                              T.C. Memo. 2015-211



                        UNITED STATES TAX COURT



            RONALD LAWSON AND KAREN BEY, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 15600-14.                         Filed October 28, 2015.



      Ronald Lawson and Karen Bey, pro se.

      Marissa J. Savit, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      LARO, Judge: Petitioners, Ronald Lawson (Mr. Lawson) and Karen Bey

(Dr. Bey), petitioned this Court to redetermine respondent’s determinations in the

notice of deficiency issued on April 3, 2014, for the 2011 and 2012 tax years

(years at issue). The deficiency amounts are $14,315 for tax year 2011 and
                                         -2-

[*2] $16,049 for tax year 2012 as well as an addition to tax under section

6651(a)(1)1 for 2012. Respondent amended his answer and asserted accuracy-

related penalties under section 6662(a) for the years at issue, with the amounts to

be determined at a later date in Rule 155 computations.

      The issues for decision are:

      (1) whether petitioners are entitled to deductions claimed on Schedules C,

Profit or Loss From Business (Sole Proprietorship), for car and truck expenses of

$26,005 and $9,990 for the respective years at issue. We hold that they are not;

      (2) whether petitioners are entitled to deductions claimed on Schedules E,

Supplemental Income and Loss, for repair expenses of $32,450 and $20,255 for

the respective years at issue. We hold that they are not;

      (3) whether petitioners have unreported Schedule C and/or Schedule E gross

receipts or sales of $18,057 and $22,101 for the respective years at issue. We hold

that they do to the extent stated in this opinion;

      (4) whether petitioners failed to report taxable income of $31,130 from a

settlement for the 2012 tax year. We hold that they did;




      1
       All section references are to the Internal Revenue Code (Code) in effect for
the years at issue, and Rule references are to the Tax Court Rules of Practice and
Procedure.
                                         -3-

[*3] (5) whether petitioners are liable for an addition to tax under section

6651(a)(1) for failure to file timely for the 2012 taxable year. We hold that they

are; and

      (6) whether petitioners are liable for accuracy-related penalties under

section 6662(a) for the years at issue. We hold that they are.

                               FINDINGS OF FACT

      The facts set forth below are based on the pleadings, witness testimony

during the trial, and other pertinent materials of the record. Some of the facts have

been stipulated. The stipulations of facts and the facts drawn from the stipulated

exhibits are incorporated herein, and we find those facts accordingly. Petitioners

were married at all relevant times and resided in the State of New York at the time

they filed their petition on July 3, 2014. Absent a stipulation to the contrary, an

appeal of this case would lie in the Court of Appeals for the Second Circuit.

      During the years at issue Dr. Bey operated a holistic wellness business and

Mr. Lawson was an employee of Quality Building Services Corp. (QBS).

Petitioners timely filed their 2011 Form 1040, U.S. Individual Income Tax Return

(2011 tax return). Petitioners filed their 2012 Form 1040 (2012 tax return) on

April 28, 2013, after the filing deadline. Respondent’s revenue agent Gene

Enriquez (RA Enriquez) examined petitioners’ 2011 and 2012 tax returns. In the
                                         -4-

[*4] course of the audit, RA Enriquez requested that petitioners produce their

business records, bank account statements, and substantiating documentation for

the expenses underlying the claimed deductions. Petitioners did not provide

RA Enriquez with the requested information. Instead, petitioners claim RA

Enriquez should have “availed himself” of the access to petitioners’ computer files

containing their business records during RA Enriquez’s two site visits to Dr. Bey’s

offices.

      On April 3, 2014, respondent issued a notice of deficiency to petitioners for

the years at issue. Respondent disallowed certain deductions that petitioners

claimed on Schedules C and E of the 2011 and 2012 tax returns. In addition, on

the basis of the bank deposits analysis (BDA) performed during the audit and

petitioners’ failure to include in income proceeds received as a result of a

settlement with Bank of America Corp. (BOA), respondent determined that

petitioners had unreported income.

I.    Schedule C Car and Truck Expenses

      Petitioners claimed deductions of $26,005 and $9,990 for business-related

car and truck expenses on Schedules C of the 2011 and 2012 tax returns,

respectively. Dr. Bey explained that she used the cars to visit her clients at their

homes. However, she did not provide the Court with any documentation
                                           -5-

[*5] supporting the expenses underlying the deductions claimed on Schedules C

for the years at issue.2 During one of RA Enriquez’s site visits, Dr. Bey claimed

that all the records related to the car and truck expenses are stored on her

computer. RA Enriquez asked petitioners to email him the relevant documents,

but petitioners neither did that nor provided the documents in any other form.

II.   Schedule E Repair Expenses

      Dr. Bey was involved in the distressed real estate business for a number of

years. In 2011 petitioners’ tax return reported five rental properties on their

Schedule E: 151 Hawthorne Avenue (Hawthorne property); 30 Ashburton Road

(Ashburton property); 8 Larter Avenue (Larter property); 11 West 184th Street;

and 832 Palisade Avenue (Palisade property).

