                              T.C. Memo. 2016-111



                         UNITED STATES TAX COURT



     JAMES CLEMENT POWELL AND LUCY H. POWELL, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 21839-14.                         Filed June 8, 2016.



      James Clement Powell and Lucy H. Powell, pro se.

      Matthew S. Reddington, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      PUGH, Judge: In a notice of deficiency, respondent determined

deficiencies and penalties with respect to petitioners’ 2011 and 2012 Federal

income tax as follows:
                                        -2-

[*2]                                                         Penalty
             Year                Deficiency                sec. 6662(a)

             2011                 $14,256                      $2,851

             2012                    4,504                       -0-

       The issues for decision are: (1) whether petitioners are entitled to a $24,253

deduction for vehicle expenses claimed by their S corporation, WPL, Inc. (WPL),

on its Form 1120S, U.S. Income Tax Return for an S Corporation, for 2011;1 (2)

whether petitioners overstated their total deductions by $18,000 because of a math

error on line 20 of the Form 1120S for 2012; (3) whether petitioners are entitled to

a $25,308 miscellaneous expense deduction and a $1,842 medical and dental

expense deduction on Schedule A, Itemized Deductions, for 2011; (4) whether

petitioners had taxable Social Security benefits of $26,768 for 2011; (5) whether

petitioners are liable for an accuracy-related penalty pursuant to section 6662(a)2




       1
        Because WPL is an S corporation, separate audit procedures do not apply,
and we may consider respondent’s arguments to both the S corporation returns and
petitioners’ individual returns in the notice of deficiency. See, e.g., Winter v.
Commissioner, 135 T.C. 238 (2010).
       2
        Unless otherwise indicated, section references are to the Internal Revenue
Code of 1986, as amended, in effect for the years in issue. Rule references are to
the Tax Court Rules of Practice and Procedure, and dollar amounts are rounded to
the nearest dollar.
                                        -3-

[*3] for 2011; and (6) whether we have jurisdiction to hear petitioners’ claim that

respondent is liable for damages under section 7433.

                               FINDINGS OF FACT

      Some of the facts have been stipulated, and the stipulated facts are

incorporated in our findings by this reference. At the time the petition was filed

petitioners resided in the Commonwealth of Virginia.

      James Powell is the sole owner of WPL. WPL is in Virginia and is engaged

in acquiring and selling petroleum marketing properties, appraising petroleum

marketing properties, and negotiating gasoline and diesel fuel supply contracts.

Lucy Powell works for WPL, and Mr. Powell works as an independent consultant

to WPL. In addition to Mrs. Powell, WPL has one other employee. Petitioners

and the other WPL employee traveled between Pennsylvania, North Carolina,

Virginia, and West Virginia for various business purposes including meeting with

clients, appraising properties, and negotiating contracts. Petitioners used personal

vehicles to travel between sites. The business mileage was recorded in three

different ways on spreadsheets that Mr. Powell maintained.

      First, for some activities Mr. Powell kept a log of the miles he drove for

clients and would record them as daily entries after he returned to his office.

Although the log reflects these as daily entries, a number of these entries for 2011
                                          -4-

[*4] appear to be estimates and/or are missing information regarding the trip:

February 1, 2, 5, 6; March 20, 21; April 5; all entries in May; June 23; July 12, 14,

21, 25; September 13 (second entry), 14, 16 (first entry); and October 18. Most of

these entries fail to list the destination, listing instead a purpose or a business or an

individual with whom Mr. Powell met. The miles listed for some entries differ

significantly from other entries for trips to the same location, with no explanation

for the difference, and are rounded numbers.3 All of the entries listed for the

month of May appear to be estimates. Finally, some entries report only the State

to which Mr. Powell drove.

