T.C. Summary Opinion 2003-83

UNITED STATES TAX COURT

MANUEL FRANCISCO PALOMO AND JANE LYON POTTER, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 7010-01S. Filed June 24, 2003.

Manuel Francisco Palomo, for petitioners.

Carina Campobasso, for respondent.

DEAN, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed. Unless otherwise

indicated, subsequent section references are to the Internal

Revenue Code in effect for the year in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure. 
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1 In the notice of deficiency respondent determined that

petitioners were liable for additional tax relating to the

failure to include income from Norman Ross Publishing, Inc.; for

unreported distributions from a qualified retirement plan; for an

unreported Mass. State tax refund; and, for unreported interest

earned from a bank account. These issues have been resolved by

the parties.

The decision to be entered is not reviewable by any other court,

and this opinion should not be cited as authority.

Respondent determined a deficiency of $7,884 in petitioners'

1999 Federal income tax and an accuracy-related penalty of

$1,577. After concessions,1 the issues remaining for decision

are: (1) Whether petitioners received unreported income; (2)

whether petitioners are subject to additional tax for an early

distribution from a qualified retirement plan; and (3) whether

petitioners are liable for the accuracy-related penalty due to

negligence.

Background

Some of the facts have been stipulated and are so found. 

The exhibits received into evidence are incorporated herein by

reference. At the time the petition in this case was filed,

petitioners resided separately in Northampton, Massachusetts. 

Petitioner Manuel Francisco Palomo is an attorney. 

Petitioner Jane L. Potter organized and directed the Parent

Teacher Organization's (PTO) after-school program at Smith

College Campus School (Smith). In 1999, Ms. Potter was in charge

of the program, planned individual sessions, and was responsible
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2 A copy of the form was not produced at trial. The Court

assumes the form was a Form 1099-MISC, Miscellaneous Income.

for finding and hiring instructors. As part of her

responsibilities, Ms. Potter promoted the after-school program

through advertising. In 1999, Ms. Potter received checks from

Smith, payable to her, in the amount of $3,038. Petitioners

received a Form 10992 on which Smith reported to the Internal

Revenue Service (IRS) that Ms. Potter received $3,038 of income

in 1999. Petitioners did not report this amount as income on

either their 1999 Form 1040, U.S. Individual Income Tax Return,

or their 1999 Form 1040X, Amended U.S. Individual Income Tax

Return.

In March 1999, both Ian Potter, Ms. Potter's father, and her

sister Susan Potter became seriously ill. Petitioners determined

that it was necessary to travel to Florida so they could tend to

their ill relatives. Petitioners withdrew $14,389 from a

qualified retirement plan (IRA) to help pay for medicines, food,

their flights to and from Florida, and other expenses related to

Mr. Potter's and Susan's illnesses. Mr. Potter died on June 29,

1999, and Susan died on July 31, 1999. Petitioners did not pay

rent for Mr. Potter or Susan, and they did not keep track of

their expenses while in Florida.

Petitioners timely filed their 1999 Federal income tax

return. Petitioners filed a Form 1040X on or about April 16,
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2001. Changes on the Form 1040X reflect an "Addition of IRA

distributions not previously reported", and an "Addition of

medical expenses incurred for care of Ian L. Potter and Susan

Potter".

In the statutory notice of deficiency, respondent determined

a deficiency in petitioners' 1999 Federal income tax of $7,884

for 1999 and an accuracy-related penalty of $1,577. 

Discussion

Taxpayers generally bear the burden of proving that the

Commissioner's determination is incorrect. Rule 142(a); Welch v.

Helvering, 290 U.S. 111 (1933). Under section 7491(a)(1),

however, the burden of proof shifts to the Commissioner if, among

other requirements, the taxpayers introduce "credible evidence

with respect to any factual issue relevant to ascertaining" their

tax liability. We find that the burden of proof does not shift

to respondent because petitioners have failed to comply with the

requirements of section 7491(a)(1). 

Section 61 provides that all income, from whatever source

derived, is includable in gross income unless specifically

excluded by another provision. See Commissioner v. Glenshaw

Glass Co., 348 U.S. 426, 431 (1955). Section 61(a)(1)

specifically includes in gross income amounts received as

compensation for services, including fees, commissions, fringe

benefits, and similar items.
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Respondent determined that the payments Ms. Potter received

from Smith, as reported to the IRS on a Form 1099, are unreported

income. Respondent's position is that the payments must be

considered payments for services rendered because petitioners

failed to provide any documentation that they were reimbursements

for out-of-pocket expenses. 

