                                 T.C. Memo. 2012-237



                           UNITED STATES TAX COURT



                       BOBBY D. PERRY, Petitioner v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 3064-11.                            Filed August 16, 2012.



      Michael Lynn Durham and W. Lance Stodghill, for petitioner.

      M. Kathryn Bellis, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


      KROUPA, Judge: Respondent determined a $306,3361 deficiency and a

$41,365 accuracy-related penalty under section 6662(a)2 with respect to

      1
          All monetary amounts are rounded to the nearest dollar.
      2
        All section references are to the Internal Revenue Code for the year at
issue, and all Rule references are to the Tax Court Rules of Practice and
                                                                        (continued...)
                                           -2-

[*2] petitioner’s Federal income tax for 2006. We must decide five issues.3 The

first issue is whether petitioner’s S corporation Perry & Co., P.C. (Company) is

entitled to deduct certain travel expenses.4 We hold it is not. The second issue is

whether petitioner is entitled to a depreciation deduction with respect to use of a

portion of his home. We hold he is not. The third issue is whether petitioner may

reduce the gross receipts of his insurance business by certain claimed costs of goods

sold. We hold he may not. The fourth issue is whether certain payments the

Company made to petitioner were rental payments or executive compensation. We

hold they were executive compensation. The final issue is whether petitioner is

liable for an accuracy-related penalty under section 6662(a) for 2006. We hold he is

liable.

                                  FINDINGS OF FACT

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

facts and the accompanying exhibits are incorporated by this reference.

          2
      (...continued)
Procedure, unless otherwise indicated.
          3
      All other issues were either conceded or settled or need not be decided
because they follow from our holdings or are computational.
          4
        For convenience, we shall address the claimed travel expenses that petitioner
contends the Company is entitled to deduct and not the correlative effect in the
Schedule E that would result if we were to allow all or a portion of the claimed
travel expenses.
                                         -3-

[*3] Petitioner resided in Texas when he filed the petition.

I. Background

      Petitioner worked as a revenue agent for the Internal Revenue Service (IRS)

for a few years and has been a certified public accountant (CPA) since 1986.

Petitioner conducted his accounting practice through the Company, operating it out

of a portion of his home. Petitioner was the Company’s sole shareholder, president

and employee, preparing tax returns and providing related consulting services.

Petitioner was involved in various other business entities and activities during 2006.

One such business involved selling insurance policies through a sole proprietorship

(insurance business).

II. Tax Returns

      The Company filed a Form 1120S, U.S. Income Tax Return for an S

Corporation, for 2006, which petitioner prepared and signed as president. The

Company claimed on the Form 1120S a $3,242 deduction for travel expenses

(claimed travel expenses). Part of the claimed travel expenses consists of $242

petitioner paid in airfare, purportedly to travel for the Company’s business.

Petitioner indicated at trial that the remaining amount was a $3,000 payment he

made to Rosa Porter, a Continental Airlines employee, to be designated her “travel

companion” so that he could purchase discounted airline tickets.
                                        -4-

[*4] Petitioner filed Form 1040, U.S. Individual Income Tax Return, for 2006.

The return included a Schedule C, Profit or Loss From Business, and a Schedule E,

Supplemental Income and Loss. The Schedule C was for petitioner’s insurance

business. Petitioner claimed on Schedule C costs of goods sold totaling $44,542

(claimed costs of goods sold). This amount included expenses purportedly paid for

rent, referral fees and record-keeping services. A $10,000 expense claimed as part

of the claimed costs of goods sold was actually paid and claimed as a deduction by

another business entity with which petitioner was involved.

      Petitioner reported as rental income on Schedule E payments he received

from the Company totaling $32,882. He also claimed a $5,732 depreciation

expense deduction (claimed depreciation expense) on Schedule E with respect to

use of his home.

III. Deficiency Determination

      Respondent examined the Form 1120S the Company filed and the Form

1040 petitioner filed for 2006. Thereafter, respondent issued petitioner a

deficiency notice for 2006. Respondent increased petitioner’s flow-through

income from the Company based upon various adjustments to the Company’s tax

items, including the disallowance of the claimed travel expenses. Respondent

disallowed the claimed costs of goods sold and the claimed depreciation expense.
                                         -5-

[*5] Finally, respondent determined that petitioner was liable for the accuracy-

related penalty under section 6662(a) for 2006.

      Petitioner timely filed a petition for redetermination.

