TAX COURT OPINION

Case: Larry Deems
Docket Number: 23421-09
Judge: Colvin
Opinion Type: bench
Filed: 01/21/2011
Pages: 17

UNITED STATES TAX COURT WASHINGTON, DC 20217 LARRY DEEMS, Petitioner, v. Docket No. 23421-09 COMMISSIONER OF INTERNAL REVENUE Respondent O R D E R Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit herewith to petitioner and to respondent a copy of transcript of Gustafson at Columbia, South Carolina, on January 12, 2011, containing his oral conclusion of in the above case before Judge David the pages of fact and opinion rendered at the findings of the the -trial the trial. In accordance with the oral findings of fact and opinion, decision will be entered under Rule 155. Dated: Washington, D.C. January 21, 2011 (Signed) David Gustafson Judge SERVED JAN 2 6 2011 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 3 Bench Opinion by Judge David Gustafson January 12, 2011 Larry Deems v. Commissioner Docket No. 23421-09 THE COURT: The Court has decided to render oral Findings of Fact and Opinion in this case, and the following represents the Court's oral Findings of Fact and Opinion. The oral Findings of Fact and Opinion shall not be relied on as precedent in any other case. This Bench Opinion is made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code of 1986, as amended, and Rule 152 of the Tax Court Rules of Practice and Procedure. By notice of deficiency dated July 16, 2009, respondent determined a deficiency in the Federal income tax of Petitioner Larry Deems for the years 2004, 2005, and 2006, plus additions to tax. For the reasons explained hereafter, we will largely sustain those deficiencies. Trial of this case was conducted on January 11, 2011,.in Columbia, South Carolina, and petitioner Larry Deems was the only witness. The parties' Stipulation of Facts was admitted into evidence (with a correction to paragraph 9), along with its Exhibits 1-J through 9-P. Exhibits 10-P and Heritage Reporting Corporation (202) 628-4888 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 4 11-P were also admitted. We find the following facts: Findings Mr. Deems resided in Georgia when he filed the petition in this suit. In 2004, 2005, and 2006, Mr. Deems was self- employed as a carpenter. Mr. Deems did not keep regular books and tecords for his business. The records that he did keep were all lost, discarded, or destroyed when he moved from Ohio to Georgia. In preparation for trial he requested information about his expenditures from vendors from whom he had purchased supplies, but he did not seek copies of bank records from his bank, or copies of his credit card records. Mr. Deems deposited his carpentry revenue into a checking account that belonged to him and his wife. Those deposits totaled $49,068 in 2004, $46,485 in 2005, and $41,651 in 2006, and we find that they all consisted of business income. Mr. Deems incurred expenses in his carpentry business, but was able to substantiate only some of them. He purchased materials from various vendors, including United Building Centers (UBC), 84 Lumber, Lowe's, and Home Depot. From UBC alone he purchased materials for $67 in 2004, $6,742 in 2005, and $13,853 Heritage Reporting Corporation (202) 628-4888 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 5 in 2006. (Ex. 11-P.) At trial respondent conceded those expenditures. However, it is inevitable that someone in Mr. Deems's line of work would incur substantial materials expense every year. We note that he made purchases of $13,853 from only one vendor in the year in which his revenue was the lowest, and we conclude that his materials purchases could never have been less than that amount. We are therefore confident--and we find--that he purchased $13,853 in materials from one or more of his vendors in each of the three years, and that he is entitled in each year to a material expense deduction in that amount. In a list prepared before trial (Ex. 9-P), Mr. Deems listed additional plausible expenses, in very round numbers, that a carpenter might well incur. However, about most of them he gave no testimony at all, and for none of them did he proffer any records or even give detailed testimony explaining how he arrived at the individual amounts. Rather, he testified: that it was his practice to bid for jobs at a rate for which half the payment would cover expenses and half would be net profit; that he allocated a conservative 45 percent of the revenue (determined by bank deposits) to expenses; and that he made guesses or estimates of what the constituents of Heritage Reporting Corporation (202) 628-4888 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 6 those total expenses might have been in the years in suit. We do not find that this general testimony substantiated specific deductible expenditures. Mr . Deems did not f ile returns f or the years 2003, 2004, 2005, or 2006. (Ex. 4-J.) His year 2003 was adjudicated in another proceeding. The IRS audited his 2004, 2005, and 2006 years; conducted a bank deposits analysis that uncovered the revenue described above; prepared