Prince v. Comm'r

¶2MEMORANDUM FINDINGS OF FACT AND OPINION

¶3LARO, Judge: Petitioner petitioned the Court to redetermine respondent's determinations as to petitioner's 1997, 1998, and 1999 Federal income taxes. Respondent determined for those respective years that petitioner had deficiencies of $ 36,861, $ 89,210, and $ 71,454 and was liable for section 6662(a) accuracy- related penalties of $ 7,372, $ 17,842, and $ 14,291. ¹ Respondent also determined as to 1997 that petitioner was liable for a $ 9,215 addition to tax under section 6651(a)(1).

¶4Following concessions, ² we are left to decide:

¶51. Whether the 3-year period of limitations under section 6501(a) has run on 1997. We hold it*248 has not.

¶62. Whether petitioner may deduct self-employment expenses in amounts greater than those allowed by respondent. We hold he may not.

¶73. Whether petitioner may deduct for 1998 a $ 37,181 net operating loss (NOL) carryover. We hold he may not.

¶84. Whether petitioner may deduct dependency*249 exemptions for his daughter Keauna (Keauna) and his son Zik (Zik). We hold he may not.

¶95. Whether petitioner may use the head of household filing status. We hold he may not.

¶106. Whether petitioner is liable for the addition to tax determined by respondent under section 6651(a)(1). We hold he is.

¶117. Whether petitioner is liable for the accuracy-related penalties determined by respondent under section 6662(a). We hold he is.

¶12             FINDINGS OF FACT

¶13Some facts were stipulated. The stipulated facts and the accompanying exhibits are incorporated herein by this reference. We find the stipulated facts accordingly. Petitioner resided in Los Angeles, California, when his petition was filed. Petitioner's daughter is Keauna, and his son is Zik. Petitioner did not reside with Keauna during the subject years, and we do not find in the record that he resided with Zik either.

¶14Petitioner filed with the Commissioner 1997, 1998, and 1999 Forms 1040, U.S. Individual Income Tax Return, using the filing status of "Head of Household". He reported on those returns that his dependents were Keauna and Zik. On his 1997 and 1999 returns, petitioner reported a loss of*250 $ 9,614 and income of $ 954, respectively, from his sole proprietorship named Jasmak Auto Parts (Jasmak). On his 1998 return, petitioner reported income of $ 17,609 from Jasmak and an NOL carryover of $ 37,181 for purported losses from Jasmak for 1994 through 1997. The items of income from Jasmak were the only items of income reported on petitioner's 1997 through 1999 returns. Petitioner filed his 1997 tax return with the Commissioner on March 26, 1999.

¶15The respective returns reported that petitioner calculated Jasmak's profit (loss) for 1997 through 1999 as follows:

¶16                1997     1998    1999

¶17Gross receipts        $ 233,394 $ 407,173 $ 356,977

¶18Returns and allowances      -0-    (7,846)   -0-

¶19Cost of goods sold:

¶20 Beginning inventory      72,411   56,270   81,431

¶21 Purchases           114,367   279,762  220,877

¶22 Ending inventory        56,270   81,431   83,236

¶23               130,508   254,101  219,072

¶24Gross profit          102,886   144,226  137,905

¶25Expenses:

