                       T.C. Memo. 1999-191



                     UNITED STATES TAX COURT



         RONALD D. AND SHIRLEY A. BLUSH, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3637-98.                     Filed June 10, 1999.



     David A. Slacter, for petitioners.

     William J. Gregg, for respondent.



                       MEMORANDUM OPINION


     PANUTHOS, Chief Special Trial Judge:    This case was heard

pursuant to section 7443A(b)(3)1 and Rules 180, 181, and 182.



     1
           Unless otherwise indicated, all section references are
to the Internal Revenue Code in effect for the years in issue.
All Rule references are to the Tax Court Rules of Practice and
Procedure.
                                     - 2 -

     Respondent determined the following deficiencies and

penalties with regard to petitioners' Federal income taxes:

                                               Penalty
           Year         Deficiency           Sec. 6662(a)

           1993           $5,210                $1,042
           1994            4,145                   829
           1995              490                    98

     After concessions by respondent,2 the issues remaining for

decision are:     (1)   Whether petitioners received unreported

taxable income in the amounts of $15,687 and $18,7143 for 1993

and 1994, respectively, as shown by unexplained bank deposits

made by them during those years; and (2) whether petitioners are

liable for an accuracy-related penalty for each of the 1993 and

1994 taxable years, pursuant to section 6662(a).

     Some of the facts have been stipulated, and they are so

found.   The stipulation of facts and the attached exhibits are

incorporated herein by this reference.           At the time of filing the

petition, petitioners resided in New Market, Virginia.




     2
          Respondent concedes the deficiency in tax and penalty
determined for the 1995 tax year. Additional concessions are
enumerated infra note 3.
     3
          Respondent's determination that petitioners received
unreported taxable income is reflected as adjustments to
petitioners' Schedule C gross receipts for the tax years in
issue. The amounts set forth above reflect concessions made by
respondent (a reduction in gross receipts for 1993 and 1994 in
the amounts of $450 and $4,904, respectively).
                                 - 3 -

Background

     Petitioner Ronald D. Blush (hereinafter petitioner) started

his business as an independent building contractor in the spring

of 1991.   Previously, petitioner had worked as a maintenance

director for the Potomac Conference Corp. (hereinafter Potomac).

Petitioner suffered an on-the-job injury in 1986 while working

for Potomac.   Petitioner received $15,076.97 and $5,000 in 1990

and 1993, respectively, as a settlement of his worker's

compensation claim.

     Petitioners purchased land in Shenandoah County, Virginia,

in 1983 for approximately $30,000.       The property consisted of

five lots, all of which were sold by petitioners during the years

1985 through 1988 for a total of $73,500.       Petitioners received

approximately $33,739 of these funds after satisfaction of the

sole mortgage on the property.    Petitioners deposited the funds

directly into their bank account.

     For the tax years in question, petitioners maintained four

bank accounts--a joint checking account, a business checking

account in the name of petitioner, a savings account in the name

of petitioner, and a checking account in the name of petitioner

Shirley A. Blush.   Petitioners deposited $93,452 and $72,808 into

their various bank accounts during 1993 and 1994, respectively.

     Petitioners timely filed their 1993 and 1994 Federal income

tax returns.   Petitioners attached Schedules C, Profit or Loss
                                 - 4 -

From Business, reporting $35,344 and $20,984 in gross receipts

for 1993 and 1994, respectively.    Upon examination of

petitioners' tax returns, respondent's revenue agent concluded

that, to some extent, petitioner's business was conducted in

cash.    Petitioners did not present adequate books or records to

respondent's revenue agent pertaining to the income generated by

petitioner's business.    The revenue agent performed a bank

deposits analysis of the tax years in issue to determine

petitioners' income.     A summary of the revenue agent's bank

deposits analysis for 1993 and 1994 reflects the following:

                                 1993

     Deposits to bank accounts                  $93,452
     Less deposits from known sources             77,315
                                                1
       Total unexplained deposits                 16,137

                                 1994

     Deposits to bank accounts                  $72,808
     Less deposits from known sources             49,190
                                                1
       Total unexplained deposits                 23,618
     1
       As previously indicated, respondent has made concessions
reducing the amounts of unexplained deposits.

     During the initial interview with petitioners'

representative, the revenue agent inquired as to the amount of

cash petitioners had on hand during the years in question.

Petitioners' representative did not provide an answer.     The

revenue agent prepared an information document request that again

inquired as to the amount of cash petitioners had on hand.

Petitioners responded that they did not know how much cash they
                                 - 5 -

had on hand.    During the course of the examination, the revenue

agent was not informed of the prior real estate transactions.       In

addition, petitioners did not come forward with the explanation

that some of the unexplained deposits were due to cash on hand.

     In the preparation of his report, the revenue agent assumed

that the unexplained deposits were unreported income, and the

unreported income was attributable to petitioner's contracting

business.    Respondent asserts (after concessions) that

petitioners had unreported income as shown by unexplained bank

deposits in the amounts of $15,687 and $18,714 during 1993 and

1994, respectively.

