                        T.C. Memo. 2005-67



                      UNITED STATES TAX COURT



                 LAURA D. SEIDEL, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 8964-03.              Filed March 31, 2005.


     Laura D. Seidel, pro se.

     John Strate and Rex Lee, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GOLDBERG, Special Trial Judge:   Respondent determined a

deficiency in petitioner’s Federal income tax of $24,593 and an

additional tax of $4,397.87 pursuant to section 72(t) for the

taxable year 1999.   Unless otherwise indicated, section

references are to the Internal Revenue Code in effect for the
                                - 2 -

year in issue, and all Rule references are to the Tax Court Rules

of Practice and Procedure.

       After concessions by the parties, the issues for decision

are:    (1) Whether petitioner received a taxable distribution of

$77,000 from Lee Seidel’s (petitioner’s former husband) section

401(k) plan (401(k) plan) pursuant to a Qualified Domestic

Relations Order (QDRO) which designated her as the alternate

payee; (2) whether petitioner is entitled to business deductions

and cost of goods sold claimed on Schedule C, Profit or Loss From

Business, for an activity named Port of Mystery, involving the

sale and repair of antique jewelry; (3) whether petitioner is

liable for the 10-percent additional tax pursuant to section

72(t) because she received an early distribution from her own

401(k) plan and from Lee Seidel’s 401(k) plan; (4) whether

petitioner is entitled to an additional itemized deduction on

Schedule A, Itemized Deductions, for taxable year 1999 for

mortgage interest in the amount of $2,471.09; (5) whether

petitioner is entitled to an additional itemized deduction for

legal fees in the amount of $2,058.50 paid to Robert Fruitman,

petitioner’s divorce attorney, in taxable year 1999; and (6)

whether petitioner underwent more than one inspection of her

books of account for taxable year 1999.
                                 - 3 -
                         FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits thereto are

incorporated herein by this reference.     Petitioner resided in

Yuba City, California, on the date the petition was filed in this

case.

Taxability of 401(k) Distribution Pursuant to a QDRO

     Petitioner married Lee Seidel (Mr. Seidel) on October 23,

1993.   During the marriage, Mr. Seidel was employed by the

California Water Service Company (CWSC).     Mr. Seidel’s employment

with CWSC commenced in 1974 and continued beyond the dissolution

of the marriage.   As an employee of CWSC, Mr. Seidel was a

participant in a tax-deferred savings plan (CWSC 401(k))

sponsored by CWSC pursuant to section 401(a) and (k).     Mr.

Seidel’s participation in the CWSC 401(k) plan began sometime

between 1983 and 1985, prior to his marriage to petitioner, and

continued during the marriage.    Mr. Seidel’s CWSC 401(k) plan

consisted of a separate property interest for contributions made

prior to his marriage to petitioner, and a community property

interest for contributions made during his marriage to

petitioner.   The parties agree that the community property

interest in Mr. Seidel’s CWSC 401(k) plan totals $77,000.

     Petitioner and Mr. Seidel each entered the marriage with

separate property interests.   Petitioner had her own house which

was encumbered by a first mortgage.      Mr. Seidel had his own house
                                 - 4 -
which he had purchased.   Mr. Seidel’s house was encumbered by a

first and second mortgage.   After their marriage, Mr. Seidel

moved into petitioner’s house.

     During the beginning years of their marriage, petitioner and

Mr. Seidel took out a second mortgage on petitioner’s house.    The

proceeds of this second mortgage were used to pay off the second

mortgage on Mr. Seidel’s house, to pay off some of petitioner’s

debts, and to purchase household assets.

     Petitioner and Mr. Seidel separated on February 11, 1998.

During settlement negotiations to dissolve the marriage,

petitioner was represented by attorney, Robert Fruitman (Mr.

Fruitman).   Mr. Seidel was represented by his attorney, Francis

L. Adams (Mr. Adams).   The marriage was dissolved by the Superior

Court of California, County of Sutter (California Superior

Court), on April 27, 1999.

     With respect to the division of Mr. Seidel’s CWSC 401(k)

plan, petitioner and Mr. Seidel agreed to a Marital Settlement

Agreement, dated April 19, 1999, and entered by the California

Superior Court on April 27, 1999, which provided:

     the parties presently have a partial community interest
     [$77,000.00] in Husband’s 401K and Husband has a partial
     separate property interest in his 401K. The parties agree
     that the sum of SEVENTY SEVEN THOUSAND DOLLARS AND NO/100
     ($77,000.00) shall be withdrawn from the 401K plan held in
     Husband’s name. Husband will then deduct the federal and/or
     state penalties and the federal and state taxes and any
     other taxes for early withdraw [sic] from that amount, and
     from that remaining balance, Husband shall arrange for the
     payment of the two (2) debts owed to First Community
                                - 5 -
     Financial Services, which are secured by deeds of trust on
     wife’s home. After those two (2) debts are paid, any
     balance of the proceeds shall be split equally between the
     parties. Any proceeds remaining in Husband’s 401K plan
     shall be confirmed to Husband as his sole and separate
     property.

     The Marital Settlement Agreement was reviewed by Lillick &

Charles, LLP, Attorneys at Law (Lillick & Charles), and by the

administrator of the CWSC 401(k) plan, for whom Lillick & Charles

acted as counsel.   Based upon this review, the plan administrator

refused to comply with the Marital Settlement Agreement because

it did not constitute a QDRO.   Due to Mr. Seidel’s continuing

employment, the plan administrator would not distribute the

called for amount to Mr. Seidel.