      The remaining daily entries list specific mileage (not rounded) and the

purpose. The following entries fall into this category: January 4; February 10, 17;

March 1, 17; April 6, 7, 20; June 1, 2, 6, 9, 15, 20, 21; July 6, 20, 22, 27, 28;

August 7, 9, 12, 31; September 1, 13 (first entry), 16 (second entry); October 17,

24; November 1, 2, 7, 9, 14, 16; December 12, 19, 20. These entries reflect a total

of 13,281 miles, 5,055 of which correspond to entries for travel before July 1,

2011, and 8,226 of which correspond to entries for travel on July 1, 2011, or later.




      3
       For instance, petitioners reported trips to Franklin as 325 miles, 348 miles,
500 miles, and 600 miles.
                                         -5-

[*5] In addition, these entries include a location or, if not, the location reasonably

can be inferred from the description given and its context.4

      Second, for other activities Mr. Powell did not record the miles as daily

entries but instead recorded them at the end of the month. He would keep track of

how many times he went out for a particular activity during the month and then

would record the miles at the end of the month as one entry. Third, because Mrs.

Powell and the other WPL employee would not keep daily logs of their mileage, at

the end of the year Mr. Powell estimated their business mileage.

      Petitioners timely filed their joint Forms 1040, U.S. Individual Income Tax

Return, for tax years 2011 and 2012, using TurboTax for the first time to prepare

their tax return for 2011.

      On their 2011 Form 1040 petitioners claimed a deduction for a loss of

$58,022 on line 17 for items reported on Schedule E, Supplemental Income and

Loss.5 The $58,022 loss reported on petitioners’ Schedule E included a $24,253


      4
         For instance, for the entries reported on March 17, September 16 (second
entry), and November 9 a location can be reasonably inferred from the context and
the descriptions given even though they do not give a specific location.
      5
        On their Form 1040 for 2011 petitioners claimed the $58,022 loss
deduction twice, once on line 14, corresponding to a loss on the sale of business
property reported on Form 4797, Sales of Business Property, and once on line 17,
corresponding to a loss from WPL reported on Form 1120S. Respondent
                                                                       (continued...)
                                       -6-

[*6] deduction for travel expenses representing petitioners’ mileage, recorded and

estimated as described above.

      On their Schedule A petitioners claimed a deduction of $47,600 which

included a $25,308 miscellaneous expense deduction6 and a $1,842 medical and

dental expense deduction. The miscellaneous expense deduction related to the

operation of an LLC that Mr. Powell referred to as the “hops business” (about 80

acres of land that petitioners own in Hillsborough, North Carolina, on which they

produce hops). Respondent disallowed both the miscellaneous expense deduction

and the medical and dental expense deduction.

      Petitioners also reported Social Security benefits of $31,492 with a taxable

amount of zero for 2011. Respondent determined that, with the adjustments made




      5
        (...continued)
disallowed the deduction for the Form 4797 loss, determining that petitioners had
deducted the loss from WPL twice and did not have a loss on a sale of business
property. Petitioners admitted in their petition “that an error had been made and
that petitioners had not incurred a 2011 loss on the sale of property of
$58,022.00”. At trial petitioners disputed the disallowance of this deduction but
provided no evidence that they were entitled to it. We consider this issue
conceded and sustain respondent’s disallowance of the deduction for the Form
4797 loss.
      6
       Petitioners reported $25,444 of miscellaneous expenses that resulted in a
$25,308 deduction after subtracting 2% of their reported adjusted gross income.
                                         -7-

[*7] to petitioners’ adjusted gross income in the notice of deficiency, the taxable

amount of Social Security benefits should have been $26,768.

      On December 9, 2013, respondent received a Form 1040X, Amended U.S.

Individual Income Tax Return, from petitioners amending the 2011 tax return and

claiming that: (1) the loss of $58,022 reported on the Form 4797 should have

been zero; (2) the taxable Social Security benefits should have been $14,622; and

(3) the other income on line 21 should be changed from $130,150 to $103,711. As

a result of the amendment, petitioners assert that the total tax owed for 2011

should be $15,484. Respondent did not accept the Form 1040X for filing and

made no adjustments to petitioners’ tax liability as a result of its submission.

