t c memo united_states tax_court ronald d and shirley a blush petitioners v commissioner of internal revenue respondent docket no filed date david a slacter for petitioners william j gregg for respondent memorandum opinion panuthos chief special_trial_judge this case was heard pursuant to sec_7443a and rule sec_180 sec_181 and sec_182 unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue all rule references are to the tax_court rules_of_practice and procedure - - respondent determined the following deficiencies and penalties with regard to petitioners' federal income taxes penalty year deficiency sec_6662 a dollar_figure dollar_figure big_number after concessions by respondent the issues remaining for decision are whether petitioners received unreported taxable_income in the amounts of dollar_figure and dollar_figure for and respectively as shown by unexplained bank_deposits made by them during those years and whether petitioners are liable for an accuracy-related_penalty for each of the and taxable years pursuant to sec_6662 some of the facts have been stipulated and they are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference at the time of filing the petition petitioners resided in new market virginia respondent concedes the deficiency in tax and penalty determined for the tax_year additional concessions are enumerated infra note respondent's determination that petitioners received unreported taxable_income is reflected as adjustments to petitioners' schedule c gross_receipts for the tax years in issue the amounts set forth above reflect concessions made by respondent a reduction in gross_receipts for and in the amounts of dollar_figure and dollar_figure respectively background petitioner ronald d blush hereinafter petitioner started his business as an independent building contractor in the spring of previously petitioner had worked as a maintenance director for the potomac conference corp hereinafter potomac petitioner suffered an on-the-job injury in while working for potomac petitioner received dollar_figure and dollar_figure in and respectively as a settlement of his worker's compensation claim petitioners purchased land in shenandoah county virginia in for approximately dollar_figure the property consisted of five lots all of which were sold by petitioners during the years through for a total of dollar_figure petitioners received approximately dollar_figure of these funds after satisfaction of the sole mortgage on the property petitioners deposited the funds directly into their bank account for the tax years in question petitioners maintained four bank accounts---a joint checking account a business checking account in the name of petitioner a savings account in the name of petitioner and a checking account in the name of petitioner shirley a blush petitioners deposited dollar_figure and dollar_figure into their various bank accounts during and respectively petitioners timely filed their and federal_income_tax returns petitioners attached schedules c profit or loss q4e- from business reporting dollar_figure and dollar_figure in gross_receipts for and respectively upon examination of petitioners' tax returns respondent's revenue_agent concluded that to some extent petitioner's business was conducted in cash petitioners did not present adequate books_or_records to respondent's revenue_agent pertaining to the income generated by petitioner's business the revenue_agent performed a bank_deposits analysis of the tax years in issue to determine petitioners' income a summary of the revenue agent's bank_deposits analysis for and reflects the following deposits to bank accounts dollar_figure less deposits from known sources big_number total unexplained deposits ‘big_number deposits to bank accounts dollar_figure less deposits from known sources big_number total unexplained deposits ‘big_number ' as previously indicated respondent has made concessions reducing the amounts of unexplained deposits during the initial interview with petitioners' representative the revenue_agent inquired as to the amount of cash petitioners had on hand during the years in question petitioners' representative did not provide an answer the revenue_agent prepared an information_document_request that again inquired as to the amount of cash petitioners had on hand petitioners responded that they did not know how much cash they - - had on hand during the course of the examination the revenue_agent was not informed of the prior real_estate transactions in addition petitioners did not come forward with the explanation that some of the unexplained deposits were due to cash on hand in the preparation of his report the revenue_agent assumed that the unexplained deposits were unreported income and the unreported income was attributable to petitioner's contracting business respondent asserts after concessions that petitioners had unreported income as shown by unexplained bank_deposits in the amounts of dollar_figure and dollar_figure during and respectively discussion unreported income gross_income includes all income from whatever source derived see sec_61 sec_6001 requires all taxpayers to maintain adequate books_and_records of taxable_income in the absence of adequate_records the commissioner is authorized to reconstruct a taxpayer's income by any reasonable method that clearly reflects the taxpayer's income see sec_446 see also 348_us_121 999_f2d_760 4th cir affg tcmemo_1992_153 94_tc_654 43_tc_824 one of these methods the bank_deposits and cash expenditure method - - has long been sanctioned by the courts see 102_tc_632 bank_deposits are prima facie evidence of income see 399_f2d_744 4th cir affg tcmemo_1967_67 clayton v commissioner supra pincite 87_tc_74 when the commissioner uses the bank_deposits method of analysis to reconstruct a taxpayer's income this method assumes that all money deposited ina taxpayer's bank account during a given period constitutes taxable_income the commissioner must take into account any nontaxable source or deductible expense of which he has knowledge see clayton v commissioner supra pincite 96_tc_858 affd 959_f2d_16 2d cir petitioners contend that the funds deposited into their bank accounts are not taxable_income petitioners assert the funds came from a cash hoard comprising gain from prior real_estate transactions and worker's compensation settlements petitioner testified that he did not particularly like banks and he wanted to have more control_over his money he testified that while he deposited funds he sometimes withdrew funds and held the cash petitioner attributed his distrust of banks to black friday a date in date when the stock market experienced a severe decline petitioner testified that - he began depositing his cash reserves when he started his business in petitioner did not keep any records of how much cash he kept at home or how much he had in his possession at any given time petitioners could not adequately explain where the cash was kept although petitioners testified that cash from real_estate transactions and from worker's compensation settlements was withdrawn from the bank and kept at home the testimony was not specific as to the dates or amounts in addition petitioner testified that some portion of his business was conducted in cash and that some household bills were paid in cash again the testimony was vague the court is not required to accept unsubstantiated testimony see 338_f2d_602 9th cir affg 41_tc_593 we hold that petitioner's explanation of a cash hoard nontaxable source is not credible we are further satisfied that respondent gave petitioners proper credit for all nonincome sources of deposits we sustain respondent's determination taking into consideration respondent's concessions sec_6662 a respondent determined petitioners were liable for the accuracy-related_penalty under sec_6662 for both and the accuracy-related_penalty is equal to percent of any portion of an underpayment_of_tax required to be shown on the - - return that is attributable to the taxpayer's negligence or disregard of rules or regulations see sec_6662 and b negligence consists of any failure to make a reasonable attempt to comply with the provisions of the internal_revenue_code sec_6662 disregard consists of any careless reckless or intentional disregard id an exception applies to the accuracy-related_penalty when the taxpayer demonstrates there was reasonable_cause for the underpayment and he acted in good_faith with respect to such underpayment see sec_6664 whether the taxpayer acted with reasonable_cause and in good_faith is determined by the relevant facts and circumstances the most important factor is the extent of the taxpayer's effort to assess the proper tax_liability see stubblefield v commissioner tcmemo_1996_537 sec_1 b income_tax regs sec_1_6664-4 income_tax regs specifically provides circumstances that may indicate reasonable_cause and good_faith include an honest misunderstanding of fact or law that is reasonable in light of the experience knowledge and education of the taxpayer tt is the taxpayer's responsibility to establish he is not liable for the accuracy-related_penalty imposed by sec_6662 a see rule a 92_tc_501 petitioners failed to explain adequately why they did not report all of their taxable_income for and on the basis of the entire record we conclude that --- - petitioners have not established that the underpayment_of_tax was due to reasonable_cause and that they acted in good_faith accordingly we hold petitioners are liable for the accuracy- related penalty on account of respondent's concession the penalty will be in an amount less than that determined in the notice_of_deficiency to reflect the foregoing decision will be entered under rule