     Mr. Fruitman and Mr. Adams negotiated a second Marital

Settlement Agreement which incorporated a Domestic Relations

Order (DRO).   They submitted the proposed QDRO with their

respective party’s approval to Lillick & Charles on May 28, 1999.

The Marital Settlement Agreement did not provide for the payment

of funds from petitioner to Mr. Seidel for use in making the

mortgage interest payment at issue in the present case.

Petitioner expressly waived all spousal support in the Marital

Settlement Agreement.

     Lillick & Charles advised Mr. Fruitman and Mr. Adams on June

7, 1999, that the proposed DRO was satisfactory, met the

requirements of a QDRO, and that the plan administrator would

make the distribution pursuant to the QDRO.
                              - 6 -
     On July 19, 1999, Mr. Seidel, Mr. Adams, petitioner, and Mr.

Fruitman signed a Stipulation and Order with respect to the QDRO.

This Stipulation and Order, which was stamped “Endorsed Filed

Aug. 3, 1999" by the Superior Court of the State of California,

requested that the Court issue an order as follows:

     1. A completed Qualified Domestic Relations Order will be
     prepared and submitted to the Plan for approval and the Plan
     will advise counsel of their approval prior to the
     signatures of the parties and their counsel and prior to
     the submission to the court.

     The parties presently have a partial community interest
     ($77,000.00) in Husband’s 401K and Husband has a partial
     separate property interest in his 401K. The parties agree
     that the sum of SEVENTY SEVEN THOUSAND DOLLARS AND ZERO
     CENTS ($77,000.00) shall be withdrawn from the 401K plan in
     Wife’s name, as an Alternate Payee, and paid over to
     Wife’s attorney. The Plan’s administrators will
     automatically withhold a portion of the Federal and State
     tax obligation resulting from early withdrawal of the funds.
     Wife’s attorney will pay out of the remaining fund balance
     an amount sufficient to pay off the two (2) debts owed to
     First Community Financial Services (in the approximate
     amount of $28,000), which are secured by a deed of trust on
     Wife’s home. The remaining fund balance shall be used to
     pay Husband the sum of TEN THOUSAND DOLLARS AND ZERO CENTS
     ($10,000.00). Any remaining balance shall belong to Wife.
     Wife’s attorney shall accomplish all disbursements from the
     withdrawn funds within thirty (30) days of receipt. Any
     proceeds remaining in Husband’s 401K plan shall be confirmed
     to husband as his sole and separate property.

     The QDRO issued by the Superior Court of the State of

California on August 3, 1999, was stamped “Endorsed Filed”.   This

QDRO stated in paragraph 4:

     The AP [alternate payee] account will be distributed upon
     receipt by the Plan of an endorsed filed copy of this
     Qualified Domestic Relations Order and an endorsed filed
     copy of the Stipulation and Order that concerns this
     Qualified Domestic Relations Order.
                                 - 7 -
Unlike the Stipulation and Order filed August 3, 1999, this QDRO

made no mention of the distribution of $10,000 to Mr. Seidel or

the distribution of funds to pay the debts secured by the deed of

trust.     However, the QDRO incorporated into its terms the

Stipulation and Order.

     Petitioner, through her attorney as her agent, received a

net distribution of $60,060 ($77,000 less Federal and State taxes

withheld of $16,940).     Petitioner also received a Form 1099,

Distributions from Pensions, Annuities, Retirement or Profit-

Sharing Plans, issued by New York Life Insurance Company for

taxable year 1999 reflecting a taxable distribution of $77,000.

Upon receipt of this distribution, petitioner did not redeposit

the funds into the CWSC 401(k) plan, nor did she roll the funds

over into any other qualified plan within the 60-day grace period

allowed by section 402(c).1

     On August 27, 1999, petitioner signed cashier’s checks as

follows:




     1
      Although a qualified pension plan is exempt from taxation
under sec. 501(a), any amounts actually distributed from such a
plan generally must be included in the distributee’s gross
income. Sec. 402(a). In order to avoid the tax consequence of a
plan distribution, the distributee may “roll over” the amount of
the distribution into another eligible plan within 60 days. Sec.
402(c).
                                    - 8 -


     Check Number           Payee                      Amount

     2016074195             Lee Seidel                 $10,000.00
     2016074191             First Community
                            Financial Services         $24,159.662
     2016074192             First Community
                            Financial Services          $6,847.462

     Also during 1999, petitioner received a $10,141.98

distribution from Putnam Investments (her own 401(k) plan) and a

$11,567.62 distribution from Standard Insurance Company.

However, petitioner reported total pension and annuity

distributions on her 1999 Federal income tax return of only

$40,172.   This amount represents one-half of the net distribution

from Mr. Seidel’s CWSC 401(k) plan of $30,030 and $10,142

received from Putnam Investments.       Therefore, respondent in the

notice of deficiency adjusted petitioner’s pension and annuity

income upward by $58,537.    In the notice of deficiency respondent

determined (1) that petitioner failed to report the $11,567

distribution from Standard Insurance Company, and the additional

$46,970 distribution from New York Life from Mr. Seidel’s CWSC




     2
      These check payments made to First Community Financial
Services were made to pay off the principal balance of a second
mortgage on petitioner’s house, which was a liability assumed
during petitioner and Mr. Seidel’s marriage, and as such was a
joint liability, and to pay off another unspecified joint
liability.
                                 - 9 -
401(k) plan, and (2) that petitioner was not entitled to a $5,442

“cost of goods sold” deduction on Schedule C.3

     Although petitioner reported one-half of the net

distribution of $60,060, or $30,030 in gross income on her 1999

Federal income tax return, she claimed the entire credit of

$15,400 for the Federal income tax withheld on the $77,000

distribution from Mr. Seidel’s CWSC 401(k) plan, together with an

itemized deduction on Schedule A of $1,540 for the State and

local income taxes withheld on the $77,000 distribution.