                                      OPINION

      Petitioner, a CPA and former IRS revenue agent, was involved in various

business activities during 2006. We are asked to decide whether petitioner and the

Company are entitled to deduct certain expenses and whether petitioner may treat

certain expenses as costs of goods sold. We also must decide whether certain

payments petitioner received from the Company were rental payments or executive

compensation. Finally, we must decide whether petitioner is liable for an accuracy-

related penalty. We begin with the burden of proof.

I. Burden of Proof

      Generally, the Commissioner’s determinations are presumed correct, and the

taxpayer bears the burden of proving otherwise. Rule 142(a); see Welch v.

Helvering, 290 U.S. 111, 115 (1933). The burden of proof may shift to the

Commissioner if the taxpayer proves that he or she has satisfied certain

requirements. Sec. 7491(a); see Baker v. Commissioner, 122 T.C. 143, 168

(2004). Petitioner has neither claimed that the burden shifts to respondent nor
                                        -6-

[*6] shown that he complied with the requirements of section 7491(a). The burden

of proof, therefore, remains on petitioner. See Rule 142(a).

II. Expenses at Issue

      A. Travel

      We first turn to the claimed travel expenses. Generally, taxpayers may

deduct ordinary and necessary business expenses incurred during the taxable year in

carrying on a trade or business. Sec. 162(a). The taxpayer must maintain records

sufficient to substantiate the amounts of the deductions claimed. Sec. 6001; sec.

1.6001-1(a), Income Tax Regs. If a taxpayer establishes that he or she paid or

incurred a deductible business expense but does not establish the amount, this Court

may approximate the amount of the allowable deduction, bearing heavily against the

taxpayer whose inexactitude is of his or her own making. Cohan v. Commissioner,

39 F.2d 540, 543-544 (2d Cir. 1930). For the Cohan rule to apply, however, a basis

must exist on which this Court can make an approximation. Vanicek v.

Commissioner, 85 T.C. 731, 742-743 (1985).

      With respect to certain business expenses specified in section 274(d), more

stringent substantiation requirements apply and the Cohan rule is superseded. See

Sanford v. Commissioner, 50 T.C. 823, 827 (1968), aff’d per curiam, 412 F.2d 201

(2d Cir. 1969). Deductions for travel expenses, gifts, and meals and
                                         -7-

[*7] entertainment, as well as for “listed property”, are disallowed unless the

taxpayer substantiates them by adequate records or by sufficient evidence

corroborating the taxpayer’s own statement. Sec. 274(d).5 The substantiation for

travel expenses must show (A) the amount of each travel expense; (B) the time and

place of travel and (C) the business purpose for travel. Sec. 1.274-5T(b)(2),

Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).

      Petitioner failed to substantiate the claimed travel expenses under section

274(d). The only evidence supporting the claimed travel expenses is petitioner’s

own self-serving testimony that the expenses were incurred. Petitioner did not

substantiate that he met the requirements under section 1.274-5T(b)(2), Temporary

Income Tax Regs., supra, by adequate records or sufficient evidence corroborating




      5
        Substantiation of expenses by adequate records requires that the taxpayer
maintain an account book, a diary, a log, a statement of expenses, trip sheets or
similar records prepared contemporaneously with the expenditure supplemented by
other documentary evidence. Sec. 1.274-5(c)(2)(iii), Income Tax Regs.; sec.
1.274-5T(c)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985).
Substantiation by other sufficient evidence requires the production of corroborative
evidence in support of a taxpayer’s statement specifically detailing how he met the
requirements. Sec. 1.274-5T(c)(3), Temporary Income Tax Regs., 50 Fed. Reg.
46020 (Nov. 6, 1985).
                                         -8-

[*8] his testimony for each of the claimed travel expenses.6 Petitioner therefore is

not entitled to deduct any of the claimed travel expenses for 2006.

      B. Depreciation

      We now turn to the claimed depreciation expense with respect to use of

petitioner’s home. Subject to certain exceptions, section 280A bars a taxpayer from

deducting expenses incurred with respect to use of the taxpayer’s residence. See

sec. 280A. We need not consider whether section 280A precludes petitioner from

being entitled to deduct the claimed depreciation expense because he failed to

establish that he met the basic depreciation requirements under section 167.

      A taxpayer is allowed to deduct a reasonable allowance for the exhaustion

and wear and tear of property used in a trade or business or held for the production

of income. Sec. 167(a). Depreciation is computed on the adjusted basis of the

property, the applicable depreciation method, the applicable recovery period and the

applicable convention. Secs. 167(c)(1), 168(a); Hosp. Corp. of Am. v.

