                  T.C. Summary Opinion 2005-11



                     UNITED STATES TAX COURT



               CYNTHIA PAMELA ALDRIDGE DUMOND AND
               JEFFREY ALLEN DUMOND, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6692-03S.               Filed January 31, 2005.


     Jeffrey Allen Dumond, pro se.

     J. Anthony Hoefer, for respondent.



     GOLDBERG, Special Trial Judge:    This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed.    The decision to be

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

should not be cited as authority.    Unless otherwise indicated,

subsequent section references are to the Internal Revenue Code in
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effect for the 1999 and 2000 years in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

     Respondent determined a deficiency in petitioners’ Federal

income tax of $1,260 and an accuracy-related penalty of $252 for

the taxable year 1999.   Respondent also determined a deficiency

in petitioners’ Federal income tax of $1,260 and an accuracy-

related penalty of $252 for the taxable year 2000.

     The issues for decision are:   Whether petitioners should be

allowed business expense deductions for amounts paid to their

minor children during 1999 and 2000, and whether petitioners are

liable for the section 6662(a) accuracy-related penalties for

negligence or disregard of rules or regulations in the years in

issue.

     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.     Petitioners resided in

Des Moines, Iowa, on the date the petition was filed.

Petitioner-husband Jeffrey Allen Dumond (petitioner) appeared

before the Court and presented petitioners’ case.     Petitioner-

wife Cynthia Pamela Aldridge Dumond did not appear.

                            Background

     Petitioners timely filed their Federal income tax returns

for the taxable years 1999 and 2000.     Petitioners filed their
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1999 and 2000 income tax returns as married filing jointly using

the cash method of accounting.

     During 1999 and 2000, petitioner operated a vending machine

business, State of the Art Vending.      Petitioner purchased this

business in 1999, acquiring vending machines and a clientele

list.   During 1999 and 2000, State of the Art Vending serviced 10

clients.

     On his Schedule C, Profit or Loss From Business, for taxable

years 1999 and 2000, petitioner deducted labor expenses of $8,400

in each year, which consisted of $4,200 paid to each of his two

minor children.   In the statutory notice, respondent disallowed

the amounts paid to his children after determining that the

amounts were not ordinary and necessary expenses paid or incurred

in a trade or business.

                            Discussion

     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).      Section 7491(a) shifts the

burden of proof to the Commissioner under certain circumstances.

The burden does not shift with respect to any factual issue

relating to petitioners’ liability for the income tax

deficiencies because petitioners neither alleged that section
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7491 was applicable nor established that they complied with the

statutory substantiation requirements of section 7491(a), as

shown below.    Sec. 7491(a)(2)(A) and (B).

Business Expenses--Wages Paid to Children

     Section 162(a)(1) provides that there shall be allowed as a

deduction all the ordinary and necessary expenses paid or

incurred during the taxable year in carrying on a trade or

business, including a reasonable allowance for salaries or other

compensation for personal services actually rendered.

     Section 1.162-7(a), Income Tax Regs. provides:    “The test of

deductibility in the case of compensation payments is whether

they are reasonable and are in fact payments purely for

services.”    See Elec. & Neon, Inc. v. Commissioner, 56 T.C. 1324,

1340 (1971), affd. without published opinion 496 F.2d 876 (5th

Cir. 1974).    The question of whether amounts paid represent

reasonable compensation for services is one of fact determined

from all the facts and circumstances of the case.     Charles

Schneider & Co. v. Commissioner, 500 F.2d 148, 151 (8th Cir.

1974), affg. T.C. Memo. 1973-130; Home Interiors & Gifts, Inc. v.

Commissioner, 73 T.C. 1142, 1155 (1980).

     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, 292 U.S. 435, 440 (1934).    This includes the burden of
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substantiation.   Hradesky v. Commissioner, 65 T.C. 87, 89-90

(1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976).

     Petitioner testified that he paid wages of $4,200 a year in

1999 and 2000 to each of his two children.   Petitioners’ children

were ages 10 and 5 in 1999.   Petitioner testified that the

payments to his children were based on what he believed the “law

allowed for, so that they [his children] would not have to file

taxes.”