      On their 2012 Form 1040 petitioners reported a tax liability of $25,523, and

on their 2012 Form 1120S for WPL they reported ordinary business income of

$31,239. On WPL’s Form 1120S petitioners were instructed to add lines 7

through 19, which report the individual deductions that the S corporation claimed,

and write the sum--the total deductions for the S corporation--on line 20. But on

WPL’s Form 1120S, the sum of lines 7 through 19 is $213,415, whereas the total

amount of deductions reported on line 20 is $231,415. In the notice of deficiency

respondent determined an assessment for 2012 because of this apparent math

error, claiming that the total expenses on WPL’s Form 1120S should have been
                                        -8-

[*8] $213,415. At trial Mr. Powell presented a profit and loss statement for WPL

for 2012 that reported the total expenses as $231,415. The profit and loss

statement included expenses that were shown on lines 7 through 19 of WPL’s

Form 1120S but with numbers that differed from those shown on the individual

lines. The sum of the individual items on the profit and loss statement matched

the sum shown on the profit and loss statement and matched the total expenses

shown on line 20 of the Form 1120S.

      Petitioners timely filed their petition seeking redetermination of deficiencies

and an accuracy-related penalty in the notice of deficiency.

                                     OPINION

I. Burden of Proof

      Ordinarily, the burden of proof in cases before the Court is on the taxpayer.

Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). Under section

7491(a), in certain circumstances the burden of proof may shift from the taxpayer

to the Commissioner. Petitioners have not claimed or shown that they meet the

specifications of section 7491(a) to shift the burden of proof to respondent as to

any relevant factual issue.
                                        -9-

[*9] Deductions are a matter of legislative grace, and a taxpayer must prove his

or her entitlement to deductions. INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

II. WPL’s 2011 Schedule E Vehicle Expense Deduction

      Generally, an S corporation shareholder determines his or her tax liability

by taking into account a pro rata share of the S corporation’s income, losses,

deductions, and credits. Sec. 1366(a)(1). At issue is whether petitioners are

entitled to a $24,253 vehicle expense deduction for WPL that respondent

disallowed for tax year 2011. We must determine whether WPL properly claimed

its deductions for 2011 before we can determine whether petitioners are entitled to

deduct flowthrough business losses from WPL.

      Taxpayers are required to substantiate expenses underlying each claimed

deduction by maintaining records sufficient to establish the amount of the

deduction and to enable the Commissioner to determine the correct tax liability.

Sec. 6001; Higbee v. Commissioner, 116 T.C. 438, 440 (2001). Under the Cohan

rule, where a taxpayer is able to demonstrate that he or she has paid or incurred a

deductible expense but cannot substantiate the precise amount, the Court may

estimate the amount of the expense if the taxpayer produces credible evidence

providing a basis for the Court to do so. Cohan v. Commissioner, 39 F.2d 540,
                                       - 10 -

[*10] 544 (2d Cir. 1930). Section 274(d) supersedes the Cohan rule, however,

imposing strict substantiation requirements for certain expenses such as vehicle

expenses. Sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014

(Nov. 6, 1985).

      To meet these strict substantiation requirements, a taxpayer must

substantiate by adequate records or by sufficient evidence corroborating the

taxpayer’s own statement: (1) the amount of the expense; (2) the time and place of

the travel or use; and (3) the business purpose of the expense. Sec. 274(d). To

substantiate by adequate records, the taxpayer must provide: (1) an account book,

a log, or a similar record and (2) documentary evidence, which together are

sufficient to establish each element with respect to an expenditure. Sec. 1.274-

5T(c)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985).

      Section 274(d) contemplates that no deduction or credit shall be allowed on

the basis of mere approximations or unsupported testimony of the taxpayer.

