TAX COURT OPINION

Case: Kevin M. Baker
Docket Number: 1051-05
Judge: Holmes
Opinion Type: memo
Filed: 10/30/2008
Pages: 12

T .C . Memo . 2008-24 7 UNITED STATES TAX COURT KEVI M . BAKER, Petitioner v . COMMISSIONER OF INTERNAL REVENUE, Responden t Docket No . 1051-051 . Filed October= 30, 2008 . Michael C Whelan , for petitioner . . Thomas D . Yang , for respondent .. MEMORANDUM OPINION HOLMES,' Judge : Ke in Baker did not file his 2002 tax return on time . The Commissio er prepared a "substitute for return" using the information h had to determine how much tax Bake r owed . Baker then belatedly submitted-a return that reported much more income, but also much higher deductions than the Commissioner had known bout . We have to sort through variou s SERVED OCT 3 0 2008 procedural problems to figure out what, if any, deficiency i n Baker's 2002 income tax remains . Background 'Baker has an entrepreneurial spirit, and he earned incom e from numerous ventures in 2002 . His largest single source o f income was the wages he earned as president of Blue Worl d Technologies . He also earned income from his investments in tw o passthrough entities :' He was a 45-percent shareholder in Blue World and a member of Guardian Enterprises, LLC . To thos e sources he added a small amount of interest income and some miscellaneous income . But despite his success, Baker failed to file . an individual tax return for 2002 . The Commissioner was not totally ignorant about Baker's earnings because Blue World had reported the $165,038 in wages that it had paid Baker . The Commissioner also knew about $157 of interest income . When the Commissioner learns--usually from third parties with an obligation to report it--that someone has received income but not filed a return, section 6020(b)2 give s ' A passthrough entity pays no tax on income at the corporate level ; instead, profits and losses " pass through" the The . most entity to the members , who pay individual income tax . common types are partnerships , S corporations , and limited liability companies . 2 Unless otherwise indicated, all section references are to the'Internal Revenue Code for the year at issue ; all Rule references are to the Tax Court Rules of Practice and Procedure . 3 - him the power to prepa e a "substitute for'return" (SFR) . An SFR is not a .comprehensivereturn ; the Commissioner uses only one of two filing statuses -s'ngle"or'married 'f(cid:127)iling'separately -and he allows only one person 1 exemption and no business expenses or personal deductions . ee 2 Administration, Internal'-Revenue Manual'(CCH), pt . 5 .19 2 .6 .4 .5°(l0),'at 18, 32 2 The Commissioner sed,Baker's $165,195 in wages and interest income to prepare the FR . The Commissioner picked the married- filing-separately fili g'status and allowed only the corresponding standard deduction . See sec . 63(c)(2) .' Afte r subtracting the standad deduction from Baker's income, the Commissioner calculate that Baker owed a deficiency of'$47,629 The Commissioner credited Baker for the taxes that Blue World'had withheld . He then dete mined additions to tax for Baker' s failure to timely file and timely pay . See secs . 6651(a)(1), 6651 (a) (2 ) Theecommissioner n tified Baker of all this-by sending him a notice of deficiency wi h the SFR attached . Because an SFR i s usually stingy with deductions , a taxpayer who gets one often responds by filing a pe ition with-us and then preparing a return reflecting the much mor complete information he has about himself--especially abo t. greater deductions, the willingness of his wife to accept marr ed-filing-jointly status, and whether he has children or other d pendents .° Baker's case started normally--he filed a petition with us, and it seemed heade d toward a contest over whether the Commissioner's SFR included .too ; 4 - much,income or ;too few deductions or chose a less-favorabl e filing status . But this case left the road most traveled when Baker submitted his own 2002 tax return . What made this return unusual was that it greatly increased Baker's reported income . Instead of the $165,195 that the Commissioner knew about-and had included on the SFR, Baker's own return reported over .:.$575,000, because Baker reported passthrough income from Blue World and Guardian as well as miscellaneous and interest income . But with the increase in income, Baker also reported such large deductions that he claimed a refund . The Commissioner has accepted some of these, but a number are still at issue . Disputed Deductio n Short-term capital loss carryover Long-term capital loss carryover Blue World los s Blue World at-risk-loss carryover Guardian Enterprises los s Blue World charitable contributions carryover 'Blue World charitable contribution 'Amoun t $138,939 28,19 1 136,423 199,105 20,686 27, 29 4 45 0 Though Baker submitted his 2002 return before the Commissioner filed his answer, the Commissioner neither asserted an increased deficiency in his answer nor filed an amended answer . The - 5 - Commissioner ' s pretria .memorandum also stated that only th e original $47, 629 .".defi c ency was at issue . Baker-was an Illi oisan when he filed his petition, and th e case was tried in Chic go .i The trial largely consisted of th e proffering of -unaudite corporate tax returns from Baker' s passthrough businesses their accompanying K-1s, .and Baker's ow n old 1040s with a litan of assertions of their-accuracy . Baker's accountant added his o n assertions of€ .the accuracy of many o f these documents, even .hough'one of his colleagues had actuall y prepared them . Discussion : We'start with the threshold question : How- much is at issue? The Commissioner sent Baker a notice of deficiency based, solely on the SFR ., But Baker reported . substantially more income on his 2002 tax return . We h ve jurisdiction to increase the amount of the deficiency "if"clam therefor is asserted by the Secretary at or before the hearing r a rehearing ." 