     Mr. Seidel did not report any part of the distribution from

the CWSC 401(k) plan on his Form 1040, U.S. Individual Income Tax

Return, for taxable year 1999.

     Following the examination by the Internal Revenue Service

(IRS) of Mr. Seidel’s and petitioner’s 1999 Federal income tax

returns, Mr. Seidel took the position that petitioner should

include the full amount of the distribution of $77,000 in her

income for 1999, and petitioner took the position that Mr. Seidel

should include one-half of the distribution in his income.    As a

result, respondent issued notices of deficiency to both Mr.

Seidel and petitioner to avoid the possibility of being in a

whipsaw position.   Respondent determined that Mr. Seidel failed

to report $30,030 (one-half of the net distribution) in his


     3
      The amount of $5,442 which was disallowed by respondent is
actually the total net loss reported on Schedule C from
petitioner’s activity, Port of Mystery.
                                  - 10 -
income for 1999, and petitioner was responsible for additional

income in the amount of $46,970.      Mr. Seidel filed a petition to

this Court at docket No. 8003-03S, in which he contested his

liability as to the additional one-half of the net distribution

from his CWSC 401(k) plan.    Mr. Seidel’s case and this case were

tried separately on the Court’s San Francisco, California, Trial

Session beginning on March 1, 2004.

Port of Mystery

     During 1997, petitioner began an activity under the name

Port of Mystery, to sell and repair antique and estate jewelry.

Although petitioner had no prior experience in this field,

petitioner claimed she had an “eye” for jewelry.     During taxable

year 1999, petitioner did not maintain books and records for Port

of Mystery, such as a general ledger or other appropriate

journals.     However, petitioner did attach a Schedule C, Profit or

Loss from Business, to her 1999 Federal income tax return.      On

her Schedule C, petitioner claimed as follows:

     Income                                           Amount

     Gross   receipts                                   $750
     Less:   Cost of goods sold                        4,449
     Gross   profit                                   (3,699)
     Gross   income                                   (3,699)

     Expenses

     Advertising                                         $25
     Car and truck expenses                              273
     Depreciation and section 179 expense                181
     Travel expenses                                     150
     Utilities                                           394
                              - 11 -
     Other expenses:
          Show booth expenses                         500
          Bank fees                                   120
          Security 6%                                  57
          Pest control 6%                              43
               Total expenses                      $1,743
               Net Business Loss                   $5,442

     As part of her business expenses, petitioner claimed a truck

and automobile expense of $273 on her original return and

increased such expense to $451 on her “amended return”.4

However, no actual log of expenses or mileage was kept as to

petitioner’s claimed automobile expense.   Petitioner did keep

documents of jewelry shows that she claims she attended and

records of clients’ addresses that petitioner allegedly visited

on business matters.   Petitioner did not keep a mileage log for

any business trips made in taxable year 1999.   As to her other

business expenses, petitioner does not know how these expenses

and deductions were calculated.

     Petitioner was disabled and unable to work from February to

June 1999.   While on disability, petitioner spent no time on her

jewelry activity, the Port of Mystery.   During taxable year 1999,

petitioner participated in only two shows to exhibit Port of

Mystery jewelry.   The first show was a 3-day show which was held

in Sacramento, California; the second was a 2-day show which was

held in Marysville, California.


     4
      Such amended return was not filed with the Internal Revenue
Service but was merely exchanged with respondent’s counsel as
part of the parties’ informal document exchange.
                                - 12 -
     Petitioner admitted that she “didn’t know anything about

antique and estate jewelry as to value before [she] started the

business.”    During taxable year 1999, petitioner purchased a

considerable number of books and periodicals to assist her in

learning the business of selling and repairing antique and estate

jewelry.

Additional Tax--Section 72(t)

     During taxable year 1999, petitioner received a taxable

distribution from her 401(k) plan held by Putnam Investments of

$10,412.     Petitioner was “nearing [her] 40th birthday” in 1999.

Audit Examination

     Petitioner timely filed a Form 1040 for taxable year 1999.

Petitioner attached to her Form 1040 for taxable year 1999 a

“Special Handling” cover letter requesting a review of her

return.    Respondent mailed petitioner a letter dated June 9,

2000, thanking her for her inquiry and stating that the IRS had

not “resolved the matter.”    Petitioner received a letter dated

September 14, 2001, advising her that based upon review of third

party records, respondent proposed changes to her Form 1040 for

taxable year 1999.    Petitioner never entered into a closing

agreement with the IRS with respect to taxable year 1999.

Petitioner never received a letter stating that the IRS had

accepted her 1999 tax return, nor had she received a letter

stating that her 1999 tax return had been audited as requested.
                              - 13 -
Petitioner also submitted a Form 1040X, Amended U.S. Individual

Income Tax Return, for taxable year 1999 to respondent’s counsel

as part of the parties’ informal document exchange but did not

file the Form 1040X with the IRS.