Commissioner, 109 T.C. 21, 45 (1997). Petitioner has the burden to prove these




      6
       We note in particular that petitioner did not substantiate for any travel he did
as Ms. Porter’s travel companion (if any) that he met the requirements under sec.
1.274-5T(b)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).
                                        -9-

[*9] items. See Langer v. Commissioner, T.C. Memo. 2008-255, aff’d, 378 Fed.

Appx. 598 (8th Cir. 2010).

      Here, petitioner failed to prove the adjusted basis of the portion of his home

with respect to which he claimed the depreciation expense. There is no persuasive

evidence in the record on the cost of the home (and the portion of that amount

attributable to the underlying real property) or the cost of improvements. Nor is

there any persuasive evidence in the record establishing the percentage of

petitioner’s home that was actually used by the Company to conduct business. In

addition, there is no evidence as to when the home and the improvements were

placed in service. Accordingly, we find that petitioner has failed to meet his burden

of proof under section 167 with respect to the claimed depreciation expense.

      While we are allowed to estimate the amount of an expense that we find to

be deductible when the exact amount cannot be ascertained, for us to do so,

petitioner had to supply us with some basis upon which an estimate could be

made. See Vanicek v. Commissioner, 85 T.C. at 742-743. There is no evidence in

the record on the adjusted basis of petitioner’s home other than his own self-

serving and uncorroborated testimony. We are not required to accept such

testimony and decline to do so. See Tokarski v. Commissioner, 87 T.C. 74, 77
                                         - 10 -

[*10] (1986). Accordingly, we lack a basis to estimate the claimed depreciation

expense attributable to any use of petitioner’s home. We therefore hold that

petitioner is not entitled to the claimed depreciation expense.

      C. Costs of Goods Sold

      Petitioner contends that he is entitled to reduce the gross receipts from his

insurance business by the claimed costs of goods sold. We disagree. Cost of goods

sold may be subtracted from gross receipts to compute gross income in a taxpayer’s

manufacturing, merchandising or mining business. See sec. 1.61-3(a), Income Tax

Regs.7 We have held that a business must involve the sale of a material product to

which direct cost may be allocated to reduce gross receipts by the costs of goods

sold in computing gross income. Guy F. Atkinson Co. v. Commissioner, 82 T.C.

275, 298 (1984), aff’d, 814 F.2d 1388 (9th Cir. 1987); Hahn v. Commissioner, 30

T.C. 195, 198 (1958), aff’d, 271 F.2d 739 (5th Cir. 1959). More generally, we have

held that gross receipts equal gross income where a business is primarily engaged in

providing services; i.e., ability, know-how and experience. Guy F. Atkinson Co. v.

Commissioner, 82 T.C. at 298; Hahn v. Commissioner, 30 T.C. at 198.




      7
       Taxpayers must show their entitlement to the amount of costs of goods sold
claimed. See Rule 142(a).
                                         - 11 -

[*11] Here, petitioner claimed costs of goods sold with respect to his insurance

business. The insurance business income was primarily, if not exclusively, derived

from the sale of insurance policies. An insurance policy is a contract, not a material

product to which direct costs may be allocated. Moreover, we note that selling

insurance policies generally involves meeting the particular preferences and

purposes of buyers. Such tailoring generally requires ability, know-how and

experience. We find that petitioner’s insurance business was primarily engaged in

rendering services. Accordingly, we hold that the insurance business’ gross income

equals its gross receipts.8

III. Payments at Issue

      We now address the characterization of payments totaling $32,882 that

petitioner received from the Company in 2006. The parties dispute whether the

payments were rental payments or executive compensation. The payments are

includible in petitioner’s income and deductible by the Company whether they are

characterized as rental payments or executive compensation. The main tax

      8
         Petitioner failed to raise whether the expenses claimed as cost of goods sold
may be deducted as business expenses under sec. 162 in his pretrial memorandum,
at trial or in his posttrial briefs. We note, however, that petitioner is not entitled to
deduct these expenses as business expenses under sec. 162(a). Petitioner failed to
establish that he actually paid $10,000 of the expenses claimed as costs of goods
sold and failed to establish that the remaining expenses were ordinary and necessary
business expenses. See sec. 162(a).
                                       - 12 -

[*12] consequence of characterizing the payments as executive compensation rather

than rental payments is that the payments will be subject to Federal employment

taxes if they are properly characterized as executive compensation.

      Petitioner argues that the payments he received from the Company were

rental payments. More specifically, he contends that he rented a portion of his home

to the Company and that the relevant payments were for rent the Company owed

him. We disagree.