      On their 2011 tax return petitioners claimed a Schedule E repair expense

deduction of $32,450, including $2,000 and $3,250 for the Ashburton property

and the Palisade property, respectively.




      2
       Schedule C attached to the 2011 tax return was in the name of Mr. Lawson.
However, on the basis of the testimonies of Mr. Lawson and Dr. Bey at trial, as
well as the employee identification number used on Schedules C for the years at
issue, we find that the expenses reported on Schedule C attached to the 2011 tax
return are attributable to the business of Dr. Bey.
                                         -6-

[*6] On Schedule E in the 2012 tax return petitioners reported having only one

rental property, the Larter property, and claimed a repair expense deduction of

$20,255.

       During 2011 and 2012 petitioners resided at both the Ashburton and the

Palisade properties. Dr. Bey had business offices at the Hawthorne and the

Palisade properties.

       After the audit respondent disallowed all repair expense deductions claimed

on Schedules E for the years at issue. Petitioners did not keep records

substantiating the repair expenses and attempted to claim deductions for repair

expenses for the properties they resided at--the Ashburton and Palisade properties.

Petitioners explained that some of the repair expenses were reimbursed by

insurance or third-party payments.

III.   BDA and Unreported Income

       Dr. Bey informed RA Enriquez during the audit that she received mainly

cash from her clients, which she deposited in part and retained in part. Because

petitioners did not provide RA Enriquez with their business records and bank

statements when requested, RA Enriquez had to subpoena petitioners’ bank

account statements. RA Enriquez then prepared a BDA to enable him to verify the

correctness of petitioners’ reported gross receipts.
                                         -7-

[*7] During the years at issue petitioners had at least five bank accounts: Chase

5403; Chase 5679; New York Commercial Bank (NYCB); Citibank 8771 (Citi

8771); and Citibank 8435 (Citi 8435). Petitioners admitted that they used their

personal bank accounts for business purposes.

      When RA Enriquez completed the BDA, petitioners had an opportunity to

dispute or offer alternative explanations to RA Enriquez’s findings. Petitioners

chose not to pursue this option.

      A BDA is not a perfect tool, and there were some issues as to the

correctness of RA Enriquez’s conclusions. Respondent admitted that

RA Enriquez’s BDA improperly excluded Mr. Lawson’s gross wages instead of

excluding the net wages. Respondent’s Technical Services Unit caught this error

and corrected it before issuing the notice of deficiency to petitioners.

      This, however, was not the only problem with RA Enriquez’s BDA.

Respondent later conceded that two deposits made during March 2012 to

petitioners’ Citi 8435 account for $2,000 and $2,025 were improperly included in

the BDA.
                                        -8-

[*8] Other issues with RA Enriquez’s BDA are discussed below.

      A.     Wages and Deposits Previously Omitted From the BDA

      Respondent’s amended pretrial memorandum notified the Court and

petitioners that wages that QBS paid to Mr. Lawson were excluded from the BDA

both at the individual bank account level and at the end of the analysis when total

annual net wages were excluded from the BDA. Our review of the record shows

that the following deposits in 2012 were affected by this error:

   Date                   Amount               Exhibit No.          Payor

   9/27                   $823.58             33-R at 0093          QBS

 10/22                    1,011.82            33-R at 0103          QBS

 11/15                      913.04            33-R at 0105          QBS

 11/21                      684.22            33-R at 0105          QBS

 11/29                      624.50            33-R at 0105          QBS

   12/6                     793.35            33-R at 0105          QBS

 12/13                      883.23            33-R at 0111          QBS

 12/20                      644.42            33-R at 0111          QBS

In addition, we find that the deposit made on December 27, 2012, of $863.35

should be treated as wages. Respondent should address the treatment of this
                                        -9-

[*9] deposit in the Rule 155 computations. All of the affected deposits were made

in Mr. Lawson’s Chase 5679 account.

      In addition, respondent requested the Court to allow in the Rule 155

computations a check for $550 deposited into the NYCB account in March 2012

that respondent failed to address in the original BDA. Petitioners did not provide

any testimony or other evidence as to why the check should not be included.

      B.     Unreported Rent

      On the basis of the BDA, respondent concluded that petitioners received

rent from Tiasha Wamack of $1,150 per month for the Hawthorne property in

2012. Respondent alleges that the total unreported rent was at least $5,300 for the

2012 tax year. Petitioners should have reported the rent on Schedule E but failed

to do so or to otherwise report the Hawthorne property on Schedule E for 2012 tax

year. On briefs petitioners pointed out that one of the checks from Tiasha

Wamack deposited in June 2012 for $1,150 was returned for insufficient funds.

Petitioners did not present any other evidence refuting respondent’s conclusions.

      C.     Security Deposits

      Dr. Bey identified checks and bank deposits that she claims are security

deposits for various rental properties. Dr. Bey’s explanation is inconsistent with

the notes on some of the checks. Specifically, a check for $1,800 made payable to
                                       - 10 -

[*10] Dr. Bey from Carolina Cobena dated January 4, 2011, has a note on it

stating the check is for rent from January 4 to February 4, 2011. Another check

for $2,300 made payable to Dr. Bey from Tiasha Wamack dated November 23,

2011, is notated as “Security +1st Month Dec. Rent” for the Hawthorne property.

