T.C. Mem o. 2 01 6- 15 5

UNITED STAT ES TAX COURT
MARK L. NEBEKER, Peti ti on er v . COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No s. 3 11 35 -1 2, 1 95 5- 13
. Fi le d Au gu st16 , 20 16
.
Alv ahLava r Tay lo r an d Li saO. Nels on , for pe ti ti on er. Heathe r K. McCl us ke y

an d Al ex an de r J. Di Pi rro -Bea rd(stud en t), fo r res po nd en t.

MEMORANDUM FINDINGS OF FACT AND OPINION GOEKE, Ju dg e: Pet it io ne r fo rm eda su cces sf ul so le pro pr ie to rs hi p b efo re th e y ears at i ss ue , andth e m an ne r in whi chhe acco un te d fo r th e in de pe nd en t co nt ract or

ex pe ns es hi s b us in es s i nc urredwith re sp ectto hi s cl ie nt s b eg in ni ng in 20 04 ha s l edto in co m e ta x i ss ue s wi th th e In te rn al Rev enue Serv ic e (IR S) an d-2
-

[* 2] ul ti m at el y

to no ti ces of d efi ci en cy

fortax y ears 20 06 an d 2 00 9. Th e n ot ic es of de fic ie nc y

de te rm in edde fic ie nc ie s, an ad di ti on to tax un de r se ct io n 6 65 1( a)(1 ), 1
an d p en al ti es un de r se ct io n 6 66 2( a) as fol lo ws: 2
Year Defi ci en cy Add it io n t o t ax se c. 66 51 (a)( 1) Pen al ty

se c. 66 62 (a) 20 06 $2 23 ,35 9 $5 5,8 40 $4 4,6 72 20 09 89 ,46 2
--- 17 ,89 2

FINDINGS OF FACT Pet it io ne r res id edinCal ifo rn iawhenhe ti m el y fil edth e p et it io n. Pet it io ne r’s bu si ne ss , th e Pro ject M an , was a s ol e p ro pr ie to rs hi p, an d h e rep orte d it s i nc om e an d e xp en se s o n aSch edul e C, Pro fitor Lo ss Fro m Bu si ne ss . The Pro ject M anop erat edna ti on wid e an d h adanim pr es si ve li stof c li en ts . Pet it io ne r ha s 4 -1 /2 y ears of e du cat io n fr om Oran ge Co as t Co ll eg e an d Bri gh am You ng Uni ve rs ity

bu t d idno t re cei ve a ba ch el or ’s deg ree. Pe ti ti on er stud ie d b us in es s m an ag em en t an d c omm un ic at io ns whi le at Ora ng e Co as t Co ll eg e Unl es s o th erwi se in di cat ed , all sec ti on refe ren ces are t o t he Int ern al 1 Rev enue Co de ineffe ctforth e y ears at i ss ue , andall Ru le refe ren ces are t o t he Tax Co urt Ru le s o f Prac ti ce an d P ro cedur e. W e ro un d a ll m on et ary am ou nt s t o th e n eare stdo ll ar. So m e o th er i ss ue s h av e b eenset tl ed , andpe ti ti on er co nc ed es th e se ct io n 2 66 51 (a)( 1) ad di ti on to tax fortax y ear 2 00 6.-3
-

[* 3] an d B rig ha m

Young Uni ve rs ity

bu t t oo k o nl y

ba si c acc ou nt in g c ou rs es an d di d n ottak e an y

tax cla ss es . Pet it io ne r ha s o pe rat edth e Pro ject M ansi nc e 1 99 5. Itpro vi de d p ro ject
m an ag em en t co ns ul ti ng pri m ari ly for aer os pa ce an d d efen se co m pa ni es . The Pro ject M an ’s m ai n c li en ts in cl ud edSik or sky Airc raft , Prat t & Whi tn ey Eng in e Bu il de rs , Mo og Aero sp ace, Ham il to n S un ds tra ndAero sp ace, andHum ph reys & Ass oc ia te s. Pet it io ne r was si ng le du rin g 2 00 6 a nd20 09 . Peti ti on er fi le d h is Fo rm 10 40 , U.S. Ind iv idua l In co m e Tax Return, l at e fo r 20 06 , onDecem be r 22 , 20 09 . Bot h pe ti ti on er an d h is return p rep arersi gn edth e 2 00 6 re turnon Decem be r 22 , 20 09
. Pet it io ne r ti m el y

fil edhi s i nd iv idua l Fe de ral in co m e ta x re tu rnfor 20 09
. Pet it io ne r m ai nt ai ne d asep arat e b us in es s b an k a cco un t fo r th e Pro ject M an . He us edMi cro so ft M on ey so ftwa re t o t rackhi s b us in es s i nc om e an d e xp en se s. The Pro ject M an ’s cli en ts wou ldpa y all am ou nt s o weddi rect ly viach eckor d ire ct de po si t, wh ic h wer e al l d ep os it edin to th e b us in es s b an k a cco un t. Pet it io ne r ge ne ral ly repo rte d a s i nc om e th e am ou nt s the Pro ject M anactua ll y

rece iv eddu rin g th e cal en da r y ear o n t he Sch edul e C at ta ch edto hi s i nc om e ta x re tu rnforth at pa rti cu la r cal en da r y ear.-4
-

[* 4] Bec au se of t he na tu re o f th e Pro ject M an ’s work , th e b us in es s re qu ire d

