Court Opinion

ID: 4337302
Source: CourtListenerOpinion
Date Created: 2018-11-14 03:17:12.2182+00
Date Added: 2024-06-11T14:20:44.997636
License: Public Domain

T.C. Summary Opinion 2008-138

                       UNITED STATES TAX COURT

         LADISLAU P. AND ANDREA HORVATH, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

     Docket No. 10782-06S.             Filed October 30, 2008.

     Ladislau P. and Andrea Horvath, pro sese.

     John M. Tkacik, Jr., for respondent.

     RUWE, Judge:   This case was heard pursuant to the provisions

of section 7463 of the Internal Revenue Code in effect when the

petition was filed.1   Pursuant to 7463(b), the decision to be

     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                               - 2 -

entered is not reviewable by any other court, and this opinion

shall not be treated as precedent for any other case.

     Respondent determined deficiencies in petitioners’ Federal

income taxes of $23,179 and $29,776 and accuracy-related

penalties under section 6662(a) of $4,636 and $5,955 for years

2002 and 2003 (years at issue), respectively.2   After

concessions, we must decide:   (1) Whether petitioners have

unreported income for the years at issue; (2) whether petitioners

are entitled to deduct, under section 162, business expenses

related to both (a) the use of their automobiles for the years at

issue, and (b) their reported supplies expense for 2003; and (3)

whether petitioners are liable for section 6662(a) accuracy-

related penalties for the years at issue.

                           Background

     Some of the facts have been stipulated and are so found.

At the time their petition was filed, petitioners resided in

Ohio.

     Petitioners are husband and wife.   They owned Transil Dental

Lab (Transil), which was operated out of their residence.

Petitioners’ business consisted of making dental molds, crowns,

dentures, and other related dental products for various dentists.

Mrs. Horvath worked both as the manager of the business and as

     2
       Where appropriate, figures have been rounded to the
nearest dollar.
                                - 3 -

the delivery and pickup driver.    During the years at issue,

petitioners owned several vehicles, which were used to make

deliveries for Transil.    Petitioners maintained business records

which included a mileage log for the business use of each

vehicle.    Shell credit card statements (gas receipts) entered

into evidence at trial showed the locations and amounts of

gasoline purchased by petitioners during the years at issue.      The

gas receipts showed total expenses of $1,389 for 2002 and $1,383

for 2003.    Petitioners also entered into evidence various

automobile repair receipts and vehicle registrations which showed

odometer readings for several of the vehicles for years before,

during, and after the years at issue.    Further documentary

evidence entered at trial included an example of the number of

deliveries petitioners made on a weekly basis and a list of the

dentists and the distance between their home and the dentists’

offices.

     Petitioners’ Schedules C, Profit or Loss From Business,

reported gross receipts of $71,000 and $75,2503 for 2002 and

2003, respectively.    Petitioners’ reported expenses included,

among others, $21,900 and $10,800 of car and truck expenses,

calculated using the standard mileage rate, for 2002 and 2003,

     3
       While petitioners’ 2003 Schedule C shows gross receipts of
$75,250, the parties’ stipulation of facts indicates, without
further explanation, that petitioners’ gross receipts on their
2003 Schedule C were $75,190.
                                - 4 -

respectively, and a supplies expense of $20,068 for 2003.      After

deductions for returns and allowances and total expenses,

petitioners reported net profits/business income of $14,417 for

2002 and $13,079 for 2003.    Petitioners’ business income was the

only income reported by petitioners for the years at issue.

     After petitioners filed their tax returns for the years at

issue, their business records, including the mileage logs, were

destroyed when their basement flooded in 2004.

     Respondent determined that petitioners had unreported income

on the basis of deposits into their bank accounts.    For 2002,

petitioners deposited funds into two checking accounts at Ohio

Savings Bank.4   Total deposits into the two accounts during 2002

was $160,144.    Respondent identified $53,027 in nontaxable

transfers between the two accounts in 2002 and concluded that

petitioners’ total income was $107,116.    However, petitioners’

bank statements also showed a “DEBIT MEMO”5 of $4,271 on January

31, 2002, and a “DEBIT MEMO” of $9,000 on March 20, 2002.

