                           T.C. Memo. 2008-247



                         UNITED STATES TAX COURT



                     KEVIN M. BAKER, Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket No. 1051-05.                  Filed October 30, 2008.


     Michael C. Whelan, for petitioner.

     Thomas D. Yang, for respondent.


                           MEMORANDUM OPINION


        HOLMES, Judge:   Kevin Baker did not file his 2002 tax return

on time.     The Commissioner prepared a “substitute for return”

using the information he had to determine how much tax Baker

owed.     Baker then belatedly submitted a return that reported much

more income, but also much higher deductions than the

Commissioner had known about.     We have to sort through various
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procedural problems to figure out what, if any, deficiency in

Baker’s 2002 income tax remains.

                             Background

     Baker has an entrepreneurial spirit, and he earned income

from numerous ventures in 2002.    His largest single source of

income was the wages he earned as president of Blue World

Technologies.   He also earned income from his investments in two

passthrough entities:1    He was a 45-percent shareholder in Blue

World and a member of Guardian Enterprises, LLC.    To those

sources he added a small amount of interest income and some

miscellaneous income.    But despite his success, Baker failed to

file an individual tax return for 2002.

     The Commissioner was not totally ignorant about Baker’s

earnings because Blue World had reported the $165,038 in wages

that it had paid Baker.    The Commissioner also knew about $157 of

interest income.   When the Commissioner learns--usually from

third parties with an obligation to report it--that someone has

received income but not filed a return, section 6020(b)2 gives



     1
       A passthrough entity pays no tax on income at the
corporate level; instead, profits and losses “pass through” the
entity to the members, who pay individual income tax. The most
common types are partnerships, S corporations, and limited
liability companies.
     2
       Unless otherwise indicated, all section references are to
the Internal Revenue Code for the year at issue; all Rule
references are to the Tax Court Rules of Practice and Procedure.
                               - 3 -

him the power to prepare a “substitute for return” (SFR).     An SFR

is not a comprehensive return; the Commissioner uses only one of

two filing statuses--single or married filing separately--and he

allows only one personal exemption and no business expenses or

personal deductions.   See 2 Administration, Internal Revenue

Manual (CCH), pt. 5.19.2.6.4.5 (10), at 18, 322.

     The Commissioner used Baker’s $165,195 in wages and interest

income to prepare the SFR.   The Commissioner picked the married-

filing-separately filing status and allowed only the

corresponding standard deduction.   See sec. 63(c)(2).   After

subtracting the standard deduction from Baker’s income, the

Commissioner calculated that Baker owed a deficiency of $47,629.

The Commissioner credited Baker for the taxes that Blue World had

withheld.   He then determined additions to tax for Baker’s

failure to timely file and timely pay.   See secs. 6651(a)(1),

6651(a)(2).

     The Commissioner notified Baker of all this by sending him a

notice of deficiency with the SFR attached.   Because an SFR is

usually stingy with deductions, a taxpayer who gets one often

responds by filing a petition with us and then preparing a return

reflecting the much more complete information he has about

himself--especially about greater deductions, the willingness of

his wife to accept married-filing-jointly status, and whether he

has children or other dependents.   Baker’s case started
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normally--he filed a petition with us, and it seemed headed

toward a contest over whether the Commissioner’s SFR included too

much income or too few deductions or chose a less-favorable

filing status.   But this case left the road most traveled when

Baker submitted his own 2002 tax return.   What made this return

unusual was that it greatly increased Baker’s reported income.

Instead of the $165,195 that the Commissioner knew about and had

included on the SFR, Baker’s own return reported over $575,000,

because Baker reported passthrough income from Blue World and

Guardian as well as miscellaneous and interest income.

     But with the increase in income, Baker also reported such

large deductions that he claimed a refund.   The Commissioner has

accepted some of these, but a number are still at issue.

                  Disputed Deduction                    Amount
   Short-term capital loss carryover                 $138,939
   Long-term capital loss carryover                      28,191
   Blue World loss                                      136,423
   Blue World at-risk-loss carryover                    199,105
   Guardian Enterprises loss                             20,686
   Blue World charitable contributions carryover         27,294
   Blue World charitable contribution                       450

Though Baker submitted his 2002 return before the Commissioner

filed his answer, the Commissioner neither asserted an increased

deficiency in his answer nor filed an amended answer.    The
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Commissioner’s pretrial memorandum also stated that only the

original $47,629 deficiency was at issue.

     Baker was an Illinoisan when he filed his petition, and the

case was tried in Chicago.   The trial largely consisted of the

proffering of unaudited corporate tax returns from Baker’s

passthrough businesses, their accompanying K-1s, and Baker’s own

old 1040s with a litany of assertions of their accuracy.   Baker’s

accountant added his own assertions of the accuracy of many of

these documents, even though one of his colleagues had actually

prepared them.