“ tra ceab il ity ”, m ean in g tha t p et it io ne r ha d t o b e ab le to tra ckall da tareg ard in g t he Pro ject M an ’s in co m e an d e xp en se s an d t o m at chth e ex pe ns es with t he in vo ic es he subm it te d t o t he Pro

ject M an ’s cli en ts . Becau se th e Pro ject M anwas i nv ol ve d with Go ve rn m en t p ro gr am s, the Pro ject M an ’s reco rd s wer e subjec t t o b ei ng au di te d a t an y

ti m e. Pet it io ne r co de d t he Pro ject M an ’s in vo ic es to cli en ts ve ry sp eci fic al ly in o rd er t o b e ab le to m at chth e ex pe ns es with t he in vo ic es subm it te d to th e cl ie nt s. The Pro ject M anan d i ts cli en ts di d n otha ve un ifo rm co nt ractua l
arra ng em en ts . Each c li en t h adit s o wn m etho d o f rei m bu rs in g fo r tr av el expe ns es , bu t the re were ge ne ral ly two d is ti nc t m etho ds of r ei m bu rs em en t. The pa rti es ch arac te riz e th e rei m

bu rs em en t m etho ds as “ do ll ar fo r do ll ar” a nd“ wrap pe d ra te ”. Dol lar fo r do ll ar i s ap tl y

na m edas i t co nn ot es rei m bu rs em en t fo r th e actua l trav el
ex pe ns es pe ti ti on er an d the Pro ject M an ’s subc on tra ct or s i nc urredonth e b as is of
rece ip ts subm it te d t o t he cli en ts . Sik or sky Airc raftus edth e wrap pe d ra te m etho d to av oi d re vi ewin g s pe ci fic tra ve l ex pe ns es by add in g afla t fe e to th e h ou rly rates
. Thi s fl atfee was ba se d upo n p rio r th ree years’ workof t he Pro ject M anfor Si ko rs ky Aircra ft a ndit s p aren t co m pa ny.-5
-

[* 5] The Pro

ject M anwou ldpa y

it s i nd ep en de ntco nt ract or s an ho ur ly rate fo r labo r an d fo r ex pe ns es in curredfortra ve li ng to it s cl ie nt ’s lo cat io n. Th e Pro ject Man pa idth e in de pe nd en t co ntract or s ev ery two week s fo r labo r an d t rav el
ex pe ns es th ey

in cu rred , reg ard le ss of wh ethe r th e Pro ject M an ’s cli en ts ha d p ai d th e in vo ic es ass oc ia te d wi th th e subc on tra ct or s’ lab oran d e xp en se s. Pet it io ne r wou ldsubm itin vo ic es to th e Pro ject M an ’s cli en ts ap pr ox im at el y ev ery fo uror fiv e week s. Th es e in vo ic es it em iz edth e subc on tra ct or s’ ti m e an d trav el ex pe ns es as so ci at edwith t he pa rti cu la r cl ie ntrece iv in g e achin vo ic e. Eachsubc on tra ct or was als o g iv ena co de d n um be r th atwas re fle ct edon th e in vo ic es . The cli en ts typic al ly w ou ldno t p ay th e Pro ject M anforat l eas t 6 0 d ay s af te r th e Pro ject M ansubm it te d i nv oi ces to th em . There were m any ti m es , ho wev er, whe n the cli en ts di d n otsen d p aym en t o f in vo ic es forat l eas t 9 0 d ay s. On
oc cas io n, p et it io ne r di d n otrece iv e p aym en ts fro m th e Pro ject M an ’s cli en ts foras m uc h a s s ix m on th s af

te r th e d at es on whi chth e in vo ic es were s ub m it te d. At ti m es , th e Pro

ject M anwou ldrece iv e p orti on s o f th e p aym en ts fro m th e cl ie nt s fo r subc on tra ct orlab or

an d t rav el ex pe ns e rei m

bu rs em en ts intax y ears th atwere l at er th anth e y ears inwhi chth e Pro ject M anha d p ai d the in de pe nd en t co nt ract or s fo r th e work re fle ct edon th e in vo ic es .-6
-

[* 6] Bec au se th e Pro

ject M an ’s in vo ic es were co de d fo r pu rp os es of m ai nt ai ni ng

“ tra ceab il ity ”, pe ti ti on er wo ul d a tt em ptto m at chan y

pa ym en ts m ad e b y

th e cl ie nt s to th e in vo ic es sen t t o t he m an d m at chth e rev enue with the ex pe ns es ass oc ia te d with g en erat in g tha t re ve nu e whe th er the rev enue rel at edto ex pe ns es fro m a pr io r y ear o r th e cu rren t year. Pet it io ne r de du ct edth e subc on tra ct orexpe ns e o n h is Sch edul e C as “ ou ts id e se rv ic es ” fo r th e y ear i n wh ic h h is cli en t p ai d t he rel at edin vo ic e. Pet it io ne r th us cl ai m edth e in co m e ta x d educ ti on forou ts id e labo r as so ci at edwith p aym en ts m ad e to subc on tra ct or s fo r th e y ear i n wh ic h the Pro ject M anrece iv edpa ym en t fo r th e subc on tra ct orex pe ns e th e Pro ject M anin cu rred , reg ard le ss of wh ethe r th e Pro ject Man pa idth e subc on tra ct orina pr io r y ear. Ma rti n DeKarv er, p et it io ne r’s cert ifi ed publ ic acco un tant(C.P.A.), ap pr ov edth is m etho d o f de te rm in in g t he am ou ntof each y ear’s d educ ti on forou ts id e se rv ic es . Thi s p ro ces s o f de ferr in g t ax de du ct io ns for th e Pro ject M an ’s subc on tra ct or labo r an d s ub co nt ract ortra ve l ex pe ns es be ga n i n 2 00 4 a ndco nt in ue d a ll th e way th ro ug h 2 00 9. On h is Fed eral in co m e ta x re tu rn s p et it io ne r cl ai m edot he r expe ns e de du ct io ns forou ts id e se rv ic es of $ 1,3 73 ,30 9 a nd$3 92 ,21 0 fo r 20 06 an d 2 00 9,
res pe ct iv el y . The p art ie s ag ree p et it io ne r actua ll y pa id$1 ,08 7,5 51 .72 an d-7
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[* 7] $1 80 ,66 5.6 2 fo r ou ts id e se rv ic es ex pe ns es of t he Pro ject M andu rin g 2 00 6
an d 2 00 9, re sp ect iv el y . The remaini ng $2 85 ,75 7.2 8 and$2 11 ,54 4.3 8 a re am ou nt s pe ti ti on er p ai d fo r ou ts id e se rv ic es forpri ory ears for whi chhe de ferr ed de du ct io ns un ti l 2 00 6 a nd20 09 , res pe ct iv el y . Peti ti on er t oo k t hi s ac ti on on th e ba si s o f Mr. DeKarve r’s advi ce. Res po nd en t i ss ue d t wo n ot ic es of d efi ci en cy , on e fo r eac h year atis su e, an d p et it io ne r ti m el y pe ti ti on edth is Co urt. C.P.A. Mr. DeKarve r ha s b eenli cen se d i n C al ifo rn iaas aCPA s in ce 1 97 1. He h as pr ep aredtax returns si nc e atlea st19 81 . Tax y ear 2 00 0 was th e fi rs t year for whi chMr. DeKarv er p rep areda ta x re tu rnforpe ti ti on er. He p rep aredpe ti ti on er’s Fed eral in co m e ta x re tu rn s fo r 20 06 an d 2 00 9. Aro un d 2 00 4 p et it io ne r ex pe rie nc eda gr owt h s pu rt i n h is bu si ne ss . Howev er, b ecau se of d el ay inpa ym en ts fro m

