TAX COURT OPINION

Case: Eric Williams
Docket Number: 27137-12
Judge: Buch
Opinion Type: bench
Filed: 04/11/2017
Pages: 15

CT UNITED STATES TAX COURT WASHINGTON, DC 20217 ERIC WILLIAMS, Petitioner, v. ) ) ) ) Docket No. 27137-12. COMMISSIONER OF INTERNAL REVENUE, Respondent ) ) ) ) ORDER Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit with this order to petitioner and respondent a copy of the pages of the transcript of the trial in this case before Judge Ronald L. Buch at Kansas City, Missouri, containing his oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fact and opinion, decision will be entered under Rule 155. (Signed) Ronald L. Buch Judge Dated: Washington, D.C. April 11, 2017 SERVED Apr 11 2017 Capital Reporting Company 1 Bench Opinion by Judge Ronald L. Buch 2 March 15, 2017 3 Eric Williams v. Commissioner Docket No. 27127-12 1-7 137 - a 3 v2. 4 5 6 7 8 The following represents the Court's oral findings of fact and opinion. Thes oral findings of fact and opinion may not be relied upon as precedent in any other case. This opinion is in conformity 9 with Internal Revenue Code section 7459(b) and Rule 10 11 12 13 14 15 16 17 18 19 152(a) of the Tax Court Rules of Practice and Procedure. Any section references refer to the Internal Revenue Code or the Treasudy regulations in effect during the years at issue, and Rule references are to the Tax Court Rules of Practilce and Procedure. The parties have done an excellent job of resolving many issues in this case. The remaining issues in this case are (1) whether Mr. Williams had unreported gross receipts; (2) whethbr Mr. Williams is entitled to certain Schedule C expenses; (3) 20 whether Mr. Williams is liable for at failure to file 21 addition to tax for 2006 and 2007; (4) whether 22 Mr. Williams is liable for an accuraéy-related 23 penalty for 2006 through 2008; and ( ) whether 24 Mr. Williams is entitled to a dependéncy exemption 25 and head of household filing status. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 4 1 2 Background Although the record is not clear, Mr. 3 Williams appears to be engaged in a variety of 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 businesses involving lawn maintenan e, sprinkler installation, and snow removal. Mr Williams received income and incurred expenses with respect to his business. Mr. Williams' business owned at times as few as four and as many as seven vehicles used exclusively for business. He reporüed the income and the expenses on a Schedule C. During the years in issue, Mr. Williams' brother lived at his home, and a portion of that home was used for the business. On August 9, 2012, the Commissioner 1ssued a notice of deficiency for 2006, 2007, 2008, and 2009, determining deficiencies for each year, asserting accuracy-related penalties for each year in issue, and asserting additions to tax for failure to file for 2005, 2007, and 2009. In determining the deficiency, the Commissioner adjusted Mr. Williams' gross receipts using a bank deposit analysis. The Commissioner also disallowed portion of Schedule C expenses. While residing in Missouri, Mr. Williams timely petitioned to challenge the Commissioner's determinations. 866.488.DEPO www.CapitalReportingCompány.com Capital Reporting Company Discussion 5 As a general matter, the Commissioner's determinations in the notice of deficiency are presumed correct, and the taxpayer bears the burden of proving an error. Rule 142(a); Weldh v. Helvering, 290 U.S. 111, 115 (1933). In limited situations, the burden can shift to the Commissioner under section 7491(a), but the record does not establish that the criteria under section 7491 have bedn met, therefore, the burden of proof remains on Mr. Milliams. Income tax deductions are .considered a "matter of legislative grace," and tihe taxpayers bear the burden of proving that they are entitled to any deductions. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992)l. Taxpayers are required to maintain sufficient records to "show 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 whether or not such person is liable for tax". Sec. 18 19 20 21 22 23 24 25 6001. These records must be retaine for as long as the contents may become material andimust be kept available for.inspection. I. Gross receipts The Commissioner may compute taxable income through the use of a bank deposit analysis. The Commissioner's use of a bank deposit analysis method has long been approved in such an instance. See, 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 6 1 2 3 4 5 6 7 8 e.g. Tokarski v. Commissioner, 87 T.C. 74, 77, 1986. This method "assumes that all money deposited in a taxpayer's bank account during a given period constitutes taxable income, but the Government must take into account any nontaxable source or deductible expense of which it has knowledge." Clayton v. Commissioner, 102 T.C. 632, 645-646 (1994) (citing DiLeo v. Commissioner, 96 T. C. 858, 868 (1991) ) . 