     Petitioner testified that the services provided by his

children included:   Riding along on the weekly routes to the

vending machines, putting candy bars into the machines, sorting

the totes full of candy, breaking down the cardboard and sorting

out the recyclable products of waste produced by the business.

The older child also helped with counting money.   Petitioner

testified that his children worked approximately 10 hours per

week.   Petitioner admitted, however, that he did not know for

sure how often his children worked every week and that he did not

keep any record of their hours.

     Petitioner offered into evidence copies of checks and a bank

statement to establish payment of wages to his children.

Petitioner testified that his children were paid once a year at

the end of December.   However, the checks made out to his

children were not cashed until at least 2 months later because

there was not enough capital in the business to cash the checks
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when they were issued.   Even after the checks were endorsed by

the payee children and petitioner, he retained control of the

proceeds.   Petitioner did not set up separate accounts for his

children in which to deposit their alleged wages; instead,

petitioner kept the proceeds and either reinvested the proceeds

into his business or deposited said proceeds into his own

personal account.   Petitioner also never established an hourly

rate for his children’s services.   His children were paid a set

amount for both years.

     Petitioner has failed to carry his burden of proof with

respect to the deductions taken for wages paid to his children,

and thus respondent’s determination must be sustained.    See

Romine v. Commissioner, 25 T.C. 859 (1956); Chappell v.

Commissioner, T.C. Memo. 2001-146; Medina v. Commissioner, T.C.

Memo. 1983-253; Snyder v. Commissioner, T.C. Memo. 1975-221.

Accuracy-Related Penalty

     Respondent determined that petitioners are liable for the

accuracy-related penalty under section 6662(a) with respect to

the underpayment attributable to the disallowed deductions for

Schedule C wages.

     Section 7491(c) provides that the Commissioner shall have

the burden of production in any court proceeding with respect to

the liability of any individual for any penalty, addition to tax,

or additional amount.    Specifically, section 7491(c), which was
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enacted by the Internal Revenue Service Restructuring and Reform

Act of 1998 (RRA 1998), Pub. L. 105-206, sec. 3001(a), 112 Stat.

726, provides as follows:

          SEC. 7491(c) Penalties.–-Notwithstanding any other
     provision of this title, the Secretary shall have the burden
     of production in any court proceeding with respect to the
     liability of any individual for any penalty, addition to
     tax, or additional amount imposed by this title.

Section 7491(c) is effective with respect to court proceedings

arising in connection with examinations commencing after July 22,

1998.   RRA 1998 sec. 3001(c)(1), 112 Stat. 727.   There is no

dispute that the examination in the present case commenced after

July 22, 1998.

     Section 6662(a) imposes a 20-percent penalty on the portion

of an underpayment attributable to any one of various factors,

one of which is negligence or disregard of rules or regulations.

Sec. 6662(b)(1).   “Negligence” includes any failure to make a

reasonable attempt to comply with the provisions of the Internal

Revenue Code, including any failure to keep adequate books and

records or to substantiate items properly.   Sec. 6662(c); sec.

1.6662-3(b)(1), Income Tax Regs.   Section 6664(c)(1) provides

that the penalty under section 6662(a) shall not apply to any

portion of an underpayment if it is shown that there was

reasonable cause for the taxpayer’s position and that the

taxpayer acted in good faith with respect to that portion.    The

determination of whether a taxpayer acted with reasonable cause
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and in good faith is made on a case-by-case basis, taking into

account all the pertinent facts and circumstances.        Sec. 1.6664-

4(b)(1), Income Tax Regs.    The most important factor is the

extent of the taxpayer’s effort to assess his proper tax

liability for the year.     Id.

     It is clear that petitioner was negligent with respect to

the disallowed deductions for Schedule C wages.        Petitioner did

not keep adequate books and records or otherwise substantiate the

deductions reported on Schedule C, as required by the Internal

Revenue Code.   Amounts that were allegedly paid to his children

always remained in his control.     We sustain respondent’s

determination with respect to the section 6662(a) accuracy-

related penalty.

     Reviewed and adopted as the report of the Small Tax Case

Division.

                                          Decision will be entered

                                  for respondent.