hi s cl ie nt s fo r bo th 20 04 an d 2 00 5, he wou ldha ve pa idli tt le if any tax forth os e y ears un de r th e cas h m etho d o f
acco un ti ng . Peti ti on er was co nc ern edth e returns di d n otrefl ectth e p ro fithe was actua ll y m ak in g. Mr. DeKarve r no ti cedth e Pro ject M anha d v ery li tt le in co m e, or po ss ib ly,
ev ena lo ss for20 04 . Mr. DeKarv er que st io ne d wh y pe ti ti on er s ta y edina bu si ne ss th atwas l os in g m on ey . He ask edpe ti ti on er, an d p et it io ne r ex pl ai ne d t ha t-8
-

[* 8] th e Pro

ject M anwas p ay in g i nd ep en de ntco nt ract orex pe ns es forwhi chitwas no t re cei vi ng th e in co m e unt il m uc h l at er. As a r es ul t o f di sc us si on s wi th Mr. DeKarv er, p et it io ne r be ga n d eferrin g d educ ti on s fo r th e Pro ject M an ’s exp en se s fo r ou ts id e se rv ic es un ti l i t re cei ve d t he in co m e as so ci at edwith t ho se ex pe ns es . Mr. DeKarve r ch eck edth e b ox ne xtto th e cas h m etho d o f acc ou nt in g o n pe ti ti on er’s Sch edul es C fo r ta x years 2 00 6 a nd20 09 . Mr. DeKarv er t es ti fie d h e di d n otfeel th e n eedto ch eck“ ot he r” b ecau se he di d n otth in k t he m etho d h ad ch an ge d fr om

cas h a cco un ti ng . Trav el Exp en se s Pet it io ne r cl ai m eda Sch edul e C trav el expe ns e d educ ti on of $ 53 ,03 2 fo r ta x y ear 2 00 6. Atth e ti m e h e p rep aredth e return M r. DeKarv er tho ug htall of t he tra ve l ex pe ns es forwhi chpe ti ti on er cl ai m eda de du ct io n fo r 20 06 were fo r bu si ne ss . Peti ti on er as se rts th athe ha d a“ syste m cras h” at s om e p oi ntan d s om e da taha d t o b e d own lo ad edfro m ot he r so ur ces , res ul ti ng inm is cat eg or iz at io n o f
so m e tr av el ex pe ns es . Pet it io ne r no w ass ert s the cla im edde du ct io n o f $5 3,0 32 fortra ve l ex pe ns es co m pr is es th e fo ll owi ng :-9
-

[* 9] Expe ns e Am ou nt

Adv ert is in g $3 0,8 90 .00 Trav el m is c. 5,73 1.7 7 Tax i/ li m o 75 .00 Lod gi ng 7,5 20 .40 Airf are 5,8 28 .89 Car r en ta l 2,9 86 .17 Tota l 53,0 32 .23 The on ly doc um en ts pe ti ti on er p ro vi de d t o s ub st an ti at e th e am ou nt s p ai d fo r ex pe ns es forwhi chhe cla im eda tr av el ex pe ns e d educ ti on for20 06 were Mi cro so ft M on ey

so ftwa re s umm ari es , on e in vo ic e fro m Dest in at io n C y cl in g, an d th ree p ag es of C it ib an k c red itcardst at em en ts . The Dest in at io n C y cl in g i nv oi ce d oe s n otin cl ud e a b reak do wn o f wha t i s in cl ud edinth e $ 30 ,89 0 c os t. The bu lkof the cla im edexpe ns es rel at es to two bi cy cl in g t rip s p et it io ne r to okto Euro pe . Peti ti on er h adrace d b ik es for10 y ears . Des ti na ti on Cy cl in g i s a c om pa ny tha t p ut s o n d iff

eren t t ou r an d c y cl in g ev en ts , pre do m in an tl y

inEuro pe . Dest in at io n C y cl in g o rg an iz edth e two bi cy cl in g tri ps to Euro pe inwhi chpe ti ti on er p art ic ip at edin20 06 . The two trip s wer e as so ci at edwith t he Tou r de Fran ce i n F ran ce i n J ul y 20 06 an d t he Giro d’Ita li a in-1 0-

[* 10 ] Ita ly in M ay

20 06 . Peti ti on er h as pa rti ci pa te d i n Des ti na ti on Cy cl in g t rip s i n th e p as t. Pet it io ne r te st ifi edhe was app ro ach edab ou t b eco min g i nv ol ve d wi th th e two cy cl in g e ve nt s b ecau se Dest in at io n C y cl in g was lo ok in g fo r ad di ti on al sp on so rs . By

pa y in g asp on so rs hi p fe e, pe ti ti on er was ab le to pa rti ci pa te inbo th th e Tou r de Fran ce an d t he Giro D’ Ita li a. Fo r th e ev en t i n F ran ce, p art ic ip an ts were ab le to rid e th e actua l To urde Fran ce co ur se , vi si ti ng ev ery ci ty of th e ro ut e. Eachof t he two cy cl in g e ve nt s la st edforab ou t 1 8 t o 1 9 d ay s. Sp on so rs hi p o f bo th ev en ts co sta to ta l o f $3 0,8 90
. The sp on so rs hi p fe e co ve redpe ti ti on er’s p art ic ip at io n i n t he ev en ts , un ifo rm s, an d ot he r it em s s uc h a s a c rew wh o t oo k c are o f m eal s. The Pro ject M an ’s lo go as we ll as a ll th e o th er s po ns or s’ lo go s ap pe aredon th e g ro up ’s gea r. Pet it io ne r was th e o nl y in di vi du al ass oc ia te d wi th th e Pro ject Man to pa rti ci pa te inth e ev en t. Pet it io ne r te st ifi edth atbe fo re g oi ng on th e b ic y cl in g t rip s h e res earc he d po te nt ia l b us in es s o pp ortu ni ti es to pu rs ue inEuro pe . Howev er, p et it io ne r la te r adm it te d s om e o f th e res earc h was do ne whi le th e in st an t ca se s wer e b ei ng co ns id eredby the IRS Offi ce o f App eal s. Networki ng durin g t he tri ps turn edou t to be m or e d iff

ic ul t than p et it io ne r ha d e xp ect ed . Duri ng th e d ay pe ti ti on er an d-1 1-

