TAX COURT OPINION

Case: Ladislau P. & Andrea Horvath
Docket Number: 10782-06S
Judge: Ruwe
Opinion Type: summary
Filed: 10/30/2008
Pages: 14

WTZXS LADISLAU P . ND ANDREA HORVATH, 'Petitioners M . COMMISSIONE OF INTERNAL REVENUE,' Respondent .Docket No .. 10782-{065 . Filed October 30, 2008 . RUWE,-' Judge : "This case was heard pursuant to the provision s of section 7463 of thE-Internal Revenue-Code in effect when th e petition' was filed .' 'ursuant to 7463(b), the decision to b e 1 Unless otherwise indicated, all section references are to the Internal Revenue Code in . effect for the years at, issue, and all Rule references ., e to the Tax Court Rules of Practice an d Procedure . SE WED OCT 3 0 2008 entered is not reviewable by any other court, and this opinio n shall not be treated as precedent for any other case . Respondent determined deficiencies in petitioners' Federal income taxes of $23,179 and $29,776 and accuracy-related penalties under section 6662(a) of $4,636 and $5,955 for years 2002 and 2003 (years at issue), respectively .2 After concessions, we must decide : (1) Whether petitioners have unreported income for the years at issue ; (2) whether petitioner s are entitled to deduct, under section 162, business expense s related to both (a) the use of their automobiles for the years at issue, and (b) their reported supplies expense for 20 ;03 ; and (3) whether petitioners are liable for section 6662(a) accuracy- related penalties for the years at issue . Backgroun d Some of the facts have been stipulated and are s'o found . At the time their petition was filed, petitioners resided i n Ohio . ,Petitioners are husband and wife . They owned Transil Denta l Lab (Transil) which was operated out of their residence . Petitioners' business consisted of making dental molds, crowns, dentures, and other related dental products for various dentists- . Mrs . Horvath worked both as the manager of . the business and a s 2 Where appropriate, figures have been rounded to the nearest dollar . - 3 the delivery and pick p driver ., During the years at issue, petitioners owned sev ral vehicles, which were'used to make deliveries for Transi Petitioners maintained business records ] which included ,a mile ge log for" the business use of each vehicle . Shell credit card statements (gas receipts) entered into evidence(cid:127)at~tria showed the locations, and amounts of gasoline purchased by petitioners during the years at issue . 'The gas receipts showed t tal expenses of $1,389 for 2002 and $1,383 ) for 2003 . Petitioner also entered into evidence various automobile repair rec iptsand vehicle registrations .which showed odometer readings for several of the .-vehicles-for years before, during, and after the years-at issue . Further documentary evidence entered at t ial .included an example of the number of deliveries ' petitioner made on a,=weekly basis and a list of the dentists and the dist nce between their home°and the dentists' offices . Petitioners' Sch4dules C, Profit or Loss From Business , reported gross receipts of $71,000 and,$75,2503 for 2002 and 2003, respectively . etitioners' reported expensesincluded, among others, $21,900 and $10,800'of car and truck expenses, calculated using the tandard(cid:127)mileage rate, for 2002 and 2003 , While petitioners' 2003 Schedule C shows gross receipts o f 11 $75,250, the parties' stipulation of facts(cid:127) further explanation, that petitioners' gross receipts on their 2003 Schedule-C'were 75,190 . (cid:127)indicates, withou t !I - 4 - respectively, and a supplies expense of $20,068 for 2003 . After deductions for returns and allowances and total expenses, petitioners reported net profits/business income of $14,417 for 2002'and $13,079 for 2003 . Petitioners' business income was the only income reported by petitioners for the years at issue . After petitioners filed their tax returns for the years at issue, their business records, including the mileage logs, were destroyed when their basement flooded in 2004 . 'Respondent determined that petitioners had unreported incom e on the . basis of deposits into .their bank accounts . For 2002, petitioners deposited funds into two checking accounts at Ohio Savings Bank .4 Total deposits into the two accounts during 2002 was $160,144 . Respondent identified $53,027 in nontaxable transfers between the two accounts in 2002 and concluded that petitioners' total income was $107,116 . However, petitioners' bank statements also showed a "DEBIT MEMOi5 of $4,271 on January 31, 2002, and a "DEBIT MEMO" of $9, .000 on March 20, 2002 . Respondent's bank deposits analysis arrived at net deposits by subtracting transfers between petitioners' accounts but did not consider the two debit memos made by the bank . After subtractin g ' One of the Ohio Savings Bank checking accounts was in the name of Transil, account no . xxxxxxx5493, while the other was in petitioner Ladislau Horvath's name, account no . xxxxxxx6660 . 