                              OPINION

     As a general rule, the determinations of the Commissioner in

a notice of deficiency are presumed correct, and the taxpayer

bears the burden of proving the Commissioner’s determinations in

the notice of deficiency to be in error.   Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933).

1.   Taxability of 401(k) Distribution Pursuant to a QDRO

     As previously stated, because Mr. Seidel took the position

that petitioner should include the full amount of the

distribution in income and petitioner took the position that Mr.

Seidel should include one-half of the distribution in income,

respondent issued notices of deficiency to Mr. Seidel and

petitioner to avoid the possibility of being in a whipsaw

position.   Thus, respondent asserted that Mr. Seidel was

responsible for including the unreported income in the amount of

$30,030 on his 1999 tax return, and respondent also asserted that

petitioner was responsible for including in income the amount of

$46,970 representing the difference between $77,000 and the

$30,030 reported on her 1999 tax return.
                                - 14 -
     In the present circumstance, respondent is caught in a

potential “whipsaw” position.    A whipsaw occurs when different

taxpayers treat the same transaction involving the same items

inconsistently, thus creating the possibility that income could

go untaxed or two unrelated parties could deduct the same

expenses on their separate returns.       In such circumstances,

respondent is fully entitled to defend against inconsistent

results by determining in notices of deficiency that both parties

to the transaction are liable for the deficiency.       Estate of

Dooley v. Commissioner, T.C. Memo. 1992-557; Moore v.

Commissioner, T.C. Memo. 1989-306.

     Petitioner contends that Mr. Seidel should be liable for

one-half of the QDRO distribution:       (1) Due to the community

property law of California; or (2) due to the “beneficial receipt

of the proceeds by Mr. Seidel”.    We note that contrary to her

contention, petitioner claimed the entire credit of $15,400 for

the Federal income tax withheld on the total $77,000 distribution

from Mr. Seidel’s CWSC 401(k) plan, together with the entire

itemized deduction of $1,540 for the State and local income taxes

withheld on the $77,000 distribution.

     Generally, under section 402(a), a distribution from a

qualified retirement plan is taxed to the distributee.       Section

402(a) provides in part:

          Except as otherwise provided in this section, any
                              - 15 -
     amount actually distributed to any distributee by any
     employees’ trust described in section 401(a) which is exempt
     from tax under section 501(a) shall be taxable to the
     distributee, in the taxable year of the distributee in which
     distributed, under section 72 (relating to annuities).

Under section 402(a), the general rule is that a distribution

from an exempt employees’ trust (under a tax-qualified employees’

plan) is taxed to the “distributee” under section 72, which

generally provides for current taxation of distributions as

ordinary income.

     The Code does not define the word “distributee” as used in

section 402(a), neither do the regulations.   The Court has

concluded that a distributee of a distribution under a plan

ordinarily is the participant or beneficiary who, under the plan,

is entitled to receive the distribution.   See Darby v.

Commissioner, 97 T.C. 51, 58 (1991); Estate of Machat v.

Commissioner, T.C. Memo. 1998-154; Smith v. Commissioner, T.C.

Memo. 1996-292.

     Section 402(e)(1)(A), however, provides an exception to this

general rule.   Section 402(e)(1)(A) provides that an “alternate

payee” who is the spouse or former spouse of the plan participant

shall be treated as the distributee of any distribution or

payment made to the “alternate payee” under a “qualified domestic

relations order” as defined in section 414(p).   Therefore, a

distribution made to such an alternate payee under a QDRO will be

taxable to the alternate payee, and not to the plan participant,
                                - 16 -
because section 402(e)(1)(A) treats the alternate payee as the

distributee.

     The Retirement Equity Act of 1984 (REA 1984), Pub. L. 98-

397, sec. 204(b), 98 Stat. 1445, added section 414(p), which

defines a QDRO.     Section 414(p) provides, in pertinent part, the

following:

     SEC. 414(p). Qualified Domestic Relations Order Defined.--
     For purposes of this subsection and section 401(a)(13)--

          (1) In General.--

               (A) Qualified domestic relations order.--The term
          “qualified domestic relations order” means a domestic
          relations order--

                       (i) which creates or recognizes the existence
                  of an alternate payee’s right to, or assigns to an
                  alternate payee the right to, receive all or a
                  portion of the benefits payable with respect to a
                  participant under a plan, and

                       (ii) with respect to which the requirements
                  of paragraphs (2) and (3) are met.

               (B) Domestic Relations Order.-–The term “domestic
          relations order” means any judgment, decree, or order
          (including approval of a property settlement agreement)
          which--

                       (i) relates to the provision of child
                  support, alimony payments, or marital property
                  rights to a spouse, former spouse, child, or other
                  dependent of a participant, and

                        (ii) is made pursuant to a State domestic
                  relations law (including a community property
                  law).

Prior to the enactment of the Retirement Equity Act, some courts

had held that State law domestic support orders assigning or
                               - 17 -
attaching pension benefits were preempted by ERISA’s spendthrift

provision.    S. Rept. 98-575, at 20 (1984), 1984-2 C.B. 447, 456

(recognizing conflicting decisions).    Congress’s primary intent

in recognizing the QDRO exception was to clarify that these

domestic support obligations did not fall within the scope of

ERISA preemption.    See Mackey v. Lanier Collection Agency &

Serv., Inc., 486 U.S. 825, 838-839 (1988).

