Court Opinion

ID: 6216802
Source: CourtListenerOpinion
Date Created: 2022-02-09 17:01:32.280229+00
Date Added: 2024-06-11T08:59:48.909864
License: Public Domain

United States Tax Court
                                 Washington, DC 20217

EDWARD WESTWEALTH LEW,

                Petitioner

                v.                              Docket No. 20747-19.

COMMISSIONER OF INTERNAL
REVENUE,

                Respondent

                                       ORDER

      Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is

      ORDERED that the Clerk of the Court shall transmit herewith to petitioner
and to respondent a copy of the pages of the transcript of the oral findings of fact and
opinion rendered at the conclusion of the trial. It is further

       ORDERED that the parties shall, on or before May 10, 2022, file with the Court
their computations in this case, pursuant to Rule 155, Tax Court Rules of Practice
and Procedure.

                                     (Signed) Kathleen Kerrigan
                                               Judge

                                   Served 02/09/22
                                                                  3
1    Bench Opinion by Judge Kathleen Kerrigan

2    January 27, 2022

3    Edward Westwealth Lew v. Commissioner of Internal Revenue

4    Docket No. 20747-19

5                THE COURT:   The Court has decided to render the

6    following as its oral findings of fact and opinion in this

7    case.   This bench opinion is made pursuant to the

8    authority granted by section 7459(b) of the Internal

9    Revenue Code and Tax Court Rule 152; and it shall not be

10   relied upon as precedent in any other case.    Rule

11   references in this opinion are to the Tax Court Rules of

12   Practice and Procedure, and section references are to the

13   Internal Revenue Code, as amended and in effect at all

14   relevant times.    All monetary amounts are rounded to the

15   nearest dollar.

16               By notice of deficiency dated August 21, 2019,

17   respondent determined deficiencies of $33,606, $75,807,

18   and $29,324 for 2015, 2016, and 2017 (years in issue),

19   respectively, additions to tax pursuant to section

20   6651(a)(1) of $5,156, $12,763, and $1,863 for 2015, 2016,

21   and 2017, respectively, pursuant to section 6651(a)(2) for

22   2016 and 2017, and pursuant to section 6654(a) of $142 for

23   2017, and a penalty pursuant to section 6662(a) of $6,206

24   for 2015.   Respondent concedes the addition to tax

25   pursuant to section 6651(a)(2) for 2017 and the section
                                                                  4
1    6662(a) penalty for 2015.

2               Trial in this case was conducted during the

3    Court's remote Kansas City, Missouri trial session on

4    January 25, 2022.   Petitioner represented himself.

5    Respondent was represented by Halvor R. Melom.    The

6    parties' stipulation of facts and first supplemental

7    stipulation of facts were admitted into evidence along

8    with the attached exhibits.   On the evidence before us,

9    and using the burden-of-proof principles explained below,

10   the Court finds the following facts:

11                         FINDINGS OF FACT

12              Petitioner resided in California at the time he

13   filed his petition in this case.   During the years in

14   issue petitioner was a dentist.    In 2015 and 2016 he was

15   also owner of Dickey's Barbecue Pit restaurant (Dickey's).

16   He sold his interest in Dickey's in 2016.

17              Petitioner filed an income tax return for 2015

18   but did not file income tax returns for 2016 and 2017.

19   Petitioner received income that was documented by third-

20   party reports.   ADP Totalsource XVI Inc. (ADP) issued Form

21   W-2, Wage and Tax Statement for 2015.    Chinatown Service

22   Center Inc. (Chinatown) issued Forms W-2 for the years in

23   issue.   The State of California issued a Form 1099-G,

24   Government Payments, reporting a state income tax return

25   for 2014 that was received by petitioner in 2017.       Legacy
                                                                     5
1    Reserves LP issued Schedule K-1, Partner's Share of

2    Income, Deductions, Credits, etc., for 2016.    TD

3    Ameritrade Clearing, Inc. reported qualified dividends on

4    Form 1099-DIV, Dividends and Distributions, for 2016.

5    Petitioner also was issued three Schedules K-1 from three

6    S corporations in which petitioner was the sole

7    shareholder:    Edward W Lew DMD Inc., Edward Westwealth Lew

8    DMD Inc., and Edward Lew DMD A Dental Corporation for the

9    years in issue.

10              Petitioner did not report most of these amounts

11   on his income tax returns.    For 2015 he only reported

12   wages from ADP.    He failed to report on his income tax

13   returns ordinary income and losses from the three S

14   corporations.    He also did not report any income from the

15   Schedules K-1.

16              Petitioner operated Dickey's through an LLC,

17   Westward Holdings, LLC (Westward) and he was the only

18   member of the LLC.    The LLC did not file its own tax

19   returns.   Westward had two bank accounts at the same bank.