5 On the basis of the bank . statements, we interpret the "DEBIT MEMO" as a nontaxable transaction reversing tIe corresponding deposit from petitioners' bank account ., the two debitmemos the .net deposits into petitioners' bank accounts in 2002 were $93,845 . For 2003, petiti ners deposited-funds into four checkin g accounts, .two at .Ohio Savings :Bank. and two at Charter One Bank .6 f Respondent determined total deposits into the four accounts o f $167,286 and identif.i d $60,257 of nontaxable transfers betwee n the accounts . After llowing for transfers, respondent concluded that petitioners' tot l income was .~$107,028 . One of petitioners . bank statements, however, showed a "DEBIT MEMO" of $241 on January 21, 2003, whi . h respondent did not consider . After subtracting-the-debit memo, the net-deposits into petitioners ' ,bank accounts were $1 6,788 in 2003 . Discussion . I . Unre orted Incom e As a general rule, the Commissioner's determinations set forth-in a .notice of deficiency are presumed correct, and the taxpayer bears-the burden of proving that these determinations are in error .- Rule 142(a) ; Welchv . Helvering, 290 .U .S . 111, 11 5 (1933) . 6 The two . Ohio Savings Bank checking accounts .,are the same, two identified previously . See supra note 4 . These two accounts were closed on .Aug . 31, 2003 . The two checking accounts at Charter One Bank were opened on Aug . 27, 2003, one in the name of Transil, account no . xx-xxx3l3-0, and the other in petitioners' ;, names, account no . xx -xxx07O-2 . 6 Where taxpayers are unable to produce substantiatin g business records of their income, the Commissioner may use the bank deposits method to reconstruct and compute the taxpayers' income . See Estate of Mason v . Commissioner , 64 T .C . :j651, 656 (1975), affd . 566 F .2d 2 (6th Cir . 1977) . A bank deposit is prima facie evidence of income . Tokarski v . Commissioner , 87 T .C . 74, 77 (1986) . The bank deposits method of reconstruction assumes that all of the money deposited into the taxpayers' accounts is includable in .gross income unless the taxpayers show that the deposits are not taxable . DiLeo v . Commissioner , 96 T .C . 858, 868 (1991), affd . 959 F .2d 16 (2d Cir . 1992) .- The Commissioner, however, must take into account any nontaxable items and deductible expenses of which the Commissioner has knowledge . Id . For 2002, respondent argues that petitioners had"total deposits of $160,144 and nontaxable transfers of $53, .027 . For 2003, respondent argues that petitioners had total deposits of $167,286 and nontaxable transfers of $60,257 . Respondent argues that his bank deposits analysis supports a finding that petitioners had net deposits of $107,116 for 2002 and $107,029 for 2003 . Because petitioners' Schedules C reported gros s receipts of only $71,000 for 2002 and $75,250 for 2003, respondent contends that the difference between these figures amounts to unreported income of $36,116 for 2002"and $31,779 for 2003 . Petitioners do not dispute' respondent's use of the bank deposits method of reconstruction and do not allege'any specific error in respondent's computations . Rather, petitioners contend that' they maintained usiness records during the years at issu e that were destroyed, that their tax returns for those years accurately reported their income and expenses, and that respondent's determin tions are therefore erroneous . After reviewing petitioners" bank statements,'it appears that respondent errors ously included''$13,271 for 2002 and $24 1 for 2003 in petitioners' total net deposits . The bank . statements indicate that respondent's bank deposits calculations °included a $4,271 deposit on January 31, 2002, a $9,000 deposit on March 20 2002, and a $241 depo it on January 21, 2003, without considerin g the corresponding deb t memos . Each-of these deposits appears t o be attributable to transactional errors reflected in the bank statements .' The bank statements indicate that each of the "deposits" was corrected with a same-day "DEBIT MEMO" removing the "deposit" .from, pe itioners' account . On the basis of the foregoing, we find that petitioners . understated their gross receipts by $22,845 i 200 .2 and by $31,538 in,2003 . ' .Th'e statutory notice of deficiency originally-determined unreported income of 37,677 for 2002 and .t$50,593 for 2003 . At trial, respondent reduced his allegation of unreported income to $36,116 for 2002 and 31,779 for 2003 . II. Disallowed Deduction s - 8 Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving he is entitled to the deductions claimed . Rule 142(a) ; INDOPCO, Inc . v . Commissioner , 503 .U .S . 