department of the treasury washington dc third party communication none date of communication not applicable_person to contact ----------------------- id no ------------------- --------------------------------------------------- telephone number -------------------- refer reply to cc psi b3 plr-116433-14 date date internal_revenue_service number release date index number ----------------------------------- -------------------------------------- -------------------------------------------- -------------------------------------- x ----------------------------------- ------------------------ state ----------------- date -------------------------- date ----------------------- date --------------------- date ---------------------------- date ---------------------- date ---------------------------- date ------------------ year ------- year ------- dear ---------------- this letter responds to a letter dated date and subsequent correspondence written on behalf of x requesting a ruling under sec_1362 of the internal_revenue_code plr-116433-14 facts the information submitted states that x was formed as a state limited_liability_company pursuant to an operating_agreement dated as of date and made an election to be treated as an s_corporation effective date x’s operating_agreement was amended and restated as of date to authorize the issuance of new classes of membership interests in x preferred units class b common units and class c common units the shares held by the original members were classified as class a common units the amended operating_agreement provided that a holder of the preferred units would receive preferential_distribution rights over the other members class a and class b common unit holders would share in the distributions income and losses of x on a pro_rata basis though the class a common unit holders would also receive preferential liquidation rights the class c common units holder would only receive a distribution upon the liquidation of x beginning on date through date x issued interests in some of the new classes of membership including preferred units to individual_retirement_accounts iras on date and date x redeemed all outstanding preferred units on date x redeemed all outstanding class c common units exchanged all class b common units for class a common units and amended its operating_agreement to eliminate all references to any second classes of stock as of date x only had one class of stock held by eligible shareholders x timely filed its tax returns as an s_corporation for all years x reported all items of income loss deduction and credit on a pro_rata basis for class a and b common units and made distributions only to class a and b common units no allocations or distributions were made to preferred units or class c common units x represents that it was not aware that issuing new classes of stock to shareholders and issuing stock to ineligible shareholders could terminate x's s_corporation_election x represents that any termination of its s_corporation_election was not motivated by tax_avoidance or retroactive tax planning x and its shareholders agree to make any adjustments consistent with the treatment of x as an s_corporation as might be required by the secretary x requests a ruling that termination of x’s s_corporation_election due to the issuance of multiple classes of stock or having ineligible shareholders was inadvertent within the meaning of sec_1362 furthermore notwithstanding the termination of its s_corporation_election x requests that it will be treated as an s_corporation from date and thereafter plr-116433-14 law and analysis sec_1361 provides that the term s_corporation means with respect to any taxable_year a small_business_corporation for which an election under sec_1362 is in effect for such year sec_1361 provides that the term small_business_corporation means a domestic_corporation which is not an ineligible_corporation and which does not a have more than shareholders b have as a shareholder a person other than an estate a_trust described in sec_1361 or an organization described in sec_1361 who is not an individual c have a nonresident_alien as a shareholder and d have more than one class of stock sec_1_1361-1 of the income_tax regulations provides that except as otherwise provided in sec_1_1361-1 relating to nominees sec_1_1361-1 relating to certain trusts or sec_1361 relating to certain exempt_organizations a corporation in which any shareholder is a corporation partnership or trust does not qualify as a small_business_corporation revrul_92_73 1992_2_cb_224 holds that a_trust that qualifies as an individual_retirement_account under sec_408 is not a permitted s_corporation shareholder under sec_1361 sec_1_1361-1 provides in part that a corporation that has more than one class of stock does not qualify as a small_business_corporation except as provided in sec_1_1361-1 relating to instruments obligations or arrangements treated as a second class of stock a corporation is treated as having only one class of stock if all outstanding shares of stock of the corporation confer identical rights to distribution and liquidation proceeds differences in voting rights among shares of stock of a corporation are disregarded in determining whether a corporation has more than one class of stock sec_1_1361-1 provides in part that the determination of whether all outstanding shares of stock confer identical rights to distribution and liquidation proceeds is made based on the corporate charter articles of incorporation bylaws applicable state law and binding agreements relating to distribution and liquidation proceeds collectively the governing provisions a commercial contractual agreement such as a lease employment agreement or loan agreement is not a binding agreement relating to distribution and liquidation proceeds and thus is not a governing provision unless a principal purpose of the agreement is to circumvent the one class of stock requirement although a corporation is not treated as having more than one class of stock so long as the governing provisions provide for identical distribution and liquidation rights any distributions including actual constructive or deemed plr-116433-14 distributions that differ in timing or amount are to be given appropriate tax effect in accordance with the facts and circumstances sec_1362 provides that except as provided in sec_1362 a small_business_corporation may elect to be an s_corporation sec_1362 provides that an election under sec_1362 will be terminated whenever at any time on or after the 1st day of the 1st taxable_year for which the corporation is an s_corporation such corporation ceases to be a small_business_corporation sec_1362 provides in part that if an election under sec_1362 by any corporation was terminated under sec_1362 the secretary determines that the circumstances resulting in such termination were inadvertent no later than a reasonable period of time after discovery of the circumstances resulting in such termination steps were taken so that the corporation for which the termination occurred is a small_business_corporation and the corporation for which the termination occurred and each person who was a shareholder in the corporation at any time during the period specified pursuant to sec_1362 agrees to make such adjustments consistent with the treatment of the corporation as an s_corporation as may be required by the secretary with respect to such period then notwithstanding the circumstances resulting in such termination such corporation shall be treated as an s_corporation during the period specified by the secretary sec_1_1362-4 provides in part that in the case of stock held by an ineligible shareholder that causes an inadvertent termination for an s_corporation under sec_1362 the commissioner may require the ineligible shareholder to be treated as a shareholder of the s_corporation during the period the ineligible shareholder actually held stock in the corporation conclusion based solely on the facts submitted and representations made we conclude that x’s s_corporation_election terminated on date as a result of x issuing units in more than one class of stock between date and date some of which were issued to ineligible shareholders we further conclude that the termination constituted an inadvertent termination within the meaning of sec_1362 x has taken corrective action so that it once again meets the requirements of a small_business_corporation under sec_1361 in addition x and its shareholders agree to make the adjustments discussed below therefore we determine that pursuant to the provisions of sec_1362 x will be treated as continuing to be an s_corporation from date and thereafter provided that x’s s_corporation_election was otherwise valid and plr-116433-14 apart from the inadvertent termination ruling described above has not otherwise terminated under sec_1362 as a condition for this ruling for any_tax periods between date and date in which x reported a net_loss shareholders who were iras will be treated as the shareholders of the shares of stock held by them at that time for any_tax periods between date and date in which x reported a net gain the beneficiaries of the iras will be treated as the shareholders of the shares of stock held by iras furthermore this ruling is contingent on x making corrective distributions so that the shareholders of the preferred units class a common units and class b common units receive distributions proportionate to their interests in x from date through date within days of the date of this letter if x has not already done so under these facts and circumstances we are not requiring x to make corrective distributions to the holder of the class c common units for taxable years ending year and year x and the shareholders of the preferred units class a common units and class b common units agree to amend their tax returns consistent with the treatment described above if x fails to make the corrective distributions or if x or these shareholders fail to treat themselves as described above this ruling shall be null and void except as specifically set forth above we express or imply no opinion as to the federal tax consequences of the facts described above under any other provision of the code in particular no opinion is expressed as to whether x is otherwise eligible to be an s_corporation this ruling is directed only to the taxpayer that requested it sec_6110 provides that it may not be used or cited as precedent pursuant to a power_of_attorney on file with this office we will send a copy of this letter_ruling to x’s authorized representative plr-116433-14 the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the rulings requested it is subject_to verification on examination sincerely holly porter chief branch office of the associate chief_counsel passthroughs special industries enclosures a copy of this letter a copy for sec_6110 purposes


internal_revenue_service number release date index number ----------------------------- ------------------------------------ ------------------------------------------ ----------------------------------- ----------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------- id no ------------------ telephone number ---------------------- refer reply to cc corp b01 plr-128576-16 date march legend global parent opco former parent sub1 sub2 --------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- ------------------------------ --------------------------------------------------------------------------------------- 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--------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- plr-128576-16 sub3 sub4 --------------------------------------------------------------------------------------- -------------- --------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- -------------------------------------------- state a -------------- date date date date date date date ------------------- --------------------------- ------------------------ ------------------------ ----------------- ---------------------------- ---------------------------- dear ------------------- this letter responds to your authorized representative’s letter dated date requesting rulings on certain federal_income_tax consequences of the transaction described below the transaction the information provided in that request and in subsequent correspondence is summarized below the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalties of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination plr-128576-16 facts global parent is a state a corporation and the parent of a worldwide group of corporations global parent’s stock is publicly traded global parent is also the common parent of a consolidated_group within the meaning of sec_1 h the global parent group prior to date through an entity disregarded for federal_income_tax purposes global parent wholly owned opco opco indirectly