       The parties are in agreement that Mr. Seidel’s CWSC 401(k)

plan meets the requirements of section 401(a).    That being so,

distributions from the CWSC 401(k) plan are governed by section

402.

       Petitioner relies on Powell v. Commissioner, 101 T.C. 489

(1993), in arguing that the funds distributed through the QDRO

remained community property and should be taxed as an indirect

distribution.    Interpreting Darby v. Commissioner, supra, the

Court in Powell v. Commissioner, supra at 498, stated that “an

owner was not necessarily a distributee and * * * [that Darby]

specifically observed that its statement that a ‘distributee’ had

to be a participant or beneficiary was not an exclusive

definition of that word.”    Applying the law as modified by REA

1984, the Court in Powell found that the plan participant’s

former spouse was the “distributee” and thereby taxable on her

share of the pension benefits.    Id.
                               - 18 -
     The QDRO incorporated by its own terms the Stipulation and

Order filed August 3, 1999.    The QDRO also included a calculation

of the community property interest in Mr. Seidel’s CWSC 401(k)

plan and the Stipulation and Order provided for the division of

such community property interest.    The terms of the Stipulation

and Order governed petitioner’s actions and those of her attorney

as to the proceeds received through the distribution from Mr.

Seidel’s CWSC 401(k) plan.    The Stipulation and Order required

petitioner’s attorney to pay out of the fund so distributed,

within 30 days of its receipt by him, two liabilities owed

jointly by petitioner and Mr. Seidel to First Community Financial

Services, and to pay to Mr. Seidel $10,000.    In fact,

petitioner’s attorney made these payments, and petitioner never

actually received the proceeds that went to fulfill these

obligations.

     Based on the particular facts of this case, we find that

under the present QDRO, which by its terms incorporated the

Stipulation and Order filed August 3, 1999, petitioner was

alternate payee of only a portion of the distribution; i.e.,

$51,497.   This amount consists of the whole distribution of

$77,000 less $25,503.   The amount of $25,503 is attributable to

Mr. Seidel as beneficiary and distributee, and it consists of
                              - 19 -
$15,503, which is one-half of the two joint liabilities paid off

by the proceeds of the CWSC 401(k) distribution, plus the $10,000

check given to Mr. Seidel from the proceeds of the CWSC 401(k)

distribution in compliance with the Stipulation and Order.

     Therefore, petitioner is liable for the tax on the

additional portion of the distribution in the amount of $21,467,

which she has not reported and of which she was the beneficiary

and alternate payee.

     As stated in Powell v. Commissioner, supra at 498-499:

      Our conclusion is not affected by the fact that initially
      the entire distribution was made to [petitioner]. We think
      [she] received the distribution * * * on behalf of the
      community and that [her] later payment to [Mr. Seidel], [by
      way of cash and relief of joint liabilities], was a transfer
      to [him] of funds that at all times belonged to [him].

2.   Schedule C Deductions for the Port of Mystery

      Under section 162, a taxpayer may deduct the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on his or her trade or business.   A taxpayer is engaged

in a trade or business if the taxpayer is involved in the

activity (1) with continuity and regularity, and (2) with the

primary purpose of making a profit.    Commissioner v. Groetzinger,

480 U.S. 23, 35 (1987); Antonides v. Commissioner, 893 F.2d 656,

659 (4th Cir. 1990), affg. 91 T.C. 686 (1988).

      Petitioner has the burden of proving that she was engaged in

a trade or business, i.e., Port of Mystery, and that she is
                              - 20 -
entitled to the deductions claimed.5   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); Welch v. Helvering, 290 U.S.

111 (1933).   Section 7491(a) shifts the burden of proof to the

Commissioner respecting tax liability under certain

circumstances.   The burden does not shift in this case because

petitioner neither alleged that section 7491(a) was applicable

nor established that she fully complied with the statutory

substantiation requirements of section 7491 as shown below.   Sec.

7491(a)(2)(A) and (B).

     If petitioner fails to establish Port of Mystery’s

entitlement to the deductions under section 162,6 and fails to

show error in respondent’s determination that Port of Mystery was

an activity not engaged in for profit, then section 183 limits

     5
      The Internal Revenue Service Restructuring & Reform Act of
1998, Pub. L. 105-206, sec. 3001, 112 Stat. 726, added sec.
7491(a), which is applicable to Court proceedings arising in
connection with examinations commencing after July 22, 1998.
Under sec. 7491(a), Congress requires the burden of proof to be
placed on the Commissioner, where a taxpayer introduces credible
evidence with respect to factual issues relevant to ascertaining
the taxpayer’s liability for tax, and meets certain other
requirements. In the instant case, petitioner has not raised the
application of this provision, and petitioner has not presented
such credible evidence, nor met all other applicable
requirements; therefore, the burden remains with petitioner.
     6
      Sec. 183(c) provides that an activity is not engaged in for
profit if the activity is “other than one with respect to which
deductions are allowable for the taxable year under section 162
or under paragraph (1) or (2) of section 212.”
                              - 21 -
Port of Mystery’s deductions for expenses attributable to the

activity, as provided in section 183(b).