20   Petitioner failed to report any income or expenses with

21   respect to Dickey's for 2015 and 2016.    A review of

22   Westward's bank receipts showed gross receipts of $917,228

23   and $575,347 for years 2015 and 2016, respectively.       For

24   2015 and 2016 respondent allowed costs of goods sold

25   (COGS) and certain expense deductions, including wages
                                                                   6
1    paid in 2015 and 2016.

2                 Petitioner sold his interest in Dickey's in

3    2016.   One of the two bank accounts for Westward has a

4    statement which includes images of two checks for $80,000

5    and $60,161.    The first was marked in the memo line

6    "Dickey's Barbeque Pit proceeds disbursement" and the

7    second was marked in the memo line "Dickey's Barbeque Pit

8    net proceeds balance."     Respondent determined those

9    amounts were unreported long-term capital gain.

10                Petitioner filed an extension for his 2015

11   income tax resulting in a due date of October 15, 2016.

12   Petitioner filed his 2015 return on January 8, 2018.

13   Petitioner did not file income tax returns for 2016 and

14   2017.

15                               OPINION

16                Generally, the Commissioner's determinations in

17   a notice of deficiency are presumed correct, and the

18   taxpayer bears the burden of proving those determinations

19   erroneous.     Rule 142(a)(1); Welch v. Helvering, 290 U.S.

20   111, 115 (1933).    In unreported income cases such as this,

21   the Commissioner must establish "some evidentiary

22   foundation" connecting the taxpayer with the income-

23   producing activity or demonstrating that the taxpayer

24   actually received unreported income.     See Weimerskirch v.

25   Commissioner, 596 F.2d 358, 361-362 (9th Cir. 1979), rev'g
                                                              7
1    67 T.C. 672 (1977); see also Edwards v. Commissioner, 680

2    F.2d 1268, 1270-1271 (9th Cir. 1982) (holding that the

3    Commissioner's assertion of a deficiency is presumptively

4    correct once some substantive evidence is introduced

5    demonstrating that the taxpayer received unreported

6    income).    The requisite evidentiary foundation is minimal

7    and need not include direct evidence.     See Banister v.

8    Commissioner, T.C. Memo. 2008-201, aff'd, 418 F. App'x 637

9    (9th Cir. 2011).

10               If the Commissioner introduces some evidence

11   that the taxpayer received unreported income, the burden

12   shifts to the taxpayer, who must establish by a

13   preponderance of the evidence that the deficiency was

14   arbitrary or erroneous.    See Hardy v. Commissioner, 181

15   F.3d 1002, 1004 (9th Cir. 1999), aff'g T.C. Memo. 1997-97.

16               Respondent met the burden of production as to

17   the unreported income determined in the notice of

18   deficiency.    Respondent produced the Forms W-2, Form 1099-

19   G, Schedules K-1, and bank documents with respect to

20   wages, unreported income, and unreported capital gains.

21   Unreported Income

22               Gross income generally includes all income from

23   whatever source derived, including wages, income derived

24   from business, and gains derived from dealings in

25   property.     § 61(a); Commissioner v. Glenshaw Glass Co.,
                                                              8
1    348 U.S. 426, 429-430 (1955); Wilcox v. Commissioner, 848

2    F.2d 1007, 1008 (9th Cir. 1988), aff'g T.C. Memo. 1987-

3    225; Treas. Reg. § 1.61-2(a)(1).

4              The United States Supreme Court has held

5    consistently that Congress defined gross income to exert

6    the "the full measure of its taxing power."    Commissioner

7    v. Glenshaw Glass Co., 348 U.S. at 429 (quoting Helvering

8    v. Clifford, 309 U.S. 331, 334 (1940)).

9    State Refund

10             Generally, if an amount was deducted on a prior

11   year's tax return which resulted in a reduction of tax and

12   a tax benefit to the taxpayer, a subsequent recovery by

13   the taxpayer of such amount must be included in gross

14   income in the year the recovery is received.     § 111(a);

15   Kadunc v. Commissioner, T.C. Memo. 1997-92.

16             Therefore, gross income includes a refund of

17   State income tax in the year received to the extent that

18   the payment of such tax was claimed as a deduction in a

19   prior taxable year which deduction resulted in a reduction

20   of Federal income tax.   See Kadunc v. Commissioner, supra.

21   Petitioner provided no evidence to show that he did not

22   receive a refund from the State of California.

