al l eg ed
n o n t ax ab l e d ep o s it(al l eg ed2 0 1 2 n o n t ax ab l e d ep o si t). Pet i t io n ers cl ai m thata $ 7 0 0 d ep o s i ti n to t h e S0 1 3 ch eck i n g acco u n ti n Decem b er 2 0 1 2 co n s i s tedo f

“p ro ceed s o f t he s al e o f fu rn itu re fro m M s . Cl ab o rn fo l lo wi n g h er d eat h ” an dwas

“p arto f Pet i t i o n er wi fe’ s i n h eri t an ce”. Pet i t i o ners al so cl ai m th atthey “p ro v i d ed
co m p l et e ex p l an at i o n o f t h i s d ep o s i t[$ 7 00 d ep o s iti n t o the S0 1 3 ch eck in g acco u nt ] t o Ap p eal s an d t o Res p on d en tp ri o r t o tri al du ri n g th e p ret ri al co n feren ce, b u tPet i t i o n ers were d en i ed t h e o p p o rtun i t y t o s t i p ul at e t h is ev i d en ce b y the Res po n d en t ”. W i t h res p ect t o th ei r t ax ab l e y ear 2 0 1 3 , p et it i o n ers m ai n t ai n th atres p o n d en t refu sedt o s t i pu l at e cert ai n “ d ep o s i treco rd s ” fo r t h e p eri o d J an u ary 1 5 thro u g h Decem b er 3 1 , 2 0 13 . Acco rd i n g t o p et i ti o ners , “ [i ] f t h e d ep os i treco rd s fo r al l o f 2 0 1 3 h adb een co rrect l y

s ub m i t t edan ds t i p u l at ed , th ey wo u l ds h o w” t h atn u m ero u s d ep o s i t s , al b ei tm o s to f t h em rel at i vel y s m al l i n am o u n t, wh i ch th e rev en u e ag en t h adi n cl u d ed i n t ax ab l e d ep o s i t s fo r t h ei r t ax ab l e y ear 2 0 1 3 , were n on t ax ab l e- 3 9 -

[* 3 9 ] (al l eg ed2 01 3 n o n t ax ab l e d ep o s i t s ). 1 8 (W e s h al l s om et i m es refer co ll ect i v el y t o the al leg ed2 0 1 1 n o nt ax ab l e d ep o s i t s , the al leg ed2 0 12 n o n tax ab l e d ep os i t s , an d th e al l eg ed2 01 3 n o n t ax ab l e d ep o s i t s as p et i t io n ers ’ al l eg edn on t ax ab l e d ep o s i t s .) Pet i t i o ners rel y

al m o stex cl us i vel y

o n th ei r co n t en ti o n s o n b ri ef, n o to n
ev i d en ce i n the reco rd , t o es t ab l i s h th ei r cl ai m s reg ard i n g p et i t io n ers ’ al l eg ed
n o n t ax ab l e d ep o s it s . Fo r ex am p l e, p et i ti o n ers d o n o t p oi n t t o o r rel y o n an y p art
o f t h e reco rdth ati n factes tab l i s h es th ei r cl ai m s t hatth e $ 1 36 ,0 0 0 d ep o s itan dth e $ 9 0 0 d ep o s i ti n to t h e COD acco u n to n Au g u s t2 9, 2 0 1 1 , were i n t eracco u n ttran s fers
. W e ackn o w l ed g e t h atth e d es cri p t i o n s o f th e $ 13 6 ,0 0 0 an d$ 9 0 0 d ep o s i t s i n th e p ert i n en t reco rd s o f t h e W EOKIE acco u n ts as “NEW ACCOUNT DEPOSIT