79, 84 (1992) ; New Colonial Ice Co . v . Helvering, 292 U .S . :435, 440 .(1934) . Section 162(a) allows a taxpayer to deduct all the ordinary and necessary expenses paid or incurred in carrying on a trade or business . Petitioners claimed business deductions for the use of their personal vehicles and for supplies used, in their business . Respondent disallowed these deductions due to petitioners' lack of substantiation . a . Car and Truck Expenses 'Section 274(d) provides : .SEC . 274 . DISALLOWANCE OF CERTAIN ENTERTAINMENT, ETC ., EXPENSES . (d) Substantiation Required .--No deduction or ,credit shall be allowed-- * * * * * * * (4) with respect to any listed property (as defined in section 280F(d)(4)) , unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer's own statement (A) the amount of such expense or other item, (B) the time and place of the travel , ;entertainment, amusement, recreation, or use of :the facility or property, or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of persons entertained, using the facility or property, or receiving the gift . * * * Section 280F(d)(4)(A) i) provides that passenger automobiles are "listed property" . Tus, the heightened substantiation requirements of secti n 274(d)' are' applicable to petitioners' claimed car,and truck expense deductions . Substantiation-i to be made by either "adequate records" or "sufficient evidence corroborating the taxpayer's own statement" . Sec . 274(d) ; sec . 1 .2 4-5T_(c)(1 .), Temporary'Income .Tax Regs ., 50 Fed . Reg . 46016 (Nov . 6, 1985) . . "To meet,the, 'adequate records' requirements of secti n 274(d), a taxpayer shall, maintain a n .account book,°diary, log, statement-of expense, trip sheets, or similar record * * :*,,-and documentary evidence" . Sec . 1 .274 5T(c)(2)(i'), Temporar Income Tax Regs . .,-50 Fed . Reg . 46017 (Nov . 6, 1985) In lieu of substantiating'the actual amount of an expenditure related't the business use of a passenger automobile, a taxpaye may use the .standard mileage rate established by the Commissioner . s Sec . 1 . 274=5 (j) (2) , 'Income Taxi Regs . Petitioners -kept a log of . their business use of their automobiles that woulc have provided the required information . However, petitioners' estified and provided documentation to prove that these reco ds were lost as a result of flood damage i n 8 The optional standard mileage rate for business use of .a passenger automobile as 36 .5 cents and 36 cents per mile for 2002 and 2003, respectively . See Rev . Proc . 2001-54,~sec . 5, 2001-2 C .B . 530, 531 ; Rev . Proc . 2002-61, sec . 5, 2002-2 C .B . 616, 618 .- 10 - 2004 ., Where, as here, the taxpayer establishes that ,the failure to produce adequate records is due to .the loss of the . records through circumstances beyond the taxpayer's control, such as destruction by flood, the taxpayer may substantiate a ; deduction by reasonable reconstruction of his expenditures or use . Sec . 1 .274-5T(c)(5), Temporary Income Tax Regs ., 50 Fed . Reg . 4602 2 ail (Nov . 6, 1985) ; see also Malinowski v . Commissioner , 71 T .C . 1120, 1125 (1979) ; Schneider v . Commissioner , T .C . Memo . 1978- 447 . Where documentation is unavailable "the Court may, although it is not required to .do so, accept the taxpayer's testimony to substantiate the deduction ." Davis v . Commissioner ,, T .C . Memo . 2006'272 ; see also Boyd v . Commissioner , 122 T .C . 305, 320 (2004) ; Watson . v . Commissioner , T .C . Memo . 1988-29 . Petitioners have presented credible testimony and evidence sufficient to reconstruct a portion of their car and truck expenses . It is clear that petitioners used their vehicles for deliveries in their business . They testified that their vehicles were used primarily for business purposes . Petitioners also testified and :presented documentary evidence of the locations of and the frequency with which they traveled to the various dentists' offices . - 11 - Petitioners prod ced'-partial gasoline receipts totaling $1,389 for 2002 and $ ,383 for 2003 .9 The Energy Information' Administration report that the average price of gasoline in the ' Midwestern United Sta es was 136 .5 cents per gallon and 154 . 