TAX COURT OPINION

Case: Robert J. & Bernita M. King
Docket Number: 289-10
Judge: Marvel
Opinion Type: bench
Filed: 10/24/2011
Pages: 13

UNITED STATES TAX COURT WASHINGTON, DC 20217 ROBERT J. & BERNITA M. KING, Petitioners v. COMMISSIONER OF INTERNAL REVEN TE, Respondent . ) ) ) ) ) ) ) ) ) Docket No. 289-10. 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 the pages of the the to petitioners and to respondent a copy of transcript of Marvel at Oklahoma City, Oklahoma, on September 21, 2011, containing her oral conclusion of trial. findings of fact and opinion rendered at the above case before Judge L. Paige the trial of In accordance with the oral findings of fact and opinion, decision will be entered under Rule 155. (Signed) L. Paige Marvel Judge Dated: Washington, D . C. October 21, 2011 SERVED OCT 2 4 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 L ., Paige Marvel - September 21, 2011 Robert J. & Bernita M. King Docket No. 289-10 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 (HEREINAFTER BENCH OPINION) SHALL NOT BE RELIED UPON AS PRECEDENT IN ANY OTHER CASE. This Bench pinion is rendered pursuant to section 7459(b) of the Internal Revenue Code and Rule 152, Tax Court Rules of Practice and Procedure. Unless otherwise indicated, all section references are to the Internal Rever ue Code of 1986 as amended and in effect for the relevant period, and all Rule references are to bhe Tax Court Rules of Practice and Procedure. By statutory notice of deficiency dated September 24, 2009, respondent determined income tax deficiencies of $53,347 and $268,295 with respect to petitioners' 2006 and 2007 taxable years, respectively. Respondent also determined section 6662 accuracy-related penalties of $10,203 and $53,659, with respect to 2006 and 2007 respectively, and an addition to tax under section 6651(a) (1) with respect 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 to 2007. Petitioners timely contested respondent's determinations by filing a petition in this Court. On the date petitioners filed their petition, they resided in California. On January 10, 2011, the parties filed a stipulation of settled issues that resolved several of the factual issues in this case. On June 22, 2011, respondent's request for admissions was filed and served on petitioners. Among other things, the request for admissions advised petitioners that, pursuant to Rule. 90(c) and (f), each matter in the request would be deemed admitted, and conclusively established for purposes of this case, unless petitioners served a written answer or objection to each matter in the request within 30 days of the date the request was served on petitioners. Petitioners did not file the required answers or objections by the deadline so each matter in the request was deemed admitted for purposes of this case. Petitioners also stipulated that they filed their 2007 return late, and they conceded at the beginning of trial that they were liable for the section 6651(a) (1) addition to tax for 2007. As a result of the stipulation of settled issues, the deemed admissions, and petitioners' concessiony', petitioners are liable for reduced Lph4 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 deficiencies for each of the years 2006 and 2007 and for a section 6651(a) (1) addition to tax for 2007. The only issue remaining for decision is whether petitioners are liable for the section 6662 penalties for 2006 and 2007. Petitioners rely on section 6664(c) and contend that they should not be liable for the sectidn 6662 penalties because they had reasonable cause for the underpayments and they acted in good faith with r gard to the underpayments. Petitioners assert that they relied on a competent professional tax adv ser. A trial was held on September 12, 2011, in Los Angeles, California, at which petitioner Robert J. King (petitioner), who appeared pro se on behalf of himself and his wife,: testified. Respondent was represented by Elaine T. Fuller. FINDINGS OF FACT Some of the relevant facts have been stipulated. The stipulated facts, including facts drawn from stipulated exhibits, are incorporated herein by this reference. Petitioners are married individuals who filed joint Federal income tax returns for 2006 and 2007. Attached to eÂch return was a Schedule C, Profit or Loss From Business, which reported income 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 and expense deductions with respect to a real estate management business operated by one or both of the petitioners. Both the 2006.and 2007 Schedules C reported substantial net losses. The returns were prepared by a Mr. Frank Jenkins, who submitted the returns electronically to the Internal Revenue Service but who does not appe.ar to have signed the returns as a paid preparer. During 2006 and 2007, petitioner, who had retired from Raytheo Corporation after working there for approximately 20 years, , volunteered as