¶26 Advertising       *251     7,212    2,206   4,394

¶27 Commissions and fees      19,460   23,562   24,348

¶28 Insurance            3,428    4,785   6,097

¶29 Interest             -0-     529    -0-

¶30 Legal and prof. services    2,678    9,167   7,971

¶31 Office expense          -0-     -0-    1,782

¶32 Rent              36,000   36,000   36,000

¶33 Repairs and maintenance     5,152    2,446   1,686

¶34 Supplies            1,648    1,049    -0-

¶35 Taxes and licenses        197    2,985   2,338

¶36 Travel              795     150   1,143

¶37 Utilities            2,750    1,200   1,200

¶38 Bank charges           425     991    929

¶39 Depreciation          4,565    8,058   8,058

¶40 Dues and subscriptions       82     182    215

¶41 Freight             1,274     94    106

¶42 Janitorial            320     355   1,070

¶43 Medical/health*252          -0-    1,760    -0-

¶44 Miscellaneous expenses      110     839    272

¶45 Postage              301     517    674

¶46 Salary expense         11,000   20,200   22,000

¶47 Security             422     433    428

¶48 Telephone            6,342    7,581   8,245

¶49 Transportation         3,435    2,028   3,061

¶50 Sales tax            3,118    -0-    3,226

¶51 Finance charges          727    -0-     982

¶52 Other               530    -0-    -0-

¶53 Interest expense         529    -0-     726

¶54               112,500   127,117  136,951

¶55Profit (loss)          (9,614)   17,109    954

¶56The "Salary expense" represented payments which Jasmak made to petitioner for his services. Petitioner now acknowledges that the deduction of these payments was improper.

¶57In 2000, the Commissioner began auditing petitioner's 1997 through 1999 taxable years. As a result*253 of this audit, the Commissioner increased (decreased) petitioner's reported taxable income as follows and reflected these adjustments in the subject notice of deficiency mailed to petitioner on February 21, 2002:

¶58                 1997    1998    1999

¶59Self-employment income:

¶60 Unreported gross receipts   $ 16,338  $ 26,631 $ 24,988

¶61Self-employment expenses:

¶62 Advertising           5,952    -0-    2,610

¶63 Commissions           19,261   23,397   24,105

¶64 Depreciation           1,315    4,801   4,848

¶65 Insurance            3,428    4,785   6,097

¶66 Legal              2,410    8,240   7,174

¶67 Purchases            52,174   127,641  100,764

¶68 Returns and allowances      -0-    6,760    -0-

¶69 Salary             11,000   20,200   22,000

¶70 Sales tax            3,118    2,985   3,226

¶71 Telephone            4,439    5,307   5,770

¶72 Transportation          1,767    1,040*254   1,530

¶73Other items of income:

¶74 NOL carryover           -0-    37,181    -0-

¶75AGI adjustments:

¶76 Insurance             -0-     (594)   -0-

¶77 Self-employment         (5,549)   (6,337)  (7,166)

¶78Deductions and exemptions:

¶79 Standard deduction        1,900   2,000   2,050

¶80 Exemptions            5,300   7,938   7,040

¶81                122,853  271,975  205,036

¶82At trial, respondent conceded as to 1997 that he incorrectly disallowed $ 49,529 of the purchases, $ 2,308 of the sales tax expense, and $ 4,449 of the advertising expense. Respondent also conceded that petitioner's 1997 gross income did not include $ 11,077 of the determined unreported gross receipts and that petitioner's 1999 gross income did not include any of the determined unreported gross receipts.

¶83                OPINION

¶841. Burden of Proof

¶85Taxpayers generally must prove respondent's determinations wrong in order to prevail. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115, 78 L. Ed. 212, 54 S. Ct. 8 (1933). As one exception to this rule, section 7491(a) *255 places upon respondent the burden of proof with respect to any factual issue if the taxpayer maintained adequate records, satisfied applicable substantiation requirements, cooperated with respondent, and introduced during the court proceeding credible evidence on the factual issue. ³ The legislative history of section 7491(a) clarifies that taxpayers must prove that they have satisfied the adequate records, substantiation, and cooperation requirements before that section places the burden of proof upon the Commissioner. ⁴ H. Conf. Rept. 105-599, at 239 (1998), 1998-3 C.B. 747, 993("The taxpayer has the burden of proving that it meets each of these conditions, because they are necessary prerequisites to establishing that the burden of proof is on the Secretary."). The legislative history provides further as to the term "credible evidence", which is not defined in the statute, that

¶86*256    Credible evidence is the quality of evidence which, after

¶87   critical analysis, the court would find sufficient upon which to

¶88   base a decision on the issue if no contrary evidence were

¶89   submitted (without regard to the judicial presumption of IRS

¶90   correctness). A taxpayer has not produced credible evidence for

¶91   these purposes if the taxpayer merely makes implausible factual

¶92   assertions, frivolous claims, or tax protestor-type arguments.