Dr. Bey testified that two postal money orders from Rafael Martinez of $1,000 and

$400 represent a security deposit for the Larter property, but there are no notations

on the money orders or any other documents clarifying the purpose of the money

orders. The record is silent as to whether petitioners ever returned these or other

alleged security deposits or whether the deposits were used to cover any damage

to the respective rental properties.

      D.     Transfers to Other Accounts of Petitioners and Between Petitioners

      Further, Dr. Bey identified checks that she issued to herself to transfer

money from her NYCB account to her other accounts for convenience.

Respondent pointed out that some of these checks had a different name of issuer

than that of Dr. Bey. Dr. Bey explained that she uses various names, including

Karen Bey, K. Bey, Shya Bey, Shakema Bey, and Karema Bey because of the

differences in her birth and ordained names. Respondent maintains on the basis of

notations on some of the checks as rent or for the Larter property that Shya K. Bey

was petitioners’ tenant. However, a review of the evidence submitted by the
                                      - 11 -

[*11] parties, including statements for the Citi 8771 and NYCB accounts, shows

that checks issued by “Dr Shya K Bey” or “Dr K Bey” were issued from the

NYCB account that belongs to Dr. Bey. The numbers on the checks and the

amounts deposited to the Citi 8771 account are the same as the check numbers and

amounts showing on the NYCB statements. Thus, we find that these checks were

indeed checks issued by Dr. Bey to herself.3

      On briefs petitioners identified a number of checks they issued to each

other. RA Enriquez properly identified and excluded some of these checks from

the BDA, including the check from Mr. Lawson to Dr. Bey for $29,000 as a loan.

However, RA Enriquez did not exclude from the BDA a number of checks issued

by Dr. Shya K. Bey to Mr. Lawson and deposited in the Chase 5679 account. As

discussed above, the amounts and numbers on the checks are the same as the




      3
        The exhibits showing the affected checks are as follows: Exh. 31-R, at
Bates Nos. 0033 ($900), 0035 ($1,150), 0039 ($1,256), 0041 ($1,680), 0044
($2,175), 0046 ($2,174.40), 0052 ($2,350, returned for insufficient funds), 0055
($2,850), 0063 ($1,895, returned for insufficient funds), and 0071 ($1,950).
Corresponding writeoffs from the NYCB account, including check numbers, are
included on various pages of Exh. 25-R. All other checks that petitioners
identified as issued to themselves are properly included in the BDA.
                                           - 12 -

[*12] amounts and numbers of checks reported on Dr. Bey’s NYCB account

statements. Thus, we find that these checks were issued by Dr. Bey to Mr.

Lawson.4

      E.       Checks Returned for Insufficient Funds

      Petitioners identified on briefs several deposited checks that should have

been excluded by RA Enriquez from the BDA because they were returned for

insufficient funds. Some of these checks have been identified and excluded by RA

Enriquez. In addition to those checks, our review of the evidence submitted by the

parties shows that the following checks that petitioner identified are listed on the

corresponding 2012 bank statements as returned for insufficient funds:

            Account                       Amount                   Bates No.

            Citi 8435                   $1,150.00                   0017

                                            90.00                   0040

                                          340.00                    0044

                                         2,200.00                   0090
                                    1
          Chase 5679                    19,079.41             0112, 0118, 0119


               1
              This alleged insurance payment for petitioners’ Porsche Cayenne was
      returned for insufficient funds.


      4
       Exhibits showing the affected checks are as follows: Exh. 33-R at Bates
Nos. 033 ($600), 0035 ($825), 0037 ($1,950), 0039 ($1,300), 0041 ($850), and
0022 ($700). Other checks that petitioners identified as issued to each other are
properly included in the BDA.
                                           - 13 -

[*13] F.          Federal and State Tax Refunds

         Petitioners claim that RA Enriquez did not exclude from the BDA deposits

representing State and Federal tax refunds that petitioners received in 2011 and

2012. This statement is true only with respect to one check from the U.S. Treasury

of $5,832.13 deposited in the Chase 5403 account on July 24, 2012. RA Ramirez

excluded from the BDA other checks representing State and Federal tax refunds.5

         G.       Miscellaneous Deposits

         Petitioners identified on briefs some checks received as loans,6 checks

cashed in accommodation to out-of-State relations,7 and funds received from

offsetting accounts.8 The record does not have any further substantiation for such

items.




         5
       We do not opine on whether RA Ramirez’s treatment of State tax refunds
as nontaxable is correct because the parties did not raise this issue in their
pleadings. This issue is thus deemed waived.
         6
       Exh. 36-R at Bates Nos. 0046 and 0056. Another check identified as a
loan, Exh. 36-R at Bates No. 0040, was returned for insufficient funds.
         7
             Exh. 36-R at Bates Nos. 0113, 0030, 0031, 0032, and 0033.
         8
             Exh. 36-R at Bates Nos. 0028, 0029, and 0110.
                                       - 14 -

[*14] H.    Alleged Insurance and Damage to the Property Proceeds

      Petitioners claim that RA Enriquez should have excluded some of the

deposits from his BDA because the deposits represent payments received from

escrow or as property damage insurance proceeds.