[* 11 ] th e o th er ev en t p art ic ip an ts were b us y with c y cl in g e ve nt s. Pet it io ne r sp en t a co up le of d ay s i n Eu ro pe forpe rs on al ti m e aft er ea chev en t. Prep arat io n o f Tax Returns Mr. DeKarve r se t as id e anho uror t wo t o m eetwith p et it io ne r inpe rs on as pa rt o f pr ep ari ng pe ti ti on er’s t ax returns . Whe n p et it io ne r pr ep aredFo rm s 1 09 9- MIS C, Mi sc el lane ou s In co m e, fo r th e in de pe nd en t co nt ract or s atth e en d o f eac h y ear, the am ou nt s l is te d wo ul d i nc lu de th e am ou nt s p ai d fo r labo r bu t n otth e rei m bu rs edtra ve l ex pe ns es . OPINION I. Acco un ti ng Metho d Pet it io ne r m ai nt ai ns th e Pro ject M andi d n otch an ge it s ac co un ti ng m etho d bu t ra th er u se d am etho d o f de du ct io n fo r subc on tra ct orexpe ns es th atwas co ns is te ntwith c as h b as is acco un ti ng . Res po nd en t co un te rs th atth is m etho d o f
acco un ti ng is no t co ns is te ntwith t he cas h m etho d a ndth eref or e th e Pro

ject M an di d n otfol lo w th e cas h m etho d fo r rep orti ng it s ex pe ns es forin de pe nd en t co nt ract or s. Re sp on de nt ’s pri nc ip al arg um en t i s b as edon sec ti on 1.4 46
- 1( c)(1 )(i v) (a), In co m e Tax Reg s., wh ic h p ro vi de s tha t i f in co m e is rep orte d o n t he
cas h m etho d, ex pe ns es m us t al so be rep orte d o n t he cas h m etho d. Pe ti ti on er-1 2-

[* 12 ] co un te rs th atany

reas on ab le m etho d t ha t cl earl y refl ect s i nc om e is
acce pt ab le . See i d. p aras . (a)(2 ), (c)( 1) (iv ). Pet it io ne r al so m ai nt ai ns th atres po nd en t’s ad jus tm en ts are a c ha ng e o f
acco un ti ng m etho d a ndres po nd en t’s fa il ur e to tre atth e ad jus tm en ts as s uc h pr ev en ts an y

ad jus tm en t. Bo th pa rti es fai l t o a de qu at el y di sc us s o n b rie f th e pr op er treat m en t o f res po nd en t’s ad jus tm en ts if p et it io ne r’s m etho d i s d eem ed in va li d, b utch an ge of a cco un ti ng m etho d a dju st m en ts are re qu ire d b y sec ti on 48 1. The pa rti es gi ve us li tt le inth e way of aut ho rit y

to ad dr es s the ir di sa gr eem en t, b utsec ti on 1.4 46 -1 (c)( 1) (iv )(a) , Inc om e Tax Reg s., co nv in ces us th atres po nd en t was co rrec t t o a dju stth e m etho d the Pro ject M anus ed
. The m or e 3 di ffi cu ltqu es ti on is whet he r res po nd en t’s ch an ge requi res th e ap pl ic at io n o f
se ct io n 4 81
.

Any com bi na ti on of t he m etho ds of a cco un ti ng setou t i n s ec. 4 46 is 3 pe rm it te d i n c on ne ct io n wi th a tr ad e o r bu si ne ss if the co m bi na ti on cle arl y

refl ect s in co m e an d i s co ns is te nt ly use d. Se c. 1.4 46 -1 (c)( 1) (iv )(a) , Inc om e Tax Reg s. Here, u se of t he cas h m etho d i n c om pu ti ng gro ss in co m e fro m a tr ad e o r bu si ne ss ne ces si ta te s u se of t he cas h m etho d i n c om pu ti ng ex pe ns es of t he tra de or bu si ne ss . Peti ti on er fa il edto cle arl y refl ectin co m e b ecau se he ap pl ie d am etho d of de du ct in g s ub co ntract orex pe ns es th atwas i nc on si st en t wi th th e cas h m etho d o f acco un ti ng . See, e.g ., Grid er v . Comm is si on er, T.C. Mem o. 1 99 9- 41 7 (h ol di ng th ata ta xp ay er’s m etho d o f acc ou nt in g tha t i s p la in ly con tra ry to th e reg ul at io ns do es no t cl earl y

refl ectin co m e).-1 3-

[* 13 ] Sect io n 4 46 (e) p ro vi de s au th or ity for res po nd en t’s ad

jus tm en t o f th e Pro

ject Man ’s m etho d o f acc ou nt in g. Se ct io n 4 46 (e) p ro vi de s tha t a t ax pa y er wh o ch an ge s the m etho d o f acc ou nt in g o n the ba si s o f whi chhe reg ul arl y co m pu te s h is in co m e inke ep in g h is bo ok s s ha ll , bef or e co m pu ti ng hi s t ax ab le in co m e und er the
ne w m etho d, s ecu re the co ns en t o f th e Sec ret ary. Pet it io ne r ne ve r fi le d a n ap pl ic at io n t o c ha ng e th e m etho d o f acc ou nt in g, n ordi d h e fo ll ow the pro cedur e fo r au to m at ic co ns en t l ai d o utinRev . Pro c. 97 -2 7, 1 99 7- 1 C .B. 68 0. Un de r se ct io n 4 46 (e) re sp on de ntcanrequi re the Pro ject M anto ab an do n t he ne w m etho d of acco un ti ng an d t o re po rt t ax ab le in co m e u si ng th e o ldm etho d o f acc ou nt in g. See, e.g ., Com