1 8 As an il l u s t rat i o n o f th e t y p e o f al leg ed2 0 13 n o n tax ab l e d ep os i t s , p et i

t i on ers co n t en d t h atth e “ d ep os i treco rd s ” fo r t he p eri o di n 2 0 1 3 aft er J an u ary 1 4 , 2 0 1 3 , th at , acco rd i n g t o p et i t io n ers , res p o n den trefu s edt o s t i p u l at e wo u l d d em o n s trat e t h at$ 4 , 3 5 0 o f a $ 1 4 ,2 6 3 .0 3 d ep o si t i nt o t h e S0 1 3 ch eck i n g acco un to n J an u ary 1 6 , 2 0 1 3, was “ Pet i t i o n er wi fe’ s p ro p o rt io n at e am o u ntfro m the s al e o f th ei r [s i c] m ot h er’ s (M arg aret Cl ab o rn ) jewel ry , s i l v er, an ds co ot er”. As fu rt h er ex am p l es , p et i t i o ners cl ai m

th atth ey rep o rt ed as t ax ab l e i n co m e cert ai n o f t h e al l eg ed2 0 1 3 n o n t ax ab l e d ep o si t s an dth atres p o nd en t ’ s i ncl u s io n o f th o s e d ep o s i t s i n p et i ti o n ers ’ i n co m e fo r t h e y ears ati s s u e wo u l dres u l ti n d o ubl e t ax at i o n o f t h e s am e i n co m e. Two i l l u s t rat i o n s o f t h i s ty p e o f al l eg ed2 01 3 n o n t ax ab l e d ep o s i t s are p et i t i o n ers ’ co n t en ti o n s (1 ) t h at$ 5 0 o f a $ 1 , 0 8 5 .2 2 d ep o s i ti n t o t h e S0 1 3 ch eck i n g acco un ti n Feb ru ary 2 0 1 3 was fro m

“ a Ci t i b an k d iv i d en dch eck ” wh i ch p et i t i o n ers cl ai m

th ey rep o rt edi n th e Sch edu le B, In t eres tan dOrd i nary Di v id en ds , i n cl u d edwi t h th ei r 2 0 1 3 retu rn an d (2 ) t h at$ 1 5 8
. 2 2 o f th e s am e $ 1 ,0 8 5 .2 2 d ep o s i ti nt o th e S0 1 3 ch eck i n g acco u ntwas fro m “ a W es tern Gas & Ro y al ty ch eck ” wh ich p et i t i o n ers cl ai m th ey rep o rt edi n t h ei r 2 0 1 3 Sch edu l e E.- 4 0 -

[* 4 0 ] TRANSFER--SM ITH, SHEI” an d “ DEPOSIT TRANSFER--SM ITH, SHEILA C”, res p ect iv el y , s u g g es tth at t h o s e d ep os i t s i n vo l v ed , i nt er al i a, s o m e ty p e o f “ tran s fer”. W e al s o ackn o wl ed g e t h ati two u l db e u n u s u al fo r a h an dym an l i ke M r. Sm i t h an d an o ffi ce m an ag er l i k e M s . Sm i t h , wh o h adn o o t h er s o u rce o f
s ub s t an t i al i n co m e du ri n g t h e y ears ati ss u e t h ati s d i scl o s edb y th e reco rdi n th i s
cas e, t o d ep o s i t$ 1 3 6 ,0 0 0 i n o ne t ran s act i o n . Ho w ev er, n on e o f t h e reco rd s o f t h e W EOKIE acco u n t s o r an y o t her ev i den ce i n t h e reco rdes t ab l i s h es t hatM r. Sm i t h
o r M s . Sm i t h m ad e a wi t h drawal o f $ 1 3 6 ,0 00 an d an o t h er wi t h drawal o f $ 9 0 0 fro m o n e o r m o re acco u n ts th ato n e o r b ot h o f t h em m ai n t ai n edato n e o r m o re fi nan ci al i n s t i tut i o n s . 1 9 Inth i s reg ard , we n o te t h atth e reco rdes t ab li s hes th atth e
rev en u e ag en tex cl u dedfro m t o t al d ep o s i t s as n o n t ax ab l e i n d et erm i n i ng t ax ab l e d ep os i t s u n d er t he b an kd ep o s it s an al y s es i n qu es t i o n a $ 2 5 ,0 0 0 d ep o s i ti n t o th e COD acco un t, wh i ch was al s o m ad e o n Au g u s t 2 9 , 2 01 1 , th e d at e o n wh i ch th e