a track and field coach. He holds a master's degree in education. Consistent with·his practice in other years, petitioner gathered petitioners' tax information for 2006 and 2007, and gave it to Mr. Jenkins, who then prepared petitioners': 2006 and 2007 Federal income tax returns and filed them electronically. He did not know anything about Mr. Jenkins' professional credentials, including whether Mr. Jenkins was a certified public accòuntant. In the notice of deficiency, respondent determined, among other adjustments, that petitioners were not entitled to report the ·results of the 2006 and 2007 real estate activity on·Schedules C and instead must report the results of the real estate 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 activity on Schedules E, Supplemental Income and Loss, because petitioners failed to prove that they materially participated in the real estate activity. Respondent also determined that (1) any losses generated by the activity were passive and (2) the business expense deductions claimed on the 2006 and 2007 Schedules C should be disallowed in full for lack of substantiation., Although these issues have been resolved, petitioner.testified that the documents and records he needed to substantiate the income and expenses from the real estate activity were in Mr. Jenkins' possession and that he had relied on Mr. Jenkins to prepare petitioners' 2006 and 2007 returns. Petitioners did not subpoena Mr. Jenkins or call him as a witness. OPINION Deficienbies determined by the Commissioner in a notice of deficiency are presumed correct, and ordinarily the taxpayer has the burden of proving that respondent's determinations are erroneous. Rule 142; Welch v. Helvering, 290 U.S. 111, 115 (1933). Under section 7491, the burden of proof may shift to the Commissioner but only if the taxpayer satisfies all of the section 7491(a) requirements. Petitioners have not done so and therefore bear the burden 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 8 convincing the Court that respondent's determinations are in error. The only issue remaining for decision is whether petitioners are liable for the section 6662 penalties for 2006 and 2007. Section 6662(a) and (b) .authorizes the Commissioner to impose a 20 percent penalty on any portion of an underpayment of tax required to be shown on a return that is attributable to one or more of the following: Negligence or disregard of rules a regulations, substantial understatement of income tax, substantial valuation misstatement, substantial overstatement of pension liabilities, or substantial estate or gift tax valuation understatement. Respondent alleges that petitioners are liable for the section 6662 penalties either because they substantially understated their income tax for 2006 and 2007 within the meaning of section 6662(b) (2) and (d), or the 2006 and 2007 underpayments are attributable to negligence or disregard of rules or regulations within the meaning of section 6662 (b) (1) and (c). Generally, section 6662(a) and (b) (1) authorizes the Commissioner to impose a 20-percent penalty on the portion of an underpayment of income tax attributable to negligence or disregard of rules 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 apd regulations. The term "negligence" includes any failure to make a reasonable attempt to comply with the provisions of the. internal revenue laws, and the term "disregard" includes any careless, reckless, or intentional disregard. Sec. 6662 (c); sec. 1.6662- 3(b) (1) and (2), Income Tax Regs. Disregard of rules or regulations is ca¼eless if "the taxpayer does not exercise reasonable diligence to determine the correctness of a retÛrn position" and is reckless if "the taxpayer makes little or no effort to determine whether a rule or regulation exists, under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person woùld observe." Sec. 1.6662- 3(b) (2), Income Tax Regs.; see also Neely v. Commissioner, 85 T.C4 934, 947 (1985). Section 6662(a) and (b) (2) also authorizes the Commissioner to impose a 20-percent penalty if there is a substantial understatement of income tax. An "understatement" means the excess of the amount of the tax required to be shown on the return over the amount of the tax imposed which is shown on the return, reduced by any rebate. Sec. 6662(d) (2) (A). An understatement isi substantial in the case of an individual if the amount of the understatement 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 10 taxable year 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 with respect to the taxpayer's liability for the section 6662(;a) penalty and must produce sufficient evidence indicating that it is appropriate to impose the penalty. See sec. 7491(c). Once the Commissioner meets his burden of production, the taxpayer must come forward with persuasive evidence that the Commissioner's determination is incorrect or that the