¶93   The introduction of evidence will not meet this standard if the

¶94   court is not convinced that it is worthy of belief. If after

¶95   evidence from both sides, the court believes that the evidence

¶96   is equally balanced, the court shall find that the Secretary has

¶97   not sustained his burden of proof. [Id. at 240-241, 1998-

¶98   3 C.B. at 994-995.]

¶99We have in previous cases involving section 7491 applied the definition of the term "credible evidence" as discerned from the legislative history. E.g., Higbee v. Comm'r, 116 T.C. 438, 442-443 (2001); Forste v. Comm'r, T.C. Memo. 2003-103; Managan v. Comm'r, T.C. Memo. 2001-192.*257 We do likewise here. We conclude that section 7491(a) does not apply here to place the burden of proof upon respondent in that petitioner has failed to introduce during this proceeding credible evidence on any factual issue. We note that section 7491(a) also is inapplicable here in that we do not find that petitioner maintained adequate records, satisfied applicable substantiation requirements, or cooperated with the Commissioner.

¶1002. Period of Limitations

¶101Section 6501(a) generally gives the Commissioner 3 years from the date on which a return is filed to assess a tax as to that return. Petitioner filed his 1997 tax return with the Commissioner on March 26, 1999, and the Commissioner mailed the subject notice of deficiency to petitioner on February 21, 2002. We conclude that respondent's issuance to petitioner of the notice of deficiency for 1997 was within the 3-year period of section 6501(a). ⁵

¶102*258 3. Self-Employment Expenses

¶103In addition to the general burden of proof discussed above, petitioner must prove his entitlement to any deduction, e.g., by maintaining sufficient records to substantiate his claimed deductions. New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440, 78 L. Ed. 1348, 54 S. Ct. 788 (1934); Lychuk v. Comm'r, 116 T.C. 374, 384 (2001); see also sec. 6001; sec. 1.6001-1(a), Income Tax Regs. Petitioner's burden requires that he introduce sufficient evidence to: (1) Make a prima facie case establishing that respondent committed the errors alleged in the petition and (2) overcome the evidence favorable to respondent. See Lobe v. Comm'r, T.C. Memo. 2001-204; Lawler v. Commissioner, T.C. Memo. 1995-26.

¶104Petitioner has failed to carry his burden of proof as to this issue. The record does not disprove respondent's determination as to the self-employment expenses, as adjusted by respondent's concessions at trial. We sustain that determination, as adjusted. Lobe v. Comm'r, T.C. Memo. 2001-204 (and cases cited therein).

¶1054. NOL Deduction

¶106Section 172 allows a taxpayer to deduct an NOL for a*259 taxable year. The amount of the NOL deduction equals the sum of the NOL carryovers plus NOL carrybacks to that year. Sec. 172(a). Absent an election to the contrary, an NOL for any taxable year must first be carried back 3 years and then carried over 15 years. Sec. 172(b)(1)(A), (2) , and (3). ⁶ Petitioner, as a taxpayer attempting to deduct an NOL, bears the burden of establishing both the existence of the NOL and the amount of any NOL that may be carried over to 1998. Rule 142(a)(1); United States v. Olympic Radio & Television, Inc., 349 U.S. 232, 235, 99 L. Ed. 1024, 75 S. Ct. 733, 131 Ct. Cl. 814 (1955); Keith v. Commissioner, 115 T.C. 605, 621 (2000). Such a deduction is a matter of legislative grace; it is not a matter of right. United States v. Olympic Radio & Television, Inc., supra at 235; Deputy v. du Pont, 308 U.S. 488, 493, 84 L. Ed. 416, 60 S. Ct. 363 (1940).

¶107*260 Petitioner claimed on his return that the NOL applied in 1998 arose in 1994 through 1997. The record does not establish that petitioner incurred an NOL in any of those years. We sustain respondent's determination as to this issue.