      Checks documenting some of the alleged insurance payments for damages

to petitioners’ real property were sometimes not issued in the names of petitioners

but were nevertheless deposited into their accounts.9 When questioned regarding

the other names on the alleged insurance checks, Dr. Bey explained that they were

the original mortgage holders on the properties. Petitioners did not provide any

documentation relating to these insurance policies, such as contracts or

correspondence evidencing existence of the policies. There are no agreements on

the record between petitioners and the original mortgage holders documenting

allocation of insurance expenses and proceeds.


      9
        The checks Dr. Bey identified during the trial as insurance payments are:
Exh. 31-R, Bates 0016, for $5,484.25 payable to K Bey & Co. (no payment
description on the check; petitioners claim this was an insurance payment for the
Palisade Property); Exh. 31-R, Bates 0022 and 0025, for $1,072.80 and $1,072.79,
respectively, payable to Dr K Bey & Co., Juliana & Gregory Jean (payment
description on the check is “for payment of restricted escrow”; petitioners claim it
is for the insurance on one of the properties); Exh. 31-R, Bates 0048, for
$4,849.51 payable to K Bey and Co., Angelina Schwickrath (petitioners claim it
was an insurance payment for the Palisade property; the check refers to a loan
number).
                                        - 15 -

[*15] Petitioners also failed to provide any evidence of the alleged damages to the

respective properties. Dr. Bey explained that to get the insurance payments, she

usually had to do the repairs first, take photographs of the repairs done, and send

the photographs to the insurance company or a bank. Only after doing those

things would she be reimbursed for the expenses. Petitioners failed to introduce

into evidence any documentation in support of the alleged insurance payments.

      On briefs petitioners identified additional insurance proceeds as follows:

Exhibit 27-R, Bates 0027 (void escrow check already excluded from the BDA)

and Exhibit 36-R, Bates 0058 and 0067 (checks for $4,749.28 and $4,155,

respectively, issued by Castle Point Insurance Co. for a claim number ending in

77-01). Again, there is no evidence on the record that would further explain the

nature of the payments.

      In 2012 petitioners received an insurance payment from Allstate for a

damaged Porsche Cayenne that they owned. Allstate issued three checks in the

same amount and for the same loss but sent the checks to three different addresses.

Two of the checks were returned for insufficient funds after petitioners attempted

to deposit them. One of the checks, however, was deposited successfully in the

Citi 8435 account. RA Enriquez excluded from the BDA two of the checks (likely

as returned for insufficient funds) but did not do the same for the third check.
                                       - 16 -

[*16] IV.     Unreported Income From Settlement With BOA

      In 2011 Mr. Lawson filed a complaint in the Supreme Court of the State of

New York, County of Westchester, against Samba Gassama, Gassama Enterprises

Corp. (collectively, Gassama), and BOA. The complaint alleged that Gassama

stole six checks totaling $50,000 from Mr. Lawson and fraudulently deposited

them into Gassama’s accounts. Mr. Lawson alleged that BOA acted negligently in

transferring funds out of Mr. Lawson’s BOA account. BOA denied any

wrongdoing.

      At the end of 2011 Mr. Lawson filed another complaint in the Supreme

Court of the State of New York, County of Westchester, against Anthony Philips

and BOA. The second complaint alleged that Mr. Lawson deposited into his BOA

account a check for $18,020.33 that was issued by Liberty Mutual Insurance Co.

to Mr. Lawson and Anthony Philips and endorsed by both of them. The complaint

alleged that the check represented the payment for Mr. Lawson’s services for

renovating Anthony Philips’ real property. Subsequently, BOA transferred the

funds to Anthony Philips upon his request after it received an affidavit of forged

signature. Mr. Lawson argued that BOA breached its fiduciary duty to him and

acted negligently in transferring funds out of his account. BOA denied any

wrongdoing.
                                       - 17 -

[*17] After several months of negotiations Mr. Lawson and BOA reached a

settlement in both cases. Mr. Lawson executed a general release for both

complaints as to BOA, and the parties filed stipulations of discontinuance with

prejudice as to defendant BOA only. As a result of the settlement, on July 26,

2012, Mr. Lawson’s attorney issued a check to Mr. Lawson for $31,130,

representing the $40,000 received from BOA, less legal fees and court costs.

      RA Enriquez identified the check as settlement proceeds in the BDA but did

not exclude it as nontaxable. Later, petitioners admitted that they received

settlement proceeds of $31,130 in 2012.10

                                     OPINION

I.    Burden of Proof

      The Commissioner’s determinations in a notice of deficiency are generally

presumed to be correct, and the taxpayer bears the burden of proving by a

preponderance of the evidence that the determinations are incorrect. Sec.