1 9 Pet i t i o ners cl ai m

th atth e $ 1 3 6 , 0 0 0 an d$ 9 0 0 d ep o s it s were t ran s fers fro m “ a p ers o n al acco u nto wn edb y Pet i t i o n er wi fe es t ab l i s h edo ne y ear p ri o r t o th e fi rs t y ear o f au d i t i n t o a Cert i fi cat e o f Dep o s ito wn edjo i n t l y b y Pet i t i o n ers . ” No t h i n g i n the reco rdes t ab li s h es the ex i s t en ce o f a b an k acco u n to r o t h er d ep o s i t o ryacco u nti n th e n am e o f M s . Sm i t h, l etal o ne t h atan y s u ch b an kacco u n t o r d ep o s i t o ry acco u n t w as t h e s o urce o f t h e $ 1 3 6,0 0 0 d ep o s i tan dth e $ 9 0 0 d ep os i t . Pet i t i o n ers al s o cl ai m

th at“ [n ] ei t h er o f t h es e d ep o s i t s were cas h d ep o s i t s an dthe RA co u l d h av e eas il y

traced b o t h b ackt o tran s fers b et ween th e p ers o n al acco u n t o f Pet i t i o n er wi fe * * * an d Pet i t i o ners ’ jo i n tacco u n t s .” W e h el d ab o v e th atp et i ti o n ers are n o tal l owedt o l o o kb eh i n d t h e n o t i ce.- 4 1 -

[* 4 1 ] $ 1 3 6 ,0 00 d ep o s i tan dth e $ 9 0 0 d ep o s i twere m ad e i nt o th atacco u n t . Th e d es cri p t io n o f t h at$ 2 5 ,0 0 0 d ep o s i t i n th e p ert i n en treco rd s o f t h e W EOKIE acco u nt s was “ DEPOSIT TRANSFER--SM ITH, RONNIE J ”. Un l i k e t h e $ 1 3 6 ,0 0 0 d ep os i tan dth e $ 9 0 0 d ep os i t, h o wev er, t h e reco rd es t ab l i sh es th atp et i t i o ners wi th drew $ 2 5 ,0 0 0 fro m

th e S0 1 3 ch eck i n g acco un to n t h e s am e d ay o n wh i ch th ey
m ad e t h at$ 2 5 , 0 0 0 d ep o si t in t o th e COD acco u nt . Onth e reco rdb efo re u s , we fi n dth at p et i t io n ers h av e fai l edt o carryth ei r b u rd eno f es t ab l is h in g thatthe s o u rce o f t h e $ 1 3 6 , 0 0 0 d ep o si t an d t h e s o u rce o f th e $ 9 00 d ep os i t were o n e o r m o re acco u n t s th ato ne o r b o t h o f t hem m ai n t ai n edat
o n e o r m o re fi n an ci al i n s t i tu t i o n s an dth at co ns equ en t l y each o f t h o se d ep o s i t s was
an i n t eracco un ttran s fer. An o th er ex am

p l e o f p et i t i o ners ’ at t em

p t s t o h av e u s s u s t ai n wi t h ou t s up p o rt i n the reco rdth ei r co n t en ti o n s th at cert ai n o f th e t ax ab l e d ep o s i t s t hatth e rev en u e ag en t d et erm in edu n d er t h e b an kd ep o s it s an al y s es i n qu es t io n are n o tt ax ab l e rel at es t o thei r cl ai m

th atres p o n d en trefu s ed t o s t ip u l at e cert ai n “ d ep o s i treco rd s” fo r t h e p eri o d Jan uary1 5 t h ro u g h Decem b er 3 1 , 2 0 1 3 . Ev en i f we were t o accep t , wh i ch we d o n o t, p et i t i o n ers ’ co n t en t i o n th at res p on d en trefu s edt o s t i p u l at e cert ai n “ d ep o s i treco rd s ” fo r t h e p eri odJ an u ary 1 5 t h ro u gh Decem

b er 3 1 , 2 0 1 3 , p et i t i o n ers d o n o tp ro v i d e an y reas o n ab l e ex p l an at i o n as t o wh y th ey d i dn o to ffer- 4 2 -