m is si on er v . O. Liqu id at in g C or p., 2 92 F.2d22 5, 2 31 (3dCir
. 19 61 ), rev ’g T.C. Mem o. 1 96 0- 29 . Furt he r, un de r se ct io n 1 .46 6- 1( c)(1 )(i v) (a), In co m e Tax Reg s., a t ax pa y er wh o u se s the cas h m etho d i n c om pu ti ng gro ss in co m e fro m

a tr ad e o r bu si ne ss sh al l u se th e cas h m etho d i n c om pu ti ng expe ns es of su chtra de or b us in es s. Th e Pro ject M anis th eref

or e p recl ud edfro m

ch an gi ng it s m etho d o f acc ou nt in g u nd er s ect io n 4 46 (e) andth e reg ul at io ns th ereu nd er, reg ard le ss of wh ethe r th e m etho d p ro po se d i s p ro pe r. Sect io n 1 .44 6- 1( a), In co m e Tax Reg s., p ro vi de s tha t “ th e te rm ‘ m etho d o f
acco un ti ng ’ in cl ud es no t o nl y th e o ve ral l m etho d o f acc ou nt in g o f th e ta xp ay er b ut al so th e acc ou nt in g t reatm en t o f an y it em .” The re gu la ti on furth er p ro vi de s tha t-1 4-

[* 14 ] [a] chang e inth e m etho d o f acc ou nt in g i nc lu de s a c ha ng e in th e ov eral l p lan o f acc ou nt in g fo r gr os s i nc om e o r de du ct io ns or ach an ge in th e tr eat m en t o f an y

m at eri al it em

us edinsu chov eral l p lan. Altho ug h am etho d o f acc ou nt in g m ay ex is t u nd er thi s d efi ni ti on witho utth e n eces si ty of a p at te rnof c on si st en t treat m en t o f anit em , in m os t i ns ta nc es a m etho d o f acc ou nt in g i s n otest ab li sh edforan it em witho utsu chco ns is te nttre atm en t. A m at eri al it em is an y it em th atin vo lv es th e p ro pe r ti m e fo r th e in cl us io n o f th e it em inin co m e orth e ta ki ng of ade du ct io n. Ch an ge s i n m etho d o f acc ou nt in g in cl ud e * * * a ch an ge in vo lv in g t he ad op ti on * * * o f an y othe r sp eci al iz edm etho d o f co m pu ti ng tax ab le in co m e, * * * an d ach an ge whe re the Int ern al Rev enue Co de an d re gu la ti on s u nd er the Int ern al Rev enue Co de sp eci fic al ly requ ire th atth e co ns en t o f th e Co m m is
si on er m us t b e o bt ai ne d b efo re ad op ti ng su cha ch an ge . Id . par a. (e)( 2) (ii ) (em

ph as is ad de d) ; s ee al so id . sec . 1.4 81 -1 (a)( 1) . An es se nt ia l ch arac te ris ti c o f “ m at eri al it em ” wit hi n t he pu rv ie w of the reg ul at io n g ov ern in g a ch an ge inacco un ti ng m etho d i s tha t i t d et erm in es th e ti m in g o f in co m e o r de du ct io ns . Secs . 44 6, 4 81 ; Kn ig ht -Ri dd er News pape rs , Inc . v. Un it edSta te s, 7 43 F.2 d 7 81 , 79 8 (1 1t h C ir. 1 98 4)
. W e h av e co nc lu de d t ha t a s ect io n 2 67 (a)( 2) di sa ll owa nc e co ns ti tu te d a ch an ge ina ta xp ay er’s m etho d o f acc ou nt in g u nd er s ect io n 4 81 . Bos am iav. Co m m is si on er, 6 61 F.3d25 0 (5 th Cir . 20 11 ), aff’g T.C. Me m o. 2 01 0- 21 8. InCo nn or s, In c. v. Co m

m is si on er, 7 1 T.C. 9 13 (19 79 ), a cas h b as is tax pa y er co ns is te nt ly deduc te d b on us es pa idto it s p res id en t an d s ol e st oc kh ol de r on th e accrua l b as is . The t ax pay er ac cru eda bo nu s i n 1 97 3, cl ai m edth e d educ ti on for-1 5-

[* 15 ] 19 73 , andpa idth e b on us in19 74 . Id. at91 4- 91 5. InCo nn or s, In c., th is Co urt h el d t ha t the Co m

m is si on er’s requi rem en t tha t the tax pa y er re po rt t hi s m at eri al it em

inth e y ear p ai d was a ch an ge inth e ta xp ay er’s m etho d o f acc ou nt in g an d u nd er s ect io n 4 81 th e Co m m is si on er was au th or iz edto in cl ud e in th e ta xp ay er’s i nc om e fo r 19 74 th e am ou ntof t he bo nu s the tax pa y er erro ne ou sl y de du ct edfor19 73
. Fo ll owi ng Co nn or s, In c., we co nc lu de th atpe ti ti on er’s m etho d o f de ferr in g hi s d educ ti on is a m etho d o f acc ou nt in g t ha t h e co ns is te nt ly use d. Thus , res po nd en t’s ad

jus tm en t i n t he no ti ce o f de fic ie nc y to th atm at eri al it em

fortax y ears 20 06 an d 2 00 9 c on st itut es a ch an ge inhi s ac co un ti ng m etho d, wh ic h trig ge rs th e ap pl ic at io n o f se ct io n 4 81
.

“ If the re h as be ena ch an ge inm etho d o f acc ou nt in g, the n s ect io n 4 81
co m es in to op erat io n a ndad jus tm en ts ne ces sa ry

to pre ve ntanom is si on of t ax ab le in co m e m us t b e m ad e.” Pri m o P an ts Co . v. Co m m is si on er, 7 8 T.C. 7 05 , 72 0 (1 98 2) . “ Whe re the st atut ory no ti ce an d p le ad in gs are s uf fic ie ntto rai se th e is su e of ch an ge inacco un ti ng m etho d, the ap pl ic at io n o f se ct io n 4 81 is pa te nt . * * * Here, the st atut ory

no ti ce ra is edth e is su e o f ch an ge inacco un ti ng m etho d; th eref or e, se ct io n 4 81 was trig ge red .” Em ertv. Co m m is si on er, T.C. Mem o. 19 99 -1 75 , sl ip op . at 4 (fn . ref. o m it te d) , aff’d, 2 49 F.3d11 30 (9t h C ir. 2 00 1)
.-1 6-