owned all the equity interests in former parent former parent wholly owned sub1 sub1 wholly owned sub2 sub2 wholly owned sub3 and sub3 wholly owned sub4 sub1 through sub4 collectively the subsidiaries the subsidiaries were all domestic corporations and members of the global parent group sub4 was the successor to a predecessor_corporation in a reorganization that the taxpayer represents qualified under sec_368 the reorganization on date all of the basis in such predecessor’s stock became reflected in the basis of sub4 stock any reference herein to sub4 includes a reference to such predecessor as the context requires prior to date former parent was the common parent of a consolidated_group the former parent group in the former parent group former parent wholly owned sub4 sub4 wholly owned sub1 sub1 wholly owned sub2 and sub2 wholly owned sub3 on date former parent sold a portion of the stock of sub4 to sub3 in exchange for a note from sub3 the sale the sub4 sale and the note the sub3 note former parent realized a capital_gain on the sub4 sale the intercompany gain and the intercompany gain was deferred under sec_1_1502-13 on date sub4 distributed all of its interest in sub1 to former parent on date opco acquired former parent and as a result the former parent group terminated former parent and the subsidiaries joined the consolidated_group of which opco was the common parent the opco group on date global parent acquired opco and as a result the opco group terminated opco former parent and the subsidiaries joined the global parent group on date former parent contributed its remaining interest in sub4 to sub1 and then caused sub1 to contribute the interest in sub4 to sub2 and then to sub3 as a result of the successive contributions sub wholly owned sub4 transaction on date and date the following steps were completed in the order specified below i on date sub4 converted to a limited_liability_company llc under state a law plr-128576-16 ii iii iv v on date sub3 converted to a llc under state a law on date sub2 converted to a llc under state a law on date sub1 converted to a llc under state a law on date former parent converted to a llc under state a law the steps described above collectively are the conversions representations a b c d e f the sub3 note was repaid in full with cash property or a combination thereof and at all times prior to its repayment the sub3 note was an intercompany obligation within the meaning of sec_1_1502-13 the conversions each qualified for non-recognition of gain_or_loss under sec_332 and sec_337 there is no plan or intention for former parent and the subsidiaries to i convert back to a corporation under state law or ii make an election under sec_301_7701-3 to be classified as a corporation for federal_income_tax purposes the effects of the sub4 sale have not previously been reflected on the former parent group’s the opco group’s or the global parent group’s returns neither the former parent group the opco group nor the global parent group has derived and no taxpayer will derive any federal_income_tax benefit from the sub4 sale that gave rise to the intercompany gain or the redetermination of the intercompany gain including adjustment to basis in member stock under sec_1_1502-32 sub3’s basis in the sub4 stock involved in the sub4 sale was eliminated in the liquidation of sub4 without the recognition of gain_or_loss with respect to such sub4 stock and sub3’s basis in such sub4 stock was not further reflected in any successor asset within the meaning of sec_1_1502-13 rulings based solely on the information submitted and the representations set forth above we rule as follows the intercompany gain is redetermined to be excluded from gross_income under sec_1_1502-13 accordingly the intercompany gain is plr-128576-16 excluded from former parent’s gross_income for the global parent group’s consolidated_return_year that includes the day of the sub4 liquidation the amount of the intercompany gain that is redetermined to be excluded from gross_income will not be taken into account as earnings_and_profits of any member and will not be treated as tax-exempt_income under sec_1_1502-32 caveats except as expressly provided herein no opinion is expressed or implied concerning the tax treatment of the proposed transaction under any provision of the code and regulations or the tax treatment of any condition existing at the time of or effects resulting from the proposed transaction that is not specifically covered by the above rulings specifically we express no opinion on whether the reorganization qualified under sec_368 procedural statements this letter is directed only to the taxpayer requesting it sec_6110 of the code provides that this letter may not be used or cited as precedent a copy of this letter must be attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of this ruling letter pursuant to the power_of_attorney on file in this matter a copy of this letter is being sent to your authorized representative sincerely ______________________________ william w burhop assistant to the branch chief branch office of associate chief_counsel corporate


t c memo united_states tax_court valerie jean genck petitioner v commissioner of internal revenue respondent docket no filed date valerie jean genck pro_se reginald r corlew for respondent memorandum opinion dinan special_trial_judge this case was heard pursuant to the provisions of sec_7443a and rule sec_180 sec_181 and sec_182 unless otherwise indicated all section references are to the internal_revenue_code in effect for the taxable_year in issue all rule references are to the tax_court rules_of_practice and procedure respondent determined a deficiency in petitioner's federal_income_tax for in the amount of dollar_figure an addition_to_tax pursuant to sec_6651 in the amount of dollar_figure and an accuracy-related_penalty pursuant to sec_6662 in the amount of dollar_figure the issues for decision are whether petitioner is entitled to schedule c business_expense deductions whether petitioner is liable for the sec_6651 addition_to_tax and whether petitioner is liable for the sec_6662 accuracy-related_penalty some of the facts have been stipulated and are so found the stipulations of fact and the attached exhibits are incorporated herein by this reference petitioner resided in hollywood florida on the date the petition was filed in this case petitioner works as a self-employed musician and band manager she and her husband matthew genck are members and managers of a jazz band named paris the band petitioner spends an average of hours per week performing as the band's lead singer matthew plays the bass guitar although petitioner and matthew are primarily responsible for managing the band they generally split the band's profits and expenses three ways with respondent's adjustments to petitioner's liability for self-employment taxes and deduction for one-half of such liability are computational and will be resolved by the court's holdings on the issues in this case petitioner's brother-in-law john genck who is the band's drummer composer and technical expert the band also has a full-time keyboard player jim gazier and various part-time accompanying musicians who do not share in the band's profits the band performs at weddings and nightclubs at various locations in the tricounty area of dade county broward county and palm beach county florida petitioner and matthew reside in an apartment located above a marketplace pincite hollywood boulevard in hollywood florida the apartment is divided in roughly equal areas into living quarters and an office the two areas are connected by a single door the living quarters consist of two bedrooms a living room a kitchen and a bathroom the office consists of a large studio and a smaller room located adjacent thereto the studio contains recording equipment and computers it also contains filing cabinets in which the band's contracts sheet music and supplies are stored the smaller room contains a desk a telephone a couch and a kitchenette unlike the band's other expenses since the office is part of petitioner and matthew's apartment they each paid and claimed deductions for percent of the band's office-related expenses for petitioner spends an average of hours per week managing the band out of the office she promotes the band through the distribution of advertising flyers which are designed on the office computers she books the band's performances and negotiates contracts with its clients she maintains files of the band's lyrics music books and audio and video demos she is responsible for hiring accompanying musicians coordinating their stage apparel and issuing their paychecks all of the above-mentioned management activities are conducted in the office the first issue for decision is whether petitioner is entitled to schedule c business_expense deductions petitioner filed her return under married_filing_separately filing_status on a schedule c attached to her return petitioner reported gross_receipts in the amount of dollar_figure and claimed the following deductions bad_debt car and truck expenses depletion insurance interest professional services office expenses rental of business property supplies travel meals and entertainment utilities stage clothes stage makeup miscellaneous dry cleaning donations dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure in the statutory_notice_of_deficiency respondent disallowed all of the claimed deductions respondent's determinations in the statutory_notice_of_deficiency are presumed to be correct and petitioner bears the burden of proving otherwise rule a 290_us_111 moreover deductions are strictly a matter of legislative grace and petitioner bears the burden of proving her entitlement to any deductions claimed rule a 503_us_79 292_us_435 sec_162 allows a deduction for the ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying_on_a_trade_or_business although we will address each of petitioner's claimed business_expense deductions separately infra we generally find that petitioner's testimony was entirely credible and do not hesitate to rely on it petitioner appeared at trial in possession of well-organized written documentation of all of the claimed expenses in our view respondent's counsel accepted her testimony as adequate substantiation in light of his repeated failure to ask her to corroborate her testimony with documentary_evidence moreover the statutory_notice_of_deficiency does not reveal respondent's basis for the blanket disallowance of the claimed deductions significantly respondent's counsel was unable to state at trial whether or not substantiation of the amounts claimed was an issue in the case we therefore only address the question of whether she is entitled to deductions for the amounts paid home_office expenses - rent and utilities petitioner claimed deductions for rent and utilities paid with respect to her home_office in the amounts of dollar_figure and dollar_figure respectively sec_280a provides that in the case of a taxpayer who is an individual no deduction otherwise allowable under chapter of the code relating to normal taxes and surtaxes shall be allowed with respect to the use of a dwelling_unit which is used by the taxpayer during the taxable_year as a residence the term dwelling_unit includes a house apartment