[* 4 2 ] th o s e “ d ep o s i treco rd s ” i n t o ev i d en ce atth e t ri al i n thi s cas e. 2 0 An dwe
can n otfat h o m

an y reas o n ab l e ex pl an at i o n fo r t h e fai l u re o f p et i t i o n ers , wh o h av e th e b u rd en o f p ro o f o n t h e i s su es p res en t ed , t o d o s o u n l es s , o f co u rs e, th ey d o n o t h av e an y s u ch reco rd s . A fi n al i l l u s t rat i o n o f p et i t i o n ers ’ at t em p t s t o h av e u s s u s t ai n wi t ho u t
s up p orti n th e reco rdthei r co n ten t i o n s th atcert ai n o f t h e t ax ab l e d ep o s i t s th atth e
rev en u e ag en td et erm i n edu n d er t h e b an k d ep os i t s an al y s es i n qu es t i o n are n o t t ax ab l e co n cern s p et i t i o n ers ’ cl ai m s th atcert ai n o f t hei r al l eg edn o n t ax ab l e d ep os i t s rel at edt o d ep o s i ts fro m an i nh eri t an ce th atM s . Sm i t h recei v edo r t o d ep os i t s th atth ey

rep o rt edas i nco m e. Th e reco rds i m p l y d o es n o t es t ab l i s h th o s e cl ai m s . Bas edup on o ur ex am i n at i o n o f t h e en t i re reco rdb efo re u s , we fi n dth at p et i t i o n ers h av e fai l ed t o carryth ei r b urd en o f es t ab l is h i n g thatth ey are n ot req u i redt o i n cl u d e i n i n co m e fo r t h e res p ect i v e y ears at i s s u e p et i t i o ners ’ al l eg ed
n o n t ax ab l e d ep o s it s . Onth atreco rdb efo re u s , we fi n dth at p et i t i o n ers h av e fai l ed t o carryth ei r b u rd en o f es tab l i s h i n g t h atth ey are n o treq u i redt o i n cl ud e i n i n 2 0 W e reject as h i g h l y qu es t i o n ab le p et i t i o n ers ’ as sert io n o n b ri ef t h at“ [d ] ue t o s o m e co n fu si o n l ead i ng up t o an dattri al , th e Pet i t i o n ers d i d n o th av e ad equ at e o p p o rtu ni t y

t o p res en t ex t en s i ve ev i d en ce attri al cl earl y o u t l i n i ng th e n o n -t ax ab l e d ep os i t s ”.- 4 3 -

[* 4 3 ] co m e fo r each o f th e y ears ati s s u e a cert ai n ad d i t i o n al am o u n to f i n co m e th atres p o n d en t d et erm i nedi n th e n o t i ce fo r each o f th o s e y ears . W e tu rn n o w t o wh et h er p et i t i o n ers are en t i t l edfo r each o f t h ei r t ax ab l e y ears 2 0 1 1 , 2 0 1 2, an d2 01 3 t o d eductcert ai n ex p en s es thatth ey co n t en dwere p ai d i n p erfo rm i n g th ei r res p ect i v e p ers o n al s erv i ces du ri n g each o f t ho s e y ears . 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, an dp et i t i o ners b ear t h e b u rd en o f p ro v in g en t i t l em en tt o an y d edu ct i on s cl ai m ed
. See INDOPCO, In c. v . Co m m i s s i on er, 5 0 3 U.S. 7 9 , 8 4 (1 9 9 2). Th e Co d e an dth e reg u l at i o ns th ereu n der req u i red p et i t i o n ers t o m ai n t ai n reco rd s s u ffi ci en tt o es t ab l i s h th e am o u nto f an y d edu ct i o n s cl ai m ed . See s ec. 6 0 0 1 ; s ec. 1
. 6 0 0 1 -1 (a), In co m e Tax Reg s . M o reo v er, s ect i o n 1 6 2 (a) g en eral l y