Compare Jackson v. Commissioner, T.C. Memo. 2014-160 (married taxpayers met

strict substantiation requirement for deduction of depreciation and interest

expenses for a recreational vehicle (RV) for one tax year at issue in deficiency

case but not for the other year; for one year, taxpayers produced a

contemporaneously made calendar listing dates of RV rallies and clients with
                                        - 11 -

[*11] whom they met in connection with taxpayers’ insurance brokerage business,

and taxpayers also produced a list that detailed types of conversations held with

clients at the rallies, but for the other year, taxpayers produced no substantiating

records), and Sievers v. Commissioner, T.C. Memo. 2014-115 (finding taxpayer’s

credible testimony about the vehicles and equipment used in a landscape business

and the amount of fuel that they required, corroborated by log showing fuel

purchases and supporting bank records, met the strict substantiation requirement)

with Boler v. Commissioner, T.C. Memo. 2002-155 (corporation could not deduct

travel expenses of sole shareholder’s wife for allegedly running errands for the

corporation absent evidence of the amount, time, place, and business purpose of

those travel expenses on behalf of the corporation).

      Although a contemporaneous log is not required, corroborative evidence to

support a taxpayer’s reconstruction “of the elements * * * of the expenditure or

use must have a high degree of probative value to elevate such statement” to the

level of credibility of a contemporaneous record. Sec. 1.274-5T(c)(1), Temporary

Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6 1985). Compare Reynolds v.

Commissioner, 296 F.3d 607, 617 (7th Cir. 2002) (taxpayer’s reconstructed chart

of claimed expenses did “not contain the type of specific detail mandated by the

Treasury Regulations; all of the travel and car maintenance expenses * * * [were]
                                        - 12 -

[*12] listed by month rather than by specific trip”), aff’g T.C. Memo. 2000-20,

and Grossnickle v. Commissioner, T.C. Memo. 2015-127 (taxpayer’s typewritten

statement that showed only total business mileage and the total dollar amount

claimed, along with more detailed noncontemporaneous log, did not rise to the

level of credibility of a contemporaneous record because source of information

and taxpayer’s methodology in log’s preparation were not adequately explained),

with Larson v. Commissioner, T.C. Memo. 2008-187 (although taxpayer’s

monthly mileage logs were not themselves contemporaneous, they were

exhaustively detailed, and taxpayer credibly testified that logs were prepared from

weekly charts which were in turn prepared from contemporaneous hand-held

mileage logs).

      Likewise, mileage logs that report only the State to which the taxpayer

traveled fall short of the strict reporting requirements because they fail to specify

the location. Adams v. Commissioner, T.C. Memo. 2013-92 (mere listing of the

State of the destination of taxpayer’s purported business trip does not meet the

strict substantiation requirements for the deduction of vehicle mileage expenses).

      Only those daily entries described above, see supra p. 4, that list specific

mileage and detail the purpose and location (or for which location can be

reasonably inferred) meet the strict substantiation requirements as
                                        - 13 -

[*13] contemporaneous documentation. The remaining daily entries appear to be

estimates and/or omit required information as to purpose and location. Mr.

Powell’s testimony did not compensate for the defects or otherwise lend the

necessary credibility to his logs. Likewise the mileage that Mr. Powell estimated

and recorded at the end of the month and the mileage he estimated at the end of the

year do not rise to the level of credibility required to substantiate the mileage he

reported. Nor did petitioners provide other credible evidence to corroborate the

mileage reported as monthend and yearend estimates.

      For the 2011 Schedule E vehicle expense deduction, we therefore hold that

petitioners are permitted to deduct mileage expenses for 13,281 miles. At a rate of

51 cents per mile for the entries dated before July 1, 2011 (5,055 miles), and a rate

of 55.5 cents per mile for the entries dated July 1, 2011, or later (8,226 miles), the

total deduction that we allow for vehicle expenses is $7,143. See Notice 2010-88,

2010-51 I.R.B. 882; Announcement 2011-40, 2011-29 I.R.B. 56.

III. WPL’s 2012 Schedule E Deduction

      In the notice of deficiency respondent indicated that he had assessed

additional tax on petitioners’ 2012 Schedule E for a mathematical error. Since the

mathematical error was reflected in a notice of deficiency along with other
                                          - 14 -

[*14] adjustments, the Court has jurisdiction to decide this issue. See sec.