Petitioners' position is twofold. First, petitioners argue

that because similar checks from Smith were not treated by the

IRS in 1997 as income, that they should not now be treated

differently. Each taxable year, however, stands alone, and the

Commissioner may challenge in a succeeding year what was condoned

or agreed to in a former year. Rose v. Commissioner, 55 T.C. 28

(1970). Thus, a taxpayer must follow the reporting requirements

in any given taxable year to be entitled to deduct or exclude

certain expenses from income, even if the Commissioner did not

challenge a similarly claimed deduction in a prior year. As a

result, what occurred in relation to petitioners' 1997 taxes is

inapposite to the decision in this case.

Second, petitioners argue that they did not include in

income the $3,038 received from Smith because it was a

reimbursement for out-of-pocket expenses that were related to the

administration of the after-school program. This Court is not

bound to accept a taxpayer's self-serving, unverified, and
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undocumented testimony. Tokarski v. Commissioner, 87 T.C. 74, 77

(1986).

Smith issued a Form 1099 stating that Ms. Potter received

$3,038 in 1999. Ms. Potter testified that she was not

compensated by Smith for her involvement in the after-school

program. She does, however, admit to receiving "reimbursement

checks". Other than their testimony, petitioners have presented

no evidence to substantiate their position that the money from

Smith represented reimbursements for Ms. Potter's out-of-pocket

expenses. Ms. Potter testified that the checks from Smith were

"to cover the cost of the advertising and the, the copying costs,

the color copying costs, of all the programs that I was trying to

run." She claims to have given the receipts to a secretary, and

that a treasurer of the Smith PTO wrote the reimbursement checks. 

Mr. Palomo testified that when preparing their Federal income tax

return he ignored the Form 1099 petitioners received because,

based on his mental calculations, "it was going to be a wash."

In a prior hearing before this Court, Mr. Palomo agreed to

do his best to provide names, telephone numbers, and addresses of

people involved with the Smith PTO. At no point, however, did

petitioners provide the name or names of anyone at Smith to

verify their claims.

 Petitioners have not provided either the Commissioner or

the Court with any evidence substantiating the existence of out-
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3 An early distribution with respect to a distributee who

continues employment with the employer is one made before the

employee attains the age of 59-1/2. See sec. 72(t)(2)(A)(i). It

is unclear what the age of either petitioner was at the time of

the distribution from the IRA. The Court concludes, based on the

unrefuted assumptions made at trial and in the exhibits, that

neither petitioner had attained the age of 59-1/2.

of-pocket expenses. Because petitioners have failed to

substantiate that the Smith payments were reimbursements for outof-pocket expenses, we concur with respondent's determination as

to this issue. Sec. 6001.

In general, section 72 deals with the tax treatment of

distributions from pensions, annuities, and IRAs. See secs.

72(a), (e), 408(d). Section 1.72-1(a), Income Tax Regs.,

provides that section 72 prescribes rules relating to the

inclusion in gross income of amounts received under a life

insurance, endowment, or annuity contract unless such amounts are

specifically excluded from gross income under other provisions of

chapter 1 of the Code. The burden is on petitioners to

demonstrate that the payments in question fall into a specific

statutory exclusion. See Commissioner v. Glenshaw Glass Co., 348

U.S. at 429-431. 

Under section 72(t), a 10-percent additional tax is imposed

on an early distribution from a qualified retirement plan, to the

extent that the distribution is includable in gross income.3 An

exception to the additional tax is provided in section

72(t)(2)(B) for medical expenses. Section 72(t)(2)(B) provides
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that the additional tax does not apply to "Distributions made to

the employee * * * to the extent such distributions do not exceed

the amount allowable as a deduction under section 213 to the

employee for amounts paid during the taxable year for medical

care".

Section 213 allows a deduction for expenses paid during the

taxable year, not compensated by insurance or otherwise, for

medical care of the taxpayer, his spouse or a dependent (as

defined in section 152), to the extent that such expenses exceed

7.5 percent of adjusted gross income. As relevant here, section

152(a)(1) defines a "dependent" to mean a taxpayer's father or

sister who received or is treated under section 152(e) as having

received over half of his or her support from the taxpayer for

the calendar year in which the taxable year of the taxpayer

begins. To claim a dependent, taxpayers must establish the total

amount of support furnished from all sources for the taxable year

at issue and demonstrate that they provided the claimed dependent

with over half of the amount. See Archer v. Commissioner, 73

T.C. 963, 967 (1980); Blanco v. Commissioner, 56 T.C. 512,

514-515 (1971); sec. 1.152-1(a)(2)(i), Income Tax Regs.