al l o w s a d edu ct i o n fo r o rd i naryan dn eces s ary ex p en ses p ai do r i n cu rreddu ri n g th e t ax ab l e y ear i n carry i n g o n an y trad e o r b u s in es s . Inad d i t i o n , fo r cert ai n k i n d s o f ex p en ses thatare o t h erwi s e d edu ct i b l e u n d er s ect i on 1 6 2 (a),
s u ch as th o s e fo r “ l i s tedp ro p ert y ”, as d efi n edi n s ect i on 2 8 0 F(d )(4 ), a t ax p ay er
m u sts at i sfy

cert ai n ad di t i o n al s ub s t an t i at i on req u i rem en t s s etfo rt h i n s ect io n 2 7 4 (d ) b efo re s u ch ex p en s es wi l l b e al l o wedas d edu ct i o n s. Pet i t i o ners rel y

upo n cert ai n b an ks t at em en ts , cert ai n cred i tcard s tat em en ts , an d cert ai n v eh i cl e reco rd s th atare i n th e reco rdt o es t ab l i s h thatth ey are en t i t l ed t o d eductcert ai n ex p en s es th atth ey co n t en d were p ai d i n p erfo rm i n g t h ei r res p ec-- 4 4 -

[* 4 4 ] t i v e p ers o n al s erv ices du ri n g each o f th e y ears ati s s u e. Th e d ocu m en t s o n wh i ch p et i t i on ers rel y

d o n ot es t ab l is h t h e res p ect i v e t y p es o r t h e res p ect i v e
am ou n t s o f t h e v ari o u s ex p en s es fo r wh i ch p et i t i o n ers are cl ai m i ng d edu ct i o n s . No r d o t h o se d o cu m en ts es tab l i s h th atan y s uch cl ai m edex p en s es are o rd i n ary an d
n eces s ary ex p en ses thatp et i t i o n ers p ai do r i n cu rreddu ri ng o n e o r m ore o f t h e y ears ati s s u e i n p erfo rm i ng th ei r res p ect i ve p ers o n al s erv ices
. Onth e reco rdb efo re u s , we fi n dth at p et i t io n ers h av e fai l edt o carryth ei r b u rd eno f es t ab l is h in g thatcert ai n ex pen s es fo r wh i ch t h ey are cl ai m i n g d edu ct i o n s fo r each o f t h e y ears ati ss u e are o rd i naryan dn eces s ary ex p en ses th atth ey p ai do r i n cu rred du ri n g o n e o r m o re o f t h o se y ears ati ss ue i n p erfo rm i n g t hei r
res p ect i ve p ers o n al s erv i ces du ri n g each o f t h o s e y ears . On t hatreco rd , we al s o fi ndth at , ev en i f p et i ti o n ers h adcarri edth at b u rd en , th ey h av e fai l ed t o carryth ei r b u rd eno f es t ab l is h in g thatcert ai n k i n d s o f ex p en s es fo r wh i ch th ey are cl ai m i n g d educt i o n s fo r each o f t h e y ears ati s su e, s uch as th o s e fo r “ l i s t edp ro pert y ”, as d efi n edi n s ect i o n 2 8 0 F(d )(4 ), s at i sfy cert ai n ad d i ti o n al req u i rem en t s i n s ect i o n 2 7 4 (d ). Bas edup on o ur ex am i n at i o n o f t h e en t i re reco rdb efo re u s , we fi n dth at p et i t i o n ers h av e fai l ed t o carryth ei r b urd en o f es t ab l is h i n g thatth ey are en t i t l ed fo r each o f t h ei r t ax ab l e y ears 2 0 1 1 , 2 0 1 2 , an d2 0 13 t o d edu ct cert ai n ex p en s es- 4 5 -