substitutes for returns on April 20, 2009, on which it included that revenue (Exs. 5- through 7-J); and on July 16, 2009, issued the notice of deficiency determining the resulting tax and additions to tax (Ex. 1-J) . Mr. Deems timely filed his petition on September 30, 2009. Opinion The IRS's determination is presumed correct, and the taxpayer bears the burden to prove any adjustment to the income the IRS determined and to prove his entitlement to any deductions he claims. Rule 142 (a) ; Welch v. Helvering, 290 U.S. 111, 115 (1933) . I. Income The taxpayer bears the responsibility to maintain books and records that are sufficient to establish his income. See sec. 6001; sec. Heritage Reporting Corporation (202) 628-4888 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 7 1.446-1(a) (4), Income Tax Regs. (26 C.F.R.). Mr. Deems failed to fulfill that responsibility. The IRS may use any of several methods to reconstruct a taxpayer's taxable income; and when a taxpayer fails to keep adequate books and records, the Commissioner is authorized by section 446 to determine the existence and amount of the taxpayer's income by any method that clearly reflects income. See Holland v. United States, 348 U.S. 121, 130-132 (1954). A bank deposit is prima facie evidence of income, and bank deposits analysis is a method of income reconstruction that this Court has long accepted. Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). When a taxpayer keeps inadequate or incomplete books or records and has large bank deposits, the IRS is not acting arbitrarily or capriciously by resorting to the bank deposits method. See DiLeo v. Commissioner, 96 T.C. 858, 867-868 (1991), affd. 959 F.2d 16 (2d Cir. 1992). Mr. Deems moved the Court in limine to exclude the bank records from evidence because, he contends, they were improperly obtained. The IRS had issued an administrative summons to Mr. Deems's bank, and Mr. Deems petitioned a district court to quash the summons. A Magistrate issued an order on February 26, 2009, dismissing the petition, and thereafter the bank Heritage Reporting Corporation (202) 628-4888 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 8 provided Mr. Deems's records to the IRS. Mr. Deems filed an objection to the Magistrate's dismissal order (objecting, inter alia, that he had never consented to the matter being handled by a Magistrate rather.than a District Judge); and on May 8, 2009, the Magistrate vacated his prior order. Mr. Deems's objection is apparently still pending. However, before the Magistrate issued that second order on May 8, the bank had already released the records and the IRS had already prepared the substitutes for return (on April 20, 2009). The IRS was entitled to obtain newly the same records by subpoena for use at the trial of this case (and did obtain the bank's authentication of the records). To bar this evidence would require a radical and unwarranted expansion of the exclusionary rule. See Jones v. Commissioner, 97 T.C. 7 (1991). The bank deposits method of reconstruction assumes that all of the money deposited into a taxpayer's account is taxable income unless the taxpayer can show that the deposits are not taxable. The IRS need not show a likely source of the income when using the bank deposits method, but the IRS must take into account,any nontaxable items or deductible expenses of which the IRS has knowledge. See Price v. United States, 335 F.2d 671, 677 (5th Cir. 1964). At Heritage Reporting Corporation (202) 628-4888 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 9 trial Mr. Deems stated that some of the deposits might have been loan proceeds (which would not have been taxable), but he was unable to point to any deposit that he could say actually constituted loan proceeds. We therefore hold that all the deposits, in the totals stated above, were taxable income of his carpentry business. II. Deductions A. Business deductions Any amount claimed as a business expense must be substantiated, and taxpayers are required to maintain records sufficient to substantiate the expenses claimed. Sec. 6001; Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), affd. 540 F.2d 821 (5th Cir. 1976); sec. 1.6001-1(a), Income Tax Regs. When a taxpayer adequately establishes that he paid or incurred a deductible expense but does not establish the precise amount, the Court may in some instances estimate the allowable deduction, bearing heavily against the taxpayer whose inexactitude is of his own making. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). There must, however, be sufficient evidence in the record to provide a basis upon which an estimate may be made and to permit the Court to conclude that a deductible expense, rather Heritage Reporting Corporation (202) 628-4888 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 10 than a nondeductible personal expense, was incurred in at least the amount allowed. Vanicek v. Commissioner, 85 T.C. 731, 743 (1985). Beyond the amounts that we found were spent for materials, Mr.