7482(b)(1)(A); Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

Pursuant to section 7491(a)(1), the burden of proof may shift to the Commissioner

      10
         The request for admissions labeled the proceeds an “insurance settlement”,
but the parties later identified the proceeds in their briefs as proceeds from a
settlement with BOA. We do not opine on whether it was appropriate to include
in petitioners’ income the full amount of the settlement, $40,000. Respondent did
not raise this argument in his pleadings, and we thus deem it waived.
                                       - 18 -

[*18] with respect to factual matters if the taxpayer meets certain requirements.

For the burden to shift, the taxpayer must (1) comply with the substantiation

requirements as provided in the Code; (2) maintain records as required under the

Code; and (3) cooperate with reasonable requests by the Commissioner for

witnesses, information, documents, meetings, and interviews. Sec. 7491(a)(2).

      Petitioners argue in their posttrial briefs that the burden of proof should

shift to respondent pursuant to section 7491(a). However, petitioners did not

comply with respondent’s information requests and discovery deadlines, failed to

provide the requested documents from their computer, and, as discussed more

thoroughly below, did not meet the substantiation requirements regarding their

alleged expenses. Thus, petitioners did not satisfy the requirements for the burden

to shift under section 7491(a).

II.   Deductions/Expenses

      Deductions are a matter of legislative grace, and the taxpayer bears the

burden of proving his entitlement to any deductions claimed. INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992); Deputy v. du Pont, 308 U.S. 488, 493

(1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); Welch v.

Helvering, 290 U.S. at 115. A taxpayer is required to maintain sufficient records

to substantiate expenses underlying the deductions claimed on Federal income tax
                                        - 19 -

[*19] returns. Sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs.; see also

Hradesky v. Commissioner, 65 T.C. 87, 90 (1976), aff’d, 540 F.2d 821 (5th Cir.

1976).

      A.     Deductibility of Schedule C Car and Truck Expenses

      Petitioners claimed deductions for car and truck expenses of $26,005 and

$9,990 for the respective years at issue. Respondent denied these deductions in

their entirety because petitioners failed to substantiate the expenses.

      Section 162 allows a deduction for all ordinary and necessary expenses paid

or incurred during the tax year in carrying on any trade or business. Section

274(d) precludes a deduction for specified expenses unless a taxpayer

substantiates by adequate records or by sufficient evidence corroborating the

taxpayer’s own statement the following five elements: the amount, date, time,

place, and business purpose of the expense. To meet the adequate records

requirement for the expenses enumerated in section 274, a taxpayer must maintain

an account book, a diary, a log, a statement of expense, trip sheets, or a similar

record and documentary evidence which, in combination, would be sufficient to

establish each element of expenditure or use. Sec. 1.274-5T(c)(2)(ii)(A),

Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985). Section 274

and section 1.274-5T, Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6,
                                        - 20 -

[*20] 1985), provide heightened substantiation requirements for any listed

property under section 280F(d)(4). Listed property under section 280F(d)(4)

includes any passenger automobile. Colvin v. Commissioner, T.C. Memo.

2007-157, aff’d, 285 F. App’x 157 (5th Cir. 2008).

      Petitioners argue that the car and truck expense deductions for the

respective years at issue are justified because Dr. Bey’s business requires her to

travel frequently to her clients’ personal residences. Petitioners assert that

Dr. Bey’s willingness to allow RA Enriquez to examine her computer--which

petitioners claim contained the necessary information--qualifies as sufficient

substantiation.

      Respondent argues that petitioners did not provide RA Enriquez or the

Court with adequate records or sufficient evidence as required under section 274.

RA Enriquez testified that during the audit Dr. Bey did not provide him with any

documentation to substantiate the car and truck expenses or even inform him that

she traveled to her clients’ personal residences.

      After reviewing the record, we do not see any evidence corroborating the

existence of reported car and truck expenses except for petitioners’ self-serving

testimony. We agree with respondent that petitioners’ failure to substantiate the

respective car and truck expenses justifies a complete disallowance. Accordingly,
                                        - 21 -

[*21] we sustain respondent’s disallowance of petitioners’ claimed Schedule C car

and truck expense deductions for the years at issue.

      B.     Deductibility of Schedule E Repair Expenses

      Petitioners claimed repair expense deductions of $32,450 and $20,055 for

the respective years at issue. Respondent denied these deductions in their entirety.

      Section 212 allows a deduction for ordinary and necessary expenses paid or

incurred while managing or maintaining property held for the production of

income. To be entitled to a deduction, a taxpayer must meet applicable

substantiation requirements by keeping adequate records. Sec. 6001; Roberts v.

Commissioner, 62 T.C. 834, 836-837 (1974); sec. 1.6001-1(a), (e), Income Tax

Regs. Taxpayers who fail to substantiate any item may be denied the claimed

deduction. Hunter v. Commissioner, T.C. Memo. 2014-164.

      Petitioners argue that respondent’s disallowance of all the repair expense

deductions for the years at issue is arbitrary and erroneous. Petitioners assert that

they had records to substantiate the respective expenses and that they provided

sufficient evidence of those expenses for the years at issue.

      Respondent argues that petitioners failed to meet their burden of proof.

Respondent points out that petitioners did not provide a single document

establishing that they incurred the repair expenses reported on Schedules E for the
                                         - 22 -

[*22] years at issue. Petitioners also did not prove that such expenses were

ordinary or necessary and should not be capitalized.