23   S Corporation Income

24             Section 1366(a) provides that income, losses,

25   deductions, and credits of an S corporation are passed
                                                                 9
1    through pro rata to its shareholders on their individual

2    income tax returns.   The character of each item of income

3    is determined as if it were realized directly from the

4    source from which the corporation realized it or incurred

5    in the same manner as it was by the corporation.    §

6    1366(b).   A shareholder's gross income includes his or her

7    pro rata share of the S corporation's gross income.     §

8    1366(c).

9               Petitioner was the sole shareholder of three S

10   corporations during the years in issue.    Petitioner failed

11   to substantiate any amount of adjusted stock or debt for

12   these three corporations.   He is not entitled to flow-

13   through loss that he claimed on his Schedule E,

14   Supplemental Income and Loss, for 2015.   He is also not

15   entitled to losses reported for these S corporations on

16   their Schedules K-1 for the years in issue; however, he is

17   allowed flow-through loss of $16,992 for 2017 for Edward W

18   Lew DMD, Inc. because there was enough stock basis for

19   2015 and 2016 to permit the deduction.    Respondent

20   concedes this adjustment of $16,992 for 2017.

21              Petitioner failed to report his share of the

22   income reported on the Schedules K-1 for the three S

23   corporations for the years in issue.   Therefore, no

24   additional adjustments should be made to respondent's

25   determinations.
                                                               10
1    Sale of Property

2               Taxpayers are required to recognize gain on the

3    sale of property in an amount equal to the difference

4    between the amount realized and their basis.    § § 1001 and

5    1012.   A long-term capital gain is the gain from the sale

6    of a capital asset held for longer than a year.     §

7    1222(4).   The taxpayer has the burden of showing

8    entitlement to basis in an asset sold.   See Arnold v.

9    Commissioner, T.C. Memo. 2003-259. Petitioner failed to

10   substantiate any basis, and therefore, he has an

11   unreported long-term capital gain of $140,162 for 2016.

12   Business Income

13              Where the taxpayer fails to keep sufficient

14   records under section 6001, the Commissioner may compute

15   taxable income through a method that "does clearly reflect

16   income."   § 446(b); Petzoldt v. Commissioner, 92 T.C. 661

17   (1989).

18              The Commissioner's use of the bank deposits

19   method has long been approved when the taxpayer fails to

20   keep sufficient records under section 6001.    Nicholas v.

21   Commissioner, 70 T.C. 1057, 1064 (1978); see also Good v.

22   Commissioner, T.C. Memo. 2012-323, at *25.

23              This method "assumes that all money deposited in

24   a taxpayer's bank account during a given period

25   constitutes taxable income, but the Government must take
                                                             11
1    into account any nontaxable source or deductible expense

2    of which it has knowledge."     Clayton v. Commissioner, 102

3    T.C. 632, 645-646 (1994).     The bank deposits method

4    provides prima facie evidence of income, and the

5    Commissioner is not required to prove the likely source of

6    the income.     Tokarski v. Commissioner, 87 T.C. 74, 77

7    (1986).

8                The taxpayer shoulders the burden of

9    establishing that items "should be excluded from income or

10   allowed as deductions."     Gemma v. Commissioner, 46 T.C.

11   821, 833 (1966); see also Clayton v. Commissioner, 102

12   T.C. at 645.

13               Petitioner failed to report any income or

14   expenses with respect to Dickey's for 2015 and 2016.

15   Respondent reviewed the bank statements of Westward and

16   totaled the deposits to determine the gross receipts not

17   reported.     Petitioner also failed to report Schedule C

18   other income of $1,261 and $1,439 for 2015 and 2016,

19   respectively.

20               An ordinary expense is one that commonly or

21   frequently occurs in the taxpayer's business, Deputy v. du

22   Pont, 308 U.S. 488, 495 (1940), and a necessary expense is

23   one that is appropriate and helpful in carrying on the

24   taxpayer's business, Commissioner v. Heininger, 320 U.S.

25   467, 471 (1943); Treas. Reg. § 1.162-1(a).     A taxpayer may
                                                                  12
1    not deduct a personal, living, or family expense unless

2    the Code expressly provides otherwise.     § 262(a).

3    Normally, the Court may estimate the amount of a

4    deductible expense if a taxpayer establishes that an

5    expense is deductible but is unable to substantiate the

6    precise amount.   See Cohan v. Commissioner, 39 F.2d 540,

7    543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C.

8    731, 742-743 (1985).    This principle is often referred to

9    as the Cohan rule.     See, e.g., Estate of Reinke v.

10   Commissioner, 46 F.3d 760, 764 (8th Cir. 1995), aff'g T.C.

11   Memo. 1993-197.

12             COGS is an offset subtracted from gross receipts

13   in determining gross income, Treas. Reg. § § 1.61-3(a),

14   1.61-6(a), and is not a deduction, see Metra Chem Corp. v.