'Sec ." 6214(a) . To assert an increased deficiency, the Commissioner must formally plead a claim for-an increase in either the answer or a n amended answer . Estate of Petschek v . Commissioner , 81 T .C . 260 , 271-72 (1983), affd . 7318 F .2d 67 (2d Cir . 1984) ; Koufman v . Commissioner , 69 T .C . 4 73, 475-7.6 .(1977) . Even if . the partie s stipulate an increase i~ income the Commissioner is required t o formally plead an increase in the deficiency . Tool Producers, 6 - Inc . v . Commissioner , T .C . Memo . 1995-407, affd . 97-F .13d 1452 (6th Cir . 1996) . This, the Commissioner did not do .3 And the Commissioner did not amend his answer, either . 'Even if we peek outside the pleadings, we can find no assertion of an increased deficiency . The Commissioner' s pretrial memorandum and amended pretrial memorandum both list $47,629 as the amount in dispute,,and he sticks-to that number in his posttrial brief . The only time the Commissioner refers to Baker's increases in income is in the "Respondent's Request fo r Finding of Fact" section of his posttrial brief . The,refer,enc e is a'list that begins : "Petitioner also included in his 200 2 income tax return income items which were not set forth in the notice of deficiency ; these income items are conceded by Petitioner and'are as follows . The Commissioner then lists the increases . But this list is not an amended answer and is therefore not,a claim for an increased deficiency . Thus, we hold that only the $47,692 deficiency is at issue, and the burden is~ on Baker to prove that it is erroneous . See .Rule .142(a) . 3 The Commissioner's pretrial' memorandum shows a smaller addition to tax than that shown on the notice of deficiency . The reason is that he conceded that Baker is not liable for the section .6651(a)(2) addition to tax for failure to timely pay . Therefore, under section 6651(c)(1), the rate used to determine the section 6651(a)(1) addition will be increased . Baker's defense t the deficiency is that he . had sufficient deductions -in 2002 to ffset :nearly all of his income . A significant obstacle t his success is that he chooses to argue that it is the Commiss-oner's burden .=to . disprove his entitlement to these deductions . He argues that his deductions are new matters because the Commissioner did not deny-them in the notice of deficiency . Baker 's not,the first taxpayer to .try this . Se e Widemon v . . Commissions T .C . .Memo . 2004-162 . In Widemon ; we ' decided-that the burden remained with-the taxpayer-because his deductions were a new 'theory and not a 'new . matter . Id ., . And in Rappaport v .,Commissio er, T .C . Memo . 2006-87,' just as in this case , a taxpayer filed a tax return claiming extra income and large deductions'after the Commissioner had already'sent'a notice of deficiency . We hel in Rappaport that, because the taxpayer' himself had raised the matter of the new .deductions, we would'no t shift the burden of prof onto-the Commissioner to disprove them . Id . Widemon and Rappaport remain good law,,and the distinction . that they draw would e able'us to quickly reject Baker's claim, but we can dismiss his argument even without them . In -this case, the Commissioner deter fined a deficiency-based on Baker's unreported wage and interest income . Baker then petitioned us to redetermine the defici ncy, alleging that he was not liable for the deficiency because the "Notice of Deficiency may not-have - 8 given ; him credit for * * * business deductions or other item s affecting taxable income ." He never'alleged that the income was not his or(cid:127)not taxable . Therefore, the issue of whether he ;,:is entitled to .his claimed deductions is not a new matter, but'it is the original and only matter hehas asked us to decide . ,Now that these procedural obstacles are settled into place, and we have the burden of proof worked out ., we can determine the correct amount .of the deficiency . We begin by determining Baker's 2002 income . This step is easy because Baker reported his income on a signed tax return . We treat his tax return as a n admission to all .the reported income . See Lare v : Commissioner , 62 T .C . 739, 750 (1974), affd . without published opinion 521 F .2d 139911 (3d Cir . 