8 cents per . gallon in 2 02 . and 2003, respectively .' The U .S . Department of Transp o tation reports the average fuel efficiency of U .S . passenger car as 22 miles per gallon in 2002 and 22 ..2 miles per gallon in 2 03 . On this .basis,-we conclude tha t petitioners' business use' of their vehicles-totaled at leas t 20,000 miles in 2002 ~nd 18,000 miles in,2003 .and tha t petitioners are. enti t ed to deductions for business use . of thei r vehicles using the s ndard mileage rate ..''See sec . 1 .274- 5 (j) (2) , Income Tax R gs . ; Rev . Proc . 2001-54,,sec . .5, 2001-2 C .B . 530, 531 ;'"Rev . oc . 2002-61, sec . 5, 2002-2 C .B . 616, 618 . b . Business Sugplies Expens e Petitioners! 200 Schedule C reported a supplies expense of $20,068 . Respondent' llowed $6,216 and disallowed the remaining $13,852 (disallowed p rtion) . Both petitioners and,respondent indicated at trial that the disallowed portion of the supplies expense deduction remained at issue ; however, neith r party offered any evidence' . Becaus e petitioners bear the urden of proof., we .find that petitioners are not entitled to a deduction for business supplies expenses i t 9 For some of the months in each year there were no receipts . - 12 - excess of the-amount allowed by respondent for 2003 . Rule 142(a) ; Levin v . Commissioner , 87 T .C . 698, 722-723 (1986), affd . 832 F .2d 403 (7th Cir . 1987) . III . . Section 6662(a) Accuracy-Related Penalt y Section 6662(a) provides that a taxpayer is liable for a 20- percent accuracy-related penalty on any portion of an underpayment of tax required to be shown on a return.„attributable to, inter alia, (1),negligence or disregard of the rules or regulations or, (2) a substantial understatement of income tax . See sec . 6662(b) . xRespondent's position with respect to the accuracy-related penalties is unclear . The notice of deficiency sent :,to petitioners included accuracy-related penalties under section 6662(a) . At the beginning of trial the parties indicated that the only issues remaining in dispute for 2002 were unreported income and a car and truck expense deduction and forp2003 were unreported income, a car and truck expense deduction, and a supplies expense deduction . In any event, the penalty under section 6662(a) shall not be imposed upon any portion . of an underpayment where the taxpayer shows that he or she acted with reasonable cause and .,9in good faith with respect to such portion . See sec . 6664(c),(1) ; Higbee v . Commissioner , 116 T .C . 438, 448 (2001) . The determination o f whether a taxpayer acted with reasonable cause and in good faith 1 3 is made on a case -by-clase basis, taking into account all th e pertinent facts and circumstances . Higbee v . Commissioner , supra at 448 ; Sec . 1 .6664-4(b)(1), Income Tax Regs . The most important factor is the extent of the taxpayer's effort to assess his proper tax liability for'the year . Sec . 1 .6664-4(b)(1), Income Tax Regs . ',,"Circumstances that may indicate reasonable cause and good faith i clude * * * the experience, knowledge, and education of the taxpayer ." Id . On the basis of petitioners' testimony, we are satisfied that petitioners maintained business records to the best of their ) ability and . that information reported on their .2002 and 2003 ta x I returns reflected a go d faith effort to assess their correct taxi liabilities . As previ usly noted, petitioners' business records for the years at issue were destroyed by flood in 2004 . Eve n though petitioners have been unable to completely reconstruct their records, we are ersuaded and conclude that petitioners made a substantial eff rt to .assess their proper tax liabilitie s for the years at issue and, consequently, that petitioners acted with reasonable'cause and in good .faith as required under section 6664(c)(1) . Accordingly, we hold that petitioners are not liable for section 6662 .(a) ac uracy-related penalties for 2002 and 2003 . - 14 - In reaching our holdings herein, we have considered all arguments made, and to the extent not mentioned above, we find them to be moot, irrelevant, or without merit . To reflect the foregoing, Decision will be entere d under Rule 155 . 11