     Section 162(a) allows a deduction for ordinary and necessary

business expenses paid or incurred during the taxable year in

carrying on any trade or business.     To be “ordinary” the

transaction which gives rise to the expense must be of a common

or frequent occurrence in the type of business involved.      Deputy

v. du Pont, 308 U.S. 488, 495 (1940).     To be “necessary” an

expense must be “appropriate and helpful” to the taxpayer’s

business.   Welch v. Helvering, supra at 113-114.

     Deductions are a matter of legislative grace, and the

taxpayer bears the burden of proving that he or she is entitled

to any deduction claimed.   Rule 142(a); New Colonial Ice Co. v.

Helvering, supra.   This includes the burden of substantiation.

Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), affd. per

curiam 540 F.2d 821 (5th Cir. 1976).

     Section 6001 and the regulations promulgated thereunder

require taxpayers to maintain records sufficient to permit

verification of income and expenses.     As a general rule, if the

trial record provides sufficient evidence that the taxpayers have

incurred a deductible expense, but the taxpayer is unable to

adequately substantiate the precise amount of the deduction to

which he or she is otherwise entitled, the Court may estimate the

amount of the deductible expense and allow the deduction to that
                              - 22 -
extent, bearing heavily against the taxpayer whose inexactitude

in substantiating the amount of the expense is of his own making.

Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).    However, in

order for the Court to estimate the amount of an expense, the

Court must have some basis upon which an estimate may be made.

Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).    Without

such a basis, any allowance would amount to unguided largesse.

Williams v. United States, 245 F.2d 559, 560-561 (5th Cir. 1957).

Further, section 274(d) prohibits the estimation of expenses for

travel or deductions with respect to certain listed property;

thus, the Cohan rule does not apply to these types of expenses.

Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968), affd. per

curiam 412 F.2d 201 (2d Cir. 1969).    Listed property includes

automobiles.   Sec. 280F(d)(4).

     During taxable year 1999, petitioner did not maintain books

and records for her jewelry activity, Port of Mystery, such as a

general ledger or other appropriate journals.    Petitioner

purportedly kept “notes” of cash receipts received through her

activity.   However, petitioner claims that she could not produce

such receipts because her computer, which contained a record of

such receipts and notes, “crashed”.    Petitioner did not attempt

to reconstruct her records after her computer purportedly failed.

     Petitioner claimed she incurred cost of goods sold in the

amount of $4,449 on her original return but changed such claim
                              - 23 -
for cost of goods sold to $2,007 on her “amended return”.7

However, as stated above, petitioner did not maintain proper

books or even notes to substantiate such a claim.    Therefore, we

hold that petitioner is not entitled to any claim for cost of

goods sold during the taxable year 1999.

     Petitioner claimed a truck and automobile expense of $273 on

her original return and has increased such expense to $451 on her

“amended return”.   No actual log of expenses or mileage was kept

as to petitioner’s claimed automobile expense.    However,

petitioner did keep documents of shows that she claims she

attended and records of clients’ addresses that petitioner

allegedly visited on business matters.   In addition, petitioner

introduced into evidence parking receipts from Sacramento and a

check from a client in the Bay Area, both of which petitioner

claims substantiates her travel to these areas.    Petitioner

attempts to use these such documents to substantiate her claimed

automobile expense.   However, petitioner did not keep a mileage

log for such trips.

     Aside from the above-mentioned parking receipts, check, and

other documents, petitioner offered no further records to

substantiate her travel or automobile expenses.    Her evidence

     7
      Such amended return, as previously noted, was not filed
with the Internal Revenue Service but was merely exchanged with
respondent’s counsel as part of the parties’ informal document
exchange.
                                   - 24 -
does not meet the substantiation requirements of section 274

because it does not show mileage traveled, route taken, or

business purpose of these expenses.         Sec. 274(d).

       As to petitioner’s other Schedule C deductions, including

utilities expense, cable expense, and bank charges, petitioner

testified that she did not know how these deductions were

calculated.       She did not substantiate such expenses.   Therefore,

this Court holds that such deductions are not allowed and

respondent’s disallowance of such deductions is sustained.

       Due to our holding that petitioner has not substantiated any

of the claimed Schedule C deductions for Port of Mystery, it is

not necessary for us to determine whether Port of Mystery was an

activity engaged in for profit.

3.   Additional Tax--Section 72

       Generally, section 72(t)(1) imposes a 10-percent additional

tax on early distributions from qualified retirement plans,8

unless the distribution comes within one of several statutory

exceptions.       For example, distributions that are made on or after

the date on which the taxpayer attains the age of 59½ are not

“early”, and therefore not subject to the 10-percent additional

tax.       Sec. 72(t)(2)(A)(i).   As relevant to the present case,

section 72(t)(2)(C) provides an exception for distributions “to


       8
      As relevant to the present case, a “qualified retirement
plan” includes an individual retirement account (IRA) and a
qualified pension or profit-sharing plan. Sec. 4974(c)(1), (4).
                              - 25 -
an alternate payee pursuant to a qualified domestic relations

order”.

      In the present situation, the QDRO, issued in connection

with Mr. Seidel’s CWSC 401(k) plan, designated petitioner as the

alternate payee of $51,497 of the distribution as we have found.

Therefore, petitioner is not liable for the 10-percent additional

tax pursuant to section 72(t) with respect to the portion of the

$77,000 distribution from Mr. Seidel’s CWSC 401(k) plan that is

includable in her gross income as the alternate payee.   Sec.

72(t)(2)(C).