condominium or similar_property and all structures or other_property appurtenant to such dwelling_unit sec_280a sec_280a provides for exceptions to sec_280a in pertinent part sec_280a states that sec_280a shall not apply to any item to the extent that such item is allocable to a portion of the dwelling_unit which is exclusively used on a regular basis as the principal_place_of_business for any trade_or_business of the taxpayer we are convinced from the record that percent of petitioner's apartment was exclusively used on a regular business for her band management activities we must also however address the question of whether the home_office constitutes her principal_place_of_business the supreme court in 506_us_168 postulated two primary considerations to decide whether an office located within a taxpayer's dwelling_unit is a taxpayer's principal_place_of_business the relative importance of the activities performed at each business location and the time spent at each place id pincite we find that the importance of and the time spent on the activities performed at the office are sufficient to support its treatment as petitioner's principal_place_of_business as manager of the band in addition to the various managerial and administrative activities conducted at the office the band recorded and edited its promotional video and audio tapes in the studio the office computers and other equipment were also used to both create and mix portions of the band's songs we are further persuaded by the fact that petitioner spent an average of hours per week working in the home_office petitioner's role as the band's manager and the importance and extent of her time spent on activities performed in the office convinces us that her home_office constitutes her primary place of business as the band manager accordingly we hold that petitioner is entitled to the deductions claimed by her as her share of the rent and utilities attributable to her home_office car and truck expenses petitioner claimed a deduction in the amount of dollar_figure for expenses paid for transporting the band's equipment and members from the home_office to their various performance locations since we have found supra that petitioner's home_office is properly treated as her primary place of business as the band manager it follows that the claimed transportation_expenses are not commuting expenses and may therefore be deductible under sec_162 as travel_expenses between places of business 73_tc_766 kahaku v commissioner tcmemo_1990_34 insurance petitioner claimed a deduction for insurance paid in the amount of dollar_figure she testified that the claimed expense represents the amount_paid by her for car insurance however petitioner failed to address whether such amount was allocated according to her business and personal_use of the car we therefore hold that petitioner is not entitled to the claimed insurance deduction of dollar_figure meals and entertainment petitioner claimed a deduction for meals and entertainment in the amount of dollar_figure after accounting for certain limitations the amount claimed consists of the per_diem_allowance for meals paid for by petitioner while she was performing at various locations based upon our review of the record we hold that such meal expenses are not deductible because the amount claimed was for personal living_expenses sec_262 bad_debt petitioner claimed a deduction for a bad_debt in the amount of dollar_figure on her return as her share of an uncollected fee for one of the band's performances in august of the band entered into a contract with the spectrum club to perform two nights for dollar_figure the band contracted with side men independent musicians to perform with the group and guaranteed the side men's wages spectrum paid the band for one night's performance it did not pay the band for the second night the band however paid the side men their wages for the second night's performance based upon the facts presented we find that petitioner may not deduct the dollar_figure claimed as a bad_debt we do however hold that she is entitled to claim the dollar_figure as an ordinary and necessary business_expense sec_162 depreciation petitioner claimed a deduction in the amount of dollar_figure as depletion at trial the parties agreed that the claimed deduction was intended to be for depreciation of equipment purchased during petitioner submitted a number of checks in support of the claimed deduction she contends that she properly deducted the entire cost of the equipment pursuant to sec_179 sec_179 allows a taxpayer to elect to treat the cost of sec_179 property as a current_expense in the year such property is placed_in_service within certain dollar limitations sec_179 an election under sec_179 must be made on the taxpayer's original return for the taxable_year or a timely filed amended_return sec_179 sec_1_179-4 income_tax regs the election must specify the items of sec_179 property to which the election applies and the cost of each of the items sec_179 sec_1_179-4 and income_tax regs petitioner did not make the requisite election on her return because she failed to specify the items for which the sec_179 deduction was claimed therefore we hold that she is not entitled to a sec_179 deduction for after reviewing the checks submitted by petitioner we are satisfied that the amounts were paid for musical equipment consisting of covers and cases that may be depreciated however petitioner failed to provide an explanation for the difference between the amount listed on her return dollar_figure and the amount substantiated by the checks dollar_figure we hold that petitioner is entitled to depreciate musical equipment placed into service in in the total amount of dollar_figure which represents her one-third share of the total amount shown on the checks we instruct the parties to determine the proper amount of petitioner's depreciation deduction in the petitioner failed to attach to her return a form_4562 on which the specific items to be deducted under sec_179 must be listed rule computation in accordance with the appropriate sec_168 classification interest petitioner claimed a deduction for interest_paid in the amount of dollar_figure the interest claimed consists of one- half of the interest_paid during on petitioner's credit card debt and interest_paid during on a loan obtained by petitioner to pay for studio recording time sec_163 provides that there shall be allowed as a deduction all interest_paid or accrued within the taxable_year on indebtedness however sec_163 generally disallows any deduction for personal_interest paid_or_accrued during the taxable_year although petitioner testified that she used her credit cards for both business and personal expenses we accept her estimate that percent of her credit card interest was paid on debt incurred for business purposes based upon her credible testimony since the interest_paid on the debt incurred to pay for studio recording time is directly related to petitioner's business we hold that she is entitled to her claimed deduction for interest_expense rental of recording studio petitioner claimed a deduction for rental of business property in the amount of dollar_figure the amount claimed includes dollar_figure paid as rent for the home_office discussed supra and dollar_figure paid as rent for studio recording time petitioner did not explain what the remaining amount of dollar_figure was claimed for therefore we hold that petitioner in addition to the dollar_figure of rent for the home_office is only entitled to a deduction in the amount of dollar_figure for studio recording time as an ordinary and necessary business_expense sec_162 professional services petitioner claimed a deduction for professional services in the amount of dollar_figure the amount claimed represents payments to an engineer for mastering the final tracks of the band's audio and video tapes we hold that this expense is deductible as an ordinary and necessary business_expense sec_162 office expenses petitioner claimed a deduction for office expenses in the amount of dollar_figure the amount claimed consists of payments for stamps paper goods typewriter ribbons and computer disks we hold that these expenses are deductible as ordinary and necessary business_expenses sec_162 supplies petitioner claimed a deduction for supplies in the amount of dollar_figure the amount claimed consists of payments for promotional glossy photographs and cassettes and compact disks containing songs requested by customers but not previously included in the band's repertoire we hold that these expenses are deductible as ordinary and necessary business_expenses sec_162 travel petitioner conceded at trial that she could not explain the claimed deduction for travel in the amount of dollar_figure accordingly we hold that she is not entitled to a deduction for that amount stage clothes petitioner claimed a deduction for stage clothes in the amount of dollar_figure the amount claimed consists of clothes purchased by petitioner and worn during her performances we had the opportunity at trial to view examples of the type of clothing worn by petitioner in her performances and agree with her that such clothes are not suitable for ordinary use we hold that the amount she paid for stage clothes is deductible as an ordinary and necessary business_expense sec_162 teschner v commissioner tcmemo_1997_498 stage makeup petitioner claimed a deduction for stage makeup in the amount of dollar_figure we hold that the amount claimed is deductible as an ordinary and necessary business_expense sec_162 dry cleaning donations and miscellaneous expenses petitioner claimed deductions for dry cleaning donations and miscellaneous expenses in the amounts of dollar_figure dollar_figure and dollar_figure respectively petitioner failed to explain the nature of these expenses or how they specifically relate to her music business we hold that the amounts claimed are not deductible as ordinary and necessary business_expenses the second issue for decision is whether petitioner is liable for the sec_6651 addition_to_tax for sec_6651 imposes an addition_to_tax for failure to timely file a return unless the taxpayer establishes that such failure is due to reasonable_cause and not due to willful neglect reasonable_cause requires the taxpayer to demonstrate that she exercised ordinary business care and prudence and was nonetheless unable to file a return within the prescribed time 469_us_241 willful neglect means a conscious intentional failure or reckless indifference id pincite the addition_to_tax equal sec_5 percent of the tax required to be shown on the return if the failure_to_file is for not more than month with an additional percent for each additional month or fraction of a month during which the failure_to_file continues not to exceed a maximum of percent sec_6651 petitioner's return was due on date sec_6072 she applied for and received an automatic 4-month extension of time to file until date sec_6081 sec_1_6081-4 income_tax regs petitioner's return was not received by respondent until date allowed an extra day to file the return sec_7503 since date fell on a sunday petitioner was petitioner did not dispute in her petition or address at trial respondent's determination that she is liable for the sec_6651 addition_to_tax we