[* 16 ] Sect io n 1 .48 1- 1( a)(1 ), In co m e Tax Reg s., p ro vi de s tha t [i]n c om pu ti ng tax ab le in co m e fo r th e ta xabl e y ear o f th e ch an ge , th ere s ha ll be tak enin to acco un t tho se ad jus tm en ts whi chare de te rm in edto be ne ces sa ry so le ly by reas on of s uc h c ha ng e in ord er to pre ve ntam ou nt s fr om

be in g dup li cat edor o mit te d. Th e ‘y ear o f th e ch an ge ’ is th e ta xabl e y ear f orwhi chth e ta xabl e in co m e o f th e ta xp ay er i s co m

pu te d u nd er a m etho d o f acc ou nt in g d iff eren t fr om th atus edforth e p rece di ng tax ab le y ear. The refo re, the ch an ge inth e m etho d o f acc ou nt in g t oo k p la ce i n 2 00 6. We ho ld th atsec ti on 48 1 a dju st m en ts are re qu ire d, an d we l eav e th e ap pl ic at io n o f se ct io n 48 1 i n t he se cas es to th e p art ie s’ agr eem en t o r a Ru le 15 5 c om pu ta ti on . II. Trav el Exp en se s Deduc ti on s fo r tr av el in g e xp en se s ar e al lo wab le on ly if in cu rredwhi le away fro m ho m e in th e p ur su itof atra de or b us in es s. Sec . 16 2( a)(2 ). Sub st an ti at io n o f th es e ex pe ns es m

us t b e p ro vi de d. Se c. 27 4( d) . Spe ci fic al ly, fo r tr av el ex pe ns es a ta xp ay er m

us t s ub st an ti at e th e am ou ntof t he ex pe ns e, th e ti m e an d p la ce o f th e tri p, an d t he bu si ne ss pu rp os e o f th e ex pe ns e. See s ec. 2 74 (d ); s ec. 1 .27 4- 5T(b )(2 ), Tem

po rary Inco m e Tax Reg s, 5 0 F ed . Reg . 46 01 4 (No v. 6 , 19 85 ). Add it io na ll y , deduc ti on s fo r fo rei gntra ve l ex pe ns es ge ne ral ly are all owe d o nl y for th e p orti on of t he expe ns es all oc ab le to a ta xp ay er’s trad e o r bu si ne ss act iv ity . See
se c. 27 4( c); sec . 1.2 74 -4 (a), In co m e Tax Reg s.-1 7-

[* 17 ] Pet it io ne r cl ai m eda de du ct io n o f $5 3,0 32 forSch edul e C trav el ex pe ns es on hi s t ax return fo r ta x year 20 06 . To subs ta nt ia te ex pe ns es no t re la te d t o t he Euro pe anbi cy cl in g t rip s, p et it io ne r pr ov id edon ly a Micr os of t M on ey do cu m en t refl ect in g asu m

m ary of hi s trav el bro ke n d ownby categ ory of t rav el expe ns e. Howev er, the re i s n oten ou gh in fo rm at io n p ro vi de d t o e st ab li sh th atth e ex pe ns es were ac tu al ly pai d o r wha t the bu si ne ss pu rp os e was foreach ex pe ns e. Fo r in st an ce, ex pe ns es id en ti fie d a s “ PM trai ni ng ” are far t oo va gu e to be est ab li sh ed
as bu si ne ss ex pe ns es . Oth er ex pe ns es , su chas t ho se id en ti fie d a s “ Si ko rs ky Pro gr am Rev ie w”, se em

to be th os e whi chwou ldha ve be enrei m bu rs edby the cl ie nt . Peti ti on er fa il edto off er an y tes ti m on y

to supp le m en t the do cum en ta ry ev id en ce an d e st ab li sh th es e were d educ ti bl e b us in es s ex pe ns es . The ex pe ns es id en ti fie d o n p et it io ne r’s Mi cro so ft M on ey do cu m en ts as

“ Giro Ch al le ng e WorldBic y cl e Rel ie f” an d “ TDF [Tou r de Fran ce] W or ldBic y cl e Rel ie f” ar e n ow b ei ng cla im edas p ro m ot io na l o r adve rti si ng expe ns e d educ ti on s. The lar ge stex pe ns e p et it io ne r in cu rredwith re sp ectto th e Eur op eanbi cy cl in g tri ps is th e $ 30 ,89 0 p ai d t o Des ti na ti on Cy cl in g, wh ic h p et it io ne r ha s es tabl is he d he pa id . Howev er, the Dest in at io n C y cl in g i nv oi ce fa il s t o d is cl os e wha t the
ex pe ns es co ve red
.-1 8-

[* 18 ] Fo r th e res t o f th e Eur op eanbi cy cl in g t rip ex pe ns es , pet it io ne r pr oduc edno rece ip ts or o th er p ro of

of p aym en t. Rat he r, pe ti ti on er re li es on ly on the Mi cro so ft Mo ne y su m m ary sh eet s. Als o, p et it io ne r ne ithe r ga ve anex actnu m be r of da y s fo r each tri p n or

co m pu te d t he no nd educ ti bl e p orti on of e ach ex pe ns e o n t he ba si s o f bu si ne ss an d n onbu si ne ss da y s. Mo stim po rta nt ly, ho wev er, p et it io ne r ha s fa il ed to sh ow a b on a fi de bu si ne ss pu rp os e fo r th e b ic y cl in g t rip s. Pet it io ne r te st ifi edhe ha s ra cedbi cy cl es fory ears an d h as parti ci pa te d i n o th er Des ti na ti on Cy cl in g ev en ts . On th e rec or d b efo re u s we fi ndpe ti ti on er d idno t h av e a b us in es s p ur po se fo r th e b ic y cl in g t rip expe ns es . The Dest in at io n C y cl in g e ve nt s s eem to be m or e tr ip s fo r pe ti ti on er’s
en te rta in m en t tha n o ne s wi th a bu si ne ss pu rp os e. Pet it io ne r’s te st im on y as t o t he bu si ne ss pu rp os e o f th e ev en ts rev eal eda va gu e an d g en eral iz edid ea tha t h e wou ldne two rkwhi le he was o n t he tri ps . Howev er, p et it io ne r of fere d n o e vi de nc e ot he r th anhi s o wn s el f-s erv in g t es ti m on y th athe actua ll y

di d any bu si ne ss act iv ity whi le on th e two bi cy cl in g t rip s. Adv ert is in g e xp en se s ar e g en eral ly deduc ti bl e if th ey are o rd in ary, ne ces sa ry , andreas on ab le inam ou ntan d b ear areas on ab le rel at io n t o t he bu si ne ss . See s ec. 1 62 ; s ec. 1 .16 2- 1( a), In co m e Tax Reg s. A sp on so rs hi p m ay als o b e de du ct ib le , bu t the tax pay er h as to pro ve itwas p ro xi m at el y rel at edto hi s-1 9-