[* 4 5 ] th atth ey

co n t en d were p ai di n p erfo rm i n g th ei r res p ect i v e p ers o n al s erv i ces du ri n g each o f th o s e y ears . W e tu rn n o w t o t h e l as t i s s u e p res en t ed , n am el y , wh et h er p et it i o n ers are
en t i t l edfo r t h ei r t ax ab l e y ear 2 0 1 1 t o d edu ct $ 21 ,9 4 0 wi t h res p ect t o a cl ai m edn et
o p erat i n g l o s s carry o v er (s o m et i m es , cl ai m ed NOL d edu ct i o n ). Sect i o n 1 7 2 (a) al l o ws a d edu ct i o n fo r a n eto perat i n g l o s s fo r th e t ax ab l e y ear i n an am o u n tequ al t o the s u m

o f (1 ) t h e n eto perat i n g l o s s carry o v ers t o s u ch y ear an d(2 ) t h e n et
o p erat i n g l o s s carryb ack s t o su ch y ear. A n eto p erat i n g l o s s i s d efi n edas th e
ex ces s o f d edu ct i o n s al l owedb y ch ap t er 1 o f t h e Co d e o v er t h e g ro s s i n co m e,
s ub jectt o cert ai n m o d ifi cat i o n s i n s ect i o n 1 7 2 (d ). 2 1 See s ec. 1 72 (c). In s up p o rto f t h ei r p o s it i o n th atth ey are en t i t l edfo r t h ei r t ax ab l e y ear 2 0 1 1 t o thei r cl ai m edNOL d educt i o n , p et i t i o n ers arg u e t hat“ [r] es p o n d en terred i n d i s al lo wi n g th e Pet i t i o n ers ’ NetOp erat i n g Lo s s i n th e am ou n to f $ 2 1 ,9 4 0 rep o rt ed
o n Pet it i o n ers ’ F1 0 40 fo r t ax y ear 2 0 1 1 s i n ce RA [t h e rev enu e ag en t ] n ev er ex am i n edt ax retu rn s an dreco rd s an dn ev er g av e Pet i t i o n ers an o p po rtu n i t y t o s ub s t an t i at e t h atam o u n t .”

2 1 On e o f t h e m od i fi cat i o n s i n s ec. 1 7 2 (d )(1 ) i s th atn o n eto p erat in g l o s s d educt i o n i s t o b e al l o wedi n cal cu l at i n g t h e am o u n to f a n eto p erat i n g l o s s .- 4 6 -

[* 4 6 ] W e h el dab ov e t hatp et i t i o n ers , n otres p o n d en t , h av e t h e b u rd eno f p ro o f o n each o f t h e i ss ues p res en t ed . Pet it i o n ers d i dn o to ffer an y ev i d en ce atth e t ri al i n th i s cas e t h at es t ab l i s h es th atth ey are en t i t l ed fo r th ei r t ax ab l e y ear 2 0 1 1 t o th ei r cl ai m edNOL d edu ct i o n . 2 2 Bas edup on o ur ex am i n at i o n o f t h e en t i re reco rdb efo re u s , we h o ldth at p et i t i o n ers h av e fai l ed t o carryth ei r b urd en o f es t ab l is h i n g thatth ey are en t i t l ed fo r t h ei r t ax ab l e y ear 2 0 1 1 t o d edu ct$ 2 1 ,9 40 wi t h res p ectt o a cl ai m edn eto p erat i n g l os s carry o v er. W e h av e co n s id eredal l o f t h e p art i es ’ res p ect i v e co n t en t i o ns an darg u m en t s th atare n o t d i s cu ss edh erei n , an dwe fi n dth em t o b e wi t h ou tm eri t , i rrel ev an t , an d/o r m o o t . To refl ectthe fo reg o i n g an d t h e p art ies ’ co n ces s i o n s , Deci s i o n wi ll b e en t ered
u n der Ru l e 1 5 5
.

2 2 Pet i t i o ners d i dn o t ev en o ffer i n to ev i d en ce an y t ax retu rn (s ) t hatth ey

h ad fi led fo r a t ax ab l e y ear b efo re t h e y ears at i s s ue. Ev en i f t h ey h ad , we h av e co n s i st en t l y h el d t h ata t ax p ay er i s n o ten t i t l edt o a d edu ct i o n cl ai m edi n a t ax retu rn th atth e t ax p ay er h as fi l edm erel y b ecau se o f t h e fi l i n g o f t he ret u rn . See, e.g ., W i lk i n so n v . Co m

m i s s i on er, 7 1 T.C. 6 3 3, 6 3 9 (1 9 7 9).