¶1085. Dependency Exemptions/Filing Status

¶109Section 152(a) allows a taxpayer such as petitioner to treat a son and a daughter as dependents if the taxpayer provided during the taxable year more than half of the support of each. See also sec. 151(a), (c) (individual taxpayer may deduct an exemption amount for each of his or her dependents). Support generally includes amounts used for a dependent's food, shelter, clothing, medical and dental care, education, and the like. Sec. 1.152-1(a)(2)(i), Income Tax Regs. To meet the support test required as to a dependent, a taxpayer must show: (1) The total amounts received by the dependent from all sources, (2) the amounts actually applied for the support of the dependent, (3) the sources which contributed to the total support costs expended on behalf of the dependent, and (4) that the taxpayer provided over half of the total expenditures for the dependent's support. Barnes v. Commissioner, T.C. Memo. 1986-585.*261

¶110Petitioner has not persuaded us that he provided more than one-half of the support of either Keauna or Zik. We conclude that he is not entitled to treat either of them as his dependent. We also conclude that petitioner may not file as head of household. Under section 2(b)(1)(A)(i), an individual such as petitioner will qualify for head of household status if he maintains as his home a household that is the principal place of abode of a son or daughter for more than one-half of the taxable year. The record establishes that petitioner did not reside with Keauna during the subject years and does not establish that Zik resided with him either.

¶1116. Addition to Tax/Accuracy-Related Penalties

¶112Section 6651(a)(1) imposes an addition to tax for failing to file a return on or before the specified filing date unless it is shown that this failure is due to reasonable cause and not due to willful neglect. Reasonable cause may exist if a taxpayer exercised ordinary business care and prudence and was nonetheless unable to file the return within the date prescribed by law. Sec. 301.6651-1(c)(1), Proced. & Admin. Regs. Willful neglect means a "conscious, intentional failure or reckless indifference. *262 " United States v. Boyle, 469 U.S. 241, 245, 83 L. Ed. 2d 622, 105 S. Ct. 687 (1985).

¶113Section 6662(a) imposes a penalty of 20 percent on the portion of an underpayment of tax attributable to, among other things, a substantial understatement of tax. Sec. 6662(b)(1) and (2). A substantial understatement of tax is one that exceeds the greater of 10 percent of the tax required to be shown on the return or $ 5,000. Sec. 6662(d)(1)(A). An accuracy-related penalty does not apply to any portion of an understatement as to which the facts and circumstances show that the taxpayer acted with reasonable cause and in good faith. Sec. 6664(c)(1); sec. 1.6664-4(b)(1), Income Tax Regs.

¶114Respondent bears the burden of production with respect to this addition to tax and these accuracy-related penalties. Sec. 7491(c). In order to meet this burden, respondent must produce sufficient evidence establishing that it is appropriate to impose these items. Once respondent has done so, the burden of proof is upon petitioner. Higbee v. Comm'r, 116 T.C. at 449.

¶115Respondent has satisfied his burden of production with respect to the addition to tax in that the record establishes that petitioner*263 filed his 1997 tax return after its due date. Respondent has also satisfied his burden of production with respect to the section 6662(a) accuracy-related penalties to the extent that the record establishes that petitioner understated his tax for each of the subject years by the greater of 10 percent of the tax required to be shown on the return or $ 5,000. With regard to both the addition to tax and the accuracy-related penalties, petitioner must establish reasonable cause in order to prevail. Id. Petitioner filed his 1997 tax return more than 11 months after the due date, and he has presented no evidence establishing that his failure to file that return timely was due to reasonable cause and not due to willful neglect. Petitioner has also failed to introduce any evidence establishing that he acted with reasonable cause or in good faith with respect to the items underlying the accuracy-related penalties. We sustain respondent's determination as to the addition to tax and the accuracy-related penalties (to the extent that the parties computation(s) under Rule 155 establishes that petitioner understated his tax for each of the subject years by the greater of 10 percent of the tax required*264 to be shown on the return or $ 5,000).

¶116All arguments made by the parties and not discussed herein have been rejected as meritless. To reflect concessions,

¶117Decision will be entered under Rule 155.