6213(b)(1); see also Winter v. Commissioner, 135 T.C. 238.

      We find credible Mr. Powell’s explanation that the discrepancy arose from

an error in transferring numbers from WPL’s profit and loss statement to lines 7

through 19 of the Form 1120S only. Petitioners correctly transcribed the total

amount of the expenses from the profit and loss statement of WPL onto line 20 of

Form 1120S. Petitioners’ error therefore did not affect the total amount of tax they

were required to pay for 2012. At trial respondent asserted only that petitioners

had admitted to a math error and did not address petitioners’ argument that this

was a simple transcription error from the profit and loss statement of WPL to the

tax form that did not affect their total tax liability. Nor did respondent challenge

the validity of the expenses reflected on the profit and loss statement. We will not

attempt now to audit the profit and loss statement, and, without a specific

challenge to any expenses deducted for 2012, we will allow the additional $18,000

deduction on petitioners’ 2012 Schedule E. See Niemann v. Commissioner, T.C.

Memo. 2016-11, at *5-*6 (finding prejudice where the Commissioner raised

substantiation for the first time at trial and only after original assertion that

deductions were “double-claimed” was proven not to be true, preventing the
                                       - 15 -

[*15] taxpayer from being able to present documents to substantiate the expenses

at issue).

IV. 2011 Schedule A Itemized Deductions

       Respondent disallowed two of petitioners’ 2011 Schedule A expense

deductions: a $1,842 medical and dental expense deduction and a $25,308

miscellaneous expense deduction.

       A. Medical and Dental Expense Deduction

       Section 213(a) authorizes a taxpayer who itemizes deductions to deduct

expenses paid during the taxable year for the medical care of the taxpayer, the

taxpayer’s spouse, or a dependent to the extent that such expenses exceed 7.5% of

adjusted gross income. For 2011 petitioners reported $2,353 of medical and

dental expenses and claimed an itemized deduction for these expenses of $1,842.

Respondent determined that, because of the changes to petitioners’ adjusted gross

income, the unreimbursed medical and dental expense deduction should be

disallowed. This is a computational adjustment required in the light of the

previous holdings. After the changes to petitioners’ adjusted gross income

mentioned previously, 7.5% of petitioners’ adjusted gross income will exceed their

unreimbursed medical and dental expenses, and therefore we sustain the

disallowance of the deduction.
                                        - 16 -

[*16] B. Miscellaneous Expense Deduction

      Petitioners also reported $25,444 of miscellaneous expenses and, after

subtracting 2% of their reported adjusted gross income, claimed a $25,308

miscellaneous expense deduction on their 2011 Schedule A. This deduction

relates to many expenses incurred in connection with petitioners’ North Carolina

“hops business”. Respondent disallowed the entire amount. Petitioners bear the

burden of demonstrating their entitlement to deduct the claimed expenses. See

INDOPCO, Inc. v. Commissioner, 503 U.S. at 84; New Colonial Ice Co. v.

Helvering, 292 U.S. at 440. Petitioners have appeared before the Court on two

previous occasions and are aware of the rules requiring substantiation of their

expenses. Powell v. Commissioner, T.C. Memo. 2014-235; Powell v.

Commissioner, T.C. Dkt. No. 9562-14S (filed Apr. 29, 2014). The Court’s

standing pretrial order, dated February 24, 2015, also advised petitioners that all

documents should be stipulated amongst the parties or exchanged before trial.

Nonetheless, petitioners failed to produce at trial any documentation to

substantiate the expenses underlying their deductions. The Court held the record

open after trial for the parties to stipulate additional documents relating to these

expenses. However, the parties were unable to reach an agreement. Petitioners

have failed to demonstrate to the Court that respondent unreasonably withheld
                                       - 17 -

[*17] agreement. Therefore, we sustain respondent’s disallowance of the

miscellaneous expense deduction.