therefore find that she has failed to prove that her failure to timely file her return was not due to willful neglect or that such failure was due to reasonable_cause accordingly we hold that petitioner is liable for the sec_6651 addition_to_tax for the third issue for decision is whether petitioner is liable for the sec_6662 accuracy-related_penalty for respondent's determination of negligence is presumed to be correct and petitioner bears the burden of proving that the penalty does not apply rule a welch v helvering u s pincite 58_tc_757 sec_6662 imposes a 20-percent penalty on the portion of an underpayment attributable to any one of various factors one of which is negligence or disregard of rules or regulations sec_6662 respondent determined that petitioner is liable for the accuracy-related_penalty imposed by sec_6662 for her underpayment_of_tax in and that such underpayment was due to negligence or disregard of rules or regulations negligence includes a failure to make a reasonable attempt to comply with the provisions of the internal revenue laws or to exercise ordinary and reasonable care in the preparation of a tax_return sec_6662 sec_1_6662-3 income_tax regs disregard includes any careless reckless or intentional disregard of rules or regulations sec_6662 sec_1_6662-3 income_tax regs sec_6664 however provides that the penalty under sec_6662 shall not apply to any portion of an underpayment if it is shown that there was reasonable_cause for the taxpayer's position with respect to that portion and that the taxpayer acted in good_faith with respect to that portion the determination of whether a taxpayer acted with reasonable_cause and in good_faith is made on a case-by-case basis taking into account all the pertinent facts and circumstances sec_1_6664-4 income_tax regs the most important factor is the extent of the taxpayer's effort to assess her proper tax_liability for the year id after reviewing the record and considering our holdings on the claimed deductions we find that petitioner has proved that she acted in good_faith with respect to her underpayment_of_tax the record shows that she made a reasonable effort to assess her proper tax_liability accordingly we hold that petitioner is not liable for the sec_6662 accuracy-related_penalty for to reflect the foregoing decision will be entered under rule


internal_revenue_service number release date index number 263a 263a 263a 263a ---------------------------- --------------------------- ------------------ -------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact --------------- id no ------------- telephone number --------------------- refer reply to cc ita b06 plr-100399-08 date date legend taxpayer ------------------------------------------------------ date date product s date ----------------- --------------------- ---------------------- ------------- --------------------- dear ------------------------ taxpayer is requesting a ruling under sec_1_381_c_5_-1 of the income_tax regulations to receive the commissioner’s consent to change to a method other than the principal method_of_accounting specifically taxpayer is requesting consent to change its method_of_accounting for and allocating costs under sec_263a of the internal_revenue_code and the regulations thereunder for the taxable_year beginning date and ending date the facts submitted indicate that taxpayer filed a consolidated_return with s its wholly- owned subsidiary for the taxable_year ending date taxpayer was under examination on the date the private_letter_ruling request was filed taxpayer submitted a statement certifying that to the best of taxpayer's knowledge the same method_of_accounting is not an issue under consideration or an issue placed in suspense by the examining agent s taxpayer manufactures product taxpayer accounts for its inventory under the first-in_first-out fifo method valued at cost or market whichever is lower taxpayer plr-100399-08 allocates its direct_material_costs direct_labor_costs and indirect_costs fully allocable to production activities to property produced using the standard_cost_method taxpayer states that it does not capitalize certain indirect_costs required to be capitalized under sec_263a these costs include royalties and book tax differences related to inventoriable costs taxpayer uses reasonable factors and relationships to determine capitalizable mixed_service_costs taxpayer allocates additional sec_263a costs to ending inventory based on a direct labor turnover ratio s does not allocate any additional sec_263a costs to ending inventory taxpayer liquidated s on date in a transaction qualifying as a tax-free_liquidation under sec_332 subject_to sec_381 and the regulations thereunder the businesses of taxpayer and s were not operated as separate trades_or_businesses under sec_446 and sec_1_446-1 immediately after the transactions insofar as taxpayer combined the separable books_and_records into a single trial balance taxpayer is requesting a private_letter_ruling because of sec_1_381_c_5_-1 this regulation provides in relevant part that if an acquiring_corporation is not permitted to continue the use of the method of taking inventories used by it or the distributor or transferor_corporation or corporations on the date of distribution or transfer and is not permitted under sec_1_381_c_5_-1 to use the principal method of taking inventories then such acquiring_corporation must request the commissioner to determine the appropriate method of taking inventories taxpayer determined that its method_of_accounting for and allocating costs under sec_263a is the principal method under sec_1_381_c_5_-1 taxpayer states that the principal method_of_accounting for and allocating costs under sec_263a is an impermissible method under sec_263a and the regulations thereunder accordingly taxpayer must request a private_letter_ruling under sec_1_381_c_5_-1 to use a method other than the principal method sec_1 236a-1 g i provides in relevant part that using reasonable factors or relationships a taxpayer must allocate mixed_service_costs using a direct_reallocation_method a step-allocation_method or any other reasonable allocation method as defined under the principles of sec_1_263a-1 sec_1_263a-1 provides in relevant part that an allocation method is reasonable if with respect to the taxpayer’s production activities taken as a whole i the total costs actually capitalized during the taxable_year do not differ significantly from the aggregate costs that would be properly capitalized using another permissible method described in sec_1_263a-1 with appropriate consideration given to the volume and value of the taxpayer’s production activities the availability of costing information the time and cost of using various allocation_methods and the accuracy of the allocation method chosen as compared with other allocation_methods ii the allocation method is applied consistently by the taxpayer and iii the allocation method is not used to plr-100399-08 circumvent the requirements of the simplified methods in sec_1_263a-1 sec_1_263a-2 sec_1_263a-3 or the principles of sec_263a sec_1_263a-2 provides the formula for allocating additional sec_263a costs to eligible_property remaining on hand at the close of the taxable_year under the simplified_production_method under its proposed method taxpayer will determine capitalizable mixed_service_costs using a reasonable allocation method see sec_1_263a-1 under this method taxpayer will allocate its service_costs to particular activities based on a factor or relationship that reasonably relates the service cost to the benefits received from the service activity taxpayer will determine the capitalizable portion of the cost of most of its mixed service departments based on the proportion of time employees in the department spend performing the service activity in support of production taxpayer will determine an initial capitalization factor for each department in the year_of_change and will update the factor at regular intervals taxpayer will use the simplified_production_method without the historic absorption ratio election to allocate its additional sec_263a costs to ending inventory see sec_1 263a- b the sec_471 costs under the simplified_production_method will include direct material direct labor and indirect_costs fully allocable to production activities other than interest the additional sec_263a costs under the simplified_production_method will include mixed_service_costs allocable to production activities royalties and book tax differences relating to inventoriable costs pursuant to sec_1_381_c_5_-1 taxpayer will compute the adjustments necessary to reflect taxpayer and s’s change to the proposed sec_263a method in the same manner as if on the date of the liquidation taxpayer and s initiated a change to the proposed sec_263a method and will take the adjustments into account in computing taxable_income in the taxable_year that includes the transaction accordingly the commissioner under sec_1_381_c_5_-1 grants consent to taxpayer to use a method other than the principal method_of_accounting as determined under sec_1_381_c_5_-1 and allows taxpayer to change its method_of_accounting to its proposed method except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter taxpayer’s use of a reasonable allocation method for determining its capitalizable mixed_service_costs is based on the assumption that the total costs actually capitalized during the taxable_year under the proposed method will not differ significantly from the aggregate costs that would properly be capitalized using the methods_of_accounting for mixed_service_costs described in the regulations see sec_1_263a-1 we express no opinion regarding the propriety of taxpayer's plr-100399-08 method of allocating mixed_service_costs between production and non-production activities using a reasonable allocation method under sec_1_263a-1 these determinations are to be made by the operating division director in connection with the examination of taxpayer's federal_income_tax returns this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent one item on the priority guidance plan is guidance under sec_263a regarding the treatment of negative additional sec_263a costs under sec_1_263a-1 therefore should guidance be issued that is inconsistent with the conclusions reached in this private_letter_ruling the method_of_accounting utilized as a result of this private_letter_ruling will be subject_to change within the framework of sec_446 and sec_481 the ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for a ruling it is subject_to verification on examination in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representatives a copy of this letter must be attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter_ruling sincerely roy a hirschhorn senior technician reviewer branch income_tax accounting cc