      Petitioner did not produce a rental agreement between himself and the

Company for 2006. Petitioner did not provide any checks or documentation

demonstrating that the Company paid him rent for use of his home. More generally,

there is no documentation in the record reflecting that the Company rented a portion

of petitioner’s home. The only evidence supporting petitioner’s claim that the

Company rented a portion of his home is his testimony. This Court is not required

to accept petitioner’s self-serving, unverified and undocumented testimony, and we

decline to do so. See Tokarski v. Commissioner, 87 T.C. at 77.

      Respondent argues and we agree that the payments were executive

compensation. The record does not reflect that the payments at issue were
                                        - 13 -

[*13] anything other than executive compensation.9 Accordingly, we hold that the

$32,882 the Company paid to petitioner was executive compensation.

IV. Accuracy-Related Penalty

      The final issue we address is respondent’s determination that petitioner is

liable for an accuracy-related penalty under section 6662(a) on the underpayment

for 2006. Respondent conceded in his reply brief that petitioner is not liable for the

accuracy-related penalty on the portion of the underpayment attributable to

unreported interest income stemming from petitioner’s and respondent’s settlement

of certain issues regarding a Roth individual retirement account (Roth IRA).10

Accordingly, we focus on whether petitioner is liable for the accuracy-related

penalty on the remaining portion of the underpayment for 2006 (remaining

underpayment).

      A taxpayer is liable for an accuracy-related penalty on any part of an

underpayment attributable to, among other things, a substantial understatement of



      9
       We note that petitioner does not dispute in his opening brief or reply brief
respondent’s contention that the payments should be characterized as executive
compensation if we find that they were not rental payments.
      10
         Petitioner and respondent entered into a Stipulation of Settled Issues in
unrelated cases at Docket Nos. 12211-09 and 30575-09. The parties settled several
issues relating to a Roth IRA. Based on the Roth IRA settlement, the parties
stipulated in this case that petitioner had unreported interest income of $75,970.
                                        - 14 -

[*14] income tax. Sec. 6662(b)(2). There is a substantial understatement of income

tax if the amount of the understatement exceeds the greater of either 10% of the tax

required to be shown on the return or $5,000. Sec. 6662(a), (b)(2), (d)(1)(A); sec.

1.6662-4(a) and (b), Income Tax Regs.; see Jarman v. Commissioner, T.C. Memo.

2010-285.

      The Commissioner has the burden of production with respect to the accuracy-

related penalty. Sec. 7491(c); Rule 142(a); see Higbee v. Commissioner, 116 T.C.

438, 446-447 (2001). We find that respondent has met his burden of production if

Rule 155 computations show petitioner has a substantial understatement of income

tax for 2006. See Higbee v. Commissioner, 116 T.C. at 446; Jarman v.

Commissioner, T.C. Memo. 2010-285.

      A taxpayer is not liable for an accuracy-related penalty, however, if the

taxpayer acted with reasonable cause and in good faith with respect to any portion

of the underpayment. Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. The

determination of whether a taxpayer acted with reasonable cause and in good faith

depends on the pertinent facts and circumstances, including the taxpayer’s efforts

to assess his or her proper tax liability; the knowledge, experience and education

of the taxpayer, and the reliance on the advice of a professional. Sec.

1.6664-4(b)(1), Income Tax Regs. The taxpayer has the burden of proving the
                                        - 15 -

[*15] reasonable cause and good-faith exception. Sec. 7491(c); Rule 142(a); see

Higbee v. Commissioner, 116 T.C. at 446-447.

      Petitioner, a CPA and former IRS revenue agent, prepared the Form 1040 he

filed for 2006 and the Form 1120S that the Company filed for the same year.

Petitioner exercised a lack of care and reckless disregard for rules and regulations in

reporting income and claiming deductions against income on the returns, resulting in

the remaining underpayment. Petitioner failed to offer any persuasive evidence that

he acted with reasonable cause and in good faith with respect to any portion of the

remaining underpayment.

      We find under the relevant facts and circumstances that petitioner did not act

with reasonable cause and in good faith with respect to any portion of the remaining

underpayment. Accordingly, we hold that petitioner is liable for the

accuracy-related penalty on the remaining underpayment.

      We have considered all arguments made in reaching our decision and, to the

extent not mentioned, we conclude that they are moot, irrelevant or without merit.

      To reflect the foregoing,


                                                       Decision will be entered under

                                                 Rule 155.