Discussion

1.   Unreported Income

     Gross income includes all income from whatever source

derived.    See sec. 61(a).   Section 6001 requires all taxpayers to

maintain adequate books and records of taxable income.     In the

absence of adequate records, the Commissioner is authorized to

reconstruct a taxpayer's income by any reasonable method that

clearly reflects the taxpayer's income.    See sec. 446(b); see

also Holland v. United States, 348 U.S. 121, 130-132 (1954);

Williams v. Commissioner, 999 F.2d 760 (4th Cir. 1993), affg.

T.C. Memo. 1992-153; Parks v. Commissioner, 94 T.C. 654, 658

(1990); Meneguzzo v. Commissioner, 43 T.C. 824, 831 (1965).       One

of these methods, the bank deposits and cash expenditure method,
                               - 6 -

has long been sanctioned by the courts.    See Clayton v.

Commissioner, 102 T.C. 632, 645 (1994).

     Bank deposits are prima facie evidence of income.      See Mills

v. Commissioner, 399 F.2d 744, 749 (4th Cir. 1968), affg. T.C.

Memo. 1967-67; Clayton v. Commissioner, supra at 645; Tokarski v.

Commissioner, 87 T.C. 74, 77 (1986).    When the Commissioner uses

the bank deposits method of analysis to reconstruct a taxpayer's

income, this method assumes that all money deposited in a

taxpayer's bank account during a given period constitutes taxable

income.   The Commissioner must take into account any nontaxable

source or deductible expense of which he has knowledge.     See

Clayton v. Commissioner, supra at 646; DiLeo v. Commissioner, 96

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

     Petitioners contend that the funds deposited into their bank

accounts are not taxable income.   Petitioners assert the funds

came from a cash hoard comprising gain from prior real estate

transactions and worker's compensation settlements.

     Petitioner testified that he did not particularly like

banks, and he wanted to have more control over his money.     He

testified that, while he deposited funds, he sometimes withdrew

funds and held the cash.   Petitioner attributed his distrust of

banks to "Black Friday" (a date in October 1987 when the stock

market experienced a severe decline).     Petitioner testified that
                               - 7 -

he began depositing his cash reserves when he started his

business in 1991.

     Petitioner did not keep any records of how much cash he kept

at home or how much he had in his possession at any given time.

Petitioners could not adequately explain where the cash was kept.

Although petitioners testified that cash from real estate

transactions and from worker's compensation settlements was

withdrawn from the bank and kept at home, the testimony was not

specific as to the dates or amounts.   In addition, petitioner

testified that some portion of his business was conducted in cash

and that some household bills were paid in cash.   Again, the

testimony was vague.   The Court is not required to accept

unsubstantiated testimony.   See Wood v. Commissioner, 338 F.2d

602, 605 (9th Cir. 1964), affg. 41 T.C. 593 (1964).   We hold that

petitioner's explanation of a cash hoard (nontaxable source) is

not credible.   We are further satisfied that respondent gave

petitioners proper credit for all nonincome sources of deposits.

We sustain respondent's determination, taking into consideration

respondent's concessions.

2.   Section 6662(a)

     Respondent determined petitioners were liable for the

accuracy-related penalty under section 6662(a) for both 1993 and

1994.   The accuracy-related penalty is equal to 20 percent of any

portion of an underpayment of tax required to be shown on the
                                 - 8 -

return that is attributable to the taxpayer's negligence or

disregard of rules or regulations.       See sec. 6662(a) and (b)(1).

"Negligence" consists of any failure to make a reasonable attempt

to comply with the provisions of the Internal Revenue Code.       Sec.

6662(c).     "Disregard" consists of any careless, reckless, or

intentional disregard.     Id.

     An exception applies to the accuracy-related penalty when

the taxpayer demonstrates (1) there was reasonable cause for the

underpayment, and (2) he acted in good faith with respect to such

underpayment.     See sec. 6664(c).   Whether the taxpayer acted with

reasonable cause and in good faith is determined by the relevant

facts and circumstances.     The most important factor is the extent

of the taxpayer's effort to assess the proper tax liability.       See

Stubblefield v. Commissioner, T.C. Memo. 1996-537; sec. 1.6664-

4(b)(1), Income Tax Regs.     Section 1.6664-4(b)(1), Income Tax

Regs., specifically provides:

        Circumstances that may indicate reasonable cause and
        good faith include an honest misunderstanding of fact
        or law that is reasonable in light of the experience,
        knowledge and education of the taxpayer. * * *

        It is the taxpayer's responsibility to establish he is not

liable for the accuracy-related penalty imposed by section

6662(a).     See Rule 142(a); Tweeddale v. Commissioner, 92 T.C.

501, 505 (1989).     Petitioners failed to explain adequately why

they did not report all of their taxable income for 1993 and

1994.     On the basis of the entire record, we conclude that
                                 - 9 -

petitioners have not established that the underpayment of tax was

due to reasonable cause and that they acted in good faith.

Accordingly, we hold petitioners are liable for the accuracy-

related penalty.   On account of respondent's concession, the

penalty will be in an amount less than that determined in the

notice of deficiency.

     To reflect the foregoing,

                                              Decision will be entered

                                         under Rule 155.