9 Nontaxable sources include funds attributable to 10 11 12 "loans, gifts, inheritances, or assëts on hand at the beginning of the taxable period. " Burgo v. Commissioner, 69 T. C. 729, 743 n. 14 (1978) (quoting 13 Troncelliti v. Commissioner, T. C. Memo. 1971-72) . 14 15 16 17 18 19 20 21 22 23 24 25 A bank deposits analysis provides prima facie evidence of income, and the Commissioner is not required to prove the likely source of the income. Tokarski v. Commissioner, 87 T. C. 741, 77 (1986) . The taxpayer bears the burden of establishing that items "should be excluded from income or allowed as deductions." Gemma v. Commissioner, 46 T.C. 821, 833 (1966) . Mr. Williams has established that the bank deposit analysis included amounts that are derived from nontaxable sources. Mr. Williams established that the bank deposit analysis included amounts that 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 Mr. Williams received from his brother for living 2 expenses, but only to the following extent. 3 Mr. Williams established that the gross receipts set 7 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 forth in the supplemental stipulation should be further reduced by 2006, 2007, and 2008 in the amounts of $1,871.05, $1,373.97, and $2,210.95, respectively. These amounts are amounts from nontaxable sources. II. Business Expenses Taxpayers can deduct "ordinary and necessary expenses paid or incurred during the taxable year in carrying on of any trade or business." Sec. 162(a). Taxpayers must have strict substantiation for certain expenses related to travel, meals and entertainment, gifts, and listed property under section 280F(d)(4). For the years at issue, listed property included, among other things, passenger automobiles and other property used as a means of transportation. Sec. 280F(d)(4). Under the strict substantiation rules the taxpayer must have adequate records or sufficient evidence to corroborate (1) the amount of the expense, (2) the time and place the expense was incurred, (3) the business purpose of the expense, and (4) the business relationship of the 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 8 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 taxpayer to any others benefitted by the expense. Sec. 274(d). To substantiate by adequate records, the taxpayer must maintain an account book, a log, a diary, or similar record and documentary evidence to establish each element of an expense. Sec. 1.274- 5T(c)(2) (I), Temp. Income Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985). While a contemporaneous log is not required, a taxpayer's subsequent reconstruction of his or her expenses requires corroborative evidence to support such a reconstruction. The corroborative evidence, coupled with the reconstruction, can elevate that subsequent reconstruction to the same level of credibility as a contemporaneous record. Sec. 1.274-5T(c)(1). A. Car and Truck Expenses The Commissioner disallowed a portion of Car and Truck Expenses for each year in issue because 19 Mr. Williams did not substantiate the expenses. Car 20 21 22 23 24 25 and truck expenses are subject to strict substantiation, Sec. 274(d). Mr. Williams provided contemporaneous receipts from third parties showing vehicle maintenance and odometer readings between services. Because the vehicles were used exclusively for business, he has substantiated his car and truck 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 2 3 4 5 expenses by adequate records. Thus., Mr. Williams has substantiated the following mileage to the extent they exceed the amount already alloaed by way of stipulation. For the 2006, 2007, 2008, and 2009 years, Mr. Williams has shown that he incurred 6 mileage of 80,875 miles, 116,851 miles, 103,659 7 miles, 102,374 miles, respectively. Regarding the 8 9 10 11 12 13 14 15 16 17 18 19 20 use of five or more vehicles, the r venue procedures provide that a taxpayer may not use mileage for "five or more automobiles owned or leased by a taxpayer and used simultaneously". See, e.g., Rev. Proc. 2007-70 sec. 5.06(1) (b). It is clear that this is a conjunctive test, and Mr. Williams established that he, at times, owned five or more vehicles, but he also established that he did not use them simultaneously. Therefore, he may laim mileage in the amounts established. B. Meals and Entertainment Expenses The Commissioner disallowéd Meals and Entertainment Expenses for each year in issue because 21 Mr. Williams did not substantiate t e expenses. 