      The evidence in the record regarding the repair expense substantiation is

almost nonexistent. A few checks attached to the BDA that could be identified as

insurance proceeds for damage to petitioners’ property are insufficient to qualify

as proper substantiation without underlying support, such as receipts, invoices,

purchase orders, or similar documentation. Petitioners’ self-serving testimony is

unpersuasive. See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). Moreover,

petitioners’ testimony contradicts the positions they took on the 2011 and 2012 tax

returns in that they claimed repair expense deductions for what may have been

covered by insurance or other third-party payments, such as security deposits. In

addition, in 2011 petitioners tried to claim on their Schedule E a deduction for

repair expenses they incurred on their personal residences, which is clearly outside

the scope of section 212. Under these circumstances, we hold that petitioners did

not meet their burden of proof to substantiate the repair expenses. Accordingly,

we sustain respondent’s disallowance of petitioners’ repair expense deductions for

those expenses for the years at issue.
                                       - 23 -

[*23] III.   Unreported Income

      Gross income includes all income from whatever source derived unless

otherwise specifically excluded. Sec. 61(a). The definition of gross income

broadly includes any instance of undeniable accession to wealth, clearly realized,

and over which the taxpayer has complete dominion and control. Commissioner v.

Glenshaw Glass Co., 348 U.S. 426, 431 (1955). Section 6001 requires a taxpayer

to keep books and records sufficient to establish the taxpayer’s gross income,

deductions, losses, and credits. Sec. 1.6001-1(a), Income Tax Regs. Section 7602

authorizes the Commissioner to examine books, papers, records, and other data

potentially relevant or material to the determination of a taxpayer’s Federal

income tax liability. Where an individual fails to maintain adequate books and

records, the Commissioner may reconstruct the taxpayer’s income using any

method which, in his opinion, clearly reflects income. Sec. 446(b); see also

Petzoldt v. Commissioner, 92 T.C. 661, 686-687 (1989); Dyer v. Commissioner,

T.C. Memo. 2012-224, at *16; Gutierrez v. Commissioner, T.C. Memo. 2003-321,

slip op. at 8 (citing Holland v. United States, 348 U.S. 121, 130-132 (1954)). The

reconstruction of a taxpayer’s income need only be reasonable in the light of the

surrounding facts and circumstances. Petzoldt v. Commissioner, 92 T.C. at 687.
                                        - 24 -

[*24] One such method of income reconstruction, the bank deposits method, has

long been sanctioned by the courts. See, e.g., Burke v. Commissioner, 929 F.2d

110, 112 (2d Cir. 1991), aff’g in part, vacating in part T.C. Memo. 1989-671.

Under the bank deposits method, bank deposits and cash expenditures are totaled

unless the cash was derived from bank withdrawals. Id. Amounts representing

proceeds of loans, redeposits, and identifiable nonincome are then subtracted, and

the remainder is treated as taxable income unless it is shown to be otherwise. Id.;

see also Clayton v. Commissioner, 102 T.C. 632, 645-646 (1994) (taxpayer bears

burden of showing that Commissioner’s determination is incorrect). But see

Teichner v. Commissioner, 453 F.2d 944, 945-949 (2d Cir. 1972) (bank deposits

determined to be nonincome fruits of check-kiting scheme), rev’g and remanding

T.C. Memo. 1970-31. Mistakes in a bank deposits analysis do not necessarily

invalidate the results. See Dyer v. Commissioner, T.C. Memo. 2012-224.

      Respondent argues that RA Enriquez’s BDA demonstrates that the

respective checks included in the BDA are unreported taxable income because up

until the trial petitioners did not raise any objections to the BDA.

      Petitioners argue that numerous errors within the BDA warrant excluding

the entire BDA as an unreliable basis for determining unreported income.
                                         - 25 -

[*25] We acknowledge that RA Enriquez’s BDA had certain flaws, but we do not

agree that those flaws warrant setting it aside. In the light of the utter lack of

cooperation from petitioners during the audit, RA Enriquez and respondent

showed substantial and reasonable efforts in compiling the BDA and making sure

the findings are correct. Matching information on numerous deposits from five

banking accounts is a difficult task. With that in mind, on the basis of the parties’

testimony at trial and the record in this case, we conclude that the BDA should be

modified as set forth below.

      First, we find that items that respondent conceded should not be included in

the BDA should be excluded from the calculations. In addition, the $550 check

that respondent asked us to include in the BDA should be so included because

petitioners failed to show it is nontaxable.

      Second, we find that Mr. Lawson’s net wages that were excluded twice from

the BDA should be excluded only once.

      Third, we find that the amounts of rent unreported on Schedule E for the

2012 tax return regarding the Hawthorne Property were properly included in the

BDA with the exception of one check that was returned for insufficient funds. See

Exhibit 36-R at 0017, 0101 (check for $1,150 from Tiasha Wamack, subsequently

returned).
                                         - 26 -

[*26] Fourth, we find that the alleged security deposits for rental properties have

been properly included in the BDA because petitioners failed to meet the burden

of proof on this issue. Petitioners did not provide the Court with sufficient records

or other evidence corroborating their self-serving testimony. Further, there is no

evidence in the record to support that said security deposits were ever returned to

lessees.