[* 19 ] bu si ne ss . See Sn ow v . Comm is si on er, 3 1 T.C. 5 85 , 59 1- 59 2 (1 95 8) . Also , a cl ai m edadve rti si ng ex pe ns e can no t b e a “ th in clo ak forth e p ur su itof aho bb y .” Ro dg ers Dairy

Co . v. Co m

m is si on er, 1 4 T.C. 6 6, 7 3 (1 95 0)
. As a fa ctua l m atte r, pe ti ti on er s eek s t o c ha ract eri ze the $3 0,8 90 ex pe ns e pa idto Dest in at io n C y cl in g a s an adve rti si ng expe ns e rat he r th ana tr av el ex pe ns e as cla im edon hi s 2 00 6 i nc om e ta x re turn . Peti ti on er t es ti fie d a n e rro r oc cu rred be cau se he ha d alo ss of d at a atso m e p oi ntan d h adto reco ns tru ctso m e ex pe ns es . He te st ifi edth atAm eri canExp res s au to m at ic al ly categ or iz edso m e ex pe ns es as tra ve l. We no te th atpe ti ti on er p ai d t he $3 0,8 90 expe ns e wit h h is Cit ib an k c red it card . Evenst il l, h ow Am eri canExp res s o r an y ot he r cre di t ca rdco m

pa ny cat eg or iz es anexpe ns e wou ldno t h av e b eendi sp os it iv e. Mr. DeKarv er t es ti fie d th atat t he ti m e h e p rep aredth e return h e kne w abo utth e Eur op eanbi cy cl in g t rip s an d t ho ug htth e as so ci at edex pe ns es were trav el ex pe ns es . Reg ard le ss , pet it io ne r fai le d t o a de qu at el y est ab li sh th atth e am ou ntpa idto pa rti ci pa te inth e Eur op eancy cl in g e ve nt s i s a v al idadve rti si ng ex pe ns e. Pet it io ne r ha s n otsh own th e $ 30 ,89 0 was anord in ary an d n eces sa ry bu si ne ss ex pe ns e, an d t he ex pe ns e b ears no pro xi m at e rel at io n t o p et it io ne r’s bu si ne ss . Pet it io ne r te st ifi edon ly gen eral ly abo utth e wor ldwid e p op ul ari ty of th e Tou r de Fran ce as well as t he ex is te nc e o f aer os pa ce/ de fen se type co m pa ni es inEuro pe .-2 0-

[* 20 ] Pet it io ne r’s res earc h o n the m at te r was als o v ag ue an d c om pr is edm os tl y ai rp la ne di ag ram s an d g en eral li st s o f ai rp la ne co m po ne ntm anuf

actur ers . Pet it io ne r adm it te d t he re was no on e el se inhi s i ndus try tak in g p artinth e ev en t. Add it io na ll y , pet it io ne r was rid in g 1 20 m il es pe r da y , m ean in g t he re was ve ry li tt le ti m e to do an yth in g wo rkrel at ed . The p res en ce o f th e Pro ject M an ’s lo go on jerse y s an d o th er g ear i s n otsu ffi ci en t t o ju st ify the $3 0,8 90 co stof p art ic ip at io n as a de du ct ib le bu si ne ss expe ns e. III. Sec ti on 66 62 (a) Pe na lty an d t he Reas on ab le Cau se Exce pt io n Res po nd en t d et erm in eda 20 % accu racy-rela te d p en al ti es with re sp ectto pe ti ti on er’s und erp aym en ts of t ax un de r se ct io n 6 66 2( a) an d (b )(2 ) at tri bu tabl e to subs ta nt ia l u nd ers ta te m en ts of i nc om e ta x. Th ere i s a s ub st an ti al un de rs ta te m en t of in co m e ta x i f th e am ou ntof t he un de rs ta te m en t ex ceed s the gre at er o f 10 % of th e ta x re qu ire d t o b e sh ownon th e return o r $5 ,00 0. Se c. 66 62 (d )(1 )(A). Res po nd en t m eet s the bu rd enof p ro du ct io n b y est ab li sh in g t ha t the am ou ntof pe ti ti on er’s und ers ta te m en t o f in co m e ta x e xc eed edth e g reat er o f 10 % of t he tax requi redto be sh own on th e return o r $5 ,00 0 fo r eac h year atis su e. See s ec. 74 91 (c). The sec ti on66 62 (a) p en al ty is n otap pl ie d t o a ny po rti on of a n un de rp aym en t wh enth e ta xp ay er s ho ws “ th ere was a reas on ab le cau se forsu ch-2 1-

[* 21 ] po rti on an d tha t the tax pa y er ac te d i n g oo d fa ith wi th res pe ctto su ch po rti on .” Sec. 6 66 4( c)(1 ). Und er the reg ul at io n i m pl em en ti ng sec ti on 66 64 (c), the de ci si on as t o wh ethe r a t ax pa y er ac te d wi th reas on ab le cau se an d i n g oo d fa ith i s m ad e o n a“ cas e-b y -cas e” b as is , tak in g i nt o a cco un t al l the pe rti ne ntfact s an d ci rcu m st an ces . Sec. 1 .66 64 -4 (b )(1 ), In co m e Tax Reg s. Th is reg ul at io n a ls o pr ov id es : Gen eral ly, th e m os t i m