* Deems did not substantiate the expenditures he alleges. The Cohan rule does not excuse a taxpayer from the obligation to substantiate, but simply permits alternate proof in certain circumstances. Except for his materials expenses, Mr. Deems's claims of deductions suffer from an almost wholesale failure of proof. His very general testimony, which addressed only some of the alleged expenses, does not enable the Court to determine with any certainty--nor even to estimate roughly--the expenditures that Mr. Deems may have made in the years at issue. Moreover, section 274(d) imposes stringent substantiation requirements for claimed deductions relating to the use of "listed prope,rty", which is defined under section 280F(d) (4) (A) ( ) to include passenger automobiles. Under this provision a deduction for vehicle expense (such as Mr. Deems claim for "Truck and fuel expense") will be disallowed unless the taxpayer substantiates specified elements of the use by adequate records or by sufficient Heritage Reporting Corporation (202) 628-4888 11 evidence corroborating the taxpayer's own statement. See sec. 274(d); sec. 1.274-5T(c) (1), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985). The elements that must be substantiated to deduct the business use of an automobile are: ( ) the amount of the expenditure; (ii) the mileage for each business use of the automobile and the total mileage for all uses of the automobile during the taxable period; (iii) the date of the business use; and (iv) the business purpose of the use of the automobile. See sec. 1.274-5T(b) (6), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985)'. Mr. Deems kept no log or other record of his business use of his vehicle, and he gave no testimony about the distances he drove for his business. He did not meet the enhanced standard of section 274(d). Although we found Mr. Deems's testimony to be sincere, he was largely unable to substantiate the expenses he claimed for the years in suit, and he was unable to provide us with enough information to be able to even estimate reasonably any of the expenses, other than materials. We must therefore hold that Mr. Deems is not entitled to deduct these expenses, other than materials. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Heritage Reporting Corporation (202) 628-4888 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 12 B. Itemized personal deductions Mr. Deems's lists of deductions (Ex. 9-P) included amounts for what he argues are seven itemized personal deductions. Deductions are strictly a matter of legislative grace, and taxpayers must satisfy the specific requirements for any deduction claimed. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Furthermore, as we have stated, taxpayers are required to maintain records sufficient to substantiate their claimed deductions. See sec. 6001; 26 C.F.R. sec. 1.6001-1(a). For one of the seven claimed itemized deductions--Mortgage Interest--the IRS's records (Ex. 2-J) included third-party information showing amounts of $7,419 for 2004, $6,742 for 2005, and $6,085 for 2006; and the IRS now concedes deductions for these amounts. For the other six claimed deductions, however, the record includes no substantiating documents whatsoever. About four of them ("Medical Insurance", "Auto Insurance", "Homeowners Insurance", and "County Taxes"), Mr. Deems did not even give testimony. For the two on which he did give testimony--"Medical and Dental expenses", and "Church Tithes"--that testimony was very general and summary and was insufficient to prove expenditures in Heritage Reporting Corporation (202) 628-4888 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 13 any amount. Pertinent to the claimed charitable contribution deduction for church tithes, section 170(a) allows as a deduction any charitable contribution made within the taxable year. But deductions for charitable contributions are allowable only if verified under the regulations prescribed by the Secretary. Sec. 170(a) (1). To verify a charitable contribution of money, the regulations require the taxpayer to maintain one of the following for each contribution: (1) a canceled check; (2) a receipt from the donee; or (3) in the absence of a check or receipt, other reliable written records. A receipt or record used for this purpose must show the name of the donee, the date of the contribution, and the amount of the contribution. 