      Fifth, we find that the checks Dr. Bey issued to herself to transfer the funds

from one bank account to another and the checks Dr. Bey and Mr. Lawson issued

to each other should be excluded from the BDA to the extent described in the

findings of fact. See supra pp. 10-11.

      Sixth, we find that the checks identified as returned for insufficient funds or

checks reflecting tax refunds, as described in the findings of fact, see supra pp. 12-

13, should be excluded from the BDA.

      Seventh, with respect to the alleged loans, funds from offsetting accounts,

and deposits for out-of-State relatives, we find that petitioners did not introduce

sufficient evidence to refute the BDA findings. Thus, no modification of the BDA

is necessary.

      Eighth, with respect to the insurance proceeds and payments for the

property damage, we find that the petitioners did not meet the burden of proof to
                                         - 27 -

[*27] show that any such receipts were nontaxable. Petitioners’ testimony and

briefs seem to be inconsistent with the positions they took on their 2011 and 2012

tax returns by claiming large repair expense deductions on Schedules E for rental

properties and car and truck expense deductions on Schedules C. Besides

petitioners’ unpersuasive testimony and sparse information the Court obtained

from reviewing the checks attached to the BDA, the record is devoid of any

corroborating evidence confirming the details of the insurance policies, whether

the insured property was used in petitioners’ business, and other details necessary

to determine whether the insurance proceeds were taxable or not. For example,

Dr. Bey testified that she used personal cars to visit her clients, but the record is

silent on whether she used a specific car--here, the Porsche Cayenne--for which

she claims to have received a nontaxable insurance payment, in her business. The

same goes for the alleged insurance payments covering the damages to petitioners’

real estate. There are simply not enough details in the record to tie the payments

to specific properties and specific items of damage. Thus, petitioners failed to

meet their burden of proof, and the alleged insurance proceeds and payments for

the property damage were properly included in the BDA.
                                        - 28 -

[*28] Accordingly, except for the amounts we deemed excluded above, we sustain

respondent’s determination that the unreported income in the BDA was proper,

and petitioners are liable for any resulting deficiencies.

IV.   Litigation Settlement Proceeds

      Gross income includes all income from whatever source derived unless

specifically excluded. Sec. 61(a); Simpson v. Commissioner, 141 T.C. 331

(2013). Proceeds from the settlement of a lawsuit constitute taxable income unless

the taxpayer can establish that the proceeds come within the clear scope of a

statutory exclusion. Commissioner v. Schleier, 515 U.S. 323, 336-337 (1995).

Taxpayers generally bear the burden of proving that they fall squarely within the

requirements for any exclusion from gross income. Simpson v. Commissioner,

141 T.C. at 339 (citing Forste v. Commissioner, T.C. Memo. 2003-103).

      Under the origin of the claim doctrine, courts look into the nature of the

underlying claim to determine whether a settlement payment or judicial award is

excludible from gross income and to determine the proper tax treatment of the

proceeds. See United States v. Gilmore, 372 U.S. 39 (1963); Hort v.

Commissioner, 313 U.S. 28 (1941). Courts look to the terms of a settlement

agreement to determine whether a settlement is taxable. See, e.g., Freda v.

Commissioner, T.C. Memo. 2009-191, aff’d, 656 F.3d 570 (7th Cir. 2011). Where
                                        - 29 -

[*29] the agreement is silent as to the basis of the settlement or where the

agreement does not specify that the payment was for a reason that a court finds to

be nontaxable, this Court has held the settlement payment to be taxable. See, e.g.,

Freeman v. Commissioner, 33 T.C. 323 (1959); Ahmed v. Commissioner, T.C.

Memo. 2011-295, aff’d, 498 F. App’x 919 (11th Cir. 2012).

      Petitioners admitted that they received the $31,130 settlement for the claims

against BOA but argue that the settlement proceeds are not taxable income under

the origin of the claim doctrine. Petitioners assert that the recovered amount

constitutes a nontaxable return of funds improperly taken from Mr. Lawson.

      Respondent argues that the settlement agreement between Mr. Lawson and

BOA does not specify a nontaxable reason for the settlement and therefore the

settlement proceeds are taxable.

      Petitioners failed to establish that the settlement proceeds are within the

clear scope of a statutory exclusion. Examination of the complaints filed in cases

forming the basis for the settlement at hand shows that Mr. Lawson alleged that

BOA acted negligently in transferring the funds from his account. As a condition

to receiving the settlement payout, Mr. Lawson executed a general release of his

claims against BOA and agreed to the filing of stipulations of discontinuance with

prejudice in both cases. The general release and the stipulations are silent as to
                                        - 30 -

[*30] whether the payment was supposed to restore funds taken from Mr.

Lawson’s account or was just to get rid of a nuisance lawsuit. In any event, we

note that petitioners failed to point to any statutory exception, such as section

104(a)(2), or any other authority that would allow us to conclude that the

settlement proceeds in the current case should be treated as nontaxable. Thus, we

hold that petitioners did not meet their burden of proof in demonstrating that the

settlement funds were nontaxable. Accordingly, RA Enriquez properly included

the settlement proceeds as unreported income for the 2012 tax year.