t c memo united_states tax_court darryl l jones petitioner v commissioner of internal revenue respondent tarri m harrold-jones petitioner v commissioner of internal revenue respondent docket nos filed date janet l bolvin for petitioners melanie e senick for respondent memorandum findings_of_fact and opinion goeke judge mrs harrold-jones provided services to mr jones’ law office petitioners elected to file separate form sec_1040 individual_income_tax_return and both reported their activities as if mrs harrold-jones had been an independent_contractor respondent issued mr jones a notice_of_determination of worker classification reclassifying mrs harrold-jones as an employee of the law office respondent also issued petitioners separate notices of deficiency regarding their and returns in the notices respondent asserted that petitioners had underreported their and income claimed unsubstantiated net_operating_loss carryforwards nols and improperly claimed various deductions after concessions the issues for decision are the parties agree that on his schedule c profit or loss from business mr jones understated his gross_receipts by a total of dollar_figure petitioners concede that mr jones underreported his schedule c gross_receipts by at least dollar_figure and failed to report on his return offsetting gambling winnings and losses petitioners concede that on his return mr jones improperly claimed the following deductions the standard_deduction depreciation expenses of dollar_figure and car and truck expenses of dollar_figure petitioners concede that on his return mr jones improperly claimed depreciation expenses of dollar_figure car and truck expenses of dollar_figure and office expenses of dollar_figure respondent concedes that mr jones was entitled to deduct dollar_figure of contract labor expenses on his return and dollar_figure of rent expense on his return amounts his notice_of_deficiency disallowed petitioners concede that on mrs harrold-jones’ return she improperly claimed a dollar_figure nol carryforward deduction they also concede that on her and returns she failed to report offsetting gambling winnings and losses finally petitioners agree with respondent’s adjustments to mrs harrold- jones’ and schedules e supplemental income and loss respondent concedes that he included a nontaxable deposit of dollar_figure in his calculation of mrs harrold-jones’ taxable bank_deposits whether respondent properly reclassified mrs harrold-jones as an employee of the law office we hold that he did not whether mr jones omitted from schedule c of his return dollar_figure of gross_receipts we hold that he did not whether mr jones improperly claimed a dollar_figure nol carryforward deduction on his return we hold that he did whether mr jones improperly claimed a deduction for dollar_figure of contract labor expenses on schedule c of his return we hold that he did but that he is entitled to claim additional deductions to the extent mrs harrold-jones’ unreported income is attributable to payments from him whether mrs harrold-jones underreported her and income we hold that she did whether mrs harrold-jones improperly claimed various deductions on schedule c of her and returns we hold that she did and whether petitioners are liable for accuracy-related_penalties under sec_6662 we hold that they are not unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure findings_of_fact some facts have been stipulated and are so found petitioners resided in alaska when they filed their petitions we have consolidated their cases for trial briefing and decision mr jones is the owner of the law offices of darryl l jones law office mrs harrold-jones owns and operates a company called tarri’s business services during the years in question mrs harrold-jones performed services for the law office and also leased it commercial office space and business equipment petitioners each filed form sec_1040 for and on which they elected married_filing_separately status i respondent’s worker classification determination mr jones received a notice_of_determination of worker classification dated date informing him that respondent had determined that mrs harrold- jones was an employee during taxable years and petitioners’ returns for those years indicated that they believed mrs harrold-jones was an independent_contractor mr jones reported her payments as contract labor and rent expenses on his schedule c and mrs harrold-jones reported them as gross_receipts on her schedule c mrs harrold-jones paid self-employment_tax and mr jones paid no payroll_taxes for her on the basis of the determination respondent sought payroll_taxes from mr jones disallowed a deduction mrs harrold-jones had claimed for self- employment_taxes and reclassified as wages income mrs harrold-jones had reported on her schedules c mr jones did not file a petition with the tax_court contesting the determination mr jones regularly hires extra workers to help him manage his caseload and in he enlisted mrs harrold-jones to work on two of his largest cases petitioners were concerned that working together might damage their marital relationship so they carefully arranged their business relationship to give mrs harrold-jones as much freedom as possible mrs harrold-jones did not work at the law office she worked from petitioners’ home which was about miles away mr jones told mrs harrold-jones what he needed her to do but he allowed her to accomplish her tasks in her own time and in her own way petitioners agreed that mr jones could discharge mrs harrold-jones if the arrangement became unproductive one of the cases on which mrs harrold-jones worked involved a protracted criminal investigation against mr jones’ client the client had an eccentric personality but got along well with mrs harrold-jones so mr jones appointed her to review documents with the client and keep her calm and focused mrs harrold-jones also performed basic legal research for the law office she did not receive regular wages her cases settled in and and she received a percentage of the fees mr jones collected in addition to the paralegal services mrs harrold-jones provided she also kept track of the law office’s business receipts whenever a member of the office staff received payment from a client that person would fax a copy of the check or cash to mrs harrold-jones who would make a record of the receipt mr jones did not pay her for these services this was simply part of her role as keeper of the family finances ii respondent’s income_tax deficiency determinations petitioners received separate notices of deficiency also dated date concerning their and returns respondent determined that mr jones had underreported his income and had improperly claimed a number of deductions on his and returns respondent determined that mrs harrold-jones had underreported her and income and had claimed various improper deductions on her and schedules c and e respondent also determined that mr jones and mrs harrold-jones were liable for accuracy-related_penalties under sec_6662 a petitioners’ bookkeeping and tax reporting procedures before we address the determinations in the notices of deficiency we will briefly describe petitioners’ bookkeeping and tax reporting procedures during the years in issue mr jones maintained a receipt book at his office in which he recorded client payments he also kept a handwritten check register on which he recorded and classified his expenditures all of the income mrs harrold-jones reported on her returns for the years in issue was from the law office she used a computer_program to track and categorize her expenses darlene dotzler a certified_public_accountant with more than years of experience prepared petitioners’ returns for the years in issue petitioners gave ms dotzler their records about two weeks before the filing deadlines for both years she calculated the law office’s total receipts from mr jones’ receipt books and his bank statements she also prepared the forms 1099-misc miscellaneous income the law office distributed to its contract workers including mrs harrold- jones ms dotzler reported as total receipts for tarri’s business services the amounts reflected on mrs harrold-jones’ forms 1099-misc from the law office ms dotzler identified deductible expenses by reviewing petitioners’ bank statements mr jones’ handwritten check register and mrs harrold-jones’ computer-generated expense report when ms dotzler had completed the returns she reviewed them with petitioners for reasonableness we now turn our attention to the disputed entries on petitioners’ returns b mr jones’ schedule c gross_receipts mr jones reported gross_receipts of dollar_figure on his schedule c respondent determined that mr jones should have reported dollar_figure respondent arrived at this total by reviewing mr jones’ bank statements and a report ms dotzler had prepared summarizing his receipt book entries respondent identified taxable deposits and transfers to mr jones’ bank account totaling dollar_figure respondent also found that mr jones had recorded dollar_figure of client payments in his receipt book for respondent added the totals from these sources to calculate mr jones’ gross_receipts during the years in issue mr jones did not deposit client payments as he received them he made deposits only when the law office needed money for expenses consequently respondent could not match the payments mr jones recorded in his receipt book with the deposits reflected on the law office’s bank mr jones did not record credit card receipts in the books but ms dotzler included them on his return statements respondent concluded that mr jones’ deposits represented additional receipts not recorded in the receipt book mr jones concedes that he should have reported total receipts of dollar_figure on his schedule c the additional dollar_figure respondent calculated remains in dispute c mr jones’ nol carryforward respondent disallowed a dollar_figure nol deduction mr jones claimed on his return during respondent’s examination mr jones produced copies of his tax returns from to except for those from and and a schedule his accountant had prepared detailing the nols the law office had generated and used in each of those years the schedule indicates that the law office generated the disputed nols in taxable years and d mr jones’ contract labor expense deduction mr jones reported contract labor expenses of dollar_figure on his schedule c for the law office respondent initially determined that mr jones had incurred and paid contract labor expenses of only dollar_figure in respondent has since conceded that mr jones was entitled to an additional dollar_figure the parties also now agree that mr jones erroneously included in contract labor expenses rental payments he made to mrs harrold-jones totaling dollar_figure excluding the misclassified rental expenses dollar_figure of the contract labor expenses remain in dispute e mrs harrold-jones’ and schedule c gross_receipts on her return mrs harrold-jones reported income of dollar_figure dollar_figure on schedule c and dollar_figure on schedule e during the examination respondent’s revenue_agent reviewed mrs harrold-jones’ bank statements and determined she had made taxable deposits of dollar_figure in petitioners have prepared a schedule detailing mrs harrold-jones’ deposits the schedule is ambiguous about which deposits were taxable respondent interprets the schedule to reflect dollar_figure in taxable deposits and has consequently adopted that total as the amount mrs harrold-jones should have reported instead of the dollar_figure the revenue_agent calculated on her return mrs harrold-jones reported income of dollar_figure dollar_figure on schedule c and dollar_figure on schedule e respondent reviewed mrs harrold-jones’ bank