While petitioners testified that they provided some support

to Mr. Potter and Susan, the Court cannot conclude that

petitioners provided more than one-half of the total support for

either of them. Ms. Potter testified that in 1999 Mr. Potter
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received income from a pension. It is also important to note

that petitioners did not list Mr. Potter or Susan as dependents

on either their Form 1040 or Form 1040X. As a result, the Court

concludes that neither Mr. Potter or Susan qualify as

petitioners' dependents under section 152.

Even if Mr. Potter and Susan were qualified dependents,

petitioners failed to satisfy the substantiation requirements of

section 1.213-1(h), Income Tax Regs. Petitioners claimed a

medical expenses deduction of $9,847. Petitioners provided a

computer printout detailing the expenses but failed to provide

any underlying evidence or documentation to substantiate the

claimed deductions. During trial Mr. Palomo was questioned about

the discrepancy between the amounts shown on his computer

printout and the Form 1040X. Petitioners' Form 1040X shows

$9,847.00 of Medical and Dental Expenses and the computer

printout shows $4,607.45 in medical expenses. Mr. Palomo

testified that he determined the total amount spent while in

Florida by estimating the amount they spent each day and

multiplied it by their total number of days in Florida. Mr.

Palomo's testimony failed to provide a satisfactory explanation

as to the differences in the amounts; it was improbable, vague,

and as a result, unreliable.

Petitioners are not entitled to deduct the claimed medical

expenses and as a result cannot offset any of the 10-percent

additional tax due because of the early withdrawal from their
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IRA. Accordingly, the Court sustains respondent's determination

as to this issue.

Respondent also determined that a section 6662 accuracyrelated penalty is due with respect to petitioners' tax return

for 1999. 

Section 6662(a) imposes a penalty of 20 percent of the

portion of the underpayment attributable to negligence or

disregard of rules or regulations. See sec. 6662(a) and (b)(1). 

Negligence is defined as any failure to make a reasonable attempt

to comply with the provisions of the Internal Revenue Code, and

the term "disregard" includes any careless, reckless, or

intentional disregard. Sec. 6662(c).

Pursuant to section 7491(c), respondent bears the burden of

production with respect to a section 6662 penalty. In order to

meet respondent's burden of production, respondent must come

forward with sufficient evidence indicating that it is

appropriate to impose the accuracy-related penalty in this case. 

Higbee v. Commissioner, 116 T.C. 438, 446 (2001). However, the

accuracy-related penalty does not apply if petitioners

demonstrate that there was reasonable cause for the underpayment

and that they acted in good faith with respect to the

underpayment. See sec. 6664(c). Whether taxpayers acted with

reasonable cause and good faith depends on the pertinent facts

and circumstances. See McCallson v. Commissioner, T.C. Memo.
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1993-528; sec. 1.6664-4(b)(1), Income Tax Regs. The most

important factor is the taxpayer's effort to assess his proper

tax liability. Stubblefield v. Commissioner, T.C. Memo. 1996-

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

Taxpayers are required to keep records sufficient to

establish the amount of deductions or other matters required to

be shown on their returns. Sec. 6001; sec. 1.6001-1(a), Income

Tax Regs. Failure to maintain adequate records may constitute

negligence. Schroeder v. Commissioner, 40 T.C. 30, 34 (1963). 

The record here shows that Mr. Palomo is a highly educated

individual. The Court finds it unreasonable that petitioner, an

attorney, would base his analysis of taxable income on knowledge

from a class he took 20 years earlier in law school rather than

from appropriate legal research. Petitioner testified that he

failed to even make the minimal effort of consulting the IRS

information booklet that accompanied his Federal income tax

return. The Court finds that his explanations do not demonstrate

an honest misunderstanding of fact or law that is reasonable in

light of his experience, knowledge, and education. 

The Court concludes that petitioners failed to keep adequate

records. The Court also finds that petitioners failed to make a

reasonable attempt to determine whether they were entitled to

take medical expense deductions for Mr. Potter and Susan and

whether they were allowed to omit the Smith income from their
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return. Further, petitioners failed to produce any evidence to

show that they acted with reasonable cause and good faith for the

year at issue. Thus, the Court sustains respondent's

determination that petitioners are liable for the accuracyrelated penalty under section 6662(a) for 1999.

Reviewed and adopted as the report of the Small Tax Case

Division. 

Decision will be entered

under Rule 155.