V.    Sections 6651(a)(1) and 6662(a)

      The burden of production is on the Commissioner with respect to the

liability of a taxpayer for any penalty or addition to tax. Sec. 7491(c); Rule

142(a)(2). To meet this burden, the Commissioner must produce sufficient

evidence indicating that it is appropriate to impose an addition to tax or a penalty

on the taxpayer. Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001).

Because respondent first introduced the issue of penalties under section 6662(a) in

his amended answer, respondent bears the burden of proof on this issue under

Rule 142(a)(1).
                                          - 31 -

[*31] A.     Section 6651(a)(1)

      Section 6651(a)(1) imposes an addition to tax for failure to timely file a

Federal tax return when due equal to 5% for each month that the return is late, not

to exceed 25%. The addition to tax for failure to file timely does not apply where

the failure was due to reasonable cause and not due to willful neglect. Id. The

burden of showing reasonable cause under section 6651(a) remains on the

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

      Petitioners admitted that they filed their 2012 tax return late. Thus,

respondent has met the burden of production with regard to an addition to tax

under section 6651(a)(1) for the 2012 tax year. Petitioners did not argue during

the trial or in their briefs that their failure to timely file the 2012 tax return was

due to reasonable cause and not willful neglect. Accordingly, we sustain

respondent’s determination and we hold that petitioners are liable for an addition

to tax under section 6651(a)(1).

      B.     Section 6662(a)

      Section 6662(a) imposes a 20% accuracy-related penalty on the

underpayment of tax required to be shown on a return. Section 6662(b)(1) and (2)

imposes an accuracy-related penalty on a portion of any underpayment which is

attributable to (1) negligence or disregard of rules or regulations or (2) a
                                        - 32 -

[*32] substantial understatement of income tax. Negligence includes “any failure

to make a reasonable attempt to comply with the provisions” of the Code or to

exercise “ordinary and reasonable care in the preparation of a[n] [income] tax

return.” Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. Negligence also

includes any failure to maintain adequate books and records or to substantiate

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

careless, reckless or intentional disregard” of the rules or regulations. Id. subpara.

(2). A substantial understatement of income tax exists if the amount of the

understatement exceeds the greater of 10% of the tax required to be shown on the

return or $5,000. Sec. 6662(d)(1)(A). Once the Commissioner has met the burden

of production, the taxpayer must come forward with persuasive evidence that the

imposition of a penalty is inappropriate because, for example, the taxpayer acted

with reasonable cause and in good faith. Sec. 6664(c)(1); Higbee v.

Commissioner, 116 T.C. at 448-449.

      The exact amount of petitioners’ understatement for each of the years at

issue shall be computed as a part of the Rule 155 calculations. Even if petitioners’

understatements are not substantial within the meaning of section 6662(d)(1)(A),

respondent may meet his burden by demonstrating that petitioners negligently

claimed deductions to which they are not entitled.
                                        - 33 -

[*33] Respondent argues that petitioners failed to keep adequate books and

records because they did not produce records sufficient to substantiate their

expenses during the audit or to this Court during the trial. Respondent contends

that this basis alone is sufficient to impose section 6662(a) accuracy-related

penalties for the years at issue.

      Petitioners argue that they maintained appropriate records and offered them

for RA Enriquez’s examination, which demonstrates a good-faith attempt to

comply with the Code. Petitioners assert that RA Enriquez’s failure to “avail

himself” of access to petitioners’ records stored on a computer during his two site

visits should not subject them to accuracy-related penalties.

      We agree with respondent. Petitioners failed to produce documentation

during the audit and at trial to substantiate their expenses. Petitioners’ allegations

that RA Enriquez should have reviewed all their business records during a short

site visit are misguided and do not qualify as a good-faith attempt to comply with

the requirements of the Code. The BDA shows petitioners failed to include in

income numerous deposits and failed to maintain adequate books and records to

explain the nature of many items, including the alleged insurance payments for

property damage and security deposits. Finally, petitioners failed to include in

income the proceeds of the BOA settlement. Taken together, all these
                                        - 34 -

[*34] circumstances show that petitioners did not make a reasonable attempt to

comply with the provisions of the internal revenue laws or to exercise ordinary

and reasonable care in the preparation of a tax return.

      Petitioners also failed to show that they acted with reasonable cause under

section 6664(c). Petitioners’ conduct with respect to keeping adequate records

and making these records available in the course of the audit shows they were

negligent. Thus, respondent has met his burden of proof with regard to imposing

accuracy-related penalties under section 6662(a). Accordingly, we sustain

respondent’s determination and hold that the imposition of accuracy-related

penalties under section 6662(a) is appropriate.

      We have considered all of the arguments raised by petitioners and

respondent, and to the extent not discussed herein we conclude they are irrelevant,

moot, or without merit.

      To reflect the foregoing and concessions by respondent,


                                                      Decision will be entered

                                                 under Rule 155.