Respondent’s bank deposits analysis arrived at net deposits by

subtracting transfers between petitioners’ accounts but did not

consider the two debit memos made by the bank.    After subtracting

     4
       One of the Ohio Savings Bank checking accounts was in the
name of Transil, account no. xxxxxxx5493, while the other was in
petitioner Ladislau Horvath’s name, account no. xxxxxxx6660.
     5
       On the basis of the bank statements, we interpret the
“DEBIT MEMO” as a nontaxable transaction reversing the
corresponding deposit from petitioners’ bank account.
                                 - 5 -

the two debit memos the net deposits into petitioners’ bank

accounts in 2002 were $93,845.

     For 2003, petitioners deposited funds into four checking

accounts, two at Ohio Savings Bank and two at Charter One Bank.6

Respondent determined total deposits into the four accounts of

$167,286 and identified $60,257 of nontaxable transfers between

the accounts.   After allowing for transfers, respondent concluded

that petitioners’ total income was $107,028.   One of petitioners’

bank statements, however, showed a “DEBIT MEMO” of $241 on

January 21, 2003, which respondent did not consider.   After

subtracting the debit memo, the net deposits into petitioners’

bank accounts were $106,788 in 2003.

                            Discussion

I.   Unreported Income

     As a general rule, the Commissioner’s determinations set

forth in a notice of deficiency are presumed correct, and the

taxpayer bears the burden of proving that these determinations

are in error.   Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933).

     6
       The two Ohio Savings Bank checking accounts are the same
two identified previously. See supra note 4. These two accounts
were closed on Aug. 31, 2003. The two checking accounts at
Charter One Bank were opened on Aug. 27, 2003, one in the name of
Transil, account no. xxx-xxx313-0, and the other in petitioners’
names, account no. xxx-xxx070-2.
                                - 6 -

     Where taxpayers are unable to produce substantiating

business records of their income, the Commissioner may use the

bank deposits method to reconstruct and compute the taxpayers’

income.   See Estate of Mason v. Commissioner, 64 T.C. 651, 656

(1975), affd. 566 F.2d 2 (6th Cir. 1977).     A bank deposit is

prima facie evidence of income.    Tokarski v. Commissioner, 87
T.C. 74, 77 (1986).    The bank deposits method of reconstruction

assumes that all of the money deposited into the taxpayers’

accounts is includable in gross income unless the taxpayers show

that the deposits are not taxable.      DiLeo v. Commissioner, 96
T.C. 858, 868 (1991), affd. 959 F.2d 16 (2d Cir. 1992).     The

Commissioner, however, must take into account any nontaxable

items and deductible expenses of which the Commissioner has

knowledge. Id.

     For 2002, respondent argues that petitioners had total

deposits of $160,144 and nontaxable transfers of $53,027.      For

2003, respondent argues that petitioners had total deposits of

$167,286 and nontaxable transfers of $60,257.     Respondent argues

that his bank deposits analysis supports a finding that

petitioners had net deposits of $107,116 for 2002 and $107,029

for 2003.    Because petitioners’ Schedules C reported gross

receipts of only $71,000 for 2002 and $75,250 for 2003,

respondent contends that the difference between these figures
                                 - 7 -

amounts to unreported income of $36,116 for 2002 and $31,779 for

2003.7

     Petitioners do not dispute respondent’s use of the bank

deposits method of reconstruction and do not allege any specific

error in respondent’s computations.      Rather, petitioners contend

that they maintained business records during the years at issue

that were destroyed, that their tax returns for those years

accurately reported their income and expenses, and that

respondent’s determinations are therefore erroneous.

     After reviewing petitioners’ bank statements, it appears

that respondent erroneously included $13,271 for 2002 and $241

for 2003 in petitioners’ total net deposits.     The bank statements

indicate that respondent’s bank deposits calculations included a

$4,271 deposit on January 31, 2002, a $9,000 deposit on March 20,

2002, and a $241 deposit on January 21, 2003, without considering

the corresponding debit memos.    Each of these deposits appears to

be attributable to transactional errors reflected in the bank

statements.   The bank statements indicate that each of the

“deposits” was corrected with a same-day “DEBIT MEMO” removing

the “deposit” from petitioners’ account.     On the basis of the

foregoing, we find that petitioners understated their gross

receipts by $22,845 in 2002 and by $31,538 in 2003.