22 Meals and Entertainment Expenses arà subject to 23 24 25 strict substantiation. Sec. 274(d).i Mr. Williams provided a spreadsheet that showed these expenses. That spreadsheet, however, was not exchanged in 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 10 1 2 3 4 5 advance of trial. While Mr. Williams was allowed to introduce other documents that he did not exchange in advance, in fairness to the Commissioner, we must exclude this document. The Commissioner did not have an opportunity to review the expensøs, evaluate their 6 deductibility, interview potential witnesses 7 8 regarding the exhibits, or do any of the other things that would typically be done in advance of trial. 9 Accordingly, the meals and entertainment expenses are 10 11 12 13 14 15 16 17 18 19 20 21 disallowed for failure to substantiate. C. Business Use of Home Mr. Williams raised at trial the issue of the business use of his home. However, the Commissioner used the same percentage of the home as originally reported by Mr. Williams and also shown on documents provided by Mr. Williams. As for the basis in the home, Mr. Williams did notWestablish a basis in the structure beyond that allowed (land is not depreciable). D. Cost of Goods Sold and Office Supplies The Commissioner disallowed a portion of 22 Mr. Williams' cost of goods sold for lack of 23 24 25 substantiation. Mr. Williams provided a spreadsheet of additional expenses, half of which the Commissioner allowed. He provided no additional 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company support of why the items on that sheet were deductible. Accordingly, Mr. Williams has not met · his burden to show that he is entitled to additional 11 expenses beyond those already allowed. III. Dependency Exemption Mr. Williams raised the issue of being allowed a dependency exemption for his daughter and head of household status. But he did not meet his burden of proof to show that his daúghter's mother did not claim the dependency exemption. Accordingly, he did not prove that he is entitled to the dependency exemption or head of hou$ehold status. IV. Failure to File Addition to Tax Section 6651(a) (1) imposes an addition to tax for failure to timely file a Federal income tax return unless the taxpayer shows that the failure was due to reasonable cause and not due to willful neglect. Sec. 6651 (a ) (1) ; Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). The Commissioner bears the burden of production for this penalty before the burden shifts to the taxpayer to pro e that the penalty should not apply. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. at 446-447. A taxpayer may have reasonable cause if the taxpayer exercised ordinary business care and prudence but was not able 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 12 1 2 3 to timely file. See sec. 301.6651-i(c)(1), Proced. & Admin. Regs. Willful neglect means a "conscious, intentional failure or reckless indifference." 4 United States v. Boyle, 469 U.S. 241, 245 (1985). 5 Mr. Williams undoubtedly ad personal 6 difficulties around the time his 2007 return was due. 7 8 9 10 11 Those personal difficulties are not|pertinent to the filing of the 2006 and 2009 returns) so the penalties for late filing are sustained for those returns. For 2007, we reach a different answer. That return was due in 2008, at a time when Mr. 12 Williams' personal life was in chaos, with his then- . . 13 girlfriend having personal issues that put the whole 14 15 16 17 18 19 20 21 22 23 24 25 family into disarray. Usually personal circumstances like this would not be enough, especially if the taxpayer is able to keep a business running well. But the record shows that the business was also declining. The most analogous case that we can find is Hayes v. Commissioner, 26 T.C.M. (CCH) 393 (T.C. 1967). I'll read from that: "To excuse late filing a taxpayer must show reasonable cause. Prevention from a timely filing of one's return because of a heavy workload or business engagements is not generally conside ed a sufficient 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 13 excuse to be 'reasonable cause.' Cowden v. 3 Commissioner, 365 F.2d 832 (C.A. 1, 1966), affirming per curiam a Memorandum Opinion of this Court. However, illness is 'reasonable cause' if it can be shown that the taxpayer is prevented from filing a timely return because of such illness. Alma Williams, 16 T.C. 893, 906 (1951). Here the petitioners had two children who were seriously ill with pneumonia in early 1961. Mildred had a ruptured appendix