                  T.C. Summary Opinion 2002-28



                     UNITED STATES TAX COURT



              PETER AND MARY POSSAS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5171-00S.             Filed March 29, 2002.



     Peter and Mary Possas, pro se.

     Monica J. Miller, for respondent.



     PANUTHOS, Chief 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
                                 - 2 -

Revenue Code in effect for the years in issue, and all Rule

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

     Respondent determined deficiencies in petitioners’ Federal

income taxes of $7,297 in 1995 and $8,355 in 1996 and section

6662(a) accuracy-related penalties of $1,459.40 and $1,646,

respectively.     After concessions by both parties,1 the issues for

decision are:     (1) Whether petitioners received unreported income

of $8,355 in 1996; (2) whether petitioners are entitled to the

claimed deductions for advertising expenses in 1995 and 1996; and

(3) whether petitioners are liable for accuracy-related penalties

for 1995 and 1996 under section 6662(a).

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

Petitioners resided in Odessa, Florida, at the time they filed

their petition.

                              Background

         Petitioner Peter Possas (Mr. Possas) worked as a manager at

a Nissan automobile dealership during the years at issue.     His

wages in 1995 totaled $108,867.57 and in 1996 totaled $92,657.87.

Mr. Possas paid for flyers to advertise the automobile

dealership.     The dealership had advanced him money to pay for a


     1
        Respondent conceded the claimed employee business expense
deduction for 1995 of $5,156.60. Respondent conceded that
petitioners did not have unreported income in 1995. Petitioners
conceded receipt of a taxable award from Mr. Possas’s employer in
1996 of $2,637. Petitioners conceded that they were not entitled
to a deduction for the “unidentified expenses” claimed on their
1995 return of $8,532.
                                - 3 -

portion of the advertising expenses and withheld money from his

paycheck as an “account receivable” for repayment.       Mr. Possas’s

annual payroll statement for 1995 reflects an “account

receivable” withheld of $5,156.60.      His annual payroll statement

for 1996 indicates an “account receivable” withheld of

$17,821.68.    Mr. Possas paid for the remainder of the advertising

expenses separately, without the advanced funds from his

employer.

     Petitioner Mary Possas (Mrs. Possas) was a licensed

cosmetologist.    She had worked as a hairdresser in a salon before

1995 but started working independently in 1995 as a way to make

friends.    She worked either at an area in the kitchen in her home

or at the home of a client.    The schedule of approximate charges

for her hairdressing activity was as follows:

               Service                  Approximate Charge

            Adult haircut                    $7 - 10
            Child haircut                     5
            Blow-dry                          7
            Permanent with haircut           30 - 40
            Hair color                       20 - 30

Clients paid her either in cash or with a check.       Mrs. Possas

usually did not receive tips from her clients.

     Mrs. Possas purchased various supplies, such as shampoo,

conditioner, permanent solution, and hair color, at either a

beauty supply store or at another store.      She maintained a supply
                               - 4 -

of towels, gloves, brushes, hair spray, and rollers and owned a

blowdrier and a “bonnet” style hairdrier.

     Petitioners maintained and produced certain records such as

calendars used as appointment books for 1995 and 1996,

photocopies of canceled checks, and a copy of a journal in which

petitioners noted expenses (apparently both personal and

hairdressing related) from November 1995 through the end of 1996

and mileage for Mrs. Possas’s automobile.   Her appointment books

indicate that she had 276 appointments in 1995 and 347 in 1996.

Many of the appointments in her appointment books indicate the

services performed for her client (e.g., “perm”, “hilite”, and

“H/C”).   She did not maintain a separate bank account for her

hairdressing activity.

     Petitioners filed their Federal income tax returns for 1995

and 1996 as married filing jointly.2   Petitioners estimated the

income reported and expense deductions claimed on their returns

because they failed to keep accurate records of income or

expenses associated with the hairdressing activity.   Petitioners

attached Form 2106, Employee Business Expenses, to Schedule A,


     2
         The record in this case does not contain a copy of
petitioners’ 1995 Federal income tax return. Rather, the record
contains an “RTVUE” for 1995. An RTVUE is the Commissioner’s
record of line items from Forms 1040, 1040A, 1040EZ, and
accompanying schedules. The RTVUE is created as the returns are
processed at the service center. We assume for purposes of this
case that items and amounts reflected on this document are
identical to petitioners’ 1995 income tax return and, for
convenience, shall refer to it as petitioners’ 1995 return.
                               - 5 -

Itemized Deductions, and claimed deductions for unreimbursed

employee business expenses for the advertising expenses.