     7
       The statutory notice of deficiency originally determined
unreported income of $37,677 for 2002 and $50,593 for 2003. At
trial, respondent reduced his allegation of unreported income to
$36,116 for 2002 and $31,779 for 2003.
                                       - 8 -

II.   Disallowed Deductions

      Deductions are a matter of legislative grace, and the

taxpayer bears the burden of proving he is entitled to the

deductions claimed.           Rule 142(a); INDOPCO, Inc. v. Commissioner,

503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934).          Section 162(a) allows a taxpayer to deduct

all the ordinary and necessary expenses paid or incurred in

carrying on a trade or business.            Petitioners claimed business

deductions for the use of their personal vehicles and for

supplies used in their business.            Respondent disallowed these

deductions due to petitioners’ lack of substantiation.

      a.   Car and Truck Expenses

      Section 274(d) provides:

      SEC. 274.       DISALLOWANCE OF CERTAIN ENTERTAINMENT, ETC.,
                      EXPENSES.

           (d) Substantiation Required.--No deduction or
      credit shall be allowed--

                  *       *       *     *       *     *     *

                (4) with respect to any listed property
           (as defined in section 280F(d)(4)),

      unless the taxpayer substantiates by adequate records
      or by sufficient evidence corroborating the taxpayer’s
      own statement (A) the amount of such expense or other
      item, (B) the time and place of the travel,
      entertainment, amusement, recreation, or use of the
      facility or property, or the date and description of
      the gift, (C) the business purpose of the expense or
      other item, and (D) the business relationship to the
      taxpayer of persons entertained, using the facility or
      property, or receiving the gift. * * *
                                 - 9 -

Section 280F(d)(4)(A)(i) provides that passenger automobiles are

“listed property”.     Thus, the heightened substantiation

requirements of section 274(d) are applicable to petitioners’

claimed car and truck expense deductions.

        Substantiation is to be made by either “adequate records” or

“sufficient evidence corroborating the taxpayer’s own statement”.

Sec. 274(d); sec. 1.274-5T(c)(1), Temporary Income Tax Regs., 50

Fed. Reg. 46016 (Nov. 6, 1985).     “To meet the ‘adequate records’

requirements of section 274(d), a taxpayer shall maintain an

account book, diary, log, statement of expense, trip sheets, or

similar record * * *, and documentary evidence”.     Sec. 1.274-

5T(c)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov.

6, 1985).     In lieu of substantiating the actual amount of an

expenditure related to the business use of a passenger

automobile, a taxpayer may use the standard mileage rate

established by the Commissioner.8    Sec. 1.274-5(j)(2), Income Tax

Regs.

     Petitioners kept a log of their business use of their

automobiles that would have provided the required information.

However, petitioners testified and provided documentation to

prove that these records were lost as a result of flood damage in

        8
       The optional standard mileage rate for business use of a
passenger automobile was 36.5 cents and 36 cents per mile for
2002 and 2003, respectively. See Rev. Proc. 2001-54, sec. 5,
2001-2 C.B. 530, 531; Rev. Proc. 2002-61, sec. 5, 2002-2 C.B.
616, 618.
                                - 10 -

2004.     Where, as here, the taxpayer establishes that the failure

to produce adequate records is due to the loss of the records

through circumstances beyond the taxpayer’s control, such as

destruction by flood, the taxpayer may substantiate a deduction

by reasonable reconstruction of his expenditures or use.     Sec.

1.274-5T(c)(5), Temporary Income Tax Regs., 50 Fed. Reg. 46022

(Nov. 6, 1985); see also Malinowski v. Commissioner, 71 T.C.
1120, 1125 (1979); Schneider v. Commissioner, T.C. Memo. 1978-

447.     Where documentation is unavailable “the Court may, although

it is not required to do so, accept the taxpayer’s testimony to

substantiate the deduction.”     Davis v. Commissioner, T.C. Memo.

2006-272; see also Boyd v. Commissioner, 122 T.C. 305, 320

(2004); Watson v. Commissioner, T.C. Memo. 1988-29.