1975) . Therefore, . we find that Baker earne d $578,997 in 2002 . Our next step is to determine if Baker substantiated any of the deductions he claimed on his 2002 tax return . Wep,can make this, determination easier by dividing his deductions into two classes : Those that Baker tried to substantiate with old tax returns and .those that he tried to substantiate with mor e persuasive documentation . We start with those deductions supported with nothing more than old tax returns--a class which includes all the deduction s at issue except for Baker's short-term capital-loss carryover . We finish our consideration .by citing our long series of precedents in-which we have held that a taxpayer's : returns do no t substantiate deductio n or losses because they are nothing more.- than a statement of hi claims . Wilkinson v . Commissioner , 71> . T .C . 633,, 639 (1979) .oberts,v . Commissioner , 62 T .C . 834, ;83 7 (1974) . To hold other ise would undermine our ;presumption that the Commissioner '. s _de t rmination-is correct .- See Rule 142 ; Hall e v . Commissioner , 7 T . C 245, 247 (1946), affd . 175 F .2d'500 (2d Cir . 1949) For t e same reason, we long ago establishe d that under circumstan c s like these, a taxpayer can',t'undermine the'rule that old ret u- ns are not substantiation of deductions or losses by adding- :to th m .the bare-testimony that those ol d returns are correct, w thout records or credible testimony about , the'individualitems o the returns .. ,See id . at 250 . . And a taxpayer also can't successfully substantiate his 'old returns by arguing that the,Commi sioner-is'somehow estopped from challenging his deductions because the Commissioner failed to . . . . challenge the'same or similar deductions in earlier years . Lerch ] v . .Commissioner , 877-.F 2d 624, 627 n .6 (7th Cir . 1989),_affg . T .C . Memo . 1987.-295 ; P kar . v . Commissioner, 1113 T .C . . 158,, 16 6 (1999) Much the same rul s apply to the K-ls that Baker offered . to substantiate the deduc ions from his passthrough businesses ; , they, too, are only statements of his claims , not proof of them .. LeBouef v . Commissioner,, T .C . Memo . 2001 - 261 . Baker's LLC, - 10 - Guardian Enterprises, had only two members in 2002, so the Commilssioner classified it as a partnership under thellCode in the absence of the firm's election-to be treated as a corporation . Sec .,301 .7701-3(b)(1)(i), Proced . & Admin . Regs . The Code's default rule for small partnerships, section 6231(a)(1)(B)(i), also applies to Guardian, so the Commissioner was allowed to audit Guardianiat the individual partner level . And this means, under precedents like LeBouef , that Baker had to prove the accuracy of the items on the K-1 that he got from Guardian--:he couldn't just rely on them in the absence of a partnership-level audit as partners in some larger partnerships might be able t o do . Taxpayers do have a duty to report the losses and deductions from,S corporations consistently with their corporation's return . Sec . 6037(c) . But since 1996, individual S corporatio n shareholders have been answerable for all the issues on their corporation's returns . See Small Business Job Protection Act of 1996, Pub . L . 104-188, sec . 1307(c) (1), 110 Stat . 1781 (repealing unified audit ; procedures for S corporations) . Baker has given us no reason for not applying our holding in LeBouef to hi s S-co rporation'K-ls, as we do to his LLC K-1, and he introduced nothing but those bare K-ls in proof of his deductions, and losses . What a taxpayer n eds to- substantiate his deductions and losses are records su f icient .to permit verification of a deduction or loss . sec . 6001 ; sec . 1 .6001-1(a) ., Income Tax Regs . By offering onl- old tax returns and K-1s, with _ nonspecific"testimony f their accuracy, Baker has .failed t o substantiate almost a his claimed deductions . The one exceptio n is his deduction for a short-term capital- loss carryover . Fore is,'he had 1099s dating back to 1996 ., We find this to be persua ive that he had realized a loss back in 1996 . Baker's problem is that their use to prove, a . deduction i n 2002 requires that he prove his capital gains and losses from 1996-2002 to show the 1996 loss hadn't been used up . Burns v . Commissioner , T .C . Memo . 1997-83 ; Williams v . Commissioner , T .C . Memo . 1991-317, affd . without published opinion 996 F .2d 1230 (9th Cir . 1993) . See s c . 1 .1212-1(b), Income Tax Regs . Baker offers only tax returns for the intervening years, so we find that he also failed to ubstantiate the short-term capital loss that he wanted to carry into 2002 . In conclusion, we ind that Baker admitted to $578,997 in income by reporting'the income on his 2002 tax return . The only defense he offered was hat in 2002 he had enough deductions to offset most of this income . We find' that he failed t o substantiate any of tho e in dispute . But only the $47,692 deficiency is at issue, and the Commissioner has conceded many of 12 - Baker's other deductions . Therefore (though unlikely given the size of his income compared to the concessions we know about), Baker's liability may be reduced . The last issue is whether Baker is liable for an ;! 4 addition to tax under section 6651(a)(1) for a failure to timely file his tax return . The Commissioner has the burden of production . Sec . 7491 ;(c) . He met his burden because Baker conceded that he filed his 2002 tax return late and offers no explanation for his tardiness . Because computations may be"needed , Decision will be entere d under Rule 155 .