26 C.F.R. sec. 1.170A-13(a) (1). Mr. Deems had no such receipt or record for his charitable contributions. Of his itemized deductions, only his mortgage interest deduction is substantiated and can be allowed. III. Additions to tax A. Section 6651(a) (1) Section 6651(a) (1) authorizes the imposition of an addition to tax for failure to file a timely Heritage Reporting Corporation (202) 628-4888 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 14 return unless the taxpayer proves that such failure is due to reasonable cause and is not due to willful neglect. See also United States v. Boyle, 469 U.S. 241, 245 (1985); Harris v. Commissioner, T.C. Memo. 1998-332. The Certification of Lack of Record (Ex. 4-J) shows that the IRS received no returns from Mr. Deems and satisfies respondent's burden of production under section 7491 . Mr. Deems does not \ allege that he did file returns. The addition applies "unless it is shown that such failure is due to reasonable cause and not due to willful neglect". Mr. Deems does not claim reasonable cause, and the record shows no basis for such a claim. Mr. Deems failed to timely file his Forms 1040 for the 2004 through 2006 tax years, and we hold that he is liable for the addition to tax under section 6651(a) (1) for those years. B. Section 6651(a) (2) Section 6651(a) (2) imposes an addition to tax for failure to pay the amount of tax shown on a return. The addition to tax under section 6651(a) (2) applies only when an amount of tax is shown on a return. Cabirac v. Commissioner, 120 T.C. 163, 170 (2003). The Commissioner's burden of production with respect to the section 6651(a) (2) addition to tax Heritage Reporting Corporation (202) 628-4888 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 15 requires him to introduce evidence that a return showing the taxpayer's tax liability was filed for the year in question. Wheeler v. Commissioner, 127 T.C. 200, 210 (2006), affd. 521 F.3d 1289 (10th Cir. 2008). In a case such as this one where the taxpayer did not timely file returns for the tax years at issue, the Commissioner must introduce evidence that a valid substitute for return was made pursuant to section 6020(b). Sec. 6651(g) (2). To constitute a valid substitute for return under section 6020(b), "the return must be subscribed, it must contain sufficient information from which to compute the taxpayer's tax liability, and the return form and any attachments must purport to be a 'return'." Spurlock v. Commissioner, T.C. Memo. 2003-124. The substitutes for returns attached to the parties' stipulation (Stip. 6-8; Exs. 5-J to 7-J) satisfy section 6020(b), and respondent has therefore satisfied his burden of production under section 7491 with respect to the section 6651(a) (2) addition to tax. As with the addition under section 6651(a) (1), the addition under section 6651(a) (2) applies "unless it is shown that such failure is due to reasonable cause and not due to willful neglect". Mr. Deems does not claim reasonable cause, and the Heritage Reporting Corporation (202) 628-4888 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 record shows no basis for such a claim. Accordingly, we hold that Mr. Deems is liable for the addition to tax under section 6651(a) (2) for the 2004 through 2006 16 tax years. C. Section 6654 Section 6654 imposes an addition to tax on an individual taxpayer who underpays his estimated tax. A taxpayer has an obligation to pay estimated tax for a particular year if he has a "required annual payment" for that year. Sec. 6654(d). A "required annual payment" is defined in section 6654(d) (1) (]B) as: the lesser of-- (i)90 percent of the tax shown on the return for the taxable year (or, if no return is filed, 90 percent . of the tax for such year), or (ii)100 percent of the tax shown on the return of the individual for the Heritage Reporting Corporation (202) 628-4888 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 17 preceding taxable year. Clause (ii) shall not apply if * * * the individual did not file a return for such preceding taxable year. Thus, respondent's; burden of production under section 7491 requires him to produce, for each year for which the addition is asserted, evidence that the taxpayer had a required annual payment under section 6654 (d) ; and in order to do so he must demonstrate the tax shown on the taxpayer's return for the preceding year, unless he can show that the taxpayer did not file a return for that preceding year. Wheeler v. Commissioner, supra at 210-212. The years at issue are 2004, 2005, and 2006. For each "preceding taxable year"--i.e., 2003, 2004, and 2005--Mr. Deerns filed no return. The Commissioner has thus carried his burden of production under section 7491 with respect to the section 6654 additions for the years at issue. The section 6654 addition to tax is mandatory (i.e., it says that the addition "shall be added", and it provides no "reasonable cause" exception) unless the taxpayer can place himself Heritage Reporting Corporation (202) 628-4888 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 18 within one of the computational exceptions provided for in subsection (e) thereof. Grosshandler v. Commissioner, 75 T.C. 1, 20-21 (1980) . Mr. Deems has not made any argument about section 6654, and there is no showing that any of the exceptions applies. Accordingly, we hold that Mr. Deems is liable for the addition to tax under section 6654 for the 2004, 2005, and 2006 tax years. Decision will be entered under Rule 155. This concludes the Court's oral Findings of Fact and Opinion in this case. (Whereupon, at 11:00 a.m., the bench opinion in the above-entitled matter was concluded.) // // // // // // // // // // // // Heritage Reporting Corporation (202) 628-4888