requiring an emergency operation in the first part of April and was incapacitated. Then, in June, John suffered a 1 2 3 4 5 6 7 8 9 10 11 12 mental and physical collapse which necessitated his 13 hospitalization and eventual return to Maine in a 14 wheelchair. During these illnesses, while petitioners 15 16 17 18 19 20 21 22 23 24 25 were staying in California and their income tax return was being prepared by a management concern there, all the personal records necessary to complete the tax return were located in Maine. In view of these circumstances, we conclude that petitioners could not have obtained the necessary records and thus had 'reasonable cause' for not filing their return until August 3, 1961. Therefore, we hold that respondent erred in determining an addition to tax under section 6651(a), Internal Revenue Code of 1954, for the year 1960." 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 14 1 I realize that's a long q ote. Perhaps 2 more succinctly, "reasonable cause for failure to 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 file may exist if the taxpayer's or a family member's illness or incapacity prevents the taxpayer from filing his or her tax return but not if the taxpayer is able to continue his or her business affairs despite the illness or incapacity. See Ruggeri v. Commissioner, T.C. Memo. 2008-300 (and cases cited therein)." Hardin v. Commissioner, 103 T.C.M. 1861 (2012). See also, Evans v. Commissioner, T.C. Memo 2016-7 (factors that constitute reasonable cause include serious illness of a family member). In Mr. Williams' case, it appears that he was simultaneously unable to manage his business affairs at the time that his 2007 return was due. In Mr. Williams' case, we find reasonable cause for failure to file existed fEom the due date of the 2007 return until January 15L 2009. A failure to file penalty does not apply for that period. V. Accuracy-Related Penalties Substantial Understatement Section 6662(a) and (b) imposes a 20 percent accuracy-related penalty on any portion of an underpayment of tax that is due to, among other things, any negligence or disregard, of rules or 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Com any 15 1 2 regulations or a substantial understatement of income tax. The term "negligence" includeå any failure to 3 make,a reasonable attempt to comply with the 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 provisions of the Code, and the terh "disregard" includes any careless, reckless, or intentional disregard. Sec. 6662(c). Additionally, a taxpayer is negligent if he fails to maintain sufficient records to substantiate the items in question. See Higbee v. Commissioner, 116 T.C. at 449; sec. 1.662- 3(b)(1), Income Tax Regs. An underhtatement of income tax is "substantial" when thé understatement exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. Sec. 6662(d)(1) (A). The Commissioner bears the burden of production for this penalty before the burden shifts to the taxpayer to prove that the pønalty should not apply. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. at 446-447. The Commissioner may have met his burden regarding substantial understatement. In accordance with this opinion, Mr. Williams' exact understatement for the years in issbe depends on the Rule 155 computations. If these computations establish a substantial understatement of income tax for each year, the Commissioner will have met his 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 16 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 burden of production. See 01agunju v. Commissioner, T.C. Memo. 2012-119. The Commissioner did not raise an accuracy- related penalty on any portion of the underpayment of tax due to negligence in the notice of deficiency. He did not raise negligence in the notice of deficiency nor in his answer. Thus,; an accuracy- related penalty due to negligence is not properly before us. If the Rule 155 computations establish a substantial understatement of incom tax for any year, the accuracy-related penalty does not apply to any portion of the underpayment where Mr. Williams establishes that he had reasonable cause and acted in good faith. Although Mr. Williams used a return preparer, the deficiencies principally relate to failure to substantiate expenses and he did not establish reasonable cause for such failure. Thus, he did not establish a defense to an accuracy-related penalty imposed for a substantial understatement, if such a penalty applies. Decision in this case will be entered under Rule 155. (Whereupon, at 6:21 p.m., he above- entitled matter was concl ded.) 866.488.DEPO www.CapitalReportingCompany.com