                             Discussion

     We start with the threshold question:    How much is at issue?

The Commissioner sent Baker a notice of deficiency based solely

on the SFR.   But Baker reported substantially more income on his

2002 tax return.   We have jurisdiction to increase the amount of

the deficiency “if claim therefor is asserted by the Secretary at

or before the hearing or a rehearing.”    Sec. 6214(a).

     To assert an increased deficiency, the Commissioner must

formally plead a claim for an increase in either the answer or an

amended answer.    Estate of Petschek v. Commissioner, 81 T.C. 260,

271-72 (1983), affd. 738 F.2d 67 (2d Cir. 1984); Koufman v.

Commissioner, 69 T.C. 473, 475-76 (1977).    Even if the parties

stipulate an increase in income the Commissioner is required to

formally plead an increase in the deficiency.    Tool Producers,
                               - 6 -

Inc. v. Commissioner, T.C. Memo. 1995-407, affd. 97 F.3d 1452

(6th Cir. 1996).   This, the Commissioner did not do.3   And the

Commissioner did not amend his answer, either.

     Even if we peek outside the pleadings, we can find no

assertion of an increased deficiency.   The Commissioner’s

pretrial memorandum and amended pretrial memorandum both list

$47,629 as the amount in dispute, and he sticks to that number in

his posttrial brief.   The only time the Commissioner refers to

Baker’s increases in income is in the “Respondent’s Request for

Finding of Fact” section of his posttrial brief.   The reference

is a list that begins:   “Petitioner also included in his 2002

income tax return income items which were not set forth in the

notice of deficiency; these income items are conceded by

Petitioner and are as follows.”   The Commissioner then lists the

increases.   But this list is not an amended answer and is

therefore not a claim for an increased deficiency.   Thus, we hold

that only the $47,692 deficiency is at issue, and the burden is

on Baker to prove that it is erroneous.   See Rule 142(a).




     3
       The Commissioner’s pretrial memorandum shows a smaller
addition to tax than that shown on the notice of deficiency. The
reason is that he conceded that Baker is not liable for the
section 6651(a)(2) addition to tax for failure to timely pay.
Therefore, under section 6651(c)(1), the rate used to determine
the section 6651(a)(1) addition will be increased.
                               - 7 -

      Baker’s defense to the deficiency is that he had sufficient

deductions in 2002 to offset nearly all of his income.     A

significant obstacle to his success is that he chooses to argue

that it is the Commissioner’s burden to disprove his entitlement

to these deductions.   He argues that his deductions are new

matters because the Commissioner did not deny them in the notice

of deficiency.   Baker is not the first taxpayer to try this.      See

Widemon v. Commissioner, T.C. Memo. 2004-162.   In Widemon, we

decided that the burden remained with the taxpayer because his

deductions were a new theory and not a new matter.   Id.       And in

Rappaport v. Commissioner, T.C. Memo. 2006-87, just as in this

case, a taxpayer filed a tax return claiming extra income and

large deductions after the Commissioner had already sent a notice

of deficiency.   We held in Rappaport that, because the taxpayer

himself had raised the matter of the new deductions, we would not

shift the burden of proof onto the Commissioner to disprove them.

Id.

      Widemon and Rappaport remain good law, and the distinction

that they draw would enable us to quickly reject Baker’s claim,

but we can dismiss his argument even without them.   In this case,

the Commissioner determined a deficiency based on Baker’s

unreported wage and interest income.   Baker then petitioned us to

redetermine the deficiency, alleging that he was not liable for

the deficiency because the “Notice of Deficiency may not have
                               - 8 -

given him credit for * * * business deductions or other items

affecting taxable income.”   He never alleged that the income was

not his or not taxable.   Therefore, the issue of whether he is

entitled to his claimed deductions is not a new matter, but it is

the original and only matter he has asked us to decide.

     Now that these procedural obstacles are settled into place,

and we have the burden of proof worked out, we can determine the

correct amount of the deficiency.    We begin by determining

Baker’s 2002 income.   This step is easy because Baker reported

his income on a signed tax return.     We treat his tax return as an

admission to all the reported income.    See Lare v. Commissioner,

62 T.C. 739, 750 (1974), affd. without published opinion 521 F.2d

1399 (3d Cir. 1975).   Therefore, we find that Baker earned

$578,997 in 2002.

     Our next step is to determine if Baker substantiated any of

the deductions he claimed on his 2002 tax return.    We can make

this determination easier by dividing his deductions into two

classes:   Those that Baker tried to substantiate with old tax

returns and those that he tried to substantiate with more

persuasive documentation.

     We start with those deductions supported with nothing more

than old tax returns--a class which includes all the deductions

at issue except for Baker’s short-term capital-loss carryover.