Petitioners reported income and claimed expenses for the

hairdressing activity on Schedule C, Profit or Loss From

Business, in the following amounts:

           Type                         1995            1996

  Schedule A expenses:
  Employee business expenses           $29,585     $22,227
  (advertising)

  Schedule C income:
  Gross receipts                         3,600           3,600
  Cost of goods sold                    (2,600)         (2,600)
    Gross income                         1,000           1,000

  Schedule C expenses:
  Car and truck                         6,900            6,510
  Legal and professional services         100              100
  Travel                                   40               40
  Expenses for business use of home       293              666
  Commissions and fees                    -                750
  Advertising                             -                250
  Insurance                               -                675
  Interest                                -              1,400
  Office expenses                         -                100
  Taxes and licenses                      -                650
                                      1
  Unexplained expenses                  8,532              100
                                    2
    Total                             15,572            11,241
                                                   (3
    Net income (loss)                  (14,865)      10,141)
       1
         As noted above, petitioners conceded that they are
  not entitled to the claimed “unexplained expenses” in 1995.
       2
          We note that the total of these items is actually
  $15,865. The record does not provide an explanation as to
  the discrepancy.
       3
          The actual amount should be ($10,241). The record
  does not provide a basis for the discrepancy.
                                 - 6 -

Respondent’s Determination of Omitted Income for 1996

     Respondent first examined petitioners’ 1996 tax return.

Respondent allowed the claimed advertising expense with respect

to Mr. Possas’s activity; however, respondent disallowed the

claimed expenses relating to the hairdressing activity.

Respondent also reconstructed petitioners’ income and prepared a

bank deposit analysis.   The examiner totaled the deposits made in

1996 into each of petitioners’ bank accounts and then traced

these deposits to known sources of income, such as wages reported

on the return and Forms W-2, Wage and Tax Statement, prizes and

awards, redeposited liquidated certificates of deposit (CDs), and

transfers between accounts.   Respondent assumed that the

unexplained deposits were the gross receipts from Mrs. Possas’s

hairdressing activity.

     The examiner concluded that petitioners were “entitled to

some form of expense, because you cannot be a beautician without

having to spend something”.   The examiner used statistics from

the Bureau of Labor Statistics (BLS) to calculate the “profit

margin” for a beautician using a “gross profit percentage”, which

was 65 percent, and applied this profit margin to the

reconstructed gross receipts.3    This application resulted in



     3
        Respondent used figures for beauticians available from
the Bureau of Labor Statistics from a document entitled “Sole
Proprietorship Returns from 1994”. The figures are for net
income and take average industry expenses into consideration.
                               - 7 -

unreported income of $12,815 ($19,715 x 65 percent).4

Advertising Expense Deduction for 1995

      The examiner allowed the claimed advertising expense

deduction of $29,585 in full for 1995.   The examiner compared Mr.

Possas’s wages in 1996 ($92,657.87) to his advertising expenses

in 1996 ($22,227), and applied this ratio to Mr. Possas’s wages

in 1995 ($108,867.57).

      Respondent had not questioned the advertising expense

deduction for 1995 before trial, and until the morning of trial,

petitioners had not produced records substantiating the expense.

At trial, respondent claimed that petitioners were not allowed

$24,429 of the claimed expense deduction.

                            Discussion

1.   Burden of Proof

      Generally the taxpayer bears the burden of proof.   Rule

142(a)(1).   If the Commissioner raises an issue that was not

raised in the notice of deficiency, the Commissioner bears the

burden of proof with respect to that issue.   Id.

      When the Commissioner determines that a taxpayer received

unreported income, the taxpayer bears the burden of proof if the

determination in the notice of deficiency is “supported by ‘some



      4
        Respondent reconstructed petitioners’ 1995 omitted income
using the unexplained deposits for 1996. As indicated,
respondent conceded this adjustment for the 1995 tax year before
trial.
                                - 8 -

evidentiary foundation linking the taxpayer to the alleged

income-producing activity.’”    Blohm v. Commissioner, 994 F.2d

1542, 1549 (11th Cir. 1993) (quoting Weimerskirch v.

Commissioner, 596 F.2d 358, 362 (9th Cir. 1979), revg. 67 T.C.

672 (1977)), affg. T.C. Memo. 1991-636.    The Commissioner need

only provide a minimal showing.    Id.   Once the Court determines

that the Commissioner provided the minimal evidentiary showing,

the taxpayer then bears the burden of proving that the notice of

deficiency is arbitrary or erroneous.     Gatlin v. Commissioner,

754 F.2d 921, 923 (11th Cir. 1985) (citing Jackson v.

Commissioner, 73 T.C. 394, 401 (1979)), affg. T.C. Memo. 1982-

489.