      However, petitioner concedes that she received a taxable

distribution from her 401(k) plan held by Putnam Investments for

taxable year 1999 in the amount of $10,412.   Petitioner also

testified that she was “nearing [her] 40th birthday” in the

taxable year 1999.   Therefore, the distribution from petitioner’s

401(k) plan is considered “early” and subject to the 10-percent

additional tax, unless one of the enumerated statutory exceptions

applied.   Petitioner put forth no arguments that an exception

applied to such distribution; thus the distribution of $10,412

from Putnam Investments is subject to the 10-percent additional

tax under section 72(t).

4.   Mortgage Interest Deduction

      Section 163(a) allows a deduction for all interest paid or

accrued within the taxable year on indebtedness.   Section
                               - 26 -
163(h)(1), however, provides that, in the case of a taxpayer

other than a corporation, no deduction is allowed for personal

interest.   Qualified residence interest is excluded from the

definition of personal interest and thus is deductible under

section 163(a).    See sec. 163(h)(2)(D).    Qualified residence

interest is any interest which is paid or accrued during the

taxable year on acquisition indebtedness or home equity

indebtedness.   See sec. 163(h)(3)(A).     Acquisition indebtedness

is any indebtedness secured by the qualified residence of the

taxpayer or incurred in acquiring, constructing, or substantially

improving the qualified residence.      See sec. 163(h)(3)(B).    Home

equity indebtedness is any other indebtedness secured by the

qualified residence to the extent the aggregate amount of such

indebtedness does not exceed the fair market value of the

qualified residence reduced by the amount of acquisition

indebtedness on the residence.    See sec. 163(h)(3)(C)(i).      The

amount of home equity indebtedness for any taxable year cannot

exceed $100,000.   See sec. 163(h)(3)(C)(ii).     The indebtedness

generally must be an obligation of the taxpayer and not an

obligation of another.   See Golder v. Commissioner, 604 F.2d 34,

35 (9th Cir. 1979), affg. T.C. Memo. 1976-150.

     However, a deduction with respect to interest arising out of

a joint obligation of a taxpayer and another party is only

allowable to the taxpayer to the extent he or she makes payment
                              - 27 -
of the interest out of his or her own funds.    See Finney v.

Commissioner, T.C. Memo. 1976-329, and authorities cited therein.

     In Finney, the taxpayer and his wife were separated during

the taxable year 1971 and held a residence as tenants by the

entirety during that year.   Although the mortgage interest

payments were nominally made by the taxpayer’s wife, this Court

concluded that he had satisfied his burden of proving that the

funds used to make the interest payments were his funds, and he

was therefore entitled to the deduction.    However, in reaching

this conclusion we relied upon a stipulation entered into between

respondent, the husband, and the wife that the funds used to make

the interest payments were supplied by the husband.

     Another case dealing with this issue is Kohlsaat v.

Commissioner, 40 B.T.A. 528 (1939).    In Kohlsaat, the Board of

Tax Appeals9, likewise, concluded that taxpayer-husband was

entitled to a deduction for mortgage interest payments made with

respect to a former marital residence even though the payments

were nominally made by his ex-wife.    However, in that case the

divorce decree provided that in addition to his obligation to

make monthly alimony payments to his ex-wife, he was directed to

pay $225 per month to his ex-wife, and she was directed to use

these funds to make the mortgage payments for which he was


     9
      The Revenue Act of 1942, ch. 619, 56 Stat. 798, established
the Tax Court of the United States on Oct. 21, 1942, which
superseded the United States Board of Tax Appeals.
                                - 28 -
primarily and personally liable.    Because of these circumstances,

the Board concluded: “No part of the $225 monthly payments

represented alimony or any ‘allowance’ to the wife.    She could

not use the funds for any other purpose than to pay the carrying

charges on the mortgaged property and to reduce the principal

mortgage debt.    In so doing she acted as agent or trustee for the

petitioner.”     Kohlsaat v. Commissioner, supra at 534.

     Petitioner provided no documentation, such as canceled

checks or Forms 1099, that substantiates her claim that she made

payments of mortgage interest in the amount of $2,471.09 in

taxable year 1999.    Petitioner’s only evidence, in this respect,

is a statement from First Community Financial Services addressed

to Mr. Seidel reflecting that he paid $2,471.09 in interest in

taxable year 1999.    Since there is no evidence that petitioner’s

funds were in fact used to make these payments, and the burden of

proof is upon her to establish that it was in fact her funds that

were used to make the payments, we must conclude that petitioner

is not entitled to the deduction claimed because she has not

established that the payments were made with her funds.    Rule

142; Diez-Arguelles v. Commissioner, T.C. Memo. 1984-356;

Kazupski v. Commissioner, T.C. Memo. 1982-182; Finney v.

Commissioner, supra; Kohlsaat v. Commissioner, supra.
                                 - 29 -
5.   Attorney’s Fees Deduction

      At trial, petitioner claimed an itemized deduction on

Schedule A for attorney’s fees in the amount of $2,058.50.

      Personal, living, and family expenses generally are not

deductible by taxpayers.    Sec. 262(a).   Attorney’s fees and other

costs paid in connection with a divorce generally are personal

expenses and therefore nondeductible.      Sec. 1.262-1(b)(7), Income

Tax Regs.   On the other hand, expenses paid for the production or

collection of income, or in connection with the determination,

collection, or refund of any tax, generally are deductible.      Sec.