15   Commissioner, 88 T.C. 654, 661 (1987).    Any amount claimed

16   as COGS must be substantiated, and taxpayers are required

17   to maintain records sufficient for this purpose.        § 6001;

18   Nunn v. Commissioner, T.C. Memo. 2002-250, slip op. at 16;

19   Treas. Reg. § 1.6001-1(a).

20             Respondent used discretion provided under Cohan

21   to allow petitioner a substantial amount of COGS and

22   Schedule C expenses.    Petitioner provided no

23   substantiation for the allowance of increase COGS or

24   additional expenses.

25             Therefore, petitioner is entitled to only the
                                                                13
1    amount allowed by respondent.

2               Petitioner contends that he should be allowed

3    deductions for the repayment of loans to himself, to

4    another person, and for payments of car that petitioner

5    contends was used in the business.    Respondent did not

6    include loans in income.    Petitioner did not provide

7    substantiation of the loans and was not able to show the

8    amount of the payment that was interest.    Accordingly,

9    there will be no further deduction beyond the deductions

10   already allowed by respondent.

11   Additions to Tax

12              Section 6651(a)(1) authorizes the imposition of

13   an addition to tax for failure to timely file a return.

14   The 2015 tax return was filed after October 15, 2016.      No

15   returns were filed for 2016 and 2016.    Petitioner did not

16   show reasonable cause and is liable for the additions to

17   tax pursuant to section 6651(a)(1) for the years in issue.

18              Section 6651(a)(2) imposes an addition to tax on

19   taxpayers for their failure to timely pay the amount of

20   tax shown on a return.     This addition to tax applies only

21   when an amount of tax is shown on a return.     § 6651(a)(2),

22   (g)(2).   When a taxpayer has not filed a valid return, the

23   section 6651(a)(2) addition to tax may not be imposed

24   unless the Secretary has prepared a substitute for return.

25   See Wheeler v. Commissioner, 127 T.C. 200, 210 (2006),
                                                                  14
1    aff'd, 521 F.3d 1289 (10th Cir. 2008).     Respondent has

2    established that the Secretary prepared a substitute for

3    return for 2016   that satisfies the requirements of

4    section 6020(b) by providing Forms 4549, 886-A, and 13496

5    for 2016.   See Cabirac v. Commissioner, 120 T.C. 163, 170-

6    172 (2003), aff'd without published opinion, 94 A.F.T.R.

7    2d (RIA) 2004-5490 (3d Cir. 2004).

8                Respondent has shown that petitioner has failed

9    to pay his Federal income tax obligation for 2016.

10   Petitioner has not shown reasonable cause and is liable

11   for the addition to tax pursuant to section 6651(a)(2).

12               Section 6654(a) imposes an addition to tax on

13   underpayment of estimated tax unless an exemption applies.

14   Respondent's burden of production under section 7491(c)

15   with respect to the section 6654(a) tax has been satisfied

16   since petitioner had income tax liability for 2016 and

17   made no estimated tax payments for that year.

18               Generally, no reasonable cause exception exists

19   for the section 6654(a) addition to tax.     Treas. Reg. §

20   1.6654-1(a)(1).    There are exceptions to the section

21   6654(a) addition to tax, but petitioner does not meet the

22   requirements of these exceptions.    See § 6654(e).

23               Accordingly, petitioner is liable for the

24   addition to tax pursuant to section 6654(a).

25               This concludes the Court's oral Findings of Fact
                                                               15
1    and Opinion in this case.   A decision will be entered

2    under Rule 155.

3              (Whereupon, at 12:23 p.m., the above-entitled

4              matter was concluded.)

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1            CERTIFICATE OF TRANSCRIBER AND PROOFREADER

2    CASE NAME:        Edward Westwealth Lew v. Commissioner

3    DOCKET NO.:       20747-19

4        We, the undersigned, do hereby certify that the

5    foregoing pages, numbers 1 through 16 inclusive, are the

6    true, accurate and complete transcript prepared from the

7    verbal recording made by electronic recording by Bruce

8    Carlson on    ,    before the United States Tax Court at its

9    session in Kansas City, MO, in accordance with the

10   applicable provisions of the current verbatim reporting

11   contract of the Court and have verified the accuracy of

12   the transcript by comparing the typewritten transcript

13   against the verbal recording.

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17       _______________________________________________

18       Lori Rahtes, CDLT-108                        2/5/22

19       Transcriber                                  Date

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22       _______________________________________________

23       Jennifer Lindeman                            2/5/22

24       Proofreader                                  Date

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