       Section 7491, enacted as part of the Internal Revenue

Service Restructuring and Reform Act of 1998, Pub. L. 105-206,

sec. 3001, 112 Stat. 726, which can shift the burden of proof

from the taxpayer to the Commissioner, is not applicable to this

case because petitioners’ audit commenced in April 1998, which

predates July 22, 1998, the effective date of section 7491.

       Petitioners had two main sources of income, Mr. Possas’s

wages for his position as a manager and Mrs. Possas’s

hairdressing activity.    Because petitioners kept no records as to

their income or expenses from the hairdressing activity, they

estimated these amounts on their returns.    We find that

respondent has provided the required evidentiary foundation
                                 - 9 -

sufficient to link petitioners to the receipt of additional

income from Mrs. Possas’s hairdressing activity, and the

determination in the notice of deficiency was neither arbitrary

nor erroneous.   See Blohm v. Commissioner, supra at 1548-1549.

Accordingly, petitioners bear the burden of proof with respect to

the unreported income for 1996.

      Respondent claimed at trial that petitioners are not

entitled to the previously allowed advertising expense deduction

of $29,585 for 1995.     Rather, they are entitled to a deduction of

only $5,156.60 (i.e., the amount that petitioners substantiated

and respondent conceded).    Because this is a new matter,

respondent bears the burden of proof with respect to the

disallowed portion of the claimed advertising expense deduction

of $24,428.40.   Rule 142(a)(1).

2.   Unreported Income

      We must first decide whether respondent’s determination that

petitioners had unreported income in 1996 is reasonable.     Gross

income includes all income from whatever source derived.     Sec.

61(a).   Generally, a taxpayer is required to maintain adequate

books and records of income.    Sec. 6001; sec. 1.6001-1(a), Income

Tax Regs.

       When a taxpayer has failed to provide adequate records

substantiating income, the Commissioner is authorized to

reconstruct the taxpayer’s income by using any reasonable method
                               - 10 -

that clearly reflects income, including an indirect method.     Sec.

446(b); Holland v. United States, 348 U.S. 121 (1954).    The

reconstruction need only be reasonable in light of all facts and

circumstances.    Clayton v. Commissioner, 102 T.C. 632, 643

(1994); Giddio v. Commissioner, 54 T.C. 1530, 1532 (1970).

      The Commissioner is authorized to use bank deposit records

to reconstruct a taxpayer’s income.     Clayton v. Commissioner,

supra at 645.    Bank deposits are prima facie evidence of income.

Id.   In calculating a taxpayer’s taxable income, the Commissioner

must take into account any deductible expense of which he has

knowledge.    Id. at 645-646 (citing DiLeo v. Commissioner, 96 T.C.

858, 868 (1991), affd. 959 F.2d 16 (2d Cir. 1992)).

      The Commissioner’s use of data compiled by BLS is an

acceptable and reasonable method of reconstructing net income.

Pollard v. Commissioner, 786 F.2d 1063 (11th Cir. 1986), affg.

T.C. Memo. 1984-536; Giddio v. Commissioner, supra.     Statistics

from BLS provide an estimate of the taxpayer’s net business

income and take into account business deductions.     Sherrer v.

Commissioner, T.C. Memo. 1999-122, affd. 5 Fed. Appx. 719 (4th

Cir. 2001).

      The examiner sought to reconstruct petitioners’ income and

expenses using bank records only after petitioners could not

substantiate their income and expenses.    After the examiner

totaled the deposits into petitioners’ bank accounts in 1996, she
                               - 11 -

subtracted from this amount known deposits, including CDs that

petitioners had liquidated.

     Petitioners made an attempt to explain the source of funds

in their bank accounts.   Mr. Possas testified that they had

purchased CDs at First Union Bank and cashed them in to use as a

downpayment on a house that they purchased in 1995.    Mr. Possas’s

testimony was vague.   The bank records that petitioners produced

to the Court, which purportedly show that the CDs they liquidated

were deposited into their bank accounts, do not clearly account

for the deposits.    We are not convinced that petitioners cashed

in CDs in excess of $7,064, which is the amount that respondent

identified and gave petitioners credit for in calculating

unreported income.    See Clayton v. Commissioner, supra at 646.

     Petitioners provided a copy of Mrs. Possas’s appointment

book that reflects the 347 hairdressing appointments in 1996 and

also indicates many of the services performed for her clients.