V. Social Security Benefits

      Section 86 provides for the taxability of Social Security benefits pursuant to

a statutory formula. If a taxpayer’s “modified adjusted gross income” plus one-

half of the Social Security benefits received during the taxable year exceeds the

“base amount”, then a portion of the taxpayer’s Social Security benefits is

includible in gross income. Sec. 86(a)-(d); see also McAdams v. Commissioner,

118 T.C. 373, 375-376 (2002). The “base amount” is $32,000 in the case of a joint

return. Sec. 86(c)(1)(B).

      Petitioners received $31,492 of Social Security benefits for tax year 2011.

Respondent determined that $26,768 of petitioners’ Social Security benefits was

taxable for tax year 2011. If, after Rule 155 computations, petitioners’ modified

adjusted gross income plus one-half of the Social Security benefits they received

during 2011 exceeds $32,000, then a portion of petitioners’ Social Security

benefits will be includible in gross income as provided in section 86. The precise
                                       - 18 -

[*18] amount of Social Security benefits includible in petitioners’ gross income

for 2011 also will be determined through Rule 155 computations.7

VI. Section 6662 Penalty

      Petitioners contest the imposition of an accuracy-related penalty under

section 6662(a) and (b)(2) for an underpayment of tax attributable to a substantial

understatement of income tax for 2011.

      There is a substantial understatement of income tax if the amount of the

understatement exceeds the greater of 10% of the tax required to be shown on the

return for the tax year or $5,000. Sec. 6662(d)(1)(A); sec. 1.6662-4(a) and (b),

Income Tax Regs. If the Rule 155 computations confirm a substantial

understatement, then respondent has met his burden of production, see sec.

7491(c), and petitioners are liable for the penalty unless they can demonstrate that

respondent’s penalty determination was incorrect, for example because there was

reasonable cause for any portion of the underpayment and that they acted in good

faith, see sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at 446-447.


      7
        At trial counsel for respondent also mentioned an adjustment to
petitioners’ self-employment tax liability for each of 2011 and 2012. The notice
of deficiency includes no adjustment to petitioners’ self-employment tax liability
for either tax year, however, and counsel for respondent did not propose any
adjustments to their self-employment tax liability. Therefore, the issue of
petitioners’ self-employment tax liability is not properly before us.
                                        - 19 -

[*19] The decision as to whether a taxpayer acted with reasonable cause and in

good faith is made on a case-by-case basis, taking into account all pertinent facts

and circumstances. See sec. 1.6664-4(b)(1), Income Tax Regs. Generally, the

most important factor is the extent of the taxpayer’s efforts to assess the proper tax

liability. Id.; see Halby v. Commissioner, T.C. Memo. 2009-204.

      Petitioners claim that their use of tax preparation software caused the

mistakes. In the absence of evidence of a mistake in the software or a more

thorough effort by petitioners to determine their correct tax liability, we cannot

conclude that they have shown reasonable cause for the underpayment on their

2011 tax return. We further hold that petitioners’ substantiation, which was to

precede any tax preparation, largely fell short of what was required. We therefore

hold that if Rule 155 computations confirm a substantial understatement,

petitioners are liable for the penalty for an underpayment attributable to a

substantial understatement of income tax under section 6662(a) and (b)(2).

VII. Section 7433 Damages

      Petitioners seek $25,000 and $10,000 in damages for tax years 2011 and

2012, respectively, from respondent under section 7433. Section 7433(a) provides

that a taxpayer may bring a civil action for damages against the United States in a

U.S. District Court if an officer or employee of the Internal Revenue Service
                                       - 20 -

[*20] recklessly or intentionally or by reason of negligence disregards any

provision of the Internal Revenue Code. This Court therefore lacks jurisdiction to

hear petitioners’ section 7433 claim. See, e.g., Petito v. Commissioner, T.C.

Memo. 2002-271.

      Any contentions we have not addressed we deem irrelevant, moot, or

meritless.

      To reflect the foregoing,


                                                     Decision will be entered under

                                                Rule 155.