We finish our consideration by citing our long series of
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precedents in which we have held that a taxpayer’s returns do not

substantiate deductions or losses because they are nothing more

than a statement of his claims.   Wilkinson v. Commissioner, 71

T.C. 633, 639 (1979); Roberts v. Commissioner, 62 T.C. 834, 837

(1974).   To hold otherwise would undermine our presumption that

the Commissioner’s determination is correct.    See Rule 142; Halle

v. Commissioner, 7 T.C. 245, 247 (1946), affd. 175 F.2d 500

(2d Cir. 1949).   For the same reason, we long ago established

that under circumstances like these, a taxpayer can’t undermine

the rule that old returns are not substantiation of deductions or

losses by adding to them the bare testimony that those old

returns are correct, without records or credible testimony about

the individual items on the returns.   See id. at 250.   And a

taxpayer also can’t successfully substantiate his old returns by

arguing that the Commissioner is somehow estopped from

challenging his deductions because the Commissioner failed to

challenge the same or similar deductions in earlier years.       Lerch

v. Commissioner, 877 F.2d 624, 627 n.6 (7th Cir. 1989), affg.

T.C. Memo. 1987-295; Pekar v. Commissioner, 113 T.C. 158, 166

(1999).

     Much the same rules apply to the K-1s that Baker offered to

substantiate the deductions from his passthrough businesses;

they, too, are only statements of his claims, not proof of them.

LeBouef v. Commissioner, T.C. Memo. 2001-261.    Baker’s LLC,
                              - 10 -

Guardian Enterprises, had only two members in 2002, so the

Commissioner classified it as a partnership under the Code in the

absence of the firm’s election to be treated as a corporation.

Sec. 301.7701-3(b)(1)(i), Proced. & Admin. Regs.    The Code’s

default rule for small partnerships, section 6231(a)(1)(B)(i),

also applies to Guardian, so the Commissioner was allowed to

audit Guardian at the individual partner level.    And this means,

under precedents like LeBouef, that Baker had to prove the

accuracy of the items on the K-1 that he got from Guardian--he

couldn’t just rely on them in the absence of a partnership-level

audit as partners in some larger partnerships might be able to

do.

      Taxpayers do have a duty to report the losses and deductions

from S corporations consistently with their corporation’s return.

Sec. 6037(c).   But since 1996, individual S corporation

shareholders have been answerable for all the issues on their

corporation’s returns.   See Small Business Job Protection Act of

1996, Pub. L. 104-188, sec. 1307(c)(1), 110 Stat. 1781 (repealing

unified audit procedures for S corporations).     Baker has given us

no reason for not applying our holding in LeBouef to his

S-corporation K-1s, as we do to his LLC K-1, and he introduced

nothing but those bare K-1s in proof of his deductions and

losses.
                                - 11 -

     What a taxpayer needs to substantiate his deductions and

losses are records sufficient to permit verification of a

deduction or loss.     See sec. 6001; sec. 1.6001-1(a), Income Tax

Regs.     By offering only old tax returns and K-1s, with

nonspecific testimony of their accuracy, Baker has failed to

substantiate almost all his claimed deductions.

     The one exception is his deduction for a short-term capital-

loss carryover.     For this, he had 1099s dating back to 1996.    We

find this to be persuasive that he had realized a loss back in

1996.     Baker’s problem is that their use to prove a deduction in

2002 requires that he prove his capital gains and losses from

1996-2002 to show the 1996 loss hadn’t been used up.        Burns v.

Commissioner, T.C. Memo. 1997-83; Williams v. Commissioner, T.C.

Memo. 1991-317, affd. without published opinion 996 F.2d 1230

(9th Cir. 1993).     See sec. 1.1212-1(b), Income Tax Regs.    Baker

offers only tax returns for the intervening years, so we find

that he also failed to substantiate the short-term capital loss

that he wanted to carry into 2002.

        In conclusion, we find that Baker admitted to $578,997 in

income by reporting the income on his 2002 tax return.       The only

defense he offered was that in 2002 he had enough deductions to

offset most of this income.     We find that he failed to

substantiate any of those in dispute.     But only the $47,692

deficiency is at issue, and the Commissioner has conceded many of
                               - 12 -

Baker’s other deductions.    Therefore (though unlikely given the

size of his income compared to the concessions we know about),

Baker’s liability may be reduced.

     The last issue is whether Baker is liable for an addition to

tax under section 6651(a)(1) for a failure to timely file his tax

return.    The Commissioner has the burden of production.   Sec.

7491(c).    He met his burden because Baker conceded that he filed

his 2002 tax return late and offers no explanation for his

tardiness.

     Because computations may be needed,


                                     Decision will be entered

                                under Rule 155.