taxpayer had reasonable cause or substantial authority for the position. See Higbee v. Commissioner, 116 T.C. 438, 447 (2001). Respondent met his burden of production regarding the substantial understatement component of the penalty. The parties do not dispute that the amount of the understatement for each taxable year exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000, although the exact amount of the understatement shall be computed as part of the Rule 155 calculations. Even if the understatement is not substantial, respondent met his burden of production with respect to negligence as a result of deemed admissions. Moreover, petitioners 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 11 did not substantiate the expense deductions they claimed with respect to their real estate activity during 2006 and 2007 nor did they prove that they had maintained the necessary records to substantiate the deductions they claimed. Petitioners had the burden of producing sufficient evidence to prove that respondent's penalty determinations are iÃcorrect. See id. at 446-447. They contend that.thëy should not be liable for the I accuracy-related penalties on the ground of the reasonable cause and good-faith defense under section 6664 (c) (1). Specifically, petitioners contend that they provided all their records to their return preparer and that they relied on the preparer to properly prepare their 2006 and 2007 returns. Generally, section 6664(c) (1) provides an exception to the section 6662(a) accuracy-related. penalty with respect to any portion of an underpayment if the taxpayer shows that k/K there is reasonable cause L for such portion and that the taxpayer acted in good faith with respect to such portion. The determination of reasonable cause and good faith is made on a case- by-case basis, taking into account all pertinent facts and circumstances. Sec. 1.6664-4(b) (1), Income Tax Regs. The most important factor is the extent of 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 12 taxpayer's effort to assess the proper tax liability. Id. For the reasonable cause exception to apply, the taxpayer must prove that he or she exercised ordinary business care and prudence as to the disputed item. See Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 98 (2000), affd. 299 F.3d 221 (3d Cir. 2002). The taxpayer bears the burden of proving that he or she meets the requirements for relief under the section 6664 (c) (1) reasonable cause exception. See Higbee v. Commissioner, supra at 446-447. We determine reasonable cause and good faith on a case- by-case basis, taking into account all pertinent facts and circumstances. Sec. 1.6664-4(b) (1), Income Tax Regs. The most important factor is the extent of the taxpayer's effort to assess his or her proper tax liability, st-ceter-a, H. LM Reliance upon the advice of a tax professional may establish reasonable cause and good faith. See United States v. Boyle, 469 U.S. 241, 250 (1985). Reliance on a tax professional is not an "absolute defense" but is merely "a factor to be considered." Freytag v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991). Whether reasonable cause exists when a taxpayer has relied on a tax professional to 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 prepare a return must be determined on the basis of all of the facts and circumstances. See Neonatology Associates, P.A. v. Commissioner, supra at 98. The taxpayer claiming reliance on a tax professional must prove by a preponderance of the evidence each of the following: "(1) The adviser was a competent professional who had sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the adviser, and (3) the taxpayer actually relied in good faith on the adviser's judgment." Id. at 99. Mr. Jenkins did not testify at trial. Petitioners introduced no credible evidence as to the type of records they maintained and gave to Mr. Jenkins. They made no discernible effort to obtain copies of the records. Petitioners also failed to establish that Mr. Jenkins was a competent professional with sufficient expertise. In fact, petitioners did not know anything about Mr. Jenkins' professional background, including whether he was a certified public accountant. CONCLUSION Petitioners have failed to prove that they had reasonable cause for the underpayments and that they acted in good fäith with respect to 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 14 underpayments as required by section 6664 (c) . Consequently, we sustain respondent ' s determination that petitioners are liable for the section 6662 penalties in reduced amounts . Decision will be entered under Rule 155. THIS CONCLUDES THE COURT'S ORAL FINDINGS OF FACT AND OPINION IN THIS CASE. (Whe reupon, at 10 : 15 a . m. , the bench opinion in the above-entitled matter was concluded.) // // // // // // // // // // // // // // // // Heritage Reporting Corporation (202) 628-4888