Mrs. Possas testified as to the prices of the various services

she performed.   Thus, there is a basis in petitioners’ records

for an estimate of their income, if not precise as to the total

amount of income, then at least accurate with respect to those

known appointments.    Petitioners made no effort, however, to

calculate their income from the hairdressing activity.
                                 - 12 -

      Respondent used BLS statistics to calculate petitioners’ net

income for the 1996 tax year for the hairdressing activity

because petitioners’ records were inadequate.      By relying on the

BLS statistics, respondent allowed petitioners’ deductions for

expenses based on industry statistics but did not rely on

petitioners’ actual and substantiated expenses.      The examiner

testified that “The only thing I was provided with substantially

was a handful of checks for what was supposed to be expenses for

her for the business.”      Petitioners did not provide the Court

with additional information to substantiate their expenses, such

as receipts or testimony.

      Respondent’s use of the bank deposit analysis and BLS

statistics to reconstruct income for 1996 is reasonable.

Respondent’s determination in this regard is sustained.

3.   Advertising Expenses

      Generally, a taxpayer is allowed a deduction for ordinary

and necessary advertising expenses under section 162 and section

1.162-1, Income Tax Regs.      Only those business expenses greater

than the amounts advanced or reimbursed by the employer are

deductible by the employee under section 162 and section 1.162-

17(b)(3) or (c), Income Tax Regs.

      Petitioners claimed an advertising expense deduction for the

1995 tax year as an unreimbursed employee business expense

deduction.   As indicated, respondent bears the burden of proof on
                               - 13 -

this issue.   Respondent was unable to provide the Court with any

facts indicating that petitioners are not entitled to the claimed

deduction.    Rather, respondent admitted that the examiner

initially allowed the claimed deduction in full for the 1995 year

on the basis of the application of a ratio of the same expense

for petitioners’ 1996 year.

      Accordingly, petitioners are allowed the full amount of the

claimed advertising expense deduction for the 1995 year.

4.   Section 6662(a) Accuracy-Related Penalty

      Respondent determined that petitioners are liable for the

accuracy-related penalty for 1995 and 1996 under section 6662(a)

because of negligence or disregard of rules or regulations or

substantial understatement.    The accuracy-related penalty is

equal to 20 percent of any portion of an underpayment of tax

required to be shown on the return that is attributable to, among

other choices, the taxpayer’s negligence or disregard of rules or

regulations or any substantial understatement of income tax.

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

a reasonable attempt to comply with the provisions of the Code

and any failure by the taxpayer to keep adequate books and

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

1.6662-3(b)(1), Income Tax Regs.    “Disregard” includes any

careless, reckless, or intentional disregard.      Sec. 6662(c).   A

taxpayer has a substantial understatement of income tax if the
                                - 14 -

amount of the understatement exceeds the greater of either 10

percent of the tax required to be shown on the return for the

taxable year or $5,000.   Sec. 6662(d)(1)(A).

     The penalties provided for in section 6662 are not imposed

on any portion of an underpayment if it is shown that there was

reasonable cause for such portion and the taxpayer acted in good

faith with respect to that portion.      Sec. 6664(c)(1); sec.

1.6664-4(b), Income Tax Regs.    Whether the taxpayer has acted

with reasonable cause and in good faith is determined by relevant

facts and circumstances, including the taxpayer’s own efforts to

assess his proper tax liability.    Sec. 6664(c); Stubblefield v.

Commissioner, T.C. Memo. 1996-537.

     Petitioners conceded that they are not entitled to a claimed

deduction in 1995 of $8,532.    Petitioners failed to provide a

basis or an explanation for the claimed deduction.      We conclude

that they are liable for the section 6662(a) accuracy-related

penalty.

     Petitioners admitted that they estimated income and expenses

from the hairdressing activity on their 1996 return.      Petitioners

produced a limited number of relevant documents (e.g., copies of

canceled checks, copies of appointment books, and copies of a

journal of certain expenses).    Petitioners also conceded receipt

of a taxable award from Mr. Possas’s employer for 1996.
                                - 15 -

     As indicated above, petitioners possessed facts sufficient

to allow them to estimate their income and expenses with respect

to the hairdressing activity.    Petitioners failed to make any

attempt to calculate their income and expenses for 1996.

Accordingly, they are liable for the section 6662(a) accuracy-

related penalty for 1996.

     Reviewed and adopted as the report of the Small Tax Case

Division.

     To reflect the foregoing,



                                          Decision will be entered

                                     under Rule 155.