statements and determined she had made taxable deposits of dollar_figure in f mrs harrold-jones’ home sale at trial mrs harrold-jones testified that she sold a house in and deposited about dollar_figure of the proceeds into her business account her return does not include any information concerning the sale respondent’s revenue_agent noted the deposits in her bank_deposits analysis and classified them as nontaxable on the basis of mrs harrold-jones’ testimony respondent now contends that on her return she failed to report capital_gain from the sale g mrs harrold-jones’ miscellaneous_expense_deductions mrs harrold-jones failed to provide documentation for a number of deductions she claimed on her and schedules c and respondent consequently disallowed them the table below summarizes the deductions respondent disallowed deduction supplies expense office expense insurance expense depreciation expense car and truck expense other expense utility expense dollar_figure big_number big_number big_number --- big_number big_number dollar_figure big_number big_number big_number --- big_number petitioners timely filed petitions contesting the determinations in their notices of deficiency opinion i mrs harrold-jones’ employment status a jurisdiction the parties have stipulated that mr jones did not timely file a petition challenging respondent’s determination that mrs harrold-jones was an employee accordingly we will not disturb respondent’s assessment of the additions to employment_tax he asserted in the notice_of_determination of worker classification mrs harrold-jones disputed respondent’s worker classification determination in the petition she filed in response to her notice_of_deficiency we have regularly allowed taxpayers in income_tax deficiency proceedings to challenge a change in their worker classification when the change caused any portion of their deficiency see eg weber v commissioner 103_tc_378 aff’d per curiam 60_f3d_1104 4th cir respondent’s determination that mrs harrold-jones was an employee of the law office resulted in his disallowance of her self-employment_tax deduction which contributed to her income_tax deficiencies accordingly we will review respondent’s worker classification determination b burden_of_proof we presume that a worker classification determination made by the commissioner is correct but a taxpayer may rebut that presumption by demonstrating by a preponderance_of_the_evidence that the determination was erroneous rule a 290_us_111 77_f3d_236 8th cir applying this standard to a worker classification determination c common_law test whether an individual performing services for a principal is an employee rather than an independent_contractor is a factual question to which common_law principles apply weber v commissioner t c pincite see sec_3121 sec_3306 in evaluating the relationship between the principal and the worker we consider the degree of control the principal exercised over the details of the work which party invested in the facilities the worker used the worker’s opportunity for profit or loss whether the principal could have discharged the worker whether the work was part of the principal’s regular business the permanency of the relationship and the relationship the parties believed they were creating 117_tc_263 weber v commissioner t c pincite we consider all facts and circumstances no one factor dictates the outcome ewens miller inc v commissioner t c pincite d analysi sec_1 degree of control the principal’s degree of control_over the details of the agent’s work is the most important factor in determining whether an employment relationship exists see 538_us_440 weber v commissioner t c pincite in an employer-employee relationship the principal must have the right to control not only the result of the employee’s work but also the means and method used to accomplish that result 63_tc_621 the degree of control necessary to find employee status varies according to the nature of the services provided weber v commissioner t c pincite when the nature of the work is more independent a lesser degree of control by the principal may still result in a finding of an employer-employee relationship robinson v commissioner tcmemo_2011_99 aff’d 487_fedappx_751 3d cir mr jones did not control the details of mrs harrold-jones’ work he told her what he needed done and she was free to decide how to accomplish it mrs harrold-jones’ most important responsibility was keeping an important client calm in the face of a lengthy criminal investigation the client was eccentric but got along well with mrs harrold-jones so mr jones trusted her to interact with the client and review documents with her mr jones cared only about the client’s satisfaction and did not control how mrs harrold-jones achieved it these facts suggest that mrs harrold-jones was an independent_contractor investment in facilities the fact that a worker provides his or her own facilities generally indicates independent_contractor status ewens miller inc v commissioner t c pincite mrs harrold-jones worked from her home_office and the law office did not pay any of her expenses this suggests mrs harrold-jones was an independent_contractor opportunity for profit or loss when workers have no opportunities for profit or loss they are more like employees than independent contractors see d r fin servs inc v commissioner tcmemo_2011_252 mrs harrold-jones did not receive regular wages and received payment only after the cases she worked on had settled the payments she received depended on the amounts of the settlements in her cases and she conceivably could have received nothing for her efforts thus she risked loss and her profits were linked to her performance these facts suggest mrs harrold-jones was an independent_contractor right to discharge petitioners admit that mr jones had the right to discharge mrs harrold- jones this suggests she was an employee regular business when an agent performs her work in the ordinary course of a principal’s business the agent appears to be more like an employee than an independent_contractor id mrs harrold-jones primarily worked on two cases for the law office she reviewed documents with clients and performed general legal research these activities were part of the regular business of the law office these facts suggest mrs harrold-jones was an employee permanency of the relationship a transitory work relationship may indicate independent_contractor status ewens miller inc v commissioner t c pincite mrs harrold-jones worked for the law office only while the two cases mr jones assigned her were ongoing she has not worked for the law office since the cases settled although she worked for the law office for five or six years her tenure was dependent on the continuation of her cases and could have ended at any time her tenure was lengthy but by no means permanent these facts suggest that she was an independent_contractor relationship the parties thought they created the law office treated mrs harrold-jones as an independent_contractor and she considered herself an independent_contractor the law office issued her forms 1099-misc and she paid self-employment_tax during the years in issue the record reflects that neither mr jones nor mrs harrold-jones thought mrs harrold-jones was an employee this suggests she was an independent_contractor conclusion after considering the record and weighing all of the factors we conclude that mrs harrold-jones was an independent_contractor during the years in issue although some of the relevant factors suggest mrs harrold-jones was an employee on balance the record indicates that she was an independent_contractor mr jones did not control the details of mrs harrold-jones’ work she worked from home and he did not supervise her although she ultimately worked for the law firm for several years her service depended on the length of her cases and could have ended at any time without payment if the cases had not settled favorably finally petitioners did not believe they were creating an employment relationship and took pains to avoid such a relationship we think these factors sufficiently establish that mrs harrold-jones was an independent_contractor and we hold accordingly ii petitioners’ income_tax deficiencies a burden_of_proof in these cases we address respondent’s determinations that petitioners failed to report income and improperly claimed deductions the burden_of_proof analysis is slightly different for each of these issues unreported income taxpayers are required to maintain sufficient records to enable the commissioner to establish the amount of their taxable_income sec_6001 sec_1_6001-1 and b income_tax regs if such records are lacking the commissioner may reconstruct the taxpayers’ income by any method that is reasonable under the circumstances 92_tc_661 we presume the commissioner’s determination is correct when it is based upon a reasonable method olsen v commissioner tcmemo_1982_697 respondent used the bank_deposits method to reconstruct petitioners’ income that method is well established and was reasonable under the circumstances petitioners bear the burden of proving that the deposits respondent has identified do not represent unreported income 96_tc_858 aff’d 959_f2d_16 2d cir in calculating mr jones’ unreported income respondent added to mr jones’ bank_deposits receipts mr jones had recorded in his receipt books as we discuss below this was not reasonable and we do not presume respondent’s estimate is correct to the extent it resulted from the inclusion of these additional receipts consequently respondent bears the burden of proving that the amounts from mr jones’ receipt books represent unreported income in excess of mr jones’ bank deposit totals business_expense deductions sec_162 allows taxpayers to claim deductions for ordinary and necessary business_expenses such deductions are a matter of legislative grace and taxpayers bear the burden of proving their entitlement to them rule a 503_us_79 b mr jones’ deficiencie sec_1 mr jones’ gross_receipts respondent reviewed mr jones’ records and determined that he underreported his gross_receipts by dollar_figure mr jones concedes that he underreported his receipts by dollar_figure we must resolve the dispute concerning the remaining dollar_figure respondent prepared a bank_deposits analysis indicating mr jones had made taxable deposits of dollar_figure mr jones produced a summary of his receipt book indicating that he had received dollar_figure in client payments during respondent tried to trace the payments in the receipt book to mr jones’ bank statements but could not he concluded that the deposits were completely independent of the payments in the receipt book and consequently added the totals together mr jones testified that some overlap existed between the bank_deposits and the payments he recorded in his receipt book he claims that respondent could not trace the payments to his bank statements because he did not deposit the payments as he received them respondent’s revenue_agent admitted that if the bank statement did not reflect a deposit within five days of the payment_date in the receipt book she concluded that the entries did not correspond mr jones credibly testified that he rarely made deposits within five days of receipt this explains respondent’s inability to reconcile