        Petitioners have presented credible testimony and evidence

sufficient to reconstruct a portion of their car and truck

expenses.     It is clear that petitioners used their vehicles for

deliveries in their business.     They testified that their vehicles

were used primarily for business purposes.    Petitioners also

testified and presented documentary evidence of the locations of

and the frequency with which they traveled to the various

dentists’ offices.
                                - 11 -

     Petitioners produced partial gasoline receipts totaling

$1,389 for 2002 and $1,383 for 2003.9    The Energy Information

Administration reports that the average price of gasoline in the

Midwestern United States was 136.5 cents per gallon and 154.8

cents per gallon in 2002 and 2003, respectively.    The U.S.

Department of Transportation reports the average fuel efficiency

of U.S. passenger cars as 22 miles per gallon in 2002 and 22.2

miles per gallon in 2003.   On this basis, we conclude that

petitioners’ business use of their vehicles totaled at least

20,000 miles in 2002 and 18,000 miles in 2003 and that

petitioners are entitled to deductions for business use of their

vehicles using the standard mileage rate.    See sec. 1.274-

5(j)(2), Income Tax Regs.; Rev. Proc. 2001-54, sec. 5, 2001-2

C.B. 530, 531; Rev. Proc. 2002-61, sec. 5, 2002-2 C.B. 616, 618.

     b.    Business Supplies Expense

     Petitioners’ 2003 Schedule C reported a supplies expense of

$20,068.   Respondent allowed $6,216 and disallowed the remaining

$13,852 (disallowed portion).

     Both petitioners and respondent indicated at trial that the

disallowed portion of the supplies expense deduction remained at

issue; however, neither party offered any evidence.    Because

petitioners bear the burden of proof, we find that petitioners

are not entitled to a deduction for business supplies expenses in

     9
       For some of the months in each year there were no
receipts.
                                - 12 -

excess of the amount allowed by respondent for 2003.     Rule

142(a); Levin v. Commissioner, 87 T.C. 698, 722-723 (1986), affd.

832 F.2d 403 (7th Cir. 1987).

III.    Section 6662(a) Accuracy-Related Penalty

       Section 6662(a) provides that a taxpayer is liable for a 20-

percent accuracy-related penalty on any portion of an

underpayment of tax required to be shown on a return attributable

to, inter alia, (1) negligence or disregard of the rules or

regulations or (2) a substantial understatement of income tax.

See sec. 6662(b).

       Respondent’s position with respect to the accuracy-related

penalties is unclear.    The notice of deficiency sent to

petitioners included accuracy-related penalties under section

6662(a).    At the beginning of trial the parties indicated that

the only issues remaining in dispute for 2002 were unreported

income and a car and truck expense deduction and for 2003 were

unreported income, a car and truck expense deduction, and a

supplies expense deduction.

       In any event, the penalty under section 6662(a) shall not be

imposed upon any portion of an underpayment where the taxpayer

shows that he or she acted with reasonable cause and in good

faith with respect to such portion.      See sec. 6664(c)(1); Higbee

v. Commissioner, 116 T.C. 438, 448 (2001).     The determination of

whether a taxpayer acted with reasonable cause and in good faith
                               - 13 -

is made on a case-by-case basis, taking into account all the

pertinent facts and circumstances.      Higbee v. Commissioner, supra

at 448;   Sec. 1.6664-4(b)(1), Income Tax Regs.     The most

important factor is the extent of the taxpayer’s effort to assess

his proper tax liability for the year.      Sec. 1.6664-4(b)(1),

Income Tax Regs.    “Circumstances that may indicate reasonable

cause and good faith include * * * the experience, knowledge, and

education of the taxpayer.” Id.

     On the basis of petitioners’ testimony, we are satisfied

that petitioners maintained business records to the best of their

ability and that information reported on their 2002 and 2003 tax

returns reflected a good faith effort to assess their correct tax

liabilities.   As previously noted, petitioners’ business records

for the years at issue were destroyed by flood in 2004.        Even

though petitioners have been unable to completely reconstruct

their records, we are persuaded and conclude that petitioners

made a substantial effort to assess their proper tax liabilities

for the years at issue, and, consequently, that petitioners acted

with reasonable cause and in good faith as required under section

6664(c)(1).    Accordingly, we hold that petitioners are not liable

for section 6662(a) accuracy-related penalties for 2002 and 2003.
                             - 14 -

     In reaching our holdings herein, we have considered all

arguments made, and to the extent not mentioned above, we find

them to be moot, irrelevant, or without merit.

     To reflect the foregoing,

                                        Decision will be entered

                                   under Rule 155.