212(1), (3).    This is the case even if the expenses are paid in

connection with a divorce.    Swain v. Commissioner, T.C. Memo.

1996-22, affd. without published opinion 96 F.3d 1439 (4th Cir.

1996); sec. 1.262-1(b)(7), Income Tax Regs.

      The legal fees which petitioner paid to her attorney were

paid in order to secure petitioner’s divorce and property

settlement.    Petitioner expressly waived all spousal support

(i.e., alimony).    However, a portion of petitioner’s attorney’s

fees was paid in order to secure the production of income;

namely, the distribution from Mr. Seidel’s CWSC 401(k) plan

includable in her income as alternate payee.     Therefore, under

section 212 and under the Cohan rule, we may estimate the amount

of the Schedule A itemized deductible expense.     Thus, we hold
                              - 30 -
that petitioner may claim a deduction for attorney’s fees in the

amount of $1,377.10

6.   Audit Examination

      Section 7605(b) provides:

      No taxpayer shall be subjected to unnecessary examination or
      investigations, and only one inspection of a taxpayer’s
      books of account shall be made for each taxable year unless
      the taxpayer requests otherwise or unless the Secretary,
      after investigation, notifies the taxpayer in writing that
      an additional inspection is necessary.

      This Court stated in Digby v. Commissioner, 103 T.C. 441,

445 (1994):

     The Supreme Court, after a review of the legislative
     history, interpreted the purpose of section 7605(b) as being
     congressional recognition of “a need for a curb on the
     investigating powers of low-echelon revenue agents, and
     considered that it met this need simply and fully by
     requiring such agents to clear any repetitive examination
     with a superior.” United States v. Powell, 379 U.S. 48, 55-
     56 (1964); 61 Cong. Rec. 5855 (Sept. 28, 1921). The Powell
     case involved the enforcement of a summons to appear before
     a special agent and produce for reexamination certain
     corporate records, on the ground that suspected fraud would
     reopen the expired 3-year period of limitations on
     assessment and collection. Section 7605(b) was considered
     in that context to determine whether that section, either
     alone or in conjunction with others, placed a probable cause
     standard or other restrictions on the Commissioner’s agents
     before a tax year may be reexamined. The Supreme Court
     held, with respect to section 7605(b) that, generally, “no
     severe restriction was intended”, and regarding unnecessary
     examinations, courts are not required “to oversee the
     Commissioner’s determinations to investigate.” United
     States v. Powell, supra at 54, 56.


      10
      This amount was arrived at by multiplying petitioner’s
total attorney’s fees by a fraction, the numerator of which is
the taxable portion of CASC 401(k) plan distribution and the
denominator of which is the total amount of the CASC 401(k) plan
distribution ($2,058.50 x ($51,497 ÷ $77,000) = $1,377).
                              - 31 -
     Thus, the Internal Revenue Service is generally limited to

one inspection of a taxpayer’s books and records for each taxable

year unless the taxpayer requests a second audit or the Service

notifies the taxpayer in writing that an additional inspection is

necessary.   United States v. Powell, supra; De Masters v. Arend,

313 F.2d 79, 85 (9th Cir. 1963).

     However, the review of records of third parties does not

constitute an inspection of the taxpayer’s books and records.

Digby v. Commissioner, supra at 447.   Moreover, mere

communication with the taxpayer does not fall within the scope of

an inspection of books and records.    Benjamin v. Commissioner, 66

T.C. 1084, 1098-1099 (1976), affd. 592 F.2d 1259 (5th Cir. 1979).

     With this background we consider petitioner’s contention

that respondent has violated the requirements of section 7605(b)

by subjecting petitioner to three separate inspections of her

books and records.

     Petitioner attached to her Form 1040 for taxable year 1999,

a “Special Handling” cover letter requesting a review of her

return.   Petitioner presented no evidence that respondent audited

her return as a result of this request.   In fact, respondent

mailed petitioner a letter thanking her for her inquiry and

stating that the IRS had not “resolved the matter.”     Such a

response to a taxpayer’s inquiry does not constitute an
                                - 32 -
inspection of her books of account.      See Benjamin v.

Commissioner, supra.

     Petitioner received a letter dated September 14, 2001,

advising her that based upon review of third party records,

respondent proposed changes to her Form 1040 for taxable year

1999.   The review of records of third parties does not constitute

a review of a taxpayer’s books and records.      Digby v.

Commissioner, supra.

     Petitioner’s argument that respondent has violated section

7605(b) is grounded on respondent’s issuing to petitioner a tax

refund before auditing her 1999 tax return.     Petitioner admits

that she never entered into a closing agreement with the IRS with

respect to taxable year 1999.    Petitioner also admits that she

never received a letter stating that the IRS had accepted her

1999 tax return, nor had she received a letter stating that her

1999 tax return had been audited as requested by her special

handling request.

     Instead, petitioner’s argument of multiple audits relies on

petitioner’s testimony that her refund was evidence of an audit

that resulted from her special handling request.     Such testimony

and argument do not substantiate her claim of a violation of

section 7605(b).

     There is no evidence in the record that substantiates

petitioner’s claim that the IRS audited her income tax return by
                              - 33 -
inspecting her books of account before issuing petitioner her

1999 income tax refund.   We hold that respondent did not subject

petitioner to multiple inspections of her books of account and

thus did not violate section 7605(b).

     To reflect the foregoing,


                                      Decision will be entered

                                 under Rule 155.