the two sources we believe that respondent’s method caused him to double count some of mr jones’ receipts we find implausible respondent’s conclusion that none of mr jones’ deposits corresponded with any payment he recorded in his receipt book the commissioner is entitled to a presumption of correctness when he reconstructs a taxpayer’s income using any reasonable method olsen v commissioner tcmemo_1982_697 emphasis added respondent’s method was reasonable only to the extent it involved reviewing mr jones’ bank records adding mr jones’ receipt book total to his bank deposit total was not reasonable accordingly we do not presume respondent’s calculation was correct to the extent it exceeded mr jones’ taxable bank_deposits respondent has not produced sufficient evidence proving mr jones received and failed to report the additional payments in question accordingly we hold that mr jones did not underreport his gross_receipts by the dollar_figure remaining in dispute mr jones’ nol deduction sec_172 permits taxpayers to deduct their nols nols result when taxpayers’ allowable deductions exceed their gross_income sec_172 taxpayers may carry an nol back to each of the taxable years preceding the taxable_year of the loss or carry it forward over each of the taxable years following the taxable_year of the loss sec_172 taxpayers may elect to waive the two-year carryback period sec_172 on his return mr jones deducted nols he claims he generated in and mr jones elected to waive the carryback period for each of those years respondent disallowed the deduction to prevail petitioners must prove that mr jones suffered nols in the relevant years and that those nols were not absorbed in the years preceding to carry that burden petitioners must introduce convincing evidence not only of mr jones’ nols for the relevant years but also of his taxable_income for the other years carry years in the period beginning with and ending with see eg leitgen v commissioner tcmemo_1981_525 aff’d without published opinion 691_f2d_504 8th cir mr jones has produced two forms of documentary_evidence concerning his nol carryforward first he has presented a schedule detailing the nols he generated and used from second he has furnished all his returns from except those for and mr jones contends that this evidence sufficiently substantiates his entitlement to the nol carryforward he claimed we disagree although the schedule accurately reflects the operating losses mr jones reported on his returns at least for those in the record mr jones has presented little evidence concerning the activity that generated those losses or his income for the carry years his accountant testified that some of the losses resulted from mr jones’ advancing expenses in contingent_fee cases this vague testimony and mr jones’ tax returns alone are insufficient to substantiate the nol deduction see 71_tc_633 owens v commissioner tcmemo_2001_143 accordingly we hold that mr jones was not entitled to claim an nol deduction for taxable_year mr jones’ contract labor expense deduction respondent determined that mr jones claimed an excessive contract labor expense deduction after concessions and excluding expenses misclassified but otherwise deductible expenses of dollar_figure remain in dispute mr jones’ lone evidence concerning his contract labor deduction is a handwritten check register that does not agree with the amount he claimed on his return even if the register agreed with the return amount it could not by itself substantiate his contract labor expenses because it provides only the name of the payee and mr jones’ classification of the expense mr jones has presented no invoices or other evidence to substantiate the business_purpose of the expenses the register reflects respondent’s revenue_agent prepared a schedule detailing the amounts he disallowed petitioners have not offered any evidence substantiating the purpose of the identified payments accordingly we sustain respondent’s disallowance of dollar_figure of mr jones’ contract labor expense deduction c mrs harrold-jones’ deficiencie sec_1 mrs harrold-jones’ and income mrs harrold-jones reported income of dollar_figure and dollar_figure for and respectively respondent’s revenue_agent reviewed her bank statements and determined she should have reported dollar_figure and dollar_figure respectively respondent now argues that an exhibit petitioners prepared for trial represents their admission that mrs harrold-jones should have reported dollar_figure for respondent has presented no evidence of his own supporting the increased amount we find petitioners’ exhibit too ambiguous to represent an admission and consider instead respondent’s initial determination that mrs harrold-jones should have reported income of dollar_figure on her return the exhibit in question is a summary petitioners’ counsel prepared of mrs harrold-jones’ bank_deposits the schedule includes all deposits to each of mrs harrold-jones’ two bank accounts the total for the first account is dollar_figure which appears beside the caption net deposited income petitioners clearly intend this portion of the schedule to reflect that mrs harrold-jones made taxable deposits of dollar_figure to this account the second account’s total dollar_figure appears beside the caption net deposits excluding interest_income this caption does not indicate petitioners believed mrs harrold-jones made taxable deposits of dollar_figure to the second account the caption indicates that the total excludes interest_income but it does not indicate that the other deposits represented taxable_income mrs harrold-jones has had ample opportunity to review the additional taxable deposits respondent identified but she has presented little persuasive evidence that the deposits were nontaxable a dollar_figure check from mr jones represents the most significant deposit petitioners claim is nontaxable in their brief petitioners claim the payment was a christmas gift but at trial mrs jones could not remember the purpose of the deposit despite prompting from her counsel she has identified some other deposits she contends are nontaxable but her argument is based on the payor and the memo line of each check deposited this evidence is insufficient to establish the deposits she made were nontaxable accordingly we sustain respondent’s determination of mrs harrold-jones’ and taxable_income however in keeping with our conclusion that she was not an employee of the law firm we hold that her additional income was self- employment income not wages although respondent determined that some of mrs harrold-jones’ additional taxable receipts were from the law office he did not allow a corresponding increase in mr jones’ schedule c deductions we hold that mr respondent has not asserted additional self-employment_tax associated with mrs harrold-jones’ unreported income jones is entitled to deductions to the extent mrs harrold-jones’ increases in income are attributable to payments from him mrs harrold-jones’ home sale solely on the basis of mrs harrold-jones’ testimony at trial respondent alleged that mrs harrold-jones had sold property and failed to report capital_gain because respondent did not raise this argument until after trial it constitutes a new_matter and he bears the burden of proving facts sufficient to sustain his position see rule a mrs harrold-jones testified that she thought the sale occurred in but was not sure the record is unclear about when mrs harrold-jones sold the home the extent of her gain and whether the gain was taxable respondent has not proved mrs harrold-jones should have reported capital_gain on the home sale for and we accordingly hold for petitioners on this issue mrs harrold-jones’ miscellaneous_expense_deductions respondent’s revenue_agent reviewed a number of schedule c expenses for which mrs harrold-jones claimed deductions mrs harrold-jones produced documentation substantiating only portions of many of the deductions she claimed respondent disallowed the portions of the deductions mrs harrold- jones could not substantiate mrs harrold-jones has provided a list of checks she wrote during but she has presented no evidence demonstrating a business_purpose for any of the payments she has offered expense account detail reports for her deductions but has presented no supporting documents this evidence is insufficient to prove her entitlement to deductions greater than those respondent allowed and we accordingly sustain his decision to disallow them iii penalties a taxpayer may be liable for a penalty on any underpayment_of_tax attributable to negligence or disregard of rules or regulations or a substantial_understatement_of_income_tax sec_6662 and b and taxpayers may avoid accuracy-related_penalties if they can show they had reasonable_cause for their underpayments and that they acted in good_faith sec_6664 sec_1_6664-4 income_tax regs see also 115_tc_43 aff’d 299_f3d_221 3d cir sec_1_6662-3 sec_1_6664-4 income_tax regs respondent imposed accuracy-related_penalties on petitioners because he determined their underpayments were attributable to substantial understatements of income_tax or in the alternative negligence petitioners argue that they are not liable for penalties because they had reasonable_cause for their underpayments and acted in good_faith the basis for petitioners’ reasonable_cause defense is their reliance on ms dotzler to prepare their returns when taxpayers rely on the professional judgment of a competent tax adviser to whom they have provided all necessary and relevant information the taxpayers’ behavior may be consistent with ordinary business care and prudence 469_us_241 to establish reasonable_cause via reliance on the advice of a tax adviser taxpayers must prove by a preponderance_of_the_evidence that the adviser was a competent professional who had sufficient expertise to justify reliance the taxpayers provided necessary and accurate information to the adviser and the taxpayers relied in good_faith on the adviser’s judgment neonatology assocs p a v commissioner t c pincite petitioners have established these facts ms dotzler is a certified_public_accountant with more than years of experience her credentials and experience sufficiently justified petitioners reliance on her to prepare their returns petitioners provided ms dotzler with complete and accurate financial records during the years in issue petitioners furnished bank statements expense reports and income records and they were available at all hours to answer questions ms dotzler testified that petitioners provided her with sufficient information with which to prepare their returns she admitted that she made several mistakes that petitioners who lacked tax expertise could not have detected petitioners credibly testified that they relied in good_faith on ms dotzler to prepare their returns petitioners reviewed ms dotzler’s work and failed to recognize errors she made but we do not believe their failure was in bad faith petitioners have successfully established reasonable_cause for their underpayments and accordingly are not liable for accuracy-related_penalties in reaching our holdings herein we have considered all arguments made and to the extent not mentioned above we conclude they are moot irrelevant or without merit to reflect the foregoing decisions will be entered under rule