po rta ntfact oris th e ex te ntof t he tax pa y er’s effo rt t o a ss es s the tax pa y er’s p ro pe r li ab il ity . Circ um st an ces th at m ay in di cat e rea so nabl e cau se an d g oo d fa ith i nc lu de anho ne st m is un de rs ta nd in g o f fac t o r la w th atis reas on ab le inli gh t o f al l o f th e fact s an d c irc um st an ces , in cl ud in g t he ex pe rie nc e, kn owl ed ge , and educ at io n o f th e ta xp ay er * * * . Reli an ce o n * * * pro fes si on al advi ce, o r ot he r fac ts , ho wev er, co ns ti tu te s re as on ab le cau se an d g oo d fai th if, u nd er al l the cir cu m st an ces , su chrel ia nc e was reas on ab le an d th e ta xp ay er ac te d i n g oo d fa ith. * * * Id
. All fact s an d c irc um st an ces , in cl ud in g t he tax pay er’s educ at io n, so ph is ti cat io n, an d b us in es s ex pe rie nc e, are t ak enin to acco un t i n d et erm in in g whe th er the tax pa y er re as on ab ly reli edon th e o pi ni on or a dv ic e o f a p ro fes si on al
. Id . par a. (c)( 1) . A taxpay er i s n otco ns id eredto ha ve reas on ab ly reli edingo od fai th onadvi ce u nl es s al l o f th e requi rem en ts of p arag rap h (c )(1 ) are sat is fie d. Rel ia nc e m ay

no t b e rea so nabl e an d i n g oo d fa ith i f, fo r ex am pl e, th e ta xp ay er kn ew orsh ou ldha ve kn own th atth e advi se r la ck edkn owl ed ge inth e rel ev an t-2 2-

[* 22 ] asp ect s o f Fed eral tax law o r if th e advi ce was ba se d o n u nr eas on ab le factua l
orleg al ass um

pt io ns . Id.

“ Adv ic e” i n t hi s co nt ex t i s d efi ne d a s “ an y co m m un ic at io n, i nc lu di ng th e op in io n o f a p ro fes si on al tax advi se r, se tt in g fo rth th e an al y si s o r co nc lu si on of a pe rs on , othe r th anth e ta xp ay er, p ro vi de d t o (o r fo r th e b en efi t o f) the tax pa y er an d
on whi chth e ta xp ay er re li es , di rect ly or in di rect ly”. Id. subp ara. (2 ). In o rd er fo r a ta xp ay er t o re ly on p ro fes si on al advi ce t o e st ab li sh reas on ab le cau se , th e ta xp ay er m

us t s ho w: “ (1 ) [t ]he advi se r was a co m pe te ntpro fes si on al who ha d
su ffi ci en t ex pe rti se to jus ti fy rel ia nc e, (2 ) th e ta xp ay er p ro vi de d n eces sa ry an d
accu rat e in fo rm at io n t o t he advi se r, an d (3 ) th e ta xp ay er ac tu al ly reli edingo od fai th onth e advi se r’s jud gm en t.” Neo na to lo gy Asso cs ., P.A. v. Co m m is si on er, 11 5 T.C. 4 3, 9 8- 99 (20 00 ), aff’d, 2 99 F.3d22 1 (3 d C ir. 2 00 2)
. Pet it io ne r as se rts he rel ie d o n h is return p rep arer , Mr. DeKarv er, t o e st ab li sh th e rea so nabl e cau se ex cep ti on ap pl ie s b oth fo r th e d educ ti on s d is al lo wedfor tra ve l an d a dv ert is in g e xp en se s an d fo r th e acc ou nt in g m etho d. As to th e fi rs t pr on g, M r. DeKarv er i s a l ic en se d C PA who ha s b eenpre parin g t ax returns an d pr ov id in g t ax advi ce fo r m or e th an30 y ears . Mr. DeKarv er h adsu ffi ci en t trai ni ng an d e xp eri en ce t o ju st ify reli an ce.-2 3-

[* 23 ] As t o t he sec on d p ro ng , pet it io ne r pr ov id edMr. DeKarv er wi thth e av ai labl e reco rd s an d d idno t wi th ho ldin fo rm at io n fr om hi m . Res po nd en t ar gu es Mr. DeKarv er d idno t h av e co m pl et e in fo rm at io n andth athe was m is le d abo utth e ex pe ns es pa idfor

th e tr ip s t o F ran ce an d It al y . Whi le we wou ldag ree M r. DeKarv er’s an al y si s o f th e tr ip s i s p oo r an d d is joi nt ed , we fin d h e was gi ve n acce ss to th e fac ts su rro un di ng th e tr ip s. Sat is fact io n o f th e la stpro ng of t he tes t, wh ethe r pe ti ti on er re as on ab ly reli ed up on Mr. DeKarv er’s ad vi ce, i s the m os t d iff ic ul t fo r us to de te rm in e. Reg ard in g th e acc ou nt in g i ss ue , we fin d t he rel ia nc e was reas on ab le an d b as edup on a pl au si bl e th eo ry

fora la ym ansu chas p et it io ne r. Reg ard in g the tra ve l ex pe ns es , we fi ndth e rel ia nc e is a cl os er que st io n, g iv enpe ti ti on er’s unc on vi nc in g b us in es s pu rp os e fo r th e ex pe ns es as a dv ert is in g a ndth e in subs ta nt ia l d oc um en tati on of t he tra ve l-r el at edex pe ns es . Alth ou gh pe ti ti on er was care le ss infai li ng to m ai nt ai n cl ear t rav el reco rd s, h e act edingo odfai th inpro vi di ng whatin fo rm at io n h e h ad
av ai labl e to Mr. DeKarv er an d re as on ab ly bel ie ve d M r. DeKarv er h adall th e in fo rm at io n n eces sa ry

to accu rat el y

pre pa re h is tax returns . Peti ti on er was no t a ta x e xp ertan d c ou ldno t b e ex pe ct edto sec on d- gu es s M r. DeKarv er’s ad vi ce reg ard in g t he ex pe ns es forth e Eur op eantri ps on th es e fac ts . Acco rd in gl y , we wil l n otsu st ai n t he pe na lt ie s u nd er s ect io n 6 66 2( a).-2 4-

[* 24 ] The Co urt h as co ns id eredall ot he r arg um en ts m ad e b y th e p art ie s an d, t o th e ex te ntno t s pe ci fic al ly addres se d h erei n, h as co nc lu de d t ha t the y are i rrel ev an t,
m oo t, o r witho utm eri t. To re fle ctth e fo reg oi ng , Deci si on s wi ll be en te redun de r Ru le 15 5.